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1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 12b-25
SEC FILE NUMBER
0-23634
NOTIFICATION OF LATE FILING
(Check One): |X| Form 10-K |_| Form 20-F |_| Form 11-K |_| Form 10-Q |_| Form N-SAR
For Period Ended: December 31, 1999
[ ] Transition Report on Form 10-K
[ ] Transition Report on Form 20-F
[ ] Transition Report on Form 11-K
[ ] Transition Report on Form 10-Q
[ ] Transition Report on Form N-SAR
For the Transition Period Ended:
-----------------------------
If the notification relates to a portion of the filing checked above, identify
the Item(s) to which the notification relates:
- --------------------------------------------------------------------------------
PART I - REGISTRANT INFORMATION
KFx Inc.
- --------------------------------------------------------------------------------
Full Name of Registrant
- --------------------------------------------------------------------------------
Former Name if Applicable
1999 Broadway, Suite 3200
- --------------------------------------------------------------------------------
Address of Principal Executive Office (Street and Number)
Denver, Colorado USA 80202
- --------------------------------------------------------------------------------
City, State and Zip Code
PART II - RULES 12B-25(b) AND (c)
If the subject report could not be filed without unreasonable effort or expense
and the registrant seeks relief pursuant to Rule 12b-25(b), the following should
be completed. (Check appropriate box)
|X| (a) The reasons described in reasonable detail in Part III of this
form could not be eliminated without unreasonable effort or
expense;
|X| (b) The subject annual report, semi-annual report, transition
report on Form 10-K, Form 20-F, 11-K or Form N-SAR, or portion
thereof, will be filed on or before the fifteenth calendar day
following the prescribed due date; or the subject quarterly report
of transition report on Form 10-Q, or portion thereof will be
filed on or before the fifth calendar day following the prescribed
due date; and
|_| (c) The accountant's statement or other exhibit required by Rule
12b-25(c) has been attached if applicable.
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PART III - NARRATIVE
State below in reasonable detail the reasons why Forms 10-K, 20-F, 11-K, 10-Q,
N-SAR, or the transition report or portion thereof, could not be filed within
the prescribed time period.
The Registrant is unable to complete the information for the timely presentation
of its Annual Report on Form 10-K for the period ended December 31, 1999 due to
the fact that the Registrant recently consummated a financing for its
subsidiary, Pegasus Technologies, Inc., as reported on its Current Report on
Form 8-K filed with the SEC on March 24, 2000 and is currently negotiating a
sale of the K-Fuel production facility, in which the Registrant owns a 5%
interest, in Gillette, Wyoming.
PART IV - OTHER INFORMATION
(1) Name and telephone number of person to contact in regard to this notification
Seth L. Patterson (303) 297-4982
-------------------------------------------------- -------------------------------- -------------------
(Name) (Area Code) (Telephone Number)
(2) Have all other periodic reports required under Section 13 or 15(d) of
the Securities Exchange Act of 1934 or Section 30 of the Investment
Company Act of 1940 during the preceding 12 months or for such shorter
period that the registrant was required to file such report(s) been
filed? If answer is no, identify report(s). |X| Yes |_| No
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(3) Is it anticipated that any significant change in results of operations
from the corresponding period for the last fiscal year will be
reflected by the earnings statements to be included in the subject
report or portion thereof? |X| Yes |_| No
If so, attach an explanation of the anticipated change, both
narratively and quantitatively, and, if appropriate, state the reasons
why a reasonable estimate of the results cannot be made.
================================================================================
KFx Inc.
- --------------------------------------------------------------------------------
(Name of Registrant as Specified in Charter)
has caused this notification to be signed on its behalf by the undersigned
hereunto duly authorized.
Date March 28, 2000 By /s/ Seth L. Patterson
---------------------- ---------------------------------
Seth L. Patterson,
Executive Vice President and
Chief Financial Officer
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The Registrant expects significant changes in its results of operations for the
fiscal year ended December 31, 1999 compared to the fiscal year ended December
31, 1998. Anticipated condensed financial information for these years is
contained in the table below. The changes from 1998 to 1999 reflect increased
revenues and operating expenses for Pegasus, as Pegasus expanded its business,
grew its marketing and sales organization and increased its research and
development activities. The changes also reflect increased revenues and
decreased operating expenses for K-Fuel resulting primarily from a $1 million
K-Fuel license fee and reduced contract revenues and related expenses. The
information below for 1999 is subject to resolution of issues related to the
potential sale of the K-Fuel production facility, as noted in Part III of this
Form 12b-25, and completion of the audit of the Company's 1999 financial
statements.
Twelve Months Twelve Months
Ended Ended
12/31/99 12/31/98
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STATEMENTS OF OPERATIONS
Operating revenues $ 3,063,682 $ 2,220,585
Operating loss $(7,318,690) $(6,419,014)
Net loss $(8,572,075) $(6,783,817)
Basic and diluted loss per share $(.36) $(.28)
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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, 1999
[ ] 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)
1999 BROADWAY, SUITE 3200, DENVER, COLORADO USA 80202
(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 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. [ ]
As of April 13, 2000, the aggregate market value of the Registrant's common
stock held by non-affiliates of the Registrant was approximately $33,147,000. At
April, 2000, 24,934,289 shares of common stock of the Registrant were
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Registrant's
definitive Proxy Statement for the Annual Meeting of Shareholders to be held on
June 22, 2000 are incorporated by reference into Part III.
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KFX INC.
FORM 10-K ANNUAL REPORT
FOR THE YEAR ENDED DECEMBER 31, 1999
TABLE OF CONTENTS
--------------------------------
PAGE
NO.
