<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, 1999
[_] 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 preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [_]
On November 10, 1999 there were 24,482,240 shares of the Registrant's common
stock, $.001 par value, outstanding.
<PAGE>
KFX INC.
FORM 10-Q QUARTERLY REPORT
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets - September 30, 1999 (Unaudited) and December 31, 1998................. 3
Consolidated Statements of Operations - Three Months Ended
September 30, 1999 and 1998 (Unaudited)....................................................... 4
Consolidated Statements of Operations - Nine Months Ended
September 30, 1999 and 1998 (Unaudited)....................................................... 5
Consolidated Statements of Cash Flows - Nine Months Ended
September 30, 1999 and 1998 (Unaudited)....................................................... 6
Notes to Consolidated Financial Statements (Unaudited)............................................. 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.......................................................................... 10
Item 3. Quantitative and Qualitative Disclosures about Market Risk..................................... 17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................................................. 18
Item 6. Exhibits and Reports on Form 8-K............................................................... 18
SIGNATURES.............................................................................................. 19
</TABLE>
2
<PAGE>
KFX INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30,
1999 December 31,
(Unaudited) 1998
--------------- ------------
<S> <C> <C>
ASSETS
Current
Cash and cash equivalents......................................... $ 1,271,757 $ 5,649,992
Accounts receivable and unbilled revenue.......................... 889,670 952,977
Accounts receivable -affiliates................................... 31,873 193,842
Accrued interest income........................................... - 17,200
Prepaid expenses.................................................. 136,647 190,795
Deferred job costs................................................ 149,693 -
------------ ------------
Total current assets........................................... 2,479,640 7,004,806
------------ ------------
Property, plant and equipment, net of accumulated depreciation...... 2,500,915 3,243,812
Patents, net of accumulated amortization............................ 2,383,134 2,722,069
Investment in and advances to KFX Fuel Partners, L.P................ 3,429,310 3,779,412
Investment in K-Fuel, LLC........................................... 1,060,013 159,967
Investment in Charco Redondo, LLC................................... 629,238 629,238
Goodwill, net of accumulated amortization........................... 2,463,493 2,066,669
Debt issue costs, net of accumulated amortization................... 1,369,565 1,738,565
Prepaid royalty..................................................... 498,000 498,500
Other assets........................................................ 732,801 829,251
------------ ------------
$ 17,546,109 $ 22,672,289
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current
Accounts payable.................................................. $ 441,144 $ 188,578
Accrued expenses.................................................. 273,344 247,011
Due to related parties............................................ 14,538 471,504
Interest payable.................................................. 252,762 531,007
Deferred revenue.................................................. 429,000 381,000
Current maturity of long-term debt................................ 686,168 704,207
------------ ------------
Total current liabilities...................................... 2,096,956 2,523,307
------------ ------------
Deferred income..................................................... 1,000,000 -
Long-term debt, less current maturities............................. 689,625 890,793
Convertible debentures.............................................. 17,000,000 17,000,000
------------ ------------
Total liabilities.............................................. 20,786,581 20,414,100
------------ ------------
Commitments and contingencies
Stockholders' equity (deficit)
Preferred stock, $.001 par value, 20,000,000 shares authorized;
None issued.................................................... - -
Common stock, $.001 par value, 80,000,000 shares authorized;
24,482,240 and 23,951,740 shares issued and outstanding........ 24,482 23,952
Additional paid-in capital........................................ 49,080,632 48,304,942
Accumulated deficit............................................... (52,345,586) (46,070,705)
------------ ------------
Total stockholders' equity (deficit)........................... (3,240,472) 2,258,189
------------ ------------
$ 17,546,109 $ 22,672,289
============ ============
</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 September 30,
1999 1998
--------------------------------
<S> <C> <C>
OPERATING REVENUES
Software licenses and services...................................... $ 524,184 $ 510,428
Contract revenue.................................................... 35,320 246,353
----------- -----------
Total operating revenues.......................................... 559,504 756,781
----------- -----------
OPERATING COSTS & EXPENSES
Costs of software licenses and services............................. 353,478 185,933
Marketing, general and administrative expenses...................... 1,514,516 1,037,690
Software research and development................................... 108,373 55,325
K-Fuel demonstration plant and laboratory operations................ 96,962 236,038
Depreciation and amortization....................................... 672,128 719,658
----------- -----------
Total operating costs and expenses................................ 2,745,457 2,234,644
----------- -----------
OPERATING INCOME (LOSS)............................................. (2,185,953) (1,477,863)
Interest and other income........................................... 23,980 119,940
