<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 June 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 proceeding 12 months, and (2) has been subject to such filing requirements
for the past 90 days.
Yes [X] No [_]
On August 6, 1999 there were 23,955,240 shares of the Registrant's common stock
outstanding.
<PAGE>
KFX INC.
FORM 10-Q QUARTERLY REPORT
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page No.
-------
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets - June 30, 1999 (Unaudited) and December 31, 1998............. 3
Consolidated Statements of Operations - Three Months Ended
June 30, 1999 and 1998 (Unaudited)..................................................... 4
Consolidated Statements of Operations - Six Months Ended
June 30, 1999 and 1998 (Unaudited)..................................................... 5
Consolidated Statements of Cash Flows - Six Months Ended
June 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................................................................. 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk......................... 14
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders............................... 15
Item 6. Exhibits and Reports on Form 8-K................................................... 16
SIGNATURES.................................................................................. 16
</TABLE>
2
<PAGE>
KFX INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30,
1999 December 31,
(Unaudited) 1998
--------------------------------------
<S> <C> <C>
ASSETS
Current:
Cash and cash equivalents........................................... $ 3,476,080 $ 5,649,992
Accounts receivable and unbilled revenue............................ 735,943 952,977
Accounts receivable -affiliates..................................... 85,900 193,842
Accrued interest income............................................. - 17,200
Prepaid expenses.................................................... 99,199 190,795
Deferred job costs.................................................. 125,728 -
------------ ------------
Total current assets........................................... 4,522,850 7,004,806
------------ ------------
Property, plant and equipment, net of accumulated depreciation......... 2,736,724 3,243,812
Patents, net of accumulated amortization............................... 2,473,078 2,722,069
Investment in and advances to KFX Fuel Partners, L.P................... 3,438,967 3,779,412
Investment in K-Fuel, LLC.............................................. 1,092,924 159,967
Investment in Charco Redondo, LLC...................................... 629,238 629,238
Goodwill, net of accumulated amortization.............................. 1,825,496 2,066,669
Debt issue costs, net of accumulated amortization...................... 1,492,565 1,738,565
Prepaid royalty........................................................ 498,000 498,500
Other assets........................................................... 713,437 829,251
------------ ------------
$ 19,423,279 $ 22,672,289
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current:
Accounts payable.................................................... $ 317,902 $ 188,578
Accrued expenses.................................................... 339,484 247,011
Due to related parties.............................................. - 471,504
Interest payable.................................................... 479,774 531,007
Deferred revenue.................................................... 428,480 381,000
Current maturity of long-term debt.................................. 686,167 704,207
------------ ------------
Total current liabilities...................................... 2,251,807 2,523,307
------------ ------------
Deferred income........................................................ 1,000,000 -
Long-term debt, less current maturities................................ 694,625 890,793
Convertible debentures................................................. 17,000,000 17,000,000
------------ ------------
Total liabilities.............................................. 20,946,432 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;
23,951,740 and 23,951,740 shares issued and outstanding............. 23,952 23,952
Additional paid-in capital............................................. 48,304,942 48,304,942
Accumulated deficit.................................................... (49,852,047) (46,070,705)
------------ ------------
Total stockholders' equity (deficit)........................... (1,523,153) 2,258,189
------------ ------------
$ 19,423,279 $ 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 June 30,
1999 1998
--------------------------------------
OPERATING REVENUES
<S> <C> <C>
Software licenses and services......................................... $ 329,559 $ 395,859
Contract revenue....................................................... 95,905 290,043
K-Fuel licensefee...................................................... 1,000,000 -
----------------- -----------------
Total operating revenues....................................... 1,425,464 685,902
----------------- -----------------
OPERATING COSTS & EXPENSES
Costs of software licenses and services................................ 251,261 404,513
K-Fuel royalty expense................................................. 250,000 -
Marketing, general and administrative expenses......................... 1,384,355 737,010
Software research and development...................................... 77,804 -
K-Fuel demonstration plant and laboratory operations................... 119,861 233,176
Depreciation and amortization.......................................... 698,522 695,073
----------------- -----------------
Total operating costs and expenses............................. 2,781,803 2,069,772
----------------- -----------------
OPERATING INCOME (LOSS)................................................ (1,356,339) (1,383,870)
Interest and other income.............................................. 240,212 203,968
Interest expense....................................................... (289,637) (291,282)
Equity in loss of unconsolidated affiliates............................ (129,454) (107,144)
----------------- -----------------
Loss before income taxes............................................... (1,535,218) (1,578,328)
