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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------
FORM 10-K
For Annual and Transition Reports
Pursuant to Sections 13 or 15(d)
of the Securities Exchange Act of 1934
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
[NO FEE REQUIRED]
For the fiscal year ended September 30, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
[NO FEE REQUIRED]
For the transition period from .............. to ..............
Commission file number 0-27803
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COVOL TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 87-0547337
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3280 North Frontage Road
Lehi, Utah 84043
(Address of principal executive offices) (Zip Code)
(801) 768-4481
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Covol Technologies, Inc. Common Stock, $.001 par value
(Securities are traded on the OTC Bulletin Board under the symbol "CVOL")
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 ___
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K [ ].
The aggregate market value of the voting stock held by non-
affiliates of the registrant on December 1, 1996 was $101,167,500.
The number of shares outstanding of each of the registrant's
classes of common stock as of December 1, 1996 was 8,895,542.
-----------------------------------
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following documents are incorporated herein by reference:
None.
TABLE OF CONTENTS
Page
PART I
ITEM 1. BUSINESS................................................. 1
ITEM 2. PROPERTIES............................................... 14
ITEM 3. LEGAL PROCEEDINGS........................................ 15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...... 17
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS..................................... 17
ITEM 6. SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA......... 20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.................... 23
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA............. 28
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE................. 28
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT...... 28
ITEM 11. EXECUTIVE COMPENSATION.................................. 31
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT.......................................... 38
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.......... 41
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, AND REPORTS ON
FORM 8-K................................................ 43
2
PART I
ITEM 1. BUSINESS
The Company
The primary business of Covol Technologies, Inc. (the
"Company") is to commercialize patented and proprietary technologies used to
recycle waste by-products from the coal and steel industries into a marketable
source of fuel and revert materials in the form of briquettes (the "Briquetting
Technology"). The Company has three plants, consisting of one prototype
briquetting plant and two commercial plants. The prototype briquetting plant,
located in Price, Utah, was built in 1992 and has produced commercial quantities
of coal, coke and revert material briquettes. The Company has two commercial
briquetting plants, one coke and revert material plant which produces coal, coke
and revert material products, located in Vineyard, Utah (referred to herein as
the "Geneva Plant"), and one synthetic coal plant, located in Price, Utah
(referred to herein as the "Utah Plant"). The Geneva Plant is operational,
however the primary contract for the sale of briquettes expired on December 31,
1996. See "BUSINESS--Business of Company--Geneva Plant. The Utah Plant is also
operational, and commenced commercial operations in December of 1996. The
Company is in the process of attempting to secure financing for additional
plants which will utilize the Briquetting Technology. See "BUSINESS--PacifiCorp"
and "BUSINESS--Gallagher."
The Company was originally incorporated in Nevada in 1987
under the name Cynsulo, Inc. In 1988 the Company consummated an initial public
offering of its common stock in Nevada in which the Company sold 200,000 shares
for $20,000. At the time of such public offering, the Company was engaged in no
material business activities. In December 1988, the Company acquired all of the
issued and outstanding shares of McParkland Corporation ("McParkland") and
changed its name to McParkland Properties, Inc. McParkland invested in
discounted notes and contracts through the Federal Deposit Insurance
Corporation. In 1989, management became aware of certain irregularities relating
to the original purchase of two loan packages. As a result of an investigation
conducted by management, the purchase of McParkland was rescinded in February
1990, and the Company's name was changed to Riverbed Enterprises, Inc. In
August, 1990, the Company's focus was changed to the growing and marketing of
certain agricultural products, primarily alfalfa. In 1991, the Company acquired
technology regarding binding agents used to make briquettes. The Company shifted
its focus to the research and development of better and stronger binding agents
which resulted in patenting the Briquetting Technology. The Company then changed
its focus from its agricultural business and devoted its primary efforts to the
development and commercialization of the Briquetting Technology. The Company's
name was changed to Enviro-Fuels Technology, Inc. in July 1991, to Environmental
Technologies Group International in 1994, and to Covol Technologies, Inc. in
August 1995, at which time the Company was reincorporated in Delaware.
In order to generate cash flow to support research and
development for the Briquetting Technology, in 1993, the Company acquired three
construction companies engaged in providing contracting and construction
services to the steel, copper and other heavy industries. The companies were
Industrial Management and Engineering, Inc. ("IME"), State Incorporated
("State") and Central Industrial Construction, Inc. ("CIC"). Additionally, in
1994, the Company acquired Larson Limestone Company, Inc. ("Larson"), which
mines, produces and markets limestone products for industrial applications. IME,
State, CIC and Larson are collectively referred to as the "Subsidiaries."
In September 1995, the Company made a strategic decision to
focus its efforts exclusively on commercializing the Briquetting Technology and
to divest itself of its Subsidiaries. Accordingly, on February 1, 1996, the
3
Company entered into a Share Purchase Agreement ( the "Agreement") with Michael
McEwan and Gerald Larson, former principals of the Subsidiaries (the "Buyers"),
to sell all of the common shares of the Subsidiaries to Buyers for a $5,000,000
promissory note (the "Note"). Mr. McEwan is the son of Lloyd C. McEwan, a former
director of the Company. The Note is collateralized by 100,000 shares of stock
of the Company owned by Buyers and is payable together with interest at 6% per
annum as follows: interest only for the first year payable on or before January
31, 1997; principal and interest are payable annually with the Note amortized
over a fifteen year period commencing February 1, 1997 with the first payment
due January 31, 1998; and all unpaid principal and interest payable January 31,
2000. The Company will have voting control over the shares securing the Note
until the Note has been paid. The Company agreed to make a capital contribution
to the Subsidiaries in the amount of approximately $3,500,000 to pay down
accounts payable, accrued liabilities and lines of credit of the Subsidiaries.
The Company paid the $3,500,000 required to close under the Agreement and closed
on September 26, 1996. There have been continuing discussions regarding accounts
payable in an amount estimated at between $300,000 and $650,000 that were not
apparent at the time the Agreement was entered into. The Company has accrued
$650,000 in the September 30, 1996 financial statements. In addition, the Buyers
have verbally committed to pledge an additional 100,000 shares of stock of the
Company owned by Buyers to secure payment of the Note. The Company expects to
reach final settlement with the Buyers by January 31, 1997. There is no
assurance that the Company will be able to finalize all matters relating to the
sale by January 31, 1997. The terms of the Agreement were arrived at by arm's
length negotiations between the parties and approved by the nonaffiliated
members of the Board of Directors and the stockholders of the Company.
Effective January 1, 1994, the Company changed its fiscal
year-end from December 31 to September 30. Effective June 14, 1995, the Company
implemented a one-for-twenty reverse stock split. Effective January 23, 1996 the
Company implemented a two-for-one forward stock split. Except as otherwise
indicated, all information set forth herein has been adjusted to give effect to
such stock splits.
The Company is dependent on raising sufficient capital to
finance its expansion plans and working capital requirements until October 1997.
The Company intends to finance its capital needs through the receipt of down
payments on the sale of future plants, license fees and royalties from the sale
of its first full scale briquetting facility and from commercial loans and
equity placements. No assurances can be made that the Company will be able to
raise sufficient capital or operate profitably.
Business of Company
The Company has developed the Briquetting Technology to
recycle waste by-products from the steel and coal industries into a marketable
source of fuel and revert material in the form of briquettes. During the
steel-making process, steel mills produce, among other waste by-products, revert
materials (small particles containing iron-rich materials). Coke breeze is a
very fine residue resulting from the production and storage of coke, a coal
derivative used in the steel making process. During the coal mining process,
coal fines (small coal particles ranging from dust size to less than 1/4" in
diameter) are produced. These waste materials have historically presented a
disposal problem for steel and coal producers, who may incur substantial costs
in complying with federal and state environmental laws and regulations relating
to their storage and disposal.
The Briquetting Technology employs pressure and chemical
agents to bind coke breeze, coal fines and other revert materials into
briquettes. The coke and coal briquettes produced through use of the Briquetting
Technology are suitable for industrial and commercial use and are comparable to
high grade newly-mined coal and formed coke. The revert material briquettes
4
produced through use of the Briquetting Technology are further processed in
reducing furnaces to reclaim iron and other materials. The revert processed
through use of the Briquetting Technology is comparable to scrap iron, a common
form of raw material used by the United States steel-making industry (as opposed
to newly-mined iron ore). The Company believes that its coke and coal briquettes
and reclaimed iron can be produced and marketed at prices which are competitive
with newly-mined coal, formed coke and other sources of scrap iron. Moreover,
the Company believes that the Briquetting Technology will be attractive to steel
and coal producers in addressing the environmental issues surrounding the
disposal of waste by-products generated in the production process.
The Company's fundamental business strategy has been to
commercialize the Briquetting Technology through joint ventures, licenses and
collaborative arrangements with steel, coke and coal producers or investors to
build and equip briquetting plants on-site at the producers' facilities.
Geneva Plant. In May 1995, the Company entered into a
collaborative agreement with Geneva Steel Company ("Geneva") to build and
operate a commercial briquetting plant in Vineyard, Utah defined above as the
Geneva Plant. That agreement was amended and restated in May, 1996. Pursuant to
the Amended and Restated Briquetting Services Agreement and Lease Agreement with
Geneva (collectively, the "Geneva Agreements") Geneva has provided the Company
with a building containing approximately 9,000 square feet. The Company equipped
the building to serve as a coal, coke and revert material briquetting plant. The
Company estimated that the Geneva Plant's initial capacity was 15 tons of
briquettes per hour or approximately 100,000 tons per year. Geneva provided the
Company with revert materials and the Company was obligated to produce and
deliver to Geneva briquettes conforming to agreed-upon specifications and in
agreed to quantities. Geneva bears all transportation costs with respect to
delivery of revert materials to the Geneva Plant and the shipment of briquettes.
Pursuant to the Geneva Agreements, the Company began producing briquettes in May
1996, and produced approximately 24,600 tons of revert briquettes by December
31, 1996 at the Geneva Plant. The Company has made various adjustments and
improvements to the plant to satisfy emissions and air quality standards
administered by the Utah State Division of Air Quality. Although the Geneva
Agreements expired on December 31, 1996, the Company continues to produce
briquettes for purchase by Geneva. Upon the expiration of the Geneva Agreements,
the lease of the building housing the plant also expired resulting in a
tenancy-at-will between the parties.
