UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the quarterly period ended December 31, 1999
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the transition period from ______ to ______
Commission file number 0-27808
COVOL TECHNOLOGIES, INC.
------------------------
(Exact name of registrant as specified in its charter)
Delaware 87-0547337
-------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3280 North Frontage Road
Lehi, Utah 84043
---------- -----
(Address of principal executive offices) (Zip Code)
(801) 768-4481
------------------
(Registrant's telephone number, including area code)
Not applicable
--------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
The number of shares outstanding of the Registrant's common stock as of
February 4, 2000 was 17,808,915.
<PAGE>
COVOL TECHNOLOGIES, INC.
TABLE OF CONTENTS
Page No.
PART I FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL INFORMATION (Unaudited):
Consolidated Balance Sheets As of September 30, 1999
and December 31, 1999........................................3
Consolidated Statements of Operations For the three
months ended December 31, 1998 and 1999..................... 5
Consolidated Statement of Changes in Stockholders'
Equity (Deficit) For the three months ended December
31, 1999.................................................... 6
Consolidated Statements of Cash Flows For the three
months ended December 31, 1998 and 1999..................... 7
Notes to Consolidated Financial Statements.................... 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.....................................15
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS...............................................19
ITEM 2. CHANGES IN SECURITIES...........................................19
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.................................19
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............20
ITEM 5. OTHER INFORMATION...............................................20
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................20
SIGNATURES.................................................................21
Certain statements in this Report constitute forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995. As such,
actual results may vary materially from current expectations. For a discussion
of certain of the factors that could cause actual results to differ from
expectations, please see the information set forth under the caption entitled
Forward Looking Statements in PART I, ITEM 2 hereof. There can be no assurance
that Covol's results of operations will not be adversely affected by such
factors. Covol undertakes no obligation to revise or publicly release the
results of any revision to these forward-looking statements. Readers are
cautioned not to place undue reliance on these forward looking statements, which
reflect management's opinion only as of the date hereof.
2
<PAGE>
ITEM 1. CONSOLIDATED FINANCIAL INFORMATION (Unaudited)
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
(thousands of dollars) 1999 1999
- ------------------------------------------------------------------------------------------- ---------------- -----------------
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 461 $ 7,457
Receivables 3,155 7,015
Due from related party 2,722 2,951
Inventories 573 394
Facilities and equipment held for sale 20,139 17,915
Prepaid expenses and other current assets 19 45
Deferred income taxes -- 3,000
---------------- -----------------
Total current assets 27,069 38,777
---------------- -----------------
Property, plant and equipment, net of accumulated depreciation 14,182 3,785
---------------- -----------------
Other assets:
Restricted cash and investments 843 690
Facility-dependent note and accrued interest receivable 7,879 8,119
Facility transferred under note receivable arrangement 2,641 2,641
Intangible assets, net of accumulated amortization 3,647 1,347
Deposits and other assets 1,834 1,801
---------------- -----------------
Total other assets 16,844 14,598
---------------- -----------------
Total assets $58,095 $57,160
================ =================
</TABLE>
(continued)
The accompanying notes are an integral
part of the consolidated financial statements
3
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS, continued
(Unaudited)
September 30, December 31,
(thousands of dollars and shares) 1999 1999
- -------------------------------------------------------------------------------------------- --------------- ----------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
<S> <C> <C>
Accounts payable $ 1,179 $ 1,034
Due to related party 2,706 2,888
Accrued interest payable, current 1,452 1,257
Accrued liabilities 2,905 3,252
Notes payable, current 20,626 17,746
--------------- ----------------
Total current liabilities 28,868 26,177
--------------- ----------------
Long-term liabilities:
Notes payable, non-current 17,887 19,979
Accrued interest payable, non-current 210 259
Deferred revenues from advance license fees 7,501 7,271
Deferred compensation 208 211
--------------- ----------------
Total long-term liabilities 25,806 27,720
--------------- ----------------
Total liabilities 54,674 53,897
--------------- ----------------
Minority interest in consolidated subsidiaries 117 --
--------------- ----------------
Commitments and contingencies
Redeemable convertible preferred stock, $0.001 par value, issued and outstanding 60 shares
at September 30, 1999 and 45 shares at December 31, 1999 (aggregate liquidation
preference of $5,697 at December 31, 1999) 4,332 3,234
--------------- ----------------
Stockholders' equity (deficit):
Convertible preferred stock, $0.001 par value; authorized 10,000 shares, issued and
outstanding 17 shares at September 30, 1999 and December 31, 1999
(aggregate liquidation preference of $3,542 at December 31, 1999) 1 1
Common stock, $0.001 par value; authorized 25,000 shares, issued and outstanding
12,766 shares at September 30, 1999 and 17,177 shares at December 31, 1999 13 17
Capital in excess of par value 78,457 81,216
Accumulated deficit (71,713) (73,757)
Notes and interest receivable related parties, from issuance of, or collateralized
by, common stock, net of allowance (6,564) (6,272)
Deferred compensation from stock options (1,222) (1,176)
--------------- ----------------
Total stockholders' equity (deficit) (1,028) 29
--------------- ----------------
Total liabilities and stockholders' equity (deficit) $58,095 $57,160
=============== ================
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
4
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended December 31,
(thousands of dollars, except per-share data) 1998 1999
- -------------------------------------------------------------- ---------------- --------------- --------------- -----------------
Revenues:
<S> <C> <C>
License fees $ 701 $4,036
Binder sales 533 1,352
Gain on sale of facility -- 5,341
Other 148 320
--------------- -----------------
Total revenues 1,382 11,049
--------------- -----------------
Operating costs and expenses:
Cost of coal briquetting operations 3,646 1,589
Cost of binder 376 860