Income tax benefit..................................................... - -
----------------- -----------------
NET INCOME(LOSS)...................................................... $ (1,535,218) $ (1,578,328)
================= =================
BASIC AND DILUTED NET LOSS PER COMMON SHARE............................ $ (.064) $ (.066)
================= =================
Weighted average shares outstanding.................................... 23,952,000 23,928,000
================= =================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE>
KFX INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Unaudited
Six Months Ended June 30,
1999 1998
----------------------------------------
OPERATING REVENUES
<S> <C> <C>
Software licenses and services....................................... $ 706,691 $ 395,859
Contract revenue..................................................... 274,930 534,738
K-Fuel licensefee.................................................... 1,000,000 -
------------------- ------------------
Total operating revenues..................................... 1,981,621 930,597
------------------- ------------------
OPERATING COSTS & EXPENSES
Costs of software licenses and services.............................. 491,596 404,513
K-Fuel royalty expense............................................... 250,000 -
Marketing, general and administrative expenses....................... 2,588,510 1,516,380
Software research and development.................................... 100,608 -
K-Fuel demonstration plant and laboratory operations................. 239,458 434,673
Depreciation and amortization........................................ 1,401,897 1,308,397
------------------- ------------------
Total operating costs and expenses........................... 5,072,069 3,663,963
------------------- ------------------
OPERATING INCOME (LOSS).............................................. (3,090,448) (2,733,366)
Interest and other income............................................ 297,493 358,739
Interest expense..................................................... (580,898) (575,340)
Equity in loss of unconsolidated affiliates.......................... (407,489) (124,762)
------------------- ------------------
Loss before income taxes............................................. (3,781,342) (3,074,729)
Income tax benefit.................................................... - -
------------------- ------------------
NET INCOME(LOSS)..................................................... $ (3,781,342) $ (3,074,729)
=================== ==================
BASIC AND DILUTED NET LOSS PER COMMON SHARE............................$ (.158) $ (.129)
=================== ==================
Weighted average shares outstanding.................................... 23,952,000 23,927,000
=================== ==================
</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
Six Months Ended June 30,
1999 1998
----------------------------------------
OPERATING ACTIVITIES
<S> <C> <C>
Net loss....................................................... $ (3,781,342) $ (3,074,729)
Adjustments to reconcile net loss to cash
Used in operating activities:
Depreciation and amortization................................ 1,401,897 1,308,397
Common stock and warrants issued for services................ - 214,750
Equity in loss of unconsolidated affiliates.................. 407,489 124,762
Other income................................................. - (39,310)
Changes in operating assets and liabilities, net of assets and
liabilities acquired:
Accounts receivable, including unconsolidated affiliates..... 324,976 (451,550)
Accrued interest income...................................... 17,200 20,710
Deferred job costs........................................... (125,728) -
Supplies inventory........................................... - (148,995)
Accounts payable............................................. 129,324 31,029
Accrued expenses............................................. 92,473 (85,836)
Due to related parties....................................... (471,504) 8,361
Interest payable............................................. (51,233) (38,184)
Deferred revenue............................................. 47,480 260,000
Deferred income.............................................. 1,000,000 -
Prepaids expenses and other.................................. 184,782 (127,398)
------------------ -------------------
Cash used in operating activities................................... (824,186) (1,997,993)
------------------ -------------------
INVESTING ACTIVITIES
Purchases of equipment......................................... (56,098) (133,270)
Pending patent applications.................................... (70,768) (160,764)
Investments in KFX Fuel Partners, L.P.......................... - (189,683)
Investments in K-Fuel, LLC..................................... (1,000,000) (9,690)
Investments in Charco Redondo, LLC............................. - (537,000)
Purchase of controlling interest in Pegasus Technologies, LLC,
net of cash acquired.......................................... - (1,610,657)
Other........................................................... (8,652) (4,687)
------------------ -------------------
Cash used in investing activities................................... (1,135,518) (2,645,751)
------------------ -------------------
FINANCING ACTIVITIES
Proceeds from issuance of notes payable........................ - 50,000
Payments on notes payable...................................... (214,208) (10,000)
------------------ -------------------
Cash provided by (used in) financing activities..................... (214,208) 40,000
------------------ -------------------
Increase (decrease) in cash and cash equivalents.................... (2,173,912) (4,603,744)
Cash and cash equivalents, beginning of period...................... 5,649,992 14,078,773
------------------ -------------------
Cash and cash equivalents, end of period............................ $ 3,476,080 $ 9,475,029
================== ===================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest......................................... $ 632,131 $ 610,076
================== ===================
</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)
Six Months Ended June 30, 1999
- ------------------------------
None
Six Months Ended June 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.