Gain on sale of mine................................................ - 700,500
Interest expense.................................................... (288,999) (292,204)
Equity in loss of unconsolidated affiliates......................... (42,567) (208,684)
----------- -----------
Loss before income taxes............................................ (2,493,539) (1,158,311)
Income tax benefit.................................................. - -
----------- -----------
NET INCOME (LOSS)................................................... $(2,493,539) $(1,158,311)
=========== ===========
BASIC AND DILUTED NET LOSS PER COMMON SHARE......................... $ (0.10) $ (.05)
=========== ===========
Weighted average shares outstanding................................. 24,155,000 23,931,000
=========== ===========
</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 September 30,
1999 1998
-------------------------------
<S> <C> <C>
OPERATING REVENUES
Software licenses and services...................................... $ 1,230,875 $ 906,287
Contract revenue.................................................... 310,250 781,091
K-Fuel license fee.................................................. 1,000,000 -
----------- -----------
Total revenue and other income............................... 2,541,125 1,687,378
----------- -----------
OPERATING COSTS & EXPENSES
Costs of software licenses and services............................. 845,074 590,446
K-Fuel royalty expense.............................................. 250,000 -
Marketing, general and administrative expenses...................... 4,103,026 2,554,070
Software research and development................................... 208,981 55,325
K-Fuel demonstration plant and laboratory operations................ 336,420 670,711
Depreciation and amortization....................................... 2,074,025 2,028,055
----------- -----------
Total operating costs and expenses............................. 7,817,526 5,898,607
----------- -----------
OPERATING INCOME (LOSS)............................................. (5,276,401) (4,211,229)
Interest and other income........................................... 321,473 478,679
Gain on sale of mine................................................ - 700,500
Interest expense.................................................... (869,897) (867,544)
Equity in loss of unconsolidated affiliates......................... (450,056) (333,446)
----------- -----------
Loss before income taxes............................................ (6,274,881) (4,233,040)
Income tax benefit.................................................. - -
----------- -----------
NET INCOME (LOSS)................................................... $(6,274,881) $(4,233,040)
=========== ===========
BASIC AND DILUTED NET LOSS PER COMMON SHARE......................... $ (0.26) $ (.18)
=========== ===========
Weighted average shares outstanding................................. 24,020,000 23,928,000
=========== ===========
</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 September 30,
1999 1998
-------------------------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss............................................................. $ (6,274,881) $ (4,233,040)
Adjustments to reconcile net loss to cash
used in operating activities
Depreciation and amortization.................................... 2,074,025 2,028,055
Common stock and warrants issued for services.................... 13,125 214,750
Equity in loss of unconsolidated affiliates.................... 450,056 333,446
Gain on sale of mine........................................... - (700,500)
Other income................................................... - (11,150)
Changes in operating assets and liabilities, net of assets and
liabilities acquired
Accounts receivable, unbilled revenue and deferred revenue....... 273,276 (481,172)
Other assets..................................................... (22,411) (663,277)
Accounts payable and accrued expenses............................ 546,345 64,401
Due to related parties........................................... (456,966) -
Interest payable................................................. (278,245) (258,972)
Deferred income.................................................. 1,000,000 -
------------- -------------
Cash used in operating activities...................................... (2,675,676) (3,707,459)
------------- -------------
INVESTING ACTIVITIES
Purchases of equipment............................................... (79,190) (517,956)
Pending patent applications.......................................... (136,716) (140,239)
Investments in KFX Fuel Partners, L.P................................ (267,446) (199,340)
Investments in K-Fuel, LLC........................................... (1,000,000) -
Investments in Charco Redondo, LLC................................... - (572,066)
Purchase of controlling interest in Pegasus Technologies,
Limited, net of cash acquired....................................... - (1,610,657)
Other................................................................ - (50,000)
------------- -------------
Cash used in investing activities...................................... (1,483,352) (3,090,258)
------------- -------------
FINANCING ACTIVITIES
Proceeds from issuance of notes payable.............................. - 115,000
Payments on notes payable............................................ (219,207) (69,800)
------------- -------------
Cash provided by (used in) financing activities........................ (219,207) 45,200
------------- -------------
Increase (decrease) in cash and cash equivalents....................... (4,378,235) (6,752,517)
Cash and cash equivalents, beginning of period......................... 5,649,992 14,078,773
------------- -------------
Cash and cash equivalents, end of period............................... $ 1,271,757 $ 7,326,256
============= =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest............................................... $ 1,148,142 $ 1,126,149
============= =============
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
6
<PAGE>
KFX INC.
