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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 1998,
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission file number 0-27803
COVOL TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 87-0547337
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
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:
Common Stock, $.001 par value
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 as of December 17, 1998 was $59,671,125 based upon the closing
price on the Nasdaq National Market(R) reported for such date. This calculation
does not reflect a determination that persons whose shares are excluded from the
computation are affiliates for any other purpose.
The number of shares outstanding of the registrant's common stock as of
December 17, 1998 was 12,494,029.
---------------------------
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following document are incorporated herein by reference:
Portions of the registrant's definitive proxy statement to be issued in
connection with registrant's annual stockholders' meeting to be held in 1999.
TABLE OF CONTENTS
Page
PART I
ITEM 1. BUSINESS...................................................... 3
ITEM 2. PROPERTIES.................................................... 18
ITEM 3. LEGAL PROCEEDINGS............................................. 19
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........... 20
EXECUTIVE OFFICERS OF THE REGISTRANT.......................... 20
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS........................................... 23
ITEM 6. SELECTED FINANCIAL DATA....................................... 25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS..................................... 26
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK..... 32
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................... 32
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE............................32
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............ 32
ITEM 11. EXECUTIVE COMPENSATION........................................ 32
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.................................................... 32
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................ 32
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K................................................... 33
SIGNATURES.............................................................. 42
Forward-Looking Statements
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. Registrant undertakes no obligation to revise or
publicly release the results of any revision to these forward looking
statements. Readers are cautioned not to place undue reliance on these forward
looking statements, which reflect management's opinion only as of the date
hereof.
2
PART I
ITEM 1. BUSINESS
The Company
Covol Technologies Inc. is a technology development company focused on
"Recycling Yesterday's Waste into Tomorrow's Resources."(TM)
Company History
Covol was originally incorporated in Nevada in 1987 under the name
Cynsulo, Inc. Subsequently, the company acquired all of the issued and
outstanding shares of McParkland Corporation and changed its name to McParkland
Properties, Inc. The purchase of McParkland was rescinded in February 1989, and
the company's name was changed to Riverbed Enterprises, Inc. In 1991, the
company acquired technology consisting of binding agents used to make
briquettes. From 1991 to 1995 the company focused on the research and
development of binding agents principally for iron, coal and coke waste
particles. The company's name was changed to Enviro-Fuels Technology in 1991, to
Environmental Technologies Group International in 1994, and to Covol
Technologies, Inc. in 1995, at which time the company was reincorporated in
Delaware.
In 1995, management of Covol recognized the applicability of its
technology to the production of synthetic fuel. Since 1996, the primary focus of
Covol has been on developing and commercializing the synthetic fuel technology.
Background
As a result of efforts by government and business to balance
environmental concerns with the needs of business and recognize the need to
efficiently use diminishing resources, the recycling industry has developed and
pursued many endeavors to recycle, recover and/or enhance the usefulness of
wastes and by-products. Covol has developed a family of binder technologies used
to form fine materials from wastes and by-products into briquettes to capture
their inherent resource value.
Coal mines, ferrous and non-ferrous metals producers, and other
industries produce waste and other by-products. Cost-effective processes have
not been implemented generally to capture and use many such wastes, despite
their potential usefulness and potential value. Storage and disposal of many of
these by-products is costly and can be environmentally harmful. Covol's binder
technologies are designed to enable the conversion of by-products from the coal
and metals industries into valuable fuels and resources. Covol's primary focus
over the past two years has been the commercialization of the application of its
binder technologies to coal fines.
Covol's binder technologies are being used to transform coal fines into
a usable fuel. Coal fines are small particles of coal produced as a waste
by-product of coal production. Coal fines can be found throughout coal producing
regions of the United States and the world. A recent study of the coal industry
estimated that there are more than 2 billion tons of coal fines residing in
waste ponds and landfills in the United States alone. Millions of tons are added
to this amount each year. Although coal fines have inherent fuel value, they
present recovery and handling challenges that make it difficult to capture that
value. Covol's binder technologies molecularly bond the coal fines into a formed
fuel. Because this process is accomplished through a significant chemical
reaction, the resulting product has been classified as a "synthetic fuel" within
the meaning of Section 29 of the U.S. Internal Revenue Code. Sales of the fuel
therefore qualify for a significant tax credit. The resulting fuel is more
easily handled and transported than are coal fines. The composition of the
resulting fuel varies in its potential heat, ash and sulfur content and other
characteristics, depending primarily upon the composition of the coal fines used
as feedstock, and secondarily on the processing of the feedstock. The possible
end markets for the resulting synthetic fuel are as diverse as the markets for
coal. Different end users have different requirements for fuel type and quality,
3
whether the fuel be synthetic or coal. The application of Covol's binder
technologies can be customized to address the specific needs of prospective
customers.
The Covol binder technologies can also be used to transform coke dust
into formed coke. Coke, which is processed metallurgical coal, is primarily used
in the iron making process as a reducing agent and also as an economical fuel
source. Coke dust, also known as "coke breeze," is a fine residue by-product
resulting from the production, handling and storage of coke and is marketable in
its "dust" state because of its high carbon and energy content. In tests, Covol
has succeeded in aggregating coke dust into hard briquettes designed to
withstand the weight, heat and other environmental factors inside of metal
making furnaces, which appear potentially marketable at prices above briquette
production costs.
The Covol binder technologies can also be used to convert iron rich
wastes into usable iron. Mill scale, bag-house dust, furnace sludge, blast
furnace dust and other iron rich materials, are all waste by-products created by
steel producers. These by-products present environmental problems for the steel
industry. Because of their high iron content, they also have high potential
value. Approximately 775 million tons of finished steel are consumed annually in
the world with the U.S. producing approximately 100 million tons. The capture of
even a fraction of the waste and other by-products of this steel production in
the U.S. alone could provide millions of tons of feedstock material for
processing. On a test basis, the Covol binder technologies have been
demonstrated to be capable of producing briquettes from such steel production
wastes. Such briquettes can be further processed in metal reducing furnaces to
form high grade pig iron, a common form of feed material used in the steel
industry.
Additional fuel or resource by-products to which the Covol binder
technologies appear applicable after initial testing include: molybdenum,
silicon carbide, grinding swarf, lead dross, zinc oxide, titanium dioxide,
phosphorous, and charcoal. Briquettes containing these by-products appear
potentially marketable to ferrous and non-ferrous metals producers and to other
industrial consumers.
Except for synthetic fuel production, the Covol binder technologies
listed above have not been commercially applied. No assurance can be given that
Covol will be able to implement these applications profitably.
Covol Binder Technologies
The Covol binder technologies are designed to aggregate and process
wastes and other by-products that are in a fine particulate state into usable
fuels and resources in the form of briquettes, pellets or extrusions. These
technologies also provide a way to "engineer" fuels or resources with
value-added qualities, such as moisture reduction, elimination or neutralization
of pollutants such as sulfur dioxide and nitric oxide, improvement of handling
strength, reduction of impurities, and formation into uniform shapes and sizes
to maximize efficiencies in combustion or in processing. The resulting products
manufactured using the Covol binder technologies are broadly categorized as
"engineered fuels" and "engineered resources" and can be marketed to utilities,
ferrous and nonferrous metal producers, and other major industrial users.
The Covol binder technologies chemically bond together fines, sludge,
and dust such as coal fines, iron production wastes and coke dust that up to now
have been considered by-products and waste materials. The process, in simplified
terms, mixes the resource-rich wastes or other by-products with a chemical
formula. The mixed materials are conveyed into a briquetter, a pelletizer or an
extruder which utilizes pressure together with a chemical reaction to bond and
shape the materials into the desired size and density required for the specific
application. The materials may be processed further to meet specific market
requirements.
Covol has licensed its technology to other parties to produce and sell
the products manufactured with the Covol binder technologies. Covol has
contracted with Dow Chemical Company to produce chemical binder materials for
the production of synthetic fuel made from coal fines. Substantially all of the
equipment and machinery used for producing synthetic fuel is considered standard
or "off-the-shelf" and is commercially available both domestically and
internationally.
4
Covol has been issued seven U.S. patents and four foreign patents and
has other U.S. and foreign patents pending. The patented technology principally
relates to the application of Covol's binder technologies to iron production
wastes, coke, coal and other carbon based materials. Covol is in the process of
expanding the existing patents and applying for new patents related to waste
recovery applications. See "ITEM 1. BUSINESS - Proprietary Protection" for a
discussion of Covol's patents, trademarks and other intellectual property.
Business Strategy
The Covol binder technologies represent the foundation for Covol's
business strategy. Covol believes that its success depends upon its ability to
engineer industrial wastes and other by-products into value-added fuels and
resources. Covol has divided its strategy into four general approaches:
engineered fuels, engineered resources, licensing and technology transfers and
strategic acquisitions.
Engineered Fuels. Engineered fuels include fuels recovered or enhanced
primarily from carbon based materials. The Covol binder technologies provides a
use for fuel-rich wastes and by-products by aggregating them into a solid form
for improved handling and processing, and by making such modifications as may be
required for a given application of the resulting fuel, for example, reduced
moisture, increased hardness or enhanced energy content. Covol's engineered
fuels include the production of fuel from briquetted coal fines, coke dust and
silicon carbide.
For the past two years Covol's business strategy has been focused
almost exclusively upon synthetic fuel from coal fines. There are currently 24
synthetic fuel facilities located in 8 states that are utilizing Covol's
synthetic fuel technology. Twenty of the facilities are owned by unaffiliated
third parties and four are currently owned by Covol. Two of the four facilities
owned by Covol are under options to sell to licensees that would be expected to
pay royalties to Covol. Covol does not expect one of the options to be
exercised. Covol is actively pursuing the sale of the four facilities. Covol
intends to sell all or part of each facility that Covol owns. Covol has no
current ability to use the potential tax benefits that Covol's facilities can
produce.
