SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

x       Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2004

¨       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)

Registrant’s Telephone Number, including area code: (303) 293-2992

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

Yes x No ¨

The aggregate market value of the voting and non-voting common equity held by non-affiliates of KFx Inc. as of June 30, 2004, the last business day of KFx Inc.’s most recently completed second fiscal quarter was $106,773,000 computed by reference to the price at which KFx Inc.’s common stock was last traded on that date, as reported on the American Stock Exchange.

At March 4, 2005, 65,289,000 shares of common stock of the Registrant were outstanding.

Documents Incorporated by Reference:

The information required by Part III of this Report (Items 10, 11, 12, 13 and 14) is incorporated by reference to portions of KFx’s proxy statement to be filed with the Securities and Exchange Commission within 120 days of December 31, 2004 for our 2005 Annual Meeting.

TABLE OF CONTENTS

CAUTIONS ABOUT FORWARD LOOKING STATEMENTS

                This Annual Report on Form 10-K includes forward-looking statements about events, products or financial performance that may not exist, or may not have occurred.  For example, statements like we “expect,” we “believe,” we “plan,” we “intend” or we “anticipate” are forward-looking statements.  Investors should be aware that our actual operating results and financial performance may differ materially from our expressed expectations because of risks and uncertainties about the future including risks related to economic and competitive conditions.  In addition, we will not necessarily update the information in this Annual Report on Form 10-K if any forward-looking statement later turns out to be inaccurate.  Details about risks affecting various aspects of our business are included throughout this Form 10-K. Investors should read all of these risks carefully, and should pay particular attention to risks affecting the following areas: competition issues discussed on page 11; government regulation discussed on pages 8 to 11; intellectual property and proprietary rights discussed on page 7; specific risk factors discussed on pages 13 to 18; and commitments and contingent liabilities described in Note 15 to the financial statements included in this Annual Report on Form 10-K.

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PART I

                 In this Annual Report on Form 10-K, we use the terms “KFx,” “we,” “our,” and “us” to refer to KFx Inc. and its subsidiaries.  All references to K-Fuel, K-Fuel^™and K-Fuel Plus^™refer to our patented process and technology explained in detail throughout this Annual Report on Form 10-K.  All references to years, unless otherwise noted, refer to our fiscal year, which ends on December 31st.

                Our common stock is traded on the American Stock Exchange under the symbol “KFX.” Our principal executive office is located at 55 Madison Street, Suite 745, Denver, Colorado 80206 and our telephone number is (303) 293-2992.

  Our web site address is www.kfx.com.  Through this web site, we make available, free of charge, on the Investor Info section of our web site our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports, as soon as reasonably practicable after these reports are electronically filed with or furnished to the Securities and Exchange Commission.  We also make available through our web site other reports filed with the SEC under the Exchange Act, including our proxy statements and reports filed by officers and directors under Section 16(a) of that Act.  We do not intend for information contained in our web site to be part of this Annual Report on Form 10-K.

ITEM 1.       BUSINESS

OVERVIEW

                KFx is a “clean coal” company with a patented process and technology, which we refer to as K-Fuel technology, that uses heat and pressure to physically and chemically transform coal with a lower heat value, as measured by British Thermal Units (or Btus) into coal with a higher heat value, while at the same time removing significant amounts of certain impurities, including mercury, sulfur dioxide, or SO₂,emissions of oxides of Nitrogen, or NOx.  Throughout the Western United States there are significant coal resources with heat values less than 9,000 Btus.  Such heat values are considered low grade and serve as feedstocks for our process.  Many coal-fired, electric generating units, or EGUs, which comprise our primary market, burn coal that is 11,000 Btus or greater.  Our technology adds value for coal producers and the electric power generation industry by significantly improving the quality of lower-grade coal and facilitating its compliance with certain air emission standards.  We believe the current pricing of coal in the U.S. and the declining availability of cleaner, higher-Btu coal to comply with environmental regulation, referred to as compliance coal, has created a near-term and long-term opportunity for K-Fuel.  Furthermore, certain federal tax credits were enacted in 2004 to encourage the development of cleaner fuel sources.  Based upon testing we have performed to date, we believe that K-Fuel meets the tax credit requirements of a refined coal and we believe our future plants that will produce K-Fuel will be eligible for the credit if they are operational by January 1, 2009.  Such credits add to the economic feasibility of processing and selling K-Fuel.

                 We continue to make significant headway toward the commercialization of our proprietary K-Fuel technology.  Among the key milestones we achieved in 2004 and in early 2005 were:

	•	On March 14, 2005 we signed a non-binding letter of intent to acquire MR&E, LLC, a research, engineering and project management firm with an office in Gillette, Wyoming, the site of our 750,000-tons per year plant.
	•	By December 31, 2004, we had received all necessary permits for construction and operation of our 750,000-tons per year plant in Gillette, Wyoming, poured the concrete foundation and had spent approximately $19.4 million toward the construction of such plant.
	•	On December 17, 2004, we completed a license agreement with Cook Inlet Coal, LLC for the use of our K-Fuel technology at a coal processing plant to be built and operated by them in Alaska.
	•	On November 24, 2004, we sold 4 million shares of common stock to accredited institutional investors in a $48 million private placement, before fees and expenses, with the proceeds of the sale helping fund the accelerated development of facilities for the production of K-Fuel.
	•	On June 24, 2004, we signed an agreement with Arch Coal, Inc., which included an investment of $2 million from Arch Coal and the evaluation of a potential joint development of an 8 million-tons per year K-Fuel plant at their Coal Creek mine near Gillette, Wyoming.
	•	On May 21, 2004, we closed the purchase of Landrica Development Company from Black Hills Corp. which included the acquisition of approximately 1,000 acres of land, a rail loop with load out facilities, a coal crusher, related buildings, water disposal wells and about 500,000 tons of coal reserves.

                We continue to advance the commercial viability of our patented K-Fuel technology through research and development, the operation of a demonstration facility and most recently with the construction of a commercial-scale production plant.  We have been developing the technology for approximately 20 years through a series of patents and modifications to

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such patents.  Our latest modification involved the use of Lurgi South Africa (Pty) Limited’s and Sasol-Lurgi Technology Company (Pty) Limited proprietary equipment.  See further discussion of our strategic alliance with Sasol-Lurgi below.  Traditionally, the Sasol-Lurgi equipment is used for coal gasification.  We have modified this equipment for use with our K-Fuel technology and these changes have resulted in our application for a new patent.  See further discussion regarding our patents below in Patents and Trade Secrets.  We believe the combination of the Sasol-Lurgi equipment with our technology will result in a cleaner, environmentally acceptable higher-grade fuel, which will be economical to produce on a commercial scale.

