UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
AMENDMENT #1
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
AND EXCHANGE ACT OF 1934
For the transition period from _____________________________
Commission file number 0-27803
COVOL TECHNOLOGIES, INC.
------------------------
(Exact name of registrant specified in its charter)
DELAWARE 87-0547337
-------- ----------
State or other jurisdiction of (I.R.S. Employer
incorporation or organization Identification No.)
3280 North Frontage Road, Lehi, Utah 84043
------------------------------------------
(Address of principal executive offices) (Zip Code)
(801) 768-4481
--------------
(Registrant's telephone number, including area code)
(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 14 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
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class of Stock Amount Outstanding
-------------- ------------------
$.001 par value Common Stock 7,944,870 Shares of Common Stock
at May 8, 1997
COVOL TECHNOLOGIES, INC.
TABLE OF CONTENTS
Page No.
--------
Part I - Financial Information
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets..............................1
Consolidated Statements of Operations....................2
Consolidated Statements of Cash Flows....................3
Notes to Financial Statements............................4
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations...............................................9
Part II - Other Information
Item 1. Legal proceedings.......................................14
Item 2. Changes in securities...................................14
Item 3. Defaults upon senior securities.........................15
Item 4. Submission of matters to a vote.........................15
of security holders
Item 5. Other information.......................................15
Item 6. Exhibits and reports on Form 8-K........................16
This report contains forward looking statements within the meaning of
the Private Securities Litigation Reform Act. The cautionary language
regarding forward looking statements set forth in Item 2 of Part I of
this report should be carefully reviewed in connection with the review
of any portion of this report.
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATE BALANCE SHEETS
(Unaudited)
------------------------------
As of As of
March 31, September 30,
ASSETS 1997 1996
----------------- ------------------
Current assets:
Cash and cash equivalents $ 44,253 $ 490,106
Receivables 32,084 77,744
Inventories 363,594 162,757
Advances on inventory 750,000 0
Notes receivable - current 362,995 0
Notes receivable - related parties, current 1,732 3,733
Prepaid expenses and other current assets 82,535 44,733
----------------- ------------------
Total current assets 1,637,193 779,073
----------------- ------------------
Property, plant and equipment, net of accumulated depreciation 8,031,556 7,125,245
----------------- ------------------
Other assets:
Cash surrender value of life insurance 152,112 152,112
Notes receivable - non-current 3,423,753 0
Notes receivable - related parties, non-current 672,125 700,000
Deposits and other assets 107,010 15,642
----------------- ------------------
Total other assets 4,355,000 867,754
----------------- ------------------
Total assets $ 14,023,749 $ 8,772,072
================= ==================
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 1,005,750 $ 2,183,278
Payable for coal briquetting equipment 1,402,040 0
Accrued liabilities 518,617 333,936
Notes payable - current 573,545 958,086
Notes payable - related parties, current 895,470 786,000
----------------- ------------------
Total current liabilities 4,395,422 4,261,300
----------------- ------------------
Long-term liabilities:
Notes payable and convertible debentures - non-current 4,847,133 150,980
Deferred revenue from advance license fees 1,400,000 0
Deferred compensation 218,179 212,612
----------------- ------------------
Total long-term liabilities 6,465,312 363,592
----------------- ------------------
Total liabilities 10,860,734 4,624,892
----------------- ------------------
Minority interest in consolidated subsidiaries 4,077,874 4,380,544
----------------- ------------------
Commitments and contingencies (notes 3 and 7)
Stockholders' deficit:
Common stock: $0.001 par value; authorized: 25,000,000
shares issued and outstanding: 7,944,870 at March 31, 1997
and 7,610,373 at September 30, 1996 7,945 7,610
Common stock to be issued: 0 shares at March 31, 1997
and 103,750 at September 30, 1996 0 104
Capital in excess of par value 36,825,649 32,780,515
Capital in excess of par value - common stock to be issued 0 934,896
Accumulated deficit (24,691,742) (21,196,476)
Notes and interest receivable - related parties from issuance of
or collateralized by common stock (net of allowance) (note 4) (7,587,966) (7,580,071)
Deferred compensation from stock options (5,468,745) (5,179,942)
----------------- ------------------
Total stockholders' deficit (914,859) (233,364)
----------------- ------------------
Total liabilities and stockholders' deficit $ 14,023,749 $ 8,772,072
================= ==================
The accompanying notes are an integral
part of the consolidated financial statements
1
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
-------------------
Three months Three months Six months Six months
Ended Ended Ended Ended
March 31, March 31, March 31, March 31,
1997 1996 1997 1996
--------------- --------------- ---------------- ------------
Revenues:
Synthetic fuel sales $ 20,194 $ 0 $ 124,341 $ 0
Binder sales 4,017 0 4,017 0
--------------- --------------- ---------------- ------------
Total revenues 24,211 0 128,358 0
--------------- --------------- ---------------- ------------
Operating costs and expenses:
Cost of briquetting operations 467,612 430,326 832,192 430,326
Research and development 65,396 90,357 170,463 525,251
Selling, general and administrative 422,523 675,618 1,229,837 1,671,590
Compensation expense on stock options 235,739 2,576,910 548,698 2,889,869
Compensation expense on issuance of
common stock 40,500 45,873 40,500 69,123
Minority interest in income (loss) of
consolidated subsidiaries (342,518) 0 (360,670) 0
--------------- --------------- ---------------- ------------
Total operating costs and expenses 889,252 3,819,084 2,461,020
5,586,159
--------------- --------------- ---------------- ------------
Operating income (loss) (865,041) (3,819,084) (2,332,662) (5,586,159)
--------------- --------------- ---------------- ------------
Other income (expense):