Limited Partnerships. In June 1996, the Company formed Utah
Synfuel #1, Ltd. ("Utah Synfuel #1") and Alabama Synfuel #1, Ltd. ("Alabama
Synfuel #1"), each a Delaware limited partnership (collectively the
"Partnerships"). The respective Partnerships are intended to (i) purchase a
nonexclusive license from the Company for the Briquetting Technology, (ii)
purchase a coal briquetting facility from the Company and (iii) sell such
facility to a third party purchaser. Utah Synfuel #1 intends to purchase the
coal briquetting Utah Plant and Alabama Synfuel #1 intends to purchase the coal
briquetting Birmingham, Alabama plant (the "Alabama Plant"). The Company will
grant to each of the Partnerships a non-exclusive license to use the Briquetting
Technology with respect to coal for a fee of $500,000 (totalling to $1,000,000).
The Company intends to retain at least a 60% interest in Utah Synfuel #1 and up
to an 83% interest in Alabama Synfuel #1. The Company has privately placed the
remaining partnership interests in the Partnerships. Specifically, the Company
received $3,277,500 ($3,080,000 at September 30, 1996) for the remaining
partnership interests in Utah Synfuel #1 and $1,762,500 ($1,305,000 at September
30, 1996) for the remaining partnership interests in Alabama Synfuel #1.
Notably, the Company is currently analyzing whether the original disclosure
provided to investors should be supplemented. The Company may decide to revise
the information in the original private placement memorandums for those
offerings, and may offer to such investors the opportunity to rescind their
purchases. If all such investors rescind, the Company would be required to pay
up to $5,040,000 ($4,385,000 at September 30, 1996) plus applicable interest
less the amount of income received thereon.
5
The Company has used a portion of the funds raised in the
Partnerships to purchase equipment for each of the plants. The Utah Plant has
been completed and commenced commercial operations in December of 1996. The
Alabama Plant is expected to be completed by June 1997. However, no assurances
can be made that the completion date for the Alabama Plant will be met.
The Company, as general partner for the Partnerships, is
currently negotiating transactions with potential buyers of the Utah Plant and
Alabama Plant, which is yet to be constructed or acquired. The Company believes
that the sale of the Utah Plant and Alabama Plant would include (i) a $500,000
sublicensing fee (which would be paid by the buyer to the Partnership in
exchange for the license of the Briquetting Technology), (ii) a royalty payment
to the Partnership based on per ton amount to be agreed on with the buyer, and
(iii) a promissory note delivered by the buyer in payment of the purchase price,
which would be payable to the Partnership from the cash flow of such plant. The
Company and Alabama Synfuel #1 have entered into a letter of intent with an
unregulated subsidiary of PacifiCorp, a large low-cost electric and telephone
utility, to sell the Alabama Plant to be constructed or acquired by Alabama
Synfuel #1, on substantially the terms listed above. See "BUSINESS--PacifiCorp"
for more information regarding the terms of the PacifiCorp letter of intent. The
PacifiCorp purchase transaction is subject to various conditions and no binding
agreement has been entered into. The Company and Utah Synfuel #1 have also
entered into a letter of intent with Arthur J. Gallagher & Co., an international
insurance brokerage and risk management services firm, to sell the Utah Plant,
to be acquired by Utah Synfuel #1 on substantially the terms listed above. See
"BUSINESS--Gallagher" for more information regarding the terms of the Gallagher
letter of intent. The Gallagher purchase transaction is also subject to various
conditions and no binding agreement has been entered into. No assurances can be
made that any of the plants being constructed or acquired by the Partnerships
will be sold.
Under the organizational documents of the Partnerships, the
Company is entitled to distributions from the Partnerships according to the
Company's percentage interest in the net distributable cash flow of the
Partnerships. The Company may also enter into loading agreements and operating
and maintenance agreements that would provide for payments directly from the
buyer of a plant. The binder materials used to produce the briquettes will
likely be sold to the buyer of a plant by the Company based on the Company's
cost plus an agreed upon percentage profit.
Greystone Joint Venture. In June 1995, the Company entered
into a license agreement (the "Greystone Joint Venture Agreement") with
Greystone Environmental Technologies, Inc. ("Greystone") to form a 50/50 joint
venture (the "Greystone Joint Venture") to commercialize and exploit the
Briquetting Technology for the production of coke and revert material
briquettes. The Greystone Joint Venture Agreement was amended on January 3,
1996. The Greystone Joint Venture has an exclusive world-wide license to
commercialize and exploit the Briquetting Technology for the production of coke
briquettes and a license to commercialize and exploit the Briquetting Technology
for the production of revert material briquettes in the Alabama and Gary,
Indiana regions. The Geneva Plant is not a part of the Greystone Joint Venture
or the Greystone Joint Venture Agreement.
The Greystone Joint Venture will be on a 50/50 basis, except
in the Gary, Indiana region where Greystone has a 12% interest in the entity
with an opportunity to increase its interest to a maximum of 20%. Greystone will
manage the Greystone Joint Venture on a day-to-day basis and the parties have
agreed to contribute the necessary capital to the Greystone Joint Venture in
proportion to their respective interests therein. The Greystone Joint Venture
will purchase all of its requirements for binding agents used in the Briquetting
Technology from the Company. Greystone is a newly-formed company, although its
principals have significant experience in the steel and coke production
industries.
6
In accordance with the Greystone Joint Venture Agreement,
Greystone made an initial payment of $100,000 to the Company, and was required
to make additional payments out of profits or capital of the Greystone Joint
Venture until a total aggregate of $500,000 had been paid to the Company for the
license. Greystone has failed to make the additional payments required under the
Greystone Joint Venture Agreement and, accordingly, has received notice that an
event of default has occurred thereunder. The Company believes that an uncured
event of default under the Greystone Joint Venture Agreement results in a
termination of the license.
As of December 1996, the Greystone Joint Venture has not
secured funding to proceed with the development and operation of any plants. The
Company believes that Greystone is continuing to seek funding.
Coal Venture. On January 30 1996, the Company entered into a
letter of understanding with CoBon Energy, L.L.C. ("CE"), a Utah professional
services company based in Salt Lake City, Utah, to form five entities to
commercialize and exploit the Briquetting Technology for the production of coal
briquettes (the "Coal Venture"). In August 1996, CE and the Company modified the
letter of understanding. Under the modified letter of understanding, the Company
has agreed to give CE a 1.6% interest in Alabama Synfuel #1, plus a license to
use the Briquetting Technology for specified plant locations up to an aggregate
capacity of 1.5 million tons of coal per year for each plant location. In
consideration for the interest in Alabama Synfuel #1 and the license, CE is
required to make a one-time payment of (i) $2.00 per ton for the production of
coal in the range of 500,001 to 1,000,000 tons and (ii) $2.50 per ton for the
production in the range of 1,000,001 to 1,500,000 tons. CE has not yet built any
plants which utilize the Briquetting Technology.
Business Strategy
Coke and Revert Material Briquettes. Subject to possible
termination of the license under the Greystone Joint Venture Agreement (as
explained above), the Company has agreed to exclusively market through the
Greystone Joint Venture the Briquetting Technology as it applies to coke. The
Greystone Joint Venture intends to market such technology to steel and coke
producers for the production of coke briquettes. The Company has also agreed to
exclusively market through the Greystone Joint Venture the Briquetting
Technology as it applies to revert material in the Gary, Indiana and Alabama
regions of the United States. With respect to the revert briquettes, the Company
may market the Briquetting Technology in other regions directly or through other
joint ventures or other arrangements. The Company, directly or through the
Greystone Joint Venture, will seek to enter into collaborative arrangements with
steel and coke producers to build, equip and operate briquetting plants on-site
at the producers' facilities. The Company believes that such arrangements will
benefit both the Company and steel and coke producers because they will (i)
provide the Company with an ongoing supply of inexpensive coke breeze and revert
materials while ensuring a ready customer for the briquettes produced, (ii)
provide the steel or coke producer with an economical means to dispose of waste
materials while providing a ready source of briquettes and/or iron feedstock,
and (iii) minimize transportation costs for waste by-products, raw materials and
briquettes, thereby increasing the economic competitiveness of the Company's
products.
The operations of the Geneva Plant will allow the Company to
show an operating on-site plant to assist in the establishment of other similar
sites throughout the United States. There is no assurance that such plant will
be profitable or that the Company, either directly or through the Greystone
Joint Venture, will be able to enter into comparable arrangements with other
steel and coke producers or to obtain the funding necessary to construct such
plants.
7
Coal Briquettes. The Company intends to build and place in
service plants which utilize the Briquetting Technology at or near coal fine
deposits. The Company intends to sell such plants to third parties. The Company
will license to each plant the use of the Briquetting Technology for a royalty
payment and will provide to each plant the binding agents. The contract will
provide that the payment for the binding agents will be at cost plus a mark up
to be negotiated between the plant owner and the Company. There is no assurance
the Company will be successful in funding the construction of the plants or in
operating any plants.
In June 1996, the Company formed Utah Synfuel #1 and Alabama
Synfuel #1, the Partnerships, which are intended to purchase, manage and sell
the coal briquetting Utah Plant and Alabama Plant. As described above, the
Company is conducting negotiations for the sale of these facilities by the
Partnerships. See "BUSINESS--Business of Company--Limited Partnerships." The
Company has retained brokers to locate potential buyers for plants that may be
constructed by the Company or its subsidiaries. See "BUSINESS--AGTC Brokerage
Disagreement." The Company has not entered into any binding agreements to sell
either the Utah Plant or the Alabama Plant.
The Company will not sell the Briquetting Technology but will
license it for use at each plant and contract with each plant to supply the
binding agents. The Company intends to contract with third party chemical
companies for the mixing and production of the binding agent. At the point at
which the Company has sufficient volume demand it intends to manufacture the
binding agent at a facility or facilities to be established.
