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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------
FORM 10-K
For Annual and Transition Reports
Pursuant to Sections 13 or 15(d)
of the Securities Exchange Act of 1934
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
[NO FEE REQUIRED]
For the fiscal year ended September 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
[NO FEE REQUIRED]
For the transition period from .............. to ..............
Commission file number 0-27803
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COVOL TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 87-0547337
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3280 North Frontage Road
Lehi, Utah 84043
(Address of principal executive offices) (Zip Code)
(801) 768-4481
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Covol Technologies, Inc. Common Stock, $.001 par value
(Securities are traded on the OTC Bulletin Board under the symbol "CVOL")
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No[ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K [ ].
The aggregate market value of the voting stock held by non-affiliates
of the registrant on December 15, 1997 was $96,571,353.
The number of shares outstanding of each of the registrant's classes
of common stock as of December 15, 1997 was 9,298,175.
-----------------------------------
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following documents are incorporated herein by reference:
None.
TABLE OF CONTENTS
Page
PART I
ITEM 1. BUSINESS................................................... 1
ITEM 2. PROPERTIES................................................. 19
ITEM 3. LEGAL PROCEEDINGS.......................................... 20
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........ 21
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS........................................ 21
ITEM 6. SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA............ 27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS........................ 30
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT
MARKET RISK................................................ 38
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................ 38
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE........................ 38
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT......... 39
ITEM 11. EXECUTIVE COMPENSATION..................................... 45
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT................................................. 50
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............. 53
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, AND REPORTS ON FORM 8-K.... 56
Statements in this Form 10-K, including those concerning the Registrant's
expectations regarding its business, and certain of the information presented in
this report, constitute forward looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. As such, actual results may
vary materially from such expectations. For a discussion of the factors that
could cause actual results to differ from expectations, please see the caption
entitled "Forward Looking Statements" in Item 1 and 7 hereof. There can be no
assurance that the Registrant's results of operations will not be adversely
affected by such factors.
PART I
ITEM 1. BUSINESS
The Company
The primary business of Covol Technologies, Inc. (the "Company" or
"Covol") is to commercialize patented and proprietary technologies (the
"Briquetting Technology") used to recycle waste by-products from the coal, steel
and other industries into a marketable source of fuel, revert materials and
other marketable resources in the form of briquettes, extrusions or pellets
("briquettes").
Covol was originally incorporated in Nevada in 1987 under the name
Cynsulo, Inc. In 1988, the Company consummated an initial public offering of its
common stock in Nevada in which the Company sold 200,000 shares for $20,000. At
the time of such public offering, the Company was engaged in no material
business activities. In December 1988, the Company acquired all of the issued
and outstanding shares of McParkland Corporation and changed its name to
McParkland Properties, Inc. ("McParkland"). McParkland invested in discounted
notes and contracts through the Federal Deposit Insurance Corporation. In 1989,
management became aware of certain irregularities relating to the original
purchase of two loan packages. As a result of an investigation conducted by
management, the purchase of McParkland was rescinded in February 1990, and the
Company's name was changed to Riverbed Enterprises, Inc. In August 1990, the
Company's focus was changed to the growing and marketing of certain agricultural
products, primarily alfalfa. In 1991, the Company acquired technology consisting
of binding agents used to make briquettes. The Company shifted its focus to the
research and development of better and stronger binding agents which resulted in
patenting the Briquetting Technology. The Company then changed its focus from
its agricultural business and devoted its primary efforts to the development and
commercialization of the Briquetting Technology. The Company's name was changed
to Enviro-Fuels Technology, Inc. in July 1991, to Environmental Technologies
Group International in 1994, and to Covol Technologies, Inc. in August 1995, at
which time the Company was reincorporated in Delaware.
In 1993, the Company acquired three construction companies engaged in
providing contracting and construction services to the steel, copper and other
heavy industries. The companies were Industrial Management and Engineering, Inc.
("IME"), State Incorporated ("State") and Central Industrial Construction, Inc.
("CIC"). Additionally, in 1994, the Company acquired Larson Limestone Company,
Inc. ("Larson"), which mines, produces and markets limestone products for
industrial applications. IME, State, CIC and Larson are collectively referred to
as the "Construction Companies."
In September 1995, the Company made a strategic decision to focus its
efforts exclusively on commercializing the Briquetting Technology and to divest
itself of the Construction Companies. Accordingly, on February 1, 1996, the
Company entered into a Share Purchase Agreement ( the "Agreement") with Michael
McEwan and Gerald Larson, former principals of the Construction Companies (the
"Buyers"), to sell all of the common shares of the Construction Companies to
Buyers. See "ITEM 1. BUSINESS--Construction and Limestone Businesses."
Partnerships. In June 1996, the Company formed Utah Synfuel #1, Ltd.
("US #1") and Alabama Synfuel #1, Ltd. ("AS #1"), each a Delaware limited
partnership (collectively the "Partnerships"). The Company has retained a 60%
interest in US #1 and a 80% interest in AS #1 and privately placed the remaining
partnership interests in the Partnerships. The limited partners paid $3,277,500
for the remaining partnership interests in US #1 and $2,062,500 for the
remaining partnership interests in AS #1.
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Funds raised in AS #1 and US #1 were used to purchase equipment and
begin construction on the synthetic coal briquetting plants in Birmingham,
Alabama (the "Alabama Plant"), through AS #1, and in Price, Utah (the "Utah
Plant"), through US #1. The Company and AS #1 subsequently entered into a
contract to sell the Alabama Plant to Birmingham Syn Fuel, L.L.C. ("BSF"), an
affiliate of PacifiCorp Financial Services, Inc. ("PacifiCorp"). See "ITEM 1.
BUSINESS--Business of the Company--Alabama Plant." The Utah Plant was sold to
Coaltech No. 1 LP ("Coaltech"), a Delaware limited partnership, which consists
of the Company as a 1% general partner, AJG Financial Services, Inc. as a 24%
limited partner and Square D Company as a 75% limited partner. See "ITEM 1.
BUSINESS--Business of the Company--Utah Plant." Under the partnership agreements
for the Partnerships, the Company is entitled to distributions from the
Partnerships according to the Company's percentage interest in the net
distributable cash flow of the Partnerships.
Flat Ridge Corporation. On October 15, 1997, the Company organized Flat
Ridge Corporation ("FRC"), a Utah corporation, as a wholly-owned subsidiary. The
purpose of FRC is to develop sites for the construction of briquetting
facilities. To date FRC has incurred costs for the permitting of a site in West
Virginia. There has been no other significant business conducted by FRC.
Covol Australia. On December 6, 1996, Covol Australia, Ltd. ("CAL"), an
Australian corporation, was formed by the Company and MT Technologies, Inc., a
British Virgin Islands corporation with offices in Hong Kong. The Company
initially retained a 15% interest in CAL and entered into a licensing agreement
with CAL for the use of the Briquetting Technology in Australia. On September
10, 1997, the Company acquired from the other CAL stockholders their interests
in exchange for 30,000 shares of Company common stock, thus making CAL a
wholly-owned subsidiary of the Company, amounts paid in excess of tangible
assets acquired are shown in the financial statements as payment for services.
The Company intends to commercialize its Briquetting Technology in Australia and
in other foreign countries. There was no significant business activity conducted
by CAL during the fiscal year ended September 30, 1997.
As of the filing of this report, the consolidated business of the
Company consisted of Covol as the parent company, FRC and CAL as wholly-owned
corporate subsidiaries, and US #1 and AS #1 as limited partnerships, of which
the Company is both the general partner and a limited partner, holding a 60% and
80% interest, respectively.
Effective January 1, 1994, the Company changed its fiscal year-end from
December 31 to September 30. Effective June 14, 1995, the Company implemented a
one-for-twenty reverse stock split relating to its common stock. Effective
January 23, 1996, the Company implemented a two-for-one forward stock split
relating to its common stock. Except as otherwise indicated, all information set
forth herein has been adjusted to give effect to such stock splits. Effective
June 25, 1997, the Company approved a new class of preferred stock in an
authorized amount of 10,000,000 shares.
The Company anticipates that its expansion plans and working capital
requirements through the fiscal year ending September 30, 1998 will be met
through payments from the sale of briquetting facilities, advance license fees
which consist of a one-time payment for the use of the Briquetting Technology
royalties, based on production by licensees of the Company's Briquetting
Technology, profits from the sale of binder and proceeds from project financings
and equity and debt offerings as of the date of this Annual Report. Depending
upon the amount and timing of these capital resources, the Company may be
required to raise additional capital through private offerings of equity and
debt securities. No assurances can be made that the Company will operate
profitably, receive sufficient revenues from the sources listed above, or if
need be, will be able to raise sufficient capital through equity or debt
offerings.
2
Business of Company
The Company has developed the Briquetting Technology to recycle waste
by-products such as iron revert, coke breeze and coal fines from the steel and
coal industries into marketable sources of fuel or raw materials in the form of
briquettes. During the steel-making process, steel mills produce, among other
waste by-products, revert materials (small particles containing iron-rich
materials). Coke breeze is a fine residue resulting from the production and
storage of coke, a coal derivative used in the steel-making process. During the
coal-mining process, coal fines (small coal particles ranging from dust size to
less than 1/4" in diameter) are produced. Notwithstanding the significant
potential value in the revert materials, coke breeze and coal fines, the steel
and coal industries historically have not been able to develop effective
processes whereby these valuable resources can be captured and utilized. Indeed,
these materials have presented a disposal problem for steel and coal producers,
who may incur substantial costs in complying with federal and state
environmental laws and regulations relating to their storage and disposal.
The Briquetting Technology employs pressure and chemical agents to bind
coal fines, coke breeze and revert materials into briquettes. The coal and coke
briquettes produced through use of the Briquetting Technology are suitable for
industrial and commercial use and are comparable to run-of-mine coal and formed
coke. The revert material briquettes produced through use of the Briquetting
Technology are further processed in reducing furnaces to reclaim iron and other
materials. The revert processed through use of the Briquetting Technology is
comparable to scrap iron, a common form of raw material used by the steel-making
industry. See "ITEM 1. BUSINESS--Briquetting Technology." The Company believes
that its coal and coke briquettes and reclaimed iron can be produced and
marketed at prices which are competitive with run-of-mine coal, formed coke and
other sources of scrap iron. Moreover, the Company believes that the Briquetting
Technology will be attractive to steel and coal producers in addressing the
environmental issues surrounding the disposal of waste by-products generated in
the production process.
In addition to the uses described above, the Briquetting Technology may
also have other applications. The Company has successfully briquetted other
materials such as molybdenum, grinding swarf, lead dross and rutile to name a
few. The Company has not explored the commercial viability of these and other
applications.
The Company's fundamental business strategy is to commercialize the
Briquetting Technology through investors, limited partnerships, licenses, joint
ventures and collaborative arrangements with steel, coke and coal producers.
Because of the potential for tax credits in connection with the production of
synthetic fuels from coal fines at briquetting plants placed in service by June
30, 1998 (see "ITEM 1. BUSINESS--Tax Credits"), the principal focus of the
Company during fiscal year 1997 has been the development and commercialization
of the Briquetting Technology with respect to coal. The Company will continue to
focus on the coal application through fiscal year 1998.