Write-up (Write-down) of note
receivable (note 4) (431,250) (199,575) 293,750 (199,575)
Interest income 50,051 92,864 177,857 111,356
Interest expense (1,568,592) (29,776) (1,634,468) (44,048)
Other income (expense) 3,064 (144,797) 4,453 (144,198)
Loss on sale of assets (4,196) 0 (4,196) 0
--------------- --------------- ---------------- ------------
Total other income (expense) (1,950,923) (281,284) (1,162,604) (276,465)
--------------- --------------- ---------------- ------------
Loss from continuing operations before
income taxes (2,815,964) (4,100,368) (3,495,266) (5,858,883)
Income tax provision 0 (23,000) 0 (23,000)
--------------- --------------- ---------------- ------------
Loss from continuing operations (2,815,964) (4,123,368) (3,495,266) (5,881,883)
--------------- --------------- ---------------- ------------
Discontinued operations:
Loss from discontinued operations 0 (440,588) 0 (590,480)
Loss on disposal of discontinued operations 0 291,025 0 (291,025)
--------------- --------------- ---------------- ------------
Income (loss) from discontinued operations 0 (731,613) 0 (881,505)
--------------- --------------- ---------------- ------------
Net loss $ (2,815,964) $ (4,854,981) $ (3,495,266) $ (6,763,388)
=============== =============== ================ ============
Net loss per common share:
Loss per share from continuing operations $ (0.36) $ (0.58) $ (0.45) $ (0.90)
Loss per share from discontinued operations 0.00 (0.10) 0.00 (0.13)
--------------- --------------- ---------------- ------------
Net loss per share (note 2) $ (0.36) $ (0.69) $ (0.45) $ (1.03)
=============== =============== ================ ============
Weighted average shares outstanding 7,854,178 7,084,704 7,785,579 6,546,244
=============== =============== ================ ============
The accompanying notes are an integral
part of the consolidated financial statements
2
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
---------------------------------
Six Months Ended Six Months Ended
Ended Ended
March 31, March 31,
1997 1996
------------------- ------------------
Cash flows from operating activities:
Net loss $ (3,495,266) $ (6,763,388)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 104,345 86,421
Common stock issued for services 40,500 361,456
Write-down (write-up) of note receivable (293,750) 199,575
Amortization of deferred compensation on stock options 548,698 2,889,869
Loss on disposal of discontinued subsidiaries 0 291,025
Interest earned on notes receivable - related parties, collateralized by
common stock (79,165) (88,594)
Interest expense based upon issuance of convertible debt at a discount 1,428,571 0
Loss on sale of equipment 4,196 0
Deferred income taxes 0 23,000
Loss applicable to minority interests in subsidiaries (360,670) 0
Increase (decrease) from changes in assets and liabilities of continuing
operations:
Receivables 45,660 20,562
Inventories (200,837) (22,208)
Advances on inventory (750,000) 0
Prepaid expenses and other current assets (37,802) 5,402
Deposits and other assets (91,368) (42,553)
Accounts payable (1,177,528) 218,872
Payable for coal briquetting equipment 1,402,040 0
Accrued liabilities 184,681 (171,557)
Deferred compensation 5,567 5,287
Deferred revenue from advance license fees 1,400,000 0
Discontinued operations non-cash charges and working capital changes 0 (202,259)
------------------- -------------------
Net cash used in operating activities (1,322,128) (3,189,090)
------------------- -------------------
Cash flows from investing activities:
Cash paid for property, plant and equipment (4,514,852) (1,736,669)
Issuance of notes receivable (49,456) 0
Issuance of notes receivable - related parties 0 (8,495)
Proceeds from notes receivable 24,728 0
Proceeds from notes receivable - related parties 29,876 0
Increase in cash surrender value of life insurance 0 (6,250)
------------------- -------------------
Net cash used in investing activities (4,509,704) (1,751,414)
------------------- -------------------
Cash flows from financing activities:
Proceeds from cash overdraft 0 14,464
Proceeds from issuance of limited partnership interests in subsidiaries 350,000 0
Payments on distribution to limited partnership interests in subsidiaries (292,000) 0
Proceeds from notes payable 4,710,721 0
Proceeds from notes payable - related party 109,470 0
Payment on notes payable (260,713) (11,159)
Payment on notes payable - related parties 0 (2,169,339)
Proceeds from note receivable - related parties collateralized by common stock 103,000 164,841
Proceeds from issuance of common stock (net) 665,501 5,650,531
------------------- -------------------
Net cash provided by financing activities 5,385,979 3,649,338
------------------- -------------------
Net decrease in cash (445,853) (1,291,166)
Total cash and cash equivalents, beginning of period 490,106 1,291,166
------------------- -------------------
Total cash and cash equivalents, end of period $ 44,253 $ 0
=================== ===================
Supplemental schedule of noncash investing and financing activities:
Common stock issued for notes receivable $ 0 $ 6,159,375
Common stock issued on payment of notes payable 138,396 0
Obligations assumed in connection with sale of subsidiaries 0 4,636,435
Note receivable for subsidiaries (net of imputed interest) 0 4,349,575
Notes receivable issued for sale of briquetting facility 3,500,000 0
The accompanying notes are an integral
part of the consolidated financial statements.
3
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
---------------------------------
1. Management Opinion:
In the opinion of management, the accompanying financial statements present
fairly the financial position of Covol Technologies, Inc. and Subsidiaries (the
Company) as of September 30, 1996 and March 31, 1997, the results of its
operations for the three months and six months ended March 31, 1996 and March
31, 1997 and its cash flows for the six months ended March 31, 1996 and March
31, 1997. The results of operations for the periods presented 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 Company's Annual Report included in Form 10-K
for the year ended September 30, 1996.
2. Loss Per Share Calculation
Primary average shares include only common shares outstanding. The computation
of fully diluted net loss per common share was antidilutive in each period for
which a net loss was presented.
3. Inventories and Advances on Inventories
Inventories and advances on inventories are stated at the lower of average cost
or market, and consist of coal fines, synthetic fuel and binder materials.