Construction Agreements
In December 1995, the Company entered into a design and
construction agreement with Lockwood Greene Engineers, Inc. ("Lockwood") to
design and build the Utah Plant. The Company paid Lockwood an advance payment of
$500,000 on the facility on February 9, 1996. The total cost of the Utah Plant
to the Company is expected to be $3,600,000. Lockwood and the Company have
agreed to cooperate with each other in future projects by either party in the
field of coal agglomeration or metallic recovery. Also in December 1995, the
Company entered into additional contracts to design and build additional
facilities with Lockwood, each of which were subsequently terminated by the
Company in 1996 with all applicable cancellation charges either satisfied or
settled.
In December 1996, the Company entered into a total of thirteen
design and construction agreements (the "1996 Construction Agreements") for the
design and construction of eleven new coal fines agglomeration facilities and
the retrofiting of two existing facilities (the Utah Plant and Geneva Plant).
Depending upon the specific agreement, the contractor is either TIC The
Industrial Company, CEntry Constructors, L.C. or Centerline Engineering
Corporation, a Lockwood Greene Company. Under two of the 1996 Construction
Agreements, the Company is a joint owner with Ferro Resources, L.L.C. The 1996
Construction Agreements are subject to numerous conditions and no assurances can
be given that the Company will be successful in financing or constructing any of
the thirteen facilities. The 1996 Construction Agreements generally require that
a notice to proceed be issued by the Company (and its co-owner, if any) on or
before September 30, 1997 and that the plant be placed in service by June 30,
1998. An advance payment of $250,000 is due at the time a notice to proceed is
issued by the Company (and its co-owner, if any). The 1996 Construction
Agreements may be terminated at the Company's (and co-owner's, if any) option
with a penalty of 6% of the total contract price, if established, or the
guaranteed maximum price if the total contract price is not established. If the
Company is unsuccessful in obtaining financing or otherwise fails to construct a
facility, a penalty would be owed to the contractor. If this were to occur on
all thirteen facilities, the Company would be required to pay an aggregate
penalty of $3,012,000.
8
Indemnification to Lockwood
In December 1996, the Company entered into six indemnification
agreements with Lockwood whereby the Company agreed to indemnify Lockwood should
it be required to pay liquidated damages to certain third party owners under
various design and construction agreements for six coal agglomeration
facilities. Under the various design and construction agreements, if the
facilities are not completed by June 1, 1998 then $750,000 in liquidated damages
would be due and payable. The indemnification agreement will only apply if the
third party owners actually decide to build the facilities with Lockwood as the
design/builder. The maximum amount of contingent liability to the Company under
the indemnification agreements is $4,500,000 ($750,000 per design and
construction agreement). If triggered, the payments under the indemnification
agreements would not be due and owing until June 2, 1998.
PacifiCorp
In September 1996, the Company and Alabama Synfuel #1 entered
into a letter of intent with an unregulated subsidiary of PacifiCorp, a large,
low-cost electric and telephone utility, to purchase the coal briquetting
Alabama Plant that will be built and/or acquired by Alabama Synfuels #1. The
letter of intent generally provides for an entity designated by PacifiCorp to
purchase the Alabama Plant from Alabama Synfuel #1 (or to purchase Alabama
Synfuel #1's right to acquire the Alabama Plant) for a one-time $500,000
licensing fee, a promissory note in the amount of $3,400,000, that will be
payable out of the cash flow of the plant, and a per ton royalty fee. The
Company may retain up to an 83% interest in Alabama Synfuel #1 and would be
entitled to its percentage share of all cash distributed by Alabama Synfuel #1.
The letter of intent also provides for a convertible loan from
PacifiCorp to the Company in an amount up to $5,000,000. PacifiCorp would retain
a security interest in all of the assets related to the Alabama Plant. The loan
if made, may be convertible into Company common stock. The Company common stock
received upon conversion would be subject to piggy-back and demand registration
rights.
The obligations of PacifiCorp and its affiliates are subject
to PacifiCorp, the Company and Alabama Synfuel #1 entering into definitive
agreements. PacifiCorp will also require favorable tax rulings from the IRS and
completion of the Alabama Plant prior to consummating the purchase of the Plant.
The funding of the loan is subject to entering into the definitive agreements
and the filing of a request for tax rulings from the IRS, which the Company
believes will be complete by approximately January 31, 1997.
In December 1996, PacifiCorp and the Company entered into an
additional agreement for the construction of six additional facilities beyond
the Alabama Plant. Pursuant to this agreement, PacifiCorp has entered into
binding agreements with a third-party for the construction of the additional
facilities. Additionally, PacifiCorp has committed $250,000 per plant for a
total of $1.5 million to the entities through which PacifiCorp will build the
facilities. The commitment was made to facilitate the construction of the
facilities with the third-party. All of the facilities will utilize the
Briquetting Technology under license agreements with the Company. See
"BUSINESS--Recent Licensing Agreements."
Gallagher
In November 1996, the Company and Utah Synfuel #1 entered into
a letter of intent with Arthur J. Gallagher & Co., an international insurance
brokerage and risk management services firm, to purchase the Utah Plant that
will be acquired by Utah Synfuels #1. The letter of intent generally provides
9
for an entity designated by Gallagher to purchase the Utah Plant from Utah
Synfuel #1 (or to purchase Utah Synfuel #1's right to acquire the Utah Plant)
for $2,500,000 (payable upon the satisfaction of certain performance
conditions), a one-time $500,000 licensing fee and a per ton royalty fee that
will be payable out of the cash flow of the Utah Plant. The Company may retain
approximately a 60% interest in Utah Synfuel #1 and would be entitled to its
percentage share of all cash distributed by Utah Synfuel #1.
The obligations of Gallagher and its affiliates are subject to
Gallagher, the Company and Utah Synfuel #1 entering into a definitive agreement.
In December 1996, Gallagher and the Company entered into an additional
agreement to construct four additional facilities beyond the two plants
contemplated by the letter of intent. Pursuant to this additional agreement,
Gallagher entered into binding agreements with a third-party to construct the
additional facilities. All of the facilities will utilize the Briquetting
Technology under license agreements with the Company. See "BUSINESS--Recent
Licensing Agreements."
In December 1996, the Company entered into a Debenture
Agreement and Security Agreement with AJG Financial Services, Inc., an affiliate
of 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
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. The Subordinated Debenture is
subordinated and junior in right to all other existing indebtedness of the
Company which is not expressly pari passu with or subordinated to the
Subordinated Debenture. Finally, the Company has granted piggy-back and demand
registration rights to AJG Financial Services, Inc. for the Company common stock
issued upon conversion of the Subordinated Debenture.
On January 2, 1997, the Company borrowed $588,683 of the
$2,900,000 draw down amount described above. In consideration for the amount
drawn down, the Company issued a Senior Debenture in such amount accruing
interest at prime plus two percent (2%) and maturing three years from the date
of issuance (the "Senior Debenture"). The Senior Debenture is 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 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.
Alabama Power Company
In April 1996, the Company entered into a sale and purchase
agreement for coal with Alabama Power Company. Under the agreement, the Company
has agreed to process coal into coal briquettes and to sell such briquettes to
Alabama Power Company at a base price per ton, plus or minus certain
adjustments, for a period of five years commencing on January 1, 1997. According
to the agreement, Alabama Power Company is required to purchase a base tonnage
of 250,000 tons per year until December 31, 1999. There are numerous conditions
and obligations to be performed by both parties prior to January 1, 1997 and on
an ongoing basis before coal briquettes are required to be purchased by Alabama
10
Power Company. Given the delays associated with the financing and construction
of the Alabama Plant, the Company is now in technical default under the
agreement. It is uncertain what actions Alabama Power Company will take, if any,
in response to the default.
Port Hodder
In September 1996, the Company entered into a purchase
agreement with E. J. Hodder and Associates, Inc. for the purchase of a certain
land leasehold interest and equipment consisting of a barge loading facility
servicing the Warrior River located at the Alabama Plant. The total purchase
price for the facility is $927,000 consisting of $342,000 in cash and $585,000
of Company common stock. The land lease commenced on September 1, 1996 and
expires on May 23, 1998 with rights to extend to May 23, 2006. The Company
intends to use the facility in connection with the operations of the Alabama
Plant.
K-Lee Supply Agreement
In September 1996, the Company entered into a supply agreement
with K-Lee Processing, Inc. and Concord Coal Recovery Limited Partnership for a
continuous supply of coal fines to the Alabama Plant. Under this agreement, the
Company is obligated to purchase a minimum of 20,000 tons of coal fines per
month, commencing upon the completion of the Alabama Plant and expiring on
December 1, 2001, at a fixed price per ton during the first year (subject to
adjustment for moisture and ash content) with an escalating price thereafter.
AGTC Brokerage Disagreement
In accordance with an April 1996 letter agreement between the
Company and AGTC, a partnership formed by AGTC, Inc., Alpine Coal Company, Inc.
and E. J. Hodder & Associates, Inc., AGTC was engaged by the Company on a best
efforts basis, to investigate, identify and participate in the selection of (i)
project sites for the construction of suitable coal extrusion manufacturing
facilities for the Company, (ii) suitable coal fines reserves and (iii) suitable
users or consumers of the coal product produced. The compensation for such
services consisted of a monthly retainer of $35,000 and a commission of 8% on
the gross sales or monetized price of a project. In the fourth month following
the execution of the letter agreement a dispute arose among the parties
regarding AGTC's performance and compensation due under the agreement.
Accordingly, the Company terminated the agreement pursuant to its terms. AGTC
subsequently claimed that it was entitled to a commission on the proposed sale
of the Alabama Plant. The Company, on the advice of counsel, believes that
AGTC's claim has no merit.
Savage Mojave
In November 1996, the Company signed a primary contract with
Savage Industries, Inc. ("Savage") to form up to two limited liability companies
("LLCs") to be owned 50% by Savage and 50% by the Company, with each LLC
entering into a contract with Savage, the Company and a qualified third party
contractor for the design, construction, start-up and certification of a coal
fines agglomeration facility. All profits and losses of the respective LLCs
shall be borne by Savage and the Company according to their respective ownership
interest. Savage has the right but not the duty to operate the facilities and to
provide transportation of the raw materials and the briquettes. The Company in
turn will (i) provide its license to the binding process (at no cost) and (ii)
provide the binder required to produce the briquettes on a cost plus basis.
