UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
(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, 1998
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 as 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 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
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 10,432,192 Shares of Common Stock
at May 7, 1998
This Quarterly Report on Form 10-Q/A amends the Quarterly Report on Form 10-Q
for the quarterly period ended March 31, 1998.
COVOL TECHNOLOGIES, INC.
TABLE OF CONTENTS
Page No.
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL INFORMATION (Unaudited).......................... 3
Consolidated Balance Sheets - As of March 31, 1998 and
September 30, 1997
Consolidated Statements of Operations - For the three
months ended March 31, 1998 and 1997 and for the
six months ended March 31, 1998 and 1997
Consolidated Statements of Cash Flows - For the
six months ended March 31, 1998 and 1997
Notes to Financial Statements
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS........................16
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK.......................................................23
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS..........................................23
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS..................24
ITEM 3. DEFAULTS UPON SENIOR SECURITIES............................25
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........25
ITEM 5. OTHER INFORMATION..........................................25
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K...........................25
EXHIBIT 27.1 FINANCIAL DATA SCHEDULE....................................27
Statements in this Form 10-Q, including those concerning the Registrant's
expectations regarding its business, and certain of the information presented 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 such expectations. For a discussion of the factors which
could cause actual results to differ from expectations, please see the caption
entitled "Forward Looking Statements" in ITEM 2 hereof. There can be no
assurance that the Registrant's results of operations will not be adversely
affected by such factors.
2
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
As of As of
March 31, September 30,
1998 1997
ASSETS --------------- ----------------
Current assets:
Cash and cash equivalents $ 558,682 $ 4,780,301
Receivables 396,757 12,595
Receivable - stock subscriptions 0 577,500
Inventories 1,548,083 1,818,991
Advances on inventories 1,989,772 1,086,964
Notes receivable - related parties, current 346,395 275,516
Prepaid expenses and other current assets 224,433 51,865
--------------- ----------------
Total current assets 5,064,122 8,603,732
--------------- ----------------
Property, plant and equipment, net of accumulated depreciation 29,851,003 13,619,271
--------------- ----------------
Other assets:
Notes receivable 7,757,290 0
Notes receivable - related parties, non-current 3,627,129 3,816,604
Deposits and other assets 605,607 321,207
--------------- ----------------
Total other assets 11,990,026 4,137,811
--------------- ----------------
Total assets $ 46,905,151 $ 26,360,814
=============== ================
The accompanying notes are an integral
part of the consolidated financial statements
3
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
As of As of
March 31, September 30,
1998 1997
LIABILITIES AND STOCKHOLDERS' EQUITY --------------- ----------------
Current liabilities:
Accounts payable $ 641,159 $ 1,045,147
Payable for coal briquetting equipment 3,121,003 1,967,686
Due to related party 454,294 1,038,667
Accrued liabilities 521,410 1,023,126
Accrued contractor liability 1,056,500 1,477,000
Advance on binder facilities 790,703 0
Convertible debentures, current 1,000,000 3,302,422
Notes payable, current 2,536,679 1,945,104
--------------- ----------------
Total current liabilities 10,121,748 11,799,152
--------------- ----------------
Long-term liabilities:
Accrued interest 329,353 204,402
Notes payable, non-current 15,028,325 2,900,000
Notes payable - related parties, non-current 146,588 489,096
Deferred revenues from advance licensing fees 1,650,000 1,650,000
Deferred compensation 229,752 223,891
--------------- ----------------
Total long-term liabilities 17,384,018 5,467,389
--------------- ----------------
Total liabilities 27,505,766 17,266,541
--------------- ----------------
Minority interest in consolidated subsidiaries 3,028,118 3,165,996
--------------- ----------------
Commitments and contingencies (Note 10)
Stockholders' equity:
Preferred stock: $0.001 par value; authorized 10,000,000 shares,
issued and outstanding, 315,882 shares at March 31, 1998 and
303,024 shares at September 30, 1997 316 303
Common stock: $0.001 par value; authorized 25,000,000 shares,
issued and outstanding, 10,256,175 shares at March 31, 1998 and
8,627,290 shares at September 30, 1997 10,256 8,627
Common stock to be issued: 63,060 shares at March 31, 1998 and
462,285 shares at September 30, 1997 63 462
Capital in excess of par value - preferred 5,184,626 5,094,634
Capital in excess of par value - common 55,104,729 41,818,549
Capital in excess of par value - common stock to be issued 417,638 3,291,783
Accumulated deficit (32,376,300) (32,191,556)
Notes and interest receivable - related parties from issuance of or
collateralized by common stock (net of allowance) (7,701,798) (7,411,278)
Deferred compensation from stock options (4,268,263) (4,683,247)
--------------- ----------------
Total stockholders' equity 16,371,267 5,928,277
--------------- ----------------
Total liabilities and stockholders' equity $ 46,905,151 $ 26,360,814
=============== ================
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 Three months Six months Six months
ended ended ended ended
March 31, March 31, March 31, March 31,
1998 1997 1998 1997
--------------- -------------- -------------- ---------------
Revenues:
License fees $ 3,586,000 $ 0 $ 4,586,000 $ 0
Synthetic fuel sales 4,888 20,194 4,888 124,341
Binder sales 84,602 4,017 91,605 4,017
Coal fines 1,903,553 0 1,903,553 0
Operation and maintenance fees 31,655 0 66,277 0
--------------- -------------- -------------- ---------------
Total revenues 5,610,698 24,211 6,652,323 128,358
--------------- -------------- -------------- ---------------
Operating costs and expenses:
Cost of coal briquetting operations 730,252 467,612 1,187,199 832,192
Cost of coal fines 1,903,553 0 1,903,553 0
Research and development 72,202 65,396 227,893 170,463
Selling, general and administrative 1,150,848 422,523 1,891,402 1,229,837
Compensation related to stock options
and issuance of common stock 238,556 276,239 446,047 589,198
Loss (gain) on sale of facility (78,401) 4,196 (78,401) 4,196
Write-down (write-up) of note
receivable - related parties collateralized
by common stock (270,000) 431,250 (562,500) (293,750)
--------------- -------------- -------------- ---------------
Total operating costs and expenses 3,747,010 1,667,216 5,015,193 2,532,136
--------------- -------------- -------------- ---------------
Operating income (loss) 1,863,688 (1,643,005) 1,637,130 (2,403,778)
--------------- -------------- -------------- ---------------
Other income (expense):
Interest income 180,677 50,051 302,680 177,857
Interest expense (1,179,925) (1,568,592) (2,292,432) (1,634,468)
Minority interest in net losses
of consolidated subsidiaries 52,211 342,518 137,878 360,670
Other income 15,000 3,064 30,000 4,453
--------------- -------------- -------------- ---------------
Total other income (expense) (932,037) (1,172,959) (1,821,874) (1,091,488)
--------------- -------------- -------------- ---------------
Net income (loss) $ 931,651 $ (2,815,964) $ (184,744) $ (3,495,266)
--------------- -------------- -------------- ---------------
Earnings (loss) per share:
Basic $ 0.09 $ (0.36) $ (0.03) $ (0.45)
=============== ============== ============== ===============
Diluted $ 0.08 $ (0.36) $ (0.03) $ (0.45)
Weighted average shares outstanding:
Basic 9,573,529 7,854,178 9,381,673 7,785,579
Diluted 12,031,250 7,854,178 9,381,673 7,785,579
The accompanying notes are an integral
part of the consolidated financial statements
5
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Six Months
ended ended
March 31, 1998 March 31, 1997
-------------- ---------------
Cash flows from operating activities:
Net loss $ (184,744) $ (3,495,266)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 177,698 104,345
Common stock issued for services 0 40,500
Write-up of note receivable - related parties (562,500) (293,750)
Interest expense based upon issuance of convertible debt and warrants
at a discount 2,265,543 1,428,571
Amortization of deferred compensation related to stock options 446,047 548,698
