UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended June 30, 2000
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ______ to ______
Commission file number 0-27808
COVOL TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 87-0547337
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3280 North Frontage Road
Lehi, Utah 84043
(Address of principal executive offices) (Zip Code)
(801) 768-4481
(Registrant's telephone number, including area code)
Not applicable
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No[ ]
The number of shares outstanding of the Registrant's common stock as of August
4, 2000 was 23,572,890.
COVOL TECHNOLOGIES, INC.
TABLE OF CONTENTS
Page No.
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL INFORMATION (Unaudited):
Consolidated Balance Sheets - As of September 30, 1999
and June 30, 2000............................................ 3
Consolidated Statements of Operations - For the three
months ended June 30, 1999 and 2000 and the nine months
ended June 30, 1999 and 2000................................. 5
Consolidated Statement of Changes in Stockholders' Equity
(Deficit) - For the nine months ended June 30, 2000.......... 6
Consolidated Statements of Cash Flows - For the nine
months ended June 30, 1999 and 2000.......................... 7
Notes to Consolidated Financial Statements..................... 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.................................... 14
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.............................................. 22
ITEM 2. CHANGES IN SECURITIES.......................................... 22
ITEM 3. DEFAULTS UPON SENIOR SECURITIES................................ 22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............ 23
ITEM 5. OTHER INFORMATION.............................................. 23
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K............................... 23
SIGNATURES................................................................ 24
Certain statements in this Report constitute forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995. As such,
actual results may vary materially from current expectations. For a discussion
of certain of the factors that could cause actual results to differ from
expectations, please see the information set forth under the caption entitled
"Forward Looking Statements" in PART I, ITEM 2 hereof. There can be no assurance
that Covol's results of operations will not be adversely affected by such
factors. Covol undertakes no obligation to revise or publicly release the
results of any revision to these forward-looking statements. Readers are
cautioned not to place undue reliance on these forward looking statements, which
reflect management's opinion only as of the date hereof.
2
ITEM 1. CONSOLIDATED FINANCIAL INFORMATION (Unaudited)
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, June 30,
(thousands of dollars) 1999 2000
- ------------------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 461 $11,326
Receivables 3,155 5,558
Due from related party 2,722 --
Inventories 573 --
Facilities and equipment held for sale 20,139 1,680
Prepaid expenses and other current assets 19 212
----------------------------------
Total current assets 27,069 18,776
----------------------------------
Property, plant and equipment, net of accumulated depreciation 14,182 2,872
----------------------------------
Other assets:
Restricted cash and investments 843 160
Facility-dependent note and accrued interest receivable 7,879 6,538
Facility transferred under note receivable arrangement 2,641 --
Intangible assets, net of accumulated amortization 3,647 1,263
Deferred income taxes -- 3,000
Other assets 1,834 1,294
----------------------------------
Total other assets 16,844 12,255
----------------------------------
Total assets $58,095 $33,903
==================================
(continued)
The accompanying notes are an integral
part of the consolidated financial statements
3
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS, continued
(Unaudited)
September 30, June 30,
(thousands of dollars and shares) 1999 2000
- ------------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 1,179 $ 255
Due to related party 2,706 --
Accrued interest payable, current 1,452 83
Accrued liabilities 2,905 5,884
Notes payable, current 20,626 7,113
----------------------------------
Total current liabilities 28,868 13,335
----------------------------------
Long-term liabilities:
Notes payable, non-current 17,887 251
Accrued interest payable, non-current 210 --
Deferred revenues 7,501 10,451
Deferred compensation 208 177
----------------------------------
Total long-term liabilities 25,806 10,879
----------------------------------
Total liabilities 54,674 24,214
----------------------------------
Minority interest in consolidated subsidiaries 117 --
----------------------------------
Commitments and contingencies (Note 8)
Redeemable convertible preferred stock, $0.001 par value, issued and outstanding 60 shares
at September 30, 1999 and 0 shares at June 30, 2000 4,332 --
----------------------------------
Stockholders' equity (deficit):
Convertible preferred stock, $0.001 par value; authorized 10,000 shares,
issued and outstanding 17 shares at September 30, 1999 and June 30, 2000
(aggregate liquidation preference of $3,636 at June 30, 2000) 1 1
Common stock, $0.001 par value; authorized 50,000 shares, issued and
outstanding 12,766 shares at September 30, 1999 and 23,525 shares,
including 17 shares of treasury stock, at June 30, 2000 13 23
Capital in excess of par value 78,457 83,847
Accumulated deficit (71,713) (73,293)
Other (7,786) (889)
----------------------------------
Total stockholders' equity (deficit) (1,028) 9,689
----------------------------------
Total liabilities and stockholders' equity (deficit) $58,095 $33,903
==================================
The accompanying notes are an integral
part of the consolidated financial statements
4
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended June 30, Nine Months Ended June 30,
(thousands of dollars, except per-share data) 1999 2000 1999 2000
- ---------------------------------------------------------------------------------------------------------------------------------
Revenues:
License fees $ 853 $ 3,591 $2,140 $12,424
Binder sales 409 2,709 1,365 5,945
Gains on sale of facilities -- 8,527 -- 13,868
Gains on non-recurring transactions -- -- -- 1,079
Other 315 173 597 633
-------------------------------------------------------------------
Total revenues 1,577 15,000 4,102 33,949
-------------------------------------------------------------------
Operating costs and expenses:
Cost of binder 291 1,860 941 4,088
Cost of operations 3,027 777 9,226 3,066
Loss on sale of facilities -- -- -- 598
Asset write-offs and other non-recurring charges -- 1,559 556 13,421
Selling, general and administrative 1,338 1,405 3,500 3,403
Compensation expense from stock options 749 591 1,074 683
-------------------------------------------------------------------
Total operating costs and expenses 5,405 6,192 15,297 25,259
-------------------------------------------------------------------
Operating income (loss) (3,828) 8,808 (11,195) 8,690
-------------------------------------------------------------------
Other income (expense):
Interest income 308 324 1,298 1,434
Interest expense (1,981) (951) (4,394) (4,716)
Other, net (26) 78 (851) 62
-------------------------------------------------------------------
Total other income (expense) (1,699) (549) (3,947) (3,220)
-------------------------------------------------------------------
Income (loss) before income taxes and extraordinary item (5,527) 8,259 (15,142) 5,470
Income tax benefit -- -- -- 3,000
-------------------------------------------------------------------
Income (loss) before extraordinary item (5,527) 8,259 (15,142) 8,470
Extraordinary loss on early extinguishment of debt -- (6,037) -- (7,860)
-------------------------------------------------------------------
Net income (loss) $(5,527) $ 2,222 $(15,142) $ 610
===================================================================
Basic and diluted income (loss) per common share $(.48) $.09 $(1.28) $.01
===================================================================
The accompanying notes are an integral
part of the consolidated financial statements
5
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
For the Nine Months Ended June 30, 2000
(Unaudited)
Notes and
interest
receivable-
related
parties, from
issuance of, Deferred
Convertible Preferred or collater- compen-
Stock Common Stock Capital in alized sation
(thousands of ----------------------------------------- excess Accumulated by, common from stock Common stock
dollars and shares) Shares Amount Shares Amount of par value deficit stock options in treasury
- -----------------------------------------------------------------------------------------------------------------------------------
Balances at
September 30, 1999 17 $1 12,766 $13 $78,457 $(71,713) $(6,564) $(1,222) $ --
Preferred stock
cash dividends (297)
Reclassification of
redeemable convertible
preferred stock to
convertible preferred
stock 38 -- 2,710
Common stock issued
on conversion of
redeemable convertible
and convertible
preferred stock and
in payment of dividends (2) -- 2,812 3 1,631 (11)
Redemption of convertible
preferred stock (36) -- (2,572) (1,882)
Common stock issued
for cash 4,008 4 5,250
Common stock issued on
conversion of debt 3,726 3 3,101
Common stock issued in
connection with
redemption of debt 214 -- 256
Common stock issued
in connection with cash
and cashless exercises
of warrants 811 1 420
Value of common stock
warrants issued in
connection with
convertible debt
financing -- -- 468
Value of extended
common stock warrants
and repriced stock
options issued in
connection with debt
financing -- -- 70
Cancellation of notes
receivable - related
parties and common stock
collateralizing the notes (812) (1) (5,944) 6,164
Write-down of notes
receivable - related
parties 82
Amortization of deferred
compensation from stock
options 683
Purchase of treasury
stock, at cost (32)
Net income for the
nine months ended
June 30, 2000 610
-----------------------------------------------------------------------------------------------------------
Balances at
June 30, 2000 17 $1 23,525 $23 $83,847 $(73,293) $(318) $(539) $(32)
===========================================================================================================
The accompanying notes are an integral
part of the consolidated financial statements
6
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended June 30,
(thousands of dollars) 1999 2000
- ---------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income (loss) $(15,142) $ 610
Adjustments to reconcile net income (loss) to net cash provided
by (used in) operating activities:
Depreciation and amortization 1,432 912
Recognition of deferred revenue (680) (490)
Deferred income taxes -- (3,000)
Net gains on sale of facilities and equipment 153 (13,355)
Gains on non-recurring transactions -- (1,079)
Non-cash portion of asset write-offs and other non-recurring charges 556 11,680
Amortization of deferred compensation from stock options 1,074 683
Interest expense related to amortization of debt discount and debt issuance costs 1,160 2,990