Performance under the agreement is subject to numerous conditions, including,
but not limited to establishing a criteria for the design of such facilities and
satisfaction of the Section 29 Tax Credit provisions of the Internal Revenue
Code of 1986, as amended.
11
In November 1996, the Company also entered into an agreement
with Savage whereby the Company agreed (i) to license the Briquetting Technology
to a limited liability company, to be formed by Savage and Flyash Haulers, Inc.,
for a monthly licensing fee based upon each ton of qualified fuel produced, all
relating to a briquetting facility to be located in Laughlin, Nevada, (ii) to
provide, upon request, coal fines to the limited liability company, (iii) to
provide technical assistance to the limited liability company, and (iv) to
reimburse to Savage, from the monthly license fees, an amount equal to 16% of
the cash capital required to upgrade the Laughlin, Nevada facility. The Company
does not expect to receive monthly license fees until mid 1997. No assurances
can be made that Savage will be successful in the production and sale of
synthetic coal. The agreement expires by its terms on December 31, 2009.
Recent Licensing Agreements
In December 1996, the Company entered into agreements with
various third parties for the licensing of the Briquetting Technology. Such
third parties are not expected to construct the facilities utilizing the
Briquetting Technology until late calendar year 1997. While the Company may
receive some advance license fees,the Company does not expect to receive the
majority of the licensing fees from such agreements until the facilities have
been placed into operation. In addition, the Company will receive royalty
payments based on production and sales at the facilities.
The Briquetting Technology
The Company has developed a special binding formula, which
allows for the production of high-grade briquettes which withstand degradation
both during shipment and the burn cycle. In simplified terms, in the briquetting
process, the material to be briquetted may be washed to remove impurities. The
material is then mixed with the binding agent and fed into a briquetter, which
utilizes indirect pressure to combine the feed material into a briquette having
the desired shape, size and density. Briquettes are then air-cured to achieve
maximum strength. Waste coke breeze, coal fines and other revert material
discharged from the briquetter are also recaptured and recycled. Cured
briquettes are expelled onto a continuous belt for handling. The briquetting
process takes approximately two hours to complete.
Substantially all the equipment and machinery used in the
briquetting process are commercially available. The Company has arrangements
with certain manufacturers for the supply of a portion of the equipment and
machinery but there can be no assurance that the Company will be able to acquire
all necessary equipment and machinery on terms acceptable to the Company.
Proprietary Protection
The Company has received three United States patents and has
two United States patent applications pending (one of which received a notice of
allowance in October 1996) and two international patent applications under the
Patent Cooperation Treaty covering certain aspects of the Briquetting
Technology. There can be no assurance as to the scope of protection afforded by
the patents. Moreover, there are other industrial waste recycling technologies
in use and others may subsequently be developed, which do (or will) not utilize
processes covered by the pending patents. There can be no assurance that any
patent issued will not be infringed or challenged by other parties, infringe
against patents held by other parties or that the Company will have the
resources to enforce any proprietary protection afforded by the patent or defend
against an infringement claim.
In addition to patent protection, the Company also relies on
trade secrets and know-how and employs various methods to protect the
Briquetting Technology. However, such methods may not afford complete protection
12
and there can be no assurance that others will not independently develop such
know-how or obtain access to the Company's know-how, concepts, ideas and
documentation. Since the Company's proprietary information is important to its
business, failure to protect its trade secrets may have a material adverse
effect on the Company.
Research and Development
The Company has devoted significant research and development
efforts to the refinement and commercialization of the Briquetting Technology.
The Company's research and development expenses were approximately $387,000,
$1,265,000 and $1,044,000, respectively, in the nine months ended September 30,
1994, and the years ended September 30, 1995 and September 30, 1996. The Company
at the present time is developing other related technologies to implement in
steel mills and other mineral industries. In addition, the Briquetting
Technology is being refined to apply to the commercial operations in the Geneva
Plant.
Construction and Limestone Businesses
In order to generate cash flow to support research and
development for the Briquetting Technology, in 1993 the Company acquired IME,
State and CIC, three construction companies engaged in providing contracting and
construction services to heavy industry. In addition to the foregoing, in 1994
the Company acquired Larson, which provides limestone products for industrial
applications. The Company believes that the relationships between its
Subsidiaries and their customers assisted the Company in exploring and
developing relationships with steel producers in connection with the
commercialization of the Briquetting Technology.
The Company's construction and limestone businesses accounted
for substantially all of its revenues and cash flow during the nine months ended
September 30, 1994 and the year ended September 30, 1995.
In September 1995, the Company made a strategic decision to
focus its efforts exclusively on commercializing the Briquetting Technology and
to divest itself of its Subsidiaries. On September 26, 1996, the Company
substantially completed the divestiture of its Subsidiaries. See
"BUSINESS--Business of Company--General".
Government Regulation
General. The Company's present and proposed briquetting
operations are subject to federal, state and local environmental regulations
that impose limitations on the discharge of pollutants into the air and water
and establish standards for the treatment, storage and disposal of waste
products. In order to establish and operate its briquetting plants, the Company
will be required to obtain various state and local permits. The Company has
obtained all permits required to date, believes that it will be able to obtain
future permits without inordinate difficulty or expense and that it is in
substantial compliance with all material laws and regulations governing the
briquetting operations. The Company believes that environmental compliance for
its new briquetting plant at the Geneva facility will not entail significant
costs. However, the Company's briquetting operations may entail risk of
environmental damage and the Company may incur liabilities in the future arising
from the discharge of pollutants into the environment or its waste disposal
practices. See "ITEM 3--LEGAL PROCEEDINGS--Utah Division of Air Quality."
Failure to obtain necessary permits to construct and operate
future briquetting plants could have a material adverse effect on the Company,
and other developments, such as the enactment of more stringent environmental
13
laws and regulations, could require the Company to incur significant capital
expenditures. If the Company does not have the financial resources or is
otherwise unable to comply with such laws and regulations, such failure could
also have a material adverse effect on the Company.
The Company's construction and limestone products businesses
were also governed by extensive environmental and occupational safety laws and
regulations. The Company believes that it was in substantial compliance with all
such material laws and regulations while it owned the Subsidiaries. There can be
no assurance that failure to comply with applicable laws and regulations,
whether in existence or subsequently enacted would not have a material adverse
effect on the Company.
Tax Credit
Section 29 of the Internal Revenue Code of 1986, as amended
(the "Code") provides a credit (the "Section 29 Credit") against the regular
federal income tax, measured by unrelated party sales by a taxpayer of qualified
fuels, including solid synthetic fuel produced in the United States from coal,
the production of which is attributable to the taxpayer. Where more than one
person has an interest in a production facility, the Code provides generally
that the attributable production is determined by allocation among the
interested persons in proportion to their interests in gross sales.
In order to be a solid synthetic fuel produced from coal for
purposes of the Section 29 Credit, the produced fuel must differ significantly
in chemical composition, as opposed to physical composition, from the
alternative substance used to produce it. The Company has received a private
letter ruling from the Internal Revenue Service (the "Service") in which the
Service, based on representations made to it, agrees that the Briquetting
Technology, as explained to the Service, results in a significant chemical
change to waste coal fines and transforms them into a solid synthetic fuel, and
accordingly the Service concludes, based on the facts presented to it, that (i)
the Company, with the use of its patented process, produces a "qualified fuel"
within the meaning of Section 29(c)(1)(C) of the Code, and (ii) assuming the
other requirements of Section 29 are met, the sale of the "qualified fuel" will
entitle the Company to claim the Section 29 Credit in the taxable year of sale.
In its ruling, the Service noted that no temporary or final regulations
pertaining to one or more of the issues addressed in the ruling have been
adopted and that the ruling will be modified or revoked by the adoption of
temporary or final regulations to the extent the regulations are inconsistent
with any conclusions in the ruling. The Service notes, however, that a private
letter ruling from the Service is not revoked or modified retroactively, except
in rare and unusual circumstances, provided certain criteria are satisfied,
including that (i) there has been no misstatement or omission of material facts,
(ii) the facts at the time of the transaction are not materially different from
the facts on which the letter ruling was based, (iii) there has been no change
in the applicable law, (iv) the letter ruling was originally issued for a
proposed transaction and (v) the taxpayer directly involved in the letter ruling
acted in good faith in relying on the letter ruling, and revoking the letter
ruling retroactively would be to the taxpayer's detriment.
The Section 29 Credit is also subject to the passive activity
rules of Section 469, and therefore will generally not be available to
individuals and closely held corporations.
The Section 29 Credit is equal to $3.00 in 1979 dollars (or
$5.83 in 1995 dollars) for each oil barrel equivalent ("OBE") of the qualifying
fuel produced and sold. This equates to approximately $25.00 per ton of coal
briquettes. The OBE is defined generally as an amount of fuel having a 5.8
million Btu content. The Section 29 Credit allowed may not exceed the taxpayer's
regular tax liability reduced by certain other credits. The credit cannot be
utilized to offset the Alternative Minimum Tax.
14
The Section 29 Credit was designed to provide protection for
qualifying fuels against market price declines, and it is therefore subject to a
phaseout (under an annually adjusted formula) after the unregulated oil price
reaches specified levels. In 1994 dollars, the credit would have phased out had
the reference price for oil exceeded $45.14 per barrel, but the reference price
determined for 1994 was $13.19, and no phaseout occurred. In 1995 dollars, the
credit would have phased out had the reference price for oil exceeded $46.00,
but the reference price determined for 1995 was $14.62 and no phaseout occurred.
There presently is no reference price for 1996. The credit is also subject to by
reduction insofar as an otherwise qualifying facility benefits from grants or
subsidized financing provided by federal, state or local governments, or from
tax-exempt bond financing.
During 1996, the time periods applicable to Section 29 tax
credits were extended. The Section 29 Credit will, under present law, be
available for sales completed by December 31, 2007 to the extent attributable to
production from facilities placed in service by June 30, 1998, provided that
such facilities are constructed pursuant to a binding written contract in effect
by December 31, 1996. Unless the Section 29 credit is extended, the Company will
be limited to the 1996 Construction Agreements which were entered into by
December 31, 1996. See "BUSINESS--Construction Agreements."