Interest written off 15,151 0
Interest earned on notes receivable - related parties, collateralized by
common stock 0 (79,165)
Loss (gain) on sale of equipment (78,400) 4,196
Minority interest in net losses of consolidated subsidiaries (137,878) (360,670)
Increase (decrease) from changes in assets:
Receivables (384,162) 45,660
Inventories 270,908 (200,837)
Advances on inventory (902,808) (750,000)
Prepaid expenses and other current assets (172,568) (37,802)
Deposits and other assets (46,400) (91,368)
Accounts payable (403,988) 224,512
Due to related party, net (584,373) 0
Accrued liabilities (188,189) 184,681
Accrued contractor liability (420,500) 0
Accrued interest 124,951 0
Note payable for inventory 768,500 0
Deferred compensation 5,861 5,567
Deferred revenue from advance license fees 0 1,400,000
-------------- ---------------
Net cash (used in) provided by operating activities 8,149 (1,322,128)
-------------- ---------------
Cash flows from investing activities:
Cash paid for property, plant and equipment (21,677,713) (4,514,852)
Issuance of notes receivable (1,257,290) (49,456)
Equipment Deposit (238,000) 0
Advances on binder facility 790,703 0
Proceeds from notes receivable 0 24,728
Proceeds from notes receivable - related party 118,596 29,876
-------------- ---------------
Net cash used in investing activities (22,263,704) (4,509,704)
-------------- ---------------
Cash flows from financing activities:
Proceeds from issuance of limited partnership interests in subsidiaries 0 350,000
Distributions to limited partnership interests in subsidiaries 0 (292,000)
Proceeds from notes payable 16,338,073 4,710,721
Proceeds from notes payable - related party 0 109,470
Payments on notes payable (2,622) (260,713)
Payments on notes payable - related parties (342,508) 0
Proceeds from notes receivable - related parties, collateralized by common stock 301,829 103,000
Proceeds from issuance of preferred stock, (net) 90,005 0
Proceeds from issuance of common stock (net) 873,396 665,501
Proceeds from issuance of common stock to be issued (net) 198,263 0
Proceeds from receivable - stock subscriptions 577,500 0
-------------- ---------------
Net cash provided by financing activities 18,033,936 5,385,979
-------------- ---------------
Net decrease in cash (4,221,619) (445,853)
Total cash and cash equivalents, beginning of period 4,780,301 490,106
-------------- ---------------
Total cash and cash equivalents, end of period $ 558,682 $ 44,253
============== ===============
The accompanying notes are an integral
part of the consolidated financial statements
6
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Six Months
ended ended
March 31, 1998 March 31, 1997
-------------- ---------------
Supplemental schedule of noncash investing and financing activities:
Payable for briquetting facility $ 1,153,317 $ 1,402,940
Common stock issued on conversion of notes payable 7,000,000 138,396
Common stock issued for notes receivable - related party collateralized by
common stock 45,000 0
Notes receivable issued for sale of briquetting facility 6,500,000 3,500,000
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. 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 March 31, 1998 and September 30, 1997, the results of its
operations for the three months and six months ended March 31, 1998 and March
31, 1997 and its cash flows for the six months ended March 31, 1998 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, 1997 and the Company's Quarterly Report
included on Form 10-Q for the quarter ended December 31, 1997.
2. Earnings/Loss Per Share Calculation
During fiscal 1998 the Company adopted SFAS No. 128 "Earnings Per Share." Basic
earnings (loss) per share is computed based upon the weighted average number of
common shares outstanding. The computation of diluted earnings per common share
includes contingent issuances of securities that would have a dilutive effect on
earnings per share. Contingent issuances were antidilutive in each period for
which a net loss was reported; therefore, the amounts reported for basic and
diluted loss per share are the same for those periods. See Note 9.
3. Inventories and Advances on Inventories
Inventories and advances on inventories are stated at the lower of average cost
or market, and consist of synthetic fuel, binder materials, and coal fines.
4. Change in Estimate of Fair Value of Note Receivable
During the three and six months ended March 31, 1998, the Company decreased the
allowance for impairment on the $5,000,000 face value note receivable from two
stockholders by $270,000 and $562,500, respectively, to an adjusted loan value
of $2,152,500. During the three and six months ended March 31, 1997, the Company
increased and decreased the allowance by $(431,250) and $293,750, respectively.
The changes in the allowance were based on changes in the market value of the
Company's common stock that collateralizes the note receivable. The allowance is
subject to future fluctuations in the Company's common stock.
5. Notes Receivable
On November 14, 1997, the Company entered into a financial agreement with CoBon
Energy, L.L.C. (CoBon), relating to the purchase of equipment for a synthetic
fuel production facility. The original agreement provided that the Company will
purchase, on CoBon's behalf, up to $1 million worth of equipment for use in the
facility. Subsequently, the maximum amount of the financing was increased to
approximately $1,400,000 to provide for additional borrowings by CoBon. As
consideration for the loan, the Company will have the right to receive certain
royalties from the operations of the facility. If the facility is not completed
for any reason, the Company will retain title to the purchased equipment. The
Company has paid or incurred costs totaling $812,290 for equipment and has
loaned CoBon $445,000, bringing the total note receivable to $1,257,290 as of
March 31, 1998.
8
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
5. Notes Receivable, continued
On February 20, 1998, the Company sold the Alabama briquetting facilities to
Birmingham Synfuel, L.L.C., a wholly-owned subsidiary of PacifiCorp. The
purchase price was $6,500,000 and resulted in a gain of approximately $78,000.
The purchase price was paid with a note receivable that bears interest at 12%
and shall be repaid in equal consecutive quarterly installments, subject to
certain provision limitations, including the net operating cash flow from the
Alabama facility. All accrued interest and unpaid principal is due and payable
on February 20, 2003.
6. Advance on Binder Facilities
During the quarter ended March 31, 1998, the Company received advances of
approximately $490,000 from A.T. Massay, PacifiCorp, and CoBon for binder
facilities under construction, bringing total advances for binder facilities to
$790,703 as March 31, 1998.
7. Notes Payable and Convertible Debentures
A.J.G. Financial Services, Inc.
During October 1997, the Company entered into an agreement with A.J.G. Financial
Services, Inc. ("AJG") to provide financing of approximately $4,300,000 for the
building of a wash plant at an interest rate of 6%. In addition, the Company
granted warrants in an amount equal to 10% of the amount financed. Half of these
warrants have a strike price of $10 and half have a strike price of $20. Based
upon the market price of the Company's common stock on the date of the
agreement, $398,222 of interest expense was recognized due to the $10 warrants.
As of March 31, 1998, the Company had borrowed $4,325,433 under this
arrangement. The Company began start-up testing of the wash plant during April,
1998.
During the quarter ended March 31, 1998, the Company entered into an additional
agreement with AJG to borrow up to $6.5 million at an interest rate of 6% per
annum to be used for construction of a briquetting facility located in West
Virginia. As of March 31, 1998 the Company had borrowed $4,698,880 under this
agreement. The loan is due in full February, 2001.
PacifiCorp Financial Services, Inc.
During December 1997, the Company executed a Convertible Loan and Security
Agreement with PacifiCorp Financial Services, Inc. ("PFS"). The agreement
modifies an agreement finalized on March 20, 1997 which provides funding for
completing construction of the Alabama project, acquiring coal fines and for
other purposes related to the project. The modification increased the amount
available from $5,000,000 to $7,000,000 with a provision that borrowings up to
the lessor of actual borrowings or $6,000,000 are convertible into common stock
under the same terms as the original March 20, 1997 agreement (at a price of
$7.00 per share). Based upon the December 1997 amendment, an interest expense of
$714,286 was recognized during the quarter ended December 31, 1997 because the
conversion price is below the market price.
