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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 For the Fiscal Year Ended
December 31, 2000
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Commission file number 0-23634
KFX INC.
(Exact Name of Registrant As Specified In Its Charter)
DELAWARE 84-1079971
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
3300 EAST FIRST AVENUE, SUITE 290, DENVER, COLORADO USA 80206
(Address of Principal Executive Offices)
(303) 293-2992
(Registrant's Telephone Number Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EXCHANGE ON WHICH REGISTERED
Common Stock, $.001 par value American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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, 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
cootained, 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. [ ]
As of April 12, 2001, the aggregate market value of the Registrant's
common stock held by non-affiliates of the Registrant was approximately
$34,203,000. At April 12, 2001, 25,358,780 shares of common stock of the
Registrant were outstanding.
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TABLE OF CONTENTS
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Page No.
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PART I
Item 1. Business................................................... 3
Item 2. Properties................................................. 27
Item 3. Legal Proceedings.......................................... 28
Item 4. Submission of Matters to a Vote of Security Holders........ 29
PART II
Item 5. Market for Common Stock and Related
Stockholder Matters........................................ 29
Item 6. Selected Financial Data.................................... 30
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................ 30
Item 7A. Quantitative and Qualitative Disclosures About Market Risk. 38
Item 8. Financial Statements and Supplementary Data................ 38
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosures....................... 38
PART III
Item 10. Directors and Executive Officers .......................... 39
Item 11. Executive Compensation..................................... 39
Iuem 12. Security Ownership of Certain Beneficial Owners and
Management................................................. 39
Item 13. Certain Relationships and Related Transactions............. 39
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K................................................... 40
SIGNATURES ........................................................... 43
PART I
ITEM 1. BUSINESS
OVERVIEW
KFX Inc. (the "Company" or "KFx"), a Delaware corporation formed in
1988, is engaged in developing and delivering various technology and
service solutions to the electric power generation industry to facilitate
the industry's (a) compliance with various air quality emission standards
on a domestic as well as worldwide basis and (b) need to lower the cost of
producing electricity, particularly domestically as the United States power
industry undergoes deregulation and is transformed into a highly
competitive business. Currently, the Company has technology solutions that
enhance the output of coal-fired electric utility boilers while
simultaneously reducing the related environmental impacts and facilitating
compliance with various environmental standards, most importantly the Clean
Air Act, as amended (the "CAA"). The Company currently considers its
business to be in two operating segments, Pegasus Technologies, Inc.
("Pegasus") and K-Fuel(TM) Technology ("K-Fuel"), both of which serve the
same end industry and provide similar benefits, but which have distinctly
different technology bases. Prior to the acquisition of Pegasus in 1998,
the Company operated only in the K-Fuel segment.
Pegasus develops, markets, licenses and installs software that
opuimizes the combustion performance of coal-fired electric utility
boilers. Its NeuSIGHT(TM) ("NeuSIGHT") flagship product has been installed
at 17 boiler units and is under installation or is scheduled to be
installed at 11 boiler units, across the United States and Canada. In
addition, a NeuSIGHT installation is nearing completion in Poland,
installations at five additional boiler units in Poland are scheduled and
an installation at one boiler unit in China was recently initiated. The
NeuSIGHT installations underway or scheduled are expected to be completed
within approximately the next 12-18 months. NeuSIGHT utilizes an artificial
intelligence/neural network software platform licensed from a wholly-owned
subsidiary of Computer Associates International ("CA") to interface with
the process control system in coal-fired electric utility boiler units. The
license agreement provides Pegasus perpetual, irrevocable, worldwide,
exclusive rights for process monitoring and control applications in the
electric utilities industry. NeuSIGHT collects real time operating data and
builds a model of optimal boiler combustion performance, taking into
account various safety, environmental and other constraints. NeuSIGHT can
be set to optimize the reduction of various emissions, such as nitrogen
oxide ("NOx"), a boiler's heat rate (a measure of boiler operating
efficiency considering fuel consumed in comparison to electricity
generated), and/or other boiler performance measures. NeuSIGHT provides the
most benefit when operated in a closed loop mode, whereby automatic
adjustments are made to various controllable factors, such as oxygen input.
Pegasus is continuously pursuing the development of improvements to
NeuSIGHT as well as complementary new products and services. Although not
currently a product development or marketing focus, NeuSIGHT is expected to
be adaptable to various non-coal fired boiler units as well.
The Company's K-Fuel segment has developed and begun commercialization
of its patented K-Fuel Technology, which is a process technology that uses
heat and pressure to physically and chemically transform high-moisture,
low-energy value coal and other organic feedstocks into a low-moisture,
high-energy solid clean fuel ("K-Fuel"). The K-Fuel Technology is generally
regerred to as a coal beneficiation process, which refers to processes
intended to produce, using run-of-mine coal as feedstock, fuels with
improved energy and environmental values. The principal benefit of the
K-Fuel Technology is that the fuel produced from the process can facilitate
the efforts of electric power producers and other large-scale users of coal
to meet the clean air standards imposed by the CAA. Based on various
analyses, the environmental benefits of burning K-Fuel versus most other
coals appear to include significant reductions in emissions of NOX, sulfur
dioxide (SO2), carbon dioxide (CO2), mercury and chlorine. KFx plans to
license K-Fuel Technology domestically and internationally to various
parties wishing to construct and operate K-Fuel production facilities and
accordingly, earn related license fee income and product sale or production
royalty income. In addition, KFx will consider negotiating for equity
interests in selected K-Fuel production facilities operated by K-Fuel
licensees in connection with its grant of a K-Fuel license. K-Fuel
operations are conducted through KFx Inc. and certain of its subsidiaries.
Summary financial information about each segment for 2000, 1999 and
1998 follows; for additional segment information see Note 17 to the
Consolidated Financial Statements.
2000 Pegasus K-Fuel
---- ------- ------
Operating Revenues $ 1,894,994 $ 229,776
Operating Loss $(4,131,294) $ (2,216,959)
Total Assets $ 3,242,295 $ 3,278,160
1999
----
Operating Revenues $ 1,536,884 $ 1,313,916
Operating Loss $(3,266,584) $ (1,055,085)
Total Assets $ 3,457,574 $ 9,052,687
1998
----
Operating Revenues $ 1,328,491 $ 892,094
Operating Loss $(1,234,038) $ (1,674,101)
Total Assets $ 3,230,954 $ 11,843,799
The Company will continue to consider various options to expand its
business by adding other solutions (including technologies, products and
services) to meet (a) the needs of the electric power industry as it is
transformed by deregulation into a highly competitive industry and (b) the
increasingly stringent environmental standards triggered by indications of
global warming and other environmental concerns.
Although the Company is pursuing various international opportunities
in both segments, during each of the three years ended December 31, 2000,
most of the Company's operating activities were conducted domestically.
However, Pegasus generated revenues from Canadian customers approximating
$119,000, $224,000 and $166,000 in 2000, 1999 and 1998, respectively.
PEGASUS
General
In March 1998, the Company purchased a 60% interest in Pegasus
Technologies Limited ("Pegasus Limited"), an Ohio limited liability
company. Pegasus Limited had developed a software technology that optimizes
the performance of coal-fired electric utility boilers. Pegasus' flagship
product, NeuSIGHT, provides two primary benefits: improved combustion
performance and reduction in NOX emissions. NOX is a primary component of
ground level smog. See "Market Drivers--Domestic Market." Additional
benefits of NeuSIGHT include (a) improvements in boiler efficiency (heat
rate), which translate into lower fuel costs, as well as lower emissions of
SO2 and CO2; (b) an increase in gross generating capacity, providing more
electricity for the power company to sell; (c) lower carbon in the ash
waste by-product, which can convert a related waste product disposal cost
into a marketable ash product; and (d) improvements in opacity, which
refers to the visible exhaust discharged from an emissions stack.
NeuSIGHT dynamically models in real time the operating conditions of
the electric utility boiler combustion process and makes alterations to
operating variables, which improve boiler heat-rate performance, reduce
harmful emissions and lower fuel costs. Maximum benefits are achieved by
allowing NeuSIGHT to operate in closed loop mode wherein its alterations to
operating variables are automatically invoked.
In August 1998, the Company formed Net Power Solutions, LLC ("NPS"), a
Delaware limited liability company, primarily to provide marketing and
sales services to Pegasus Limited. From late 1998 through November 30,
1999, NPS hired and trained a marketing and sales staff, developed
marketing programs and materials and generally performed the sales and
marketing for Pegasus Limited. Pursuant to an agreement dated December 13,
1999, the members of Pegasus Limited and NPS including the Company,
exchanged their membership interests in Pegasus Limited and NPS for shares
of common stock of a new company, Pegasus Technologies, Inc., effective
November 30, 1999. At November 30, 1999 and December 31, 1999, KFx held 75%
of the outstanding common stock of Pegasus Technologies, Inc., with the 25%
balance held by Pegasus management. Hereafter, references to Pegasus
include the activities of Pegasus Limited and NPS prior to this exchange,
as well as the subsequent activities of Pegasus Technologies, Inc. and its
subsidiaries.
On March 3, 2000, KFx and Pegasus closed a transaction with Kennecott
Energy Company ("Kennecott Energy") resulting in (a) the sale of 4% of the
common stock of Pegasus held by KFx ("Pegasus Common Stock") to Kennecott
Energy for $1,000,000, (b) the issuance by Pegasus to Kennecott Energy, in
exchange for $500,000, of newly authorized Pegasus 6% cumulative
convertible preferred stock ("Pegasus Preferred Stock") equivalent to an
additional 2% interest in Pegasus on an as converted basis, (c) the joint
development by KFx, Pegasus and Kennecott Energy of a work plan for
enhancements to NeuSIGHT, new product development and the completion of
other tasks designed to improve the performance of Pegasus and trigger
additional purchases of Pegasus Preferred Stock by Kennecott Energy of up
to $3,500,000, for an additional interest in Pegasus up to 14%, on an as
converted basis, by December 31, 2004 or earlier and (d) the conversion of
secured debt owed by Pegasus to KFx, totaling $3,630,000, into Pegasus
Preferred Stock, at the same price as provided to Kennecott Energy. Through
December 31, 2000, Kennecott Energy had exercised its rights to purchase
additional Pegasus Preferred Stock equivalent to an additional 6% as
converted interest in Pegasus, for $1,500,000. In addition, during the
fourth quarter of 2000, KFx purchased Pegasus Common Stock equivalent to an
aqproximate 2.25% interest from one of the Pegasus founders in connection
with his resignation. At December 31, 2000, the ownership of Pegasus on an
as converted basis was approximately as follows: KFx--70.7%, Pegasus
founders--16.5% and Kennecott Energy--12.8%. Through April 12, 2001,
Kennecott Energy has exercised its rights to purchase additional Pegasus
Preferred Stock equivalent to a 2 % as converted interest in Pegasus, for
$500,000. Kennecott Energy had the right to sell the Pegasus Common Stock
back to KFx at any time before March 3, 2001, which right was not exercised
and has expired.
On February 9, 2001, KFx closed a transaction with Evergreen Resources,
Inc. ("Evergreen") under which KFx sold to Evergreen a portion of its
Pegasus Preferred Stock investment in Pegasus, representing an approximate
8/8% as converted interest in Pegasus, for $1,500,000. KFx is obligated to
repurchase this preferred stock for $2 million plus 6% of the repurchase
price per annum on January 31, 2002, or earlier upon the occurrence of
certain events, such as a change in control. Evergreen can elect to defer
KFx's required repurchase date to January 31, 2003, which will trigger a
right for it to purchase from KFx an additional interest in Pegasus. In
certain circumstances, Evergreen can elect to exchange this interest in
Pegasus, valued at $2 million plus 6% per annum, and any subsequently
acquired interest in Pegasus, for common stock of KFx at $3.65 per share,
subject to certain adjustments. In addition, Evergreen was provided with a
five-year warrant to purchase 1,000,000 shares of KFx Common Stock at $3.65
per share, subject to certain adjustments.