Section 29 of the Code contains no provision for carryback or
carryforward of Section 29 Credits. Once earned, however, the nonconventional
fuel credits are not subject to subsequent recapture. By virtue of the various
limitations and other factors described above, there can be no assurances that
any particular amount of Section 29 Credit will be allowable and usable.
Competition
The Company may experience substantial competition from other
alternative fuel technology companies, as well as companies that specialize in
the disposal and recycling of waste products generated by steel, coal and coke
production. Many of these companies have greater financial, technical,
management and other resources than does the Company. The Company believes that
key factors in its ability to compete will be the quality of its briquettes and
their pricing compared to other sources of coal, coke and scrap iron. The
Company anticipates that it will be able to compete favorably in these regards
although there can be no assurance that it will do so successfully.
Employees
The Company currently employs approximately 28 persons
full-time. Approximately 9 of such persons are in corporate administration, and
19 are in briquetting operations, including research, development and marketing.
None of such employees are covered by a collective bargaining agreement. In
connection with the establishment and operation of each briquetting plant, the
Company will seek to hire between eight to ten persons, principally in
operations.
The discontinuation of the limestone and construction business
has resulted in a material decrease in the number of persons employed since
November, 1995. Since that time, there has been a reduction of approximately 200
employees in the discontinued limestone and construction business due to layoffs
and seasonal reductions.
Confidentiality Provisions
As part of its business, the Company typically enters into
agreements concerning its projects which contain confidentiality provisions. The
Company is, on occasion, required to disclose such agreements to the Securities
15
Exchange Commission as part of its ongoing reporting requirements under the
Securities Exchange Act of 1934. Moreover, disclosure of such agreements may be
required in connection with the Company's private placement of securities.
Notably, some of the agreements do not contain the standard exceptions for the
disclosure of information which is required to be disclosed under law.
Accordingly, no assurances can be given that the Company has not inadvertently
disclosed information regarding its various projects in violation of
confidentiality covenants entered into by the Company.
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 and certain other information
presented in this report 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 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 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.
(vi) Changes in governmental regulation or failure to comply with
existing regulation could result in operational shutdowns of
its facilities.
(vii) The continuance of the Section 29 Tax Credit.
(viii) Ability to meet financial commitments under existing
contractual arrangements.
ITEM 2. PROPERTIES
The Company owns a 5,000 square-foot building in Lehi, Utah,
which houses its executive offices. The building is mortgaged with a
non-affiliated party pursuant to an adjustable rate mortgage with an original
principal balance of $275,000 due in 2002. The mortgage is adjustable quarterly
and the total monthly payment was $3,711 on the remaining $175,383 balance as of
December 31, 1996. The mortgage, which was originally an obligation of IME, has
been assumed by the Company as a result of the sale of IME. This assumption has
not been approved by the lender and therefore may cause the lender to accelerate
the note. The Company has taken no formal steps to obtain the consent of the
lender, other than verbal discussions. In the event the lender accelerates the
note, the Company believes that it will be able to refinance the building on
comparable terms prior to any foreclosure action. However, there is no assurance
that the Company will be able to obtain such financing in a timely manner, which
would force the Company to relocate its executive offices.
In June 1996, the Company purchased an 8,000 square-foot site
located in Price, Utah, on which the Company's prototype briquetting plant is
located, for $150,000. Included in the purchase was a 1,400 square-foot office
building which houses equipment.
16
In May 1995, the Company entered into a lease with Geneva
Steel Company for a 9,000 square foot building in Vineyard, Utah as part of the
Geneva Agreements described in "ITEM 1--BUSINESS--Business of Company--Geneva.
The Company pays no cash rent on these facilities. The purpose of the lease is
to allow the Company to apply the Briquetting Technology to Geneva's coke breeze
and steel revert materials. Upon the execution of the Geneva Agreements, the
lease with Geneva expired resulting in a tenancy-at-will between the parties.
As part of the acquisition of the Port Hodder facility, the
Company entered into a land lease of approximately 15.45 acres with a
non-affiliated party for the Alabama Plant for an annual rental of $1. See "ITEM
1--BUSINESS--Port Hodder." In June 1996, the Company entered into a land lease
of approximately 12 acres in Price, Utah with a non-affiliated party at a
monthly rental of $600.00. The lease term commenced on June 20, 1996 and expires
on December 31, 2007.
ITEM 3. LEGAL PROCEEDINGS
CoalPlex Litigation
On October 31, 1995, the Company as plaintiff filed a
complaint in the United States District Court for the District of Utah, Central
Division against CoalPlex International, Inc., a Nevada corporation ("CoalPlex")
and Daniel J. Longworth (collectively, the "Defendants"). The suit alleged that
the Defendants breached a nondisclosure agreement dated October 3, 1995 pursuant
to which the Company had given the Defendants confidential information; that the
Defendants intentionally interfered with the Company in its acquisition of the
option on the Wellington, Utah property; that the Defendants had commercially
disparaged the Company and that common law fraud was committed on the Company.
The Company sought an injunction against the Defendants and damages of
$1,000,000. The Company recently withdrew the suit without prejudice based upon
assurances from CoalPlex that it would refrain from any further breaches of the
non-disclosure agreement and from contacting the Company's customers, employees
or contacts.
Farrell Larson Litigation
In May 1995 the Company's wholly owned subsidiary, Larson,
filed a complaint in the Fourth Judicial District Court in and for the County of
Utah, State of Utah against Farrell Larson, Larson's former president and
director. In January, 1996 the complaint was amended to add the Company as a
plaintiff. In addition Irene Larson, Gary Burningham d/b/a Burningham and
Company, and Burningham Enterprises, Inc. were added as defendants. The
plaintiffs alleged that the defendants misrepresented facts and made material
omissions in connection with the sale of 50% of Larson to the Company in 1994.
Furthermore, the plaintiffs alleged that the share purchase agreement was
breached by defendant Farrell Larson and that state securities laws were
violated. The complaint sought to enjoin Farrell Larson from harassing the
Company and sought an order releasing all collateral held to secure plaintiff's
performance including the 50% of Larson held in escrow as security for the note
given by the Company in the purchase of Larson, and damages of not less than
$325,000, treble damages in accordance with Utah securities laws, punitive
damages of $1,000,000 and costs. In February 1996, Farrell Larson and Irene
Larson filed counterclaims against the Company asserting breach of contract by
the Company and Larson in respect to the agreements through which the Company
purchased Farrell Larson's 50% interest in Larson; breach of the covenant of
good faith and fair dealing with respect to the same contracts; interference
with contractual and economic relations; defamation, which relates to alleged
statements by the Company concerning the litigation, either just prior to or
during the litigation; breach of fiduciary duty, alleging that the Company owed
Farrell Larson a fiduciary duty with respect to the conduct of business of
Larson; and violation of Larson's bylaws. In their counterclaim, Farrell Larson
17
and Irene Larson ask for the forfeiture of the shares of Larson acquired by the
Company, for management of Larson to be reinstated as directed by Farrell
Larson, for reimbursement of all attorney fees and costs incurred by Farrell
Larson, for an order allowing Farrell Larson to foreclose on collateral held
under the Share Purchase Agreement with the Company, for final payment of
$325,000 under other contracts between the Company and Farrell Larson, and other
unspecified amounts of actual and punitive damages.
In connection with the facts at issue in the Company's action
against Farrell Larson; in January 1996 Farrell Larson and his wife, Irene
Larson, filed a new lawsuit in the Fourth Judicial District Court in and for
Utah County, State of Utah against, among other defendants, Michael Midgley (the
then Chief Financial Officer of the Company and then President and director of
Larson), Mark Hardman (a Vice-President and director of Larson), and Kenneth M.
Young (the Company's then Chairman of the Board and former President). This
complaint included three causes of action: (i) interference with Larson's
business relations, (ii) defamation, and (iii) breach of fiduciary duty. The
factual basis for these claims for relief are substantially the same as the
facts at issue in the Company's action against Farrell Larson. Accordingly, the
Court consolidated these two cases at the Company's request so that all of the
related issues will be resolved together. The Company believes that all acts
alleged as basis for liability against Messrs. Midgley, Hardman and Young were
performed by them in the course and scope of their employment for the Company
and Larson.
As part of the sale of the Subsidiaries, the Company has
agreed to fund all legal proceedings with Farrell Larson and indemnify the
Buyers from any liability.
In September of 1996, the plaintiffs and defendants entered
into a settlement agreement whereby: (i) Farrell Larson and Irene Larson
(collectively, the "Larsons") released any claims on the amounts held in escrow
securing the note given by the Company in purchase of Larson, (ii) the Larsons
released all liens caused to be filed or recorded against the real property and
personal property of the plaintiffs, (iii) Burningham was required to pay off or
refinance its loans relating to two Beall trailers and remove Larson as a
guarantor on such lease, (iv) the Larsons agreed to the Company's sale of Larson
to any third party, (v) Burningham and Larson agreed not to purchase any stock
of the Company and (vi) the parties agree to a dismissal of the suits with
prejudice.
Notices of Violation--Utah Division of Air Quality
In April 1996, the Company and Nevada Electric Investment
Company ("NEICO") received a Notice of Violation under Utah Administrative Code
R 307-10-1 and R307-1-8 regarding asbestos in Carbon County, Utah occurring on
January 11, 1996. In August 1996, the Company agreed to pay a negotiated
settlement amount of $11,000 over the next two years to the Utah Division of Air
Quality. The Company believes the asbestos problem has been corrected.
In August 1996, the Company received a Notice of Violation
regarding numerous dust complaints received by the Utah Division of Air Quality
regarding the Geneva Plant. The Company notified the Utah Division of Air
Quality in September of 1996 regarding the corrective actions taken by the
Company.
AGTC Brokerage Disagreement
See "ITEM 1--BUSINESS--AGTC Brokerage Disagreement."
18
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Pursuant to a written consent of stockholders, the following
matters were approved by stockholder consent on approximately January 22, 1996:
1. The sale of the Subsidiaries was approved by
Stockholders owning 1,909,558 shares of common stock,
or approximately 54.72% of the outstanding common
stock on that date.
2. The amendment of the Company's 1995 Stock Option Plan
(the "Option Plan") to increase the number of shares
of common stock available under the plan from 450,000
shares to 1,200,000 shares was approved by
Stockholders owning 1,909,558 shares of common stock,
or approximately 54.72% of the outstanding common
stock on that date.