During the quarter the Company entered into contractual arrangements to acquire
coal fines and to conduct recovery and preparation activities. Total obligations
to acquire the fines are approximately $5,500,000 of which $750,000 has been
paid with the balance due over time. The company has accounted for the initial
amount paid as an advance payment for inventory. The Company will reflect in
inventory the cost for such fines as they are processed into synthetic fuel.
4. Change in Estimate of Fair Value of Note Receivable
During the three months ended March 31, 1997, the Company increased the
allowance for impairment on the $5,000,000 face value note receivable from two
stockholders by $431,250 to an adjusted loan value of $1,943,750. The increase
in the allowance was based upon a $3.875 per share decrease in the Company's
common stock that collateralizes the note receivable. The estimate is subject to
future fluctuations due to market changes. (See Part II, Item 5 for discussion
of note receivable.)
5. Convertible Debentures
AJG Financial Services, Inc.
In December 1996, the Company entered into a Debenture Agreement and Security
Agreement with AJG Financial Services, Inc., an affiliate of Arthur J.
Gallagher, whereby the Company borrowed $1,100,000, and may, under certain
circumstances, draw down an additional amount of up to $2,900,000 (for a total
borrowed amount of $4,000,000). In consideration for the loan of $1,100,000, the
4
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
-----------------------
5. Convertible Debentures, continued
Company issued a Convertible Subordinated Debenture accruing interest at 6% per
annum and maturing three years from its date of issuance (the "Subordinated
Debenture"). The interest and principal of the Subordinated Debenture is payable
on maturity. The Company does not have the right to prepay any portion of the
principal of the Subordinated Debenture, and the Company is required to prepay
the Subordinated Debenture if a change in control of the Company occurs. All or
a portion of the unpaid principal due on the Subordinated Debenture is
convertible into Company common stock. Subsequent to the March 31, 1997 quarter
AJG Financial Services, Inc. executed an option to convert the loan of
$1,100,000 to an equity position.
During the quarter ended March 31, 1997, the Company borrowed $2,792,172 of the
$2,900,000 available under the Debenture Agreement with AJG Financial Services,
Inc. as described above. In consideration for the amount drawn down, the Company
issued Senior Debentures in such amount accruing interest at prime plus two
percent (2%) and maturing three years from the date of issuance (the "Senior
Debentures"). The Senior Debentures are collateralized by all real and personal
property purchased by the Company with the proceeds of the Senior Debentures.
The proceeds of the Subordinated Debentures and the Senior Debentures may be
used to satisfy contractual obligations of the Company, for working capital and
to purchase equipment to be used to construct synthetic fuel facilities to be
managed and/or sold by the Company or affiliates of the Company.
PacifiCorp Financial Services, Inc.
As a part of its Alabama transaction with PacifiCorp, the Company executed a
Convertible Loan and Security Agreement with PacifiCorp Financial Services, Inc.
("PFS") dated March 20, 1997. The agreement provides for the Company to borrow
up to $5,000,000 primarily for: completing construction of the Alabama project,
acquiring coal fines and for other purposes related to the project. To secure
the loan, the Company and Alabama Synfuel #1, Ltd. gave PFS a security interest
in all personal and real property assets connected with the Alabama project. The
loan accrues interest at prime plus two (2%) with interest and principal payable
on March 20, 1998. The agreement provides PFS with the option to convert the
unpaid principal and interest and any remaining loan commitment amount into
shares of the Company's common stock, convertible at $7.00 per share. As of
March 31, 1997 the Company had not drawn down any funds on the $5,000,000 credit
line. As of May 15, 1997, the Company had drawn $1,014,723 of the $5,000,000
credit line. The quoted price for the Company's common stock was $9.00 on March
20, 1997. The difference of $2.00 between the conversion price and market value
resulted in an interest change of $1,428,571 in the March 31, 1997 quarter.
5
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
-----------------------
6. Stockholders' Deficit
The table below presents the activity in stockholders' deficit from January 1,
1997 through March 31, 1997.
Notes and interest
receivable-related Deferred
Common Stock Common Stock to be issued parties from compen-
Capital in Capital in issuance of, or sation
excess of excess of Accumulated collateralized on stock
Shares Amount par value Shares Amount par value Deficit by, common stock options
------ ------ --------- ------ ------ --------- ------- ---------------- -------
Balance at January 1, 1997 7,734,123 $7,734 $33,952,892 85,000 $85 $632,415 ($21,875,778) ($8,283,480) ($5,129,484)
Common stock issued for cash 60,000 60 584,940 (60,000) (60) (584,940)
received in a prior period
Cash received in payment on 1,500
notes receivable - related parties
from issuance of common stock
Common stock issued for cash, 125,000 125 105,376 (25,000) (25) (47,475)
including exercise of stock
options (net)
Deferred compensation related 575,000 (575,000)
to the issuance of stock options
at below market value to officers,
directors, employees and consultants
Amortization of deferred 235,739
compensation on stock options
Interest earned on notes receivable - (80,986)
related parties from issuance of or
collateralized by common stock
Write-down of notes receivable - 775,000
related party
Common stock issued for services 4,834 5 40,495
Common stock issued to repay 20,913 21 138,375
note payable
Interest expense based upon 1,428,571
issuance of convertible debt
at a discount
Net loss for the quarter ended (2,815,964)
March 31, 1997
--------- ------ ----------- ------- --- -------- ------------ ----------- -----------
Balance at March 31, 1997 7,944,870 $7,945 $36,825,649 0 $0 $0 ($24,691,742) ($7,587,966) ($5,468,745)
========= ====== =========== ======= === ======== ============= =========== ===========
6
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
--------------------------
7. Contingencies
In connection with construction agreements entered into by the Company in
December 1996, in order to assure the agreements would be considered binding on
the Company, the Company agreed to penalty clauses in the aggregate amount of
$3,012,000 if the Company fails to build the facilities. There can be no
assurance that the facilities will be built. In connection with licensing
agreements entered into by the Company, in December 1996, the Company entered
into indemnity agreements with a contractor which resulted in a contingent
liability of up to $4,500,000 on or after June 2, 1998.