Extraordinary loss on early extinguishment of debt -- 7,860
Write-down of notes receivable - related parties 749 82
Increase (decrease) from changes in operating assets and liabilities (3,690) 3,762
-------------------------------
Net cash provided by (used in) operating activities (14,388) 10,655
-------------------------------
Cash flows from investing activities:
Proceeds from sale of facilities and equipment 170 34,579
Purchase of property, plant and equipment and facilities held for sale (685) (551)
Purchase of rights to technology and other assets (127) (75)
Increase in investments in and loans to non-affiliated companies -- (450)
Decrease in restricted cash and other assets 50 589
Proceeds from facility transferred under note receivable arrangement 392 --
-------------------------------
Net cash provided by (used in) investing activities (200) 34,092
-------------------------------
Cash flows from financing activities:
Proceeds from issuance of notes payable and warrants, net 10,453 6,980
Payments on notes payable, including redemption premiums (4,802) (41,754)
Proceeds from issuance of common stock and warrants, net 3,775 5,254
Proceeds from issuance of preferred stock and warrants, net 6,367 --
Preferred stock redemption -- (4,454)
Preferred stock dividends -- (297)
Proceeds from exercise of warrants -- 421
Purchase of common stock for the treasury -- (32)
-------------------------------
Net cash provided by (used in) financing activities 15,793 (33,882)
-------------------------------
Net increase in cash and cash equivalents 1,205 10,865
Cash and cash equivalents, beginning of period 727 461
-------------------------------
Cash and cash equivalents, end of period $ 1,932 $11,326
===============================
Supplemental schedule of non-cash investing and financing activities:
Cancellation of notes receivable - related parties and the common
stock collateralizing the notes $ -- $6,164
Reclassification of redeemable convertible preferred stock to
convertible preferred stock -- 2,710
Common stock issued on conversion of redeemable convertible and
convertible preferred stock and in payment of dividends 2,444 1,634
Common stock issued on conversion of convertible debt and debt -- 3,104
Common stock issued to purchase minority interests in subsidiaries 519 --
Common stock issued for rights to technology 375 --
Notes payable issued for equipment and rights to technology 850 --
Property, plant and equipment acquired through reduction of
accounts receivable 413 --
The accompanying notes are an integral
part of the consolidated financial statements
7
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
----------
1. Nature of Operations and Basis of Presentation
Covol Technologies, Inc. and its Subsidiaries' ("Covol") primary business
is to commercialize its proprietary binder technologies which are used to
recycle waste by-products from the coal, steel and other industries into
marketable fuel and resources. Through June 1998, Covol's focus was on the
construction of facilities and the licensing of its binder technologies to
entities that constructed facilities that convert coal fines into synthetic
fuel briquettes. Currently, Covol's licensees are operating 28 facilities
in ten states at various levels of production. There are 24 synthetic fuel
plants that utilize Covol's patented technology and four additional
facilities that use an alternative technology that Covol acquired in fiscal
1999. During 1999 and 2000, Covol actively pursued the sale of its four
owned facilities and the licensing of its technology to the buyers, which
sales and licensing were completed in August 1999, December 1999, January
2000 and April 2000, respectively (see Note 5). Covol has no current plans
to construct additional synthetic fuel facilities. During the quarter ended
June 30, 2000, Covol began evaluating, pursuing and making equity
investments in and loans to unrelated entities. Currently these activities
are not material but are expected to expand in the future.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the rules and regulations of the Securities and
Exchange Commission for quarterly reports on Form 10-Q. In the opinion of
management, all adjustments considered necessary for a fair presentation
have been included. All adjustments, except the extraordinary loss on early
extinguishment of debt (see Note 2) and the items described in Notes 5 and
6, consist of normal recurring adjustments. The results of operations for
the three- and nine-month periods ended June 30, 2000 are not necessarily
indicative of the results to be expected for the full year. Certain
information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. It is suggested that these
financial statements be read in conjunction with the consolidated financial
statements and notes thereto included in Covol's Annual Report on Form 10-K
for the year ended September 30, 1999 and in Covol's Quarterly Reports on
Form 10-Q for the quarters ended December 31, 1999 and March 31, 2000.
Certain prior period amounts have been reclassified to conform with the
current period's presentation. The reclassifications had no effect on net
loss or total assets.
2. Financing and Equity Transactions
During and subsequent to the quarter ended June 30, 2000, Covol completed
several transactions, including the following.
Convertible Debt -- In April and May 2000, Covol redeemed all of the
$20,000,000 face value convertible debt. Early prepayment costs of
approximately $6,037,000 were recognized as an extraordinary item as a
result of the redemption consideration paid plus the acceleration of
amortization of the unamortized debt discount and debt issuance costs in
excess of the debt carrying value. Also, Covol redeemed, concurrent with
the debt redemption, all of the preferred stock held by this entity (see
Preferred Stock on the following page).
Note Payable to a Corporation -- In April 2000, the holder of the 14% note
payable described in Note 3 converted $2,000,000 of principal into
approximately 1,186,000 shares of common stock and warrants for the
purchase of approximately 296,000 shares of common stock. The due date for
the remaining $1,000,000 of principal was extended to April 2001, but was
repaid in July 2000. The warrants are exercisable through April 2005 at a
price of $2.10 per share.
Note Payable to a Bank -- During the quarter ended June 30, 2000, Covol
entered into a note payable arrangement with a bank, under which Covol
borrowed $4,000,000. The note is repayable in quarterly principal
installments of $1,000,000, plus interest at prime plus 2% (11.5% at June
30, 2000). The first payment was made on August 1, 2000 and additional
payments are required in November 2000, February 2001 and May 2001. The
note is secured by licensee fees payable to Covol from the production and
sale of synthetic fuel from four synthetic fuel facilities and by a
$6,500,000 note receivable due to Covol. The loan agreement contains
certain operating covenants and restrictions common for such loans.
8
Preferred Stock -- In April 2000, 1,910 shares of series D convertible
preferred stock were converted into approximately 150,000 shares of common
stock. In April and May 2000, Covol redeemed all of the remaining 35,631
shares of the series D preferred stock. The total amount paid to redeem the
preferred stock was approximately $4,454,000, including a redemption
premium of approximately $1,882,000 which was charged directly to
stockholders' equity.
Common Stock -- In April 2000, Covol issued approximately 379,000 shares of
common stock and warrants for the purchase of approximately 133,000 shares
of common stock to certain officers and directors for net cash proceeds of
approximately $588,000. The warrants are exercisable through March 2005 at
a price of $1.56 per share.
Treasury Stock -- During the quarter ended June 30, 2000, Covol began
acquiring shares of its common stock in connection with a stock purchase
plan announced in May 2000. The program authorizes Covol to purchase stock
in the open market or through negotiated transactions. Through June 30,
2000, Covol purchased approximately 17,000 shares for approximately
$32,000. Subsequent to June 30, 2000 through August 4, 2000, Covol
purchased approximately 258,000 additional shares for approximately
$835,000.
Warrants -- During the quarter ended June 30, 2000, warrants for the
purchase of approximately 165,000 shares of common stock were exercised for
cash proceeds of approximately $218,000. As of June 30, 2000, warrants for
the purchase of approximately 1,022,000 shares of common stock were
outstanding, with exercise prices ranging from $1.32 to $3.84 per share.
3. Notes Payable
Notes payable consist of the following:
September 30, June 30,
(thousands of dollars) 1999 2000
-----------------------------------------------------------------------------------------------------------------------------
Note payable to a corporation, bearing interest at 6%, collateralized by a coal wash plant
in Utah, principal and interest due October 2000. $ 4,313 $1,838
Note payable to the same corporation referred to in the preceding paragraph, bearing
interest at prime, repaid in December 1999. 2,900 --
Note payable to the same corporation referred to in the preceding two paragraphs, bearing
interest at 6%, repaid in January 2000. 6,500 --
Note payable to a limited liability company, bearing interest at 10%, repaid in April 2000
(see Note 5). 9,191 --
Convertible secured note payable to an investment company, issued at a discount, bearing a
stated interest rate of 2.5% on the $20,000 face amount, redeemed in May 2000 (see Note 2). 10,265 --
Convertible secured note payable to a Covol shareholder, issued at a discount,
bearing a stated interest rate of 8%. This note, which increased in amount in
October 1999, along with another convertible note payable to an unrelated entity issued
in December 1999, were redeemed by Covol in January 2000. 622 --
Note payable to a corporation, bearing interest at 14%. $1,000 of principal
was paid in January 2000. The remaining $3,000 of principal was originally due
April 2000, but in April 2000, $2,000 was converted into shares of common
stock and warrants for the purchase of common stock and $1,000 was extended to
April 2001, as described in Note 2. The $1,000 balance outstanding as of June 30, 2000
was repaid in July 2000. A member of Covol's Board of Directors is affiliated with
this corporation. 4,000 1,000
Note payable to a bank, bearing interest at prime plus 2% (11.5% at June 30,
2000), principal and interest payable in four quarterly installments beginning
August 2000 through May 2001, collateralized by licensee fees payable to Covol
from the production and sale of synthetic fuel from four synthetic fuel facilities
and by a $6,500 note receivable due to Covol (see Note 2). -- 4,000
Other 722 526
------------------------------
38,513 7,364
Less: current portion (20,626) (7,113)
------------------------------
Total non-current $17,887 $251
==============================
9
The weighted average stated interest rate on notes payable was 7.9% at September
30, 1999 and 10.4% at June 30, 2000; however, when debt discounts and debt
issuance costs are considered, the effective interest rate on notes payable at
September 30, 1999 was approximately 15%.
