<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
================================================================================
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
[-] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
================================================================================
Commission file number 0-23634
KFX INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 84-1079971
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) Identification number)
1999 Broadway, Suite 3200, Denver, Colorado USA 80202
(Address of principal executive offices)
(303) 293-2992
(Registrant's telephone number including area code)
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 proceeding 12 months, and (2) has been subject to such filing requirements
for the past 90 days.
Yes [X] No [_]
On November 9, 1998 there were 23,931,040 shares of the Registrant's common
stock outstanding.
<PAGE>
KFX INC.
FORM 10-Q QUARTERLY REPORT
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE NO.
--------
Part I. Financial Information
Item 1. Consolidated Financial Statements
<S> <C>
Consolidated Balance Sheets September 30, 1998 (Unaudited) and December 31, 1997......... 3
Consolidated Statements of Operations Three Months Ended
September 30, 1998 and 1997 (Unaudited)................................................ 4
Consolidated Statements of Operations Nine Months Ended
September 30, 1998 and 1997 (Unaudited)................................................ 5
Consolidated Statements of Cash Flows Nine Months Ended
September 30, 1998 and 1997 (Unaudited)................................................ 6
Notes to Consolidated Financial Statements (Unaudited).................................... 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................................................. 11
Part II. Other Information................................................................. 17
Signatures.................................................................................. 18
</TABLE>
2
<PAGE>
KFX INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
Sept 30,
1998 DECEMBER 31,
ASSETS (Unaudited) 1997
------ --------------------------------------
<S> <C> <C>
Current:
Cash and cash equivalents............................................ $ 7,326,256 $ 14,078,773
Accounts receivable.................................................. 478,771 220,729
Accounts receivable from unconsolidated affiliates................... 453,599 -
Unbilled revenue..................................................... 181,000 -
Accrued interest income.............................................. 22,400 52,000
Prepaid expenses..................................................... 46,452 109,696
Supplies inventory................................................... 704,877 -
------------ ------------
Total current assets.............................................. 9,213,355 14,461,198
------------ ------------
Property, plant and equipment, net of accumulated depreciation......... 3,735,836 4,458,305
Patents, net of accumulated amortization............................... 2,801,992 3,087,853
Investment in KFX Fuel Partners, L.P................................... 3,471,682 3,787,138
Investment in K-Fuel, LLC.............................................. 135,517 224,016
Investment in Charco Redondo, LLC...................................... 575,066 -
Goodwill, net of accumulated amortization.............................. 2,191,581 -
Debt issue costs, net of accumulated amortization...................... 1,861,565 2,230,565
Prepaid royalty........................................................ 500,000 500,000
Other assets........................................................... 219,280 308,631
------------ ------------
$ 24,705,874 $ 29,057,706
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current:
Accounts payable..................................................... $ 433,369 $ 363,881
Accrued expenses..................................................... 103,119 190,001
Deferred revenue..................................................... 71,000 -
Due to related parties............................................... 521,596 557,522
Interest payable..................................................... 245,449 504,421
Current maturities of long-term debt................................. 990,000 280,000
------------ ------------
Total current liabilities......................................... 2,364,533 1,895,825
------------ ------------
Long-term debt, less current maturities................................ 610,000 500,000
Convertible debentures................................................. 17,000,000 17,000,000
Mine reclamation liability............................................. - 1,166,000
------------ ------------
Total liabilities................................................. 19,974,533 20,561,825
------------ ------------
Commitments and contingencies (Note 2)
Stockholders' equity:
Preferred stock, $.001 par value, 20,000,000 shares authorized;
None issued....................................................... - -
Common stock, $.001 par value, 80,000,000 shares authorized;
23,931,040 and 23,926,040 shares issued and outstanding........... 23,931 23,926
Additional paid-in capital........................................... 48,227,338 47,758,843
Accumulated deficit.................................................. (43,519,928) (39,286,888)
------------ ------------
Total stockholders' equity........................................ 4,731,341 8,495,881
------------ ------------
$ 24,705,874 $ 29,057,706
============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE>
KFX INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Unaudited
Three Months Ended Sept. 30,
1998 1997
---------------------------------------------
<S> <C> <C>
Software licenses and services......................................... $ 510,428 $ -
Contract revenue....................................................... 246,353 450,341
Interest and other income.............................................. 119,940 334,372
Gain on sale of mine................................................... 700,500 -
----------- -----------
Total revenue and other income....................................... 1,577,221 784,713
----------- -----------
Cost of software licenses and services................................. 185,933 -
Marketing, general and administrative expenses (including $393,118
related to software revenues)......................................... 1,037,690 756,926
Research and development............................................... 118,822 184,529
