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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ______________ to ____________________
Commission File No. 2-93124
SGI INTERNATIONAL
(Exact name of registrant as specified in its Charter)
UTAH 33-0119035
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
1200 Prospect Street, Suite 325, La Jolla, California 92037
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (619) 551-1090
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock (No Par Value)
(Title of class)
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 filer pursuant to Item 405 of
Regulation S-K (ss. 229.405 of this chapter) is not contained herein, and will
not be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant was approximately $4.8 million as of March 11, 1999. The number of
shares of Common Stock, no par value, outstanding as of March 11, 1999, was
25,814,196.
DOCUMENTS INCORPORATED BY REFERENCE
As noted in Part III of this Form 10-K, portions of the registrant's proxy
statement, to be filed within 120 days of December 31, 1998, have been
incorporated by reference.
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PART I
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ITEM 1: BUSINESS
The following discussion contains forward-looking statements, which involve
risks and uncertainties. Such forward-looking statements include, but are not
limited to, statements regarding future events and the Company's plans and
expectations. The Company's actual results may differ significantly from the
results discussed in the forward-looking statements as a result of certain
factors including, but not limited to, those discussed herein. See
"Forward-Looking Statements."
SGI International, a Utah corporation, (together with its subsidiaries,
hereinafter referred to as the "Company"), has its principal office in La Jolla,
California. The Company is primarily in the business of developing and marketing
energy-related technologies, which at the present include the LFC Process and
the OCET Process. The LFC Process is designed to convert and upgrade low-rank
coal to create a higher Btu more efficient and less environmentally polluting
fuel to produce power and simultaneously produce low temperature coal tars,
which contain valuable chemicals. The OCET Process is designed to increase the
efficiency of oil refineries by deasphalting crude oil as well as residual oil
bottoms ("resid"), which is produced in oil refining. Through Assembly
Manufacturing Systems, Inc. ("AMS"), a wholly owned subsidiary, the Company is
also in the business of supplying custom precision automated assembly equipment.
(a) Historical Development of Business
Originally organized in July 1980 to pursue the development and
commercialization of the LFC Process, the Company known then as Synfuel Genesis,
Inc. merged with Vision Development, Inc. in June 1985 and changed its name to
SGI International. In mid-1989 the Company and Shell Mining Company ("SMC")
entered into a 50/50 partnership (the "TEK-KOL partnership") to jointly own,
commercialize and license the Liquids from Coal ("LFC") Process. Also in 1990, a
subsidiary of SMC, the ENCOAL Corporation ("ENCOAL"), pursuant to a Cooperative
Agreement with the Department of Energy, began constructing a LFC demonstration
plant, which began operation in 1992. In November 1992, Zeigler Coal Holding
Company ("Zeigler"), which became one of the largest coal producing companies in
the United States, purchased SMC and its assets, including the ENCOAL
Demonstration Plant. From 1990 through April 1995, the principal business of the
Company was to continue the development of the LFC Process through research at
the ENCOAL Demonstration Plant, testing the efficacy of applying the LFC Process
to low-rank coals on a worldwide basis, and working to develop LFC Plant
projects domestically and internationally.
In April 1995 the Company agreed with SMC that the ENCOAL Demonstration Plant
was operational. As part of that agreement, the Company and SMC agreed to make
the TEK-KOL Partnership an operating entity to pursue LFC Process licensing and
other opportunities both overseas and in the United States. The TEK-KOL
Partnership pursued LFC Process development and LFC project development until
termination in November 1998. During 1995 the Company commenced development of
the Opti-Crude Enhancement Technology Process ("OCET"), which is designed to
deasphalt crude oil and increase the ratio of high quality fuels refined from
residual oil bottoms. Also in late 1995 the Company acquired AMS, which is in
the business of fabricating and selling custom precision automated assembly
equipment.
In May 1998, the Company gave notice to Zeigler that it was terminating the
TEK-KOL Partnership Agreement. Termination occurred on November 11, 1998. The
Company and its current partner AEI Resources, who acquired Zeigler in 1998, are
in the process of dissolving the partnership and winding up all partnership
affairs. See Note 4 of Notes to Consolidated Financial Statements incorporated
by reference in Item 8 of Part II of this form 10-K for additional information
regarding the termination of the TEK-KOL partnership.
On August 6, 1998, the Company entered into a Letter of Intent with Mitsubishi
Corporation ("Mitsubishi") to form a joint venture to pursue the development and
commercialization of the LFC Process both domestically and
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internationally. Effective January 14, 1999, the Company entered into a number
of agreements with MLFC Corporation ("MLFC"), a subsidiary of Mitsubishi
Corporation, relating to the formation of a joint venture with MLFC regarding
the LFC Process. The Company and MLFC entered into an LFC Joint Venture
Formation Agreement, Operating Agreement, License Agreement, Services Agreement
and Security Agreement for the purpose of further developing the LFC Process and
licensing its use in proposed LFC plants to be constructed domestically and
internationally. See Notes 4 and 13 of Notes to Consolidated Financial
Statements incorporated by reference in Item 8 of Part II of this form 10-K for
additional information regarding the Joint Venture with Mitsubishi.
(b) Financial information about the Company's industry segments
In June 1997, the Financial Accounting Standards Board (FASB) issued Statement
No. 131, "Disclosures about Segments of an Enterprise and Related Information,"
which the Company has adopted in the current year. The Company identifies its
segments based on strategic business units that are in turn based along
technological lines. These strategic business units offer products and services
to different markets in accordance with their underlying technology.
Accordingly, the Company's three business segments are centered on the
operations associated with the LFC Process, the OCET Process, and automated
assembly and manufacturing systems. The Company's operations are primarily
centered in the United States. However, through its various collaborative
arrangements (previously with TEK-KOL and now Mitsubishi) the Company will
continue to market the LFC Process on an international basis. For the financial
results of the Company's operating segments, see Note 6 of Notes to Consolidated
Financial Statements incorporated by reference in Item 8 of Part II of this form
10-K.
(c) Narrative Description of Business
LFC OPERATING SEGMENT
Overview. The Company has developed a patented technology, which it refers to as
the LFC Process. The LFC Process is intended to convert and upgrade low-rank
coal and simultaneously produce a hydrocarbon liquid. The LFC Process produces
two products, one called Process Derived Fuel (PDF), and the other, Coal Derived
Liquids (CDL). PDF produced by the LFC Process has a higher heating value and
improved environmental properties when compared to the host coal. The Company
believes the LFC Process could upgrade a significant portion of the world's
abundant low-rank coal reserves into a higher Btu coal and also produce valuable
chemical products from the CDL. In the opinion of management, the PDF could
provide cost-effective compliance with certain environmental legislation and
regulations, including the 1990 Clean Air Act Amendments, and other current and
possibly future U.S. and international environmental regulations.
The LFC Process produces PDF and CDL by heating low-rank coal under carefully
controlled conditions. The Company believes many existing users of coal in the
U.S., such as electric utilities, face costly capital expenditures to modify
their coal-fueled electric power plants to comply with the Clean Air Act
Amendments. According to the Department of Energy, the Clean Air Act impacts
over 261 generating units at 100 coal fired electrical generating plants in the
U.S. and, by the year 2000, requires many major U.S. power plants to achieve
specified reductions of nitrogen oxide (NOx) and sulfur dioxide (SOx) emissions.
The Company believes many countries outside the United States, who currently
generate much of their electricity from burning coal and who have substantial
low rank coal reserves, could use the LFC Process to provide a more
cost-effective and environmentally friendly fuel source for the production of
power.
In 1989, the Company contributed the LFC Process to the TEK-KOL Partnership.
TEK-KOL consisted of the Company and Shell Mining Company. In November 1992,
Zeigler Coal Holding Company ("Zeigler") purchased Shell Mining Company and
became one of the larger coal companies in the U.S. In September 1998, AEI
Resources ("AEI") acquired all of Zeigler thereby also acquiring all of
Zeigler's interest in the LFC Process and TEK-KOL. AEI then sold all of its
Powder River Basin coal mines (including the North Rochelle mine and the
Buckskin mine, the latter mine being the site for the ENCOAL plant ) to Vulcan
Coal Holding Company ("Vulcan"). AEI retained all of its interest in the LFC
Process, one half of the TEK-KOL Partnership, the ENCOAL Demonstration Plant,
the permits for a commercial LFC Plant at North Rochelle and other LFC interests
through a subsidiary, Wyoming
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Coal Technology, Inc. ("WCT"). The LFC Process has been used at the
Demonstration Plant, owned by the ENCOAL Corporation (now owned
by WCT), in Gillette, Wyoming to produce PDF and CDL for a number of test burns
with various coal users.
To date, the Company individually or through it TEK-KOL Partnership, granted
four licenses for the LFC Process which includes a non-exclusive license to
Rosebud Energy Corp., a license for the operation of the LFC Demonstration Plan,
a license to itself and a license to LFC Technologies, LLC, to pursue the
purpose of the joint venture with Mitsubishi Corp.
The Company intends to license the LFC Process to electric utilities, coal
producers, steel companies, foreign governments or agencies thereof, or
affiliates of these parties. While the Company also intends to be actively
involved in owning and operating domestic and international LFC Plants. The
resources required to develop, construct and operate an LFC Process plant are
likely to require in excess of $450 million, over a year of construction and
expertise in major plant development and would therefore require substantial
additional funding to participate in such ownership.
LFC Process Description and Development. The LFC Process, developed and patented
in the 1980's by the Company, uses a mild gasification process that causes
chemical changes in the feed coal by drying, pyrolyzing and stabilizing it under
carefully controlled conditions. The process partially devolatizes and
chemically changes the coal, producing gases and an upgraded, higher Btu solid
product. The gases are cooled and partially condensed to form a low-temperature
coal tar called CDL. The remaining gases are consumed in the process for heat.
Each ton of coal feed produces approximately one-half ton of PDF and one-half
barrel of CDL. The non-condensable gases provide 70% of the process heat
requirements. The Company believes that the overall process is 90% energy
efficient. The LFC Process can process high-moisture, subbituminous and lignite
coals (low rank) and is unique among coal upgrading technologies in that it
produces two marketable products. The key to the LFC Process is a computerized
control system that optimizes the quality of the products depending on specific
market needs and composition of the feed coal. The LFC Process has been used at
the ENCOAL Demonstration Plant, which has produced and shipped to a variety of
customers for testing over eighty-three thousand tons of PDF and over one
hundred and nineteen thousand barrels of CDL. The Company believes the operation
of the Demonstration Plant has provided key operational and engineering design
data for the LFC Process.
The Company believes four key factors in the LFC Process differentiate it from
other coal cleaning, liquefaction, or gasification technologies. First, the
process simultaneously produces solids and liquids. Second, the control system
regulates the coal heating rate and temperature level to control the governing
kinetics of gasification and stabilization reactions producing products that are
consistent in quality. Third, the PDF can be stabilized and therefore is less
likely to self-ignite. Fourth, for the purpose of controlling the gasification
conditions (to obtain the desired co-products), computer models of coal reaction
kinetics, sensors, and servo-mechanisms can be incorporated into the control
system.
The Company's marketing efforts are in part based on the Company's belief that
low-grade (or low-rank) coals of the world are relatively disadvantaged in the
marketplace compared to higher-rank bituminous coals. Low-rank coals generally
have higher water content, which makes them more expensive to transport to
distant markets. Additionally, their lower heat value can make them a less
efficient boiler fuel. The Company estimates the transportation cost component
of a Western, low-rank coal's delivered price can be 3 to 5 times the cost of
the coal at the mine. The Company expects PDF and CDL can reduce transportation
costs by removing water, and economically producing lower sulfur, lower NOx,
higher heat-rate, cleaner burning coals along with potentially valuable
co-product coal tar derived chemicals. The Company believes PDF can be a means
for helping utilities meet the requirements of the Clean Air Act and its
amendments.
LFC Process Demonstration Plant. In 1989, ENCOAL Corporation and the U.S.
Department of Energy ("DOE") each committed to fund one-half of the costs to
construct, own and operate a "Clean Coal Demonstration Plant" using the LFC
Process at the Buckskin Mine near Gillette, Wyoming. The Demonstration Plant was
constructed as part of the U.S. government's Clean Coal Technology Program.
Several amendments of the original Cooperative Agreement with the DOE extended
the shared funding of the Demonstration Plant to September 1996.
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Additional, no-cost shared, amendments extended the Agreement end date to July
1997 to permit completion of final reporting. TEK-KOL licensed the LFC Process
to SMC Mining for use at the Demonstration Plant. Construction of the
Demonstration Plant began in 1990 and was completed in 1992. The Demonstration
Plant was not expected to, and did not, produce any licensing royalties to the
Company.
In November 1992, Zeigler Coal Holding Company ("Zeigler") purchased Shell
Mining Company and its assets, including the ENCOAL Corporation and
Demonstration Plant. The purpose of the Demonstration Plant was to demonstrate
the validity of the LFC Process and it was not intended as a commercial plant.
To date, the Demonstration Plant has produced approximately 120,500 tons of PDF
and 121,700 barrels of CDL, and has shipped 83,600 tons of PDF to 8 utility
customers and 119,285 barrels of CDL to 8 industrial users. Test burns of PDF,
based on the Company's analysis, indicate PDF is a viable fuel which can be used
with minimal modification of the coal burning equipment. The Company believes
PDF can be a means for helping utilities or other coal burning facilities meet
the requirements of the Clean Air Act and its amendments. There can be no
assurance these test results will be duplicated in a future commercial facility,
if any, using the LFC Process.
The Company believes the operation of the Demonstration Plant from 1992 through
the third quarter of 1997, when its operations were discontinued, has provided
invaluable design data and engineering parameters to assist in the commercial
development of the LFC Process. The cessation of operations of the Demonstration
Plant may have a material adverse impact on the marketing of the LFC Process and
co-products. Although the Company believes it has completed the basic
development of the LFC Process, the Company continues to refine the process in
order to reduce the cost and improve efficiencies for a future commercial LFC
plant. Further, a number of utilities have indicated they would like to have PDF
delivered to them for test burns, which if successful, would be used for the
purpose of purchasing additional quantities from large scale commercial LFC
plants. To provide these test burn quantities, the Company believes it would be
valuable to restart operation of the Demonstration Plant. Consequently, the
Company has entered into discussions with AEI to, among other things, acquire
the Demonstration Plant for operation, product testing and process enhancements.
There can be no assurance that the Company will successfully acquire the
Demonstration Plant or after having done so will be able to license the process,
sell LFC products commercially, or if sold, generate profits for the Company.
Termination of the TEK-KOL Partnership. On May 11, 1998, the Company gave notice
to Bluegrass Coal Development Company ("Bluegrass"), formerly SMC Mining Company
and a subsidiary of Zeigler Coal Holding Company, in accordance with the TEK-KOL
Partnership Agreement (the "Partnership Agreement"), that it was unilaterally
terminating the Partnership Agreement effective six months from the date of
notice (November 11, 1998). Upon termination, the parties are required to take
those steps necessary to dissolve the partnership and wind up all partnership
affairs. All tangible assets are to be sold or otherwise disposed of and all
intangible assets comprising intellectual property are to be transferred to both
parties such that each party owns an undivided 50% interest in all patents,
trade secrets, trademarks, and all other intellectual property. However, upon
termination, the Company has a worldwide exclusive through April 12, 2000, to
market and license the LFC Process. After April 12, 2000, both parties have the
right to market and license the present technology worldwide. Bluegrass (its
successor is WCT) may continue to use the LFC Process on any of its sole
projects. Both the Company and WCT are obligated to continue funding the TEK-KOL
partnership until dissolution, which must be accomplished within 18 months from
November 11, 1998.
Royalties earned on licenses entered into through the term of the Company's
exclusive period, ending on April 12, 2000, are paid 80% to the Company and 20%
to Bluegrass (WCT), up to a date 10 years from the date of dissolution. For
licenses entered into after April 12, 2000, royalties are divided equally
between the parties for a period of 10 years after the date of dissolution.
Royalties received after 10 years from the date of dissolution are retained
entirely by the licensor. While not anticipated, the termination of the
Partnership Agreement could have a material adverse impact on the business and
operations of the Company.
Joint Venture with Mitsubishi Corporation (LFC Technologies, LLC). Effective
January 14, 1999, the Company entered into a number of agreements with MLFC
Corporation ("MLFC"), a subsidiary of Mitsubishi Corporation, relating to the
formation of a joint venture with MLFC regarding the LFC Process. The Company
and MLFC entered into an LFC Joint Venture Formation Agreement, Operating
Agreement, License Agreement,
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Services Agreement and Security Agreement for the purpose of further developing
the LFC Process and licensing its use in proposed LFC plants to be constructed
domestically and internationally.
The LFC Joint Venture Agreement between the Company and MLFC provides for the
formation of a limited liability company called LFC Technologies, LLC ("LFC
Tech") to conduct research and development activities relating to the LFC
Process, for MLFC to market the LFC Process outside the U.S. and for the Company
to market the LFC Process inside the U.S.
The License Agreement between LFC Tech and the Company provides for the grant to
LFC Tech of a non-exclusive worldwide royalty-free license in connection with
the purposes of LFC Tech, to use the LFC Process and related rights, including
improvements developed by LFC Tech to reduce the costs of an LFC plant, and to
design, contract and sell LFC-related products jointly in the United States
until January 14, 2001, unless extended by mutual agreement. The fee for the
license to MLFC was the execution by LFC Tech of a Services Agreement with the
Company. The Company also agreed, to among other things, permit the technical
employees of LFC Tech to inspect the Demonstration Plant, disclose confidential
LFC information, provide copies of technical data regarding the design,
construction and operation of the Demonstration Plant.
The Operating Agreement between MLFC and the Company governs the management of
the new joint venture Company, LFC Tech, and is for a term extending through
January 14, 2001. The purpose of LFC Tech is to conduct research and project
development activities with respect to the LFC Process. The Company and MLFC
each must contribute $125,000 every three months for two years to LFC Tech, and
each has a 50 percent interest in profits and losses of the business operated by
LFC Tech, which is managed by two managers, one from the Company and one from
MLFC. Upon the occurrence of certain "milestone" events MLFC and the Company are
required to form a new company ("Newco") to hold the LFC patents and related
technology and MLFC is required to pay to the Company $4 million for the
transfer of the LFC Process to Newco ("Transfer Payment"). The Transfer Payment
is to be paid to the Company only on the first to occur of the following: (1)
the start of construction or an irrevocable commitment to start construction of
an LFC plant with a minimum capacity of 15,000 tons per day; (2) the receipt by
MLFC of at least $4 million in connection with the admission of a new equity
participant into Newco, and/or the licensing or royalties from one or more LFC
plants; or (3) such other conditions as the parties agree. The Transfer Payment
is also conditioned on all of the following: (a) MLFC and the Company enter into
a shareholder's agreement satisfactory to both parties; (b) the Company has
obtained and transferred to Newco the entire ownership, subject to an adjustment
in the event less than the entire ownership is transferred, in the LFC Process
and improvements, free of liens or encumbrances; (c) through the formation of
Newco, MLFC acquires a 50 percent equity interest in the LFC Process and
improvements; and (d) the Company grants to MLFC exclusive rights to manufacture
and sell new plants incorporating the LFC Process and related improvements and
to use or to grant to third parties sublicenses to use or grant the LFC Process
and improvements.
The Amended and Restated Services Agreement between MLFC, LFC Tech and the
Company provides that the Company will provide certain services to LFC Tech
including soliciting potential customers in the U.S., developing LFC projects in
the U.S. and performing engineering work. The Services Agreement is for a
minimum period of at least 2 years and provides a fixed payment to the Company
of $1 million per year, payable $250,000 per quarter after an initial payment of
$250,000 upon execution of the agreement.
Markets
Domestic Markets. The Company believes the principal markets for PDF will be the
domestic electric utility markets where utilities burn coal to generate
electricity, and the non-coking coal metallurgical market which produces steel
and metals. The Company currently believes future PDF production from an LFC
Process plant could be sold into the utility market and the metallurgical
market.
CDL from the Demonstration Plant has in general been sold into the residual fuel
oil market. Of the approximately 121,000 barrels of CDL that have been produced
by the Demonstration Plant, the vast majority has been sold into the residual
fuel oil market to oil distributors who have blended the CDL or sold it as fuel
oil for use in industrial boilers.
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PDF Electric Utility Markets. The Company believes that electric utilities that
are located east of the Mississippi River and burn predominantly bituminous rank
coals represent the largest potential market for PDF. Specifically, those
generating stations that both, use high sulfur coals and that may be affected by
pending state implementation plans to reduce nitrogen oxide emissions, represent
the best marketing opportunities.
This belief is predicated on Title IV of the Clean Air Act Amendment Phase II
(effective January 1, 2000) which will require that electric utilities built
before 1990 with annual generating capacity in excess of 25 megawatts reduce
total emissions of sulfur dioxide from power plant stacks below 1.2 lbs. SOx per
MMBtu. Phase II will affect 2,500 boilers at 1,000 electrical generating plants
and other industrial users of coal. When using PDF produced from coal feedstock
mined from Wyoming's southern Powder River Basin, test data has indicated that a
SOx emission rate of between 0.3 and 0.5 lbs. per MMBtu can be expected. While
PDF represents a product from a new technology that may reduce NOx, SOx, and
water emissions from power plant stacks, there can be no assurance any of these
utilities would elect to use PDF once development is completed.
PDF Industrial Markets. A relatively small market of industrial coal users may
provide an economically attractive and diversified customer base for PDF. The
Company believes that, longer-term, a potentially growing market for non-coking
metallurgical coals could provide an opportunity for PDF sales. More immediate,
industrial plants that currently use coal to generate both process heat and
electricity on site may provide a niche market for PDF.
CDL Markets. Considerable work has been done over the last two years to
determine the composition of CDL. The Company now believes that the separation
of CDL into three fractions creates opportunities to participate in markets with
considerably higher value than the fuel oil market. The light fraction of CDL is
felt by the Company to be an acceptable cresylic acid feedstock at a value above
$30 per barrel. The Company's opinion has been bolstered by discussions with
companies who are potential customers for such a product. The middle faction of
CDL will most likely remain an industrial fuel. However, work continues to
upgrade a portion of this fraction to a higher value fuel product such as diesel
fuel. The heavy fraction of CDL is felt by the Company to have a potential
application in the asphalt sealer and high quality anode product markets. Test
programs are now underway at two major tar chemical processors to verify these
markets.
International Markets. As stated previously, the Company believes that the
current domestic market holds the most short term economic potential. However,
the international coal market is estimated by the Company to be substantially
larger at approximately four times the size of the domestic market. While the
Company has completed several feasibility studies in China, Russia, Indonesia
and Australia, and entered into various memorandums of understanding with
international governments and private entities the current poor economic
conditions in these countries has negatively impacted the progress of these
projects. Consequently, the Company does not expect these projects to progress
until economic conditions improve. The Company's objective in these foreign
markets is primarily to meet the needs of providing more energy efficient and
environmentally friendly products as an upgraded coal utility fuel and low
temperature coal tars and chemical products for domestic use and/or to provide a
value added export product.
Competition. The principal markets for PDF and CDL are in the energy industry,
which is intensely competitive. There are many companies engaged in research
into ways to clean or convert coal into a more environmentally acceptable fuel
or other commercially viable products. Many of the Company's existing or
potential competitors have substantially greater financial, technical and human
resources and may be better equipped to develop, test and license coal-refining
technologies. In addition, some of these companies have extensive experience in
operating refining plants and many of these companies have extensive experience
in operating coal-burning plants. These companies may develop and introduce
coal-refining technologies competitive with or superior to those of the Company
prior to any market acceptance for the LFC Process or other technologies
developed by the Company or its subsidiaries.
The relative speed with which the Company markets the LFC Process and enters
into licenses or other agreements with third parties who, thereafter construct,
own and operate a plant using the LFC Process and their success in supplying
processed coal products, are expected to be important competitive factors. The
Company expects the
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principal competitive factors to include, among other things, how quickly the
Company can develop LFC projects and market products to provide electric
utilities an alternate means to comply with air emission regulations, as well
as how economically LFC Process coal products can be produced, at what quality
levels and how fast demand for such products develops, compliance with
environmental standards, transportation costs, cost comparisons
to other energy fuels, and the strength of any patents for the LFC Process or
for other related technologies.
The demand, if any, by coal-fired electrical generation facilities for processed
coal products derived from using the LFC Process may also be materially impacted
by competing fuels such as natural gas and emission control technologies, such
as selective catalytic reduction. The Company believes other factors which may
influence competition include the availability and cost of delivered coal, the
difference between the costs of other energy alternatives and coal prices and
availability, regulatory efforts to reduce pollution and other emissions,
regulatory incentives, if any, to utilize clean coal based energy sources and
the reliability and cost effectiveness of the LFC Process relative to other
competing technologies.
The Company's competitive position also depends upon its ability to attract and
retain qualified personnel, obtain patent protection or otherwise develop
proprietary products or processes and secure sufficient capital resources for
the period between development and testing of the LFC Process and any possible
introduction of the technology into the commercial market place.
The Company is aware of several entities in the U.S. and in foreign countries,
which are engaged in producing clean-burning coal. These include the Rosebud
SynCoal Partnership, owned by a subsidiary of Montana Power Company, which owns
a plant in Colstrip, Montana. Also, KFX, Inc., a public company, is engaged in
producing a clean coal product: Carbontec, which produces upgraded coal at a
pilot plant; and Custom Coals, International, which makes a clean coal product.
There can be no assurance that the Company will be able to compete successfully
with any of these companies.
Patents and Proprietary Technology. The Company has patents or patent
applications for eight LFC Process and LFC Process related patents in the U.S.
and in five foreign countries.
The Company has non-exclusive worldwide rights to license the use of the MK Dust
Control System pursuant to the License Agreement with Bluegrass (WCT). There can
be no assurance any additional patents will be issued to the Company as a result
of the pending applications, or, if issued, such patents combined with the
existing Company patents will be sufficiently broad to afford protection against
competitors using similar technology. The Company's success will depend in large
part on its ability to obtain patents for the LFC Process improvements and
related technologies, if any, to defend patents once obtained, to maintain trade
secrets and to operate without infringing upon the proprietary rights of others,
both in the United States and in foreign countries.
There can be no assurance that any patents issued to the Company will not be
challenged, invalidated or circumvented, or that the rights granted thereunder
would provide competitive advantages to the Company. Litigation over patent or
other intellectual property claims could result in substantial costs to the
Company. U.S. patents do not provide any remedies for infringement occurring
before a patent is granted. As patent rights are territorial, the Company may
not have an effective remedy against use of their patented technology in any
country in which the Company does not, at the time, have an issued patent.
The commercial success of the Company may also depend upon avoiding the
infringement of patents issued to competitors. TEK-KOL owns all of the
technology relating to the LFC Process through which the Company currently owns
50%. If competitors prepare and file patent applications in the United States
claiming technology also claimed as proprietary by the Company, the Company may
incur substantial costs in participating in interference proceedings declared by
the U.S. Patent office ("PTO") to determine the priority of the invention. An
adverse outcome of such proceedings could subject the Company to significant
liabilities to third parties and could require the Company to license disputed
rights from third parties or cease using the infringing technology. Although the
Company believes its current and proposed activities do not and will not
infringe upon patents for competing technologies, there can be no assurance the
Company's belief would be affirmed in any litigation over any patent or that the
Company's future technological developments will be outside the scope of these
patents.
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A U.S. patent application is maintained under conditions of confidentiality
while the application is pending in the PTO, so the Company cannot determine the
extent or nature of inventions being claimed in pending patent applications
filed by its competitors. If competitors infringe on the Company patents which
are pending but not yet issued, TEK-KOL and the Company will not be able to
pursue infringement claims against them unless the infringement continues after
such patents are issued.
The Company also relies on certain proprietary information, which may not be
patentable. Although the Company has taken steps to protect its proprietary
information, in part through the use of confidentiality agreements with certain
employees, potential partners, consultants and contractors, there can be no
assurance these agreements will not be breached, the Company would have adequate
remedies for any breach, or the Company's proprietary information will not
otherwise become known or be independently developed or discovered by others
including its competitors.