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 percent interest of Pegasus Technologies, LLC.
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 Technologies, LLC. See Note 2.
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 prior year capitalized contract services which were reimbursed by KFP in
July 1998.
The accompanying notes are an integral part of these consolidated financial
statements.
7
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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
percent interest in K-Fuel, L.L.C. ("K-Fuel, LLC"), 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 June 30, 1999, and for the three
and six months ended June 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 six months ended June 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 six months ended June, 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, 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 $2,574,000 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 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.
Unaudited pro forma operating results for the six months ended June 30,
1998 as if the acquisition of Pegasus had occurred as of January 1, 1998 are
summarized as follows:
Operating revenues............................... $ 979,000
Net loss......................................... $ (3,422,000)
Basic and diluted net loss per common share...... $ (.14)
8
<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 the Company's goals for 1999; availability of
potential funding sources; expected future operating results and financial
condition; potential impact of and proposed solutions for certain operational
issues at the KFx Fuel Partners Gillette, Wyoming facility (KFP Facility);
expected K-Fuel Technology licenses; results of test burns of K-Fuel; expected
results of further test burns of K- Fuel; anticipated markets for the Company's
products and services; and potential expansions of product and service offerings
and related potential sources of capital. 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 financing; 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; availability of tax credits under Section
29 of the Internal Revenue Code; 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 half of 1999, as compared to the first half of 1998, are 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, in which KFx holds a 5% interest.
During the first half of 1999, NPS/Pegasus received firm orders for
software licenses and installation and related services totaling approximately
$930,000, approximately half of which were received in each quarter. At June
30, 1999, the backlog of firm orders approximated $1.8 million, which is
expected to be translated in revenues over approximately the next twelve months.
It should be noted that the Company was not able to recognize revenue from 1999
software license orders approximating $100,000 in the second quarter and
$255,000 in the first half due to related installation service commitments that
preclude license fee revenue recognition under generally accepted accounting
principles. Management is changing certain business practices that are expected
to alleviate the application of this restriction to its business, on a
prospective basis, later this year.
Other significant developments in the first half of 1999 include the
successful commercial burn of K-Fuel in February 1999 and the Company's
agreement with Thermo Ecotek Corporation (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
9
<PAGE>
KFX INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
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 TCK in the efforts to sell the plant and has begun
discussions with various parties.
The $1,535,000 net loss in the second quarter of 1999 was
approximately $711,000 lower than the $2,246,000 net loss in the first quarter
of 1999 primarily due to the $1 million K-Fuel license fee from KECC, less
related royalty expense of $250,000. Likewise, this license fee and an
additional $1 million payment from KECC recorded as deferred income resulted in
approximately $614,000 of positive cash from operating activities in the second
quarter of 1999 compared to approximately $1,438,000 of cash used by operating
activities in the first quarter of 1999. Net of the royalty, which was paid in
July 1999, and the investment of $1 million in the K-Fuel, LLC, this transaction
with KECC added $750,000 to cash balances.