Effective March 3, 1998, PFS exercised their option to convert all outstanding
borrowings under this arrangement. The conversion of the borrowings in excess of
$6,000,000 resulted in an interest charge of $714,285 during the quarter ending
March 31, 1998 because the conversion price is below the market price. PFS also
asserted that the Company sold common stock during 1997 at a price that caused
the antidilution provisions of its conversion agreement with Covol to become
applicable. This resulted in the issuance of additional common stock with a
value of approximately $220,000. This amount was charged to interest expense
during the quarter ended March 31, 1998.
9
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
7. Notes Payable and Convertible Debentures, continued
DTE Energy Services, Inc.
In October 1997, the Company entered into a financial agreement with DTE Energy
Services, Inc. ("DTE") relating to the purchase of equipment for up to two
synthetic fuel production facilities. The agreement allows the Company to borrow
up to $2,000,000 with interest at LIBOR plus 1.0% (LIBOR was 6.69% on March 31,
1998). The Company has drawn $1,999,719 under the agreement as of March 31,
1998. These borrowings were repaid during May 1998.
Trans Pacific Stores
On March 17, 1998, the Company entered into a loan agreement with Trans Pacific
Stores, Ltd. ("TPS") wherein TPS agreed to loan the Company up to $4,000,000.
The loan is collateralized by future earned license fees payable to the Company
from the synthetic fuel manufacturing facilities constructed by Pace Carbon
Fuels, LLC. Interest on the outstanding principal balance accrues at twelve
percent (12%) per annum. The interest rate is adjusted to thirteen percent (13%)
on September 20, 1998 and to fourteen percent (14%) on December 20, 1998. Each
time the interest rate is adjusted, a one percent (1%) renewal fee of $40,000 is
due and payable. Interest on the unused portion of the borrowing will accrue
interest at one percent (1%) per annum until the loan is paid in full. The
outstanding principal and interest is due in full before March 20, 1999. As of
March 31, 1998, $530,300 had been borrowed under this arrangement. A member of
the Company's Board of Directors is affiliated with TPS.
Fun Enterprises
On January 29, 1998, the Company entered into a loan and security agreement with
Fun Enterprises, Pty Ltd. ("Fun"), a current holder of the Company's Class B
preferred stock, relating to the development and construction of a mobile,
skid-mounted synthetic fuel production facility at a coal preparation site of an
eastern coal company. The agreement allows the Company to borrow up to
$5,800,000. The interest rate will be 12% per annum until August 31, 1998, and
15% per annum thereafter until paid in full. Fun will also have the right to
receive certain royalties after the facility is sold. As of March 31, 1998 the
Company has drawn $3,100,000 on the loan. The loan is due in full at the earlier
of the sale of the facility or August 31, 1999.
10
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
7. Notes Payable and Convertible Debentures, continued
The following is a table summarizing notes payable and convertible debentures
previously discussed.
March 31, 1998 September 30, 1997
------------------- -----------------------
Note payable to a corporation, bearing interest at 6%
collateralized by plant and equipment. $ 4,325,433 $ 1,057,849
Note payable to a corporation, bearing interest at 6%. 50% of accrued
interest due February 26, 1999 and balance of accrued interest and principal
due February 26, 2001 4,698,880 -
Note payable to a corporation bearing interest at prime (8.5% at March
31, 1998) plus 2%. Collateralized by plant and equipment. Principal
and interest due December 20, 1999 2,813,294 2,787,255
Convertible note payable to a corporation, bearing interest at prime (8.50% at
March 31, 1998) plus 2%. Collateralized by plant, equipment and coal fines. Loan
of $6,686,473 plus accrued interest of $313,527 converted to common stock
March 20, 1997. - 3,302,422
Note payable to a corporation bearing interest at LIBOR plus 1.0%
(LIBOR was 6.69% on March 31, 1998). Amounts are due at the
earlier of the closing of alternative financing or December 31, 1998. 1,999,719 -
Note payable to a corporation. Interest on the outstanding principal balance
accrues at twelve percent (12%) per annum. The interest rate is adjusted to
thirteen percent (13%) on September 20, 1998 and to fourteen percent (14%) on
December 20, 1998. Each time the interest rate is adjusted, a one percent (1%)
renewal fee of $40,000 is due and payable. Interest on the unused portion of the
borrowing will accrue interest at one percent (1%) per annum until the loan is
paid in full. The balance and interest is due in full before March 20, 1999. The
loan is secured by future earned license fees. 530,300 -
Note payable to a corporation bearing interest at 12% per annum until August 31,
1998, and 15% per annum thereafter until paid. The loan
is due in full at the earlier of the sale of the facility or August 31, 1999 3,100,000 -
Note payable to an individual bearing interest at 9% with monthly
payments. 97,378 -
Convertible debenture to two individuals and one trust, bearing interest
at prime (8.5% at March 31, 1998) plus 2%. Principal and interest due
June 30, 1998. Convertible at $11.00 per share. 1,000,000 1,000,000
------------------- -----------------------
$18,565,004 $8,147,526
Less: current portion (3,536,679) (5,247,526)
------------------- -----------------------
Total non-current $15,028,325 $2,900,000
=================== =======================
11
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
8. Stockholders' Equity
The table below presents the activity in stockholders' equity from January 1,
1998 through March 31, 1998.
Notes and
interest
receivable
-related
parties
from
issuance
of, or Deferred
Preferred Stock Common Stock Common Stock to be issued collater- compen-
Capital in Capital in Capital in alized sation
excess of excess of excess of Accumulated by, common on stock
Shares Amount par value Shares Amount par value Shares Amount par value Deficit stock options
------ ------ --------- ------ ------ --------- ------ ------ --------- ------- ----------- -------
Balance at
January 1,
1998 315,882 $316 $5,184,626 9,210,575 $9,211 $47,058,967 0 $0 $0 ($33,307,951) ($7,701,088) ($4,475,756)
Common stock
issued for
cash from
exercise of
stock options 12,100 12 31,822
Common stock
to be issued
for cash from
exercise of
stock options 36,060 36 198,290
Conversion of
notes payable 1,000,000 1,000 6,999,000 27,000 27 219,348
Common stock
issued for
note receivable
- - - related
party, collater-
alized by
common stock 30,000 30 44,970 (45,000)
Cash received in
payment on
notes receivable
- - - related
parties from
issuance of
common stock 298,829
Compensation
expense
related to
issuance and
conversion of
stock options 3,500 3 36,310
Amortization of
deferred
compensation on
stock options 207,493
Interest earned
on notes
receivable
related parties
from issuance
of or collater-
alized by common
stock 15,461
Interest expense
based upon
issuance of
convertible debt
and warrants
at a discount 933,660
Write-up of note
receivable -
related parties (270,000)
Net income for
the quarter
ended March
31, 1998 931,651
------- ---- ---------- ---------- ------- ----------- ------ --- -------- ------------ ---------- ----------
Balance at
March 31, 1998 315,882 $316 $5,184,626 10,256,175 $10,256 $55,104,729 63,060 $63 $417,638 ($32,376,300)($7,701,798)($4,268,263)
======= ==== ========== ========== ======= =========== ====== === ======== =========== ========== ==========
12
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
9. Computation of Earnings (Loss) Per Share (EPS)
For the Three Months Ended March 31, 1998
Three months Six months
Basic earnings (loss) per share calculation ended ended
March 31, 1998 March 31, 1998
- - ---------------------------------------------------------------- ----------------------------- ---------------------------
Basic Diluted Basic Diluted
------------ ------------- ------------ ------------
Net income (loss) $ 931,651 $ 931,651 $ (184,744) $ (184,744)
============= ============
Preferred stock dividends accrued (84,413) (84,413)
------------ ------------
Net income (loss) basic EPS $ 847,238 $ (269,157)
============ ============
Number of common shares outstanding 10,256,175 10,256,175 10,256,175 10,256,175
Effect of using weighted average common
shares outstanding (682,646) (682,646) (874,502) (874,502)
------------ ------------- ------------ ------------
Weighted average number of common shares 9,573,529 9,573,529 9,381,673 9,381,673
Dilutive effect:
Common stock options 1,215,985 -
Common stock warrants 500,283 -
Convertible preferred stock 741,453 -
------------- ------------
Dilutive weighted average number of common
shares outstanding 12,122,154 9,381,673
============= ============
Options to purchase 1,663,500 shares of common stock at prices between $1.50 and
$11.50 per share were outstanding during the second quarter of fiscal 1998 and
were included in the computation of diluted EPS. For the quarter ended March 31,
1997, these options were not included in the computation of loss per share
because any effect would have been antidilutive.