----
PART I
Item 1. Business..................................................................................... 3
Item 2. Properties................................................................................... 31
Item 3. Legal Proceedings............................................................................ 31
Item 4. Submission of Matters to a Vote of Security Holders.......................................... 32
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters........................ 33
Item 6. Selected Financial Data...................................................................... 34
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................................... 35
Item 7A. Quantitative and Qualitative Disclosures About Market Risk................................... 44
Item 8. Financial Statements and Supplementary Data.................................................. 45
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial
Disclosures.................................................................................. 45
PART III
Item 10. Directors and Executive Officers of the Registrant........................................... 46
Item 11. Executive Compensation....................................................................... 46
Item 12. Security Ownership of Certain Beneficial Owners and Management............................... 46
Item 13. Certain Relationships and Related Transactions............................................... 46
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.............................. 47
SIGNATURES
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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
compliance with air quality emission standards on a worldwide basis and its
transformation to intensive competition domestically as the United States power
industry undergoes deregulation. 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
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.
Summary financial information about each segment for 1999 and 1998 follows;
for additional segment information see Note 18 to the Consolidated Financial
Statements.
1999 Pegasus K-Fuel
- ---- -------------- --------------
Operating Revenues $ 1,536,884 $ 1,313,916
Operating Loss $ (3,266,584) $ (1,055,085)
Total Assets $ 3,452,104 $ 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
Pegasus develops, markets, licenses and installs software that optimizes
the combustion performance of coal-fired electric utility boilers. Its
NeuSIGHT(TM) flagship product has been installed at 12 boiler units and is under
installation or is scheduled to be installed at 15 boiler units, across the
United States and Canada. NeuSIGHT utilizes an artificial intelligence/neural
network software platform licensed from Computer Associates International to
interface with the process control system in coal-fired electric utility boiler
units. 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
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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 referred 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 (SO(2)), carbon dioxide (CO(2)), 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. In
addition, KFx expects to hold equity interests in selected K-Fuel production
facilities. K-Fuel operations are conducted through KFx Inc. and certain of its
subsidiaries.
The Company will continue to consider various options to expand its
business by adding other solutions (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, 1999, most of
the Company's operating activities was conducted domestically. However, certain
Canadian customers of Pegasus generated revenues approximating $224,000 and
$166,000 in 1999 and 1998, respectively.
PEGASUS
GENERAL
In March 1998 the Company purchased a 60% interest in Pegasus Technologies
Limited, an Ohio limited liability company, (Pegasus Limited). 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 translates into lower fuel
costs, as well as lower emissions of SO(2) and CO(2); (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.
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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, 75% of the outstanding common stock of Pegasus Technologies,
Inc. was held by KFx, 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 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.
As a result of this transaction, at April 13, 2000, the ownership of Pegasus is
approximately as follows: KFx--74%, Pegasus management--20% and Kennecott
Energy--6%. Kennecott has the right to sell the Pegasus Common Stock back to KFx
at any time before March 3, 2001 at a price equal to the greater of $1,000,000
or fair market value.
In connection with the March 2000 transaction, Pegasus and Kennecott Energy
also formed a 50/50 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.
In the fourth quarter of 1999, Pegasus released (a) the new 5.0 version of
its flagship NeuSIGHT product that is expected to facilitate quicker and more
cost effective installations and provide other benefits to clients and (b)
Performance Calculation Tool(TM), an add-on module to NeuSIGHT that allows power
station engineers to create and run performance calculations, such as heat rate,
without the need to know a specific programming language. During 1999 and 1998
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Pegasus research and development expenses totaled $335,766 and $138,335,
respectively. Kennecott Energy's investment in Pegasus is expected to accelerate
enhancements to NeuSIGHT, the development of new products and services and other
improvements in the operations of Pegasus in 2000 and beyond, and
correspondingly increase research and development expenses.
As of March 31, 2000, Pegasus has firm unfilled sales commitments (backlog)
for 18 NeuSIGHT licenses and related installations at an estimated contract
value of $2,485,000, which are generally expected to be filled within
approximately the next 12-18 months. At March 26, 1999, such backlog
approximated $1,263,000 for 12 NeuSIGHT licenses and completion of related
installation services.
During 1999, two individual clients, Carolina Power & Light, and Houston
Light & Power accounted for greater than 10%, each, of consolidated revenues (19
and 11, respectively%). During 1998, three individual clients accounted for
greater than 10%, each, of consolidated revenues, Houston Light & Power, Union
Electric, and Cinergy (22%, 13%, and 10%, respectively). 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 three of the same clients are included in
both years' 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, as a subcontractor to Pegasus, in North America.
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 a 50/50 sharing of gross profits from the
installation services provided by SAIC to Pegasus customers under the agreement.
Through December 31, 1999, no payments to SAIC or related accruals have been
required under these profit sharing provisions.
During the first quarter of 2000, Pegasus entered into value added reseller
("VAR") agreements with Babcock & Wilcox ("B&W") and ABB Centrum ("ABB"). The
VAR agreements grant non-exclusive resale rights for NeuSIGHT and related
installation services to B&W on a worldwide basis and to ABB for Poland, Hungary
and the Czech Republic. Minimum license purchases during the initial one year
terms of these VAR agreements require payments to Pegasus through February 2001
totaling $452,000. The VAR agreements are for one-year renewable terms and
contain provisions preventing competition with Pegasus, requiring Pegasus to
provide certain training and granting preferred pricing to B&W and ABB. Pegasus
will pursue additional VAR arrangements with appropriate parties as a means to
quickly and cost effectively gain access to potential customers.