Alabama Plant
The Company, through AS #1, is currently constructing the Alabama Plant
in Birmingham, Alabama. The plant will manufacture synthetic fuel from coal and
is expected to have an annual capacity of approximately 360,000 tons. The
Company anticipates that the construction of the Alabama Plant will be completed
by February 15, 1998. However, there are no assurances that the construction of
the Alabama Plant will be completed by that date or that it will produce at its
expected capacity.
Pursuant to the Alabama Project Purchase Agreement, dated as of March
20, 1997 (the "Alabama Purchase Agreement"), between the Company, AS #1 and
Birmingham Syn Fuel, L.L.C. ("BSF") a wholly-owned subsidiary of PacifiCorp
Financial Services, Inc. (together with any affiliates, "PacifiCorp"), the
3
Company and AS #1 have agreed to sell, and BSF has agreed to buy, the Alabama
Plant, subject to the terms and conditions of the Alabama Purchase Agreement.
The purchase price for the Alabama Plant should approximate the cost of the
Alabama Plant and will be payable in the form of a nonrecourse promissory note
secured by certain portions of the Alabama Plant. There are several conditions
precedent to the closing of the sale of the Alabama Plant. One condition to
closing was the receipt by BSF of a Private Letter Ruling ("PLR") from the
Internal Revenue Service ("IRS"). BSF received a favorable PLR in August 1997.
The receipt of the PLR triggered the payment of $250,000 in advance license fees
under the license agreement, which was included in deferred revenue as of
September 30, 1997, and will be recognized upon completion of the Alabama Plant.
An additional fee of $250,000 is payable upon the completion of the Alabama
Plant construction. The Company believes that it has met or will meet all other
conditions for the sale of the Alabama Plant; however, there is no assurance
that all conditions will be met.
Pursuant to a license agreement, BSF will pay quarterly royalty
payments at a prescribed dollar amount multiplied by the amount of British
thermal units ("Btu") in the product produced and sold during the calendar
quarter. The prescribed dollar amount is subject to adjustment based upon the
"inflation adjustment factor" as set forth in Section 29(d)(2) of the Internal
Revenue Code of 1986, as amended (the "Code"). The amount to be paid is subject
to adjustment to the extent that BSF incurs an operating loss on the production
and sale of synthetic fuel (exclusive of the amount BSF pays as a license fee
for the use of the technology).
The Company also has agreed to provide binder material to BSF for the
manufacture and production of synthetic fuel at an amount equal to the Company's
cost plus a prescribed mark-up. The mark-up may be reduced to the extent BSF
incurs a loss on the production and sale of synthetic fuel, but not below the
Company's cost for such binder materials.
Pursuant to a conditional option agreement, the Company agreed to
purchase all of the rights, title and interests of certain PacifiCorp parties in
BSF and all interests of PacifiCorp in its original $5 Million draw down loan
(described herein, and subsequently amended to $7 Million) if a PLR was not
received. Based upon BSF's receipt of the PLR in August 1997, the Company
believes that the conditional option agreement has terminated according to its
terms.
Utah Plant
The Company, through US #1, constructed the Utah Plant in Price, Utah.
The Utah Plant is a synthetic fuel briquetting facility with a production
capacity of approximately 360,000 tons per year. On March 10, 1997, the Company,
together with US #1, finalized the sale of the Utah Plant for $3.5 Million, in
the form of a nonrecourse promissory note (the "Utah Note"), all in accordance
with a Utah Project Purchase Agreement, dated as of March 7, 1997, between the
Company, US #1 and Coaltech (the "Utah Purchase Agreement"). The sale of the
Utah Plant resulted in a loss of approximately $581,000. The aggregate principal
balance of the Utah Note accrues interest at a fixed interest rate of 9.6552%
per annum, and is to be repaid in forty-four (44) equal consecutive quarterly
installments of principal and interest in the amount of $130,000, commencing on
March 31, 1997. As of September 30, 1997, one payment has been received. The
Utah Note is secured by a security interest in the Utah Plant, and in the event
of a default under the Utah Note, the Company's and US #1's sole right to
recovery is limited to the Utah Plant as pledged collateral without any recourse
against Coaltech. Accordingly, payments under the Utah Note will be subject to
the profitable production and sale of briquettes at the Utah Plant. If payments
are made on the Utah Note and the sublicense agreement described below, the
Company is only entitled to receive a distribution, if any, in accordance with
its percentage ownership of US #1. Currently, the Company has a 60% interest in
US #1.
The purchaser of the Utah Plant, Coaltech, consists of AJG Financial
Services, Inc., a Delaware corporation and wholly-owned subsidiary of Arthur J.
Gallagher & Co. ("Gallagher"), and Square D Company, a Delaware corporation and
4
wholly-owned subsidiary of Groupe Schneider, as 24% and 75% limited partners,
respectively, and the Company as a 1% general partner. Coaltech is a limited
partnership with no assets other than the Utah Plant, capital contributions made
by the partners and the sublicense described below.
In connection with the execution and delivery of the Utah Purchase
Agreement, US #1 granted Coaltech a non-exclusive sublicense of the Briquetting
Technology all pursuant to a License Agreement, dated as of March 7, 1997, by
and among US #1 as licensor, the Company as vendor, and Coaltech as licensee and
vendee (the "Utah License Agreement"). Under the Utah License Agreement, US #1
received an advance license fee of $1.4 Million, included in deferred revenue as
of September 30, 1997, and depending upon the amount of briquettes that are
produced and sold as "qualified fuels" under Section 29 of the Code, US #1 may
receive an earned license fee payable quarterly. The earned license fee is based
upon the product of an established dollar amount multiplied by the Btu of the
briquettes manufactured and sold at the Utah Plant. The established dollar
amount is subject to annual adjustment based upon an "inflation adjustment
factor" as set forth in Section 29(d)(2) of the Code. US #1 also has the
opportunity to receive an additional $1.1 Million as a goal fee if (i) the Utah
Plant during any consecutive seven day period produces and sells 7,140 tons of
qualifying briquettes, (ii) the Company completes the installation of additional
equipment at the facility (which has been installed), and (iii) notice is given
to Coaltech regarding such production and installation. The Company cannot
predict with any certainty the amount of ongoing license fees that may be
generated under the Utah License Agreement.
Also under the Utah License Agreement, the Company has agreed to sell
certain proprietary binder material necessary to produce the briquettes to
Coaltech at an established rate per ton subject to annual adjustment based upon
the producer price index. The Utah License Agreement extends to the later of (i)
January 1, 2008 or (ii) the corresponding date after which tax credits may not
be claimed or otherwise available under Section 29 of the Code.
The Company contracted with Coaltech to act as operator of the facility
for a quarterly fee based upon the amount of briquettes produced and sold per
year. The Company cannot predict with any certainty the amount of quarterly fees
that may be generated under its operation and maintenance agreement with
Coaltech. Moreover, the Company granted Coaltech a put option to require the
Company to purchase from Coaltech the Utah Project if (i) all of the Coaltech
limited partners are unable to utilize the federal income tax credits under
Section 29 of the Code, (ii) the economic benefits accruing to or experienced by
all of the Coaltech limited partners shall differ significantly from what was
initially projected, or (iii) there is a permanent force majeure or material
damage or destruction of the Utah Plant. If the put option is exercised prior to
the third anniversary date of the grant, the option price will be equal to the
fair market value of the limited partnership interests of the optionees on a
going concern basis, but in no event will the option price exceed 50% of the
capital contributions made by the optionees to fund payments due under the Utah
Note, the Utah License Agreement and broker fees. If the put option is exercised
on or after the third anniversary date, the option price will be $10 and the
optionees will not be entitled to any other payments.
As part of the sale of the Utah Plant, the Company and US #1 entered
into a Supply and Purchase Agreement with Coaltech. Under the agreement, the
Company agreed to provide coal fines to the Utah Plant for processing into
synthetic fuel at an amount equal to the Company's per ton costs (including any
wash costs). See discussion of wash plant below. Furthermore, US #1 agreed to
purchase from Coaltech the synthetic fuel produced at its cost plus one dollar
per ton. Coaltech has the right to market its synthetic fuel to a third party,
with US #1 having a right of first refusal to purchase such synthetic fuel. The
Company incurred a loss of $1,547,674 in the year ended September 30, 1997 in
connection with this agreement.
Finally, the building and surrounding property that accommodates the
Utah Plant was constructed so as to be capable of housing a second briquetting
facility. The Company granted to Coaltech the right to purchase a second line if
5
constructed at the Utah Plant site under terms comparable to the sale of the
Utah Plant. If the Company sells a second line to Coaltech, it is also obligated
to sell the building, binder plant, and other equipment that were not part of
the Utah Plant sold. The decision to construct the second line is dependent
upon, among other things, identifying adequate fines to operate a second line,
marketing of the synthetic fuel from a second line, and financing for
construction of the second line. The Company can give no assurance that the
second facility will be built, or that, if built, such facility will be
purchased by Coaltech.
Since the Utah Plant was first placed in service it has experienced
several problems, including insufficient drying capability for the synthetic
fuel product, inadequate clean coal fines as a feedstock for operations, and
inability to market to end-consumers the synthetic fuel product produced from
the high ash feedstock. The steps the Company has taken or is taking to address
these problems are described below.
Subsequent to the sale of the Utah Plant and as a condition of the
sale, the Company removed the dryers that were then a part of the facility and
added a larger dryer having the capacity to dry the output from the Utah Plant.
This installation was completed in May 1997. The Company believes this
modification has remedied the drying problem.
In order to provide coal fines to the Utah Plant, the Company entered
into a purchase agreement with Earthco to acquire the NEICO coal fines. See
"ITEM 1. BUSINESS--Supply of Coal Fines--NEICO Fines Purchase." The estimated
amount of clean coal fines equivalent at the NEICO site is 2 million tons. The
NEICO fines require washing to remove ash and to otherwise improve the quality
of the fines. Hence the Company is constructing of a wash plant at the NEICO
fines site. The estimated cost of the wash plant is approximately $4 Million.
The financing for the construction of the wash plant is being provided by
Gallagher, and is evidenced by a promissory note executed and delivered by the
Company to Gallagher which is secured by the property purchased with the
proceeds of the loan. The promissory note bears interest at 6% per annum with
principal and interest being due and payable in two years. As additional
consideration to Gallagher for financing the wash plant, the Company, in October
1997, agreed to grant Gallagher warrants to purchase approximately 400,000
shares of Company common stock, with fifty percent of the shares having a
purchase price of $10 per share and fifty percent of the shares having a
purchase price of $20 per share. The warrants are immediately exercisable and
expire in two years. The Company estimates that the wash plant will be
operational in January 1998 and will be able to process approximately 80 tons of
clean fines per hour. If the wash plant operates at expected capacity, it will
provide sufficient quality feedstock to operate the Utah Plant at its capacity.
As stated above, and in accordance with the Supply and Purchase Agreement with
Coaltech, the Company will provide the washed coal fines at its cost, which will
equal the amount paid under the NEICO Fines Purchase agreement plus washing
costs.
At the time the Company commenced construction and operation of the
Utah Plant there were sufficient clean coal fines held by third parties in the
general area of the Utah Plant to provide sufficient clean feedstock for
operating the plant without a wash plant until the wash plant was completed.