Warrants to purchase 1,441,523 shares of common stock at prices between $7.00
and $10.00 per share were outstanding during the second quarter of fiscal 1998
and were included in the computation of diluted EPS. Additional warrants to
purchase 638,750 shares of common stock at prices between $15.00 and $30.00 per
share were outstanding during the second quarter of fiscal 1998 and were not
included in the computation of earnings per share because any effect would have
been antidilutive. For the quarter ended March 31, 1997, warrants were not
included in the computation of loss per share because any effect would have been
antidilutive.
Convertible debt of $1,000,000 was outstanding during the second quarter of
fiscal 1998. The debt is convertible into 90,909 shares of common stock and was
not included in the computation of diluted earnings per share because the effect
would have been antidiluted. For the quarter ended March 31, 1997, convertible
debt was not included in the computation of loss per share because any effect
would have been antidilutive.
13
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Preferred stock convertible into 741,453 shares of common stock at of $7.00 was
outstanding during the second quarter of fiscal 1998 and was included in the
computation of diluted EPS.
10. Contingencies
During 1996, the Company or its licensees entered into thirty contracts for the
construction of manufacturing facilities that would use the Company's
proprietary Briquetting Technology in the conversion of coal fines into
synthetic fuel. All of these construction contracts contain penalties if the
contracting party fails to proceed with the construction of these facilities.
Fifteen of these construction contracts were entered into by independent third
parties and Covol Technologies was not a party. Accordingly, no liability for
failing to proceed exists with these contracts. Four contracts were entered into
jointly by Covol and its joint venture partners. The remaining eleven are Covol
contracts. Of the contracts for which Covol has liability or shared liability
there are two joint venture facilities that will not be constructed and there
are three contracts where the facilities may not be constructed. As of September
30, 1997, the Company accrued a liability of $1,477,000 for these potential
penalties. During the first six months ended March 31, 1998, the Company paid
penalties in the amount of $102,500 and reversed $318,000 for a construction
contract where notice to proceed was subsequently given. Accordingly, as of
March 31, 1998, the remaining accrued contractor liability is $1,056,500.
In December 1996, the Company entered into six indemnification agreements in
connection with six of the construction contracts entered into by independent
third parties. These contracts contain liquidating damages of $750,000 per
contract if construction of the facilities is not completed by June 1, 1998. The
Company has indemnified the contractor for these potential liabilities. The
contracting party has decided not to construct three of these facilities.
Accordingly, the Company believes the maximum contingent liability under these
indemnification agreements is $2,250,000. As of the date of the current filing,
the three facilities were under construction that are the subject of the
indemnificaiton agreement. These facilities are mechancially complete and on
schedule for completion prior to June 1, 1998. The Company believes that payment
of this liability is unlikely and has, therefore, not recorded a liability for
these potential penalties.
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.,
filed a civil complaint against the Company alleging breach of the letter of
intent in the amount $500,000 plus damages. The case is currently in discovery
and the Company believes that it will be successful in defending the suit.
11. Subsequent Event
During May 1998, the Company obtained financing from two substantial entities to
be used for the completion of construction and working capital requirements of
the Mountaineer synthetic fuel facility. There is $8,500,000 of total funds
available under this arrangement including $500,000 for an advance licensing fee
for the Company's coal briquetting technology. As of May 7, 1998, $6,250,000 had
been received or was available. These funds have been used to payoff the DTE
loan totaling $1,999,719, pay advance licensing fees, cover construction costs
on the Mountaineer facility incurred to date and to fund necessary construction
costs through June 30, 1998 to be incurred in completion of the facility.
Additional funds will be made available as needed. The lenders have the option
to apply funds advanced towards the purchase of the facility.
On April 21, 1998 the Company entered into loan agreements with each Carbon
Resources and C.C. Pace Capital, L.L.C. (the "Borrowers"), to lend, in quarterly
installments, up to an aggregate principal amount not to exceed $14,250,000
during the period from and including November 1, 1998 to and including February
1, 2008. The Company has agreed to make the initial advance on November 1, 1998
in the amount of $375,000, or such other amounts as provided for in the loan
14
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
agreement, and thereafter on the first day of each February, May, August and
November during the loan period. Interest accrues on the principle amount of the
loan outstanding at a simple annual rate of six percent (6%). Repayment of the
loan shall be paid from amounts, if any, distributed to the Borrowers by the
General Partner of Pace Carbon Synfuels, L.P., which owns 100% of the
memberships in the Project Companies discussed below.
The Company also entered into Amended and Restated License and Binder Purchase
Agreements with each PC Virginia Synthetic Fuel #1, L.L.C., PC West Virginia
Synthetic Fuel #1, L.L.C., PC West Virginia Synthetic Fuel #2, L.L.C., PC West
Virginia Synthetic Fuel #3, L.L.C., (collectively the "Project Companies") as of
February 3, 1998. The Company is entitled to receive royalties under the terms
and as described in the Licensing Agreements. The Licensing Agreements provide
for a one-time advance license fee and earned royalty on a quarterly basis at a
prescribed amount multiplied by the MM btu content per ton of each product.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Results of Operations
Three months ended March 31, 1998 compared to the three months ended March 31,
1997
Revenues. For the quarter ended March 31, 1998, total revenues
increased by $5,586,487 to $5,610,698 from $24,211 for the quarter ended March
31, 1997. There were $3,586,000 in advance license fees recognized during the
quarter ended March 31, 1998 while no license fees were recognized during the
quarter ended March 31, 1997. Advance license fees are normally due when
construction of the related briquetting facility begins or when certain
construction milestones or other conditions are met. Advance license fees for
the quarter ended March 31, 1998 related to five briquetting facility contracts.
The Utah Plant was placed in service in early 1997. However, production and
sales of synthetic fuel were significantly curtailed due to the high levels of
ash content in feedstock used for production at the Utah Plant. To remedy the
problem of ash content, the Company has constructed a wash plant for the Utah
Plant that is currently going through start-up procedures. Accordingly,
synthetic fuel sales of $4,888 during the quarter ended March 31, 1998 were less
than the sales of $20,194 during the quarter ended March 31, 1997. The Company
believes that as the wash plant becomes operational, it will be able to supply
sufficient quality coal fines to the Utah Plant to allow the plant to operate
profitably at or near capacity. The Company has had various discussions with
potential end-users of the synthetic fuel product. However, there is currently
no contract or obligation in place for the sale of the synthetic fuel produced
at the Utah Plant. The Company received revenues from binder sales in the amount
of $84,602 for the quarter ended March 31, 1998 as compared to sales of $4,017
that were made in the quarter ended March 31, 1997. The Company expects binder
sales to increase proportionate to future synthetic fuel production and sales
increases. The Company received revenues from the sale of coal fines in the
amount of $1,903,553 for the quarter ended March 31, 1998 under an agreement to
sell the coal fines at their cost. The Company had revenues from operation and
maintenance fees of $31,655 for the quarter ended March 31, 1998 and no such
fees for the corresponding period in 1997.