                In addition, we operate a research, development, and demonstration facility near Gillette, Wyoming that includes a Class A laboratory and pilot plants capable of processing small amounts of most types of source coal into K-Fuel using our proprietary technology.  We refer to this lab and the pilot plants, collectively, as the demonstration facility.  We maintain this demonstration facility to provide complex technological data to our potential customers and governmental agencies in assessing the benefits of the K-Fuel process.  Potential customers provide feedstock to us, which we process through our demonstration facility to determine if the resultant K-Fuel meets their specifications, such as heat value, moisture content and amount of impurities.  This facility does not contain Sasol-Lurgi equipment.  However, it contains equipment that can replicate the processing environment of the Sasol-Lurgi equipment, except on a smaller scale. 

                In 2004, we began construction of a 750,000-tons per year plant in the Powder River Basin in Wyoming, which we refer to as the 750,000-ton plant.  Sasol-Lurgi is providing, under a professional services agreement, the engineering, design and certain project management services for the process portion of this plant.  The 750,000-ton plant is intended to demonstrate that the K-Fuel process performs as expected on a commercial scale and will serve as a basis for larger plants.  The equipment used in the K-Fuel process is modular in design, which makes it easy to expand.  In fact, the 750,000-ton plant is expandable to a 8 million-tons per year, which we expect to be the size of our typical commercial plant.  Therefore, we believe that the 750,000-ton plant provides a model for larger plants, as the most important modification to increase the size of the plant is the addition of process modules, the equipment that actually processes the coal.  Construction is currently in process and expected to be completed during the summer of 2005.  Throughout the fourth quarter of 2005, we anticipate testing, commissioning and initial commercial production of the plant.

                Currently, we operate our business in one segment.  This segment primarily contains:

	•	the construction of our 750,000-ton plant;
	•	our corporate operations; and
	•	our research and development activities.

                The majority of the assets associated with this segment are those related to the development and construction costs and equipment of the 750,000-ton plant, cash and our patents.  We currently manage our business in one segment as our operations are focused on demonstrating our technology and the commercial viability of our product.  We entered into a licensing agreement with Cook Inlet Coal, LLC in December 2004 and received $7.5 million in cash.  See further discussion of the licensing agreement below in Other Development Activities.  While we collected cash related to licensing and other insignificant activities, we do not yet believe that our business has reached a level of complexity that would result in segment presentation.  As a result, our results of operations are evaluated and allocations of capital resources are based upon the operations of one segment.  In the future, we plan to develop and operate K-Fuel production plants both domestically and internationally, both wholly owned and through joint ventures, as well as to license the K-Fuel technology to third parties.  As our operations expand, we expect to increase the number of segments under which we manage our business to reflect the increasing complexity of our operations. 

                We incorporated under the laws of the state of Delaware in 1988.  Our financial statements include all of our wholly owned subsidiaries, including Landrica Development Company, which was acquired in May 2004.  During 2003, as a part of an exchange transaction with Kennecott Energy Company, we transferred our ownership of Pegasus Technologies, Inc. to Kennecott for its remaining interest in K-Fuel LLC, or KFL, that we did not own.  As a result of this exchange, we have accounted for Pegasus as a discontinued operation and have accordingly removed its effects from our results of continuing operations for 2003 and 2002.  KFL is now a wholly owned subsidiary. 

OUR K-FUEL PRODUCT AND OUR STRATEGY

                Our K-Fuel technology has been evolving for approximately 20 years with the most recent modification incorporating the Sasol-Lurgi proprietary coal processing equipment.  Research and development is an iterative process that resulted in improvements in the K-Fuel product and often times reduced production costs.   The following are some of the most important steps we have taken in the development of the K-Fuel technology:

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	•	We identified opportunities for improvement in the production of K-Fuel through the operation of the plant we jointly owned with Thermo Ecotech Corporation.
	•	Our demonstration facility completed product testing by processing feedstock provided by potential customers to create K-Fuel, with positive results.  This product testing also indicated areas for improvement.  After a through review of these areas, we made significant modifications at our demonstration facility that we believe will resolve these problems on a commercial scale.
	•	We entered into a strategic alliance with Sasol-Lurgi to combine their proprietary equipment with our patented technology that further improved our process.

                 During the years ended December 31, 2004, 2003 and 2002, our research and development costs were approximately $723,000, $1.6 million and $640,000, respectively.  During 2004, we re-evaluated costs incurred and determined that costs related to technical and engineering services met the definition of research and development.  As a result, we reclassified such costs incurred in prior years to research and development to be consistent with our current year presentation.  In addition, we indirectly incurred research and development costs related to our prior investment in KFL totaling approximately $92,000 and $54,000 in 2003 and 2002, respectively.  Our near-term strategy is to complete the construction of the 750,000-ton plant; identify potential sites for additional, larger facilities; obtain capital for further expansion; market our product to coal-fired EGUs and other potential purchasers; identify and obtain feedstock contracts and negotiate transportation of K-Fuel.

The KFP Plant

                Thermo Ecotek Corporation and KFx constructed a 500,000-ton per year K-Fuel production facility, or the KFP Plant, near Gillette, Wyoming, using an older version of our K-Fuel technology.  The KFP Plant operated and produced commercially salable K-Fuel in 1998 and 1999.  In June 1999, however, Thermo Ecotek suspended all K-Fuel production at the KFP Plant, due to its strategic restructuring.  Thereafter, we sold our interest in the KFP Plant to Thermo Ecotek Corporation and in September 2002, the major equipment at the KFP Plant was purchased by a third party and removed from the site.  The KFP Plant experienced certain problems while operating, relating to tar and fines (small particulates of coal) build-up within the system during production and product quality issues related to product dusting.  We believe we have resolved these issues by modifying the K-Fuel process using a more uniform size of raw coal that will heat evenly, adjusting heat and pressure levels and utilizing the Sasol-Lurgi equipment, among other things.

Product Testing

                In late 2000, we conducted K-Fuel product testing for third parties using Powder River Basin coal, or PRB coal, as the feedstock.  PRB coal typically has among the lowest mercury content of any naturally available coal in the U.S.  Analysis of the K-Fuel by-product produced during the test burn indicated that the K-Fuel products produced lower amounts of SO₂, NOx, mercury and chlorine than untreated combusted PRB coal.  Analysis of testing also indicated that an improved process could be designed to produce enhanced K-Fuel within potentially attractive economic constraints, with improved reliability and have lower capital and operating costs than any previous K-Fuel plant design.  The Btu value of the K-Fuel product tested was approximately 11,200 to 11,600 Btus per pound.  Upon combustion, the K-Fuel product produced approximately 20% lower NOx emissions and lower mercury emissions, as compared to untreated PRB coal and SO₂emissions, well below the 1.2 pound per million Btu limit contained in the second phase of the Clean Air Act, described more fully under “Market for K-Fuel – Environmental Regulation.”  Additionally, based on the results of a February 1999 test burn, K-Fuel reduced NOx emissions (when using PRB coal as the feedstock) as compared to typical eastern coals by levels approximating 25%.  As higher quality feedstock generally results in higher quality outputs, the results of the 2000 and 1999 test burns may have been different if a feedstock other than PRB coal were used.