4. Basic and Diluted Earnings per Share
Three Months Ended June 30, Nine Months Ended June 30,
(thousands of dollars and shares, except per-share data) 1999 2000 1999 2000
-------------------------------------------------------------------------------------------------------------------------
Numerator:
Income (loss) before extraordinary item $(5,527) $8,259 $(15,142) $8,470
Extraordinary item -- (6,037) -- (7,860)
--------------------------------------------------------------
Net income (loss) (5,527) 2,222 (15,142) 610
Preferred stock dividends (undeclared) (170) (66) (307) (331)
Imputed preferred stock dividends (313) -- (353) (58)
--------------------------------------------------------------
Numerator for basic earnings per share -- net income
(loss)attributable to common stockholders (6,010) 2,156 (15,802) 221
Effect of dilutive securities - preferred stock dividends -- 19 -- 92
--------------------------------------------------------------
Numerator for diluted earnings per share -- net income
(loss) attributable to common stockholders after
assumed conversions $(6,010) $2,175 $(15,802) $313
==============================================================
Denominator:
Denominator for basic earnings per share --
weighted-average shares outstanding 12,512 22,988 12,320 18,208
Effect of dilutive securities:
Shares issuable upon exercise of options and
warrants -- 226 -- 188
Shares issuable upon conversion of preferred stock -- 1,052 -- 3,020
--------------------------------------------------------------
Total dilutive potential shares -- 1,278 -- 3,208
--------------------------------------------------------------
Denominator for diluted earnings per share --
weighted-average shares outstanding after assumed
exercises and conversions 12,512 24,266 12,320 21,416
==============================================================
Basic earnings per share:
Income (loss) before extraordinary item $(.48) $.35 $(1.28) $.44
Extraordinary item -- (.26) -- (.43)
--------------------------------------------------------------
Net income (loss) per common share $(.48) $.09 $(1.28) $.01
==============================================================
Diluted earnings per share:
Income (loss) before extraordinary item $(.48) $.34 $(1.28) $.38
Extraordinary item -- (.25) -- (.37)
--------------------------------------------------------------
Net income (loss) per common share $(.48) $.09 $(1.28) $.01
==============================================================
During the quarter and nine months ended June 30, 2000, Covol's potentially
dilutive securities consisted of options and warrants for the purchase of
common stock, convertible debt and convertible preferred stock. Only the
options, warrants and the series D convertible preferred stock, all of
which was redeemed in April and May 2000 (see Note 2), were dilutive. For
the fiscal 2000 periods, all other potentially dilutive securities were
anti-dilutive and were not considered in the calculation of diluted
earnings per share. For both 1999 periods, all potentially dilutive
securities were anti-dilutive and were not considered in the calculation.
5. Sale of Facilities
Covol's business plan called for the construction and sale of synthetic
fuel manufacturing facilities and the licensing of Covol's technology to
facility purchasers to generate ongoing royalties. In December 1999, Covol
sold one of the three remaining synthetic fuel facilities it owned. This
facility was located in Price, Utah. Covol reported a gain on this
transaction of approximately $5,341,000.
10
In January 2000, Covol sold a synthetic fuel facility located in North
Fork, West Virginia and an option to acquire a licensee facility located in
Nevada, to a major U.S. utility. Covol reported a combined loss on these
transactions of approximately $598,000. Both facilities were subsequently
relocated and in June 2000 additional net cash proceeds, totaling
approximately $6,500,000, were received by Covol when the two facilities
reached commercial operation at the new locations. Accordingly, $6,500,000
was recognized as revenue in the quarter ended June 30, 2000.
In April 2000, Covol sold its remaining owned synthetic fuel facility,
located in Tallmansville, West Virginia. Net cash proceeds to Covol, after
payment of related debt and other obligations were approximately $300,000.
Covol reported a gain on this transaction of approximately $1,227,000.
Covol intends to sell the proprietary binder material used at the facility
and will also receive an ongoing royalty based upon production and sale of
synthetic fuel from this facility.
In June 2000, upon obtaining firm synthetic fuel "off-take" agreements and
by meeting a specified operating performance milestone, Covol received an
additional cash payment related to the August 1999 sale of a synthetic fuel
facility. The cash proceeds from this payment, net of obligations to third
parties, approximated $3,777,000. Of the net amount received, Covol
recognized $800,000 as revenue and deferred the recognition of $2,977,000,
which amount will be recognized as revenue on a straight-line basis
beginning July 2000 through December 2007. In addition, in July 2000, Covol
met a second performance milestone which will result in the receipt of
another payment to Covol. This amount is expected to be approximately
$3,600,000, net of obligations due to a third party, and is expected to be
recognized as revenue in the September 2000 quarter.
6. Asset Write-offs and Other Non-recurring Charges
In the June 2000 quarter, Covol recorded non-recurring asset write-offs and
employee severance charges totaling approximately $1,559,000. In the
December 1999 quarter, Covol recorded an impairment charge of approximately
$10,300,000 related to assets located in Price, Utah. This impairment
charge consisted of an approximate $8,100,000 writedown to net realizable
value of certain plant and equipment which remains on the site and is now
idle, plus an approximate $2,200,000 writeoff of an intangible asset. Covol
also recorded other asset write-offs and non-recurring charges in the
December 1999 and March 2000 quarters. For the nine months ended June 30,
2000, all of the asset write-offs and non-recurring charges totaled
approximately $13,421,000, of which $11,680,000 represented non-cash
charges.
In addition, in the June 2000 quarter, Covol recorded approximately
$552,000 of non-cash, non-recurring incremental amortization of deferred
compensation from stock options, resulting from the termination of
employees whose stock options became fully vested upon termination.
7. Income Taxes
In the quarter ended December 31, 1999, Covol recognized $3,000,000 of its
deferred tax asset. Covol believes it is more likely than not that this
portion of the total deferred tax asset will be realized as a result of
improved operations, combined with income to be recognized from the
amortization of deferred revenues in subsequent periods. Covol has not
recognized any income tax expense for the nine months ended June 30, 2000
due to available net operating loss carryforwards.
8. Commitments and Contingencies
Commitments and contingencies as of June 30, 2000 not disclosed elsewhere,
are as follows.
In the June 2000 quarter, Covol's Board of Directors approved two employee
benefit plans, the Covol Technologies, Inc. 401(k) Profit Sharing Plan and
the 2000 Employee Stock Purchase Plan. Under the terms of the 401(k) Plan,
employees may elect to make tax-deferred contributions to the Plan of up to
15% of their compensation, subject to statutory limitations. Covol may
elect to match employee contributions up to a specified maximum rate, which
matching contributions, if made, vest over a four-year period. Covol is not
required to have net income in order to make a matching contribution.
11
The 2000 Employee Stock Purchase Plan provides eligible employees with an
opportunity to increase their proprietary interest in the success of Covol
by purchasing stock in Covol on favorable terms and to pay for such
purchases through payroll deductions. A total of 500,000 shares of common
stock are reserved for issuance under the Plan. Under the Plan, employees
purchase shares of stock directly from Covol, which shares are made
available either from Covol's authorized but unissued shares or from
treasury shares, including shares repurchased on the open market. Covol's
current intent is to use shares being purchased on the open market to meet
these requirements. The Plan is intended to comply with Section 423 of the
Internal Revenue Code, but is not subject to the requirements of ERISA.
Employees purchase stock through payroll deductions of from 1% to 10% of
cash compensation, subject to certain limitations. The stock is purchased
in a series of calendar-month offerings. The cost per share to the employee
is 85% of the lesser of the fair market value at the beginning of the
offering period or the end of the offering period. Substantially all
employees of Covol are eligible to participate in the 401(k) Plan and the
Stock Purchase Plan after meeting certain age and length of employment
requirements.
In March 1997, Covol transferred the Utah Synfuel #1 facility to Coaltech.