However, the clean coal fines held by third parties were sold to other
purchasers leaving the Company with no clean coal fines source to service the
needs of the Utah Plant. Without sufficient quality feedstock, the Utah Plant
has, therefore, operated at well below its capacity, processing approximately
18,000 tons of synthetic fuel all of which had a relatively high level of ash
and most of which has not been sold. Accordingly, the Company incurred a loss on
the production of synthetic fuel product at the Utah Plant. See "ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION."
6
The Company has experienced problems with the marketing of the
synthetic fuel product manufactured at the Utah Plant site. The Company believes
that the marketing problem is principally due to the high ash content in the
product which resulted from the use of low quality coal fines. Most users of the
synthetic fuel product are not capable of handling a product with high levels of
ash. The Company expects that the marketing problems for the product will be
resolved once the quality of the coal fines used in the processing of the
product is improved. The Company believes this improvement will occur once the
wash plant is operational.
The Company can give no assurance that the Utah Plant will produce at
capacity once the Utah Plant and the wash plant are fully operational.
Furthermore, the Company can give no assurance that the finished product will be
commercially marketable.
License Agreements
In December 1996, the Company entered into agreements with various
third parties for the licensing of the Briquetting Technology. In order to
qualify for Section 29 treatment, the facilities that will be utilizing the
Briquetting Technology are required to be placed in service no later than June
30, 1998. While the Company may receive some advance license fees, the Company
does not expect to receive the majority of the licensing fees from such
agreements until after the facilities have been placed into operation.
Additionally, while the Company expects several facilities to be placed in
service prior to June 30, 1998, some of the licenses granted will likely not be
used since all of the facilities anticipated to use the licenses may not be
constructed by June 30, 1998. There is no assurance that the facilities licensed
to use the Briquetting Technology as described below will be in service by June
30, 1998.
PacifiCorp. In December 1996, PacifiCorp Syn Fuel, L.L.C.
("PacifiCorp") entered into binding agreements with a third-party contractor for
the construction of six facilities in addition to the Alabama Plant. Each
facility is designed to manufacture approximately 360,000 tons annually. The
Company entered into a license agreement with PacifiCorp for the use of the
Briquetting Technology at the six facilities subject to the construction
agreements. PacifiCorp subsequently announced the construction of three
facilities, with the construction of two single-line synthetic fuel processing
facility located in Walker County, Alabama and a single-line facility located
in Tuscaloosa County, Alabama. Under the terms of the license agreement,
PacifiCorp will owe $1,000,000 in advance license fees and will pay a quarterly
license fee at a prescribed amount (subject to annual adjustment for inflation)
times the Btu of product produced and sold during the quarter. The Company will
also provide binder at its cost plus a prescribed mark-up. In October 1997,
PacifiCorp determined that it was not going forward with the remaining three
facilities for which it entered into binding contracts in 1996.
The Company can give no assurance that PacifiCorp will ultimately
construct and qualify the three facilities under Section 29, that the licensing
fees will be received, nor can assurance be given that the facilities will
operate at the estimated capacity.
Gallagher. In December 1996, AJG Financial Services, Inc., a
wholly-owned subsidiary of Arthur J. Gallagher & Co. ("Gallagher"), entered into
binding contracts with a third-party contractor for the construction of four
facilities in addition to the Utah Plant. Each facility has an estimated
capacity of 360,000 tons annually. The Company entered into a license agreement
with Gallagher to utilize the Briquetting Technology at the four facilities.
Gallagher has indicated to the Company that it is developing the site for the
four facilities, has ordered the necessary equipment, and has otherwise
proceeded with the construction of the four facilities. Under the terms of the
license and other financing agreements with the Company, Gallagher will pay an
advance license fee in the amount of $500,000 for each facility, subject to
certain conditions, and will pay a prescribed amount of royalty each quarter
7
(subject to annual adjustment for inflation), based on the amount of Btu of the
product produced and sold during the quarter. The Company will supply binder to
the four facilities at an amount equal to cost plus an agreed upon mark-up.
The Company can give no assurance that Gallagher will ultimately
construct and qualify the four facilities under Section 29, that the licensing
fees will be received, nor can assurance be given that the facilities will
operate at the estimated capacity.
Pace Carbon Fuels, L.L.C. In December 1996, Pace Carbon Fuels, L.L.C.,
a joint venture between C.C. Pace Resources and Carbon Resources of Florida
("Pace"), entered into binding contracts with a third-party contractor for the
construction of four facilities, having an estimated annual production capacity
of approximately 600,000 tons per plant. In December 1996, the Company entered
into a license agreement with Pace for the use of the Briquetting Technology at
these facilities.
Pace has indicated to the Company that it is financing and developing
the projects through a limited partnership, Pace Carbon Synfuels Investors, L.P.
("LP"). Interests in the LP are being sold to third-party investors. The LP has
filed for and received a favorable PLR from the IRS. Three of the facilities are
anticipated to be constructed in West Virginia and one facility in Virginia.
Sale of interests in the LP are being conducted independently by Pace and its
agent to qualified investors. The Company has not participated in, facilitated
or otherwise been involved in any part of the offering of interests in the LP by
Pace.
Under the license agreements, the Company will receive an advance
license fee of $1.39 per ton of rated capacity payable upon completion of the
financing of the facilities, but in no event later than January 31, 1998. In
addition, the plants will generate quarterly royalty fees measured by the amount
of Btu of the project produced and sold times a prescribed license fee rate
(subject to annual adjustment for inflation). The Company will also provide
binder material at the Company's cost plus an agreed upon mark-up.
A licensee of the Company, CoBon Energy ("CE"), introduced Pace to the
Company. The Company entered into an agreement that provided that if CE did not
complete projects with capacity of 1,500,000 tons, some portion or all of the
royalties flowing from 500,000 tons of the Pace capacity would be payable to CE.
Given the projects currently under development by CE, it is likely that
royalties on 500,000 tons will be payable to CE. See "ITEM 1. BUSINESS--Business
of the Company--Joint Ventures--CoBon Energy".
The Company can give no assurance that Pace will ultimately construct
and qualify the four facilities, that the licensing fees will be received by the
Company, nor can any assurance be given that the facilities will operate at the
estimated capacities.
Savage Mojave Plant. In November 1996, the Company entered into an
agreement with Savage Industries ("Savage") whereby the Company agreed: (i) to
license the Briquetting Technology to a limited liability company, to be formed
by Savage and Flyash Haulers, Inc., for a monthly licensing fee based upon each
ton of qualified fuel produced, all relating to an upgraded briquetting facility
located in Laughlin, Nevada (the "Mojave Plant"); (ii) to provide binder
material on a cost plus basis; (iii) to provide, upon request, coal fines to the
Mojave Plant; (iv) to provide technical assistance to the Mojave Plant; and (v)
to reimburse to Savage, from the monthly license fees, an amount equal to 16% of
the cash capital required to upgrade the Mojave Plant. Savage filed for and
received a favorable PLR from the IRS with respect to this project. The plant
has an estimated annual capacity of 120,000 tons. Based on status reports by
Savage to the Company, the Company expects to receive monthly license fees
starting early 1998. No assurances can be made that Savage will be successful in
the production and sale of synthetic fuel. The agreement expires by its terms on
December 31, 2009.
8
Pelletco Corporation. In September 1997, the Company entered into a
license agreement with Pelletco Corporation ("Pelletco"), a special-purpose
entity affiliated with Palmer Capital Corporation and Logan Capital Company. The
license is for up to six synthetic fuel projects with estimated annual capacity
of 360,000 tons per plant. Pelletco had entered into binding construction
contracts for the six projects prior to December 31, 1996. Under the terms of
the license agreement, the net profits from the projects will be shared equally
by the Company and Pelletco. The Company will also provide binder material to
the projects at the Company's cost plus an agreed upon mark-up. The Company can
give no assurance that one or more of the plants will be constructed, that the
licensing fees will be received, or that any facility that is constructed will
operate at the estimated capacity.
Joint Ventures
Savage. In November 1996, the Company signed a primary contract with
Savage to form up to two limited liability companies ("LLCs") to be owned 50% by
Savage and 50% by the Company, with each LLC entering into a contract with
Savage, the Company and a qualified third-party contractor for the design,
construction, start-up and certification of a synthetic fuel facility. Under the
terms of the agreement, Savage was responsible for identifying and developing
the projects. However, these projects were not sufficiently developed in the
agreed upon time under the contracts. Accordingly, these projects are not
proceeding forward. The Company's share of liquidated damages for not building
the facilities is $205,000, payable in installments starting in November 1997
through June 1998, which liability has been recorded in the Company's financial
statements for the fiscal year ended September 30, 1997.
Ferro Resources. In December 1996, the Company together with Ferro
Resources, L.L.C. ("Ferro") as joint owners, entered into binding contracts with
a third-party contractor for the construction of two briquetting facilities with
a production capacity of 360,000 tons annually per plant. Under the terms of the
arrangement, Ferro was to develop the projects and the Company was to provide
the Briquetting Technology. The net proceeds of the projects were to be shared
equally by the Company and Ferro. In April 1997, the beneficial owner of Ferro,
Mr. Max E. Sorenson, joined the Company as an executive officer. See "ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS." Subsequent to the 1997 fiscal
year-end, the Company entered into discussions with Mr. Sorenson to purchase the
membership interests in Ferro for $10,000 plus a percentage of income from the
projects constructed under the Ferro/Company construction contracts. Under the
proposed terms of the agreement, Mr. Sorenson has the opportunity to receive up
to $1.5 Million over a period of up to ten years based upon performance factors
of the specified projects. The Company's purpose for entering into such an
agreement is to obtain all right, title and interest in the two Ferro/Company
construction contracts. Given the preliminary nature of the discussions with
Ferro, the terms described above may vary from the terms of the definitive
agreement, if consummated.
The Company is working with other parties in the financing and
developing of the projects that will be constructed under the Ferro/Company
contracts. If the facilities are not constructed, the Company is liable for
liquidated damages in the amount of 6% of the maximum contract price, or
approximately $636,000 in total. The Company can give no assurance that the
facilities will be constructed or that, if constructed, the facilities will
operate at estimated capacity.
CoBon Energy. On January 30, 1996, the Company entered into a letter of
understanding with CoBon Energy, L.L.C. ("CE"), a Utah professional services
company based in Salt Lake City, Utah, to form five entities to commercialize
and exploit the Briquetting Technology for the production of coal briquettes. In
August 1996, CE and the Company modified the letter of understanding. Under the
modified letter of understanding, the Company agreed to give CE a 1.6% interest
in AS #1, plus a license to use the Briquetting Technology for specified plant
locations up to an aggregate capacity of 1.5 million tons of synthetic fuel per
9
year. In consideration for the interest in AS #1 and the license, CE is required
to make a one-time payment of (i) $2.00 per ton for annual production of
synthetic fuel in the range of 500,001 to 1,000,000 tons and (ii) $2.50 per ton
for annual production in the range of 1,000,001 to 1,500,000 tons. The binder
material for these projects will be provided by the Company on a cost plus
basis.