CONSOLIDATED STATEMENT OF CASH FLOWS - (Continued)
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
(Unaudited)
Nine Months Ended September 30, 1999
- ------------------------------------
During August 1999, the Company issued 527,000 shares of its common stock
in exchange for an additional 15% interest in Pegasus Technologies, Limited
(Pegasus). This transaction was recorded based on the average price of KFx
common stock shortly before the transaction was completed, which approximated
$1.45 per share. Accordingly, the additional investment in Pegasus was recorded
at approximately $763,000.
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.
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 175,000 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% interest of Pegasus. Using the Black-Scholes
option-pricing model, the stock options were valued at $253,750; this amount is
included in goodwill and acquisition costs related to the acquisition of
Pegasus. See Note 2.
In April 1998, the company reclassified $80,199 from its investment in KFx
Fuel Partners, L.P. (KFP) to accounts receivable from affiliates for certain
prior year capitalized contract services, which were reimbursed by KFP in July
1998.
In September 1998, the Company sold its Fort Union Mine (Pit #1) to KFP in
exchange for KFP's assumption of all reclamation liabilities related to the
mine. Pit #1 was carried at $465,500 prior to the sale along with a
corresponding reclamation liability of $1,166,000.
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, Net
Power Solutions, LLC (NPS) and KFX Wyoming Inc. (KFXW), and its majority-owned
subsidiaries, Pegasus Technologies, Limited (Pegasus), KFX Technology, Inc.
(KFXT), and Heartland Fuels Corporation (HFC). The Company's 51% interest in K-
Fuel, L.L.C. (K-Fuel, LLC) and its 5% 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, 1999 and for the
three and nine months ended September 30, 1999 and 1998 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
1998 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, 1998 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, 1999 are not necessarily indicative of
the results of operations expected for the year ended December 31, 1999.
Net loss per common share for the three and nine months ended September 30,
1999 and 1998 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. Pegasus Technologies, Limited
On March 23, 1998, the Company acquired a 60% 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 $2,574,000 and
consisted of a cash payment of $1,100,000, $600,000 in four-year promissory
notes, the agreement to provide an immediate capital contribution of $500,000
and certain costs related to the acquisition.
Of the total purchase price, approximately $2,435,000 was allocated to
goodwill, since at the date of acquisition, fair value of the underlying net
assets of Pegasus was negative and there were no significant assets nor any
research and development in process. Goodwill is being amortized over five
years.
8
<PAGE>
KFX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Unaudited) (continued)
During August 1999, the Company issued 527,000 shares of its common stock
in exchange for an additional 15% interest in Pegasus. This transaction was
recorded based on the average price of KFX common stock shortly before the
transaction was completed, which approximated $1.45 per share. Accordingly, the
additional investment in Pegasus was recorded at approximately $763,000, all of
which has been allocated to goodwill, which will be amortized over five years.
Unaudited pro forma operating results for the nine months ended September
30, 1999 and 1998, as if both purchases of equity in Pegasus had occurred as of
January 1, 1998, are summarized as follows:
<TABLE>
<CAPTION>
Nine Months Ending September 30,
--------------------------------
1999 1998
----------------------------------
<S> <C> <C>
Operating Revenues................................... $2,541,000 $1,736,142
Net Loss............................................. $6,389,000 $4,699,000
Basic and diluted net loss per common share.......... $ .27 $ .20
</TABLE>
Note 3. Contingencies
On November 4, 1999, Link Resources, Inc., a Georgia corporation, (Link)
and its two sole shareholders, Linda E. Kobel (Kobel) and Gary A. Sanden
(Sanden), filed a complaint against the Company in US District Court for the
District of Colorado. The complaint alleges that KFX, Link, Kobel and Sanden had
entered into an agreement requiring KFX to acquire Link and that KFX breached
such agreement. The complaint seeks damages in excess of $3.5 million. Although
this matter is still in discovery and its ultimate resolution cannot be
predicted with certainty, based on a preliminary review of the underlying facts
and discussion with counsel, management believes that this complaint is without
merit. KFX intends to contest this complaint vigorously. Accordingly, management
does not believe that this matter will have a material impact on the results of
operation or financial position of the Company.