In connection with this transaction, Covol licensed Coaltech to use Covol's
proprietary binder technologies for a non-refundable advance license fee of
$1,400,000, which is being recognized as income through 2007, the
contractual term of the license agreement, and a recurring license fee that
was payable quarterly and that was based upon synthetic fuel produced and
sold at the Coaltech facility. Covol contracted with Coaltech to operate
the facility for which Covol received a quarterly fee, which was also based
upon synthetic fuel produced and sold. In accordance with generally
accepted accounting principles and after discussions with the staff of the
Securities and Exchange Commission, the transfer of the facility to
Coaltech was not reflected as a sale for accounting purposes. The original
cost of the facility less cash payments received from Coaltech, was
reflected in the consolidated balance sheet as of September 30, 1999 as
facility transferred under note receivable arrangement. This asset was
realized in February 2000 in connection with the reduction of the amount
due under a note payable to one of the limited partners of Coaltech.
Additionally, Covol entered into a supply and purchase agreement with
Coaltech wherein Covol agreed to provide to Coaltech coal fines for
processing into synthetic fuel at a price equal to Covol's cost. Covol
agreed to purchase from Coaltech the synthetic fuel produced, at Coaltech's
cost plus one dollar per ton. As a result of this commitment to purchase
Coaltech's production, Covol experienced significant losses related to the
write-down of the synthetic fuel purchased to the lower of cost or market.
This write-down historically approximated 90% of the amount Covol paid for
the synthetic fuel.
In anticipation of a relocation of the Utah facility by Coaltech, on
October 29, 1999 Covol received notification from the limited partners of
Coaltech that they were effecting a retirement of Covol as the general
partner of the partnership and were terminating Covol as operator of the
Utah facility. The limited partners also asserted that as a consequence of
the retirement of Covol as general partner, Covol was deemed to have
forfeited its 1% interest in the partnership. The notification demanded
that Covol indemnify the limited partners for all of their losses, damages,
payments, costs and expenses. Covol disputed the limited partners' demands.
On December 1, 1999, the parties entered into negotiations and as a result
an interim standstill agreement was reached pursuant to which the limited
partners and Covol agreed not to pursue formal proceedings against each
other pending the outcome of the settlement negotiations. In February 2000,
Covol, Coaltech and one of the limited partners of Coaltech reached a
settlement regarding both the note payable due to the limited partner from
Covol and the note receivable due to Covol from Coaltech. In June 2000,
Covol entered into a settlement agreement and release with Coaltech and the
two limited partners of Coaltech. The terms of this settlement agreement
provide for termination of all of the agreements between Covol and Coaltech
described above. In addition, Covol received a settlement payment from
Coaltech which was materially consistent with the net amount due from
Coaltech and the limited partners. Accordingly, no gain or loss was
recognized in the financial statements as a result of the settlement. In
connection with this settlement agreement, Coaltech entered into a new
license and binder supply agreement to purchase proprietary binder
materials from Covol and to use Covol's technology in the production of
synthetic fuel when operations of the facility are resumed. The new license
agreement could potentially result in a significant reduction in royalties
to be received by Covol.
In June 1996, Covol formed Alabama Synfuel #1, Ltd. to construct a
synthetic fuel facility. In connection with the construction of this
facility, Covol entered into a supply agreement for coal fines to be used
at the facility. Covol assigned
12
this agreement to the purchaser of the facility and accordingly, has no
ongoing obligation. Covol has been paid for the coal fines sold to the
facility purchaser, but has a dispute with the provider of the coal fines
for a portion of the coal fines Covol paid for. The resolution of this
dispute is not expected to have a material impact on Covol.
In September 1996, Covol entered into an agreement with Coalco Corporation
whereby Coalco was to advise Covol with respect to the financing and sale
of certain synthetic fuel manufacturing facilities. A dispute arose between
Covol and Coalco about services rendered or to be rendered by Coalco and
the amount and timing for payment for such services. A settlement was
reached in November 1999 whereby Covol agreed to pay Coalco $1,500,000 plus
a royalty based on the synthetic fuel sold from five licensee-owned
facilities. All of the $1,500,000 has been paid to Coalco as of June 30,
2000. Pelletco, an affiliate of Coalco, is a licensee of Covol.
In February 1997, Covol entered into a contract with Earthco regarding a
parcel of real property located near Price, Utah, in which Covol obtained
certain possessory and related interests, Covol's primary purpose being to
obtain a source of coal fines to serve as feedstock for a nearby synthetic
fuel facility. In August 1999, Covol sent a notice of default to Earthco,
alleging that Earthco had breached a material provision of the contract
because Earthco did not have title to the property. Covol has refused to
tender its August 1999 payment and subsequent payments because of Earthco's
breach. In addition, Covol contends that the quantity and/or quality of
recoverable coal fines was substantially less than what Covol had
understood when entering into the contract, thereby creating grounds to
reform the terms of the contract. Earthco subsequently countered with
allegations that Covol has breached its obligations under the contract,
including failure to make the August 1999 payment.
In November 1999, Covol was served with a Complaint in litigation pending
in the Seventh Judicial District Court of Carbon County, Utah titled Nevada
Electric Investment Company v. Earthco, et al. In the Complaint, Nevada
Electric Investment Company ("NEICO") alleges that it is the lawful owner
of the property near Wellington, Utah described in Covol's lease from
Earthco. NEICO seeks a declaratory judgement that Covol is not entitled to
possession of the property due to the lack of ownership by Earthco. The
Complaint also seeks further relief from Earthco. Covol received Earthco's
Answer, Counterclaims and Cross-claim in December 1999. Earthco's
cross-claim against Covol alleged breach of contract and requested
substantial damages in an amount to be proven at trial but alleged to be in
excess of $5,000,000. Covol filed its Reply and Cross-claim against Earthco
in January 2000 denying Earthco's claims and asserting claims of
misrepresentation, breach of lease, unjust enrichment, and related claims
and for general and consequential damages in an amount to be proven at
trial. The disputes among Covol, Earthco and NEICO are at an early stage
and resolution is uncertain. Covol intends to defend against claims and
prosecute its own claims vigorously.
During the six months ended March 31, 2000, Covol recorded approximately
$6,800,000 of license fee revenues from a single licensee that owns four
synthetic fuel facilities that use Covol's proprietary binder technology.
These revenues related to sales of synthetic fuel at these facilities
primarily between June 1999 and March 2000 which were late reported by this
licensee in early calendar 2000. Covol and this licensee agreed to amend
the license fee arrangements for prior and future periods, which amendments
were finalized in May 2000. No adjustment to amounts previously recorded in
the consolidated financial statements was necessary as a result of these
amendments. In addition, in May 2000 the future interest rate on the
$6,500,000 note receivable from this licensee was reduced from 12% to 6%.
Covol is involved in several legal proceedings that have arisen out of the
normal course of business. Covol believes that many of these claims are
without merit and in all cases intends to vigorously defend its position.
Management does not believe that the outcome of these activities will have
a significant effect upon the operations or the financial position of
Covol.
9. Events subsequent to June 30, 2000
In addition to events subsequent to June 30, 2000 disclosed elsewhere,
Covol has made several strategic investments and loans aggregating
$2,715,000 from July through August 4, 2000. Combined with $450,000 of
investments and loans made in June 2000, Covol currently has made a total
of $3,165,000 of strategic investments and loans.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following Management's Discussion and Analysis should be read in conjunction
with the accompanying unaudited consolidated financial statements and notes
thereto.
Three Months Ended June 30, 2000 Compared to Three Months Ended June 30, 1999
Revenues. Total revenues for the three months ended June 30, 2000 ("2000")
increased by $13,423,000 to $15,000,000 as compared to $1,577,000 for the three
months ended June 30, 1999 ("1999"). During 2000, Covol recognized license fees
totaling $3,591,000 while $853,000 of license fees were recognized during 1999.
The license fees in 2000 consisted of the straight-line amortization of
one-time, non-refundable initial license fees of $230,000, reduced by a one-time
adjustment of $201,000, and recurring earned license fees or royalty payments of
$3,562,000. License fees in 1999 consisted of the straight-line amortization of
one-time, non-refundable initial license fees of $227,000 and recurring license
fees or royalty payments of $626,000. Initial license fees are not expected to
increase in future periods and are recognized on a straight-line basis over the
period covered by Covol's license agreements with licensees. Recurring earned
license fees or royalty payments, which over the long term are expected to
increase in future periods, are due quarterly based upon synthetic fuel produced
and sold as reported to Covol by its licensees. The increase in 2000 earned
license fees was due primarily to a significant increase from a licensee that
owns and operates four synthetic fuel facilities.
Covol provides proprietary binder material to its licensees either at a fixed
price or at Covol's cost plus a contracted markup. Covol purchases the binder
materials under a long-term contract with a large chemical company. Binder sales
during 2000 were $2,709,000 with a corresponding direct cost of $1,860,000.
Binder sales during 1999 were $409,000 with a corresponding direct cost of
$291,000. The increase in binder sales in 2000 over 1999 was due to increased
synthetic fuel production by Covol's licensees.