Asset write-offs and other non-recurring charges -- 11,021
Selling, general and administrative 929 912
Compensation expense from stock options 162 46
--------------- -----------------
Total operating costs and expenses 5,113 14,428
--------------- -----------------
Operating loss (3,731) (3,379)
--------------- -----------------
Other income (expense):
Interest income 756 800
Interest expense (1,036) (2,055)
Write-down of notes receivable related
parties, collateralized by common stock (571) (292)
Other, net 24 --
--------------- -----------------
Total other income (expense) (827) (1,547)
--------------- -----------------
Net loss before income taxes (4,558) (4,926)
Income tax benefit -- (3,000)
--------------- -----------------
Net loss $(4,558) $(1,926)
=============== =================
Basic and diluted loss per common share $(.39) $(.16)
=============== =================
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
5
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
For the Three Months Ended December 31, 1999
(Unaudited)
Convertible Preferred
Stock Common Stock Capital in
-------------------------- --------------------------- excess of par
(thousands of dollars and shares) Shares Amount Shares Amount value
- -------------------------------------------------------- ------------- ----------- ------------ -------------- ----------------
<S> <C> <C> <C> <C> <C>
Balances at September 30, 1999 17 $1 12,766 $13 $78,457
Preferred stock cash dividends
Common stock issued on conversion of redeemable
convertible preferred stock, preferred stock and in
payment of dividends - - 1,793 2 1,107
Common stock issued on conversion of convertible debt 2,618 2 1,114
Value of common stock warrants issued in connection
with convertible debt financing - - 468
Value of extended common stock warrants and repriced
stock options issued in connection with debt financing - - 70
Write-down of notes receivable related parties
Amortization of deferred compensation from stock
options
Net loss for the three months ended December 31, 1999
------------- ------------ ------------ -------------- ----------------
Balances at December 31, 1999 17 $1 17,177 $17 $81,216
============= ============ ============ ============== ================
<CAPTION>
Notes and
interest
receivable
-related
parties, from
issuance of,
or Deferred
collateralized compensation
Accumulated by, common from stock
(thousands of dollars and shares) deficit stock options
- -------------------------------------------------------- ------------- --------------- --------------
<S> <C> <C> <C>
Balances at September 30, 1999 $(71,713) $(6,564) $(1,222)
Preferred stock cash dividends (107)
Common stock issued on conversion of redeemable
convertible preferred stock, preferred stock and in
payment of dividends (11)
Common stock issued on conversion of convertible debt
Value of common stock warrants issued in connection
with convertible debt financing
Value of extended common stock warrants and repriced
stock options issued in connection with debt financing
Write-down of notes receivable related parties 292
Amortization of deferred compensation from stock 46
options
Net loss for the three months ended December 31, 1999 (1,926)
------------- --------------- --------------
Balances at December 31, 1999 $(73,757) $(6,272) $(1,176)
============= =============== ==============
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
6
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended December 31,
(thousands of dollars) 1998 1999
- ------------------------------------------------------------------------------------------------- ----------------- -------------
Cash flows from operating activities:
<S> <C> <C>
Net loss $ (4,558) $(1,926)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 408 583
Recognition of deferred revenue from advance license fees (227) (230)
Deferred income taxes -- (3,000)
Gain on sale of facility -- (5,341)
Asset write-offs and other non-recurring charges -- 10,412
Amortization of deferred compensation from stock options 162 46
Interest expense related to amortization of debt discount and debt issuance costs 82 1,150
Write-down of notes receivable related parties 571 292
Increase (decrease) from changes in operating assets and liabilities, net of effects
from investing and financing activities (660) (4,193)
----------------- -------------
Net cash used in operating activities (4,222) (2,207)
----------------- -------------
Cash flows from investing activities:
Proceeds from sale of facility and equipment -- 9,497
Purchase of property, plant and equipment and facilities held for sale (410) (69)
Decrease (increase) in deposits collateralizing letters of credit and restricted cash (143) 153
Purchase of other assets -- (75)
Proceeds from facility transferred under note receivable arrangement 130 --
Purchase of rights to technology (100) --
----------------- -------------
Net cash provided by (used in) investing activities (523) 9,506
----------------- -------------
Cash flows from financing activities:
Proceeds from issuance of notes payable and warrants, net 1,049 2,758
Payments on notes payable -- (2,954)
Preferred stock dividends -- (107)
Proceeds from issuance of common stock and warrants, net 3,774 --
Payments on notes payable related parties (78) --
Other (52) --
----------------- -------------
Net cash provided by (used in) financing activities 4,693 (303)
----------------- -------------
Net increase (decrease) in cash and cash equivalents (52) 6,996
Total cash and cash equivalents, beginning of period 727 461
----------------- -------------
Total cash and cash equivalents, end of period $ 675 $ 7,457
================= =============
Supplemental schedule of non-cash investing and financing activities:
Common stock issued on conversion of preferred stock and in payment of dividends $2,159 $1,227
Common stock issued on conversion of convertible debt -- 1,116
Common stock issued to purchase minority interests in subsidiaries 519 --
Common stock issued for rights to technology 375 --
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
7
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
---------------------
1. Nature of Operations and Basis of Presentation
Covol Technologies, Inc. and Subsidiaries' (Covol) primary business is to
commercialize its binder technologies which are used to recycle waste
by-products from the coal, steel and other industries into marketable fuel
and resources. Through June 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 December 31, 1999, Covol and its licensees were operating 28
facilities in ten states at various levels of production. During 1999,
Covol has been actively pursuing the sale of its four owned facilities. One
of the facilities was sold in August 1999, another was sold in December
1999 and a third was sold in January 2000 (see Note 5). Covol expects to
sell the remaining facility in early 2000. 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. There are four facilities that use an
alternative technology that Covol acquired in early fiscal 1999. In the
aggregate, 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 purchaser's 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.