Governmental Regulation. The LFC Process, as it is proposed to be used in the
operation of a LFC plant, will likely be subject to numerous federal and state
regulations. Although the Company intends to own a portion of any future
commercial LFC plant constructed in the United States, it is more likely to be
wholly owned by others since the Company does not now have, and may not in the
near future have, the financing necessary to develop, construct or operate such
plants. LFC plants will likely require numerous permits, approvals and
certificates from appropriate federal, state and local governmental agencies
before construction of any such facility may begin, and will be subject to
periodic maintenance or review requirements once any such facilities begin
production. Such permits and regulations include: (i) air quality; (ii)
wastewater discharge; (iii) land quality; and (iv) hazardous waste treatment
storage and disposal. There can be no assurance that such approval will be
granted to any licensees of the LFC Process in the event a plant is proposed to
be constructed and operated using the LFC Process. In addition, there can be no
assurance future domestic or international governmental regulations will not
change and the necessary permits and approvals for any future commercial-scale
production facilities will not be prohibitively expensive or difficult to
obtain. Any failure by any licensee of the LFC Process to obtain required
regulatory approvals, or any substantial delay in obtaining such approval, could
have a material adverse effect on the Company.
Mine Health and Safety Administration ("MHSA") regulations and approvals may be
applicable to any use of the LFC Process at a plant constructed for such use.
The Demonstration Plant in Wyoming has operated under the oversight of the MHSA
since construction began. The Company believes the ideal location for an LFC
Process plant will be on the grounds of or adjacent to a coal mine to minimize
transportation costs.
The Clean Air Act and amendments specify certain air emission requirements for
electrical utility companies and industrial coal users. The Company believes the
Clean Air Act is now, and will in the future be, a significant factor in
creating demand and a market in the U.S. for the LFC Process and products. The
Company believes electric utilities and industrial coal users who use the LFC
products will be subject to the Clean Air Act, and compliance with such
regulations could be fully or partially met through the use of the LFC Process.
Beginning on January 1, 2000, Phase II of the Clean Air Act Amendments imposes a
permanent cap on sulfur dioxide emissions and requires nitrogen oxide
reductions. A full or partial repeal of the Clean Air Act could have a material
adverse impact on the Company. The Company is unable to predict future
regulatory changes and their impact on the demand for the LFC Process.
OCET OPERATING SEGMENT
Overview. The OCET Corporation, a wholly owned subsidiary of the Company, is a
development stage company incorporated in the state of Delaware. OCET is
developing an energy-related technology referred to as the OCET Process. The
OCET Process is designed to deasphalt crude oil or resid. Resid is the residue
remaining after processing crude oil in a refinery to produce liquid fuels and
lubricants. The OCET Process is still in development, and will require
additional research and development before it is ready (if ever) for commercial
use. Future funding necessary to carry on the development of the OCET Process
will be primarily for the operation and maintenance of
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the OCET Process Development Unit ("PDU"). See Note 6 of Notes to Consolidated
Financial Statements incorporated by reference in Item 8 of Part II of the form
10-K for additional information.
In laboratory tests, both petroleum resid and heavy crudes have been
successfully deasphalted using bench scale continuous prototype processing
equipment. The results of these laboratory tests indicated the ability to
produce deasphalted oil which OCET believes is comparable in quality and yield
to that produced by commercial solvent deasphalting processes. During the later
part of 1998, extensive testing of Venezuelan Merey crude in the Company's
recently completed PDU, showed measurable improvements by way of reduced metals
content and reduced viscosity, over the same material processed under the same
conditions without the benefit of the OCET Process. As these early results are
considered positive by the Company additional testing on other crudes considered
more responsive to the OCET Process are planned in 1999. There can be no
assurance the results of such laboratory tests will be proved in actual
commercial scale developments, or that any commercial use will be made of the
OCET Process.
The Company's principal efforts in commercializing the OCET Process are intended
to focus on licensing the technology to petroleum engineering and construction
companies, oil refineries, oil companies, and other parties with related
interests. The Company is also seeking other collaborative arrangements with
manufacturers and developers of deasphalting equipment as potential partners.
Construction and operation of a future commercial scale facility using the OCET
Process is dependent upon funding from the petroleum engineering and
construction companies, oil refinery, oil company, or other third parties.
Industry data available to OCET indicates that there has been a shift of crude
oils over time to being higher in resid volume and contaminant levels, and
therefore, the need for a successful deasphalting technology has increased.
Experts in the industry, employed by the Company, believe that the quality of
crude oils has declined and has a greater amount of asphaltenes, nickel,
vanadium, and other contaminants in both the crude oil as well as in the resid.
This reduces the value of the crude and resid since these elements inhibit the
refiners ability to produce high value products.
The OCET Process uses solvent to destabilize the crude oil or resid, followed by
electric field processing to separate the asphaltenes, metals and unwanted
contaminants contained in the resid in order to produce a higher quality liquid.
The electric field processing distinguishes the OCET Process from other
deasphalting processes known to the Company, and the Company believes OCET will
provide an additional method for controlling the rate, selectivity and
efficiency of the separation.
Research and Development. The Company has constructed a model PDU which it
believes is capable of measuring OCET Process performance under refinery-like
conditions of temperature and pressure. Concurrently, OCET has developed the
analytical methods and put in place laboratory staff, capable of measuring the
performance of the PDU and presenting the data in industry standard terms, for
the purpose of marketing the process to potential customers. These analytical
resources are also capable of measuring properties of feedstocks and other
refinery streams, so as to gauge the performance of the OCET process against
competitive processes in an effort to determine its commercial value and
optimize process performance.
Markets. OCET believes domestic and worldwide demand for crude oil and refining
products is expected to increase. Consequently, worldwide refining capacity is
also expected to increase, in conjunction with an expected increase in the
supply of low quality heavy crudes. OCET believes new as well as upgraded
existing oil refineries are likely to be called upon to meet increased worldwide
demand for fuels and to supply both distillate and residual fuels with decreased
sulfur levels to decrease pollution, while relying on increasingly heavy crude
as feedstock, especially on the Gulf Coast and Eastern Seaboard.
The target application for the OCET Process has initially been the upgrading of
refinery resid to produce high quality lube oil blend stock, feedstocks for
refinery catalytic upgrading processes, hydro-cracking or hydro-treating and
boiler grade coker feed because the liquid product could be reduced in
asphaltenes, metals, sulfur, nitrogen, carbon residue and other contaminants.
OCET believes there are other potential markets, including deasphalting and
viscosity reduction of heavy crude oil at the well site, upgrading crude oil
before introduction into the crude distillation tower at the refinery, removal
of metals from deasphalted oils, cleaning of used motor oil to remove
9
<PAGE>
metals and other contaminants, and removal of hydrocarbons and metals such as
selenium from wastewater and the upgrading of existing deasphalting processes.
Competition. The OCET Process is expected to enhance existing solvent
deasphalting processes and to compete with alternative methods for separation of
resids, solvent extraction processes and catalytic processes. The primary method
for disposing of resid is delayed coking, which exposes resid to high enough
temperatures to break apart some of the chemical bonds to produce gases, liquids
and solid coke, but has high capital, operating and environmental costs
producing very low value coke as a product. Whereas the OCET process seeks to
upgrade the value of the resid stream by improving the efficiency of the
dominant deasphalting process which utilizes solvents.
There can be no assurance the OCET Process will be determined to be commercially
viable, or will be developed to the point where it can be determined to be
commercially viable, or that there will be a market for the OCET Process, or, if
a market develops, OCET will license its technology or otherwise produce revenue
from the OCET Process or any other enterprise or technology development.
The OCET Process is still in development and has not been licensed or used on a
commercial scale plant. The OCET Process will require significant additional
research and development, including substantial additional funding to finish
development of the process and demonstrate its potential (if any) for commercial
use. There can be no assurance such efforts will be successfully completed. At
the present time, OCET has no agreements with any oil refinery or other party to
use the OCET Process in a commercial or large scale testing facility.
Patents and Proprietary Technology. OCET filed a patent application in September
1994 for the OCET Process, which was allowed in January of 1998. There can be no
assurance any patents issued to the Company, or OCET will not be challenged,
invalidated or circumvented, or that the rights granted thereunder will provide
competitive advantages to the Company. Litigation over patent or other
intellectual property claims could result in substantial costs to the Company.
ASSEMBLY AND MANUFACTURING SYSTEMS INC. OPERATING SEGMENT
AMS, a wholly-owned subsidiary of the Company, is a supplier of custom made
precision assembly equipment. AMS designs and builds custom, automated assembly
systems marketed principally to manufacturers in three principal industries:
medical, automotive and high-tech (which includes the electronics and
communications industries). These assembly systems integrate multiple
manufacturing functions often into a single custom production line built to the
customer's specifications.
Assembly functions integrated into products manufactured by AMS include:
material and component handling, dispensing and placement of film or liquid
adhesives, sealants or customer-formulated materials such as pharmaceuticals,
marking and encoding, assembly of components, riveting, swaging, inspection
functions including machine vision inspection, testing, data collection and
analysis. Completed AMS assembly systems may be from bench top size to almost a
hundred feet in length, and may incorporate all types of subsystems, including
robots, machine vision, conveyors, welders, mechanical tests, electronic tests
and others as specified by the customer. AMS believes it is well positioned to
capitalize on what it forecasts is an ongoing consolidation and growth in the
fragmented automation assembly market.
Automation system functions integrated into products manufactured by AMS are
generally computer controlled through custom software written by AMS, and
incorporate control, data handling, reporting and safety functions. The
completed automation systems are generally tested and accepted by the customer
at AMS prior to shipment and installation at the customer's site.
AMS believes that a majority of its current customers and future customers
purchase automation systems for several reasons including support of new product
introductions and start-up, labor cost reductions, increase in capacity,
increase in quality, increase in productivity, and a favorable return on
investment and/or payback.
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AMS believes it offers customers a number of competitive advantages over its
competitors including successful on-time project execution, competitive pricing,
systems which meet specified performance criteria, engineering and manufacturing
expertise and experience and innovative machine concepts. The typical AMS
contract price is currently in excess of $350,000.
Marketing and Sales. AMS relies primarily on personal contact by its executive
and sales personnel to secure new customers and to market its products. AMS
regularly participates in local, regional and national trade show meetings in
its key industry groups. AMS believes personal contact by its sales and
engineering staff is critical to retain new customers.
AMS has targeted large, established manufacturing companies in the medical,
automotive and high-tech industries as prospective clients. AMS targets
companies that need small manufactured equipment and devices, requiring
mechanical or electric mechanical assembly and test, or inspection with material
handling, as key accounts. To assist in marketing products and services, AMS
also works to develop new applications for target customers for their various
manufacturing needs.
As part of its current marketing focus, AMS is targeting Fortune 1000 businesses
with assembly contracts in the range of $750,000 to $1.5 million per project to
increase market share and benefit from economies of scale.
Major Customers. Revenue from sales of automated assembly equipment accounted
for 99%, 99% and 93% of the Company's revenues in 1998, 1997 and 1996,
respectively. The Company has three customers whose sales represent a
significant portion of sales in the automated assembly systems segment. Sales to
one of these customers was in excess of 21% in 1998 and 16% in 1996. Sales to
another customer was in excess of 29% in 1998 and 17% in 1997. Sales to a third
customer accounted for approximately 18% in 1998 and 11% in 1996. As is typical
in the automated assembly industry, AMS relies on a limited number of customers
for a substantial percentage of its net sales. In 1998 sales revenues derived
from four customers represent approximately 84% of total sales. In 1997 sales
revenues derived from three customers represent approximately 51% of total sales
and in 1996 sales revenues derived from four customers represent approximately
78% of total sales.
AMS does not have long term contracts with any of its customers and expects that
a small number of customers will continue to account for a substantial portion
of sales for the foreseeable future. The loss of, or a significant reduction in,
orders by these or other significant customers could adversely impact the
Company's results of operations. Furthermore, the concentration of the Company's
revenues in a limited number of large customers may cause significant
fluctuations in the Company's future annual and quarterly operating results. Due
to the small number of annual projects attempted by AMS, a significant
performance problem with any one of AMS' projects could have a material adverse
effect on AMS. There can be no assurance revenue from customers who accounted
for significant revenue in past periods, individually, or as a group, will
continue, or if continued, will reach or exceed historical levels in any period.
Manufacturing. All design, engineering, fabrication, assembly and testing of
AMS's products are carried out at its facility in Simi Valley, California.
Proprietary software and in-house procedures are used to ensure the quality and
timeliness of project execution, and AMS's custom automation related software
incorporate control, data handling, reporting and safety features. AMS also uses
state-of-the-art computer-aided design practices to create the customized
assembly processes for its customers.
To manufacture certain of its automation equipment, AMS uses subcontractors for
common industrial services such as machining, fabrication of welded structures,
painting and power coating on an as-needed basis. Manufacturing operations
include purchasing, receiving, cutting, machining, grinding, electrical
fabrication and testing, machine assembly as well as testing and all other
functions required to complete the automated assembly product. When needed, AMS
also employs a number of subcontractors for special assembly operations
including welding, power coating, wire electric discharge machining and other
unique operations.
AMS has implemented certain quality control procedures for its manufacturing
facility. AMS's quality control personnel regularly monitor the manufacturing
process and have initiated numerous procedures which assist in
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quality control. AMS believes new customers, particularly Fortune 1000 customers
with large assembly project, may impose additional quality control standards.
It is possible such customer or other quality control standards may require
additional substantial expenditures over a long period of time, or that AMS may
determine that such expenses are not cost-effective.
Raw Materials. The primary raw materials used by AMS in assembly systems include
such items as stock steel shapes, aluminum extrusions, billet and plate
software. These raw material items are converted by AMS into the needed support
structures and are custom-machined in house to be incorporated into the
automated assembly systems purchased by AMS customers. Raw materials used by AMS
are generally standard industry materials which AMS believes can be provided
from multiple sources of supply. AMS believes the most critical machine
subsystems such as computers, vision systems, part feeders, conveyors and robots
are also common and have multiple sources of supply. Up to approximately 75% of
the AMS assembly system components are purchased off the shelf. AMS does not
have any long term contracts with any of its raw material suppliers, and
believes numerous suppliers would be available in the event its current
suppliers were not available.
Competition. The Company believes competition in the automation assembly
industry is fragmented, and that no single competitor dominates the industry.
While AMS competes with at least 85 other companies which are engaged in the
automation assembly business, AMS believes the majority of these competitors
provide assembly equipment for smaller projects, and cannot handle the larger
projects (over $250,000 in price) for which AMS is currently competing. AMS's
principal competitors include Remmele Corp., Vanguard Automation, and
Bosch-Weldun Automation. Many of AMS's competitors have substantially greater
financial, marketing and technological resources than AMS.
The automation industry is characterized by rapid technological change, and
competitors may develop their automation products more rapidly than AMS. AMS
believes competition among automation companies is based primarily on price, the
speed and quantity of products produced, timely delivery, product quality,
safety, product innovation and assistance in marketing and customer service. The
competitive position of AMS will depend in part on AMS's ability to remain
current in automation manufacturing and to increase the innovation, speed and
reliability of its automated assembly processes. There can be no assurance AMS
will be able to compete successfully.
Patents and Proprietary Technology. AMS owns one patent jointly with Ethicon, a
customer, however, AMS does not believe this patent is critical for the
operation of its business.
Backlog. Backlog consist of uncompleted portions of engineering and construction
contracts with various corporate entities. Backlog of all uncompleted contracts
at December 31, 1998, totaled approximately $571,000, compared to a backlog as
of December 31, 1997, of approximately $1.3 million. Although backlog reflects
business which is considered to be firm, cancellations or scope adjustments may
occur. Where appropriate backlog has been adjusted to reflect known project
cancellations, deferrals and revisions in project scope and cost, both upward
and downward.
Liability Insurance. The medical, automotive, high-tech and other products
expose AMS to possible product liability claims, if the use of such products
results in personal injury, death or property damage. AMS maintains product
liability insurance in the principal amount of $2 million through April 1999.
There can be no assurance such insurance will be adequate in terms and scope to
protect AMS against material adverse effects in the event of a successful claim,
or that such insurance will be renewed with acceptable terms and conditions.
EMPLOYEES
As of December 31, 1998, the Company, employed approximately 56 full time
employees. None of the Company's employees are represented by a labor union or
bound by a collective bargaining agreement. The Company believes that the
relations with its employees are positive.
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ITEM 2. PROPERTIES
The Company leases 5,500 square feet of office space at 1200 Prospect Street,
Suite 325, La Jolla, California 92037. The term of the lease expires in December
2000. In addition, the Company leases office space in a suburb of Denver,
Colorado for marketing purposes. The term of this lease expires in December
1999. The Company also maintains an administrative office in Gillette, Wyoming
for engineering and administrative purposes. The initial term of this lease
expires in July 1999. The Company's OCET subsidiary leases 5,080 square feet of
laboratory space at 11588-20 and 21 Sorrento Valley Road, San Diego, California
92121 pursuant to a lease which expires in May 2000. AMS leases 20,000 square
feet of office and manufacturing space at 2222 Shasta Way, Simi Valley,
California 93065, which includes 15,000 square feet of manufacturing space which
is currently being leased on a monthly basis. The Company and AMS believe their
current facilities will be adequate for their respective expected needs for the
foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
The Company and its subsidiaries are from time to time involved in litigation
arising in the ordinary course of their respective businesses. The only lawsuit
currently pending against the Company is Walsh vs. AMS, filed on September 7,
1997, in the San Diego Superior Court. The Walsh case relates to events
occurring prior to the acquisition of AMS by the Company. The lawsuit asserts
claims, for among other things, breach of contract relating to a loan of
approximately $300,000. AMS has filed an answer denying liability and discovery
is proceeding. In the opinion of the Company, the pending litigation, if
adversely decided, should not have a material adverse effect on the Company.
On October 26, 1998, AMS filed a lawsuit against Anatol Automation and Anatol
Manufacturing in Orange County Superior Court. The lawsuit seeks approximately
$600,000 in compensatory damages and in excess of $2,000,000 in punitive damages
for interference with advantageous business relationships, interference with
contract, and appropriation of trade secrets in violation of the California
Uniform Trade Secret Act.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the three months ended December 31, 1998, to a
vote of the shareholders.
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===============================================================================
PART II
===============================================================================
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED SHAREHOLDER MATTERS
The Common Stock of the Company is currently traded and prices are quoted on the
NASD OTC Bulletin Board under the symbol SGII. The following table sets forth
the high and low bid prices for SGI Common Stock during the periods indicated.
The prices represent bid quotations and do not include retail mark-ups,
mark-downs or fees, nor do they necessarily represent actual trades.
<TABLE>
High Low
============================================
<S> <C> <C>
1998
First Quarter $ 1.47 $ 0.75
Second Quarter 1.72 0.63
Third Quarter 1.70 0.28
Fourth Quarter 0.57 0.27
1997
First Quarter $ 6.25 $ 4.19
Second Quarter 4.31 1.88
Third Quarter 3.22 1.03
Fourth Quarter 2.38 1.09
============================================
</TABLE>
As of March 2, 1999, the Company had approximately 2,200 stockholders of
record, and believes it has beneficial owners in excess of that number.
The Company has not declared any cash dividends on the Common Stock and does not
currently intend to pay any cash dividends on the Common Stock in the
foreseeable future.
The Company had the following sales of unregistered securities during the three
month period ended December 31, 1998.
On October 1, 1998, the Company issued incentive stock options to employees, at
fair market value pursuant to its 1996 Omnibus Stock Plan. The incentive options
are exercisable for a total of 205,000 shares of common stock at $0.265 per
share, the closing bid price on the date of grant, to employees of the Company.
The options expire on October 1, 2003, and are not exercisable until either a
registration statement under the Securities Act shall be effective at the time
of exercise, or the common shares underlying the option are issuable under an
applicable exemption from the registration requirements of the Securities Act.
The incentive options were granted in reliance upon exemptions from registration
pursuant to Section 4(2) of the Securities Act and Regulation D promulgated
thereunder.
As provided in related service or consulting agreements, the Company on October
1, 1998, granted eight warrants to purchase an aggregate 205,000 common shares
to four consultants and four outside directors for services rendered, pursuant
to the exemptions provided by Section 4(2) of the Securities Act and Regulation
D. Investment representations were obtained from the individuals and legends
were placed on the certificates. The exercise prices were not lower than the
closing bid price on the grant date and expire on October 1, 2003. The warrants
are first exercisable one year from the date of grant at $0.265 per share. In
connection therewith the Company recorded compensation expense of $44,710.
On October 30, 1998, the Company was able to extend or exchange approximately
$4.4 million in existing debt for new securities of the Company including
amended or new convertible debt securities, preferred stock and also paid
approximately $30,000 in existing debt. The Company retired $3,650,416 in
existing 10%, 11% and 12% interest
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bearing notes and convertible debentures which were required to be paid prior
to October 31, 1998, in exchange for new or amended 12% convertible debentures,
in the same amount, due September 30, 1999. These debentures may be prepaid by
the Company, in whole or in part, at any time prior to September 30, 1999. The
debentures are convertible at the option of the holder subsequent to November
13, 1998, in whole or in part, at the lower of a calculated number as of the
closing date ($0.406), or the average of the ten day closing bid price of the
Company's common stock prior to the date the notice of conversion is received
by the Company. The Company obtained an extension to September 30, 1999, of
approximately $724,000 of debt, and in connection therewith, agreed to grant 69
Series 98D preferred shares convertible with no further payment into an
aggregate of approximately 48,000 shares of the common stock valued at $27,500
and recorded as prepaid interest. During the three month period ended December
31, 1998 debenture holders converted $167,410 of their debentures into 480,971
shares of common stock. These securities were issued only to existing debt
holders pursuant to the exemptions provided by Sections 3(a)(9) and Section
4(2) of the Securities Act and Regulation D.
Prior to completion of the Series 98C mandatorily redeemable preferred stock
offering, the Company, in conjunction with the offering received $350,000 in
cash as a bridge loan from three foreign accredited investors. The bridge loan
was in the form of three 12% notes payable to the three investors who also
participated in the Series 98C Preferred stock offering. These securities were
issued by the Company in reliance upon exemptions from registration provided by
Section 4(2) of the Securities Act and the provisions of Regulation D. The notes
were exchanged for the Series 98C preferred stock and the Company issued 15,508
shares of common stock for interest valued at $4,652. (See Note 9 to the Notes
to Consolidated Financial Statements for additional information.)
On November 4, 1998, the Company issued 950 shares of $0.01 par value, 6%
Convertible Preferred Series 98C and six warrants to four foreign investors for
cash and notes payable. The Company received net proceeds of $918,000
representing the completion of the first tranche of this Preferred series. The
securities were issued by the Company in reliance upon exemptions from
registration provided by Section 4(2) of the Securities Act and the provisions
of Regulation D. These shares have a liquidation preference of $1,000 per share
and accrue dividends at the rate of 6% per annum which are cumulative. The
number of shares of common stock to be issued upon conversion of the 98C
Preferred Shares will be determined by dividing the amount to be converted by
the lesser of $0.46 or 75% of the five lowest closing bid prices of the common
stock during the Lookback Period. The Lookback Period is defined as the five
trading days immediately preceding the date the notice of conversion is received
by the Company. After the last trading day of each month that the Series 98C
Preferred Stock remains outstanding, starting on the first day of the fourth
month after November 4, 1998, the Lookback Period will be increased by two
trading days per month until the Lookback Period equals a maximum of 30 trading
days. The 98C Preferred Stock is redeemable at the option of the Company, in
whole or in part, in cash, at 125% of the Liquidation value plus accrued and
unpaid dividends. In the event the 98C Preferred Stock is not converted two
years from the Closing Date then the outstanding 98C Preferred Stock shall be
redeemed by the Company as if the Company voluntarily elected such redemption.
The six warrants which are convertible into 47,500 shares of common stock,
contain an exercise price equal to 110% of the average closing bid price for the
five trading days preceding the closing date. The warrants are exercisable two
days following the closing date and expire on November 4, 2003.
The shares of common stock underlying the 98C Preferred shares and warrants are
subject to a Registration Rights Agreement, which required the Company to file a
registration statement for these securities with the Securities and Exchange
Commission ("SEC"). The Company pursuant to this agreement filed and obtained
effectiveness of the required registration statement within the prescribed time
period
In connection with the sale of the first tranche of 98C Preferred Shares, the
Company paid an unaffiliated placement agent (Settondown Capital International,
Ltd.) a fee consisting of $25,000 in cash, 70 shares of 98C Preferred Stock
having a value of $70,000 and warrants to purchase 47,500 shares of common stock
as compensation for placement services. The securities were issued by the
Company in reliance upon exemptions from registration provided by Section 4(2)
of the Securities Act and the provisions of Regulation D. The warrants are
exercisable at 110% of the average closing bid price for the five trading days
preceding the closing date. The warrants are exercisable two days following the
closing date and expire on November 4, 2003. In addition to the placement agent
fees the Company paid $7,000 in cash for legal and escrow fees incurred in
connection with this transaction. The net proceeds of this transaction were used
for working capital purposes.
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On November 16, 1998, the Company as provided in a related service agreement,
granted one warrant to purchase an aggregate 35,000 common shares to one
employee, pursuant to the exemptions provided by Section 4(2) of the Securities
Act and Regulation D. Investment representations were obtained from the
individual and legends were placed on the certificate. The exercise price was
not lower than the closing bid price on the grant date and expire on December
31, 2003. The warrant is first exercisable one year from the date of grant at
$0.35 per share.
On December 1, 1998 (a closing date), the Company issued 250 shares of $0.01 par
value, 6% Convertible Preferred Series 98C ("Series 98C Preferred") and one
warrant to one foreign investor for cash. The Company received net proceeds of
$247,500 which represents the second tranche of the Series 98C Preferred.
Additionally, on December 11, 1998 (a closing date), the Company issued 250
shares of $0.01 par value, Series 98C Preferred and one warrant to one foreign
investor for cash. The Company received net proceeds of $247,500 which
represents the third tranche of the Series, 98C Preferred. The securities were
issued by the Company in reliance upon exemptions from registration provided by
Section 4(2) of the Securities Act and the provisions of Regulation D. These
shares have a liquidation preference of $1,000 per share and a dividend
preference of 6% per annum, cumulative. The number of shares of common stock to
be issued upon conversion for each tranche of the Series 98C Preferred will be
determined by dividing the amount to be converted by the lesser of (i) $0.36 for
the second tranche and $0.40 for the third tranche or (ii) 75% of the five
lowest closing bid prices of the common stock during the Lookback Period. The
Lookback Period is defined as the five trading days immediately preceding the
date the notice of conversion is received by the Company. After the last trading
day of each month that the Series 98C Preferred remains outstanding, starting on
the first day of the fourth month after the respective closing date, the
Lookback Period will be increased by two trading days per month until the
Lookback Period equals a maximum of 30 trading days. The Series 98C Preferred is
redeemable at the option of the Company, in whole or in part, in cash, at 125%
of the liquidation value plus accrued and unpaid dividends. In the event the
Series 98C Preferred is not converted two years from the closing date of the
tranche then the outstanding Series 98C Preferred Stock shall be redeemed by the
Company as if the Company voluntarily elected such redemption, subject to Utah
law. The warrants are convertible into 12,500 shares of common stock each, at an
exercise price equal to 110% of the average closing bid price for the five
trading days preceding the Closing Date ($0.38 for the second tranche and $0.40
for the third tranche). The warrants are exercisable beginning two days
following the closing date and expire five years from the respective closing
date.
The shares of common stock underlying the 98C Preferred and warrants are subject
to a Registration Rights Agreement, which requires the Company to file a
registration statement for these securities with the Securities and Exchange
Commission ("SEC"). The registration statement was filed and declared effective
by the SEC within the prescribed time period.
In connection with the sale of the second and third tranches of the Series 98C
Preferred, the Company paid an unaffiliated placement agent a fee consisting of
50 shares of 98C Preferred Stock having a face value of $50,000 and warrants to
purchase 25,000 shares of common stock as compensation for placement services.
The securities were issued by the Company in reliance upon exemptions from
registration provided by Section 4(2) of the Securities Act and the provisions
of Regulation D. The warrants are exercisable at 110% of the average closing bid
price for the five trading days preceding the closing date. The warrants are
exercisable beginning two days following the closing date and expire five years
from the closing date. The net proceeds of this transaction will be used for
working capital purposes.
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ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data has been derived from the audited
consolidated financial statements of the Company, certain of which appear
elsewhere in this Annual Report together with the reports of the Company's
Independent Auditors, whose reports include an explanatory paragraph relating to
an uncertainty concerning the Company's ability to continue as a going concern.
The selected financial data should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Company's consolidated financial statements and notes thereto.