                According to March 2003, March 2004 and February 2005 independent reports, K-Fuel provides an effective pre-combustion mercury reduction technology.  According to this independent research, a significant level of mercury is removed from coal during the K-Fuel production process.

Sasol-Lurgi Agreement

                Effective January 2, 2003, we signed an exclusive business development and intellectual property rights agreement with Sasol-Lurgi to combine the K-Fuel technology with Sasol-Lurgi’s technical services and equipment.  We believe that Sasol-Lurgi’s 70 plus years of experience in designing and building coal processing plants, including more than 450 process plants and equipment installations since the first unit was constructed in 1927, add expertise to the commercial implementation of the K-Fuel process.  Together with Sasol-Lurgi, we developed engineering specifications and Sasol-Lurgi assists in the supervision of the fabrication of various component pieces of the equipment by third parties.  With Sasol-Lurgi, we have modified the equipment and adjusted the temperature and pressure inside the vessels to meet the conditions necessary to produce

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K-Fuel.  Pursuant to the terms of the agreement, Sasol-Lurgi provides us with engineering, design and certain project management services and they agreed not to sell their coal beneficiation equipment utilizing our technology to any other company in the world.  We will be required to pay Sasol-Lurgi a one-time fee of approximately 11%, on purchases of their proprietary equipment design series and other fees.  Once the fabrication and delivery of the equipment is complete, there are no further licensing or other fees to be paid to Sasol-Lurgi.  The agreement is in effect until such time that we no longer use the equipment for a period of three consecutive years.  

Landrica Development Company

                On May 21, 2004, we acquired all of the outstanding stock of Landrica from Wyodak Resources Development Corporation for cash of $523,000 and assumption of a reclamation liability of $2.7 million.  The assumption of the reclamation liability was secured with cash and is presented as restricted cash on the Consolidated Balance Sheets in Item 8 of this report.  The results of Landrica have been included in the Consolidated Financial Statements from the date of acquisition.  Landrica owns a non-operating coalmine facility with assets that include land, buildings, coal handling equipment, a railroad loop and other pieces of equipment and property.  We are constructing our 750,000-ton plant on the land owned by Landrica.  We believe that owning the land on which the demonstration facility and the 750,000-ton plant are located will provide efficiencies in operations and construction of the plant.  In addition, the other assets located on the parcel may be incorporated into the operation of the 750,000-ton plant or used for other income-related operations.  See further discussion of the acquisition in Item 2 - Properties and Note 3 - Acquisitions - Landrica Development Company in Item 8 of this report.

750,000-ton Plant

                As mentioned above, we commenced the design and construction of the 750,000-ton plant in the Powder River Basin, near Gillette, Wyoming.  The fabrication of the vessels began in May 2003.  We have obtained the long lead-time permits and construction of the plant commenced in November 2004.  We believe that construction will be completed by the end of the summer with final testing, commissioning and commercial production scheduled for the fourth quarter of 2005.  Our schedule contemplates slower progress in the first few months of 2005 than in the spring and summer of 2005 due to the winter conditions in Wyoming.  The plant has a budget of approximately $52 million through final testing and commissioning.  The increase in the budget from previously reported amounts of $48 million is the result of an increase in contingent reserves related to engineering costs, increase in the price of steel and additional costs to expedite certain parts of the construction process.  Through December 31, 2004, we have spent approximately $20.1 million, including amounts reserved associated with a retirement obligation of $671,000 as required by the Wyoming Department of Environmental Quality, or DEQ.  The costs to construct this facility are reflected in Plant Construction in Progress in our Consolidated Balance Sheets in Item 8 of this report.  The 750,000-ton plant is being constructed with a gas-fired boiler to produce the steam used in the K-Fuel process.  A gas-fired boiler was selected primarily because the time to obtain permits is dramatically less than the time to obtain a permit for a coal-fired boiler.  In future plants, we anticipate using coal-fired boilers because the operating costs of a coal-fired boiler are substantially less than those of a gas-fired boiler, based upon current pricing of natural gas.  We do not anticipate generating significant operating income from this plant in the near future due to operating costs and the capacity of the plant.  We are evaluating converting this gas-fired boiler to a coal-fired boiler, subject to appropriate permitting and regulatory approvals.  While we believe our timing and cost estimates to complete the construction and testing of the facility are reasonable, we can provide no assurance the plant will be completed in a timely manner or that it will be completed at or under the targeted costs.   Further, we can provide no assurance that the plant will operate as intended.

Other Development Activities

                We are engaged in a number of other activities to develop the K-Fuel product and expand our business.  We investigate other potential sites for construction of future facilities including activities such as site evaluation, filing for certain permits and preliminary design specifications.  As part of the site development process, we will evaluate the quality and quantity of available feedstock sources and costs of transportation for both raw materials and finished products.  We evaluate the status of these potential sites on a quarterly basis and if any site is no longer being considered or we anticipate that it will not be utilized in the future, we write-off all associated costs in our Consolidated Statement of Operations in Item 8 of this report.  We have written off costs related to sites no longer being considered in the amount of $1.3 million for the year ended December 31, 2004.  There were no such write-offs for the years ended December 31, 2003 and 2002.  See further discussion in Note 5 – Plant Construction in progress in Item 8 of this report.

                We are also active in investigating alternatives to obtain additional capital to support the construction of more plants.  These alternatives primarily relate to selling licenses to other parties to construct plants and negotiating potential joint venture agreements.  We have not yet entered into a joint venture or licensing agreements beyond the Cook Inlet Coal license agreement entered into in December 2004.  We anticipate seeking debt financing or project financing as we start to construct larger facilities.  Additionally, as we develop our K-Fuel product, we expect to identify other opportunities to expand our business by

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including other value-added services or other clean fuel alternatives.  While we believe that we will obtain additional capital through one or more of the alternatives described, we can provide no assurance that any of the alternatives will be available to us or be on terms acceptable to us.

                On December 17, 2004, our wholly owned subsidiary, KFL, entered into a license agreement with Cook Inlet Coal, an affiliate of Kanturk Partners LLC, under which KFL agreed to license to Cook Inlet Coal its proprietary coal processing technology for use at a coal processing plant to be operated by Cook Inlet Coal in Alaska.  Pursuant to the agreement, KFL was paid a non-refundable technology access fee of $7.5 million on December 24, 2004.  The agreement also provides for additional payments upon plant commencement and plant completion and certain royalty payments once the plant is operational.  The plant commencement and plant completion fees vary in amount depending upon the capacity of the plant and the royalty payments are based on future profits and tax credits, if any, generated by the plant.  The maximum permitted output of the plant is eight million short tons per annum.  The plant is to be situated near the Cook Inlet of Alaska, but another location may be authorized by KFL under certain circumstances.  The term of the agreement is five years and shall automatically renew for consecutive five-year terms for the operational life of the plant, provided that if Cook Inlet Coal has not begun construction within the first six years of the term, the license agreement will automatically terminate.  In connection with the license agreement, K-Fuel and Cook Inlet Coal entered into a services agreement under which KFL will provide services to Cook Inlet Coal related to the implementation of the technology granted to Cook Inlet Coal under the license agreement.  While we anticipate that Cook Inlet Coal will build a plant, we can provide no assurance that they will build a plant or the ultimate timing of any construction.  As the permitting, design, construction and start-up period is estimated to be at least three years, we do not anticipate significant Cash Flow from Operations pursuant to this agreement in the near future.