Operating Costs and Expenses. Operating costs and expenses increased
$2,079,794 to $3,747,010 for the quarter ended March 31, 1998 from $1,667,216
for the quarter ended March 31, 1997. Operating costs and expenses attributable
to the briquetting operations increased $262,640 to $730,252 for the quarter
ended March 31, 1998 from $467,612 for the quarter ended March 31, 1997. The
costs for briquetting operations for the quarter ended March 31, 1998 were more
than for the quarter ended March 31, 1997 costs due to material, labor and other
costs for the increased refinement and implementation of the briquetting process
as the Company moves into commercial production levels at the Utah and Alabama
facilities. When Utah Synfuel #1, a Delaware limited partnership ("US #1"), and
the Company sold the Utah facility to Coaltech, US #1 entered into an agreement
to purchase synthetic fuel produced at the Utah Plant for costs incurred plus $1
per ton. The Utah Plant incurred significant costs for coal fines, labor, binder
materials, repairs and maintenance, equipment rental and other costs as it
worked through various production issues. These costs are included in the cost
of coal briquetting operations. As the wash plant moves towards normal
operational levels and efficiencies, the Company anticipates that the costs
incurred per ton of synthetic fuel produced will be more in line with the sales
value of the synthetic fuel and will reduce the net operating loss that results
from these operations. See "ITEM 1. BUSINESS--Business of Company--Utah Plant"
of the Company's Form 10-K. During the quarter ended March 31, 1998 the Company
incurred $1,903,553 in cost of coal fines sold under the arrangement discussed
in the previous paragraph.
Research and development costs increased $6,806 or 10% during the
quarter ended March 31, 1998 from $65,396 for the quarter ended March 31, 1997.
The Company expects continued research and development costs in its ongoing
efforts to refine further the Company's synthetic fuels and other technology.
Selling, general and administrative expense increased $728,325 or 172%
to $1,150,848 for the quarter ended March 31, 1998 from $422,523 for the quarter
ended March 31, 1997. The increase related to necessary personnel increases,
increased outside professional services relative to facility construction,
increased travel and transportation expenses incurred to monitor construction at
16
the numerous facility locations, increased expenses incurred to pursue financing
alternatives necessary to meet the Company's needs and general infrastructure
cost increases as the Company continues to grow and expand.
For the quarter ended March 31, 1998, increased expenses were partially
offset by a decrease in compensation expense resulting from the issuance of
stock and stock options as compared to the quarter ended March 31, 1997. The
decrease of $37,683 is attributable to a reduction in the use of stock and stock
options in compensating employees and consultants of the Company. The reduction
is also reflective of a general change in the Company philosophy regarding the
strike price for options granted. Generally, stock options that will be granted
by the Company in the future are not expected to be "in-the-money" at the date
of grant.
During the quarter ended March 31, 1998, the Company recorded a gain of
$78,401 on the sale of the Alabama facility as compared to a loss of $4,196 from
facility sales during the quarter ended March 31, 1997.
In fiscal 1996, the Company was required, under generally accepted
accounting principles, to adjust the $5 Million 6% promissory note (the "Note")
from the sale of Industrial Management and Engineering, Inc., State
Incorporated, Central Industrial Construction, Inc. and Larson Limestone
Company, Inc. (the "Construction Companies") to the ascertainable value of the
Company's common stock collateralizing the Note. This accounting treatment
resulted in a write-down of the note receivable by $2,699,575 in fiscal 1996.
For the quarter ended March 31, 1998, this adjustment resulted in a write-up of
the Note by $270,000 compared to a write-down of $431,250 for the quarter ended
March 31, 1997. The Note is guaranteed by the Buyers of the Construction
Companies and there has been no event of default or past due payment occur on
the Note. The Company has no reason to believe that the payments under the terms
of the Note will not be made.
Total Other Income and Expenses. For the quarter ended March 31, 1998,
the Company had other income totaling $247,888 and other expenses of $1,179,925
for net other expenses of $932,037. For the quarter ended March 31, 1997, the
Company had other income totaling $395,633 and other expenses of $1,568,592 for
net other expenses of $1,172,959. This decrease of $240,922 consisted
principally of a decrease in interest expense of $388,667 resulting from the
issuance of less convertible debt where the conversion price was "in-the-money".
The minority interest in the operations of the consolidated subsidiaries changed
by $290,307 as a result of the subsidiaries incurring smaller losses during the
quarter ended March 31, 1998 compared to the comparable period in 1997.
The Company has net operating loss carryforwards that are available to
offset future taxable income. Because the Company has not generated significant
revenues relating to the Briquetting Technology with corresponding net income,
no benefit has been recorded relative to the future utilization of the net
operating loss carryforwards. This benefit may be recorded in the near term if
the Company continues to realize net income.
Net Income. For the quarter ended March 31, 1998, the Company had net
income of $931,651 as compared with a net loss of $2,815,964 for the quarter
ended March 31, 1997 resulting in a net increase of $3,747,615 in net income.
This increase resulted primarily from a significant increase in total revenues,
and a significant decrease in interest expense offset by an increase in
operating costs and expenses, all as previously discussed.
Amended Form 10-Q. All financial information for the quarter ended and
six months ended March 31, 1997 and comparison between that period and the
corresponding period in 1998 are based upon the restarted financial statements
filed in the Company's Form 10-Q/A, Amendment No. 1 for the period ended March
31, 1997.
17
Results of Operations
Six months ended March 31, 1998 compared to the six months ended March 31, 1997
Revenues. For the six months ended March 31, 1998, total revenues
increased by $6,523,965 to $6,652,323 from $128,358 for the six months ended
March 31, 1997. There were $4,586,000 in advance license fees received during
the six months ended March 31, 1998 while no license fees were received during
the comparable period during 1997. Advance license fees are normally due when
construction of the related briquetting facility begins or when certain
construction milestones or other conditions are met. The Utah Plant was placed
in service in early 1997. However, production and sales of synthetic fuel were
significantly curtailed due to the high levels of ash content in feedstock used
for production at the Utah Plant. To remedy the problem of ash content, the
Company has constructed a wash plant for the Utah Plant that is currently going
through start-up procedures. Accordingly, synthetic fuel sales of $4,888 during
the six months ended March 31, 1998 were less than the sales of $124,341 during
the corresponding period ended March 31, 1997. The Company believes that, as the
wash plant becomes operational, it will be able to supply sufficient quality
coal fines to the Utah Plant to allow the plant to operate profitably at or near
capacity. The Company has had various discussions with potential end-users of
the synthetic fuel product. However, there is currently no contract or
obligation in place for the sale of the synthetic fuel produced at the Utah
Plant. The Company received revenues from binder sales in the amount of $91,605
for the six months ended March 31, 1998 as compared to sales of $4,017 that were
made during the six months ended March 31, 1997. The Company expects binder
sales to increase proportionate to future synthetic fuel production and sales
increases. The Company received revenues from the sale of coal fines in the
amount of $1,903,553 for the six months ended March 31, 1998 under an agreement
to sell the coal fines at their cost. The Company had operation and maintenance
fees of $66,277 for the six months ended March 31, 1998 and no such fees
revenues for the corresponding period in 1997.
Operating Costs and Expenses. Operating costs and expenses increased
$2,483,057 to $5,015,193 for the six months ended March 31, 1998 from $2,532,136
for the six months ended March 31, 1997. Operating costs and expenses
attributable to the briquetting operations increased $355,007 to $1,187,199 for
the six months ended March 31, 1998 from $832,192 for the six months ended March
31, 1997. The costs for briquetting operations for the six months ended March
31, 1998 increased when compared to the six months ended March 31, 1997 due to
material, labor and other costs for the increased refinement and implementation
of the briquetting process as the Company moves into commercial production
levels at the Utah and Alabama facilities. During the six months ended March 31,
1998 the Company incurred $1,903,553 in costs for coal fines sold under the
arrangement previously discussed.