<TABLE>
YEARS ENDED DECEMBER 31, 1998 1997 1996 1995 1994
==================================================================================================================
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenues $ 4,643,989 $ 5,322,724 $ 4,244,268 $ 900,306(1) $ 552,503
Net loss (5,542,609) (5,708,302) (4,259,365) (6,824,940)(1) (5,844,121)
Imputed dividends(2) (1,890,387) (770,226) -- -- --
Net loss applicable
to common stock (7,432,996) (6,478,528) (4,259,365) (6,824,940) (5,844,121)
Net loss per common
share - basic (0.50) (0.88) (0.80) (2.46)(1) (3.02)
Weighted average common
shares outstanding 14,751,222 7,324,953 5,357,010 2,774,084 1,933,032
Balance Sheet Data:
Current assets $ 1,374,244 $ 1,648,745 $ 2,295,167 $ 944,910 $ 717,406
Working capital deficiency (4,262,493) (4,284,559) (4,015,187) (2,369,079) (3,348,255)
Total assets 4,807,508 5,590,445 6,628,678 6,592,086 8,198,362
Long-term debt (excluding
current portion) 104,750 114,250 123,750 4,631,250 3,575,835
Stockholders' equity (deficiency) (2,383,327) (457,109) 194,574 (1,629,578) 556,866
==================================================================================================================
</TABLE>
(1) The Company acquired AMS effective October 30, 1995. AMS recorded revenue
of $867,000 and income from operations of $238,000 for the period October
31, 1995, through December 31, 1995.
(2) No cash dividends have been declared or paid since inception. Imputed
dividends related to preferred stock issued with a non-detachable
beneficial conversion feature. See Note 2 to the Notes to Consolidated
Financial Statements.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements: This Annual Report on Form 10-K contains statements
relative to: (i) projections, (ii) estimates, (iii) future research plans and
expenditures, (iv) potential collaborative arrangements, (v) opinions of
management, and (vi) the need for and availability of additional financing;
which may be considered forward-looking statements.
The forward-looking statements included herein are based on current expectations
that involve a number of risks and uncertainties. These forward-looking
statements are based on assumptions regarding the Company's business and
technology, which involve judgments with respect to, among other things, future
scientific, economic and competitive conditions, and future business decisions,
as well as risk factors detailed from time to time in the Company's SEC reports
including this Form 10-K, all of which are difficult or impossible to predict
accurately and many of which are beyond the control of the Company. Although the
Company believes that the assumptions underlying the forward-looking statements
are reasonable, any of the assumptions could prove inaccurate and, therefore,
there can be no assurance that the results contemplated will be realized and
actual results may differ materially.
Readers are urged to carefully review and consider the various disclosures made
by the Company in this report and in the Company's other reports filed with the
SEC that attempt to advise interested parties of the risks and factors that may
affect the Company's business. Therefore, historical results and percentage
relationships will not necessarily be indicative of the operating results of any
future period.
RESULTS OF OPERATIONS
Year ended December 31, 1998, compared to Year ended December 31, 1997.
Net Loss per Common Share. Basic net loss per common share decreased $0.38 per
share over the prior year. After excluding the effect of non-recurring imputed
dividends the Company's basic net loss per common share decreased approximately
$0.40 per share over the prior year. The imputed dividends are related to the
beneficial conversion feature associated with the issuance of convertible
preferred stock. Also see Note 2 "Net Loss per Share" to the Notes to
Consolidated Financial Statements. The decrease in basic net loss per share for
the current year is attributable to an increase in the weighted average number
of common shares outstanding and a net loss decrease before imputed dividends of
approximately $166,000 over the prior year.
Sales and Cost of Sales. Sales and cost of sales for the current year decreased
13% and 11%, respectively, over 1997. Sales and cost of sales are primarily
attributable to AMS and are recorded using the percentage of completion method.
The Company believes this decline in sales is primarily the result of the
General Motors strikes which began in early June and ended in late July,
impacting third quarter orders for automated assembly equipment in the
automotive sector. As a result, the Company experienced a 39% decline in sales
to this sector for the year. The Company does not anticipate any significant
long-term effects on future sales to this sector as fourth quarter sales
exceeded those of 1997. The decline in the Company's backlog and the widely
reported economic instability in the Asian-Pacific region indicates that certain
domestic customers in the electronics or high-tech sectors, who have seen their
Asian-Pacific revenues decline are ordering less automated assembly equipment.
Consequently, AMS's sales to this sector have declined approximately 18%, over
1997 sales. The projected length and severity of this slowdown to this sector is
unknown at this time. AMS experienced a 53% increase in sales to the medical
sector primarily due to the sales to one customer who made up approximately 21%
of total sales for 1998. Sales to this sector are projected to remain
approximately the same in 1999.
Other Income. Other income for 1998, remained substantially unchanged over the
prior year. The small fluctuations are directly related to the cash balances
maintained and the interest rates available for short term deposits.
Loss on Investment in TEK-KOL. The Company's share of the TEK-KOL loss for 1998,
decreased approximately 34% over 1997. The overall decrease for the year is
primarily attributable to a significant amount of development work
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<PAGE>
being performed on CDL upgrading in 1997. During 1997 the CDL enhancement
program was in full swing and TEK-KOL spent approximately $281,000 less in 1998
than in 1997. This decrease in expenses is primarily attributable to the results
obtained from the program in 1997 which allowed the parties to narrow their
development focus. CDL enhancement efforts by the Company and TEK-KOL in 1998
were continued alone and in collaboration with other outside third parties who
are absorbing some of the costs of development. In addition, TEK-KOL's operating
expenses are influenced by the number and timing of feasibility studies
performed. During 1997 the partnership spent considerable time and money
evaluating several international projects which were curtailed in 1998 due to
the widely reported economic instability in the international markets where
these projects would be sited.
On November 11, 1998, in accordance with the Company's notice of termination,
the active operations of the TEK-KOL partnership terminated. Upon termination,
the parties are required to take those steps necessary to dissolve the
partnership and wind up all partnership affairs. All tangible assets are to be
sold or otherwise disposed of and all intangible assets comprising intellectual
property are transferred to both parties such that each party owns an undivided
50% interest in all patents, trade secrets, trademarks, and all other
intellectual property. Although management estimates that the Company will be
required to contribute approximately $250,000, of which $180,172 has been
accrued for as of December 31, 1998, no formal plan for dissolution has been
approved by the partners. Consequently, the Company is currently unable to
project the future income or loss, if any, that will be associated with the
dissolution of the TEK-KOL partnership.
Engineering Research and Consulting Expenses. Engineering research and
consulting expenses are essentially related to the Company's activities
pertaining to the OCET and LFC technologies. Engineering research and
development expenses for 1998, decreased approximately 4% over the prior year.
The decrease is primarily attributable to a 38% reduction in the number of
employees working at the Company's OCET laboratory which is partially offset by
an increase in laboratory costs, as the Company continues its evaluation of the
OCET Process.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for 1998, decreased approximately 11% over the prior
year. The decrease is primarily related to the Company's reduced expenditures
for financial consultants and public relations expenses in 1998 and a one time
charge of $155,000 related to the write-off of certain contingent notes
receivable in 1997. In addition, selling, general and administrative expenses
for AMS decreased approximately $45,000 over the prior year due to a decrease in
administrative personnel and related expenses. This decrease is offset in part
by the Company agreeing to issue an additional 110,000 shares of restricted
common stock, valued at approximately $105,000, to the 97D convertible preferred
stock investors in settlement of a contractual dispute, an increase of
approximately $61,000 in insurance costs for improved coverage and approximately
$50,000 of financial penalties associated with delays in registering the common
shares underlying certain securities of the Company.
Legal and Accounting Expenses. Legal and accounting expenses for 1998, increased
34% over the prior year period. The increase is related primarily to legal and
accounting expenses incurred in preparing and filing the Company's two
registration statements on Form S-2 with the Securities and Exchange Commission.
Depreciation and Amortization Expenses. Depreciation and amortization expenses
for 1998, increased 15% over the prior year. The increase is due primarily to
purchases and construction of additional equipment at the OCET laboratory and
AMS.
Interest Expense. Interest expense for 1998, remained substantially unchanged
over the prior year.
Year ended December 31, 1997, compared to Year ended December 31, 1996.
Sales and Cost of Sales. Sales and cost of sales are primarily attributable to
AMS and are recorded using the percentage of completion method. Net sales for
1997 increased 34% over 1996. The Company attributes the increase in sales to a
change in marketing strategy. AMS is currently focusing its marketing efforts on
the western region of the U.S. with a heightened emphasis on the high-tech
industry. In 1997, sales to the high-tech industry increased 225% over the prior
year and sales to the automotive and medical industries declined 19% and 31%
respectively, primarily as a
19
<PAGE>
result of the change in marketing strategy. Cost of sales as a percentage of
sales declined 13%, compared to the prior year, as the
1996 cost of sales amount contained the results of a job overrun. Management
believes that the current year results are more indicative of future operations
at AMS.
Other Income. Other income for 1997 decreased 86% from 1996. The decrease is
related to the forgiveness of certain royalty obligations by a related party
totaling $142,000 and the reversal of estimated tax expenses related to the
acquisition of AMS, totaling approximately $110,000 in the prior year.
Loss on Investment in TEK-KOL. The Company's TEK-KOL loss for the year increased
102% over 1996. This increase is primarily the result of TEK-KOL's efforts to
increase the economic value of CDL and thereby improve the entire economics of
an LFC plant. In addition to the CDL enhancement program costs, TEK-KOL received
certain non-recurring payments of approximately $350,000 under an agreement with
MHI during the prior year.
Engineering Research and Consulting Expenses. The Company's engineering research
and consulting expenses for 1997 increased 91% over 1996. The increase relates
to the Company's heightened efforts to develop the OCET process.
Selling, General and Administrative Expenses. Selling, general and
administrative expense increased 71% over 1996 after adjusting for a 1996
non-recurring non-cash charge of $158,000, related to employee warrant exercises
with non-recourse notes. AMS's addition of sales personnel and its increased
marketing efforts account for approximately 50% of the overall increase. The
remaining portion of the 1997 increase is related to the Company's expanded
usage of public relations and financial consultants, as well as a one-time
charge of approximately $155,000 related to the write-off of certain contingent
notes receivable.
Legal and Accounting Expenses. The Company's legal and accounting expenses for
the year ended December 31, 1997, decreased 14% from 1996, after adjusting for
non-recurring non-cash charges of $316,000, related to employee warrant
exercises with non-recourse notes. The remaining decrease is due to cost
reduction activities in these areas.
Depreciation and Amortization Expenses. Depreciation and amortization expense
increased 17% over 1996. The increase is due primarily to purchases and
construction of additional equipment at the Company's OCET laboratory.
Interest Expense. Interest expense increased 8% ($43,000) over 1996, after
adjusting for a one-time non-recurring imputed interest charge of $176,000. The
imputed interest charge is related to the issuance of 12% convertible
debentures, with a non-detachable beneficial conversion feature on the date of
issuance. The increase is due primarily to increased borrowing on the line of
credit as compared to the prior year.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1998, the Company had assets totaling $4.8 million, including
restricted cash of $0.4 million, and a working capital deficiency of $4.3
million. The Company anticipates continued operating losses over the next twelve
months and has both short-term and long-term liquidity deficiencies as of
December 31, 1998. Current notes payable, convertible debentures, and associated
accrued interest aggregating $4.3 million and $4.5 million primarily contribute
to the Company's working capital deficiency at December 31, 1998, and 1997,
respectively. (See Note 5 to the Notes to Consolidated Financial Statements.)
Other short-term liquidity requirements are expected to be satisfied from
existing cash balances, proceeds from the sale of future equity securities or
other collaborative arrangements. Negotiations are on-going for the public and
private placement of equity securities, the proceeds of which are intended to be
used to satisfy the short-term liquidity deficiency. In the event that the
Company is unable to finance operations at the current level, various
administrative activities would be curtailed and certain research and
development efforts would be reduced. The Company will not be able to sustain
operations if it is unsuccessful in securing sufficient financing and/or
generating revenues from operations.
The Company had long-term liquidity deficiencies at December 31, 1998. Over the
long-term, the Company will require substantial additional funds to maintain and
expand its research and development activities and ultimately to commercialize,
with or without the assistance of corporate partners, any of its proposed
technologies. The Company believes the long-term liquidity deficiency will be
satisfied through future equity sales, increased positive
20
<PAGE>
cash flows from operations, and research or other collaborative agreements,
until such time, if ever, as the commercialization of the LFC and OCET
Processes result in positive cash flows. The Company is seeking collaborative
or other arrangements with larger well capitalized companies, under which such
companies would provide additional capital to the Company in exchange for
exclusive or non-exclusive licenses or other rights to certain technologies
and products the Company is developing. Although the Company is presently
engaged in discussions with a number of suitable candidate companies, there
can be no assurance that an agreement or agreements will arise from these
discussions in a timely manner, or at all, or that revenues that may be
generated thereby will offset operating expenses sufficiently to reduce the
Company's short-term or long-term funding requirements.
Cash used in operating activities for the year ended December 31, 1998,
increased 20% over 1997. Cash used in operating activities for the year ended
December 31, 1997, remained substantially unchanged over 1996. The use of funds
from operating activities is essentially attributable to the Company's net loss
of approximately $5.5 million, $5.7 million and $4.3 million for the years ended
December 31, 1998, 1997, and 1996, respectively. These losses were incurred
primarily as a result of the Company's administrative and technology development
activities.
The Company's investing activities amounted to a use of funds of approximately
$865,000 and $1,413,000 for the years December 31, 1998, and 1997, respectively.
This represents a 39% decrease in investing activities over 1997. The decrease
is primarily attributable to the Company's reduced investment in the TEK-KOL
partnership and construction of the OCET Process Development Unit which
principally took place in 1997. In 1996 the Company's investing activities
resulted in a source of funds when it collected approximately $1.7 million on
certain notes receivable.
In 1998 and 1997 investing capital was utilized primarily in the funding of the
TEK-KOL Partnership's operations; acquisition and construction of equipment at
the OCET laboratory; and the acquisition of equipment at AMS. Additional capital
contributions to the TEK-KOL Partnership are expected to be required from time
to time prior to its final pending dissolution. The Company is required to
contribute one-half of any such required capital contributions. Management
presently estimates that the Company may be required to contribute approximately
$250,000 in 1999 for past operations and dissolution related expenditures. In
addition, the Company, as of January 14, 1999, has entered into a joint venture
with MLFC a wholly-owned subsidiary of Mitsubishi Corporation. (See Note 13 to
the Notes to Consolidated Financial Statements.) In accordance with the joint
venture agreement, the Company anticipates expenditures of approximately
$500,000 for 1999. This joint venture funding requirement is anticipated to be
offset by the receipt of $1.0 million from the joint venture in accordance with
a service agreement executed by the parties. The amount of funds used for
investing activities in a given period are directly related to development
requirements and funds availability. In 1999 the Company is projecting capital
expenditures for equipment at OCET and AMS to remain consistent with prior
years. The Company does not have material commitments for capital expenditures
as of December 31, 1998.
The Company's financing activities raised approximately $4.3 million, $4.2
million and $3.4 million for the years ended December 31, 1998, 1997, and 1996.
These funds were raised primarily through the private placement of equity
securities. The amount of money raised during a given period is dependent upon
financial market conditions, technological progress and the Company's projected
funding requirements. The Company anticipates that future financing activities
will be influenced by the aforementioned factors.
The Company had notes payable and associated accrued interest aggregating $4.5
million required to be paid prior to October 31, 1998. In October 1998, the
Company satisfied these liabilities through its 98D exchange offering. This
exchange offering extended the due date of these liabilities to September 30,
1999, in exchange for primarily convertible debt and equity securities. (See
Note 5 to the Notes to Consolidated Financial Statements.)
As noted previously, significant future financing activities will be required to
fund future operating and investing activities and to maintain debt service.
While the Company is engaged in continuing negotiations to secure additional
capital and financing, there is no assurance such funding will be available or
if received will be adequate.
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<PAGE>
IMPACT OF INFLATION
The results of the Company's operations for periods discussed have not been
significantly affected by inflation. Further, although AMS often sells products
on a fixed quote basis, the average time between the receipt of an order and
delivery is generally under nine months. Therefore, AMS generally is not
adversely affected by increases in the cost of raw materials and components.
This could change in situations in which AMS is working against a substantial
backlog and may not be able to pass on higher costs to customers. In addition,
interest on the Company's line-of-credit is tied to the prime rate and therefore
may increase with inflation.
YEAR 2000
The Year 2000 issue exists because many computer systems and applications use
two-digit date fields to designate a year. As the century date change occurs,
date-sensitive systems may recognize the year 2000 as 1900, or not at all. This
inability to recognize or properly treat the year 2000 may cause systems to
process financial and operational information incorrectly.
The Company recognizes the need to ensure its operations will not be adversely
impacted by Year 2000 software failures. Software failures due to processing
errors potentially arising from calculations using the year 2000 date are a
known risk. The Company has assessed the impact on its computer systems of the
Year 2000 issue. The financial impact of making the required systems changes are
not expected to be material to the Company's consolidated financial position,
results of operations or cash flows.
Additionally, the Company is reviewing the year 2000 issue with it's suppliers,
shippers, customers, and other external business partners. There can by no
assurance, however, that all the systems of its suppliers, shippers, customers
and other external business partners will function adequately. If the systems of
the Company's suppliers, shippers, customers, and other external business
partners are not year 2000 compliant, it could have a material adverse effect on
the Company.
RECENT ACCOUNTING PRONOUNCEMENTS
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position (SOP) 98-5, "Reporting on the Costs of Start-Up
Activities." This SOP is effective for fiscal years beginning after December 15,
1998, and generally requires that all start-up costs, as defined, be expensed as
incurred. The Company is in the process of identifying any previously
capitalized costs which may have to be expensed under this guidance. Any
required adjustment, pursuant to SOP 98-5 will be recorded in the first quarter
of 1999, as the cumulative effect of a change in accounting principle, as
described in Accounting Principles Board Opinion No. 20, "Accounting Changes."
Entities adopting SOP 98-5 are not required to report the pro forma effects of
retroactive application.
Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about
Segments of an Enterprise and Related Information" is effective for financial
statements for periods beginning after December 15, 1997. SFAS No. 131
establishes standards for the way that public business enterprises report
financial and descriptive information about reportable operating segments in
annual financial statements and interim financial reports issued to
stockholders. SFAS No. 131 supersedes SFAS No. 14, "Financial Reporting for
Segments of a Business Enterprise," but retains the requirement to report
information about major customers. The Company has adopted SFAS No. 131 for the
fiscal year ended December 31, 1998.
The Financial Accounting Standards Board had issued certain other pronouncements
as of December 31, 1998, that will become effective in subsequent periods;
however, management does not believe that any of those pronouncements will
affect any financial accounting measurements or disclosures the Company will be
required to make based on its current operations.
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<PAGE>
RISK FACTORS
You should carefully consider the risks described below before making an
investment decision. The risks and uncertainties described below are not the
only ones facing our company. Additional risks and uncertainties not presently
known to us or that we currently deem immaterial may also affect our business
operations.
If any of the following risks actually occur, our business, financial condition
or results of operations could be materially adversely affected. In such case,
the trading price of our common stock could decline, and you could lose all or
part of your investment.
Historical Losses; Probable Future Losses
We have had a net loss in every year since we were incorporated in 1980. As of
December 31, 1998, we had an accumulated deficit of approximately $56.3 million
and a working capital deficiency of approximately $4.3 million. Our operations
may result in substantial and continuing losses in the future. We have only
generated limited revenue from our principal business which is the LFC Process.
Almost all of our recent revenues have been provided by AMS, our principal
subsidiary. AMS provided 99% of our gross revenues in each of the years ended
December 31, 1998, and 1997, and 93% of the gross revenues for the year ended
December 31, 1996. To achieve profitability, we must, among other things,
successfully complete development of the LFC Process and license the LFC Process
to third parties who will operate an LFC Process plant on a commercial scale.
Accordingly, we cannot assure you that we will be able to achieve profitability
at all or on a sustained basis.
Substantial Debt
We have substantial debt and debt service obligations. On December 31, 1998, we
had approximately $4.3 million in debt which is due on September 30, 1999. The
debtholders have a right to convert this debt into equity which may occur prior
to September 30, 1999. Other than this, we have no procedures in place to retire
any of the debt prior to the due date. Absent conversions into equity, unless we
receive substantial additional financing or can extend or convert the debt,
based on current operations, we may not be able to pay the principal or interest
payments on our debt. If we can't pay or refinance our debts, we may be unable
to continue in business. We cannot assure you that we will receive enough
funding to pay our debts, or that we will be able to refinance or convert our
debts before or when they become due.
Substantial Capital Requirements
We must raise substantial additional financing to market our proposed LFC
Process and OCET Process, to conduct research and development and to pay our
debt obligations. During the next year, we must pay our LFC related obligations
and approximately $4.3 million on our debt. We do not currently have the funds
available to pay these obligations. Based on past operations and funding
activities, we typically have on average three months worth of operating capital
available. We intend to raise the funds necessary for these expenses through
selling equity or debt securities, or by executing one or more strategic
partnerships, licenses or other similar transactions. We have no commitments for
any additional financing and we cannot assure you any additional financing will
be available on acceptable terms. If additional financing is not available, we
maybe required to reduce or suspend operations, seek to sell our assets or sell
securities on favorable terms. Our $400,000 line of credit is secured by
collateral and we are uncertain we can obtain additional bank financing in the
near term. Our future financing requirements will be affected by numerous
factors including results of LFC Process and OCET Process tests, research and
development results and competitive and technological factors.
No Established Markets for Either LFC Process or OCET Process Products
While we believe a market will develop in the United States and abroad for LFC
Process and OCET Process products, no market for these products currently
exists. We must establish and develop a market for the LFC Process products
among potential customers such as electric utility companies and industrial coal
users and for the OCET Process by oil refineries and others. The market
viability of the LFC Process won't be known until third parties such as large
electric utilities or coal mining companies construct and operate commercial
scale facilities
23
<PAGE>
which produce PDF and CDL. Until all components of the LFC
Process and OCET Process are completed, which is expected to take additional
time, money and testing, we may not be able to license parties to build and/or
operate either an LFC Process or an OCET Process plant.
Demonstration Plant Operations Discontinued
The Demonstration Plant was built to demonstrate the LFC Process, and has
produced and shipped PDF and CDL. ENCOAL discontinued the operations of the
Demonstration Plant in the fourth quarter of 1997 and its successor is unlikely
to resume operations. The cessation of operations of the Demonstration Plant may
have a material adverse impact on our ability to market and license the LFC
Process and therefore on our business and operations.
Limited Licenses for LFC Process; No Licenses for OCET Process
TEK-KOL, which owns the LFC Process, has issued four license agreements for the
LFC Process. The four current licenses for the LFC Process are expected to
generate nominal revenues in the near future. There can be no assurance we will
successfully market, license or sell either the LFC Process or the OCET Process.
We will be dependent upon third parties to finance the construction, development
and operation of plants using the LFC Process and the OCET Process. We do not
have any license agreements for the use of the OCET Process as the OCET Process
is in the development stage.
Dependence on Others
We do not presently have adequate capital, experience, resources or personnel to
finance, design, engineer, construct and operate an LFC Process or OCET Process
production plant. Therefore, we will be dependent on entering into agreements
with third parties to provide such financial participation and services for both
the LFC Process and OCET Process. We believe it would require $450 million or
more, several years of construction and expertise in major plant development and
operations to develop, construct and operate the first commercial LFC Process
plant. We cannot assure you we will enter into any agreement with any third
parties, or even if such agreements are entered into that they will be
successful or profitable. If we are not successful in our attempts to license
the LFC Process and/or the OCET Process it will have a material adverse impact
on our business and operations.
Dilutive Effects of Outstanding Securities
We have a substantial number of options, warrants and other convertible
securities which are outstanding. The exercise of the options and warrants or
the conversion of a significant number of the convertible securities could
result in substantial additional dilution to our existing shareholders. As long
as such options, warrants or convertible securities are outstanding, our ability
to obtain equity capital on favorable terms may be adversely affected. Several
of our outstanding series of convertible preferred stock are convertible into a
variable number of shares of common stock pursuant to a formula which results in
the holders receiving more shares of common stock the lower the trading price of
our common stock.
Conversion of some of our preferred stock and the resale of the common stock
could result in a lower market price for our securities. Such conversions could
also result in other holders of our convertible securities receiving more shares
of common stock resulting in even greater potential dilution.
Going Concern Assumption
The reports of our independent auditors on our financial statements for December
31, 1998, 1997, and 1996, contain an explanatory paragraph indicating that our
recurring operations losses, working capital deficiencies and certain other
matters raise substantial doubt about our ability to continue as a going
concern. We will require substantial additional funding in the future, and our
independent auditors' report on our future financial statements may include a
similar explanatory paragraph if we are unable to raise sufficient funds or
generate sufficient cash from operations to cover our cost of operations. The
statements by our independent accountants may have a material adverse affect on
our ability to raise money or enter into agreements to commercialize the LFC
Process or
24
<PAGE>
the OCET Process and therefore may materially adversely affect our
business, financial condition and results of operations.
Liquidity of Trading Market; Penny Stock
Shares of our common stock are quoted on the OTC Bulletin Board system. This
over-the-counter market on an electronic bulletin board generally supports
quotations for securities of companies that do not meet the NASDAQ Small Cap
Market listing requirements. As a result, investors may find it more difficult
to dispose of, or to obtain accurate price quotations of, our common stock than
they would if our common stock were quoted on the NASDAQ Small Cap Market. In
addition, quotation on the OTC Bulletin Board depends on the willingness of
broker-dealers to make a market in our common stock. We cannot assure you that
our common stock will continue to be so quoted or that there will continue to be
a market for buying and selling our common stock. Our common stock is also
subject to so-called "penny stock" rules that impose additional sales practice
and market making requirements on broker-dealers who sell and/or make a market
in such securities. Such rules may discourage the ability or willingness of
broker-dealers to sell and/or make a market in our common stock.
Target Market for LFC Process Plant Products
We believe the potential market for the processed coal to be produced by future
LFC Process plants includes utilities, independent power producers, certain
manufacturers of steel using new technologies, and other industrial enterprises
which use coal, both in and outside of the United States. The potential market
for the coal-derived liquid fuels includes industrial fuel users, refineries and
makers of chemical products in the United States and foreign countries. Our
ability to market the LFC Process to these markets will be dependent upon
various factors, including the user's current and future commitment to coal or
oil based energy, changes in the cost of delivered coal and oil, and the
difference between the costs of coal generated power versus other energy
sources.
Dependence on U.S. Regulations of Air Emissions
We believe a significant factor which assists in creating demand for the LFC
Process in the United States is the Clean Air Act, as amended. The Clean Air Act
specifies certain air emission requirements for electric utility companies and
industrial fuel users which are potential markets for the LFC Process, and we
believe these requirements could be fully or partially met through the use of
our LFC Process. A full or partial repeal of the Clean Air Act could weaken or
eliminate demand for the LFC Process and could have a material adverse impact on
our business and operations.
Competition and Technology Obsolescence
The principal market for LFC Process products is the energy industry, which is
intensely competitive. Many utility companies, coal companies and other
companies are engaged in research to clean or convert coal into a less polluting
and more efficient fuel or other commercial products. Many of our competitors
have substantially greater financial, technical and human resources than us and
may be better equipped to develop, test and license coal related technologies.
In addition, some of these companies have extensive experience in operating coal
technology plants. These companies may develop and introduce coal related
technologies competitive with or superior to our LFC Process prior to any market
acceptance for the LFC Process or other technologies developed by us or our
affiliates.
We expect that LFC Process product competition will be based, among other
things, on how economically, if at all, the LFC Process coal products can be
produced, their quality, compliance with environmental standards, transportation
costs, government incentive programs, comparison to energy generating
alternatives, and the strength of any patents on the LFC Process or other
potential technologies.
The automation assembly industry within which AMS competes is highly
competitive. Competition is based primarily on price, the speed and quantity of
products produced, timely delivery, product quality, safety, product innovation
and assistance in marketing and customer service. AMS competes with at least 85
other companies in the automation assembly business. Many of AMS's competitors
are substantially larger and more diversified, and
25
<PAGE>
have substantially greater financial and marketing resources than AMS. We
cannot assure you AMS will be able to compete successfully.
Patents and Intellectual Property
Patents and other proprietary rights are very important to our success and
competitive position. We have patents issued and pending in the U.S. for both
the LFC Process and OCET Process. We also have foreign counterparts for certain
of these patent applications. We cannot assure you that any of the pending
patent applications will be issued or, if issued, will provide meaningful
protection or not be challenged or invalidated. Any patents obtained will be for
a limited time, generally not exceeding 17 years from the date of issuance or 20
years from the date of filing.