In December 1996, CE introduced Pace to the Company. At that time, the
Company entered into an agreement with CE that provided that if CE did not
complete projects with aggregate annual capacity of 1,500,000 tons, some portion
or all of the royalties flowing from 500,000 tons of annual production of the
Pace projects would be payable to CE. Given the amount of estimated tonnage of
projects currently under development by CE, it is likely that the royalties
payable on 500,000 tons of capacity of Pace will be payable to CE.
In December 1996, CE entered into binding contracts for projects with
estimated annual capacity of at least 1.5 million tons in aggregate. CE has been
developing several different sites for the construction of briquetting
facilities. On November 14, 1997, the Company entered into an agreement with CE
to provide financing for the ordering of necessary equipment for a CE project
with an estimated annual production capacity of 680,000 tons and other services
in exchange for a percentage of the annual proceeds from such project.
Approximately $400,000 has been advanced by the Company under this financing.
The Company can give no assurance that any CE facilities will be constructed and
placed in service prior to June 30, 1998 or that any fees will be paid to the
Company pursuant to the agreement as described above.
Geneva Plant. In May 1995, the Company entered into a collaborative
agreement with Geneva Steel Company ("Geneva") to build and operate a commercial
iron revert briquetting plant in Vineyard, Utah (the "Geneva Plant"). That
agreement was amended and restated in May 1996. Currently, the Geneva Plant is
not operational and the Company is a tenant-at-will with respect to the
facility. The Company no longer expects the Geneva Plant to be used as an iron
revert briquetting facility at the Geneva site. In addition to its use as an
iron revert briquetter, the Company has also used the Geneva Plant in the
briquetting of coke breeze and synthetic fuel made from coal fines. In December
1996, the Company entered into a binding contract to install a dryer in the
Geneva Plant that would allow for the operation of the plant as a synthetic fuel
manufacturing facility. The Company plans to use the Geneva Plant for the
production of synthetic fuel, subject to the termination of the lease by Geneva.
No assurance can be given that the Geneva Plant will be operated as a qualified
synthetic fuel facility or that the Geneva Plant will be capable of operating
profitability either in the briquetting of synthetic fuel or iron revert.
Other Construction Agreements
In December 1996, in addition to the contracts previously described and
explained, the Company entered into eight design and construction agreements
(the "1996 Construction Agreements") for the design and construction of eight
new synthetic fuel facilities each having capacity of approximately 360,000 tons
per year. Depending upon the specific agreement, the contractor is either The
Industrial Company ("TIC"), CEntry Constructors, L.C. or Centerline Engineering
Corporation ("Centerline"), a Lockwood Greene Company. The 1996 Construction
Agreements, among other things, require that the plants be placed in service by
June 30, 1998. An advance payment of $250,000 is due at the time a notice to
proceed is issued by the Company (or its assignee). The 1996 Construction
Agreements may be terminated at the Company's option with a penalty of 6% of the
total contract price. If the Company is unsuccessful in obtaining financing or
otherwise fails to construct a facility, the 6% penalty would be owed to the
contractor.
AT Massey/Fluor Corporation. The Company has assigned two of the
construction contracts with Centerline to Appalachian Synfuel L.L.C.
("Appalachian"), a wholly-owned subsidiary of Fluor Corporation. The notice to
10
proceed has been issued on the two contracts. The facilities will be built as a
double-line solid synthetic fuel agglomeration facility to be located at A.T.
Massey Coal Company, Inc.'s ("AT Massey") Marfork Prep Plant Site in Boone
County, West Virginia. The double-line facility is expected to have an aggregate
annual capacity of approximately 720,000 tons. In conjunction with the
assignment of the two contracts, the Company entered into a license agreement
with Appalachian for the use of the Briquetting Technology. Under the agreement,
the Company will be paid an advance license fee of $1 Million, with $250,000
payable upon execution of the license agreement and the balance payable upon the
receipt by Appalachian of a PLR, if applied for, or upon the satisfaction of
certain conditions if the PLR is not applied for. A quarterly license fee will
also be paid at a prescribed amount (adjusted annually for inflation) for the
Btu of product that is produced and sold up to a prescribed amount of
production. The Company also granted to Appalachian the right to pay a lump sum
payment for the facilities, in lieu of quarterly license fees over the term of
the agreement. The Company will provide binder to the facility on a cost plus
basis. The agreement is subject to other conditions including the payment of
$300,000 to Appalachian if the facilities are not constructed. No assurance can
be given that Appalachian will construct and qualify the facilities for Section
29 treatment or that the plants will be operated at the estimated capacity.
Major Utility. The Company has entered into a non-binding letter of
interest to sell one synthetic fuel facility to Mountaineer Synfuel, L.L.C.
("Buyer"), a Delaware limited liability company and a wholly-owned subsidiary of
a major utility, and is in discussions regarding the sale of a second facility.
The agreement is subject to numerous conditions, including but not limited to,
the obtaining of a PLR from the IRS, the production of a product that meets
certain specifications, the obtaining of necessary permitting, and the securing
of coal fines sources. There is no assurance that the parties will reach an
agreement with respect to the sale of this facility. The Company has entered
into an interim construction financing agreement with this Buyer to finance up
to $1 Million for the Company's purchase of equipment and other project
development costs relating to other facilities described immediately above.
Approximately $560,000 has been advanced under this agreement with such advances
occurring after the Company's fiscal 1997 year end. The Company's obligation to
repay the amounts borrowed is secured by the collateral purchased with the
proceeds of the financing. Interest accrues on the amount advanced at a per
annum rate equal to the LIBOR rate plus 1% payable monthly commencing December
1, 1997. The principal amount of the financing is payable upon the closing of a
take-out construction loan or December 31, 1998, whichever occurs first. The
construction financing will be applied against the purchase of the facilities if
the Buyer elects to buy or will be repaid over time on terms and conditions to
be determined in a definitive construction financing agreement to be negotiated
by the parties. Under the terms of the non-binding letter of interest, the
Company will provide use of the Briquetting Technology and the Buyer, subject to
entering into a definitive agreement, will pay an advance license fee of $1
Million per plant upon completion of the plant and purchase by Buyer. The Buyer
will also pay a quarterly license fee determined by taking the product of a
prescribed amount (adjusted annually for inflation) times the Btu of the
synthetic fuel product produced and sold during the quarter. The Company will
also supply binder material to the project on a cost plus basis. With respect to
the additional site under discussion with the Buyer, which facility is commonly
referred to as Pocahontas Synfuel ("PS"), the Company has given notice to
proceed and has commenced construction. The plant is located in McDowell County,
West Virginia and is expected to have an annual capacity of 360,000 tons. In
addition to the synthetic fuel facility, a wash plant is also being built to
provide cleaned coal fines to the project. In the event no agreement is reached,
the Company will attempt to arrange alternative financing for the construction
of the facility or an alternative buyer.
If the facilities are not constructed, the Company will be subject to a
penalty in the amount of approximately $318,000 per plant. See ITEM 1.
BUSINESS--Business of Company--Other Construction Agreements-Construction
Penalties." The Company can give no assurance that the Buyer will elect to
purchase one or both of the facilities, that the facilities will be constructed
and qualified under Section 29 prior to June 30, 1998, or that the production of
11
the facilities will be at the estimated annual capacity. If the Company reaches
a definitive agreement regarding the sale of one or both synthetic fuel
facilities to the Buyer, the terms of such sale will be disclosed.
Other Construction Contracts. Four additional projects are being
developed by the Company with various other parties. Due to various conditions
and requirements, including but not limited to, securing the necessary
financing, required permits, adequate fines sources and end product users, there
can be no assurance given that these projects will be constructed so as to
qualify for Section 29 or that, if constructed, the facilities will operate at
the estimated capacity.
Construction Penalties. Each of the construction contracts provide for
a 6% penalty if the construction is not pursued by the Company. The Company has
accrued as a liability the 6% penalty (approximately $1,272,000) that would be
due if four of the facilities are not constructed under the construction
agreements as the Company believes that it is probable four facilities will not
be constructed.
Indemnification to Centerline. In December 1996, the Company entered
into six indemnification agreements with Centerline whereby the Company agreed
to indemnify Centerline should it be required to pay liquidated damages to
PacifiCorp under various design and construction agreements for six coal
agglomeration facilities. See "ITEM 1. BUSINESS--Business of Company--License
Agreements--PacifiCorp." Under the original terms of the various design and
construction agreements, if the facilities are not completed by June 1, 1998
then $750,000 in liquidated damages for each facility would be due and payable
by Centerline. The indemnification agreement only applies if PacifiCorp actually
decides to build the facilities with Centerline as the design/builder.
PacifiCorp has elected to not build three of the projects, and therefore the
indemnity agreement with respect to those facilities will not longer apply.
Accordingly, the maximum amount of contingent liability to the Company under the
indemnification agreements is $2,250,000 ($750,000 per design and construction
agreement).
Supply of Coal Fines
The Company uses coal fines to produce synthetic fuel briquettes.
Accordingly, supply of coal fines is essential to the feasibility of a synthetic
fuel briquetting facility. In selecting sites for briquetting plants, the
Company considers the availability of coal fines near the plant site and
attempts to secure sufficient coal fines to operate its plants at capacity. In
so doing, the Company generally attempts to contractually arrange for the
purchase of coal fines prior to the construction of briquetting facilities. In
addition, the Company may in certain instances be contractually obligated to
provide coal fines to the purchaser of a synthetic fuel facility.
K-Lee Supply Agreement. In September 1996, the Company entered into a
supply agreement with K-Lee Processing, Inc. and Concord Coal Recovery Limited
Partnership for a continuous supply of coal fines to the Alabama Plant. Under
this agreement, the Company is obligated to purchase a minimum of 20,000 tons of
coal fines per month through December 1, 2001, at a fixed price per ton during
the first year (subject to adjustment for moisture and ash content) with an
escalating price thereafter. This agreement will be assigned by the Company to
BSF at the closing of the sale of the Alabama Plant to BSF.
NEICO Fines Purchase. In February 1997, the Company entered into a
contractual arrangement with a non-affiliated party, Earthco, to acquire the
NEICO coal fines and to conduct recovery and preparation activities at a
location near Wellington, Utah (approximately six miles from the Utah Plant
site). The estimated quantity of clean coal fines at this site is 2 million
tons. Total obligations to acquire the fines are approximately $5,500,000
between February 1997 and May 2002, of which $750,000 was paid upon execution of
the agreement. During the fiscal year, the Company made an additional payment of
approximately $396,000. Other than relatively minor amounts used in start-up
12
production at the Utah Plant, these fines are available for future production.
Accordingly, the Company has accounted for the payments made to date as advance
payments for inventory. The Company will reflect in inventory the cost for such
fines as they are processed into clean coal fines.
Black Diamond Enterprises Agreement. In May 1997, the Company entered
into an arrangement with Black Diamond Enterprises, Inc. ("BDE") for the
purchase of coal fines in McDowell County, West Virginia. The fines will require
washing and will service the feedstock needs of the synthetic fuel facility that
is being constructed near Northfork, West Virginia, under the name Pocahontas
Synfuel. See ITEM 1. BUSINESS--Business of the Company--Other Construction
Agreements--Major Utility." The agreement provides that BDE will supply washed
coal fines with certain specifications at a prescribed price which includes a
percentage of the net proceeds received by the Company from the project. The
agreement also gives BDE certain rights to market the synthetic fuel produced at
the site.