Most of the synthetic fuel facilities were initially placed into
operation in the second calendar quarter of 1998 and Covol and its licensees are
currently in the process of ramping up production and entering into contracts
for product sales. Covol is working with its licensees to secure coal fines
feedstock, improve production and refine its chemical formulas. Covol and its
licensees are also negotiating sales and marketing contracts for the synthetic
fuel. Several of the owners of facilities are building or contemplating building
wash plants to wash the coal fines which are then processed into synthetic fuel.
Feedstock supply, production and product quality and the marketing of the
synthetic fuel all directly affect the amount and timing of royalties to be
received by Covol from the synthetic fuel facilities. Accordingly, assisting
licensees to optimize the production from these facilities is currently Covol's
highest priority.
Covol has received one-time advance license fees with respect to most
of the synthetic fuel facilities. In the future, most of the revenues related to
such facilities are expected to come from royalties that are tied to production
and sale of synthetic fuel pursuant to licensing agreements in place. Covol also
expects to generate net revenues from the sale of binder materials to the
facilities.
Covol believes that the Covol binder technologies may also be applied
profitably without the benefit of a tax credit. There are millions of tons of
coal fines in the U.S. and internationally that could be washed and briquetted,
and, in the opinion of Covol, sold at a reasonable profit above the fines
purchase and processing costs. Additionally, the Covol binder technologies are
well-adapted to the processing of "ultra fines," the face powder sized coal
fines created in preparing coal for industrial use. Ultra fines can be recovered
by equipping coal preparation facilities with modern float cell technology.
These ultra fines have historically been slurried into waste ponds and,
depending upon the preparation facility, might constitute as much as 10% of the
processed coal. The Covol binder technologies allow for the recovery of such
fines by removing the high levels of moisture they contain and forming them into
a solid product that can be handled and sold. Finally, there are certain coals
with high inherent moisture levels, such as Powder River Basin coals. The
processing of these coals with the Covol binder technologies may reduce the
moisture levels, thus increasing heat content, improving combustion
efficiencies, and
5
reducing transportation costs because of the reduced weight. Covol intends to
aggressively pursue these and other similar synthetic fuel applications.
Another engineered fuel application Covol is pursuing is coke. Coke is
processed metallurgical coal which serves as both a fuel and a reducing agent in
iron and steel making. The production and handling of coke produces fine
particles of coke dust. The aggregation of coke dust into briquettes that are
designed to withstand the rigors of handling, heat and weight in metal making
furnaces results in a useable fuel. Covol has patented technology and is in the
process of patenting additional technology related to coke dust processing.
Covol has acquired property where coke and coke dust has been landfilled. Covol
intends to recover this coke and to briquette a portion of it for use as a fuel
as described above.
Silicon carbide is a product manufactured from a blend of carbon based
materials and high silica sand. In addition to its principle use in the
abrasives industry, silicon carbide is also used as an alloy and a high-quality
fuel in specialized metal making applications. This application is covered under
existing and applied-for patents. Covol has not yet applied the aggregation of
silicon carbide in a full-scale operation.
Engineered Resources. Steel mills, nonferrous metal producers and other
mineral industries produce wastes and other by-products that may contain
valuable unrecovered resources. These wastes often create environmental
compliance, storage and disposal problems. The Covol binder technologies provide
a way to solve disposal problems, extract the inherent resources, process the
materials with current industrial methods, and enhance the materials with
qualities that add value and that customize the materials for alternative uses.
The resulting products are collectively referred to as "engineered resources."
Covol has not yet commercially applied the Covol binder technologies in
engineered resources. However, Covol has devoted significant research and
development resources to improving and perfecting its technology for these
applications, particularly in the processing of iron production wastes.
During the steel-making process, steel mills produce, among other waste
by-products, small particles of iron-rich materials. The Covol binder
technologies are able to bind such particles into briquettes which can be
further processed in reducing furnaces to reclaim the iron and other materials.
Covol believes that products produced from such wastes could be marketed at
prices which are competitive with other sources of iron and that this technology
will be attractive in addressing the environmental issues surrounding the
disposal of waste by-products generated in the steel making process.
Covol will seek to enter into collaborative arrangements with steel and
iron producers to build, equip and operate briquetting and processing plants at
the producers' facilities. Covol believes that such arrangements will benefit
both Covol and the metal producers because they will:
o provide Covol with an ongoing supply of inexpensive iron tailing
materials while ensuring a ready customer for the briquettes produced;
o provide the steel producer with an economical means to dispose of waste
materials while providing a ready source of briquettes and/or iron
feedstock; and
o minimize transportation costs for waste by-products, raw materials and
briquettes, thereby increasing the economic competitiveness of Covol's
products.
Covol has developed and tested its technologies with other fine
particulate wastes and other by-products, including: molybdenum, titanium
dioxide, grinding swarf, lead dross, zinc oxide and phosphorous. Covol intends
to continue to evaluate these and other engineered resource applications.
Licensing and Technology Transfer. Covol believes that the Covol binder
technologies include valuable intangible properties in the form of patents,
processes, formulations and know-how. Covol intends to devote significant human
and capital resources in the continued development and refinement of various
applications of these technologies. Covol hopes to augment its own efforts with
technical support from major suppliers of binding
6
materials. Covol has entered into licensing agreements with third parties for
the use of its synthetic fuel technology. Covol intends to actively pursue
additional licensing, joint venture and other collaborative arrangements with
coal, coke, ferrous and non-ferrous metals producers and other resource
producers to utilize Covol's technologies in recycling, recovering or enhancing
fuels and resources from wastes and other by-products, both domestically and
worldwide.
Strategic Acquisitions. Covol believes that it has a unique opportunity
to pursue acquisitions that are synergistic with Covol's financial and
environmental objectives and initiatives. The Covol binder technologies may be
applied to waste streams that are otherwise of little or no value. Covol intends
to pursue possible acquisitions of businesses aligned to the industries in which
the Covol binder technologies may be applied.
Covol intends to broaden its position in the synthetic fuel industry
and other resource industries through the acquisition or licensing of
technologies that are complementary to the Covol binder technologies.
Subsidiaries
Covol has organized various special purpose entities to facilitate some
of the transactions relating to the 24 synthetic fuel facilities. The entities
are listed with Covol's position and interest in the entity as of December 31,
1998 described as follows:
o Alabama Synfuel #1 Ltd., a Delaware limited partnership of which Covol
serves as general partner and owns 98%
o Utah Synfuel #1 Ltd., a Delaware limited partnership of which Covol
serves as general partner and owns 100%
o Flat Ridge Corporation, a Utah corporation, a wholly-owned subsidiary
of Covol
o Commonwealth Synfuel, L.L.C., a Utah limited liability company of which
Covol is managing member and owns 100%
The following chart illustrates Covol's corporate structure. Covol's
ownership of each subsidiary is 100% unless otherwise indicated.
[CHART OMITTED DESCRIBED AS FOLLOWS]
[Chart with box centered containing the word "Covol." A line is drawn proceeding
down from that box which divides into four branches, each of which terminates in
one of four boxes, all aligned horizontally, labeled respectively as follows:
o Alabama Synfuel #1 Ltd. (98% owned)
o Utah Synfuel #1 Ltd.
o Flat Ridge Corporation
o Commonwealth Synfuel, L.L.C.]
Tax Credits
Section 29 of the U.S. Internal Revenue Code provides a credit against
regular federal income tax with respect to sales of qualified fuel to an
unrelated party. 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.
7
In order to qualify as a solid synthetic fuel produced from coal for
purposes of the Section 29 credit, the fuel produced must differ significantly
in chemical composition, as opposed to physical composition, from the raw
material used to produce it. Covol has received a Private Letter Ruling, or PLR,
from the IRS in which the IRS, based on representations made to it by Covol,
ruled that the synthetic fuel technology produces a significant chemical change
compared to coal fines and this qualifies the end product as a solid synthetic
fuel. Accordingly the IRS has ruled, based on the facts presented to it, that:
o Covol, with the use of its patented process, produces a "qualified
fuel" within the meaning of Section 29 of the tax code; and
o assuming the other requirements of Section 29 are met, the sale of the
"qualified fuel" will entitle Covol 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 would 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 that:
o there has been no misstatement or omission of material facts,
o the facts at the time of the transaction are not materially different
from the facts on which the PLR was based,
o there has been no change in the applicable law,
o the PLR was originally issued for a proposed transaction and
o the 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.
Covol received its PLR in September 1995. At least six other PLRs
covering twelve of the synthetic fuel facilities have been obtained by third
parties in connection with licenses of Covol's synthetic fuel 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 approximately $6.10 in 1997 dollars
for each oil barrel equivalent of the qualifying fuel produced and sold. This
equates to approximately $20.00-$28.00 per ton of synthetic fuel briquettes,
depending upon the recoverable heat content. The oil barrel equivalent is
defined generally as an amount of fuel having a recoverable heat content of 5.8
million Btu's. 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 phase out
after the unregulated oil price reaches specified levels under an annually
adjusted formula. In 1997 dollars, the credit would have phased out had the
reference price for oil exceeded $47.78 per barrel, but the reference price
determined for 1997 was $18.92 and no phase out occurred. There presently is no
reference price for 1998. However, the average price of oil in the U.S. was
lower in 1998 than 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.
8
Section 29 of the tax code contains no provision for carryback or
carryforward of Section 29 credits. Once earned, 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 before January 1, 2008. The
qualified fuels sold must be produced at facilities placed in service by June
30, 1998. The synthetic fuel facilities must have been constructed pursuant to a
binding written contract in effect as of December 31, 1996.