We seek to protect our patents and other proprietary rights, but these actions
may be inadequate to protect our patents and other proprietary rights or to
prevent others from claiming violations of their patents and other proprietary
rights. Any claims, with or without merit, against our patents and proprietary
technology would subject us to costly litigation and the diversion of our
technical and management personnel and could have a material adverse impact on
our business, financial condition and results of operations.
Risks Associated with International Development Efforts
We have been actively pursuing LFC Process projects in Russia, Indonesia and
China for a number of years. While we believe international operations in these
countries represent potentially significant opportunities, we do not have any
agreements to construct or operate an LFC Process plant in any of these
countries. Because of the Asian and Russian economic crisis, these proposed
projects may not progress any further until economic conditions in Asia and in
Russia improve. We also believe the market for the LFC Process in China may be
adversely affected by the Asian economic crisis. If we do business in foreign
companies it also exposes us to many risks not present in the United States,
including political, military, privatization, supply, currency exchange and
higher credit risks. We cannot assure you that we will reach any agreement to
commercialize the LFC Process in these or any other foreign countries. The
termination of the TEK-KOL Agreement and the suspension of Demonstration Plant
operations may also materially adversely impact our marketing and licensing
efforts for the LFC Process in these and other countries overseas.
Electric Utility Regulatory Changes
The domestic electric utility industry is in the early stages of deregulation.
The National Energy Policy Act of 1992 exempts a new class of facilities from
certain federal utility regulation and liberalizes access for non-utility
generators. This legislation also initiated competition in the wholesale
electric market. In addition, many states are considering the elimination of
many of the regulations that currently limit the ability of parties to sell
within specific geographic boundaries. We believe these regulatory changes will
result in utilities and other power generators striving to reduce costs. We also
believe these changes will result in increased competition in the electric
wholesale and retail markets and increase pressures on all suppliers to electric
utilities to reduce costs. These factors may make it more difficult to obtain
the pricing needed to sell LFC Process products into the United States utility
market.
Dependence Upon Key Personnel
Our success in developing the LFC Process, the OCET Process and additional
marketable products and processes and achieving a competitive position is
dependent in large part on our ability to retain qualified scientific and
management personnel. We cannot assure you we can retain such personnel. If we
lost any of these individuals, it could have a material adverse impact on the
business and operations of the Company. Our potential growth and expansion into
areas requiring additional expertise, such as expanded programs for the LFC
Process and OCET Process requires additional research, testing, engineering and
marketing personnel which could place increased demands on our human resources.
If we expand and can not attract and retain personnel with appropriate expertise
it could have a material adverse effect on our prospects for success. We also
rely on consultants and advisors to assist us with marketing, management, and
research and development strategies. Our consultants and advisors are
26
<PAGE>
self-employed or are employees of other companies, and may have commitments to,
or consulting or advisory contracts with, more than one other entity that may
affect their ability to contribute to our projects.
AMS's success will depend, in large part, on its ability to retain qualified
project management, qualified engineers and management personnel. We cannot
assure you we will be able to retain such personnel. The loss of any of these
individuals could have a material adverse impact on AMS's business.
Environmental and Other Government Laws and Regulations
Potential LFC Process and OCET Process plants and the operations of AMS are now
and will likely in the future be subject to federal, state and local
environmental and other laws and regulations. These laws and regulations include
the Clean Air Act and various regulatory provisions of the United States
Department of Energy, the Environmental Protection Agency and the Internal
Revenue Service, as well as the laws and regulations of other countries and
international treaties. Future tax policy could also negatively impact our
prospects if the government encouraged production of other than coal for fuel
sources.
It is likely LFC Process Plants will be subject to the application of various
environmental regulations designed to ensure, among other things,
environmentally compatible plant operations. Failure to comply with applicable
regulatory requirements can result in fines, suspensions of regulatory
approvals, operating restrictions, criminal prosecution and other negative
consequences. Furthermore, additional government regulation may be established
in the future, which could prevent or delay the commercialization of either the
LFC Process and/or the OCET Process.
Market Value of Company's Securities
We must obtain substantial additional funds from investors for the sale of our
debt or equity securities to continue in business. In the event the market price
of our publicly traded Common Stock decreases below a certain price, we may be
unable to sell additional equity, or if we are able to sell securities, we may
not obtain sufficient consideration from the sale of our securities to provide
adequate funding to continue our operations.
Exercise of Existing Warrants and Conversion of Convertible Securities
We will be able to issue shares of Common Stock registered for resale upon
exercise of the warrants, options and/or the conversion of any convertible
securities only if there is an effective registration statement filed with the
Commission or an applicable exemption is available. Also, the Common Stock must
be qualified or exempt from qualification under applicable state securities laws
for each state in which the various holders of the warrants, options and
convertible securities live. Subject to our other contractual obligations, we
reserve the right in our discretion to not register or qualify the Common Stock
in any state where the time and expense do not justify registration or
qualification. The warrants, options and convertible securities may be deprived
of any value in the event we do not satisfy or we choose not to satisfy such
state and federal requirements. Although it is our present intention to satisfy
such requirements, we cannot assure you we will be able to do so.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
Not Applicable.
27
<PAGE>
ITEM 8. FINANCIAL STATEMENTS
Index to Consolidated Financial Statements
Reports of Independent Auditors...........................................29-30
Consolidated Balance Sheets - December 31, 1998, and 1997....................31
Consolidated Statements of Operations for the years ended
December 31, 1998, 1997, and 1996............................................32
Consolidated Statements of Stockholders' Equity (Deficiency) for the
years ended December 31, 1998, 1997, and 1996................................33
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997, and 1996.........................................34-35
Notes to Consolidated Financial Statements................................36-66
28
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders
SGI International
We have audited the accompanying consolidated balance sheets of SGI
International and Subsidiaries as of December 31, 1998 and 1997, and the related
consolidated statements of operations, stockholders' equity (deficiency) and
cash flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the 1998 and 1997 consolidated financial statements referred to
above present fairly, in all material respects, the financial position of SGI
International and Subsidiaries at December 31, 1998 and 1997, and their results
of operations and cash flows for the years then ended, in conformity with
generally accepted accounting principles.
As discussed in Note 2 to the consolidated financial statements, the Company's
principal assets are related to the "LFC" Process and the "OCET" Process. The
recovery of these assets is dependent upon future events, including the
Company's ability to adequately fund its on-going development operations and any
capital contributions that may be required for its new joint venture, LFC
Technologies, LLC. Furthermore, the ability to successfully bring both the LFC
Process and OCET Process technologies to commercialization will ultimately
depend on the Company's ability to attract sufficient additional equity, debt or
other third-party financing. These factors and the Company's working capital
deficiency and recurring losses from operations, among others, raise substantial
doubt about its ability to continue as a going concern. Management's plans in
regard to these matters are also discussed in Note 2 to the consolidated
financial statements. The accompanying 1998 and 1997 consolidated financial
statements do not include any adjustments relating to the recoverability and
classification of reported asset amounts or the amounts and classification of
liabilities that might result from the outcome of this uncertainty.
J. H. COHN LLP
/s/ J. H. Cohn LLP
San Diego, California
February 26, 1999
29
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Shareholders
SGI International
We have audited the accompanying consolidated statement of operations of SGI
International and the related consolidated statements of stockholders' equity
(deficiency) and cash flows for the year ended December 31, 1996. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements of SGI International referred to above
present fairly, in all material respects, the consolidated results of its
operations, its stockholders' equity (deficiency) and its cash flows for the
year ended December 31, 1996, in conformity with generally accepted accounting
principles.
As discussed in Note 2 of the notes to consolidated financial statements, the
Company's principal assets are related to the LFC (Liquids From Coal) Process.
The recovery of these assets is dependent upon future events, including the
Company's ability to attract sufficient additional equity and/or financing
needed to fund its portion of the TEK-KOL Partnership, that is responsible for
completion and commercialization of the LFC Process. These factors and the
Company's working capital deficiency and recurring losses from operations at
December 31, 1996, raise substantial doubt about its ability to continue as a
going concern. The consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
ERNST & YOUNG LLP
/s/ Ernst & Young LLP
San Diego, California
March 20, 1997
30
<PAGE>
<TABLE>
SGI INTERNATIONAL AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 1997
==========================================================================================================
<S> <C> <C>
ASSETS
Current assets:
Cash $ 239,885 $ 429,232
Restricted time deposit 402,500 402,500
Trade accounts receivable, less allowance for doubtful accounts
of $84,460 229,759 346,763
Costs and estimated earnings in excess of billings on contracts 275,967 146,364
Receivable from TEK-KOL Partnership 78,479 26,066
Inventories 64,371 64,843
Prepaid expenses and other current assets 83,283 232,977
- ----------------------------------------------------------------------------------------------------------
Total current assets 1,374,244 1,648,745
- ----------------------------------------------------------------------------------------------------------
LFC Process related assets:
Royalty rights, net 1,257,000 1,571,250
LFC cogeneration project, net 315,853 421,137
Investment in TEK-KOL Partnership 490,232 481,685
Notes receivable, net 150,000 150,000
Australia LFC project, net 86,877 115,836
LFC Process Control 3,834 -
Other technological assets, net 27,250 29,598
- ----------------------------------------------------------------------------------------------------------
2,331,046 2,769,506
Property and equipment, net of accumulated depreciation and
amortization of $920,941 and $589,789 766,695 788,740
Goodwill, net of accumulated amortization of $144,721 and $96,790 335,523 383,454
- ----------------------------------------------------------------------------------------------------------
$ 4,807,508 $ 5,590,445
==========================================================================================================
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Accounts payable $ 224,310 $ 287,458
Borrowings on line-of-credit 400,000 400,000
Billings in excess of costs and estimated earnings on contracts 156,411 193,792
Current maturities of long-term notes payable 690,000 3,061,875
12% convertible debentures 3,494,880 976,573
Accrued salaries, benefits and related taxes 139,486 240,368
Payable to TEK-KOL Partnership 180,172 100,000
Interest payable 161,991 483,930
Other accrued expenses 189,487 189,308
- ----------------------------------------------------------------------------------------------------------
Total current liabilities 5,636,737 5,933,304
Long-term notes payable, less current maturities 104,750 114,250
- ----------------------------------------------------------------------------------------------------------
Total liabilities 5,741,487 6,047,554
- ----------------------------------------------------------------------------------------------------------
Commitments and contingencies
Mandatorily redeemable preferred stock $.01 par value, liquidation
value of $1,570,000 plus accumulated dividends (Note 9) 1,449,348 -
Stockholders' deficiency:
Convertible preferred stock, $.01 par value; 20,000,000 shares
authorized, 64,044 and 90,997 shares issued and outstanding (Note 7) 641 910
Common stock, no par value; 75,000,000 shares authorized,
21,568,344 and 9,258,250 shares issued and outstanding 45,688,545 39,927,760
Paid-in capital 8,258,140 8,511,878
Accumulated deficit (56,330,653) (48,897,657)
- ----------------------------------------------------------------------------------------------------------
Total stockholders' deficiency (2,383,327) (457,109)
- ----------------------------------------------------------------------------------------------------------
$ 4,807,508 $ 5,590,445
==========================================================================================================
</TABLE>
See notes to consolidated financial statements.
31
<PAGE>
<TABLE>
SGI INTERNATIONAL AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998 1997 1996
================================================================================================================
<S> <C> <C> <C>
Revenues:
Net sales $ 4,600,190 $ 5,279,589 $ 3,938,854
Other 43,799 43,135 305,414
- ----------------------------------------------------------------------------------------------------------------
4,643,989 5,322,724 4,244,268
================================================================================================================
Expenses:
Cost of sales 3,456,185 3,898,737 3,440,381
Engineering, research and consulting 1,211,539 1,267,195 664,887
Loss on investment in TEK-KOL partnership 612,626 932,477 462,613
Selling, general and administrative 2,628,562 2,952,489 1,880,655
Legal and accounting 676,799 504,325 905,466
Depreciation and amortization 840,676 734,027 627,161
Interest 760,211 741,776 522,470
- ----------------------------------------------------------------------------------------------------------------
10,186,598 11,031,026 8,503,633
- ----------------------------------------------------------------------------------------------------------------
Net loss (5,542,609) (5,708,302) (4,259,365)
Imputed preferred stock dividends for Series 97B 8%,
97D 7%, 97F 8%, and 98A 6% convertible
preferred stock 1,434,891 770,226 -
Imputed dividends for Series 98C 6%
mandatorily redeemable preferred stock 455,496 - -
- ----------------------------------------------------------------------------------------------------------------
Net loss applicable to common stock $ (7,432,996) $ (6,478,528) $ (4,259,365)
================================================================================================================
Net loss per common share - basic $ (.50) $ (.88) $ (.80)
================================================================================================================
Weighted average shares outstanding 14,751,222 7,324,953 5,357,010
================================================================================================================
</TABLE>
See notes to consolidated financial statements.
32
<PAGE>
<TABLE>
SGI INTERNATIONAL AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY)
CONVERTIBLE TOTAL
PREFERRED STOCK COMMON STOCK STOCKHOLDERS'
------------------- ----------------------- PAID-IN ACCUMULATED NOTES EQUITY
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT RECEIVABLE (DEFICIENCY)
====================================================================================================================================
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1995 103,729 $1,037 3,859,671 $32,255,357 $4,582,215 $(38,159,764) $(308,423) $ (1,629,578)
Issuance of common stock for
notes payable, services
and interest - - 587,278 750,799 - - - 750,799
Issuance of common stock at $0.48
to $3.30 per share for cash, net - - 1,377,306 2,593,844 - - - 2,593,844
Exercise of warrants to purchase
common stock for cash
and notes payable - - 243,528 270,509 - - - 270,509
Issuance of convertible
preferred stock for notes
payable and interest 105 1 - - 1,583,396 - - 1,583,397
Conversion of preferred stock (15,101) (151) 26,822 247,722 (245,511) - - 2,060
Repurchase of preferred stock (1) - - - (41,223) - - (41,223)
Warrants granted for notes
payable, accounts payable
and interest - - - - 141,603 - - 141,603
Compensation expense for warrants
exercised with notes receivable - - - - 474,105 - - 474,105
Collection of notes receivable - - - - - - 308,423 308,423
Net loss - - - - - (4,259,365) - (4,259,365)
- ------------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1996 88,732 887 6,094,605 36,118,231 6,494,585 (42,419,129) - 194,574
Issuance of common stock for
services and interest - - 281,027 384,401 - - - 384,401
Issuance of common stock at $1.88
to $4.52 per share for cash, net - - 578,042 1,146,081 - - - 1,146,081
Exercise of warrants to purchase
common stock for cash - - 150,000 141,385 - - - 141,385
Imputed interest on issuance
of 12% convertible debenture - - - - 175,922 - - 175,922
Issuance of convertible preferred
stock for cash and notes payable 3,406 34 - - 3,000,733 - - 3,000,767
Conversion of preferred stock (1,141) (11) 2,154,576 2,137,662 (2,137,651) - - -
Issuance of warrants to purchase
common stock to non-employees - - - - 208,063 - - 208,063
Net loss - - - - - (5,708,302) - (5,708,302)
Preferred Series 97B 8%, 97D 7%,
and 97F 8% imputed dividends - - - - 770,226 (770,226) - -
- ------------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1997 90,997 910 9,258,250 39,927,760 8,511,878 (48,897,657) - (457,109)
Issuance of common stock for
services and operating
activities - - 242,079 190,317 - - - 190,317
Issuance of common stock at $0.60
to $0.81 per share for cash, net - - 194,502 156,800 - - - 156,800
Issuance of common stock
for 12% convertible debentures - - 480,971 167,410 - - - 167,410
Exercise of warrants to purchase
common stock for cash - - 25,000 15,000 - - - 15,000
Issuance of convertible preferred
stock for cash and notes payable 3,300 33 - - 2,803,167 - - 2,803,200
Conversion of preferred stock (30,322) (303) 11,367,542 5,231,258 (5,230,955) - - -
Issuance of preferred stock
for future interest 69 1 - - 27,530 - - 27,531
Accretion on mandatorily
redeemable preferred stock - - - - - (36,348) - (36,348)
Issuance of warrants to purchase
common stock to non-employees - - - - 89,350 - - 89,350
Interest expense related to
issuance of warrants - - - - 203,131 - - 203,131
Net loss - - - - - (5,542,609) - (5,542,609)
Preferred Series 97B 8%, 97D 7%,
97F 8%, 98A 6%, and 98C 6%
imputed dividends - - - - 1,854,039 (1,854,039) - -
- ------------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1998 64,044 $ 641 21,568,344 $45,688,545 $ 8,258,140 $(56,330,653) - $(2,383,327)
====================================================================================================================================
</TABLE>
See notes to consolidated financial statements.
33
<PAGE>
<TABLE>
SGI INTERNATIONAL AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998 1997 1996
=====================================================================================================================
<S> <C> <C> <C>
Operating activities:
Net loss $(5,542,609) $(5,708,302) $(4,259,365)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 840,676 734,027 659,660
Write-down and write-off of LFC related assets - 154,903 -
Common stock and warrants issued for services
and operating activities 190,317 279,251 211,650
Imputed interest on 12% convertible debentures - 175,922 -
Non-employee compensation expense on issuance of
warrants 89,350 208,063 -
Imputed interest on warrants issued to note holders 203,131 - -
Compensation for warrants exercised with notes receivable - - 474,105
Equity in net loss of TEK-KOL Partnership 612,626 932,477 462,613
Forgiveness of royalty payable to officer/stockholder - - (141,790)
Changes in operating assets and liabilities:
Trade accounts receivable (12,599) 508,257 (388,584)
Inventories 472 3,446 -
Receivable from TEK-KOL Partnership (52,413) (1,635) 51,093
Prepaid expenses and other current assets 177,225 (87,193) 102,248
Accounts payable (63,148) (156,978) (239,147)
Billings in excess of costs and estimated earnings on
Contracts (37,381) (194,100) 212,147
Accrued salaries, benefits and related taxes (100,882) 115,426 (154,161)
Interest payable 21,903 5,231 113,095
Other accrued expenses 179 (34,840) (154,420)
- ---------------------------------------------------------------------------------------------------------------------
Net cash used in operating activities (3,673,153) (3,066,045) (3,050,856)
- ---------------------------------------------------------------------------------------------------------------------
Investing activities:
Purchase of time deposit - - (402,500)
LFC process related assets:
Collection of notes receivable and related interest, net - - 1,717,258
Additions to LFC Process controls and other
technological assets (3,834) (10,129) (1,302)
Investment in TEK-KOL Partnership (621,173) (950,000) (330,500)
Payable to TEK-KOL Partnership 80,172 16,749 (228,748)
Purchase of property and equipment (313,146) (469,469) (408,727)
Other assets (6,713) - 12,876
- ---------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities (864,694) (1,412,849) 358,357
=====================================================================================================================
</TABLE>
34
<PAGE>
<TABLE>
SGI INTERNATIONAL AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998 1997 1996
====================================================================================================================
<S> <C> <C> <C>
Financing activities:
Borrowings on line-of-credit $ - $ 100,000 $ 300,000
Proceeds from issuance of notes payable 350,000 - 50,000
Payments of notes payable (39,500) (210,125) (125,250)
Proceeds from issuance of convertible preferred
stock and warrants, net 2,803,200 2,990,767 -
Proceeds from issuance of mandatorily redeemable preferred stock 1,063,000 - -
Redemption of preferred stock - - (41,223)
Proceeds from issuance of common stock 171,800 1,287,466 3,174,836
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 4,348,500 4,168,108 3,358,363
- --------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash (189,347) (310,786) 665,864
Cash at beginning of the year 429,232 740,018 74,154
- --------------------------------------------------------------------------------------------------------------------
Cash at end of the year $ 239,885 $ 429,232 $ 740,018
====================================================================================================================
Supplemental disclosure of cash flow information:
Cash paid for interest $ 458,000 $ 411,000 $ 195,000
Supplemental disclosure of non-cash activities:
Series 97 convertible preferred stock issued for
notes payable and interest - 13,000 -
Convertible debentures and common stock
issued for notes payable and interest 2,689,000 977,000 -
Common stock and warrants issued for current liabilities - 116,000 -
Common stock issued for convertible debentures 167,000 - -
Mandatorily redeemable preferred stock issued for notes payable 350,000 - -
Series 96 convertible preferred stock issued for notes
payable and interest - - 1,583,000
Convertible preferred stock issued for future interest 27,531 - -
Accretion of mandatorily redeemable preferred stock 36,348 - -
Warrants exercised in exchange for notes payable - - 230,000
Common stock or warrants issued for notes payable,
services and operating activities 190,000 384,000 751,000
Conversion of preferred stock 5,231,000 2,138,000 246,000
====================================================================================================================
</TABLE>
See notes to consolidated financial statements.
35
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS, ORGANIZATION AND PRINCIPLES OF CONSOLIDATION
SGI International (the "Company") was organized in 1985 as the successor to
certain other businesses. Through 1994, the principal business of the Company
was to license the Liquids From Coal ("LFC") Process technology as exclusive
licensing agent for the TEK-KOL Partnership (the Company's investment in TEK-KOL
is discussed in Note 4), to provide expert technical services to all LFC Process
related activities and projects and to develop Clean Coal Refineries worldwide.
During 1995, the Company commenced development of the Opti-Crude
Enhancement Technology Process ("OCET" Process) which is designed to increase
the amount of high quality fuels refined from residual oil, and the Company
acquired a manufacturing business that fabricates and sells automated assembly
equipment. Since inception, the Company has financed its research and
development of the LFC and OCET processes primarily through the private
placement of debt and equity securities and to a lesser extent through other
collaborative arrangements.
The Company has the following wholly-owned subsidiaries at December 31, 1998:
Assembly & Manufacturing Systems, Inc. ("AMS"); OCET Corporation ("OCET"); and
U.S. Clean Coal Refineries, Inc. ("USCCR"). AMS designs, manufactures and
installs automated assembly equipment, and was acquired in October 1995. OCET
was organized in February 1995 to research and develop the Opti-Crude
Enhancement Technology, a process for further refining residual oil bottoms.
USCCR was organized in October 1994 to market clean coal refinery
project development programs.
SGI Australia Pty. Ltd. ("SGIA") was organized in 1985 and became a
wholly-owned subsidiary in 1993. SGIA was established to commercialize the LFC
Process technology in Australia and New Zealand. During 1997, the Company
dissolved SGIA as it was determined that a special purpose subsidiary was no
longer required to effectively market the LFC Process in Australia.
The consolidated financial statements include the accounts of the Company and
its subsidiaries. All significant intercompany transactions have been eliminated
in consolidation.
2. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation. The accompanying consolidated financial statements are
prepared on a going concern basis. The recovery of amounts invested in the
Company's principal assets, the LFC Process and OCET Process assets, are
dependent upon the Company's ability to adequately fund its on-going development
operations and any capital contributions that may be required for its new joint
venture ("LFC Technologies, LLC") with MLFC Corporation, a wholly owned
subsidiary of Mitsubishi Corp. Furthermore, the ability to successfully bring
both LFC Process and OCET Process technologies to commercialization will
ultimately depend on the Company's ability to attract sufficient additional
equity, debt or other third-party financing.
Success in commercialization of the LFC Process and OCET Process is dependent in
large part upon the ability to enter into satisfactory arrangements with other
partners, financiers or customers and upon the ability of these third parties to
perform their responsibilities. The resources required to profitably develop,
construct and operate an LFC plant are likely to include hundreds of millions of
dollars, and expertise in major plant development and operations. There can be
no assurance any licenses, joint venture agreements or other arrangements will
be available on acceptable terms, if at all; that any revenue will be derived
from such arrangements; or that, if revenue is generated, any of these
arrangements will be profitable to the Company. If the Company is unsuccessful
in its attempts to license the LFC Process or OCET Process, or if such third
parties are unsuccessful in profitably developing and operating LFC plants, the
planned business and operations of the Company will likely not succeed and the
Company would not be able to recover the carrying value of the long-lived assets
related to either the LFC or OCET Process.
The Company had negative working capital of $4.3 million and an accumulated
deficit of $56.3 million at December 31, 1998. These factors and the Company's
recurring losses from continuing operations, among others, raise substantial
doubt about the Company's ability to continue as a going concern. The Company is
currently seeking additional financing through public or private sales of its
securities to fund working capital requirements.
36
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Company will also seek funding through additional strategic partnerships,
joint ventures or similar arrangements to commercialize the technologies. There
can be no assurance that any collaborative financing arrangements through a
joint venture, and/or with strategic partners, will be available when needed, or
on terms acceptable to the Company. If adequate funds are not available, the
Company may be required to curtail or terminate one or more of its operating
activities. The Company is engaged in continuing negotiation to secure
additional capital and financing, and while management believes funds can be
raised, there is no assurance that its efforts will be successful. The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
Estimates and Assumptions. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and disclosures made in the accompanying notes to the consolidated
financial statements. Actual results could differ from those estimates.
Concentration of Credit Risk. The Company invests its excess cash in interest
bearing deposits with major banks, commercial paper and money market funds.
Although certain of the cash accounts may exceed the federally insured deposit
amount, management does not anticipate non-performance by the other parties.
Management reviews the stability of these institutions on a periodic basis.
Inventories. Inventories are stated at the lower of cost or market. The Company
uses the first-in, first-out method of determining cost.
Accounting for Long-Lived Assets. Effective January 1, 1996, the Company adopted
Financial Accounting Standards Board ("FASB") Statement No. 121, "Accounting for
Long-Lived Assets and Long-Lived Assets to Be Disposed Of." The Company records
impairment losses on long-lived assets used in operations when events and
circumstances indicate that assets might be impaired and the undiscounted cash
flow estimated to be generated by those assets are less than the carrying
amounts of those assets. The LFC and OCET Process related assets and other
long-lived assets are evaluated continually by management for evidence of
impairment. In performing its evaluation, management considers such factors as
competing technologies, current and future market potential for products
generated from the LFC and OCET Process technologies, viability of projects or
assets and progress of related projects. The Company's estimate of undiscounted
cash flows indicated that such carrying amounts are expected to be recovered.
This analysis is ultimately based upon the successful development, construction
and operation of a commercial LFC plant as discussed in the second paragraph of
this Note under "Basis of Presentation". It is reasonably possible that the
estimate of undiscounted cash flows may change in the near term resulting in the
need to write-down the LFC or OCET Process related assets to fair value.
Depreciation and Amortization. Royalty rights, the LFC cogeneration project and
the Australian LFC project (See Note 4) are stated at cost and are being
amortized over ten years. Process demonstration equipment is stated at cost and
is being depreciated over three years. Property and equipment is stated at cost
and is being amortized over three to five years. Goodwill related to the AMS
acquisition is being amortized over ten years. Depreciation and amortization on
the LFC Process related assets and other long-lived assets are calculated using
the straight-line method and the depreciation and amortization periods are based
on management's estimates of the useful lives of the respective assets.
Revenue Recognition. Revenue is generally recognized on a
percentage-of-completion method. Revenues from engineering and consulting
services are recorded as the services are performed and earned in accordance
with the contracts to perform such services. Revenues from manufacturing
contracts are recorded using the percentage-of-completion method of accounting,
based upon the ratio of costs incurred to total estimated costs. Estimated
losses are recorded in their entirety when loss contracts are identified.
Contracts may extend over one or more accounting periods, and revisions in
estimated costs and revenue recognition during the course of the work are
reflected during the accounting period in which the facts that require such
revisions become known. Other income consists primarily of interest income and
is recorded as earned.
37
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Billings. Costs and earnings in excess of billings and conversely billings in
excess of costs and earnings arise from the use of the percentage-of-completion
method of accounting, cost reimbursement-type contracts and the timing of
billings.
Stock Based Compensation Awards. Management recommends and the Board of
Directors authorizes warrant and option grants to employees and other
individuals on a periodic basis. Warrant grants are not made pursuant to a
qualified plan; therefore, all warrants issued have a non-qualified tax status.
All options granted are made pursuant to the Company's 1996 Omnibus Stock Option
Plan and are made only to employees of the Company.
In accordance with the provisions of Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), the Company has
elected to follow Accounting Principles Board Opinion No. 25 "Accounting for
Stock Issued to Employees" ("APB 25") and related interpretations in accounting
for stock based compensation awards to employees. Under APB 25, if the exercise
price of the Company's warrants or options granted to employees equals or
exceeds the fair value of the underlying stock on the grant date, no
compensation expense is recorded. Stock based compensation awards issued to
non-employees are accounted for in accordance with SFAS 123. See Note 7 for pro
forma disclosures required by SFAS 123.