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INTELLECTUAL PROPERTY
NeuSIGHT utilizes a neural network technology licensed from a subsidiary of
Computer Associates International (CA) under an agreement which, among other
terms, grants Pegasus Limited 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 Limited, at which time CA sold
such interest to KFx in exchange for 527,000 common shares of KFx. The
programming code that constitutes NeuSIGHT is a trade secret.
COMPETITION
Pegasus faces competition from several companies that offer software
products providing combustion optimization benefits to the electric power
industry. Management believes the NeuSIGHT software solution offers several
competitive advantages over competitor's offerings. Most significantly, in an
independent study completed in December 1998, 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 an 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 re-tuning, 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 solutions 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 competing companies may have greater financial and other
resources. In addition, Pegasus may face new competition from other vendors to
the electric power generation industry, many of which have significantly greater
financial and other resources than Pegasus.
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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 capital 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 also be used for coal fuel product
facilities, but the Company expects they may be more likely used for 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 the Company under a 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. 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 in the near term 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, carbon
dioxide (CO2), mercury and chlorine. K-Fuel is the first beneficiated coal
product that has not exhibited any significant signs of spontaneous combustion.
In addition, K-Fuel has been demonstrated to increase gross power generation,
reduce fuel-pulverizing requirements, blend well with other
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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. Efforts are underway to determine ways in
which dust can be reduced.
In May 1998, the Southern Research Institute conducted a test burn of
approximately 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:
EMISSIONS (PPM)
BTU (CORRECTED TO 3% O2 DRY BASIS)
(AS RECEIVED) 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 Powder River
Basin ("PRB") coal in one of the station's boiler units. Initial results of the
test burn indicate that K-Fuel appeared to produce: a) a reduction in NOx
emissions while maintaining full load yet reducing auxiliary 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 ("AEP").
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. KFx is working to improve the
handling characteristics of K-Fuel.
One of the Company's subsidiaries has a contract with Western Research
Institute, a non-profit research organization based in Laramie, Wyoming, to
perform research related to the K-Fuel technology. During 1998 revenues from
this contract approximated 15% of consolidated revenues. Such revenues in 1999
were less than 10% of consolidated revenues. The costs under this research
contract and costs related to various support services provided by the Company
to KFP in connection with the development, start-up and operations of the KFP
Facility approximated $414,000, $889,000, and $1,251,000 in 1999, 1998 and 1997,
respectively.
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
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Kennecott Energy Company ("Kennecott Energy"). The joint venture, a Delaware
limited liability company named K-Fuel, L.L.C. ("K-Fuel, LLC"), is expected 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 or both will have an equity
interest 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 million to the Company to
enter into the K-Fuel, LLC joint venture. In June 1999, in connection with
certain amendments to the Kennecott Agreement, Kennecott Energy paid to KFx a
non-refundable $1,000,000 payment that can be applied only toward the grant of a
future K-Fuel license to Kennecott Energy and an additional $1,000,000, that KFx
was required to invest in K-Fuel, LLC to support the next phase of K-Fuel
commercialization. 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 a future K-Fuel license accounted for 35% of
consolidated revenues in 1999. As of April 14, 2000, there were no commitments
to construct any Commercial Projects.
The Company has a 51% percent interest in K-Fuel, LLC and Kennecott Energy
has a 49% interest. At such time as entities in which Kennecott 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 1999, 1998 and 1997,
Kennecott Energy incurred related research and development costs totaling
approximately $141,000, $51,000 and $879,000, respectively, in connection with
certain commitments to K-Fuel, LLC.
If Kennecott Energy has not, by December 31, 2006, approved for
construction Commercial Projects in which Kennecott Energy will have an equity
interest having a design capacity equal to 1 million TPY of K-Fuel product, then
the Company may purchase Kennecott Energy's interest in K-Fuel, LLC for a
purchase price equal to: (a) 100% of the aggregate amount expended on third
party costs; and (b) 75% of the aggregate amount charged for internal Kennecott
Energy costs incurred under any Work Plan, plus a reasonable return on such
amounts. The Company waived this purchase right in connection with Kennecott
Energy's investment in Pegasus in March 2000.
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,
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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, 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 ("Bonus Royalty")
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.
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 $.001 par value common stock ("Common Stock") for $6 million, or
approximately 14% of the outstanding Common Stock as of December 31, 1996, and
in 1997 purchased an additional 1.25 million shares of Common Stock for $2.5
million, increasing its ownership to approximately 18% of the outstanding Common
Stock. As part of the transaction TCK was also granted (i) a warrant ("Warrant
A") to purchase an additional 7,750,000 shares of Common Stock (subject to
certain adjustments) at an exercise price of $3.65 per share, exercisable on
January 1, 2000 and expiring July 1, 2001; and (ii) a warrant ("Warrant B"),
that gives it the right to purchase the number of shares of Common Stock (at the
then prevailing market price) that, when added to all shares owned by TCK on the
exercise date, including any shares acquired by the exercise of Warrant A, would
be sufficient to give TCK 51% of the outstanding Common Stock, on a fully
diluted basis. Warrant B has the same exercise and termination dates as Warrant
A, but is not exercisable unless Warrant A is fully exercised. TCK has agreed
to cancel two warrants pursuant to agreements entered into on April 12, 2000,
as discussed below.