In addition to the operating results for the quarter ended December 31,
1999, 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 3, Covol has $17,746,000 of long-term debt
that becomes due during the 12 months ending December 31, 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 $5,700,000 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 the earnings target was met for the
quarter
8
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
---------------------
ended December 31, 1999 and expects continued compliance during the
remaining quarters of fiscal 2000. Covol and a third-party solicitor have
been actively contacting shareholders in an effort to obtain approval for
this transaction.
Covol funded its operations during the quarter ended December 31, 1999 and
during the past fiscal year primarily through the issuance of debt and
equity securities and the sale of synthetic fuel facilities. 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 facility
held for sale, funds receivable upon reaching performance milestones
related to a synthetic fuel facility sold in August 1999 and the facility
and option sold in January 2000 (see Note 5), funds from operations, and
only if no other alternatives exist, additional financing. Covol believes
that if necessary, it will be able to extend the repayment terms of its
debt and that future proceeds from the sale of facilities will be
sufficient to fund Covol's operations until its operating activities begin
producing positive cash flow.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the rules and regulations of the Securities and
Exchange Commission for quarterly reports on Form 10-Q. In the opinion of
management, all adjustments considered necessary for a fair presentation
have been included. All adjustments, except as described in Note 6, consist
of normal recurring adjustments. The results of operations for the periods
presented are not necessarily indicative of the results to be expected for
the full year. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted. It is
suggested that these financial statements be read in conjunction with the
consolidated financial statements and notes thereto included in Covol's
Annual Report on Form 10-K for the year ended September 30, 1999. Certain
prior period amounts have been reclassified to conform with the current
period's presentation. The reclassifications had no effect on net loss,
total assets or total liabilities.
2. Financing Transactions
During and subsequent to the quarter ended December 31, 1999, Covol
completed several financing transactions, including the following.
Convertible Debt
During the quarter ended December 31, 1999, Covol issued convertible
secured debt and warrants to purchase approximately 1,172,000 shares of
common stock, in two unrelated transactions, for total net proceeds of
approximately $2,800,000. 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. The
debt was convertible at market and, during this period, convertible debt
with a face amount of approximately $1,460,000 and a carrying value of
approximately $1,116,000 was converted into approximately 2,618,000 shares
of common stock. In January 2000, Covol redeemed the remaining convertible
debt issued during the quarter, and currently none of the convertible debt
issued remains outstanding.
Preferred Stock
During the quarter ended December 31, 1999, the remaining 200 shares of
Series C preferred stock, along with related accumulated but undeclared
dividends, were converted into approximately 189,000 shares of common
stock. Also, during the quarter, 15,202 shares of Series D redeemable
convertible preferred stock were converted into approximately 1,604,000
shares of common stock. Subsequent to December 31, 1999 and through
February 4, 2000, an additional 2,962 shares of Series D redeemable
convertible preferred stock were converted into approximately 426,000
shares of common stock.
Warrants and Options
In addition to the issuance of warrants described above, the terms of
existing warrants for the purchase of approximately 183,000 shares of
common stock at an exercise price of $7.50 per share were amended to extend
the exercise periods for
9
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
---------------------
approximately seven months. Also the terms of existing options for the
purchase of approximately 60,000 shares of common stock were amended to
reduce the exercise price from $8.58 per share to $2.93 per share. The
extended warrants and repriced options were valued at approximately
$70,000, which value is being amortized as interest over the term of the
related debt.
3. Notes Payable
<TABLE>
<CAPTION>
Notes payable consist of the following:
September 30, December 31,
(thousands of dollars) 1999 1999
---------------------------------------------------------------------------------------------- -------------- ---------------
<S> <C> <C>
Note payable to a corporation, bearing interest at 6%, collateralized by a coal wash plant
in Utah, principal and interest originally due January 2000, amended to be due October 2000, $ 4,313 $ 4,325
as described below.
Note payable to the same corporation referred to in the preceding paragraph, bearing
interest at prime, repaid in December 1999. 2,900 --
Note payable to the same corporation referred to in the preceding two paragraphs, bearing
interest at 6%, repaid in January 2000 (see Note 5). 6,500 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 9,191 9,191
from six synthetic fuel facilities.