Equity Transactions. The values assigned to the restricted common shares issued
for services are recorded at the estimated fair value of the services rendered
or the value of the restricted common shares issued, which ever is more readily
determinable. The common stock of the Company is currently traded and prices
quoted on the NASD OTC Bulletin Board under the symbol SGII. In the course of
accounting for the issuance of its various equity securities the Company
frequently refers to the closing bid price of its common stock, as quoted on the
OTC Bulletin Board. The Company believes that the OTC Bulletin Board quoted bid
price is the best indication of the stock's fair market value. This belief is
premised on the stock's daily trading volumes which averaged approximately
207,000, 38,000, and 53,000 shares for 1998, 1997 and 1996, respectively.
Income Taxes. Income taxes are provided for in accordance with the provisions of
SFAS No. 109. Under this method, the Company recognizes deferred tax assets and
liabilities for the expected future tax effects of temporary differences between
the carrying amounts of assets and liabilities used for financial reporting and
income tax purposes, as well as operating loss carryforwards. A valuation
allowance is recorded to reduce a deferred tax asset to that portion that is
expected to, more likely than not, be realized.
Segment Reporting. SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information" is effective for financial statements for periods
beginning after December 15, 1997. SFAS No. 131 establishes standards for the
way that public business enterprises report financial and descriptive
information about reportable operating segments in annual financial statements
and interim financial reports issued to stockholders. SFAS No. 131 supersedes
SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise," but
retains the requirement to report information about major customers. The
Company has adopted SFAS No. 131 for the fiscal year ended December 31, 1998.
Net Loss per Share. Basic net loss per share is computed based on the weighted
average number of common shares outstanding and includes preferred stock
dividends. Diluted net loss per share is not presented since the effect of
shares issuable upon the assumed conversion of preferred stock and convertible
debentures and the assumed exercise of outstanding stock options and warrants
would be anti-dilutive. For purposes of computing net loss per share, preferred
stock dividends include "imputed dividends" for preferred stock issued with a
non-detachable beneficial conversion feature near the date of issuance. Imputed
dividends represent the aggregate difference between conversion price and the
fair market value of the common stock as of the date of issuance of the
preferred stock, without regard to the actual date on which the preferred stock
may be converted.
38
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In February 1997, the FASB issued SFAS No. 128, "Earnings per Share" which had
to be adopted by the Company by December 31, 1997. SFAS No. 128 replaced
Accounting Principles Board Opinion ("APB") No. 15 and simplified the
computation of earnings per share ("EPS") by replacing the presentation of
primary EPS with a presentation of basic EPS. Basic EPS includes no dilution and
is computed by dividing income available to common stockholders by the
weighted-average number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution from securities that could share in the earnings
of the Company, similar to fully diluted EPS under APB No. 15. The Statement
requires dual presentation of basic and diluted EPS by entities with complex
capital structures. All per share amounts for all periods presented had to be
restated to conform to SFAS No. 128 requirements. The Company adopted SFAS No.
128 as of December 31, 1997, however, no restatement of the previously
determined per share amounts was necessary as the effects of the assumed
conversion and exercise of the outstanding convertible securities, warrants and
options would have been anti-dilutive.
Recent Accounting Pronouncements. In April 1998, the American Institute of
Certified Public Accountants issued Statement of Position (SOP) 98-5, "Reporting
on the Costs of Start-Up Activities." This SOP is effective for fiscal years
beginning after December 15, 1998, and generally requires that all start-up
costs, as defined, be expensed as incurred. The Company is in the process of
identifying any previously capitalized costs which may have to be expensed under
this guidance. Any required adjustment, pursuant to SOP 98-5 will be recorded in
the first quarter of 1999, as the cumulative effect of a change in accounting
principle, as described in Accounting Principles Board Opinion No. 20,
"Accounting Changes." Entities adopting SOP 98-5 are not required to report the
pro forma effects of retroactive application.
Reclassification. Certain prior year amounts have been reclassified to conform
to the fiscal 1998 presentation. These changes had no impact on previously
reported results of operations, cash flows or stockholder's equity.
3. COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS
Billings. As of December 31, 1998, costs incurred and estimated earnings of
approximately $1,524,000 on contracts in progress exceeded billings of
approximately $1,405,000 by $119,000. As of December 31, 1997, billings on
contracts in progress of $2,404,000 exceeded costs incurred and estimated
earnings on contracts of $2,357,000 by $47,000. The amounts are included in the
accompanying consolidated balance sheets under the following captions:
<TABLE>
DECEMBER 31, 1998 1997
===============================================================================
<S> <C> <C>
Costs and estimated earnings in excess
of billings on contracts $ 275,967 $ 146,364
Billings in excess of costs and estimated
earnings on contracts (156,411) (193,792)
- -------------------------------------------------------------------------------
$ 119,556 $ (47,428)
===============================================================================
</TABLE>
Property and Equipment
<TABLE>
DECEMBER 31, 1998 1997
===============================================================================
<S> <C> <C>
Office furniture and fixtures $ 118,000 $ 109,000
Laboratory equipment 1,018,000 836,000
Machinery and equipment 123,000 118,000
Computer equipment 377,000 295,000
Leasehold improvements 52,000 21,000
- -------------------------------------------------------------------------------
1,688,000 1,379,000
Less accumulated depreciation (921,000) (590,000)
- -------------------------------------------------------------------------------
Net property and equipment $ 767,000 $ 789,000
===============================================================================
</TABLE>
39
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. LFC PROCESS RELATED ASSETS
Notes receivable. In June 1985, Montana One Partners ("MOP"), a California
limited partnership, was formed to develop several LFC cogeneration facilities
including the LFC-CoGen Plants in Colstrip, Montana (the "Colstrip Project") and
Healy, Alaska (the "Healy Project"). The Company was the sole general partner.
Originally, the limited partners purchased a 5.93% preferred interest in MOP for
$1,462,000; 84.07% was acquired by the Company and 10% by an affiliate, AEM
Corp. In 1988 the MOP partnership sold these projects, among others, to four
individuals who formed Rosebud Energy Corp. ("Rosebud"). By December 31, 1991,
the Company had acquired the limited partners 5.93% interest and AEM's 10%
interest for cash, contingent notes payable and warrants to acquire common
shares of the Company. The notes payable to the MOP former limited partners
("FLP's") and AEM are payable only out of the Company's collections on the
contingent notes receivable from Rosebud.
From 1996 through 1997 the Company through a number of transactions, collected
or wrote-off as uncollectible, the various notes receivable from the Rosebud
individuals, except for the Healy Project. In addition, the Company through a
series of transactions during this same period settled the contingent notes
payable of approximately 76% of the amounts due the FLP's.
On December 11, 1997, the Company finalized an agreement with AEM, whereby the
Company issued 25,714 shares of restricted common stock and two warrants to
acquire an aggregate of 37,714 of common shares at $5.75 per share, in exchange
for current obligations to AEM of approximately $116,000. In addition, the
Company acquired all of AEM's interest in future collections on the contingent
notes receivable, as well as a 12% distributed net profits interest in a
potential LFC cogeneration facility.
The balance of notes receivable and related accounts represent amounts due from
the 1988 sale of the Healy Project to the four individuals who formed Rosebud.
The amounts due as stated previously are contingent amounts payable to the
remaining FLP's and because of the contingencies on the note payments, no gain
or interest income will be recognized until the proceeds received are in excess
of the basis of assets sold. The components of the net carrying value of the
remaining notes receivable on the accompanying consolidated balance sheets are
as follows:
<TABLE>
DECEMBER 31, 1998 1997
===============================================================================
<S> <C> <C>
8% notes receivable $ 150,000 $ 150,000
Interest receivable 192,336 166,265
- -------------------------------------------------------------------------------
342,336 316,265
Deferred gain and interest income (165,672) (141,631)
8% notes contingently payable to FLP's (26,664) (24,634)
- -------------------------------------------------------------------------------
Net carrying value $ 150,000 $ 150,000
===============================================================================
</TABLE>
Royalty Rights. LFC Technology Partners ("LFCTP") originally financed research
and development of the LFC Process technology under certain research agreements
entered into with the Company from 1982 to 1986. As provided under the research
agreements, LFCTP provided cash and issued notes to the Company in exchange for
all rights in the LFC Process technology. On October 1, 1987, the Company and
LFCTP entered into an Amended Technology Transfer Agreement (the transfer
agreement), which provided for the transfer of all rights in the LFC Process
technology to the Company in exchange for three levels of royalty payments. The
first level of royalty payments was satisfied during 1992.
In 1992, the Company and LFCTP entered into a Settlement Agreement which
provided for modifications of the second and third level royalty payments. In
exchange for 12,500 shares of Series 92C convertible preferred stock, LFCTP's
third level royalty rights under the transfer agreement were reduced from 12.5%
of the Company's future net cash receipts (as defined) to zero and LFCTP's
second level royalty rights under the transfer agreement were reduced from
approximately $9 million at December 1992 to $10,000 per month plus 25% of net
cash receipts generated by the Colstrip Project.
40
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. LFC PROCESS RELATED ASSETS (CONTINUED)
Royalty rights aggregating $3,142,500 were recorded in 1992 based upon the value
of the underlying common shares. Royalty expense will be recognized as would
have been required under the transfer agreement or evenly over 10 years,
whichever is greater. Amortization expense of $314,250 was recorded during 1998,
1997, and 1996, and accumulated amortization totals $1,885,500 and $1,571,250 at
December 31, 1998, and 1997, respectively.
LFC Cogeneration Project. The Company has substantially completed the design and
engineering of an LFC facility for use in conjunction with an electric
cogeneration plant. Amounts capitalized at December 31, 1998, relate primarily
to plans and drawings for the design of such a facility. Amortization expense of
$105,000 was recorded during 1998, 1997, and 1996, and accumulated amortization
totaled $736,000 and $631,000 at December 31, 1998, and 1997, respectively.
Pursuant to the Colstrip Sale Agreements, the Company granted Rosebud a
non-exclusive license for LFC Process cogeneration plants with an aggregate
capacity of 350 megawatts which provides for the Company to receive royalties of
up to $1,000,000 from future plant financings and operations.
Investment in TEK-KOL Partnership. The Company entered into a Technology
Purchase Agreement (the "Agreement") with Shell Mining Company ("SMC") on
September 28, 1989. Under the Agreement, SMC acquired a one-half interest in the
LFC Process technology, related stand-alone assets and patents in exchange for
$650,000 in cash, a $550,000 note, and forgiveness of $350,000 of current debt.
SMC also agreed to pay additional consideration totaling $1,000,000 when the
first LFC plant became operational or $40,000 per month, up to an aggregate of
$1,000,000 beginning July 1992. Because of the time period involved over which
the proceeds were collected, the Company recognized the revenue as the
consideration was received.
The Company and SMC formed Tek-Kol on September 30, 1989, and each partner
contributed its respective one-half interest in the LFC Process, related LFC
stand-alone assets and patents to the partnership. TEK-KOL was formed to own and
license the LFC Process technology. As a result of the Agreement and subsequent
partnership formation, the Company recorded the book value of its one-half
interest in the assets contributed, $412,000, as its investment in TEK-KOL. The
Company accounts for its investment in TEK-KOL using the equity method. TEK-KOL
became operational in 1995 and the Company has recorded approximately $613,000,
$932,000 and $463,000 as its share of TEK-KOL's 1998, 1997 and 1996 net losses,
respectively.
The partnership agreement requires the Company to contribute one-half of any
required capital contributions as mutually determined by the partners. The
Company recorded a liability to TEK-KOL of approximately $180,000 and $100,000
at December 31, 1998, and 1997, respectively, for the unpaid portion of its
share of estimated required contributions.
The partnership agreement originally designated the Company as licensing
contractor. In accordance with the partnership agreement the Company was
required to perform certain services as the licensing contractor at its own
expense without pass through to the partnership. Effective May 1, 1995, the
partnership agreement was amended to among other things, enable the Company to
receive reimbursement for its past licensing expenditures through an amendment
that provides for the Company to receive 75% of all royalties, fees, and other
monies paid to TEK-KOL by third parties, until such time that the Company has
received $2.0 million. After the Company had received $2.0 million, all
royalties, fees, and other monies paid to TEK-KOL, if any, would be shared
evenly. Ongoing licensing activities were to be the responsibility of TEK-KOL.
The Company will record licensing revenues as these monies are received. To
date, the Company has not been reimbursed for past licensing related
expenditures.
TEK-KOL granted the Company a royalty-free LFC Process license for cogeneration
plants with an aggregate capacity of 350 megawatts and a royalty-bearing LFC
Process license which requires the Company to pay royalties of approximately
12.5% of the net proceeds from the sale of liquids produced by its first two
sole LFC Projects. Royalties to TEK-KOL for all products produced by additional
SGI sole projects are subject to negotiation based on prevailing industry
practices.
41
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. LFC PROCESS RELATED ASSETS (CONTINUED)
TEK-KOL granted an LFC Process license to SMC through which TEK-KOL will receive
royalties of approximately 12.5% of the net proceeds from the sale of liquids
produced by the first Level I and Level II plants. Royalties to TEK-KOL for all
products produced by any subsequent SMC plants are subject to royalties
negotiated based on prevailing industry practices.
On May 11, 1998, the Company gave notice to Bluegrass Coal Holding Company
("Bluegrass") a subsidiary of Zeigler Coal Holding Company, in accordance with
the TEK-KOL Partnership Agreement (the "Partnership Agreement"), that it was
unilaterally terminating the Partnership Agreement effective six months from the
date of the notice. Upon termination, the parties are required to take those
steps necessary to dissolve the partnership and wind up all partnership affairs.
All tangible assets are to be sold or otherwise disposed of and all intangible
assets comprising intellectual property are to be transferred to both parties
such that each party owns an undivided 50% interest in all patents, trade
secrets, trademarks, and all other intellectual property. However, upon
termination, the Company has a worldwide exclusive right through April 12, 2000,
to market and license the LFC Process. After April 12, 2000, both parties have
the right to market and license the present technology worldwide. Bluegrass may
continue to use the LFC Process on any of its sole projects.
Royalties earned on licenses entered into through the term of the Company's
exclusive period ending on April 12, 2000, are paid 80% to the Company and 20%
to Bluegrass, up to a date 10 years from the date of dissolution. For licenses
entered into after April 12, 2000, royalties are divided equally between the
parties for a period of 10 years after the date of dissolution. Both the Company
and Bluegrass are obligated to continue funding the TEK-KOL Partnership until
dissolution. While not anticipated, the termination of the Partnership Agreement
could have a material adverse impact on the business and operations of the
Company.
In September 1998, AEI Resources ("AEI") acquired all of Zeigler thereby also
acquiring all of Zeigler's interest in the LFC Process, half of the TEK-KOL
Partnership, the ENCOAL Demonstration Plant, the permits for a commercial LFC
Plant at North Rochelle and other LFC interests. These assets are currently held
through a subsidiary named Wyoming Coal Technology, Inc. ("WCT").
Joint Venture with Mitsubishi. On August 6, 1998, the Company entered into a
Letter of Intent with Mitsubishi Corporation ("Mitsubishi") to form a joint
venture. The Letter of Intent provides for the formation of a new company (the
"Joint Venture") to be owned equally by Mitsubishi and SGI. The Joint Venture's
primary objective is to develop LFC projects in the Powder River Basin of
Wyoming and further develop and market the LFC Process and its products. This is
a non-binding Letter of Intent and contemplates the parties will negotiate the
additional terms of and enter into a definitive Joint Venture and other
agreements.
In accordance with the Letter of Intent, SGI is to provide the Joint Venture
with personnel for engineering, LFC project development, and technology and
product marketing in the United States. In addition, SGI is to develop strategic
relationships and refine the Coal Derived Liquids ("CDL") upgrading process. In
consideration for these services, Mitsubishi is to pay SGI a set annual fee per
year for at least two years or until the parties transition the Joint Venture
into an operating entity.
Pursuant to the Letter of Intent, Mitsubishi is to provide to the Joint Venture,
engineering to optimize the LFC Process, to reduce the cost of LFC plant
equipment, to optimize the CDL upgrading process, and to market the technology
and products outside of the United States. Upon the occurrence of certain
events, the parties have agreed to convert the Joint Venture to an operating
entity, and SGI is to then transfer the LFC patents to this entity for an agreed
upon payment from Mitsubishi. Subsequent to year end SGI and MLFC, a
wholly-owned subsidiary of Mitsubishi Corp., entered into a definitive joint
venture agreement establishing LFC Technologies, LLC. (See Note 13 for more
information.)
42
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. LFC PROCESS RELATED ASSETS (CONTINUED)
Australia LFC Project. The Company has capitalized certain costs associated with
preliminary site reviews and engineering studies relative to Australian coals as
part of an effort to market the LFC Process technology. The Company owns the
right to license the LFC Process technology in Australia and New Zealand. The
capitalized costs are being amortized over a ten year estimated life and
amortization expense of $29,000 was recorded during 1998, 1997 and 1996.
Accumulated amortization at December 31, 1998, and 1997, is $203,000 and
$174,000, respectively.
5. LINE-OF-CREDIT AND NOTES PAYABLE
The Company maintains a $400,000 line-of-credit with a financial institution.
The line-of-credit is secured by a $402,500 certificate of deposit maturing May
1999, and borrowings on the line-of-credit bear interest at 2% over the
certificate of deposit interest rate. Borrowings on the line-of-credit were
$400,000 at December 31, 1998, and 1997.
Notes payable consist of the following:
<TABLE>
DECEMBER 31, 1998 1997
====================================================================================================================
<S> <C> <C>
12% notes, due through September 2000, unsecured $ 16,625 $ 26,125
10-12% notes, due on September 30, 1999, unsecured 690,000 3,050,000
12% convertible debentures due on September 30, 1999, unsecured 3,483,005 976,573
Non-interest bearing convertible debenture, due no earlier than 2000, unsecured 100,000 100,000
- --------------------------------------------------------------------------------------------------------------------
4,289,630 4,152,698
Less current portion 4,184,880 4,038,448
- --------------------------------------------------------------------------------------------------------------------
Long-term portion $ 104,750 $ 114,250
====================================================================================================================
</TABLE>
During 1986 and 1987, the Company sold securities to qualified investors through
private placement offerings which included 12% notes payable. Principal payments
of $2,375 and 12% interest payments are due quarterly through maturity in
September 2000. The 12% notes payable also include contingent interest ranging
from 6% to 24%. The contingent interest begins accruing quarterly upon
completion of construction, start-up and testing of a commercial LFC Plant. No
commercial LFC Plants have been built and no interest expense related to this
contingency has been recorded to date. The notes are convertible into restricted
common stock at the rate of .075 shares per $1 of outstanding principal.
Prepayment of the principal results in the payment of an amount which would
cause the annual return from the original note date to become 18% to 24%,
compounded annually. An additional payment equal to 25% of the outstanding
principal is also required upon prepayment. The balance outstanding under these
notes totaled $16,625 and $26,125 at December 31, 1998, and 1997, respectively.
During March and April of 1996, the original maturity dates for notes payable
with a carrying value of $165,000 were extended and notes payable with a
carrying value of $725,000 were converted into 2.5 Series 95R preferred shares
and 70 Series 96A preferred shares, all with a $10,000 per share liquidation
preference.
In 1996, accrued interest of $89,000 was satisfied through the issuance of the
Series 95R and 96A preferred shares, the Company prepaid interest through
September 30, 1997, of $62,200 on certain notes through the issuance of 14,288
restricted common shares, and accrued interest through December 31, 1996, of
$529,000 became due September 30, 1997.
The Company received $100,000 from a foreign corporation in 1995 in exchange for
a non-interest bearing debenture with a $100,000 face value. The debenture is
due one year from the occurrence of certain future events, none of which
occurred to date. Accordingly, the debenture is classified as long-term debt in
the accompanying consolidated balance sheet. The debenture is convertible based
on future events, and would have converted into approximately 303,000 common
shares at December 31, 1998, had those events occurred.
43
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. LINE-OF-CREDIT AND NOTES PAYABLE (CONTINUED)
On July 15, 1997, the Company converted one $10,000 note payable and associated
accrued interest of $2,748 into one share of Series 97C convertible preferred
stock. The convertible preferred share is fully paid and non-assessable, has no
voting rights, has a preference in liquidation of $10,000 and is convertible
into 13,500 shares of common stock on or after August 30, 1998, without further
payment.
In October 1997, the Company was able to extend, exchange or convert
approximately $4.8 million in existing debt for new securities of the Company
including common stock, warrants and revised, amended or new convertible debt
securities and also paid approximately $400,000 in existing debt. The Company
retired approximately $250,000 in existing 10%, 11% and 12% interest bearing
notes which were required to be paid by October 31, 1997, in exchange for
$250,000 of 12% convertible debentures due September 30, 1998, with a conversion
price of $1.20. The Company obtained an extension to September 30, 1998, of
approximately $3,428,000 of debt, and in connection therewith, agreed to grant
warrants to purchase an aggregate of 152,500 shares of common stock at an
exercise price of $1.20 per share for each quarterly period the debt remains
unpaid. The warrants expire on December 31, 1999. The Company retired an
additional $727,000 of existing 10%, 11% and 12% interest bearing notes which
were required to be paid by October 31, 1997, in exchange for $727,000 of
convertible debentures due September 30, 1998, with a conversion price of $1.20.
In connection therewith, and in part as consideration for all interest due
through the maturity of the extended notes, the Company issued 95,439 shares of
restricted common stock. The 12% convertible debentures are convertible into
approximately 814,000 shares of restricted common stock. No note payments were
made prior to the due date and the Company issued warrants to purchase 610,000
common shares, as previously discussed, to noteholders. Imputed interest expense
of $175,922 was recorded in connection with the issuance of the 12% convertible
debentures. These notes and debentures were extended or exchanged for new debt
securities on October 30, 1998, as discussed herein.
Prior to completion of the Series 98C mandatorily redeemable preferred stock
offering ("Series 98C Preferred Stock"), the Company, in conjunction with the
offering received $350,000 in cash as a bridge loan from three foreign
accredited investors. The bridge loan was in the form of three 12% notes payable
to the three investors who also participated in the Series 98C Preferred Stock
offering. The notes were exchanged for the Series 98C Preferred Stock and the
Company issued 15,508 shares of common stock for interest valued at $4,652. (See
Note 9 for additional information.)
On October 30, 1998, the Company was able to extend or exchange approximately
$4.4 million in existing debt for new securities of the Company including
amended or new convertible debt securities, preferred stock and also paid
approximately $30,000 in existing debt. The Company retired approximately
$3,650,416 in existing 10%, 11% and 12% interest bearing notes and convertible
debentures which were required to be paid prior to October 31, 1998, in exchange
for new or amended 12% convertible debentures, in the same amount, due September
30, 1999. These debentures may be prepaid by the Company, in whole or in part,
at any time prior to September 30, 1999. The debentures are convertible at the
option of the holder subsequent to November 13, 1998, in whole or in part, at
the lower of a calculated number as of the closing date ($0.406), or the average
of the ten day closing bid price of the Company's common stock prior to the date
the notice of conversion is received by the Company. The Company obtained an
extension to September 30, 1999, of approximately $724,000 of debt, and in
connection therewith, agreed to grant 69 Series 98D preferred shares convertible
with no further payment into an aggregate of approximately 48,000 shares of the
common stock valued at approximately $27,500. This amount was recorded as
prepaid interest and is being amortized over the life of the debt. During the
three month period ended December 31, 1998, debenture holders converted $167,410
of their debentures into 480,971 shares of common stock.
Scheduled principal payments of notes payable are as follows:
<TABLE>
YEARS ENDED DECEMBER 31,
- --------------------------------------------------------------
<S> <C>
1999 4,184,880
2000 104,750
- --------------------------------------------------------------
Total payments $ 4,289,630
- --------------------------------------------------------------
</TABLE>
44
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. INFORMATION ON INDUSTRY SEGMENTS
In June 1997, the FASB issued Statement No. 131, "Disclosures about Segments of
an Enterprise and Related Information," which the Company has adopted in the
current year. The Company identifies its segments based on strategic business
units that are in turn based along technological lines. These strategic business
units offer products and services to different markets in accordance with their
underlying technology. Accordingly, the Company's three business segments are
centered on the operations associated with the LFC Process, the OCET Process
and automated assembly and manufacturing systems. The Company's operations are
primarily centered in the United States, however, through its various
collaborative arrangements (with TEK-KOL and now Mitsubishi) the Company will
continue to market the LFC Process technology on an international basis. The
accounting policies of the segments are the same as those described in the
summary of significant accounting policies. The Company evaluates performance
of each segment based on profit or loss from operations before income taxes.
The Company has no significant intersegment sales or transfers.
<TABLE>
AUTOMATED
ASSEMBLY LFC PROCESS OCET PROCESS CORPORATE TOTAL
===========================================================================================================
<S> <C> <C> <C> <C> <C>
1998
Revenues $ 4,582,000 $ - $ 21,000 $ 41,000 $ 4,644,000
Net Profit (Loss) 208,000 (1,273,000) (1,253,000) (3,225,000) (5,543,000)
Equity in operations
of investee - (613,000) - - (613,000)
Identifiable assets, net 1,303,000 2,331,000 632,000 542,000 4,808,000
Depreciation &
Amortization 107,000 451,000 272,000 11,000 841,000
R&D expenditures - 223,000 989,000 - 1,212,000
Interest expense - - - 760,000 760,000
- -----------------------------------------------------------------------------------------------------------
1997
Revenues $ 5,280,000 $ - $ - $ 43,000 $ 5,323,000
Net Profit (Loss) 425,000 (1,582,000) (1,265,000) (3,286,000) (5,708,000)
Equity in operations
of investee - (932,000) - - (932,000)
Identifiable assets, net 1,310,000 2,770,000 638,000 872,000 5,590,000
Depreciation &
Amortization 83,000 457,000 168,000 26,000 734,000
R&D expenditures - 192,000 1,075,000 - 1,267,000
Interest expense - - - 742,000 742,000
- -----------------------------------------------------------------------------------------------------------
1996
Revenues $ 4,049,000 $ - $ 2,000 $ 193,000 $ 4,244,000
Net Profit (Loss) (142,000) (1,087,000) (488,000) (2,542,000) (4,259,000)
Equity in operations
of investee - (463,000) - - (463,000)
Identifiable assets, net 1,527,000 3,354,000 392,000 1,356,000 6,629,000
Depreciation &
Amortization 48,000 448,000 131,000 627,000
R&D expenditures - 176,000 489,000 - 665,000
Interest expense - - - 552,000 552,000
===========================================================================================================
</TABLE>
Net Profit (Loss) from operations is net sales less all costs, excluding income
taxes and including other income.
45
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. INFORMATION ON INDUSTRY SEGMENTS (CONTINUED)
AMS operates in three segments of the automated assembly systems industry:
high-tech, medical and automotive. The sales for 1998, 1997 and 1996 are
presented below.
<TABLE>
1998 1997 1996
===============================================================================
<S> <C> <C> <C>
High-tech $ 2,434,000 $ 2,967,000 $ 943,000
Medical 1,177,000 717,000 1,028,000
Automotive 971,000 1,596,000 1,968,000
- -------------------------------------------------------------------------------
Total Sales $ 4,582,000 $ 5,280,000 $ 3,939,000
===============================================================================
</TABLE>
Sales revenue was derived primarily from contracts to manufacture assembly
equipment with four, three and four customers in 1998, 1997 and 1996,
respectively. Revenue from sales of automated assembly equipment accounted for
99%, 99% and 93% of the Company's revenues in 1998, 1997 and 1996, respectively.
The Company has three customers whose sales represent a significant portion of
sales in the automated assembly systems segment during the last three years.
Sales to one of these customers was in excess of 21% in 1998 and 16% in 1996.
Sales to another customer was in excess of 29% in 1998 and 17% in 1997. Sales to
a third customer accounted for approximately 18% in 1998 and 11% in 1996. As is
typical in the automated assembly industry, AMS relies on a limited number of
customers for a substantial percentage of its net sales. In 1998 sales revenues
derived from four customers represent approximately 84% of total sales. In 1997
sales revenues derived from three customers represent approximately 51% of total
sales and in 1996 sales revenues derived from four customers represent
approximately 78% of total sales. AMS does not have long-term contracts with any
of its customers and expects that a small number of customers will continue to
account for a substantial portion of its sales for the foreseeable future.
7. STOCKHOLDERS' EQUITY (DEFICIENCY)
Convertible Preferred Stock. The outstanding Preferred Stock of the Company at
December 31, 1998, consisted of 64,044 shares of Preferred Stock. The
outstanding Preferred Stock series are: 90B; 90C; P-90; PS-90; 91A; 91C; 91D;
91E; 91M; 91P; 91R; 91S; 91V; 92A; 92B; 93A; 93B; 93C; 94A; 94B; 95R; 96A; 96B;
97C; 97D; 98A, and 98D. The primary distinction between such series of Preferred
Stock relates to the dividend, convertible rights and liquidation preferences
for each.