Research and development costs increased $57,430 or 34% during the six
months ended March 31, 1998 from $170,463 for the six months ended March 31,
1997. The Company expects continued research and development costs in its
ongoing efforts to refine further the Company's synthetic fuels or other
technologies.
Selling, general and administrative expense increased $661,565 or 54%
to $1,891,402 for the six months ended March 31, 1998 from $1,229,837 for the
six months ended March 31, 1997. The increase related to necessary personnel
increases, increased outside professional services relative to facility
construction, increased travel and transportation expenses incurred to monitor
construction at the numerous facility locations, increased expenses incurred to
pursue financing alternatives necessary to meet the Company's needs and general
infrastructure cost increases as the Company continues to grow and expand.
For the six months ended March 31, 1998, compensation expense resulting
from the issuance of stock and stock options decreased by $143,151 as compared
to the six months ended March 31, 1997. The decrease is attributable to
reduction in the use of stock and stock options in compensating employees and
consultants of the Company. The reduction is also reflective of a general change
in the Company philosophy regarding the strike price for options granted.
Generally, stock options that will be granted by the Company in the future are
not expected to be "in-the-money" at the date of grant.
During the six months ended March 31, 1998 the Company recognized a
gain of $78,401 on the sale of the Alabama facility as compared to a loss of
$4,196 from facility sales during the six months ended March 31, 1997.
18
For the six months ended March 31, 1998, the adjustment relative to the
note received from the sale of the Construction Companies resulted in a write-up
of the Note by $562,500 compared to a write-up of $293,750 for the six months
ended March 31, 1997. The Note is guaranteed by the Buyers of the Construction
Companies and there has been no event of default or past due payment on the
Note. The Company has no reason to believe that the payments under the terms of
the Note will not be made.
Total Other Income and Expenses. For the six months ended March 31,
1997, the Company had other income totaling $542,980 and other expenses of
$1,634,468 for net other expenses of $1,091,488. For the six months ended March
31, 1998, the Company had other income totaling $470,558 and other expenses of
$2,292,432 for net other expenses of $1,821,874. This increase in expenses of
$730,386 consisted principally of an increase in interest expense of $657,964
resulting from the issuance of convertible debt where the conversion price was
"in-the-money". The minority interest in the operations of the consolidated
subsidiaries changed by $222,792 as a result of the subsidiaries having smaller
losses during the six months ended March 31, 1998 compared to the comparable
period in 1997.
Net Income. For the six months ended March 31, 1998, the Company had a
net loss of $184,744 as compared with a net loss of $3,495,266 for the six
months ended March 31, 1997 resulting in a net decrease in the loss of
$3,310,522. This decrease resulted primarily from a significant increase in
total revenues and was offset by smaller increases in operating costs and
expenses, and an increase in other expenses of $730,386.
Liquidity and Capital Resources
For the six months ended March 31, 1998, management believes the
Company made significant progress in its movement from continued development and
refinement of the Company's proprietary technology to commercial operations. The
decrease in cash used by the Company in operating activities from $(1,322,128)
for the six months ended March 31, 1997 to $(229,851) for the six months ended
March 31, 1998 was largely due to the decrease in the net loss of $3,495,266 for
the six months ended March 31, 1997 compared to $184,744 for the six months
ended March 31, 1998. This decrease was offset by $1,400,000 of advanced license
fees that were received during the six months ended March 31, 1997 that were
deferred.
The Company made cash payments for property, plant and equipment of
$21,677,713 during the six months ended March 31, 1998. These additions related
to the wash plant at the Utah facility, three synthetic fuel facilities, a
second line at the Utah facilities, binder plants and briquetting equipment.
Except for the wash plant, the Company plans on selling these assets to third
parties. This investment was funded by cash available at September 30, 1997 of
$4.8 million and proceeds from the issuance of notes payable of $16.3 million.
The Company believes it will be able to meet future cash flow needs through
additional issuances of notes payable, issuances of equity securities and from
cash generated by operations.
During December 1997, the Company executed an amendment to the
Convertible Loan and Security Agreement with PacifiCorp Financial Services, Inc.
("PFS"). The agreement modifies an agreement reached on March 20, 1997 which
provides funding for completing construction of the Alabama project and
acquiring coal fines and for other purposes related to the project. The
modification increased the amount available from $5,000,000 to $7,000,000 with a
provision that borrowings up to the lessor of actual borrowings or $6,000,000
are convertible into common stock under the same terms as the original March 20,
1997 agreement (at a price of $7.00 per share). As of March 3, 1998, PacifiCorp
exercised its option to convert the full amount owing under the loan into shares
of common stock. The Company had borrowed $6,686,473 and interest of $313,527
had been accrued. An agreement was reached between the Company and PacifiCorp
which allowed them to convert the full $7,000,000 owing under the loan into
1,000,000 shares of common stock. The Company also issued 27,000 shares to PFS
under antidilution provisions of this agreement.
On March 6, 1998 the Company and Alabama Synfuel #1 completed the sale
of a synthetic fuel briquetting plant in Birmingham, Alabama ("Alabama Plant")
to PacifiCorp under the terms of the Project Purchase Agreement dated March 20,
1997 and as subsequently amended. The purchase price for the facility was
$6,500,000 and was paid with a note that bears interest at twelve percent (12%)
per annum. The promissory note executed by PacifiCorp to the Company is
collateralized by the Alabama Plant.
19
In October 1997, the Company entered into an agreement with AJG
Financial Services, Inc. ("AJG"), whereby AJG agreed to provide financing for
the wash plant being constructed by the Company to provide washed coal fines to
the Utah Plant. The financing consists of a note bearing interest at 6% per
annum with principal and interest due and payable two years from the time the
debt is incurred. As additional consideration to AJG for the financing, the
Company agreed to grant warrants to purchase Company common stock in an amount
equal to 10% of the dollar amount financed, with fifty percent of the shares
having a purchase price of $10 per share and fifty percent of the shares having
a purchase price of $20 per share. The warrants are immediately exercisable and
expire in two years.
As of March 31, 1998, the Company had a working capital deficit of
$5,057,626, compared to a working capital deficit of $3,195,420 at September 30,
1997. This increase resulted primarily from construciton financing of
briquetting facilities with short-term financing. At March 31, 1998, the Company
owned three facilities that were in various stages of construction. The Company
expects to sell the majority of these facilities and recoup its investment and
retire the related borrowings. The Company believes that additional advanced
license fees to be received, and, if necessary, available financing will be
sufficient to fund the operations of the Company until cash flows from
operations are sufficient to fund the Company's operations. However, there is no
assurance that the Company will be able to obtain the necessary financing or
receive sufficient cash flows from operations during fiscal year 1998.
The Company anticipates that cash flow from: (i) licensing and royalty
fees from plants utilizing the Briquetting Technology; (ii) the sale of chemical
binder to plants utilizing the Briquetting Technology; (iii) operating fees for
the operation of facilities owned by third parties; (iv) payments on notes
receivable and (v) proceeds of equity and debt offerings will be available and
used to fund working capital and other operating needs through fiscal 1998.
In the third and fourth quarters of the fiscal year ending September
30, 1998, the Company anticipates payments of advance license fees for each site
utilizing the Company's Briquetting Technology, except for the Savage Mojave
project. The timing for and amount of such fees varies and is tied to the
commencement of construction, the completion of construction, the receipt of an
IRS Private Letter Ruling ("PLR") for a particular project, receipt of project
financing or the sale of a facility. Since these conditions should be met no
later than September 30, 1998, all such advance license fees, if any, will be
earned by the end of the fiscal year ending September 30, 1998.