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 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 10,265 11,089
synthetic fuel from five synthetic fuel facilities.
Convertible secured notes payable to a Covol shareholder and an unrelated entity, issued at
a discount, bearing a stated interest rate of 8% on the $2,540 combined face amount
outstanding at December 31, 1999. The notes were redeemed by Covol in January 2000 (see 622 1,950
Note 2).
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 future license fees payable to Covol from the production
and sale of synthetic fuel from certain synthetic fuel facilities. A member of Covol's 4,000 4,000
Board of Directors is affiliated with this corporation.
Other 722 670
-------------- ---------------
38,513 37,725
Less: current portion (20,626) (17,746)
-------------- ---------------
Total non-current $17,887 $19,979
============== ===============
</TABLE>
In February 2000, Covol entered into an assignment and amendment agreement
with Coaltech and the lender of the $4,325,000 note payable described above
(which is a limited partner of Coaltech). Under the terms of the agreement,
Covol assigned its interest in a note receivable due from Coaltech
(classified as facility transferred under note receivable arrangement in
the consolidated balance sheet) to the lender. The principal and interest
due under the $4,325,000 note payable (which totaled approximately
$4,880,000 at December 31, 1999) was reduced by the note receivable balance
leaving a remaining balance of approximately $1,962,000, which amount, plus
future accrued interest, is now due October 2000. All note payments,
including interest, under the note receivable arrangement which have been
paid to Covol from Coaltech, have reduced the carrying amount of that
asset. Accordingly, in the March 2000 quarter, Covol will recognize a gain
of approximately $300,000 representing the interest on the note receivable
which has not been recognized to date.
Substantially all facilities and equipment held for sale and most of
Covol's property, plant and equipment and license fees from the production
and sale of synthetic fuel from owned and licensed synthetic fuel
facilities are collateral for notes
10
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
---------------------
payable. The weighted average interest rate on notes payable was 7.9% at
September 30, 1999 and 7.6% at December 31, 1999.
4. Basic and Diluted Loss per Share
<TABLE>
<CAPTION>
Three Months Ended
-----------------------------------
December 31, December 31,
(thousands of dollars and shares, except per-share data) 1998 1999
------------------------------------------------------------- ---------------------- ------------------ ----------------
Numerator:
<S> <C> <C>
Net loss $(4,558) $(1,926)
Preferred stock dividends (undeclared) (60) (146)
Imputed preferred stock dividends -- (58)
------------------ ----------------
Net loss attributable to common stockholders $(4,618) $(2,130)
================== ================
Denominator - weighted-average shares outstanding 11,976 13,610
================== ================
Basic and diluted loss per common share $(0.39) $(0.16)
================== ================
</TABLE>
5. 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. Covol reported a gain on this transaction of approximately
$5,341,000. Covol will also sell proprietary binder material used at the
facility and will receive an ongoing royalty based upon production and sale
of synthetic fuel from this facility. Net cash proceeds to Covol after
payment of construction debt and certain other obligations were
approximately $5,500,000.
In January 2000, Covol sold a synthetic fuel facility located in North
Fork, West Virginia and an option to acquire a licensee facility located in
Nevada, to a major U.S. utility. Combined net cash proceeds to Covol after
payment of related debt and other obligations were approximately
$1,500,000. Covol will report a combined loss on these transactions of
approximately $600,000 in the March 2000 quarter. Both facilities will be
relocated to the purchaser's site and additional funds, totaling
approximately $8,500,000, are due to Covol when the two facilities reach
commercial operation at the new location, at which time the $8,500,000 will
be recognized as revenue. Following receipt of the subsequent payment
related to the relocation and commercial operation of the West Virginia
facility, Covol has agreed to pay $2,000,000 to the current site owner and
feedstock supplier to terminate those contractual relationships. Covol will
provide binder used at both facilities and will receive future royalties
based upon production and sale of synthetic fuel at the facilities.
Also in January 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 should occur prior to March 31, 2000. Funds from the sale of this
facility are expected to be sufficient to repay the debt incurred in the
construction and operation of this facility, which debt has an outstanding
balance of $9,191,000 at December 31, 1999. The debt is due June 30, 2000.
6. Asset Write-offs and Other Non-recurring Charges
Coaltech owns a synthetic fuel facility which is located on the same
property as the facility that was sold by Covol in December 1999. As a
result of the anticipated relocation of the facility owned by Coaltech,
combined with the sale and relocation of Covol's owned facility and the
Earthco Complaint, all of which relate to the same property site in Price,
Utah (see Notes 5 and 8), Covol recorded in the December 1999 quarter an
impairment charge of approximately $10,300,000. This impairment charge
consisted of an approximate $8,100,000 writedown to net realizable value of
certain plant and equipment which remains on the site and is now idle, plus
an approximate $2,200,000 writeoff of an intangible asset which is no
longer considered recoverable due to the relocation of the Coaltech
facility.
11
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
---------------------
Covol recorded other asset write-offs and non-recurring charges in the
quarter ended December 31, 1999 which, when added to the charges described
in the preceding paragraph, totaled approximately $11,021,000. Of this
amount, approximately $10,412,000 did not involve the use of cash.