The Company entered into a letter of intent with Innovative Technologies in July
of 1995 to apply Covol's briquetting technology to certain metallic ores
supplied by Innovative. The Company conducted numerous tests of the ore through
the fall of 1995, and concluded from the results that the venture was not
economically viable. Accordingly, final agreement to process the ore was never
reached. Innovative filed suit in March 1997, alleging that Covol breached its
letter of intent with Innovative. Covol intends to defend the suit. On March 4,
1997, Innovative Holding Company, Inc., a California corporation, and ORO
Limited, a California limited partnership, filed a civil complaint against the
Company alleging breach of the letter of intent in the amount of $500,000 plus
damages. The Company intends to defend the suit.
On January 30, 1997, S.C. Marketing, Inc., a California corporation, filed a
civil complaint against the Company alleging breach of contract in the amount of
$137,440 plus damages. The Company entered into a settlement agreement with S.C.
Marketing, Inc. whereby it issued 20,913 shares of Company common stock in
settlement of the complaint (valued at $138,396 and previously accrued as a note
payable).
On February 1, 1996, the Company entered into a Stock Purchase Agreement with
former principals of IME, State, CIC and Larson to sell all of the common shares
of the subsidiaries to the Buyers for a $5,000,000 face value 6% promissory
note. The Buyers have raised various contentions regarding the Note and the
Agreement. The Note is collateralized by 130,000 shares of the Company's common
stock and 50,000 options to purchase common stock at $1.50 per share owned by
the Buyers and held by the Company and personal guarantees of the Buyers. The
Buyers claim that Covol is responsible to pay additional amounts beyond the
$3,500,000 provided for in the agreement. Furthermore, the Buyers claim that the
Company represented to them payment terms that are different from the original
promissory note. The Company accrued as of September 30, 1996 approximately
$650,000 of additional expenses related to the discontinued operations for the
wind-down period which were paid or accrued by the subsidiaries. The Company is
investigating the claims made by the Buyers and the Company anticipates that an
amicable settlement can be reached. However, there can be no assurance that a
settlement will be reached with the Buyers.
In connection with the engagement of RAS Securities Corp. as placement agent and
as settlement of a dispute regarding the Letter Agreement, the Company entered
into a Settlement Agreement, dated as of January 27, 1997, with RAS and certain
principals of RAS whereby the Company agreed to issue approximately 26,300
shares of Company common stock to the Individuals in settlement of certain
alleged rights under a Letter Agreement, dated as of April 5, 1996, by and among
RAS and the Company. Under the disputed Letter Agreement, RAS exercised certain
warrants to purchase 65,000 shares of Company common stock. In accordance with
the RAS Settlement Agreement, the parties are mutually released from their
respective rights and obligations, if any, under the Letter Agreement.
7
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Continued)
--------------------------
8. Other Matters
In March 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, Earnings Per Share. This statement
establishes standards for computing and presenting earnings per share ("EPS")
and makes them comparable to international EPS standards. This statement is
effective for financial statements for both interim and annual periods ending
after December 15, 1997. The Company is currently evaluating the impact of the
recently issued statement and will adopt the requirements for the year ending
September 30, 1998.
The Company has reviewed other 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 the Company. Based on that review, the
Company believes that none of these pronouncements will have a significant
effect on current or future earnings or operations.
9. Sale of Utah Briquetting Project.
On March 10, 1997, the Coal briquetting facility located near Price, Utah (the
"Utah Project") was sold to Coaltech No. 1 L.P., ("Coaltech") a limited
partnership. The sold property consisted of tangible personal property used in
the manufacture of synthetic coal fuel. The sale was effective March 7, 1997.
The ownership of Coaltech reflects Covol Technologies, Inc. as general partner
(holding a 1% interest), AJG Financial Services, Inc. and Square D Company. AJG
Financial Services, Inc. is a wholly-owned subsidiary of Arthur J. Gallagher &
Co., and Square D Company is a subsidiary of Groupe Schneider. The Sale was
funded by a promissory note of $3,500,000 with quarterly payments of $130,000
through December 31, 2007.
In connection with the sale to Coaltech No. 1 L.P., Coaltech paid an initial
license fee of $1,400,000 to the Company, for use of the coal briquetting
technology. The Company has entered into an agreement to purchase the production
of the Utah facility from Coaltech. Accordingly, this fee is reflected as
deferred revenue from advance license fees in the March 31, 1997 balance sheet.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
Results of Operations
Three months ended March 31, 1997 compared to three months ended March 31, 1996
Revenues
In the three months ended March 31, 1997, the Company had revenues of $24,211
that resulted from the sale of synthetic fuels and binder sales.
Margins, Costs and Expenses
The Company's operating loss of $865,041 for the quarter ended March 31, 1997
decreased by $2,954,043 compared to a loss of $3,819,084 reported in the
comparable period in 1996. The reduction in operating loss was due principally
to: a reduction in compensation expense on stock options of $2,576,910 to
$235,739; a decrease in research and development expenses of $24,961 due to the
Company's focus on commercialization of its technology through the construction
and startup of its first full scale briquetting facility; a decrease in selling,
general and administrative expenses of $253,095 related principally to
reductions in costs for outside professional services and travel expenses; a
decrease in cost of briquetting operations of $37,286 to $467,612. Compensation
expense on stock options for the three months ended March 31, 1996 of $2,576,910
is based on the restated financial statements for that period filed in the
Company's Form 10-Q/A, Amendment No. 1 for the period ended March 31, 1996.