Demonstration plant and laboratory operations.......................... 172,541 196,656
Equity in loss of unconsolidated affiliates............................ 208,684 145,305
Depreciation and amortization (including $143,922 related to software
revenues)............................................................. 719,658 523,331
Interest expense....................................................... 292,204 201,350
----------- -----------
Total costs and expenses............................................. 2,735,532 2,008,097
----------- -----------
Net loss............................................................... $(1,158,311) $(1,223,384)
=========== ===========
Basic and diluted net loss per common share............................ $(.05) $(.05)
=========== ===========
Weighted average shares outstanding.................................... 23,931,000 23,926,000
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE>
KFX INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Unaudited
Nine Months Ended Sept. 30,
1998 1997
-------------------------------------------
<S> <C> <C>
Software licenses and services......................................... $ 906,287 $ -
Contract revenue....................................................... 781,091 859,097
Interest and other income.............................................. 478,679 419,235
Gain on sale of mine................................................... 700,500 -
----------- -----------
Total revenue and other income....................................... 2,866,557 1,278,332
----------- -----------
Costs of software licenses and services................................ 590,446 -
Marketing, general and administrative expenses (including $640,856
related to software revenues)......................................... 2,554,070 2,077,412
Research and development............................................... 222,460 421,487
Demonstration plant and laboratory operations.......................... 503,576 586,901
Equity in loss of unconsolidated affiliates............................ 333,446 248,996
Depreciation and amortization (including $276,182 related to software
revenues)............................................................. 2,028,055 1,408,129
Interest expense....................................................... 867,544 267,521
----------- -----------
Total costs and expenses............................................. 7,099,597 5,010,446
----------- -----------
Net loss............................................................... $(4,233,040) $(3,732,114)
=========== ===========
Basic and diluted net loss per common share............................ $(.18) $(.16)
=========== ===========
Weighted average shares outstanding.................................... 23,928,000 23,784,000
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
5
<PAGE>
KFX INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Unaudited
Nine Months Ended Sept. 30,
1998 1997
--------------------------------------
Operating Activities:
<S> <C> <C>
Net loss.......................................................... $(4,233,040) $(3,732,114)
Adjustments to reconcile net loss to cash used in operating
activities:
Depreciation and amortization................................ 2,028,055 1,408,129
Write-off of project development costs....................... - 163,445
Common stock and warrants issued for services................ 214,750 -
Equity in loss of unconsolidated affiliates.................. 333,446 248,996
Gain on sale of mine......................................... (700,500) -
Other, net................................................... (11,150) (103,678)
Changes in operating assets and liabilities, net of assets and
liabilities acquired:
Accounts receivable, including unconsolidated affiliates..... (371,172) (87,686)
Accrued interest income...................................... 29,600 (24,000)
Supplies inventory........................................... (704,877) -
Accounts payable, accrued expenses and due to related parties 64,401 (178,277)
Interest payable............................................. (258,972) 138,323
Unbilled revenue and deferred revenue, net................... (110,000) -
Other, net................................................... 12,000 451
----------- -----------
Cash used in operating activities...................................... (3,707,459) (2,166,411)
----------- -----------
Investing Activities:
Purchases of equipment............................................ (517,956) (16,175)
Pending patent applications....................................... (140,239) (48,724)
Investments in KFX Fuel Partners, L.P............................. (199,340) (581,764)
Investments in K-Fuel, LLC........................................ - (325,122)
Investments in Charco Redondo, LLC................................ (572,066) -
Purchase of controlling interest in Pegasus Technologies, LLC,
net of cash acquired............................................. (1,610,657) -
Other............................................................. (50,000) (33,224)
----------- -----------
Cash used in investing activities...................................... (3,090,258) (1,005,009)
----------- -----------
Financing Activities:
Debt placement costs.............................................. - (1,859,749)
Proceeds from convertible debentures.............................. - 17,000,000
Proceeds from sale of common stock................................ - 2,500,000
Proceeds from issuance of notes payable........................... 115,000 -
Payments on notes payable......................................... (69,800) (290,000)
----------- -----------
Cash provided by financing activities.................................. 45,200 17,350,251
----------- -----------
Increase (decrease) in cash and cash equivalents....................... (6,752,517) 14,178,831
Cash and cash equivalents, beginning of period......................... 14,078,773 1,403,625
----------- -----------
Cash and cash equivalents, end of period............................... $ 7,326,256 $15,582,456
=========== ===========
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest............................................ $ 1,126,149 $ 128,858
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
6
<PAGE>
KFX INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Nine Months Ended September 30, 1998
- ------------------------------------
In January 1998, the Company converted $170,000 of current accounts payable
at December 31, 1997 related to general corporate legal services into a
promissory note. See Note 6.