9
<PAGE>
KFX INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Form 10-Q filing 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. This Form 10-Q should be read
in conjunction with the Company's Form 10-K for the year ended December 31, 1998
and Management's Discussion and Analysis of Financial Condition and Results of
Operations included therein. The Company's actual results may differ materially
from those anticipated in these forward-looking statements.
The forward-looking statements contained in this filing include, among
others, statements regarding potential expansions of product and service
offerings and related potential sources of capital; expected K-Fuel technology
licenses; other potential sources of funding; expected future operating results
and financial condition; future recognition as revenue of NPS/Pegasus order
backlog; benefits to customers of installing its NeuSIGHT combustion
optimization software; results of commercial test burns of K-Fuel; expected
results of further commercial test burns of K- Fuel; anticipated markets for the
Company's products and services; and the potential impact of TCK's decisions to
hold the KFP Facility for sale and suspend operations at the KFP Facility.
Important factors that could cause actual results to differ materially from
those anticipated include, but are not limited to, adverse market and various
other conditions that could inhibit the Company's ability to obtain capital and
other funding; competition and technological developments by competitors; lack
of market interest in the Company's existing and any new products and services;
changes in environmental, electric utility and other governmental regulations;
actions of the Company's strategic partners; breadth or degree of protection
available to the Company's intellectual property; availability of key management
and skilled personnel; unanticipated problems that arise from research and
development activities; cost overruns, delays and damage that may occur in
developing, permitting, financing and constructing K-Fuel production facilities;
and domestic and international economic and political conditions. The Company
does not undertake to update, revise or correct any of the forward-looking
statements.
OVERVIEW
The principal factors impacting the Company's results of operations in the
first nine months of 1999, as compared to the first nine months of 1998, include
the $1 million K-Fuel license fee received in late June 1999 from Kennecott
Energy and Coal Company (KECC), partially offset by related royalty expense of
$250,000; the acquisition of Pegasus Technologies, Limited (Pegasus) in late
March 1998 and the related formation of its sister marketing subsidiary, Net
Power Solutions, LLC (NPS) in mid 1999; and the start up of operations at the
KFP facility in April 1998 and later suspension of operations in June 1999. KFx
holds a 5% interest in the KFP facility, which is 95% owned by the operating
partner, Thermo Ecotek Corporation (TCK).
The K-Fuel license was included in an amendment to the operating agreement
of the K-Fuel, LLC, in which KFx has a 51% interest and KECC has a 49% interest.
The near term mission of K-Fuel, LLC is to develop a 3 million ton-per-year K-
Fuel production facility that is economic in today's energy markets. This
amendment also resulted in the payment by KECC to KFx of an additional $1
million, which, in accordance with the terms of the amendment, KFx invested in
K-Fuel, LLC to fund further development activities associated with this next
phase of K-Fuel commercialization. This additional $1 million payment was
recorded as deferred income, which will be amortized into income as related
development expenses are incurred.
10
<PAGE>
KFX INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
During 1999 through November 10, NPS/Pegasus has received firm orders for
software licenses and installation and related services approximating $1.8
million. The backlog of firm orders at November 10, 1999 approximated $1.9
million, which is expected to be recognized as revenues over approximately the
next twelve months.
The receipt of NeuSIGHT orders has been hampered by two federal appeals
court decisions in May 1999 that have effectively suspended two NOx reduction
programs initiated by the Environmental Protection Agency (EPA). The two
programs affected are the 8-hour national ambient air quality standard for
ozone, of which NOx is a primary component, and a requirement for 22 eastern and
midwestern states and the District of Columbia to submit plans this fall to
achieve a reduction in NOx emissions of approximately 85% beginning in 2003.
Although the ultimate governing requirements of the Clean Air Act (CAA) remain
in place, these court actions create confusion as to the manner of achieving
compliance with the CAA. Pending resolution of these matters, utilities may
elect to delay or abandon certain of their planned activities designed to
achieve compliance with the relevant sections of the CAA, which activities may
include purchase and installation of NeuSIGHT. Accordingly, despite other
benefits provided by NeuSIGHT that can generate significant immediate operating
cost reductions to utilities, management believes that NPS/Pegasus is
experiencing delays in the receipt of orders for NeuSIGHT and is likely to
experience further delays until this matter is resolved.
Under generally accepted accounting principles, the Company was unable to
recognize revenue from software license orders approximating $275,000, and
related costs approximating $90,000, for the nine months ended September 30,
1999, due to related installation service commitments. Management is working to
change certain internal business practices and certain utility industry
practices in an effort to alleviate the application of this restriction to its
business, on a prospective basis.