A summary of the issued and outstanding convertible preferred stock at December
31, 1998, is as follows:
<TABLE>
COMMON SHARES
SHARES ISSUED PREFERENCE IN ISSUABLE
PREFERRED STOCK AND OUTSTANDING LIQUIDATION ON CONVERSION
===============================================================================
<S> <C> <C> <C>
Series P-90 400 $ 40,000 100,000
Series PS90 8 2,000 1,000
Series 90 6 640 560
Series 91 62,654 296,340 5,995
Series 92 15 1,510 110
Series 93 66 6,650 2,438
Series 94 191 19,095 8,119
Series 95 67 771,111 1,695,607
Series 96 62 719,000 490,500
Series 97 76 85,000 319,214
Series 98 499 430,000 1,994,227
- -------------------------------------------------------------------------------
64,044 $2,371,346 4,617,770
===============================================================================
</TABLE>
During 1998, shareholders elected to convert 30,322 Preferred Shares into
approximately 11,368,000 shares of common stock.
46
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. STOCKHOLDERS' EQUITY (DEFICIENCY) (CONTINUED)
1998 Preferred Stock Transactions
On January 8, 1998, the Company, for the net proceeds of $490,000 issued 550
shares of Series 97G 8% Convertible Preferred Stock to two foreign accredited
investors pursuant to the provisions of Regulation S. The Series 97G Preferred
Shares accrue dividends at a rate of 8% per annum and are cumulative. As per the
subscription agreements, the Company also issued warrants to purchase a total of
25,000 common shares at $1.35 per share and 194,502 shares of restricted common
stock. The warrants became exercisable 10 days subsequent to the closing date
and expire on January 8, 2003. As of December 31, 1998, the Series 97G Preferred
Shares were fully converted into approximately 655,000 common shares.
On March 6, 1998, the Company, for net proceeds of $1,980,000, issued 2,200
shares of Series 98A 6% Convertible Preferred Stock to two accredited investors
representing the first tranche of the series. The 98A Preferred Shares accrue
dividends at a rate of 6% per annum and are cumulative. See Description of
Securities below for a summary of the rights and conversion privileges of the
Series 98A Preferred Stock holders. As per the subscription agreements the
Company also issued warrants to purchase a total of 90,000, common shares at
$1.27 per share. The warrants became exercisable 10 days after issuance and
expire on March 6, 2003.
On April 1, 1998, the Company agreed to amend the terms and conditions of the
Series 97D Preferred Stock Purchase Agreement dated August 12, 1997, ("97D
Agreement") with the two purchasers thereof. In accordance with this amendment,
the Company agreed to issue an additional 100,000 shares of restricted common
stock of the Company to one purchaser and 10,000 shares of restricted common
stock to the other purchaser in exchange for a mutual release of possible claims
by the Company and the purchasers thereof. The 97D Agreement contained a
"favored nations" clause which obligated the Company to pay the purchasers a
certain amount in the event the Company sold convertible securities for $550,000
or less with similar terms and conditions and where the conversion price
provided a greater discount than that given to the purchasers in the 97D
Agreement. The 97D Agreement also granted the purchasers registration rights
which provided monetary penalties in the event the registration statement
relating to the shares to be registered was not declared effective within the
required time. The Company entered into an agreement for the sale of convertible
securities in January 1998 which was alleged by the purchasers in the 97D
Agreement to trigger the favored nations and registration rights penalty
provisions. The additional shares issued to the two purchasers settled the
possible claims resulting from the favored nations and the registration rights
provisions without relieving the Company of the obligation to continue paying a
penalty monthly. The 110,000 shares of common stock were valued by the Company
at approximately $105,000 based on a 10% discount to the $1.07 bid price of the
common stock of the Company on the closing date.
On July 28, 1998, the Company, for net proceeds of $490,000, issued 550 shares
of Series 98A 6% Convertible Preferred Stock to two accredited investors,
representing the second and final tranche. The 98A Preferred Shares accrue
dividends at a rate of 6% per annum and are cumulative. See Description of
Securities below for a summary of the rights and conversion privileges of the
Series 98A Preferred Stock holders. The Company also issued warrants to purchase
a total of 70,000 common shares at $1.18 per share to these investors. The
warrants became exercisable 10 days after issuance and expire on March 6, 2003.
On October 30, 1998, as part of its 98D Exchange offering with various
noteholders the Company issued 69 shares of Series 98D Preferred Stock. Each
share of the Series 98D Preferred Stock is convertible into 700 shares of Common
Stock of the Company at the option of the holder, at any time after 15 days from
October 30, 1998, for a period of two years from October 30, 1998. On the second
anniversary from October 30, 1998, the Series 98D Preferred Stock automatically
converts into Common Stock. The Series 98D Preferred Stock was valued by the
Company at $27,530 and recorded as prepaid interest.
47
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. STOCKHOLDERS' EQUITY (DEFICIENCY) (CONTINUED)
1997 Preferred Stock Transactions
In April 1997, the Company executed a funding agreement with certain foreign
accredited investors which provided for the sale of the Company's common stock
in three tranches of $1,000,000 each, pursuant to Regulation S. On May 30, 1997,
this agreement was modified and the Company issued 1,000 shares of $.01 par
value 8% Convertible Preferred Series 97B stock and ten warrants to purchase
30,000 shares at $2.30 per share to four foreign accredited investors for an
aggregate $1,000,000. The 97B Preferred Shares accrued dividends at a rate of 8%
per annum and were cumulative.
The dividend was only payable in common stock of the Company. The warrants were
immediately exercisable and expire on May 30, 2002. As of December 31, 1997, all
the preferred shares had been converted into 756,006 common shares of the
Company. Imputed dividends aggregating $236,419 were recorded in connection with
the issuance of the 97B Preferred shares. The imputed dividends have been
included in the computation of net loss per share as disclosed in Note 1.
On July 15, 1997, the Company converted one $10,000 note payable with accrued
interest of $2,748 by issuing one share of Series 97C convertible preferred
stock. The convertible preferred share has no voting rights, has a preference in
liquidation of $10,000 and is convertible into 13,500 shares of common stock on
or after August 30, 1998, without further payment.
On August 12, 1997, the Company issued 550 shares of $.01 par value, 7%
Convertible Preferred Series 97D and six warrants with an exercise price of
$2.44 per share, for net proceeds of approximately $505,000. See Description of
Securities below for a description of the rights and conversion privileges of
the Series 97D Preferred Stock holders which were amended on April 1, 1998. The
97D Preferred Shares accrue dividends at a rate of 7% per annum and are
cumulative. The dividend is only payable in common stock of the Company. Imputed
dividends aggregating $144,654 were recorded in connection with the issuance of
the 97D Preferred Shares. The imputed dividends have been included in the
computation of net loss per share as disclosed in Note 1 to the consolidated
financial statements. In conjunction with the Series 97D Preferred Shares the
Company issued six warrants representing 676,923 shares of common stock. The
warrants became exercisable at $2.44 per share on August 22, 1997. Pursuant to
an amendment effective September 1, 1998, the warrants shall expire on September
30, 1999.
On November 6, 1997, the Company issued 1,750 shares of $.01 par value, 8%
Convertible Preferred Stock Series 97F to certain foreign investors, and five
warrants, to five purchasers for $1,000 per share for an aggregate purchase
price of $1,750,000. The number of shares of common stock underlying the 97F
Preferred shares and warrants were registered by the Company pursuant to a
Registration Rights Agreement or sold by the investors pursuant to Regulation S.
The number of common shares issued upon conversion of the 97F Preferred Shares
were determined by dividing the amount invested by the lesser of: (a) $1.40 or
(b) the product of 75% multiplied by the average of the closing bid price for
the five trading days preceding the conversion date. The five warrants which are
convertible into 70,000 shares of common stock, contain a conversion price equal
to 110% of the average closing bid price for the five trading days preceding the
closing date ($1.54). The warrants all expire on November 6, 2002.
In connection with the sale of the 97F Preferred Shares, the Company paid two
unaffiliated placement agents, fees consisting of $70,000 in cash, 105 shares of
97F Preferred Shares having a value of $105,000, and warrants to purchase 35,000
shares of common stock as compensation for placement. The warrants contain a
conversion price equal to 110% of the average closing bid price for the five
trading days preceding November 6, 1997. The warrants all expire on November 6,
2002. In addition, the Company paid $8,750 in cash for legal and escrow fees
incurred in connection with this transaction. The net proceeds to the Company of
$1,671,250 were used for working capital and for research and development of the
OCET and LFC processes. Imputed dividends aggregating $389,153 were recorded in
connection with the issuance of the 97F Preferred Shares. The imputed dividends
have been included in the computation of net loss per share as disclosed in Note
1 to the consolidated financial statements. As of December 31, 1998, all the 97F
Preferred Shares had been converted into 2,722,370 shares of common stock.
48
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. STOCKHOLDERS' EQUITY (DEFICIENCY) (CONTINUED)
Description of Securities
All outstanding series of Preferred Stock are fully paid and nonassessable. The
Preferred Stock has no preemptive rights to subscribe for any additional
securities which may be issued by the Company. No sinking fund or similar
provision has been provided in respect to any of the outstanding series of
Preferred Stock. The rights of the holders of each series of Preferred Stock are
subordinate to those of the Company's general creditors, and every previously
issued series of Preferred Stock. All of the outstanding series of Preferred
Stock are subject to adjustment in certain events, including for stock
dividends, stock splits, reclassifications, consolidations, mergers, etc. The
Company has never declared or paid a cash dividend on any of its outstanding
Preferred Stock, and it is not likely any cash dividends will be declared for
some time.
Except as required by mandatory provisions of Utah law, the holders of the
various series of outstanding Preferred Stock have no voting rights.
Series 90B and 90C
Dividends. The Series 90B and 90C Preferred Stock are entitled to dividends of
$8 per share annually, payable in quarterly installments out of unreserved
earned surplus, before any dividends shall be payable on any other class of
stock or any other series of Preferred Stock of the Company, other than a
previously issued series of Preferred Stock and before any funds are set aside
for the purchase of, or retirement of, the whole or any part of any series of
Preferred Stock, or any other class of stock of the Company. Dividends are
cumulative and are payable before dividends on any Common Stock are paid.
Redemption. The Series 90B and 90C Preferred Stock do not have the right to
require its redemption. The Series 90 Preferred Stock has been redeemable by the
Company as a series, in whole or in part, since August 31, 1992, at any time and
from time to time effective on 60 days prior notice, at $100 for each share,
plus the amount of any unpaid cumulative dividends which have then become
payable with respect thereto. The right of the Company to redeem the Series 90B
and 90C Preferred Stock is subject to compliance with Utah law, including
without limitation, certain retained earnings requirements.
Liquidation. In the event of any liquidation, dissolution or winding up of the
Company, whether voluntary or involuntarily, the holders of the Series 90B and
90C Preferred Stock are entitled to be paid out of the assets of the Company
available for distribution to shareholders, prior to any distribution with
respect to any other class of stock, liquidating distributions in the amount of
$100 per share, plus all accrued and unpaid dividends up to the date fixed for
distribution, whether or not such dividends have been earned or declared.
Conversion. Each share of the Series 90B and 90C Preferred Stock is convertible,
at the option of the holder thereof without further payment at any time, into 88
shares of Common Stock unless previously redeemed.
Series P-90
Dividends. The Series P-90 Preferred Stock are entitled to dividends of $8 per
share annually, payable in quarterly installments out of unreserved earned
surplus, before any dividends shall be payable on any other class of stock or
any other series of Preferred Stock of the Company, other than previously issued
series of Preferred Stock and before any funds are set aside for the purchase
of, or retirement of, the whole or any part of any series of Preferred Stock, or
any other class of stock of the Company. Dividends are cumulative and are
payable before dividends on any Common Stock are paid.
49
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. STOCKHOLDERS' EQUITY (DEFICIENCY) (CONTINUED)
Redemption. The Series P-90 Preferred Stock has been redeemable by the Company
as a series, in whole or in part, since January 1, 1996, at $100 per share, plus
the amount of any unpaid cumulative dividends which have then become payable
thereto. The right of the Company to redeem this series is subject to compliance
with Utah law, including without limitation certain retained earnings
requirements.
Liquidation. In the event of any liquidation, dissolution or winding up of the
Company, whether voluntary or involuntarily, the holders of the Series P-90
Preferred Stock are entitled to be paid out of the assets of the Company
available for distribution to shareholders, prior to any distribution with
respect to any other class of stock, liquidating distributions in the amount of
$100 per share, plus all accrued and unpaid dividends up to the date fixed for
distribution, whether or not such dividends have been earned or declared.
Conversion. Each share of Series P-90 Preferred Stock is convertible into 250
shares of Common Stock of the Company, at the option of the holder and upon
payment to the Company at the time of conversion of $1.375 per common share.
Series PS-90
Dividends. Dividends of $20 per share annually are payable on the Series PS-90
Preferred Stock, in quarterly installments out of unreserved earned surplus,
before any dividends shall be payable on any other class of stock or any other
series of Preferred Stock other than previously issued series of Preferred
Stock, and before any sum shall be set aside for the purchase of, or retirement
of, the whole or any part of the Series PS-90 Preferred Stock, or any other
class of stock. The dividends on the PS-90 Preferred Stock are cumulative, and
are payable prior to the payment of any dividends on the Common Stock.
Redemption. The holders of the PS-90 Preferred Stock have no right to require
redemption of their Preferred Stock. The Series PS-90 Preferred Stock has been
redeemable by the Company as a series, in whole or in part, since December 31,
1993, and any time and from time to time effective on 60 days prior notice, at
$250 per share of Series PS-90 Preferred Stock, plus the amount of any unpaid
cumulative dividends which have become payable with respect thereto. The right
of the Company to redeem this series of Preferred Stock is subject to compliance
with Utah law, including without limitation, certain retained earnings
requirements.
Liquidation. In the event of liquidation, dissolution or other termination of
the Company, the holders of the shares of the Series PS-90 Preferred Stock are
entitled to $250 per share, plus all accrued and unpaid dividends up to the date
fixed for distribution whether or not earned or declared. Such payments shall be
made before any payment or distribution is made to the holders of the Common
Stock or any other series of Preferred Stock and concurrently with the 90B, 90C
or P-90 series.
Conversion. Each share of the PS-90 Preferred Stock is convertible into 125
shares of Common Stock at the election of the shareholder upon payment to the
Company of $1.375 per common share at the time of conversion.
Series 91A, 91C, 91D and 91E
Dividends. Dividends of $8 per share annually will be payable on the Series 91A,
91C, 91D and 91E Preferred Stock in quarterly installments out of unreserved
earned surplus, before any dividends shall be payable on any other class of
stock or any other series of Preferred Stock other than previously issued series
of Preferred Stock and before any sum shall be set aside for the purchase of, or
retirement of, the whole or any part of the Series 91 Preferred Stock or any
other class of stock, other than any previously issued series of Preferred Stock
of the Company. Dividends are cumulative and are payable prior to the payment of
any dividends on the Common Stock of the Company.
50
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. STOCKHOLDERS' EQUITY (DEFICIENCY) (CONTINUED)
Redemption. The holders of the Series 91A, 91C, 91D and 91E Preferred Stock have
no right to require redemption of the shares. The Company has been able to
redeem the shares in a series, in whole or in part since December 31, 1993, at
any time and from time to time effective on 60 days prior notice, at $100 per
share, plus the amount of unpaid cumulative dividends which have then become
payable with respect thereto. The right of the Company to redeem this series of
Preferred Stock is subject to compliance with Utah law, including without
limitation certain retained earnings requirements.
Liquidation. In the event of the voluntary liquidation, dissolution or other
termination of the Company, the holders of the shares of the Series 91A, 91C,
91D and 91E Preferred Stock shall be entitled to a cash payment of $100 per
share, plus all accrued and unpaid dividends up to the date fixed for
distribution, whether or not such dividends have been earned or declared. Such
payment shall be made before any payment or distribution is made to the holders
of the Common Stock, or any other series of Preferred Stock other than the
previously issued series of Preferred Stock of the Company.
Conversion. Each share of the Series 91A, 91C, 91D and 91E Preferred Stock is
convertible into 25 shares of Common Stock at the election of the shareholder
without further payment.
Series 91M
Dividends. No dividends are payable on the Series 91M convertible Preferred
Stock.
Redemption. Neither the Company nor the holders have the right to cause or
require redemption of the Series 91M Preferred Stock.
Liquidation. In the event of the voluntary liquidation, dissolution or other
termination of the Company, the holders of Series 91M convertible Preferred
Stock are entitled to a cash payment of $2 per share. Such payment shall be made
before any payment or distribution is made to the holders of the Common Stock,
or any other series of Preferred Stock other than the previously issued series
of Preferred Stock of the Company.
Conversion. Since September 30, 1993, each 5,000 shares of Series 91M Preferred
Stock is convertible into 300 shares of Common Stock of the Company, at the
election of the shareholder without further payment. The Company shall have the
absolute right to cause conversion of the 91M Preferred Shares at any time, or
from time to time without additional payment upon 60 days prior written notice.
In the event the Company elects to convert the 91M shares to Common Stock, each
share of Series 91M Preferred Stock shall be converted into 300 shares of the
Company's Common Stock.
Series 91P
Dividends. No dividends are payable on the Series 91P Preferred Stock.
Redemption. Neither the Company nor the holders have the right to cause
redemption of the Series 91P Preferred Stock.
Liquidation. In the event of the voluntary liquidation, dissolution or other
termination of the Company, the holders of shares of the Series 91P Preferred
Stock shall be entitled to a cash payment of $2.50 per share. Such payment shall
be made before any payment or distribution is made to the holders of the Common
Stock, or any other series of Preferred Stock other than previously issued
series of Preferred Stock of the Company.
51
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. STOCKHOLDERS' EQUITY (DEFICIENCY) (CONTINUED)
Conversion. Since July 15, 1993, each 4,000 shares of Series 91P Preferred Stock
is convertible into 250 shares of Common Stock of the Company at the election of
the shareholder and without further payment. The Company shall also have the
absolute right to cause conversion of the Series 91P Preferred Shares at any
time or from time to time upon 60 days prior written notice. In such event, each
share of Series 91P Preferred Stock shall be convertible into 250 shares of
Common Stock.
Series 91R
Dividends. Dividends of 8% per annum will be payable on the Series 91R Preferred
Stock, in quarterly installments out of unreserved earned surplus, before any
dividends shall be payable on any other class of stock or any other shares of
Preferred Stock other than previously issued series of Preferred Stock, and
before any sum shall be set aside for the purchase of, or retirement of, the
whole or any part of the Series 91R Preferred Stock or any other class of stock,
other than any previously issued series of Preferred Stock of the Company.
Dividends payable on the Series 91R Preferred Stock are cumulative and are
payable prior to the payment of any dividends on the Common Stock of the
Company.
Redemption. The holders do not have the right to require redemption of the
Series 91R Preferred Stock. The Company may redeem the Series 91R Preferred
Stock in whole or part, at any time and from time to time effective on 60 days
prior written notice, at $10,000 per Series 91R Preferred Share, plus the amount
of any unpaid cumulative dividends which have then become payable with respect
thereto. The right of the Company to redeem the Series 91R Preferred Shares is
subject to compliance with Utah law, including without limitation certain
retained earnings requirements.
Liquidation. In the event of the voluntary liquidation, dissolution or other
termination of the Company, the holders of shares of the Series 91R Preferred
Stock shall be entitled to a cash payment of $10,000 per share, plus all accrued
and unpaid dividends up to the date fixed for distribution, whether or not such
dividends have been earned or declared. Such payment shall be made before any
payment or distribution is made to the holders of the Common Stock, or any other
series of Preferred Stock other than previously issued series of Preferred Stock
of the Company.
Conversion. During the 60 day notice period provided for redemption by the
Company, each share of the Series 91R Preferred Stock is convertible into 167
shares of Common Stock without further payment at the election of the
shareholder. Since October 15, 1993, the holders of the preferred shares have
been able to demand conversion into Common Stock.
Series 91S
Dividends. No dividends are payable on the Series 91S Preferred Stock.
Redemption. Neither the Company nor the holders have the right to cause
redemption of the Series 91S Preferred Stock.
Liquidation. In the event of the voluntary liquidation, dissolution or other
termination of the Company, the holders of shares of the Series 91S Preferred
Stock shall be entitled to a cash payment of $3.50 per share. Such payment shall
be made before any payment or distribution is made to the holders of the Common
Stock, or any other series of Preferred Stock other than previously issued
series of Preferred Stock of the Company.
Conversion. Since September 30, 1993, each share of Series 91S Preferred Stock
has been convertible into 150 shares of Common Stock of the Company, at the
election of the shareholder. The Company also has the right to cause conversion
of the Series 91S Preferred Stock at any time, or from time to time upon 60 days
prior written notice. In such event, each share of 91S Preferred Stock shall be
convertible into 150 shares of Common Stock.
52
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. STOCKHOLDERS' EQUITY (DEFICIENCY) (CONTINUED)
Series 91V
Dividends. The holders of the 91V Preferred Stock have no right to dividends.
Redemption. The holders of the Series 91V Preferred Stock do not have the right
to require the redemption of the Series 91V Preferred Stock. The Company has a
right to cause redemption of the Series 91V Preferred Stock as a series, in
whole or in part, at any time and from time to time effective on 60 days prior
notice, at $100 per share. The right of the Company to redeem the Series 91V
Preferred Stock is subject to compliance with Utah law, including without
limitation certain retained earnings requirements.
Liquidation. In the event of the voluntary liquidation, dissolution or other
termination of the Company, the holders of shares of the Series 91V Preferred
Stock shall be entitled to a cash payment of $100 per share. Such payment shall
be made before any payment or distribution is made to the holders of the Common
Stock, or any other series of Preferred Stock other than previously issued
series of Preferred Stock of the Company.
Conversion. During the 60 day notice period provided wherein the Company may
redeem the Series 91V Preferred Stock, or at any other prior time, each share of
the Series 91V Preferred Stock is convertible into 8 shares of Common Stock of
the Company without further payment at the election of the shareholder.
Series 92A and 92B
Dividends. The Series 92A and 92B Preferred Stock have no dividend rights.
Redemption. The Series 92A and 92B Preferred Stock holders do not have the right
to require its redemption. The Company may redeem the Preferred Stock as a
series, in whole or in part, at any time and from time to time effective on 60
days prior notice, at $100 per share. The right of the Company to redeem the
shares is subject to compliance with Utah law, including without limitation
certain retained earnings and requirements.
Liquidation. In the event of the voluntary liquidation, dissolution or other
termination of the Company, the holders of shares of the Series 92A and 92B
Preferred Stock shall be entitled to a cash payment of $100 per share. Such
payment shall be made before any payment or distribution is made to the holders
of the Common Stock, or any other series of Preferred Stock other than
previously issued series of Preferred Stock of the Company.
Conversion. Each share of the Series 92A Preferred Stock is convertible into 6
shares of Common Stock. Each share of the Series 92B Preferred Stock is
convertible into 8 shares of Common Stock. Each share is convertible without
further payment at the election of the shareholder.
Series 93A, 93B and 93C
Dividends. The Series 93A, 93B and 93C Preferred Stock have no dividend rights.
Redemption. The holders of the Series 93A, 93B and 93C Preferred Stock have no
option or right to require redemption of their shares. The Series 93A, 93B and
93C Preferred Stock is redeemable by the Company as a series, in whole or in
part, effective on 60 days prior notice, at $100 per share.
Liquidation. In the event of any liquidation, dissolution or winding up of the
Company, whether voluntary or involuntary, the holders of the Series 93A, 93B
and 93C Preferred Stock are entitled to be paid out of the assets of the Company
available for distribution to shareholders, liquidating distributions in the
amount of $100 per share. The liquidation preference shall be payable before any
payment or distribution is made to the holders of the Common Stock, or any other
series of Preferred Stock other than previously issued series of Preferred
Stock.
53
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. STOCKHOLDERS' EQUITY (DEFICIENCY) (CONTINUED)
Conversion. Each share of the Series 93A, 93B and 93C Preferred Stock is
convertible, at the option of the holder without further payment, into either 15
or 38 shares of the Company depending upon the due date and interest rate on the
promissory note purchased in connection with the private placement under which
the shares of these three series of Preferred Stock were issued.
Series 94A and 94B
Dividends. The Series 94A and 94B Preferred Stock have no dividend rights.
Redemption. The holders of the Series 94A and 94B Preferred Stock have no option
or right to require redemption of their shares. The Series 94A and 94B Preferred
Stock is redeemable by the Company as a series, in whole or in part, effective
on 60 days prior notice, at $100 per share.
Liquidation. In the event of any liquidation, dissolution or winding up of the
Company, whether voluntary or involuntary, the holders of the Series 94A and 94B
Preferred Stock are entitled to be paid out of the assets of the Company
available for distribution to shareholders, liquidating distributions in the
amount of $100 per share. The liquidation preference shall be payable before any
payment or distribution is made to the holders of the Common Stock, or any other
series of Preferred Stock other than previously issued series of Preferred
Stock.
Conversion. Each share of the Series 94A and 94B Preferred Stock is convertible,
at the option of the holder without further payment, into from 25 to 45 shares
of the Company depending upon the due date and interest rate on the promissory
note purchased in connection with the private placement with which the shares of
these series of Preferred Stock were issued.
Series 95R
Dividends. No dividends are payable on the Series 95R Preferred Stock.
Redemption. The holders of the Series 95R Preferred Stock have no option or
right to require redemption. The Series 95R preferred shares are redeemable by
the Company as a series effective on 60 days prior notice, at $10,000 per share.
Liquidation. In the event of any liquidation, dissolution or winding up of the
Company, whether voluntary or involuntary, the holders of the Series 95R
Preferred Stock are entitled to be paid out of the assets of the Company
available for distribution to shareholders, liquidating distributions in the
amount of $10,000 per share for each share of Series 95R Preferred Stock. Such
liquidation payments are to be made before any payment or distribution is made
to the holders of the Common Stock, or any other series of Preferred Stock other
than previously issued series of Preferred Stock.
Conversion. Each share of the Series 95R Preferred Stock has been convertible
since November 1, 1997, at the option of the holder without further payment,
into Common Stock with a bid based market value of (i) $18,000; or (ii) $16,500.
Alternatively, each share of Series 95R Preferred Stock can be converted into
12,500 shares of Common Stock, at the option of the holder.
Series 96A and 96B
Dividends. The Series 96A and 96B Preferred Stock have no dividend rights.
Redemption. Neither the holders of the Series 96A or 96B Preferred Stock nor
the Company have any option or right to require or cause redemption.
54
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. STOCKHOLDERS' EQUITY (DEFICIENCY) (CONTINUED)
Liquidation. In the event of any liquidation, dissolution or winding up of the
Company, whether voluntary or involuntary, the holders of the Series 96A and 96B
Preferred Stock are entitled to be paid out of the assets of the Company
available for distribution to shareholders, liquidating distributions in the
amount of $10,000 and $13,000 per share, respectively. The liquidation
preference shall be payable before any payment or distribution is made to the
holders of the Common Stock, or any other series of Preferred Stock other than
previously issued series of Preferred Stock.
Conversion. Each share of the Series 96A Preferred Stock has been convertible,
at the option of the holder without further payment since April 30, 1998, into
13,500 common shares. Each share of Series 96B Preferred Stock has been
convertible at the option of the holder without further payment since August 30,
1998, into 3,000 shares of Common Stock.
Series 97C
Dividends. No dividends are payable on the Series 97C Preferred Stock.
Redemption. The holders of the Series 97C Preferred Stock have no option or
right to require redemption. The Series 97C preferred shares are redeemable by
the Company as a series effective on 60 days prior notice, at $10,000 per share.
Liquidation. In the event of any liquidation, dissolution or winding up of the
Company, whether voluntary or involuntary, the holders of the Series 97C
Preferred Stock are entitled to be paid out of the assets of the Company
available for distribution to shareholders, liquidating distributions in the
amount of $10,000 per share for each share of Series 97C Preferred Stock. Such
liquidation payments are to be made before any payment or distribution is made
to the holders of the Common Stock, or any other series of Preferred Stock other
than previously issued series of Preferred Stock.
Conversion. Each share of the Series 97C Preferred Stock has been convertible
since August 30, 1998, at the option of the holder without further payment, into
13,500 shares of Common Stock.