In January 1998, the Company granted warrants to purchase 200,000 shares of
the Company's common stock at an exercise price of $3.75 per share in exchange
for certain professional services. Using the Black-Scholes option-pricing model,
the warrants were valued at $196,000; this amount is included in marketing,
general and administrative expenses for the nine months ended September 30,
1998.
On March 23, 1998, the Company issued $600,000 in promissory notes and
granted purchase options for 75,000 shares of the Company's common stock under
the Company's 1996 Stock Option and Incentive Plan in connection with the
Company's acquisition of a 60 percent interest in Pegasus Technologies, LLC.
Using the Black-Scholes option-pricing model, the stock options were valued at
$144,750; this amount is included in goodwill and acquisition costs related to
the acquisition of Pegasus Technologies, LLC. See Note 5.
Also in connection with the Pegasus Technologies, LLC acquisition, the
Company granted purchase options for 100,000 shares of the Company's common
stock under the Company's 1996 Stock Option and Incentive Plan to a consultant
relating to certain acquisition activities. Using the Black-Scholes option-
pricing model, the stock options were valued at $109,000; this amount is
included in goodwill and acquisition costs related to the acquisition of Pegasus
Technologies, LLC. See Note 5.
In April 1998, the Company reclassified $269,883 from its investment in KFx
Fuel Partners, L.P ("KFP") to accounts receivable from affiliates for certain
capitalized contract services which were reimbursed by KFP in July 1998. See
Note 3.
In May 1998, the Company issued 5000 shares of its common stock to satisfy
professional service obligations totaling $18,750.
In September 1998, the Company sold its Fort Union Mine ("Pit #1") to KFP
for assumption of all reclamation liabilities related to the mine. Pit #1 was
recorded on the books on the date of sale at a value $465,500 with corresponding
reclamation liabilities of $1,166,000.
Nine months Ended September 30, 1997
- -------------------------------------
During July 1997, the Company issued a warrant to purchase 453,333 shares
of common stock as part of the convertible debenture financing. Using the Black-
Scholes option-pricing model, the warrant was valued at $567,000; this amount is
included in the total of convertible debenture issuance costs.
The accompanying notes are an integral part of these consolidated financial
statements.
7
<PAGE>
KFX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Unaudited)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements include
the accounts of KFX Inc. ("KFX" or the "Company") and its wholly-owned
subsidiaries, KFX Wyoming Inc. ("KFXW") and Net Power Solutions, LLC (Net Power
Solutions), and its majority-owned subsidiaries, KFX Technology Inc. ("KFXT",
formerly Energy Brothers Technology, Inc.), Atlantic Partners Ltd. ("APL"),
Heartland Fuels Corporation ("HFC") and Pegasus Technologies, LLC ("Pegasus").
The Company's 67 percent interest in KSA Partnership ("KSA"), its 51 percent
interest in K-Fuel, L.L.C. ("K-Fuel, LLC"), its 12.6% interest in Charco
Redondo, LLC ("Charco") and its 5 percent interest in KFX Fuel Partners, L.P.
("KFP") are accounted for as equity investments as the Company does not have the
authority or ability to independently control or manage these entities. All
significant intercompany transactions have been eliminated in consolidation.
The consolidated financial statements at September 30, 1998, and for
the three and nine months ended September 30, 1998 and 1997 are unaudited. In
the opinion of the Company's management, all adjustments, consisting of only
normal recurring adjustments necessary for a fair statement of the results for
the interim periods, have been made. Certain reclassifications have been made
to the 1997 financial statements to conform to the current year presentation.
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. These financial statements should be
read in conjunction with the audited financial statements and notes to financial
statements for the year ended December 31, 1997 included in the Company's Form
10-K. The accounting policies used in the preparation of these unaudited
quarterly financial statements are the same as those policies used in the
preparation of the audited annual financial statements except as modified for
appropriate interim accounting policies. The results of operations for the
three and nine months ended September 30, 1998 are not necessarily indicative of
the results of operations expected for the year ended December 31, 1998.
Basic and diluted net loss per common share for the three and nine
months ended September, 30 1998 and 1997 are based on the weighted average
number of shares of common stock outstanding during the period, and excludes
common equivalent shares (common stock options and warrants) as the effect would
be anti-dilutive.