Synthetic Fuel Manufacturing Facilities
The following table represents a summary of the 24 synthetic fuel
manufacturing facilities constructed and placed in operation before June 30,
1998 by Covol and its licensees.
SYNTHETIC FUEL MANUFACTURING FACILITIES
No. of Annual Rated
Name of Facility Plants1 Location Owner/Licensee2 Operator Capacity (tons)3
---------------- ------- -------- --------------- -------- ----------------
Utah Synfuel #1 1 Price, Utah Coaltech No. 1 Company 360,000
L.P.4
Carbon Synfuel 1 Price, Utah Company5 Company 360,000
Mohave Synfuels 1 Laughlin, Savage Industries Flyash Haulers, 280,000
Nevada Inc. Inc.
Birmingport 1 Mulga, Birmingham Syn Birmingham Syn 360,000
Alabama Fuel, L.L.C.7 Fuel, L.L.C.
Brookwood 1 Brookwood, PacifiCorp Syn PacifiCorp Syn 360,000
Alabama Fuel, L.L.C8 Fuel, L.L.C.
Pumpkin Center 2 Flat Creek, PacifiCorp Syn PacifiCorp Syn 720,000
#1 & #2 Alabama Fuel, L.L.C. Fuel, L.L.C.
Norton 1 Norton, PC Virginia Constellation 600,000
Virginia Synthetic Fuel #1,
L.L.C.
Chelyan 1 Chelyan, West PC West Virginia Constellation 600,000
Virginia Synthetic Fuel #1,
L.L.C.
Muddlety 1 Muddlety, West PC West Virginia Constellation 600,000
Virginia Synthetic Fuel #2,
L.L.C.
Eckman 1 Eckman, West PC West Virginia Constellation 600,000
Virginia Synthetic Fuel #3,
L.L.C.
Appalachian 2 Peccus, West Appalachian AT Massey 720,000
Synfuel Virginia Synfuel, L.L.C.
Mountaineer 1 Tallmansville, Company6 Savage 360,000
Synfuel West Virginia Industries Inc.
Pocahontas 1 North Fork, Company Company 360,000
Synfuel West Virginia
9
Ginger Hill 1 Ginger Hill, Ginger Hill Maple Creek 300,000
Pennsylvania Synfuels, L.L.C. Mining
Robena 1 Paisley, Robena, L.L.C. Consolidation 580,000
Pennsylvania Coal
Commonwealth 1 Karthaus, Company River Hill Coal 360,000
Synfuel Pennsylvania
Pennsylvania 1 Somerset, Somerset Fuels, Somerset Fuels, 600,000
Synfuel Project Pennsylvania L.L.C. L.L.C.
USA Coal, #1, 4 Pawnee, Illinois A.J.G. Financial USA Coal 1,440,000
#2, #3, & #4 Services, Inc.
Pleasant Ridge 1 Alledonia, Ohio Pleasant Ridge Ohio Valley 340,000
--- ----------
Synfuels, L.L.C. Coal
Total 24 9,900,000
==== =========
1 A plant is a finished synthetic fuel manufacturing facility constructed
pursuant to a binding construction agreement entered into on or before
December 31, 1996.
2 Most owners/licensees are special purpose entities owned by one or more
other companies.
3 This is an amount as engineered and determined by equipment manufacturers.
Most facilities are not yet operating at rated capacity. There is no
assurance that the facilities will operate at rated capacity in the future.
4 Coaltech No. 1 L.P. consists of AJG Financial Services, Inc., a
wholly-owned subsidiary of Arthur J. Gallagher & Co., and Square D Company,
a wholly-owned subsidiary of Groupe Schneider, as limited partners, and
Covol as 1% general partner. Covol has entered into an operating agreement
with Coaltech to operate the Utah Synfuel #1 facility.
5 Covol granted Coaltech an option to purchase the facility, but does not
expect the option to be exercised.
6 Covol granted Mountaineer Synfuel, L.L.C. an option to purchase the
facility, which option expires in January 1999. The purchase option
transaction for the Mountaineer facility provides that Covol is the
managing member of Mountaineer Synfuel, L.L.C.
7 Birmingham Syn Fuel, L.L.C. is an affiliate of PacifiCorp Financial
Services, Inc.
8 PacifiCorp Syn Fuel, L.L.C. is an affiliate of PacifiCorp Financial
Services, Inc.
Covol Contracts. Consistent with the requirements for obtaining Section 29
tax credits, in December 1996 Covol entered into fourteen design and
construction agreements for the design and construction of new synthetic fuel
manufacturing facilities each having capacity of approximately 360,000 tons per
year. Depending upon the specific agreement, the contractor was either TIC,
CEntry Constructors & Engineers, PICOR or Centerline Engineering Corporation.
The PICOR contracts were part of a joint venture with Savage Industries. The
construction agreements, among other things, required that the plants be placed
in service no later than June 30, 1998.
Covol obtained financing and successfully constructed five facilities from
its construction agreements. Of these, one was built by TIC for Covol and sold
to Birmingham Syn Fuel, L.L.C., a special purpose entity owned by PacifiCorp
Financial Services, Inc., two were built for Covol by Centerline and are under
option for sale to Mountaineer Synfuel, L.L.C. and to Coaltech No. 1 L.P., and
two were built by TIC and are held for sale by Covol.
10
Covol assigned four other construction agreements to licensees and those
licensees successfully constructed four facilities as follows:
Fluor Corporation. Covol assigned two of its fourteen construction
agreements to Appalachian Synfuel L.L.C., a wholly owned subsidiary of Fluor
Corporation. The facilities were built at A.T. Massey Coal Company, Inc.'s
Marfork Prep Plant Site near Peccus, in Boone County, West Virginia. In
conjunction with the assignment of the two contracts, Covol entered into a
license agreement with Appalachian for the use of the Covol binder technologies.
Under the agreement, Covol was paid an advance license fee. A quarterly license
fee is also to be paid based upon the Btu of product produced and sold up to a
prescribed amount of production per year. Covol also granted Appalachian the
right to pay a lump sum payment for the facilities, in lieu of quarterly license
fees over the term of the agreement. Covol will provide binder to the facility
on a cost plus basis.
Pelletco Corporation. Covol assigned two of its construction agreements
with Centerline to affiliates of Pelletco Corporation. One contract was assigned
to Pleasant Ridge Synfuels, L.L.C. which constructed a facility in Alledonia,
Ohio. One contract was assigned to Ginger Hill Synfuels, L.L.C. which
constructed a facility at Ginger Hill, Pennsylvania. In connection with these
two facilities, Covol entered into technology license and agreements to supply
Covol's chemical binder, providing Covol with advanced license fees and
quarterly license fees equal to 50% of the licensees' net cash flow. Covol will
provide binder to the two facilities on a cost plus basis.
Unused Contracts. Covol did not build facilities under five of its fourteen
construction agreements, including the two PICOR contracts as part of a joint
venture with Savage Industries. The construction agreements provided for
penalties if the construction was not pursued by Covol. Covol accrued this
liability during the fiscal year ended September 30, 1997, of which the
remaining liability at September 30, 1998 is $755,000. Covol believes that
construction under any of the five unused contracts is not likely.
Additional Licensed Facilities. In addition to the nine facilities
constructed under Covol's construction agreements, Covol licensed its technology
to eight licensees for use at fifteen facilities constructed by these licensees.
In total, Covol has licensed or constructed plants using the Covol binder
technologies at 24 synthetic fuel facilities that operate at 18 locations in the
Rocky Mountain region, Southern Appalachia, Central Appalachia, Northeast
Appalachia, Northwest Appalachia, and the Illinois Basin, which are the primary
coal supply regions of the United States.
A facility generally consists of a conditioner and binder additive and
mixing system, briquetting or aggregating equipment, a product dryer, and other
supporting systems. However, each facility was individually engineered and
constructed, including systems and components specially selected by the
respective owners, so that there is variation in features from facility to
facility. Covol has manufactured and sold binder mixing plants for installation
at synthetic fuel manufacturing facilities. Six such plants were manufactured
and sold in 1998.
License and Binder Supply Agreements. All non-Covol entities that have
constructed or own facilities using the Covol binder technologies have entered
into a technology license and binder supply agreement with Covol. Most license
agreements provide for an advance license fee of $1.39 per ton of rated
capacity, payable upon reaching project milestones. Covol has received most of
the advance license fees related to these facilities. In addition, pursuant to
the license agreement, the licensee pays a quarterly earned license fee at a
prescribed dollar amount multiplied by the recoverable heat denominated in Btu's
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 of the tax code. In some cases, the amount to
be paid is subject to adjustment to the extent that licensees incur an operating
loss on the production and sale of synthetic fuel, exclusive of the amount
licensees pay as a license fee for the use of the technology. Some license
agreements also provide for a goal fee based on time schedules and production
amounts. The license agreements generally have a term until the later of January
1, 2008 or the corresponding date after which tax credits may not be claimed or
are not otherwise available under Section 29 of the tax code.
11
Covol also agreed, pursuant to the binder supply agreements, to provide
binder material to licensees for the manufacture and production of synthetic
fuel. The price for the binder sold to the licensees falls into two categories:
o a fixed price, or
o an amount equal to Covol's cost plus a prescribed mark-up.
In some cases, the mark-up may be reduced to the extent the licensee incurs
a loss on the production and sale of synthetic fuel, but not below Covol's cost
for such binder materials. The binder is currently manufactured by Dow Chemical
Corporation for Covol utilizing Covol's patented and proprietary technology.
Covol arranges with Dow for shipping of the binder directly to the facilities.
