UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 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.
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(Exact name of registrant as specified in its charter)
Delaware 87-0547337
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3280 North Frontage Road
Lehi, Utah 84043-9534
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(Address of principal executive offices) (Zip Code)
(801) 768-4481
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates
of the registrant as of January 4, 2000 was $10,904,271 based upon the closing
price on the Nasdaq National Market(R) reported for such date. This calculation
does not reflect a determination that persons whose shares are excluded from the
computation are affiliates for any other purpose.
The number of shares outstanding of the registrant's common stock as of
January 4, 2000 was 17,176,911.
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following document are incorporated herein by reference:
Portions of the registrant's definitive proxy statement to be issued in
connection with registrant's annual stockholders' meeting to be held February
29, 2000.
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TABLE OF CONTENTS
Page
PART I
ITEM 1. BUSINESS...................................................... 3
ITEM 2. PROPERTIES.................................................... 15
ITEM 3. LEGAL PROCEEDINGS............................................. 15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........... 16
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS........................................... 17
ITEM 6. SELECTED FINANCIAL DATA....................................... 20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS........................... 21
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK..... 29
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................... 29
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE............................29
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............ 29
ITEM 11. EXECUTIVE COMPENSATION........................................ 29
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.................................................... 30
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................ 30
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K................................................... 30
SIGNATURES.............................................................. 37
Forward-Looking Statements
Statements in this Form 10-K, including those concerning the Registrant's
expectations regarding its business, and certain of the information presented in
this report, constitute forward looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. As such, actual results may
vary materially from such expectations. For a discussion of the factors that
could cause actual results to differ from expectations, please see the caption
entitled "Forward Looking Statements" in Item 1 and 7 hereof. There can be no
assurance that the Registrant's results of operations will not be adversely
affected by such factors. Registrant undertakes no obligation to revise or
publicly release the results of any revision to these forward looking
statements. Readers are cautioned not to place undue reliance on these forward
looking statements, which reflect management's opinion only as of the date
hereof.
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PART I
ITEM 1. BUSINESS
The Company
Covol Technologies Inc. is a technology development company focused on
"Recycling Yesterday's Waste into Tomorrow's Resources."(TM)
Company History
Covol was originally incorporated in Nevada in 1987 under the name
Cynsulo, Inc. but underwent various name changes from 1987 to 1995. In 1991,
Covol acquired technology consisting of binding agents used to make briquettes.
From 1991 to 1995 Covol focused on the research and development of binding
agents principally for iron, coal and coke waste particles. Covol's name was
changed to Covol Technologies, Inc. in 1995, at which time Covol was
reincorporated in Delaware.
In 1995, management of Covol recognized the applicability of its
technology to the production of synthetic fuel. Since 1996, the primary focus of
Covol has been on developing and commercializing the synthetic fuel technology.
Background
As a result of efforts by government and business to efficiently use
diminishing resources, the recycling industry has developed innovative
approaches to recycle, recover and/or enhance the usefulness of wastes and
by-products. Covol has developed a family of binder technologies used to form
fine materials from wastes and by-products into briquettes to capture their
inherent resource value.
Cost-effective processes have not been fully implemented generally to
capture industrial wastes, despite their potential usefulness and potential
value. Storage and disposal of many of these by-products is costly and can be
environmentally harmful. Covol's binder technologies are designed to enable the
conversion of by-products from the coal and metals industries into valuable
fuels and resources. Covol's primary focus over the past three years has been
the commercialization of the application of its binder technologies to coal
fines.
Covol's binder technologies are being used to transform coal fines into
a useable fuel. Coal fines are small particles of coal produced as a waste
by-product of coal production. A recent study of the coal industry estimated
that there are more than 2 billion tons of coal fines residing in waste ponds
and landfills in the United States alone. Although coal fines have inherent fuel
value, they present recovery and handling challenges that make it difficult to
capture that value. Covol's binder technologies molecularly bond the coal fines
into a formed fuel through a significant chemical reaction; the resulting
product has been classified as a "synthetic fuel" within the meaning of Section
29 of the U.S. Internal Revenue Code. Sales of the fuel therefore qualify for a
significant tax credit.
The Covol binder technologies can also be used to transform coke dust
into formed coke. Coke, which is processed metallurgical coal, is primarily used
in the iron making process as a reducing agent and also as an economical fuel
source. Coke dust, also known as "coke breeze," is a fine residue by-product
resulting from the production, handling and storage of coke and is marketable in
its "dust" state because of its high carbon and energy content. In tests, Covol
has succeeded in aggregating coke dust into hard briquettes designed to
withstand the weight, heat and other environmental factors inside of metal
making furnaces, which appear potentially marketable at prices above briquette
production costs.
The Covol binder technologies can also be used to convert iron rich
wastes into usable iron. Mill scale, bag-house dust, furnace sludge, blast
furnace dust and other iron rich materials, are all waste by-products created by
steel producers. These by-products present environmental problems for the steel
industry. Because of their high iron content, they also have high potential
value. Approximately 775 million tons of finished steel are consumed
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annually in the world with the U.S. producing approximately 100 million tons.
The capture of even a fraction of the waste and other by-products of this steel
production in the U.S. alone could provide millions of tons of feedstock
material for processing. On a test basis, the Covol binder technologies have
been demonstrated to be capable of producing briquettes from such steel
production wastes. Such briquettes can be further processed in metal reducing
furnaces to form high grade pig iron, a common form of feed material used in the
steel industry.
Additional fuel or resource by-products to which the Covol binder
technologies appear applicable after initial testing include: molybdenum,
silicon carbide, grinding swarf, lead dross, zinc oxide, titanium dioxide,
phosphorous, and charcoal. Briquettes containing these by-products appear
potentially marketable to ferrous and non-ferrous metals producers and to other
industrial consumers.
Except for synthetic fuel production, the Covol binder technologies
listed above have not been commercially applied. No assurance can be given that
Covol will be able to implement these applications profitably.
Covol Binder Technologies
Binder Technology. Covol has licensed its technology to other parties
to produce and sell the products manufactured with the Covol binder
technologies. Covol has contracted with Dow Chemical Company to produce chemical
binder materials for the production of synthetic fuel made from coal fines.
Substantially all of the equipment and machinery used for producing synthetic
fuel is considered standard or "off-the-shelf" and is commercially available
both domestically and internationally.
Covol has been issued eight U.S. patents and eight foreign patents and
has other U.S. and foreign patents pending. The patented technology principally
relates to the application of Covol's binder technologies to iron production
wastes, coke, coal and other carbon based materials. Covol is in the process of
expanding the existing patents and applying for new patents related to waste
recovery applications. See "ITEM 1. BUSINESS - Proprietary Protection" for a
discussion of Covol's patents, trademarks and other intellectual property.
Business Strategy
The Covol binder technologies represent the foundation for Covol's
business strategy. Covol believes that its success depends upon its ability to
engineer industrial wastes and other by-products into value-added fuels and
resources. Covol has divided its strategy into two general approaches:
engineered fuels and engineered resources.
Engineered Fuels. Engineered fuels include fuels recovered or enhanced
primarily from carbon based materials. The Covol binder technologies provides a
use for fuel-rich wastes and by-products by aggregating them into a solid form
for improved handling and processing, and by making such modifications as may be
required for a given application of the resulting fuel, for example, reduced
moisture, increased hardness or enhanced energy content. Covol's engineered
fuels include the production of fuel from briquetted coal fines, coke dust and
silicon carbide.
For the past three years Covol's business strategy has been focused
almost exclusively upon synthetic fuel from coal fines. There are currently 24
synthetic fuel facilities located in 8 states that are utilizing Covol's
synthetic fuel technology. Twenty-two of the facilities are owned by
unaffiliated third parties and two are currently owned by Covol. Covol is
actively pursuing the sale of the two facilities that it owns.
All of the synthetic fuel facilities were initially placed into
operation before the end of the second calendar quarter of 1998 and Covol and
its licensees are currently in the process of increasing production levels and
entering into contracts for product sales. Covol is working with its licensees
to improve production and optimize quality. Feedstock supply, production and
product quality and the marketing of the synthetic fuel all directly affect the
amount and timing of royalties to be received by Covol from the synthetic fuel
facilities. Accordingly, assisting licensees to optimize the production from
these facilities is one of Covol's highest priorities.
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Covol has received one-time initial license fees with respect to most
of the synthetic fuel facilities. These initial license fees will be recognized
as revenue over the life of the license agreements. In the future, most of the
revenues related to such facilities are expected to come from royalties that are
tied to production and sale of synthetic fuel pursuant to licensing agreements
in place. Covol also expects to generate net revenues from the sale of binder
materials to the facilities.
Another engineered fuel application Covol is pursuing is coke. Coke is
processed metallurgical coal which serves as both a fuel and a reducing agent in
iron and steel making. The production and handling of coke produces fine
particles of coke dust. The aggregation of coke dust into briquettes that are
designed to withstand the rigors of handling, heat and weight in metal making
furnaces results in a useable fuel. Covol has patented technology and is in the
process of patenting additional technology related to coke dust processing.
Engineered Resources. Steel mills, nonferrous metal producers and other
mineral industries produce wastes and other by-products that may contain
valuable unrecovered resources. These wastes often create environmental
compliance, storage and disposal problems. The Covol binder technologies provide
a way to solve disposal problems, extract the inherent resources, process the
materials with current industrial methods, and enhance the materials with
qualities that add value and that customize the materials for alternative uses.
The resulting products are collectively referred to as "engineered resources."
Covol has devoted significant research and development resources to improving
and perfecting its technology for these applications, particularly in the
processing of iron production wastes.
Covol has developed and tested its technologies with fine particulate
wastes and other by-products, including: molybdenum, titanium dioxide, grinding
swarf, lead dross, zinc oxide, phosphorous, and iron. Covol intends to continue
to evaluate these and other engineered resource applications.
Strategic Acquisitions. Covol believes that it may have unique
opportunities to pursue acquisitions that are synergistic with Covol's financial
and environmental objectives and initiatives. The Covol binder technologies may
be applied to waste streams that are otherwise of little or no value. Covol
intends to pursue possible acquisitions of businesses aligned to the industries
in which the Covol business strategy of resource recovery may be applied.
Covol intends to broaden its position in the synthetic fuel industry
and other resource industries through the acquisition or licensing of
technologies that are complementary to the Covol binder technologies.
Subsidiaries
Covol has organized various special purpose entities to facilitate some
of the transactions relating to the 24 synthetic fuel facilities. The entities
are listed with Covol's position and interest in the entity as of December 31,
1999 described as follows:
o Alabama Synfuel #1 Ltd., a Delaware limited partnership of which Covol
serves as general partner and owns 100%
o Utah Synfuel #1 Ltd., a Delaware limited partnership of which Covol
serves as general partner and owns 100%
o Flat Ridge Corporation, a Utah corporation, a wholly-owned subsidiary
of Covol
o Commonwealth Synfuel, L.L.C., a Utah limited liability company of which
Covol is managing member and owns 100%
o Carbon Synfuel, L.L.C., a Utah limited liability company of which Covol
is the managing member and owns 99%
o Pocahontas Synfuel, L.L.C., a Utah limited liability company of which
Covol is the managing member and owns 99%
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o Mountaineer Fuels, L.L.C., a Utah limited liability company of which
Covol is the managing member and owns 99%
o Synfuel Investments, Inc., a Utah corporation of which Covol is the
sole stockholder; Synfuel Investments owns a 1% ownership interest in
each of Carbon Synfuel, Pocahontas Synfuel, and Mountaineer Fuels.
The following chart illustrates Covol's corporate structure. Covol's
ownership directly or indirectly of each subsidiary is 100%.
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC.
------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Common-
Alabama Utah Flat Ridge wealth Carbon Pocahontas Mountaineer Synfuel
Synfuel Synfuel Corp. Synfuel, Synfuel, Synfuel, Fuels, Investments,
#1, Ltd. #1, Ltd. L.L.C. L.L.C. L.L.C. L.L.C. Inc.
-------- ------- ------ -------- ---------- ------ ----- ----
</TABLE>
Tax Credits
Section 29 of the U.S. Internal Revenue Code provides a credit against
regular federal income tax with respect to sales of qualified fuel to an
unrelated party. Where more than one person has an interest in a qualified
facility, the Section 29 Credits generated by the facility are allocated
pursuant to the proportional interests of such persons in the facility.
In order to qualify as a solid synthetic fuel produced from coal for
purposes of the Section 29 credit, the fuel produced must differ significantly
in chemical composition, as opposed to physical composition, from the raw
material used to produce it. Covol has received a Private Letter Ruling, or PLR,
from the IRS in which the IRS, based on representations made to it by Covol,
ruled that the synthetic fuel technology produces a significant chemical change
compared to coal fines and this qualifies the end product as a solid synthetic
fuel. Accordingly the IRS has ruled, based on the facts presented to it, that:
o Covol, with the use of its patented process, produces a "qualified
fuel" within the meaning of Section 29 of the tax code; and
o assuming the other requirements of Section 29 are met, the sale of the
"qualified fuel" will entitle Covol to claim the Section 29 credit in
the taxable year of sale.
In its ruling, the IRS noted that no temporary or final regulations
pertaining to one or more of the issues addressed in the PLR have been adopted
and that the PLR would be modified or revoked by the adoption of temporary or
final regulations to the extent the regulations are inconsistent with any
conclusions in the PLR. The IRS notes, however, that a PLR is not revoked or
modified retroactively, except in rare and unusual circumstances, provided that:
o there has been no misstatement or omission of material facts,
o the facts at the time of the transaction are not materially different
from the facts on which the PLR was based,
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o there has been no change in the applicable law,
o the PLR was originally issued for a proposed transaction and
o the taxpayer directly involved in the PLR acted in good faith in
relying on the PLR, and revoking the PLR retroactively would be to the
taxpayer's detriment.
Covol received its PLR in September 1995. At least seven other PLRs
covering fourteen of the synthetic fuel facilities have been obtained by third
parties in connection with licenses of Covol's synthetic fuel technology.
However, all PLRs are only binding with respect to the specific projects
addressed in the PLR and may only be relied on by the party that has obtained
the PLR.
The Section 29 credit is equal to approximately $6.10 in 1997 dollars
for each oil barrel equivalent of the qualifying fuel produced and sold. This
equates to approximately $20.00-$28.00 per ton of synthetic fuel briquettes,
depending upon the recoverable heat content. The oil barrel equivalent is
defined generally as an amount of fuel having a recoverable heat content of 5.8
million Btu's.
The Section 29 credit was designed to provide protection for qualifying
fuels against market price declines, and it is therefore subject to a phase out
after the unregulated oil price reaches specified levels under an annually
adjusted formula. In 1997 dollars, the credit would have phased out had the
reference price for oil exceeded $47.78 per barrel, but the reference price
determined for 1998 was $10.88 and no phase out occurred. There presently is no
reference price for 1999. However, the average price of oil in the U.S. was
higher in 1999 than 1998. The credit is also subject to reduction insofar as an
otherwise qualifying facility benefits from grants or subsidized financing
provided by federal, state or local governments, or from tax-exempt bond
financing.
Section 29 of the tax code contains no provision for carryback or
carryforward of Section 29 credits. Once earned, the credits are not subject to
subsequent recapture. By virtue of the various limitations and other factors
described above, there can be no assurances that any particular amount of
Section 29 credit will be allowable and usable.
During 1996, certain of the time periods applicable to the Section 29
credit were extended. The Section 29 credit will, under present law, be
available for sales of qualified fuels completed before January 1, 2008. The
qualified fuels sold must be produced at facilities placed in service by June
30, 1998. The synthetic fuel facilities must have been constructed pursuant to a
binding written contract in effect as of December 31, 1996.
Synthetic Fuel Manufacturing Facilities
The following table represents a summary of the 24 synthetic fuel
manufacturing facilities constructed and placed in operation before June 30,
1998 by Covol and its licensees.
SYNTHETIC FUEL MANUFACTURING FACILITIES
No. of
Name of Facility Plants Location Owner/Licensee
Utah Synfuel #1 1 Price, Utah Coaltech No. 1 L.P.
Carbon Synfuel 1 Price, Utah DTE Kentucky, L.L.C.
Mohave Synfuels 1 Laughlin, Mohave Synfuels,
Nevada L.L.C.
Birmingport 1 Mulga, Birmingham Syn
Alabama Fuel, L.L.C.
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Brookwood 1 Brookwood, PacifiCorp Syn
Alabama Fuel, L.L.C.
Pumpkin Center 2 Flat Creek, PacifiCorp Syn
#1 & #2 Alabama Fuel, L.L.C.
Norton 1 Norton, PC Virginia
Virginia Synthetic Fuel #1,
L.L.C.
Chelyan 1 Chelyan, West PC West Virginia
Virginia Synthetic Fuel #1,
L.L.C.
Muddlety 1 Muddlety, West PC West Virginia
Virginia Synthetic Fuel #2,
L.L.C.
Eckman 1 Eckman, West PC West Virginia
Virginia Synthetic Fuel #3,
L.L.C.
Appalachian 2 Peccus, West Appalachian
Synfuel Virginia Synfuel, L.L.C.
Mountaineer 1 Tallmansville, Mountaineer Fuels,
Fuels West Virginia L.L.C.
Pocahontas 1 Northfork, Pocahontas
Synfuel West Virginia Synfuel, L.L.C.
Ginger Hill 1 Ginger Hill, Ginger Hill
Pennsylvania Synfuels, L.L.C.
Robena 1 Paisley, Robena, L.L.C.
Pennsylvania
River Hill 1 Karthaus, DTE River Hill,
Pennsylvania L.L.C.
Pennsylvania 1 Somerset, Central City
Synfuel Project Pennsylvania Synfuel, L.L.C.
USA Coal, #1, 4 Pawnee, Illinois A.J.G. Financial
#2, #3, & #4 Services, Inc.
Pleasant Ridge 1 Alledonia, Ohio Pleasant Ridge
--- Synfuels, L.L.C.
Total 24
Covol Contracts. Consistent with the requirements for obtaining Section
29 tax credits, in December 1996 Covol entered into fourteen design and
construction agreements for the design and construction of new synthetic fuel
manufacturing facilities each having capacity of approximately 360,000 tons per
year. Depending upon the specific agreement, the contractor was either TIC,
CEntry Constructors & Engineers, PICOR or Centerline Engineering Corporation.
The PICOR contracts were part of a joint venture with Savage Industries. The
construction agreements, among other things, required that the plants be placed
in service no later than June 30, 1998.
Covol obtained financing and successfully constructed five facilities
from its construction agreements. Of these, one was built by TIC for Covol and
sold to Birmingham Syn Fuel, L.L.C., a special purpose entity owned by
PacifiCorp Financial Services, Inc., two were built for Covol by Centerline, one
of which was sold to DTE Kentucky, L.L.C., a special purpose entity owned by DTE
Energy Services, Inc., and one of which is held for sale
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by Covol; two were built by TIC, one of which was sold to DTE River Hill,
L.L.C., a special purpose entity owned by DTE Energy Services, Inc., and one of
which is held for sale by Covol.
Covol assigned four other construction agreements to licensees and
those licensees successfully constructed four facilities as follows:
Fluor Corporation. Covol assigned two of its fourteen construction
agreements to Appalachian Synfuel L.L.C., a wholly owned subsidiary of Fluor
Corporation. The facilities were built at A.T. Massey Coal Company, Inc.'s
Marfork Prep Plant Site near Peccus, in Boone County, West Virginia. In
conjunction with the assignment of the two contracts, Covol entered into a
license agreement with Appalachian for the use of the Covol binder technologies.
Under the agreement, Covol was paid an initial license fee. A quarterly license
fee is paid based upon the Btu of product produced and sold up to a prescribed
amount of production per year. Covol also granted Appalachian the right to pay a
lump sum payment for the facilities, in lieu of quarterly license fees over the
term of the agreement. Covol provides binder to the facility on a cost plus
basis.
Pelletco Corporation. Covol assigned two of its construction agreements
with Centerline to affiliates of Pelletco Corporation. One contract was assigned
to Pleasant Ridge Synfuels, L.L.C. which constructed a facility in Alledonia,
Ohio. One contract was assigned to Ginger Hill Synfuels, L.L.C. which
constructed a facility at Ginger Hill, Pennsylvania. In connection with these
two facilities, Covol entered into technology license and agreements to supply
Covol's chemical binder, providing Covol with initial license fees and quarterly
license fees based upon the licensees' net cash flow. Covol provides binder to
the two facilities on a cost plus basis.
Unused Contracts. Covol did not build facilities under five of its
fourteen construction agreements, including the two PICOR contracts as part of a
joint venture with Savage Industries. The construction agreements provided for
penalties if the construction was not pursued by Covol. Covol accrued this
liability during the fiscal year ended September 30, 1997 and paid all penalties
related to the two PICOR contracts. The remaining liability attributable to the
other three contracts was $755,000 as of September 30, 1999. Covol believes that
construction under any of the unused contracts is not likely.
Additional Licensed Facilities. In addition to the nine facilities
constructed under Covol's construction agreements, Covol licensed its technology
to eight licensees for use at fifteen facilities constructed by these licensees.
These licensees entered into their own construction agreements prior to December
31, 1996, in compliance with Section 29.
In total, Covol has licensed or constructed plants using the Covol
binder technologies at 24 synthetic fuel facilities that operate at 18 locations
in the Rocky Mountain region, Southern Appalachia, Central Appalachia, Northeast
Appalachia, Northwest Appalachia, and the Illinois Basin, which are the primary
coal supply regions of the United States. For all facilities, the construction
agreements were entered into prior to December 31, 1996. In most instances,
Covol entered into a construction contract which was either fulfilled by Covol
or later assigned to a licensee. In certain instances, the licensees entered
into their own construction contracts.
A facility generally consists of a conditioner and binder additive and
mixing system, briquetting or aggregating equipment, a product dryer, and other
supporting systems. However, each facility was individually engineered and
constructed, including systems and components specially selected by the
respective owners, so that there is variation in features from facility to
facility.
License and Binder Supply Agreements. All non-Covol entities that have
constructed or own facilities using the Covol binder technologies have entered
into a technology license and binder supply agreement with Covol. Many license
agreements provided for an initial license fee, payable upon reaching project
milestones. Covol has received most of the initial license fees related to these
facilities which revenue will be recognized by Covol over the life of the
license agreements. In addition, pursuant to many of the license agreements, the
licensee pays a quarterly earned license fee generally at a prescribed dollar
amount multiplied by the recoverable heat denominated in Btu's in the product
produced and sold during the calendar quarter. The prescribed dollar amount is
subject to adjustment based upon the "inflation adjustment factor" as set forth
in Section 29 of the tax code. In some cases, the amount to be paid is subject
to adjustment to the extent that licensees incur an operating loss on the
production and sale of
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synthetic fuel, exclusive of the amount licensees pay as a license fee for the
use of the technology. Some license agreements also provide for a goal fee based
on time schedules and production amounts. In most cases, the fees paid to Covol
under the license agreements are not based on the sales price of the synthetic
fuel product. The license agreements generally have a term until the later of
January 1, 2008 or the corresponding date after which tax credits may not be
claimed or are not otherwise available under Section 29 of the tax code.
Covol also agreed, pursuant to the binder supply agreements, to provide
binder material to licensees for the manufacture and production of synthetic
fuel. The price for the binder sold to the licensees falls into two categories:
o a fixed price, or
o an amount equal to Covol's cost plus a prescribed mark-up.
In some cases, the mark-up may be reduced to the extent the licensee
incurs a loss on the production and sale of synthetic fuel, but not below
Covol's cost for such binder materials. The binder is currently manufactured by
Dow Chemical Corporation for Covol utilizing Covol's patented and proprietary
technology. Covol arranges with Dow for shipping of the binder directly to the
facilities.
Supply of Raw Materials
Coal Fines. The synthetic fuel manufacturing facilities use coal fines
as the primary feedstock to produce synthetic fuel. Accordingly, a supply of
coal fines is essential to the feasibility of a synthetic fuel manufacturing
facility.
Historically, lower quality coal and mining refuse and fine particles
of coal were discarded into refuse piles or impoundments. Today, coal
preparation and material handling technologies have reduced the amount of coal
that is discarded, but coal fines generated by coal mining and preparation are
still problematic for the industry. With some variation, most consumers of coal
only purchase coal with an ash content of 12% or less. Discarded coal fines are
typically too high in ash content to be used as-is in making marketable
synthetic fuel. To make use of fine coal refuse, owners of synthetic fuel plants
must either blend the refuse with "clean" coal in appropriate proportions to
yield an acceptable ash content, and/or clean the coal refuse itself. Clean coal
can be purchased from traditional coal marketers and is available to all
synthetic fuel facility owners that have a clean coal/coal refuse blending
strategy.
Coal fines cleaning is a distinct technology and to implement it
successfully requires analysis of the particular coal refuse to determine
appropriate plant design and to determine whether feedstock can be economically
produced. Capital requirements for coal cleaning or preparation plants adequate
to supply a synthetic fuel plant can be in excess of $4 million. Coal cleaning
plants require six months or more to design and construct. A feasibility
analysis must be performed to determine whether the savings achieved by the
plant justify the capital costs of construction together with operational costs,
which can vary between approximately $5-10 per ton. The costs of a cleaning
plant are compared to the alternative of purchasing clean coal for blending. The
decision to construct a coal cleaning plant does not delay delivery of synthetic
fuel to market because in all cases clean blending coal is available to purchase
as an immediate alternative. The decision to construct a coal cleaning plant is
based on how a facility most economically obtains clean feedstock.
In facilities owned and operated by licensees, the licensee secures its
own supply of coal fines. Licensees that are also coal producers utilize their
own feedstock sources. Nonproducer licensees secure deposits of coal fines to
supply their facilities.
Supply of Binder. Covol purchases its patented and proprietary binder
from Dow Chemical Company under a ten year agreement under which Covol pays a
prescribed price per pound of binder. Covol arranges with Dow for the delivery
of the binder from Dow's manufacturing plants to each of the synthetic fuel
facilities owned, operated, or licensed by Covol.
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Sale of Facilities
Covol has sold four synthetic fuel facilities. The following is a
summary of each sale:
Utah Synfuel #1. On March 10, 1997, Utah Synfuel #1 Ltd., a Delaware
limited partnership in which Covol was at the time a 64% owner and general
partner, sold the Utah synthetic fuel facility for $3.5 million, in the form of
a nonrecourse promissory note bearing interest at 9.6552% per annum and payable
in 44 equal quarterly installments, all in accordance with the Utah Project
Purchase Agreement, dated as of March 7, 1997, between Covol, Utah Synfuel #1
and Coaltech No. 1 L.P. The sale of the Utah facility resulted in a loss of
approximately $582,000 to Utah Synfuel #1. The promissory note is collateralized
by a security interest in the Utah facility, and in the event of a default under
the promissory note, Covol's and Utah Synfuel #1's sole right to recovery is
limited to the Utah facility without recourse against Coaltech. The loss of
$582,000 was not recognized for financial reporting purposes and as described in
Note 4 to the Consolidated Financial Statements, all note payments, including
interest, reduce the carrying amount of the note receivable.
Covol granted Coaltech a put option to require Covol to purchase the
Utah facility from Coaltech if:
1. all of the Coaltech limited partners are unable to utilize the
federal income tax credits under Section 29 of the tax code,
2. the economic benefits accruing to or experienced by all of the
Coaltech limited partners differ significantly from what was
initially projected, or
3. there is a permanent force majeure or material damage or
destruction of the Utah facility.
If the put option is exercised prior to the third anniversary date of
the facility sale, the option price will be equal to the fair market value of
the limited partnership interests of the optionees on a going concern basis, but
in no event will the option price exceed 50% of the capital contributions made
by the optionees to fund payments due under the promissory note, the Utah
License Agreement and broker fees. If the put option is exercised on or after
the third anniversary date, the option price will be $10 and the optionees will
not be entitled to any other payments.
As part of the sale of the Utah facility, Covol and Utah Synfuel #1
entered into a Supply and Purchase Agreement with Coaltech. Under the agreement,
Covol agreed to provide coal fines to the Utah facility for processing into
synthetic fuel at an amount equal to Covol's per ton costs, including any wash
costs. Utah Synfuel #1 also agreed to purchase from Coaltech the synthetic fuel
produced at Coaltech's cost plus one dollar per ton. Coaltech has the right to
market its synthetic fuel to a third party, with Utah Synfuel #1 having a right
of first refusal to purchase such synthetic fuel. Covol has incurred a loss each
quarter in connection with this agreement. The Utah Synfuel #1 facility has
experienced several problems, including uncertain coal fines feedstock and
product sales commitments. Subsequent to September 30, 1999, Covol received
notification from the limited partners of Coaltech that they were effecting a
retirement of Covol as the general partner and were terminating Covol as
operator of the Utah facility. Covol and Coaltech are in negotiations to resolve
the situation, including a likely settlement of the note and termination of the
Supply and Purchase Agreement.
Birmingham Syn Fuel. Alabama Synfuel #1 Ltd., a Delaware limited
partnership in which Covol was at the time a 74% owner and general partner, sold
the Birmingham Syn Fuel/Birmingport facility to Birmingham Syn Fuel, L.L.C., a
wholly-owned subsidiary of PacifiCorp Financial Services, Inc., on March 6,
1998. The purchase price for the Birmingport facility was $6,500,000 payable in
the form of a nonrecourse promissory note collateralized by certain portions of
the Birmingport facility.
River Hill. Covol and its subsidiaries, Commonwealth Synfuel, L.L.C.
and Synfuel Investments, Inc., sold the River Hill facility to DTE River Hill
L.L.C., an affiliate of DTE Energy Services, Inc., on August 28, 1999. Covol
also entered into a license and binder supply agreement which calls for ongoing
royalties and binder sales. The purchase price for the River Hill facility
consisted of a cash payment to Covol of $1,250,000, assumption of $5,000,000 of
facility debt, completion of capital improvements to the facility and an
eight-year royalty arrangement with both Covol and the construction lender, plus
contingent payments based upon facility production performance.
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Carbon Synfuel. Covol and its subsidiaries, Carbon Synfuel, L.L.C. and
Synfuel Investments, Inc., sold the Carbon Synfuel facility to DTE Kentucky,
L.L.C., an affiliate of DTE Energy Services, Inc., on December 31, 1999. Covol
also entered into a license and binder supply agreement which calls for ongoing
royalties and binder sales.
In addition to the four facilities discussed above, Covol owns two
synthetic fuel manufacturing facilities that Covol has for sale. They are
referred to as Pocahontas Synfuel located near Northfork, West Virginia; and
Mountaineer Synfuel, near Tallmansville, West Virginia. Covol is negotiating
with potential purchasers for the sale of these two facilities. Covol expects
the sales to be completed during the second quarter of fiscal year 2000.
Proprietary Protection
Covol has the following trade names and patents covering certain
aspects of Covol's technology:
Trade names:
Covol Technologies, Inc., Alabama Synfuel #1 Ltd., Utah Synfuel #1
Ltd., Carbon Synfuel, L.L.C., Mountaineer Fuels, L.L.C., Pocahontas
Synfuel, L.L.C., Flat Ridge Corporation, Synfuel Investments, Inc., and
Engineered Fuel Technologies, Inc.
Trademarks and Service Marks:
United States Trademark Registration No. 2,038,742 for licensing
services identified by "Covol", "Recycling Yesterday's Waste Into
Tomorrow's Resources."
Patents
Covol's eight U.S. and eight foreign patents expire on January 21,
2014. Other United States, Patent Cooperative Treaty, and Foreign Patent
Applications are pending. There can be no assurance as to the scope of
protection afforded by the patents. In addition, there are other industrial
waste recycling technologies in use and others may subsequently be developed,
which do not, or will not utilize processes covered by the patents or pending
patents. There can be no assurance that any patent issued will not be infringed
or challenged by other parties, infringe on patents held by other parties or
that Covol will have the resources to enforce any proprietary protection
afforded by the patent or defend against an infringement claim.
In addition to patent protection, Covol also relies on trade secrets,
know-how and confidentiality agreements to protect the Covol binder
technologies. However, such methods may not afford complete protection and there
can be no assurance that others will not independently develop such know-how or
obtain access to Covol's know-how, concepts, ideas, and documentation.
Since Covol's proprietary information is important to its business,
failure to protect ownership of its proprietary information would likely have a
material adverse effect on Covol. Covol's current and expected revenues are
dependent upon license agreements by which licensees use the Covol binder
technologies to manufacture synthetic fuel and then pay license fees to Covol.
Covol expects that revenues will continue to be tied to future licensing
agreements in the application of Covol binder technologies to iron rich wastes,
coke dust, and other potentially useful wastes and by-products. Covol believes
that its patents, trade secrets, know-how and confidential information are the
basis upon which Covol is able to obtain licensing agreements.
Confidentiality Provisions
As part of its business, Covol typically enters into agreements
concerning its projects which contain confidentiality provisions. Covol is, on
occasion, required to disclose such agreements to the Securities and Exchange
Commission as part of its ongoing reporting requirements under the Securities
Exchange Act of 1934. In addition, disclosure of such agreements may be required
in connection with Covol's SEC registrations or private placement of securities.
Some of the agreements may not contain the standard exceptions for the
disclosure of
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information which is required to be disclosed under law. Consequently, no
assurances can be given that Covol has not inadvertently disclosed information
regarding its various projects in violation of confidentiality covenants entered
into by Covol.
Government Regulation
Covol's and its licensees' synthetic fuel operations are subject to
federal, state and local environmental regulations that impose limitations on
the discharge of pollutants into the air and water and establish standards for
the treatment, storage and disposal of waste products. In order to establish and
operate the synthetic fuel plants, Covol and its licensees obtained various
state and local permits. Covol believes that it or its licensees have obtained
all required permits to construct and operate synthetic fuel facilities, and
that they are in substantial compliance with all relevant laws and regulations
governing the synthetic fuel operations.
Compliance with permits, regulations, and the approved processes does
not create pollution or contamination. Still the possibility exists that
regulatory noncompliance or accidental discharges, in spite of safeguards, could
create an environmental liability. Acid is the only stored raw material used in
the approved process that is classified as hazardous. Therefore, Covol's and its
licensees' synthetic fuel operations entail risk of environmental damage and
Covol or its licensees may incur liabilities in the future arising from the
discharge of pollutants into the environment or from waste disposal practices.
Failure by Covol or its licensees to maintain necessary permits to
operate synthetic fuel plants and to comply with permit requirements could have
a material adverse effect on Covol or its licensees. Other developments, such as
the enactment of more stringent environmental laws and regulations, could
require Covol or its licensees to incur significant capital expenditures. If
Covol or its licensees do not have the financial resources or are otherwise
unable to comply with such laws and regulations, such failure could also have a
material adverse effect on Covol.
Covol's goal is to establish itself as the provider of technologies
that will assist others in the processing and reclamation of their wastes and
by-products, and Covol seeks for itself and its licensees to avoid creating
waste streams or compounding environmental reclamation problems. However, the
synthetic fuel manufacturing process using Covol binder technologies typically
uses dilute acids. Covol and its licensees must comply with hazardous material
handling and storage regulations related to acid solutions and stored
concentrates.
Covol's and its licensees' synthetic fuel operations are also subject
to federal and state safety and health standards. Covol is committed to
providing effective management of worker safety and health protection. In
addition, Covol has developed a safety policy designed to raise and maintain a
high level of safety awareness by both management and employees. Failure to
comply with safety and health standards could have a material adverse affect on
Covol, for example, a regulatory inspector could close the operation until Covol
meets the required standards.
Major Customers
Approximately 21% of revenues in 1998 and 40% of revenues in 1999 were
from a single licensee, 27% of revenues in 1998 and 15% of revenues in 1999 were
from a second licensee and 15% of revenues in 1998 and 13% of revenues in 1999
were from a third licensee. No other single customer accounted for over 10% of
total revenues in any year presented.
Competition
Products made using the Covol binder technologies compete with other
synthetic products as well as traditional source materials. Competitive factors
include price, quality, delivery cost and waste handling costs. Covol may
experience competition from other alternative fuel technology companies and
their licensees, particularly those companies with technologies to produce coal
based solid synthetic fuels. Competition may come in the form of the licensing
of the competing technologies to process coal fines or in the marketing of end
products qualifying as synthetic fuel. Competition includes, for example,
Krystal Bond, KFx Inc. and Startec Inc. Covol will also experience competition
from traditional coal and fuel suppliers and natural resource producers in
addition to those
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companies that specialize in the disposal and recycling of waste products
generated by coal, coke, steel and other resource production. Many of these
companies have greater financial, management and other resources than Covol.