The Company anticipates license fees from the production and sale of
synthetic fuel from the Utah Plant, Alabama Plant and Savage Mojave project, if
any, after the second quarter of fiscal year 1998. The balance of the
briquetting facilities licensing the Briquetting Technology are expected to be
placed into service during the third quarter of 1998. Accordingly, the Company
expects that there will be earned license fees payable from production and sales
from these plants beginning during the third quarter of 1998, but are not
expected to be significant until late 1998 or early 1999.
Advance license fees and ongoing license fees attributable to the Utah
Plant and the Alabama Plant are payable to US #1 and AS #1, respectively. The
Company would receive its share of such license fees, net of partnership
expenses, in the form of cash distributions in proportion to the Company's
interests in the partnerships, 63% for US #1 and 74% for AS #1.
The Company has contracted with its licensees to provide binder
materials on a cost plus basis. The Company expects to have increased sales of
binder materials to the Utah Plant and the Alabama Plant in the third quarter of
fiscal year 1998. As previously mentioned, the balance of the synthetic fuel
facilities that will be utilizing the Briquetting Technology are expected to be
placed in service late in the third quarter of the fiscal year ending September
30, 1998. The Company expects to earn the gross profit from the sale of binder
to these other plants when they commence production and in amounts that are
proportionate to their production.
Under current contracts, the only facility for which the Company has
operational responsibility is the Utah Plant. The Company will earn a prescribed
amount per ton for product at this facility. The Company expects that there
could be other plants for which the Company will have operational responsibility
20
and for which it will earn an operation and maintenance fee. The Company does
not expect that operation and maintenance fees will constitute a material
portion of its revenues in the future.
The Company intends to seek additional project specific financing for
the completion of construction for certain synthetic fuel facilities. That
financing is expected to be in the form of traditional debt financing, debt with
an interest in the cash flow attributable to the facility being financed, or
financing by a potential purchaser of the facility. Facilities being built by
licensees of the Company's technology will generally be financed by such
licensees. There is no assurance that the Company or its licensees will be able
to obtain the necessary financing to complete the construction of the synthetic
fuel facilities currently in process.
Existing Debt Arrangements
In November 1996, the Company issued convertible subordinated
debentures in the principal amounts of $300,000, $200,000 and $500,000 to Mr.
Douglas M. Kinney, Mr. Gordon L. Deane and the Douglas M. Kinney 1999 Retained
Annuity Trust, respectively. The convertible subordinated debentures accrue
interest at prime plus two percent (2%) with interest and principal payable in
full on June 30, 1998. All or a portion of the unpaid principal due on the
debenture is convertible into Company common stock at $11 per share. Through a
separate subscription agreement, the Company has granted piggy-back registration
rights to the investors for Company common stock issued upon conversion of the
convertible subordinated debentures. The Company has the right to prepay the
principal of the convertible subordinated debentures.
In December 1996, the Company entered into a Debenture Agreement and
Security Agreement with AJG, whereby the Company borrowed $1,100,000, pursuant
to a Convertible Subordinated Debenture accruing interest at 6% per annum and
maturing three years from its date of issuance (the "Subordinated Debenture")
and $2,900,000 pursuant to Senior Debentures accruing interest at prime plus two
percent (2%) and maturing three years from the date of issuance (the "Senior
Debenture"). The Subordinated Debenture (including accrued interest) was
converted to 140,642 shares of the Company's common stock on May 5, 1997. The
Company has granted piggy-back and demand registration rights to AJG for the
Company common stock issued on conversion of the Subordinated Debenture. The
Senior Debentures are collateralized by all real and personal property purchased
by the Company with the proceeds of the Senior Debenture. The proceeds of the
Subordinated Debenture and the Senior Debenture were used to satisfy contractual
obligations of the Company, for working capital and to purchase equipment used
to construct briquetting facilities to be managed and/or sold by the Company or
affiliates of the Company.
The Company is constructing a wash plant to provide washed coal fines
to the Utah Plant for the manufacture of synthetic fuel. A portion of the
construction is being financed through AJG. The total estimated cost for the
wash plant is approximately $7.7 Million. As of March 31, 1998, the Company had
borrowed $4,325,433 under its arrangement with AJG. The financing is evidenced
by a promissory note executed and delivered by the Company to AJG and is secured
by the wash plant. The note currently bears interest at 6% per annum with
principal and interest due and payable two years from the time the debt was
incurred. As additional consideration to AJG for the financing, the Company
agreed to grant warrants to purchase Company common stock in an amount equal to
10% of the dollar amount financed, with fifty percent of the shares having a
purchase price of $10 per share and fifty percent of the shares having a
purchase price of $20 per share. The warrants are immediately exercisable and
expire in two years.
On March 20, 1997, the Company entered into a Convertible Loan and
Security Agreement (the "Loan Agreement") with PacifiCorp. On December 12, 1997,
the Company and PacifiCorp amended the Loan Agreement. Under the amended Loan
Agreement terms, the Company may borrow up to $7,000,000 as evidenced by a draw
down promissory note (the "Promissory Note") payable to PacifiCorp. As of March
3, 1998 the Company had drawn $6,686,473 under the Loan Agreement and interest
of $313,527 had accrued. Principal and accrued interest on the Promissory Note
are due and payable on August 31, 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
21
the Alabama Plant; (ii) finance the purchase of coal fines for the Alabama
Plant; (iii) fund the net working capital needs of the Alabama Plant; (iv)
finance the development and construction of a wash plant for coal fines; and (v)
other uses related to the Alabama Plant 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. On May 5,
1997, PacifiCorp filed a Schedule 13D with the Securities and Exchange
Commission reporting its beneficial ownership as being in excess of 5% of the
shares of Company common stock should PacifiCorp convert the full amount of the
Loan. On March 3, 1998, PacifiCorp exercised its option to convert the full
amount of $7,000,000 owing under the loan into 1,000,000 shares of common stock
plus an additional 27,000 shares pursuant to anti-dilution provisions of the
loan agreement. 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 were acquired by PacifiCorp pursuant to the Loan
Agreement.
During the quarter ended March 31, 1998, the Company entered into an
interim construction financing agreement with DTE Energy Services, Inc. to
finance up to $2 Million for the Company's purchase of equipment and payment of
other project development costs relating to certain facilities. As of May 1998,
approximately $1,999,720 has been advanced under this financing agreement. The
Company's obligation to repay the amounts borrowed is collateralized by the
assets purchased with the proceeds of the financing. Interest accrues on the
amount advanced at a per annum rate equal to the LIBOR rate plus 1% adjusted
monthly. The principal amount of the financing is payable upon the closing of a
take-out construction loan or December 31, 1998, whichever occurs first. The
company repaid these borrowings during May 1998. See "ITEM 1. BUSINESS--Business
of Company--Other Construction Agreements--Major Utility" of the Company's Form
10-K.
On March 20, 1998 the Company entered into a loan and security
agreement with Fun Enterprises, Pty Ltd. ("Fun"), a current holder of the
Company's Class B preferred stock, relating to the development and construction
of a mobile, skid-mounted synthetic fuel production facility at a coal
preparation site of an eastern coal company. The agreement allows the Company to
borrow up to $5,800,000. The interest rate will be 12% per annum until August
31, 1998, and 15% per annum thereafter until paid. Fun will also have the right
to receive certain royalties after the facility is sold. As of the date of this
filing the Company has drawn $5,120,000 under this arrangement. The loan is due
in full at the earlier of the sale of the facility or December 31, 1999. The
Company has entered into a letter of intent with the eastern coal company to
provide feedstock for the plant, to operate the plant, and to provide synthetic
fuel sales services. Construction of the facility has commenced.
On March 17, 1998, the Company entered into a loan agreement in which
Trans Pacific Stores, Ltd. ("TPS") agreed to loan the Company up to $4,000,000.