RESULTS OF OPERATIONS - THREE MONTHS ENDED JUNE 30, 1999 VS. THREE MONTHS ENDED
JUNE 30, 1998
Operating revenues for the second quarter of 1999 were approximately
$740,000 greater than the second quarter of 1998 due to a $1 million K-Fuel
license fee payment from KECC, partially offset by declines in contract revenues
of $194,000 and software licenses and services of $66,000. 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. The amendment included various other revised and updated terms intended
to facilitate pursuit of the mission of K-Fuel, LLC.
Contract revenues stem from laboratory and related services performed
by KFx for KFP and services performed pursuant to a K-Fuel related research
contract with a third party. Revenues from services performed for KFP declined
approximately $96,000 as a result of TCK's suspension of operations at KFP in
June 1999 and related matters. Revenues from the research contract declined
$95,000 due to certain administrative changes at the third party which resulted
in a reduced level of research activities during the first half of 1999, as
compared to the first half of 1998.
Operating costs and expenses for the second quarter of 1999 were
approximately $712,000 greater than the second quarter of 1998 due primarily to
additional 1999 marketing, general and administrative costs of NPS/Pegasus
approximating $472,000, associated with developing a professional marketing and
sales organization, and a $78,000 increase in NPS/Pegasus research and
development costs from 1998 to 1999, associated with enhancements to NeuSIGHT
and development of new products. Offsetting these increased costs at
NPS/Pegasus was a decline in cost of sales approximating $153,000. In addition,
1999 includes $250,000 in royalty expense associated with the K-Fuel license
fee; no K-Fuel royalty expense was incurred in 1998. KFx corporate general and
administrative and related expenses also increased in 1999 over 1998 by
approximately $152,000 due to various costs incurred in connection with pursuing
the Company's strategy of offering total operating solutions to the power
generation industry. Offsetting these increased costs at the KFx level was a
decrease approximating $113,000 at the K-Fuel demonstration plant and laboratory
due to the decreased activity levels discussed above.
10
<PAGE>
KFX INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
RESULTS OF OPERATIONS - SIX MONTHS ENDED JUNE 30, 1999 VS. SIX MONTHS ENDED
JUNE 30, 1998
Operating revenues increased from the first half of 1998 to the first
half of 1999 by approximately $1,051,000 due primarily to the K-Fuel license fee
from KECC. An increase in software license and services revenue approximating
$311,000, resulting from the first half of 1998 including only one quarter of
NPS/Pegasus operations (the Pegasus acquisition was completed on March 23,
1998), was largely offset by a decline in contract revenues approximating
$260,000, triggered by TCK's suspension of KFP operations and the research
contract administrative matters, both of which are discussed above.
Operating cost and expenses for the first half of 1999 were
approximately $1,408,000 higher than the first half of 1998 due primarily to
additional 1999 marketing, general and administrative costs of NPS/Pegasus
approximating $1,269,000, associated with developing a professional marketing
and sales organization and research and development activities. Of this amount
approximately $718,000 results from 1998 containing only three months of
NPS/Pegasus activity from closing of the Pegasus acquisition on March 23, 1998.
Largely due to the same factor, cost increases were also incurred at NPS/Pegasus
in the first half of 1999 over 1998 in cost of sales approximating $87,000 and
depreciation and amortization of goodwill approximating $277,000. In addition,
1999 includes $250,000 in royalty expense associated with the K-Fuel license
fee; no K-Fuel royalty expense was incurred in 1998. Offsetting these increases
was a decline in K-Fuel demonstration plant and laboratory costs approximating
$195,000 and a decrease in KFx corporate general and administrative cost
approximating $288,000 resulting from reductions experienced in the first
quarter of 1999 partially offset by the increases in the second quarter
discussed above.
Interest and other income declined due to a decrease in the average
balance of cash investments. The increase in equity in loss of unconsolidated
subsidiaries of approximately $283,000 results from TCK's commencement of
operations at the KFP facility in April 1998.