Pace Loan. In December of 1996 Covol entered into license agreements with
affiliates of Pace Carbon Fuels, L.L.C. (collectively "Pace") for the use of the
Covol binder technologies at four synthetic fuel manufacturing facilities owned
by Pace. In 1998 Pace requested a reduction in the license fees payable to Covol
under the license agreements. Upon condition of immediate payment by Pace of
advance license fees, Covol agreed to a reduction in future license fees. This
reduction was accomplished by a ten year loan agreement whereby Covol would loan
to Pace up to $750,000 each quarter beginning in November 1998. Covol's loan to
Pace will be repaid at the end of the ten years only if the Pace projects have
accumulated sufficient prescribed earnings. Pace has requested a loan of
$750,000 for the November 1998 quarter. Covol believes that its current loan
obligation to Pace is limited to the earned license fees payable to Covol for
the quarter ended September 30, 1998, which is believed to be approximately
$300,000. Pace and Covol are negotiating in an attempt to resolve their
differences.
Covol Synthetic Fuel Facility Operations
Covol is the operator at three facilities: Utah Synfuel #1, Carbon Synfuel,
and Pocahontas Synfuel. Of these facilities, Utah Synfuel #1 is not owned by
Covol, and Covol operates the facility under agreement with the owner, Coaltech.
The operating agreement provides that Covol will act as operator of the facility
for a quarterly fee based upon the amount of synthetic fuel produced and sold
per year. Covol cannot predict with any certainty the amount of fees that may be
generated under its operating agreement.
Covol has contracts with independent operators to operate Covol's
Commonwealth Synfuel and Mountaineer Synfuel facilities. River Hill Coal Company
operates the Commonwealth facility and Savage Industries Inc. operates the
Mountaineer facility. Both operating contracts compensate the operator with a
prescribed fee plus reimbursement of costs.
Supply of Raw Materials
The synthetic fuel manufacturing facilities use coal fines as the primary
feedstock to produce synthetic fuel. Accordingly, a supply of coal fines is
essential to the feasibility of a synthetic fuel manufacturing facility.
Historically, lower quality coal and mining refuse and fine particles of
coal were discarded into refuse piles or impoundments. Today, coal preparation
and material handling technologies have reduced the amount of coal that is
discarded, but coal fines generated by coal mining and preparation are still
problematic for the industry. With some variation, most consumers of coal only
purchase coal with an ash content of 12% or less. Discarded coal fines are
typically too high in ash content to be used as-is in making marketable
synthetic fuel. To make use of fine coal refuse, owners of synthetic fuel plants
must either blend the refuse with "clean" coal in appropriate proportions to
yield an acceptable ash content, and/or clean the coal refuse itself. Clean coal
can be purchased from traditional coal marketers and is available to all
synthetic fuel facility owners that have a clean coal/coal refuse blending
strategy. Covol's strategy at all of the facilities it owns or operates includes
clean coal/coal refuse blending.
Coal fines cleaning is a distinct technology and to implement it
successfully requires analysis of the particular coal refuse to determine
appropriate plant design and to determine whether feedstock can be economically
produced. Capital requirements for coal cleaning or preparation plants adequate
to supply a synthetic fuel plant can
12
be in excess of $4 million. Coal cleaning plants require six months or more to
design and construct. A feasibility analysis must be performed to determine
whether the savings achieved by the plant justify the capital costs of
construction together with operational costs, which can vary between
approximately $5-10 per ton. The costs of a cleaning plant are compared to the
alternative of purchasing clean coal for blending. The decision to construct a
coal cleaning plant does not delay delivery of synthetic fuel to market because
in all cases clean blending coal is available to purchase as an immediate
alternative. The decision to construct a coal cleaning plant is based on how a
facility most economically obtains clean feedstock. Covol constructed a coal
cleaning plant to supply Utah Synfuel #1 and Carbon Synfuel and is reviewing the
feasibility of coal cleaning plants at two other synthetic fuel facilities.
In facilities owned and operated by licensees, the licensee secures its own
supply of coal fines. Licensees that are also coal producers utilize their own
feedstock sources. Nonproducer licensees secure deposits of coal fines to supply
their facilities. Covol has arranged for the supply of coal fines for the
following facilities it owns or operates:
Utah Synfuel #1 and Carbon Synfuel. In February 1997, Covol entered into a
contract with a non-affiliated party, Earthco, to acquire coal fines and to
lease property to conduct fines recovery and preparation activities at a
location near Wellington, Utah, approximately six miles from the Utah Synfuel
plant site. Covol paid an initial amount to Earthco upon execution of the lease
agreement to acquire the fines and lease the associated land and will continue
to make quarterly payments through May 2000. Covol constructed a preparation
plant at the site which became operational in May 1998 and which produces
feedstock from the acquired raw fines for the Utah Synfuel #1 and Carbon Synfuel
facilities. The estimated quantity of coal fines at this site is in excess of 2
million tons although the recoverable amount may be less. Additional fines will
be required to supply the longer term requirements of Utah Synfuel #1 and Carbon
Synfuel.
Pocahontas Synfuel. In May 1997, Covol entered into a joint venture with
Black Diamond Enterprises, Inc. under which Black Diamond has certain rights to
market the synthetic fuel produced at the facility and to a percentage of the
net proceeds received by Covol from the project. In addition, Black Diamond is
to provide coal fines to the Pocahontas Synfuel facility. Black Diamond owns the
land in McDowell County, West Virginia upon which the Pocahontas facility is
located and which land includes a fines pond and other coal refuse containing an
estimated 1.2 million tons of recoverable clean fines. Black Diamond and Covol
plan to construct a preparation plant to clean the raw Black Diamond fines. To
date, neither Covol nor Black Diamond have begun construction of a preparation
plant. In addition to the fines at the Pocahontas site, an affiliate of Black
Diamond operates a waste coal recovery operation with an estimated 350,000 tons
of recoverable clean fines. Covol has also acquired waste coal on a site near
the project with an estimated 500,000 tons of recoverable clean fines. After
cleaning, the coal fines from these reserves are high in recoverable heat, low
in ash, and low in sulfur. Until a preparation plant can be permitted, financed
and constructed at Pocahontas, Covol is purchasing coal fines from local sources
for processing at the facility.
Commonwealth. The Commonwealth Synfuel facility is located on property
owned by River Hill Coal Company, Inc. River Hill has approximately 6 million
tons of leased and permitted coal reserves which it actively mines. River Hill
has agreed to provide up to 400,000 tons per year of coal fines from its mining
and preparation plant operations to the Commonwealth facility. Covol intends to
assign this supply agreement to the entity that acquires this facility, which is
currently being offered for sale.
Mountaineer. The Mountaineer Synfuel facility is located on property owned
by Upshur Property, Inc., an affiliate of Anker Energy Corporation. Anker has
agreed to provide the feedstock requirements of Mountaineer Synfuel, L.C. for a
period of ten years, up to 480,000 tons of feedstock per year. Anker will supply
the feedstock from various sources owned or controlled by Anker, including
preparation plant operations and fines ponds. The price for the feedstock varies
based upon the source of the coal fines and the costs of recovery. The site
contains a fines refuse pond which is serving as a partial source for feedstock
and a preparation plant is planned to increase the quality and amount of
feedstock coming from the site refuse pond. Covol does not yet have financing
for the preparation plant. If Mountaineer Synfuel, L.L.C. exercises its option
to purchase the Mountaineer facility, Covol proposes to assign this supply
agreement to Mountaineer.
13
Alabama Inventory. In March of 1997 Covol entered into a coal fines supply
agreement (the Supply Agreement") with K-Lee Processing Inc. and Concord Coal
Recovery Limited Partnership (collectively "K-Lee"). Covol purchased coal fines
under the Supply Agreement through February of 1998 at which time Covol sold its
inventory of coal fines and assigned the Supply Agreement to Birmingham Syn
Fuel, L.L.C. Birmingham Syn Fuel removed the coal fines inventory and asserted
that the inventory was approximately 11,000 tons less than K-Lee had invoiced
and received payment from Covol. Covol is currently in negotiations attempting
to resolve the dispute.
Supply of Binder. Covol purchases its patented and proprietary binder from
Dow Chemical Company under a ten year agreement under which Covol pays a
prescribed price per pound of binder. Covol arranges with Dow for the delivery
of the binder from Dow's manufacturing plants to each of the synthetic fuel
facilities owned, operated, or licensed by Covol.
Sale of Facilities
Covol and its affiliates have developed and sold or have granted an option
to sell four synthetic fuel facilities. The following is a summary of each
option or sale:
Utah Synfuel #1. On March 10, 1997, Utah Synfuel #1 Ltd., a Delaware
limited partnership in which Covol was at the time a 64% owner and general
partner, sold the Utah synthetic fuel facility for $3.5 million, in the form of
a nonrecourse promissory note bearing interest at 9.6552% per annum and payable
in 44 equal quarterly installments, all in accordance with the Utah Project
Purchase Agreement, dated as of March 7, 1997, between Covol, Utah Synfuel #1
and Coaltech No. 1 L.P. The sale of the Utah facility resulted in a loss of
approximately $581,000 to Utah Synfuel #1. The promissory note is collateralized
by a security interest in the Utah facility, and in the event of a default under
the promissory note, Covol's and Utah Synfuel #1's sole right to recovery is
limited to the Utah facility without recourse against Coaltech.
Covol granted Coaltech a put option to require Covol to purchase the Utah
facility from Coaltech if:
1. all of the Coaltech limited partners are unable to utilize the
federal income tax credits under Section 29 of the tax code,
2. the economic benefits accruing to or experienced by all of the
Coaltech limited partners differ significantly from what was
initially projected, or
3. there is a permanent force majeure or material damage or
destruction of the Utah facility.