Other Contracts
Port Hodder. In September 1996, the Company entered into a purchase
agreement with E. J. Hodder and Associates, Inc. for the purchase of a certain
land leasehold interest and equipment consisting of a barge loading facility
servicing the Warrior River located at the Alabama Plant. The total purchase
price for the facility is $927,000 consisting of $342,000 in cash and $585,000
of Company common stock. The land lease commenced on September 1, 1996 and
expires, with extensions, on May 23, 2006. The Company intends to use the
facility in connection with the operations of the Alabama Plant.
Alabama Power Company. In April 1996, the Company entered into a sale
and purchase agreement for coal with Alabama Power Company. Due to delays
associated with the financing and construction of the Alabama Plant, the Company
was unable to perform under the contract and in February 1997 terminated the
contract in a letter to Alabama Power Company. While Alabama Power Company has
not expressly agreed to the termination, it has not indicated any intent to take
actions against the Company as a result of the termination, nor does the Company
believe any action will be taken as a result of the termination.
AGTC. In accordance with an April 1996 letter agreement between the
Company and AGTC, a partnership formed by AGTC, Inc., Alpine Coal Company, Inc.
and E. J. Hodder & Associates, Inc., AGTC was engaged by the Company on a best
efforts basis, to investigate, identify and participate in the selection of (i)
project sites for the construction of suitable coal extrusion manufacturing
facilities for the Company, (ii) suitable coal fines reserves and (iii) suitable
users or consumers of the coal product produced. The compensation for such
services consisted of a monthly retainer of $35,000 and a commission. In the
fourth month following the execution of the letter agreement a dispute arose
among the parties regarding AGTC's performance and compensation due under the
agreement. Accordingly, the Company terminated the agreement pursuant to its
terms. AGTC subsequently claimed that it was entitled to a commission on the
proposed sale of the Alabama Plant. The Company, based on the advice of counsel,
believes that AGTC's claim has no merit.
Briquetting Technology
The Company has developed a special binding formula, which allows for
the production of high-grade briquettes which withstand degradation both during
shipment and the burn cycle. In simplified terms, in the briquetting process,
the material to be briquetted may be washed to remove impurities. The material
is then mixed with binding agents and fed into a briquetter, pelletizer or
extruder which utilizes pressure to combine the feed material into a briquette
having the desired shape, size and density. Briquettes are then dried to achieve
maximum strength. Cured briquettes are expelled onto a continuous belt for
handling and storage.
13
Substantially all the equipment and machinery used in the briquetting
process are commercially available. The Company has arrangements with certain
manufacturers for the supply of certain equipment and machinery to be included
in synthetic fuel facilities currently under construction or that it plans to
construct by June 30, 1998. However, there can be no assurance that the Company
will be able to acquire all necessary equipment and machinery on terms
acceptable to the Company in sufficient time to complete and place in service
the synthetic fuel facilities.
Proprietary Protection
The Company has received four current United States patents and has one
United States patent application pending and two international patent
applications pending under the Patent Cooperation Treaty covering certain
aspects of the Briquetting Technology. There can be no assurance as to the scope
of protection afforded by the patents. Moreover, there are other industrial
waste recycling technologies in use and others may subsequently be developed,
which do (or will) not utilize processes covered by the patents or pending
patents. There can be no assurance that any patent issued will not be infringed
or challenged by other parties, infringe against patents held by other parties
or that the Company will have the resources to enforce any proprietary
protection afforded by the patent or defend against an infringement claim.
In addition to patent protection, the Company also relies on trade
secrets and know-how and employs various methods to protect the Briquetting
Technology. However, such methods may not afford complete protection and there
can be no assurance that others will not independently develop such know-how or
obtain access to the Company's know-how, concepts, ideas and documentation.
Since the Company's proprietary information is important to its business,
failure to protect its trade secrets may have a material adverse effect on the
Company.
Coke and Revert Material Briquettes
The Company will seek to enter into collaborative arrangements with
steel and coke producers to build, equip and operate briquetting plants on-site
at the producers' facilities. The Company believes that such arrangements will
benefit both the Company and steel and coke producers because they will: (i)
provide the Company with an ongoing supply of inexpensive coke breeze and revert
materials while ensuring a ready customer for the briquettes produced; (ii)
provide the steel or coke producer with an economical means to dispose of waste
materials while providing a ready source of briquettes and/or iron feedstock;
and (iii) minimize transportation costs for waste by-products, raw materials and
briquettes, thereby increasing the economic competitiveness of the Company's
products. There is no assurance that such arrangements will be profitable or
that the Company will be able to enter into arrangements with steel and coke
producers or to obtain the funding necessary to construct such plants.
Greystone Joint Venture. In June 1995, the Company entered into a
license agreement (the "Greystone Joint Venture Agreement") with Greystone
Environmental Technologies, Inc. ("Greystone") to form a 50/50 joint venture
(the "Greystone Joint Venture") to commercialize and exploit the Briquetting
Technology for the production of coke and revert material briquettes. The
Greystone Joint Venture has an exclusive world-wide license to commercialize and
exploit the Briquetting Technology for the production of coke briquettes and a
license to commercialize and exploit the Briquetting Technology for the
production of revert material briquettes in the Alabama and Gary, Indiana
regions.
In accordance with the Greystone Joint Venture Agreement, Greystone
made an initial payment of $100,000 to the Company, and was required to make
additional payments out of profits or capital of the Greystone Joint Venture
until a total aggregate of $500,000 had been paid to the Company for the
license. Greystone has failed to make the additional payments required under the
14
Greystone Joint Venture Agreement and, accordingly, has received notice from the
Company that an event of default has occurred thereunder. The Company believes
that an uncured event of default under the Greystone Joint Venture Agreement
results in a termination of the license. However, Greystone has indicated that
it believes the Greystone Joint Venture Agreement is still in effect. The
Company currently has no coke or revert briquetting operations and expects to
resolve this issue before any significant operations are begun.
Research and Development
The Company has devoted significant research and development efforts to
the refinement and commercialization of the Briquetting Technology. The
Company's research and development expenses were approximately $1,265,000,
$1,044,000 and $663,935 for years ended September 30, 1995, 1996 and 1997,
respectively. The Company at the present time is focusing its research and
development efforts principally upon its synthetic fuel binder with the intent
of enhancing the binding and other characteristics of the binder and/or to
further reduce binding process costs. The Company is also developing other
related technologies that could be implemented in steel mills and other mineral
industries.
Construction and Limestone Businesses
In order to generate cash flow to support research and development for
the Briquetting Technology, in 1993 the Company acquired IME, State and CIC,
three construction companies engaged in providing contracting and construction
services to heavy industry. In addition to the foregoing, in 1994 the Company
acquired Larson, which provides limestone products for industrial applications.
(These companies are collectively referred to as the "Construction Companies.")
In September 1995, the Company made a strategic decision to focus its
efforts exclusively on commercializing the Briquetting Technology and to divest
itself of the Construction Companies. On February 1, 1996, the Company entered
into a Stock Purchase Agreement (the "Agreement") with Michael McEwan and Gerald
Larsen ("Buyers"), former principals of the Construction Companies, to sell all
of the common shares of the Construction Companies to the Buyers for a
$5,000,000 face value 6% promissory note (the "Note"). Mr. McEwan is the son of
Lloyd C. McEwan, a former director of the Company. The Buyers subsequently
raised various contentions regarding the original Note and the Agreement. During
the past fiscal year, the Company has negotiated and has agreed to certain
modifications to the original terms of the sale of the Construction Companies.
Under the modified agreement, the interest on the Note is waived through January
31, 1998. Thereafter, annual payments of $514,814 are to be made January 31,
1999 through January 31, 2004. A final payment in the amount of $3,711,701 is
due January 31, 2005. The Note is guaranteed by the Buyers and is collateralized
with 130,000 shares of the Company's common stock and 50,000 options to purchase
the Company's common stock with a strike price of $1.50 per share. The Company
retains responsibility for certain retirement payments to a prior construction
company officer and certain lease obligations relating to the Construction
Companies. In satisfaction of payments made on behalf of the Construction
Companies by the Buyers that were attributable to the period prior to the
effective date of the sale, the Company transferred ownership of its office
building, subject to related debt, to the Buyers. See "ITEM 2. PROPERTIES."
15
Government Regulation
The Company's present and proposed briquetting operations are subject
to federal, state and local environmental regulations that impose limitations on
the discharge of pollutants into the air and water and establish standards for
the treatment, storage and disposal of waste products. In order to establish and
operate its briquetting plants, the Company will be required to obtain various
state and local permits. The Company has obtained all permits required to date,
believes that it will be able to obtain future permits without inordinate
difficulty or expense and that it is in substantial compliance with all material
laws and regulations governing the briquetting operations. The Company believes
that environmental compliance for new briquetting plants will not entail
significant costs. However, the Company's briquetting operations may entail risk
of environmental damage and the Company may incur liabilities in the future
arising from the discharge of pollutants into the environment or its waste
disposal practices.
Failure to obtain necessary permits to construct and operate
briquetting plants could have a material adverse effect on the Company. Other
developments, such as the enactment of more stringent environmental laws and
regulations, could require the Company to incur significant capital
expenditures. If the Company does not have the financial resources or is
otherwise unable to comply with such laws and regulations, such failure could
also have a material adverse effect on the Company.
The Company's construction and limestone products businesses were also
governed by extensive environmental and occupational safety laws and
regulations. The Company believes that it was in substantial compliance with all
such material laws and regulations while it owned the Construction Companies.
There can be no assurance that failure to comply with applicable laws and
regulations, whether in existence or subsequently enacted, would not have a
material adverse effect on the Company.
Tax Credits
Section 29 of the Code provides a credit (the "Section 29 Credit")
against the regular federal income tax, measured by unrelated party sales by a
taxpayer of qualified fuels, including solid synthetic fuel produced in the
United States from coal, the production of which is attributable to the
taxpayer. Where more than one person has an interest in a qualified facility,
the Section 29 Credits generated by the facility are allocated pursuant to the
proportional interests of such persons in the facility.
In order to be a solid synthetic fuel produced from coal for purposes
of the Section 29 Credit, the produced fuel must differ significantly in
chemical composition, as opposed to physical composition, from the alternative
substance used to produce it. The Company has received a PLR from the IRS in
which the IRS, based on representations made to it by the Company, agrees that
the Briquetting Technology results in a significant chemical change to coal
fines and transforms them into a solid synthetic fuel, and accordingly the IRS
concludes, based on the facts presented to it, that: (i) the Company, with the
use of its patented process, produces a "qualified fuel" within the meaning of
Section 29(c)(1)(C) of the Code; and (ii) assuming the other requirements of
Section 29 are met, the sale of the "qualified fuel" will entitle the Company to
claim the Section 29 Credit in the taxable year of sale. In its ruling, the IRS
noted that no temporary or final regulations pertaining to one or more of the
issues addressed in the PLR have been adopted and that the PLR will be modified
or revoked by the adoption of temporary or final regulations to the extent the
regulations are inconsistent with any conclusions in the PLR. The IRS notes,
however, that a PLR is not revoked or modified retroactively, except in rare and
unusual circumstances, provided certain criteria are satisfied, including that
(i) there has been no misstatement or omission of material facts, (ii) the facts
at the time of the transaction are not materially different from the facts on
which the PLR was based, (iii) there has been no change in the applicable law,
(iv) the PLR was originally issued for a proposed transaction and (v) the
16
taxpayer directly involved in the PLR acted in good faith in relying on the PLR,
and revoking the PLR retroactively would be to the taxpayer's detriment. The
Company received its PLR in September 1995. At least three other similar PLRs
have been obtained by third parties in connection with licenses of the Company's
technology. However, all PLRs are only binding with respect to the specific
projects addressed in the PLR and may only be relied on by the party that has
obtained the PLR.