On March 1, 1999 the Company announced that the first commercial burn of
K-Fuel has been successfully completed. During February 1999, approximately
12,000 tons of K-Fuel was utilized 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), which has
requested additional unit train shipments of K-Fuel. The results from this
commercial scale burn generally confirm the results of the test burn performed
by the Southern Research Institute in June 1998. It is also expected that K-Fuel
produced a reduction in sulfur dioxide (SO2) and carbon dioxide (CO2) emissions
but Clifty Creek's instrumentation precluded clear quantification of these
emissions. Additional burns at Clifty Creek are expected to clarify these
benefits. The handling characteristics of K-Fuel were acceptable with proper use
of the power station's existing dust suppressant system. KFx is working to
improve the handling characteristics of K-Fuel.
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 pretax restructuring and other charges partially
related to its decision to hold for sale its investment in the KFP Facility.
Further, TCK has suspended operations at the KFP Facility and K-Fuel is not
currently being produced. We are 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,
11
<PAGE>
KFX INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
of these actions of TCK on KFx. Management of KFx is, however, actively
assisting TCK in soliciting offers to purchase the KFP Facility and has begun
related discussions with several interested 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.
LIQUIDITY AND CAPITAL RESOURCES
During the first half of 1999 the Company used approximately $824,000 of
cash for its operating activities, including those associated with a) developing
the NPS/Pegasus business, b) continued activities related to the development of
K-Fuel, c) the pursuit of opportunities to expand its product and service
offerings and d) 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 August 6, 1999 was approximately $2.0 million; 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 from: (i) funding from
potential partners in connection with opportunities to expand the Company's
product and service offerings to the power industry; and (ii) fees from
licensing new K-Fuel facilities.
Depending on the outcome of various uncertainties, including those
discussed herein, the Company may be required to seek additional debt and/or
equity financing in mid-2000 for general operating purposes. If acquisitions or
significant capital investments are made in this time period, the need to seek
additional debt and/or equity financing may be accelerated. 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 to derive material net income or positive
net operating cash flows from its 5% ownership interest in KFP, which operates
the Gillette Wyoming K-Fuel facility and is 95% owned by TCK, in the foreseeable
future. 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 or 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 to purchase additional KFx common shares and obtain control of KFx that
it holds 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 will 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 the terms of the Convertible
Debentures and by various provisions of an existing agreement with TCK, unless
such provisions are cancelled in connection with the sale of KFx stock held be
TCK as discussed above. With respect to the Company's 6% Convertible Debentures,
the Company may
12
<PAGE>
KFX INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
only incur unsecured indebtedness of up to $8.0 million (of which not in excess
of approximately $500,000 was outstanding as of August 6, 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 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.
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 and third parties' computer systems could potentially have a material
adverse impact on the Company's business, financial condition and results of
operations.
The Company is nearing substantial completion of its process to evaluate
the potential impacts of the Year 2000 issue and implement 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 its executive offices. The Company
completed remediation steps recommended as a result of this analysis at a
nominal cost. Future upgrades to these systems and/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 Net Power Solutions and Pegasus are Year 2000 compliant and does not believe
that there is a significant risk to the Company's future business operations.
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.
The Company has engaged a third party consultant to perform an analysis
of its non-IT systems at its laboratory facility near Gillette, Wyoming. This
location does not have any IT systems. Once this analysis is complete the
Company plans to implement any recommended remedial actions, which based on the
analysis performed to date, are expected to be at a nominal cost and are
expected to be completed during the third quarter of 1999.
13
<PAGE>
KFX INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
The Company has also been advised that KFP has decided not to undertake
a planned Year 2000 analyses 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 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.
To date, the costs incurred by the Company with respect to the Year 2000
issue have not been material. The Company cannot estimate future costs until the
analyses referred to in the preceding paragraphs are completed. The Company
expects, however, but can provide no assurances, that the future costs will not
be material.
The Company does not expect 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 and results of operations.
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.