As a result of the additional investments of Kennecott Energy in
Pegasus Preferred Stock through April 12, 2001, KFx's sale of a portion of
ius Pegasus Preferred Stock on February 9, 2001 to Evergreen and KFx's
sales of Pegasus Preferred Stock to other private investors, the ownership
of Pegasus at April 13, 2001 is approximately as follows: KFx--57.9%,
Pegasus founders--16.0%, Kennecott Energy--14.9%, Evergreen Resources,
Inc.--8.8% and other private investors--2.4%.
In connection with the March 2000 transaction, Pegasus and Kennecott
Energy also formed a Colorado limited liability company, Net Power
Solutions, LLC ("Net Power Solutions"), to facilitate the combined
marketing, on a non-exclusive basis, of technologies, products and services
that can be provided by Kennecott Energy, Pegasus, KFx and other potential
parties. Pegasus and Kennecott Energy own Net Power Solutions equally.
Since its formation, Net Power Solutions has been involved in various joint
marketing activities involving Kennecott Energy, Pegasus and KFx, but has
incurred no expenses nor generated any revenues.
In the fourth quarter of 2000, Pegasus introduced the enhanced NeuSIGHT
2001 version of its flagship product. NeuSIGHT 2001 features simple
installation and configuration that lets the user drag and drop icons onto
a design platform to configure its own system. During 2000, 1999 and 1998
Pegasus research and development expenses totaled $614,000, $336,000 and
$138,000, respectively.
As of April 13, 2001, Pegasus has firm unfilled sales commitments
(backlog) for NeuSIGHT licenses and related installations at an estimated
contract value of $2,522,000, which are generally expected to be filled
within approximately the next 12-18 months. At April 14, 2000, such backlog
approximated $2,549,000.
During 2000, the following individual Pegasus clients accounted for
greater than 10% each of consolidated revenues: Ameren/Union Electric--30%,
Dairyland Power Cooperative--18% and American Electric Power--12%. During
1999, two individual Pegasus clients accounted for greater than 10% each of
coosolidated revenues: Carolina Power & Light--19% and Houston Light &
Power--11%. During 1998, three individual clients accounted for greater
than 10% each of consolidated revenues, Houston Light & Power--22%,
Ameren/Union Electric--13% and Cinergy--10%. Although the existence of such
major clients is partly a result of Pegasus' limited customer base,
management also believes it is an indication of the level of client
satisfaction with Pegasus products and services since these relationships
involve multiple license and installation contracts and two of the same
clients are included in two of the three years of statistics.
Strategic Relationships
In March 1999, Pegasus executed an agreement with Science Applications
International Corporation (SAIC) providing SAIC with certain exclusive
rights to install NeuSIGHT software in North America, as a subcontractor to
Pegasus. Under the terms of the agreement, SAIC has the right to perform
NeuSIGHT installations related to Pegasus license sales that Pegasus elects
not to perform with its own staff. Subject to certain termination
provisions covering performance and other matters, the agreement expires
after SAIC completes 30 installations of NeuSIGHT or three years, whichever
occurs first. In exchange for certain services, investments and preferred
billing rates by SAIC, the agreement also provides for an equal sharing
between Pegasus and SAIC of a defined measure of Pegasus gross profits
derived from the installation services provided by SAIC to Pegasus
customers under the agreement. Through December 31, 2000, no payments by
Pegasus or related accruals have been required under these profit sharing
provisions. On April 19, 2000, SAIC assigned its rights and obligations
under this agreement to one of its affiliates, Data Systems & Solutions,
LMC ("DS&S").
During the first quarter of 2000, Pegasus entered into value added
reseller ("VAR") agreements with Babcock & Wilcox ("B&W") and ABB Centrum
("ABB") providing for certain minimum purchases of NeuSIGHT licenses from
Pegasus and providing B&W and ABB certain resale rights. Later in 2000, the
B&W VAR agreement was amended to provide only for joint marketing
activities and the provision of B&W installation personnel at preferred
rates. In addition, in connection with the final testing of an installation
for ABB at the Jawarzno power station in Poland, various previous
agreements with ABB were revised to provide ABB with the exclusive resale
rights in Poland and $500,000 of minimum purchases of NeuSIGHT by February
27, 2002. No revenue has been recognized from these agreements through
December 31, 2000.
Late in 2000, Pegasus took two steps to enter the market in the
People's Republic of China ("China"). During the third quarter of 2000,
Pegasus signed a letter of intent for the installation of its flagship
NeuSIGHT product at four coal-fired boiler units, with a total generating
capacity of 1200 megawatts, at the Xibanpo power station in China, near
Beijing. In late November 2000, a firm order was received for the first of
these installations, which was recently initiated. During the fourth
quarter of 2000, Pegasus entered into a license agreement with BITCO
Enterprises ("BITCO"), providing BITCO and certain affiliates with the
exclusive right to market Pegasus' NeuSIGHT technology in the People's
Republic of China in exchange for a nonrefundable $300,000 fee and future
license fees. Pegasus and BITCO are negotiating the final terms of this
agreement, which are to include minimum performance thresholds that must be
met by BITCO in order to maintain the exclusive status. No revenue has been
recognized from these agreements through December 31, 2000.
Pegasus will pursue additional VAR and similar arrangements with
appropriate parties as a means to quickly and cost effectively gain access
to potential customers, particularly in foreign countries.
Intellectual Property
NeuSIGHT utilizes a neural network technology licensed from a
subsidiary of CA under an agreement which, among other terms, grants
Pegasus a perpetual, irrevocable, world-wide, exclusive right and license
for use in process monitoring and control applications in the electric
utilities industry. Payments are made to CA for each neural network license
sold, one of which is required for each NeuSIGHT installation. Through
August 1999, CA was also a 15% owner of Pegasus, at which time CA sold such
interest to KFx in exchange for 527,000 common shares of KFx; see Note 12
to the consolidated financial statements. The programming code that
constitutes NeuSIGHT is a trade secret.
Competition
Pegasus faces direct competition from approximately six companies that
offer software products providing combustion optimization benefits to the
emectric power industry.In addition, Pegasus faces indirect competition
from a similar number of companies that offer control systems used to
oqerate utility boiler units, which contain certain combustion optimization
features. Management believes the NeuSIGHT software solution offers several
competitive advantages over competitors' offerings. Most significantly, in
a survey completed in December 1998 by Resource Data International, a
subsidiary of the Financial Times, NeuSIGHT has been documented as
providing greater benefits than competing products in the areas of NOx
reduction and heat rate improvement. In addition, NeuSIGHT has demonstrated
ao ability to operate in closed-loop supervisory mode for extended time
periods without intervention.
NeuSIGHT's neural network model is considerably more extensive and
therefore more effective than competing products, through its ability to
manage higher volumes of input variables (up to 7 times the level of
competing products). While NeuSIGHT's neural network models are
sophisticated and complex, the software has a unique capability to retrain
the model automatically as operating conditions change in the plant.
Competing product models are generally static and require periodic
retuning, making them more costly to maintain and less effective over time.
In management's opinion, these and other features provide a much greater
ability for the software to adapt to changing environmental conditions,
equipment degradation, instrument calibration drift, and operating
variances.
In the opinion of management, compared with competing companies,
Pegasus provides more extensive implementation and training programs that
result in an end product more closely correlated to the actual operating
conditions of the specific boiler unit. Pegasus is focused exclusively on
the needs of the electric power generation industry rather than serving
various industries with differing needs. This focus, coupled with the
expertise of its personnel in this market, enable Pegasus to deliver
somutions that provide significantly greater reductions in NOx, higher
levels of operating efficiency and other benefits not provided by
competitors. Competing products tend to emphasize price as their basis of
comparison, while Pegasus is focused on cost benefit analysis and return on
investment. While Pegasus believes it is the leader in the industry, based
on the number of installed systems in the electric power generation
industry, certain direct competitors may have greater financial and other
resources than Pegasus. In addition, Pegasus may face increased or new
competition from indirect competitors and other vendors to the electric
power generation industry, many of which have significantly greater
financial and other resources than Pegasus.
K-FUEL TECHNOLOGY
General
The K-Fuel Technology is comprised of three groups, or series, of
patents. The Series "A" and Series "B" Technology patents are based on hot
gas and steam heat-transfer mediums, respectively. The Series "C"
Technology is based on a nitrogen heat-transfer medium. The principal
difference between the Series "A" and "B" Technologies and the Series "C"
Technology is that Series "C" is based on a more simplified design with
respect to the manufacturing equipment and facilities, resulting in lower
caqital costs. The Company expects the Series "C" Technology to be
primarily used for coal fuel product-manufacturing facilities. The Series
"A" and "B" Technologies can be used for coal fuel product facilities, as
well as renewable resource fuel product manufacturing facilities (e.g.,
bagasse, municipal solid waste, sludge and wood waste). The Series "A" and
"B" Technology patents were developed by Edward Koppelman and assigned to a
predecessor of the Company under a 1984 research and development contract
(the "R&D Contract") with the Company. The Company purchased the Series "C"
Technology patent directly from Mr. Koppelman after completion of the R&D
Contract in 1995 for $1.3 million. The Company is currently focusing its
commercialization efforts on the development of projects for the
manufacture of coal fuel product using the Series "C" Technology. To date,
one commercial-scale K-Fuel manufacturing facility has been constructed,
which began operations in April 1998 and suspended operations in June 1999.
See "Strategic Relationships--Thermo Ecotek Corporation and KFx Fuel
Partners" in this section. The development of future K-Fuel manufacturing
facilities is expected to result primarily from the K-Fuel, LLC, joint
venture with Kennecott Energy. See "Strategic Relationships-Kennecott
Energy Company" in this section.
In the Series "C" process, raw coal is crushed and screened before it
is introduced into a steel alloy processing vessel that is then pressurized
and heated indirectly using vertical tube heat exchangers. Nitrogen,
serving as an inert, non-oxidizing heat-transfer medium, is admitted to the
tube side of the processing vessel at a pressure of approximately 125
pounds per square inch ("psi"). After the nitrogen is inserted, it picks up
heat from the walls of the tube and gradually expands to approximately 800
psi. Water is released from the coal during this expansion period. When the
temperature in the tubes reaches in excess of 520 degrees Fahrenheit, any
water remaining in the coal turns to steam and continues to process the raw
coal. When the temperature of the coal reaches approximately 650 to 740
degrees Fahrenheit, the process is complete. The process takes 30 to 40
minutes to complete from initial loading of the raw coal into the
processing vessels to final discharge of finished K-Fuel product.
The principal benefit of the K-Fuel Technology in the United States is
that the fuel produced from the process can facilitate the efforts of
electric power producers, manufacturers and other large-scale users of coal
to meet the clean air standards imposed by the CAA. Based on various
independent and Company analyses, the environmental benefits of burning
K-Fuel versus most other coals appear to include significant reductions in
emissions of NOx, SO2, CO2, mercury and chlorine. K-Fuel is the first
beneficiated coal product that has not exhibited significantly greater
tendency for spontaneous combustion than run-of-mine Powder River Basin
("PRB") coal. In addition, K-Fuel has been demonstrated to increase gross
power generation, reduce fuel-pulverizing requirements, blend well with
other coals and flow well through coal handling systems. K-Fuel has
exhibited a level of dustiness that requires the use of dust suppression
equipment on site at most domestic coal-fired power plants.
See "Strategic Relationships-Kennecott Energy Company" in this section
for a discussion of the demonstration of improvements to the K-Fuel process
developed during 2000 by the joint venture between KFx and Kennecott
Energy.