PATENTS AND TRADE SECRETS

                Over the past 20 years, KFx has obtained multiple patents for different versions of the K-Fuel technology using a variety of methods to apply heat and pressure to beneficiate high moisture coal feedstocks.  We have patents or patent applications for the K-Fuel technology issued or pending in the United States and in over 40 foreign countries.  As we continue to develop and make enhancements to K-Fuel, we intend to continue to file for patent protection.  The technological details that are most important to our process are those contained in our most recent patent application.  As mentioned above, we have modified our technology to resolve certain issues identified through the operation of the KFP Plant and through product testing at our demonstration plant by using a more uniform size of coal so that it will heat evenly, adjusting heat and pressure levels and utilizing the Sasol-Lurgi equipment.  As a result of these changes, we filed for a new patent in May 2004.  Our case has been assigned to an examiner, but the examiner has not commenced an evaluation of our patent application.  Generally, the patent approval process can take three or more years to complete.  While we believe that we will be granted a new patent, we can provide no assurance that the patent will be granted.  Further, the patenting process can take several years and as a result we are uncertain as to the timing of the ultimate granting or denial of our patent.  If the patent is granted, it will expire in 2024.  If this patent is not granted, we believe that earlier patents, expiring as late as 2021, will provide us adequate protection.

                We have undertaken a number of precautions, in addition to obtaining patents, to keep our technology proprietary.  In order to access or review the technology for any purpose, we require non-disclosure agreements or confidentiality provisions be incorporated into other agreements.  All of our licensing agreements and the standard joint venture agreement we developed contain confidentiality provisions.  Such agreements or clauses are signed by significant vendors, such as Sasol-Lurgi, that access our technology in the course of providing a service to us.  Additionally, all employees are required to sign similar confidentiality agreements.  Further, the employee agreements include provisions stating that any inventions relating to our technology as a result of employment are our property.  These types of agreements create a legal obligation by the signor to use the information only for the agreed upon purpose and not to disclose any of the information to third parties.  We believe that we have adequately safeguarded our proprietary technology.  However, we can make no assurance that others will not successfully replicate our K-Fuel product in part or in total without infringing our patents.

MARKET FOR K-FUEL

                The current market price of Eastern compliance coal compared with Western coal has enhanced the economics of producing K-Fuel.  Over the last couple of years, the pricing differential has increased dramatically.  While we believe it is economical to produce K-Fuel when the pricing differential is at lower levels, this increase in the price differential has improved the economics of selling K-Fuel.  Additionally, the available supplies of Eastern compliance coal, primarily Central Appalachian coals, are declining.  Based upon the reserve estimates by the U.S. Department of Energy, adjusted by KFx for recent production, there is approximately 100 billion tons of compliance coal in the U.S. and it is declining at 1% per year.  Further, we estimate that there is approximately 134 billion tons of coal in the U.S. that could serve as a feedstock for our process.  As a result, the potential market for Western coal and K-Fuel are expanding.  Lastly in 2004, the legislation permitting tax credits for producers of synthetic fuels passed, further improving the potential economics of producing K-Fuel, assuming production produced from a K-Fuel plant qualifies for the credits, which we believe we it does. 

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                Our primary market is domestic coal-fired EGUs and coal suppliers.  We market K-Fuel to EGUs as a replacement for certain current coal-fuel sources, which require high Btu, low sulfur coal.  As reported by the U.S. Department of Energy, U.S. coal production in 2003 was nearly 1.1 billion tons, of which electric utilities consumed nearly 92%.  Based upon preliminary reports, coal production increased by approximately 4% during 2004.  Coal-fired electricity generation currently accounts for 51% of the nation’s total electricity supply.  We believe that K-Fuel will provide a cleaner burning fuel source, which will assist utilities in complying with environmental regulations, at prices that are competitive with compliance coal prices.  For a number of years various regulations and other requirements have placed increasingly stringent standards on air emissions from the EGU industry and others.  In addition, there has been and will continue to be increasing pressure from regulation, legislation and competitive market forces to meet such air emission standards in more cost effective ways and to improve the overall efficiency of electric power generation.  Our process creates a market for lower-grade western coal, as the K-Fuel process uses this lower-grade coal as a feedstock to create enhanced higher-grade coal, which can then be sold to third parties.

Environmental Regulation

                There are numerous pieces of existing and proposed legislation and regulations that we believe will have profound impacts on fossil fuel-fired, and specifically coal-fired, EGUs.  According to the U.S. Environmental Protection Agency, or EPA, power generation in the U.S. is responsible for 67% of SO₂emissions, 22% of NOx emissions and 37% of mercury emissions released into the environment by human activity.  Regulation of these pollutants is important to improving environmental and public health.  SO₂ and NOx emissions contribute to acid rain and deposition, which adversely impact water and soil ecosystems.  SO₂ and NOx pollution also contribute to the formation of particulate matter, or (PM), which reduces visibility and aggravates heart and lung diseases (such as asthma).  NOx contributes to ground-level ozone formation, also known as smog, and aggravates lung diseases.  Mercury is a toxic pollutant that enters the human food chain when fish with high levels of methylmercury (a converted form of mercury) are consumed.  Women of childbearing age are the most sensitive population since consuming high levels of methylmercury can cause serious neurological development problems in developing fetuses.

                The following is a brief overview of legislation and regulatory drivers to provide further background of the environmental setting, which affects the market for our K-Fuel product.  While this is not a comprehensive overview of all legislation and regulations, it does provide information on some of the most applicable policies.

                The Clean Air Act and Acid Rain Program.  The Clean Air Act, or CAA, of 1970, and subsequent amendments have been the primary drivers requiring reductions in emissions of SO₂and NOx from sources such as EGUs, along with other air quality programs.  A key component of the CAA is the Acid Rain Program, also known as Title IV of the CAA, which was a significant part of the CAA Amendments of 1990.