Gains on Sale of Facilities. In 2000, Covol sold a synthetic fuel facility and
recognized a gain of $1,227,000. Also, $6,500,000 of contingent sales proceeds
related to the January 2000 sale of a facility and sale of an option to acquire
a facility were received and recognized as revenue. Finally, Covol received
approximately $3,777,000 of contingent sales proceeds related to the sale of a
facility in August 1999, of which $800,000 was recognized as revenue and the
balance deferred (see Note 5 to the Consolidated Financial Statements).
Operating Costs and Expenses. Total operating costs and expenses increased by
$787,000 to $6,192,000 during 2000 from $5,405,000 during 1999. Cost of
operations decreased $2,250,000 from $3,027,000 during 1999 to $777,000 during
2000. During 2000, Covol incurred significantly lower operating expenses in
connection with the continued refinement and implementation of the briquetting
process associated with the 24 facilities placed in service during 1998, and in
particular the operating costs associated with the four facilities owned by
Covol which have now been sold. Consistent with its business plan to sell the
facilities and earn royalties from facility owners, Covol sold its four owned
facilities in August 1999, December 1999, January 2000 and April 2000,
respectively (see Note 5 to the Consolidated Financial Statements). In 1999,
cost of operations primarily related to labor and operating expenses at the
owned synthetic fuel facilities and the wash plant located in Utah, losses
related to the writedown of inventory purchased from Coaltech, and costs
incurred in providing assistance to Covol's licensees in resolving ramp-up
issues at their synthetic fuel facilities. Covol expects future costs of
operations to remain significantly below 1999 levels.
Asset write-offs and other non-recurring charges. In 2000, Covol recorded
non-recurring asset write-offs and employee severance charges totaling
approximately $1,559,000. There were no such charges in 1999.
Selling, general and administrative expenses increased $67,000 or 5% to
$1,405,000 during 2000 from $1,338,000 for 1999. The increase in expenses in
2000 is due to an increase in payroll and other compensation-related costs which
more than offset decreases in most other cost categories.
Compensation expense from stock options decreased $158,000 to $591,000 for 2000
from $749,000 for 1999. This expense relates to options granted in prior periods
that vest over several years and the compensation value that is being recognized
as an expense over the vesting period. During both periods, Covol terminated
employees to whom compensatory stock options were granted in prior years. These
stock options vested upon termination, resulting in the accelerated write off of
the unamortized deferred compensation related to these individuals. These
accelerated write-offs totaled approximately $600,000 in 1999 and approximately
$550,000 in 2000. As a result of employee terminations, future amortization
expense will be reduced.
14
Other Income and Expense. During 2000, Covol reported net other expenses of
$549,000 compared to $1,699,000 for 1999. This decrease of $1,150,000 relates to
positive variances of $1,030,000 in interest expense, $49,000 in the
mark-to-market adjustment of the carrying value of a related party note
receivable collateralized by Covol common stock, and $71,000 in interest income
and other income.
Interest expense decreased in 2000 due to the higher average levels of
outstanding borrowings and higher effective cost of debt which existed in 1999
as compared to 2000, most notably as a result of the convertible debt issued at
a discount during March 1999, which was completely paid off in May 2000.
Interest expense of $718,000 in 2000 resulted from the amortization of debt
discount and debt issuance costs. Interest expense of $834,000 in 1999 consisted
of amortization of debt discount and debt issuance costs. Interest expense is
expected to significantly decrease in the future as a result of repayment of
debt related to the sale of company-owned facilities in late 1999 and 2000 and
the complete redemption of outstanding convertible debt in 2000.
During 1996, Covol sold certain construction companies and received as
consideration a $5,000,000 note receivable ("Note"). The Note is "marked to
market" each quarter based upon the market value of Covol's common stock held as
collateral and is reflected in the consolidated balance sheet at the underlying
value of this collateral, $318,000 at June 30, 2000. This adjustment resulted in
a write-up of $49,000 during 2000, compared to no change during 1999.
Extraordinary Item. In May and June 2000, Covol redeemed all of the convertible
debt issued in March 1999. The loss recognized as a result of the cash paid plus
the acceleration of amortization of the unamortized debt discount and debt
issuance costs totaled approximately $6,037,000. This loss is reflected as an
extraordinary item in the Consolidated Statements of Operations.
Net Income. For 2000, net income of $2,222,000 represents an improvement of
$7,749,000 from the net loss of $5,527,000 in 1999. This is primarily due to
increased revenues, especially gains on the sale of facilities. Covol did not
recognize any income tax expense in 2000, due to available net operating loss
carryforwards, nor in 1999 due to the net loss incurred.
Nine Months Ended June 30, 2000 Compared to Nine Months Ended June 30, 1999
Revenues. Total revenues for the nine months ended June 30, 2000 ("2000")
increased by $29,847,000 to $33,949,000 as compared to $4,102,000 for the nine
months ended June 30, 1999 ("1999"). During 2000, Covol recognized license fees
totaling $12,424,000 while $2,140,000 of license fees were recognized during
1999. The license fees in 2000 consisted of the straight-line amortization of
one-time non-refundable initial license fees of $691,000, reduced by a one-time
adjustment of $201,000, and recurring earned license fees or royalty payments of
$11,934,000. License fees in 1999 consisted of the straight-line amortization of
one-time non-refundable initial license fees of $680,000 and recurring license
fees or royalty payments of $1,460,000. The increase in 2000 earned license fees
was due primarily to significant increases from a licensee that owns and
operates four synthetic fuel facilities (see Note 8 to the Consolidated
Financial Statements). Binder sales during 2000 were $5,945,000 with a
corresponding direct cost of $4,088,000. Binder sales during 1999 were
$1,365,000 with a corresponding direct cost of $941,000. The increase in binder
sales in 2000 over 1999 was due to increased synthetic fuel production by
Covol's licensees.
Gains on sale of facilities. In December 1999, Covol sold a synthetic fuel
facility located in Price, Utah and reported a gain of approximately $5,341,000.
In April 2000, Covol sold a synthetic fuel facility located in Tallmansville,
West Virginia and recognized a gain of $1,227,000. Also, $6,500,000 of
contingent sales proceeds related to the January 2000 sale of a facility and
sale of an option to acquire a facility were received and recognized as revenue.
Finally, Covol received approximately $3,777,000 of contingent sales proceeds
related to the sale of a facility in August 1999, of which $800,000 was
recognized as revenue and the balance deferred (see Note 5 to the Consolidated
Financial Statements). There were no sales of synthetic fuel facilities in 1999.
Gains on Non-recurring Transactions. In 2000, Covol recorded non-recurring gains
of approximately $1,079,000 related to the satisfaction of a contingent contract
liability for $755,000 and a $324,000 gain recognized on a note receivable
transaction.
Operating Costs and Expenses. Total operating costs and expenses increased by
$9,962,000 to $25,259,000 during 2000 from $15,297,000 during 1999, primarily
due to non-recurring charges of approximately $13,421,000 in 2000 and only
$556,000 in 1999. Cost of operations decreased $6,160,000 from $9,226,000 during
1999 to $3,066,000 during 2000. During 2000, Covol incurred significantly lower
operating expenses in connection with the continued refinement and
implementation of the briquetting process associated with the 24 facilities
placed in service during 1998, and in particular the operating costs
15
associated with the four facilities owned by Covol which have now been sold. In
1999, cost of operations primarily related to labor and operating expenses at
the owned synthetic fuel facilities and the wash plant located in Utah, losses
related to the writedown of inventory purchased from Coaltech, and costs
incurred in providing assistance to Covol's licensees in resolving ramp-up
issues at their synthetic fuel facilities. Covol expects future costs of
operations to remain significantly below 1999 levels.
Loss on Sale of Facilities. In addition to the sales of facilities on which
gains were recognized, Covol sold a synthetic fuel facility and an option to
acquire a licensee facility in January 2000. Covol reported a combined loss on
these transactions of approximately $598,000 (see Note 5 to the Consolidated
Financial Statements).
Asset write-offs and other non-recurring charges. Coaltech owns a synthetic fuel
facility which is located on the same property as the facility that was sold by
Covol in December 1999. As a result of the anticipated relocation of the
facility owned by Coaltech, combined with the sale and relocation of Covol's
owned facility, all of which relate to the same property site in Price, Utah
(see Notes 5 and 8 to the Consolidated Financial Statements), Covol recorded in
the December 1999 quarter an impairment charge of approximately $10,300,000.
This impairment charge consisted of an approximate $8,100,000 writedown to net
realizable value of certain plant and equipment which remains on the site and is
now idle, plus an approximate $2,200,000 write-off of an intangible asset which
was no longer considered recoverable due to the relocation of the Coaltech
facility.
Covol recorded additional non-recurring asset write-offs and employee severance
charges in 2000 which, when added to the charges described in the preceding
paragraph, totaled approximately $13,421,000. Of this amount, approximately
$11,680,000 represented non-cash charges. In 1999, Covol recorded non-recurring
charges of approximately $556,000.