7. Income Taxes
In the quarter ended December 31, 1999, Covol reduced its deferred tax
asset valuation allowance by $3,000,000. Covol believes it is more likely
than not that this portion of its total deferred tax assets will be
realized as a result of income resulting from the sale in January 2000 of a
synthetic fuel facility and an option to acquire a synthetic fuel facility.
8. Commitments and Contingencies
Commitments and contingencies as of December 31, 1999 not disclosed
elsewhere, are as follows.
Included in accrued liabilities at September 30, 1999 and December 31, 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, Covol 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 through 2007, 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 received 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.
In anticipation of a relocation of the Utah facility by Coaltech, 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. As
more fully described in Note 3, in February 2000, Covol, Coaltech and one
of the limited partners of Coaltech reached a settlement regarding both the
note payable due to the limited partner from Covol and the note receivable
due to Covol from Coaltech. It is likely that the ultimate outcome of these
negotiations will result in relocation of the Utah facility to a new
location and termination of contractual and operational activities between
Covol and the limited partners with settlement payments materially
consistent with amounts reflected in the accompanying consolidated
financial statements. It is also expected that the limited partners
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COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
---------------------
will continue to purchase binder materials from Covol and use Covol's
technology in the production of synthetic fuel when operations of the
facility are resumed.
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. Covol assigned this agreement to the purchaser of the
facility and accordingly, has no ongoing obligation. Covol has been paid
for the coal fines sold to the facility purchaser 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 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, $469,000 was accrued as of
September 30, 1999 and was paid in November 1999. An additional $279,000
was paid in December 1999 and $622,000 was paid subsequent to December 31,
1999 through February 4, 2000. The remaining balance of $130,000 is
expected to be paid upon the receipt of cash proceeds from the future sale
of the remaining synthetic fuel facility 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 secured note (see
Note 3). 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 the one remaining owned synthetic fuel
facility. Current negotiations contemplate the relocation of the facility
by the purchaser. Covol may incur up to $3,000,000 in costs associated with
relocation. Any costs paid by Covol will reduce the net proceeds and the
gain recognized on the sale of the facility.
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 and November 1999 payments 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, 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 $5,000,000. 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
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COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
---------------------
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.
During the quarter ended December 31, 1999, Covol recorded approximately
$3,000,000 of license fee revenues from a single licensee that owns four
synthetic fuel facilities that use Covol's proprietary binder technology.
These revenues represent production and sales of synthetic fuel at these
facilities primarily between June and December 1999 and were only recently
reported by this licensee. Covol and this licensee are discussing the
ongoing license fee arrangements. These discussions could result in a
reduction of future license fees, but Covol and the licensee have not yet
agreed to any changes in the license fee agreements.
In January 2000, Covol received a letter from Nasdaq informing Covol that
it may not meet continued listing requirements of the Nasdaq Stock Market.
Covol has responded to Nasdaq indicating why it believes the listing should
be continued and that it expects to be in compliance with all listing
requirements by March 31, 2000 or shortly thereafter and is awaiting a
response from Nasdaq.
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.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following Management's Discussion and Analysis should be read in conjunction
with the accompanying unaudited consolidated financial statements and notes
thereto.
Three Months Ended December 31, 1999 Compared to Three Months Ended December 31,
1998
Revenues. Total revenues for the three months ended December 31, 1999 ("1999")
increased by $9,667,000 to $11,049,000 as compared to $1,382,000 for the three
months ended December 31, 1998 ("1998"). During 1999, Covol recognized license
fees totaling $4,036,000 while $701,000 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 $230,000 and recurring earned
license fees or royalty payments of $3,806,000. License fees in 1998 consisted
of the straight-line amortization of one-time non-refundable initial license
fees of $226,000 and recurring license fees or royalty payments of $475,000.
Initial license fees are not expected to increase in future periods and 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 over the long term are expected to increase in future periods, are due
quarterly based upon synthetic fuel produced and sold as reported to Covol by
its licensees. The increase in 1999 earned license fees was due in part to a
single licensee that only recently reported a significant increase in sales of
synthetic fuel in the last half of calendar 1999. Covol and this licensee are
discussing the ongoing license fee arrangements. These discussions could result
in a reduction of future license fees, but Covol and the licensee have not yet
agreed to any changes in the license fee agreements.
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. Binder sales during
1999 were $1,352,000 with a corresponding direct cost to Covol of $860,000.
Binder sales during 1998 were $533,000 with a corresponding direct cost to Covol
of $376,000. The increase in binder sales in 1999 over 1998 was due to increased
synthetic fuel production by Covol's licensees.
Covol expects continuing increases 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 because Covol is dependent upon its 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 acceptance of synthetic fuel by potential purchaser's
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 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 fuel
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 in Covol's Annual Report on
Form 10-K for the year ended September 30, 1999 for an explanation of
qualifications for Section 29 tax credits.
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<PAGE>
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. 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. To date, however, 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.
Gain on sale of facility. In 1999, Covol sold one of the three remaining
synthetic fuel facilities it owned. This facility was located in Price, Utah.
Covol reported a gain on this transaction of approximately $5,341,000. There
were no sales of synthetic fuel facilities in 1998, however Covol sold a
facility in August 1999 and sold a facility and an option to acquire a facility
in January 2000 (see Note 5 to the consolidated financial statements).