NOTE 2. COMMITMENTS AND CONTINGENT LIABILITIES
In November 1995, the Company filed a lawsuit against Fru-Con
Construction Corporation and Fru-Con Engineering, Inc. (collectively, "Fru-Con")
in the Wyoming State Court, 6th Judicial District. The action was removed to
the United States District Court for the District of Wyoming. The Company's
lawsuit requests that the court enter a judgment that Fru-Con has no interest or
claim in or against the Company or any of the Company's property or interests,
or that Fru-Con is barred from such claims. Fru-Con had asserted claims for
approximately $1.8 million for engineering services and an interest in K-Fuel
plants built in North America by virtue of contractual arrangements with a
limited partnership sponsored by corporations in which a predecessor entity to
the Company had a partnership interest. Because the work done by Fru-Con was
for a limited partnership in which the Company's predecessor entity was not a
partner, and because payment for the work performed by Fru-Con was contingent
upon successful project financing which never materialized, as well as for other
legal and factual reasons, the Company believes that Fru-Con has no valid rights
or claims against the Company. On May 20, 1997, the District Court granted the
Company's Motion for Summary Judgment on all claims. Fru-Con subsequently
appealed to the 10th Circuit Court of Appeals. On September 1, 1998 the Appeals
8
<PAGE>
KFX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Unaudited) (Continued)
Court affirmed the District Court's opinion. The Company believes that any
further developments in this matter will not have a material impact on the
Company's financial position or results of operations.
On March 9, 1998, Fidelity and Deposit of Maryland, as subrogee of
Walsh Construction Company, a division of Guy F. Atkinson Company, filed a
construction lien against KFP (as defined below) with respect to the
construction of the KFP Facility (as defined below) in the amount of
approximately $5.9 million. It is not possible at this time to evaluate the
merits of the claim or the range of potential loss. However, the Company
believes that the ultimate resolution of this action will not have a material
impact on the Company's financial position or results of operation.
NOTE 3. KFX FUEL PARTNERS, L.P.
In August 1995, the Company and Thermo Ecotek Corporation ("TCK"), acting
through wholly-owned subsidiaries KFXW and Eco Fuels, Inc. (100 percent owned by
TCK), formed KFP and began construction of a 500,000 TPY K-Fuel coal production
facility (the "KFP Facility") near Gillette, Wyoming using the Company's Series
"C" K-Fuel Technology. The Company has a 5 percent interest in KFP, with the
remaining 95 percent held by TCK. TCK is the managing general partner for KFP
and makes all day-to-day operating decisions.
In connection with the commencement of operations of the KFP Facility
in April 1998, the Company reclassified $269,883 to accounts receivable from
affiliates for certain capitalized contract services, which were reimbursed by
KFP in July 1998.
NOTE 4. CHARCO REDONDO, LLC
In December 1997, the Company purchased a 12.6 percent interest in
Charco for $540,000. The Company has made additional investments approximating
$25,000 pursuant to cash calls made by Charco through September 30, 1998.
NOTE 5. PEGASUS TECHNOLOGIES, LLC
On March 23, 1998, the Company acquired a 60 percent interest in Pegasus, an
Ohio limited liability company that develops and markets computer software
products intended to optimize combustion and provide related benefits in coal-
fired electric utility power plants. The purchase price totaled $2,200,000 and
consisted of a cash payment of $1,100,000, $600,000 in four-year promissory
notes and the agreement to provide an immediate capital contribution of
$500,000. The promissory notes bear interest at 5% and require annual principal
payments of $150,000 each anniversary date until fully paid in March 2002. In
addition, the Company agreed to issue to certain Pegasus principals non-
qualified stock options to purchase 75,000 common shares under the Company's
1996 Stock Option and Incentive Plan. The stock options were granted at an
exercise price of $3.75 per share, vest 20 percent each anniversary of the date
of grant, and expire in March, 2005. Using the Black-Scholes option-pricing
model, the stock options were valued at $144,750; this amount is included in
goodwill and acquisition costs related to the acquisition of Pegasus. In
addition, the Company agreed to provide Pegasus $1,400,000 in working capital
guarantees secured through lines of credit or other financing sources mutually
acceptable to the Company and Pegasus.
In connection with the acquisition of Pegasus, the Company issued
100,000 fully vested non-qualified stock options under the Company's 1996 Stock
Option and Incentive Plan to a consultant who provided certain acquisition
services. The stock options were granted at an exercise price of $3.75 per
share and expire in May, 2001. Using the Black-Scholes option-pricing model,
the options were valued at $109,000; this amount is included in goodwill and
acquisition costs related to the acquisition of Pegasus.
9
<PAGE>
KFX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Unaudited) (Continued)
The financial condition of Pegasus at September 30, 1998 and its
results of operations for the period March 24, 1998 to September 30, 1998 are
included in the consolidated financial statements of the Company. The proforma
impact as if the acquisition of Pegasus had occurred as of January 1, 1997 is
not material.
NOTE 6. PROMISSORY NOTE
In January 1998, the Company converted $170,000 of current accounts
payables at December 31, 1997 related to general corporate legal services into a
promissory note. Interest accrues at six percent per annum with quarterly
interest and principal payments beginning on March 31, 1999. Any unpaid
principal and interest is due on December 31, 2001.