The Section 29 Credit is subject to the passive activity rules of
Section 469, and therefore may not be available to individuals and closely held
corporations.
The Section 29 Credit is equal to $3.00 in 1979 dollars (or $5.95 in
1996 dollars) for each oil barrel equivalent ("OBE") of the qualifying fuel
produced and sold. This equates to approximately $20.00-$28.00 per ton of
synthetic fuel briquettes. The OBE is defined generally as an amount of fuel
having a 5.8 million Btu content. The Section 29 Credit allowed may not exceed
the taxpayer's regular tax liability reduced by certain other credits. The
credit cannot be utilized to offset the Alternative Minimum Tax.
The Section 29 Credit was designed to provide protection for qualifying
fuels against market price declines, and it is therefore subject to a phaseout
(under an annually adjusted formula) after the unregulated oil price reaches
specified levels. In 1996 dollars, the credit would have phased out had the
reference price for oil exceeded $46.62 per barrel, but the reference price
determined for 1996 was $18.46 and no phaseout occurred. There presently is no
reference price for 1997. The credit is also subject to reduction insofar as an
otherwise qualifying facility benefits from grants or subsidized financing
provided by federal, state or local governments, or from tax-exempt bond
financing.
Section 29 of the Code contains no provision for carryback or
carryforward of Section 29 Credits. Once earned, however, the credits are not
subject to subsequent recapture. By virtue of the various limitations and other
factors described above, there can be no assurances that any particular amount
of Section 29 Credit will be allowable and usable.
During 1996, certain of the time periods applicable to the Section 29
Credit were extended. The Section 29 Credit will, under present law, be
available for sales of qualified fuels completed by December 31, 2007 to the
extent attributable to production from facilities placed in service by June 30,
1998, provided that such facilities are constructed pursuant to a binding
written contract in effect by December 31, 1996.
On February 6, 1997, the Treasury Department released the General
Explanations of the Administration's Revenue Proposals, which summarized the tax
related provisions from the President's Fiscal Year 1998 Budget submission to
Congress (the "Federal Budget"). The initial version of the Federal Budget
proposed that the placed-in-service date be changed to June 30, 1997 for
facilities constructed under binding contracts entered into on or before
December 31, 1996. On August 5, 1997, President Clinton signed the Taxpayer
Relief Act of 1997 (the "Act"). The Act did not include the proposed change to
Section 29. Hence, the June 30, 1998 deadline for placing in service synthetic
fuel plants remains intact.
Competition
The Company may experience substantial competition from other
alternative fuel technology companies, as well as companies that specialize in
the disposal and recycling of waste products generated by steel, coal and coke
production. Many of these companies have greater financial, technical,
management and other resources than does the Company. The Company believes that
key factors in its ability to compete will be the quality of its briquettes and
17
their pricing compared to other sources of coal, coke and scrap iron. The
Company anticipates that it will be able to compete effectively although there
can be no assurance that it will do so successfully.
Employees
The Company currently employs approximately 40 persons full-time.
Approximately 17 of such persons are in corporate administration, and 23 are in
briquetting operations, including research, development and marketing. None of
such employees are covered by a collective bargaining agreement. In connection
with the establishment and operation of a briquetting plant where the Company
retains responsibility for the operations, the Company will seek to hire between
eight to ten persons per plant.
Confidentiality Provisions
As part of its business, the Company typically enters into agreements
concerning its projects which contain confidentiality provisions. The Company
is, on occasion, required to disclose such agreements to the Securities and
Exchange Commission as part of its ongoing reporting requirements under the
Securities Exchange Act of 1934, as amended. Moreover, disclosure of such
agreements may be required in connection with the Company's private placement of
securities. Notably, some of the agreements do not contain the standard
exceptions for the disclosure of information which is required to be disclosed
under law. Accordingly, no assurances can be given that the Company has not
inadvertently disclosed information regarding its various projects in violation
of confidentiality covenants entered into by the Company.
Forward Looking Statements
Statements regarding the Company's expectations as to the financing,
development and construction of facilities utilizing its Briquetting Technology,
the receipt of licensing fees and other information presented in this Annual
Report on Form 10-K that are not purely historical by nature, including those
statements regarding the Company's future business plans, the construction and
estimated completion of facilities, the estimated capacity of facilities, the
availability of coal fines, the marketability of the synthetic fuel and other
briquettes and the financial viability of the proposed facilities, constitute
forward looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Although the Company believes that its
expectations are based on reasonable assumptions within the bounds of its
knowledge of its business and operations, there can be no assurance that actual
results will not differ materially from its expectations. In addition to matters
affecting the Company's industry or the coal industry or the economy generally,
factors which could cause actual results to differ from expectations set forth
in the above-identified forward looking statements include, but is not limited
to, the following:
(i) The commercial success of the Briquetting Technology.
(ii) Procurement of necessary equipment to place facilities into
operation.
(iii) Securing of necessary sites, including permits and raw
materials, for facilities to be constructed and operated.
(iv) Timely construction and completion of facilities, and in
particular, the coal briquetting facilities by the
placed-in-service date.
(v) Ability to obtain needed additional capital on terms
acceptable to the Company.
(vi) Changes in governmental regulation or failure to comply with
existing regulation which may result in operational shutdowns
of its facilities.
(vii) The availability of tax credits under Section 29 of the Code.
(viii) The commercial feasibility of the Briquetting Technology upon
the expiration of Section 29 tax credits.
18
(ix) Ability to meet financial commitments under existing contractual
arrangements.
ITEM 2. PROPERTIES
The Company leases an approximately 5,000 square-foot building in Lehi,
Utah, which houses its executive offices ("Corporate Headquarters"). The Company
previously owned its Corporate Headquarters. However, in August 1997, the
Company sold its Corporate Headquarters to Michael L. McEwan and Gerald M.
Larson ("Buyers") and entered into a triple-net lease with Buyers, dated August
1, 1997 (the "Headquarters Lease"). The Headquarters Lease provides for a
monthly rent of $5,000 during the initial term which expires on July 31, 2000.
Thereafter, the Lease will automatically extend indefinitely for successive
one-year periods at the sole option of the Company, and the monthly rent will
increase by 5% per year. The Corporate Headquarters were transferred to Buyers
as part of the settlement and closing between the Company and the Buyers for the
sale of the Construction Companies. See "ITEM 1. BUSINESS--Construction and
Limestone Businesses."
In October 1997, the Company purchased an 8,000 square-foot site
located in Price, Utah, on which the Company's prototype briquetting plant is
located, for $150,000. Included in the purchase was a 1,400 square-foot office
building which houses equipment. The property is subject to a 10-year $100,000
mortgage held by the seller. The equity in the property was pledged as part of
the collateral for a $2.9 Million loan to the Company from Gallagher. See "ITEM
7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS--Liquidity and Capital Resources--Existing Debt Arrangements."
In May 1995, the Company entered into a lease with Geneva Steel Company
for a 9,000 square foot building in Vineyard, Utah as part of the Geneva
Agreements described in "ITEM 1. BUSINESS--Business of Company--Joint
Ventures--Geneva Plant." The Company pays no cash rent on these facilities. The
purpose of the lease is to allow the Company to apply the Briquetting Technology
to Geneva's coke breeze and iron revert materials. Subsequent to the execution
of the Geneva Agreements, the lease with Geneva expired resulting in a
tenancy-at-will between the parties. The Company intends to use the Geneva
briquetting facility in the manufacture of synthetic fuel at the Geneva site or
some other location. See "ITEM 1. BUSINESS--Business of Company--Joint
Ventures--Geneva Plant."
As part of the acquisition of the Port Hodder facility, the Company
entered into a land lease for the Alabama Plant of approximately 15.45 acres
with a non-affiliated party for an annual rental of $1. See "ITEM 1.
BUSINESS--Business of the Company--Other Contracts--Port Hodder." The Alabama
Purchase Agreement provides for the assignment of this property to PacifiCorp as
part of the sale of the Alabama Plant. See "ITEM 1. BUSINESS--Business of the
Company--Alabama Plant."
In June 1996, the Company entered into a land lease of approximately 12
acres in Price, Utah with a non-affiliated party at a monthly rental of $600.
The land is the site on which the Utah Plant was constructed. The lease term
commenced on June 20, 1996 and expires on December 31, 2007 but may be extended.
See "ITEM 1. BUSINESS--Business of the Company--Utah Plant." In October 1996,
the Company commenced construction on the land of a 22,000 square-foot building
to house the Utah Plant. In March 1997, this building was leased by the Company
to Coaltech as part of the sale of the Utah Plant. However, the Company retained
responsibility for operations of the property pursuant to an Operations and
Maintenance Agreement between the Company and Coaltech. The Company has
constructed two ancillary buildings to the Utah Plant, a 1,650 square-foot
binder plant and a 3,400 square-foot wash plant. If the Company elects to
construct a second line at the Utah Plant location, Coaltech has the option to
acquire the second line. In addition, the option includes the purchase of other
equipment and the building housing the Utah Plant. See "ITEM
1.BUSINESS--Business of the Company--Utah Plant."
19
In February 1997, the Company purchased the NEICO coal fines containing
approximately 2 million tons of coal fines from a non-affiliated party, Earthco.
The fines are located at a site approximately six miles from the Utah Plant. In
conjunction with the coal fines purchase, Earthco granted to the Company a lease
of the property whereon the fines are located. The leased property consists of
two parcels, consisting of approximately 30 acres and 357 acres respectively.
Under the terms of the agreement, the Company will pay $5,500,000 for the fines
with further adjustments if fines in excess of the estimated amount are
recovered. The Company has the option to purchase the property under lease
subject to certain conditions. See "ITEM 1. BUSINESS--Business of
Company--Supply of Coal Fines--NEICO Fines Purchase."
ITEM 3. LEGAL PROCEEDINGS
On June 5, 1997, Brandt Filtration Group, Inc. ("Brandt") filed a
complaint against the Company in the State Court for Gwinnett County, State of
Georgia. The plaintiff also named Pacific Power & Light Company ("Pacific") as a
defendant. The plaintiff sought $160,340 plus other unspecified damages and
legal expenses. The complaint alleges that the Company breached a contract to
purchase air filtration equipment for the Alabama Plant from Brandt and further
alleges that the Company acted as agent for Pacific. Pacific removed the action
to the United States District Court for the Northern District of Georgia (Civil
Action No. 1:97-CV-2018). On September 15, 1997, Brandt and the Company entered
into a settlement agreement whereby the Company agreed to pay an aggregate of
$156,964 ($122,111 plus cancellation charges of $34,253) and Brandt agreed to
dismiss all of its claims in the lawsuit with prejudice.