Series 97D, 98A, and 98D
Dividends. The Amended Series 97D Preferred Stock (the "Series 97D Preferred
Stock") has a right to cumulative dividends, out of assets legally available
therefore, at a per share rate equal to 7% per annum of its liquidation
preference of $1,000 per share. The Series 98A Preferred Stock has the right to
cumulative dividends out of assets legally available therefore, at a per share
rate equal to 6% per annum of the liquidation preference of $1,000 per share.
The Series 98D Preferred Stock has no dividend rights.
Redemption. Neither the holders of the Series 97D Preferred Stock nor the
Company have any option or right to require or cause redemption of the Series
97D Preferred Stock. The holders of the Series 98A Preferred Stock may not
require its redemption. The Company may redeem the Series 98A Preferred Stock at
130% of the liquidation preference ($1,000), plus the amount of any unpaid
cumulative dividends which have become payable with respect thereto. The Series
98D Preferred Stock is not redeemable by any party.
Liquidation. The Series 97D and 98A are each entitled to be paid out of the
assets of the Company available for distribution to shareholders, liquidating
distributions in the amount of $1,000 per share. The liquidation preference with
respect to each series shall be payable before any payment or distribution is
made to the holders of the Common Stock, or any other series of Preferred Stock
other than previously issued series of Preferred Stock. The Series 98D Preferred
Stock has no liquidation preference.
55
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. STOCKHOLDERS' EQUITY (DEFICIENCY) (CONTINUED)
Conversion. The Series 97D Preferred Stock has been convertible, at the option
of the holder thereof, since August 12, 1997. Each share is convertible into the
number of shares of Common Stock derived by dividing the conversion rate by the
conversion price. The conversion rate is the liquidation preference of $1,000
per share of Series 97D Preferred Stock and the Dividend Amount. The Dividend
Amount is equal to the Liquidation Preference of $1,000 per share multiplied by
7% per annum, multiplied by the number of days since the closing date, divided
by 365 days. The conversion price is determined based on the date that the
conversion notice is received ("Conversion Date") and shall equal the lesser of
(a) $2.44 or (b) 75% of the average of the closing bid price of the shares of
Common Stock of the Company on the five trading days ending on the date
proceeding the Conversion Date. There are monetary penalties to the Company if
Common Stock is not delivered to the holder within five days of receipt of a
notice of conversion and receipt of the Preferred Stock to be converted.
The Series 97D Preferred Stock is convertible, subject to the following
limitations. The holder is precluded from converting any portion of the
Preferred Stock which would cause holder to be deemed to be the beneficial owner
of 4.99% or more of the issued and outstanding Common Stock of the Company. The
Common Stock underlying the Series 97D Preferred Stock and the warrants issued
in connection with the sale thereof have demand registration rights. The Company
is obligated to use its best efforts to maintain any registration statement or
post-effective amendment current until the earlier of the date that all of such
securities have been sold pursuant to the registration statement, or the date
the holders receive a legal opinion of counsel that the securities may be sold
under Rule 144, or the second anniversary of the effective date of the
registration statement.
The Series 98A Preferred Stock has been convertible, at the option of the holder
thereof, since May 6, 1998. Each share is convertible into the number of shares
of Common Stock derived by dividing the conversion rate by the conversion price.
The conversion rate is the liquidation preference of $1,000 per share of Series
98A Preferred Stock and the dividend amount. The dividend amount is equal to the
liquidation preference of $1,000 per share multiplied by 6% per annum,
multiplied by the number of days since March 6, 1998, divided by 365 days. The
conversion price is determined based on the date that the conversion notice is
received ("Conversion Date") and shall equal the lesser of (a) $1.075, or (b)
75% of the average of the closing bid price of the shares of Common Stock of the
Company on the five trading days ending on the date proceeding the Conversion
Date. There are monetary penalties to the Company if the Common Stock is not
delivered to the holder with five days of receipt of a notice of conversion and
receipt of the Preferred Stock to be converted. The Series 98A must be converted
no later than March 6, 2000.
The holder of the Series 98A Preferred Stock is precluded from converting any
portion which would cause the holder to be deemed to be the beneficial owner of
4.99% or more of the issued and outstanding Common Stock of the Company, except
where an event of default has occurred and remains uncured for ten business
days.
Each share of the Series 98D Preferred Stock is convertible into 700 shares of
Common Stock of the Company at the option of the holder, at any time after 15
days from October 30, 1998, for a period of two years from October 30, 1998. On
the second anniversary from October 30, 1998, the Series 98D Preferred Stock
automatically converts into Common Stock.
Dividends on all preferred shares are only payable when the Company has
sufficient accumulated earnings. Cumulative dividends of $134,000 were in
arrears under the Series 98, 97, 91, PS90, 90 and P-90 preferred share
agreements at December 31, 1998.
56
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. STOCKHOLDERS' EQUITY (DEFICIENCY) (CONTINUED)
Common Stock
1998 Common Stock Transactions
During the quarter ended March 31, 1998, the Company issued 14,886 restricted
common shares to four domestic individuals for services rendered, valued at
approximately $21,000. For the quarter ended June 30, 1998, the Company issued
1,685 restricted common shares to one domestic individual for services rendered,
valued at approximately $1,638. On August 19, 1998, the Company issued 40,000
restricted common shares to two consultants in accordance with their related
service agreements for services, valued at approximately $34,500.
1997 Common Stock Transactions
In January 1997, the Company issued one individual and one domestic corporation
11,250 and 26,500 common shares, respectively, as
compensation for placement agent services.
The Company executed a stock purchase agreement with a foreign accredited
investor on April 15, 1997, which provided for the sale of the Company's common
stock in five weekly tranches aggregating $1,000,000. Pursuant to this agreement
the Company issued 537,320 shares of common stock. The number of shares in each
tranche was determined by dividing the amount invested by the product of 75%
multiplied by the average of the closing bid price for the five trading days
preceding the investment.
During April 1997, the Company raised $29,735, net of discounts aggregating
$24,329, through the issuance of 15,008 restricted common
shares to one employee.
In May 1997, the Company issued 112,000 restricted common shares to a domestic
entity for financial consulting services rendered, valued at $161,700.
On December 11, 1997, the Company issued 25,714 shares of restricted common
shares and two warrants to acquire an aggregate of 37,714 of common shares at
$5.75 per share to AEM as more fully disclosed in Note 4 under "Notes
Receivable."
Throughout the year ended December 31, 1997, the Company issued 36,088
restricted common shares to seven domestic individuals pursuant to Regulation D
for services rendered and recorded compensation expense of approximately
$108,000.
1996 Common Stock Transactions
The Company received $304,000 and $50,000 from an entity controlled by a
Director in 1995 and 1996, respectively, in exchange for 10% notes payable due
on December 31, 1996. In March 1996, the Company issued 283,200 restricted
common shares in satisfaction of the aggregate principal and accrued interest of
$375,000.
The Company received $230,000 from LFCTP in 1995 in exchange for 10% notes
payable due through 2000 and warrants to purchase 230,000 common shares at $1.00
per share. The notes payable were collateralized by the notes receivable
discussed in Note 4. In 1996, LFCTP exercised the warrant in exchange for the
previously issued note payable and the Company issued 230,000 restricted common
shares. Accrued interest of $18,000 on the notes was satisfied through the
issuance of 2,096 restricted common shares.
57
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. STOCKHOLDERS' EQUITY (DEFICIENCY) (CONTINUED)
During 1996, the Company raised $2,596,000 through the issuance of 1,377,306
restricted common shares for cash. The Company issued 49,626 restricted common
shares for services and recorded compensation expense of $65,000 in 1996. As
discussed in Note 5, the Company issued restricted common shares in exchange for
notes payable, accrued interest, and future interest obligations.
Warrants and Options. As of December 31, 1998, the Company had outstanding
warrants and options entitling the holders thereof to purchase approximately 6.5
million shares of Common Stock of the Company at exercise prices which range
from $0.265 to $47.50 and with varying expiration dates. The exercise price of
the warrants and options are generally subject to adjustment in the event of
stock splits, stock dividends and similar events. Some outstanding warrants
expire only on the occurrence of certain conditions precedent, which are not
dates certain. The warrants and options are not divided into any series or
class, and there was no public market for either the warrants or options as of
December 31, 1998. The warrants and options do not confer upon the holders any
voting or dividend rights or any other rights of a shareholder of the Company.
(See Note 8 for additional information on the issuance of stock options in
accordance with the Company's 1996 Omnibus Stock Option Plan.)
The following table summarizes disclosures required by SFAS 123 for warrant and
option activity subsequent to December 31, 1995:
Common shares underlying outstanding warrants and options
<TABLE>
Underlying Weighted-average
Common Shares exercise price
===============================================================================
<S> <C> <C>
Balance, January 1, 1996 1,699,270 $ 1.91
Granted 1,310,100 3.75
Forfeited (24,816) 1.50
Exercised (473,528) 1.06
Expired (3,450) 50.00
- -------------------------------------------------------------------------------
Balance, December 31, 1996 2,507,576 2.97
Granted 2,050,610 1.85
Exercised (150,000) 0.94
Expired (6,411) 46.74
- -------------------------------------------------------------------------------
Balance, December 31, 1997 4,401,775 2.18
Granted 2,264,500 0.75
Exercised (25,000) 0.60
Expired (122,676) 5.50
- -------------------------------------------------------------------------------
Balance, December 31, 1998 6,518,599 1.61
===============================================================================
</TABLE>
1998 Warrant Transactions
On March 31, 1998, the Company granted certain debt holders, pursuant to the
Company's 1998 debt restructuring, warrants to purchase an aggregate of 152,500
restricted common shares on or before December 31, 1999, at an exercise price of
$1.20 per share. In connection therewith the Company recorded interest expense
of approximately $94,700 based on the estimated fair value of the warrants.
During the first quarter of 1998, as provided in related service or consulting
agreements, the Company granted nine warrants to purchase an aggregate 120,000
common shares, to one employee, four directors and four consultants for services
rendered during the three month period ended March 31, 1998. In connection
therewith, the Company recorded compensation expense to non-employees of
approximately $18,000, based on the estimated fair value of the warrants. The
exercise prices were not lower than the closing bid price on the grant date and
expire on December 31, 2003. The warrants become exercisable one year from the
grant date at $0.84 per share.
58
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. STOCKHOLDERS' EQUITY (DEFICIENCY) (CONTINUED)
On April 21, 1998, the Company granted eleven warrants to purchase an aggregate
201,000 common shares, to the employees of its TEK-KOL partnership, who were not
employees of the Company. The common shares underlying the warrants vest 25% on
the first day the warrant holder becomes an employee of the Company or other
entity owned by the Company. Consequently, no compensation expense was recorded
by the Company. The remaining shares shall vest 25% each three month period
thereafter, as long as the warrant holder continues to be an employee. The
exercise price was not lower than the closing bid price on the grant date and
expire on December 31, 2004. The warrants are exercisable at $0.42 per share.
On June 30, 1998, the Company granted certain debt holders, pursuant to the
Company's 1997 debt restructuring, warrants to purchase an aggregate of 152,500
restricted common shares on or before December 31, 1999, at an exercise price of
$1.20 per share. In conjunction therewith, the Company recorded approximately
$93,000 of interest expense.
As provided in related service or consulting agreements, the Company granted
eight warrants to purchase an aggregate 60,000 common shares, to one employee,
four directors and three consultants for services rendered during the three
month period ended June 30, 1998. In connection therewith, the Company recorded
compensation expense to non-employees of approximately $26,340 based on the
estimated fair value of the warrants. The exercise prices were not lower than
the closing bid price on the grant date and expire on December 31, 2003. The
warrants become exercisable one year from the grant date at $0.625 per share.
Effective September 1, 1998, the Company in settlement of certain claims made by
the holders of six warrants representing 676,923 common shares, at an exercise
price of $2.44, agreed to extend the expiration date of the six warrants to
September 30, 1999.
On September 30, 1998, the Company granted certain debt holders, pursuant to the
Company's 1997 debt restructuring, warrants to purchase an aggregate of 152,500
restricted common shares exercisable on or before December 31, 1999, at an
exercise price of $1.20 per share. The warrants are first exercisable one year
from the date of grant. In connection therewith, the Company recorded interest
expense of approximately $15,100, based on the estimated fair value of the
warrants.
As provided in related service or consulting agreements, the Company on October
1, 1998, granted six warrants to purchase an aggregate 130,000 common shares to
two consultants and four directors for services rendered, valued at
approximately $33,200. The exercise prices were not lower than the closing bid
price on the grant date and expire on October 1, 2003. The warrants are first
exercisable one year from the date of grant at $0.265 per share.
On November 16, 1998, the Company, as provided in a related service agreement,
granted one warrant to purchase an aggregate 35,000 common shares to one
employee. The exercise price was not lower than the closing bid price on the
grant date and expire on December 31, 2003. The warrant is first exercisable one
year from the date of grant at $0.35 per share.
1997 Warrant Transactions
As provided in related service agreements, the Company granted warrants to
purchase 545,250 common shares to 39 employees during 1997. The warrant exercise
prices were not lower than the closing bid price on the grant dates. The
warrants all expire on December 31, 2001, and are exercisable at $1.03 per
share.
As provided in related agreements, the Company granted warrants to 9 consultants
to purchase 187,223 common shares during 1997 in return for services valued at
$208,063 based on the estimated fair value of the warrants. In addition, the
Company issued warrants to purchase 1,082,137 common shares in conjunction with
the various financings throughout the year, as more fully disclosed in Note 5
and elsewhere in Note 7 of the consolidated financial statements.
59
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. STOCKHOLDERS' EQUITY (DEFICIENCY) (CONTINUED)
The Company changed the exercise prices for 2,667,153 shares to exercise prices
of $20.00 to $.875 per share from exercise prices of $1.375 to $.60 per share in
1995. The Company changed the exercise prices for 844,500 shares to an exercise
price of $1.03 per share from exercise prices of $1.72 to $4.375 per share in
1997. The repricings changed the exercise price to the then current common stock
closing bid price.
In 1996, the Company granted the owner of a domestic research company a warrant
to purchase 100,000 restricted common shares at $1.72 per share in exchange for
a note payable previously issued by the Company, accrued interest and accounts
payable totaling $141,600.
The warrant at the option of the holder was exercised in 1996.
The weighted average grant date fair market value of warrants and options
granted in 1998, 1997 and 1996 are $0.75, $1.85 and $3.75 per share,
respectively. All warrants and options granted are not subject to repurchase by
the Company. Approximately 5.2 million common shares underlying warrants and
options have been registered with the SEC as of December 31, 1998.
The following table provides the weighted-average exercise price and the
weighted-average remaining contractual life for outstanding warrants and options
at December 31, 1998, grouped into four exercise price ranges.
<TABLE>
Warrants and Options Outstanding Warrants and Options Exercisable
----------------------------------------------- -----------------------------------------------
Number Wt. Avg. Wt. Avg. Number Wt. Avg. Wt. Avg.
Outstanding Remaining Exercise Exercisable Remaining Exercise
Range at 12/31/98 Life (Years) Price at 12/31/98 Life (Years) Price
===============================================================================================================
<S> <C> <C> <C> <C> <C> <C>
$ 0.26 - $ 0.88 2,641,064 3.9 $ 0.56 1,042,064 2.8 $ 0.58
$ 1.03 - $ 2.49 3,166,294 3.2 1.50 2,507,794 3.1 1.60
$ 4.25 - $ 5.87 615,037 4.0 5.04 615,037 4.0 5.04
$ 9.50 - $20.00 106,204 8.8 10.88 106,204 8.8 10.88
- ---------------------------------------------------------------------------------------------------------------
6,528,599 4,271,099
===============================================================================================================
</TABLE>
Pro Forma Information. As of December 31, 1998, the Company has outstanding
warrants and options as described above. The Company has elected to follow APB
25 and related interpretations in accounting for the warrants and options. As
the exercise price of the warrants and options issued by the Company to
employees equaled the market price of the underlying stock on the grant dates,
no compensation expense was recorded in 1998, 1997 and 1996 under APB 25.
Pro forma information regarding net loss and net loss per share is required by
SFAS 123, and has been determined as if the Company had accounted for the
warrants and options granted subsequent to December 31, 1994, under the fair
value method of SFAS 123. The fair value for these options was estimated at the
grant date using a Black-Scholes option pricing model with the following
weighted-average assumptions for years 1998, 1997, and 1996: risk-free interest
rate of approximately 6%; expected volatility factor ranging from .737 to 1.721,
expected life of the option of 2.0 years, and an expected dividend yield of
zero.
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 the expected stock price volatility. Because
the Company's warrants and options have characteristics significantly different
from those of traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of the Company's warrants and options. For purposes of
60
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. STOCKHOLDERS' EQUITY (DEFICIENCY) (CONTINUED)
pro forma disclosures, the estimated fair value of the warrants and options are
expensed during the grant year. The Company's historical and pro forma
information follows (in thousands, except for net loss per share information):
<TABLE>
YEARS ENDED DECEMBER 31, 1998 1997 1996
=====================================================================================
<S> <C> <C> <C>
Net loss
Historical $ (7,433) $ (6,479) $ (4,259)
Pro Forma (7,858) (7,858) (6,859)
Net loss per share - basic
Historical $ (0.50) $ (0.88) $ (0.80)
Pro Forma (0.53) (1.07) (1.28)
=====================================================================================
</TABLE>
The Company granted warrants to employees for the purchase of 3,530,000 OCET
common shares at $1.00 per share in 1995, and canceled a warrant for 850,000 of
those shares in January 1996. There is no current market for OCET common stock.
At December 31, 1998, warrants for the purchase of 2,680,000 OCET common shares
are outstanding and exercisable. All warrants to purchase OCET common shares
expire December 31, 1999.
8. STOCK OPTION AND PERFORMANCE INCENTIVE PROGRAM
In June 1997, the stockholders approved the 1996 Omnibus Stock Option Plan (the
"Stock Plan") pursuant to which a maximum aggregate of 2,000,000 shares was
reserved for grant. Under the Stock Plan, employees may be given an opportunity
to purchase, by way of option, or stock purchase rights, common stock of the
Company. The Stock Plan also provides for the use of stock appreciation rights
and long term performance awards as employee incentives. All options granted
become fully vested to employees with one year of service. The terms and
conditions of each award are at the discretion of the Board of Directors or any
duly authorized committee. As of December 31, 1998, and 1997, the Company had
outstanding options to purchase an aggregate of 1,107,000 and 236,000 common
shares, respectively, none of which had been registered with the SEC. The
Company applies APB 25 and related interpretations in accounting for its plan.
In accordance with SFAS 123, as more fully described in Note 7, the options have
been aggregated with the warrants for the fair value pro forma disclosure
required.
In 1997, the Company granted incentive stock options, pursuant to the Stock
Plan, exercisable for a total of 236,000 shares of common stock at $1.03 per
share to employees. The options are exercisable upon effective registration
under the Securities Act of 1933 or the common shares underlying the options are
issuable under an exemption from the registration requirements under the
Securities Act. The options shall expire on September 11, 2007.
During 1998, the Company granted incentive stock options to purchase 859,000
shares of common stock to employees pursuant to the Stock Plan. The options are
exercisable between $0.265 and $0.843, upon effective registration under the
Securities Act of 1933 or when the common shares underlying the options are
issuable under an exemption from the registration requirements under the
Securities Act. All the options issued in 1998 expire on the date of grant in
2003.
9. MANDATORILY REDEEMABLE PREFERRED STOCK
Mandatorily redeemable preferred stock consists of 2,200 authorized shares of
Series 98C 6% Convertible Preferred stock, of which 1,570 shares were issued and
outstanding as of December 31, 1998.
61
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. MANDATORILY REDEEMABLE PREFERRED STOCK (CONTINUED)
On November 4, 1998, the Company issued 950 shares of $0.01 par value, 6%
Convertible Preferred Series 98C and six warrants to four foreign investors for
cash and notes payable. The Company received net proceeds of $918,000
representing the completion of the first tranche of this Preferred series. These
shares have a liquidation preference of $1,000 per share and accrue dividends at
the rate of 6% per annum which are cumulative. The number of shares of common
stock to be issued upon conversion of the 98C Preferred Shares will be
determined by dividing the amount to be converted by the lesser of $0.46 or 75%
of the five lowest closing bid prices of the common stock during the Lookback
Period. The Lookback Period is defined as the five trading days immediately
preceding the date the notice of conversion is received by the Company. After
the last trading day of each month that the Series 98C Preferred Stock remains
outstanding, starting on the first day of the fourth month after the closing
date, the Lookback Period will be increased by two trading days per month until
the Lookback Period equals a maximum of 30 trading days. The holder of the
Series 98C Preferred Stock is precluded from converting any portion which would
cause the holder to be deemed to be the beneficial owner of 4.99% or more of the
issued and outstanding Common Stock of the Company. The 98C Preferred Stock is
redeemable at the option of the Company, in whole or in part, in cash, at 125%
of the Liquidation value plus accrued and unpaid dividends. In the event the 98C
Preferred Stock is not converted two years from the Closing Date then the
outstanding 98C Preferred Stock shall be redeemed by the Company as if the
Company voluntarily elected such redemption. For the Series 98C Preferred Stock,
upon the occurrence of certain events including a change in control, sale of
substantially all the assets, the consummation of one or more equity financings
resulting in net proceeds of $4 million, or an event of default, the Company
must pay to the holders liquidated damages in the amount of 125% of the $1,000
per share liquidation preference. The six warrants which are convertible into
47,500 shares of common stock, contain an exercise price equal to 110% of the
average closing bid price for the five trading days preceding the closing date
($0.51). The warrants are exercisable two days following the closing date and
expire on November 4, 2003.
The shares of common stock underlying the 98C Preferred shares and warrants are
subject to a Registration Rights Agreement, which requires the Company to file a
registration statement for these securities with the Securities and Exchange
Commission ("SEC"). The registration statement was filed and declared effective
by the SEC within the prescribed time period.
In connection with the sale of the first tranche of 98C Preferred Shares, the
Company paid an unaffiliated placement agent a fee consisting of $25,000 in
cash, 70 shares of 98C Preferred Stock having a value of $70,000 and warrants to
purchase 47,500 shares of common stock as compensation for placement services.
The warrants are exercisable at 110% of the average closing bid price for the
five trading days preceding the closing date ($0.51). The warrants are
exercisable two days following the closing date and expire on November 4, 2003.
In addition to the placement agent fees the Company paid $7,000 in cash for
legal and escrow fees incurred in connection with this transaction. The net
proceeds of this transaction will be used for working capital purposes.
On December 1, 1998 (a closing date), the Company issued 250 shares of $0.01 par
value, 6% Convertible Preferred Series 98C ("Series 98C Preferred") and one
warrant to one foreign investor for cash. The Company received net proceeds of
$247,500 which represents the second tranche of the Series 98C Preferred.
Additionally, on December 11, 1998 (a closing date), the Company issued 250
shares of $0.01 par value, Series 98C Preferred and one warrant to one foreign
investor for cash. The Company received net proceeds of $247,500 which
represents the third tranche of the Series, 98C Preferred. These shares have a
liquidation preference of $1,000 per share and a dividend preference of 6% per
annum, cumulative. The number of shares of common stock to be issued upon
conversion for each tranche of the Series 98C Preferred will be determined by
dividing the amount to be converted by the lesser of: (i) $0.36 for the second
tranche and $0.40 for the third tranche; or (ii) 75% of the five lowest closing
bid prices of the common stock during the Lookback Period. The warrants are
convertible into 12,500 shares of common stock each, at an exercise price equal
to 110% of the average closing bid price for the five trading days preceding the
Closing Date ($0.38 for the second tranche and $0.40 for the third tranche). The
warrants are exercisable beginning two days following the closing date and
expire five years from the respective closing dates.
62
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. MANDATORILY REDEEMABLE PREFERRED STOCK (CONTINUED)
The shares of common stock underlying the second and third tranches of the 98C
Preferred and warrants are subject to a Registration Rights Agreement, which
requires the Company to file a registration statement for these securities with
the Securities and Exchange Commission ("SEC"). The registration statement was
filed and declared effective by the SEC within the prescribed time period.
In connection with the sale of the second and third tranches of the Series 98C
Preferred, the Company paid an unaffiliated placement agent a fee consisting of
50 shares of 98C Preferred Stock having a face value of $50,000 and warrants to
purchase 25,000 shares of common stock as compensation for placement services.
The warrants are exercisable at 110% of the average closing bid price for the
five trading days preceding the closing date. The warrants are exercisable
beginning two days following the closing date and expire five years from the
closing date. The net proceeds of this transaction will be used for working
capital purposes.
The difference between the estimated fair value of the redeemable preferred
shares at their issue date and the mandatory redemption amount is being ratably
accreted, over the two year term of the Series 98C Preferred, by charges to
accumulated deficit. At the redemption date, the carrying amount of such shares
will equal the mandatory redemption amount plus accumulated dividends unless the
shares are converted by the holders prior to the redemption date. As of December
31, 1998, the Series 98C Preferred shares were convertible into approximately
6.8 million shares of common stock. Imputed and accreted dividends aggregating
$455,496 were recorded in connection with the issuance of the 98C Preferred
Shares. The imputed dividends have been included in the computation of net loss
per common share as disclosed in Note 1
10. RELATED PARTY TRANSACTIONS
SGI has entered into the following transactions with related parties:
a) The Company sold 200 Series P-90 preferred shares for $22,000 to two
officers in 1990. Each preferred share is convertible into 250 restricted
common shares upon payment of a price that was reduced from $15.00 per
share to $1.375 per share in 1995.
b) During 1995 and 1996, the Company issued 10% notes payable totaling
$354,000 to an entity controlled by a Board member. The notes and accrued
interest were converted into 283,200 restricted common shares in 1996.
c) The Company had receivables from two officers of $398,000 at December 31,
1994. A portion of this receivable was offset by obligations of the
Company to both of the officers and the remaining $224,000 was reserved at
December 31, 1995. In January 1996, the Company agreed to forgive the
loans made to a former officer.
d) The Company has an agreement with an officer/stockholder for the
assignment of his patent to the Company. The agreement provides for a
royalty equal to the greater of: (i) $50,000 per calendar year or (ii)
one-tenth of one percent (.1%) of royalty revenues received by the Company
(or any joint venture of which the Company is a partner) through December
31, 2000, conditioned only upon the continued use of the LFC Process
technology during such period by the Company and/or any such joint
venture. During 1996, the officer/stockholder agreed to forego all past
and future royalty payments pursuant to the agreement. The accrued
liability of $142,000 at December 31, 1995, was recorded as other income
in 1996.
e) Three employees exercised warrants in August 1995 for 274,154 common
shares in exchange for notes payable of $308,000. The 8% notes were
non-recourse and were payable on August 23, 1999, only if the bid price
for the Company's common stock was in excess of $3.00 per share on that
date. As of January 1995 the employees had pledged 321,341 restricted
common shares as collateral for the notes payable. During the first
quarter of 1996, the Company recorded compensation expense of $474,000
related to these transactions, as this was the first period in which the
average price of the warrants exercised was less than the market price.
The Company has accounted for
63
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. RELATED PARTY TRANSACTIONS (CONTINUED)
these transactions in accordance with the consensus for Emerging Issues
Task Force Issue No. 95-16, "Accounting for Stock Compensation
Arrangements with Employer Loan Features under APB Opinion No. 25." The
compensation expense was determined as the product of the aggregated
common shares issued upon exercise and the difference between the market
price of the common stock and the exercise price of the warrants. During
the second quarter of 1996, the three employees exchanged 8% recourse
notes payable August 23, 1999, for the non-recourse notes. The Company
collected all principal and interest payments prior to December 31, 1996.
f) As of December 31, 1997, the Company owed an officer/director approximately
$121,000 in deferred compensation which was paid in 1998.
11. COMMITMENTS AND CONTINGENCIES
(a) The Company leases its corporate offices under an operating lease
agreement which provides for annual escalation of rental payments and
expires in December 2000. The Company's OCET subsidiary leases its
laboratory facilities under an operating lease agreement which expires in
May 2000. AMS leases its manufacturing facility under an operating lease
agreement which expired in October 1998 and is currently on a monthly
basis. Under the terms of the lease agreements, the lessee pays taxes,
maintenance and insurance. As of December 31, 1998, the Company had no
other significant commitments under capital or operating leases. Total
rent expense relating to leased facilities was approximately $395,000,
$387,000, and $316,000 in 1998, 1997, and 1996, respectively.