Covol believes that it will be able to compete effectively although there can be
no assurance that it will do so successfully.
Employees
Covol and its subsidiaries currently employ 52 persons full-time.
Twenty-seven of such persons are in corporate administration including research,
development and marketing, and twenty-five are in synthetic fuel and coal
washing operations. None of these employees are covered by a collective
bargaining agreement.
Forward Looking Statements
Statements regarding Covol's expectations as to the financing,
development, construction, operation and sale of facilities utilizing the Covol
binder technologies, the marketing of products, the receipt of licensing fees,
the ability to extend or refinance existing obligations, and other information
presented in this Annual Report on Form 10-K that are not purely historical by
nature, including those statements regarding Covol's future business plans, the
operation of facilities, the estimated capacity of facilities, the availability
of coal fines, the marketability of the synthetic fuel and other briquettes and
the financial viability of the facilities, constitute forward looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
Although Covol believes that its expectations are based on reasonable
assumptions within the bounds of its knowledge of its business and operations,
there can be no assurance that actual results will not differ materially from
its expectations. In addition to matters affecting Covol's industry or the coal
industry or the economy generally, factors which could cause actual results to
differ from expectations stated in these forward looking statements include,
among others, the following:
(1) The commercial success of the Covol binder technologies.
(2) Successful sale of Covol owned facilities.
(3) Operating issues for licensed and Covol owned facilities
including 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.
(4) Marketing issues relating to market acceptance of products
manufactured using Covol's technology, including control of
moisture content, hardness, special handling requirements and
other characteristics of the synthetic fuel product which
affect its marketability and its sales price.
(5) Securing of necessary sites, including permits and raw
materials, for relocation and operation of facilities.
(6) Maintenance of placed in service requirements under Section 29
of the tax code by synthetic fuel manufacturing facilities.
(7) Ability to obtain needed additional capital on terms
acceptable to Covol.
(8) Changes in governmental regulations or failure to comply with
existing regulations which may result in operational shutdowns
of Covol or licensee facilities.
(9) The availability of tax credits under Section 29 of the tax
code.
(10) The commercial feasibility of the Covol binder technologies
upon the expiration of Section 29 tax credits.
(11) Ability to meet financial commitments under existing
contractual arrangements.
(12) Ability to meet non-financial commitments under existing
contractual arrangements, including requirements to obtain
stockholder approval of certain transactions.
(13) Ability to commercialize the non-synthetic fuel related Covol
binder technologies which have only been tested in the
laboratory and not in full-scale operations.
(14) Dependence on licensees to successfully implement Covol binder
technologies.
(15) The market acceptance of products manufactured with Covol
binder technologies in the face of competition from
traditional products.
(16) Ability to produce products with Covol binder technologies
with acceptable hardness, moisture level, and other
characteristics.
(17) Success in the face of competition by others producing
synthetic fuel and other recycled products.
(18) Sufficiency of intellectual property protections.
ITEM 2. PROPERTIES
Covol leases an approximately 5,000 square-foot building in Lehi, Utah,
which houses its executive offices ("Corporate Headquarters"). In August 1997,
Covol entered into a triple-net lease dated August 1, 1997 (the "Headquarters
Lease"). The Headquarters Lease provides for a monthly rent of $5,000 during the
initial term which expires on July 31, 2000. Thereafter, the Headquarters Lease
will automatically extend indefinitely for successive one-year periods at the
sole option of Covol, and the monthly rent will increase by 5% per year.
In October 1997, Covol purchased an 8,000 square-foot site located in
Price, Utah, on which Covol's prototype briquetting plant is located, for
$150,000. Included in the purchase was a 1,400 square-foot office and warehouse
building which houses equipment. The property is subject to a 10-year $100,000
mortgage held by the seller. The property is currently being leased to a third
party for a one-year term.
In June 1996, Covol entered into a land lease of approximately 12 acres
in Price, Utah with a non-affiliated party at a monthly rental of $600. The
lease term commenced on June 20, 1996 and expires on December 31, 2007 but may
be extended. In 1996 Covol constructed a 22,000 square-foot building to house
the Utah Synfuel #1 facility. In March 1997, this building was subleased by
Covol to Coaltech as part of the sale of the Utah Synfuel #1 facility. Covol has
constructed an ancillary building, a 1,650 square-foot binder plant.
In February 1997, Covol entered into a lease agreement with Earthco for
two contiguous parcels located in Wellington, Utah (approximately 6 miles from
the Utah Synfuel #1 site). The first parcel covers approximately 30 acres and
has a lease term of 15 years. On this parcel, Covol constructed a 3,400
square-foot wash plant at a cost of approximately $8 million. The second parcel
covers approximately 357 acres and has a lease term of 5 years. The lease
permits Covol to conduct fines recovery operations. The lease provides for total
obligations to lease the parcels and acquire the associated fines of
approximately $5.5 million, of which $700,000 was paid at the time of lease
execution and for payments 4 times each year until May of 2002 for the balance.
However, Earthco's ownership rights, and in turn, Covol's leasehold rights are
the subject of a lawsuit initiated by NEICO. See "ITEM 3. LEGAL PROCEEDINGS --
NEICO/Earthco Suit" for a discussion of the dispute.
In 1997, Covol entered into a 5 year, $850 per month sublease with
Combustion Resources, Inc. for approximately 2,400 square feet of building space
in Provo, Utah.
In 1998, Covol entered into a one year, $1,500 per month lease with
Mobile Auto & Storage for approximately 4,000 square feet of building space in
Lehi, Utah. This property provides office and laboratory facilities for some of
Covol's research and development personnel.
In May 1998, Covol entered into a 10 year, $1,000 per year lease with
Upshur Property, Inc., for approximately 10 acres of property in Tallmansville,
Upshur County, West Virginia. The property is the site of the Mountaineer
Synfuel facility. The lease has been terminated and the facility is being sold
and relocated.
In May 1998, Covol purchased approximately 80 acres of undeveloped
property near Sunnyside, Utah for $100,000. In June of 1998 Covol entered into a
five year lease with an option to purchase approximately 40 acres of property
with office and warehouse improvements. The lease payments are $2,000 per month,
escalating to $3,500 per month over time. The leased property is adjacent to the
purchased property. Covol plans to conduct some operations on the two properties
in the future.
None of Covol's subsidiaries have interests in real property.
ITEM 3. LEGAL PROCEEDINGS
Asbestos Investigation. In January 1996, a manager of Covol entered
property owned by Nevada Electric Investment Company, a subsidiary of Nevada
Power Corporation, in connection with an offer by Covol to purchase
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the property, and with certain other employees of Covol, removed some asbestos
over a two-day period. In May of 1996 Covol received a notice of violation and
order for compliance from the State of Utah, Division of Air Quality alleging
that asbestos was improperly handled, removed, and disposed of. Covol complied
with the order and in September of 1996 entered into a settlement agreement with
the State of Utah and paid a fine in the amount of $11,000. In late 1997 the
U.S. Environmental Protection Agency began its own investigation, referring the
matter to the U.S. Attorney's office. In December 1999 the former manager
entered into a misdemeanor plea bargain and the U.S. Attorney agreed that
criminal matters arising out of the incident are at an end.
NEICO/Earthco Suit. On February 21, 1997, Covol entered into a contract
on a parcel of real property located near Price, Utah, in which Covol obtained
certain possessory and related interests, Covol's primary purpose being to
obtain a source of coal fines to serve as feedstock for a nearby synthetic fuel
facility. On August 24, 1999, Covol sent a notice of default to Earthco,
alleging that Earthco had breached a material provision of the contract because
Earthco did not have title to the property. Covol refused to tender its August
21, 1999 payment because of Earthco's breach. In addition, Covol contends that
the quantity and/or quality of recoverable coal fines was substantially less
than what Covol had understood when entering into the contract, thereby creating
grounds to reform the terms of the contract. Earthco subsequently countered with
allegations that Covol has breached its obligations under the contract,
including failure to make the August 21, 1999 payment.
On November 1, 1999, Covol was served with a Complaint in litigation
pending in the Seventh Judicial District Court of Carbon County, Utah styled
Nevada Electric Investment Company v. Earthco, et al. In the Complaint, and
consistent with Covol's position, Nevada Electric Investment Company ("NEICO")
alleges that it is the lawful owner of the property near Wellington, Utah
described in Covol's lease from Earthco. NEICO seeks a declaratory judgement
that Covol is not entitled to possession of the property due to the lack of
ownership by Earthco. The Complaint also seeks further relief from Earthco.
Covol received Earthco's Answer, Counterclaims and Cross-claim dated
December 16, 1999. Earthco's cross-claim against Covol alleged breach of
contract and prayed for substantial damages in an amount to be proven at trial
but alleged to be in excess of $5 million. Covol filed its Reply and Cross-claim
against Earthco on January 7, 2000 denying Earthco's claims and asserting claims
of misrepresentation, breach of lease, unjust enrichment, and related claims and
for general and consequential damages in an amount to be proven at trial.
The disputes among Covol, Earthco and NEICO are at an early stage and
resolution is uncertain. Covol intends to defend against claims and prosecute
its own claims vigorously.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
[Remainder of Page Intentionally Left Blank]
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The shares of common stock of Covol trade on The Nasdaq Stock
Market(sm) under the symbol "CVOL".
The following table sets forth, for the periods presented, the high and
low trading prices of Covol's common stock as reported by Nasdaq from April
1998, to September 1999, and bid quotations as reported by National Quotation
Bureau, Inc. from October 1997 through March 1998. The quotations do not reflect
adjustments for retail mark-ups, mark-downs or commissions and may not
necessarily represent actual transactions. Since Covol has several market
makers, the bid prices among the different market makers will generally vary.
Accordingly, the bid price may not be representative of actual trades. The
following prices may not be considered valid indications of market value due to
the limited and sporadic trading in the shares of common stock during certain
periods.
Low High
Fiscal 1998
Quarter ended December 31, 1997 $ 8.88 $13.94
Quarter ended March 31, 1998 10.50 14.06
Quarter ended June 30, 1998 12.25 17.44
Quarter ended September 30, 1998 9.00 17.25
Fiscal 1999
Quarter ended December 31, 1998 $4.25 $9.38
Quarter ended March 31, 1999 4.13 8.13
Quarter ended June 30, 1999 3.25 7.00
Quarter ended September 30, 1999 2.50 6.06
As of January 4, 2000, there were approximately 511 shareholders of
record of Covol's common stock.
Covol has not paid dividends on its common stock to date and does not
intend to pay dividends on its common stock in the foreseeable future. Covol
intends to retain earnings, if any, to finance the development and expansion of
its business and to pay debt service and dividends on preferred stock. Payment
of common stock dividends in the future will depend, among other things, upon
Covol's ability to generate earnings, its need for capital and its overall
financial condition.
Recent Sales of Unregistered Securities
The following sets forth all securities issued by Covol within the past
fiscal year without registration under the Securities Act of 1933, as amended.
No underwriters were involved in any stock issuances nor were any commissions
paid in connection therewith. However, Covol did pay finders fees in the form of
cash, stock or warrants in connection with various securities issuances.
The issuance of qualified options is required to be based on market
value. Accordingly, the exercise price is set based on the market price of
Covol's common stock, even though the options convert into restricted stock.
Covol believes that the following issuances of shares of common stock,
notes, debentures and other securities were exempt from the registration
requirements of the Securities Act of 1933, as amended, pursuant to the
exemption set forth in Section 4(2) thereof. Each security was issued subject to
transfer restrictions. Each certificate for each security bears a restricted
legend. Each investor made representations to Covol that it was
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accredited as that term is defined in Regulation D and that the security was
acquired for investment purposes. However, Covol has effective three
registration statements filed on form S-3. These registration statements have
registered many of the securities described in this section.
In 1996, Covol formed two limited partnerships, Alabama Synfuel #1 Ltd.
and Utah Synfuel #1 Ltd., to assist with the financing of construction at two
synthetic fuel manufacturing facilities. These two facilities have been sold and
are now owned by Birmingham Syn Fuel, L.L.C. and Coaltech No. 1 L.P. On
September 9, 1998 Covol offered the limited partners in Utah Synfuel #1 and
Alabama Synfuel #1 an exchange of Covol's common stock for their limited
partnership interests. The exchange ratio was based in part on an independent
valuation of the limited partnership's assets and other factors including but
not limited to current and future expected cash flow of the partnerships and
current market values of Covol's common stock as quoted on NASDAQ. The exchange
ratio for Utah Synfuel #1 was 112.828 shares of common stock per each limited
partnership unit and 125.97 shares for each Alabama Synfuel #1 limited
partnership unit. The limited partnership's units originally sold for $1,000 per
unit.
As of November 10, 1998, all of the limited partners in Utah Synfuel #1
and all but one of the limited partners in Alabama Synfuel #1 had agreed to
exchange their limited partnership interests for shares of Covol's common stock,
and accordingly Utah Synfuel #1 became a wholly-owned subsidiary of Covol. In
November 1999 the last limited partner in Alabama Synfuel #1 exchanged its
limited partnership interest as a part of a licensing agreement so that Alabama
Synfuel #1 also became a wholly-owned subsidiary of Covol.
During November 1998, Covol completed a financing transaction that
consisted of $400,000 of debt and approximately $3,500,000 of equity issued to
28 investors. The debt had a term of twelve months, bears interest at 15% per
annum, with an interest only payment due in six months and with the balance of
interest and principal due at maturity. The debt is collateralized by certain
assets of Covol and is due prior to maturity upon the placement of long-term
financing by Covol. The equity transaction consisted of the sale of a unit at a
price of $5.00. A unit consisted of one share of restricted common stock of
Covol plus a warrant to purchase one additional share of restricted common stock
at an exercise price of $7.50. The warrants expire June 30, 2000 if not
exercised. The stock and shares issuable pursuant to the related warrants bear
"piggyback" registration rights.
During January 1999, Covol completed a financing transaction with a
major shareholder and lender to Covol, that consisted of the sale of 1,000
shares of a new series of non-voting preferred stock, designated as Series C 7%
Convertible Preferred Stock. Covol received approximately $900,000 in net
proceeds from the issuance of this preferred stock, which has the following
rights and privileges:
o Dividends on the preferred stock are cumulative and accrue whether or
not they have been declared or whether Covol has any profits. The
dividend rate is 7% per year of the liquidation value of $1,000 per
share.
o The preferred stock is convertible into common shares in incremental
stages beginning April 1999 through July 1999, at which time all of the
outstanding shares became convertible to common stock. The number of
common shares to be received upon conversion is determined by
multiplying the number of preferred shares by $1,000 and dividing that
number by the conversion price (originally $5.50 per share, subject to
market adjustment). Upon conversion, all accrued and unpaid dividends
are paid or converted into shares of common stock.
o Covol may at its option redeem the outstanding preferred stock
beginning July 1999 for a redemption price equal to 125% of the
liquidation value plus any accrued and unpaid dividends thereon.
Warrants for the purchase of 72,727 shares of common stock were issued
in conjunction with this preferred stock. The warrants are exercisable from
April 1999 through July 2001 at an exercise price of $6.88 per share. The
warrants issued and changes made to other existing warrants were valued at
approximately $500,000. The exercise deadline for certain other warrants with an
exercise price of $7.00 per share held by the shareholder were extended to June
2000 and certain additional warrants with an exercise price of $30.00 per share
were relinquished and canceled. Covol granted registration rights for the
restricted common shares issuable upon conversion of the
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preferred stock or upon exercise of the common stock warrants. Through January
4, 2000, all of the series C preferred stock had been converted. Approximately
237,000 shares of common stock were issued on conversion of the preferred stock
and related accrued but unpaid dividends.
On March 17, 1999, Covol completed a financing transaction with a large
investment fund. The financing consisted of the issuance of $20,000,000 face
value of convertible secured debt, issued at a 50% discount, and the issuance of
60,000 shares of cumulative convertible preferred stock (series D) for
$6,000,000, for total gross proceeds of $16,000,000. Warrants for the purchase
of common stock were also issued as part of the financing and were valued at
approximately $3,000,000. Net cash proceeds were used to retire maturing
short-term debt and related accrued interest, for working capital uses and other
general corporate purposes. This transaction is described in detail in the Form
8-K filed March 24, 1999 and in the Form 10-Q/A for the quarterly period ended
March 31, 1999. Beginning in November 1999 and through January 4, 2000, Covol
has issued 1,603,775 shares of common stock on conversion of 15,202 shares of
series D preferred stock.
In September 1999, Covol entered into a transaction with an affiliate
of a major shareholder and lender to Covol, to provide financing of up to $4
million in the form of convertible secured debt. The agreement provides for
Covol to make draws as needed. Covol received $850,000 at the time of closing,
less a placement fee of 10%, and subsequent to September 30, 1999 received a
total of $1,650,000, less a placement fee of 10%. The debt is convertible at
$3.00 per share, or market, whichever is less, and is convertible at the rate of
25% every 30 days beginning 30 days from the date of closing, subject to certain
restrictions. Covol can redeem all outstanding debt at a rate of 125% of face
value by providing 30 days notice. Borrowings are due in March 2001, if not
converted earlier, and interest payments are due quarterly beginning December
1999. Covol assigned the royalties to be received from a licensed synthetic fuel
facility as collateral for the financing. In November and December 1999,
approximately 2,532,000 shares of common stock were issued on conversion of
$1,460,000 of the convertible debt.
The agreement requires the issuance of warrants to purchase Covol
shares equal to 40% of the shares issuable under any borrowings under this
financing arrangement. The warrants have a three-year exercise period and an
exercise price of $3.60 per share. Warrants for the purchase of a total of
approximately 350,000 shares of common stock were issued and were assigned a
value, using the Black-Scholes option valuation model, of approximately
$477,000.
In December 1999, Covol placed $1,500,000 of financing with an investor
rather than drawing the entire $4,000,000 of funding as provided under the
September financing arrangement. The terms and conditions of this financing are
similar to the September financing. As of December 20, 1999, Covol had received
a total of $1,500,000, less a placement fee of 10%. The debt is convertible at
$.73 per share, the market price at closing, or market price on the conversion
date, whichever is less. The debt is convertible after January 21, 2000.
The agreement requires the issuance of warrants to purchase Covol
shares equal to 40% of the shares issuable under the debt agreement. Warrants
for the purchase of approximately 935,000 shares were issued. The warrants have
a three-year exercise period and an exercise price of $.88 per share, and were
assigned a value, using the Black-Scholes option valuation model, of
approximately $269,000.
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<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data are derived from the consolidated
financial statements of Covol. This information should be read in conjunction
with the consolidated financial statements, related notes and other financial
information included herein. In 1996, Covol sold its construction subsidiaries.
All construction - related operations were reflected as discontinued operations
in the 1995 and 1996 financial statements. The note receivable received by Covol
as consideration for the sale is "marked to market" each quarter based on the
market value of Covol's stock held as collateral, and the resulting adjustments
are reflected in Covol's statement of operations. The selected financial data as
of and for the years ended September 30, 1995 and 1996 and as of September 30,
1997 are derived from audited financial statements not included herein. The
selected financial data for the year ended September 30, 1997, and as of and for
the years ended September 30, 1998 and 1999 were derived from the financial
statements of Covol which have been audited by PricewaterhouseCoopers LLP
included elsewhere herein.
<TABLE>
<CAPTION>
Year Ended September 30,
---------------------------------------------------------------------
(thousands of dollars, except per-share data) 1995 1996 1997 1998 1999
- ----------------------------------------------- -------------- -------------- ------------- -------------- ------------
OPERATING DATA:
<S> <C> <C> <C> <C> <C>
Total revenues $ 129 $ 295 $ 147 $ 3,074 $ 6,719
Loss from continuing operations (4,524) (12,955) (10,498) (11,308) (28,393)
Net loss (5,654) (13,836) (10,498) (11,308) (28,393)
Basic and diluted net loss per
common share:
Loss per share from continuing
operations (1.00) (1.86) (1.32) (1.17) (2.39)
Net loss per share (1.25) (1.99) (1.32) (1.17) (2.39)
Purchase of property, plant and
equipment and facilities
held for sale 694 5,055 7,194 36,963 861
September 30,
-------------- -------------- ----------------------------------------
(thousands of dollars) 1995 1996 1997 1998 1999
- ------------------------------------------------ -------------- -------------- -------------- ----------- ------------
BALANCE SHEET DATA:
<S> <C> <C> <C> <C> <C>
Working capital (deficit) $(480) $(3,482) $(3,471) $ 7,497 $(2,037)
Net property, plant and equipment 1,330 7,125 13,619 15,809 14,182
Total assets 2,660 8,072 26,590 68,061 58,095
Long-term obligations 177 364 5,362 23,256 30,138
Total stockholders' equity (deficit) 1,183 (233) 6,426 14,746 (1,028)
</TABLE>
19
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the information set forth under the caption entitled "ITEM 6. SELECTED
FINANCIAL DATA" and the consolidated financial statements and notes thereto for
Covol included elsewhere herein.
Year Ended September 30, 1999 Compared to Year Ended September 30, 1998
The information set forth below compares Covol's operating results for
1999 with its operating results for 1998.
Revenues. Total revenues for the year ended September 30, 1999 ("1999")
increased by $3,645,000 to $6,719,000 as compared to $3,074,000 for the year
ended September 30, 1998 ("1998"). During 1999, Covol recognized license fees
totaling $3,526,000 while $860,000 of license fees were recognized during 1998.
The license fees in 1999 consisted of the straight-line amortization of one-time
non-refundable initial license fees of $875,000 and recurring earned license
fees or royalty payments of $2,651,000. License fees in 1998 consisted of the
straight-line amortization of one-time non-refundable initial license fees of
$654,000 and recurring license fees or royalty payments of $206,000. Initial
license fees, which are not expected to increase in future periods, are normally
received when construction of the related synthetic fuel facility begins, when
construction is completed, or when certain construction milestones or other
conditions are met, but are recognized on a straight-line basis over the period
covered by Covol's license agreements with licensees. Recurring earned license
fees or royalty payments, which are expected to increase in future periods, are
due quarterly based upon synthetic fuel produced and sold as reported to Covol
by its licensees.
Synthetic fuel sales were $767,000 in 1999 compared to $32,000 in 1998
and represent the sale of product from Covol-owned facilities. This revenue is
expected to decrease in the future as Covol sells the remaining Covol-owned
facilities. One facility was sold in September 1999, another facility was sold
in December 1999 and Covol expects to sell its two remaining owned facilities in
early 2000. Covol sold six binder mixing plants to licensees during 1998 for
$1,088,000, generating a gross profit of $200,000. There were no such sales of
binder mixing plants during 1999 nor are any expected in the future. Covol
provides binder material to its licensees either at a fixed price or at Covol's
cost plus a contracted markup. Covol purchases the binder materials under a
long-term contract with a large chemical company. Total binder sales during 1999
were $2,140,000 with a corresponding direct cost to Covol of $1,695,000. Total
binder sales during 1998 were $994,000 with a corresponding direct cost to Covol
of $642,000. Covol expects a significant increase during 2000 of production of
synthetic fuel by its licensees as licensees move toward full production levels
with a corresponding increase in earned license fees or royalty payments and
sales of binder products. However, Covol cannot assure increases in license
fees, royalty payments and binder sales as the primary factor is Covol's
licensees ability to successfully obtain adequate feedstock coal fines, process
fines into synthetic fuel, and develop markets for synthetic fuel now and in the
future. Covol believes that its licensees have made significant progress in
these areas during 1999 but continued success cannot be assured.
Synthetic fuel is a relatively new product and competes with standard
coal products. Industrial coal users must be satisfied that the synthetic fuel
is a suitable substitute for standard coal products. Moisture content, hardness,
special handling requirements and other characteristics of the synthetic fuel
product may affect its marketability and its 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 coal contracts already in place. Reliance on spot
markets and the overall downward trend in coal prices have generally produced
lower sales prices as compared to long-term coal supply contracts common in the
utility industry. Market acceptance of the synthetic fuel product appears to
have improved during 1999 even though Covol's owned facilities and its licensees
have only been able to secure long-term contracts for the sale of a small
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 has tried to solve this problem by identifying buyers for its
owned facilities that are either consumers of coal or who have access to
long-term coal
20
<PAGE>
contracts. Synthetic fuel is a coal substitute and 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 initial market resistance for
synthetic fuel has decreased and believes long-term contracts can now be secured
allowing Covol and its licensees to market the synthetic they produce at prices
similar to coal.
Section 29 of the Internal Revenue Code provides a tax credit for the
production and sale of qualified synthetic fuel. Covol and Covol's licensees
have received numerous private letter rulings from the IRS in which the IRS
agrees that synthetic fuel manufactured using Covol's technology qualifies for
the Section 29 tax credits. Covol is aware of at least eight private letter
rulings issued by the IRS that cover Covol's technology. Based upon the language
of Section 29 and private letter rulings issued by the IRS to Covol and Covol's
licensees, Covol believes the synthetic fuel facilities were built and completed
by June 30, 1998 and are therefore eligible for Section 29 tax credits. See ITEM
1. BUSINESS - Tax Credits for an explanation of qualifications for Section 29
tax credits.
The synthetic fuel facilities that qualify for tax credits under
Section 29 of the tax code receive economic benefits from the tax credits in
addition to the benefits from operations. It is possible that synthetic fuel
facilities built after June 30, 1998 that are not eligible for tax credits could
not be operated profitably. Section 29 expires on December 31, 2007 after which
tax credits will not be available to the synthetic fuel facilities. In order to
remain competitive and commercially viable after 2007, Covol and its licensees
must manage their costs of production and feedstock, and must also develop the
market for synthetic fuel with prices comparable to coal. Covol has developed
and patented technologies related to the briquetting of wastes and by-products
from the coal, coke and steel industries and has also tested in the laboratory
the briquetting of other materials. However, to date, Covol has only
commercialized the coal-based synthetic fuel application. The other applications
have not been commercialized or proven out in full-scale operations. The level
of success Covol has in commercializing these other applications will directly
impact Covol's future success and its ability to expand operations beyond the
coal applications.
Our accounting and valuation procedures assume all of the Covol owned
facilities qualify for section 29 tax credits so that synthetic fuel production
will continue to be the highest and best use of our equipment and facilities. If
the facilities lost their qualification under Section 29, the equipment and
facilities' carrying value would likely be higher than the fair value based on
the alternative highest and best use, which could result in an impairment charge
at that time.
Operating Costs and Expenses. Operating costs and expenses increased by
$16,444,000 or 130% to $29,132,000 during 1999 from $12,688,000 during 1998.
Cost of coal briquetting operations increased $7,391,000 from $5,565,000 during
1998 to $12,956,000 during 1999. During 1999, Covol incurred significantly
higher operating expenses in connection with the continued refinement and
implementation 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 being 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 inventory purchased from Coaltech, and costs incurred in providing
assistance to Covol's licensees in resolving ramp-up issues at their synthetic
fuel facilities. Covol expects to continue incurring operating losses into 2000
until all of these facilities are sold. Covol expects to realize a gain when the
facilities are sold and would expect the cost of coal briquetting operations to
be reduced to a level significantly less than the 1998 level.
Until October 1999, Covol operated one of the synthetic fuel facilities
for Coaltech, a partnership for which Covol was the general partner. Under the
operating agreement, Covol is contractually obligated to purchase all of the
synthetic fuel produced at cost plus $1 per ton. Production of synthetic fuel
from this facility during 1999 and 1998 was not significant and accordingly, the
cost per ton was significantly in excess of the current market value. These
costs and the corresponding write-down of this inventory to its market value are
included in the cost of coal briquetting operations. The write-down was
approximately $1,815,000 during 1999 and $1,400,000 during 1998. Covol operated
the Coaltech Utah facility at a loss because of the need to gain operating
experience (it was the first synthetic fuel facility Covol built and operated),
test alternative production methods, maintain operational status for Section 29
qualification, maintain the relationship with AJ Gallagher, an owner of the Utah
facility who is
21
<PAGE>
a major licensee and partner of Covol, and other related business reasons.
Subsequent to September 30, 1999, Covol received notification from the limited
partners of Coaltech that they were effecting a retirement of Covol as the
general partner and were terminating Covol as operator of the Utah facility.
Covol and Coaltech are in negotiations to resolve the situation, including a
likely settlement of the note and termination of the supply and purchase
agreement. Settlement payments are expected to be consistent with amounts
reflected in the accompanying consolidated financial statements. Proceeds from
this settlement will be used to repay the $4,313,000 note payable due January
2000 to one of the limited partners. It is also expected that the limited
partners will continue to purchase binder materials from Covol and use Covol's
technology in the production of synthetic fuel when operations of the Utah
facility are resumed.
Asset Write-offs and Other Non-recurring Charges. In May 1995, Covol
entered into an agreement with Geneva Steel Company to build and operate a
synthetic fuel 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 1999.
During 1997, Covol entered into an agreement to purchase coal fines for
feedstock for a synthetic fuel facility in Utah. Beginning in 1997 and
continuing through May 1999, Covol made payments totaling approximately
$3,917,000, of which $240,000 was transferred to cost of coal briquetting
operations. The net amount paid was recorded as advances on inventories.
Quarterly payments of approximately $396,000 are required under the agreement.
The agreement provides for total payments of $5,500,000 between February 1997
and May 2000 for the removal of 2 million tons of coal fines (at a price of
$2.75 per ton) from the property. 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 entered into the contract
based on its understanding that the other party to the agreement (the "Seller")
was the owner of the property and that there were in excess of 2 million tons of
recoverable coal fines on the property. Subsequently, Covol learned that a third
party disputes that the Seller is the owner of the property, and that there may
be substantially less than 2 million tons of recoverable fines on the property.
Consequently, in August 1999, Covol notified the Seller that unless the Seller
could procure and provide evidence that it could warrant title to the property
and would adjust contract payments to reflect the actual recoverable fines at
the property, Covol may elect to terminate the contract and seek appropriate
damages. On this basis, Covol has refused to make further quarterly payments to
the Seller under the contract. The Seller responded by denying Covol's claims
and alleging issues of property reclamation and bonding and failed contract
payment. Covol denies these allegations. Covol no longer has purchasing
responsibilities for the facility as the owner has notified Covol of its
intention to relocate the facility. The dispute is in an early stage of
litigation and resolution is uncertain. See "ITEM 3. LEGAL PROCEEDINGS". Based
on the uncertainty of recovering the net advances paid through litigation, Covol
wrote off the entire $3,677,000 of advances on inventories in the fourth quarter
of 1999.
In addition to the above charges, in the fourth quarter of 1999 Covol
wrote off a $660,000 note receivable and recorded a liability for approximately
$469,000 related to a settlement agreement with a company that had provided
Covol with advise with respect to the use of certain synthetic fuel technology,
certain financing obtained, and the sale of certain synthetic fuel manufacturing
facilities.
These write-offs and the settlement provision total approximately
$5,362,000, which amount is recorded as asset write-offs and other non-recurring
charges in the consolidated statement of operations.
Selling, general and administrative expenses increased $291,000 or 7%
to $4,727,000 during 1999 from $4,436,000 for 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 $450,000, due primarily to increased headcount and salary costs,
professional services increased approximately $20,000 and travel decreased
approximately $50,000 from 1998 to 1999. Also, there was approximately $250,000
of commissions incurred in connection with the placement of synthetic fuel
license agreements in 1998 while there were no such commissions in 1999. Changes
in the other categories from year to year were not material.
Compensation expense from stock options, stock warrants, and issuance
of common stock increased
22
<PAGE>
$1,614,000 to $2,553,000 for 1999 from $939,000 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 several employees to whom compensatory
stock options were granted in prior years. These stock options were not
forfeited upon termination, resulting in the write off of the unamortized
deferred compensation related to these individuals.
Loss on sale of facility. In 1998, Covol sold a synthetic fuel facility
located in Alabama on which a loss of $218,000 was recognized. In 1999, Covol
sold a facility located in Pennsylvania on which a loss of approximately
$1,839,000 was recognized. The sales price on the 1999 transaction consisted of
a cash payment to Covol of $1,250,000, assumption of $5,000,000 of facility
debt, completion of capital improvements to the facility and an eight-year
royalty arrangement with both Covol and the construction lender. Covol can
receive additional cash payments in the form of both accelerated and increased
royalties upon obtaining firm synthetic fuel "off-take" agreements in excess of
100,000 tons per year and operating the facility at rated capacity for a ten-day
period. Covol must achieve these performance milestones by June 30, 2000. The
maximum amount under these provisions of approximately $9,700,000 is achieved if
"off-take" agreements to sell 360,000 tons per year are put in place for the
synthetic fuel production of the facility in addition to the ten-day operations
period. Further, Covol can receive an additional $4,000,000 payment if the
facility operates at 115% of capacity for a three-month period in any
consecutive three months prior to December 31, 2001. Covol will recognize
revenue and a corresponding gain under the royalty arrangement upon receipt of
the royalty payments and for achievement of performance milestones. Covol also
sold a synthetic fuel facility in December 1999, and entered into agreements to
sell two other facilities in January 2000, as more fully described in Note 17 to
the consolidated financial statements.
Other Income and Expense. During 1999, Covol had net other expenses of
$5,980,000 compared to $1,694,000 for 1998. This increase of $4,286,000 relates
primarily to an increase in interest expense of $3,508,000, a change between
periods of $1,228,000 in the mark-to-market adjustment of the carrying value of
the related party note receivable collateralized by common stock, and a decrease
in minority interest in losses of consolidated subsidiaries of $401,000,
partially offset by an increase in interest income of $1,006,000.
Interest expense in 1998 of $2,745,000 consisted primarily of
amortization of the discount incurred upon the issuance of convertible debt and
warrants at a discount. Interest expense of $6,253,000 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 $2,075,000 of
amortization of debt discount and debt issue costs. Interest expense has
increased significantly as a result of the debt issued during 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 held as
collateral and is reflected in the consolidated balance sheet at the underlying
value of this collateral, $400,000 at September 30, 1999. This adjustment
resulted in a write-down of $1,209,000 during 1999, compared to a write-up of
$19,000 during 1998 for a net change of $1,228,000. A $515,000 payment on this
Note during 1999 was included in interest income for 1999, while no interest
income on the Note was recognized in 1998. Another reason for the increase in
interest income in 1999 over 1998 relates to a full year's interest being
recognized on the $6,500,000 note receivable from the sale of the Alabama
facility in March 1998.
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
$392,000 in 1998 to approximately $0 in 1999.
Net loss. For 1999, the net loss of $28,393,000 represents a change of
$17,085,000 from the net loss of $11,308,000 in 1998. This is primarily due to
the increase in cost of briquetting operations, the asset write-offs and other
non-recurring charges, and the increase in interest expense. Covol did not
recognize any income tax benefit in
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<PAGE>
1999 or 1998 since the realization of its deferred tax asset of approximately
$21,800,000, consisting primarily of net operating loss carryforwards, is
dependent on generation of future taxable income.
Year Ended September 30, 1998 Compared to Year Ended September 30, 1997
The information set forth below compares Covol's operating results for
1998 with its operating results for 1997.
Revenues. Total revenues for the year ended September 30, 1998
increased by $2,927,000 to $3,074,000 as compared to $147,000 for 1997. During
1998 Covol recognized license fees totaling $860,000 while $105,000 of license
fees were recognized during 1997. These fees consisted of the straight-line
amortization of one-time non-refundable initial license fees of $654,000, and
recurring license fees or royalty payments of $206,000. The fees in 1997 related
solely to amortization of the Coaltech non-refundable initial license fee.
Initial license fees are normally received when construction of the related
synthetic fuel facility begins, when construction is completed, or when certain
construction milestones or other conditions are met, but are recognized on a
straight-line basis over the period covered by Covol's license agreements with
licensees. Recurring license fees or royalty payments are due quarterly based
upon synthetic fuel produced and sold as reported to Covol by its licensees.
Covol sold six binder mixing plants to licensees during 1998 for $1,088,000,
generating a gross profit of $200,000. Covol provides binder material to its
licensees either at a fixed price or at Covol's cost plus a contracted markup.
Covol purchases the binder materials under a long-term contract with a large
chemical company. Total binder sales during 1998 were $994,000 with a
corresponding direct cost to Covol of $642,000.