Operating Costs and Expenses. Operating costs and expenses increased by
$9,315,000 to $14,428,000 during 1999 from $5,113,000 during 1998. Cost of coal
briquetting operations decreased $2,057,000 from $3,646,000 during 1998 to
$1,589,000 during 1999. During 1999, Covol incurred significantly lower
operating expenses in connection with the continued refinement and
implementation of the briquetting process associated with the 24 facilities
placed in service during 1998, and in particular the operating costs of the
facilities owned by Covol which have now been sold or are being held for sale.
The expenses primarily related to labor and operating expenses at the 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 the cost of coal briquetting operations
to continue to decrease in 2000 as compared to 1999 levels. Covol sold one
facility in August 1999, another in December 1999 and a third in January 2000.
The remaining facility is expected to be sold in early 2000.
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 was 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 $55,000 during 1999 and $1,150,000 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 a major licensee and partner of Covol, and other related
business reasons. In October, 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 termination of the supply and purchase agreement. In February 2000,
Covol, Coaltech and one of the limited partners of Coaltech reached a settlement
regarding both the note payable due to the limited partner from Covol and the
note receivable due to Covol from Coaltech. Final settlement payments are
expected to be materially consistent with amounts reflected in the accompanying
consolidated financial statements. 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 (see Note 8 to the consolidated financial statements).
Asset write-offs and other non-recurring charges. Coaltech owns a synthetic fuel
facility which is located on the same property as the facility that was sold by
Covol in December 1999. As a result of the anticipated relocation of the
facility owned by Coaltech, combined with the sale and relocation of Covol's
owned facility, all of which relate to the same property site in Price, Utah
(see Notes 5 and 8), Covol recorded in the December 1999 quarter an impairment
charge of approximately $10,300,000. This impairment charge consisted of an
approximate $8,100,000 writedown to net realizable value of certain plant and
equipment which remains on the site and is now idle, plus an approximate
$2,200,000 writeoff of an intangible asset which is no longer considered
recoverable due to the relocation of the Coaltech facility.
Covol recorded other asset write-offs and non-recurring charges in the quarter
ended December 31, 1999 which, when added to the charges described in the
preceding paragraph, totaled approximately $11,021,000. Of this amount,
approximately $10,412,000 did not involve the use of cash.
Selling, general and administrative expenses decreased $17,000 or 2% to $912,000
during 1999 from $929,000 for 1998. The largest components of selling, general
and administrative expenses for both 1999 and 1998 were payroll, professional
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<PAGE>
services and travel expenses. Payroll costs increased approximately $100,000,
while professional services and travel expenses decreased approximately $100,000
from 1998 to 1999. Changes in other categories from year to year were not
material.
Compensation expense from stock options decreased $116,000 to $46,000 for 1999
from $162,000 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 the fiscal year ended September
30, 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. As a result of the write-off, amortization expense
has decreased and will continue below fiscal 1999 levels in the remainder of
fiscal year 2000.
Other Income and Expense. During 1999, Covol had net other expenses of
$1,547,000 compared to $827,000 for 1998. This increase of $720,000 relates
primarily to a negative variance in interest expense of $1,019,000 and positive
variances between periods of $279,000 in the mark-to-market adjustment of the
carrying value of a related party note receivable collateralized by Covol common
stock and $44,000 in interest income.
Interest expense increased in 1999 due to the higher level of debt which existed
in 1999 as compared to 1998, most notably as a result of the convertible debt
issued at a discount during March 1999. Interest expense of $1,150,000 in 1999
consisted of amortization of debt discount and debt issuance costs, while only
$82,000 of interest expense in 1998 consisted of amortization of debt discount
and debt issuance costs. Interest expense is expected to decrease as a result of
repayments of debt related to the sale of facilities in late 1999 and 2000 and
the redemptions of convertible debt in January 2000 (see Note 2 to the
consolidated financial statements).
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, $108,000 at December 31, 1999. This adjustment
resulted in a write-down of $292,000 during 1999, compared to a write-down of
$571,000 during 1998, for a variance of $279,000. Interest income of $515,000
was recognized in both 1999 and 1998 on this Note.
Income Taxes. In the quarter ended December 31, 1999, Covol reduced its deferred
tax asset valuation allowance by $3,000,000. Covol believes it is more likely
than not that this portion of its total deferred tax assets will be realized as
a result of income resulting from the sale in January 2000 of a synthetic fuel
facility and an option to acquire a synthetic fuel facility. Covol did not
recognize any income tax benefit in 1998.
Net Loss. For 1999, the net loss of $1,926,000 represents a change of $2,632,000
from the net loss of $4,558,000 in 1998. This is primarily due to increased
revenues, especially license fees and the gain on sale of facility, the
reduction in cost of coal briquetting operations, recognition of the income tax
benefit, offset by the 1999 asset write-offs and other non-recurring charges and
the increase in interest expense.
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 calendar 1999. One facility was sold in
August 1999, another was sold in December 1999 and a third was sold in January
2000. Covol currently owns one facility which is being offered for sale and
anticipates the sale of this facility in early 2000. Proceeds from the sale of
facilities have been 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 three owned
facilities operated during the quarter ended December 31, 1999 approximated
$230,000 per month. These operating expenses fluctuate depending on the level of
activity at the owned facilities.