Other significant developments in the first nine months of 1999 include the
successful commercial burn of K-Fuel in February 1999 and the Company's
agreement with TCK reached in June 1999 to assist in selling TCK's investment in
KFx, consisting of 4.25 million shares of KFx common shares. This agreement
includes TCK's agreement to cancel its warrants, including a control warrant, to
purchase additional common stock of KFx, upon the sale of these shares. This
agreement was made in connection with certain restructuring decisions by TCK
made in May 1999, which resulted in its decision to hold for sale its interest
in the KFP facility and suspend operations at the facility in June 1999. KFx is
actively assisting in the efforts to sell the plant and TCK is in active
negotiations with various parties.
In late August 1999 the Company increased it ownership of Pegasus to 75%,
through the purchase of an additional 15% interest in exchange for 527,000
shares of KFx common stock. The Company's Board of Directors approved this
transaction, in part, based on an independent valuation of Pegasus indicating a
value of approximately $14,106,000, or $2,116,000 for a 15% interest. Under
generally accepted accounting principles, however, this transaction is recorded
based on the average price per share of KFX common stock shortly before the
transaction was completed, which approximated $1.45 per share. Accordingly, an
additional investment in Pegasus approximating $763,000 was recorded.
RESULTS OF OPERATIONS - THREE MONTHS ENDED SEPTEMBER 30, 1999 VS. THREE MONTHS
ENDED SEPTEMBER 30, 1998
Although software related revenues increased slightly, total operating
revenues for the third quarter of 1999 decreased by approximately $197,000 when
compared to the third quarter of 1998. This decrease was primarily due to a
$211,000 decline in contract revenues associated with services provided to KFP's
11
<PAGE>
KFX INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
Gillette K-Fuel plant and a K-Fuel research and development contract with a
third party. The decline stemmed from TCK's suspension of operations at KFP in
June 1999 and certain administrative changes at the third party research and
development contracting agency. As discussed below, related operating costs
have been reduced as well. The Company is continuing discussions with the third
party contracting agency and its funding source in an effort to resume
historical levels of activity and related revenues.
Operating costs and expenses for the third quarter of 1999 increased by
approximately $511,000 when compared to the third quarter of 1998. This increase
was primarily due to additional 1999 third quarter costs at NPS/Pegasus
approximating $401,000. Specifically, the NPS/Pegasus cost increases included
approximately $168,000 in costs of revenue, $189,000 in costs associated with
developing a professional marketing and sales organization, and $53,000 in
research and development associated with enhancements to NeuSIGHT and
development of new products. Increases in costs at KFx from the third quarter of
1998 to the third quarter of 1999 approximating $244,000 were incurred primarily
in connection with pursuing the Company's strategy of offering total operating
solutions to the power generation industry. This increase was partially offset
by approximately $135,000 in cost reductions associated with the decline in
research and development contract revenues discussed above.
Primarily as a result of the factors discussed above, the operating loss in
the third quarter of 1999 exceeded the operating loss in the third quarter of
1998 by approximately $708,000. In addition, the Company experienced an
increase in net non-operating income/expense items approximating $627,000 from
the third quarter of 1998 to the third quarter of 1999. This increase resulted
primarily from (a) a decline in interest and other income approximating $96,000,
due to a decline in the average balance of cash investments; (b) the recognition
in 1998 of a $700,000 gain on sale of mine; and (c) the June 1999 suspension of
operations at KFP, which reduced KFx's equity loss from KFP by approximately
$166,000 in the third quarter of 1999, as compared to the third quarter of 1998.
RESULTS OF OPERATIONS - NINE MONTHS ENDED SEPTEMBER 30, 1999 VS. NINE MONTHS
ENDED SEPTEMBER 30, 1998
Operating revenues increased approximately $854,000 from the first nine
months of 1998 to the first nine months of 1999 due primarily to the $1 million
K-Fuel license fee from KECC. In addition, software related revenues increased
approximately $325,000, but K-Fuel related research and development contract
revenue declined approximately $471,000 for the reasons discussed above in the
third quarter comparison. The increase in software license and services revenue
stemmed from the first three quarters of 1998 including only two quarters of
NPS/Pegasus operations since the Pegasus acquisition was completed near the end
of March 1998.