Selling, general and administrative expenses decreased $97,000 or 3% to
$3,403,000 during 2000 from $3,500,000 for 1999. The decrease in expenses in
2000 is due to decreases in nearly all cost categories, largely offset by an
increase in payroll and other compensation-related costs.
Compensation expense from stock options decreased $391,000 to $683,000 for 2000
from $1,074,000 for 1999. During both periods, Covol terminated employees to
whom compensatory stock options were granted in prior years. These stock options
vested upon termination, resulting in the accelerated write off of the
unamortized deferred compensation related to these individuals. These
accelerated write-offs totaled approximately $600,000 in 1999 and approximately
$550,000 in 2000. As a result of employee terminations, future amortization
expense will be reduced.
Other Income and Expense. During 2000, Covol reported net other expenses of
$3,220,000 compared to 3,947,000 for 1999. This decrease of $727,000 relates
primarily to positive variances of $667,000 in the mark-to-market adjustment of
the carrying value of a related party note receivable collateralized by Covol
common stock, and $382,000 in interest income and other, offset by a $322,000
increase in interest expense.
Interest expense increased in 2000 due to the higher average levels of
outstanding borrowings and higher effective cost of debt which existed in 2000
as compared to 1999, most notably as a result of the convertible debt issued at
a discount during March 1999. Interest expense of $2,990,000 in 2000 resulted
from the amortization of debt discount and debt issuance costs, while only
$1,160,000 of interest expense in 1999 consisted of amortization of debt
discount and debt issuance costs. Interest expense is expected to significantly
decrease in the future as a result of repayment of debt related to the sale of
company-owned facilities in late 1999 and 2000 and the complete redemption of
outstanding convertible debt in May 2000.
Income Taxes. In the quarter ended December 31, 1999, Covol recognized
$3,000,000 of its deferred tax asset. Covol believes it is more likely than not
that this portion of the total deferred tax asset will be realized as a result
of improved operations, combined with income to be recognized from the
amortization of deferred revenues in subsequent periods. Covol did not recognize
any income tax benefit in fiscal 1999 due to the net loss incurred.
Extraordinary Item. In January 2000, Covol redeemed all of the convertible debt
issued from September 1999 through December 1999. The redemption consideration
given included approximately $1,000,000 in redemption premiums plus
approximately 214,000 shares of common stock. The loss recognized as a result of
the redemption consideration paid plus the acceleration of amortization of the
unamortized debt discount and debt issuance costs totaled approximately
$1,823,000. In May and June 2000, Covol redeemed all of the convertible debt
issued in March 1999. The loss recognized as a result of the redemption
consideration paid plus the acceleration of amortization of the unamortized debt
discount and debt issuance costs totaled approximately $6,037,000. The combined
losses on all redemptions, totaling approximately $7,860,000, are reflected as
an extraordinary item in the Consolidated Statements of Operations.
16
Net Income. For 2000, net income of $610,000 represents an improvement of
$15,752,000 from the net loss of $15,142,000 in 1999. This is primarily due to
increased revenues, including gains on the sale of facilities, and decreased
cost of operations, partially offset by increased asset write-offs and other
non-recurring charges and an extraordinary loss.
Liquidity and Capital Resources
During 1998, Covol and its licensees completed the construction of and began
operations at 24 synthetic fuel facilities. Covol owned four facilities which it
held for sale and sold during 1999 and 2000. Proceeds from the sale of
facilities have been used primarily to retire debt that was incurred principally
in connection with the construction and operation of the facilities, and to a
lesser extent, for working capital needs.
Net cash provided by operating activities during the nine months ended June 30,
2000 ("2000") was $10,655,000 compared to $14,388,000 of cash used during the
nine months ended June 30, 1999 ("1999"). Most of this change in cash flow from
operations is attributable to the 2000 net income of $610,000 as compared to the
1999 net loss of $15,142,000, augmented by the non-cash nature of many of the
material expenses included in results of operations for 2000. During 2000,
proceeds from the sale of facilities were approximately $34,500,000, net
proceeds from the issuance of notes payable and related common stock warrants
totaled approximately $6,980,000, and net proceeds from the issuance of common
stock and related common stock warrants totaled approximately $5,254,000.
Approximately $41,754,000 of notes payable were repaid during 2000 and
approximately $4,454,000 of cash was used for preferred stock redemptions.
With the exception of the sale of facilities in 2000, Covol's investing
activities in both 2000 and 1999 were not significant. Covol believes that funds
required for investing activities, other than strategic investments and bridge
loans, will continue to be relatively low during the remainder of fiscal 2000.
Covol has no current plans to construct additional synthetic fuel facilities or
to incur significant costs to acquire property, plant and equipment, but does
have plans to increase its strategic investments and lending activities as
opportunities arise (see Note 9 to the Consolidated Financial Statements).
Covol's working capital improved from a working capital deficit of approximately
$1,799,000 at September 30, 1999 to a positive working capital position of
approximately $5,441,000 as of June 30, 2000. Several factors caused this
change, most notably an increase in cash from the sale of facilities and
increased royalty revenues. The most significant changes in working capital, in
addition to the increase in cash, were the reduction of approximately
$18,459,000 in facilities and equipment held for sale and the reduction of
approximately $13,513,000 in current notes payable. Both of these changes
primarily resulted from the sales of synthetic fuel facilities in 2000.
Covol expects its operations to produce positive cash flows in the near-term
future. In addition to expected positive cash flows from operations, Covol will
receive additional funds, totaling approximately $3,600,000, when the final
contingent payment from the sale of a synthetic fuel facility in August 1999 is
received. This payment is expected to be received prior to the end of fiscal
2000. In addition to cash provided by operating activities and contingent
proceeds from the sale of a facility, Covol has initiated negotiations with two
financial institutions in order to secure a line of credit. Covol believes these
negotiations will ultimately be successful.
As of June 30, 2000, Covol's notes payable total approximately $7,364,000, of
which approximately $7,113,000 is due within the 12 months ending June 30, 2001.
Since June 30, 2000, approximately $2,000,000 of notes payable has been repaid,
reducing the remaining balance of notes payable to approximately $5,000,000.
Covol believes it will have sufficient cash reserves to meet its obligations
both during the remainder of fiscal 2000 and during the fiscal year ending
September 30, 2001.
Other Items
Covol has reviewed all recently issued, but not yet adopted, accounting
standards in order to determine their effects, if any, on the results of
operations or financial position of Covol. Based on that review, Covol believes
that none of these pronouncements will have any significant effects on current
or future financial position or results of operations.
Risk Factors
We Have a History of Losses; No Assurance of Profit
We have incurred total losses of approximately $74,000,000 from February 1987
through December 31, 1999. Until the quarter ended March 31, 2000, all quarters
have had net losses. We may not be profitable in the future. We are dependent on
17
collection of license fees and other payments from licensees for revenue. It is
not certain whether earned royalties from licensees will continue to be
sufficient to meet operating requirements. Potential future operating cost
reductions are limited due to our need to work with licensees in order to
sustain and increase earned royalties.
Ongoing Financial Viability Depends on Operations Success for License Revenues
Our existence depends on the ability of our licensees to produce and sell
synthetic fuel which will generate license fees to us. There are twenty-four
synthetic fuel plants that utilize our patented technology and from which we
intend to earn license fees. There are four additional facilities which utilize
a technology that we acquired during fiscal 1999. Substantially all of the
ongoing royalties we have earned to date have been generated by six facilities.
Improved operations at each of these plants depends on the ability of the plant
owner to produce a marketable quality of synthetic fuel, and the ability of the
plant owner to market the synthetic fuel. Licensees must successfully address
all operational issues, including but not limited to, feedstock availability,
cost, moisture content, Btu content, correct binder formulation, operability of
equipment, product durability, resistance to water absorption and overall costs
of operations, which in many cases to date have resulted in unit costs in excess
of resale prices. In some cases, licensees may be forced to relocate plants and
enter into new strategic contracts to address marketing and operating issues.
Licensee plant relocations will delay generation of license fees for Covol. It
is not certain how much time our licensees will require for the full resolution
of all of these marketing and operational issues.
Debt Terms and Covenants Restrict Our Activities
On May 31, 2000 we entered into a loan agreement that contains restrictions on
business activities and covenants for future activities. We also agreed to meet
specific monthly and quarterly earnings targets beginning in June 2000 and for
subsequent months and quarters until debt is repaid. These terms and conditions
also restrict or prohibit specific activities without debtholder approval,
including for example, materially changing the business of Covol, incurring more
than a specified amount of additional indebtedness, entering into a merger,
reorganization, recapitalization, or similar transaction, and making loans or
investments greater than a specified amount without the debtholder's approval.
Non-compliance could result in all indebtedness becoming immediately due and
payable.