The cost for briquetting operations was substantially more than the revenue
generated for the sales of briquettes because the amount includes costs for the
continuing refinement and development of the briquetting process and product.
For a more detailed discussion of the Company's operations see the Company's
Form 10-K for fiscal year ended September 30, 1996 and Form 10-Q for the quarter
ended December 31, 1996.
Interest expense for the quarter ended March 31, 1997 increased by $1,538,816
over the corresponding quarter in 1996 primarily as a result of convertible debt
of $5,000,000 that was finalized during that quarter and included a conversion
price that was below the market value of the Company's common stock.
Net Loss
For the quarter ended March 31, 1997, the Company has a net loss of $2,815,964
as compared to a net loss of $4,854,981 for the comparable period in 1996. In
addition to the items described above, the decrease in net loss is also due to
the difference in loss from discontinued operations. For the three months ended
March 31, 1996 the loss from discontinued operations was $731,613. There was no
additional loss for discontinued operations recorded for the quarter ended March
31, 1997. The decrease in operating expenses was offset by an increase in
write-down of the note receivable related to the sale of the Company's
previously owned subsidiaries (discontinued operations) in the amount of
$231,675 to $431,250.
9
Results of operations
Six months ended March 31, 1997 compared to six months ended March 31, 1996
Revenues
In the six months ended March 31, 1997, total revenues were $128,358. The
Company had revenue of $124,341 from the sale of briquettes in the six months
ended March 31, 1997 and binder sales of $4,017. The sale of briquettes is
primarily attributable to production from the Utah Project.
Margins, Costs and Expenses
The Company's operating loss decreased to $2,332,662 for the six months ended
March 31, 1997 from $5,586,159 loss reported in the comparable period in 1996.
The change in operating loss was due principally to: a reduction in compensation
expense on stock options of $2,341,171 to $548,698; increase in cost of
briquetting operations of $512,826 to $832,192; a decrease in research and
development expenses of $354,788 due to the Company's focus on commercialization
of its technology through the construction and startup of its first full scale
briquetting facility; a decrease in selling, general and administrative expenses
of $441,753 related principally to reductions in costs for outside professional
services and travel expenses; and an increase of the minority interest in loss
of consolidated subsidiaries of $360,670 from $0 for the comparable period in
1996. Compensation expense on stock options for the six months ended March 31,
1996 of $2,889,869 is based on the restated financial statements for that period
filed in the Company's Form 10-Q/A, Amendment No. 1 for the period ended March
31, 1996.
Cost of briquetting operations for the six months ended March 31, 1997 was
$832,192, an increase of $401,866 from the comparable period in 1996. The cost
for briquetting operations was substantially more than the revenue generated for
the sales of briquettes because the amount includes costs for the continuing
refinement and development of the briquetting process and product. For a more
detailed discussion of the Company's operations, see the Company's Form 10-K for
fiscal year ended September 30, 1996 and Form 10-Q for the quarter ended
December 31, 1996.
Net Loss
For the six months ended March 31, 1997, the Company had a net loss of
$3,495,266 as compared to a net loss of $6,763,388 for the comparable period in
1996. In addition to the items described above, the decrease in net loss is also
due to other income of $3,947 for the six months ended March 31, 1997 compared
to other expenses of $276,465 incurred in the same period for 1996 and no loss
from discontinued operations for the period ended March 31, 1997. For the six
month period ended March 31, 1996 the Company incurred a loss from discontinued
operations of $881,505.
Liquidity and Capital Resources
The Company continues to make progress toward the commercialization of its
technology and movement towards becoming an operating company with less emphasis
on development. Cash used by the Company in operating activities decreased
$1,866,962 during the six months ending March 31, 1997 ($1,322,128 compared to
$3,189,090 for the same period in 1996) principally due to an increase of
revenues and a decrease in research and development expense, selling, general
and administrative expense and compensation expense on stock options.
The Company increased its investment in property, plant and equipment from
$1,736,669 for the six months ended March 31, 1996 to $4,514,852 for the six
months ended March 31, 1997 due principally to the development of the Utah
Project. The Company was able to fund these capital expenditures principally
through the issuance of common stock, funding through limited partners of Utah
Synfuel #1, Ltd. ("Utah Synfuel"), of which the Company is the general partner
and 60% equity owner, and the issuance of notes payable.
In connection with construction agreements entered into by the Company in
December 1996, in order to assure the agreements would be considered binding on
the Company, the Company agreed to penalty clauses in the aggregate amount of
10
$3,012,000 if they failed to build the facilities. There can be no assurance
that the facilities will be built. In connection with licensing agreements
entered into by the Company, in December 1996, the Company entered into
indemnity agreements with a contractor which may result in a contingent
liability of up to $4,500,000 on or after June 2, 1998. For a more detailed
description of the construction and licensing agreements, see the Company's Form
10-K for fiscal year ended September 30, 1996.
During the quarter, the Company entered into contractual arrangements to acquire
coal fines and to conduct recovery and preparation activities. The total
obligation to acquire the coal fines is approximately $5,500,000 of which
$750,000 has been paid with the balance due over 3 years. $395,833 of such
obligation is due in fiscal year 1997.
On January 27, 1997, the Company engaged RAS Securities Corp., to act as
placement agent on a "best efforts" private offering of a minimum aggregate
principal amount of $1,000,000 ($3,000,000 maximum) of 8% Convertible
Subordinated Debentures of the Company to accredited investors. This offering
was terminated by the Company on March 27, 1997 without the placement of any
debentures.
In connection with the engagement of RAS Securities Corp. ("RAS") as placement
agent and as settlement of a dispute regarding the Letter Agreement (defined
below), the Company entered into a Settlement Agreement, dated as of January 27,
1997 (the "RAS Settlement Agreement"), with RAS and certain principals of RAS
(the "Individuals") whereby the Company agreed to issue approximately 26,300
shares of Company common stock to the Individuals in settlement of certain
alleged rights under a Letter Agreement, dated as of April 5, 1996 (the "Letter
Agreement"), by and among RAS and the Company. Under the disputed Letter
Agreement, RAS exercised certain warrants to purchase 65,000 shares of Company
common stock. In accordance with the RAS Settlement Agreement, the parties are
mutually released from their respective rights and obligations, if any, under
the Letter Agreement.