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In August 1995, the Company and TCK, acting through respective wholly-owned
subsidiaries, formed KFX Fuel Partners, L.P. ("KFP"), a Delaware limited
partnership, 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" K-Fuel Technology. The Company has a 5% interest in KFP, with the remaining
95% held by TCK. TCK is the managing general partner for KFP and makes all
day-to-day operating decisions. In addition to its 5% ownership of KFP, the
Company has the right to receive a production royalty of 3 percent of the gross
sales of KFP, payable quarterly. See "Patents, Licenses and Royalty Agreements."
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 April 12, 2000 the Company executed agreements with various parties that
initiate the redevelopment of the KFP Facility. Pursuant to the agreements, if
all conditions to closing are met, (a) a subsidiary of Black Hills Corporation
(BHK) will purchase the KFP Facility and receive 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) BHK will be given the right to
one seat on KFx's board of directors and KFx will grant BHK a warrant to
purchase 1.3 million shares of KFx common stock at $3.65 per share, subject to
certain adjustments, (c) KFx will relinquish its 5% interest in KFP and provide
certain releases in exchange for cash proceeds estimated at $1.5 million, will
retain its 5% royalty right and certain real and personal property and has
negotiated a revenue-based service fee, (d) TCK will sell the remaining 2.25
million common shares of KFx it owns to private investors and cancel the
warrants it holds to purchase a control position in KFx's common stock. KFx and
BHK are proceeding to finalize plans and secure the necessary capital to rectify
certain design flaws in the balance-of-plant systems, including the addition of
an incinerator to eliminate certain process waste streams, and to modify the
plant to replace natural gas with waste coal as the facility's energy source.
The cost to implement these plans is estimated at $10 million to $12 million. If
efforts to finalize plant modification plans and secure related capital are not
successful by August 2000, BHK has the option to salvage the equipment and
reclaim the site. The terms of the agreements provide for closing of these
transactions not later than April 28, 2000. The carrying value of the Company's
investment in KFP has been written down effective December 31, 1999 by $1.8
million, to the $1.5 million near term cash proceeds expected if these
transactions close.
During 1998 and through mid 1999 the Company, in conjunction with K-Fuel
LLC, performed certain marketing activities for KFP, for which the Company was
reimbursed. During
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1998 certain support service provided by a subsidiary of KFx to KFP approximated
25% of consolidated revenues; such services in 1999 were less than 10% of
consolidated revenues.
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, which
was originally adopted in 1980, provides a tax credit to the producer of fuel
from alternative sources. The credit is equal to $3.00 in 1979 dollars for each
barrel equivalent of crude oil ("OBE"), which is defined as 5.8 million Btu.
Section 29 contains provisions requiring a phase out of the credit that begins
as the reference price of oil (the average price of oil for the year as
announced by the Secretary of the Treasury) exceeds $47.90 per barrel (in 1998
dollars, the latest available information) and is fully phased out if the
reference price exceeds $60.13 (in 1998 dollars). For 1998 the reference price
of oil was $10.88 per barrel. Section 29 applies to qualified fuels which are
produced in a facility placed in service before July 1, 1998 pursuant to a
binding written contract in effect before January 1, 1997, and which are sold
after December 1992 and before January 2008. Calculated in 1998 dollars, the
current tax credit value ranges from $24.75 to $26.36 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. TCK and the Company believe that the KFP Facility meets
the requirements to qualify for Section 29 tax credits. 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.
Other than alternative minimum tax provisions, generally there is no
provision for carrybacks or carryovers in the event the taxpayer cannot use the
entire alternative fuel production credit available for the taxable year. There
are also no recapture provisions that apply to this credit. The Company is
currently unable to directly utilize any Section 29 tax credits derived from its
5% ownership of KFP because of its cumulative net operating loss carryforward.
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 infrastructure (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.
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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 of $90 million. In June
1996, the Company entered into a royalty amendment agreement with Edward
Koppelman, the inventor of the K-Fuel Technology. Prior to the agreement, Mr.
Koppelman was entitled to a royalty of 2 percent on the gross sales value of
K-Fuel product produced by any entity, including any product produced by the
Company. 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,
the Company paid Mr. Koppelman $300,000 cash and issued a promissory note for
$200,000. See Note 9 to the consolidated financial statements, which begin on
page F-1. The resulting $500,000 prepaid royalty is being amortized based on the
difference between what royalty payments to Mr. Koppelman would have been on the
original royalty agreement and the amended royalty agreement reached in 1996.
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 based on licensing and royalty revenues received by the Company
and the geographic source of the revenues:
UNITED EXPIRATION DATE OR
ROYALTY OBLIGATION 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 and does not
include the plant constructed in 1996 by KFP.
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
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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, sulfur dioxide 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. Because of
an over-compliance situation that has developed in Phase I of the CAA, prior to
December 31, 1999 there was an abundant supply of emission credits in the U.S.
market. The impact of Phase II implementation of the CAA, which began in January
2000 is not yet determinable. Additionally, existing supplies of naturally
low-sulfur coal are continually being depleted.
The Company is not able to predict the impact that competing coal
beneficiation 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. 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"). The proposed Indonesia Project is an
approximately 1.5 million metric ton-per-year ("MTPY") facility, with an
estimated development and construction cost of approximately $160 million,
including approximately $21 million to develop an existing coal reserve of PTBA
estimated at approximately 180 million metric tons. The Company expects to have
no direct financial ownership in the initial Indonesia Project other than
license fees, royalties and bonus royalty. The funding for the Indonesia
Project, other than the feasibility study costs incurred in 1996, is expected to
be funded 100 percent by Kennecott Energy and PTBA. Feasibility study costs
incurred in 1997 and 1998 for the Indonesia Project were not material. It is
possible that PTBA will participate in the Indonesia Project only as a supplier
of raw coal feedstock, rather than being the coal supplier and a partner in the
Indonesia Project. Also, with the Company's consent, Kennecott Energy may
transfer its rights in the Indonesia Project to one or more international
affiliates.