14
<PAGE>
KFX INC.
PART II - OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of the Shareholders of the Company was held on June
17, 1999 for the purposes of (i) electing two directors to the Board of
Directors; (ii) ratifying and approving the Company's 1999 Stock Incentive Plan;
and (iii) ratifying the selection of PricewaterhouseCoopers LLP as the Company's
independent accountants for the year ended December 31, 1999.
The following votes were cast by shareholders with respect to the
election of directors named in the Company's proxy statement for the Annual
Meeting:
<TABLE>
<CAPTION>
Shares Voted For Shares Voted Against Shares Abstained
-------------------------- -------------------------- --------------------------
<S> <C> <C> <C>
Jack C. Pester 21,467,222 37,150 28.605
Theodore Venners 21,498,722 37,150 28,605
</TABLE>
The following votes were cast by shareholders with respect to the Company's
1999 Stock Incentive Plan:
<TABLE>
<CAPTION>
Shares Voted For Shares Voted Against Shares Abstained
------------------------- -------------------------- --------------------------
<S> <C> <C> <C>
1999 Stock Incentive Plan 15,172,000 1,263,639 39,500
</TABLE>
The following votes were cast by shareholders with respect to the selection
of PricewaterhouseCoopers LLP as the Company's independent accountants for the
year ended December 31, 1999:
<TABLE>
<CAPTION>
Shares Voted For Shares Voted Against Shares Abstained
-------------------------- -------------------------- --------------------------
<S> <C> <C> <C>
PricewaterhouseCoopers, LLP 21,498,462 17,815 16,700
</TABLE>
15
<PAGE>
KFX INC.
OTHER INFORMATION (continued)
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
The following is a complete list of exhibits filed as part of this Form
10-Q. For electronic filing purposes only, this report contains Exhibit 27,
Financial Data Schedule. Exhibit numbers correspond to the numbers in the
Exhibit Table of Item 601 of Regulation S-K.
Exhibit 10.01 First Amended Limited Liability Company Agreement of K-Fuel,
L.L.C. dated June 29, 1999.(1)(2)
___________________________
(1) Incorporated by reference from the Registrant's Current Report on Form 8-K
dated June 29, 1999, as filed with the Securities and Exchange Commission.
(2) Certain portions of this Exhibit have been omitted based upon a request for
confidential treatment. The omitted portions have been separately filed
with the Securities and Exchange Commission.
(B) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the quarterly period ended June
30, 1999.
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: August 13, 1999
16
<PAGE>
KFX INC.
EXHIBIT INDEX
The following is a complete list of exhibits filed as part of this Form
10-Q. For electronic filing purposes only, this report contains Exhibit 27,
Financial Data Schedule. Exhibit numbers correspond to the numbers in the
Exhibit Table of Item 601 of Regulation S-K.
Exhibit 10.01 First Amended Limited Liability Company Agreement of K-Fuel,
L.L.C. dated June 29, 1999.(1)(2)
___________________________
(1) Incorporated by reference from the Registrant's Current Report on Form 8-K
dated June 29, 1999, as filed with the Securities and Exchange Commission.
(2) Certain portions of this Exhibit have been omitted based upon a request for
confidential treatment. The omitted portions have been separately filed
with the Securities and Exchange Commission.
17
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 3,476,080
<SECURITIES> 821,843
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 4,522,850
<PP&E> 2,736,724
<DEPRECIATION> 0
<TOTAL-ASSETS> 19,423,279
<CURRENT-LIABILITIES> 2,251,807
<BONDS> 17,000,000
0
0
<COMMON> 23,952
<OTHER-SE> (1,547,105)
<TOTAL-LIABILITY-AND-EQUITY> 19,423,279
<SALES> 1,981,621
<TOTAL-REVENUES> 1,981,621
<CGS> 741,596
<TOTAL-COSTS> 5,072,069
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 580,898
<INCOME-PRETAX> (3,781,342)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,781,342)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,781,342)
<EPS-BASIC> .158
<EPS-DILUTED> .158
</TABLE>