The Company anticipates that cash flow from (i) the sale of certain coal
facilities, (ii) fees for the operation of facilities owned by third parties,
(iii) licensing and royalty fees from new plants utilizing the briquetting
technology, (iv) the sale of chemical binder to new plants utilizing the
briquetting technology, (v) sale of synthetic fuel product, (vi) fees from port
operations and loading, (vii) cash distributions from its partnership interests
and (viii) collections on notes receivable will be used to fund working capital
and other operating needs. Most of the cash flow from the above sources will not
occur until late 1997 and in subsequent years.
At March 31, 1997, the Company had a working capital deficit of $2,758,229. The
Company is currently in discussions with various sources for equity financing.
The Company believes that the resources described above and the potential equity
financing will be adequate for the Company to meet its obligations in fiscal
year 1997 notwithstanding its working capital deficit at March 31, 1997.
However, there is no assurance that the Company will be able to obtain the
necessary equity financing.
Loan from PacifiCorp
On March 20, 1997, the Company entered into a Convertible Loan and Security
Agreement (the "Loan Agreement") with PacifiCorp Financial Services, Inc., an
Oregon corporation ("PacifiCorp"). Under the Loan Agreement the Company may
borrow up to $5,000,000 as evidenced by a draw down promissory note (the
"Promissory Note") payable to PacifiCorp. As of May 15, 1997, the Company has
drawn $1,014,723 under the Loan Agreement. Principal and accrued interest on the
Promissory Note is due and payable on March 20, 1998 (the "Due Date"), unless
the Promissory Note is converted into Company common stock. Interest due on the
Promissory Note is calculated based on a 360 day year and the actual number of
days lapsed, and will be compounded monthly. The interest rate is a rate per
annum equal to the lesser of (i) the highest rate allowed by law, or (ii) the
sum of the rate of interest publicly announced by Morgan Guaranty Trust Company
of New York in New York City from time to time plus two percent (2%) per annum.
The proceeds of the loan (the "Loan") may be used by the Company to (i) complete
construction of the coal briquetting facility to be located in Birmingham,
Alabama (the "Alabama Project"), (ii) finance the purchase of coal fines for the
Alabama Project, (iii) fund the net working capital needs of the Alabama
Project, (iv) finance the development and construction of a wash plant for coal
fines and (v) other uses related to the Alabama Project approved by PacifiCorp
in its sole discretion. The Company's obligation to repay the Loan is secured by
a security interest and lien on certain property relating to the Alabama Plant.
In addition, PacifiCorp has the right to convert all or a portion of the
11
principal and unpaid interest on the Loan at any time into shares of Company
common stock at a conversion price of $7.00 per share, subject to certain
adjustments as provided in the Loan Agreement. On May 5, 1997, PacifiCorp filed
a Schedule 13D with the Securities and Exchange Commission reporting its
beneficial ownership of 714,286 shares of Company common stock should PacifiCorp
convert the full amount of the Loan. Pursuant to the Registration Rights
Agreement, dated as of March 20, 1997, between the Company and PacifiCorp,
PacifiCorp has been granted certain "demand" and "piggy-back" registration
rights with respect to shares of Company common stock that could be acquired by
PacifiCorp pursuant to the Loan Agreement.
Pending Sale of Alabama Project
Pursuant to the Alabama Project Purchase Agreement, dated as of March 20, 1997
(the "Purchase Agreement"), by and between the Company, Alabama Synfuel #1 Ltd.,
a Delaware limited partnership ("Alabama Synfuel") and Birmingham Syn Fuel,
L.L.C., an Oregon limited liability company ("Birmingham Syn Fuel"), the Company
and Alabama Synfuel have agreed to sell, and Birmingham Syn Fuel has agreed to
buy, the Alabama Project, subject to the terms and conditions of the Purchase
Agreement. The purchase price for the Alabama Project would be $3,400,000 and
would be payable in the form of a nonrecourse promissory note secured by certain
property of the Alabama Project. There are numerous conditions to the closing of
the sale of the Alabama Project, including, but not limited to, the receipt of
an Internal Revenue Service Letter Ruling (the "Letter Ruling").
In connection with the Loan from PacifiCorp described above and the pending sale
of the Alabama Project, Birmingham Syn Fuel I, Inc., and Birmingham Syn Fuel II,
Inc. (collectively, the "PFS Parties"), PacifiCorp, Alabama Synfuel and the
Company entered into the Conditional Option Agreement, dated as of March 20,
1997 (the "Conditional Option Agreement"). Under the Conditional Option
Agreement, the Company granted to the PFS Parties and to PacifiCorp a put option
to require the Company to simultaneously purchase all of the rights, title and
interest of the PFS Parties in Birmingham Syn Fuel and all of the interest of
PacifiCorp in the Loan and in the other Transactional Documents (as that term is
defined in the Purchase Agreement) excluding shares obtained in conversion of
the Loan if (i) the Alabama Project is not completed consistent with Birmingham
Syn Fuel's approved plans and specifications and placed in service (within the
meaning of Section 29 of the Internal Revenue Code of 1996) by June 30, 1997,
(ii) a Letter Ruling (as defined above) is not received by June 30, 1997 which
is satisfactory to Birmingham Syn Fuel or (iii) if, at any time, there has
occurred and is continuing an "Event of Default" under the Loan Agreement (each
being referred to herein as a "Put Event"). In no event, however, shall a Put
Event occur after receipt of a satisfactory Letter Ruling by Birmingham Syn
Fuel.