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In January 1997, the Company and K-Fuel, LLC entered into an amended
agreement with RCD regarding certain future performance fees related to a
successful Indonesia K-Fuel project. In the event that the Company and/or
K-Fuel, LLC construct or license an Indonesia K-Fuel project utilizing at least
25 percent raw coal feedstock supplied by PTBA, RCD would be entitled to a fee
of $2.00 per U.S. short ton (2,000 lbs.) for the first 1.5 million tons of
installed capacity, and a fee of $1.33 per ton for the second 1.5 million tons
of installed capacity. The fees RCD derives from individual K-Fuel projects in
Indonesia supplied by PTBA coal are not expected to impact the license fees or
royalties the Company would separately receive under its license agreement with
K-Fuel, LLC.
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.
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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 action ruled that EPA had not exceeded its authority or followed
improper procedures and the EPA's SIP Call was mostly affirmed. Since this
decision is subject to appeal, the final outcome of this matter cannot be
predicted with certainty. Nonetheless, affirmation of the EPA SIP Call is
expected to accelerate demand for the Company's technologies, products and
services. Furthermore, the validity of the ultimate governing requirements of
the CAA have not been in question, only the specifics of various EPA initiatives
to achieve compliance therewith.
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 is 2.5 lbs. SO2 per million Btu ("MMBtu") of heat output. Phase
II, which began January 1, 2000 is expected to affect over 1,400 electrical
generating plants and other industrial users of coal. 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. The impact of Phase II implementation
of the CAA is not yet determinable.
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
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generation capacity of 200 megawatts (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 83%). Coal-fired
electricity generation currently accounts for approximately 56% 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 between the years 2000 and 2010. 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 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.
Carbon dioxide (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 approximate up to 5%
and 6%, respectively. As of January 13, 2000, eighty-four countries, including
the European Community, have signed the Kyoto Protocol. Although the United
States signed the Kyoto Protocol in December, 1998, it has not yet been ratified
by the United States Senate, as would be required to be applicable in the United
States. The Company is not able to predict if and when the United States Senate
might ratify the Kyoto Protocol and the impact that such action or inaction
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.
In February 1998, the EPA submitted a report to Congress that found that
mercury emissions from coal-fired power plants were the hazardous pollutant from
utilities of greatest concern. Under the CAA the EPA required that all
coal-fired electric utility steam generating boiler units provide certain
information in 1999 that will allow the EPA to calculate the annual mercury
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emissions from each unit. This information will be used to determine if it is
appropriate and necessary to regulate emissions of hazardous pollutants, as
defined, which include mercury, from electric utility boiler units. The EPA is
not expected to release its analysis of this data until May 31, 2000 and it has
until December 2000 to decide if it will regulate mercury emissions from power
plants. According to an analysis by Resource Data International ("RDI"), 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 and 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. The EPA has until the
end of 2000 to decide whether it will pursue mercury emission control
regulations. 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 Deregulation in 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 1998 investor-owned power utility information, of the $125
billion in operation and maintenance ("O&M") expenses (including fuels), 25%
went to fuel costs 14% 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 1998, 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 1998 was reduced
by about 30%, or more than 150,000 employees. In the opinion of management,
competition in a deregulated power
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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
capital 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 industry. The Company's objective, with
respect to international opportunities 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 currently has international commercialization opportunities
related to K-Fuel in Indonesia and Turkey, 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 and Pegasus currently derives certain
revenues from Canada. Pegasus announced the execution of a non-exclusive
world-wide value added reseller agreement with Babcock & Wilcox in January 2000
and a non-exclusive value added reseller agreement with ABB Centrum covering
Poland, Hungary and the Czech Republic, in February 2000. 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"), in consideration for its
commitment to contribute $540,000 to Charco as working capital. Funding under
this commitment began in January 1998,
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and during 1998 the Company contributed $629,000 to Charco to satisfy this
commitment and additional capital calls.
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 extract crude oil that otherwise cannot be extracted by
conventional production techniques. The technology licensed to Charco is based
on a patent 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 the Masek Technology.
Charco is pursuing further improvements to the technology. Efforts at KFx and
Charco are currently underway to obtain outside financing to complete
development of the Charco Redondo Lease. There can be no assurance that such
financing will be obtained. If such financing cannot be obtained on satisfactory
terms or at all, this project could be abandoned. Additionally, KFx may consider
alternatives to dispose of this investment and expects that if such an
alternative is pursued its investment could be recovered in full.
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 a total of $2,000,000 to Synthetic, of which a total of $50,000
was paid upon execution of the option agreement and $50,000 was paid when the
option was amended in 1999. The Company is not committed to pay any additional
amounts to Synthetic under the option agreement until certain performance
milestones of the Charco Pilot Project are met. The option will expire if it is
not exercised after such milestones are met. One of the two milestones was met
during 1999. The remaining milestone will be achieved only if the Charco Redondo
Lease is placed in production after further development.
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 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.
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PEGASUS
The operations of Pegasus are not significantly impacted by governmental
regulation with respect to the development and delivery of NeuSIGHT and related
software products and services.
K-FUEL
In the United States, the K-Fuel product is not expected to be subject to
significant 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. Typically, 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.