                The Acid Rain Program seeks to cap SO₂ emissions from fossil-fuel-fired EGUs at half of 1980 emissions, ultimately reaching a cap of 8.95 million tons by 2010.  NOx emissions specifically from coal-fired EGUs are also reduced as part of the Acid Rain Program, to reach 6.1 million tons by 2002, 2 million tons below forecasted 2000 levels without the program.  The SO₂ emissions requirements were structured in two phases, the first phase began in 1995 and the second phase in 2000.  NOx emissions were also reduced in two phases, 1996 and 2000.  The SO₂ program established a cap and trade market-based program, to reduce emissions in a cost-effective and efficient manner.  Cap and trade requires that facilities have enough allowances to cover total emissions, where one allowance is equal to one unit (usually a ton) of emissions.  Facilities must control emissions at or below the cap and can then bank excess allowances for future use or sell remaining allowances to facilities that do not meet the cap.  The NOx program did not permit a cap and trade approach but instead established emission rate limits according to boiler types for coal-fired units.  As of 2003, the most recent year for which EPA has data, SO₂ emissions from fossil-fuel-fired EGUs were 10.6 million tons, a 38% reduction from 1980 levels and NOx emissions from coal-fired EGUs were 4.2 million tons, nearly 4 million tons less than the emissions forecasted for 2000 and 37% below 1990 levels.  In 2003, approximately 3,500 fossil fuel-fired units were subject to the SO₂ program and approximately 1,000 coal-fired units were subject to the NOx program.

                Clear Skies Act.  The Clear Skies Initiative was announced in February 2002.  In 2002 and 2003 the legislation, known as the Clear Skies Act, was introduced in the U.S. House of Representatives and U.S. Senate but did not pass through Congress.  The Clear Skies Act seeks to decrease emissions of SO₂, NOx and mercury from fossil fuel-fired EGU’s nationwide.  The Clear Skies Act would impose a mandatory, nationwide cap on EGUs to achieve reductions in all three pollutants, as detailed below:

	•	Reducing SO2emissions by 73%, from an actual 11.2 million tons in 2000 to 4.5 million tons in 2010, 3.0 million tons in 2016, and 2.5 million tons by 2018
	•	Reducing NOx emissions by 67% from an actual 5.1 million tons in 2000 to 2.1 million tons in 2008 and 1.7 million tons by 2016; and

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•

Reducing mercury emission by 69% from an actual 48 tons in 2000 to 34 tons in 2010 and 15 tons in 2016 (this cap impacts only coal-fired power plants).

                The Clear Skies Act sets a cap on emissions of SO₂, NOx and mercury and allows power plants to control emissions through a market-based cap and trade system, similar to the SO₂ cap and trade program established in the Acid Rain Program, described above. 

                Hearings in the Senate that were held in January and February failed to gain passage in the senate environment and Public Works Committee on March 9, 2005.  President Bush and the EPA support of the Clear Skies Act and hope it will still be able to gain Congressional approval this session.  The legislation may be added to another piece of legislation, such as the energy bill.

                Clean Air Interstate Rule.  The Clean Air Interstate Rule, or CAIR, was proposed by the EPA in January 2004.  CAIR will cap SO₂ and NOx emissions in two phases, 2010 and 2015, and 2009 and 2015, respectively.  Upon full implementation, SO₂ emissions will be reduced by 70% and NOx emissions by 61%.  CAIR requires these reductions from a region comprised of 28  mostly eastern states and the District of Columbia compared to nationwide in the Clear Skies Act.  Because emissions can be transported through air currents across state lines, impacting air quality in other “downwind” states, the regulation seeks to cap emissions in these selected states to improve state and regional air quality.  EPA anticipates states will achieve the emissions cap by reducing emissions from coal-fired power plants, though states can choose to include other sources as well.

                EPA was poised to finalize the CAIR rule by the end of 2004 but postponed the final rule in order to allow opportunity for Congress to pass the Clear Skies Act in 2005.  EPA prefers that Congress pass legislation reducing EGU emissions nationwide through federal legislation than through regulation.  Due to the failure of the Clear Skies Act to gain the necessary votes in the Senate Environment and Public Works Committee on March 9, the EPA finalized the CAIR rule on March 10.  The emission reductions achieved by CAIR for the affected region includes:

	•	Reducing SO2emissions by 73%, by 4.3 million tons by 2010 and by 5.4 million tons by 2015, achieving a cap of 2.5 million tons
	•	Reducing NOx emissions by 61%, by 1.7 million tons by 2009 and by 2 million tons by 2015, achieving a cap of 1.3 million tons

                However if passed there is the possibility that the implementation could be delayed by potential litigation.

                Clean Air Mercury Rule.  EPA also proposed the Clean Air Mercury Rule, or CAMR, in January 2004.  Currently, mercury emissions from coal-fired power plants are unregulated and CAMR could impose mandatory mercury emissions reduction on these sources for the first time.  EPA’s regulation was to be finalized by December 15, 2004 but finalization was extended to March 15, 2005 to allow time for additional analysis and public comment.

                EPA has proposed two possible ways to reduce mercury emissions from coal-fired power plants.  Under the Maximum Achievable Control Technology, or MACT, approach, each individual coal-fired unit would be required to cap mercury emissions.  This would reduce mercury emissions from coal-fired power plants from 48 tons currently to approximately 34 tons by early 2008, a 30% reduction.  An alternative approach proposed by EPA allows coal-fired power plants to cap emissions in two phases and trade mercury allowances.  The first cap in 2010 would be achieved as a co-benefit of facilities installing SO₂ and NOx emissions control equipment to comply with the CAIR rule because these controls can help to reduce mercury.  The second phase cap, in 2018,will reduce coal-fired power plant emissions to 15 tons.  This approach realizes a total reduction in mercury emissions of nearly 70%.

                We expect that the CAMR will be finalized on or before March 15, 2005.  Statements by EPA officials as well as President Bush indicate that it is likely that EPA will proceed with a cap and trade program for mercury emissions from coal-fired EGUs.  Based upon such statements, we believe this approach will be the one finalized in the CAMR though there is the possibility that the MACT approach could be finalized instead of a cap and trade program.  The timeframe and emission caps, described above, as proposed by EPA may be the same or slightly modified in the final CAMR.  We also anticipate that litigation against the final CAMR is likely and could postpone implementation of a mercury standard for a significant period of time.

                American Jobs Creation Act Tax Credits.  In 2004, Congress passed tax credits for refined coal within the American Jobs Creation Act.  The tax credit is expected to be approximately $5.35 per ton, for each ton of refined coal produced during the qualifying period with annual adjustments in the credit amount for inflation.  In order to qualify for the tax credit, the refined

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coal must realize a reduction of at least 20% in NOx emissions and at least 20% in either SO₂ or mercury emissions and have an increase in market value of at least 50%.  Based upon testing we have performed to date, we believe that K-Fuel meets the requirements of a refined coal and we believe our future plants that will produce K-Fuel will be eligible for the credit if they are operational by January 1, 2009.  Generally, the eligible plants will earn the refined coal credit for each ton produced over a ten-year period from the date the plant is placed in service.

                Greenhouse Gas Emissions.  Currently, greenhouse gas emissions (such as carbon dioxide (CO₂) and others) are not regulated in the U. S.  The Kyoto Protocol, the international treaty to reduce emissions of greenhouse gases, was finalized in November 2004 and came into effect on February 16, 2005 without United States participation.  Several members of Congress have proposed legislation to reduce greenhouse gas emissions through various methods in the U. S. but such efforts have not been successful.  It is likely that legislation will be introduced in the 2005 session seeking to reduce greenhouse gas emissions, either as a bill focusing solely on greenhouse gases or as a bill that also encompasses reductions in SO₂, NOx and mercury.