NOTE 7. SALE OF MINE
In September 1998, the Company sold its Fort Union Mine ("Pit #1") to
KFP for assumption of all reclamation liabilities related to the mine. Pit #1
was recorded on the books on the date of sale at a value $465,500 with
corresponding reclamation liabilities of $1,166,000.
10
<PAGE>
KFX INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
The following discussion contains, in addition to historical
information, forward-looking statements, within the meaning of Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended, that include risks and uncertainties. The
Company's actual results may differ materially from those anticipated in these
forward-looking statements. These statements comprehend the current intent,
beliefs and expectations of the Company and its management with respect to the
factors discussed below, as well as general economic and business conditions,
regulatory changes, competition, market acceptance of new product offerings and
other factors discussed in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" at Item 7 of the Company's Annual Report on
Form 10-K for the year ended December 31, 1997. The Company does not undertake
to update, revise or correct any of the forward-looking statements.
Excluding a joint venture fee of $1 million in 1996, to date the
Company has not generated any other material revenues from the licensing of the
K-Fuel Technology to third party licensees or the direct manufacturing of K-
Fuel. In August 1995, the Company and Thermo Ecotek Corporation ("TCK"), acting
through wholly-owned subsidiaries formed KFP and began construction of a 500,000
TPY K-Fuel coal production facility (the "KFP Facility") near Gillette, Wyoming
using the Company's Series "C" K-Fuel Technology. The Company has a 5 percent
interest in KFP, with the remaining 95 percent held by TCK. TCK is the managing
general partner for KFP and makes all day-to-day operating decisions. The KFP
Facility is the only commercial-scale K-Fuel production facility constructed to
date.
Although production from the KFP Facility is substantially behind the
original schedule, it appears that virtually all significant problems have been
identified and corrections to the plant have been substantially completed or are
underway. Solutions to the remaining issues of tar and fines waste streams and
product dusting are being actively resolved by plant management. Plant
operations are improving almost daily and good quality K-Fuel product has been
produced over the last several months.
Because the technology being developed at the KFP Facility is new, no
assurance can be given that other difficulties will not arise or that these
problems can be corrected and optimal and sustained performance can be achieved.
The Company does not believe its share of such additional costs to bring the KFP
Facility to optimal operating performance, if incurred, will be material.
Political instability has delayed the proposed Indonesian K-Fuel
project. It is expected that this project will be a high priority for Indonesia,
however, since the intent is to produce product for export, which will generate
hard currency for the troubled Indonesian economy. Testing and feasibility
analysis on the proposed project in Turkey to produce home heating fuel for
domestic use using K-Fuel technology continue to progress and are expected to be
completed this month. Results to date are positive and the outlook for this
project in 1999 is favorable.
Until the Company successfully negotiates additional K-Fuel-related
third-party licensing and royalty agreements, independently constructs and
operates additional commercial-scale K-Fuel production facilities, or
successfully enters into other lines of environmental and/or energy technology
businesses, net operating losses attributable to the Company's clean fuel line
of business will continue. The royalties and profit interests to be derived from
the Company's 5 percent ownership interest in the KFP Facility will not be
sufficient to meet all of the operating and debt service needs of the Company
based on current and future anticipated operating plans and budgets and current
results of operations. Until such time as the Company has in place sufficient
additional commercial-scale K-Fuel production facilities (either owned
11
<PAGE>
KFX INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
independently or through joint venture entities similar to the KFP Facility) or
has successfully entered into other lines of environmental and/or energy
technology businesses to generate positive cash flow from operations, the
Company will be dependent on additional debt and/or equity financing.
The Company has recently made investments in environmental and energy
technologies not directly related to the K-Fuel Technology that may provide a
more rapid economic return than the K-Fuel Technology. The Company's majority-
owned subsidiary Pegasus (acquired on March 23, 1998) and the Company's wholly-
owned subsidiary, Net Power Solutions, are contributing or are expected to
contribute revenues significant to the Company's results of operations but these
subsidiaries are not yet profitable. Pegasus and Net Power Solutions are
striving to increase implementation efficiencies to reduce costs and also
increase revenues through increased marketing efforts and other measures to
become profitable. It is not known when the operations of Pegasus and Net Power
Solutions will turn profitable.