Operating Costs and Expenses. Operating costs and expenses increased by
$2,372,000 or 23% to $12,688,000 during 1998 from $10,316,000 during 1997. Cost
of coal briquetting operations increased $305,000 from $5,260,000 during 1997 to
$5,565,000 during 1998. During 1997, Covol recorded an expense for $1,477,000
relating to construction penalties for failure to proceed under several
contracts Covol had entered into. There was no similar expense in 1998. However,
during 1998 Covol incurred significantly higher operating expenses in connection
with the continued refinement and implementation of the briquetting process, and
the commercialization of this process in connection with the 24 facilities
placed in service during 1998, including the four facilities held for sale.
These expenses related in part to the construction and operation of four
synthetic fuel facilities built by Covol that were held for sale, costs incurred
in providing assistance to Covol's licensees during the ramp-up of their
synthetic fuel facilities, and increased personnel costs. These increases during
1998 effectively offset the 1997 construction penalty expenses. Covol operated
one of the synthetic fuel facilities for Coaltech, a partnership for which Covol
is the general partner. Under this operating agreement, Covol is contractually
obligated to purchase all of the synthetic fuel produced at cost plus $1 per
ton. Production of synthetic fuel from this facility during 1998 was not
significant and accordingly, the cost per ton is significantly in excess of the
current market value. These costs and the corresponding write-down of this
inventory to its market value are included in the cost of coal briquetting
operations. The write-down was approximately $1,400,000 during 1998 and
$1,548,000 during 1997.
Selling, general and administrative expenses increased $1,438,000 or
48% to $4,436,000 during 1998 from $2,998,000 for 1997. Approximately $500,000
of this increase related to a substantial increase in travel and related costs
as Covol's employees spent a significantly greater amount of time at Covol
facilities and licensee-owned facilities. The balance of the increase in
expenses relates to approximately $250,000 of commissions incurred in connection
with the placement of synthetic fuel license agreements, $175,000 in increased
professional fees and a $500,000 increase in payroll and related costs,
resulting from additional employees hired.
Compensation expense on stock options, stock warrants, or issuance of
common stock decreased $1,119,000 or 54% to $939,000 for 1998 from $2,058,000
for 1997. This decrease is attributable to a change in policy to only grant
stock options at strike prices that are not "in-the-money," for the purpose of
providing an incentive to the recipient of the options to create shareholder
value. The majority of the 1998 expense relates to options granted in prior
years that vest over several years and the compensation value that is being
recognized as an expense over the vesting period.
In 1998, Covol sold the facility owned by Alabama Synfuel #1 Ltd. for
$6,500,000, in exchange for a note receivable due not later than February 2003.
A loss of $218,000 was incurred from the sale of this facility. Covol
24
<PAGE>
believes the note receivable, which is classified as a facility-dependent note
receivable in the consolidated balance sheet, is collectible from the debtor, or
in the event of the debtor's failure to satisfy the obligation, by the debtor's
parent, Covol that will ultimately utilize the tax credits generated from the
synthetic fuel facility. In 1997, Utah Synfuel #1 transferred its facility to
Coaltech for $3,500,000, evidenced by a promissory note payable in 44 quarterly
installments of $130,000 starting March 31, 1997. The actual cost to construct
the Utah Synfuel #1 facility was $4,082,000. In accordance with generally
accepted accounting principles and after discussion with the staff of the
Securities and Exchange Commission, this transaction has not been reflected as a
sale for accounting purposes. The original cost of the facility, less cash
payments received from Coaltech, is reflected in the consolidated balance sheet
as a facility transferred under note receivable arrangement.
During 1996, Covol sold certain construction companies and received as
consideration a $5,000,000 note receivable ("Note") with interest at 6% payable
over five years. It was determined that the Note should be discounted to an
appropriate market rate and accordingly, the Note was discounted at 10.25%
resulting in a discount of $1,281,000. The Note is collateralized by stock and
stock options of Covol and is reflected in the consolidated balance sheet at the
underlying value of the collateral. Accordingly, the Note is "marked to market"
each quarter based upon the market value of Covol's common stock. This
adjustment resulted in income of $19,000 being recognized during 1998, compared
to an expense of $60,000 recognized during 1997. The Note is guaranteed by the
buyer of the construction companies and there has been no event of default or
past due payment on the Note. Covol does not accrue interest on this Note and as
of September 30, 1998 the Note had a carrying value of $1,609,000 in Covol's
consolidated balance sheet.
Other Income and Expense. During 1998, Covol had net other expenses of
$1,694,000 compared to $329,000 for 1997. This increase of $1,365,000 relates
primarily to an increase of $618,000 in net interest expense and a decrease of
$853,000 in minority interest in the net losses of consolidated subsidiaries
(Utah Synfuel #1 and Alabama Synfuel #1). During September 1998, Covol offered
the limited partners of Utah Synfuel #1 and Alabama Synfuel #1 an exchange of
their limited partnership interests for common stock of Covol. These exchanges,
most of which were accounted for in September 1998, were substantially completed
in November 1998, at which time Utah Synfuel #1 became a wholly-owned subsidiary
of Covol and Alabama Synfuel #1 became a 98%-owned subsidiary of Covol.
Net Loss. For 1998, the loss increased by $810,000 from $10,498,000 for
1997 to $11,308,000. The increase is primarily due to increased operating costs
and other expenses as discussed previously. Covol did not recognize any income
tax benefit in 1998 or 1997 since the realization of its deferred tax assets,
consisting primarily of net operating loss carryforwards, depends on generation
of future taxable income.
Liquidity and Capital Resources
Liquidity. During 1998, Covol and its licensees completed the
construction of and began operations at 24 synthetic fuel facilities. Covol
owned four facilities which it held for sale during 1999. One facility was sold
in August 1999 and another was sold in December 1999. Covol currently owns two
facilities which are being offered for sale and anticipates the sale of these
facilities in early 2000. 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 the facilities and for working capital needs.
Total operating expenses associated with the four owned facilities cost
approximately $500,000 per month during the quarter ended September 30, 1999.
These operating expenses fluctuate depending on the level of activity at the
owned facilities.
Net cash used in operating activities for the year ended September 30,
1999 ("1999") was $17,516,000 compared to $5,366,000 of cash used during the
year ended September 30, 1998 ("1998"). Most of this change in cash flow from
operations is attributable to the 1999 net loss of $28,393,000 as compared to
$11,308,000 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 $11,193,000, proceeds
from the issuance of preferred stock totaled $6,367,000 and proceeds from the
issuance of common stock totaled $3,775,000.
25
<PAGE>
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 ($35,454,000) and from working capital. Covol
believes that funds required for investing activities will continue to be
significantly lower during 2000 as compared to 1998 because the construction of
synthetic fuel facilities that qualified for federal income tax credits under
Section 29 of the IRC was completed during 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 and Covol has no current plans to construct
additional synthetic fuel facilities.
There are 24 synthetic fuel plants that currently utilize Covol's
patented technology and from which Covol intends to earn license fees and / or
profits from the sale of binder. These facilities do not presently operate at
levels needed to generate significant revenues to Covol. Improved operations at
the plants depend on the ability of the plant owners to produce synthetic fuel
that meets market specifications in order for the plant owners to market the
synthetic fuel. Covol is assisting the plant owners in their efforts to overcome
production and marketing problems. Covol anticipates that recurring license fees
or royalties from the production and sale of synthetic fuel will continue to
increase during 2000 and beyond. 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 expected to
be sufficient to cover Covol's operating costs and expenses at some point during
2000.
In order for operating activities to produce significant positive cash
flow, 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 Covol's 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
Covol and its licensees because they have committed to purchase a substantial
portion of their coal requirements through long-term coal contracts already in
place. Reliance on spot markets and the overall downward trend in coal prices
have generally produced lower sales prices as compared to long-term coal supply
contracts common in the utility industry. Market acceptance of the synthetic
fuel product appears to have improved during 1999 even though Covol's owned
facilities and its licensees have only been able to secure long-term contracts
for the sale of a small 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 initial market resistance for
synthetic fuel has decreased and believes long-term contracts can now be secured
allowing Covol and its licensees to market the synthetic fuel they produce at
prices similar to coal.
Covol incurred a net loss for the year ended September 30, 1999 of
$28,393,000 and used $17,516,000 of cash in its operating activities for the
year. As discussed in Note 6 to the consolidated financial statements, Covol has
$20,626,000 of long-term debt due during the year ending September 30, 2000. In
addition, Covol's convertible note payable with a face amount of $20,000,000 and
related redeemable convertible preferred stock with an aggregate liquidation
preference of approximately $5,600,000 at December 31, 1999 contain certain
provisions including an increase in the interest rate, immediate convertibility,
required escrow payments and possible immediate payment of outstanding amounts
in the event of a default by Covol. Such an event could include a failure of
Covol's shareholders to approve the issuance of the convertible debt and
convertible preferred stock by March 31, 2000 or failure of Covol to achieve the
targeted earnings levels. Covol believes that shareholder approval will be
obtained and that Covol will achieve the targeted earnings levels during fiscal
2000.
26
<PAGE>
Covol has funded its operations during the year ended September 30,
1999 primarily through the issuance of debt and equity securities, and the sale
of a synthetic fuel facility. During November 1998, Covol issued common stock
and common stock warrants for total net proceeds of approximately $3,729,000.
During January 1999, Covol issued convertible preferred stock and warrants for
total net proceeds of approximately $899,000. During March 1999, Covol issued
convertible secured debt, convertible redeemable preferred stock and common
stock warrants for total net proceeds of approximately $14,581,000. From
September through December 1999, Covol issued convertible secured debt and
warrants for total net proceeds of approximately $3,500,000 and is currently in
discussions with creditors to whom debt is owed in January 2000. As discussed in
Note 17 to the consolidated financial statements, in August 1999 and December
1999, Covol sold two synthetic fuel facilities for cash proceeds in excess of
amounts required to fully retire the related debt collateralized by the
facilities. Also, on January 13, 2000, Covol excuted definitive agreements for
the sale of one synthetic fuel facility and executed a letter of intent for the
sale of the only remaining facility held for sale.
Covol believes that there are several alternatives available that will
provide the working capital necessary to meet operational requirement and debt
payments as they become due, including proceeds from the sale of its remaining
facilities held for sale, funds from operations, and only if no other
alternatives exist, additional financing. Covol believes it will be able to
extend the repayment terms of its debt and that excess proceeds from the sale of
facilities will be sufficient to fund Covol's operations until its operating
activities begin producing positive cash flow.
In connection with the financing Covol obtained in March 1999, 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. As of the
date of this report, Covol expects it will be able to comply with this provision
during fiscal 2000. Covol's current operations are at levels below this
requirement; however, the sale of the Covol-owned facility in December 1999
resulted in a gain in excess of $5,000,000. Additionally, operating expenses
have decreased as a result of the sale of the facilities in August 1999 and
December 1999. 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 at a price not less than $6.67 or more
than $10.00 which calculation is based upon the current market price of Covol's
stock. 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.
Forward Looking Statements
Statements in this Item 7 regarding Covol's expectations as to the
receipt of licensing and royalty fees, revenues, the receipt of operation and
maintenance fees, the receipt of fees for sale of binder materials, reduction in
operating expenses, ability to extend or refinance debt, and other information
presented herein that are not purely historical by nature, constitute forward
looking statements within the meaning of the Private Securities Litigation
Reform Act of 1995. Although Covol believes that its expectations are based on
reasonable assumptions within the bounds of its knowledge of its business and
operations, there can be no assurance that actual results will not differ
materially from its expectations. In addition to matters affecting Covol's
industry or the coal industry or the economy generally, factors which could
cause actual results to differ from expectations set forth in the
above-identified forward looking statements include in part, the following:
27
<PAGE>
o the ability of Covol and its licensees to resolve the operational and
marketing issues described above; o the ability of licensees to produce
and sell synthetic fuel at or near the rated capacity of the synthetic
fuel facilities and willingness and ability of licensees to make timely
payments for binder materials purchased and royalty amounts due;
o ability to obtain needed additional capital on terms acceptable to
Covol;
o changes in governmental regulation or failure to comply with existing
regulation which may result in operational shutdowns of its facilities;
and
o the availability of tax credits under Section 29 of the tax code and
qualification of facilities currently in service.
See "ITEM 1. BUSINESS--Forward Looking Statements" for a description of
additional factors which could cause actual results to differ from expectations.
Impact of Inflation
During 1999, cost increases to Covol were not materially impacted by
inflation.
Other Items
Covol has reviewed all recently issued, but not yet adopted, accounting
standards in order to determine their effects, if any, on the results of
operations or financial position of Covol. Based on that review, Covol believes
that none of these pronouncements will have any significant effects on current
or future financial position or results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
None.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary financial data required by
this Item 8 are set forth in Item 14 of this Form 10-K. All information which
has been omitted is either inapplicable or not required.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There are no changes in or disagreements with accountants on accounting
or financial statement disclosure.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information to be set forth under the captions "Executive
Officers," "Section 16(a) Beneficial Ownership Reporting Compliance" and
"Proposal No. 1: Election of Director" in Covol's Proxy Statement to be dated on
or about January 17, 2000, for the Annual Meeting of Stockholders to be held on
or about February 29, 2000 (the "Proxy Statement"), are incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION
The information to be set forth under the caption "Executive
Compensation and Related Information" in the Proxy Statement is incorporated
herein by reference; provided, however, that Covol specifically excludes from
such incorporation by reference any information set forth under the captions
"Compensation Committee Report on Executive Compensation" and "Stockholder
Return Performance Graph" in the Proxy Statement.
28
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Security ownership of certain beneficial owners and management to be
set forth under the caption "Security Ownership of Directors, Nominees and
Principal Stockholders" in the Proxy Statement is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information to be set forth under the caption "Transactions with
Related Parties" in the Proxy Statement is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
Consolidated Financial Statements of Covol Technologies, Inc.
Report of Independent Accountants........................................ F-1
Consolidated Balance Sheets as of September 30, 1998 and 1999............ F-2
Consolidated Statements of Operations
for the years ended September 30, 1997, 1998 and 1999........... F-4
Consolidated Statements of Changes in Stockholders' Equity (Deficit)
for the years ended September 30, 1997, 1998 and 1999........... F-5
Consolidated Statements of Cash Flows
for the years ended September 30, 1997, 1998 and 1999........... F-8
Notes to Consolidated Financial Statements............................... F-10
2. Financial Statement Schedules
All financial statement schedules for which provision is made in the
applicable accounting regulations of the Securities and Exchange Commission are
not required under the related instructions or are inapplicable, and therefore
have been omitted.
3. Listing of Exhibits
Certain other instruments which would otherwise be required to be
listed below have not been so listed because such instruments do not authorize
securities in an amount which exceeds 10% of the total assets of Covol and its
subsidiaries on a consolidated basis and Covol agrees to furnish a copy of any
such instrument to the Commission upon request.
There is included a restated financial data schedule for the years
ended September 30, 1997 and 1998.
<TABLE>
<CAPTION>
Exhibit No. Description Location
<S> <C> <C>
2.1 Agreement and Plan of Reorganization, dated July 1, 1993 between Covol and the (1)
Stockholders of R1001
29
<PAGE>
Exhibit No. Description Location
<S> <C> <C>
2.2 Agreement and Plan of Merger dated August 14, 1995 between Covol and Covol (1)
Technologies, Inc., a Delaware corporation
2.3 Stock Purchase Agreement, dated July 1, 1993, among Covol, Lloyd C. McEwan, Michael (1)
McEwan, Dale F. Minnig and Ted C. Strong regarding the purchase of Industrial
Management & Engineering, Inc. and Central Industrial Construction, Inc.
2.4 Stock Sale Transaction Documentation, effective as of September 30, 1994, between Covol (1)
and Farrell F. Larson regarding Larson Limestone Company, Inc.
2.5 Stock Purchase Agreement dated February 1, 1996 by and among Covol, Michael McEwan (1)
and Gerald Larson regarding the sale of State, Inc., Industrial Engineering & Management,
Inc., Central Industrial Construction, Inc., and Larson Limestone Company, Inc.
2.5.1 Amendment to Share Purchase Agreement regarding the sale of the Construction Companies (1)
2.5.2 Amendment No. 2 to Share Purchase Agreement regarding the sale of the Construction (2)
Companies
3.1 Certificate of Incorporation of Covol (1)
3.1.1 Certificate of Amendment of the Certificate of Incorporation of Covol dated January 22, (1)
1996
3.1.2 Certificate of Amendment of the Certificate of Incorporation dated June 25, 1997 (6)
3.1.3 Certificate of Designation, Number, Voting Powers, Preferences and Rights of Covol's (7)
Series A 6% Convertible Preferred Stock (Originally designated as Exhibit No. 3.1.2)
3.1.4 Certificate of Designation, Number, Voting Powers, Preferences and Rights of Covol's (8)
Series B Convertible Preferred Stock (Originally designated as Exhibit No. 3.1.3)
3.1.5 Certificate of Designation, Number, Voting Powers, Preferences and Rights of Covol's (14)
Series C 7% Convertible Preferred Stock
3.1.6 Certificate of Designations, Number, Voting Powers, Preferences and Rights of the Series (15)
of the Preferred Stock of Covol Technologies, Inc. to be Designated Series D 7% Cumulative
Convertible Preferred Stock
3.2 By-Laws of Covol (1)
3.2.1 Certificate of Amendment to Bylaws of Covol dated January 31, 1996 (1)
3.2.2 Certificate of Amendment to the Bylaws dated May 20, 1997 (Originally designated as (6)
Exhibit No. 3.2.1)
3.2.3 Certificate of Amendment to the Bylaws dated June 25, 1997 (Originally designated as (6)
Exhibit No. 3.2.2)
4.1 Promissory Note between Covol and Mountaineer Synfuel, L.L.C. dated May 5, 1998 (filed (12)
as Exhibit 10.52.2 hereto)
4.2 Promissory Note dated December 8, 1998 of Covol to Mountaineer Synfuel, L.L.C. (filed as (13)
Exhibit 10.52.4 hereto)
4.3 Security Agreement dated December 8, 1998 between Mountaineer Synfuel, L.L.C. and (13)
Covol (filed as Exhibit 10.52.5 hereto)
4.4 Convertible Secured Note executed by Covol in favor of OZ Master Fund, Ltd., dated as of (15)
March 17, 1999 (filed as Exhibit 10.58.1 hereto)
30
<PAGE>
Exhibit No. Description Location
<S> <C> <C>
9.1 Special Powers of Attorney Coupled With an Interest dated February 1, 1996 between Covol, (1)
Gerald Larson and Michael McEwan
10.4 Master Equipment Lease Agreement, dated May 4, 1995, between Keycorp Leasing Ltd. and (1)
Covol
10.5 1995 Stock Option Plan (1)
10.5.1 First Amendment to the 1995 Stock Option Plan (1)
10.8 Lease Agreement, dated May 31, 1994, between Covol and Byrleen Hanson regarding (1)
Carbon County, Utah
10.11.2 License Agreement dated September 10, 1996, between Covol and CoBon Energy, LLC (3)
10.13 Promissory Note dated February 15, 1996 in favor of Covol from Michael McEwan and (1)
Gerald Larson
10.16.1 Stock Option Agreement dated June 1, 1996 with Brent M. Cook (3)
10.28 Debenture Agreement and Security Agreement, dated December 20, 1996, between AJG (3)
Financial Services, Inc. and Covol
10.30 Lease Agreement, dated December 12, 1996, between Covol and UPC, Inc. regarding Price (3)
City, Utah property
10.33 Utah Project Purchase Agreement, dated as of March 7, 1997, by and among Covol, US #1, a (4)
Delaware limited partnership, and Coaltech No. 1, L.P., a Delaware limited partnership
("Coaltech")
10.34 License and Binder Purchase Agreement, dated as of March 7, 1997, by and among Covol, (4)
US #1 and Coaltech
10.35 Operation and Maintenance Agreement, dated as of March 7, 1997, by and between Covol (4)
and Coaltech
10.36 Purchase and Supply Agreement, dated as of March 7, 1997, by and among Covol, US #1 (4)
and Coaltech
10.37 Abandonment Option Agreement, dated as of March 7, 1997, by and among Covol and the (4)
limited partners of Coaltech
10.38 Convertible Loan and Security Agreement, dated as of March 20, 1997, by and between (5)
Covol and PacifiCorp Financial Services, Inc. ("PacifiCorp")
10.38.1 Amendment to Convertible Loan and Security Agreement, dated December 12, 1997 by and (9)
between Covol and PacifiCorp
10.39 Alabama Project Purchase Agreement ("Alabama Agreement") dated as of March 20, 1997, (5)
by and among Covol, AS #1 and Birmingham Syn Fuel, L.L.C.
10.39.1 Letter Amendment, dated June 27, 1997, to Alabama Agreement. (9)
10.39.2 ** Letter Amendment, dated July 7, 1997, to Alabama Agreement. (9)
10.39.3 Letter Amendment, dated August 28, 1997, to Alabama Agreement. (9)
10.39.4 Letter Amendment, dated December 12, 1997, to Alabama Agreement. (9)
31
<PAGE>
Exhibit No. Description Location
<S> <C> <C>
10.39.5 ** Amended and Restated License Agreement, and Binder Purchase dated December 12, 1997, (9)
by and among Covol, AS #1 and Birmingham Syn Fuel.
10.39.6** Letter Amendment dated February 20, 1998, to the Alabama (10)
Project Purchase Agreement dated as of March 20, 1997, by and
among Covol, AS #1, and Birmingham Syn Fuel.
10.39.7 Call Option Agreement date February 20, 1998, between Birmingham Syn Fuel and Covol. (10)
10.39.8** Letter Amendment dated February 20, 1998, to the Amended and
Restated License and (10) Binder Purchase Agreement dated as of
December 12, 1997, by and among Covol. AS #1 and Birmingham Syn
Fuel.
10.39.9** Non-negotiable Promissory Note dated February 20, 1998, in favor of AS #1, executed by (10)
Birmingham Syn Fuel as debtor.
10.39.10 Security Agreement dated February 20, 1998, by and among Covol, AS #1 and Birmingham (10)
Syn Fuel.
10.40 Conditional Option Agreement, dated as of March 20, 1997, by and among Birmingham Syn (5)
Fuel I, Inc., Birmingham Syn Fuel II, Inc., PacifiCorp, AS #1 and Covol
10.42** Amended and Restated Agreement Concerning Additional Facilities, dated December 12, (9)
1997, by and between PacifiCorp., Birmingham Syn Fuel, LLC and Covol
10.43 Lease Agreement between Industrial Management Engineering, Inc. and Covol (9)
10.45** License and Binder Purchase Agreement, dated December 14, 1997, between Appalachian (9)
Synfuel, LLC and Covol
10.47** License Agreement, dated as of August 5, 1997, by and between Pelletco Corporation and (9)
Covol
10.48** Preparation Plant and Find Ponds Lease (Wellington, Utah), dated February 21, 1997, (9)
between Earthco and Covol
10.49** Agreement Concerning Additional Facilities, dated December 27, 1996, between AJG (9)
Financial Services, Inc. and Covol
10.50.1** Form of Amended and Restated License and Binder Purchase Agreement dated (11)
February 3, 1998, between PC Virginia Synthetic Fuel #1, PC West Virginia
synthetic Fuel #1, PC West Virginia synthetic Fuel #2, PC West Virginia Synthetic
Fuel #3 and Covol.
10.51 Employment Agreement, dated March 20, 1997 with Max E. Sorenson (9)
10.52.1 Asset Purchase Agreement between Mountaineer Synfuel, L.L.C. as Purchase and Covol as (12)
Seller dated May 5, 1998
10.52.2 Promissory Note between Covol and Mountaineer Synfuel, L.L.C. dated May 5, 1998 (12)
10.52.3 Deed of Ground Lease between Upshur Property, Inc. and Covol dated May 5, 1998 (12)
10.52.4 Promissory Note dated December 8, 1998 of Covol Technologies, Inc. to Mountaineer (13)
Synfuel, L.L.C.
10.52.5 Security Agreement dated December 8, 1998 between Mountaineer Synfuel, L.L.C. and (13)
Covol Technologies, Inc.
10.52.6 Leasehold Credit Line Deed of Trust and Security Agreement dated December 8, 1998 by (13)
Covol Technologies, Inc. for Mountaineer Synfuel, L.L.C. as Beneficiary.
32
<PAGE>
Exhibit No. Description Location
<S> <C> <C>
10.52.7 Amendment No. 1 to Deed of Ground Lease dated December 8, 1998 between Upshur (13)
Property, Inc. and Covol Technologies, Inc.
10.53.1 Debenture Agreement and Security Agreement dated as of January 9, 1998, between Covol (13)
and AJG Financial Services, Inc.
10.53.2 Debenture dated as of January 9, 1998 between Covol and AJG Financial Services, Inc. (13)
10.53.3 Warrant A dated as of January 9, 1998, issued by Covol in favor of AJG Financial (13)
Services, Inc.
10.53.4 Warrant B dated as of January 9, 1998, issued by Covol in favor of AJG Financial (13)
Services, Inc.
10.53.5 Registration Rights Agreement dated as of January 9, 1998, between Covol and AJG (13)
Financial Services, Inc.
10.54 Employment Agreement effective May 1, 1998 with Steven G. Stewart (13)
10.55 Employment Agreement effective August 1, 1997 with Dee J. Priano (13)
10.56 Employment Agreement effective April 21, 1998 with Brent M. Cook (14)
10.57 Employment Agreement effective January 1, 1999 with Steven R. Brown (14)
10.58 Securities Purchase Agreement between Covol Technologies, Inc. and OZ Master Fund, Ltd. (15)
dated as of March 17, 1999
10.58.1 Convertible Secured Note executed by Covol in favor of OZ Master Fund, Ltd. dated as of (15)
March 17, 1999
10.58.2 Registration Rights Agreement between Covol Technologies, Inc. and OZ Master Fund, Ltd. (15)
dated as of March 17, 1999
10.58.3 Security Agreement between Covol Technologies, Inc. and OZ Master Fund, Ltd. dated as of (15)
March 17, 1999
10.58.4 Series A Warrant in favor of OZ Master Fund, Ltd. dated March 17, 1999 (15)
10.58.5 Series B Warrant in favor of OZ Master Fund, Ltd. dated March 17, 1999 (15)
10.58.6 Series C Warrant in favor of OZ Master Fund, Ltd. dated March 17, 1999 (15)
10.58.7 Series D Warrant in favor of OZ Master Fund, Ltd. dated March 17, 1999 (15)
10.58.8 Series E Warrant in favor of Leeds Group dated March 17, 1999 (15)
10.58.9 Series E Warrant in favor of Howard L. Schwartz dated March 17, 1999 (15)
10.58.10 Series E Warrant in favor of Jack A. Schwebel dated March 17, 1999 (15)
10.58.11 Series E Warrant in favor of Brent M. Lockwood dated March 17, 1999 (15)
10.59 Secured Draw Down Promissory Note dated June 12, 1998 executed by Covol in favor of (16)
Trans Pacific Stores, Ltd.
10.59.1 Loan and Security Agreement dated June 12, 1998 executed by Covol in favor of Trans (16)
Pacific Stores, Ltd.
10.59.2 Letter Amendment dated May 6, 1999 between Covol and Trans Pacific Stores, Ltd. (16)
33
<PAGE>
Exhibit No. Description Location
<S> <C> <C>
10.60 Employment Agreement effective April 20, 1999 with Kirk A. Benson (17)
10.61 Purchase Agreement dated as of August 27, 1999 relating to the sale of the River Hill (18)
Project***
10.61.1 License and Binder Purchase Agreement dated as of August 27, 1999 relating to the River (18)
Hill Project***
10.61.2 Modification Agreement dated as of August 27, 1999 by and between the Purchaser of the (18)
River Hill Project, Fun Enterprises Pty Limited and Covol Technologies, Inc.***
10.62 Securities Purchase Agreement dated September 17, 1999 between Aspen Capital Resources, (19)
L.L.C. and Covol
10.62.1 Security Agreement dated September 17, 1999 between Aspen Capital Resources, L.L.C. and (19)
Covol
10.63 Securities Purchase Agreement dated December 7, 1999 between DH Financial, L.C. and *
Covol
10.63.1 Security Agreement dated December 6, 1999 between DH Financial, L.C. and Covol *
16.1 Letter to Securities and Exchange Commission, dated March 24, 1995, from Jones, Jensen & (1)
Orton & Company, certified public accountants
21.1 List of Subsidiaries of Covol *
23.1 Consent of PricewaterhouseCoopers LLP *
27.1 Financial Data Schedule for the fiscal year ended September 30, 1999 *
27.2 Restated Financial Data Schedule for the fiscal years ended September 30, 1997 and 1998 *
</TABLE>
- -----------------------
* Filed herewith.
** Confidential treatment has been granted to certain portions of this
exhibit, which portions have been deleted and filed separately with the
Securities and Exchange Commission.
*** This exhibit contains confidential material which has been omitted
pursuant to a Confidential Treatment Request. The omitted information
has been filed separately with the Securities and Exchange Commission.
Unless another exhibit number is indicated as the exhibit number for the exhibit
as "originally filed," the exhibit number in the filing in which any exhibit was
originally filed and to which reference is made hereby is the same as the
exhibit number assigned herein to the exhibit.
(1) Incorporated by reference to the indicated exhibit filed with Covol's
Registration Statement on Form 10, filed February 26, 1996.
(2) Incorporated by reference to the indicated exhibit filed with Covol's
Registration Statement on Form 10/A, Amendment No. 2, dated April 24,
1996.
(3) Incorporated by reference to the indicated exhibit filed with Covol's
Annual Report on Form 10-K for the fiscal year ended September 30,
1996.
(4) Incorporated by reference to the indicated exhibit filed with Covol's
Current Report on Form 8-K, dated March 10, 1997.
(5) Incorporated by reference to the indicated exhibit filed with Covol's
Quarterly Report on Form 10-Q, for the quarterly period ended March 31,
1997.
34
<PAGE>
(6) Incorporated by reference to the indicated exhibit filed with Covol's
Quarterly Report on Form 10-Q, for the quarterly period ended June 30,
1997.
(7) Incorporated by reference to the indicated exhibit filed with Covol's
Current Report on Form 8-K, dated August 19, 1997.
(8) Incorporated by reference to the indicated exhibit filed with Covol's
Current Report on Form 8-K, for event dated September 18, 1997, filed
October 28, 1997.
(9) Incorporated by reference to the indicated exhibit filed with Covol's
Annual Report on Form 10-K for the fiscal year ended September 30,
1997.
(10) Incorporated by reference to the indicated exhibit filed with Covol's
Current Report on Form 8-K, for event dated March 3, 1998, filed March
23, 1998.
(11) Incorporated by reference to the indicated exhibit filed with Covol's
Quarterly Report on Form 10-Q, for the quarterly period ended March 31,
1998.
(12) Incorporated by reference to the indicated exhibit filed with Covol's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1998.
(13) Incorporated by reference to the indicated exhibit filed with Covol's
Annual Report on Form 10-K, for the fiscal year ended September 30,
1998.
(14) Incorporated by reference to the indicated exhibit filed with Covol's
Quarterly Report on Form 10-Q, for the quarterly period ended December
31, 1998.
(15) Incorporated by reference to the indicated exhibit filed with Covol's
Current Report on Form 8-K, for the event dated March 17, 1999, filed
March 24, 1999.
(16) Incorporated by reference to the indicated exhibit filed with Covol's
Quarterly Report on Form 10-Q, for the quarterly period ended March 31,
1999.
(17) Incorporated by reference to the indicated exhibit filed with Covol's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1999.
(18) Incorporated by reference to the indicated exhibit filed with Covol's
Current Report on Form 8-K/A, for event dated August 27, 1999, filed
September 28, 1999.
(19) Incorporated by reference to the indicated exhibit filed with Covol's
Registration Statement on Form S-3/A (SEC file no. 333-67371), filed
October 13, 1999.
Reports on Form 8-K
The following reports on Form 8-K were filed during the quarter ended
September 30, 1999:
o July 7, 1999 Announcement of Proposed Transactions
o September 13, 1999, as amended on September 28, 1999, Announcement of
Sale of River Hill Facility
Exhibits
The response to this portion of Item 14 is submitted as a separate
section of this report. See Item 14 (a) (3) above.
Financial Statement Schedules
The response to this portion of Item 14 is submitted as a separate
section of this report. See Item 14 (a) (2) above.
35
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
COVOL TECHNOLOGIES, INC.
By:/s/ Kirk A. Benson
--------------------------------
Kirk A. Benson
Chief Executive Officer and
Principal Executive Officer
By:/s/ Steven G. Stewart
--------------------------------
Steven G. Stewart, Principal
Financial Officer
Date: January 13, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
/s/ Kirk A. Benson Chief Executive Officer January 13, 2000
- ----------------- (Principal Executive Officer) and
Kirk A. Benson Director
/s/ Steven G. Stewart Chief Financial Officer January 13, 2000
- ----------------- (Principal Financial and
Steven G. Stewart Accounting Officer)
/s/ Brent M. Cook President and Director January 13, 2000
- -----------------
Brent M. Cook
/s/ DeLance W. Squire Director January 13, 2000
- ---------------------
DeLance W. Squire
/s/ James A. Herickhoff Director January 13, 2000
- -----------------------
James A. Herickhoff
/s/ Raymond J. Weller Director January 13, 2000
- ---------------------
Raymond J. Weller
/s/ John P. Hill, Jr. Director January 13, 2000
- ---------------------
John P. Hill, Jr.