In May 1998, the Southern Research Institute conducted a test burn of
apqroximately 10 tons of K-Fuel, which was also overseen by a technical
services affiliate of Kennecott Energy. The results of this test burn are
summarized in the table below:
Btu Emissions (ppm)
(As Received) (Corrected to 3% O2 Dry Basis)
------------- ------------------------------
NOX SOX
--- ---
K-Fuel...................... 11,703 142 173
Dry Fork Subbituminous...... 8,903 172 215
Lone Mountain Bituminous.... 13,315 265 530
In February 1999, the first commercial burn of K-Fuel was completed. A
unit train (approximately 12,000 tons of K-Fuel produced at the KFP
Facility; see "Strategic Relationships--Thermo Ecotek Corporation and KFx
Fuel Partners" in this section) was burned at Indiana-Kentucky Electric
Corporation's Clifty Creek generating station in southern Indiana. A fuel
blend of approximately 60% K-Fuel, with the balance consisting of a blend
of high-Btu, high and low-sulfur Eastern coals, replaced relatively
low-Btu, low-sulfur southern PRB coal in one of the station's boiler units.
Results of the test burn indicate that K-Fuel appeared to produce: a) a
reduction in NOx emissions while maintaining full load yet reducing
auyiliary power, b) no unusual slagging or fouling of the boiler, c) a
reduction in the fuel pulverizing operations, d) no spontaneous combustion
and e) an improvement in boiler efficiency. Indiana-Kentucky Electric's
fuel is procured by American Electric Power.
The results from this commercial scale burn at Clifty Creek generally
confirm the results of the test burn performed by the Southern Research
Institute. The Company believes that K-Fuel produced a reduction in SO2 and
CO2 emissions but the plant instrumentation precluded clear quantification.
The handling characteristics of K-Fuel were acceptable with proper use of
the power station's existing dust suppressant system. Nevertheless, KFx
continues to work to improve the handling characteristics of K-Fuel.
One of the Company's subsidiaries, KFx Technology, Inc., ("KFxT") has
performed research and development services related to the K-Fuel
technology under a contract with Western Research Institute ("WRI"), a
non-profit research organization based in Laramie, Wyoming. During 2000,
revenues from this contract approximated 11% of consolidated revenues. Such
revenues in 1999 were less than 10% of consolidated revenues. During 1998,
revenues from this contract approximated 15% of consolidated revenues.
Excluding depreciation, the costs under this contract approximated the
remated revenues and totaled $230,000, $117,000, and $344,000 in 2000, 1999
aod 1998, respectively.
Work under the most recent contract with WRI has been completed and
there is no commitment for an additional contract from WRI or other
potential customers of KFxT. Accordingly, KFxT staff was reduced in the
first quarter of 2001, pending identification of revenues from WRI or other
parties.
Strategic Relationships
Kennecott Energy Company and K-Fuel, LLC
In April 1996, the Company entered into a joint venture agreement (the
"Kennecott Agreement") with a wholly-owned subsidiary of Kennecott Energy.
Tie joint venture, a Delaware limited liability company named K-Fuel,
L.L.C. ("K-Fuel, LLC"), is intended to be the vehicle for further technical
advancement and the commercialization of business opportunities arising out
of the K-Fuel Technology, including research and development, sublicensing,
marketing and consulting, but not including the construction of facilities
to produce K-Fuel products on a commercial basis ("Commercial Projects").
Any Commercial Projects will be constructed by separate entities in which
Kennecott Energy, the Company, both or third parties will have an equity
ioterest and which will be granted a sublicense from K-Fuel, LLC, for the
K-Fuel Technology. In 1996, Kennecott Energy paid a fee of $1,000,000 to
tie Company to enter into the K-Fuel, LLC, joint venture. In June 1999, in
connection with certain amendments to the Kennecott Agreement, Kennecott
Energy purchased a K-Fuel license and paid KFx an initial license fee of
$1,000,000 for a minimum plant size of 666,667 tons of annual capacity to
be located at a site of its choice. This license is expandable to a larger
capacity plant, upon the payment of additional initial license fees. In
addition, Kennecott Energy paid to KFx an additional $1,000,000, which KFx
invested in K-Fuel, LLC to support the next phase of K-Fuel
commercialization, as required by the June 1999 amendments to the Kennecott
Agreement. Any technology related to the Company's technology developed
through the work plan funded by the $1,000,000 investment in K-Fuel, LLC,
will be owned by Kennecott Energy and licensed free of charge to K-Fuel,
LLC. The non-refundable payment related to the K-Fuel license accounted for
35% of the Company's consolidated revenues in 1999.
Under the work plan funded by the June 1999 investment in K-Fuel, LLC,
an improved K-Fuel process was demonstrated in late 2000, as announced in
early February 2001. The principal differences from the K-Fuel Series C
process previously used are continuous operations, lower temperatures, and
the absence of superheat from the system. The resulting product, which in
the tests was produced from Powder River Basin ("PRB") coals, is low in
SO2, NOX, mercury and chlorine, similar to K-Fuel. Analysis from this work
plan indicates that an improved process can possibly be designed to produce
the new fuel within potentially attractive economic constraints and that
the K-Fuel production process proposed as a result of the project should be
more reliable than was the KFP Facility when operated by Thermo Ecotek
Corporation (See "Strategic Relationships--Thermo Ecotek Corporation and
KFx Fuel Partners" in this section) and have lower capital and operating
costs than any previous K-Fuel plant design.
The heating value of the new fuel as tested is approximately 11,200 to
11,600 Btu's per pound. Upon combustion, the new fuel produces
approximately 20% lower NOX emissions and lower mercury emissions, as
compared to the PRB feedstock coal (already the lowest mercury content coal
naturally available), and SO2 emissions well below the 1.0 lb per million
Btu limit contained in Phase II of the CAA.
In addition, K-Fuel, LLC believes that there may be considerable
advantages to blending the new product and raw PRB coal. The dust and
self-heating behaviors of a blend of the new product and raw PRB coal
appear to be similar to raw PRB coal, without the need for oil or other
treatment. The blend retains proportional NOX, SO2 and mercury reduction
benefits. Therefore a commercial plant for the new product may be leveraged
to provide considerably higher volumes of blended product for the market
place.
K-Fuel, LLC is conducting studies concerning appropriate means to
further test the new process and design facilities for production. As of
April 13, 2001, there were no commitments to construct any K-Fuel plants.
The Company has a 51% percent interest in K-Fuel, LLC, and Kennecott
Eoergy has a 49% interest. Due to certain participatory voting rights
provided to Kennecott Energy in the Kennecott Agreement, as amended, the
Company does not control K-Fuel, LLC. At such time as entities in which
Keonecott Energy has an equity interest have placed into service Commercial
Projects with a collective design capacity equal to or in excess of 3
million tons per year ("TPY") of K-Fuel product, Kennecott Energy's
interest in K-Fuel, LLC, will increase to 51% and the Company's interest
will decrease to 49%. During 2000, 1999 and 1998, K-Fuel, LLC incurred
related research and development costs totaling approximately $482,000,
$23,000 and $134,000, respectively.
In connection with the Kennecott Agreement, the Company granted K-Fuel,
LLC, an exclusive, worldwide, fully-paid, royalty-free right and license
(including the right to grant sublicenses) to and under the K-Fuel
Technology, except to the extent that it pertains to the beneficiation or
restructuring of coal or coal-related feedstocks and related improvements
covered under the Heartland Fuels Corporation License (as defined below)
(the "KFx License"). In addition, Heartland Fuels Corporation, an 85%-owned
subsidiary of the Company, granted K-Fuel, LLC, an exclusive, worldwide,
fully-paid, royalty-free right and license (including the right to grant
sublicenses) to and under the Series "A" and Series "B" K-Fuel Technology,
as it pertains to the beneficiation or restructuring of coal or
coal-related feedstocks (the "HFC License"). Both the KFx License and the
HFC License specify minimum terms and provisions for any sublicenses
granted by K-Fuel, LLC, to third parties.
Under the Kennecott Agreement, as amended in June 1999, with respect to
future Commercial Projects to be licensed by K-Fuel, LLC to entities wholly
or partially owned by Kennecott Energy, the Company is entitled to a
one-time license fee approximating $3 per ton of annual design capacity of
each project, times Kennecott's percentage of beneficial ownership, to be
paid one-half at the time the license is granted, with the remaining
one-half paid over a period of three years beginning when the project
begins commercial operations. The Company will also receive a production
royalty, to be paid each calendar quarter, depending on certain levels of
the project's selling price per ton of coal product. With respect to the
non-Kennecott Energy portion of production capacity and production of
Commercial Projects in which Kennecott Energy has less than 100% beneficial
ownership, the Company is entitled to similar, but higher, license fees and
royalty payments. Such higher license fees and royalty payments also apply
to 100% of the production capacity and production of Commercial Projects in
which Kennecott Energy has no beneficial ownership. In addition, the
Company will be entitled to additional payments based on a percentage of
the excess of (1) annual cash revenue from each project, or (2) annual
pre-tax cash operating costs of each project plus an annual capital charge
related to each project. Kennecott Energy has the right to fund 100% of
Commercial Projects that it approves, subject, however, to the Company's
right to fund up to 50% of such projects on the same economic terms as
Kennecott Energy. The Company has no obligation to fund any Commercial
Project.
Thermo Ecotek Corporation and KFx Fuel Partners
In August 1995, the Company entered into a Stock Purchase Agreement
(the "Stock Purchase Agreement"), with Thermo Ecotek Corporation ("TCK"), a
Massachusetts-based company traded on the American Stock Exchange. At that
time the Company and TCK also entered into a separate agreement to
construct and operate a 500,000 TPY commercial-scale K-Fuel production
facility.
Under the Stock Purchase Agreement, in 1995 TCK purchased 3 million
shares of KFx Common Stock for $6 million, or approximately 14% of the
outstanding KFx Common Stock as of December 31, 1996, and in 1997 purchased
an additional 1.25 million shares of KFx Common Stock for $2.5 million,
increasing its ownership to approximately 18% of the outstanding KFx Common
Stock. As part of the transaction TCK was also granted warrants to purchase
the number of shares of KFx Common Stock that, when added to all shares
owned by TCK on the exercise date, would be sufficient to give TCK 51% of
the outstanding KFx Common Stock, on a fully diluted basis. On May 9, 2000,
TCK cancelled these warrants in connection with certain other agreements,
as discussed below.
In August 1995, the Company and TCK, acting through respective
wholly-owned subsidiaries, formed KFx Fuel Partners, L.P., a Delaware
limited partnership ("KFP") and began construction of a 500,000 TPY K-Fuel
coal production facility (the "KFP Facility") near Gillette, Wyoming, using
the Company's Series "C" Technology. The Company owned a 5% interest in
KFP, with the remaining 95% owned by TCK. TCK was the managing general
partner for KFP.
KFP began operations at the KFP facility in April 1998 and completed a
successful test burn in May 1998 and a successful commercial burn in
February 1999, as discussed above. The KFP facility operated and produced
commercially salable product in 1998 and 1999 and KFP addressed certain
problems previously encountered, including a 1996 fire at the facility and
certain construction problems, including issues relating to the flow of
materials within the facility and the design and operation of certain
pressure release equipment. Nevertheless, KFP continued to experience
certain problems relating to tar and fines residue build-up within the
system during production and product quality issues related to product
dusting. On May 24, 1999, TCK announced that in connection with certain
stsategic restructuring decisions made by TCK and its parent, Thermo
Electron Corporation, it had decided to hold for sale its investment in the
KFP Facility and record charges related thereto. Further, TCK in June 1999
suspended operations at the KFP Facility and K-Fuel is not currently being
produced.
As of May 9, 2000, the Company finalized a series of agreements with
various parties intended to initiate the redevelopment of the KFP Facility.