If the put option is exercised prior to the third anniversary date of the
facility sale, 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 promissory 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 facility, Covol and Utah Synfuel #1 entered
into a Supply and Purchase Agreement with Coaltech. Under the agreement, Covol
agreed to provide coal fines to the Utah facility for processing into synthetic
fuel at an amount equal to Covol's per ton costs, including any wash costs. Utah
Synfuel #1 also agreed to purchase from Coaltech the synthetic fuel produced at
Coaltech's cost plus one dollar per ton. Coaltech has the right to market its
synthetic fuel to a third party, with Utah Synfuel #1 having a right of first
refusal to purchase such synthetic fuel. Covol has incurred a loss each quarter
in connection with this agreement and expects that these losses will continue
into the foreseeable future.
Carbon Synfuel. In connection with the Utah Project Purchase Agreement,
dated March 10, 1997 Covol entered into an option agreement with Coaltech to
sell a second facility, identified as Carbon Synfuel and located at the Utah
Synfuel #1 facility. If Coaltech exercises its option, Covol will sell the
second line of synthetic fuel manufacturing equipment including the building,
binder plant, and other equipment that were not part of the Utah
14
Synfuel #1 facility sale. The terms of the option provide that Coaltech would
purchase Carbon Synfuel on the same terms as Coaltech's purchase of Utah Synfuel
#1 facility. Covol does not expect the option to be exercised. Covol is actively
seeking an alternative buyer for the Carbon Synfuel facility, however there is
no assurance that a sale will be completed.
Since the Utah Synfuel #1 facility and Carbon Synfuel facility were first
placed in service they have experienced several problems, including inadequate
clean coal fines as feedstock, inadequate end product strength, and inability to
market to end-consumers the synthetic fuel product produced from the feedstock.
Covol continues to improve the synthetic fuel product quality and believes that
the improvements will achieve the results necessary for successful marketing.
Covol also has begun to see some success in marketing the product from these two
facilities to a power plant and an industrial manufacturer. Covol is seeking a
long term purchase commitment from these consumers.
The Utah Synfuel #1 and Carbon Synfuel facility are currently operating at
well below their rated capacity. Covol and its licensee have incurred a loss on
the production of synthetic fuel at the Utah Synfuel #1 and Carbon Synfuel
facilities.
In order to provide coal fines to the Utah Synfuel #1 facility, Covol
entered into a purchase agreement with Earthco to acquire the coal fines located
at Wellington, Utah. The estimated amount of coal fines at the Wellington site
is in excess of 2 million tons. The Wellington fines require washing. Covol has
constructed a wash plant at the Wellington site which supplies coal fines to
Utah Synfuel #1 and Carbon Synfuel. The cost for the plant was approximately $8
million. The financing for the construction of the wash plant was provided in
part by AJG Financial Services, Inc., and is evidenced by a debenture of Covol
to AJG which is collateralized by the wash plant assets. The debenture bears
interest at 6% per annum with principal and interest being due and payable in
October 1999. As additional consideration to AJG for financing the wash plant,
Covol, in October 1997, agreed to grant to AJG warrants to purchase
approximately 430,000 shares of Covol 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 expire two years from
issuance.
Birmingham Syn Fuel. Alabama Synfuel #1 Ltd., a Delaware limited
partnership in which Covol was at the time a 74% owner and general partner, sold
the Birmingham Syn Fuel/Birmingport facility to Birmingham Syn Fuel, L.L.C., a
wholly-owned subsidiary of PacifiCorp Financial Services, Inc., on March 6,
1998. The purchase price for the Birmingport facility was $6,500,000 payable in
the form of a nonrecourse promissory note collateralized by certain portions of
the Birmingport facility.
Mountaineer Synfuel. On May 5, 1998 Covol entered into a purchase agreement
to sell the Mountaineer synthetic fuel facility to Mountaineer Synfuel, L.L.C.,
a Delaware limited liability company. The agreement is subject to numerous
conditions, including but not limited to, the obtaining of a PLR from the IRS,
and the production of product meeting certain specifications. There is no
assurance that Mountaineer will exercise its option with respect to the purchase
of this facility. Covol also entered into a financing agreement with Mountaineer
to finance up to $9.75 million for project construction and operations working
capital. Covol's obligation to repay the financing will be extinguished if
Mountaineer exercises its purchase option; otherwise, Covol will be required to
repay the loan with ten percent interest in monthly installments of interest
only payments for the months January through June 1999 and monthly installments
thereafter of $350,000 and a balloon payment on June 30, 2000. Covol's
obligation to repay the amounts borrowed is collateralized by the assets of the
project, and income streams from the Ginger Hill and Pleasant Ridge facilities.
Under a license agreement, Covol will provide use of its technology and
Mountaineer will pay a quarterly license fee based upon the synthetic fuel
product produced and sold during the quarter. Covol will also supply binder
material to the project on a cost plus basis.
In addition to the four facilities discussed above, Covol owns and operates
two synthetic fuel manufacturing facilities that Covol has for sale. One
facility is referred to as Commonwealth Synfuel, located near Karthaus,
Pennsylvania. The other Covol-owned facility for sale is referred to as
Pocahontas Synfuel located near North Fork, West Virginia. Several entities have
expressed interest in purchasing the facilities and Covol expects the facilities
to be sold in early 1999. However, Covol cannot give assurance that it will
successfully sell either or both facilities.
15
Research and Development
Covol has devoted and continues to commit significant human and capital
resources to the development, refinement and commercialization of the Covol
binder technologies in the engineered fuel and engineered resource applications.
Covol is currently focusing its research and development efforts principally on
the synthetic fuel technology, including refinements to the chemical formula and
process, enhancements to the base binder formulations to address product quality
issues, and continued testing and development of other binder materials for the
production of synthetic fuel. Covol is also currently conducting research and
development related to application of the Covol binder technologies to iron
tailing materials, coke breeze, silicon carbide and other waste product or
resource materials.
Covol's intellectual property base consists of seven U.S. and four
international patents relating to the Covol binder technologies as applied to
coal, iron tailings, coke and other carbon based materials. Covol's research and
development efforts will be directed toward perfecting and expanding these
technologies and the filing for patents for proprietary intangible property
developed. See "ITEM 1. BUSINESS - Proprietary Protection" for a discussion of
Covol's patents, trademarks and other intellectual property.
Proprietary Protection
Covol has the following trade names and patents covering certain aspects of
Covol's technology:
Trade names:
Covol Technologies, Inc., Alabama Synfuel #1 Ltd., Utah Synfuel #1 Ltd.,
Flat Ridge Corporation and Engineered Fuel Technologies, Inc.
Trademarks and Service Marks:
United States Trademark Registration No. 2,038,742 for licensing
services identified by "Covol", "Recycling Yesterday's Waste Into
Tomorrow's Resources."
United States Patents:
United States Patent No. 5,453,103, which issued 26 September 1995.
United States Patent No. 5,487,764, which issued 30 January 1996.
United States Patent No. 5,589,118, which issued 31 December 1996.
United States Patent No. 5,599,361, which issued 4 February 1997.
United States Patent No. 5,738,694, which issued 14 April 1998.
United States Patent No. 5,752,993, which issued 19 May 1998.
United States Patent No. 5,807,420, which issued 15 September 1998.
Foreign Patents:
European Patent Office # 96905442.8-2307 filed May 1, 1998.
Australian #686624 filed on January 21, 1994; filed with U.S. Patent
Office as No. 184099 on May 28, 1998.
New Zealand #266060 filed on April 7, 1994; filed with U.S. Patent
Office on February 20, 1998.
Republic of Trinidad and Tobago #960038 filed on July 1, 1996 and
#970147 filed under PCT/US96/01798 on February 8, 1996.
Other United States, Patent Cooperative Treaty, and Foreign Patent
Applications are pending.
16
Covol's U.S. and foreign patents expire on January 21, 2014. There can be
no assurance as to the scope of protection afforded by the patents. In addition,
there are other industrial waste recycling technologies in use and others may
subsequently be developed, which do not, 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 on patents
held by other parties or that Covol will have the resources to enforce any
proprietary protection afforded by the patent or defend against an infringement
claim.
In addition to patent protection, Covol also relies on trade secrets,
know-how and confidentiality agreements to protect the Covol binder
technologies. 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 Covol's know-how, concepts, ideas, and documentation.
Since Covol's proprietary information is important to its business, failure
to protect ownership of its proprietary information would likely have a material
adverse effect on Covol. Covol's current and expected revenues are dependent
upon license agreements by which licensees use the Covol binder technologies to
manufacture synthetic fuel and then pay license fees to Covol. Covol expects
that revenues will continue to be tied to future licensing agreements in the
application of Covol binder technologies to iron rich wastes, coke dust, and
other potentially useful wastes and by-products. Covol believes that its
patents, trade secrets, know-how and confidential information are the basis upon
which Covol is able to obtain licensing agreements.
Confidentiality Provisions
As part of its business, Covol typically enters into agreements concerning
its projects which contain confidentiality provisions. Covol 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. In addition, disclosure of such agreements may be required in
connection with Covol's private placement of securities. Some of the agreements
do not contain the standard exceptions for the disclosure of information which
is required to be disclosed under law. Consequently, no assurances can be given
that Covol has not inadvertently disclosed information regarding its various
projects in violation of confidentiality covenants entered into by Covol.
Government Regulation
Covol's and its licensees' synthetic fuel 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 the synthetic fuel plants, Covol and its licensees obtained various
state and local permits. Covol believes that it or its licensees have obtained
all required permits to construct and operate synthetic fuel facilities, and
that they are in substantial compliance with all relevant laws and regulations
governing the synthetic fuel operations. However, Covol's and its licensees'
synthetic fuel operations entail risk of environmental damage and Covol or its
licensees may incur liabilities in the future arising from the discharge of
pollutants into the environment or from waste disposal practices.