36
<PAGE>
Report of Independent Accountants
To the Board of Directors
Covol Technologies, Inc. and Subsidiaries
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, stockholders' equity (deficit), and cash
flows present fairly in all material respects, the consolidated financial
position of Covol Technologies, Inc. and Subsidiaries ("Covol") as of September
30, 1998 and 1999, and the consolidated results of their operations and their
cash flows for the years ended September 30, 1997, 1998 and 1999, in conformity
with generally accepted accounting principles. These financial statements are
the responsibility of Covol's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
Salt Lake City, Utah
January 13, 2000
F-1
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of September 30,
(thousands of dollars) 1998 1999
- ----------------------------------------------------------------------------------- -------------- ----------------
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 727 $ 461
Receivables 3,200 3,155
Due from related party 1,012 2,722
Inventories 1,645 573
Advances on inventories 2,522 --
Facilities held for sale 27,582 20,139
Prepaid expenses and other current assets 361 19
-------------- ----------------
Total current assets 37,049 27,069
-------------- ----------------
Property, plant and equipment, net of accumulated depreciation 15,809 14,182
-------------- ----------------
Other assets:
Restricted cash and investments 748 843
Facility-dependent notes and accrued interest receivable 7,646 7,879
Facility transferred under note receivable arrangement 3,166 2,641
Intangible assets, net of accumulated amortization 3,118 3,647
Deposits and other assets 525 1,834
-------------- ----------------
Total other assets 15,203 16,844
-------------- ----------------
Total assets $68,061 $58,095
============== ================
</TABLE>
(continued)
The accompanying notes are an integral
part of the consolidated financial statements
F-2
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS, continued
As of September 30,
(thousands of dollars and shares) 1998 1999
- ------------------------------------------------------------------------------------ -------------- ----------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
<S> <C> <C>
Accounts payable $ 3,036 $ 1,179
Due to related party 1,609 2,706
Accrued interest payable, current 653 1,452
Accrued liabilities 2,205 2,905
Notes payable, current 22,049 20,626
-------------- ----------------
Total current liabilities 29,552 28,868
-------------- ----------------
Long-term liabilities:
Notes payable, non-current 13,930 17,887
Accrued interest payable, non-current 566 210
Notes and accrued interest payable - related parties 147 --
Deferred revenues from advance license fees 8,377 7,501
Deferred compensation 236 208
-------------- ----------------
Total long-term liabilities 23,256 25,806
-------------- ----------------
Total liabilities 52,808 54,674
-------------- ----------------
Minority interest in consolidated subsidiaries 507 117
Commitments and contingencies
Redeemable convertible preferred stock, $0.001 par value, issued and outstanding
0 shares at September 30, 1998 and 60 shares at September 30, 1999 (aggregate
liquidation preference of $7,607 at September 30, 1999) -- 4,332
Stockholders' equity (deficit):
Convertible preferred stock, $0.001 par value; authorized 10,000 shares,
issued and outstanding 316 shares at September 30, 1998 and 17 shares at
September 30, 1999 (aggregate liquidation preference of $3,705 at
September 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 12,766 shares at
September 30, 1999 11 13
Capital in excess of par value 69,284 78,457
Accumulated deficit (43,002) (71,713)
Notes and interest receivable -- related parties, from issuance of, or
collateralized by, common stock, net of allowance (7,773) (6,564)
Deferred compensation from stock options (3,775) (1,222)
-------------- ----------------
Total stockholders' equity (deficit) 14,746 (1,028)
-------------- ----------------
Total liabilities and stockholders' equity (deficit) $68,061 $58,095
============== ================
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
F-3
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended September 30,
(thousands of dollars, except per-share data) 1997 1998 1999
- --------------------------------------------------------------------- ----------------- ------------------ ------------------
Revenues:
<S> <C> <C> <C>
License fees $ 105 $ 860 $ 3,526
Synthetic fuel sales 42 32 767
Binder sales --- 994 2,140
Binder plant sales --- 1,088 ---
Other --- 100 286
----------------- ------------------ ------------------
Total revenues 147 3,074 6,719
----------------- ------------------ ------------------
Operating costs and expenses:
Cost of coal briquetting operations 5,260 5,565 12,956
Cost of binder --- 642 1,695
Cost of binder plants --- 888 ---
Asset write-offs and other non-recurring charges --- --- 5,362
Selling, general and administrative 2,998 4,436 4,727
Compensation expense from stock options, stock warrants and
issuance of common stock 2,058 939 2,553
Loss on sale of facility --- 218 1,839
----------------- ------------------ ------------------
Total operating costs and expenses 10,316 12,688 29,132
----------------- ------------------ ------------------
Operating loss (10,169) (9,614) (22,413)
----------------- ------------------ ------------------
Other income (expense):
Interest income 98 580 1,586
Interest expense (1,645) (2,745) (6,253)
Minority interest in net (income) losses of
consolidated subsidiaries 1,245 392 (9)
Write-up (write-down) of notes receivable - related parties,
collateralized by common stock (60) 19 (1,209)
Other, net 33 60 (95)
----------------- ------------------ ------------------
Total other income (expense) (329) (1,694) (5,980)
----------------- ------------------ ------------------
Net loss $(10,498) $(11,308) $(28,393)
================= ================== ==================
Basic and diluted loss per common share $(1.32) $(1.17) $(2.39)
================= ================== ==================
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
F-4
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
Notes and
interest
receivable
-related
parties, from
issuance of, Deferred
Convertible Preferred or compen-
(thousand Stock Common Stock Capital in collateralized sation
of dollars ------------------------------------------------------ excess of par Accumulated by, common from stock
and shares) Shares Amount Shares Amount valule deficit stock options
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balances at
September 30, 1996 -- $-- 7,714 $8 $33,715 $(21,196) $(7,580) $(5,180)
Common stock issued
for cash, including
exercise of stock options
and warrants 603 1 2,773
Deferred compensation
related to the issuance
of stock options at
below market value to
officers, directors
and employees 1,178 (1,178)
Common stock issued
for services 98 -- 789
Inducement related to
conversion of notes
payable into common
stock 323
Common stock
issued to repay
note payable - related
parties 21 -- 136
Common stock issued
on conversion of note
payable 141 -- 1,125
Common stock issued
under a subscription
agreement for
cash received in
October 1997 50 -- 350
Common stock issued
for cash, including
exercise of stock options 400 -- 2,798
Common stock issued
for distribution rights 30 -- 266
Common stock issued
under subscription
agreements for
cash received in
October 1997 32 -- 227
Amortization of
deferred compensation
from stock options 1,675
Interest expense related
to issuance of convertible
debt at a discount 1,429
Payment on notes
receivable - related parties 109
Write-down of notes
receivable - related parties 60
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
F-5
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT), continued
Notes and
interest
receivable
-related
parties, from
issuance of, Deferred
Convertible Preferred or compen-
(thousand Stock Common Stock Capital in collateralized sation
of dollars ------------------------------------------------------ excess of par Accumulated by, common from stock
and shares) Shares Amount Shares Amount valule deficit stock options
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Preferred stock
issued for cash,
net of offering costs 303 1 5,094
Net loss for the
year ended
September 30, 1997 (10,498)
-----------------------------------------------------------------------------------------------------------
Balances at
September 30, 1997 303 1 9,089 9 50,203 (31,694) (7,411) (4,683)
-----------------------------------------------------------------------------------------------------------
Common stock issued
to purchase minority
interests in
subsidiaries 540 1 5,383
Common stock issued
for cash, including
exercise of stock options 533 -- 3,257
Preferred stock issued
for cash, net of offering
costs 13 -- 90
Common stock issued on
conversion of notes
payable and accrued
interest to common stock 1,107 1 8,178
Interest expense related
to issuance of convertible
debt at a discount 2,046
Payment received on
notes receivable --
related parties 329
Amortization of deferred
compensation from stock
options 908
Write-up of notes
receivable - related
parties (19)
Compensation expense
related to issuance
of stock options for
services 3 -- 127
Reclassification of
notes receivable - related
parties (672)
Net loss for the year
ended September 30, 1998 (11,308)
-----------------------------------------------------------------------------------------------------------
Balances at
September 30, 1998 316 1 11,272 11 69,284 (43,002) (7,773) (3,775)
-----------------------------------------------------------------------------------------------------------
Common stock issued
to purchase minority
interests in
subsidiaries 70 -- 519
Common stock and
warrants to purchase
common stock issued for
cash, including exercise
of stock options 776 1 3,774
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
F-6
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT), continued
Notes and
interest
receivable
-related
parties, from
issuance of, Deferred
Convertible Preferred or compen-
(thousand Stock Common Stock Capital in collateralized sation
of dollars ------------------------------------------------------ excess of par Accumulated by, common from stock
and shares) Shares Amount Shares Amount valule deficit stock options
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Value of common
stock warrants
issued under terms
of existing debt
agreement and in
connection with
extension of note
payable due date -- -- 453
Common stock issued
for rights to technology 60 -- 375
Common stock issued
on conversion of
preferred stock
and in payment of
dividends (300) -- 602 1 194 (195)
Return of previously
issued common stock
by a director (14) -- --
Value of common stock
options and warrants
issued in connection
with debt financing -- -- 323
Preferred stock and
warrants to purchase
common 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 extended and
repriced warrants
issued in connection
with satisfaction of
notes payable -- -- 201
Preferred stock cash
dividends (123)
Write-down of notes
receivable - related parties 1,209
Amortization of deferred
compensation from stock
options 2,553
Net loss for the year
ended September 30, 1999 (28,393)
-----------------------------------------------------------------------------------------------------------
Balances at
September 30, 1999 17 $1 12,766 $13 $78,457 $(71,713) $(6,564) $(1,222)
===========================================================================================================
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
F-7
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended September 30,
(thousands of dollars) 1997 1998 1999
- --------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
<S> <C> <C> <C>
Net loss $(10,498) $(11,308) $(28,393)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 193 523 2,570
Recognition of deferred revenue from advance license fees (105) (654) (876)
Asset write-offs and other non-recurring charges --- --- 5,362
Amortization of deferred compensation from stock options 1,675 1,035 2,553
Loss on sale of facility and loss on disposition of equipment --- 218 1,979
Minority interest in net income (losses) of consolidated subsidiaries (1,245) (392) 9
Write-down (write-up) of notes receivable - related parties 60 (19) 1,209
Interest expense related to amortization of debt discount and debt issuance
costs --- --- 2,075
Interest expense related to issuance of convertible debt at a discount 1,429 2,046 ---
Common stock issued for services 1,055 --- ---
Inducement expense related to conversion of notes payable into common stock 323 --- ---
Increase (decrease) from changes in operating assets and liabilities, net of
effects from investing and financing activities:
Receivables (444) (3,690) (1,944)
Inventories and other current assets (1,155) (1,570) 107
Accrued interest receivable - non-current --- (486) (893)
Accounts payable and other current liabilities 2,576 935 (637)
Accrued interest payable, non-current 204 362 (356)
Deferred revenues from advance license fees 1,650 7,486 ---
Other, net (142) 148 (281)
--------------------------------------
Net cash used in operating activities (4,424) (5,366) (17,516)
--------------------------------------
Cash flows from investing activities:
Purchase of property, plant and equipment and facilities held for sale (7,194) (36,963) (861)
Proceeds from sale of facilities held for sale and equipment --- --- 1,433
Purchase of rights to technology --- --- (127)
Proceeds from facility transferred under note receivable arrangement 235 647 525
Increase in deposits collateralizing letters of credit and restricted cash --- (748) (95)
Investment in licensee facility --- (340) ---
Issuance of note receivable --- (660) ---
--------------------------------------
Net cash provided by (used in) investing activities (6,959) (38,064) 875
--------------------------------------
Cash flows from financing activities:
Proceeds from issuance of notes payable and warrants 6,070 35,454 11,193
Payment on notes payable (1,109) (330) (4,690)
Proceeds from issuance of notes payable -- related parties 595 --- ---
Payment on notes payable -- related parties (756) --- (147)
Proceeds from issuance of preferred stock and warrants, net 5,095 90 6,367
Proceeds from issuance of common stock and warrants, net 5,573 3,257 3,775
Preferred stock dividends --- --- (123)
Proceeds from receivable -- stock subscriptions --- 577 ---
Proceeds from notes receivable -- related parties, collateralized by common 109 329 ---
stock
Proceeds from issuance of minority interests in subsidiaries 302 --- ---
Cash distribution to minority interest limited partners (206) --- ---
--------------------------------------
Net cash provided by financing activities 15,673 39,377 16,375
--------------------------------------
Net increase (decrease) in cash and cash equivalents 4,290 (4,053) (266)
Cash and cash equivalents, beginning of year 490 4,780 727
--------------------------------------
Cash and cash equivalents, end of year $4,780 $ 727 $ 461
======================================
</TABLE>
(continued)
The accompanying notes are an integral
part of the consolidated financial statements
F-8
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
Year ended September 30,
(thousands of dollars) 1997 1998 1999
- -------------------------------------------------------------------------------------------------------------------------------
Supplemental schedule of non-cash investing and financing activities:
<S> <C> <C> <C>
Common stock issued to purchase minority interests in subsidiaries $ --- $5,384 $ 519
Common stock issued on conversion of preferred stock and in payment of --- --- 2,761
dividends
Common stock issued on conversion of notes payable and related accrued interest 8,179 ---
Common stock issued for rights to technology --- --- 375
Notes payable issued for rights to technology --- --- 426
Notes payable issued for equipment 1,607 --- 424
Property, plant and equipment acquired through reduction of current assets --- --- 413
Reduction of note payable upon sale of facility held for sale --- --- 5,800
Facility dependent note receivable issued for sale of facility --- 6,500 ---
Facility transferred under note receivable arrangement 4,082 --- ---
Note payable issued for inventory 1,595 --- ---
Accounts payable for facilities held for sale 1,968 588 ---
Common stock issued for notes receivable 577 --- ---
Common stock issued to repay notes payable and accrued interest -- related party 1,261 --- ---
Distribution to minority limited partners offset against note receivable 66 --- ---
Supplemental disclosure of cash flow information - cash paid for interest, net of
amounts capitalized $208 $49 $3,646
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
F-9
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-----------
1. Summary of Significant Accounting Policies
Business Organization and Nature of Operations
Covol Technologies, Inc. was originally incorporated in Nevada in 1987 and
was reincorporated in Delaware in August 1995. In June 1996, Utah Synfuel #1
Ltd. ("Utah Synfuel #1") and Alabama Synfuel #1 Ltd. ("Alabama Synfuel #1"),
each a Delaware limited partnership (collectively the "Partnerships"), were
formed. Covol Technologies, Inc. is both the general partner and a limited
partner in the Partnerships (see Note 13). 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 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
September 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 1999. During 1999, Covol
has been actively pursuing the sale of its four owned facilities. One of the
facilities was sold in August 1999 and another was sold in December 1999 (see
Notes 15 and 17). Covol expects to sell the remaining two facilities in early
2000 (see Note 17). Covol has no current plans to construct additional
synthetic fuel facilities.
There are 24 synthetic fuel plants that currently utilize Covol's patented
technology and from which Covol intends to earn license fees and / or profits
from the sale of binder. These facilities do not presently operate at levels
needed to generate significant revenues to Covol. Improved operations at the
plants depend on the ability of the plant owners to produce synthetic fuel
that meets market specifications in order for the plant owners to market the
synthetic fuel. Covol is assisting the plant owners in their efforts to
overcome production and marketing problems. Covol anticipates that recurring
license fees or royalties from the production and sale of synthetic fuel will
continue to increase during 2000 and beyond. 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
expected to be sufficient to cover Covol's operating costs and expenses at
some point during 2000.
In order for operating activities to produce significant positive cash flow,
Covol and its licensees must successfully address certain operating issues
and marketing difficulties. These difficulties 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 Covol's
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 Covol and its licensees because they have
committed to purchase a substantial portion of their coal requirements
through long-term coal contracts already in place. Reliance on spot markets
and the overall downward trend in coal prices have generally produced lower
sales prices as compared to long-term coal supply contracts common in the
utility industry. Market acceptance of the synthetic fuel product appears to
have improved during 1999 even though Covol's owned facilities and its
licensees have only been able to secure long-term contracts for the sale of a
small 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 initial market resistance for synthetic
fuel has decreased and believes long-term contracts can now be secured
allowing Covol and its licensees to market the synthetic fuel they produce at
prices similar to coal.
Principles of Consolidation
The consolidated financial statements for all years presented include the
accounts of Covol and its two subsidiaries, Utah Synfuel #1 and Alabama
Synfuel #1. All significant intercompany transactions and accounts are
eliminated in consolidation. During 1997, Covol became a 1% general partner
of Coaltech No. 1 L.P. ("Coaltech"), a Delaware limited partnership, for $10.
Based upon Covol's lack of effective control over Coaltech and the limited
partners' financial responsibility for its operations, Covol's investment in
Coaltech is accounted for using the equity method of accounting with
proportional elimination of intercompany revenues and expenses. See Notes 16
and 17.
F-10
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
Revenue and Cost Recognition
Revenues from the licensing of Covol's technology are recognized in the
period when earned. Non-refundable advance license fees are received when
certain synthetic fuel facility construction milestones are met or when the
facilities are certified operational for their intended use. These
non-refundable advance license fees are deferred and recognized on a
straight-line basis over the period covered by the related license agreement.
Recurring license fees or royalty payments are recognized in the period
synthetic fuel is produced and sold by licensees. Revenues from the sale of
coal briquettes are recognized as product is shipped. Collateral is not
required for receivables and allowances are provided for uncollectible
accounts when appropriate.
Segment Reporting
In 1999, Covol adopted Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS
131"). SFAS 131 superseded SFAS No. 14, replacing the "industry segment"
approach with the "management" approach. The management approach designates
the internal organization that is used by management for making operating
decisions and assessing performance as the source of reportable segments. The
adoption of SFAS No. 131 did not affect Covol's results of operations or
financial position. Based on Covol's method of internal reporting, Covol
operates and reports as a single industry segment, which is the
commercialization of its binder technologies. Approximately $653,000 of
revenues in 1998 and $2,673,000 of revenues in 1999 were from a single
licensee, $839,000 of revenues in 1998 and $1,032,000 of revenues in 1999
were from a second licensee and $463,000 of revenues in 1998 and $849,000 of
revenues in 1999 were from a third licensee. No other single customer
accounted for over 10% of total revenues in any year presented.
Cash and Cash Equivalents
Covol considers all highly liquid debt instruments with an original maturity
of three months or less to be cash equivalents. Cash and cash equivalents are
deposited with financial institutions located in Utah and at times may exceed
insured depository limits.
Due From/To Related Party
Due from related party consists of amounts receivable from Coaltech primarily
for operating expenses. Due to related party represents amounts due to
Coaltech for the purchase of synthetic fuel briquettes (see Notes 16 and 17).
Inventories
Inventories are stated at the lower of cost or market with cost determined
using an average cost method, and consist primarily of coal fines and
synthetic fuel available for sale. Covol has a lease arrangement that
provides for the purchase and removal of coal fines which are used as
feedstock for a synthetic fuel facility. Payments made under the lease
arrangement prior to removal of the coal fines are recorded as advances on
inventories (see Note 14).
Facilities Held for Sale
At September 30, 1999, facilities held for sale consisted of three synthetic
fuel facilities and were stated at the lower of cost or estimated net
realizable value. One of the facilities was sold in December 1999 (see Note
17). The facilities were constructed to be sold at or above their cost to
licensees of Covol's technology. Covol is actively pursuing the sale of the
remaining two facilities and anticipates completing the sales in early 2000
(see Note 17). Covol recognizes a gain or loss on facilities held for sale
when the sale is consummated. The gain or loss represents the difference
between the carrying value and the sales price and is reflected as a
component of operating costs and expenses.
Property, Plant and Equipment
Property, plant and equipment is recorded at cost, including interest on
funds borrowed during the construction period, and is depreciated using the
straight-line method over its estimated useful life. Maintenance, repairs and
minor replacements are charged to expense as incurred. Upon the sale or
retirement of property, plant and equipment, any gain or loss on disposition
is reflected in the statement of operations, and the related asset cost and
accumulated depreciation are removed from the respective accounts.
F-11
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
Restricted Cash and Investments
Restricted investments consist primarily of highly liquid interest bearing
deposits held as collateral for certain Covol obligations and cash restricted
by agreement for payments to one of Covol's major vendors.
Intangible Assets
Intangible assets consist of (i) the excess of the value of the consideration
paid for the purchase of certain limited partners' interests in subsidiaries
over the fair values of the related assets, which fair values approximated
their carrying cost (see Note 13); and (ii) rights to technology, consisting
of a coal-based synthetic fuel technology and related licensing and patent
rights. These intangible assets are being amortized on the straight-line
method over approximately ten- and nine-year periods, respectively.
Valuation of Long-Lived Assets
Covol periodically evaluates the carrying value of long-lived assets,
including intangible assets, when events and circumstances warrant such a
review. The carrying value of a long-lived asset is considered impaired when
the anticipated cumulative undiscounted cash flow from that asset is less
than its carrying value. In that event, a loss is recognized based on the
amount by which the carrying value exceeds the fair market value of the
long-lived asset. Two impairment-related losses have been recognized in
Covol's consolidated financial statements for 1999, as more fully described
in Note 14.
Common Stock, Options and Warrants
Common stock issued for services is accounted for using the fair value of the
shares of common stock, determined at the time the shares are issued. The
measurement date used to value non-employee option grants is the option grant
date. Such options, as well as warrants issued in connection with debt and
equity financings, including repricings and extensions of option and warrant
expiration dates, are valued using the Black-Scholes model. If modifications
to existing options or warrants relating to debt securities occur, the
incremental value of the modified options or warrants is capitalized and
amortized to interest expense over the remaining life of the related debt.
Loss per Share Calculation
In 1998, Covol adopted Statement of Financial Accounting Standards No. 128,
"Earnings per Share" ("SFAS 128"). SFAS 128 replaced the calculation of
primary and fully diluted earnings per share with basic and diluted earnings
per share. Unlike primary earnings per share, basic earnings per share
excludes any dilutive effects of options, warrants and convertible
securities. Diluted earnings per share is similar to the previous fully
diluted earnings per share. Loss per share amounts for all periods presented
conform to SFAS 128 requirements and no restatements were necessary (see Note
11).
For all periods presented, options, warrants and convertible securities (as
disclosed in Notes 5, 6, 7 and 10) were not included in the calculation of
loss per share because the effect would have been antidilutive.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities, and 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 period. Actual results could differ from those estimates.
Reclassifications
Certain prior year amounts have been reclassified to conform with the current
year's presentation. The reclassifications had no effect on net loss, total
assets or total liabilities.
F-12
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
2. Current Financial Condition
Covol incurred a net loss for the year ended September 30, 1999 of
$28,393,000 and used $17,516,000 of cash in its operating activities for the
year. As discussed in Note 6, Covol has $20,626,000 of long-term debt due
during the year ending September 30, 2000. In addition, Covol's convertible
note payable with a face amount of $20,000,000 and related redeemable
convertible preferred stock with an aggregate liquidation preference of
approximately $5,600,000 at December 31, 1999 contain certain provisions
including an increase in the interest rate, immediate convertibility,
required escrow payments and possible immediate payment of outstanding
amounts in the event of a default by Covol. Such an event could include a
failure of Covol's shareholders to approve the issuance of the convertible
debt and convertible preferred stock by March 31, 2000 or failure of Covol to
achieve the targeted earnings levels. Covol believes that shareholder
approval will be obtianed and that Covol will achieve the targeted earnings
levels during fiscal 2000.
Covol has funded its operations during the year ended September 30, 1999
primarily through the issuance of debt and equity securities and the sale of
a synthetic fuel facility. During November 1998, Covol issued common stock
and common stock warrants for total net proceeds of approximately $3,729,000.
During January 1999, Covol issued convertible preferred stock and warrants
for total net proceeds of approximately $899,000. During March 1999, Covol
issued convertible secured debt, convertible redeemable preferred stock and
common stock warrants for total net proceeds of approximately $14,581,000.
From September through December 1999, Covol issued convertible secured debt
and warrants for total net proceeds of approximately $3,500,000 and is
currently in discussions with creditors to whom debt is owed in January 2000.
As discussed in Note 17, in August 1999 and December 1999, Covol sold two
synthetic fuel facilities for cash proceeds in excess of amounts required to
fully retire the related debt collateralized by the facilities. Also, on
January 13, 2000, Covol executed definitive agreements for the sale of one
synthetic fuel facility and executed a letter of intent for the sale of the
only remaining facility held for sale (see Note 17).
Covol believes that there are several alternatives available that will
provide the working capital necessary to meet operational requirements and
debt payments as they become due, including proceeds from the sale of its
remaining facilities held for sale, funds from operations, and only if no
other alternatives exist, additional financing. Covol believes it will be
able to extend the repayment terms of its debt and that excess proceeds from
the sale of facilities will be sufficient to fund Covol's operations until
its operating activities begin producing positive cash flow.
3. Property, Plant and Equipment
Property, plant and equipment consists of the following at September 30:
<TABLE>
<CAPTION>
(thousands of dollars) Range of estimated useful 1998 1999
lives
--------------------------------------- ------------------------------- -------------- --------------
<S> <C> <C> <C>
Land $ 153 $ 204
Buildings and improvements 10 - 15 years 12,060 12,235
Machinery and equipment 5 - 10 years 4,666 4,757
-------------- --------------
16,879 17,196
Less accumulated depreciation (1,070) (3,014)
============== ==============
Net property, plant and equipment $15,809 $14,182
============== ==============
</TABLE>
Depreciation expense was $193,000 in 1997, $474,000 in 1998, and $1,988,000
in 1999.
F-13
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
4. Notes Receivable
Notes receivable, all of which were recorded initially at their fair value,
consist of the following at September 30:
<TABLE>
<CAPTION>
(thousands of dollars) 1998 1999
---------------------------------------------------------------------------------------------- -------------- --------------
<S> <C> <C>
Facility-dependent Notes and Accrued Interest Receivable, Non-current
Note receivable from a corporation, bearing interest at 12%, principal and
interest due not later than February 2003, collateralized by a synthetic fuel
facility in Alabama sold by Covol in 1998. This note receivable is recorded at
an amount which does not exceed its fair value. $6,500 $6,500
Accrued interest receivable from the above corporation 486 1,379
Unsecured note receivable from a corporation, bearing interest at 10%, receivable in
quarterly principal installments. This note was written off in September 1999 (see Note 14). 660 ---
-------------- --------------
$7,646 $7,879
============== ==============
Facility Transferred under Note Receivable Arrangement
Facility transferred under note receivable arrangement with Coaltech, bearing
interest at 9.7%, principal and interest payments of $130 due quarterly
through December 2007, collateralized by a synthetic fuel facility in Utah.
All note payments, including principal and interest reduce the carrying amount
of this asset (see Note 17). $3,166 $2,641
============== ==============
</TABLE>
5. Financing Transactions
During and subsequent to the year ended September 30, 1999, Covol completed
several financing transactions, including the following:
o Issuance of approximately 746,000 shares of common stock and warrants
to purchase approximately 746,000 shares of common stock pursuant to a
private offering in November 1998, for net proceeds of approximately
$3,729,000. The warrants have an exercise price of $7.50 per share and
expire in June 2000.
o Issuance of 1,000 shares of series C preferred stock and warrants to
purchase approximately 73,000 shares of common stock in January 1999,
for net proceeds of approximately $899,000 (see Note 7). The warrants
have an exercise price of $6.88 per share, expire July 2001and were
assigned a value of approximately $500,000.
o Issuance of 60,000 shares of series D redeemable convertible preferred
stock, convertible secured debt and warrants to purchase approximately
1,284,000 shares of common stock in March 1999, for total net proceeds
of approximately $14,581,000 (see Notes 6 and 7). The warrants have
exercise prices ranging from $5.00 to $10.00 per share and expiration
dates ranging from March 2002 to March 2004. The warrants, some of
which were issued in connection with the convertible preferred stock,
some in connection with the convertible debt, and some in connection
with both the preferred stock and debt, were valued at approximately
$3,000,000. The value of the warrants issued in connection with both
the preferred stock and debt was allocated on a pro-rata basis, based
on the equity and debt portions of the total financing. The restricted
common stock issuable pursuant to the conversion of the convertible
securities and exercise of approximately 971,000 warrant shares have
been provided demand and piggyback registration rights. The remaining
warrants have been provided piggyback registration rights.
o Issuance of convertible secured debt and warrants to purchase
approximately 113,000 shares of common stock in September 1999, for
total net proceeds of $740,000 (see Note 6). The warrants have an
exercise price of $3.60 per share, expire in September 2002 and were
assigned a value of approximately $184,000.
o Issuance of convertible secured debt and warrants to purchase
approximately 1,172,000 shares of common stock in October and December
1999, in two unrelated transactions, for total net proceeds of
approximately $2,815,000. The warrants have exercise prices ranging
from $.88 to $3.60 per share, have expiration dates ranging from
September 2002 to December 2002 and were assigned a value of
approximately $562,000.
F-14
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
During November and December 1999, approximately $1,460,000 of the
convertible debt issued in the September and October transactions described
above was converted into approximately 2,532,000 shares of common stock. In
January 2000, Covol gave a redemption notice to the holder of approximately
$1,040,000 of the convertible debt issued in October 1999.
<TABLE>
<CAPTION>
6. Long-term Liabilities
Notes Payable
Notes payable consist of the following at September 30:
(thousands of dollars) 1998 1999
------------------------------------------------------------------------------------------------- ------------- -------------
<S> <C> <C>
Note payable to a corporation bearing interest at prime (8.25% at September 30, 1999) plus 2%,
collateralized by plant and equipment, repaid subsequent to September 30, 1999 (see Note 17). $ 2,900 $ 2,900
Note payable to the same corporation referred to in the preceding paragraph, bearing interest
at 6%, collateralized by a coal wash plant in Utah, principal and interest due January 2000
(see Note 17). 4,263 4,313
Notes payable to the same corporation referred to in the preceding two paragraphs,
bearing interest at 6%. 50% of accrued interest is 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 owned by the
same corporation. 6,680 6,500
Note payable to a limited liability company, bearing interest at 10% payable monthly,
with principal due June 2000. 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 six synthetic fuel facilities. 8,242 9,191
Convertible secured note payable to an investment company issued at a discount, bearing a
stated interest rate of 2.5% on the $20,000 face amount. The note is due March 2004, 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. -- 10,265
Convertible secured note payable to a Covol shareholder issued at a discount, bearing a stated
interest rate of 8% on the $850 face amount. The note is due March 2001, but may be converted
into common stock by the note holder prior to maturity if not redeemed earlier by Covol.
Interest is payable quarterly beginning December 1999. The note is collateralized by license
fees payable to Covol from the production and sale of synthetic fuel from a synthetic fuel
facility. --- 622
Note payable to a corporation, bearing interest at 14% payable monthly. $1,000 of principal
was paid in January 2000 and $3,000 of principal is due April 2000. Collateralized by a
promissory note receivable and by certain future license fees receivable by Covol. A member of
Covol's Board of Directors is affiliated with this corporation. 4,000 4,000
Note payable to the same corporation referred to in the preceding paragraph, bearing interest
at 14%, paid in March 1999. 4,000 ---
Note payable to a corporation, bearing interest at 15%, paid in August 1999 (see Note 15). 5,800 ---
Other 94 722
------------- -------------
35,979 38,513
Less: current portion (22,049) (20,626)
============= =============
Total non-current $13,930 $17,887
============= =============
</TABLE>
F-15
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
Convertible Secured Note Payable
The $20,000,000 convertible secured note payable listed above is redeemable
by Covol at any time prior to September 17, 2001 for an amount equal to the
face amount of the debt. The debt is redeemable by Covol from September 18,
2001 and prior to March 17, 2002 for an amount equal to 109.85% of the face
amount of the debt. The debt is convertible into common stock of Covol at the
option of the noteholder at a discount to the market price at the time of
conversion as described below. The debt is convertible by the holder after
March 17, 2002, except upon the occurrence of an event of default. If
converted, the number of shares into which the debt can be converted would be
calculated based on a price per share of common stock equal to 33% of the
then market price at the time of conversion, but not less than $6.67 per
share nor more than $10.00 per share. Covol's present intent is to redeem the
debt prior to March 17, 2002, assuming sufficient cash from operations is
available.
A deferred asset was recorded for the portion of financing costs allocated to
the debt. This asset is being amortized over 36 months, the most likely
period of time over which the debt is expected to remain outstanding.
Amortization is computed using the effective interest method. Paid-in capital
was credited for the relative value of the warrants directly related to the
issuance of debt and the warrants allocated to the issuance of debt, as
compared to the total combined fair values of the warrants and debt. A
liability was recorded for $21,970,000, 109.85% of the face value of the
debt, and debt discount of approximately $13,300,000 was recorded to yield a
level interest rate on the net amount of debt outstanding between the issue
date and 36 months from the issue date. Each period, interest expense is
recorded consisting of the total of i) interest expense based on the stated
interest rate and the face value of the debt; ii) amortization of debt
discount; and iii) amortization of debt issue costs.
Covol will be in default of the provisions of the debt agreement if certain
events occur. These events include, in addition to events commonly considered
defaults, failure of the shareholders to approve the issuance of the
convertible debt by March 31, 2000 (see Note 16), incurring one or more
judgments in excess of $5,000,000, which judgments are not discharged, stayed
or otherwise satisfied within 30 days of the judgments, and the failure to
meet certain earnings targets. The earnings targets apply initially to the
quarter ending December 31, 1999, and then to subsequent quarterly periods.
Consolidated earnings of $5,000,000, as defined in the applicable agreement,
are required for the quarter ending December 31, 1999. In subsequent
quarters, earnings targets increase incrementally up to $6,500,000 for the
quarter ending December 31, 2001 and subsequent quarters. There are
provisions for the carryover of earnings which exceed the targets to
subsequent quarters, if necessary, subject to certain limitations. The debt
is collateralized by license fees payable to Covol from the production and
sale of synthetic fuel from four synthetic fuel facilities located in
Virginia and West Virginia.
In the event of default, the interest rate on the debt increases immediately
by 1% and increases automatically by 1% at the end of each succeeding 90-day
period, to the extent permitted by law, until the event is cured. Depending
on the nature of the event of default, in most instances, either i) the note
and accrued interest become immediately convertible into common stock and the
conversion price is subject to adjustment, based on the market price of
Covol's common stock and other factors, as provided for in the loan
agreement; or ii) all unpaid principal and interest become immediately due
and payable.
So long as any of this debt or any of Covol's series D preferred stock is
outstanding, the holders have the right, as a group, to elect one director to
Covol's Board of Directors. Payments of dividends and certain other
transactions require approval of the holders.
Collateral, Interest Rates and Debt Maturities
Substantially all of Covol's property, plant and equipment, facilities held
for sale and license fees payable to Covol from the production and sale of
synthetic fuel from owned and licensed synthetic fuel facilities are
collateral for notes payable. The weighted average interest rate on notes
payable was 8.5% at September 30, 1998 and 7.9% at September 30, 1999. Future
maturities of notes payable as of September 30, 1999 are as follows:
Year ending September 30, (thousands of
dollars)
--------------------------- ---------------------
2000 $20,626
2001 7,587
2002 129
2003 63
2004 22,000
Thereafter 41
---------------------
Subtotal 50,446
Unamortized discount (11,933)
=====================
Net carrying value $38,513
=====================
F-16
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
Notes Payable - Related Parties
Notes payable - related parties represents unsecured amounts due to two
officers of Covol bearing interest at prime plus 2%. Principal and accrued
interest were paid in April 1999.
Deferred Compensation
In 1993, Covol assumed a liability to pay a stockholder of Covol $40,000 per
year for seven years beginning February 1999. The present value of the unpaid
portion of this liability, discounted at approximately 5%, is reflected as
deferred compensation in the consolidated balance sheet.
Interest Costs
During 1997, Covol incurred total interest costs of approximately $2,023,000
(including approximately $1,429,000 of non-cash interest expense resulting
from issuance of convertible debt at a discount), of which approximately
$378,000 was capitalized. During 1998, Covol incurred total interest costs of
approximately $4,135,000 (including approximately $2,046,000 of non-cash
interest expense resulting from issuance of convertible debt at a discount),
of which approximately $1,390,000 was capitalized. During 1999, Covol
incurred total interest costs of approximately $6,253,000 (including
approximately $2,075,000 of non-cash interest expense resulting from
amortization of debt discount and debt issuance costs), none of which was
capitalized.
7. Preferred Stock
Preferred Series A - Non-Voting
As of September 30, 1999, there were 3,000 shares of Series A preferred stock
issued and outstanding. The Series A preferred shares are non-voting and have
the following rights and privileges. The holders of the shares are entitled
to cumulative dividends at the rate of 6% per year of the liquidation value
of $1,000 per share. These dividends accumulate whether or not they have been
declared or whether Covol has any profits. Additional shares of Series A
preferred stock may be issued in lieu of cash to pay accumulated dividends on
these shares. Upon the liquidation of Covol, the holders of the Series A
preferred shares are entitled to receive $1,000 per share, together with all
accumulated and unpaid dividends, if any. Each share of Series A preferred
stock includes a warrant to purchase 28.571 shares of common stock or a total
of 85,713 shares, at a price of $8.00 per share. These warrants had an
original expiration date in August 1999, but were subsequently extended to
December 2000. The holders of the shares are entitled to convert their shares
to common shares at any time. The number of common shares to be received upon
conversion is determined by multiplying the number of preferred shares by
$1,000 and dividing by the conversion price of $7.00 per share. Covol has the
right to require any holder of the Series A preferred shares to convert their
shares into common stock. No dividends have been declared through September
30, 1999. Dividends in arrears at September 30, 1999 totaled approximately
$381,000, or $126.90 per share.
Preferred Series B - Non-Voting
As of September 30, 1999, there were 14,310 shares of Series B preferred
stock issued and outstanding. There were 312,882 shares outstanding at
September 30, 1998 of which 298,572 shares, along with related accumulated
but undeclared dividends, were converted into approximately 323,000 shares of
common stock during 1999. The Series B preferred shares are non-voting and
have the following rights and privileges. The holders of the shares are
entitled to cumulative dividends at the rate of approximately 7% per year of
the liquidation value of $7 per share. These dividends accumulate whether or
not they have been declared or whether Covol has any profits. Additional
shares of Series B preferred stock may be issued in lieu of cash to pay
accumulated dividends on these shares. Upon the liquidation of Covol, the
holders of the Series B preferred shares are entitled to receive $7 per
share, together with all accumulated and unpaid dividends, if any. Each unit
(comprising 3 shares) of Series B preferred stock includes a warrant to
purchase one share of common stock at a price of $8.00 per share. These
warrants expired in September 1999. The holders of the shares are entitled to
convert their shares to the same number of shares of common stock at any
time, subject to adjustment for dilution. Accumulated dividends may be
converted by Covol into common stock at the conversion price of $7.00 per
share. No dividends have been declared through September 30, 1999. Dividends
in arrears at September 30, 1999 totaled approximately $14,000, or $1.01 per
share. Based upon the conversion price per share at the date of issuance, a
non-cash dividend of approximately $165,000 was imputed upon issuance.