                NOx SIP Call.  NOx emissions emitted from power plants, vehicles, and other sources mix with Volatile Organic Compounds (VOCs, also emitted from these sources) in the presence of heat and light to form ground-level ozone, also known as smog.  Ozone formation is most prevalent and harmful to breath for sensitive populations (including people with respiratory disease, young children and people that are active outside) during the summer months.  The NOx State Implementation Plan, or SIP, Call is EPA’s regulation requiring 21 eastern states and the District of Columbia to reduce summertime ozone formation by controlling NOx emissions from May through September.  Eight states and D.C. began reductions in 2003 with 11 more states taking part in 2004.  Two additional states will begin participating in 2007.

                Ozone and Fine Particulate Matter National Ambient Air Quality Standards.  Ozone and particulate matter, or PM, pollution have significant adverse impacts on human health.  Fine particulate matter (PM_2.5, approximately 1/30^th the size of a human hair) is especially harmful since it can be breathed deep into the lungs.  As a result, EPA has established National Ambient Air Quality Standards, or NAAQS, for ozone and PM_2.5 pollution levels that each county must not exceed.  In 2004, EPA announced that 224 counties in the U.S. are in “non-attainment” of the PM_2.5 NAAQS and 474 counties are in “non-attainment” of the ozone NAAQS.  The counties in these states must now implement policies that will reduce emissions of NOx and SO₂, which contribute to the formation of ozone and PM_2.5.  The timeline for counties to achieve these reductions varies depending on the severity of the non-attainment.  Areas will have until 2010 or 2015 to reach attainment of the PM_2.5 NAAQS and until 2007 through 2021 to attain the ozone NAAQS.

Other Domestic and International Markets

                As mentioned above, electric utility plants consume approximately 92% of the total coal produced in the U.S.  In addition to EGU’s we also plan to market our products to those remaining entities that burn coal in their boilers or processes, primarily in the manufacturing industry.  These companies are also subject to environmental regulations and could benefit from K-Fuel. 

                The international coal-fired power generation industry is approximately four times the size of the U.S. coal-fired power generation industry.  Our objective is to concentrate on international markets where there is either a significant need for more energy efficient and environmentally responsible fuel products to comply with the Kyoto Protocol or similar regulations in effect throughout the world, or where abundant lower grade 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 lower-grade, 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 for internal markets or for export.

Acceptance of our Product

                We believe that our product will be accepted by the market place, as it is a fuel source, which is also a cost-effective alternative to the increasing costs of complying with environmental regulation.  Coal-fired EGU’s have a number of options available to them to comply with regulations.  These include conversions to utilize alternative fuel sources (e.g. natural gas), installation of pollution control equipment (e.g. scrubbers) and /or injection of additives to reduce emissions (e.g. limestone injection).  These options can require significant capital or operating expenditures.  Due to the increased scrutiny of costs by the public and public utility commissions, we believe K-Fuel provides a cost-effective alternative for compliance.  However, we can provide no assurance that our product will be accepted by the market place.  See Competition below for further discussion of alternatives to our product.

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                Lastly, environmental regulations that created the cap and trade market-based programs, described above, could also create a market for our K-Fuel product.  As K-Fuel is a clean-burning fuel source, it could be used to reduce emissions.  This could permit utilities to generate allowances for use or sale of any excess allowances to non-compliant organizations.

Competition

                K-Fuel is an upgraded coal characterized by low-moisture, high-Btu content, and low sulfur, NOx, dust and mercury emissions.  As such, the known direct competitors for K-Fuel include other coal upgrading processes, other high Btu coal, low sulfur coal and so-called clean coal technology companies that produce equipment to reduce the emissions from the combustion of coal.  The indirect competition to K-Fuel includes electrical generation from natural gas, nuclear fuel, oil, wind, bio-fuels, and other renewable energy sources.  Over the past two years, pricing trends for a number of these alternatives have enhanced the competitive position of K-Fuel.  While current trends in prices for these competing energy sources improve the viability of our K-Fuel product, there can be no assurance these trends will continue.  Many of these companies may have greater financial, technical, and operational resources than we do. 

                We are aware that other companies either have performed in the past, or are currently performing development work on upgrading lower-grade coal.  Some of these companies may have greater financial, technical, and operational resources than we do.  We are unaware of any past, current, or projected coal upgrading technology for lower-grade coal that produces fuel of comparable quality, emissions reductions, and marketability with the commercial potential of K-Fuel.  We are also aware that other companies produce coal of similar energy content, moisture content, and sulfur content to that of K-Fuel.  Many of these companies may have greater financial, technical, and operational resources than we do.  We are not aware of companies that produce and market such coal with the low NOx and mercury emissions and low dust of K-Fuel.  We also believe that K-Fuel will have certain production, logistical, transportation, and distribution advantages over known competitors in particular markets.

                Potential customers could choose to install pollution equipment instead of using K-Fuel and /or injection of additives to reduce emissions.  This equipment includes low-NOx burners, over-fire air systems, selective catalytic reduction systems, sulfur scrubbers, fabric filters, electrostatic precipitators, mercury control technology, or other equipment.  In contrast to K-Fuel, most of these technologies require a significant investment of funds by the customer and impose a parasitic load on the plant, thereby reducing the salable electricity produced from the effected unit.

REGULATIONS THAT AFFECT THE CONSTRUCTION AND OPERATION OF OUR PLANTS

                As a general matter, we are subject to a number of state and federal regulations that (i) seek to limit the amounts of certain emissions into the environment; (ii) regulate the disposal of certain potentially hazardous materials; and (iii) impose certain employee safety requirements upon us.  While the coal mining and electric power generation industries are subject to significant regulation, we believe that our exposure to such regulation is more limited because of the current nature of our operations.  However, as we expand our operations we may become subject to more regulation.  For example, if we build additional plants we may install coal-fired boilers, which are subject to more permitting requirements and more environmental regulation than gas-fired boilers.  Further, if we chose to mine coal from the pit obtained in the Landrica acquisition, we or a contract miner would be subject to all of the regulations associated with coal mining.

                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 U. S. 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 required to comply with applicable environmental laws and regulations (including obtaining operating permits) once facilities begin production.  The most significant types of permits that are typically required for commercial production facilities include an operating and construction permit under the CAA, a wastewater discharge permit under the Clean Water Act, and a treatment, storage and disposal permit under the Resource Conservation Act.  Some of the federal programs have been delegated to the states and, as a result, facilities may be required to secure state permits.  Finally, the construction of new facilities may require review under the National Environmental Policy Act, or NEPA, or a state equivalent, which requires analysis of environmental impacts.

                Future international K-Fuel production plants will also be subject to various permitting and operational regulations specific to each country.  Generally, environmental permitting and operating regulations in countries outside the U.S. that we are currently pursuing for international development are not as stringent as those that are within the U.S.  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 our products and services.