CHARCO REDONDO, LLC
The operations of Charco are regulated to the extent of environmental
permitting by various state and local governmental authorities and by the Mine
Safety and Health Administration ("MSHA") with regard to its mining activities
to excavate subsurface production rooms. In addition, the Texas Railroad
Commission regulates oil drilling and production activities in the State of
Texas. To the best of the Company's knowledge, Charco is currently in compliance
with all such governmental regulations.
EMPLOYEES
The Company currently has approximately 9 full-time employees who work in
the areas of corporate and K-Fuel marketing, finance and administration, and
operation of the K-Fuel demonstration plant and laboratory. Pegasus currently
has approximately 27 full-time employees who work 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.
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RISK FACTORS
WE WILL NEED ADDITIONAL CAPITAL TO FUND OUR BUSINESS AND TO PAY INTEREST AND
PRINCIPAL, AT MATURITY, ON OUR 6% CONVERTIBLE DEBENTURES
We require substantial working capital to fund our business. At
December 31, 1999 we had a working capital deficit of $3,873,922. In past years,
we have experienced operating losses and negative cash flow and expect this
situation to continue in the future. As a result, we have been and are dependent
on sales of our equity securities , short term loans from our directors and
third parties and strategic relationships to fund construction of our K-Fuel
facility and operating costs associated with our businesses.
By selling our 6% convertible debentures in July 1997, we incurred an
additional $17,000,000 in principal amount of indebtedness. Through April 13,
2000, holders of $1.65 million of these debentures have exercised their
conversion rights and converted their debentures into 410,959 shares of our
common stock. At December 31, 1999 we had a stockholders deficit of $9.7
million.
Our current cash balances (and payments expected to be received in
connection with the sale of the K-Fuel plant and other expected services of
cash) are expected to fund our operations and debt service requirements until
approximately year end 2000 based on current operating plans. Accordingly, we
will require substantial amounts of cash to fund scheduled payments of principal
and interest on our 6% convertible debentures, working capital requirements, and
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.
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. Our ability to raise
additional capital is also limited by a stock purchase and related agreements
between us and Thermo Ecotek Corporation, one of our major stockholders. If,
however, there is a closing of the transactions contemplated under the various
agreements executed on April 12, 2000, which are intended to sell the KFP
Facility, TCK is obligated to cancel these agreements.
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WE HAVE NOT CONSISTENTLY ACHIEVED MATERIAL REVENUE SINCE OUR INCEPTION AND HAVE
INCURRED SIGNIFICANT OPERATING LOSSES
We have not consistently achieved material licensing, royalty or
product sales revenues since we were formed in 1988. In addition, no significant
revenue was earned prior to our formation when similar operations to ours were
conducted by various predecessor entities. We have incurred significant net
operating losses, including net losses of $12,730,427, $6,783,817 and $5,095,160
in 1999, 1998 and 1997, respectively. At December 31, 1999, we had an
accumulated deficit of $58,801,132, and we expect to incur additional losses 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.
IT IS DIFFICULT TO EVALUATE OUR BUSINESS AND PROSPECTS BECAUSE WE ARE SHIFTING
OUR STRATEGIC FOCUS TO THE DEVELOPMENT OF PEGASUS
KFx was organized in 1988 and in August 1995, we commenced the initial
application of our K-Fuel(TM) technology and began construction of a facility
near Gillette, Wyoming, which is owned by KFP, in order to produce K-Fuel(TM).
Until early 1998, our primary enterprise has been the business of 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(TM). Operations at the K-Fuel facility began in the second quarter of
1998. In March 1998 we acquired, through our purchase of a controlling ownership
interest in Pegasus, the software product NeuSIGHT(TM). 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(TM)
technology has significant long term value, we believe that the software
business of Pegasus offers more near term value. 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 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(TM) and related software products being developed at
Pegasus. There can be no assurance, however, that NeuSIGHT(TM) or any related
software products will experience growth or market acceptance.
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THE MARKET FOR NEUSIGHT(TM) AND RELATED SOFTWARE DEPENDS ON SUCCESSFUL SALES AND
MARKETING STRATEGIES PRODUCT IMPROVEMENT STRATEGIES
The market for NeuSIGHT(TM) 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(TM) and related software will be successful.
Additionally, we believe that increased market acceptance of
NeuSIGHT(TM) 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 additional
improvements are under development. We cannot assure you that our efforts to
further improve NeuSIGHT(TM) to more fully meet our objectives will be
successful.
OUR GENERAL PROJECT DEVELOPMENT IS UNCERTAIN
The process of developing, permitting, financing and constructing
K-Fuel(TM) 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 we evaluate and pursue may ultimately result in operating
projects. As a result, we may not be able to recover any expenses that we incur
in the evaluation and development of certain projects.
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 April 12, 2000 the Company executed agreements with various parties
that initiate the redevelopment of the KFP Facility. Necessary modifications to
the KFP Facility are estimated to cost $10 million to $12 million and such
modifications will not be feasible unless substantial capital is obtained. There
is no assurance such capital can be obtained on satisfactory terms, if at all.
There can be no assurances, however, that the KFP Facility will be successfully
restarted and K-Fuel production from this facility resumed. In addition,
although KFP believes that the KFP Facility qualifies for the Federal Oil Barrel
Equivalent Tax
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Credit, promulgated under Section 29 of the Internal Revenue Code of 1986, as
amended, which is a significant incentive for the potential new owners of the
KFP Facility, there can be no assurance that such a position will not be
successfully challenged by the Internal Revenue Service. 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.