3. The amendment of the Company's Certificate of
Incorporation to provide for a 2 for 1 common stock
split and to maintain the authorized common stock of
the Company at 25,000,000 shares, $.001 par value,
was approved by Stockholders owning 2,051,014 shares
of common stock, or approximately 58.77% of the
outstanding common stock on that date.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The shares of common stock of the Company are listed for
trading on the OTC Bulletin Board under the symbol "CVOL." The following table
sets forth, for the periods presented, the high and low bid quotations for the
common stock as reported by National Quotation Bureau, Inc. during the three
most recent calendar years. The quotations do not reflect adjustments for retail
markups, markdowns or commissions and may not necessarily represent actual
transactions. Since the Company has several market makers, the bid prices among
the different market makers will generally vary. Accordingly, the low bid price
may represent a bid price substantially below the inside bid and be less
representative of actual trades than the high bid price. The following prices
may not be considered valid indications of market value due to the limited and
sporadic trading in the shares of common stock.
19
Low Bid High Bid
------- --------
Calendar 1994
- - --------------
First Quarter $ 2.50 $ 4.375
Second Quarter $ 1.875 $ 4.375
Third Quarter $ 1.875 $ 3.43
Fourth Quarter $ 1.875 $ 3.20
Calendar 1995
- - -------------
First Quarter $ 1.25 $ 3.75
Second Quarter $ 1.25 $ 3.875
Third Quarter $ 3.00 $ 7.50
Fourth Quarter $ 5.00 $21.25
Calendar 1996
- - -------------
First Quarter $18.00 $31.50
Second Quarter $ 9.50 $22.25
Third Quarter $ 6.50 $10.75
Fourth Quarter $ 7.50 $14.375
The Company implemented a two-for-one stock split effective
January 23, 1996. The bid prices set forth above have been adjusted to reflect
the effect of that stock split.
As of December 1, 1996, there are approximately 2,103 record
holders of the Company's outstanding shares of common stock.
The Company has not paid dividends to date and does not intend
to pay dividends in the foreseeable future. The Company intends to retain
earnings, if any, to finance the development and expansion of its business.
Payment of dividends in the future will depend, among other things, upon the
Company's ability to generate earnings, its need for capital and its overall
financial condition.
Recent Sales of Unregistered Securities
The following sets forth all securities issued by the Company
within the past fiscal year without registering the securities under the
Securities Act. No underwriters were involved in any stock issuances nor were
any commissions or similar fees paid in connection therewith.
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 and debentures were exempt from the registration requirements of
the Securities Act of 1993 pursuant to the exemption set forth in Section 4(2)
thereof and the certificate for each of such security bears a restrict legend:
20
Commencing September of 1995 and ending January 1996 the
Company issued 629,021 shares of common stock in exchange for $2,280,172 cash
and 20,979 shares of common stock in exchange for $157,342.50 in services to
fifty four purchasers. Each of the purchasers was an individual or institution
whom the Company believed was an "accredited investor" within the meaning of
Rule 501(a) of Regulation D under the Securities Act of 1933.
In November 1995 the Company issued 69,334 shares of common
stock to Mr. George Browne in exchange for $260,000, received in fiscal year
1995. The Company also issued 50,000 shares of common stock to Mr. Alan
Summerhaays in exchange for consulting services valued at $322,000, received in
fiscal year 1995.
In December 1995, the Company issued 900,000 shares of common
stock to 17 employees in connection with the exercise of options granted under
the Option Plan. The aggregate exercise price, in excess of the par value of the
stock issued, 450,000 of which were issued in October 1995 to officers,
directors and employees, was paid by the 17 employees in the form of notes
receivable of approximately $6,159,000. The Notes are due and payable by the
employees on December 1, 2005, bear interest at 5.7% and are collateralized by
the stock issued upon exercise of the options. The interest rate on the Notes
reflects the cost to the Company to borrow money at the time the notes were
issued.
In December 1995, the Company issued 2,000 shares of common
stock to Mr. Anthony Pilotte in exchange for $4,000 and 3,000 shares to Mr. Mark
Hardman in exchange for services rendered valued at $11,250.
In December 1995, the Company issued 25,000 shares of common
stock to Mr. Clayton Timothy for $37,500 in cash and 10,000 shares of common
stock to Mr. Ted Strong for $15,000, both pursuant to exercises of stock
options.
In January 1996, the Company issued 10,000 shares of common
stock to Mr. Maury Shefftel for consulting services valued at $72,500 and 250
shares of common stock to Mr. Michael Buhman in exchange for $500.
On January 1, 1996, the Company granted options to purchase
120,000 shares of Common Stock at a price of $1.50 per share to certain
officers, employees and consultants. Of these options, 20,000 were exercised and
35,000 were canceled. At September 30, 1996, 65,000 of the options remain
unexercised. On this same date, the Company granted options to purchase 124,000
shares of Common Stock at prices between $2.50 and $3.50 per share to certain
consultants. These options remain unexercised at September 30, 1996.
In February 1996, the Company issued 227,115 shares of the
Company's common stock to accredited investors in connection with the sale of
units in a private placement transaction. A unit consists of five shares of
restricted common stock and one Class A warrant with an exercise price of
$25.00, one Class B warrant with an exercise price of $30.00 and one Class C
warrant with an exercise price of $35.00. The Company approximately raised
$3,244,000 through this private placement.
In March 1996, the Company issued 8,417 shares of common stock
to Mr. Jay Rice for professional services valued at $120,363.
In April 1996, Mr. Ken Young purchased 7,000 shares of Common
Stock for $100,100.
21
In April 1996, Mr. Sidney Borenstein, Mr. Eric Bashford and
Mr. Robert Schneider purchased 8,126, 14,900 and 15,074 shares of common stock
in exercise of warrants respectively for $12,189, $22,350 and $22,611,
respectively. In connection with the purchase, the Company granted certain
registration rights to the purchasers. In the event the purchased stock is not
timely registered, the Company will be required to issue additional stock to the
Purchasers. In addition, in the event that the market value of the stock is less
than $21.00 per share at the time the stock is registered, the Company will be
required to issue additional shares to the purchasers so that the purchaser may
realize the equivalent of $21.00 per share.
In June 1996, the Company issued 750 and 1,000 shares, to Mr.
Milton Young and Mr. Golden Murry, respectively, for professional service valued
at $1,500 and $3,000, respectively.
On June 3, 1996, the Company granted options to purchase
100,000 shares and 40,000 shares of Common Stock for $1.50 per share to an
Officer of the Company as part of compensation related to an employment
agreement. At September 30, 1996, these options remain unexercised.
In July, August and September of 1996, Mr. Ray Weller, Mr.
Joe Johnson, Ms. Lois Shapiro and Ribalta, Inc. purchased 32,115, 150,000,
14,900 and 43,750 shares of common stock for $459,250, $1,000,000, $22,350 and
$350,000, respectively. The Ribalta, Inc. shares were unissued at September
30,1996. Also the Shapiro share were the exercise of options.
On August 13, 1996, the Company granted 777,500 options to
purchase shares of Common Stock to certain employees, officers and directors for
$1.50 per share. Prior to September 30, 1996, 312,500 of these options were
canceled. At September 30, 1996, 465,000 shares remain unexercised.
In September 1996, the Company issued 100,000 shares for a
note receivable to George Ford for $1.00 per share pursuant to the exercise
of an option. In addition, the Company issued 1,350 shares to Ted Harker at a
price of $1.00 per share, 20,000 shares to Roger Huber at $2.50 per share and
30,000 shares to Maynard Moe at $2.50 per share. The stock issuances to Mr.
Harker, Mr. Huber and Mr. Moe were pursuant to exercises of option, which
exercise price was paid by a combination of cash and services.
In November 1996, the Company issued convertible subordinated
debentures in the aggregate principal amount of $1,000,000. See "ITEM
7--MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS--Liquidity and Capital Resources."
In December 1996, the Company issued the Subordinated
Debenture in the principal amount of $1,100,000. See "ITEM
1--BUSINESS--Gallagher."
In January 1997, the Company issued the Senior Debenture in
the principal amount of $588,683. See "ITEM 1--BUSINESS--Gallagher."
ITEM 6. SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
The following table sets forth the Company's selected
historical consolidated financial data as of and for the years ended December
31, 1992 and 1993; the nine months ended September 30, 1994 and the years ended
September 30, 1995 and 1996. The selected consolidated financial data as of and
for the years ended December 31, 1992 and 1993 are derived from the financial
statements of the Company which have been audited by Jones, Jensen, Orton &
Company. The selected consolidated financial data as of and for the nine months
ended September 30, 1994 and as of and for the years ended September 30, 1995
and 1996 were derived from the financial statements of the Company which have
been audited by Coopers & Lybrand, L.L.P. The information below should be read
in conjunction with the Consolidated Financial Statements and notes thereto and
appearing elsewhere in this document.
22
COVOL TECHNOLOGIES, INC.