Net cash used in operating activities for the three months ended December 31,
1999 ("1999") was $2,207,000 compared to $4,222,000 of cash used during the
three months ended December 31, 1998 ("1998"). Most of this change in cash flow
from operations is attributable to the 1999 net loss of $1,926,000 as compared
to $4,558,000 in 1998. Covol has been able to fund its operating activities,
including the continued refinement and commercialization of its patented binder
technologies, through the issuance of debt and equity securities and the sale of
a facility. During 1999, proceeds from the sale of facility were approximately
$9,497,000 and net proceeds from the issuance of notes payable and common stock
warrants totaled approximately $2,758,000. Approximately $2,954,000 of notes
payable were repaid during 1999.
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Capital Resources. During 1999, with the exception of the sale of the facility,
Covol's investing activities were not significant. Investing activities in 1998
consisted primarily of the purchase of property, plant and equipment and
facilities held for resale, with most of the funds for these activities coming
from the issuance of notes payable and equity securities. Covol believes that
funds required for investing activities will continue to be significantly lower
during fiscal 2000 as compared to fiscal 1999. Covol has no current plans to
construct additional synthetic fuel facilities or to incur significant costs to
acquire property, plant and equipment.
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. There are four facilities that use an alternative
technology that Covol acquired in early fiscal 1999. In the aggregate, 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 purchaser's 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.
In addition to the operating results for the quarter ended December 31, 1999,
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 3, Covol has $17,746,000 of long-term debt that becomes due
during the 12 months ending December 31, 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 $5,700,000 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 the earnings target was met for the quarter
ended December 31, 1999 and expects continued compliance during the remaining
quarters of fiscal 2000. Covol and a third-party solicitor have been actively
contacting shareholders in an effort to obtain approval for this transaction.
Covol funded its operations during the quarter ended December 31, 1999 and
during the past fiscal year primarily through the issuance of debt and equity
securities and the sale of synthetic fuel facilities. 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 facility held for sale, funds
receivable upon reaching performance milestones related to a synthetic fuel
facility sold in August 1999 and the facility and option sold in January 2000
(see Note 5), funds from operations, and only if no other alternatives exist,
additional financing. Covol believes that if necessary, it will
18
<PAGE>
be able to extend the repayment terms of its debt and that future proceeds from
the sale of facilities will be sufficient to fund Covol's operations until its
operating activities begin producing positive cash flow.
Forward Looking Statements
Statements in this Report regarding Covol's expectations as to the receipt of
licensing and royalty fees, the receipt of fees for sale of binder materials,
reduction in operating expenses, ability to extend or refinance debt, compliance
with debt covenants, and other information presented herein that are not purely
historical by nature, constitute forward looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995. Although Covol believes
that its expectations are based on reasonable assumptions within the bounds of
its knowledge of its business and operations, there can be no assurance that
actual results will not differ materially from its expectations. In addition to
matters affecting Covol's industry or the coal industry or the economy
generally, factors which could cause actual results to differ from expectations
set forth in the above-identified forward looking statements include, in part,
the following:
o the ability of 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 the 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;
o the availability of tax credits under Section 29 of the tax code and
qualification of facilities currently in service; and
o the ability to resolve contingencies.
See ITEM 1. BUSINESS Forward Looking Statements in Covol's Annual Report on Form
10-K for the year ended September 30, 1999 for a description of additional
factors which could cause actual results to differ from expectations.
Other Items
Covol has reviewed all recently issued, but not yet adopted, accounting
standards in order to determine their effects, if any, on the results of
operations or financial position of Covol. Based on that review, Covol believes
that none of these pronouncements will have any significant effects on current
or future financial position or results of operations.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See ITEM 3: LEGAL PROCEEDINGS in Covol's Annual Report on Form 10-K for the year
ended September 30, 1999 for descriptions of current legal proceedings. No
material changes have occurred since that report was filed.
ITEM 2. CHANGES IN SECURITIES
Recent Sales of Unregistered Securities
The following sets forth all securities issued by Covol within the past fiscal
quarter without registering the securities under the Securities Act of 1933, as
amended. No underwriters were involved in any stock issuances.
Covol believes that the following issuances of shares of common stock, or
securities exercisable for or convertible into shares of common stock, were
exempt from the registration requirements of the Securities Act of 1933, as
amended, pursuant to the exemption set forth in Section 4(2) or 4(6) thereof or
Regulation D promulgated thereunder and the certificate for each security bears
a restrictive legend. Each investor made representations to Covol that it was
accredited as that term is defined in Regulation D and that the security was
acquired for investment purposes.
Reference is made to the conversions of series C and series D preferred stock;
to the issuance of convertible debt and subsequent conversions and redemptions
of certain convertible debt; and to the amendments to the terms of certain
options and warrants for the purchase of common stock, all as described in Note
2 to the consolidated financial statements.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
19
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are included herein:
10.66 Assignment and Amendment Agreement with Covol, Utah Synfuel #1
Ltd., AJG Financial Services, Inc., and Coaltech No. 1 L.P.
27.1 Financial Data Schedule
(b) A report on Form 8-K was filed on November 10, 1999 for an event dated
November 1, 1999. In addition, a Form 8-K was filed on January 24,
2000 related to two events dated December 31, 1999 and January 18,
2000. The events reported in both Forms 8-K were reported under Item
5 Other Events.
20
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
COVOL TECHNOLOGIES, INC.