F-17
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
Preferred Series C - Non-Voting
As of September 30, 1999, there were 200 shares of Series C preferred stock
issued and outstanding. There were no shares outstanding at September 30,
1998. 1,000 shares were issued in January 1999, of which 800 shares, along
with related accumulated but undeclared dividends, were converted into
approximately 279,000 shares of common stock during 1999. In November 1999,
the remaining 200 shares, along with related accumulated but undeclared
dividends, were converted into approximately 189,000 shares of common stock.
Warrants for the purchase of approximately 73,000 shares of common stock were
issued in connection with the issuance of the preferred stock. The warrants
are exercisable until July 2001 at an exercise price of $6.88 per share. The
exercise deadline for certain other warrants with an exercise price of $7.00
per share held by this stockholder was extended to June 2000 and certain
additional warrants with an exercise price of $30.00 per share were
relinquished and canceled. The new and extended warrants were valued at
approximately $500,000. Covol granted registration rights for the restricted
common shares issuable upon conversion of the preferred stock or upon
exercise of the common stock warrants. Based upon the conversion price per
share at the date of issuance, a non-cash dividend of approximately $236,000
was imputed upon issuance.
Preferred Series D - Voting
As of September 30, 1999, there were 60,000 shares of Series D preferred
stock issued and outstanding, all of which were issued in March 1999. There
were no shares outstanding at September 30, 1998. This series of preferred
stock is senior, with respect to dividend rights, payments upon liquidation,
or redemption, to all other capital stock of Covol, including the other
series of preferred stock which are outstanding or which may be issued in the
future. Holders of the preferred stock have voting rights as to all matters
voted on by the holders of common stock and are entitled to one vote for each
share of common stock issuable upon conversion of the preferred stock. In
addition, holders of the preferred stock and the $20,000,000 convertible
secured note payable described in Notes 5 and 6 vote as a group for one
director.
The holders of the shares are entitled to cumulative dividends at the rate of
7% per year of the liquidation value of $100 per share. These dividends
accrue whether or not they have been declared or whether Covol has any
profits and are payable quarterly. Additional shares of Series D preferred
stock may be issued in lieu of cash to pay accrued dividends on these shares.
No dividends have been declared through September 30, 1999, but dividends are
payable quarterly and approximately $123,000 was paid in July 1999. Dividends
in arrears at September 30, 1999 totaled approximately $107,000, or $1.79 per
share, which amount was paid in October 1999. Based upon the conversion price
per share at the date of issuance, a non-cash dividend of approximately
$667,000 was imputed upon issuance.
Upon the liquidation of Covol, the holders of the Series D preferred shares
are entitled to receive $125 per share, together with all accrued and unpaid
dividends, if any. The preferred stock is redeemable at Covol's option
through March 17, 2002 at 125% of its liquidation value, subject to
adjustment for changes in the value of Covol's common stock. The preferred
stock is redeemable at the option of the preferred stockholder only upon
occurrence of a change in control or an event of default. The number of
shares of common stock into which the preferred stock is convertible is
determined by multiplying the number of preferred shares by $100 and dividing
by the lesser of $5.25 or 90% of the market value of Covol's common stock on
the date of conversion. On March 17, 2002, all outstanding preferred stock
automatically converts to common stock.
During November and December 1999, 15,202 preferred shares were converted
into approximately 1,604,000 shares of common stock.
8. Notes and Interest Receivable -- Related Parties, Collateralized by Common
Stock
Notes and interest receivable -- related parties, collateralized by common
stock, consist of the following at September 30:
<TABLE>
<CAPTION>
(thousands of dollars and shares) 1998 1999
---------------------------------------------------------------------------------------------- ------------- --------------
<S> <C> <C>
Note receivable from a stockholder, $5,000 face amount, bearing interest at
6%, renegotiated in November 1997, principal and interest of $515 due in
annual installments beginning January 1999 through January 2004, with
remaining balances due January 2005, collateralized by 150 shares of Covol's
common stock held by Covol, options expiring in January 2006 to acquire 25
shares of Covol's common stock committed by the stockholder to be provided to
Covol, and a personal guarantee of the stockholder. The carrying value is
equal to the fair value of the 150 shares and options to acquire 25 shares
and is net of unamortized discount after renegotiation of $1,281 based upon
an imputed rate of 10.25%, and an allowance for impairment of $2,129 in 1997,
$2,110 in 1998, and $3,319 in 1999. Interest income of $515 was recognized in
1999. No interest income was recognized during 1997 or 1998. $1,609 $400
F-18
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
Notes and interest receivable from 16 current and former officers and
employees, issued upon exercise of options to purchase 450 shares of common
stock at $5.31 to $8.38 per share, bearing interest at 5.7%, principal and
interest due in December 2000, collateralized by 900 shares of Covol's common
stock. No interest income was recognized during 1998 or 1999. 5,492 5,492
Notes receivable from seven officers of Covol, bearing interest at prime
(8.25% at September 30, 1999) plus 2%, principal and interest due August
2000, originally collateralized by partnership interests which were
subsequently exchanged for 79 shares of Covol's common stock (see Note 13).
No interest income was recognized during 1997, 1998 or 1999. 672 672
============= ==============
$7,773 $6,564
============= ==============
</TABLE>
9. Fair Value of Financial Instruments
SFAS No. 107 requires that the fair market value of certain financial
instruments be disclosed in the financial statements. Covol has the following
financial instruments that are subject to the provisions of SFAS No. 107:
* Cash and cash equivalents
* Receivables
* Notes receivable, including facility transferred under note
receivable arrangement
* Notes payable
* Notes receivable - related parties, from issuance of, or
collateralized by, common stock
A substantial portion of Covol's financial instruments are of a short-term
nature. Accordingly, while the fair values of some of the individual
financial instruments vary somewhat from their carrying values, the aggregate
carrying values as reflected in the consolidated financial statements for
1998 and 1999 approximated fair value, with the exception of the notes
payable in 1999 for which the aggregate market value approximated $42,300,000
at September 30, 1999.
10. Stock Options and Warrants
Stock Options
At September 30, 1999, Covol had one stock option plan (the "Option Plan")
under which 2,400,000 shares of common stock are reserved for ultimate
issuance. A committee of Covol's Board of Directors, or in its absence the
Board (the "Committee"), administers and interprets the Option Plan. This
Committee is authorized to grant options and other awards both under the
terms of the Option Plan and outside the Option Plan to eligible employees,
officers, directors, and consultants of Covol. The Option Plan provides for
the granting of both incentive stock options and non-statutory stock options.
Terms of options granted under the Option Plan, including vesting
requirements, are determined by the Committee. Options granted under the
Option Plan vest over periods ranging up to ten years, expire ten years from
the date of grant and are not transferable other than by will or by the laws
of descent and distribution. Incentive stock option grants must meet the
requirements of the Internal Revenue Code.
Covol has elected to continue to apply Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and related
interpretations in accounting for its Option Plan. The alternative fair value
method of accounting prescribed by SFAS No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"), requires the use of option valuation models that
were not developed for use in valuing employee stock options, as discussed
below. Accordingly, under APB 25, no compensation expense has been recognized
for stock option grants to employees, officers and directors when the
exercise price of stock options equals or exceeds the market price of Covol's
common stock on the date of grant.
When options are issued with terms considered compensatory, the related
compensation expense is amortized to expense over the specified vesting
period on a straight-line basis. Deferred compensation related to options
that vest over time was approximately $1,178,000 for options issued in 1997
and $0 for options issued in both 1998 and 1999. The amortized compensation
expense related to compensatory options was approximately $1,572,000,
$908,000 and $2,553,000 for 1997, 1998 and 1999, respectively. Compensation
expense related to options that vested immediately was approximately
$103,000, $127,000 and $0 for 1997, 1998 and 1999, respectively.
F-19
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
If Covol had elected to account for options granted based on their fair
value, as prescribed by SFAS 123, net loss and net loss per share would have
been increased to the pro forma amounts shown in the table below.
<TABLE>
<CAPTION>
(thousands of dollars, except per-share data) 1997 1998 1999
--------------------------------------------------------------------------- ---------------- --------------- ---------------
<S> <C> <C> <C>
Net loss attributed to common stockholders -- reported $(10,687) $(11,645) $(29,704)
-- pro forma (11,302) (14,567) (32,969)
Basic and diluted net loss per share -- reported (1.32) (1.17) (2.39)
-- pro forma (1.40) (1.46) (2.65)
</TABLE>
The fair value of each stock option grant was determined using the
Black-Scholes option pricing model and the following assumptions: expected
stock price volatility of .50 to .70, risk-free interest rate of 4.4% to
7.8%, weighted average expected option lives of 5 - 10 years and no
dividends. The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting
restrictions and are fully transferable. In addition, option valuation models
require the input of highly subjective assumptions including expected stock
price volatility. Because Covol's stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value, in
management's opinion, the existing models do not necessarily provide a
reliable single measure of the fair value of stock options.
The following table is a summary of activity for all of Covol's stock
options, including options not granted under the Option Plan, for the years
ended September 30:
<TABLE>
<CAPTION>
1997 1998 1999
--------------------------- ------------------------- --------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
(thousands of shares) Shares Price Shares Price Shares Price
------------------------------------------- ------------- ------------- ------------ ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 1,367 $1.62 1,614 $ 2.85 2,370 $6.29
Granted 445 6.08 850 12.34 667 5.40
Exercised (73) 1.84 (94) 1.93 (30) 1.50
Canceled (125) 1.50 --- --- (36) 2.34
============= ============= ============ ============ ============ =============
Outstanding at end of the year 1,614 $2.85 2,370 $ 6.29 2,971 $6.18
============= ============= ============ ============ ============ =============
Exercisable at end of year 712 $2.04 1,038 $5.23 1,801 $5.23
============= ============= ============ ============ ============ =============
Weighted average fair value of options
granted during the year below market $9.53 $10.21 n/a
Weighted average fair value of options
granted during the year at market $5.57 $9.91 $2.93
Weighted average fair value of options
granted during the year above market n/a n/a $2.92
</TABLE>
F-20
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
The following table summarizes information about all stock options
outstanding at September 30, 1999:
<TABLE>
<CAPTION>
(thousands of shares) Options Outstanding Options Exercisable
------------------------ ------------------------------------------------------------- ------------------------------------
Weighted
Number Average Weighted Number Weighted
Outstanding at Remaining Average Exercisable at Average
Range of Exercise September 30, Contractual Life Exercise September 30, Exercise
Prices 1999 in Years Price 1999 Price
------------------------ ---------------------- ------------------- ------------------ ------------------ -----------------
<S> <C> <C> <C> <C> <C>
$1.50 to $2.50 1,159 6.5 $ 1.58 982 $ 1.60
$4.13 to $9.00 1,060 8.6 6.44 524 7.66
$11.00 to $13.56 752 8.6 12.93 295 13.00
---------------------- ------------------
2,971 1,801
====================== ==================
</TABLE>
Stock Warrants
As of September 30, 1999, there were warrants outstanding for the purchase of
approximately 3,126,000 shares of common stock at prices ranging from $3.50
to $20.00 per share and with expiration dates from November 1999 to March
2004. All of these warrants were issued in connection with private placements
of common and preferred stock or notes payable during the years 1997 through
1999 (see Note 5).
In October 1998, Covol issued warrants for the purchase of 100,000 shares of
common stock pursuant to the terms of the outstanding $4,000,000 note payable
to a corporation described in Note 6. Also, certain other warrants for the
purchase of common stock have been repriced and / or the exercise period has
been extended in order to meet the terms of various agreements Covol has
entered into.
11. Basic and Diluted Loss per Share
<TABLE>
<CAPTION>
(thousands of dollars and shares, except per-share data) 1997 1998 1999
--------------------------------------------------------------------------- ---------------- --------------- ---------------
Numerator:
<S> <C> <C> <C>
Net loss $(10,498) $(11,308) $(28,393)
Preferred stock dividends (undeclared) (24) (337) (466)
Imputed preferred stock dividends (165) --- (845)
================ =============== ===============
Net loss attributable to common stockholders $(10,687) $(11,645) $(29,704)
================ =============== ===============
Denominator - weighted-average shares outstanding 8,080 9,969 12,418
================ =============== ===============
Basic and diluted loss per common share $(1.32) $(1.17) $(2.39)
</TABLE>
Imputed preferred stock dividends are calculated based upon the amount by
which the price of Covol's common stock exceeds the conversion price at the
date convertible preferred shares are issued.
12. Income Taxes
Covol accounts for income taxes using the asset and liability approach in
accordance with Statement of Financial Accounting Standards (SFAS) No. 109,
"Accounting for Income Taxes." Covol files a consolidated tax return with its
100% owned subsidiaries. The majority-owned limited partnerships file a
separate tax return, as required.
As of September 30, 1999, Covol has net operating loss carryforwards of
approximately $43,750,000 which can be used to offset future taxable income.
The net operating loss carryforwards expire from 2005 to 2019. Covol also has
approximately $190,000 in research and development tax credit carryforwards
which can be used to offset future tax liabilities. The tax credit
carryforwards expire from 2007 to 2013. The utilization of these
carryforwards against future taxable income may become subject to an annual
limitation due to changes in ownership of Covol's common stock.
F-21
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
The provision for income taxes for the years ended September 30, 1997, 1998
and 1999 differs from the statutory federal income tax rate due to the
following:
<TABLE>
<CAPTION>
(thousands of dollars) 1997 1998 1999
--------------------------------------------------------------------------- --------------- --------------- --------------
<S> <C> <C> <C>
Tax benefit at statutory rates $3,738 $1,355 $ 9,653
Change in valuation allowance (3,840) (1,377) (10,573)
State income taxes, net of federal tax effect 101 39 936
Other, including redetermination of prior years' tax estimates 1 (17) (16)
--------------- --------------- --------------
Federal income tax provision $ 0 $ 0 $ 0
=============== =============== ==============
</TABLE>
The components of the net deferred tax asset as of September 30, 1998 and
1999 are as follows:
<TABLE>
<CAPTION>
(thousands of dollars) 1998 1999
------------------------------------------------------------------------------------------- -------------- ---------------
Deferred tax assets (liabilities):
<S> <C> <C>
Net operating loss carryforwards $7,995 $ 16,319
Research and development tax credit carryforwards 189 189
Compensation expense related to common stock options 2,084 2,989
License fee revenue recognition 315 400
Write-down of notes receivable 304 1,156
Estimated liabilities 356 282
Depreciation (88) 378
Other 40 55
-------------- ---------------
Total deferred tax assets 11,195 21,768
Valuation allowance (11,195) (21,768)
-------------- ---------------
Net deferred tax asset $ 0 $ 0
============== ===============
</TABLE>
The valuation allowance increased by $10,573,000 during 1999, representing
the additional amount of deferred tax assets at September 30, 1999 not
considered recoverable through the reversal of taxable temporary differences
or the generation of future taxable income. The valuation allowance increased
by $1,377,000 during 1998 and by $3,840,000 during 1997. SFAS No. 109
requires that a valuation allowance be provided if it is more likely than not
that some portion or all of a deferred tax asset will not be realized.
Covol's ability to realize the benefit of its deferred tax assets will depend
on the generation of future taxable income through its continuing operations
or through the sale of assets. Because Covol has not generated significant
revenues to date, Covol believes that a valuation allowance of $21,768,000
should be provided as of September 30, 1999. This estimate may change in the
near term depending on the level of earned license fees received in 2000 and
on the consummation of selling the assets held for sale.
13. Purchase of Limited Partners' Interests in Subsidiaries
In September 1998, Covol formally offered the limited partners in its two
consolidated subsidiaries, Utah Synfuel #1 and Alabama Synfuel #1, an
exchange of Covol's common stock for their limited partnership interests. The
exchange ratio was based in part on an independent valuation of the limited
partnerships' assets and other factors including but not limited to current
and future expected cash flows of the partnerships and the market value of
Covol's common stock at the date of the offer, $9.00 per share. As of
September 30, 1998, substantially all of the limited partners had elected to
exchange their limited partnership interests for shares of Covol's common
stock. During October and November 1998, all but one of the other limited
partners exchanged their interests and Utah Synfuel #1 became a wholly-owned
subsidiary of Covol and Alabama Synfuel #1 became a 98%-owned subsidiary of
Covol.
Covol recorded this exchange using the market values of Covol's common stock
on the dates the limited partners tendered acceptance of Covol's offer. These
market values ranged from $6.75 to $11.13 per share. Approximately 610,000
shares of common stock were issued in these transactions. Subsequent to
September 30, 1999, Covol reached an agreement settling several outstanding
issues with the remaining limited partner of Alabama Synfuel #1 following
which Alabama Synfuel #1 became a wholly-owned subsidiary of Covol. The
carrying value of the intangible asset recorded in the exchange transactions,
net of accumulated amortization, was approximately $2,786,000 at September
30, 1999.
F-22
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
14. Asset Write-offs and Other Non-recurring Charges
In May 1995, Covol entered into an agreement with Geneva Steel Company to
build and operate a synthetic fuel 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 1999.
During 1997, Covol entered into an agreement to purchase coal fines for
feedstock for two synthetic fuel facilities in Utah. Beginning in 1997 and
continuing through May 1999, Covol made payments totaling approximately
$3,917,000, of which $240,000 was transferred to cost of coal briquetting
operations. The net amount paid was recorded as advances on inventories.
Quarterly payments of approximately $396,000 are required under the
agreement. The agreement provides for total payments of $5,500,000 between
February 1997 and May 2000 for the removal of 2 million tons of coal fines
(at a price of $2.75 per ton) from the property. 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
entered into the contract based on its understanding that the other party to
the agreement (the "Seller") was the owner of the property and that there
were in excess of 2 million tons of recoverable coal fines on the property.
Subsequently, Covol learned that a third party disputes that the Seller is
the owner of the property, and that there may be substantially less than 2
million tons of recoverable fines on the property. Consequently, in August
1999, Covol notified the Seller that unless the Seller could procure and
provide evidence that it could warrant title to the property and would adjust
contract payments to reflect the actual recoverable fines at the property,
Covol may elect to terminate the contract and seek appropriate damages. On
this basis, Covol has refused to make further quarterly payments to the
Seller under the contract. The Seller responded by denying Covol's claims and
alleging issues of property reclamation and bonding and failed contract
payment. Covol denies these allegations. The dispute is in an early stage of
litigation and resolution is uncertain. Based on the uncertainty of
recovering the net advances paid through litigation, Covol wrote off the
entire $3,677,000 of advances on inventories in the fourth quarter of 1999.
In addition to the above charges, in the fourth quarter of fiscal year 1999
Covol wrote off a $660,000 note receivable and recorded a liability for
approximately $469,000 related to a settlement agreement with a company that
had provided Covol with advise with respect to the use of certain synthetic
fuel technology, certain financing obtained and the sale of certain synthetic
fuel manufacturing facilities.
These write-offs and the settlement provision total approximately $5,362,000,
which amount is recorded as asset write-offs and other non-recurring charges
in the consolidated statement of operations.
15.Sale of Facilities
In 1998, Covol sold a synthetic fuel facility located in Alabama on which a
loss of $218,000 was recognized. The sales price was $6,500,000 payable in
the form of a nonrecourse promissory note collateralized by certain portions
of the facility.
In 1999, Covol sold a facility located in Pennsylvania on which a loss of
approximately $1,839,000 was recognized. The sales price consisted of a cash
payment to Covol of $1,250,000, assumption of $5,000,000 of facility debt,
completion of capital improvements to the facility and an eight-year royalty
arrangement with both Covol and the construction lender. Covol remains
contingently liable for $800,000 of the facility debt which liability has
been recorded in accrued liabilities in the consolidated balance sheet at
September 30, 1999. Covol entered into an agreement in which it operates the
facility on behalf of the buyer. Covol also entered into its standard supply
agreements. Covol can receive additional cash payments in the form of both
accelerated and increased royalties upon obtaining firm synthetic fuel
"off-take" agreements in excess of 100,000 tons per year and operating the
facility at rated capacity for a ten-day period. Covol must achieve these
performance milestones by June 30, 2000. The maximum amount under these
provisions of approximately
F-23
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
$9,700,000 is achieved if "off-take" agreements to sell 360,000 tons per year
are put in place for the synthetic fuel production of the facility in
addition to the ten-day operations period. Further, Covol can receive an
additional $4,000,000 payment if the facility operates at 115% of capacity
for a three-month period in any consecutive three months prior to December
31, 2001. Covol will recognize revenue and a corresponding gain under the
royalty arrangement upon receipt of the royalty payments and for achievement
of performance milestones.
Covol also sold a synthetic fuel facility in December 1999, as more fully
described in Note 17.
16. Commitments and Contingencies
Commitments and contingencies as of September 30, 1999 not disclosed
elsewhere, are as follows:
Leases
Rental expense was approximately $318,000, $480,000, and $1,309,000 for 1997,
1998 and 1999, respectively. Covol has noncancellable operating leases for
equipment and for real estate. At September 30, 1999, minimum rental payments
due under these leases, are as follows:
Year ending September 30: (thousands of dollars)
----------------------------- -----------------------
2000 $401
2001 222
2002 89
2003 41
2004 8
=======================
$761
=======================
Letters of Credit
Covol has entered into arrangements with a bank that provide for the issuance
of letters of credit totaling up to $698,000. These arrangements are
collateralized by certificates of deposit totaling approximately $588,000 in
1998 and $460,000 in 1999 that are included in restricted investments in the
accompanying consolidated balance sheet. As of September 30, 1999, there was
approximately $536,000 of liabilities covered by these arrangements.
Legal or Contractual Matters
Included in accrued liabilities at September 30, 1998 and 1999 is $755,000
related to canceled construction contracts that contain a "failure to
proceed" liability clause.
In March 1997, Covol transferred the Utah Synfuel #1 facility to Coaltech. In
connection with this transaction, Utah Synfuel #1 licensed Coaltech to use
Covol's binder technologies for a non-refundable advance license fee of
$1,400,000, which is being recognized as income over the contractual term of
the license agreement of 2007, and a recurring license fee that is payable
quarterly and that is based upon synthetic fuel produced and sold at the Utah
facility by Coaltech. Covol contracted with Coaltech to operate the facility
for which Covol receives a quarterly fee, which is also based upon synthetic
fuel produced and sold. The limited partners of Coaltech have an option
wherein they can require Covol to repurchase this facility under certain
conditions. This put option can be exercised if 1) none of the limited
partners are able to utilize the federal income tax credits under Section 29
of the tax code, 2) the economic benefits accruing to or experienced by all
of the Coaltech limited partners differ significantly from what was initially
projected, or 3) there is a permanent force majeure or material damage or
destruction of the Utah facility. If the put option is exercised prior to
March 2000, the option price will be equal to the fair market value of the
limited partnership interests of the optionees on a going concern basis, but
in no event will the option price exceed 50% of the capital contributions
paid to Covol by Coaltech. If the put option is exercised after March 2000,
the option price will be $10. In accordance with generally accepted
accounting principles and after discussions with the staff of the Securities
and Exchange Commission, this transaction has not been reflected as a sale
for accounting purposes. The original cost of the facility less cash payments
received from Coaltech, is reflected in the consolidated balance sheet as a
facility transferred under note receivable arrangement.
Additionally, Covol entered into a supply and purchase agreement with
Coaltech wherein Covol agreed to provide to Coaltech coal fines for
processing into synthetic fuel at a price equal to Covol's cost. Covol agreed
to purchase from Coaltech the synthetic fuel produced, at Coaltech's cost
plus one dollar per ton. As a result of this commitment to purchase
Coaltech's production, Covol has experienced losses related to the write-down
of the synthetic fuel purchased to the lower of cost or market. This
write-down to date has approximated 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.
F-24
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
However, Covol and Coaltech are in negotiations to modify the recurring
license fee, terminate the operating contract, settle the note receivable,
and terminate the supply and purchase agreement (see Note 17).
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 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. The former
manager has entered into a misdemeanor plea bargain and the U. S. Attorney
has agreed that the plea resolves all criminal matters arising out of the
incident.
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. A dispute arose between
Covol and Coalco about services rendered or to be rendered by Coalco and the
amount and timing for payment for such services. A settlement was reached in
November 1999 whereby Covol agreed to pay Coalco $1,500,000 plus a royalty
based on the synthetic fuel sold from five licensee-owned facilities. Of the
$1,500,000 to be paid, $479,000 was accrued as of September 30, 1999 and paid
in November 1999. An additional $279,000 was paid in December 1999 and
$470,000 is due and payable in January 2000 as a result of the sale of a
synthetic fuel facility in December 1999 (see Note 17). The remaining balance
will be paid upon the receipt of cash proceeds from any future sales of
synthetic fuel facilities held for sale. 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
F-25
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
secured note (see Notes 6 and 7). 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 stockholder meeting to seek
approval of the financing transaction. Covol filed the required registration
statement on Form S-3 covering the March 1999 financing transaction and such
registration statement has been declared effective. Failure to comply with
this or other terms and conditions of these financing agreements could result
in an increase in the interest rate, immediate convertibility, required
escrow payments and possible immediate payment of outstanding amounts.
Covol is negotiating for the sale of two synthetic fuel manufacturing
facilities held for sale. Current negotiations contemplate the relocation of
those facilities by the purchasers. Covol will likely incur costs in
terminating the relationships with the current facility site owners and
feedstock providers. In the case of the Pocahontas Synfuel facility, Covol
may incur up to $2.5 million to terminate the relationship with the site
owner and feedstock supplier. In the case of the Mountaineer Fuels facility,
Covol may incur up to $3.25 million to terminate the lease and feedstock
supply agreement.
In February 1997, Covol entered into a contract on a parcel of real property
located near Price, Utah, in which Covol obtained certain possessory and
related interests, Covol's primary purpose being to obtain a source of coal
fines to serve as feedstock for a nearby synthetic fuel facility. In August
1999, Covol sent a notice of default to Earthco, alleging that Earthco had
breached a material provision of the contract because Earthco did not have
title to the property. Covol has refused to tender its August 1999 payment
because of Earthco's breach. In addition, Covol contends that the quantity
and/or quality of recoverable coal fines was substantially less than what
Covol had understood when entering into the contract, thereby creating
grounds to reform the terms of the contract. Earthco subsequently countered
with allegations that Covol has breached its obligations under the contract,
including failure to make the August 1999 payment.
In November 1999, Covol was served with a Complaint in litigation pending in
the Seventh Judicial District Court of Carbon County, Utah titled Nevada
Electric Investment Company v. Earthco, et al. In the Complaint, and
consistent with Covol's position, Nevada Electric Investment Company
("NEICO") alleges that it is the lawful owner of the property near
Wellington, Utah described in Covol's lease from Earthco. NEICO seeks a
declaratory judgement that Covol is not entitled to possession of the
property due to the lack of ownership by Earthco. The Complaint also seeks
further relief from Earthco. Covol received Earthco's Answer, Counterclaims
and Cross-claim in December 1999. Earthco's cross-claim against Covol alleged
breach of contract and requested substantial damages in an amount to be
proven at trial but alleged to be in excess of $5 million. Covol filed its
Reply and Cross-claim against Earthco in January 2000 denying Earthco's
claims and asserting claims of misrepresentation, breach of lease, unjust
enrichment, and related claims and for general and consequential damages in
an amount to be proven at trial. The disputes among Covol, Earthco and NEICO
are at an early stage and resolution is uncertain.
Covol intends to defend against claims and prosecute its own claims
vigorously.
Covol is also involved in several legal proceedings that have arisen out of
the normal course of business. Covol believes that many of these claims are
without merit and in all cases intends to vigorously defend its position.
Management does not believe that the outcome of these activities will have a
significant effect upon the operations or the financial position of Covol.
Employment Contracts
Covol has entered into employment agreements with the Chief Executive
Officer, President, Chief Financial Officer and certain vice presidents. The
agreements, which are renewable by Covol, generally have a term of
approximately three years and provide for annual salaries and benefits
ranging from approximately $87,000 to $191,000 annually per officer,
currently totaling approximately $1,100,000 for all officers combined. All
agreements provide for termination benefits under specific conditions.
17. Events Subsequent to September 30, 1999
Events subsequent to September 30, 1999, not disclosed elsewhere, include the
following.
Coaltech Developments
On October 29, 1999, Covol received notification from the limited partners of
Coaltech that they were effecting a retirement of Covol as the general
partner of the partnership and were terminating Covol as operator of the Utah
facility. The limited partners also assert that as a consequence of the
retirement of Covol as general partner, Covol is deemed to have forfeited its
1% interest in the Partnership. The notification demands that Covol indemnify
the limited partners for all of their losses, damages, payments, costs and
expenses. Covol disputes the limited partners' demands.
On December 1, 1999, the parties entered into negotiations and as a result an
interim standstill agreement was reached pursuant to which the limited
partners and Covol have agreed not to pursue formal proceedings against each
other pending the outcome of the current settlement negotiations. It is
likely that the outcome of these negotiations will result in relocation of
the Utah facility to a new location where it will be operated by one of the
limited partners and termination of contractual and operational activities
between Covol and the limited partners with settlement payments consistent
with amounts reflected in the accompanying consolidated financial statements.
Proceeds from this settlement will be used to repay the $4,313,000 note
payable due January 2000 to one of the limited partners (see Note 6). It is
also expected that the limited partners will continue to purchase binder
materials from Covol and use Covol's technology in the production of
synthetic fuel when operations of the Utah facility are resumed.
Sale of Facilities
Effective as of December 31, 1999, Covol sold one of the three remaining
synthetic fuel facilities it owned. This facility was located in Price, Utah.
Net cash proceeds to Covol after payment of certain debt obligations will be
approximately $5,000,000. Covol will report a gain on this transaction of
approximately $5,300,000 in the period ended December 31, 1999.
On January 13, 2000, Covol executed definitive agreements for the sale of a
synthetic fuel facility located in North Fork, West Virginia. Funding under
the agreements is expected to occur within several days and will provide
sufficient funds to retire the debt incurred in connection with the
construction of the facility. The facility is expected to be relocated to the
purchaser's site. Additional funds, equal to approximately 50% of the funds
received at closing are due to Covol when the facility reaches commercial
operations at the new location. Covol will provide proprietary binder
materials used at this facility and will receive future royalties based upon
production and sale of synthetic fuel at the facility.
Also, on January 13, 2000, Covol executed a letter of intent with a major
U.S. utility company for the sale of the remaining synthetic fuel facility
owned by Covol. Covol believes execution of definitive agreements and funding
of the sale will occur within 30 days. Funds from the sale of this facility
will be sufficient to repay the debt incurred in the construction and
operation of this facility, which debt has a due date of June 30, 2000.
Impairment Charge
Coaltech owns a synthetic fuel facility on the same property as the facility
that was sold. As a result of the anticipated relocation of the facility
owned by Coaltech, combined with the sale of Covol's owned facility and the
Earthco Complaint (see Note 16), all of which relate to the same property
site in Price, Utah, Covol also will record in the December 1999 period an
impairment charge of approximately $12,000,000. This impairment charge is
expected to consist of the writedown of certain plant and equipment which
will remain on the site, having a net book value of approximately $10,000,000
and a minimal expected salvage value, plus the writeoff of the intangible
asset related to Utah Synfuel #1 recorded in the exchange transaction
described in Note 13, having a net book value of approximately $2,000,000.
F-26
<PAGE>
COVOL TECHNOLOGIES, INC.
SECURITIES PURCHASE AGREEMENT
Dated as of December 7, 1999
<PAGE>
TABLE OF CONTENTS
Page
Article I - DEFINITIONS.....................................................1
1.1 Definitions; Interpretation...................................1
Article II - ISSUANCE AND SALE OF THE SECURITIES............................7
2.1 Authorization of the Securities...............................7
2.2 Issuance and Sale of the Securities...........................8
2.3 Additional Issuances and Sales of the Securities..............8
2.4 Option to Acquire Additional Securities.......................9
Article III - CLOSING; CLOSING DELIVERIES...................................9
3.1 Closing.......................................................9
3.2 Payment for and Delivery of the Securities....................9
Article IV - REPRESENTATIONS AND WARRANTIES OF THE COMPANY.................10
4.1 Existence; Qualification; Subsidiaries.......................10
4.2 Authorization and Enforceability; Issuance of the
Securities, the Conversion Shares and the Warrant Shares....10
4.3 Capitalization...............................................11
4.4 Private Sale.................................................11
4.5 Financial Statements; Disclosure.............................12
4.6 Absence of Certain Changes...................................12
4.7 Litigation...................................................14
4.8 Licenses, Compliance with Law, Other Agreements, Etc.......14
4.9 Third-Party Approvals........................................15
4.10 No Undisclosed Liabilities..................................15
4.11 Tangible Assets.............................................15
4.12 Inventory...................................................15
4.13 Owned Real Property.........................................15
4.14 Real Property Leases........................................15
4.15 Agreements..................................................16
4.16 Intellectual Property.......................................16
4.17 Employees...................................................16
4.18 ERISA; Employee Benefits....................................17
4.19 Environmental Laws..........................................17
4.20 Transactions With Affiliates..............................18
4.21 Taxes.......................................................18
4.22 Other Investors.............................................19
4.23 Year 2000 Representations..................................19
4.24 Investment Company.........................................19
i
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4.25 Certain Fees................................................19
4.26 Solicitation Materials.....................................19
4.27 Form S-3 Filing............................................20
4.28 Listing and Maintenance Requirements Compliance.............20
4.29 Registration Rights; Rights of Participation................20
4.30 Synthetic Fuel Facilities...................................20
Article V - REPRESENTATIONS AND WARRANTIES OF THE PURCHASER................21
5.1 Authorization and Enforceability.............................21
5.2 Purchaser's Ability to Perform...............................21
5.3 Restrictions on Sale.........................................21
Article VI - COMPLIANCE WITH SECURITIES LAWS...............................22
6.1 Investment Intent of the Purchaser..........................22
6.2 Status of Securities........................................22
6.3 Accredited Investor Status..................................22
6.4 Access to Information.......................................22
6.5 Transfer of Securities, Conversion Shares and
Warrant Shares.............................................22
Article VII - CONDITIONS PRECEDENT.........................................23
7.1 Conditions Precedent........................................23
Article VIII - COVENANTS OF THE COMPANY....................................25
8.1 Restricted Actions..........................................25
8.2 Required Actions............................................27
8.3 Reservation of Common Stock..................................29
8.4 Payments Free of Withholding.................................29
Article IX - REGISTRATION RIGHTS...........................................29
9.1 Registration Rights..........................................29
9.2 Piggyback Registration Rights................................30
Article X - SURVIVAL.......................................................30
10.1 Survival....................................................30
Article XI - INDEMNIFICATION...............................................30
11.1 Indemnification.............................................31
Article XII - GENERAL PROVISIONS...........................................31
12.1 Successors and Assigns......................................31
12.2 Entire Agreement...........................................31
12.3 Notices.....................................................31
12.4 Purchaser Fees and Expenses.................................32
ii
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12.5 Amendment and Waiver.......................................33
12.6 Counterparts................................................33
12.7 Headings....................................................34
12.8 Remedies Cumulative........................................34
12.9 GOVERNING LAW...............................................34
12.10 CONSENT TO JURISDICTION; SERVICE OF PROCESS AND VENUE.....34
12.11 No Third Party Beneficiaries...............................34
12.12 Severability...............................................34
EXHIBITS
Exhibit A Security Agreement
Exhibit B Form of Convertible Secured Debenture
Exhibit C Form of Warrant
iii
<PAGE>
SECURITIES PURCHASE AGREEMENT
SECURITIES PURCHASE AGREEMENT (this "Agreement"), dated as of December
7, 1999, by and between COVOL TECHNOLOGIES, INC.(the "Company"), a Delaware
corporation with an address at 3280 North Frontage Road, Lehi, Utah 84043; and
DH FINANCIAL, L.C. or its assigns (the "Purchaser"), a Utah limited liability
company with an address at 5478 Green Street, Murray, Utah 84123.
The Company desires to issue to the Purchaser and the Purchaser desires
to purchase from the Company, upon the terms and subject to the conditions set
forth herein (i) the Convertible Secured Debenture of the Company and (ii) the
Warrants.