(FORMERLY ENVIRONMENTAL TECHNOLOGIES GROUP INTERNATIONAL)
AND SUBSIDIARIES
Year Ended Nine
December 31, Months Ended Year Ended Year Ended
September 30, September 30, September 30,
--------------------------------
1992 1993 1994 1995 1996
-------------------------------------------------------------------------
Statement of Operations Data:
Revenues:
License fees $ -- $ -- $ -- $ 100,000 $ 100,000
Briquette sales 12,447 12,688 19,867 29,310 195,165
-------------------------------------------------------------------------
Total revenues 12,447 12,688 19,867 129,310 295,165
Operating costs and expenses:
Cost of coal briquettes 8,314 22,977 32,386 37,165 859,574
Research and development 319,907 393,300 387,128 1,265,072 1,044,192
Selling, general and 266,914 426,512 393,109 1,494,270 3,796,569
administrative
Compensation expense on -- -- -- 703,527 4,772,959
stock options
Compensation expense on -- -- -- 104,000 --
stock warrants
Compensation expense on -- -- -- 148,446 100,360
issuance of common stock
Write off of purchased -- -- -- 344,900 --
technology and trade
secrets
Write-down of note receivable -- -- -- -- 2,699,575
Minority interest in net -- -- -- -- (4,456)
losses of consolidated
subsidiaries
-------------------------------------------------------------------------
Total operating costs and 595,135 842,789 812,623 4,097,380 12,268,773
expenses
-------------------------------------------------------------------------
Operating loss (582,688) (830,101) (792,756) (3,968,070) (12,973,608)
Other income (expense): -- -- -- 9,663 302,565
Interest income
Interest expense (2,091) (30,870) (21,158) (113,137) (94,706)
Other income -- -- 3,200 35,169 (166,066)
-------------------------------------------------------------------------
Total other income (expense) (2,091) (30,870) (17,958) (68,305) 41,793
-------------------------------------------------------------------------
Loss from continuing operations (584,779) (860,971) (810,714) (4,036,375) (12,931,815)
before income tax benefit
(provision)
Income tax benefit (provision) -- -- 313,100 (488,000) (23,000)
-------------------------------------------------------------------------
Loss from continuing operations (584,779) (860,971) (497,614) (4,524,375) (12,954,815)
23
Year Ended Nine
December 31, Months Ended Year Ended Year Ended
------------------- September 30, September 30, September 30,
1992 1993 1994 1995 1996
-----------------------------------------------------------------------
Discontinued operations
(Note 14):
Income (loss) from 10,050 145,965 609,354 (351,782) (590,480)
discontinued
operations (less
applicable income tax
(provision) benefit of $0.
$0. $0. $(297,800),
$253,000, and $0,
respectively)
Loss on disposal of -- -- -- (777,394) (291,025)
discontinued
operations (less
applicable income tax
benefit of $562,000 in
1995 and $0 in 1996)
-------------------------------------------------------------------------
Income (loss) from 10,050 145,965 609,354 (1,129,176) (881,505)
discontinued
operations
-------------------------------------------------------------------------
Income (loss) before cumulative (574,729) (715,006) 111,740 (5,653,551) (13,836,320)
effect of change in
accounting principle
Cumulative effect of change in -- -- 31,302 -- --
accounting principle (less
applicable income tax
provision of $15,300 in 1994)
-------------------------------------------------------------------------
Net income (loss) ($574,729) ($715,006) $143,042 ($5,653,551) ($13,836,320)
-------------------------------------------------------------------------
Net income (loss) per common share
Loss per share from continuing ($0.38) ($0.36) ($0.13) ($1.00) ($1.86)
operations
Income (loss) per share from 0.01 0.06 0.16 (0.25) (0.13)
discontinued operations
-------------------------------------------------------------------------
Income (loss) per share before (0.37) (0.30) 0.03 (1.25) (1.99)
cumulative effect of change
in accounting principle
-------------------------------------------------------------------------
Income per share of cumulative 0.00 0.00 0.01 0.00 0.00
effect of change in
accounting principle
-------------------------------------------------------------------------
Net income (loss) per share ($0.37) ($0.30) $0.04 ($1.25) ($1.99)
-------------------------------------------------------------------------
Weighted average shares outstanding 1,525,258 2,417,568 3,789,996 4,524,056 6,941,424
-------------------------------------------------------------------------
December 31, September 30,
-------------------------------------------------------------------------
1992 1993 1994 1995 1996
-------------------------------------------------------------------------
Balance Sheet Data:
Working capital ($198,944) ($423,570) ($619,907) ($480,420) ($3,482,227)
Net property and equipment 272,942 341,455 747,952 1,330,300 7,125,245
Total assets 725,596 2,129,885 4,852,637 2,659,977 8,772,072
Long-term debt 46,700 511,193 852,081 176,601 150,980
Total Stockholders' equity 451,182 1,107,915 2,989,529 1,182,768 (233,364)
24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in
conjunction with the information set forth under the caption entitled "ITEM
6.--SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA" and the financial
statements and notes thereto for the Company included elsewhere herein.
Year Ended September 30, 1996 Compared to Year Ended September 30, 1995
The information set forth below compares the Company's
operating results for fiscal year 1996 with its operating results
for fiscal year 1995.
Continuing Operations
Revenues. Revenues from the sales of briquettes increased to
$195,165 for the year ended September 30, 1996 from $29,310 recognized for the
year ended September 30, 1995. A substantial portion of the sale of briquettes
is attributable to production from the Geneva Plant. Fees from the licensing of
the Briquetting Technology were $100,000 for the year ended September 30, 1996,
and for the year ended September 30, 1995.
Operating Costs and Expenses. The operating costs of producing
briquettes increased to $859,574 for the year ended September 30, 1996 from
$37,165 for the year ended September 30, 1995. The increase is reflective of the
phase of development and operation the Company was in for fiscal year 1996 as
compared to fiscal 1995. In 1996, the Company incurred substantial material and
labor costs in implementing and improving the briquetting product and process,
the costs for which were currently expensed rather than capitalized.
Research and development expenditures decreased $220,880 or
17.5% during the year ended September 30, 1996 from $1,265,072 for the year
ended September 30, 1995. During the year ended September 30, 1996, the Company
received a notice of allowance on one of the patent applications which it filed
in 1993. The Company also continued the prosecution of two previously filed
patent applications relating to the Briquetting Technology during fiscal year
1996.
Selling, general and administrative expenses increased
$2,302,299 or 154% for the year ended September 30, 1996 from $1,494,270 for the
year ended September 30, 1995. During this period the Company was increasing
staff and other operating costs, in order to accommodate the licensing and
implementation of the Briquetting Technology, including extensive activity in
the development of the Utah Plant and Alabama Plant.
25
In fiscal year 1996, the Company recognized compensation
expense on the issuance of stock options at below market price, compensation
expense on the issuance of warrants at below market price, and compensation
expense on the issuance of common stock for services in the total amount of
$4,873,319, which represents an increase of $3,917,346 over the prior year
expense of $955,973. The Company issued stock options at below market price to
consultants who provided and will continue to provide services relating to the
exploitation of Company technology, identification of users of such technology,
finance of the Company and its projects, marketing, and general business
strategy. The options vest over ten years. The Company has expensed the total
value of such options (current stock value less strike price) in fiscal 1996 in
the amount of $2,305,000. During fiscal 1996 and for the period through the date
of filing of this document, the Company has undergone significant management
changes. The increase in this expense reflects the acceleration of the expense
for options held by prior management and other former employees as settlement in
their termination in the amount of $832,500. As an enticement to a key
executive, the Company granted 100,000 options valued at $1,163,000. This
executive signed an employment contract with the Company through May 31, 1999.
The balance of the expense related principally to the amortization of the value
of stock options, based on the vesting of such options.
Also in fiscal year 1996, the Company recognized an expense in
the form of a write-down of the Note received from the Buyers of the
Subsidiaries in the amount of $2,699,575. Under generally accepted accounting
principles, the Company is required to write down the carrying cost of the note
to the ascertainable value of the collateral securing the note. There has been
no events of default or past due payments occur on the note. See "ITEM
1--BUSINESS--The Company." See iscussion below for discontinued
operations.
Loss From Continuing Operations. For the year ended September
30, 1996, the Company had a loss from continuing operations of $(12,954,815) as
compared to $(4,524,375) for the year ended September 30, 1995. The increased
loss is primarily due to the compensation expense from the stock options, write
down of Buyers' note from the sale of the Subsidiaries, and the expenses related
to the initial production of briquettes discussed above.
Discontinued Operations
For the year ended September 30, 1996 the discontinued
operations had a net loss of $590,480 as compared to a net loss of $351,782 for
the year ended September 30, 1995. The Company also recognized an additional net
loss on the disposal of the discontinued operations in the amount of $291,025.
The Company agreed to pay certain liabilities associated with the Subsidiaries
as a condition of the sale. The actual amount of the liabilities was greater
26
than originally estimated, resulting in an additional loss from discontinued
operations in 1996. The Company is currently negotiating an increase in the
notes receivable proportional to the additional liabilities actually paid.
Year Ended September 30, 1995 Compared to the Nine Months Ended September 30,
1994
As a result of the change in the Company's fiscal year, the
comparisons of results of operations for the year ended September 30, 1995
reflect twelve months of activity as compared to nine months of activity for the
period ended September 30, 1994.
Continuing Operations
Revenues. Revenues from "Clean Coal" sales increased $9,443
or 48% for the year ended September 30, 1995 from the $19,867 recognized in the
nine months ended September 30, 1994 primarily due to closing out of the "Clean
Coal" inventory. Licensing revenues of $100,000 for the year ended September 30,
1995 represent cash received from Greystone Environmental Technology, Inc. for
the initial payment on the purchase of their coke license. See Note 15 of the
Financial Statements.
Operating Cost and Expenses. During the year ended September
30, 1995, the Company received a notice of allowance on the patent application
which it filed in 1993. The Company also filed two additional patent
applications relating to the Briquetting Technology during this time period and
built and tested a reduction furnace and installed an electric arc furnace in
Price, Utah, which was put into production to demonstrate the feasibility of the
Briquetting Technology to produce iron from waste materials. During 1995, the
Company also developed two new binders, which are more cost effective with
better thermal stability than the binders acquired in 1991 and 1992. As a result
of this activity, research and development expenditures increased $877,944 or
227% during the year ended September 30, 1995. As a result of these
developments, the Company wrote off the purchased technology and trade secrets
in the amount of $344,900.
Selling, general and administrative expenses increased
$1,101,161 in 1995 from $393,109 for the nine months ended September 30, 1994.
During this period the Company was increasing staff and other operating costs,
in order to accommodate the licensing and exploitation of the Briquetting
Technology, including starting up the Geneva plant.
In 1995, the Company recognized compensation expense on the
issuance of stock options at below market price in the amount of $703,527,
$104,000 as compensation expense on the issuance of warrants at below market
price, and compensation expense on the issuance of common stock for services in
the amount of $148,446.
27
Loss From Continuing Operations. For the year ended September
30, 1995, the Company had a loss from continuing operations of $(4,524,375) as
compared to $(497,614) for the nine months ended September 30, 1994. The
increased loss is primarily due to increased operating costs and expenses
discussed above and the recognition of tax expense of $(488,000) in 1995
compared to a benefit of $313,100 in 1994. The expense in 1995 is due to the
Company's inability to offset its net loss against discontinued operations
taxable income, while the benefit in 1994 is due to the Company's ability to
offset its net operating loss against discontinued operations income.