We or our Licensees May Not Qualify for Tax Credits Granted by Congress to
Encourage Production of Alternative Fuels
Section 29 of the Internal Revenue Code provides a tax credit for the production
and sale of qualified synthetic fuel. We received a private letter ruling from
the IRS in which the IRS agrees synthetic fuel manufactured using our technology
qualifies for the Section 29 tax credits. The IRS has issued at least seven
other private letter rulings to licensees of our technology. These rulings may
be modified or revoked by the IRS if the IRS adopts regulations that are
different from these rulings. Also, a private letter ruling may not apply if the
actual practice differs from the information given to the IRS for the ruling.
Ultimately, it is within the power of Congress to repeal Section 29. Therefore,
tax credits may not be available in the future, which would materially adversely
impact us. See our Form 10-K for fiscal year 1999, "ITEM 1. BUSINESS - Tax
Credits" for an explanation of qualifications for Section 29 tax credits.
Based upon the language of Section 29 of the tax code and private letter rulings
issued by the IRS to us and our licensees, we and our licensees believe the
synthetic fuel facilities built and completed by June 30, 1998 are eligible for
Section 29 tax credits. However, the ability to claim tax credits is dependent
upon a number of conditions including, but not limited to, the following:
o The facilities were constructed pursuant to a binding contract entered
into on or before December 31, 1996;
o All steps were taken for the facility to be considered placed in
service;
o Manufacturing procedures are applied to produce a significant chemical
change and hence a "qualified fuel";
o The synthetic fuel is sold to an unrelated party; and
o The owner of the facility is in a tax paying position and can
therefore use the tax credits.
The IRS may challenge us or our licensees on any one of these or other
conditions. Also, we or our licensees may not be in a financial position to
claim the tax credits if we or they are not profitable. In addition, the Section
29 credit is subject to phase out after the unregulated oil price reaches a
certain level, adjusted annually for inflation. The most recent published
information is for 1999 and based on that information, the credit would begin to
be phased out if the unregulated oil price reached a price of $47.03 per barrel
and would be completely phased out if the price reached $59.04 per barrel. The
1999
18
unregulated oil price as published by the IRS is $15.56 per barrel. The
inability of a licensee to claim tax credits could potentially reduce our income
from the licensee.
Our accounting and valuation procedures assume qualification for Section 29 tax
credits so that synthetic fuel production will continue to be the highest and
best use of our equipment and facilities. If they lose their qualification under
Section 29, the equipment and facilities could be overvalued in any alternative
highest and best use.
Synthetic Fuel Facilities May Not Be Commercially Viable After the Tax Credits
Expire
The synthetic fuel facilities that qualify for tax credits under Section 29 of
the code receive economic benefits from the tax credits in addition to the
benefits, if any, from operations. It is possible that synthetic fuel facilities
that are not eligible for tax credits cannot be built and operated profitably.
Section 29 expires December 31, 2007 after which tax credits will not apply to
the synthetic fuel facilities. In order to remain competitive and commercially
viable after 2007, licensees must manage their costs of production and
feedstock, and they must also develop the market for synthetic fuel with
adequate prices to cover the costs.
Other Applications of Our Technology May Not Be Commercially Viable
We have developed and patented technologies related to the briquetting of wastes
and by products from the coal, coke, and steel industries. We have also tested
in the laboratory the briquetting of other materials. However, to date we have
only commercialized our coal-based synthetic fuel application. The other
applications have not been commercialized or proven out in full-scale
operations. We may not be able to employ these other applications profitably.
See our Form 10-K for fiscal year 1999, "ITEM 1. BUSINESS - Background" for a
discussion of non-synthetic fuel applications of our technology.
New Technologies and Other New Business Plans May Not Be Commercially Viable
In addition to our efforts to develop our technology in non-synthetic fuel
applications, Covol is investigating and selectively investing in the
commercialization of the technologies of others. Covol is also investigating and
selectively investing in business opportunities unrelated to technology
commercialization. All of Covol's future business plans outside of the synthetic
fuel industry are at an early stage of development, will require significant
time, management resources, including recruitment and retention of managers, and
capital investment, and may not prove to be profitable. Covol's implementation
of new business plans will likely require the approval of Covol's May 2000 debt
holder because of covenants restricting Covol's activities.
Market Acceptance of Synthetic Fuel Production is Uncertain
We are uncertain of the market acceptance of products manufactured using our
technology. Synthetic fuel is a relatively new product and competes with
standard coal products. Industrial coal users must be satisfied that the
synthetic fuel is a suitable substitute for standard coal products. Moisture,
hardness, special handling requirements and other characteristics of the
synthetic fuel product may affect its marketability, including sales price. Our
licensees may be unable to meet the product quality requirements of all their
customers. Many industrial coal users are also limited in the amount of
synthetic fuel product they can purchase from our licensees because they have
committed a substantial portion of their coal requirements through long-term
contracts. Reliance on spot markets have generally produced lower resale prices
compared to long-term coal supply contracts in the utility industry. For these
and other possible reasons, customers may not purchase the synthetic fuel
products made with our technology. To date our licensees have secured contracts
for the sale of only a portion of their production. The suitability of synthetic
fuel as a coal substitute and particularly the quality characteristics of
synthetic fuel, the overall downward trend in coal prices, and the traditional
long-term supply contract practices of fuel buying in the utility industry have
made the identification of purchasers of synthetic fuel difficult. We do not
know if licensees will be able to secure the market contracts for their
synthetic fuel product at full production levels.
Supply of Sufficient Raw Material for Synthetic Fuel Facilities is not Assured
Our licensees have not secured all the raw material needed to operate all of the
facilities for the full term of the tax credit. Some of the owners of facilities
are constructing coal washing facilities to provide feedstock and some of the
facilities may have to be moved to sites with enough raw materials for
operation. See our From 10-K for fiscal year 1999, "ITEM 1. BUSINESS - Supply of
Raw Materials" for a discussion of the principal sources of raw materials.
19
We Must Comply With Government Environmental Regulations
The synthetic fuel facilities which use our technology must satisfy government
environmental regulations. We or the facility owners may be subject to fines for
any violation of regulations due to design flaws, construction flaws, or
operation errors. A violation may prevent a facility from operating until the
violation is cured. We or our licensees may be liable to environmental damage
from facilities not operated with environmental guidelines. See our Form 10-K
for fiscal year 1999, "ITEM 1. BUSINESS - Governmental Regulation" for a
discussion of the principal areas of federal and state regulation which we are
subject to.
We have Significant Competitors
We experience competition from:
o Other alternative fuel technology companies and their licensees,
o Companies that specialize in the recycling of waste products generated
by coal and other resource production, and
o Traditional coal, fuel, and natural resource suppliers.
Competition may come in the form of the licensing of competing technologies or
in the marketing of similar products. We currently have limited experience in
manufacturing and marketing. Many of our competitors have greater financial,
management and other resources than we have. We may not be able to compete
successfully. See our Form 10-K for fiscal year 1999, "ITEM 1. BUSINESS -
Competition" for a discussion of the competitors in the synthetic fuel industry
that we are aware of.
Limitation on Protection of Key Intellectual Property
We rely on patent, trade secret, copyright and trademark law, as well as
confidentiality agreements and other security measures to protect our
intellectual property. These rights or future rights or properties may not
protect our interests in present and future intellectual property. Competitors
may successfully contest the validity or scope of our patents or may use
concepts and processes which enable them to circumvent our technology. See our
Form 10-K for fiscal year 1999, "ITEM 1. BUSINESS - Proprietary Protection" for
a list of our trade names, patents and other intellectual property and a
discussion of its value to us.
Technological Developments by Third Parties Could Increase Our Competition
Alternative fuel sources and the recycling of waste products are the subject of
extensive research and development by our competitors. If a competitive
technology were developed which greatly increased the demand for waste products
or reduced the costs of alternative fuels or other resources, the economic
viability of our technology would be adversely affected.
Furthermore, we may not be able to develop or refine our technology to keep up
with future synthetic fuel requirements or to commercialize the other
applications of our technology as discussed in our business strategy. See our
Form 10-K for fiscal year 1999, "ITEM 1. BUSINESS - "Background" for a
discussions of our efforts to continue to develop and refine our technology.
Operations Liability May Exceed Insurance Coverage
We are subject to potential operation liability, such as injuries to employees
or third parties, which are inherent in the manufacturing of industrial
products. While we have obtained casualty and property insurance in the amount
of $10,000,000, with the intent of covering these risks, there can be no
assurance that our operations will not expose us to operation liabilities beyond
our insurance coverage.
No Dividends Are Contemplated in the Foreseeable Future
We have never paid and do not intend to pay dividends on common stock in the
foreseeable future. In addition, dividends on common stock cannot be paid until
cumulative dividends on our outstanding preferred stock are fully paid. Our
ability to pay
20
dividends without approval of the debt holder is also restricted and prohibited
by covenant as long as the debt issued in our May 2000 loan agreement remains
outstanding.