In consideration of the mutual promises, representations, warranties,
covenants and conditions set forth in this Agreement, the parties hereto agree
as follows:
Article I - DEFINITIONS
1.1 Definitions; Interpretation. For purposes of this Agreement, the
following terms have the indicated meanings:
"Affiliate" of a Person means any officer, director or employee of the
Company and any other Person that directly, or indirectly through one or more
intermediaries, controls, is controlled by, or is under common control with such
Person. For purposes of this definition, "control" of a Person means the power,
directly or indirectly, either to (i) vote 10% or more of the Capital Stock
having ordinary voting power for the election of directors of such Person or
(ii) direct or cause the direction of the management and policies of such Person
whether by contract or otherwise.
"Capital Stock" of any Person shall mean any and all shares, interests
(including membership and economic interests in a limited liability company),
rights to purchase, warrants, options, participations or other equivalents of or
interests in (however designated) equity of such Person, but excluding any debt
securities convertible into such equity prior to such conversion.
"Capitalized Lease" means any lease which is required under GAAP to be
capitalized on the balance sheet of the lessee.
"Capitalized Lease Obligation" means obligations for the payment of
rent for any Capitalized Lease; for purposes hereof, the amount of any such
obligation shall be the capitalized amount thereof determined in accordance with
GAAP.
Covol Securities Purchase Agreement - 1 - December 7, 1999
<PAGE>
"CERCLA" shall mean the federal Comprehensive Environmental Response,
Compensation, and Liability Act of 1980, as amended.
"Code" means the Internal Revenue Code of 1986, as amended.
"Common Stock" means, collectively, the Company's Common Stock, $.001
par value per share, and any Capital Stock of any class of the Company hereafter
authorized which is not limited to a fixed sum or percentage of par or stated
value in respect to the rights of the holders thereof to participate in
dividends or in the distribution of assets upon any liquidation, dissolution or
winding up of the Company.
"Confidential Information" means any proprietary information concerning
the Company's business other than information that (i) was already known to the
Person having a duty to keep confidential such information on a nonconfidential
basis prior to the time of disclosure, (ii) is or becomes generally available to
the public through no act or omission of such Person or (iii) becomes available
to such Person on a nonconfidential basis from a source other than any party
hereto (or any agent or representative thereof) if such source was not under a
prohibition against disclosing the information or otherwise bound by a
confidentiality agreement with respect thereto.
"Conversion Shares" means shares of Common Stock issued or issuable
upon conversion of the Debenture, whether or not a Debenture is presently
convertible; provided, that if there is a change such that the securities
issuable upon conversion of the Debenture are issued by an entity other than the
Company or there is a change in the securities so issuable, then the term
"Conversion Shares" shall mean shares or the security issuable upon conversion
of the Debenture if such securities are issuable in shares, or shall mean the
equivalent units in which such security is issuable if such security is not
issuable in shares.
"Current Balance Sheet" means the unaudited balance sheet of the
Company as at June 30, 1999.
"Debenture" has the meaning set forth in Section 2.1.
"Employee Plan" means an employee benefit plan (other than a
Multiemployer Plan) covered by Title IV of ERISA and any employee benefit plan
as defined in Section 3(3) of ERISA, maintained or contributed to by the
Company, or any predecessor or Subsidiary or any ERISA Affiliate at any time
during the 5-calendar years immediately preceding the date of this Agreement.
"Environmental Actions" refers to any complaint, summons, citation,
notice, directive, order, claim, litigation, investigation, judicial or
administrative proceeding, judgment, letter or other communication from any
governmental agency, department, bureau, office or other authority, or any third
party involving violations of Environmental Laws or Releases of
Covol Securities Purchase Agreement - 2 - December 7, 1999
<PAGE>
Hazardous Materials (i) from any assets, properties or businesses of the Company
or any of its Subsidiaries, licensees or predecessors in interest; (ii) from
adjoining properties or business; or (iii) from or onto any facilities which
received Hazardous Materials generated by the Company or any of its
Subsidiaries, licensees or predecessors in interest.
"Environmental Law" means the Comprehensive Environmental Response,
Compensation and Liability Act (42 U.S.C. ss. 9601, et seq.), the Hazardous
Materials Transpiration Act (49 U.S.C. 42 ss. 1801, et seq.), the Resource
Conservation and Recovery Act (42 U.S.C. ss. 6901, et seq.), the Federal Water
Pollution Control Act (33 U.S.C. ss. 1251, et seq.), the Clean Air Act (42
U.S.C. ss. 7401, et seq.), the Toxic Substances Control Act (15 U.S.C. ss. 2601,
et seq.) and the Occupational Safety and Health Act (29 U.S.C. ss. 651 et seq.),
as such laws may be amended or supplemented from time to time, and any other
present or future federal (United States or Canada), state, provincial, local or
foreign statute, ordinance, rule, regulation, order, judgment, decree, permit,
license or other binding determination of any Governmental Agency imposing
liability or establishing standards of conduct for protection of the
environment.
"Environmental Liabilities and Costs" means all liabilities (including
strict liabilities), monetary obligations, Remedial Actions, losses, damages,
punitive damages, consequential damages, treble damages, costs and expenses
(including all reasonable out-of-pocket fees, disbursements and expenses of
counsel, out-of-pocket expert and consulting fees, and out-of-pocket costs for
environmental site assessments, remedial investigations and feasibility
studies), fines, penalties, sanctions and interest incurred as a result of any
Environmental Action filed by any Governmental Agency or any third party, which
relate to any violations of Environmental Laws, Remedial Actions, Releases or
threatened Releases of Hazardous Materials from or onto (i) any property
presently or formerly owned by the Company or any of its Subsidiaries, licensees
or predecessors in interest or (ii) any facility which received Hazardous
Materials generated by the Company or any of its Subsidiaries, licensees or
predecessors in interest.
"Environmental Lien" means any Lien in favor of any Governmental Agency
for Environmental Liabilities and Costs.
"ERISA" means the Employee Retirement Income Security Act of 1974, as
amended, and any successor statute of similar import, and regulations thereunder
in each case as in effect from time to time. References to sections of ERISA
shall be construed also to refer to any successor sections.
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
"Existing Indebtedness" has the meaning set forth in Section 4.2.
"Facilities" has the meaning set forth in Section 4.30.
Covol Securities Purchase Agreement - 3 - December 7, 1999
<PAGE>
"Fair Market Value" means the closing bid price of a share of Common
Stock quoted on the NASDAQ Stock Market System.
"Family Group" means, with respect to an individual Purchaser, such
Purchaser, such Purchaser's spouse, siblings, descendants and/or ancestors
(whether natural, by marriage or adopted) and any trust solely for the benefit
of such Purchaser and/or such Purchaser's spouse, siblings, their respective
ancestors and/or descendants (whether natural, by marriage or adopted).
"Financial Statements" means (i) the unaudited balance sheets of the
Company as at December 31, 1998 and 1997, March 31, 1999 and 1998, and June 30,
1999 and 1998, and the related unaudited statements of income and consolidated
cash flow for the quarterly periods then ended, and (ii) the audited balance
sheets of the Company as at September 30, 1998 and 1997, and the related audited
statements of income and consolidated cash flow for the fiscal year periods then
ended, all as filed with the Securities and Exchange Commission on the date of
this Agreement.
"GAAP" means United States generally accepted accounting principles as
in effect from time to time, consistently applied.
"Governmental Agency" means any federal, state, local, foreign or other
governmental agency, instrumentality, commission, authority, board or body and
the National Association of Securities Dealers.
"Hazardous Materials" includes (a) any element, compound or chemical
that is defined, listed or otherwise classified as a contaminant, pollutant,
toxic pollutant, toxic or hazardous substance, extremely hazardous substance or
chemical, hazardous waste, special waste, or solid waste under Environmental
Laws; (b) petroleum and its refined products; (c) poly-chlorinated biphenyls;
(d) any substance exhibiting a hazardous waste characteristic, including but not
limited to corrosivity, ignitability, toxicity or reactivity as well as any
radioactive or explosive materials; and (e) any raw materials, building
components, including but not limited to asbestos-containing materials and
manufactured products containing hazardous substances.
"Hedging Agreement" means any interest rate swap, collar, cap, floor or
forward rate agreement or other agreement regarding the hedging of interest rate
risk exposure executed in connection with hedging the interest rate exposure of
the Company, and any confirming letter executed pursuant to such agreement, all
as amended, supplemented, restated or otherwise modified from time to time.
"includes" and "including" mean includes and including, without
limitation.
"Indebtedness" means, without duplication, as to any Person (i)
indebtedness for borrowed money; (ii) indebtedness for the deferred purchase
price of property or services (other than current trade payables incurred in the
ordinary course of business and payable in accordance
Covol Securities Purchase Agreement - 4 - December 7, 1999
<PAGE>
with customary practices); (iii) indebtedness evidenced by bonds, notes,
debentures or other similar instruments (other than performance, surety and
appeal or other similar bonds arising in the ordinary course of business); (iv)
obligations and liabilities secured by a Lien upon property owned by such
Person, whether or not owing by such Person and even though such Person has not
assumed or become liable for the payment thereof; (v) obligations and
liabilities directly or indirectly guaranteed by such Person; (vi) obligations
or liabilities created or arising under any conditional sales contract or other
title retention agreement with respect to property used and/or acquired by such
Person, even though the rights and remedies of the lessor, seller and/or lender
thereunder are limited to repossession of such property; (vii) Capitalized Lease
Obligations; (viii) all liabilities in respect of letters of credit, acceptances
and similar obligations created for the account of such Person; (ix) net
liabilities of such Person under Hedging Agreements and foreign currency
exchange agreements, as calculated on a basis satisfactory to the Purchaser and
in accordance with accepted practice; and (x) the Debenture issued hereunder
valued at the Optional Redemption Price (as defined in the Debenture) for
purposes hereof.
"Initial Closing" has the meaning set forth in Section 3.1.
"Initial Closing Date" has the meaning set forth in Section 3.1.
"Intellectual Property" means all domestic and foreign patents, patent
applications, disclosures, industrial designs, discoveries and inventions;
trademarks, service marks, trade dress, trade names, d/b/a's, Internet domain
names and corporate names and all goodwill associated therewith; published and
unpublished works of authorship, copyrights; registrations, applications and
renewals for any of the foregoing; trade secrets, Confidential Information,
know-how, technical and computer data, databases, proprietary information,
documentation and software, financial, business and marketing plans, customer
and supplier lists and all other intellectual property and proprietary rights;
and all copies and tangible embodiments of the foregoing.
"IRS" means the Internal Revenue Service.
"knowledge" or "know" when used with respect to the Company means the
knowledge of the senior management (vice president or senior) of the Company, or
any other management personnel that has had significant involvement in the
business and affairs of the Company.
"Liability" means any liability or obligation (whether absolute or
contingent, liquidated or unliquidated or due or to become due).
"Lien" means any mortgage, deed of trust, pledge, lien, security
interest, charge, encumbrance, security arrangement, restriction, covenant,
encroachment or other title imperfection of any nature whatsoever, including but
not limited to any conditional sale or
Covol Securities Purchase Agreement - 5 - December 7, 1999
<PAGE>
title retention arrangement, and any assignment, deposit arrangement or lease
intended as, or having the effect of, security.
"Material Adverse Change" means any material adverse change in the
business, condition (financial or otherwise), prospects or results of operations
of the Company and its Subsidiaries taken as a whole.
"Material Adverse Effect" means any material adverse effect on (i) the
business, condition (financial or otherwise), prospects or results of operations
of the Company and its Subsidiaries taken as a whole, or (ii) any of the
transactions contemplated hereby or by the Related Documents.
"ordinary course of business" means the ordinary course of business of
the Company consistent with past practice (including with respect to quantity,
quality and frequency).
"Permitted Liens" has the meaning set forth in Section 8.1(l).
"Person" means any individual, partnership, joint venture, corporation,
trust, unincorporated organization or other entity.
"RCRA" shall mean the federal Resource Conservation and Recovery Act,
as amended.
"Related Documents" means all documents and instruments to be executed
or adopted by the Company in connection herewith, including without limitation
the Debenture, the Security Agreement, each of the Warrants and all other
documents and instruments to be executed or adopted by the Company pursuant
thereto.
"Release" means any spilling, leaking, pumping, pouring, emitting,
emptying, discharging, injecting, escaping, leaching, seeping, migrating,
dumping or disposing of any Hazardous Material (including the abandonment or
discarding of barrels, containers and other closed receptacles containing
Hazardous Materials) into the indoor or outdoor environment, including ambient
air, soil, surface or ground water.
"Remedial Action" means all actions taken to (i) clean up, remove,
remediate, contain, treat, monitor, assess, evaluate or in any other way address
Hazardous Materials in the indoor or outdoor environment; (ii) prevent or
minimize a Release or threatened Release of Hazardous Materials so they do not
migrate or endanger or threaten to endanger public health or welfare or the
indoor or outdoor environment; (iii) perform pre-remedial studies and
investigations and post-remedial operation and maintenance activities; or (iv)
any other actions authorized by 42 U.S.C. 9601.
"SEC" means the Securities and Exchange Commission.
Covol Securities Purchase Agreement - 6 - December 7, 1999
<PAGE>
"Securities" has the meaning given that term in Section 2.1.
"Securities Act" means the Securities Act of 1933, as amended.
"Security Agreement" means the Security Agreement by and between the
Company and the Purchaser, substantially in the form attached as Exhibit "A"
hereto.
"Subsidiary" means any corporation, partnership, association or other
business entity of which (i) if a corporation, a majority of the total voting
power of shares of stock entitled (without regard to the occurrence of any
contingency) to vote in the election of directors, managers or trustees thereof
is at the time owned or controlled, directly or indirectly, by the Company or
(ii) if a partnership, association or other business entity, a majority of the
partnership or other similar ownership interest thereof is at the time owned or
controlled, directly or indirectly, by the Company. For purposes hereof, the
Company shall be deemed to have a majority ownership interest in a partnership,
association or other business entity if the Company, directly or indirectly, is
allocated a majority of partnership, association or other business entity gains
or losses, or is or controls the managing director or general partner of such
partnership, association or other business entity.
"Tax" means any federal, state, local, or foreign income, gross
receipts, license, payroll, employment, excise, severance, stamp, occupation,
premium, windfall profits, environmental (including taxes under Code ss.59A),
customs duties, Capital Stock, franchise, profits, withholding, social security
(or similar), unemployment, disability, real property, personal property, sales,
use, transfer, registration, value added, alternative or add-on minimum,
estimated, or other tax of any kind whatsoever, including any interest, penalty,
or addition thereto, whether disputed or not.
"Tax Returns" means any return, declaration, report, claim for refund,
or information return or statement relating to Taxes, including any schedule or
attachment thereto, and including any amendment thereof.
"Warrant Shares" means shares of the Common Stock obtained or
obtainable upon exercise of the Warrants, whether or not a Warrant is presently
exercisable; provided, that if there is a change such that the securities
issuable upon exercise of the Warrants are issued by an entity other than the
Company or there is a change in the class of securities so issuable, then the
term "Warrant Shares" shall mean shares of the security issuable upon exercise
of the Warrants if such security is issuable in shares, or shall mean the
equivalent units in which such security is issuable if such security is not
issuable in shares.
Article II - ISSUANCE AND SALE OF THE SECURITIES
2.1 Authorization of the Securities. The Company has authorized the
issuance and sale to the Purchaser, on the terms and subject to the conditions
of this Agreement, of (a) its Convertible
Covol Securities Purchase Agreement - 7 - December 7, 1999
<PAGE>
Secured Debenture in an aggregate principal amount of $1,500,000 and containing
the terms and conditions and in the form of the Debenture set forth in Exhibit
"B" attached hereto (the "Debenture"), and (b) its Warrants containing the terms
and conditions and in the form of the Warrant set forth in Exhibit "C" attached
hereto (the "Warrants and, together with the Debenture, the "Securities"). The
Debenture is convertible into and the Warrants are exercisable for shares of the
Company's Common Stock and the Debenture is secured by a first priority security
interest in the collateral described in the Security Agreement.
2.2 Issuance and Sale of the Securities. At the Initial Closing, on the
terms and subject to the conditions of this Agreement, the Company shall issue
to the Purchaser (a) the Debenture in the aggregate principal amount of
$1,500,000.00, and (b) Warrants initially exercisable for an aggregate of
934,725 Warrant Shares. For federal income tax purposes, the Company and the
Purchaser agree that the aggregate amount paid by the Purchaser for (i) the
Debenture is $1,500,000.00, and (ii) the Warrants is $0. Neither the Company nor
the Purchaser shall file any Tax Return or take any position with any taxing
authority inconsistent with the preceding sentence.
Article III - CLOSING; CLOSING DELIVERIES
3.1 Closing. The closing of the transactions contemplated by Section
2.2 of this Agreement (the "Initial Closing") shall take place at 4:00 p.m. on
December 7, 1999, at the offices of Corbridge Baird & Christensen, Salt Lake
City, Utah or at such other time, place and/or date as shall be agreed upon by
the parties hereto. The date upon which the Initial Closing occurs is referred
to herein as the "Initial Closing Date."
3.2 Payment for and Delivery of the Securities. At the Initial Closing,
the Company shall issue and deliver to the Purchaser, (a) a Debenture in the
aggregate principal amount of $1,500,000.00, against payment by the Purchaser,
by cash, check or wire transfer of immediately-available funds to the account
designated by the Company not less than two (2) days prior to the Initial
Closing Date, of $675,000 (net of 10% placement fee payable to DH Financial,
L.C. pursuant to Section 12.4) on the date of this Agreement and $675,000 (net
of 10% placement fee payable to DH Financial, L.C. pursuant to Section 12.4) on
or before December 20, 1999, and (b) duly issued Warrants initially exercisable
for an aggregate of 934,725 Warrant Shares.
Article IV - REPRESENTATIONS AND WARRANTIES OF THE COMPANY
The Company hereby represents and warrants to Purchaser as follows:
4.1 Existence; Qualification; Subsidiaries. Each of the Company and its
Subsidiaries is a corporation, partnership or limited liability company, as the
case may be, duly organized, validly existing and in good standing under the
laws of the state of its incorporation or formation and has full corporate or
partnership power and authority, as the case may be, to conduct its business
Covol Securities Purchase Agreement - 8 - December 7, 1999
<PAGE>
and own and operate its properties as now conducted, owned and operated. The
copies of the Certificate of Incorporation, as amended, and By-Laws of the
Company and all amendments thereto previously delivered to the Purchaser are
true, correct and complete copies of such documents. The Company and each
Subsidiary is licensed or qualified as a foreign corporation, partnership or
limited liability company and is in good standing in all jurisdictions where
such person is required to be so licensed or qualified, except where the failure
to be so licensed, qualified or in good standing would not have a Material
Adverse Effect. Except as set forth on Schedule 4.1, the Company has no
Subsidiaries and owns no Capital Stock or other securities of, and has not made
any other investment in, any other entity. All of the issued shares of Capital
Stock, partnership interests or membership interests, as the case may be, of
each Subsidiary have been duly and validly authorized and issued, are fully paid
and non-assessable and are owned directly or indirectly by the Company, free and
clear of all liens, encumbrances, equities or adverse claims.
4.2 Authorization and Enforceability; Issuance of the Securities, the
Conversion Shares and the Warrant Shares.
(a) The Company has full power and authority and has taken all
required corporate and other action necessary to permit it to execute and
deliver this Agreement and the Related Documents and to carry out the terms
hereof and thereof and to issue and deliver the Securities, the Conversion
Shares and the Warrant Shares, and none of such actions will violate any
provision of the Certificate of Incorporation of the Company, the By-Laws of the
Company or of any applicable law, regulation, order, judgment or decree or rule
of any stock exchange where the Company's Common Stock is listed or market in
which the Company's Common Stock is quoted, or result in the breach of or
constitute a default (or an event which, with notice or lapse of time or both
would constitute a default) under any material agreement (including the
Company's current secured debt instruments set forth on Schedule 4.2 (the
"Existing Indebtedness")), instrument or understanding to which the Company is a
party or by which it is bound or by which it will become bound as a result of
the transactions contemplated by this Agreement. This Agreement, each of the
Related Documents and all other agreements and instruments contemplated hereby
to which the Company is a party, have been duly executed and delivered by the
Company and each constitutes a legal, valid and binding obligation of the
Company, enforceable against the Company in accordance with its terms, except to
the extent that enforceability may be limited by (i) applicable bankruptcy,
insolvency, reorganization, moratorium and similar laws of general application
related to the enforcement of creditor's rights generally and (ii) general
principles of equity.
(b) The execution, delivery and performance of this Agreement,
each of the Related Documents and all other agreements and instruments
contemplated hereby to which the Company is a party have been duly authorized by
the Company. The Conversion Shares and the Warrant Shares, will be fully paid
and nonassessable. The Conversion Shares and the Warrant Shares have been duly
reserved for issuance upon conversion of the Debenture and exercise of the
Warrants, as the case may be, and, when so issued, will be duly authorized,
validly issued and
Covol Securities Purchase Agreement - 9 - December 7, 1999
<PAGE>
outstanding, fully paid and nonassessable shares of Common Stock. Neither the
issuance and delivery of any Conversion Shares upon conversion of the Debenture
nor the issuance and delivery of any Warrant Shares upon exercise of the
Warrants is subject to any preemptive right of any stockholder of the Company or
to any right of first refusal or other similar right in favor of any Person.
4.3 Capitalization. The authorized Capital Stock of the Company
consists of (a) 25,000,000 shares of Common Stock, par value $.001 per share, of
which, as of September 3, 1999, 12,744,009 shares were outstanding, 439,699
shares are reserved for issuance upon conversion of the Debenture, 175,880
shares are reserved for issuance upon exercise of the Warrants, and 6,250,756
shares are reserved for issuance upon the exercise of certain stock options and
warrants, and (b) 10,000,000 shares of preferred stock, par value $.001 per
share, of which (i) 3,000 shares have been designated Series A Preferred Stock,
of which 3,000 shares are issued and outstanding, (ii) 312,882 shares have been
designated Series B Preferred Stock, of which 14,310 shares are issued and
outstanding, (iii) 1,500 shares have been designated Series C Preferred Stock,
of which 200 shares are issued and outstanding, (iv) 80,000 shares have been
designated Series D Preferred Stock, of which 60,000 shares are issued and
outstanding; and (v) 3,000,000 are reserved for issuance upon conversion of
certain convertible secured debt. All of the outstanding Capital Stock has been
validly issued and is fully paid and nonassessable and has been issued in
compliance with all applicable securities laws (including the provisions of the
Securities Act and the rules and regulations promulgated thereunder). Except as
set forth in Schedule 4.3, there are no options, convertible securities,
warrants, calls, pledges, transfer restrictions (except restrictions imposed by
federal and state securities laws), voting restrictions, liens, rights of first
offer, rights of first refusal, antidilution provisions or commitments of any
character relating to any issued or unissued shares of Capital Stock of the
Company other than as contemplated in the Related Documents. Except as
contemplated by this Agreement and the Related Documents or as set forth in
Schedule 4.3, there are no preferential rights applicable to the issuance and
sale of the Securities, the Conversion Shares and the Warrant Shares.
4.4 Private Sale. Assuming the accuracy of the representations and
warranties made by recipients of the Company's Capital Stock in connection with
the acquisition of such Capital Stock, the Company has not violated any
applicable federal or state securities laws in connection with the offer, sale
and issuance of any of its Capital Stock. Subject to the accuracy of the
Purchaser's representations contained herein, neither the offer, sale and
issuance of the Securities hereunder nor the issuance and delivery of any
Conversion Shares upon conversion of the Debenture or any Warrant Shares upon
exercise of any Warrants requires registration under the Securities Act or any
state securities laws.
4.5 Financial Statements; Disclosure.
(a) The Financial Statements (together with the notes thereto,
as applicable), subject to modifications required by the current SEC review of
the Company's Registration
Covol Securities Purchase Agreement - 10 - December 7, 1999
<PAGE>
Statement on Form S-3, (i) are true, correct and complete in all material
respects, (ii) are in accordance with the books and records of the Company and
(iii) fairly present the financial condition and results of operations of the
Company as of the dates and for the periods indicated in accordance with GAAP,
except that the unaudited balance sheets and related financial statements do not
contain an auditors' opinion and do not contain footnotes and are subject to
normal, recurring year-end audit adjustments which are not material.
(b) This Agreement together with the schedules, attachments,
exhibits, written statements and certificates supplied to the Purchaser by or on
behalf of the Company with respect to the transactions contemplated hereby does
not contain any untrue statement of a material fact or omit to state a material
fact necessary to make the statements contained herein or therein, in light of
the circumstances in which they were made, not misleading. There is no fact
which has not been disclosed to the Purchaser of which the Company has
knowledge, and which has had or could reasonably be anticipated to have a
Material Adverse Effect.
(c) As of its filing date, each document filed with the SEC by
the Company, as amended or supplemented prior to the Initial Closing Date or any
Additional Closing Date, if applicable, pursuant to the Securities Act and/or
the Exchange Act, true and correct copies of which have been given to the
Purchaser, subject to modifications required by the current SEC review of the
Company's Registration Statement on Form S-3, (i) complied in all material
respects with the applicable requirements of the Securities Act and/or Exchange
Act and (ii) did not contain any untrue statement of a material fact or omit to
state any material fact necessary in order to make the statements made therein,
in the light of the circumstances under which they were made, not misleading.
Each final registration statement filed with the SEC by the Company pursuant to
the Securities Act, as of the date such statement became effective (i) complied
in all material respects with the applicable requirements of the Securities Act
and (ii) did not contain any untrue statement of a material fact or omit to
state any material fact required to be stated therein or necessary to make the
statements therein not misleading (in the case of any prospectus, in light of
the circumstances under which they were made).
4.6 Absence of Certain Changes.
(a) Except as set forth on Schedule 4.6(a) since the date of
the Current Balance Sheet, neither the Company nor any Subsidiary has:
(i) incurred any Liabilities other than current
Liabilities incurred, or obligations under contracts entered into, in
the ordinary course of business and for individual amounts not greater
than $250,000;
(ii) paid, discharged or satisfied any claim, Lien or
Liability, other than any claim, Lien or Liability (A) reflected or
reserved against on the Current Balance Sheet and paid, discharged or
satisfied in the ordinary course of business since the date of the
Covol Securities Purchase Agreement - 11 - December 7, 1999
<PAGE>
Current Balance Sheet or (B) incurred and paid, discharged or satisfied
since the date of the Current Balance Sheet, in each case in the
ordinary course of business;
(iii) sold, leased, assigned or otherwise transferred
any of its assets, tangible or intangible (other than sales of
inventory in the ordinary course of business and use of supplies in the
ordinary course of business);
(iv) permitted any of its assets, tangible or
intangible, to become subject to any Lien (other than any Permitted
Lien);
(v) written off as uncollectible any accounts
receivable other than (A) in the ordinary course of business or (B) for
amounts not greater than $50,000 in the aggregate;
(vi) terminated or amended or suffered the
termination or amendment of, or other than in the ordinary course of
business, failed to perform in all material respects all of its
obligations or suffered or permitted any material default to exist
under, any material agreement, license or permit (except the agreement
as disclosed between the Company and EARTHCO relating to a preparation
plant and fines ponds lease in Wellington, Utah);
(vii) suffered any damage, destruction or loss of
tangible property (whether or not covered by insurance) which in the
aggregate exceeds $100,000;
(viii) made any loan (other than intercompany
advances) to any other Person (other than advances to employees in the
ordinary course of business which do not exceed $10,000 individually or
$50,000 in the aggregate);
(ix) canceled, waived or released any debt, claim or
right in an amount or having a value exceeding $100,000;
(x) paid any amount to or entered into any agreement,
arrangement or transaction with, or any series of agreements,
arrangements or transactions with, any Affiliate (including its
officers, directors and employees) having a value of in excess of
$50,000 in the aggregate (other than as Company-wide employee benefits
or termination benefits paid in the ordinary course of business);
(xi) declared, set aside, or paid any dividend or
distribution with respect to its Capital Stock or redeemed, purchased
or otherwise acquired any of its Capital Stock;
(xii) other than in the ordinary course of business
or under existing contractual terms or obligations, granted any
increase in the compensation of any officer
Covol Securities Purchase Agreement - 12 - December 7, 1999
<PAGE>
or employee or made any other change in employment terms of any officer
or employee (except the arrangements as disclosed between the Company
and Messrs. Kimball, Fraley, Thompson, Madden and Cook);
(xiii) made any change in any method of accounting or
accounting practice;
(xiv) suffered or caused any other occurrence, event
or transaction outside the ordinary course of business or which could
have a Material Adverse Effect; or
(xv) agreed, in writing or otherwise, to any of the
foregoing.
(b) Since the date of the Current Balance Sheet, there has
been no Material Adverse Change.
(c) Schedule 4.6(c) hereto sets forth a complete and accurate
list as of the date hereof of (i) each place of business of the Company and each
of its Subsidiaries and (ii) the chief executive office of the Company and each
of its Subsidiaries.
4.7 Litigation. Except as set forth in Schedule 4.7, no claim, suit,
proceeding or investigation is proceeding, pending or, to the knowledge of the
Company, threatened against or affecting the Company, any Subsidiary or any
licensee or any officer or director thereof or the Company's, the Subsidiaries'
or the licensee's business which if decided adversely to any such person could
have a Material Adverse Effect.
4.8 Licenses, Compliance with Law, Other Agreements, Etc. Each of the
Company and its Subsidiaries has all material franchises, permits, licenses and
other rights to allow it to conduct its business and is not in violation, in any
material respects of any order or decree of any court, or of any law, order or
regulation of any Governmental Agency, or of the provisions of any contract or
agreement to which it is a party or by which it is bound (except the agreement
as disclosed between the Company and EARTHCO and the financing arrangement as
disclosed for the Mountaineer Facility), and neither this Agreement nor the
Related Documents nor the transactions contemplated hereby or thereby will
result in any such violation. Each of the Company's and its Subsidiary's
business has been conducted in compliance with all federal, state and local
laws, ordinances, rules and regulations, in all material respects. To the
knowledge of the Company, conditions or events of non-compliance with respect to
the Company's licensees that would have a Material Adverse Effect on the Company
or its contractual relationships with its licensees.
4.9 Third-Party Approvals. Assuming the accuracy of the representations
and warranties of the Purchaser contained in this Agreement, the Company is not
required to obtain any order, consent, approval or authorization of, or to make
any declaration or filing with, any Governmental Agency or other third party
(including under any state securities or "blue sky" laws) in connection with the
execution and delivery of this Agreement or the Related Documents, or the
consummation of the transactions contemplated hereby or thereby to occur on the
Initial Closing
Covol Securities Purchase Agreement - 13 - December 7, 1999
<PAGE>
Date or any Additional Closing Date, except for the consent and approval of OZ
Master Fund, Ltd.
4.10 No Undisclosed Liabilities. Neither the Company nor any of its
Subsidiaries has any material Liabilities except (i) as and to the extent of the
amounts reflected or reserved against on the Current Balance Sheet and (ii)
liabilities and obligations incurred in the ordinary course of business since
the date thereof that in the aggregate could not result in a Material Adverse
Effect.
4.11 Tangible Assets. Each of the Company and its Subsidiaries has good
and marketable title to, or valid leasehold interests in, all material tangible
assets used or reasonably necessary in connection with the conduct of its
business.
4.12 Inventory. All inventory of each of the Company and its
Subsidiaries, whether reflected on the Current Balance Sheet or otherwise,
consists of a quality and quantity usable or salable in the ordinary course of
business, subject to defect or obsolescence consistent with the Company's
historical experience.
4.13 Owned Real Property. Set forth on Schedule 4.13 is a true and
correct description of all real property owned by the Company and its
Subsidiaries. The Company and each of its Subsidiaries has good and marketable
title in fee simple, free and clear of all Liens (other than any Permitted
Lien), to all of the real property owned by the Company and each of its
Subsidiaries.
4.14 Real Property Leases. There exists no event of default (nor any
event which with notice or lapse of time would constitute an event of default)
with respect to the Company, any Subsidiary and, to the Company's knowledge,
with respect to any other party thereto under any agreement pursuant to which
the Company is the lessee or lessor of any real property, except for such
defaults and defects in enforceability as could not in the aggregate be expected
to have a Material Adverse Effect, and all such agreements are in full force and
effect and enforceable against the lessor or lessee in accordance with their
terms except for such defaults and defects in enforceability as could not in the
aggregate be expected to have a Material Adverse Effect (except the agreement as
disclosed between the Company and EARTHCO relating to a preparation plant and
fines ponds lease in Wellington, Utah).
4.15 Agreements. None of the Company, any Subsidiary or, to the
knowledge of the Company, any licensee is in default, nor to the knowledge of
the Company is there any basis for a valid claim of default, and to the
Company's knowledge no event has occurred which, with notice or lapse of time,
would constitute a default, under any agreement, arrangement or understanding to
which the Company, any Subsidiary or any licensee is a party, and to the
knowledge of the Company, no Person other than the Company is in default under
any such agreement, in each case other than defaults which in the aggregate
could not be expected to have a Material Adverse Effect (except the agreement as
disclosed between the Company and EARTHCO relating to a preparation plant and
fines ponds lease in Wellington, Utah). Additionally, none of the Company,
Covol Securities Purchase Agreement - 14 - December 7, 1999
<PAGE>
any Subsidiary or, to the knowledge of the Company, any licensee is party to any
agreement the performance of which in accordance with its terms (including any
termination provision thereof) could be expected to have a Material Adverse
Effect.
4.16 Intellectual Property. Schedule 4.16 sets forth a complete list of
(i) all patented, registered, applied for or otherwise material Intellectual
Property owned, filed or used by the Company; and (ii) all trade names and
material unregistered trademarks and other designations used by the Company in
connection with its business. The Company owns and possesses all right, title
and interest in and to, or has a valid and enforceable license to use, all
Intellectual Property used by the Company in its business as currently conducted
and as currently proposed to be conducted. No claim by any third party
contesting the validity, enforceability, use or ownership of Intellectual
Property owned, held or used by the Company has been made or, to the knowledge
of the Company, is threatened. To the knowledge of the Company, neither it nor
its indemnitees has violated or misappropriated the Intellectual Property of any
third party and no third party has violated or misappropriated Intellectual
Property owned, held or used by the Company. No claim by any third party has
been asserted, or to the knowledge of the Company threatened, that the Company
or its indemnitees is violating or misappropriating Intellectual Property. To
the knowledge of the Company, all Intellectual Property owned or held by the
Company is valid, subsisting and enforceable, and all such Intellectual Property
is free of all Liens, and, except as set forth on Schedule 4.16, is fully
assignable by the Company to any Person, without payment, consent of any Person
or other condition or restriction. The Company has taken all reasonable measures
to protect the secrecy, confidentiality and value of all Confidential
Information, proprietary information and trade secrets owned, held or used by
the Company (including, without limitation, entering into appropriate
confidentiality agreements with all officers, directors, employees, and other
Persons with access to such information and trade secrets). To the knowledge of
the Company, such information and trade secrets have not been disclosed to any
Persons other than Company employees or Company contractors who had a need to
know and use such information and trade secrets in the ordinary course of
employment or contract performance and who executed appropriate confidentiality
agreements.
4.17 Employees. The Company is not a party to or bound by any
collective bargaining agreement, nor has it experienced any strike, material
grievance, material claim of unfair labor practice or other collective
bargaining dispute. To the knowledge of the Company there is no organizational
effort being made or threatened by or on behalf of any labor union with respect
to its employees. To the knowledge of the Company, it has not committed any
unfair labor practice or violated any federal, state or local law or regulation
regulating employers or the terms and conditions of its employees' employment,
including laws regulating employee wages and hours, employment discrimination,
employee civil rights, equal employment opportunity and employment of foreign
nationals, except for such violations as could not be expected to have a
Material Adverse Effect.
4.18 ERISA; Employee Benefits. The Company has no Plans and agrees that
it will not adopt any Plan, other than a defined contribution 401(k) plan while
the Debenture is outstanding.
Covol Securities Purchase Agreement - 15 - December 7, 1999
<PAGE>
4.19 Environmental Laws. Except as set forth on Schedule 4.19:
(a) Each of the Company (as used in this Section 4.19, Company
shall include any predecessor and the Company's Subsidiaries) and, to the
knowledge of the Company, its licensees has complied and is in compliance with
all Environmental Laws.