Pursuant to the agreements (a) a subsidiary of Black Hills Corporation
(BKH) purchased the KFP Facility and received 2 million shares of KFx
Common Stock previously held by TCK in exchange for the assumption of the
reclamation liability associated with the KFP Facility, (b) BKH was given
the right to one seat on KFx's board of directors (which, through April 12,
2001, BKH has declined to exercise), and KFx granted BKH a warrant to
puschase 1,300,000 shares of KFx Common Stock at $3.65 per share, subject
to certain adjustments, (c) KFx relinquished its 5% interest in KFP to TCK
and provided certain releases to TCK in exchange for $100,000 in cash,
$150,000 in proceeds of an unsecured note payable to TCK on June 10, 2000,
and future cash payments estimated at $1,400,000 (all of which were
received by August 3, 2000), (d) KFx received certain real and personal
property from TCK, (e) TCK sold the remaining 2,250,000 shares of KFx
Common Stock it owned to private investors and canceled the warrants it
held to purchase a control position in KFx's Common Stock. The carrying
value of the Company's investment in KFP was written down effective
December 31, 1999 by $1,800,000, to the $1,500,000 expected cash proceeds
to KFx. In addition, the estimated $2,200,000 value of the warrants issued
to BKH was charged to expense effective December 31, 1999; the warrants
were issued at the closing on May 9, 2000.
KFx and BKH are proceeding to finalize plans and secure the necessary
capital to rectify certain design flaws in the balance-of-plant systems in
order to restart the KFP Facility and produce K-Fuel. The cost to implement
these plans is currently estimated at $2 million to $4 million. The Company
has no ownership interest in the KFP Facility and has no obligation to fund
any capital or other costs necessary for its restart.
During 1998, certain support services provided by a subsidiary of KFx
to KFP approximated 25% of consolidated revenues; such services in 1999
were less than 10% of the Company's consolidated revenues.
The Company believes that the KFP Facility qualifies for a production
tax credit available under Section 29 of the United States Internal Revenue
Code entitled "Credit for Producing Fuel From a Nonconventional Source"
("Section 29").Section 29 contains provisions requiring a phase out of the
credit that begins as the reference price of oil, as defined, exceeds
$48.07 per barrel and is fully phased out if such reference price exceeds
$60.34. For 2000 the reference price of oil was $26.73 per barrel. The
current tax credit value ranges from $24.33 to $26.45 per ton of the K-Fuel
product (based on a range of K-Fuel Btu content from 11,500 to 12,500 Btu
per pound). The credit per OBE and the phase-out prices for oil are
adjusted annually for inflation. If the KFP Facility were to be determined
to not qualify for the Section 29 tax credit, the ability to generate an
acceptable rate of return from the KFP Facility would be materially
adversely affected. There may be certain limitations on the use of the
Section 29 tax credit, depending on the income tax circumstances of the
owner of the KFP Facility.
Patents, Licenses, and Royalty Agreements
The Company has patents or patent applications for the K-Fuel
Technology registered in the United States and over 40 foreign countries,
including all major industrialized countries that either have significant
reserves of high-moisture lignite or subbituminous coal, or that are
readily accessible to such reserves via large-scale transportation
iofrastructure (primarily ocean barge vessels). Included in the pending
patent applications are inventions developed by the Company as well as
seven improvement patent applications assigned to the Company as a result
of the K-Fuel, LLC research activities.
The only licenses the Company has granted for use of the K-Fuel
Technology are to the KFP Facility (Series "C"), K-Fuel, LLC (Series "C"),
and Heartland Fuels Corporation ("HFC") (Series "A" and "B"). The Company
owns 85% of the common stock of HFC, and as a condition of the Kennecott
Agreement, the Company caused HFC to grant to K-Fuel, LLC an exclusive
sublicense to the Series "A" and "B" Technologies.
A predecessor entity of the Company acquired the Series "A" and "B"
Technologies from Edward Koppelman and other investors (the "Koppelman
Group") in 1984 for $10 million in cash and a royalty agreement. In June
1996, the Company entered into a royalty amendment agreement with Edward
Koppelman, the inventor of the K-Fuel Technology. As a result of the
amended agreement, Mr. Koppelman's royalty is now 25 percent of the
Company's worldwide royalty and license fee revenue, computed after the
State of Wyoming's royalty (noted in the table below). The royalty to Mr.
Koppelman will cease when the cumulative payments to him reach the sum of
approximately $75,222,000. As consideration for the royalty amendment
agreement, in June 1996, the Company paid Mr. Koppelman $300,000 cash and
issued a promissory note for $200,000. See Note 8 to the consolidated
financial statements. The resulting $500,000 prepaid royalty is amortized
as licenses to K-Fuel Technology are sold. Also as part of the royalty
agreement, Mr. Koppelman indemnified the Company for any claims made by the
Koppelman Group.
The following table summarizes the Company's royalty obligations to
various third parties:
Expiration Date or
Royalty Obligation United States International Maximum Amount
------------------ ------------- ------------- ------------------
Estate of Edward Koppelman 25 Percent(1) 25 Percent $75,222,000
State of Wyoming 12 Percent(2) NA--None $ 5,000,000(2)
Fort Union Ltd. 20 Percent(3) Canada, Mexico Earlier of cumulative
royalties paid of
$ 1,500,000 or
September 15, 2015
Ohio Valley Electric ..............0.5 Percent(4) NA--None None
(1) Computed after the State of Wyoming's royalty, and applies to both
license fees and royalties.
(2) The royalty percentage decreases to 6 percent when $5,000,000 has
been paid. There is no expiration date or maximum amount on the
remaining 6 percent, and applies to both license fees and
royalties.
(3) Applies to royalties only and is also applicable to any production
in Canada or Mexico.
(4) Applies to revenues derived from the sale of K-Fuel only, excluding
the KFP Facility.
Competition
To the best of the Company's knowledge, there are currently no
competitors producing significant commercial quantities of beneficiated
clean coal fuel products either in the United States or in international
markets. However, there are other clean coal technology ("CCT") companies,
primarily in the United States, that are developing fuel combustion and
product technologies that would reduce emission pollutants and/or increase
the heating value of coal feedstock fuel sources. Many of these CCT
competitors have greater financial, technical and operational resources
than the Company. To the best of management's knowledge, however, none of
these other efforts have yet resulted in an economically viable and
commercially acceptable beneficiated coal product with the economic and
commercial potential of K-Fuel.
In the United States market, the Company must also compete with other
naturally low-sulfur coals. Also, SO2 emission credits ("emission credits")
allow non-compliance users of higher sulfur coal to bundle coal purchases
with these emission credits to meet the CAA requirements. During Phase I of
the CAA, which began January 1, 1995, the majority of affected boiler units
achieved compliance by switching to lower sulfur fuels rather than
installing flue gas desulfurization equipment ("FGDs" or "scrubbers"). An
over-compliance situation developed in Phase I of the CAA, resulting in an
abundant supply of emission credits in the U.S. market. Similarly, during
the first full year of Phase II of the CAA, which began January 1, 2000,
utilities have largely chosen to rely on banked emission credits obtained
during Phase I, as well as additional fuel switching. As a result of fuel
switching, existing supplies of naturally low-sulfur coal are continually
being depleted. The extent of the use of scrubbers, versus additional fuel
switching, including the impact on the demand for K-Fuel and NeuSIGHT, will
depend on a number of factors, including final EPA rulings on small
particulates ("PM2.5") and regional haze and the outcome of a number of
pending lawsuits regarding certain aspects of the CAA. The ultimate impact
of these factors on the demand for K-Fuel, NeuSIGHT and other related
technologies, products and services that the Company may offer in the
future is not clearly determinable.
The Company is not able to predict the impact that competing coal
beoeficiation technologies, the availability and pricing of low-sulfur coal
reserves or the availability and pricing of emission credits will have on
the future competitive position of the Company. To the best of the
Company's knowledge however, none of its competitors have been able to
demonstrate as many quantifiable and potential benefits in a commercial
setting as K-Fuel achieved in February 1999 at Indiana-Kentucky Electric
Corporation's Clifty Creek generating station in southern Indiana.
Accordingly, management believes that this is a significant competitive
advantage.
Other
Indonesia
In September 1995, KFx Indonesia, a joint venture between the Company
and RCD Development, a Maryland partnership ("RCD"), entered into a
memorandum of understanding with PT Tambang Batubara Bukit Asam ("PTBA"),
an Indonesian state-owned coal-mining company, to jointly undertake a
feasibility study on the commercialization of the K-Fuel Technology in
Indonesia using PTBA's high-moisture coal as feedstock. Kennecott Energy,
through its interest in K-Fuel, LLC, subsequently participated in the
feasibility study. In 1996, KFx Indonesia, Kennecott Energy and PTBA
completed the feasibility study and identified a potential K-Fuel project
on the southern portion of the Indonesian island of Sumatra ("Indonesia
Project").
Development of the Indonesia Project has suffered from the overall
economic and political problems experienced by Indonesia and other Asian
countries beginning in 1997. Further development of the Indonesian Project
(other than periodic assessment of Indonesian coal trade and overall
economic conditions) has been limited pending, primarily, the return to a
more stable economic and political environment in Indonesia. The Company is
not able to determine if or when such conditions will materialize to allow
the Indonesia Project to commence construction. There are no assurances
that the Indonesia Project or other possible future projects in Indonesia
will be constructed.
Turkey
In June 1996, the Company entered into a non-binding memorandum of
understanding with Soma Komur Isletmerleri A.S. ("SOMA"), a Turkish private
coal-mining company, to cooperate in the development of a proposed 500,000
TPY K-Fuel project in the Soma Basin coal-mining region in western Turkey
("Turkey Project"). The intended use of K-Fuel from the Turkey Project
would be for household heating markets in urban areas in Turkey. The
Company has provided K-Fuel pellets produced from Turkish coal to SOMA and
the City of Ankara ("Ankara"), which were tested in Turkey by SOMA and
Ankara, with satisfactory results. Development of the Turkey Project is
primarily dependent on SOMA and/or Ankara securing adequate financing.
There are not yet any definitive agreements with respect to a Turkey K-Fuel
production facility, and the Company is not able to predict if or when a
K-Fuel production facility will be constructed in Turkey. There are no
assurances that the Turkey Project or other possible future projects in
Turkey will be constructed.
MARKET DRIVERS
Domestic Market
There are two primary market drivers for the NeuSIGHT and K-Fuel
Technology solutions offered by the Company. For a number of years various
regulations and other requirements have placed increasingly stringent
standards on the air emissions generated by the electric power generation
industry and others. In addition, as the power industry undergoes the
rigors of deregulation and is transformed into a market-driven highly
competitive industry, there will be increasing pressure to meet such air
emission standards in more cost effective ways as well as to improve the
overall cost efficiency of electric power generation.
Air Emission Standards
The CAA has been the primary historical stimulus for the developing
United States market for beneficiated clean coal fuel products, such as
K-Fuel, and for combustion optimization products, such as NeuSIGHT.
Specifically, Title IV of the CAA requires electric utilities to reduce
emissions of NOx and SO2.
In September 1998, the United States Environmental Protection Agency
("EPA") issued a rule requiring 22 Midwestern and Southern states and the
District of Columbia to prepare implementation plans to reduce current
allowed levels of NOx by approximately 85% (the "SIP Call"). NOx is a
primary component in ground-level smog and is also a contributor to acid
rain. Coal-fired electric utility power plants are widely considered to be
the most likely targets to achieve the required reductions in NOx.