Common Stock Price May Continue to be Volatile
Our common stock is currently traded on The Nasdaq Stock Market. The market for
our common stock has been volatile. Factors such as announcements of production
or marketing of synthetic fuel from the synthetic fuel facilities, technological
innovations or new products or competitors announcements, government regulatory
action, litigation, patent or proprietary rights developments, changes in
analyst coverage or ratings, and market conditions in general could have a
significant impact on the future market for our common stock. You may not be
able to sell our common stock at or above your purchase price.
Preferred Dividends Accumulate Until Paid and Must Be Paid Prior to Any
Dividends to Holders of Common Stock
We have issued preferred stock that has preferential dividends which accumulate
if unpaid. Dividends on common stock are prohibited until the preferential
rights of the preferred stock are satisfied. If we are liquidated, the preferred
stockholders are entitled to liquidation proceeds after creditors but before
common stockholders.
Conversion of Convertible Securities May Dilute Stockholders
We have issued a significant amount of securities which are convertible into
common stock. As of August 4, 2000, we have approximately 23,600,000 shares of
common stock outstanding and approximately 5,100,000 additional shares are
issuable upon conversion of convertible preferred stock, and upon exercise of
warrants and options. To the extent warrants, options and convertible preferred
stock are converted into common stock, stockholder interest in us will be
diluted.
Dilution of Stockholders Due to Sales of Common Stock and Conversion of
Convertible Securities May Affect Our Ability to Raise Additional Capital
Sales of common stock and convertible preferred stock and the exercise of
options and warrants may have an adverse effect on the trading price of and
market for our common stock. We may sell or issue common stock or convertible
securities in the future at market prices or at prices below the current market
price, which issuance would cause dilution to stockholders. If the market value
of the common stock decreases significantly, the offering price per share in any
future private placements or public offerings may decrease causing dilution of
ownership to other stockholders.
Forward Looking Statements
Statements regarding Covol's expectations as to the operation of facilities
utilizing the Covol binder technologies, the marketing of products, the receipt
of licensing fees, the ability to obtain a line of credit, the development and
commercialization of non-synthetic fuel technologies and other strategic
business opportunities and other information about Covol that are not purely
historical by nature, including those statements regarding Covol's future
business plans, the operation of facilities, the estimated capacity of
facilities, the availability of coal fines, the marketability of the synthetic
fuel and the financial viability of the facilities, constitute forward looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. Although Covol believes that its expectations are based on reasonable
assumptions within the bounds of its knowledge of its business and operations,
there can be no assurance that actual results will not differ materially from
its expectations. In addition to matters affecting the synthetic fuel industry
or the economy generally, factors which could cause actual results to differ
from expectations stated in these forward looking statements include, among
others, the following:
(1) The commercial success of the Covol binder technologies.
(2) Operating issues for licensed facilities including feedstock
availability, moisture content, Btu content, correct application of
binder formulation, operability of equipment, product durability,
resistance to water absorption and overall costs of operations.
(3) Marketing issues relating to market acceptance of products
manufactured using Covol's technology, including control of moisture
content, hardness, special handling requirements and other
characteristics of the synthetic fuel product which affect its
marketability and its sales price.
(4) Securing of necessary sites, including permits and raw materials, for
relocation and operation of facilities.
(5) Maintenance of placed-in-service requirements under Section 29 of the
tax code by synthetic fuel manufacturing facilities.
21
(6) Changes in governmental regulations or failure to comply with existing
regulations which may result in operational shutdowns of licensee
facilities.
(7) The availability of tax credits under Section 29 of the tax code.
(8) The commercial feasibility of the Covol synthetic fuel technologies
upon the expiration of Section 29 tax credits.
(9) Ability to meet financial commitments under existing contractual
arrangements.
(10) Ability to meet non-financial commitments under existing contractual
arrangements.
(11) Ability to commercialize the non-synthetic fuel binder technologies
which have only been tested in the laboratory and not in full-scale
operations.
(12) Ability to commercialize the technology of others and to implement
non-technology based business plans which are at an early stage of
investigation and investment and which will require significant time,
management, and capital investment.
(13) Dependence on licensees to successfully implement Covol binder
technologies and making license and other payments to Covol.
(14) The market acceptance of products manufactured with Covol binder
technologies in the face of competition from traditional products.
(15) Success in the face of competition by others producing synthetic fuel
and other recycled products.
(16) Sufficiency of intellectual property protections.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
K-Lee Processing. On March 20, 1997 Covol entered into an Amended and Restated
Supply Agreement for the purchase of coal fines from K-Lee Processing, Inc. and
Concord Coal Recovery Limited Partnership (together "K-Lee"). Covol periodically
purchased coal fines from K-Lee throughout 1997. K-Lee invoiced Covol for a
total of 108,000 tons of fines that Covol paid for. However, K-Lee failed to
deliver 11,059 tons valued at $320,716. K-Lee has refused to refund the
overpayment for non-delivered fines. On July 14, 2000, Covol filed a complaint
against K-Lee Processing, Inc. and Concord Coal Recovery Limited Partnership in
the United States District Court for the Northern District of Alabama seeking
damages in the amount of $320,716 for the coal fines purchased but not
delivered. The litigation is at an early stage and resolution is uncertain,
although Covol intends to prosecute its claims vigorously.
See also"ITEM 3: LEGAL PROCEEDINGS" in Covol's Annual Report on Form 10-K for
the year ended September 30, 1999 for descriptions of other current legal
proceedings. With respect to those matters, no material changes have occurred
since that report was filed.
ITEM 2. CHANGES IN SECURITIES
Recent Sales of Unregistered Securities
The following sets forth all securities issued by Covol within the past fiscal
quarter without registering the securities under the Securities Act of 1933, as
amended. No underwriters were involved in any stock issuances.
Covol believes that the following issuances of shares of common stock, or
securities exercisable for or convertible into shares of common stock, were
exempt from the registration requirements of the Securities Act of 1933, as
amended, pursuant to the exemptions set forth in Sections 3(a)(9), 4(2) or 4(6)
thereof or Regulation D promulgated thereunder and the certificate for each
security bears a restrictive legend. Each investor made representations to Covol
that it was accredited as that term is defined in Regulation D and that the
security was acquired for investment purposes.
Reference is made to the redemption of convertible debt; to the conversion of
debt into common stock and warrants for the purchase of common stock; to the
conversions and redemption of series D preferred stock; to the issuance of
common stock and warrants for cash; to the acquisition of treasury stock; and to
the issuance of common stock upon exercise of warrants, all as described in Note
2 to the consolidated financial statements.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are included herein:
10.69 Settlement Agreement and Mutual Release dated as of May 25,
2000 by and among Covol and Birmingham Syn Fuel, L.L.C.,
PacifiCorp Syn Fuel, L.L.C., and PacifiCorp Financial
Services, Inc.*
10.69.1 Amended and Restated Promissory Note dated as of May 25, 2000
in favor of Covol, executed by Birmingham Syn Fuel, L.L.C. as
debtor
10.69.2 Amended and Restated Security Agreement dated as of May 25,
2000 by and between Covol and Birmingham Syn Fuel, LLC
10.69.3 License and Binder Purchase Agreement dated as of May 25, 2000
by and between Birmingham Syn Fuel, L.L.C. and Covol*
10.69.4 License and Binder Purchase Agreement dated as of May 25, 2000
by and between PacifiCorp Syn Fuel, L.L.C. and Covol (related
to the Brookwood facility)*
10.69.5 License and Binder Purchase Agreement dated as of May 25, 2000
by and between PacifiCorp Syn Fuel, L.L.C. and Covol (related
to the Pumpkin Center #1 facility)*
10.69.6 License and Binder Purchase Agreement dated as of May 25, 2000
by and between PacifiCorp Syn Fuel, L.L.C. and Covol (related
to the Pumpkin Center #2 facility)*
10.70 Settlement Agreement and Release dated as of June 26, 2000 by
and among Covol, Utah Synfuel #1 Ltd., Coaltech No. 1 L.P.,
AJG Financial Services, Inc., and Square D Company*
10.70.1 License and Binder Supply Agreement dated as of June 26, 2000
by and among Coaltech No. 1 L.P., Utah Synfuel #1 Ltd. and
Covol*
27.1 Financial Data Schedule
* This exhibit contains confidential material which has been
omitted pursuant to a Confidential Treatment Request. The
omitted information has been filed separately with the
Securities and Exchange Commission.
(b) The following report on Form 8-K was filed during the quarter
ended June 30, 2000:
o Form 8-K filed on June 6, 2000, for an event dated June 5,
2000 (Early retirement of debt)
Covol also filed a Form 8-K on July 19, 2000, which was amended on Form
8-K/A filed on July 28, 2000, for an event dated July 19, 2000 (Change
in certifying accountant).
23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
COVOL TECHNOLOGIES, INC.
Date: August 10, 2000 By: /s/ Kirk A. Benson
---------------------------------------
Kirk A. Benson, Chief Executive Officer
and Principal Executive Officer
Date: August 10, 2000 By: /s/ Steven G. Stewart
---------------------------------------
Steven G. Stewart, Chief Financial
Officer and Principal Financial Officer
24