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 planned by Kennecott Energy will
not experience technical or operational problems similar or in addition to those
experienced at the Wyoming K-Fuel facility. To the extent that other technical
or operational problems materialize, they may adversely impact our ability to
develop other K-Fuel(TM) projects or facilities.
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
uneconomic. We may incur substantial costs or delays or may be unsuccessful in
developing K-Fuel production facilities as a result of such opposition.
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 may in turn result in increased
competition from other producers of beneficiated coal products or other fuel
sources to the extent that such competing fuels result in cost savings for
utilities and other power producers.
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 alternatives is not fully known.
Our future success 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(TM) technoloGY demonstration plant, the market
viability of the K-Fuel(TM) 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
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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 the any commercial-scale K-Fuel facility will be successful.
WE ARE SUBJECT TO RISKS OF CHANGING LAWS
A significant factor driving the creation of the United States market
for K-Fuel(TM), othER beneficiated coal products, NeuSIGHT(TM) 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(TM), aND combustion optimization software, like
NeuSIGHT(TM). 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.
WE RELY ON STRATEGIC PARTNERS
We have established relationships with various strategic partners to
exploit the K-Fuel(TM) technology, enhance the application of NeuSIGHT(TM) and
further penetrate the NeuSIGHT(TM) maRKet. Kennecott Energy has been a strategic
partner in the development of K-Fuel(TM) technology since earLY 1996 and 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.
WE ARE REQUIRED TO PAY THIRD PARTIES A PORTION OF LICENSING AND ROYALTY REVENUES
We anticipate that a significant portion of our future revenues with
respect to K-Fuel(TM) will be in the form of licensing and royalty payments from
third party licensees operating commercial-scale production facilities of
K-Fuel(TM). Pursuant to various license agreements we haVE executed, we are
required to pay third parties a substantial portion of licensing and royalty
revenues we receive. Amounts due under these agreements may restrict or limit
our ability to
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pursue other commercialization opportunities with respect to K-Fuel(TM) because
such payments wiLL decrease cash flow from operations.
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. Our 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, currency exchange and repatriation risks, and higher credit risks
associated with fuel purchasers. 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 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
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.
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(TM) 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 rights with respect to NeuSIGHT(TM) 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(TM) product or
similar software of third party pateNT and other property rights. At this time,
we have not filed suit against any competitor nor has another company claimed
that our products infringe on its patent or intellectual property
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rights. Any claims, with or without merit, could be time-consuming or result in
costly litigation that may materially harm our business.
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 senior management 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.
OUR ABILITY TO TAKE ADVANTAGE OF NET OPERATING LOSSES IF WE ACHIEVE
PROFITABILITY COULD BE LIMITED
Under Section 382 of the Internal Revenue Code of 1986, 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 Internal Revenue
Code. 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. In the event we achieve
profitable operations, any significant limitation on the use of our net
operating losses would have the effect of increasing our tax liability and
reducing net income and available cash resources.
THERE ARE WARRANTS OUTSTANDING THAT, IF EXERCISED, WOULD RESULT IN A CHANGE IN
CONTROL OF KFX
TCK holds warrants allowing them to purchase control of KFx. If these warrants
are not cancelled in connection with the series of agreements recently executed
in connection with the sale of the KFP Facility, KFx's ability to obtain
additional equity capital may be adversely affected. In addition exercise of
these warrants would substantially dilute existing shareholders and allow TCK to
control KFX.
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YEAR 2000 COMPLIANCE
We are aware of the issues associated with the programming code in existing
computer systems related to the Year 2000. Prior to December 31, 1999 we
completed various analyses and remediation procedures related to the Year 2000
issue and to date we have not experienced any significant disruptions or
difficulties associated with the Year 2000 issue. Nevertheless, we may still
experience significant disruptions and difficulties associated with this matter.
WE DO NOT EXPECT TO 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.
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ITEM 2. PROPERTIES
For its principal executive offices, the Company has leased approximately
5,900 square feet of office space through September 2004 located at 1999
Broadway, Suite 3200, Denver, Colorado 80202. The current base rent under the
lease is $7,839 per month, escalating gradually to $11,593 per month by the
final year of the lease. The Company is also obligated to pay, as additional
rent, allocable operating costs. 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 KFP (on a rent-free basis) 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 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
this matter is still in discovery and its ultimate resolution cannot be
predicted with certainty, based on a preliminary review of the underlying facts
and discussion with counsel,
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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.
On March 9, 1998, Fidelity and Deposit of Maryland ("F&D"), as subrogee of
Walsh Construction Company ("Walsh"), a division of Guy F. Atkinson Company,
filed a construction lien against KFP with respect to the construction of the
KFP Facility in the amount of approximately $5.9 million. It is not possible at
this time to evaluate the merits of the claim or the range of potential loss.
However, the Company believes that the ultimate resolution of this action will
not have a material adverse impact on the Company's financial position or
results of operations. In connection with this action, KFP has filed a
counterclaim in excess of $29 million against F&D, the surety for Walsh. The
counterclaim asserts various claims of faulty construction performed by Walsh at
the KFP facility. The counterclaim is in discovery and it is not possible to
predict the outcome of this action; however the Company believes that the
counterclaim will not have a material adverse impact on the Company's financial
position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 1999.
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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, 1999.