Pegasus' combustion optimization software, NeuSIGHT, leads the market,
providing about twice the NOx reduction of competing products as well as
significant heat rate improvements and other benefits. These benefits, coupled
with the low NOx and SO2 content and undetectable levels of mercury and chlorine
in high Btu K-Fuel, are expected to create marketing synergies for NeuSIGHT and
K-Fuel. With approximately twenty systems either installed, currently being
installed or on order, Pegasus provides KFx with needed revenues. Resource Data
International (RDI), a Financial Times subsidiary that specializes in the
---------------
electric power industry, conducted a market study for NeuSIGHT, which confirmed
management's belief that existing and expected emission regulations should
result in a high demand for NeuSIGHT. RDI estimates that utilities will spend
about $21.8 billion over the next ten years to comply with various emission
requirements. This fall at the World Energy Congress in Houston, Pegasus/ Net
Power Solutions announced a pay for performance pricing alternative that will
optimize their combined profitability and allow product pricing tailored to
individual customer needs. To better capitalize on the opportunity presented by
this market potential, particularly in view of future electric utility
deregulation and the requirements of the Clean Air Act, KFx formed Net Power
Solutions to aggressively market NeuSIGHT and other related products developed
by Pegasus. In addition, KFx recently hired a seasoned software executive with
strong credentials to lead this new KFx subsidiary.
KFx is currently evaluating other possible acquisitions that have the
potential to provide complementary benefits to our customers as well as
marketing synergies to Pegasus/Net Power Solutions and KFx.
The Company's investment in the Charco tertiary oil recovery project is a
pilot phase only and is not expected to contribute significant operating cash
flows in the near term. Completion of the pilot phase of Charco is not expected
to require significant investments by KFx.
The Company is also investigating making investments in various activated
carbon lines of business, but to date has not committed to any such investments.
There are no assurances that any of the businesses that the Company is
attempting to develop will produce an acceptable economic return, if at all.
12
<PAGE>
KFX INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
RESULTS OF OPERATIONS - THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 VS. THREE
AND NINE MONTHS ENDED SEPTEMBER 30, 1997
Revenues and costs associated with software licenses and services result
from the March 23, 1998 acquisition of Pegasus and the formation of Net Power
Solutions in August 1998.
The decrease in contract revenues is due to a settlement with KFP regarding
reimbursable expenses incurred by KFx, on behalf of KFP in 1997, which had been
previously recorded to the Investment in KFP. See Note 3 of Notes to
Consolidated Financial Statements.
Interest income decreased in the third quarter comparison as a result of
lower average cash balances in 1998. Conversely, somewhat higher 1998 average
cash balances in the nine month comparision produced correspondingly higher
interest income. The convertible debenture offering that was completed on July
31, 1997 generated net cash proceeds of approximately $15.1 million
The gain on sale of mine resulted from transferring the Pit 1 to KFP in
September 1998. See Note 7 of Notes to Consolidated Financial Statements.
Marketing, general and administrative expenses increased in 1998 due costs
associated with the growing operations of Pegasus and the launch of Net Power
Solutions, which costs were partially offset by savings from a 1997 personnel
reduction program and various other factors. Such Pegasus/Net Power Solutions
related costs approximated $393,000 and $640,000 for the three and nine months
ended September 30, 1998, respectively. In addition, in September 1998
approximately $150,000 in expenses were incurred in connection with the
Company's participation in a major international energy conference.
Research and development expenses decreased in 1998 primarily as a result
of the cessation after September 1997 of consulting fees to the late Edward
Koppleman, the inventor of the K-Fuel process, who passed away in October 1997.
Demonstration plant and laboratory expenses decreased in 1998 primarily as
a result of cost sharing arrangements made with respect to the KFP Facility
which were put in place in the fourth quarter of 1997.
Equity in loss of unconsolidated affiliates increased in 1998 primarily as
a result of the commencement of operations of the KFP Facility on April 1, 1998,
which to date has operated at a loss.
Depreciation and amortization expense increased in 1998 primarily due to
goodwill amortization and depreciation resulting from the Pegasus acquisition
beginning April 1998 and amortization of debt issue costs beginning August 1997.
Goodwill amortization and depreciation related to Pegasus approximated $144,000
and $276,000 for the three and nine months ended September 30, 1998,
respectively. Amortization of debt issue costs approximated $123,000 and
$369,000 for the three and nine month periods ended September 30, 1998,
respectively. Amortization of such costs for the three and nine months ended
September 30, 1997 approximated $246,000.
Interest expense increased in 1998 primarily as a result of the convertible
debenture offering completed at the end of July 1997 that has increased
quarterly interest expense by about $250,000 beginning in August 1997.
13
<PAGE>
KFX INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
LIQUIDITY AND CAPITAL RESOURCES
The current near-term (to year-end 1998) funding sources available to the
Company are (1) cash on hand, which as of November 9, 1998 was approximately
$6.2 million; (2) certain revenues under technical subcontracts to be performed
for KFP; (3) cost reimbursements from K-Fuel, LLC, relating to a collective
research and development program conducted by the Company in conjunction with
Kennecott Alternative Fuels, Inc., the Company's joint venture partner in K-
Fuel, LLC; and (4) revenues related to the operations of Pegasus (although
material net operating cash flows related to Pegasus are not expected to
materialize until 1999 or later). The Company's primary financial goal for 1998
has been to improve operating cash flow to produce a break-even level in the
fourth quarter of the year. Given the Company's financial results through the
third quarter, the ability to achieve this objective will be largely dependent
on the outcome of negotiations with one of our partners in the development of K-
Fuel. We expect these negotiations to produce a significant payment to KFx yet
this year and/or in 1999.