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RELATED PARTY TRANSACTIONS

                As described elsewhere in this report, over the past several years we have entered into various agreements with related parties.  The most significant of these transactions are summarized as follows:

	•	In 2004, we entered into a licensing agreement with Cook Inlet Coal.  Kanturk Partners owns approximately a 12% interest in Cook Inlet Coal, of which Mr. John Venners, brother of our Chairman and Chief Executive Officer, Mr. Theodore Venners, has approximately a 4.5% interest.
	•	In 2003, we entered into an agreement with Venners & Company, a company controlled by Mr. John Venners, for governmental affairs consulting services.
	•	Certain investors, including a number of funds and accounts managed by Westcliff Capital Management LLC of which one of our directors, Richard Spencer, is the manager, obtained certain licensing rights when they entered into five separate transactions to purchase our common stock and warrants during the period March 28, 2002 through August 21, 2002.  The investors have the right under certain conditions to develop or participate in the greater of K-Fuel commercial projects with an annual output capacity of 50 million tons per year or six commercial projects.  The rights granted to the investors also gave them the exclusive right to develop commercial projects in India for an indefinite period of time as long as certain conditions are met.  The investors are obligated to pay certain royalty and license fees for these three plants, if constructed.
	•	The Estate of Edward Koppelman, or the Koppelman estate, is entitled to 25% of worldwide licensing and royalty revenues up to a maximum of $73.1 million as of December 31, 2004.  Mr. Theodore Venners, our Chairman and CEO, is entitled to 50% of net distributable royalties to be paid by the Koppelman estate.  In December 2004, Mr. Theodore Venners agreed to assign to KFx his right to payments that may become due to him from the estate in connection with the Cook Inlet Coal license arrangement.

                These transactions are more fully described throughout this report, more specifically in Item 7 – Managements Discussion and Analysis of Financial Condition and Results of Operations – Revenue Trends and Note 17 – Related Party Transactions, Note 14 – Supplemental Cash Flow Information and Note 10 – Stockholders’ Equity in Item 8 of this report.

DISCONTINUED OPERATIONS

                On November 26, 2003, we completed an equity exchange transaction with Kennecott.  In accordance with terms contained in the Equity Exchange Agreement, Kennecott transferred to KFx its 49% membership interest in KFL and the full ownership of all related technology and patents developed by Kennecott.  Prior to the consummation of this transaction, KFx owned a 51% membership interest in KFL.  In exchange, KFx transferred its ownership interests in Pegasus to Kennecott.  KFx had previously held approximately 65% ownership in Pegasus.  As a part of this transaction, Kennecott also received a license and all necessary rights to build and operate up to three commercial K-Fuel plants and to market K-Fuel or other production from those plants.  Each plant can have annual capacity of up to three million tons and Kennecott will pay applicable royalty and license fees for these three plants. 

                In connection with the agreement, KFx paid $500,000 to Pavilion Technologies, Inc. to obtain agreement from Pavilion to waive their right to demand acceleration of royalty obligations due to Pavilion from Pegasus upon the change in control of Pegasus.  KFx is to be repaid 50% of this amount as part of the note receivable from Pegasus and the remaining 50% was included in the contingent obligations due from Pegasus.  As part of this transaction, an intercompany working capital loan from KFx to Pegasus with an outstanding balance of approximately $9.4 million was exchanged for a contingent earn-out agreement of up to $9.4 million in the aggregate, plus accrued interest (prime rate plus 500 basis points), payable out of a portion of future cash flows generated by Pegasus.  Due to the contingent nature of this potential stream of future cash flows, we have not recognized an asset or any associated income.  See further discussion of the note receivable in Note 4 - Note Receivable in Item 8 of this report.

EMPLOYEES

                At March 14, 2005, we had  25 full-time employees, none of which were members of unions.  We consider our relations with all employees to be good.

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RISK FACTORS

Business Risks

We have a history of losses, deficits, working capital deficits and negative operating cash flows.  As a result, we have been and continue to be very dependent on strategic relationships and sales of our equity securities to fund our operating costs.

                As of December 31, 2004 and 2003, we had working capital of approximately $73.6 million and $21.2 million, respectively, and accumulated deficits of approximately $128.6 million and $118.0 million, respectively.  At December 31, 2004 and 2003 we had stockholders’ equity of approximately $94.3 million and $31.1 million, respectively.  In prior years, we had significant accumulated deficits and working capital deficits.  We incurred net losses from continuing operations of $10.6 million, $10.2 million and $18.4 million in 2004, 2003 and 2002, respectively.  Until 2004, we experienced negative operating cash flow of $6.9 million, and $4.0 million in 2003, and 2002, respectively.  In 2004, we generated $494,000 of operating cash flows, primarily due to cash received related to the Cook Inlet Coal contract that we received.  Based upon the terms of the contract and the deliverables required, we did not recognize any revenue in 2004.  We expect to start recognizing revenue from the Cook Inlet Coal contract in 2005 as we incur costs associated with the transfer of our technology to the licensee Cook Inlet Coal.  We are currently estimating these costs for 2005 and beyond and anticipate allocating a portion of the deferred revenue to the current portion recognizable with in the next twelve months after each period end.  We have not yet achieved significant K-Fuel licensing, royalty or product sales revenue.

                We expect to incur significant additional operating losses and continued negative cash flows from operations at least for the next couple of years.  We have made, and will continue to make, very significant expenditures well before our revenues increase sufficiently to cover these additional costs.  We are not able to estimate when, if ever, our revenue will increase sufficiently to cover these costs.  Further, we may not achieve or maintain profitability or generate cash from operations in future periods.

                As a result, we have been and continue to be very dependent on strategic relationships and sales of our equity securities to fund the operating costs associated with our business.  Our continuation is dependent on our ability to utilize existing resources and to generate sufficient cash flows to meet our obligations on a timely basis, to obtain financing or refinancing as may be required, to attain profitability, or a combination thereof.  A lack of adequate financing may adversely affect our ability to respond to changing business and economic conditions and competitive pressures, absorb negative operating results, and fund capital expenditures or increased working capital requirements.

We may not be able to enter into joint ventures or other partnership arrangements for purposes of licensing our K-Fuel technology or building K-Fuel plants, and any such joint ventures that have been previously disclosed, may not result in economic benefits to us or may not progress to definitive agreements.

                We recently announced that a former member of our Board of Directors, Mark Sexton, and Evergreen Energy Company, may be interested in entering into a joint venture with us to develop and finance several new plants for the production of K-Fuel.  As of the date of this report, the parties have had discussions concerning a possible joint venture, but we can give no assurances that any future transactions with Mr. Sexton and Evergreen Energy Company are likely to occur.  If we are unable to enter into new joint ventures or other partnership arrangements for purposes of licensing our K-Fuel technology or building K-Fuel plants, or if our contemplated relationship Mr. Sexton and Evergreen Energy Company is not successful, our business and prospects may suffer.