Operating costs and expenses for the first nine months of 1999 exceeded the
1998 level for the first nine months by approximately $1,919,000, principally
due to increased costs at NPS/Pegasus approximating $1,923,000, which resulted
largely because 1998 included three fewer months of NPS/Pegasus activity. In
addition, NPS/Pegasus incurred additional costs in 1999 associated with its
efforts to develop a professional marketing and sales organization and research
and development activities associated with enhancements to NeuSIGHT and
development of new products. KFx also experienced cost increases approximating
$318,000, year to date in 1999 as compared to the comparable period of 1998,
primarily due to $250,000 in 1999 royalty expense associated with the K-Fuel
license fee from KECC. This increase was offset by approximately $322,000 in
reduced costs associated with the decline in research and development contract
revenue discussed above in the third quarter comparison.
12
<PAGE>
KFX INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
The above factors produced an increase in the operating loss for the first
nine months of 1999 over the comparable period of 1998 approximating $1,065,000.
In addition, the Company experienced a comparable increase in net non-operating
income/expense items approximating $977,000, primarily due to (a) a decline in
interest and other income approximating $157,000, due largely to a decline in
the average balance of cash investments; (b) the recognition in 1998 of a
$700,000 gain on sale of mine and (c) losses associated with operations at KFP
prior to its suspension in June 1999, which increased KFx's 1999 year to date
equity loss from KFP by approximately $122,000, when compared to the comparable
period of 1998.
On March 1, 1999 the Company announced that the first commercial burn of
K-Fuel had been successfully completed. During February 1999, approximately
12,000 tons of K-Fuel were used to conduct a burn at Indiana-Kentucky Electric
Corporation's Clifty Creek generating station in southern Indiana. Initial
results of the test burn indicate that K-Fuel appeared to produce: (a) a
reduction in nitrogen oxide (NOx) emissions while maintaining capacity and
reducing internal power consumption, (b) no unusual deterioration of internal
boiler operations, (c) a reduction in the fuel preparation costs, (d) no
spontaneous combustion and (e) an improvement in boiler efficiency. Indiana-
Kentucky Electric's fuel is procured by American Electric Power (AEP). The
results from this commercial scale burn generally confirm the results of the
test burn performed by the Southern Research Institute in June 1998. The Company
also believes that the use of K-Fuel produced a reduction in sulfur dioxide
(SO2) and carbon dioxide (CO2) emissions but Clifty Creek's instrumentation
precluded clear quantification of these results. When additional K-Fuel is
available from either the KFP Facility or a new K-Fuel plant, the Company will
pursue additional commercial scale burns of K-Fuel to clarify these benefits.
The handling characteristics of K-Fuel were acceptable with proper use of the
power station's existing dust suppressant system. Nevertheless, KFx plans to
work to reduce the dustiness of K-Fuel and improve its handling characteristics.
TCK, the operating partner and 95% owner of KFP began reporting operating
results from the KFP Facility in April 1998. Although the KFP Facility has
operated and produced commercially salable product, TCK encountered difficulties
in achieving optimal and sustained operations. On May 24, 1999, TCK announced
that it would record restructuring and other charges partially related to its
decision to hold for sale its investment in the KFP Facility. Further, TCK in
June 1999 suspended operations at the KFP Facility and K-Fuel is not currently
being produced. The Company is unable to predict with certainty the effect
(including the recoverability of the Company's $3.4 million investment related
to the KFP Facility), if any, of these actions of TCK on KFx. Management of KFx
is actively assisting in soliciting offers to purchase the KFP Facility and TCK
is in active negotiations with various parties. No assurance can be given,
however, as to when or if the KFP Facility will be sold or when, if ever, it
will resume operations.
13
<PAGE>
KFX INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
LIQUIDITY AND CAPITAL RESOURCES
During the first nine months of 1999 the Company used approximately
$2,676,000 of cash for its operating activities, including (a) approximately
$1,524,000 related to developing the NPS/Pegasus business and (b) $1,148,000 in
interest payments. Payments from KECC, net of related royalty expense,
generated $1,750,000 in operating cash flow during this period, which was offset
by approximately $1,753,000 in cash disbursements associated with KFx
activities, including (a) the pursuit of opportunities to expand the Company's
product and service offerings, (b) the continued development of K-Fuel, and (c)
general corporate activities. The Company expects most or all of its cash
requirements over the balance of 1999 with respect to day-to-day operations and
debt service requirements will be satisfied by (a) cash on hand, which as of
November 5, 1999 approximated $888,000; (b) certain contract revenues relating
to a research and development program conducted by the Company; and (c) revenues
related to the operations of NPS/Pegasus (although material positive net
operating cash flows related to NPS/Pegasus are not expected to materialize
until late 1999 or later). The Company also believes there is potential for
additional funding in 1999 and/or 2000 from: (a) potential partners in
connection with opportunities to expand the Company's product and service
offerings to the power industry and (b) fees from licensing new K-Fuel
facilities. In connection with the pursuit of these latter two potential
funding sources, the Company is in active negotiations or discussions with
certain parties.