The Company does not expect additional stock purchases by TCK in 1998
or 1999. Under the terms of the Stock Purchase Agreement, the next possible
investment by TCK is not until a period of time beginning in January 2000 and
expiring in July 2001. There are no assurances that TCK will make any
investments in the Company at that time. Additionally, the Stock Purchase
Agreement prohibits the Company from issuing shares of Common Stock to other
investors unless at least 90 percent of the proceeds from such stock issuances
are used to invest in K-Fuel production facilities. Furthermore, in the event
of any stock issuances by the Company, TCK's Warrant "A" may be subject to
certain adjustments that increase the number of shares available to TCK under
Warrant "A".
The Company does not expect material net operating revenues or net
operating cash flows from its ownership interest in KFP in the foreseeable
future. The Company's net production royalty (after fulfilling related royalty
obligations) once the KFP Facility reaches full production is projected to be
less than $150,000 per year. The potential for Section 29 tax credit for the KFP
production of K-Fuel represents additional potential value but since the Company
has a net operating loss carryforward, it is most likely that a structured
transaction would be required to generate any significant value from the
potential Section 29 tax credit. The value, amount or possibility of any such a
structured transaction is not determinable at this time.
Depending on the outcome of various uncertainties including those discussed
herein, the Company may be required to seek additional debt and/or equity
financing as early as mid to late 2000 for general operating purposes. If
acquisitions or capital investments are made in this time period, the need to
seek additional debt and/or equity financing may be accelerated.
Should the Company be required to seek any additional debt or equity
financing, the ability of the Company to do so will be affected by an existing
agreement with TCK and by the terms of the Convertible Debentures. With respect
to TCK, the Company must obtain TCK's consent to sell any Common Stock or to
incur any indebtedness other than indebtedness that is secured only by the
assets of a particular project and is non-recourse to the Company and its
subsidiaries. With respect to the Convertible Debentures, the Company may only
incur unsecured indebtedness of up to $8.0 million (of which not in excess of
approximately $1.6 million was outstanding as of November 9,1998) and
indebtedness secured only by the assets of a particular project and is non-
recourse to the Company and its subsidiaries.
There are no assurances that any of these potential funding sources will
materialize, and the Company does not currently have any commitments with
14
<PAGE>
KFX INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
respect to any such funding sources. If the overall outcome of the various
uncertainties affecting the Company is not favorable, the Company may be forced
to seek debt and/or equity financing on terms and conditions that may be
unfavorable to the Company, if available at all.
The Company's goals for 1999 are to:
. Increase revenues from Net Power Solutions/Pegasus by a factor of 2-4 times
over 1998. With this operation in a building mode, it is likely, however,
to experience negative operating cash flows for at least the first half of
1999.
. Improve operations and increase production, through TKC, at the KFP
facility, achieve several additional commercial burns with other utilities
and execute one to two license agreements. Such license agreements may be
largely dependent on obtaining an extension of the Section 29 tax credit in
1999.
. Construct an activated carbon plant at Gillette that will use a by-product
from the K-Fuel plant as a high-quality, low-cost feedstock. Technical
analysis has been finalized, major equipment has been purchased and
management is developing a financial plan that is expected may include one
or more partners.
. Fianlize the analysis of the potential of the Charco tertiary oil recovery
pilot project in which we participate. The project is progressing, but it
is premature to predict the ultimate results at this time.
. Continue to actively explore opportunities to acquire profitable operations
synergistic to the Company's existing businesses that can bring up to $10-
$20 million in annualized revenues to KFx. If appropriate opportunities are
found, management will aggressively strive to negotiate favorable terms and
close transactions, with the assistance of financial partners, as available
and appropriate, consistent with our past general practice.
As a company still in the process of developing its business lines, the nature
of the opportunities KFx is pursuing and their status make it rather difficult
to predict financial results with meaningful accuracy and also leads to
difficulties in achieving positive and stable financial results in the short
term. These issues are exacerbated by the volatile nature of the stock market.
The delays in the development of K-Fuel, coupled with the recent overall
weakness in the stock market, particularly for small cap companies, have
negatively affected KFx's stock price. Nevertheless, the continued progress of
K-Fuel, coupled with the synergies available through Pegasus and Net Power
Solutions, reaffirm management's confidence in the potential to transform the
opportunities that the Company is pursuing into long-term value for KFx
shareholders.