We have granted certain rights and limited licenses for the use of our K-Fuel technology to certain investors, including Westcliff Capital Management, LLC, and any such rights and licenses may dilute our interest in specific projects to the extent that such investors elect to participate.

                Subject to an investor rights agreement between us and several investors, including a number of funds and accounts managed by Westcliff Capital Management, LLC (managed by Richard Spencer, a member of our Board of Directors), we granted such investors the right under certain conditions to develop or participate in K-Fuel commercial projects with an annual output capacity of 50 million tons per year, or a maximum of six commercial projects, whichever is greater.  The agreement provides that the license and royalty fees charged to the investors will be the lesser of the rates specified in the agreement and the lowest rates charged to third parties other than Kennecott.  We also granted the investors the exclusive right to develop commercial projects in India until August 21, 2009, with additional seven-year terms dependent on the achievement of milestones to be determined in good faith between us and the investors.  Additionally, we may have to grant a right of first refusal to allow the investors to market the K-Fuel product in the event that we elect not to market it ourselves.  If the investors elect to exercise their rights pursuant to the investor rights agreement, we may be required to grant them certain licenses

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concerning our K-Fuel technology or allow them to participate as equity owners in any future K-Fuel plant projects, the result of which could dilute our possible ownership interest in specific projects.

Technical and operational problems may adversely impact our ability to develop K-Fuel projects or facilities and could result in delays or postponement of the production of our products.

                In the past there have been significant technical and operational problems with the construction of a K-Fuel facility.  The construction of the first commercial-scale K-Fuel production plant (the KFP Plant) began in 1995, which was completed and began operations in April 1998.  The plant experienced a series of construction problems during and after it began operations, including a 1996 fire at the plant and issues relating to the flow of materials within the processors and the design and operation of pressure release equipment.  Following the commencement of operations, the KFP Plant experienced problems relating to tar and residue build-up within the system during production and product quality issues related to product dusting.  As a result of these problems, operations at the KFP Plant were suspended.  In 2000, we tested an improved K-Fuel production process using PRB coals, which resulted in a new K-Fuel product, which is low in SO₂, NOx, mercury and chlorine when burned.  Analysis of this improved K-Fuel product indicated that this new K-Fuel production process could be more reliable than the process used by the KFP Plant.  Additionally, the new K-Fuel production facilities would require less capital and have lower operating costs than previous K-Fuel plant designs.  However, there can be no assurance that any future K-Fuel production facilities will not experience technical or operational problems similar to or in addition to those experienced at the KFP Plant.  To the extent that other technical or operational problems materialize, our ability to develop other K-Fuel projects or facilities would be jeopardized.

The K-Fuel technology has not yet shown economic viability and if such technology does not become economically viable our ability to generate revenue and/ or operating income from this technology would be impaired.

                We have only recently finished the development of the current K-Fuel technology.  Our future success depends upon our ability to successfully construct and operate commercial K-Fuel production plants on a large scale and at a profit.

                The process of developing, financing and constructing K-Fuel production plants, including obtaining necessary regulatory permits and approvals, is complex, lengthy and costly and subject to numerous risks, uncertainties and factors beyond our control, including cost overruns, delays, damage and technical delays.  In addition, local opposition to a particular project can substantially increase the cost and time associated with developing the project, and can, potentially, render a project not feasible or economical.  Future projects for the development of K-Fuel production plants may incur substantial costs or delays or may be unsuccessful as a result of such opposition.

                Only a small percentage of the potential projects that are considered and pursued may ultimately result in operating plants that are sufficiently successful to provide us with project revenues and equity participation income, license fee income, and royalty fee income.  As a result, we may not be able to recover any expenses that we incur in the evaluation and development of certain projects.

The market for the K-Fuel technology and products is unclear; therefore we may not be able to realize significant revenues from the sale of products using the K-Fuel technology.

                Although we believe that a substantial market will develop both domestically and internationally for clean coal fuel products such as K-Fuel, no established market for beneficiated fuel products exists.  As a result, the availability of accurate and reliable pricing information and transportation alternatives for bringing K-Fuel to the market are 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.  The value of our products in the marketplace may be reduced if the large differential that currently exists between the price of higher-grade eastern coals and lower-grade western coals narrows significantly.  Further, potential users of our fuel products may be able to choose among alternative fuel supplies and a lower price for these alternative supplies also can adversely affect our potential market opportunities.  The market viability for the K-Fuel technology will not be known until we complete construction of one or more commercial-scale production plants, either in the United States or internationally, that produce, on a consistent basis, commercial quantities of fuel that meet certain minimum performance specifications.  There is a risk that commercial-scale production plants when completed will be unable to generate sufficient market interest to continue in business.  Further, there can be no assurance that a commercial-scale K-Fuel plant will be economically successful.  If we are unable to complete construction and successfully operate a commercial K-Fuel production plant, we will not be able to sustain our operations or achieve future growth.

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We may not be able to effectively execute our business plan.

                You should consider our business and prospects in light of the risks and difficulties typically encountered by companies in the early stages of development of a new product such as ours.  Some of the specific risks include whether we will be able to:

	•	attract new customers, or expand services and retain customers;
	•	attract and retain credit-worthy customers;
	•	accurately assess potential markets and effectively respond to competitive developments;
	•	raise additional capital;
	•	provide a reliable product;
	•	effectively manage expanding operations;
	•	comply with evolving governmental regulatory requirements; and
	•	increase awareness of our product;

We may not be successful in addressing these and other risks, and our failure to do so would create a significant risk that the value of our common stock may decline and our results of operations and our financial condition may be adversely affected.

The cost of lower-grade coal and other costs may effect the economics of producing K-Fuel.

                We intend to use lower-grade coal as a feedstock in our process.  In addition, we have modeled the economics of a potential plant and believe that we would generate a profit by operating such a plant.  However, our models include significant estimates and assumptions for costs.  If such costs are greater than anticipated, it may not be economic to produce K-Fuel and our results of operations could be adversely affected.

The availability of lower-grade coal as a feedstock may affect future production of K-Fuel.

                We are investigating geographic regions which we believe have adequate lower-grade coal to serve as a feedstock for our process.  If such lower-grade coal becomes unavailable or the cost increases significantly, we may not be able to produce K-Fuel or produce it economically.

Deregulation in the United States power industry may result in increased competition, which could result in the recognition of lower margins 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, 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.

Competition in our markets may result in lower operating margins for our products than originally expected.

                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.  We may face competition for new K-Fuel plants from third parties with licenses for the K-Fuel technology, although we would receive licensing and royalty revenues.  Our future success may depend on our ability to adapt to such changing technologies and competition.

We are subject to risks of changing laws, which may adversely affect our ability to sell our products and services.

                Our products will be subject to federal, local, and foreign laws and regulations, including, for example, state and local ordinances relating to building codes, public safety and related matters.  In addition, as products are introduced into the market commercially, governments may impose new regulations.  Any regulation of our products, whether at the federal, state, local or foreign level, including any regulations relating to the development or sale of our products, may increase our costs and the price of our products.