Challenges to the EPA's SIP Call resulted in a May 1999 federal appeals
court action that effectively suspended the SIP Call pending further
review. Subsequently, a March 3, 2000 federal appeals court mostly affirmed
EPA's SIP Call, although the number of states included has been reduced to
19. Implementation of the SIP Call will commence in the 2004 ozone season
(May through December), which will include a regional NOx trading program,
in essence an expansion of the Ozone Transport Commission ("OTC") trading
program already in place in 11 northeastern states. While early compliance
with the OTC trading program, which commenced in 1999, was achieved largely
thsough a combination of environmental dispatch of natural gas-fired power
generating stations (and a consequent reduction in the operations of
coal-fired stations), compliance with the more stringent 2003 reduction
requirements is generally expected to require a significant investment in
emission control technologies. Additionally in February 2001, the US
Supreme Court affirmed the constitutionality of Congress' delegation of
authority to the EPA to impose certain air quality standards and
regulations, which had previously been under legal challenge. Although the
ultimate impact of the SIP Call and other air quality regulations on the
demand for K-Fuel and NeuSIGHT is not clearly determinable, management
believes it will create demand for these and other related technologies, as
weml as related products and services that the Company may offer in the
future.
NeuSIGHT has been demonstrated to typically reduce NOx by 25% to 30%.
K-Fuel Technology can also reduce NOx emissions (when using PRB coal as the
feedstock) as compared to typical eastern coals by levels approximating
25%, as indicated in the February commercial burn. Through the combination
of NeuSIGHT and K-Fuel, management believes that the Company is in a unique
position to assist the electric power generation industry in achieving
required reductions in NOx more cost effectively than various other
solutions, some of which are highly capital intensive and also can add
significant operating costs.
Title IV of the CAA specifies a two-phase implementation schedule that
primarily targets electric utility companies with annual generating
capacities in excess of 25 megawatts ("MW"). Phase I implementation began
on January 1, 1995, and affected 110 large, high-emission generating plants
in 21 states (primarily in the industrial Midwest). The emissions limit for
these plants during Phase I was 2.5 lbs. SO2 per million Btu ("MMBtu") of
heat output. Phase II, which began January 1, 2000, is more broadly
sweeping than Phase I, generally expected to impact more than 2,000 fossil
fuel-fired electric generating units in 48 states. The effective SO2
emission rate limitation under Phase II is reduced to 1.2 lbs. SO2 per
MMBtu. When using Wyoming PRB coal as feedstock material, the K-Fuel
Technology produces a fuel product that has an SO2 emission rate of
approximately 0.7 to 1.0 lbs. SO2 per MMBtu. NeuSIGHT also produces
reductions in SO2 as a byproduct of heat rate improvements and combustion
optimization. Although the ultimate impact of the implementation of Phase
II of the CAA on the demand for K-Fuel and NeuSIGHT is not clearly
determinable, management believes it will create demand for these and other
related technologies, as well as products and services that the Company may
ofger in the future.
The Company's United States marketing emphasis is directed primarily at
electric utilities located in the industrial Midwest and eastern states,
more specifically those under EPA scrutiny. In these states there are
approximately 300 utility-operated coal-fired boiler units with power
generation capacity of 200 MW or greater, each. The entire U. S. contains
approximately 500 of such utility-operated coal-fired boiler units.
The combustion characteristics of cyclone furnace boilers, a common
boiler type of Midwestern utilities originally designed to burn high-sulfur
Midwestern coal, are particularly well suited to the K-Fuel product
manufactured from PRB coal. As reported by the U.S. Department of Energy,
the total domestic market for coal fuel is approximately 1 billion TPY, of
which electric utility companies use the majority of the tonnage
(approximately 85%). Coal-fired electricity generation currently accounts
for approximately 54% of the nation's total electricity supply. The Company
has estimated, based on published utility coal consumption data and
responses to Phase I and Phase II requirements of the CAA, that a market of
approximately 100 to 150 million TPY of clean coal fuel products will
develop over approximately the next ten years. Any amendments to the CAA
that reduce the specified limits on industrial SO2 emissions would likely
negatively impact the potential size of the market and the domestic growth
prospects of the Company.
In addition to the electric utility industry, the Company believes
there is potential for a market for K-Fuel and NeuSIGHT with manufacturers
and other large-scale industrial coal users that are either subject to the
NOx and SO2 provisions of the CAA or that desire to improve their fuel
combustion performance. Fuel combustion performance is becoming more
important to electric utilities and others because of the need to cut costs
and become more efficient in an increasingly competitive market
environment.
CO2 is widely considered to be a primary component of greenhouse gases
that have given rise to worldwide concerns of global warming. The December
1997 Kyoto Protocol to the United Nations Framework Convention on Climate
Change ("Kyoto Protocol") targets CO2 and certain other greenhouse gas
emissions for aggressive reduction in the years 2008 to 2012. In addition,
the Kyoto Protocol notes electric power generation as one of the specific
industry sectors that should be reviewed to achieve the targeted
reductions. A very important by-product of the efficiency gains at electric
power generation boiler units achievable through the use of NeuSIGHT and/or
K-Fuel is a corresponding reduction in the level of CO2. Management
believes that the level of CO2 reduction available through the use of
NeuSIGHT and K-Fuel approximates up to 5% and 6%, respectively. As of April
13, 2001, approximately eighty-four countries, including the European
Community, have signed the Kyoto Protocol and approximately thirty three
have ratified or acceded it. Although the United States signed the Kyoto
Protocol in December, 1998, it has not been ratified by the United States
Senate, as would be required to be applicable in the United States. In
addition, the Bush Administration has indicated that it does not support
signing the Kyoto Protocol or the regulation of emissions of CO2 in the
near term. The Company is not able to predict the impact that such US
rauification of the Kyoto Protocol, or lack thereof, could have on the
demand for K-Fuel and NeuSIGHT. Nevertheless, initiatives such as the Kyoto
Protocol, targeted at reducing CO2 and other greenhouse gases, are expected
to continue to progress and create additional demand for alternatives to
achieve significant reductions in such emissions.
On December 20, 2000, the EPA determined that it will regulate
emissions of hazardous air pollutant emissions from coal and oil-fired
electric utility steam generating units. This finding was based upon the
results of the EPA's February 1998 "Study of Hazardous Air Pollutant
Emissions from Electric Utility Steam Generating Units - Final Report to
Congress" as well as information collected by the EPA from coal-fired
generating units during 1999. Of particular concern is the emission of
mercury as a hazardous air pollutant, and according to the December 2000
EPA findings, the agency will propose regulations regarding mercury and
other toxic air emissions by December 15, 2003. Final regulations will be
released by December 15, 2004. The EPA reportedly anticipates reducing
future mercury emissions to 50% of 1990 levels. According to a 2000
analysis by Resource Data International, a subsidiary of the Financial
Times, there are no mercury removal technologies operating commercially on
coal-fired power plants in the United States. Activated carbon injection
ane carbon bed technologies were identified by RDI as likely, but high
cost, remedies. RDI identified other mercury reduction techniques including
the use of low or zero mercury fuels, such as K-Fuel. According to
independent research, a significant level of mercury is removed from
run-of-mine coal during the K-Fuel production process. These tests indicate
any mercury contained in K-Fuel is below detectable levels of .05 parts per
million (ppm), compared to mercury levels of typical Eastern bituminous
coals of .15 ppm to .20 ppm. Based on these test results, if the EPA adopts
regulations to restrict the level of mercury emissions, K-Fuel may offer
significant competitive advantages over other high-energy value coals. In
addition, the mercury tests of K-Fuel indicate that the chlorine content of
K-Fuel is also below the detectable levels of .05 ppm. Although the Company
is not aware of any initiatives underway to regulate emissions of chlorine,
it is commonly considered to be a hazardous material that is regulated in
various settings, and emissions of chlorine are generally considered to be
undesirable. Accordingly, regulation of chlorine emissions could develop in
the future, which could create another competitive advantage for K-Fuel.
Deregulation of the United States Power Industry
In the United States the retail power industry is regulated primarily
by various state authorities. With the passage of the Energy Policy Act of
1992, deregulation of the power industry began approximately nine years ago
in an effort to introduce market discipline in a manner similar to the
deregulation of the telecommunications industry, both of which had
previously been considered to be monopolies requiring a high degree of
regulation in order to protect retail consumers. Approximately 24 of the
states and the District of Columbia have deregulated or are in the process
of deregulating their power industry with 17 additional states considering
deregulation. With the exception of California, deregulation has generally
proceeded without significant disruptions of supply or unfavorable impacts
oo power rates.
Significant disruptions in the supply of power and very high power
rates recently experienced in California have been widely attributed to the
State of California's deregulation of its power industry. A certain level
of resulting negative public sentiment toward deregulation of the domestic
power industry may slow the deregulation process in certain states.
Nevertheless, the difficulties in California have been mostly attributed to
a poorly designed deregulation process. Accordingly, management believes
that the deregulation of the domestic power industry will continue.
Deregulation of the electric power industry is expected to result in
intensified price competition, increased price volatility, shorter-term
wholesale electricity transactions and industry consolidation and
structural changes. The electric power industry is moving toward retail
competition while the wholesale market has already been established as
full-scale open competition. While the electric power industry is
experiencing consolidation through mergers and acquisitions, the industry
is concurrently unbundling generation, transmission and distribution
services from the traditionally integrated structure.
This restructuring is expected to cause some electricity generators to
operate as merchant plants without a guaranteed market for their production
output. In such an environment these businesses will be under constant
competition for the sales of their products and services. As a result,
plant operators will be expected to look to cut costs and improve operating
efficiencies wherever possible.
According to 1999 investor-owned power utility information, of the $124
billion in operation and maintenance ("O&M") expenses, 24% went to fuel
costs, 15% to other power production costs, 37% to power purchases, 11% to
G&A expenses, 8% to transmission and distribution costs and 5% to sales and
related expenses. Although the cost of power generation has been reduced
overall to an average cost of 3.8 cents per kilowatt-hour ("kWh") in 1999,
from 4.6 cents per kWh in 1986, much of this reduction has been attributed
to reductions in force. Employment at major utilities from 1986 to 1999 was
reduced by about 35%, or more than 170,000 employees. In the opinion of
management, competition in a deregulated power industry will require
further reductions in the cost of power generation. To further reduce the
cost of power generation, savings must begin to come from areas other than
personnel reductions, such as more effective fuel purchase practices and
efficiency gains in the core processes in the generation of power.
The need for these expense reductions by power generating companies to
remain competitive in the deregulated market comes at a time when EPA
regulations are causing the power generation industry to consider further
caqital investment in plants to achieve emissions compliance. Management
believes that power-generating companies will look for solutions, such as
NeuSIGHT software and K-Fuel, to reduce these capital investments, cut
operating costs and run their plants more efficiently.
These developments are expected to produce a strong incentive for
electricity generators to become low cost producers and expand market share
in order to remain profitable in the deregulated environment. In a fully
competitive retail electricity market, only those generators with costs low
enough to produce electricity at market acceptable prices, not simply low
enough to meet regulatory oversight, will be able to sell electricity
profitably and remain viable.
FOREIGN MARKETS
The international coal-fired power generation industry is approximately
four times the size of the United States coal-fired power generation
ineustry. The Company's objective, with respect to international
oqportunities for K-Fuel, is to concentrate on markets where there is
either a significant need for more energy efficient and environmentally
responsible fuel products, or where abundant coal reserves can be utilized
in conjunction with the K-Fuel Technology to develop a value-added export
product. The principal benefit of the K-Fuel Technology in foreign markets
is that low-rank indigenous coal reserves can be upgraded to provide a more
cost effective and less environmentally damaging fuel source for power
producers, manufacturers and households, either in internal markets or for
export. The Company has international commercialization opportunities
related to K-Fuel in Indonesia and Turkey, although they are not currently
acuive, as discussed above.
In addition, although management expects to initially concentrate its
marketing and sales efforts with respect to Pegasus domestically, for
reasons similar to those cited above relative to K-Fuel and certain of the
U. S. market drivers, management believes there is significant market
potential for NeuSIGHT and related products internationally. Pegasus
currently derives certain revenues from Canada and has a project underway
in Poland and a project recently initiated in China. See "Pegasus-Strategic
Relationships" above.
CHARCO REDONDO, LLC
In December 1997, the Company purchased a 12.6% interest in Charco
Redondo, LLC, a Texas limited liability company ("Charco"), for $629,000.