Failure by Covol or its licensees to maintain necessary permits to operate
synthetic fuel plants and to comply with permit requirements could have a
material adverse effect on Covol or its licensees. Other developments, such as
the enactment of more stringent environmental laws and regulations, could
require Covol or its licensees to incur significant capital expenditures. If
Covol or its licensees do 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 Covol.
Covol's goal is to establish itself as the provider of technologies that
will assist others in the processing and reclamation of their wastes and
by-products, and Covol seeks for itself and its licensees to avoid creating
waste streams or compounding environmental reclamation problems. Covol has not
assumed responsibility for environmental reclamation of coal refuse impoundments
from which Covol or its licensees obtain refuse for feedstock. Such liabilities
are and remain the responsibility of the impoundment owners or operators. In the
manufacture of synthetic fuel from coal refuse using Covol's binder
technologies, the synthetic fuel produced effectively completely consumes the
refuse. The synthetic fuel manufacturing process does not contribute to
environmental reclamation liabilities with respect to the coal refuse. However,
the synthetic fuel manufacturing process using Covol binder technologies
typically uses dilute acids. Covol and its licensees must comply with hazardous
material handling and storage regulations related to acid solutions and stored
concentrates.
Covol's and its licensees' synthetic fuel operations are also subject to
federal and state safety and health standards. Covol is committed to providing
effective management of worker safety and health protection. Covol periodically
contracts with independent safety and industrial hygiene inspectors in order to
measure a facility's regulatory compliance. In addition, Covol has developed a
safety policy designed to raise and maintain a high level of safety awareness by
both management and employees. Compliance to applicable safety and health
standards is verified through periodic inspections by regulatory agencies.
Failure to comply with safety and health standards could have a material adverse
affect on Covol, for example, a regulatory inspector could close the operation
until Covol meets the required standards.
17
Competition
Products made using the Covol binder technologies compete with other
synthetic products as well as traditional source materials. Competitive factors
include price, quality, delivery cost and waste handling costs. Covol may
experience competition from other alternative fuel technology companies and
their licensees, particularly those companies with technologies to produce coal
based solid synthetic fuels. Competition may come in the form of the licensing
of the competing technologies to process coal fines or in the marketing of end
products qualifying as synthetic fuel. Competition includes, for example,
Carbontec, Krystal Bond, KFx Inc. and Startec Inc. Covol will also experience
competition from traditional coal and fuel suppliers and natural resource
producers in addition to those companies that specialize in the disposal and
recycling of waste products generated by coal, coke, steel and other resource
production. Many of these companies have greater financial, management and other
resources than Covol. Covol believes that it will be able to compete effectively
although there can be no assurance that it will do so successfully.
Employees
Covol currently employs approximately 80 persons full-time. Approximately
30 of such persons are in corporate administration including research,
development and marketing, and 50 are in synthetic fuel and coal washing
operations. None of these employees are covered by a collective bargaining
agreement.
Forward Looking Statements
Statements regarding Covol's expectations as to the financing, development,
construction and operation of facilities utilizing the Covol binder
technologies, the marketing of products, 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 Covol's future
business plans, the operation 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 Covol 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 Covol's industry or the coal industry or the economy generally,
factors which could cause actual results to differ from expectations stated in
these forward looking statements include, among others, the following:
(1) The commercial success of the Covol binder technologies.
(2) Procurement of necessary equipment to maintain facilities'
operations.
(3) Securing of necessary sites, including permits and raw materials,
for facilities to be constructed and operated.
(4) Completion of facilities, in particular the synthetic fuel
manufacturing facilities, by the placed in service date.
(5) Ability to obtain needed additional capital on terms acceptable
to Covol.
(6) Changes in governmental regulations or failure to comply with
existing regulations which may result in operational shutdowns of
Covol or licensee facilities.
(7) The availability of tax credits under Section 29 of the tax code.
(8) The commercial feasibility of the Covol binder technologies upon
the expiration of Section 29 tax credits.
(9) Ability to meet financial commitments under existing contractual
arrangements.
(10) Ability to commercialize the non-synthetic fuel related Covol
binder technologies which have only been tested in the laboratory
and not in full-scale operations.
(11) Dependence on licensees to successfully implement Covol binder
technologies.
(12) The market acceptance of products manufactured with Covol binder
technologies in the face of competition from traditional products.
(13) Ability to produce products with Covol binder technologies with
acceptable hardness, moisture level, and other characteristics.
(14) Success in the face of competition by others producing synthetic
fuel and other recycled products.
(15) Sufficiency of intellectual property protections.
ITEM 2. PROPERTIES
Covol leases an approximately 5,000 square-foot building in Lehi, Utah,
which houses its executive offices ("Corporate Headquarters"). In August 1997,
Covol entered into a triple-net lease 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 Headquarters Lease
will automatically extend indefinitely for successive one-year periods at the
sole option of Covol, and the monthly rent will increase by 5% per year.
18
In October 1997, Covol purchased an 8,000 square-foot site located in
Price, Utah, on which Covol's prototype briquetting plant is located, for
$150,000. Included in the purchase was a 1,400 square-foot office and warehouse
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 Covol from AJG Financial Services,
Inc.
In May 1995, Covol entered into a lease with Geneva Steel Company for a
9,000 square foot building in Vineyard, Utah. Covol pays no cash rent on these
facilities. Subsequent to the execution of the Geneva Agreements, the lease with
Geneva expired resulting in a tenancy-at-will between the parties. Covol may use
the Geneva briquetting facility in the manufacture of synthetic fuel or for
testing purposes at the Geneva site or some other location.
In June 1996, Covol entered into a land lease of approximately 12 acres in
Price, Utah with a non-affiliated party at a monthly rental of $600. The lease
term commenced on June 20, 1996 and expires on December 31, 2007 but may be
extended. In 1996 Covol constructed a 22,000 square-foot building to house the
Utah Synfuel #1 and Carbon Synfuel facilities. In March 1997, this building was
subleased by Covol to Coaltech as part of the sale of the Utah Synfuel #1
facility. However, Covol retained responsibility for operations of the property
pursuant to an Operations and Maintenance Agreement between Covol and Coaltech.
Covol has constructed an ancillary building, a 1,650 square-foot binder plant.
Coaltech has an option to purchase the Carbon Synfuel facility, and if
exercised, Coaltech will take ownership of the buildings.
In February 1997, Covol entered into a lease agreement with Earthco for two
contiguous parcels located in Wellington, Utah (approximately 6 miles from the
Utah Synfuel #1 site). The first parcel covers approximately 30 acres and has a
lease term of 15 years. On this parcel, Covol constructed a 3,400 square-foot
wash plant. The second parcel covers approximately 357 acres and has a lease
term of 5 years. On this parcel, Covol conducts fines recovery operations. Covol
has the option to extend or purchase either or both parcels upon the
satisfaction of certain conditions. Total obligations to lease the parcels and
acquire the associated fines are approximately $5.5 million, of which $700,000
was paid at the time of lease execution and Covol has and will make payments 4
times each year until May of 2002 for the balance.
In 1997, Covol entered into a 5 year, $850 per month sublease with
Combustion Resources, Inc. for approximately 2,400 square feet of building space
in Provo, Utah.
In 1997, Covol entered into a one year, $9,000 lease with Stephen Mallory
for approximately 2,000 square feet of office and residential space in Dunbar,
West Virginia. This property serves as Covol's Eastern Region office.
In 1998, Covol entered into a one year, $1,500 per month lease with Mobile
Auto & Storage for approximately 4,000 square feet of building space in Lehi,
Utah. This property provides office and laboratory facilities for some of
Covol's research and development personnel.
In May 1998, Covol entered into a 10 year, $1,000 per year lease with
Upshur Property, Inc., for approximately 10 acres of property in Tallmansville,
Upshur County, West Virginia. The property is the site of the Mountaineer
Synfuel facility. The lease is assignable to Mountaineer Synfuel, L.L.C., in
connection with its facility purchase option.
In May 1998, Covol purchased approximately 80 acres of undeveloped property
near Sunnyside, Utah for $100,000. In June of 1998 Covol entered into a five
year lease with an option to purchase approximately 40 acres of property with
office and warehouse improvements. The lease payments are $2,000 per month,
escalating to $3,500 per month over time. The leased property is adjacent to the
purchased property. Covol plans to conduct some operations on the two properties
in the future.
None of Covol's subsidiaries have interests in real property.
ITEM 3. LEGAL PROCEEDINGS
Asbestos Investigation. In January 1996, a manager of Covol entered
property owned by Nevada Electric Investment Company, a subsidiary of Nevada
Power Corporation, in connection with an offer by Covol to purchase the
property, and with certain other employees of Covol, removed some asbestos over
a two-day period. In May of 1996 Covol received a notice of violation and order
for compliance from the State of Utah, Division of Air Quality alleging that
asbestos was improperly handled, removed, and disposed of. Covol complied with
the order and in September of 1996 entered into a settlement agreement with the
State of Utah and paid a fine in the amount of $11,000. In late 1997 the U.S.
Environmental Protection Agency began its own investigation, referring the
matter to the U.S. Attorney's office which proceeded with a grand jury inquiry.
Covol was served in September 1998 with a grand jury subpoena for records, with
which Covol has complied. Covol does not know the results of the grand jury
inquiry or whether the inquiry is completed. Covol does not believe that its
resolution will have a material adverse effect on Covol.
19
Indemnification to Centerline. In December 1996, Covol entered into six
indemnification agreements with Centerline whereby Covol agreed to indemnify
Centerline should it be required to pay liquidated damages to PacifiCorp under
various design and construction agreements for six synthetic fuel facilities.