Sale of Utah Project
On March 10, 1997, the Utah Project was sold to Coaltech No.1 L.P., a limited
partnership consisting of Covol Technologies, Inc. as a general partner (holding
a 1% interest), AJG Financial Services, Inc. and Square D Company effective as
of March 7, 1997. AJG Financial Services, Inc. is a wholly-owned subsidiary of
Arthur J. Gallagher & Co., and Square D Company is a subsidiary of Groupe
Schneider. See the Company's Current Report on Form 8-K, filed March 24, 1997
for additional information regarding the sale of the Utah Project.
Debentures
In December 1996, the Company entered into a Debenture Agreement and Security
Agreement with AJG Financial Services, Inc. to borrow $4,000,000. In December
1996, $1,100,000 in convertible subordinated debentures (the "Subordinated
Debentures") were issued and funded, with an additional $2,900,000 in credit
available for future draw downs pursuant to Senior Debentures (non-convertible)
to be issued by the Company. On January 2, 1997, the Company drew down $588,683,
on February 4, 1997 the Company drew down an additional $1,313,514, on February
21, 1997 the Company drew down an additional $750,000, and on February 28, 1997
the Company drew down an additional 139,975 of the available $2,900,000. The
balance of the $2,900,000 loan will be used for construction and development of
coal agglomeration facilities. In May 1997, the $1,100,000 convertible
subordinated debentures and accrued interest were converted into 140,642 shares
of common stock based on a conversion price of $8.00 per share.
12
Forward Looking Statements
Statements regarding the Company's expectations as to its liquidity, capital
resources and certain other information presented in this Form 10-Q constitute
forward looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Although the Company 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 economy and the Company's industry generally, factors which could
cause actual results to differ from expectations include, but are not limited
to, the following:
(i) The commercial success of the Company's briquetting technology.
(ii) Procurement of necessary equipment to place facilities into
operation.
(iii) Securing of necessary sites and raw materials for facilities to
be constructed and operated.
(iv) Timely construction and completion of facilities.
(v) Ability to obtain needed additional capital on terms
acceptable to the Company in order to finance the development
of the briquetting technology and working capital needs.
(vi) Changes in governmental regulation or failure to comply with
existing regulation could result in operational shutdowns of
its facilities.
(vii) The ongoing availability of tax credits under Section 29 of the
Internal Revenue Code.
(viii) Ability to meet financial commitments under existing contractual
arrangements.
With respect to tax credits under Section 29 of the Internal Revenue Code of
1996, as amended ("Section 29"), on February 6, 1997, the Treasury Department
released the General Explanations of the Administration's Revenue Proposals,
which summarizes the tax-related provisions from the President's Fiscal Year
1998 Budget submission to Congress (the "Proposed Federal Budget"). The initial
version of the Proposed Federal Budget proposes an amendment to a provision of
Section 29. Currently, Section 29 requires that facilities producing certain
qualified fuels (including solid synthetic fuel produced from coal) that are
constructed pursuant to a binding contract in place by December 31, 1996 be
placed in service by June 30, 1998. (The "placed in service date" and "binding
contract date" have been previously extended on several occasions, most recently
by the Small Business Jobs Protection Act of 1996.) The Proposed Federal Budget
proposed that the placed-in-service date be changed to June 30, 1997 (the
"Amendment"). If adopted, the Amendment would have a material adverse effect on
the financial condition of the Company.
On May 2, 1997, the Administration announced a new fiscal year 1998 Budget
Agreement with Congress. The new Budget Agreement reduces by more than 30% the
amount of revenue provisions and does not mention Section 29 or any other
specific revenue provisions, but leaves the fiscal year detail to the
tax-writing committees of Congress.
The Company, together with other interested parties, will continue to oppose the
proposed Amendment. The Company believes that the Amendment will not likely be
included in the final Federal Budget. However, no assurance can be given that
the Amendment will not be included in the final Federal Budget proposed by
Congress and the Administration.
13
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company entered into a letter of intent with Innovative Technologies
("Innovative") in July of 1995 to apply the Company's briquetting technology to
certain metallic ores supplied by Innovative. The Company conducted numerous
tests of the ore through the fall of 1995, and concluded from the results that
the venture was not economically viable. Accordingly, final agreement to process
the ore was never reached. On March 4, 1997, Innovative Holding Company, Inc., a
California corporation, and ORO Limited, a California limited partnership, filed
a civil complaint against the Company alleging breach of the letter of intent in
the amount of $500,000 plus damages. The complaint was filed in the Superior
Court of California, County of Orange (Case No. 776083). The Company intends to
defend the suit.
On January 30, 1997, S.C. Marketing, Inc., a California corporation, filed a
civil complaint against the Company alleging breach of contract in the amount of
$137,440 plus damages (valued at $138,396 and previously accrued as a note
payable). The complaint was filed in the Superior Court of California, County of
Orange (Case No. 774760). On March 26, 1997, the Company entered into a
settlement agreement with S.C. Marketing, Inc. whereby it issued 20,913 shares
of Company common stock in settlement of the complaint.
ITEM 2. CHANGES IN SECURITIES.
Recent Sales of Unregistered Securities
The following sets forth securities issued by the Company 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 nor were any
commissions or similar fees paid in connection therewith.
The Company believes that the following issuance of shares of common stock,
notes and debentures and other securities were exempt from the registration
requirements of the Securities Act of 1933, as amended, pursuant to the
exemption set forth in Section 4(2) thereof.
On January 1, 1997, the Company granted 50,000 stock options, valued as deferred
compensation of $575,000, to an executive of the Company, at an exercise price
of $1.50/share. The options vest over a two-year period starting January 1, 1997
and ending December 31, 1998.