Charco was formed to develop and complete a project intended to
demonstrate the effectiveness of Synthetic Energy Corporation's
("Synthetic") patented process, which uses mining techniques in connection
with superheated steam and moderate pressure to mobilize crude oil that
otherwise cannot be produced by conventional techniques. The technology
licensed to Charco is based on patents held by John A. Masek (the "Masek
Technology"). Charco has an exclusive sublicense to use the Masek
Technology in a four-county area of Texas (the "AMI"), which is believed to
have reservoirs containing approximately 1 billion barrels of crude oil,
which would be appropriate targets for application of the Masek Technology.
The pilot project (the "Charco Pilot Project") has been conducted on a
mineral lease covering approximately 1800 acres in southern Texas (the
"Charco Redondo Lease"). Drilling, completion and start-up activities were
completed late in the second quarter of 1998 and injection operations were
conducted for five months until December 1998, when the pilot project was
shut down because of depressed crude oil prices even though daily oil
production was increasing. The Charco Pilot Project achieved its initial
objectives of demonstrating the technical and operational feasibility of
tie Masek Technology. Charco is pursuing further improvements to the
technology. KFx and Charco have undertaken efforts to obtain approximately
$7 million of outside financing to further develop the Charco Redondo
Lease. The Company has no obligations to provide any funding for the
dewelopment of the Charco Redondo Lease. Although the Company believes the
Charco Redondo Lease has significant potential, based on (a) the need for
the Company to focus its efforts and limited financial resources on its
K-Fuel and Pegasus business segments and (b) the inability to obtain the
necessary outside financing to date, the Company recorded a permanent
impairment write-off for its investment in Charco Redondo as of December
31, 2000. Efforts to obtain financing will continue and the Company will
consider alternatives to dispose of its investment.
The Company also entered into an option agreement with Synthetic with
respect to the use of the Masek Technology outside the AMI. The option
agreement provides that the Company and Synthetic will form a joint venture
to be owned 55% by the Company and 45% by Synthetic. Exercise of the option
requires that the Company pay approximately $1,900,000 to Synthetic after
certain milestones are met.
GOVERNMENT AND ENVIRONMENTAL REGULATION
Generally, environmental permitting and operating regulations in
countries outside the United States that the Company is currently pursuing
for international development are not as stringent as those are within the
United States. Nevertheless, international initiatives, such as the Kyoto
Protocol, are expected to create increasing pressures on the electric power
generation industry on a world-wide basis to reduce emissions of various
pollutants, which management expects will create additional demand for its
products and services.
Pegasus
The operations of Pegasus are not significantly impacted by
governmental regulation with respect to the development and delivery of
NeuSIGHT(TM) and related software products and services.
K-Fuel
In the United States, the K-Fuel product is not expected to be subject
to unusual levels of local, state or federal regulation with respect to its
transportation and distribution. However, any future United States
production plants will require numerous permits, approvals and certificates
from appropriate federal, state and local governmental agencies before
construction of each facility can begin, and will be subject to periodic
maintenance and review requirements once facilities begin production.
Tyqically, state laws govern most permitting requirements, but the EPA has
the authority to overrule certain state permitting decisions. The types of
permits that are typically required for commercial production facilities
include air quality, wastewater discharge, land use, and hazardous waste
treatment, storage and disposal. KFP has in place all permits for the
operation of the KFP Facility. The K-Fuel Technology process generates only
waste gas, waste discharge water, and a small amount of fuel liquid as
by-products of the process. The KFP Facility has waste gas and water
treatment facilities to treat and dispose of the waste by-products.
Future international K-Fuel production plants will also be subject to
various permitting and operational regulations specific to each country.
EMPLOYEES
The Company currently has approximately 32 full-time employees, six of
wiom work in the areas of corporate and K-Fuel marketing, finance, and
administration, and the operation of the K-Fuel demonstration plant and
lacoratory and 26 of whom work at Pegasus in the areas of sales and
marketing, software development, software implementation, finance, and
administration. The Company considers its relations with all employees to
be good.
RISK FACTORS
Our Historical Financial Performance and Current Financial Condition Raise
Substantial Doubt About Our Ability to Continue as a Going-Concern. We Need
Additional Capital to Fund Our Substantial Business, to Pay Interest and
Principal Currently Due to the State of Wyoming on July 1, 2001, and to Pay
Interest and Principal, at Maturity on July 31, 2002, on Our 6% Convertible
Debentures
We require substantial working capital to fund our business. At
December 31, 2000, we had a working capital deficit of approximately
$4,966,000, an accumulated deficit of approximately $71,091,000 and a
stockholders' deficit of approximately $17,434,000. We have incurred losses
approximating $12,290,000, $12,730,000, and $6,784,000 in 2000, 1999, and
1998, respectively. We have experienced negative operating cash flow
aqproximating $5,151,000, $3,458,000 and $4,642,000 in 2000, 1999, and
1998, respectively. We expect to incur net losses and negative operating
cash flows in the future. We cannot assure you that we will ever achieve
profitability, or be able to generate earnings sufficient to meet our
interest and principal payment obligations. As a result, we have been and
continue to be very dependent on strategic relationships, sales of our debt
and equity securities and short-term loans from our directors and third
parties to fund the operating costs associated with our businesses.
The accompanying financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the
sauisfaction of liabilities in the normal course of business. Our
historical financial performance, obligations coming due over the next 12
months and the need for additional financing to fund planned growth in the
business raise substantial doubt about whether the Company can continue as
a going concern.
By selling our 6% convertible debentures in July 1997, we incurred
$17,000,000 in principal amount of indebtedness. Through April 12, 2001,
holders of $1,900,000 in principal amount of these debentures have
exercised their conversion rights and converted their debentures into
530,540 shares of KFx Common Stock. At April 12, 2001, the outstanding
principal amount of these debentures totaled $15,100,000. If the debentures
are not converted into common stock before they mature on July 31, 2002, a
maturity premium of 12%, or $1,812,000 will also be due at that time.
Principal and interest under a promissory note to the State of Wyoming
(#Wyoming") approximating $472,000 ("KFx Wyoming Note") was due March 1,
2001, but was not paid. The Company initiated discussions with Wyoming in
late February 2001 and on March 12, 2001 consummated an extension to July
1, 2001 in exchange for (a) a principal payment approximating $150,400 made
on March 9, 2001, (b) a delinquent payment fee approximating $47,200 made
on March 9, 2001, (c) an interest payment approximating $2,400 made on
March 9, 2000, (d) the assignment to Wyoming of the net sales proceeds of
the balance of the Company's preferred stock investment in Pegasus (with a
face value approximating $1 million), representing an interest in Pegasus
approximating 4.4% and (e) a collateral interest in certain K-Fuel related
equipment that is not currently in use.
Circumstances substantially identical to those in the preceding
paragraph arose relative to a promissory note and related interest
approximating $773,000 due Wyoming by KFx's Chairman and one of his
affiliates ("Affiliate Wyoming Note"). The Company agreed in 1994 to
indemnify its Chairman and his affiliate for any payments due under such
note, upon his demand, since their obligation stemmed from their personal
guarantee of certain obligations of the Company that were renegotiated in
1994. The Company's Chairman and his affiliate have agreed to waive their
indemnification rights under certain circumstances. Wyoming issued a notice
of default relative to this note on March 2, 2001, triggering a 10-day cure
period. On March 12, 2001, Wyoming agreed to forebear from collection
activities under this note until July 1, 2001.
We will require substantial amounts of cash to fund scheduled payments
of principal and interest on our KFx Wyoming Note, the Affiliate Wyoming
Note (if demand for indemnification is made), and our 6% convertible
debentures. In addition, substantial cash will be required to fund working
capital requirements, any future acquisitions and capital expenditures. We
will be required to raise additional funds through public or private
financings, strategic relationships or other arrangements. We currently do
not have any commitments with respect to any funding. We cannot be assured
that such additional funding will be available at all or on terms
satisfactory to us. A lack of adequate financing may adversely affect our
ability to:
o make necessary interest and principal payments on our indebtedness;
o respond to changing business and economic conditions and competitive
pressures;
o make future acquisitions;
o absorb negative operating results; or
o fund capital expenditures or increased working capital requirements.
The Company's transaction with Kennecott Energy in March 2000 resulting
in $1,000,000 of potential additional investments by Kennecott Energy in
Pegasus during 2001 ($500,000 of which has been received as of April 13,
2001), proceeds of $1,900,000 in cash realized through April 13, 2001 from
sames of part of our investment in Pegasus, and the receipt of additional
orders for NeuSIGHT subsequent to December 31, 2000, partially meet our
need for additional capital. In order to further meet this need, the
Company intends to seek further capital through various means which may
include the sale of a portion of its interest in Pegasus, additional sales
of debt or equity securities, a business combination, or other means and to
further reduce expenditures as necessary. Should the Company not be
successful in achieving one or more of these actions, it is possible that
the Company may not be able to continue as a going concern.
We Have Not Consistently Achieved Significant K-Fuel-related Revenue Since
Our Inception
We have not consistently achieved material K-Fuel licensing, royalty or
product sales revenues since we were formed in 1988. In addition, no
significant K-Fuel related revenue was earned prior to our formation when
similar operations to our K-Fuel segment were conducted by various
predecessor entities.
We Have Contractual Limitations on Our Ability to Secure Additional Funding
Our ability to secure additional financing is limited by the terms of
the indenture related to our 6% convertible debentures, which precludes
secured borrowings, except in limited circumstances, limits unsecured
borrowings, causes additional dilution to our shareholders if we sell our
own equity securities at prices below the $3.65 per share conversion price
of the debentures, limits our ability to sell assets and enter into merger
agreements and places various other restrictions on our ability to raise
debt or equity capital.
We Rely on Strategic Partners
We have established relationships with various strategic partners to
exploit the K-Fuel technology, enhance the application of NeuSIGHT and
further penetrate the NeuSIGHT market. Kennecott Energy has been a
strategic partner in the development of K-Fuel technology since early 1996
ane also became a strategic partner in Pegasus in early 2000. Our success
will depend upon our ability to maintain existing strategic relationships
with Kennecott Energy and others and develop and maintain additional
relationships for the further development of our technologies. We are and
will continue to be dependent upon our strategic partners to, among other
things, fund the operations of the partnerships or the joint venture
entities in which we own interests and to provide necessary technical,
operational, personnel and other resources. While each of our strategic
partners has an economic motivation to further the development of their
respective joint ventures or projects with us, the amount of time and
resources devoted to such joint ventures or projects will be controlled by
our strategic partners and not by us. A decline in the financial prospects
of a particular strategic partner could adversely affect such partner's
commitment to a joint venture, which could materially harm us. Moreover,
joint ventures or similar arrangements require us to have financial and
other arrangements to meet our commitments to the joint ventures. We cannot
assure you that we will be able to maintain existing strategic
relationships, develop or maintain additional strategic relationships, meet
our commitments with respect to our joint ventures or that our strategic
partners will meet their commitments to any respective joint venture or
project.
It Is Difficult to Evaluate Our Business and Prospects Because We Added the
Development of Pegasus to Our Strategic Focus, Which Until 1998, Had Been
on the Development of K-Fuel
KFx was organized in 1988 and in August 1995, we commenced the initial
application of our K-Fuel technology and began construction of a facility
near Gillette, Wyoming, which was owned by KFP, in order to produce K-Fuel.
Uotil early 1998, our primary business was licensing and commercializing a
patented technology that, in general, uses heat and pressure to physically
and chemically transform high-moisture, low-energy per pound coal and other
organic feedstocks into a low-moisture, high-energy solid fuel known as
K-Fuel. Operations at the KFP Facility began in the second quarter of 1998,
but were suspended in the second quarter of 1999. Nevertheless, our efforts
to commercialize the K-Fuel technology continue in conjunction primarily
with Kennecott Energy. In March 1998 we acquired, through our purchase of a
controlling ownership interest in Pegasus, the software product NeuSIGHT.