(b) The Company and, to the knowledge of the Company, its
licensees have obtained and complied with, and are in compliance with, all
permits, licenses and other authorizations that are required pursuant to
Environmental Laws to operate its facilities, assets, and its businesses.
(c) No Environmental Actions have been asserted against the
Company or, to the knowledge of the Company, against any licensee or facility
that may have received Hazardous Materials generated by the Company or any
licensee, regarding any actual, threatened, or alleged violation of
Environmental Laws, or any liabilities or potential liabilities (whether
accrued, absolute, contingent, unliquidated, or otherwise), including any
investigatory, remedial, or corrective obligations, relating to it or its
operations under Environmental Laws.
(d) To the knowledge of the Company, none of the following
exists at any property or facility currently or formerly owned or operated by
either the Company or, to the knowledge of the Company, any licensee: (i)
underground storage tanks, (ii) asbestos-containing material in any form or
condition, (iii) materials or equipment containing polychlorinated biphenyls, or
(iv) landfills, surface impoundments, or waste disposal areas, except for
feed-stock properties for Company facilities.
(e) Except as disclosed on Schedule 4.19, neither the Company
nor, to the knowledge of the Company, any licensee has treated, stored, disposed
of, arranged for or permitted the disposal of, transported, handled, or Released
any substance, including without limitation any Hazardous Material, or owned or
operated any property or facility (and no such property or facility is
contaminated by any such substance) in a manner that has given or would give
rise to Environmental Liabilities and Costs. There has been no Release at any of
the properties owned or operated by the Company or, to the knowledge of the
Company, at any of the properties owned or operated by its licensees or, to the
knowledge of the Company, at any disposal treatment facility which received
Hazardous Materials generated by the Company or any licensee which is reasonably
likely to result in Environmental Liabilities and Costs.
(f) Except as disclosed on Schedule 4.19, neither this
Agreement nor the consummation of the transactions that are contemplated by this
Agreement will result in any obligations for site investigation, cleanup or
notification pursuant to any so-called "transaction-triggered" or "responsible
property transfer" Environmental Laws.
(g) Neither the Company nor, to the knowledge of the Company,
any licensee has, either expressly or by operation of law, assumed or undertaken
any liability, including without
Covol Securities Purchase Agreement - 16 - December 7, 1999
<PAGE>
limitation any obligation for corrective or Remedial Action, of any other Person
relating to Environmental Laws.
4.20 Transactions With Affiliates. Except as set forth on Schedule
4.20, neither the Company nor any Subsidiary is party to any agreement,
arrangement or transaction or series of agreements, arrangements or transactions
with any Affiliate which agreements, arrangements, transactions and series of
transactions in the aggregate have a value over $50,000 (other than as
Company-wide employee benefits paid in the ordinary course of business).
4.21 Taxes.
(a) Except as disclosed on Schedule 4.21, each of the Company
and its Subsidiaries has filed all Tax Returns that it was required to file, and
has paid all Taxes due with respect to the periods covered by such Tax Returns.
(b)None of the Company and its Subsidiaries (i) has been a
member of an affiliated group filing a consolidated federal Tax Return (other
than a group the common parent of which was the Company) or (ii) has any
Liability for the Taxes of any Person (other than any of the Company and its
Subsidiaries) under Treas. Reg. ss.1.1502-6 (or any similar provision of state,
local, or foreign law), as a transferee or successor, by contract, or otherwise.
(c) Each of the Company and its Subsidiaries has withheld and
paid all taxes required to have been withheld and paid in connection with
amounts paid or owing to any employee, independent contractor, creditor,
stockholder, or other third party.
(d) Except as set forth on Schedule 4.21, there is no dispute
or claim concerning any Tax Liability of any of the Company and its Subsidiaries
either (i) claimed or raised by any authority in writing or (ii) as to which any
of the directors and officers (and employees responsible for Tax matters) of the
Company and its Subsidiaries has knowledge based upon personal contact with any
agent of such authority.
4.22 Other Investors. Set forth on Schedule 4.22 is a list of all
shareholders (including option and convertible security holders) of the Company
who as of the date hereof, based on SEC filings of such shareholders, after
giving effect to the terms hereof, own more than 5% of the fully diluted common
equity of the Company and sets forth such percentage ownership.
4.23 Year 2000 Representations. The Company represents and warrants
that:
(a) The Company does not have any computer applications that
it believes are mission critical to the operation of synthetic fuel facilities
that it operates. While the Company has not formally verified Year 2000
compliance with licensees that utilize the Company's technology in their
synthetic fuel facilities, the Company believes that the computer applications
used in the operations of these facilities are not mission critical.
Accordingly, the Company
Covol Securities Purchase Agreement - 17 - December 7, 1999
<PAGE>
believes that Year 2000 issues will not be significant to these computer
applications and therefore, upgrading or modifications to these applications to
make them Year 2000 compliant will not be significant.
(b) During 1998 the Company upgraded its network operating
system and believes that system is Year 2000 compliant and that any additional
upgrading to that system will not be significant. The Company utilizes computer
applications in the finance and accounting departments and in the corporate
office that need to be upgraded in order to be Year 2000 compliant. The Company
expects to complete the upgrade of its corporate computer applications for Year
2000 compliance by September 30, 1999.
4.24 Investment Company. The Company is not, and is not controlled by
or under common control with an affiliate of, an "investment company" within the
meaning of the Investment Company Act of 1940, as amended.
4.25 Certain Fees. Other than fees and expenses due and payable to the
Purchaser pursuant to Section 12.4, no fees or commissions will be payable by
the Company to any broker, financial advisor, finder, investment banker, or bank
with respect to the transactions contemplated by this Agreement. The Purchaser
shall not have any obligation with respect to any fees or with respect to any
claims made by or on behalf of any Persons for fees of a type contemplated in
this section that may be due in connection with the transactions contemplated by
this Agreement. The Company shall indemnify and hold harmless the Purchaser, its
employees, officers, directors, agents and partners, and their respective
Affiliates from and against all claims, losses, damages, costs (including
attorney's fees) and expenses suffered in respect to any such claimed or
existing fees.
4.26 Solicitation Materials. The Company has not (i) distributed any
offering materials to the Purchaser in connection with the offering and sale of
the Securities other than its public filings with the SEC, or (ii) solicited any
offer to buy or sell the Securities by means of any form of general solicitation
or general advertising within the meaning of Regulation D under the Securities
Act. None of the information provided to the Purchaser by or on behalf of the
Company contain any untrue statement of material fact or omit to state a
material fact required to be stated therein or necessary to make the statements
therein not misleading.
4.27 Form S-3 Filing. The Company has filed a registration statement
with the SEC on Form S-3 promulgated under the Securities Act, File No.
33-385753, to register the resale of the Conversion Shares, the Warrant Shares
and shares otherwise issuable pursuant to this Agreement.
4.28 Listing and Maintenance Requirements Compliance.
(a) The Company has not received notice (written or oral) from
the National Association of Securities Dealers that the Company is not in
compliance with its listing or maintenance requirements.
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<PAGE>
(b) Upon conversion of the Debenture into Conversion Shares or
the exercise of the Warrants for the Warrant Shares, all such Conversion Shares
and Warrant Shares shall be listed on the NASDAQ National Market System.
4.29 Registration Rights; Rights of Participation. Except as described
on Schedule 4.29 hereto, (a) the Company has not granted or agreed to grant to
any Person any rights (including "piggy-back" registration rights) to have any
securities of the Company registered with the SEC or any other Governmental
Agency which has not expired or been satisfied in full and (b) no Person,
including, but not limited to, current or former shareholders of the Company,
underwriters, brokers or agents, has any right of first refusal, preemptive
right, right of participation, or any similar right to participate in the
transactions contemplated by this Agreement or any other related document which
has not been waived. None of the rights granted to the Purchaser hereunder and
under the Related Documents conflicts with or would cause a default under any of
the agreements or arrangements listed on Schedule 4.29 hereto.
4.30 Synthetic Fuel Facilities.
(a) The Company shall take all reasonably necessary action to
ensure that the credit for producing fuel from a nonconventional source provided
under Section 29 of the Code is available and is maintained with respect to each
of the Company's and its licensee's facilities for producing synthetic fuels
("Facilities") including, without limitation, ensuring that the Facilities
produce "qualified fuels" (as defined in Section 29(c) of the Code) and such
qualified fuels are sold to persons that are not "related persons" (as defined
in Section 29(d)(7) of the Code). Each of the Facilities was placed in service
before July 1, 1998, in each case pursuant to a binding written contract in
effect on or before December 31, 1996. For purposes of this Section 4.30, each
representation made by the Company is made to the knowledge of the Company.
(b) Each of the representations and warranties made by any of
the Company, its Subsidiaries or its licensees in obtaining any private letter
ruling from the Internal Revenue Service was true and correct in all material
respects when made and as of the date the ruling was issued.
(c) Set forth on Schedule 4.30 is each private letter ruling
obtained from the Internal Revenue Service regarding the Facilities which is
addressed to the Company or any of its licensees or is otherwise able to be
relied upon by the Company. To the Company's knowledge, (i) no private letter
ruling listed on Schedule 4.30 has been amended, rescinded or revoked since the
date of issuance, and (ii) there exists no reason that the Internal Revenue
Service would deny a request by the Company or any owner of the Facilities for a
private letter ruling with regard to the Facilities owned by the Company or any
of its licensees.
Article V - REPRESENTATIONS AND WARRANTIES OF THE PURCHASER
The Purchaser hereby represents and warrants to the Company as follows:
Covol Securities Purchase Agreement - 19 - December 7, 1999
<PAGE>
5.1 Authorization and Enforceability. The Purchaser has full power and
authority and has taken all action necessary to permit it to execute and deliver
this Agreement and the other documents and instruments to be executed by it
pursuant hereto and to carry out the terms hereof and thereof. This Agreement
and each such other document and instrument, when duly executed and delivered by
the Purchaser, will constitute a valid and binding obligation of the Purchaser,
enforceable against the Purchaser in accordance with its terms, except to the
extent limited by (i) applicable bankruptcy, insolvency, reorganization,
moratorium and similar laws of general application related to the enforcement of
creditors' rights generally and (ii) general principles of equity.
5.2 Purchaser's Ability to Perform. As of the Initial Closing, the
Purchaser has the financial resources to perform fully its total obligations
under this Agreement.
Article VI - COMPLIANCE WITH SECURITIES LAWS
6.1 Investment Intent of the Purchaser. The Purchaser represents and
warrants to the Company that it is acquiring the Securities for its own account,
with no present intention of selling or otherwise distributing the same in
violation of the Securities Act.
6.2 Status of Securities. The Purchaser has been informed by the
Company that the Securities have not been registered under the Securities Act or
under any state securities laws and are being offered and sold in reliance upon
federal and state exemptions for transactions not involving any public offering.
6.3 Accredited Investor Status. The Purchaser represents and warrants
to the Company that it is an "Accredited Investor" as defined in Regulation D
under the Securities Act.
6.4 Access to Information. The Purchaser has had access to management
of the Company and has been able to ask questions of management related to the
Company and has reviewed the Company's filings pursuant to the Exchange Act.
Notwithstanding any due diligence investigations conducted by or on behalf of
the Purchaser, it is understood and agreed by each of the parties hereto that
the Purchaser is entitled to rely, and is relying, on the representations and
warranties made by the Company herein and in the Related Documents.
6.5 Transfer of Securities, Conversion Shares and Warrant Shares.
(a) Securities, Conversion Shares and Warrant Shares may be
transferred (i) pursuant to public offerings registered under the Securities
Act, (ii) pursuant to Rule 144 of the SEC (or any similar rule then in force),
(iii) to an Affiliate or member of the Family Group of the transferor (provided
that the subsequent transfer of the Securities, Conversion Shares or Warrant
Shares is restricted), or (iv) subject to the conditions set forth in Section
6.5(b), any other legally available means of transfer.
Covol Securities Purchase Agreement - 20 - December 7, 1999
<PAGE>
(b) In connection with any transfer of any Securities,
Conversion Shares or Warrant Shares (other than a transfer described in Section
6.5(a)(i), (ii) or (iii)), the holder of such shares shall deliver written
notice to the Company describing in reasonable detail the proposed transfer,
together with an opinion of counsel (which, to the Company's reasonable
satisfaction, is knowledgeable in securities law matters), to the effect that
such transfer may be effected without registration of such shares under the
Securities Act.
(c) Until transferred pursuant to clauses (a)(i) or (ii) above
or pursuant to clause (a)(i) above with an opinion of counsel pursuant to
paragraph (b) above that such legend is not required, each Debenture, Warrant,
Conversion Shares and Warrant Shares shall be imprinted with a legend
substantially in the following form:
THE SECURITIES REPRESENTED BY THIS [DEBENTURE/CERTIFICATE/ WARRANT]
WERE ORIGINALLY ISSUED ON ________, 1999 AND HAVE NOT BEEN REGISTERED
UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY APPLICABLE STATE
SECURITIES LAW. THE TRANSFER OF THE SECURITIES REPRESENTED BY THIS
[DEBENTURE/CERTIFICATE/WARRANT] IS SUBJECT TO THE CONDITIONS SET FORTH
IN THE SECURITIES PURCHASE AGREEMENT, DATED AS OF DECEMBER 7, 1999,
BETWEEN THE ISSUER (THE "COMPANY") AND THE PURCHASER NAMED THEREIN. THE
COMPANY RESERVES THE RIGHT TO REFUSE ANY TRANSFER OF SUCH SECURITIES
UNTIL SUCH CONDITIONS HAVE BEEN FULFILLED WITH RESPECT TO SUCH
TRANSFER. A COPY OF SUCH CONDITIONS SHALL BE FURNISHED WITHOUT CHARGE
TO THE HOLDER HEREOF UPON WRITTEN REQUEST TO THE COMPANY.
Article VII - CONDITIONS PRECEDENT
7.1 Conditions Precedent. The obligation of the Purchaser to purchase
any Securities hereunder is subject to the satisfaction of each of the following
conditions precedent:
(a) The issuance and sale of the Securities shall not
contravene any law, rule or regulation applicable to the Purchaser or the
Company or any of its Subsidiaries;
(b) The following conditions have been satisfied as of the
Initial Closing Date and each Additional Closing Date,
(i) The representations and warranties of the Company
contained herein and in any Related Document and in any writing
delivered pursuant hereto or thereto shall be true and correct when
made and materially true and correct as of the time of the Initial
Closing and each Additional Closing;
Covol Securities Purchase Agreement - 21 - December 7, 1999
<PAGE>
(ii) No action, suit, investigation or proceeding
shall be pending or threatened before any court or Governmental Agency
to restrain, prohibit, collect damages as a result of or otherwise
challenge this Agreement or any Related Document or any transaction
contemplated hereby or thereby;
(iii) All acts or covenants required hereunder to be
performed by the Company prior to the Initial Closing and each
Additional Closing shall have been fully performed by it; and
(iv) No Material Adverse Change shall have occurred
between the date of the Current Balance Sheet and the Initial Closing
Date or Additional Closing Date and no event or occurrence shall have
occurred that could have a Material Adverse Effect.
(c) The following documents and items shall be delivered to
the Purchaser at or prior to the Initial Closing and each Additional Closing:
(i) A fully executed counterpart of this Agreement
(at the Initial Closing only), and the fully executed Debenture, the
Security Agreement and the UCC-1 financing statements related thereto,
the Warrants and the certificates (in such denominations as the
Purchaser shall request) for the Warrants being delivered by the
Company at the Initial Closing and each Additional Closing.
(ii) Certificates of a duly authorized officer of the
Company dated as of the Initial Closing Date and each Additional
Closing Date:
(A) Stating that the following conditions
have been satisfied as of the Initial Closing Date and each
Additional Closing Date:
(1) The representations and
warranties of the Company contained herein and in any
writing delivered pursuant hereto were true and
correct when made and are materially true and correct
as of the time of the Initial Closing and each
Additional Closing;
(2) No action, suit, investigation
or proceeding is pending or threatened before any
court or Governmental Agency to restrain, prohibit,
collect damages as a result of or otherwise challenge
this Agreement or any Related Document or any
transaction contemplated hereby or thereby;
(3) All acts or covenants required
hereunder to be performed by the Company prior to the
Initial Closing and each Additional Closing have been
fully performed by it; and
Covol Securities Purchase Agreement - 22 - December 7, 1999
<PAGE>
(4) No Material Adverse Change shall
have occurred between the date of the Current Balance
Sheet and the Initial Closing Date and each
Additional Closing Date and there shall have been no
event or occurrence that could result in a Material
Adverse Effect; and
(B) Setting forth the resolutions of the
Board of Directors authorizing the execution and delivery of
this Agreement and the Related Documents and the consummation
of the transactions contemplated hereby and thereby, and
certifying that such resolutions were duly adopted and have
not been rescinded or amended;
(iii) The Company shall have paid fees payable
pursuant to Section 12.4 hereof;
(iv) A copy of a certificate of the appropriate
official(s) of the state of organization and each state of foreign
qualification of the Company and each of its Subsidiaries certifying as
of the date of the certificate to the existence in good standing of,
and the payment of taxes by, such Person in such states;
(v) A true and complete copy of the Certificate of
Incorporation, as amended, of the Company, certified as of a date not
more than six months prior to the Initial Closing Date by an
appropriate official of the state of organization of each such Person,
a true and complete copy of the Bylaws of the Company, certified as of
the Initial Closing Date by the Secretary of the Company, and a
certificate as of each Additional Closing Date by the Secretary of the
Company that there has been no change to the Certificate of
Incorporation or Bylaws of the Company since the Initial Closing Date;
and
(vi) Such other documents relating to the
transactions contemplated hereby as the Purchaser may reasonably
request.
7.2 Closing Deliveries to the Company. The Purchaser will deliver to
the Company the aggregate purchase price for the Securities to be acquired by
the Purchaser, net of a 10% placement fee payable to DH Financial, L.C..
Article VIII - COVENANTS OF THE COMPANY
8.1 Restricted Actions. Without the prior written consent of the
Purchaser, and for so long as the Debenture remains outstanding, the Company
shall not, and shall not permit any Subsidiary to:
(a) become subject to any agreement or instrument which by its
terms would (under any circumstances) restrict or impair the Company's right to
comply with or fulfill its obligations under the terms of this Agreement or any
of the Related Documents;
Covol Securities Purchase Agreement - 23 - December 7, 1999
<PAGE>
(b) use the proceeds from the sale of the Securities other
than for repayment of indebtedness, working capital and other general corporate
purposes; provided, that the Company will in no event use the proceeds to invest
in any securities other than short-term, interest-bearing government securities;
(c) enter into any transaction or series of transactions with
any stockholder, director, officer, employee or Affiliate, including, without
limitation, the purchase, sale, lease or exchange of any property, the rendering
of any service or any investment, loan or advance, unless such transaction (i)
is consummated by the Company in good faith on an arm's-length basis, (ii) is
less than $100,000 per occurrence or $250,000 in the aggregate, and (iii) is
approved by the Board of Directors, including by a majority of the Company's
disinterested directors;
(d) declare or pay any dividends, purchase or otherwise
acquire for value any of its membership interests or other Capital Stock now or
hereafter outstanding, return any capital to its members as such, or make any
other payment or distribution of assets to its stockholders as such, or permit
any of its Subsidiaries to do any of the foregoing or to purchase or otherwise
acquire for value any Capital Stock of the Company or its Subsidiaries, or make
any payment or prepayment of principal of, premium, if any, or interest on, or
redeem, decrease or otherwise retire, any Indebtedness before its scheduled due
date;
(e) materially alter or change the business of the Company;
(f) issue any stock option or warrant at less than the Fair
Market Value at the time of grant;
(g) unless the Company has issued and sold $4,000,000.00 of
the Debentures to the Purchaser, create, incur or suffer to exist any
Indebtedness, other than:
(i) Indebtedness created hereunder and under the
Debenture; and
(ii) Indebtedness existing on the date hereof, and
any extension of maturity, refinancing or modification of the terms
there of provided, however, that such extension, refinancing or
modification (A) is pursuant to terms that are not materially less
favorable to the purchaser than the terms of the Indebtedness being
extended, refinanced or modified and (B) after giving effect to the
extension, refinancing or modification, such Indebtedness is not
greater than the amount of Indebtedness outstanding immediately prior
to such extension, refinancing or modification.
(h) alter the rights, preferences and privileges of the
Securities, the Conversion Shares or the Warrant Shares;
(i) allow the use, handling, generation, storage, treatment,
release or disposal of Hazardous Materials at any property owned or leased by
the Company or any of its Subsidiaries
Covol Securities Purchase Agreement - 24 - December 7, 1999
<PAGE>
except in compliance with Environmental Laws and so long as such use, handling,
generation, storage, treatment, release or disposal of Hazardous Materials does
not result in a violation of Environmental Law which would result in a Material
Adverse Change; and
(j) grant any rights of registration under the Securities Act
relating to any of its shares of Capital Stock or other securities to any Person
other than pursuant to this Agreement, unless (i) the rights so granted to
another Person do not limit, restrict or impair the rights of the Purchaser
under this Agreement and under the Related Documents and (ii) such rights so
granted to another Person do not grant priority in registration rights to such
other Person over rights granted to Purchaser under this Agreement and under the
Related Documents.
8.2 Required Actions. For so long as the Debenture remains outstanding,
the Company shall, and shall cause each Subsidiary to:
(a) cause all properties owned by the Company or any of its
Subsidiaries or used or held for use in the conduct of its business or the
business of any of its Subsidiaries to be maintained and kept in good condition,
repair and working order (reasonable wear and tear excepted) and supplied with
all necessary equipment and will cause to be made all necessary repairs,
renewals, replacements, betterments and improvements thereof, all as in the
judgment of the Board of Directors may be necessary so that the business carried
on in connection therewith may be properly and advantageously conducted at all
times; provided, however, that the foregoing shall not prevent the Company from
discontinuing the maintenance or operation of any of such properties if such
discontinuance is, in the judgment of the management of the Company, desirable
in the conduct of its business or the business of any of its Subsidiaries and is
not disadvantageous in any material respect to the holders of the Securities;
(b) preserve and keep in full force and effect the corporate
existence, rights (charter and statutory), licenses and franchises of the
Company and each of its Subsidiaries; provided, however, that the Company shall
not be required to preserve any such right, license or franchise if the Board of
Directors shall determine that the preservation thereof is no longer desirable
in the conduct of the business of the Company and its Subsidiaries as a whole
and that the loss thereof is not disadvantageous in any material respect to the
holders of Securities;
(c) maintain the books, accounts and records of the Company
and its Subsidiaries in accordance with past custom and practice as used in the
preparation of the Financial Statements except to the extent permitted or
required by GAAP;
(d) keep all of its and its Subsidiaries' properties which are
of an insurable nature insured with insurers, believed by the Company in good
faith to be financially sound and responsible, against loss or damage to the
extent that property of similar character is usually so insured by corporations
similarly situated and owning like properties (which may include self-insurance,
if reasonable and in comparable form to that maintained by companies similarly
situated);
Covol Securities Purchase Agreement - 25 - December 7, 1999
<PAGE>
(e) comply with all material legal requirements and material
contractual obligations applicable to the operations and business of the Company
and its Subsidiaries and pay all applicable Taxes as they become due and
payable;
(f) permit representatives of any holder of the Securities and
its agents (including their counsel, accountants and consultants), subject to
the execution of a reasonable confidentiality agreement, to have reasonable
access upon reasonable notice during business hours to the Company's books,
records, facilities, key personnel, officers, directors, customers, independent
accountants and legal counsel so long as such access does not violate any
applicable Federal or state law or cause the loss of the attorney-client
privilege;
(g) at all times (i) file all reports (including annual
reports, quarterly reports and the information, documentation and other reports)
required to be filed by the Company under the Exchange Act and Sections 13 and
15 of the rules and regulations adopted by the SEC thereunder, and the Company
shall use its best efforts to file each of such reports on a timely basis, and
take such further action as any holder or holders of the Securities, the
Conversion Shares or the Warrant Shares may reasonably request (including
providing copies of such reports to the holders of the Securities, the
Conversion Shares or the Warrant Shares), all to the extent required to enable
such holders to sell Securities pursuant to Rule 144 adopted by the SEC under
the Securities Act (as such rule may be amended from time to time) or any
similar rule or regulation hereafter adopted by the SEC and to enable the
Company to register securities with the SEC on Form S-3 or any similar
short-form registration statement and upon the filing of each such report
deliver a copy thereof to each holder of the Securities, the Conversion Shares
or the Warrant Shares, (ii) if the Company is no longer subject to the
requirements of the Exchange Act, provide reports to the holders of the
Securities, the Conversion Shares or the Warrant Shares in substantially the
same form and at the same times as would be required if the Company were subject
to the Exchange Act, and (iii) provide to each initial holder of the Securities,
the Conversion Shares or the Warrant Shares and each other holder who has
entered into a confidentiality agreement with the Company, pursuant to mutually
agreeable terms, any material information distributed to the Board of Directors;
(h) maintain at all times a valid listing for the Common Stock
on a national securities exchange, the NASDAQ National Market System or the
NASDAQ SmallCap Market;
(i) maintain all material Intellectual Property Rights
necessary to the conduct of its business and own or have a valid license to use
all right, title and interest in and to, such material Intellectual Property
Rights;
(j) deliver Conversion Shares in accordance with the terms and
conditions, and time periods, set forth in the Debenture;
(k) (i) Keep any property either owned or operated by it or
any of its Subsidiaries free of any Environmental Liens or post bonds or other
financial assurances
Covol Securities Purchase Agreement - 26 - December 7, 1999
<PAGE>
sufficient to satisfy the obligations or liability evidenced by such
Environmental Liens; (ii) comply, and cause its Subsidiaries to comply, in all
material respects with Environmental Laws and shall provide to the Purchaser
documentation of such compliance which the Purchaser reasonably requests; (iii)
promptly notify the Purchaser of any Release of a Hazardous Material in excess
of any reportable quantity from or onto property owned or operated by the
Company, any of its Subsidiaries or, to the knowledge of the Company, any of its
licensees and take any Remedial Actions required to abate said Release or
otherwise to come into compliance with applicable Environmental Law; and (iv)
promptly provide the Purchaser with written notice within ten (10) days of the
receipt of any of the following: (a) notice that an Environmental Lien has been
filed against any of the real or personal property of the Company, any of its
Subsidiaries or, to the knowledge of the Company, any of its licensees; (b)
commencement of any Environmental Action or notice that an Environmental Action
will be filed against the Company or any Subsidiary; and (c) notice of a
violation, citation or other administrative order which would reasonably be
expected to cause a Material Adverse Effect; and
(m) Take such actions and execute, acknowledge and deliver,
and cause each of the Subsidiaries to take such actions and execute, acknowledge
and deliver, at its sole cost and expense such agreements, instruments or other
documents as the Purchaser may reasonably require from time to time in order to
(i) carry out more effectively the purposes of this Agreement and the Related
Documents, (ii) maintain the validity and effectiveness of any of the Related
Documents, and (iii) to better assure, convey, grant, assign, transfer and
confirm unto the Purchaser the rights now or hereafter intended to be granted to
the Purchaser under this Agreement or any Related Document.
8.3 Reservation of Common Stock. The Company shall at all times reserve
and keep available out of its authorized but unissued shares of Common Stock,
solely for the purposes of issuance upon conversion of the Debenture and the
exercise of the Warrants, such number of shares of Common Stock as are issuable
upon the conversion or exercise of the Debenture and all Warrants. All shares of
Common Stock which are so issuable shall, when issued, be duly and validly
issued, fully paid and nonassessable and free from all Taxes, liens and charges.
The Company, at its sole cost and expense, shall take all such actions as may be
necessary to assure that all such shares of Common Stock may be so issued
without violation of any applicable law or governmental regulation or any
requirements of any domestic securities exchange upon which shares of Common
Stock may be listed (except for official notice of issuance which shall be
immediately transmitted by the Company upon issuance).
8.4 Payments Free of Withholding. All payments by the Company hereunder
or under the Debenture or the Warrants shall be made free and clear of, and
without any deduction for, any Tax imposed by any taxing jurisdiction, domestic
or foreign.
Covol Securities Purchase Agreement - 27 - December 7, 1999
<PAGE>
Article IX - REGISTRATION RIGHTS
9.1 Registration Rights. The Company, at its sole cost and expense,
covenants to register or qualify or cause to be registered or qualified under
applicable federal and state securities laws the sale and resale by the
Purchaser of (i) all of the Conversion Shares, as the same may be recalculated
from time to time, (ii) all of the Warrant Shares, and (iii) all of the
additional shares of Common Stock issued, issuable or which may become issuable
to the Purchaser pursuant to this Agreement, if any (the "Registrable
Securities"), and to maintain such registration or qualification effective for
all periods during which any portion of any Debenture may be converted or any
Warrants may be exercised. The Company covenants to prepare and file or to cause
such registration or qualification to be prepared and filed with the United
States Securities and Exchange Commission within 10 calendar days after the date
of this Agreement. The Company covenants to use its best efforts to cause such
registration or qualification to become effective as soon after filing as
possible and to remain effective for all periods during which any portion of any
Debenture may be converted or any Warrants may be exercised. The Company
covenants to prepare and file with the Securities and Exchange Commission such
amendments and supplements to such registration or qualification and the
prospectus used in connection therewith as may be necessary to keep such
registration or qualification effective, to include all of the Registrable
Securities as the number changes from time to time and to comply with the
provisions of the Securities Act with respect to the disposition of all
securities covered by such registration or qualification in accordance with the
intended methods of disposition by the sellers thereof set forth in such
registration or qualification. If such registration or qualification does not
become effective on or before January 21, 2000 or remain effective thereafter as
provided herein, the Purchaser may, at its sole option, demand that the Company
redeem all or any portion of the Debenture as provided therein.
If such registration or qualification, registering all of the
Registrable Securities, has not become effective on or before January 21, 2000
or at any time ceases to remain effective thereafter as provided herein, the
Company hereby covenants and agrees to issue or cause to be issued to the
Purchaser on such date and on every date which is 30 days or a multiple thereof
after such date, until such registration or qualification shall become
effective, additional shares of Common Stock equal in number to 10% of (i) the
total number of shares of Common Stock issued or issuable upon conversion of all
of the Debenture or portions thereof which are convertible by the Purchaser and
(ii) the additional shares of Common Stock issued or issuable to the Purchaser
pursuant to this Agreement, if any, and to cause the sale and resale of all such
additional shares to be included in the registration or qualification described
herein.
9.2 Piggyback Registration Rights. The Company covenants that if at any
time when any Debenture may be converted or any Warrant may be exercised the
Company should file a non-underwritten registration statement or offering
statement on behalf of the Company pursuant to applicable federal and state
securities laws for a public offering of securities, the Company will provide
written notification to the Purchaser at least 30 days but not more than 60 days
prior to the filing date of such registration statement or offering statement
and will register or qualify or
Covol Securities Purchase Agreement - 28 - December 7, 1999
<PAGE>
cause to be registered or qualified, subject to the rights pursuant to which the
registration or qualification is filed, at the option of the Purchaser and at
the sole cost and expense of the Company, the sale and resale by the Purchaser
of the Registrable Securities and the Company will maintain such registration
statement effective for all periods during which any Debenture may be converted
or any Warrants may be exercised.
Article X - SURVIVAL
10.1 Survival. The representations, warranties, covenants and
agreements of the parties hereto contained herein, or in any writing delivered
pursuant hereto, shall survive the Initial Closing and each Additional Closing
of the transactions contemplated hereby and by the Related Documents
notwithstanding any due diligence investigation conducted by or on behalf of
Purchaser and until such time as all of the obligations of the parties hereto
have been satisfied.
Article XI - INDEMNIFICATION
11.1 Indemnification. In consideration of the Purchaser's execution and
delivery of this Agreement and acquiring the Securities hereunder and in
addition to all of the Company's other obligations under this Agreement, the
Company shall defend, protect, indemnify and hold harmless, on an after-tax
basis, the Purchaser and each other holder of the Securities and each of their
respective officers, directors, employees and agents (including, without
limitation, those retained in connection with the transactions contemplated by
this Agreement) (collectively, the "Indemnitees") from and against any and all
actions, causes of action, suits, claims, Environmental Actions, losses, costs,
penalties, fees, liabilities, Environmental Liabilities and Costs and damages,
and expenses (including, without limitation, costs of suit and attorneys' fees
and expenses) in connection therewith (irrespective of whether any such
Indemnitee is a party to the action for which indemnification hereunder is
sought) (the "Indemnified Liabilities"), incurred by the Indemnitees or any of
them as a result of, or arising out of, or relating to (a) the material breach
or inaccuracy of any representation or warranty contained in this Agreement or
any Related Document or any other instrument, agreement or document delivered to
the Purchaser in accordance herewith or therewith, (b) the execution, delivery,
performance or enforcement of this Agreement, any Related Document and any other
instrument, document or agreement executed pursuant hereto or thereto by any of
the Indemnitees, or (c) resulting from any material breach or inaccuracy of any
representation, warranty, covenant or agreement made by the Company herein or in
any Related Document. The Company shall reimburse the Indemnitees for the
Indemnified Liabilities as such Indemnified Liabilities are incurred. To the
extent that the foregoing undertaking by the Company may be unenforceable for
any reason, the Company shall make the maximum contribution to the payment and
satisfaction of each of the Indemnified Liabilities which is permissible under
applicable law.
Covol Securities Purchase Agreement - 29 - December 7, 1999
<PAGE>
Article XII - GENERAL PROVISIONS
12.1 Successors and Assigns. This Agreement shall bind and inure to the
benefit of the parties hereto and their respective successors and assigns,
including each subsequent holder of Securities, Conversion Shares or Warrant
Shares. Except as otherwise specifically provided herein, this Agreement shall
not be assignable by the Company without the prior written consent of the
Purchaser.
12.2 Entire Agreement. This Agreement and the other writings referred
to herein or delivered pursuant hereto constitute the entire agreement among the
parties with respect to the subject matter hereof and supersede all prior oral
or written arrangements or understandings.
12.3 Notices. All notices, requests, consents and other communications
provided for herein shall be in writing and shall be (i) delivered in person,
(ii) transmitted by telecopy, (iii) sent by registered or certified mail,
postage prepaid with return receipt requested, or (iv) sent by reputable
overnight courier service, fees prepaid, to the recipient at the address or
telecopy number set forth below, or such other address or telecopy number as may
hereafter be designated in writing by such recipient. Notices shall be deemed
given upon personal delivery, upon receipt of return receipt in the case of
delivery by mail, upon acknowledgment by the receiving telecopier or one day
following deposit with an overnight courier service.
(a) If to the Company:
Covol Technologies, Inc.
3280 North Frontage Road
Lehi, Utah 84043
Telecopy: (801) 768-4483
Attention: Steven G. Stewart
with a copy to (which shall not constitute notice to the Company):
Callister, Nebeker & McCullough
Ten East South Temple
Salt Lake City, Utah 84133
Telecopy: (801) 364-9127
Attention: Richard T. Beard, Esq.
(b) If to the Purchaser:
DH Financial, L.C.
5478 Green Street
Murray, Utah 84123
Telecopy: (801) 501-9882
Attention: Corwin L. Hair or Brad Dennis
Covol Securities Purchase Agreement - 30 - December 7, 1999
<PAGE>
with a copy to (which shall not constitute notice to the Purchaser):
Corbridge Baird & Christensen
39 Exchange Place, Suite 100
Salt Lake City, Utah 84111
Telecopy: (801) 534-1948
Attention: James G. Swensen, Jr., Esq.
12.4 Purchaser Fees and Expenses.
(a) The Company shall pay a placement fee to DH Financial,
L.C. equal to 10% of the aggregate principal amount of the Debenture issued
pursuant to this Agreement, payable upon issuance of each Debenture.
(b) The Company shall reimburse the Purchaser upon demand for
(i) the reasonable fees and expenses of counsel(s) to the Purchaser incurred in
connection with the documentation, negotiation and consummation of the
transactions contemplated by this Agreement and the Related Documents and (ii)
reasonable due diligence expenses incurred by the Purchaser.