The loan is secured by future earned license fees payable to the Company
resulting from the synthetic fuel manufacturing facilities constructed by Pace
Carbon Fuels, LLC. Interest on the outstanding principal balance accrues at
twelve percent (12%) per annum. The interest rate is adjusted to thirteen
percent (13%) on September 20, 1998 and to fourteen percent (14%) on December
20, 1998. Each time the interest rate is adjusted, a one percent (1%) renewal
fee of $40,000 is due and payable. Interest on the unused portion of the
borrowing will accrue interest at one percent (1%) per annum until the loan is
paid in full. The balance and interest is due in full before March 20, 1999. As
of March 31, 1998, $530,300 had been borrowed under this arrangement. A member
of the Company's Board of Directors is affiliated with TPS.
22
Forward Looking Statements
Statements regarding the Company's expectations as to the financing,
development and construction of facilities utilizing its Briquetting Technology,
the receipt of licensing fees, operating revenues and other information
presented in this Quarterly Report on Form 10-Q that are not purely historical
by nature, including those statements regarding the Company's future business
plans, the construction and estimated completion of facilities, the estimated
capacity of facilities, the availability of coal fines, the marketability of the
synthetic fuel and other briquettes and the financial viability of the proposed
facilities, 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 Company's industry or the coal industry or the economy
generally, factors which could cause actual results to differ from expectations
set forth in the above-identified forward looking statements include, but are
not limited to, the following:
(i) The commercial success of the Briquetting Technology.
(ii) Procurement of necessary equipment to place
facilities into operation.
(iii) Securing of necessary sites, including permits and
raw materials, for facilities to be constructed and
operated.
(iv) Timely construction and completion of synthetic fuel
facilities, by the placed-in-service date June 30,
1998.
(v) Ability to obtain needed additional capital on terms
acceptable to the Company.
(vi) Changes in governmental regulation or failure to
comply with existing regulation which may result in
operational shutdowns of its facilities.
(vii) The availability of tax credits under Section 29 of
the Internal Revenue Code of 1986, as amended
("Section 29").
(viii) The commercial feasibility of the Briquetting
Technology upon the expiration of Section 29 tax
credits.
(ix) Ability to meet financial commitments under existing
contractual arrangements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
PART II- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On June 26, 1997, Kirby Cochran, former President of the Company
during the period from September 1995 through May 1996, filed a complaint
against the Company in the Fourth Judicial District for Utah County, State of
Utah (Civil No. 970400507). The complaint alleged that Mr. Cochran was entitled
to a declaratory judgment awarding him options to purchase 600,000 shares of the
Company's stock and $50,000 as repayment of a purported loan. The complaint
further alleged claims of conversion, fraud, and breach of contract related to
the stock options and loan. Finally, the complaint alleged a claim for punitive
damages and other unspecified special or general damages. The Company filed a
petition to remove the action to the United States District Court for the
District of Utah (Civil No. 2:97CV0587G). On November 13, 1997, the parties
entered into a Settlement Agreement whereby Kirby Cochran agreed to release the
Company from all claims made by the lawsuit in exchange for payment on the
purported loan of $50,000.
In January 1996, a manager of the Company entered property owned by
NEICO, a subsidiary of Nevada Power Corporation, in connection with an offer by
the Company to purchase the property, and with certain other employees of the
Company, removed and contained over a two-day period some asbestos. The manager
allegedly failed to follow federal guidelines governing the handling and removal
of asbestos. This action was reported to the Division of Environmental Quality
for the State of Utah. An investigation followed in which the Company was fined
23
approximately $11,000 and was required by the State of Utah to properly dispose
of the asbestos using a qualified asbestos removal company. In the fall of 1997,
the Environmental Protection Agency began a review of the case and is currently
looking into the advisability of further claims or fines against the manager
and/or against the Company.
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 case is currently in discovery and the Comapny beleives that it
will be successful in defending the suit.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Recent Sales of Unregistered Securities
The following sets forth all 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.
However, the Company did pay finders fees in the form of cash, stock or warrants
in connection with various securities issued.
The issuance of qualified options is required to be based on market
value. Accordingly, the exercise price is set based on the market price of the
Company's common stock, even though the options convert into restricted stock.
The Company believes that the following issuances of shares of
common stock or securities for contingency issuable common stock were exempt
from the registration requirements of the Securities Act of 1933, as amended,
pursuant to the exemption set forth in section 4(2) or 4(6) therefor and
Regulation D and the certificate for each security bears a restricted legend.
In July 1997, the Company granted unqualified options to acquire
10,000 shares to Don Danks and options to acquire 10,000 to Mike Vanderhoof as a
finders fee in connection with a private placement. The exercise price is $7.00
per share. The options were actually issued in January of 1998.
In September 1997, the Company granted unqualified options to
acquire 25,000 shares to Don Danks and 25,000 shares to Mike Vanderhoof as a
finders fee in connection with a private placement. The exercise price is $9.00
per share. The options were actually issued in January of 1998.
In February 1998, the Company granted qualified options under the
Company's Stock Option Plan to acquire 20,000 shares each to two key employees
of the company. The exercise price is $11.50 per share.
In February 1998, the Company issued 37,500 shares of the Company
common stock in exercise of options at $1.50 per share to certain officers and
directors. The consideration was paid in cash.
In February 1998, the Company granted options to acquire 3,500
shares to a former employee of the Company as compensation for past services at
$1.50 per share. Said options were exercised in the same month. Accordingly, the
Company issued 3,500 shares of the Company common stock in exercise of the
options. The consideration was paid in cash.
In February 1998, a consultant of the Company exercised options
previously granted at $1.50 per share. The Company issued 3,600 shares of the
Company common stock in exercise of these options. Subsequent to the end of the
quarter an additional 16,400 shares were issued. The consideration was paid in
cash.
24
In March 1998, PacifiCorp exercised their option to convert
$7,000,000 owing under a convertible loan into shares of common stock. On March
3, 1998, 1,000,000 shares of the Company common stock were issued in
satisfaction of this loan. Subsequent to the end of the quarter, an additional
27,000 shares of the Company's common stock were issued pursuant to certain
antidilution provisions of the loan agreement.
In February 1998, the Company issued 1,000 shares of common stock
to certain accredited investors in exercise of warrants at $8.00 per share. The
consideration was paid in cash. Subsequent to the quarters end, an additional
85,117 shares of common stock were issued to certain accredited investors in
exercise of warrants at $8.00. The consideration was paid in cash. The warrants
were originally issued with units privately placed on September 30, 1997 and
October 13, 1997.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
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) 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.
10.50.1* Form of Amended and Restated License and Binder
Purchase Agreement dated February 3, 1998 between
PC Virginia Synthetic Fuel #1, PC West Virginia
Synthetic Fuel #1, PC West Virginia Synthetic
Fuel #2, PC West Virginia Synthetic Fuel #3 and
Covol Technologies Inc.
10.50.2* Loan Agreement between C.C. Pace Capital, L.L.C.
and Carbon Resources, Inc. and Covol
Technologies, Inc. dated April 21, 1998.
10.50.3 Security Agreement between C.C. Pace Capital,
L.L.C. and Carbon Resources, Inc. and Covol
Technologies, Inc. dated April 21, 1998.
Exhibit 27.1 Financial Data Schedule
* Exhibits contain 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) Reports on Form 8-K
A report on Form 8-K was filed on March 23, 1998.
25
SIGNATURE
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.
Date: March 18, 1999
COVOL TECHNOLOGIES, INC.
By: /s/ Brent M. Cook
------------------------------------------
Brent M. Cook, Chief Executive Officer and
Principal Executive Officer
By: /s/ Steven G. Stewart
------------------------------------------
Steven G. Stewart, Chief Financial Officer
26