YEAR PERIOD HIGH LOW
---- ------ ---- ---
1999 First Quarter $ 2 3/16 $ 1 1/4
Second Quarter 1 15/16 7/8
Third Quarter 1 7/8 1 1/16
Fourth Quarter 1 3/4 1 5/16
1998 First Quarter $ 3 7/8 $ 2 5/8
Second Quarter 3 5/8 2 1/2
Third Quarter 3 1/4 2
Fourth Quarter 2 3/8 1 1/8
As of April 13, 2000, the Company had 193 holders of record of the Common
Stock. This does not include holdings in street or nominee names. On April 13,
2000, the closing price of the Common Stock on the American Stock Exchange was
$2 7/8 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. In
addition, pursuant to the Stock Purchase Agreement, so long as TCK, together
with its affiliates, owns at least 1,000,000 shares of Common Stock and either
of the related warrants are outstanding, the Company may not declare or pay any
dividends on the Common Stock other than dividends payable solely in shares of
Common Stock. See "ITEM 1--BUSINESS--Strategic Relationships--Thermo Ecotek
Corporation and KFx Fuel Partners."
On August 27, 1999, the Company sold 527,000 of its $.001 par value common
stock valued at approximately $763,000 to Computer Associates International in
exchange for a 15% interest in Pegasus in a private placement pursuant to the
exemption provided by Regulation D. This common stock was later registered, with
the SEC.
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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,
1999 and the consolidated balance sheet data at December 31, 1998 and 1999 are
derived from the audited consolidated financial statements indexed on page F-1.
The consolidated statement of operations data for each of the two years in the
period ended December 31, 1996, and the consolidated balance sheet data at
December 31, 1995, 1996 and 1997 are derived from audited consolidated financial
statements not included in this Annual Report on Form 10-K.
1999 1998 1997 1996 1995
------------ ------------ ------------ ------------ ------------
STATEMENT OF OPERATIONS DATA FOR THE
YEAR ENDED DECEMBER 31:
Operating revenues ................. $ 2,850,800 $ 2,220,585 $ 1,084,823 $ 1,596,298 $ 254,363
Operating loss ..................... (7,477,042) (6,419,014) (4,930,551) (4,827,874) (8,243,306)
Loss before extraordinary item ..... (12,730,427) (6,783,817) (5,095,160) (5,628,541) (7,923,078)
Net loss ........................... (12,730,427) (6,783,817) (5,095,160) (5,628,541) (6,228,720)
Basic and diluted loss before
extraordinary item per share .... (.53) (.28) (.21) (.25) (.47)
Average shares of common stock
outstanding ..................... 24,137,000 23,931,000 23,820,000 22,458,000 18,578,000
BALANCE SHEET DATA AT DECEMBER 31:
Current assets ..................... $ 1,605,466 $ 7,004,806 $ 14,461,198 $ 1,957,005 $ 4,680,784
Working capital (deficit) .......... (3,873,922) 4,481,499 12,565,373 (166,521) 2,253,682
Total assets ....................... 14,267,995 22,672,289 29,057,706 14,923,567 18,611,493
Long-term debt ..................... 17,484,625 17,890,793 17,500,000 1,110,000 1,399,851
Stockholders' equity (deficit) ..... (9,696,018) 2,258,289 8,495,881 10,524,041 13,752,528
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This 10-K filing contains, in addition to historical information,
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended, that include risks and uncertainties. The Company's actual results
may differ materially from those anticipated in these forward-looking
statements. The forward looking statements contained in this filing include,
among others, statements regarding potential future investments in Pegasus by
Kennecott Energy and others; potential debt and/or equity funding sources for
KFx, including those related to the redevelopment of the KFP Facility; potential
conversions of the Debentures, under current terms or otherwise; expected future
operating results and financial condition; KFx's ability to dispose of its
investment in Charco and expected proceeds; the expected impact of and changes
in environmental and other regulations and their enforcement; effects of
deregulation of the electric power generation industry; expected effects of
certain organizational changes at Pegasus implemented in early 2000; expected
benefits to customers of and related market demand for current products and
products under development; commercialization of the K-Fuel Technology and
expected issuance of K-Fuel licenses; timing of filling of sales commitments;
effects of the Company's competition; impact on the Company of future possible
costs at the KFP Facility; results of test burns of K-Fuel; proposed projects in
Poland, Turkey and Indonesia; anticipated markets for the Company's products and
services; expected resolution and impact of litigation; and potential expansions
of product and service offerings. Important factors that could cause actual
results to differ materially from those anticipated include, but are not limited
to those discussed under "Risk Factors", adverse market and various other
conditions that could inhibit the Company's ability to obtain financing;
competition and technological developments by competitors; lack of market
interest in the Company's existing and any new products and services; changes in
environmental, electric utility and other governmental regulations; availability
of Section 29 or similar tax credits related to any future K-Fuel facilities;
actions of the Company's strategic partners; breadth or degree of protection
available to the Company's intellectual property; availability of key management
and skilled personnel; unanticipated problems that arise from research and
development activities; cost overruns, delays and damage that may occur in
developing, permitting, financing and constructing K-Fuel production facilities;
and domestic and international economic and political conditions. The Company
does not undertake to update, revise or correct any of the forward-looking
statements.
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OVERVIEW
Through the acquisition of 60% of Pegasus in early 1998, KFx significantly
broadened its technology solutions, by adding NeuSIGHT, Pegasus' artificial
intelligence based combustion optimization software, to K-Fuel Technology, its
patented clean coal technology, in order to better meet the evolving needs of
the electric power industry that are being stimulated by domestic industry
deregulation and increasingly stringent air quality standards worldwide. In the
fourth quarter of 1998 Pegasus began hiring a software marketing team. During
August 1999, KFx increased its ownership of Pegasus to 75% and in early March
2000, KFx sold 4% of its interest in Pegasus to Kenn