Discontinued Operations
For the year ended September 30, 1995 the discontinued
operations had a net loss of $351,782 as compared to net income of $609,354 in
1994. The Company also recognized a net loss on the disposal of the discontinued
operations in the amount of $777,394 in 1995, which includes a reserve of
$330,000 for operating losses during the disposal period, offset by a tax
benefit of $562,000. The loss in 1995 is due to the increased focus on the
Briquetting Technology and the Company's efforts to scale down the Subsidiaries
activities until a buyer could be found.
Nine Months Ended September 30, 1994 Compared to the Year Ended December 31,
1993
As a result of the change in the Company's fiscal year the
comparisons of results of operations for the nine months ended September 30,
1994 reflect nine months of activity as compared to twelve months of activity
for the period ended December 31, 1993.
Continuing Operations
Revenues. Total revenues of $19,867 for the nine months ended
September 30, 1994 were generated by the sale of the Company's "Clean Coal"
product as compared to $12,688 for the year ended December 31, 1993 primarily as
a result of the Company's efforts to reduce its inventory.
Operating Costs and Expenses. During the nine months ended
September 30, 1994 the Company was phasing out its "Clean Coal" product line,
which resulted in a negative gross margin of $12,519 for the period as compared
to a negative gross margin of $10,289 for the year ended December 31, 1993. The
Company had determined during 1994 that the home heating market for "Clean Coal"
was not going to produce the gross margins that had been anticipated and the
Company made the decision to pursue the industrial application of the
Briquetting Technology.
Research and development expenditures decreased to $387,128
for the nine months ended September 30, 1994 from $393,300 for the year ended
December 31, 1993, a decrease of $6,172 or 2%. Expenditures in 1994 were related
to improvements made to the binding process and the Company's efforts to expand
28
the application of the Briquetting Technology to steel making waste by-products.
The Company also produced test run materials for several steel plants and filed
one patent application during this period.
Selling, general and administrative expenses were $393,109 for
the nine months ended September 30, 1994 compared to $426,512 for the year ended
December 31, 1993, a decrease of $33,403 or 8%.
Loss From Continuing Operations. For the nine months ended
September 30, 1994, the Company had a loss from continuing operations of
$(497,614) before the cumulative effect of a change in accounting principle
related to the Company's method of depreciating its property, plant and
equipment, compared to a loss from continuing operations of $(860,971) for the
year ended December 31, 1993. In 1994 the Company had a tax benefit from
continuing operations of $313,100 (due to the use of net operating losses to
offset income of the discontinued operations), while in 1993 no tax benefit was
recognized.
Discontinued Operations
Net income for the discontinued operations increased to
$609,354 for the nine months ended September 30, 1994 from $145,965 for the
previous period. It was during this period that CIC started two large
construction contracts with a large mining company in Utah, which accounted for
the increase.
Liquidity and Capital Resources
While the Company continued its commitment to research and
development during fiscal 1996, the Company made significant progress toward the
commercialization of its technology and movement from a development company to
an operating company. The increase in cash used by the Company in operating
activities from $237,023 in fiscal 1995 to $2,574,713 during 1996 was largely
due to the increase in staff and the start up and operation of the Geneva Plant.
The increase in staff was necessitated by the increased planning, marketing and
development activities of the Company. The Company was able to fund this growth
principally through the issuance of common stock.
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 businesses. Accordingly in February, 1996, the
Company entered into a share purchase agreement with Mike McEwan and Gerald
Larson, former principals of the Subsidiaries, to sell all of the common stock
of the Subsidiaries. The divestiture was substantially complete on September 28,
1996 resulting in an additional loss to the Company of $881,505 during fiscal
year 1996. See "ITEM 1--BUSINESS--The Company."
29
During fiscal year 1996, the Company produced revert briquettes
at the Geneva Plant for Geneva according to specifications supplied by Geneva.
Revenues from the production of revert briquettes at the Geneva Plant amounted
to $191,427. Although the Geneva Agreements expired in December 31, 1996, the
Geneva facility has continued to produce briquettes for purchase by Geneva
Steel.
The Company anticipates that cash flow from (i) operations,
including fees for the operation of facilities owned by third parties,
(ii licensing and royalty fees from new plants utilizing the Briquetting
Technology, (iii) the sale of chemical binder to new plants utilizing the
Briquetting Technology, (iv) sale of synthetic coal products, (v) fees from port
operations and loading (vi) cash distributions from Utah Synfuel #1 and Alabama
Synfuel #1 and (vii) payments on notes receivable will be used to fund working
capital and other operating needs. See "ITEM 1--BUSINESS--Business Strategy." In
September 1996, the Company entered into a letter of intent with an unregulated
subsidiary of PacifiCorp to purchase the Alabama Plant from Alabama Synfuel #1
for a one time $500,000 licensing fee, a promissory note in the amount of
$3,400,000 that will be payable out of the cash flow of the plant, and a per ton
royalty fee. See "ITEM 1--BUSINESS--PacifiCorp." In November 1996, the Company
entered into a letter of intent with Arthur J. Gallagher & Co., to purchase the
Utah plant from Utah Synfuel #1 for $2,500,000 cash and a promissory note, a one
time $500,000 licensing fee and a per ton royalty fee payable out of the cash
flow of the Utah plant. See "ITEM 1--BUSINESS--Gallagher." The Company completed
construction of the Utah plant in connection with Utah Synfuel #1, and commenced
commercial operations in December, 1996, producing and selling more than 5,000
tons of coal briquettes prior to the end of calendar year 1996. However, the
Company has not yet closed on the sale of such plants, and there can be no
assurance that the Company will receive the anticipated cash payments from the
sale of such plants. Moreover, most of the cash flow from the above sources will
not occur until late 1997 and in subsequent years.
In May 1995, the Company secured financing in the form of an
$825,000 master equipment lease funded by a commercial bank to equip its initial
briquetting plant at Geneva's facilities. The Company has the option to purchase
the equipment from the bank at the end of the lease term.
In December 1996, the Company entered into the 1996
Construction Agreements. 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 they failed to build the facilities. See "Item
1--BUSINESS--Construction Agreements."
In December 1996, the Company entered into indemnity
agreements with Lockwood which may result in a contingent liability of
$4,500,000 on or after June 2, 1998. See "ITEM 1--BUSINESS-- Indemnification to
Lockwood."
30
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 debentures was issued
and funded with an additional $2,900,000 in credit available for future draw
downs pursuant to Senior Debentures to be issued by the Company. On January 2,
1997, the Company drew down $588,683 of the available $2,900,000. See "ITEM 1 --
BUSINESS -- Gallagher." The balance of the $2.9 million loan will be used for
working capital and for the construction and development of the coal
agglomeration facilities.
In October 1996, as part of the PacifiCorp letter of intent,
PacifiCorp agreed to a convertible loan from PacifiCorp to the Company in an
amount up to $5,000,000. See "ITEM 1--BUSINESS-- PacifiCorp."
In November of 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 convertible subordinated debenture is convertible into
Company common stock. 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. Finally, the investors have represented to the Company that they are
"Accredited Investors" as defined under Rule 501 of the Securities Act of 1933,
as amended.
The Company has had significant discussions with RAS Securities
Corp. to act as placement agent on a "best efforts" 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. Such debentures
would have an established floor and ceiling conversion price, and the shares
issued upon conversion would be entitled to piggy-back and demand registration
rights. No assurances can be given that RAS Securities Corp. will act as
placement agent or that the minimum offering will be successfully placed. Such
offering will be made only by means of a private offering memorandum and
statements relating to such offering herein are neither offers to sell nor
solicitations of offers to buy.
The Company believes that the resources desribed above will be
adequate to meet its obligations in fiscal year 1997, notwithstanding its
working capital deficit at September 30, 1996.
31
Impact of Recently Issued Accounting Standards
In March 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of".
The Statement requires that long-lived assets and certain identifiable
intangibles to be held and used by an entity be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. The Statement is effective for financial statements for
fiscal years beginning after December 15, 1995. The impact of the Statement on
the Company is not expected to be material.
In October 1995, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting
for Stock-Based Compensation". This Statement defines a fair value method of
32
accounting for an employee stock option or similar equity instrument and
encourages adoption of that method. The Statement also requires that an
employer's financial statements include certain disclosures about stock-based
compensation arrangements regardless of the method used to account for them. The
Statement is effective for financial statements for fiscal years that begin
after December 15, 1995. The Company has determined that it will adopt the
disclosure requirement of SFAS No. 123 and will continue to account for
stock-based compensation as permitted under the provision of Accounting
Principles Board Statement No. 25.
Impact of Inflation
During fiscal year 1996, cost increases to the Company were
not materially impacted by inflation.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary financial data
required by this Item 8 are set forth in Item 14 of this Form 10-K. All
information which has been omitted is either inapplicable or not required.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On April 17, 1994, the Company's Board of Directors voted that
the accounting firm then employed by the Company was to be dismissed.
There were no adverse opinions or disclaimers of opinion, nor
were there any modifications as to uncertainty, audit scope, or accounting
principles with the former accountant. There were no disagreements with the
former accountant on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure.
On October 17, 1994, the accounting firm of Coopers & Lybrand,
L.L.P. was engaged to perform the annual audit as of September 30, 1994. Coopers
& Lybrand, L.L.P. was also engaged to perform the annual audit for fiscal year
ended September 30, 1995, and 1996.
There are no other changes in and disagreements on accounting
and financial statement disclosure.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The directors and executive officers of the Company as of
January 1, 1997 are as follows:
33
Name Age Position
- - --------------------- ------------- -----------------------------------
Brent M. Cook 36 President and Chief Executive Officer
Russ Madsen 50 Interim Chairman of the Board, Vice
President-Operations and Director
Stanley M. Kimball 42 Chief Financial Officer, Treasurer
and Director
Alan D. Ayers 39 Chief Operating Officer and Director
George W. Ford 51 Vice President-Research and
Development and Director
Steven Brown 38 Vice President of Engineering and
Construction and Director
Asael T. Sorensen, Jr. 42 Secretary and General Counsel
Richard Lambert 51 Vice President of Sales and Marketing
Raymond J. Weller 50 Director
DeLance Squire