Under the original terms of the various design and construction agreements, if
the facilities were 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 applied if PacifiCorp actually decided to build
the facilities with Centerline as the design/builder. PacifiCorp elected to not
build three of the projects, and therefore the indemnity agreement with respect
to those facilities no longer applies. Accordingly, the maximum amount of
contingent liability to Covol under the indemnification agreements is $2,250,000
($750,000 per design and construction agreement). Counsel for Centerline has
notified Covol that a dispute exists between Centerline and PacifiCorp which may
require indemnification by Covol. Covol has been advised that the dispute is
proceeding to arbitration.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Covol held its Annual Meeting of Stockholders on August 27, 1998. At the
meeting, the following actions were approved by the stockholders:
James A. Herickhoff was elected a director of Covol for a three year term
to expire in 2001, by a vote of 7,703,272 in favor and 50,992 against.
John P. Hill was elected a director of Covol for a three year term to
expire in 2001, by a vote of 7,694,872 in favor and 58,992 against.
Selection by the Board of Directors of PricewaterhouseCoopers LLP as
independent auditors of Covol for the 1998 fiscal year was ratified by a vote of
7,690,463 in favor, 15,610 opposed and 43,938 abstaining.
EXECUTIVE OFFICERS OF THE REGISTRANT
NAME AGE POSITION
Brent M. Cook 38 Chief Executive Officer and Director
Stanley M. Kimball 44 President and Director
Steven G. Stewart 50 Chief Financial Officer
George W. Ford, Jr. 53 Principal Scientist and Vice President
of Science and Technology
Steven R. Brown 40 Senior Vice President of Engineering
and Development
Max E. Sorenson 49 Senior Vice President of Engineered
Resources
Dee J. ("D.J.") Priano 53 Senior Vice President of Synfuel
Engineered Fuels
Asael T. Sorensen, Jr. 44 Secretary and Corporate Counsel
Harlan M. Hatfield 38 Vice President and General Counsel
Kenneth R. Frailey 45 Vice President of Operations
Stephanie R. Black 36 Vice President of Research and
Development
20
Brent M. Cook has served as Chief Executive Officer and Director since November
1996, as President from October 1996 until July 1998, and served as Chief
Financial Officer from June 1996 until December 1996. Mr. Cook is a Certified
Public Accountant. Prior to joining Covol, Mr. Cook was Director of Strategic
Accounts-Utah Operations, for PacifiCorp, Inc. ("PacifiCorp"). His
responsibilities included the management of revenues of approximately $128
million per year, and seeking out and evaluating strategic growth opportunities
for PacifiCorp, including joint ventures and other transactions. Mr. Cook spent
more than 12 years with PacifiCorp.
Stanley M. Kimball was appointed President in July 1998 and has been a Director
since January 1997. He served as Chief Financial Officer from January 1997 to
July 1998. Prior to joining Covol, Mr. Kimball was employed by Huntsman
Corporation ("HC"). From 1989 to early 1995, Mr. Kimball served as the Director
of Tax for Huntsman Chemical Corporation ("HCC"). In May 1995, Mr. Kimball was
appointed as an officer of HCC, serving as Vice President, Tax. In July 1995,
Mr. Kimball was appointed as Vice President, Administration for HC. In this
position, he had numerous responsibilities, both for HC and for Mr. Jon M.
Huntsman personally, which included financial accounting, tax and estate
planning, and cash and investment management. In this position, Mr. Kimball also
served as Mr. Huntsman's Chief of Staff. In 1980, Mr. Kimball received a Master
of Accountancy, with emphasis in taxation, from Brigham Young University and is
a Certified Public Accountant. Between 1980 and 1989, he was employed by Arthur
Andersen & Co., and was serving as a Senior Tax Manager prior to his employment
with HCC.
Steven G. Stewart was appointed Chief Financial Officer of Covol in July 1998,
and served as Vice President of Finance and Treasurer from April 1998 through
July 1998. Prior to joining Covol, Mr. Stewart was a partner for 11 years with a
"Big Five" accounting firm, an audit partner with Ernst & Young (formerly Arthur
Young) and was the Salt Lake City office Director of High Technology and
Entrepreneurial Services. From January 1994 through September 1996, Mr. Stewart
was self-employed and provided consulting services to high technology companies,
established strategic alliances, advised companies on alternative valuation
methods applicable to acquisition targets and negotiated acquisition/sale
transactions. From October 1996 through March 1998, Mr. Stewart was a business
assurance partner at PricewaterhouseCoopers, LLP (formerly Coopers & Lybrand
LLP), with primary responsibility for public companies operating in the high
technology, mining and extractive industries. Mr. Stewart is a Certified Public
Accountant.
George W. Ford, Jr. has served as Vice President of Research and Development of
Covol since August 1993. From August 1993 to February 1997, Mr. Ford served as a
Director of Covol. From 1982 to 1993, Mr. Ford was employed at Ballard Medical
Products, Inc. in research and development, principally in the biomedical field.
Mr. Ford holds 17 national and international patents covering a wide variety of
technologies. Mr. Ford has functioned as an independent consultant working on
projects in computer programming, medical product device design and process
polymer chemistry design for the energy industry. Mr. Ford is a member of the
American Association for the Advancement of Science and the Iron and Steel
Society.
Steven R. Brown was appointed Senior Vice President of Engineering and
Development in December 1998. Since July 1998 he served as Vice President -
Synfuel Operations. Previously he served as Vice President of Engineering and
Construction of Covol since February 1995. Mr. Brown served as a Director of
Covol from September 1995 to March 1997. From 1993 to 1995, Mr. Brown was
President of Construction Management Service, Inc. Mr. Brown is a licensed
professional engineer and a licensed general contractor.
Max E. Sorenson was appointed Senior Vice President of Engineered Resources in
December 1998. He served as Vice President of Covol since April 1997. Prior to
Mr. Sorenson's employment with Covol, Mr. Sorenson was Senior Vice President of
Operations, Engineering and Technology of Geneva Steel Company. Mr. Sorenson
began his employment with Geneva Steel Company in October 1989. During his
employment with Geneva Steel Company, Mr. Sorenson also had responsibility for
raw materials, transportation contracts and information systems and also served
as Chief Engineer of Coke, Iron and Steel, and Vice President of Engineering.
Prior to joining Geneva Steel Company, Mr. Sorenson worked for 16 years for
Inland Steel, Inc., one of the largest steel companies in the United States,
where he served in various operational and technology management positions in
ironmaking and steelmaking. Mr. Sorenson obtained a B.S. degree in Metallurgical
Engineering from the University of Utah in 1973 and a Master of Science degree
in Industrial Management from Purdue University in 1978.
21
Dee J. "DJ" Priano was appointed Senior Vice President of Synfuel Engineered
Fuels in December 1998. Prior thereto, he served as Vice President of Covol
since August 1997. Mr. Priano had been employed by Kennecott Corporation for
more than 32 years prior to that time. Mr. Priano worked in several different
positions at Kennecott including Principal Planning Engineer for Kennecott's
Bingham Canyon mine, Manager of Operations Analysis, Controller of Kennecott's
Bingham Canyon mine as well as the Controller of Kennecott's U.S. Mines
Division. In addition to managing general accounting and financial reporting
activities, he was responsible for the administration of purchasing, MIS and
land and water management functions. Mr. Priano received a BS degree and Master
of Business Administration from the University of Utah.
Asael T. Sorensen, Jr. joined Covol as its legal Counsel in September 1995. He
has also served as Corporate Secretary since June 1996. From 1982 to 1995, Mr.
Sorensen was an in-house attorney for the Church of Jesus Christ of Latter-Day
Saints in Salt Lake City, Utah and practiced law primarily in the area of
contract negotiations and administration. Mr. Sorensen graduated from Brigham
Young University with a joint Juris Doctor and Master of Business
Administration. He is admitted to practice law in the State of Utah.
Harlan M. Hatfield has served as Vice President and General Counsel since July
1998 and Corporate Counsel since October 1996. His primary activities with Covol
have been the development of synthetic fuel projects, including licensing,
financing, permitting, construction, feedstocks, site selection, and other
aspects of project development. As General Counsel he oversees the legal staff
and outside legal counsel, litigation, regulatory disputes, contracts, and other
legal matters. Prior to his employment with Covol, he was in private practice at
the Seattle law firm of Oles, Morrison and Rinker for more than nine years where
he was a partner.
Kenneth R. Frailey joined Covol in August 1998, and in December 1998, was
appointed Vice President of Operations. Until August 1998, Mr. Frailey was
employed by Kennecott Corporation and General Electric for a total of
approximately 20 years. Mr. Frailey's Kennecott experience related to mining and
electrical power generation, and particularly managerial assignments in plant
operations and engineering.
Stephanie E. Black joined Covol in March of 1998 as Director of Research and
Development, and in December 1998, was appointed Vice President of Research and
Development. She was employed as a Strategic Account Manager with PacifiCorp
from June of 1995 until joining Covol. For the approximately 11 years prior to
June 1995, Ms. Black was employed with Hercules, Inc. (now Alliant Techsystems).
While with Hercules, Ms. Black acted at various times as engineer, analyst,
supervisor, and subcontract manager.
Covol's Executive Officers are elected annually by the Board of Directors
and serve at the discretion of the Board.
22
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The shares of common stock of Covol trade on The Nasdaq National(R) Market
under the symbol "CVOL".
The following table sets forth, for the periods presented, the high and low
trading prices of Covol's common stock as reported by Nasdaq from April 1998, to
September 1998, and bid quotations as reported by National Quotation Bureau,
Inc. from October 1996 through March 1998. The quotations do not reflect
adjustments for retail mark-ups, mark-downs or commissions and may not
necessarily represent actual transactions. Since Covol 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.