Depending on the outcome of various uncertainties, including those
discussed herein, the Company may be required in the near future to seek
additional debt and/or equity financing for general operating purposes. In
addition, the timing of collection of NPS/Pegasus accounts receivable and other
working capital items could significantly alter the Company's needs for at least
temporary financing.
The Company does not expect, in the foreseeable future, to derive material
net income from its 5% ownership interest in KFP, which operates the Gillette
Wyoming K-Fuel facility and is 95% owned by TCK. Under current terms, the
Company's net K-Fuel production royalty (after fulfilling related royalty
obligations) if the KFP Facility were to reach full capacity is projected to be
less than $200,000 per year. The potential for Section 29 tax credit for KFP
production 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. Management has considered potential Section 29 structured
transactions but the value, amount and likelihood of any such transaction is not
determinable at this time.
The Company does not expect additional stock purchases by TCK. On June 12,
1999 the Company entered into an agreement with TCK granting the Company
authority until at least December 10, 1999 to find a buyer for the 4.25 million
shares of KFx common stock held by TCK. The agreement requires TCK to cancel
the warrants that it holds to purchase additional KFx common shares and obtain
control of KFx, as well as cancel various restrictions on other corporate
actions of the Company, upon the sale by TCK of the 4.25 million shares of KFx
common stock, whether KFx finds the buyer or otherwise. This agreement may be
extended for 60 days under certain circumstances.
Should the Company be required to seek any additional debt and/or equity
financing, its ability to do so will be affected by various provisions of the
existing agreement with TCK, unless such provisions are cancelled in connection
with the sale of KFx stock held by TCK as discussed above, and by the terms of
the Company's 6% Convertible Debentures. With respect to the Company's 6%
Convertible Debentures, the Company may only incur unsecured indebtedness of up
to $8.0 million (of which approximately $631,000
14
<PAGE>
KFX INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
was outstanding as of November 10, 1999) and 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 TCK, the Company must obtain TCK's consent to sell
any of its 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.
There are no assurances that any of these potential funding sources will
materialize, and the Company does not currently have any commitments with
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. If the Company requires
additional financing and cannot obtain it when needed, it may default on
payments when due.
In accordance with the terms of the Indenture governing the terms of the
Company's 6% Convertible Debentures, as of November 1, 1999, the conversion
price was reset from $3.75 per share to $3.65 per share.
YEAR 2000 COMPLIANCE
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 possibly interpreting 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 conducts business. Such failures of the Company's
or third parties' computer systems could potentially have a material adverse
impact on the Company's business, financial condition or results of operations.
The Company has substantially completed its process to evaluate the potential
impacts of the Year 2000 issue and has implemented necessary remedial actions.
In 1998, the Company engaged a third party consultant to complete an
analysis of its information technology ("IT") and non-IT systems, such as office
and other hardware containing embedded technology, in the executive offices of
KFx and NPS. The Company completed remediation steps recommended as a result of
this analysis at a nominal cost. Future upgrades to these systems or new
acquisitions are subjected to a similar analysis with the assistance of the
third party consultant. The Company substantially completed similar analyses at
the offices of Pegasus during 1998. Based on the results of these analyses,
management believes that the IT and non-IT systems of its executive offices and
the offices of NPS and Pegasus are Year 2000 compliant and does not believe that
there is a significant risk to the Company's future business operations.
The Company engaged a third party consultant to perform an analysis of its
non-IT systems at its laboratory facility near Gillette, Wyoming, which was
completed in early October of 1999. This location does not have any IT systems.
The Company completed remediation steps recommended as a result of this analysis
at a nominal cost.
The Company has also been advised that KFP has decided not to undertake a
planned Year 2000 analysis with respect to its IT and non-IT systems. As
previously announced, all operations at the KFP facility have been suspended in
connection with certain restructuring decisions made by TCK in May 1999. Any
activities related to Year 2000 issues are expected to be undertaken in
connection with plant
15
<PAGE>
KFX INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
reactivation by a new investor. In view of the recent age of the KFP facility,
significant Year 2000 issues are not expected to be present.