Future minimum annual operating lease commitments are as follows:
<TABLE>
Year ending December 31,
=======================================
<S> <C>
1999 $236,000
2000 164,000
Thereafter -
- ---------------------------------------
$400,000
=======================================
</TABLE>
b) As discussed in Note 4, the Company may be required to make contributions
to the TEK-KOL Partnership and to LFC Technologies, LLC, the Company's new
joint venture with Mitsubishi Corp.
c) The Company has employment agreements with its executives, the terms of
which expire on December 31, 1999. Such agreements, which have been
revised from time to time, provide for minimum salary levels. The
agreements contain change-in-control provisions that would automatically
extend the date of the employment agreements by one year from the date of
change. The maximum contingent liability under these agreements, in such
event, is approximately $1.4 million.
d) The Company and its subsidiaries are from time to time involved in
litigation arising in the ordinary course of their respective businesses.
The only lawsuit currently pending against the Company is Walsh vs. AMS,
which relates to events occurring prior to the acquisition of AMS by the
Company. The lawsuit asserts claims, for among other things, breach of
contract relating to a loan of approximately $300,000. AMS has filed an
answer denying liability and discovery is proceeding. In the opinion of
the Company the pending litigation, if adversely decided, should not have
a material adverse effect on the Company.
e) On October 26, 1998, AMS filed a lawsuit against Anatol Automation and
Anatol Manufacturing in Orange County Superior Court. The lawsuit seeks
approximately $600,000 in compensatory damages and in excess of $2,000,000
in punitive damages for interference with advantageous business
relationships, interference with contract, and appropriation of trade
secrets in violation of the California Uniform Trade Secret Act.
64
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. INCOME TAXES
The significant components of the Company's deferred tax assets and liabilities
are:
<TABLE>
1998 1997
=======================================================================================
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 20,157,000 $ 18,623,000
Depreciation and amortization 733,000 658,000
Research and development credits 458,000 419,000
Accrued interest 116,000 192,000
Stock for services 210,000 134,000
Other 87,000 109,000
- ---------------------------------------------------------------------------------------
21,761,000 20,135,000
Deferred tax liabilities:
Other (728,000) (728,000)
- ---------------------------------------------------------------------------------------
Net deferred tax assets 21,033,000 19,407,000
Deferred tax assets valuation allowance (21,033,000) (19,407,000)
- ---------------------------------------------------------------------------------------
$ - $ -
=======================================================================================
</TABLE>
At December 31, 1998, the Company had net operating losses available for
carryforward for federal and state tax purposes of approximately $ 55,168,000
and $15,355,000, respectively. Federal and state loss carryforwards of
$1,008,000 and $2,925,000, respectively, expired in 1998 and will not be
available for carryforward into 1999. The difference between federal and state
loss carryforwards is primarily attributable to the 50% limitation of California
loss carryforwards. The Company also has federal research credit carryforwards
of approximately $450,000 which will begin to expire in 2004 unless previously
utilized.
At December 31, 1998, the Company had net operating loss carryforwards for
federal and state tax purposes expiring as follows:
<TABLE>
Year Expires Federal State
========================================================================
<S> <C> <C>
1999 $ 343,000 $ 4,645,000
2000 368,000 3,879,000
2001 849,000 1,979,000
2002 1,151,000 2,215,000
2003 1,217,000 2,837,000
2004 6,984,000 -
2005 2,288,000 -
2006 3,750,000 -
2007 8,111,000 -
2008 5,723,000 -
2009 5,057,000 -
2010 4,614,000 -
2011 4,654,000 -
2012 4,385,000 -
2013 5,674,000 -
- ------------------------------------------------------------------------
Total loss carryforwards $55,168,000 $15,555,000
========================================================================
</TABLE>
13. SUBSEQUENT EVENTS
Effective January 14, 1999, the Company entered into a number of agreements with
MLFC Corporation ("MLFC"), a wholly-owned subsidiary of Mitsubishi Corporation,
relating to the formation of a joint venture with MLFC regarding the LFC
Process. The Company and MLFC entered into a LFC Joint Venture Formation
Agreement, Operating Agreement, License Agreement, Services Agreement and
Security Agreement with the purpose of further developing the LFC Process and
licensing its use in proposed LFC process plants.
65
<PAGE>
SGI INTERNATIONAL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. SUBSEQUENT EVENTS (CONTINUED)
The LFC Joint Venture Formation Agreement between the Company and MLFC provides
for the formation of a limited liability company called LFC Technologies, LLC
("LFC Tech") to conduct research and development activities relating to the LFC
Process, for MLFC to market the LFC Process outside the U.S. and for the Company
to market the LFC Process inside the U.S.
The License Agreement between LFC Tech and the Company provides for the grant to
LFC Tech of a non-exclusive worldwide royalty-free license in connection with
purposes of LFC Tech, to use the LFC Process and related rights, including
improvements developed by LFC Tech to reduce the costs of an LFC plant, and
to design, contract and sell LFC-related products until January 14, 2001, unless
extended by mutual agreement. The fee for the license to MLFC was the execution
by LFC Tech of a Services Agreement with the Company. The License Agreement
requires the Company to provide all confidential information related to the LFC
process to LFC Tech. The Company also agreed, among other things, to permit the
technical employees of LFC Tech to inspect the Demonstration Plant, disclose
confidential LFC information, provide copies of technical data regarding the
design, construction and operation of the Demonstration Plant and to provide
copies of all patent applications.
The Operating Agreement as amended between MLFC and the Company governs the
management of the new joint venture company, LFC Tech, and is for a term
extending through January 14, 2001. The purpose of LFC Tech is to conduct
research and development activities with respect to the LFC Process and other
approved business. The Company and MLFC each must contribute $125,000 every
three months for two years to LFC Tech. Each will have a 50 percent interest in
profits and losses of the business operated by LFC Tech which is managed by two
managers, one from the Company and one from MLFC. Upon the occurrence of certain
"milestone" events, MLFC and the Company shall determine by mutual agreement the
terms and conditions for forming a new company ("Newco") to hold the LFC patents
and related technology and MLFC will be required to pay to the Company $4.0
million for the transfer of the exclusive license for the LFC Process into Newco
("Transfer Payment"). The Transfer Payment is to be paid to the Company only on
the first to occur of the following: (1) the start of construction or receipt of
an irrevocable commitment to start with construction of an LFC plant with a
minimum capacity of 15,000 tons per day; (2) the receipt by MLFC of at least
$4.0 million in connection with the admission of a new equity participant into
Newco, and the licensing or royalties from one or more LFC plants; or (3) such
other conditions as the parties agree. In addition, the Transfer Payment is also
conditioned on all of the following: (a) MLFC and the Company entering into a
shareholders' agreement satisfactory to both parties; (b) the Company has
obtained and transferred to Newco the entire ownership, subject to an adjustment
provision in the event less than the entire ownership is transferred, in the LFC
Process and improvements, free of liens or encumbrances; (c) through the
formation of Newco, MLFC acquires a 50 percent equity interest in the LFC
Process and improvements; and (d) the Company grants to MLFC exclusive rights to
manufacture and sell new plants incorporating the LFC Process and related
improvements and to use or to grant to third parties sublicenses to use or grant
the LFC Process and improvements.
The Amended and Restated Services Agreement between MLFC, LFC Tech and the
Company provides that the Company will provide certain services to LFC Tech
including soliciting potential customers in the U.S., developing LFC projects in
the U.S. and performing engineering work. The Services Agreement is for a
minimum period of two years and provides a fixed payment to the Company of $1.0
million per year, payable $250,000 per quarter after an initial payment of
$250,000 upon execution of the agreement.
The Security Agreement between the Company and MLFC grants MLFC a security
interest in all the LFC Process related patents, applications, renewals, and
continuations.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
66
<PAGE>
===============================================================================
PART III
===============================================================================
The information required by this Part III will be provided in the Company's
definitive proxy statement for the Company's 1999 Annual Meeting of Shareholders
(involving the election of Directors), which definitive proxy statement will be
filed pursuant to Regulation 14A no later than April 30, 1999, and is
incorporated herein by this reference to the following extent:
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
The information called for by this Item will be set forth under the captions
"Election of Directors - Information about Nominees and Executive Officers" and
"Section 16(A) Beneficial Ownership Reporting Compliance" in the Company's
Definitive Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by this Item will be set forth under the captions
"Information Concerning Board of Directors Compensation of Directors,"
"Compensation Committee Report on Executive Compensation" and "Executive
Compensation" in the Company's Definitive Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT
The information called for by this Item will be set forth under the caption
"Security Ownership of Certain Beneficial Owners and Management" in the
Company's Definitive Proxy Statement.
ITEM 13. CERTAIN TRANSACTIONS
The information called for by this Item will be set forth under the caption
"Certain Relationships and Related Transactions" in the Company's Definitive
Proxy Statement.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 8-K
(a) (1)&(2) Consolidated Financial Statements
The financial statements listed in Index to Consolidated Financial
Statements which appear on page 28 are incorporated by reference herein
or filed as part of this Form 10-K.
(b) 3 List of exhibits
The following documents are filed as exhibits to this Form 10-K.
<TABLE>
<S> <C>
2.1 Merger Agreement between VDI and Genesis(2) 3.1.1 Articles of
Incorporation, as amended(1) 3.1.2 Restated Articles of
Incorporation(5)
3.1.3 Articles of Amendment to the Articles of Incorporation of SGI
International(26)
3.2.1 By-laws, as amended(2)(3)
3.2.2 Amended and Restated By-laws(5)
67
<PAGE>
3.2.3 By-Laws, as Amended (9/20/90)(14)
4.1.1 Form of Warrants - Authorized Before 1987(1)
4.1.2 Form of Warrants - Series A through H(5)
4.1.21 Form of Amended Warrants(15)
4.1.22 Form of Amended Warrants(16)
4.1.3 Form of Warrants - Series I, M, S and P(5)
4.1.4 Form of Warrants - Series XX(12)
4.2 Loan Agreement with Arthur & Sophie Brody(4)
4.3 Form of Series 86B Promissory Notes(4)
4.4 Form of Series 86C Promissory Notes(4)
4.5 Form of Series 90A Units (Promissory Note and Preferred stock)(14)
4.6 Form of Series 90B Units (Promissory Note and Preferred Stock)(14)
4.7 Form of Series 90C Units (Promissory Note and Preferred Stock)(14)
4.8 Form of Series 90D Units (Promissory Note and Preferred Stock)(14)
4.9 Form of Series P90 Preferred Stock(14)
4.10 Form of Series PS90 Preferred Stock(14)
4.11 Form of Series 91A Units (Promissory Note and Preferred Stock)(17)
4.12 Form of Series 91AA Units (Promissory Note and Preferred Stock)(17)
4.13 Form of Series 91B Units (Promissory Note and Preferred Stock)(17)
4.14 Form of Series 91C Units (Promissory Note and Preferred Stock)(17)
4.15 Form of Series 91D Units (Promissory Note and Preferred Stock)(17)
4.16 Form of Series 91E Units (Promissory Note and Preferred Stock)(17)
4.17 Form of Series 91V Units (Promissory Note and Preferred Stock)(17)
4.18 Form of Series 91P Preferred Stock(17)
4.19 Form of Series 91R Preferred Stock(17)
4.20 Form of Series 91S Preferred Stock(17)
4.21 Form of Series 91T Preferred Stock(17)
4.22 Form of Series 91M Preferred Stock(17)
4.23 Form of Series 92A Preferred Stock(19)
4.24 Form of Series 92B Preferred Stock(19)
4.25 Form of Series 93A93B Units (Promissory Note and Preferred Stock)(22)
4.26 Form of Series 93B Units (Promissory Note and Preferred Stock)(22)
4.27 Form of Series 93C Units (Promissory Note and Preferred Stock)(22)
4.28 Form of Series 94A94A Units (Promissory Note and Preferred Stock)(23)
4.29 Form of Series 94B94B Units (Promissory Note and Preferred Stock)(23)
4.30 Form of Series 94C Units (Promissory Note)(23)
4.31 Form of Series 95C Convertible Preferred Stock (25)
4.32 Form of Series 95D1 Redeemable Convertible Preferred Stock (25)
4.33.1 Form of Series 95D1.03 Convertible Preferred Stock (26)
4.33.2 Form of Series 95D1.04 Convertible Preferred Stock (26)
4.34 Form of Series 95E Redeemable Convertible Preferred Stock (25)
4.35 Form of Series 95R Convertible Preferred Stock (26)
4.36 Form of Series 96A Convertible Preferred Stock (28)
4.37 Form of Series 96B Convertible Preferred Stock (28)
4.38 Certificate of Secretary re: Designation of Series 97C Preferred Stock.(29)
4.39 Certificate of Secretary re: Designation of Series 97D Preferred Stock.(29)
4.40 Form of Debenture for Series 97E.(29)
4.41 Form of Warrant for Series 97E.(29)
4.42 Certificate of Secretary re: Designation of Series 97F Preferred Stock.(29)
4.43 Amended Certificate of Secretary re: Designation of Series 97G Preferred Stock.(29)
4.44 Form of Common Stock Certificate.(29)
4.45 Form of Warrant Certificate re: Existing Warrants.(30)
4.46 Form of Stock Purchase Warrant re: 97D and 97F Preferred Stock.(30)
4.47 Form of Stock Purchase Warrant re: Series 97B Preferred Stock.(29)
4.48 Form of Stock Purchase Warrant re: Series 97G Preferred Stock.(29)
4.49 Series 97D Preferred Stock Purchase Agreement dated August 12, 1997, between the Registrant and the holders thereof.(30)
4.50 Registration Rights Agreement re: Series 97D Preferred Stock dated August 12, 1997, between the Registrant and the
holders thereof.(30)
4.51 Series 97F 8% Convertible Preferred Stock Subscription Agreement dated November 6, 1997, between the Registrant and
the holders hereof.(30)
4.52 Registration Rights Agreement re: Series 97F Preferred Stock dated November 6, 1997, between the Registrant and the
holders thereof.(30)
4.53 Series 97G 8% Convertible Preferred Stock Subscription Agreement between the Registrant and Settondown Capital dated
January 8, 1998.(29)
4.54 Series 97G 8% Convertible Preferred Stock Subscription Agreement between Registrant and Dominion Capital dated January
8, 1998.(29)
4.55 Form of Registration Rights Agreement re: Series 97G Preferred Stock dated January 8, 1998, between the Registrant and
the holders thereof.(29)
68
<PAGE>
4.56 Agreement between the Registrant and AEM dated December 11, 1997.(29)
4.57 Certificate of Secretary re: Designation of Series 98A Preferred Stock.(31)
4.58 Form of Series 98A Stock Purchase Warrant(31)
4.59 Series 98A 6% Convertible Preferred Stock Placement Agent Subscription Agreement dated March 6, 1998, between Registrant
and the holders thereof. (31)
4.60 Registration Rights Agreement for Placement Agent re: Series 98A Preferred Stock date March 6, 1998, between the
Registrant and the holders thereof. (31)
4.61 Series 98A 6% Convertible Preferred Stock Subscription Agreement dated March 6, 1998, between Registrant and the
holders thereof. (31)
4.62 Registration Rights Agreement re: Series 98A Preferred Stock dated March 6, 1998, between the Registrant and the
holders thereof. (31)
4.63 Amended Certificate of Secretary re: Designation of Series 98C Preferred Stock.(31)
4.64 Amended Certificate of Secretary re: Designation of Series 98D Preferred Stock.(31)
4.65 Form of Stock Purchase Warrant re: Series 98C Preferred Stock dated November 4, 1998.(31)
4.66 Form of Series 98C Convertible Preferred Stock Subscription Agreement dated November 4, 1998, between the Registrant
and the holders thereof.(31)
4.67 Form of Registration Rights Agreement re: Series 98C Preferred Stock dated November 4, 1998, between the Registrant
and the holders thereof.(31)
4.68 Form of Series 98D Convertible Preferred Stock.(31)
4.69 Form of Series 98D Convertible Debentures.(31)
4.70 Form of 12% Promissory Note dated September 9, 1998.(31)
4.71 Certificate of Secretary re: Designation of Series 96B Preferred Stock. (32)
4.72 Amended Certificate of Secretary re: Designation of Series 97B Preferred Stock. (32)
4.73 Amended Certificate of Secretary re: Designation of Series 97D Preferred Stock. (32)
4.74 Amended Series 97D Preferred Stock Purchase Agreement date April 1, 1998, between the Registrant and the holders
thereof.(32)
4.75 Amended Registration Rights Agreement re: Series 97D Preferred Stock, dated April 1, 1998, between the Registrant and the
holders thereof. (32)
4.76 Agreement and General Release re: Series 97D Preferred Stock, dated April 1, 1998, between the Registrant and the
holders thereof. (32)
10.1.1 Amended and Restated Agreements with LFC Technology Partners - Pre 10/1/87.(4)
10.1.2 Amended Technology Transfer Agreement dated 10/1/87.(5)
10.1.3 Research Agreement Waiver (and Amended Research Notes) dated 10/1/87.(5)
10.2 AEM Agreement.(2)(3)
10.3.1 Assignment Agreement dated 11/13/84 with Ernest Esztergar.(6)
10.3.2 First Amendment to Assignment Agreement dated 12/31/87 with Ernest Esztergar.(5)
10.4 Employment Agreement with Ernest Esztergar (1995).(26)*
10.5 Lease of executive offices (LJF).(14)
10.5.1 First amendment to Lease of Executive offices dated as of 10/17/95. (26)
10.6 Modification Agreement dated as of 10/1/87.(7)
10.6.1 Settlement Agreement dated as of December 10, 1992.(18)
10.7 Agreement to Proceed (including Agreement to Proceed, LFC Release and Addendum).(5)
10.8 Participation Agreement (including Participation Agreement, Confidentiality Agreement and Addendum).(5)
10.9 Agreement dated as of July 1, 1988, between AEM and Company.(9)
10.10 Agreement dated July 19, 1989, between SMC and Company.(10)
10.11 Technology Purchase Agreement, dated as of 9/28/89.(11)
10.12 Partnership Agreement, dated as of 9/30/89.(11)
10.12.1 First Amendment to Partnership Agreement dated as of 12/1/91.(17)
10.12.2 Second Amendment to Partnership Agreement dated as of 5/1/95.(26)
10.13 SGI Assignment Agreement, dated as of 9/30/89.(11)
10.14 SMC Assignment Agreement, dated as of 9/30/89.(11)
10.15 Coal Handling License, dated as of 9/30/89.(11)
10.16 License to SGI International, dated as of 9/30/89.(11)
10.17 License to Shell Mining Company, dated as of 9/30/89.(11)
10.18.1 First Amendment to License to Shell Mining Company, dated as of 5/01/95.(26)
10.19 ENCOAL/SGI Services Agreement, dated as of 7/18/90.(14)
10.20 SMC Services Agreement, dated as of 9/30/89.(11)
10.21 Accounting Procedures.(11)
10.22 Confidentiality Addendum.(11)
10.23 Addendum to Documents 10.19 through 10.29.(11)
10.24 Letter of Intent dated June 5, 1993, between Company & Shanxi Coal Bureau, China.(20)
10.25 Letter of Intent dated July 16, 1993, between Company & Fushun Coal Mine Administration, China. (20)
10.26 Letter of Intent dated January 28, 1994, between Company and Shandong Provincial Coal Bureau, and Comprehensive
Utilization Corporation of Shandong Coal Industry, China.(21)
10.27 Acquisition Agreement dated as of September 8, 1995.(25)
10.28.1 Lending and Commitment Agreement dated as of September 8, 1995.(25)
10.28.2 First Amendment to Acquisition and Funding Agreement dated as of September 22, 1995.(25)
10.28.3 Second Amendment to Acquisition & Funding Agreement dated as of October 20, 1995. (24)
69
<PAGE>
10.29 Technology Transfer Agreement (SGI/OCET) dated 3/17/95.(26)
10.29.1 First Amendment to Technology Transfer Agreement dated as of 5/15/95.(26)
10.29.2 Second Amendment to Technology Transfer Agreement dated as of August 25, 1996. (28)
10.30 Employment Agreement with Joseph A. Savoca dated as of June 12, 1995. (26)*
10.31 LFC Joint Venture Formation Agreement dated January 14, 1999, between Registrant and MLFC Corporation. (32)
10.32 Amended Operating Agreement dated January 14, 1999, between Registrant and MLFC Corporation. (32)
10.33 Amended License Agreement dated January 14, 1999, between Registrant and LFC Technologies, LLC. (32)
10.34 Amended and Restated Services Agreement dated January 14, 1999, between Registrant and MLFC Corporation and LFC
Technologies, LLC. (32)
10.35 Security Agreement dated January 14, 1999, between Registrant and MLFC Corporation. (32)
18.1 Letter re: Change in Accounting Principles(4)
22.1 Subsidiaries(5)
23.1 Consent of J.H. Cohn LLP, Independent Auditors (30)
23.2 Consent of Ernst & Young LLP, Independent Auditors(30)
99.1 Agreement dated June 20, 1988(8)
99.2 Modification Agreement dated August 1, 1988(8)
99.3 Colstrip Notes(8)
99.4.1 Other Notes (Healy Alaska)(8)
99.5 LTI Agreement(8)
99.6 SGI/MOP General Release(8)
99.7 Creditor Releases(8)
99.8 SGIF/DOE/METC Agreement dated 9/20/91(17)
</TABLE>
* Management contract or compensatory plan.
<TABLE>
<S> <C>
(1) Incorporated by reference to the Registrant's Registration Statement on Form S-14 (File No. 2-93124) (the "Registration
Statement") filed on September 6, 1984.
(2) Incorporated by reference to Amendment No. 2 to the Registration Statement filed on April 24, 1985.
(3) Incorporated by reference to Report on Form 10-K (File No. 2-93124) for the year ended December 31, 1985.
(4) Incorporated by reference to Report on Form 10-K (File No. 2-93124) for the year ended December 31, 1986.
(5) Incorporated by reference to Report on Form 10-K (File No. 2-93124) for the year ended December 31, 1987.
(6) Incorporated by reference to Amendment No. 1 to the Registration Statement filed on December 31, 1984.
(7) Incorporated by reference to Report on Form 10-Q (File No. 2-93124) for the quarter ended September 30, 1987.
(8) Incorporated by reference to Report on Form 10-Q (File No. 2-93124) for the quarter ended June 30, 1988.
(9) Incorporated by reference to Exhibit 10.18 (sic) in Report on Form 10-Q (File No. 2-93124) for the fiscal quarter ended
March 31,1990.
(10) Incorporated by reference to Exhibit 10.18 (sic) in Report on Form 10-Q (File No. 2-93124) for the fiscal
quarter ended September 30, 1990.
(11) Incorporated by reference to Report on Form 10-Q (File No. 2-93124) for the quarter ended March 31, 1990.
(12) Incorporated by reference to Report on Form 10-K (File No. 2-93124) for the year ended December 31, 1988.
(13) Incorporated by reference to Report on Form 10-K (File No. 2-93124) for the year ended December 31, 1989.
(14) Incorporated by reference to Report on Form 10-K (File No. 2-93124) for the year ended December 31, 1990.
(15) Incorporated by reference to Exhibit 4 in Registration Statement on Form S-8 (File No. 2-93124) filed on
December 1990.
(16) Incorporated by reference to Exhibit 4 in Registration Statement on Form S-8 (File No. 2-93124) filed on
March 1, 1991.
(17) Incorporated by reference to Report on Form 10-K (File No. 2-93124) for the year ended December 31, 1991.
(18) Incorporated by reference to Report on Form 8-K (File No. 2-93124) filed on January 15, 1993.
(19) Incorporated by reference to Report on Form 10-K (File No. 2-93124) for the l year ended December 31, 1992.
(20) Incorporated by reference to 1st Amendment to Form S-1 filed December 20, 1993.
(21) Incorporated by reference to 3rd Amendment to Form S-1 filed March 9, 1994.
(22) Incorporated by reference to Report on Form 10K (File No. 2-93124) for the year ended December 31,1993.
(23) Incorporated by reference to Report on Form 10K (File No. 2-93124) for the year ended December 31,1994.
(24) Incorporated by reference to Report on Form 10-Q (File No. 2-93124) for the quarter ending September 30, 1995.
(25) Incorporated by reference to Report on Form 8-K/A (File No. 2-93124) filed October 6, 1995.
(26) Incorporated by reference to Report on Form 10-K (File No. 2-93124) for the year ended December 31, 1995.
(27) Incorporated by reference to Report on Form 10-K (File No. 2-93124) for the year ended December 31, 1996.
(28) Incorporated by reference to Exhibit 4 in Registration Statement on Form S-8 (File No. 2-93124) filed on December 26, 1996.
(29) Incorporated by reference to Exhibit 4 in Registration Statement on Form S-2 (File No. 2-93124) filed on January 23, 1998.
(30) Incorporated by reference to Report on Form 10-Q (File No. 2-93124) for the quarter ending September 30, 1997.
(31) Incorporated by reference to Report on Form 10-Q (File No. 2-93124) for the quarter ending September 30, 1998.
(32) Incorporated by reference to Exhibit 4 and 10 in Registration Statement on Form S-2 (File No. 2-93124) filed on
February 4, 1999.
</TABLE>
70
<PAGE>
(b) Reports on Form 8-K.
The Company did not file a report on Form 8-K during the last quarter
of the fiscal year ended December 31, 1998.
(c) Exhibits - The response to this portion of Item 14 is submitted as a
separate section of this report
(d) Financial Statement schedules for which provision has been made under
the applicable regulations of the Securities and Exchange Commission
have been omitted as they are either inapplicable; not required under
the related instructions; or have been included in the financial
statements, including the notes thereto.
71
<PAGE>
SIGNATURES
Pursuant to 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 on this 17th day of March 1999.
SGI INTERNATIONAL
By: /s/ Joseph A. Savoca
Joseph A. Savoca, Chairman/CEO
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.
SIGNATURES TITLE DATE
/s/ Joseph A. Savoca Chief Executive Officer March 17, 1999
______________________ Director, Chief Financial Officer
Joseph A. Savoca
/s/ James W. Mahler Executive Vice President, Director March 17, 1999
______________________
James W. Mahler
/s/ Ernest P. Esztergar Director March 17, 1999
_______________________
Ernest P. Esztergar
/s/ Bernard V. Baus Director March 17, 1999
_______________________
Bernard V. Baus
/s/ Norman Grant Director March 17, 1999
_______________________
Norman Grant
/s/ William Harris Director March 17, 1999
_______________________
William Harris
/s/ William A. Kerr Director March 17, 1999
_______________________
William A. Kerr
72
Exhibit 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
We consent to the incorporation by reference in the Registration Statement on
Form S-2 (No. 333-44789), the Registration Statement on Form S-2 (No. 333-68811)
and the Registration Statements on Form S-8 which were previously filed by SGI
International (the "Company") of our report on the consolidated financial
statements of the Company and its subsidiaries, dated February 16, 1999, which
report appears elsewhere in this Annual Report on Form 10-K of the Company for
the fiscal year ended December 31, 1998.
/s/ J. H. COHN LLP
San Diego, California
March 16, 1999
Exhibit 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Form S-8) and in the related Prospectuses of our report dated March 20, 1997,
except for Note 11, as to which the date is April 14, 1997, with respect to the
consolidated financial statements of SGI International, included in this Annual
Report (Form 10-K) for the year ended December 31, 1996, filed with the
Securities and Exchange Commission.
/s/ Ernst & Young LLP
ERNST & YOUNG LLP
San Diego, California
March 16, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted form SGI
International's Form 10-K for the year ended December 31, 1998,
and is qualified in its entirely by reference to such financial statements.
</LEGEND>
<CIK> 0000737955
<NAME> SGI International
<MULTIPLIER> 1
<CURRENCY> 0
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1.000
<CASH> 239,885
<SECURITIES> 402,500
<RECEIVABLES> 505,726
<ALLOWANCES> 84,460
<INVENTORY> 64,371
<CURRENT-ASSETS> 1,374,244
<PP&E> 1,687,636
<DEPRECIATION> 920,941
<TOTAL-ASSETS> 4,807,508
<CURRENT-LIABILITIES> 5,636,737
<BONDS> 0
1,449,348
641
<COMMON> 45,688,545
<OTHER-SE> (48,072,513)
<TOTAL-LIABILITY-AND-EQUITY> 4,807,508
<SALES> 4,600,190
<TOTAL-REVENUES> 4,643,989
<CGS> 3,456,185
<TOTAL-COSTS> 3,456,185
<OTHER-EXPENSES> 5,970,202
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 760,211
<INCOME-PRETAX> (5,542,609)
<INCOME-TAX> 0
<INCOME-CONTINUING> (5,542,609)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (5,542,609)
<EPS-PRIMARY> (0.50)
<EPS-DILUTED> (0.50)
</TABLE>