On June 26, 1997, Kirby Cochran, former President of the Company during
the period from September 1995 through May 1996, filed a complaint against the
Company in the Fourth Judicial District for Utah County, State of Utah (Civil
No. 970400507). The complaint alleged that Mr. Cochran was entitled to a
declaratory judgment awarding him options to purchase 600,000 shares of the
Company's stock and $50,000 as repayment of a purported loan. The complaint
further alleged claims of conversion, fraud, and breach of contract related to
the stock options and loan. Finally, the complaint alleged a claim for punitive
damages and other unspecified special or general damages. The Company filed a
petition to remove the action to the United States District Court for the
District of Utah (Civil No. 2:97CV0587G). On November 13, 1997, the parties
entered into a Settlement Agreement whereby Kirby Cochran agreed to release the
Company from all claims made by the lawsuit in exchange for payment on the
purported loan of $50,000.
In January 1996, a manager of the Company entered property owned by
NEICO, a subsidiary of Nevada Power Corporation, in connection with an offer by
the Company to purchase the property, and with certain other employees of the
Company, removed and contained over a two-day period some asbestos. The manager
allegedly failed to follow federal guidelines governing the handling and removal
of asbestos. This action was reported to the Division of Environmental Quality
for the State of Utah. An investigation followed in which the Company was fined
approximately $11,000 and was required by the State of Utah to properly dispose
of the asbestos using a qualified asbestos removal company. In the fall of 1997,
the Environmental Protection Agency began a review of the case and is currently
looking into the advisability of further claims or fines against the manager
and/or against the Company.
The Company entered into a letter of intent with Innovative
Technologies ("Innovative") in July of 1995 to apply the Company's Briquetting
Technology to certain metallic ores supplied by Innovative. The Company
conducted numerous tests of the ore through the fall of 1995, and concluded from
the results that the venture was not economically viable. Accordingly, final
agreement to process the ore was never reached. On March 4, 1997, Innovative
Holding Company, Inc., a California corporation, and ORO Limited, a California
limited partnership, filed a civil complaint against the Company alleging breach
of the letter of intent in the amount of $500,000 plus damages. The complaint
20
was filed in the Superior Court of California, County of Orange (Case No.
776083). The Company intends to defend the suit.
On January 30, 1997, S.C. Marketing, Inc., a California corporation,
filed a civil complaint against the Company alleging breach of contract in the
amount of $137,440 plus damages. The complaint was filed in the Superior Court
of California, County of Orange (Case No. 774760). On March 26, 1997, the
Company entered into a settlement agreement with S.C. Marketing, Inc. whereby it
issued 20,913 shares of Company common stock in payment of a previously accrued
liability in settlement of the complaint.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
The shares of common stock of the Company are listed for trading on the
OTC Bulletin Board under the symbol "CVOL."
On October 29, 1997, the Company submitted an Application for Initial
Inclusion on the Nasdaq National Market System. While the Company believes it
meets the quantitative requirements for inclusion on the Nasdaq National Market
System, the Company does not know what, if any, qualitative requirements may be
applied by Nasdaq and there is no assurance that the Company's application will
be granted by Nasdaq.
The following table sets forth, for the periods presented, the high and
low bid quotations for the common stock as reported by National Quotation
Bureau, Inc. during the three most recent calendar years. The quotations do not
reflect adjustments for retail mark-ups, mark-downs or commissions and may not
necessarily represent actual transactions. Since the Company has several market
makers, the bid prices among the different market makers will generally vary.
Accordingly, the bid price may not be representative of actual trades. The
following prices may not be considered valid indications of market value due to
the limited and sporadic trading in the shares of common stock.
21
Low Bid High Bid
Calendar 1995
First Quarter $ 1.25 $ 3.75
Second Quarter $ 1.25 $ 3.875
Third Quarter $ 3.00 $ 7.50
Fourth Quarter $ 5.00 $21.25
Calendar 1996
First Quarter $18.00 $31.50
Second Quarter $ 9.50 $22.25
Third Quarter $ 6.50 $10.75
Fourth Quarter $ 7.50 $14.375
Calendar 1997
First Quarter $ 7.875 $15.75
Second Quarter $ 6.75 $ 8.875
Third Quarter $ 6.25 $10.125
Fourth Quarter(*) $ 8.875 $13.625
---------------
(*) Through December 15, 1997
Effective June 14, 1995, the Company implemented a one-for-twenty
reverse stock split. The Company implemented a two-for-one forward stock split
effective January 23, 1996. The bid prices set forth above have been adjusted to
reflect the effect of the stock splits.
As of December 15, 1997, there were 673 record holders of the Company's
outstanding shares of common stock.
The Company has not paid dividends to date and does not intend to pay
dividends in the foreseeable future. The Company intends to retain earnings, if
any, to finance the development and expansion of its business. Payment of
dividends in the future will depend, among other things, upon the Company's
ability to generate earnings, its need for capital and its overall financial
condition.
Recent Sales of Unregistered Securities
The following sets forth all securities issued by the Company within
the past fiscal year without registering the securities under the Securities Act
of 1933, as amended. No underwriters were involved in any stock issuances nor
were any commissions or similar fees paid in connection therewith. However, the
Company did pay finders fees in the form of cash, stock or warrants in
connection with various securities issuances.
The issuance of qualified options is required to be based on market
value. Accordingly, the exercise price is set based on the market price of the
Company's common stock, even though the options convert into restricted stock.
The Company believes that the following issuances of shares of common
stock, notes, debentures and other securities were exempt from the registration
22
requirements of the Securities Act of 1933, as amended, pursuant to the
exemption set forth in Section 4(2) thereof and the certificate for each
security bears a restricted legend.
In October 1996, the Company issued 80,000 shares of common stock at a
price of $7.00 per share to an accredited investor. Also in October 1996,
sharesof common stock was issued to an accredited investor at a price of $8.00
per share, shown as to be issued in 1996.
In November 1996, the Company issued convertible subordinated
debentures in the principal amounts of $300,000, $200,000 and $500,000 to Mr.
Douglas M. Kinney, Mr. Gordon L. Deane and the Douglas M. Kinney 1999 Retained
Annuity Trust, respectively. The convertible subordinated debentures accrue
interest at prime plus two percent (2%) with interest and principal payable in
full on June 30, 1998. All or a portion of the unpaid principal due on the
debenture is convertible into Company common stock at $11 per share. Through a
separate subscription agreement, the Company has granted piggy-back registration
rights to the investors for Company common stock issued upon conversion of the
convertible subordinated debentures. The Company has the right to prepay the
principal of the convertible subordinated debentures. The above-listed investors
have represented to the Company that they are "accredited investors" as defined
under Rule 501 of the Securities Act of 1933, as amended.
In December 1996, the Company entered into a Debenture Agreement and
Security Agreement with AJG Financial Services, Inc., an affiliate of A.J.
Gallagher & Co. ("Gallagher"), whereby the Company borrowed $1,100,000, and
could, under certain circumstances, draw down an additional amount of up to
$2,900,000 (for a total borrowed amount of $4,000,000). In consideration for the
loan of $1,100,000, the Company issued a convertible subordinated debenture
accruing interest at 6% per annum and maturing three years from its date of
issuance (the "Subordinated Debenture"). On May 5, 1997, Gallagher converted the
Subordinated Debenture and the Company issued 140,642 shares of common stock to
Gallagher in exchange for the entire $1,100,000 Subordinated Debenture and
accrued interest based on a conversion price of $8.00 per share. The Company has
granted piggy-back and demand registration rights to Gallagher for the Company
common stock issued upon conversion of the Subordinated Debenture.
On December 13, 1996, the Company granted options to acquire 2,500
shares to each of Raymond J. Weller and DeLance W. Squire, each a Director of
the Company, as director compensation. The exercise price is $1.50 per share.
The Company also granted 20,000 options to an employee at an exercise price of
$1.50 per share. Compensation recognized or deferred from these agreements to
total 256,250.
In early fiscal year 1997, the Company issued senior debentures (the
"Senior Debentures") to Gallagher in the aggregate principal amount of
$2,900,000 pursuant to the above-referenced Debenture Agreement and Security
Agreement. The Senior Debentures accrue interest at prime plus two percent (2%)
and mature three years from the date of issuance. The Senior Debentures are
collateralized by all real and personal property purchased by the Company with
the proceeds of the Senior Debentures. The proceeds of the Subordinated
Debenture and the Senior Debentures may be used to satisfy contractual
obligations of the Company, for working capital and to purchase equipment to be
used to construct synthetic fuel facilities to be managed and/or sold by the
Company or affiliates of the Company.
On January 1, 1997, the Company granted 50,000 stock options, valued as
deferred compensation of $562,500, to Stanley M. Kimball, an executive of the
Company, at an exercise price of $1.50 per share. The options vest over a
two-year period starting January 1, 1997 and ending December 31, 1998.
On January 2, 1997, 25,000 shares of common stock were issued for
$47,500, which consisted of 3,000 shares of common stock issued to an employee
of the Company in exercise of options at $1.50, 10,000 shares of common stock
issued to an accredited investor in exercise of options at $2.50 and 12,000
shares of common stock issued to an existing stockholder in exercise of warrants
at $1.50.
23
On January 13, 1997, the Company issued 100,000 shares of common stock
to a former executive of the Company in exercise of options at $1.50 per share.
The consideration was paid partly in cash and partly in offset of amounts owing
to the individual by the Company.
On or about January 27, 1997, the Company agreed to and on June 6,
1997, the Company issued 40,330 shares to certain principals of RAS Securities
Corp., each accredited investors, valued at $8.50 per share in settlement of
their claim totaling $342,765.
On February 21, 1997 and March 6, 1997, the Company issued 1,905 and
2,929 shares of common stock, respectively, to a consultant in exchange for
consulting services valued at a total amount of $40,500.
On March 24, 1997, the Company issued 60,000 shares of common stock,
previously shown to be issued, to an accredited investor in a private placement
in connection with the purchase of property for the Alabama Plant. The Company
was given a credit of $585,000 for the purchase of the property in exchange for
the 60,000 shares.
As described in "ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS--Liquidity and Capital Resources,"
on March 20, 1997, the Company executed and delivered a promissory note in the
aggregate principal amount of up to $5,000,000 to PacifiCorp in consideration
for a loan of up to $5,000,000. The loan is convertible into approximately
714,286 shares of common stock of the Company based on a $7.00 per share
conversion price. In December 1997, the amount of the note was increased to
$7,000,000 and PacifiCorp was granted the right to convert the greater of (i)
$6,000,000 of the loan and loan commitment or (ii) the actual loan balance
outstanding, to common stock at a price of $7.00 per share, subject to
adjustment.
As described in "ITEM 1. BUSINESS--Business of Company--Alabama Plant,"
on March 20, 1997, the Company executed and delivered a conditional option
agreement to PacifiCorp relating to the repurchase of their interest in
Birmingham Syn Fuel, L.L.C. and the loan made by PacifiCorp.
On March 26, 1997, the Company issued 20,913 shares of Company common
stock, valued at $138,396, recorded as a liability in 1996, in settlement of
litigation with S.C. Marketing, Inc., which the Company believes is an
accredited investor.