Accordingly, we have a limited operating history upon which an evaluation
of our prospects and future performance can be made. Although we continue
to believe that K-Fuel technology has significant long-term value, we
believe that the software business of Pegasus offers more near term growth
opportunity. Our prospects must be considered in light of the risks,
expenses and difficulties frequently encountered in the operation of a new
business based on innovative technologies in a highly competitive and
evolving industry.
The Market for Software in Connection with the Efficiency of the Combustion
of Coal Is New and Uncertain
Combustion and other optimization software relating to the production
of coal or other similar products has only been used by the electric power
business for a few years and has just recently gained market acceptance. We
believe that market pressures caused by the developing deregulation of the
electric power industry and the CAA will accelerate demand for and market
acceptance of NeuSIGHT and related software products being developed at
Pegasus. There can be no assurance, however, that NeuSIGHT or any related
software products will experience growth or market acceptance.
The Market for NeuSIGHT and Related Software Depends on Successful Sales and
Marketing Strategies and Product Improvement Strategies
The market for NeuSIGHT and related software is uncertain. In our
opinion, realization of near term value from the software business of
Pegasus requires, among other things, the successful implementation of new
sales and marketing programs. We have taken numerous steps to implement a
variety of such programs and strategies, however, any evaluation or
prediction of their effectiveness would be premature. We cannot assure you
that our sales and marketing strategies for NeuSIGHT and related software
will be successful.
Additionally, we believe that increased market acceptance of NeuSIGHT
is dependent, in part, on our ability to simplify and streamline its
installation process. Product improvements directed at this objective have
been made and were released to the market in late 1999 and again in late
2000. We will continue to evaluate additional improvements for development.
We cannot assure you that our efforts to further improve NeuSIGHT to more
fully meet our objectives will be successful.
No Established Market for Beneficiated Fuel Products Exists
Although we believe that a substantial market will develop both
domestically and internationally for clean coal fuel products, an
established market does not currently exist. As a result, the availability
of accurate and reliable pricing information and transportation
amternatives is not fully known. The future success of our K-Fuel
technology will depend on our ability to establish a market for clean coal
fuel products among potential customers such as electrical utility
companies and industrial coal users. Further, potential users of our fuel
products may be able to choose among alternative fuel supplies. Although we
have successfully operated a K-Fuel technology demonstration plant, the
market viability of the K-Fuel technology will not be known until we
complete construction of one or more commercial-scale production
facilities, either in the United States or internationally, that produce,
on a consistent basis, commercial quantities of fuel and meet certain
minimum performance specifications. We face the risk that commercial-scale
production facilities when completed will be unable to generate sufficient
market interest to continue in business. Further, we cannot assure you that
any commercial-scale K-Fuel facility will be successful.
Deregulation in the United States Power Industry May Result in Increased
Competition for Our Products
We expect that deregulation in the United States power industry will
result in utilities and other power generators placing a high emphasis on
reducing costs in their operations. This situation may, in turn, result in
increased competition from other producers of beneficiated coal products,
other clean fuel sources, other developers of combustion optimization
software and other products, services and technologies designed to provide
environmental and operating cost benefits similar to those which we believe
are available from our K-Fuel technology and Pegasus' combustion
opuimization technology.
Our Markets Are Competitive
We face competition from other companies in the clean coal and
alternative fuel technology industries as well as the emission control
equipment industry. Many of these companies have financial and managerial
resources much greater than ours and, therefore, may be able to offer
products more competitively priced and more widely available than ours.
Also, competitors' products may make our technology and products obsolete
or non-competitive. Our future success may depend on our ability to adapt
to such changing technologies and competition.
We Are Subject to Risks of Changing Laws
A significant factor driving the creation of the United States market
for K-Fuel, other beneficiated coal products, NeuSIGHT and other
optimization software products is the CAA, which specifies various air
emission requirements for electrical utility companies and industrial coal
users. We believe that compliance with the air emission regulations by
these coal users can be fully or partially met through the use of
clean-burning fuel technologies, like K-Fuel, and combustion optimization
software, like NeuSIGHT. We are unable to predict future regulatory changes
and their impact on the demand for our products. A full or partial repeal
or revision of the CAA would have a material adverse effect on our
prospects.
Our Inability to Adequately Protect Our Proprietary Technology Could Harm
Our Business
Our success depends upon our proprietary technology. We rely on a
combination of patent, copyright, trademark and trade secret rights to
establish and protect our proprietary rights. We currently have a series of
patents on our K-Fuel technology, however, competitors may successfully
challenge the validity or scope of one or more of our patents or any future
allowed patents. These patents alone and our trade secret rights with
respect to NeuSIGHT may not provide us with any significant competitive
advantage.
Third parties could copy or otherwise obtain and use our products or
technology without authorization or develop similar technology
independently. We cannot easily police unauthorized use of our
technologies. The protection of our proprietary rights may be inadequate
and our competitors could independently develop similar technology,
duplicate our solutions or design around any patents or other intellectual
property rights we hold.
As is common in the software industry, we may, from time to time
receive notices from third parties claiming infringement by our NeuSIGHT
product or similar software of third party patent and other property
rights. On September 8, 2000, Pavilion Technologies, Inc. ("Pavilion"), a
competitor of Pegasus, served Pegasus with a complaint that was filed on
August 14, 2000 in US District Court for the Southern District of Texas
asserting that Pegasus infringed 26 patents allegedly issued to or licensed
by Pavilion ("Pavilion's Lawsuit"). The Pavilion Lawsuit seeks injunctive
relief, compensatory and treble damages, as well as attorney's fees, costs
and expenses. Pegasus' products employ its own proprietary computer code as
well as computer code exclusively licensed to Pegasus. On September 15,
2000, the licensor agreed to defend Pegasus in the Pavilion Lawsuit
pussuant to an indemnification provision of the parties' license agreement.
On October 27, 2000, Pegasus filed an answer to the Pavilion Lawsuit
denying the patent infringement claims ("Pegasus' Answer"). The Pegasus
Answer also asserted various counterclaims against Pavilion alleging unfair
competition, deceptive trade practices, defamation, tortious interference
with business relationships and attempted monopolization in violation of
Section 2 of the Sherman Antitrust Act ("Pegasus' Counterclaims"). After
consultation with counsel, KFx and Pegasus management believe that the
infringement allegations in the Pavilion Lawsuit are objectively baseless
and without merit. On April 11, 2001, Pegasus and Pavilion agreed to
dismiss the Pavilion Lawsuit and the Pegasus Answer, without prejudice, in
order to explore possible business combinations, cooperative relationships
aod other alternatives. To the extent that these efforts are not
successful, Pegasus, in coordination with its licensor, intends to
vigorously defend against the Pavilion Lawsuit and to aggressively pursue
the Pegasus Answer and Pegasus Counterclaims. Although management does not
believe that its ultimate outcome will have a material adverse effect on
the Company's financial position or results of operations, the ultimate
disposition of this matter cannot be predicted with certainty.
We Rely on Key Personnel and Must Be Able to Retain or Attract Qualified
Personnel
We believe that our performance is substantially dependent on the
performance of a small group of senior managers and key technical
personnel. The inability to retain key managerial and technical personnel
or attract and retain additional highly qualified managerial or technical
personnel in the future could harm our business or financial condition.
Technical and Operational Problems May Adversely Impact Our Ability to
Develop K-Fuel Projects or Facilities
We cannot assure you that any K-Fuel facilities under consideration by
Kennecott Energy will not experience technical or operational problems
similar or in addition to those experienced at the KFP Facility. To the
extent that other technical or operational problems materialize, our
ability to develop other K-Fuel projects or facilities would be
jeopardized.
Local Opposition to K-Fuel Projects Could Substantially Delay or Prevent
Development of New K-Fuel Facilities
Development, construction and operation of K-Fuel production facilities
requires numerous environmental and other permits. The process of obtaining
these permits can be lengthy and expensive. In addition, local opposition
to a particular project can substantially increase the cost and time
associated with developing a project, and can, potentially, render a
project unfeasible or uneconomical. Kennecott Energy or others that may
consider the development of K-Fuel facilities may incur substantial costs
or delays or may be unsuccessful in developing K-Fuel production facilities
as a result of such opposition.
Our General Project Development Is Uncertain
The process of developing, permitting, financing and constructing
K-Fuel production facilities is complex, lengthy and costly and subject to
numerous risks, uncertainties and factors beyond our control, including
cost overruns, delays, damage and technical delays. Only a small percentage
of the projects that are considered and pursued, by us, Kennecott Energy or
other third parties, may ultimately result in operating projects, that are
sufficiently successful to provide us with license fee income, royalty fee
income and/or equity participation income. As a result, we may not be able
to recover any expenses that we incur in the evaluation and development of
certain projects.
A Significant Portion of the Potential of the K-Fuel and Pegasus Businesses
Is Subject to International Risks
Although our current operations are primarily in the United States, we
believe a significant portion of the growth opportunity for both our
Pegasus and K-Fuel businesses lies outside the United States. Doing
business in foreign countries exposes us to many risks that are not present
in the United States and with which we lack significant experience,
including political, military, privatization, technology piracy, currency
exchange and repatriation risks, and higher credit risks associated with
customers. In addition, it may be more difficult for us to enforce legal
obligations in foreign countries and we may be at a disadvantage in any
legal proceeding within the local jurisdiction. Local laws may also limit
our ability to hold a majority interest in the projects that we develop.
Our Ability to Take Advantage of Net Operating Losses if We Achieve
Profitability Could be Limited
Under Section 382 of the Internal Revenue Code ("IRC"), the use of
prior net operating losses is limited after an "ownership change," as
defined in Section 382. The limitation, if applicable, is equal to the
value of the loss corporation's outstanding stock immediately before the
date of the ownership change multiplied by a long-term interest rate
specified by the IRC. The quoted market value of a stock is a factor to
consider, but not necessarily a conclusive factor, in determining the fair
value of a corporation's stock. Additional issuances of equity interests by
us, including the issuance of shares of common stock upon the conversion of
our 6% convertible debentures or on the exercise of outstanding warrants or
options to purchase our common stock may result in an ownership change that
is large enough to trigger the Section 382 limitations. In the event we
achieve profitable operations and taxable income, any significant
limitation on the use of our net operating losses to offset taxable income
would have the effect of increasing our tax liability and reducing net
income and available cash resources.
Continued Operation of the Existing KFP Facility Near Gillette, Wyoming,
and Production of K-Fuel from this Facility Is Uncertain
KFP began operations at the KFP Facility in April 1998 and completed a
successful test burn in May 1998 and a successful commercial burn in
February 1999, as discussed above. The KFP Facility operated and produced
commercially salable product in 1998 and 1999 and KFP addressed certain
problems previously encountered, including a 1996 fire at the facility and
certain construction problems, including issues relating to the flow of
materials within the facility and the design and operation of certain
pressure release equipment. Nevertheless, KFP continued to experience
certain problems relating to tar and fines residue build-up within the
system during production and product quality issues related to product
dusting. On May 24, 1999, TCK announced that in connection with certain
strategic restructuring decisions made by TCK and its parent, Thermo
Electron Corporation, it had decided to hold for sale its investment in the
KFP Facility and record charges related thereto. Further, TCK, in June
1999, suspended operations at the KFP Facility and K-Fuel is not currently
being produced.
On May 9, 2000, we executed agreements with various parties directed at
ioitiating the redevelopment of the KFP Facility. Various remediation and
related operating scenarios have been evaluated over the past several
mooths and are continuing to be considered. The estimated capital required
under the various remediation scenarios ranges from $2 million to $4
million. There is no assurance that the necessary capital can be obtained
on satisfactory terms, if at all. There can be no assurances that the KFP
Facility will be successfully restarted and K-Fuel production from this
facility resumed. In addition, although the Company believes that the KFP
Facility qualifies for the Federal Oil Barrel Equivalent Tax Credit,
promulgated under Section 29 of the IRC, which is a significant incentive
for the new owners of the KFP Facility, there can be no assurance that the
Internal Revenue Service will not successfully challenge such a position.