15
<PAGE>
KFX INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
YEAR 2000 COMPLIANCE
Like many other companies, the Company is aware of the problems associated
with "The Year 2000 Issue." This issue centers on certain computer systems
being unable to recognize the year 2000 as a valid date or may interpret a date
in the format of "00" as the year 1900 rather than the year 2000. This system
issue creates risk for the Company from unforeseen problems in its own computer
systems and from third parties with which the Company deals. Such failures of
the Company and/or third parties' computer systems could potentially have a
material impact on the Company's ability to conduct its business.
Based on interviews with and publications from those vendors supplying the
Company's current business information systems, management believes those
systems to be date compliant such that they will not pose a significant risk to
the Company's future business operations. In addition, an analysis of certain
of the Company's office and related systems was completed by a third party
consultant was completed in 1998. Recommended remediation steps were completed
at a nominal cost. Future version upgrades to these systems and/or new
acquisitions will be subjected to Year 2000 date compliance as selection,
acceptance, and installation criteria.
During 1998, the Company has begun an assessment of the impact that the
Year 2000 issue may have on other systems that support the Company's operation,
These other systems include, but are not limited to, supplier systems, shipper
systems, environmental control systems, manufacturing equipment, building
security systems, etc. To date this assessment does not indicate any
significant risk to the Company's future business operation. The Company will
continue this assessment and evaluate appropriate courses of corrective action
if any are needed outside of routine maintenance or currently planned projects.
The Company has made an initial assessment of the Year 2000 issue and
related potential effects on the Company's operations, and has determined that
it will not have a material effect on its financial position or results of
operations. The Company will, however, continue to monitor this issue and take
additional steps as may be prudent to minimize the potential adverse impact of
this issue.
16
<PAGE>
KFX INC.
PART II OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
The information contained in Note 2 of the Notes to Consolidated Financial
Statements is hereby incorporated by reference.
ITEM 2 CHANGES IN SECURITIES AND USE OF PROCEEDS
During 1998 the following securities have been issued pursuant to the
exemption in Section 4.2 of the Securities Act of 1933, as amended:
<TABLE>
<CAPTION>
Date Security Sold Consideration Received Class of
- ------ ------------- ---------------------- --------
Persons
-------
<C> <S> <C> <C>
1/98 Warrants to purchase 200,000 common Professional services Consultant
shares at $3.75 per share
1/98 Reprice options to purchase 90,000 Professional services Consultant
common shares from $8 to $6 per share
3/98 Options to purchase 75,000 common Issued in connection with acquisition Principals
shares at $3.75 per share of Pegasus, see Note 5 of Notes to
Consolidated Financial Statements
5/98 Options to purchase 100,000 common Professional services in connection Consultants
shares at $3.75 per share with acquisition of Pegasus, see Note 5
of Notes to Consolidated Financial
Statements
5/98 5000 common shares at $3.75 per share Professional services Consultant
8/98 Reprice options to purchase 55,000 Professional services Consultant
common shares from $4 to $3.75 per
share and extend term 3 years to 2001
8/98 Extend term of options to purchase Professional services Consultant
75,000 common shares 3 years to 2001 and Director
</TABLE>
ITEM 5 OTHER INFORMATION
Any shareholder proposal submitted with respect to the Company's 1999 Annual
Meeting of Shareholders, which proposal is submitted outside the requirements of
Rule 14a-8 under the Securities Exchange Act of 1934, will be considered
untimely for purposed of Rules 14a-4 and 14a-5 if notice thereof is received by
the Company after March 16, 1999.
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
27 Financial Data Schedule
(B) REPORTS ON FORM 8-K
The Company filed no reports on Form 8-K during the three-month period
ended September 30, 1998.
17
<PAGE>
KFX INC.
PART II OTHER INFORMATION
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of
1934, the registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
KFX INC.
/s/ Seth L. Patterson
----------------------
Seth L. Patterson
Chief Financial Officer
Date: November 16, 1998
18
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 7,326,256
<SECURITIES> 0
<RECEIVABLES> 932,370
<ALLOWANCES> 0
<INVENTORY> 704,877
<CURRENT-ASSETS> 9,213,355
<PP&E> 11,702,488
<DEPRECIATION> 7,966,652
<TOTAL-ASSETS> 24,705,874
<CURRENT-LIABILITIES> 2,364,533
<BONDS> 17,610,000
0
0
<COMMON> 23,931
<OTHER-SE> 4,707,410
<TOTAL-LIABILITY-AND-EQUITY> 24,705,874
<SALES> 0
<TOTAL-REVENUES> 2,866,557
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 6,232,053
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 867,544
<INCOME-PRETAX> (4,233,040)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,233,040)
<EPS-PRIMARY> (0.18)
<EPS-DILUTED> (0.18)
</TABLE>