(c) The Company also agrees to pay or cause to be paid, on
demand, and to save the Purchaser harmless against liability for the payment of
all reasonable out-of-pocket expenses incurred by the Company from time to time
arising from or relating to: (i) the preservation and protection of any of the
Company's rights under this Agreement or the Related Documents, (ii) the defense
of any claim or action asserted or brought against the Purchaser by any Person
that arises from or relates to this Agreement, any Related Document, the
Purchaser's claims against the Company, or any and all matters in connection
therewith, (iii) the commencement or defense of, or intervention in, any court
proceeding arising from or related to this Agreement or any Related Document,
(iv) the filing of any petition, complaint, answer, motion or other pleading by
the Purchaser in connection with this Agreement or any Related Document, (v) any
attempt to collect from the Company, or (vi) the receipt of any advice with
respect to any of the foregoing. Without limitation of the foregoing or any
other provision of any Related Document: (A) the Company agrees to pay all
stamp, document, transfer, recording or filing taxes or fees and similar
impositions now or hereafter determined by the Purchaser to be payable in
connection with this Agreement or any Related Document, and the Company agrees
to save the Purchaser harmless from and against any and all present or future
claims, liabilities or losses with respect to or resulting from any omission to
pay or delay in paying any such taxes, fees or impositions, and (B) if the
Company fails to perform any covenant or agreement contained herein or in any
Related Document, the Purchaser may itself perform or cause performance of such
covenant or agreement, and the expenses of the Purchaser incurred in connection
therewith shall be reimbursed on demand by the Company.
Covol Securities Purchase Agreement - 31 - December 7, 1999
<PAGE>
12.5 Amendment and Waiver. No amendment of any provision of this
Agreement shall be effective, unless the same shall be in writing and signed by
the Company and the Purchaser. Any failure of the Company to comply with any
provision hereof may only be waived in writing by the Purchaser, and any failure
of the Purchaser of the Securities, the Conversion Shares or the Warrant Shares
to comply with any provision hereof may only be waived in writing by the
Company. No such waiver shall operate as a waiver of, or estoppel with respect
to, any subsequent or other failure. No failure by any party to take any action
against any breach of this Agreement or default by any other party shall
constitute a waiver of such party's right to enforce any provision hereof or to
take any such action.
12.6 Counterparts. This Agreement may be executed in any number of
counterparts, each of which shall be deemed to be an original, but all of which
together shall constitute one agreement.
12.7 Headings. The headings of the various sections of this Agreement
have been inserted for reference only and shall not be deemed to be a part of
this Agreement.
12.8 Remedies Cumulative. Except as otherwise provided herein, the
remedies provided herein shall be cumulative and shall not preclude the
assertion by any party hereto of any other rights or the seeking of any other
remedies against any other party hereto.
12.9 GOVERNING LAW. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED
IN ACCORDANCE WITH THE INTERNAL SUBSTANTIVE LAWS OF THE STATE OF UTAH WITHOUT
GIVING EFFECT TO THE LAWS OF CONFLICT OR CHOICE OF LAWS OF THE STATE OF UTAH OF
ANY OTHER JURISDICTION THAT WOULD RESULT IN THE APPLICATION OF ANY LAWS OTHER
THAN THOSE OF THE STATE OF UTAH.
12.10 CONSENT TO JURISDICTION; SERVICE OF PROCESS AND VENUE. ANY LEGAL
ACTION OR PROCEEDING WITH RESPECT TO THIS AGREEMENT OR ANY RELATED DOCUMENT MAY
BE BROUGHT IN THE COURTS OF THE STATE OF UTAH IN THE COUNTY OF SALT LAKE OR IN
THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF UTAH, AND, BY EXECUTION AND
DELIVERY OF THIS AGREEMENT, THE PARTIES HEREBY IRREVOCABLY ACCEPT IN RESPECT OF
THEIR PROPERTY, GENERALLY AND UNCONDITIONALLY, THE JURISDICTION OF THE AFORESAID
COURTS.
12.11 No Third Party Beneficiaries. Except as specifically set forth or
referred to herein, nothing herein is intended or shall be construed to confer
upon any person or entity other than the parties hereto and their successors or
assigns, any rights or remedies under or by reason of this Agreement.
Covol Securities Purchase Agreement - 32 - December 7, 1999
<PAGE>
12.12 Severability. If any term, provision, covenant or restriction of
this Agreement is held by a court of competent jurisdiction to be invalid, void
or unenforceable, the remainder of the terms, provisions, covenants and
restrictions of this Agreement shall remain in full force and effect and shall
in no way be affected, impaired or invalidated.
IN WITNESS WHEREOF, the parties have caused their duly authorized
officers to execute this Agreement as of the date first above written.
COVOL TECHNOLOGIES, INC.
Attest
By: /s/ Harlan M. Hatfield By: /s/ Steven G. Stewart
-------------------------------- ----------------------------------
Harlan M. Hatfield, General Counsel & Steven G. Stewart, Chief
Corporate Secretary Financial Officer
DH FINANCIAL, L.C.
By: /s/ Brad Dennis
--------------------------------
Its Manager
Covol Securities Purchase Agreement - 33 - December 7, 1999
<PAGE>
SCHEDULES
Schedule 4.1 Subsidiaries
Schedule 4.2 Existing Indebtedness
Schedule 4.3 Capitalization
Schedule 4.6(a) Certain Changes
Schedule 4.6(c) Places of Business
Schedule 4.7 Litigation
Schedule 4.13 Owned Real Property
Schedule 4.16 Intellectual Property
Schedule 4.19 Environmental Laws
Schedule 4.20 Transactions with Affiliates
Schedule 4.21 Taxes
Schedule 4.22 Other Investors
Schedule 4.29 Registration Rights
Schedule 4.30 Synthetic Fuel Facilities
Covol Securities Purchase Agreement - 34 - December 7, 1999
SECURITY AGREEMENT
SECURITY AGREEMENT (this "Agreement"), dated as of December 6, 1999, by
and between COVOL TECHNOLOGIES, INC.(the "Grantor"), a Delaware corporation with
an address at 3280 North Frontage Road, Lehi, Utah 84043; and DH FINANCIAL, L.C.
(the "Lender"), a Utah limited liability company with an address at 5478 Green
Street, Murray, Utah 84123.
The Grantor and Lender are parties to a Securities Purchase Agreement,
dated as of the date hereof (as amended and modified from time to time, the
"Purchase Agreement"), pursuant to which the Grantor will issue and sell and the
Lender will purchase the convertible secured debentures (the "Debentures") of
the Grantor. Capitalized terms used but not defined herein shall have the
meanings given to such terms in the Purchase Agreement and the Debentures.
The Lender has agreed to make certain loans to the Grantor. The
obligation of the Lender to lend under the Debentures is conditioned on, among
other things, the execution and delivery by the Grantor of this Agreement.
Accordingly, the Grantor and the Lender, hereby agree as follows:
1. DEFINITIONS.
As used herein, the following terms shall have the following meanings:
"Code" means the Uniform Commercial Code as in effect in the State of
Utah.
"Collateral" means (a) all of the Grantor's right, title and interest
in and to (i) that certain License and Binder Purchase Agreement, dated as of
June 26, 1998, between the Grantor and Robena L.L.C. (the "Licensee"), a
Delaware limited liability company, a copy of which is attached hereto as
Exhibit "A" and incorporated herein by this reference, and (ii) all subsequent
and future license agreements or similar agreements between the Grantor and
Robena LLC, or the Grantor and any other party which relate to the facilities
that are the subject of (i) above (collectively, as such agreements may be
amended, restated or modified from time to time, the "License Agreement"), and
(b) all proceeds of any and all of the foregoing Collateral and, to the extent
not otherwise included, all payments under insurance (whether or not the Lender
is the loss payee thereof), or any indemnity, warranty or guaranty, payable by
reason of loss or damage to or otherwise with respect to any of the foregoing
Collateral.
Covol Security Agreement - 1 - December 6, 1999
<PAGE>
"Obligations" means all indebtedness, obligations and other liabilities
of the Grantor to the Lender now or hereafter arising pursuant to the Purchase
Agreement, including, without limitation, the indebtedness evidenced by the
Debentures.
"Person" means any individual, partnership, joint venture, corporation,
trust, unincorporated organization or other entity.
The foregoing definitions shall be equally applicable to both the
singular and plural forms of the defined terms. In addition, the words
"including," "includes" and "include" shall be deemed to be followed by the
words "without limitation."
2. GRANT OF SECURITY INTEREST.
The Grantor hereby pledges and grants a continuing security interest
in, and a right of setoff against, the Collateral to the Lender, to secure
payment, performance and observance by the Grantor of the Obligations.
3. REPRESENTATIONS AND WARRANTIES.
The Grantor makes the representations and warranties set forth in this
Section 3 to the Lender.
3.1 Necessary Filings. All filings, registrations and recordings
necessary or appropriate or otherwise requested by Lender to create, preserve,
protect and perfect the security interest granted by the Grantor to the Lender
hereby in respect of the Collateral will be delivered to Lender upon execution
of this Agreement or, if requested by Lender, will be delivered to Lender within
three (3) Business Days after the date of such request.
3.2 Principal Location. The Grantor's mailing address, and the location
of its chief executive office, is the address set forth in the preamble to this
Agreement (as the same may be modified pursuant to Section 4.4); the Grantor has
no other places of business.
3.3 No Other Names. The Grantor conducted business as Enviro-Fuels
Technology during 1993 and 1994, as Environmental Technologies Group
International during 1994 and 1995 and as Covol Technologies, Inc. since 1995.
Except as discussed herein, the Grantor does not conduct and has not conducted
since 1993 any trade or business under any name except the name in which it has
executed this Agreement. The Grantor has not been a party to any merger or
consolidation in the last five years.
3.4 No Financing Statements. No financing statement describing all or
any portion of the Collateral which has not lapsed or been terminated has been
filed in any jurisdiction except financing statements naming the Lender as
secured party.
Covol Security Agreement - 2 - December 6, 1999
<PAGE>
3.5 Patents. The Grantor owns and possesses all right, title and
interest in and to, or has a valid and enforceable license to use, all patents
described in the License Agreement.
3.6 License Agreement. Each License Agreement constitutes a legal,
valid and binding obligation of the Grantor, enforceable by and against the
Grantor in accordance with its terms, except to the extent limited by (a)
applicable bankruptcy, insolvency, reorganization, moratorium and similar laws
of general application related to the enforcement of creditor's rights generally
and (b) general principles of equity. The Grantor is not in default, nor to the
knowledge of the Grantor is there any basis for a valid claim of default, and to
the Grantor's knowledge no event has occurred which, with notice or lapse of
time, would constitute a default, under the License Agreement, and to the
knowledge of the Grantor no licensee is in default under any such License
Agreement.
3.7 Collateral. The Grantor has good title to the Collateral, free and
clear of all claims, liens and encumbrances, except the security interest
created by this Agreement. The Grantor has all requisite power and authority to
pledge and grant the security interest in the Collateral for the purposes
contemplated in this Agreement and to create a first lien on the Collateral in
favor of the Lender and this Agreement shall create a valid first lien upon and
perfected first priority security interest in the Collateral subject to no prior
security interest, lien, encumbrance or other restriction. This Agreement, when
executed, has been duly and validly executed and is the legal, valid and binding
obligation of the Grantor and is enforceable against the Grantor by the Lender
in accordance with its terms.
3.8 Claims. The Collateral is not the subject of any present or
threatened suit, action, arbitration, administrative or other proceeding, and
the Grantor knows of no reasonable grounds for the institution of any such
proceedings. No authorization, approval or other action by, and not notice to or
filing with, any governmental authority or regulatory body is required either
(i) for the pledge by the Grantor of the Collateral pursuant to this Agreement
or for the execution, delivery or performance of this Agreement by the Grantor
or (ii) for the exercise by the Lender of any remedies with respect to the
Collateral.
4. COVENANTS.
Grantor hereby covenants and agrees that from the date of this
Agreement, and thereafter until this Agreement is terminated:
4.1 Inspection and Verification. The Lender and such Persons as the
Lender may designate shall have the right, at any reasonable time or times upon
three (3) days prior notice and during Grantor's usual business hours, to
inspect the Collateral, all records related thereto (and to make extracts and
copies from such records), and the premises upon which any of the Collateral is
located, to discuss Grantor's affairs with the officers of Grantor and their
independent auditors to verify under reasonable procedures the validity, amount,
quality, quantity, value and condition of, or any other matter relating to, the
Collateral.
Covol Security Agreement - 3 - December 6, 1999
<PAGE>
4.2 Records and Reports. The Grantor will maintain complete and
accurate books and records with respect to the Collateral, and furnish to the
Lender such reports relating to the Collateral as the Lender shall from time to
time reasonably request.
4.3 Financing Statements and Other Actions. The Grantor will execute
and deliver to the Lender all financing statements and amendments thereto and
other documents, and take such other actions, as are from time to time
reasonably requested by the Lender in order to perfect and to maintain and
protect the validity, enforceability and perfected status of the first priority
perfected security interest in the Collateral or to enable the Lender to
exercise and enforce its rights and remedies hereunder with respect to the
Collateral.
4.4 Change in Location or Name. The Grantor will not (a) maintain a
place of business at any location other than the location specified in the
preamble to this Agreement, (b) change its name, or (c) change its mailing
address, unless, in each case, the Grantor shall have given the Lender at least
thirty (30) days' prior written notice thereof, including the new address or
name, and delivered any financing statements or other documents requested by the
Lender.
4.5 Other Financing Statements. The Grantor will not sign or authorize
the signing on its behalf of any financing statement naming it as debtor which
covers all or any portion of the Collateral, except financing statements naming
the Lender as secured party.
4.6 Exclusivity. The Grantor will not sell, convey or otherwise dispose
of any interest in the Collateral or create, incur or permit to exist any
pledge, mortgage, lien, charge or encumbrance or any security interest
whatsoever in or with respect to any of the Collateral other than that created
hereby, without the prior written consent of the Lender, which consent will not
be unreasonably withheld..
4.7 Defense. The Grantor will defend at its sole expense, the Lender's
right, title and security interest in and to the Collateral against the claims
of any person, firm, corporation or other entity.
4.8. Intellectual Property Covenants. The Grantor shall:
(a) consistent with commercially reasonable practices, not
perform or omit to perform any act whereby any patent rights necessary for the
License Agreement may become dedicated, invalidated or unenforceable;
(b) consistent with commercially reasonable practices,
prosecute diligently any necessary patent, trademark or copyright application
which is pending with respect to the License Agreement as of the date of this
Agreement or hereafter and otherwise maintain all rights in and to the patents
necessary under the License Agreement, including making all necessary filings
and recordings and paying all required fees and taxes to record and maintain its
registration and ownership of each such patent described in the License
Agreement;
Covol Security Agreement - 4 - December 6, 1999
<PAGE>
(c) not impair any of the Lender's rights of action described
herein.
4.9 Grant of License to Use Patents. For the purpose of enabling the
Lender to exercise its rights and remedies upon an Event of Default, the Grantor
hereby grants to the Lender an irrevocable, nonexclusive license (exercisable
without payment of royalty or other compensation to the Grantor) to use, license
or sublicense any of the patents and all of the patent rights described in the
License Agreement to the extent not inconsistent with the terms of the License
Agreement, wherever the same may be located. Except as set forth in the
preceding sentence, the Lender shall have no obligations or liabilities
regarding any or all of the patents by reason of, or arising out of, this
Agreement.
5. REMEDIES UPON DEFAULT.
5.1 Remedies upon Default. If any Event of Default shall occur, whether
or not all of the Obligations shall have become due and payable, the Lender may,
in addition to its rights under the Purchase Agreement and the Debentures,
exercise any or all of the rights and remedies provided (i) in this Agreement,
or (ii) to a secured party when a debtor is in default under a security
agreement governed by the Code or any other applicable law.
5.2 Specific Performance. The Grantor agrees that, in addition to all
other rights and remedies granted to the Lender in this Agreement and under the
Debentures, the Lender shall be entitled to specific performance and injunctive
and other equitable relief, and the Grantor further agrees to waive any
requirement for the securing or posting of any bond or other security in
connection with the obtaining of any such specific performance and injunctive or
other equitable relief.
5.3 Grantor's Secured Liabilities Upon Event of Default. Upon the
request of the Lender after the occurrence of an Event of Default, the Grantor
will promptly:
(a) Assemble and make available to the Lender the Collateral
and all records relating thereto at the Company's principal place of business.
(b) Permit the Lender, or the Lender's representatives and
Lenders, to enter any premises where all or any part of the Collateral, or the
books and records relating thereto, or both, are located, to take possession of
all or any part of the Collateral and to remove all or any part of the
Collateral.
5.4 Remedies Cumulative. All rights, powers and remedies contained in
this Agreement or afforded by law shall be cumulative and all shall be available
to the Lender until the Obligations have been paid in full.
Covol Security Agreement - 5 - December 6, 1999
<PAGE>
6. WAIVERS, AMENDMENTS AND REMEDIES.
No delay or omission of the Lender to exercise any right, power or
remedy granted under this Agreement shall impair such right, power or remedy or
be construed to be a waiver of any Event of Default or an acquiescence therein,
and any single or partial exercise of any such right, power or remedy shall not
preclude other or further exercise thereof or the exercise of any other right,
power or remedy, and no waiver, amendment or other variation of the terms,
conditions or provisions of this Agreement whatsoever shall be valid unless
signed by each of the parties hereto, and then only to the extent specifically
set forth in such writing.
7. COLLECTION OF RECEIVABLES; PROCEEDS.
7.1 Collection of Receivables. Grantor hereby covenants and agrees that
the Lender may at any time after the occurrence of an Event of Default, by
giving the Grantor written notice, elect to enforce collection of any proceeds
of any and all of the Collateral, including any Earned Royalty and any payment
of profits from sales of Proprietary Binder Material (each as defined in the
License Agreement) and to require that such proceeds be paid directly to the
Lender. In such event, the Grantor covenants and agrees to, and shall permit the
Lender to, promptly notify the account debtors or obligors under the License
Agreement of the Lender's interest therein and direct such account debtors or
obligors to make payment of all amounts then or thereafter due under the License
Agreement directly to the Lender. Upon receipt of any such notice from the
Lender, the Grantor shall thereafter hold in trust for the Lender all amounts
and proceeds received by it with respect to the License Agreement or any other
Collateral, shall segregate all such amounts and proceeds from other funds of
the Grantor, and shall at all times thereafter promptly deliver to the Lender
all such amounts and proceeds in the same form as so received, whether by cash,
check, draft or otherwise, with any necessary endorsements.
7.2 Payment of Proceeds from Collateral. Upon the receipt by the
Licensee of notice from the Lender of the occurrence of an Event of Default by
the Company pursuant to the Purchase Agreement or the Debentures issued pursuant
thereto, the Grantor acknowledges and agrees that the Licensee shall (a) make no
further payments to the Company under (i) the License Agreement, including any
Earned Royalty (as defined in the License Agreement ), or (ii) any other
agreement between the Company and the Licensee with respect to the Facility, and
(b) make all payments otherwise due to the Company under (i) the License
Agreement , including any Earned Royalty, or (ii) any other agreement between
the Company and the Licensee with respect to the Facility, to the Lender as
specified by the Lender in the notice referred to above.
The Grantor further acknowledges and agrees that, notwithstanding
anything to the contrary contained in Section 3.4 of the License Agreement, (i)
payments with respect to the License Agreement, including Earned Royalty shall
be due as specified in Section 3.4 of the License Agreement and (ii) payments
shall be made in accordance with this Agreement and shall be deemed paid when
paid to the Lender. The Grantor further acknowledges and agrees that payments
made by the Licensee to the Lender under this Agreement shall be deemed to
satisfy the
Covol Security Agreement - 6 - December 6, 1999
<PAGE>
Licensee's corresponding payment obligations under the Licence Agreement. The
Grantor hereby agrees to continue to perform all of its obligations under the
License Agreement.
7.3 Application of Proceeds. (a) Upon the occurrence of an Event of
Default, the Lender shall have the continuing and exclusive right to apply or
reverse and re-apply any and all payments to any portion of the Obligations. To
the extent that the Grantor makes a payment or payments to the Lender or the
Lender receives any payment or proceeds of the Collateral, which payment or
proceeds or any part thereof are subsequently invalidated, declared to be
fraudulent or preferential, set aside or required to be repaid to a trustee,
receiver or any other party under any bankruptcy law, state or federal law,
common law or equitable cause, then, to the extent of such payment or proceeds,
the Obligations or part thereof intended to be satisfied and this Agreement
shall be revived and continue in full force and effect, as if such payment or
proceeds had not been received by such party.
(b) Should the Lender receive proceeds of the Collateral, the
Lender shall apply the proceeds of such amounts withdrawn as follows:
FIRST, to the payment of all reasonable costs and expenses
incurred by the Lender in connection with such collection or sale or otherwise
in connection with this Agreement or any of the Obligations, including but not
limited to all court costs and the reasonable fees and expenses of its Lenders
and legal counsel, the repayment of all advances made by the Lender hereunder on
behalf of the Grantor and any other costs or expenses incurred in connection
with the exercise of any right or remedy hereunder.
SECOND, to the payment in full of all unpaid interest and
penalties on the Debentures.
THIRD, to the payment in full of the unpaid principal amount
of the Debentures, to be applied on a pro rata basis.
FOURTH, to the payment and discharge in full of the
Obligations (other than those referred to above).
FIFTH, to the Grantor, its successors or assigns, or as a
court of competent jurisdiction may otherwise direct.
8. GENERAL PROVISIONS.
8.1 Compromises and Collection of Collateral. The Grantor recognizes
that setoffs, counterclaims, defenses and other claims may be asserted by
obligors with respect to certain of the proceeds of any and all of the
Collateral, including any Earned Royalty and any payment of profits from sales
of Proprietary Binder Material, that certain of such proceeds may be or become
uncollectible in whole or in part and that the expense and probability of
success in
Covol Security Agreement - 7 - December 6, 1999
<PAGE>
litigating disputed Collateral proceeds may exceed the amount that reasonably
may be expected to be recovered with respect to such Collateral proceeds. In
view of the foregoing, the Grantor agrees that the Lender may at any time and
from time to time compromise with the obligor on any Collateral proceeds, accept
in full payment of any Collateral proceeds such amount as the Lender in its sole
discretion shall determine, or abandon any Collateral proceeds, and any such
action by the Lender shall be commercially reasonable so long as the Lender acts
in good faith based on information known to it at the time it takes any such
action.
8.2 Secured Party Performance of Grantor Secured Liabilities. Without
having any obligation to do so, the Lender may, upon notice to the Grantor,
perform or pay any obligation which the Grantor has agreed to perform or pay in
this Agreement but has not performed or paid and the Grantor shall reimburse the
Lender for any amounts paid or incurred pursuant to this Section 8.2. The
Grantor's obligation to reimburse the Lender pursuant to the preceding sentence
shall be an Obligation payable on demand and shall bear interest at the rate of
2.5% per month from the date of payment until payment in full.
8.3 Authorization for Secured Party To Take Certain Action. Upon the
occurrence of an Event of Default or with the consent of the Grantor, which
consent shall not be unreasonably withheld, the Grantor irrevocably authorizes
the Lender at any time and from time to time in the sole discretion of the
Lender, and irrevocably appoints the Lender as its attorney-in-fact to act on
behalf of the Grantor, in the name of the Grantor or otherwise, from time to
time in the Lender's discretion, to take any action and to execute any
instrument which the Lender may deem necessary or advisable to accomplish the
purposes of this Agreement, including without limitation (a) to execute on
behalf of the Grantor as debtor and to file financing statements necessary or
desirable in the Lender's sole discretion to perfect and to maintain the
perfection and priority of the Lender's security interest in the Collateral; (b)
to endorse, deposit and collect any cash and other proceeds of the Collateral;
(c) to file a carbon, photographic or other reproduction of this Agreement or
any financing statement with respect to the Collateral as a financing statement
in such offices as the Lender in its sole discretion deems necessary or
desirable to perfect and to maintain the perfection and priority of the Lender's
security interest in the Collateral; (d) to enforce payment of the Earned
Royalty and the payments from sales of Proprietary Binder Material in the name
of the Lender or the Grantor; (e) to cause the proceeds of any Collateral
received by the Lender to be applied to the Obligations; (f) to sign the
Grantor's name on any invoice or bill of lading relating to any Collateral,
including any Earned Royalty and Proprietary Binder Material profits, on drafts
against customers, on schedules and assignments of such Collateral, on notices
of assignment, financing statements and other public records, on verifications
of accounts and on notices to licensees; (g) to send requests for verification
of any Collateral or any proceeds therefrom, including Earned Royalty and
Proprietary Binder Material profits to licensees or account debtors (provided
that this clause (g) shall not limit the Lender's rights under Section 4.01);
(h) to do all things necessary to carry out this Agreement; (i) to grant or
issue any exclusive or nonexclusive license under the Collateral to any Person,
to the extent consistent with the terms of the License Agreement, and (j) to
assign, pledge, convey or otherwise transfer title in or to or dispose of the
Collateral to anyone, including without limitation, to
Covol Security Agreement - 8 - December 6, 1999
<PAGE>
make assignments, recordings, registrations and applications therefor in the
United States Patent and Trademark Office, the United States Copyright Office or
any similar office or agency of the United States, any State thereof or any
other country or political subdivision thereof, and to execute and deliver any
and all agreements, documents, instruments of assignment or other papers
necessary or advisable to effect any of the foregoing or the recordation,
registration, filing or perfection thereof. The Grantor ratifies and approves
all acts of such attorney-in-fact. The Lender will not be liable for any acts or
omissions except those determined pursuant to a final, non-appealable order of a
court of competent jurisdiction to have resulted solely from the Lender's gross
negligence or willful misconduct. The power conferred on the Lender hereunder is
solely to protect its interests in the Collateral and shall not impose any duty
upon the Lender to exercise such power. This power, being coupled with an
interest, is irrevocable.
8.4 Grantor Remains Liable. Anything contained in this Agreement to the
contrary notwithstanding, (a) the Grantor shall remain solely liable to perform
its duties and obligations under the License Agreement included in the
Collateral to the extent set forth therein to the same extent as if this
Agreement had not been executed, (b) the exercise by the Lender of any of its
rights and remedies hereunder shall not release any Grantor from any of its
duties or obligations under the License Agreement included in the Collateral
except to the extent the exercise of such rights renders the performance of such
duties or obligations by the Grantor impracticable under any such agreement or
contract, and (c) the Lender shall not have any obligation or liability under
any License Agreement included in the Collateral by reason of this Agreement,
and the Lender shall not be obligated in any manner to perform any of the
obligations or duties of the Grantor thereunder or to take any action to collect
or enforce any claim for payment assigned hereunder.
9. MISCELLANEOUS
9.1 Security Interest Absolute. All rights of the Lender hereunder, the
security interest granted hereby, and all obligations of the Grantor hereunder,
shall be absolute and unconditional irrespective of (a) any lack of validity or
enforceability of the Debentures, any agreement with respect to any of the
Obligations or any other agreement or instrument relating to any of the
foregoing, (b) any change in the time, manner or place of payment of, or in any
other term of, all or any of the Obligations, or any other amendment or waiver
of or any consent to any departure from the Debentures or any other agreement or
instrument, (c) any exchange, release or non-perfection of any other Collateral,
or any release, amendment or waiver of, or consent to or departure from, any
guaranty for all or any of the Obligations, or (d) any other circumstance which
might otherwise constitute a defense available to, or a discharge of, the
Grantor in respect of the Obligations or in respect of this Agreement.
9.2 Lender's Fees and Expenses; Indemnification. (a) The Grantor agrees
to pay upon demand to the Lender the amount of all reasonable expenses,
including the fees and expenses of its counsel and of any experts of the Lender,
which the Lender may incur in connection with (i)
Covol Security Agreement - 9 - December 6, 1999
<PAGE>
the administration of this Agreement, (ii) the custody or preservation of, or
the sale of, collection from, or other realization upon, any of the Collateral,
(iii) the exercise or enforcement of any of the rights of the Lender hereunder,
or (iv) the failure by the Grantor to perform or observe any of the provisions
hereof.
(b) Without limitation of its indemnification obligations
under the Purchase Agreement or any Related Documents (as defined in the
Purchase Agreement) the Grantor agrees to indemnify the Lender against, and
defend and hold it harmless from, any and all losses, claims, damages,
liabilities and related expenses, including reasonable fees, disbursements and
other charges of counsel, incurred by or asserted against it arising out of, in
any way connected with, or as a result of, the execution, delivery or
performance of this Agreement or any claim, litigation, investigation or
proceeding relating hereto or to the Collateral, whether or not the Lender is a
party thereto; provided that such indemnity shall not, as to the Lender, be
available to the extent that such losses, claims, damages, liabilities or
related expenses are determined by a court of competent jurisdiction by final
and nonappealable judgment to have resulted from the gross negligence or willful
misconduct of the Lender.
(c) Any such amounts payable as provided hereunder shall be
additional Obligations secured by this Agreement. The provisions of this Section
9.2 shall remain operative and in full force and effect regardless of the
termination of this Agreement, the consummation of the transactions contemplated
hereby, the repayment of any of the Debentures, the invalidity or
unenforceability of any term or provision of this Agreement, or any
investigation made by or on behalf of the Lender. All amounts due under this
Section 9.2 shall be payable on written demand therefor and shall bear interest
at the rate of 2.5% per month from the date incurred by Lender until paid in
full
9.3 No Amendment of License the Agreements. The Grantor hereby agrees
not to amend or waive any provision of the License Agreements without the
written consent (which shall not be unreasonably withheld) of the Lender.
9.4 Binding Agreement; Assignments. This Agreement, and the terms,
covenants and conditions hereof, shall be binding upon and inure to the benefit
of the parties hereto and their respective successors and permitted assigns,
except that the Grantor shall not be permitted to assign this Agreement or any
interest herein or in the Collateral or any part thereof, or otherwise pledge,
encumber or grant any option with respect to the Collateral or any part thereof,
or any cash or property held by the Lender as Collateral under this Agreement,
except as contemplated by this Agreement or the Debentures.
9.5 GOVERNING LAW. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN
ACCORDANCE WITH THE INTERNAL SUBSTANTIVE LAWS OF THE STATE OF UTAH WITHOUT
GIVING EFFECT TO THE LAWS OF CONFLICT OR CHOICE OF LAWS OF THE STATE OF UTAH OR
ANY OTHER JURISDICTION THAT
Covol Security Agreement - 10 - December 6, 1999
<PAGE>
WOULD RESULT IN THE APPLICATION OF ANY LAWS OTHER THAN THOSE OF THE STATE OF
UTAH.
9.6 Consent to Jurisdiction and Service of Process. With respect to
jurisdiction, service of process, jury trial and all other procedural matters
the Grantor agrees that the provisions of Section 12.11 of the Purchase
Agreement apply to this Agreement mutatis mutandis.
9.7 Notices. All communications and notices hereunder shall be in
writing and given as provided in the Debentures.
9.8 Severability. In case any one or more of the provisions contained
in this Agreement should be invalid, illegal or unenforceable in any respect, no
party hereto shall be required to comply with such provision for so long as such
provision is held to be invalid, illegal or unenforceable and the validity,
legality and enforceability of the remaining provisions contained herein shall
not in any way be affected or impaired. The parties shall endeavor in good-faith
negotiations to replace the invalid, illegal and unenforceable provisions with
valid provisions, the economic effect of which comes as close as possible to
that of the invalid, illegal or unenforceable provisions.
9.9 Counterparts. This Agreement may be executed in two or more
counterparts, each of which shall constitute an original, but all of which, when
taken together, shall constitute but one instrument.
9.10 Termination. (a) This Agreement and the security interest granted
hereby shall terminate only after all the Obligations have been indefeasibly
paid in full and the Lender has no further commitment to lend under the
Debentures, at which time the Lender shall execute and deliver to the Grantor
all Uniform Commercial Code termination statements and similar documents
prepared by the Grantor which the Grantor shall reasonably request to evidence
such termination.
(b) Notwithstanding anything to the contrary contained in this
Agreement, this Agreement shall remain in full force and effect and continue to
be effective should any petition be filed by or against the Grantor for
liquidation or reorganization, should the Grantor become insolvent or make an
assignment for any benefit of creditors or should a receiver or trustee be
appointed for all or any significant part of the Grantor's assets, and shall
continue to be effective or be reinstated, as the case may be, if at any time
payment and performance of the obligations, or any part thereof, is, pursuant to
applicable law, rescinded or reduced in amount, or must otherwise be restored or
returned by any obligee of the obligations, whether as a "voidable preference",
"fraudulent conveyance" or otherwise, all as though such payment, or any part
thereof, is rescinded, reduced, restored or returned.
Covol Security Agreement - 11 - December 6, 1999
<PAGE>
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the date first above written.
Grantor: COVOL TECHNOLOGIES, INC.
Attest:
/s/ Harlan M. Hatfield By: /s/ Steven G. Stewart
- ------------------------------------- ---------------------------------
Harlan M. Hatfield, General Counsel & Steven G. Stewart, Chief
Corporate Secretary Financial Officer
By: /s/ Stanley M. Kimball
--------------------------------
Stanley M. Kimball, Executive
Vice President
Lender: DH FINANCIAL, L.C.
By: /s/ Brad Dennis
--------------------------------
Its Manager
Covol Security Agreement - 12 - December 6, 1999
COVOL TECHNOLOGIES, INC.
List of Subsidiaries &
Jurisdiction
Name Organization
Utah Synfuel #1, L.P. Delaware limited partnership
Alabama Synfuel #1, L.P. Delaware limited partnership
Flat Ridge Corporation Utah corporation
Commonwealth Synfuel, L.L.C. Utah limited liability company
Carbon Synfuel, L.L.C. Utah limited liability company
Pocahontas Synfuel, L.L.C. Utah limited liability company
Mountaineer Fuels, L.L.C. Utah limited liability company
Synfuel Investments, Inc. Utah corporation
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-3 (File No.'s. 333-67371, 333-79385 and 333-85753) of Covol
Technologies, Inc. (the "Company") of our report dated January 13, 2000, which
includes an explanatory paragraph regarding substantial doubt about the
Company's ability to continue as a going concern, relating to the financial
statements, which appears in this Form 10-K.
/s/ PricewaterhouseCoopers LLC
Salt Lake City, Utah
January 13, 2000
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEAR ENDED SEPTEMBER 30,
1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-END> SEP-30-1999
<CASH> 461
<SECURITIES> 0
<RECEIVABLES> 5,877
<ALLOWANCES> 0
<INVENTORY> 573
<CURRENT-ASSETS> 27,069
<PP&E> 17,196
<DEPRECIATION> 3,014
<TOTAL-ASSETS> 58,095
<CURRENT-LIABILITIES> 28,868
<BONDS> 17,887
4,332
1
<COMMON> 13
<OTHER-SE> (1,042)
<TOTAL-LIABILITY-AND-EQUITY> 58,095
<SALES> 2,907
<TOTAL-REVENUES> 6,719
<CGS> 14,651
<TOTAL-COSTS> 14,651
<OTHER-EXPENSES> 9,754
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 6,253
<INCOME-PRETAX> (28,393)
<INCOME-TAX> 0
<INCOME-CONTINUING> (28,393)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (28,393)
<EPS-BASIC> (2.39)
<EPS-DILUTED> (2.39)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED SEPTEMBER 30,
1998 AND 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> SEP-30-1998 SEP-30-1997
<PERIOD-END> SEP-30-1998 SEP-30-1997
<CASH> 727 4,780
<SECURITIES> 0 0
<RECEIVABLES> 4,212 1,099
<ALLOWANCES> 0 0
<INVENTORY> 1,645 1,819
<CURRENT-ASSETS> 37,049 8,837
<PP&E> 16,879 14,215
<DEPRECIATION> 1,070 596
<TOTAL-ASSETS> 68,061 26,590
<CURRENT-LIABILITIES> 29,552 12,308
<BONDS> 14,077 3,389
0 0
1 1
<COMMON> 11 9
<OTHER-SE> 14,734 6,416
<TOTAL-LIABILITY-AND-EQUITY> 68,061 26,590
<SALES> 2,114 42
<TOTAL-REVENUES> 3,074 147
<CGS> 7,095 5,260
<TOTAL-COSTS> 7,095 5,260
<OTHER-EXPENSES> 1,157 2,058
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 2,745 1,645
<INCOME-PRETAX> (11,308) (10,498)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (11,308) (10,498)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (11,308) (10,498)
<EPS-BASIC> (1.17) (1.32)
<EPS-DILUTED> (1.17) (1.32)
</TABLE>