With respect to Year 2000 issue compliance of Pegasus' NeuSIGHT and related
software products, Pegasus personnel have performed extensive analysis, with the
assistance of third party consultants, and believe that such products are Year
2000 compliant. The remediation costs relative to these products was nominal.
In addition, the Company substantially completed an assessment of the impact
that the Year 2000 issue may have on other systems that support the Company's
operations, including but not limited to, supplier systems, shipper systems,
systems of suppliers of banking and other financial services, environmental
control systems and building security systems. This analysis was largely based
on interviews, certifications and other correspondence. At this time, the
Company cannot determine the effects, if any, that any non-compliant systems of
such third parties may have on the Company's business, financial condition or
results of operations, and there can be no assurance that such effects, if any,
would not be material. Nevertheless, based on the analyses performed, management
does not expect these third party systems to present a significant Year 2000
risk to the Company's business, financial condition or results of operations.
To date, the costs incurred by the Company with respect to the Year 2000
issue have not been material. The Company does not expect, but can provide no
assurances, that future costs, if any, will be material.
The Company does not expect that the impact of the Year 2000 issue will be
material in the systems assessed or being assessed. The Company plans, however,
to continue to monitor this issue with respect to the various computer systems
that it relies on, directly and indirectly, and will take additional steps as it
considers prudent to minimize the potential adverse impact of this issue,
including performing additional analysis and related remediation, as may appear
necessary. In addition, if the Company determines that it will not be able to
achieve Year 2000 compliance in a function that is critical to the future of the
Company, it will immediately develop contingency plans and will attempt to
quantify any impacts of any failure to timely correct non Year 2000 compliant
computer systems. There can be no assurance that the Company will discover all
Year 2000 issues in the course of its assessment or be able to implement timely
and cost effective remedial actions for the Year 2000 issues that it does
discover, such that the Year 2000 issue will not have a material adverse impact
on the Company's business, financial condition or results of operations.
16
<PAGE>
KFX INC.
ITEM 3. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
The Company is not currently subject to a significant level of direct
market risk related to interest rates, foreign currency exchange rates,
commodity prices or equity prices. The Company has no derivative instruments or
any floating rate debt and does not expect to derive a material amount of its
revenues from interest bearing securities. Currently the Company has no
significant foreign operations. To the extent that the Company establishes
significant foreign operations in the future, it will attempt to mitigate risks
associated with foreign currency exchange rates contractually and through the
use of hedging activities and other means considered appropriate. The Company
is indirectly exposed to fluctuations in fuel commodity prices. To the extent
that fuel prices rise, there may be a tendency for greater demand for certain of
the Company's products and services since K-Fuel and NeuSIGHT have been shown to
result in lower usage of coal and coal beneficiated fuel products when used to
generate electric power. The Company's fuel-related products provide various
environmental benefits that management believes significantly mitigate the fuel
commodity risk associated with the Company's business. The Company holds no
equity market securities, but does face equity market risk relative to its own
equity securities. This risk is most likely to be manifested by influencing the
Company's ability to raise debt or equity financing, if needed.
17
<PAGE>
KFX INC.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On November 4, 1999, Link Resources, Inc., a Georgia corporation, (Link)
and its two sole shareholders, Linda E. Kobel (Kobel) and Gary A. Sanden
(Sanden), filed a complaint against the Company in US District Court for the
District of Colorado. The complaint alleges that KFX, Link, Kobel and Sanden
had entered into an agreement requiring KFX to acquire Link and that KFX
breached such agreement. The complaint seeks damages in excess of $3.5 million.
Although this matter is still in discovery and its ultimate resolution cannot be
predicted with certainty, based on a preliminary review of the underlying facts
and discussion with counsel, management believes that this complaint is without
merit. KFX intends to contest this complaint vigorously. Accordingly,
management does not believe that this matter will have a material impact on the
results of operation or financial position of the Company.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
For electronic filing purposes only, this report contains Exhibit 27,
Financial Data Schedule.
(B) REPORTS ON FORM 8-K
During the quarter ended September 30, 1999, the Company filed a
Current Report on Form 8-K dated June 29, 1999, under Item 5, Other Events, and
Item 7, Financial Statements and Exhibits.
18
<PAGE>
KFX INC.
OTHER INFORMATION (continued)
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
KFX Inc.
/s/ Seth L. Patterson
------------------------------
Seth L. Patterson
Executive Vice President & Chief Financial Officer
(Principal Financial and Accounting Officer)
Date: November 15, 1999
19
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