On April 1, 1997, the Company granted 50,000 stock options to Max
E. Sorenson, an executive of the Company, which was recorded as deferred
compensation and valued at $312,500. The exercise price is $1.50 per share for
50,000 options. The Company also issued 20,000 stock options to an employee at
an exercise price of $8.00 together with 10,000 additional stock options that
were later forfeited. In addition another employee received 5,000 stock options
with an exercised price of $1.50 per share valued at $31,250.
On April 1, 1997, the Company granted 2,500 stock options, valued at
$15,625, to Vern T. May, a Director of the Company, as director compensation.
The exercise price is $1.50 per share.
On April 15, 1997, the Company granted incentive stock options to
acquire 180,000 shares, at an exercise price of $8.25 per share, to 9 employees
of the Company.
On May 6, 1997, the Company received funds and accepted subscriptions
for the sale of 12,499 units (the "Units"), from three accredited investors.
Each Unit consisted of (i) four shares of Company common stock and (ii) four
warrants to acquire Company common stock at a price of $7.25 per share, for a
total purchase price per Unit of $24.00, or a total of $299,976. The warrants
are exercisable at any time prior to the second anniversary of their issuance.
The shares of Company common stock issuable under the warrants have piggy-back
registration rights during the two-year period following the date of the
subscriptions.
24
On May 19, 1997, the Company received $90,000 in the exercise of
options to purchase 50,000 shares of common stock at $1.80 per share, by two
accredited investors.
On July 3, 1997, the Company received funds and accepted subscriptions
for the sale of 14,285 units (the "Units") from an accredited investor. Each
Unit consisted of (i) one share of Company common stock, and (ii) one warrant to
acquire one share of Company common stock at a price of $8.00 per share for a
total purchase price per Unit of $7.00, or a total of $99,995. The warrants are
exercisable at any time prior to the second anniversary of their issuance.
On August 1, 1997, the Company granted 100,000 stock options to Dee J.
Priano, an executive officer of the Company, at an exercise price of $8.25 per
share.
On August 19, 1997, the Company privately sold 3,000 units (the
"Units") to an accredited investor for an aggregate purchase price of
$3,000,000. Each Unit consisted of (i) one share of the Company's Series A 6%
Convertible Preferred Stock, par value $.001 per share (the "Series A Preferred
Stock"), and (ii) a warrant to acquire 28.571 shares of Company common stock at
a price of $8.00 per share. The purchase price for each Unit was $1,000. The
warrants are exercisable at any time on or before August 31, 1999. The Series A
Preferred Stock sold as part of a Unit was issued pursuant to the terms of a
Certificate of Designation filed with the Delaware Secretary of State (the
"Series A Certificate of Designation"). Under the Series A Certificate of
Designation, the Series A Preferred Stock (i) accrues dividends on a daily basis
at a rate of 6% per annum on the liquidation value ($1,000) of each share from
the date of issuance until paid or converted (with no compounding of dividends
being authorized), payable semi-annually in the discretion of the Company, (ii)
is redeemable by the Company at any time after 30 days' written notice, (iii)
has no voting rights unless specifically authorized by the Delaware General
Corporate Law, (iv) is convertible at any time by the holder into common stock
at a conversion price of $7.00 per share, and (v) is convertible by the Company
at any time after August 31, 1999 after 30 days' written notice. Further, the
Series A Certificate of Designation provides for certain anti-dilution
protection to the holder of the Series A Preferred Stock if (i) certain
dividends are distributed on the common stock, (ii) a subdivision, combination
or reclassification of the outstanding common stock occurs or (iii) a
reorganization event (such as a consolidation, merger, sale of substantially all
assets or a statutory exchange) occurs. Similar anti-dilution protection was
also granted to the shares of common stock issuable under the warrants. The
Units were privately placed pursuant to the terms of a Preferred Stock Purchase
Agreement, dated August 19, 1997 (the "Purchase Agreement"), between the Company
and the accredited investor. Under the Purchase Agreement, the Company agreed
(i) to use its best efforts to create a vacancy on the Company's Board of
Directors for a term to expire on the date of the next annual meeting of the
stockholders of the Company, (ii) to submit to the Board of Directors, for their
consideration, the appointment of a representative of the accredited investor to
fill the vacancy referred to in clause (i) above, (iii) to demand registration
rights for any person owning at least 50% of the common stock issued or issuable
upon conversion of the Series A Preferred Stock and exercise of the warrants
(such shares are referred to herein as "Converted Shares") at any time prior to
August 31, 1998 subject to the rights of any other holder of common stock
previously granted demand registration rights, and (iv) to piggy-back
registration rights for the Converted Shares.
On September 16, 1997, the Company issued 10,000 shares of Company
common stock to a former employee, Mr. Dean Young, in exercise of options at
$1.50 per share. The consideration was paid in offset of amounts owing to the
individual by the Company. Mr. Young is a relative of Kenneth M. Young, the
Company's former Chief Executive Officer and Chairman of the Board.
25
On September 17, 1997, the Company issued 43,167 shares of Company
common stock, valued at $388,503, to United Group, Inc., and Robinson & Wisbaum,
Inc., both of which the Company believes are accredited investors, in settlement
of a contract dispute regarding consulting services.
As of September 18, 1997, the Company privately sold 104,294 units (the
"Units") to three accredited investors for an aggregate purchase price of
approximately $2,200,000. Each Unit consisted of (i) three shares of the
Company's Series B Convertible Preferred Stock, par value $.001 per share (the
"Series B Preferred Stock"), and (ii) a warrant to acquire one share of Company
common stock, at a price of $8.00 per share. The purchase price for each Unit
was $21.00. The warrants are exercisable at any time on or before September 30,
1999. The Series B Preferred Stock sold as part of a Unit was issued pursuant to
the terms of a Certificate of Designation filed with the Delaware Secretary of
State (the "Series B Certificate of Designation"). Under the Series B
Certificate of Designation, the Series B Preferred Stock (i) accrues dividends
on a daily basis at a rate equal to the 2-year treasury bond rate plus one and
one-half percent (initially 7.29% per annum but subject to a one-time adjustment
on March 18, 1998) on the liquidation value of each share from the date of
issuance until paid or converted (with no compounding of dividends being
authorized) payable semi-annually in the discretion of the Company, (ii) is
redeemable by the Company at any time after 30 days' written notice at the
liquidation value plus accrued and unpaid dividends, (iii) has no voting rights
unless specifically authorized by the Delaware General Corporate Law, (iv) is
convertible by the Company at any time after September 30, 1998 at a conversion
price of $7.00 per share. The Units were privately placed pursuant to
subscription agreements between the Company and the accredited investors. In
connection with the sale of the Series B Preferred Stock, the Company issued, as
a finders fee to two accredited investors, warrants to acquire an aggregate of
62,576 shares of the Company's common stock at a price of $8.00 per share at any
time prior to September 30, 1999.
As of September 30, 1997 and October 13, 1997, the Company accepted
subscriptions from 49 accredited investors for the purchase of 119,557 units
(the "Units") pursuant to a Confidential Private Placement Memorandum, dated
August 28, 1997 (the "Memorandum"), at a price of $35.00 per Unit with an
aggregate purchase price of approximately $4,200,000. Each Unit consisted of
five shares of common stock of the Company together with a warrant to purchase
one additional share of common stock. The exercise price of the warrant is $8.00
per share and the warrant must be exercised by April 30, 1998. Pursuant to the
terms of the Memorandum, the Company has granted to purchasers of the Units
piggyback registration rights on the shares of common stock underlying the Units
and the shares of common stock which have or may become issuable from the
exercise of the warrants. In connection with the sale of the Units under the
Memorandum, the Company has agreed to issue to three accredited investors finder
fees in the form of warrants to acquire an aggregate of up to 199,262 shares of
the Company's common stock at a purchase price of $8.00 per share at any time
prior to October 31, 1999. As of September 30, 1997, 350,00 shares had been
issued and 462,285 share are shown as to be issued.
In September 1997, the Company granted options to acquire 2,500 shares
to James A. Herickhoff, a Director of the Company, as director compensation. The
exercise price is $9.00 per share.
In October 1997, the Company granted options to acquire 2,500 shares
to John P. Hill, Jr., a Director of the Company, as director compensation. The
exercise price is $11.50 per share.
On November 25, 1997, the Company issued 1,500 shares of Company common
stock to an accredited investor in exercise of warrants at $8.00 per share. The
consideration was paid in cash. The warrants were originally issued with units
privately placed on September 30, 1997 and October 13, 1997.
26
On December 8, 1997, the Company issued 1,500 shares of Company common
stock to an accredited investor in exercise of warrants at $8.00 per share. The
consideration was paid in cash. The warrants were originally issued with units
privately placed on September 30, 1997 and October 13, 1997.
The Company believes that the following issuances of shares of common
stock and other securities were exempt from the registration requirements of the
Securities Act of 1933, as amended, pursuant to the exemption set forth under
Regulation S thereof:
On May 26, 1997 and July 7, 1997, and in reliance on Regulation S, the
Company received funds and accepted subscriptions for the sale of 224,000 units
and 60,000 units, respectively (the "Units"), from accredited non-U.S. persons
(the "Non-U.S. Persons"). Each Unit consisted of (i) one share of Company common
stock, and (ii) a warrant to acquire one share of Company common stock at a
price of $7.25 per share, for a total purchase price per Unit of $6.00, or a
total of $1,704,000. The warrants are exercisable at any time prior to the
second anniversary of their issuance. The shares of Company common stock
issuable under the warrants and the Finder Warrants (as defined below) have
piggy-back registration rights and conditional demand registration rights. The
conditional demand registration rights are triggered if within twelve months
from the date of subscription, the Securities and Exchange Commission imposes an
additional holding period requirement on securities issued under Regulation S,
other than the holding period restrictions currently in effect. Two Australian
entities acted as finders in the sale to the Non-U.S. Persons. As compensation
to the finders, the Company paid a cash fee of five percent of the proceeds of
such offerings to one finder and issued warrants (the "Finder Warrants") to the
other accredited investor finder to purchase 71,000 shares of Company common
stock at a price of $7.25 per share. The Finder Warrants are exercisable at any
time prior to the second anniversary of their issuance. Based upon
representations made to the Company, the finder receiving warrant was a Non-U.S.
Person and the Finder Warrants were issued in reliance on Regulation S.
ITEM 6. SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
The following table sets forth the Company's selected historical
consolidated financial data as of and for the year ended December 31, 1993, the
nine months ended September 30, 1994 and the years ended September 30, 1995
through 1997. The selected historical consolidated financial data as of and for
the year ended December 31, 1993, the nine months ended September 30, 1994 and
as of September 30, 1995 are derived from audited financial statements not
included elsewhere herein. The selected historical consolidated financial data
for the year ended December 31, 1995, and as of and for the years ended
September 30, 1996 and 1997 were derived from the financial statements of the
Company which have been audited by Coopers & Lybrand, L.L.P. included elsewhere
herein. This information should be read in conjunction with the consolidated
financial statements and notes thereto.
27
COVOL TECHNOLOGIES, INC.
(FORMERLY ENVIRONMENTAL TECHNOLOGIES GROUP INTERNATIONAL)
AND SUBSIDIARIES
Nine
Year Ended Months Ended Year Ended Year Ended Year Ended
December 31, September 30, September 30, September 30, September 30,
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1993 1994