On January 2, 1997, 25,000 shares of common stock, previously shown as common
stock to be issued, were issued for $47,500, which consisted of 3,000 shares of
common stock issued to an employee of the Company in exercise of options at
$1.50, 10,000 shares of common stock issued to an accredited investor in
exercise of options at $1.50 and 12,000 shares of common stock issued to an
existing shareholder in exercise of warrants at $1.50.
As described in Part I, Item 2 above, on January 2, 1997, February 4, 1997,
February 21, 1997, and on February 28, 1997, the Company issued senior
debentures in the aggregate principal amount of $2,792,172. The senior
debentures accrue interest at prime plus two percent (2%) and maturing three
years from the date of issuance (the "Senior Debentures"). The Senior Debentures
are collateralized by all real and personal property purchased by the Company
with the proceeds of the Senior Debentures. The proceeds of the Subordinated
Debenture and the Senior Debentures may be used to satisfy contractual
obligations of the Company, for working capital and to purchase equipment to be
used to construct coal briquetting facilities to be managed and/or sold by the
Company or affiliates of the Company.
On January 13, 1997, the Company issued 100,000 shares of common stock to a
former executive of the Company in exercise of options at $1.50 per share. The
consideration was paid part in cash and part in offset of amounts owing to the
individual by the Company.
14
As described in Part I, Item 2 above, on January 27, 1997 the Company agreed to
issue 32,500 shares to certain principals of RAS Securities Corp.
On February 21, 1997 and March 6, 1977, the Company issued 1,905 and 2,929
shares of common stock respectively, to a consultant in exchange for consulting
services in the total amount of $40,500.
On March 14, 1997, the Company issued 60,000 shares of common stock to an
accredited investor in a private placement in connection with the purchase of
property for the Alabama Project. The Company was given a credit of $585,000 for
the purchase of the property in exchange for the 60,000 shares.
As described in Part I, Item 2 above, on March 20, 1997 the Company executed and
delivered a promissory note in the aggregate principal amount of up to
$5,000,000 to PacifiCorp in consideration for a loan of up to $5,000,000. The
loan is convertible into common stock of the Company based on a $7.00 per share
conversion price.
As described in Part I, Item 2 above, on March 20, 1997 the Company executed and
delivered the Conditional Option Agreement to PacifiCorp and affiliates of
PacifiCorp relating to the repurchase of their interest in Birmingham Syn Fuel,
L.L.C. and the loan made by PacifiCorp.
As described in Part II, Item 1 above, on March 26, 1997 the Company issued
20,913 shares of Company common stock, valued at $138,396, in settlement with
S.C. Marketing, Inc.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None
ITEM 5. OTHER INFORMATION
In 1995, the Company made a strategic decision to focus its efforts exclusively
on commercializing the Briquetting Technology and to divest itself of its
construction and limestone subsidiaries ("Subsidiaries"). On February 1, 1996,
the Company entered into a Stock Purchase Agreement (the Agreement) with former
principals of IME, State, CIC and Larson (Buyers) to sell all of the common
shares of the subsidiaries to the Buyers for a $5,000,000 face value 6%
promissory note (the Note). See Item 1 of the Company's Annual Report on Form
10-K for the year ended September 30, 1996 for a detailed discussion of the
terms of the sale.
The Buyers have raised various contentions regarding the Note and the Agreement.
The Buyers claim that Covol is responsible to pay additional amounts beyond the
$3,500,000 provided for in the agreement. Furthermore, the Buyers claim that the
Company represented to them payment terms that are different from the original
promissory note. The Company accrued as of September 30, 1996 approximately
$650,000 of additional expenses related to the discontinued operations for the
wind-down period which were paid or accrued by the subsidiaries. The Company is
investigating the claims made by the Buyers and anticipates that an amicable
settlement can be reached. However, there can be no assurance that a settlement
will be reached with the Buyers.
The results of the construction and limestone operations have been classified as
discontinued operations for all periods presented in the Consolidated Statements
of Operations. The assets and liabilities of the discontinued operations have
been classified in the Consolidated Balance Sheets as "Net assets - discontinued
operations." Discontinued operations have also been segregated for all periods
presented in the Consolidated Statements of Cash Flows.
15
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Those exhibits previously filed with the Securities and
Exchange Commission as required by Item 601 of Regulation S-K,
are incorporated herein by reference in accordance with the
provisions of Rule 12b- 32.
10.38 Convertible Loan and Security Agreement, dated as of
March 20, 1997, by and between the Company and
PacifiCorp Financial Services, Inc. ("PacifiCorp")
10.39 Alabama Project Purchase Agreement, dated as of
March 20, 1997, by and among the Company, Alabama
Synfuel #1, Ltd ("Alabama Synfuel") and Birmingham
Syn Fuel, L.L.C.
("Birmingham Syn Fuel")
10.40 Conditional Option Agreement, dated as of March 20,
1997, by and among Birmingham Syn Fuel I, Inc.,
Birmingham Syn Fuel II, Inc., PacifiCorp, Alabama
Synfuel and the Company
10.41 Registration Rights Agreement, dated as of March 20,
1997, by and between the Company and PacifiCorp.
27.1 Financial Data Schedule
(b) Reports on Form 8-K
On March 24, 1997, the Company filed a Current Report on Form
8-K with the Securities and Exchange Commission disclosing its
sale of the Utah Project to Coaltech No. 1 L.P., a Delaware
limited partnership. The information was disclosed pursuant to
Item 2 of Form 8-K. Also disclosed in that report pursuant to
Item 5 of the Form 8-K was the appointment of Max E. Sorensen
as a Vice President of the Company.
16
SIGNATURE
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: May 14, 1998
COVOL TECHNOLOGIES, INC.
By: /s/ Brent M. Cook
--------------------------------------------
Brent M. Cook, Chairman of the Board,
Chief Executive Officer and Principal
Executive Officer
By: /s/ Stanley M. Kimball
--------------------------------------------
Stanley M. Kimball, Principal Financial Officer
17