Date: February 10, 2000 By: /s/ Kirk A. Benson
---------------------------------------
Kirk A. Benson, Chief Executive Officer
and Principal Executive Officer
Date: February 10, 2000 By: /s/ Steven G. Stewart
---------------------------------------
Steven G. Stewart, Chief Financial
Officer and Principal Financial Officer
21
ASSIGNMENT AND AMENDMENT AGREEMENT
THIS ASSIGNMENT AND AMENDMENT dated as of February 4, 2000 (this
"Agreement"), made by and between Covol Technologies, Inc., a Delaware
corporation ("Covol"), Utah Synfuel #1 Ltd., a Delaware limited partnership
("Utah Synfuel"), AJG Financial Services, Inc., a Delaware corporation ("AJG"),
and Coaltech No. 1 L.P., a Delaware limited partnership ("Coaltech").
RECITALS
WHEREAS, Covol and AJG are parties to that certain Debenture dated
January 9, 1999 (the "Debenture") in the principal amount of $4,367,351.28; and
WHEREAS, as of the date hereof, the total amount owing from Covol to
AJG under the Debenture is $4,927,318.23 (the "Debenture Balance"); and
WHEREAS, Covol, Utah Synfuel, and Coaltech are parties to that certain
Non- Negotiable Nonrecourse Promissory Note dated March 7, 1997 (the "Note") in
the principal amount of $3,500,000, and that certain Security Agreement of even
date therewith (the "Security Agreement") relating to the note; and
WHEREAS, as of the date hereof, the total amount owing from Coaltech to
Covol under the Note is $2,965,361.82 (the "Note Balance"); and
WHEREAS, Covol and AJG desire and are willing to amend the terms of the
Debenture; and
WHEREAS, the parties hereto desire to effect the assignment and
transfer by Covol and Utah Synfuel to AJG of all the right, title and interest
of Covol and Utah Synfuel in, under and with respect to the Note.
NOW THEREFORE, in consideration of the premises and the mutual
covenants and agreements herein contained, and for other valuable consideration,
the receipt and sufficiency of which is hereby acknowledged, the parties hereto
do hereby agree as follows:
SECTION 1. Assignment.
(a) Effective as of the date hereof, Covol and Utah Synfuel hereby (i)
irrevocably sell, assign, transfer and convey to AJG all of their right, title
and interest in and to the Note; (ii) release any and all liens, encumbrances,
and security interests of whatsoever nature against the Collateral (as defined
in the Note); (iii) agree that the Security Agreement is
1
<PAGE>
terminated effective as of the date hereof; and (iv) agree to execute, deliver,
and file such documents of release of lien, including UCC filings, as AJG shall
reasonably direct.
(b) Covol and Utah Synfuel hereby covenant and agree to pay over to
AJG, if and when received following the date hereof, any amounts (including any
sums payable as interest in respect thereof) paid to or for the benefit of Covol
or Utah Synfuel that, under subsection (a) hereof, belong to AJG.
SECTION 2. Amendment.
(a) As of the date hereof, Covol and AJG amend the Debenture as
follows: (i) the Debenture Balance is reduced by the amount of the Note Balance,
to a remaining balance of $1,939,232.04 due from Covol to AJG under the
Debenture; and (ii) the due date of the Debenture for the remaining balance plus
interest is extended from January 10, 2000 to October 31, 2000; and all other
terms and provisions of the Debenture (including terms of the letter agreement
dated 26 February 1998 by and between Covol and AJG) shall remain in full force
and effect.
(b) The amount due and payable on October 31, 2000 is the remaining
balance due under the Debenture of $1,961,956.41 plus interest of $86,756.09 for
a total of $2,048,712.40.
SECTION 3. Governing Law. This Agreement shall be construed and
enforced in accordance with and governed by the law of the State of Utah without
giving effect to the principles thereof relating to conflicts of law.
SECTION 4. Counterparts. This Agreement may be executed in any number
of counterparts, each of which shall be deemed an original, but all of which
together shall constitute one and the same agreement.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
duly executed and delivered on the date first above written.
COVOL TECHNOLOGIES, INC.
/s/ Brent M. Cook
---------------------------
Name: Brent M. Cook
Title: President
2
<PAGE>
AJG FINANCIAL SERVICES, INC.
/s/ John C. Rosengren
---------------------
Name: John C. Rosengren
Title: Vice President and
General Counsel
UTAH SYNFUEL #1 LTD.
By Covol Technologies, Inc.,
general partner
/s/ Brent M. Cook
Name: Brent M. Cook
Title: President
COALTECH NO. 1, L.P.
By: US Coal LLC, general partner
/s/ David S. O'Neill
--------------------
Name: David S. O'Neill
Title: Manager of the General
Partner
3
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLDIDATED FINANCIAL STATEMENTS AS OF AND FOR THE QUARTER ENDED DECEMBER 31,
1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
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<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> SEP-30-2000
<PERIOD-END> DEC-31-1999
<CASH> 7,457
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<RECEIVABLES> 9,966
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<TOTAL-ASSETS> 57,160
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3,234
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