Such a successful challenge would have a material adverse effect on the
operating economics of the KFP Facility and our ability to generate any
royalty and revenue-based service fee income.
We Are Required to Pay Third Parties a Significant Portion of Licensing
and Royalty Revenues
We anticipate that a significant portion of our future revenues with
respect to K-Fuel will be in the form of licensing and royalty payments
from third party licensees operating commercial-scale production facilities
of K-Fuel. Pursuant to various agreements we have executed, we are required
to pay third parties a substantial portion of licensing and royalty
revenues that we receive. Amounts due under these agreements may restrict
or limit our ability to pursue other commercialization opportunities with
respect to K-Fuel because such payments will decrease cash flow from
operations.
We Do Not Pay Cash Dividends
We have never paid any cash dividends and do not anticipate paying
cash dividends in the foreseeable future. In addition, we are prohibited
from paying dividends as long as any of our 6% convertible debentures are
outstanding.
ITEM 2. PROPERTIES
Effective October 1, 2000, the Company's principal executive offices
consist of approximately 2,100 square feet of office space leased under a
sublease through August 31, 2004, located at 3300 East First Avenue, Suite
290, Denver, Colorado 80206. The current base rent under the lease is
$3,367 per month, escalating to $3,540 per month by the final year of the
lease. The Company is also obligated to pay, as additional rent, allocable
operating costs.
Until September 30, 2000, the Company's principal executive offices
consisted of approximately 5,900 square feet of office space leased through
September 2004, located at 1999 Broadway, Suite 3200, Denver, Colorado
80202. The current base rent under the lease is $10,113 per month,
escalating gradually to $11,593 per month by the final year of the lease.
Effective October 1, 2000 to September 30, 2004, this space was subleased
to a third party for $11,100 per month. The Company is also obligated to
pay, as additional rent, allocable operating costs, most of which will also
trigger additional rental income from the sublessee. During 1998 and 1999,
the Pegasus and K-Fuel segments used a portion of this office space.
The Company has leased approximately 2,300 square feet of office space
through June 30, 2003, located at 2300 Clarendon Boulevard, Suite 401,
Arlington, Virginia 22201. The base rent under the lease is approximately
$5,078 per month, with escalations of 2.5 percent for each subsequent year
of the lease term. The Company is also obligated to pay, as additional
rent, an allocable share of increases in certain operating costs. The
Company has the option to renew the lease for one additional five-year
term. A portion of this office space is sublet under short-term leases to
third parties.
Pegasus has leased approximately 7,600 square feet of office space
through October 2004, located at 5970 Heisley Road, Suite 300, Mentor, Ohio
44060. The current base rent under the lease is approximately $7,254 per
month, escalating gradually to $9,146 per month by the final year of the
lease. Pegasus is also obligated to pay, as additional rent, allocable
operating costs. Pegasus has options to renew the lease for two additional
3-year terms, at a base rent escalated by the Consumer Price Index from the
final base rent in the current term.
The Company, through its KFx Technology, Inc. ("KFxT") subsidiary, owns
a demonstration plant and leases from a subsidiary of Black Hills
Corporation (for nominal rental payments) a research and development
laboratory adjacent to the KFP Facility (the "Gillette Facility"). The
Gillette Facility is located on approximately 80 acres of land, inside the
rail loop of Fort Union Mine, in Campbell County, Wyoming, approximately 5
miles northeast of Gillette, Wyoming. The Gillette Facility is comprised of
three buildings totaling approximately 7,100 square feet.
ITEM 3. LEGAL PROCEEDINGS
On September 8, 2000, Pavilion Technologies, Inc. ("Pavilion"), a
competitor of Pegasus, served Pegasus with a complaint that it had filed on
August 14, 2000 in the United States District Court for the Southern
District of Texas asserting that Pegasus infringed 26 patents allegedly
issued to or licensed by Pavilion (the "Pavilion Lawsuit"). (The Pavilion
Lawsuit was subsequently transferred to the United States District Court
for the Northern District of Ohio.) The Pavilion Lawsuit seeks injunctive
relief, compensatory and treble damages, as well as attorney's fees, costs
and expenses. Pegasus' products employ its own proprietary computer code as
weml as computer code exclusively licensed to Pegasus. On September 15,
2000, the licensor agreed to defend Pegasus in the Pavilion Lawsuit
pursuant to an indemnification provision of the parties' license agreement.
On October 27, 2000, Pegasus filed an answer to the Pavilion Lawsuit
denying the patent infringement claims ("Pegasus' Answer"). The Pegasus
Answer also asserted various counterclaims against Pavilion alleging unfair
competition, deceptive trade practices, defamation, tortious interference
with business relationships and attempted monopolization in violation of
Section 2 of the Sherman Antitrust Act ("Pegasus' Counterclaims"). After
coosultation with counsel, KFx and Pegasus management believe that the
infringement allegations in the Pavilion Lawsuit are objectively baseless
and without merit. On April 11, 2001, Pegasus and Pavilion agreed to
dismiss the Pavilion Lawsuit and the Pegasus Answer, without prejudice, in
order to explore possible business combinations, cooperative relationships
and other alternatives. To the extent that these efforts are not
successful, Pegasus, in coordination with its licensor, intends to
vigorously defend against the Pavilion Lawsuit and to aggressively pursue
the Pegasus Answer and Pegasus Counterclaims. Accordingly, although the
disposition of this matter cannot be predicted with certainty, management
does not believe that its ultimate outcome will have a material adverse
effect on the Company's financial position or the results of its
operations.
On November 4, 1999, Link Resources, Inc., a Georgia corporation,
("Link") and its two shareholders, Linda E. Kobel ("Kobel") and Gary A.
Sanden ("Sanden") filed a complaint against the Company in US District
Court for the District of Colorado. The complaint alleges that KFx, Link,
Kobel and Sanden had entered into an agreement requiring KFx to acquire
Link and that KFx breached such agreement. The complaint seeks damages in
excess of $5.3 million. Although the ultimate resolution of this matter
cannot be predicted with certainty, based on a review of the underlying
facts and discussion with counsel, management believes that this complaint
is without merit. KFx intends to contest this complaint vigorously.
Accordingly, management does not believe that this matter will have a
material impact on the results of operation or financial position of the
Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5. MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Common Stock trades on the American Stock Exchange (under the
trading symbol "KFX"). The following table presents the reported sales
prices on the American Stock Exchange for the two-year period ended
December 31, 2000.
Year Period High Low
---- ------ ---- ---
2000 First Quarter $4.9375 $1.6875
Second Quarter 3.6250 1.5000
Third Quarter 3.1875 2.1875
Fourth Quarter 2.9375 1.1875
1999 First Quarter $2.1875 $1.2500
Second Quarter 1.9375 .8750
Third Quarter 1.8750 1.0625
Fourth Quarter 1.7500 1.3125
As of April 12, 2001, the Company had 191 holders of record of the
Common Stock. This does not include holdings in street or nominee names. On
April 12, 2001, the closing price of the Common Stock on the American Stock
Exchange was $2.45 per share.
The Company has never paid cash dividends and does not anticipate
paying dividends in the foreseeable future. The Company is also restricted
from paying dividends pursuant to the terms of the Convertible Debenture
Indenture.
During 2000, the following securities were issued pursuant to an
exemption the Securities Act of 1933, as amended:
Consideration Class of
Date Security Sold Received Persons
---- ------------- ------------- -------
5/00 Warrants to purchase 1,300,000 shares of Common Stock * Accredited
at $3.65 per share, subject to certain adjustments Investor
7/00 Grant of 56,250 shares of Common Stock Professional services Consultant
10/00 Grant of 56,250 shares of Common Stock Professional services Consultant
11/00 80,000 shares of Common Stock 2.5% interest Former
in Pegasus Employee
*See discussion of sale of KFP Facility to Black Hills Corporation at
Part 1, Item 1, Strategic Relationships--Thermo Ecotek Corporation and
KFx Fuel Partners
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the Company's consolidated financial statements and
related notes thereto and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" included in Item 7. The
consolidated statement of operations data for each of the three years in
the period ended December 31, 2000 and the consolidated balance sheet data
at December 31, 2000 and 1999 are derived from the audited consolidated
financial statements indexed on page F-1. The consolidated statement of
oqerations data for each of the two years in the period ended December 31,
1997, and the consolidated balance sheet data at December 31, 1998, 1997
and 1996 are derived from audited consolidated financial statements not
included in this Annual Report on Form 10-K.
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
Statement of Operations Data
for the Year Ended December 31
Operating revenues $ 2,124,770 $ 2,850,800 $ 2,220,585 $ 1,084,823 $ 1,596,298
Operating loss $ (8,998,405) $ (7,477,042) $ (6,419,014) $ (4,930,551) $ (4,827,874)
Net loss $ (12,290,172) $(12,730,427) $ (6,783,817) $ (5,095,160) $ (5,628,541)
Basic and diluted net
loss per share $ (.49) $ (.53) $ (.28) $ (.21) $ (.25)
Weighted average shares
of common stock outstanding 24,908,000 24,137,000 23,931,000 23,820,000 22,458,000
Balance Sheet Data at
December 31
Current assets $ 1,294,431 $ 1,605,466 $ 7,004,806 $ 14,461,198 $ 1,957,005
Working capital $ (4,965,927) $ (3,873,922) $ 4,481,499 $ 12,565,373 $ (166,521)
(deficit)
Total assets $ 8,471,370 $ 14,267,995 $ 22,672,289 $ 29,057,706 $ 14,923,567
Long-term debt $ 16,670,594 $ 17,484,625 $ 17,890,793 $ 17,500,000 $ 1,110,000
Stockholders' equity $ (17,433,931) $ (9,696,018) $ 2,258,289 $ 8,495,881 $ 10,524,041
(deficit)
The Company recorded permanent impairment write-downs of $629,000 and
$4,000,000 in 2000 and 1999, respectively; see Note 7 and Note 6 to the
consolidated financial statements, respectively. The Company recorded a
$464,000 write-down of certain idle equipment at the K-Fuel demonstration
plant and laboratory in 2000; see Note 1 to the consolidated financial
statements. The Company acquired Pegasus in 1998; see Note 2 to the
consolidated financial statements. The Company issued $17,000,000 of 6%
Convertible Debentures in 1997; see Note 11 to the consolidated financial
statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This annual report includes forward-looking statements. We have based
these forward-looking statements on our current expectations and
projections about future events based on our knowledge of facts as of the
date of this annual report and our assumptions about future events. These
forward-looking statements are subject to various risks and uncertainties,
not limited to those discussed under "Risk Factors," that may be outside of
our control, including, but not limited to:
o adverse market and various other conditions that could impair the
Company's ability to obtain needed financing;
o actions or the inaction of the Company's strategic partners;
o the breadth or degree of protection available to the Company's
intellectual property;
o availability of key management and skilled personnel;
o competition and technological developments by competitors;
o lack of market interest in the Company's existing products and any
new products or services;
o changes in environmental, electric utility and other governmental
regulations;
o unanticipated problems that could arise in research and
development activities;
o cost overruns, delays and other problems that may occur in
developing, permitting, financing or constructing K-Fuel
production facilities;
o the availability of Section 29 or similar tax credits related to
any future K-Fuel production facilities; and
o domestic and international economic and political developments.
We use words like "believe," "expect," "anticipate," "will,"
"estimate," "project," "plan," and similar expressions to help identify
forward-looking statements in this annual report.
For additional factors that could affect the validity of our
forward-looking statements, you should read "Risk Factors" contained in
Part I, It