Low High
Fiscal 1997
Quarter ended December 31, 1996 $7.50 $14.38
Quarter ended March 31, 1997 7.88 15.75
Quarter ended June 30, 1997 6.75 8.88
Quarter ended September 30, 1997 6.25 10.13
Fiscal 1998
Quarter ended December 31, 1997 $8.88 $13.94
Quarter ended March 31, 1998 10.50 14.06
Quarter ended June 30, 1998 12.25 17.44
Quarter ended September 30, 1998 9.00 17.25
As of December 17, 1998, there were approximately 625 shareholders of
record of Covol's common stock.
Covol has not paid dividends on its common stock to date and does not
intend to pay dividends on its common stock in the foreseeable future. Covol
intends to retain earnings, if any, to finance the development and expansion of
its business and to pay debt service and dividends on preferred stock. Payment
of common stock dividends in the future will depend, among other things, upon
Covol'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 Covol within the past
fiscal year without registration under the Securities Act of 1933, as amended.
No underwriters were involved in any stock issuances nor were any commissions
paid in connection therewith. However, Covol 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
Covol's common stock, even though the options convert into restricted stock.
Covol believes that the following issuances of shares of common stock,
notes, debentures and other securities were exempt from the registration
requirements of the Securities Act of 1933, as amended, pursuant to the
exemption set forth in Section 4(2) thereof. Each security was issued subject to
transfer restrictions. Each certificate for each security bears a restricted
legend. Each investor made representations to Covol that it was accredited as
that term is defined in Regulation D and that the security was acquired for
investment purposes.
In September and October 1997, Covol 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
23
$4,200,000. Each Unit consisted of five shares of common stock of Covol together
with a warrant to purchase one additional share of common stock at the price of
$8.00, expiring April 30, 1998. Pursuant to the terms of the Memorandum, Covol
granted to purchasers of the Units piggyback registration rights on the shares
of common stock included in the Units and the shares of common stock which were
issuable upon the exercise of the warrants. A total of 597,850 shares of common
stock and 119,557 warrants were issued in the offering. Of the 119,557 warrants
issued to investors, 96,357 were exercised and 23,300 expired. In connection
with the sale of the Units under the Memorandum, Covol issued to three
accredited investors finder fees in the form of warrants to acquire an aggregate
of up to 199,262 shares of Covol's common stock at a purchase price of $8.00 per
share at any time prior to October 31, 1999, none of which had been exercised as
of September 30, 1998.
On November 25, 1997, Covol issued 1,500 shares of Covol common stock
to a single investor upon exercise of warrants at $8.00 per share, paid in cash.
The warrants were originally issued with Units privately placed in September and
October 1997.
On December 8, 1997, Covol issued 1,500 shares of Covol common stock to
a single investor upon exercise of warrants at $8.00 per share, paid in cash.
The warrants were originally issued with Units privately placed in September and
October 1997.
On January 9, 1998 Covol issued warrants for 216,272 shares of Covol
common stock at a per share exercise price of $10.00 to AJG Financial Services,
Inc. ("AJG"). Also, on January 9, 1998 Covol issued warrants for 216,272 shares
of Covol common stock at a per share exercise price of $20.00 to AJG. Covol
issued these warrants as partial consideration for AJG's loan to Covol of
$4,367,351 under Covol's debenture to AJG dated January 9, 1998.
On March 4, 1998 Covol issued 1,000,000 shares of Covol common stock to
PacifiCorp Financial Services, Inc., pursuant to PacifiCorp Financial's
conversion of its Convertible Loan and Security Agreement dated March 20, 1997
("Agreement"). On April 7, 1998 Covol issued an additional 27,000 shares of
Covol common stock to PacifiCorp Financial as satisfaction of the adjustment
provisions of the Agreement.
In 1996, Covol formed two limited partnerships, Alabama Synfuel #1 Ltd.
and Utah Synfuel #1 Ltd., to assist with the financing of construction at two
synthetic fuel manufacturing facilities. These two facilities have been sold and
are now owned by Birmingham Syn Fuel, L.L.C. and Coaltech No. 1 L.P. On
September 9, 1998 Covol offered the limited partners in Utah Synfuel #1 and
Alabama Synfuel #1 an exchange of Covol's common stock for their limited
partnership interests. The exchange ratio was based in part on an independent
valuation of the limited partnership's assets and other factors including but
not limited to current and future expected cash flow of the partnerships and
current market values of Covol's common stock as quoted on NASDAQ. The exchange
ratio for Utah Synfuel #1 was 112.828 shares of common stock per each limited
partnership unit and 125.97 shares for each Alabama Synfuel #1 limited
partnership unit. The limited partnership's units originally sold for $1,000 per
unit.
As of November 10, 1998, all of the limited partners in Utah Synfuel #1
and all but one of the limited partners in Alabama Synfuel #1 had agreed to
exchange their limited partnership interests for shares of Covol's Common Stock,
and accordingly Utah Synfuel #1 became a wholly-owned subsidiary of Covol and
Alabama Synfuel #1 became a 98%-owned subsidiary of Covol.
During September 1998 Covol completed a financing of $1,500,000 that
consisted of the sale of 55,555 units at $27.00 per unit to an investor. A unit
consisted of three shares of restricted common stock of Covol plus one warrant
to purchase one share of restricted common stock at a price of $12.00. The
warrants expire September 16, 2000 if not exercised.
During November 1998, Covol completed a financing transaction that
consisted of $400,000 of debt and approximately $3,500,000 of equity issued to
28 investors. The debt had a term of twelve months, bears interest at 15% per
annum, with an interest only payment due in six months and with the balance of
interest and principal due at maturity. The debt is collateralized by certain
assets of Covol and is due prior to maturity upon the placement of
24
long-term financing by Covol. The equity transaction consisted of the sale of a
unit at a price of $5.00. A unit consisted of one share of restricted common
stock of Covol plus a warrant to purchase one additional share of restricted
common stock at an exercise price of $7.50. The warrants expire in twelve months
if not exercised. The stock and shares issuable pursuant to the related warrants
bear "piggyback" registration rights.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data are derived from the consolidated
financial statements of Covol. This information should be read in conjunction
with the consolidated financial statements, related notes and other financial
information included herein. As more fully described in Note 15 to the
consolidated financial statements, Covol sold its construction subsidiaries in
1996. All construction - related operations have been reflected as discontinued
operations in the 1996, 1995 and 1994 financial statements. The construction
subsidiaries include one business which was acquired on September 30, 1994 and
therefore is included in discontinued operations in 1996 and 1995 only. The note
receivable received by Covol as consideration for the sale is "marked to market"
each quarter based on the market value of Covol's stock held as collateral, and
the resulting adjustments are reflected in Covol's statement of operations. The
selected financial data as of and for the nine months ended September 30, 1994,
as of and for the year ended September 30, 1995 and as of September 30, 1996 are
derived from audited financial statements not included herein. The selected
financial data for the year ended September 30, 1996, and as of and for the
years ended September 30, 1997 and 1998 were derived from the financial
statements of Covol which have been audited by PricewaterhouseCoopers LLP
included elsewhere herein.
Nine Months
Ended
Year Ended September 30, September 30,
---------------------------------------------------
(thousands of dollars, except per-share data) 1998 1997 1996 1995 1994
- ----------------------------------------------- ------------ --------------- --------------- -------------- -------------
OPERATING DATA:
Total revenues $12,699 $ 251 $ 295 $ 129 $ 20
Loss from continuing operations (3,986) (10,995) (12,955) (4,524) (498)
Net loss (3,986) (10,995) (13,836) (5,654) (143)
Basic and diluted net income (loss)
per common share:
Loss per share from continuing
operations (.43) (1.38) (1.86) (1.00) (.13)
Net income (loss) per share (.43) (1.38) (1.99) (1.25) 0.04
Purchase of property, plant and
equipment and facilities
held for sale 36,963 7,194 5,055 694 100
September 30,
------------------------------------------------------------------------
(thousands of dollars) 1998 1997 1996 1995 1994
- ------------------------------------------------ ----------- --------------- --------------- -------------- ------------
BALANCE SHEET DATA:
Working capital $ 8,549 $ 4,960 $(3,482) $ (480) $ (620)
Net property, plant and equipment 14,902 5,464 7,125 1,330 748
Total assets 66,897 26,361 8,772 2,660 4,853
Long-term obligations 16,279 5,467 364 177 852
Total stockholders' equity (deficit) 21,571 5,929 (233) 1,183 2,990
25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the information set forth under the caption entitled "ITEM 6. SELECTED
FINANCIAL DATA" and the financial statements and notes thereto for Covol
included elsewhere herein.
Year Ended September 30, 1998 Compared to Year Ended September 30, 1997
The information set forth below compares Covol's operating results for
1998 with its operating results for 1997.
Revenues. Total revenues for the year ended September 30, 1998
increased by $12,448,000 to $12,699,000 as compared to $251,000 for 1997. During
1998 Covol recognized license fees totaling $7,942,000 while no license fees
were recognized during 1997. These fees consisted of one-time advance license
fees of $7,736,000 and earned license fees or royalty payments of $206,000.
Advance license fees are normally due when construction of the related synthetic
fuel facility begins, when construction is completed, or when certain
construction milestones or other conditions are met. Covol expects to receive
approximately $4,000,000 of additional advance license fees during 1999 upon the
sale of certain synthetic fuel facilities currently owned by Covol and upon the
achievement of certain production levels at one of the synthetic fuel
facilities. Earned license fees or royalty payments are due quarterly based upon
synthetic fuel produced and sold as reported to Covol by its licensees. Covol
had sales of binder and coal fines to a related party during 1998 totaling
$2,543,000 compared to $209,000 during 1997. These revenues resulted primarily
from coal fines that were sold to the related party at Covol's cost as provided
for under the binder and license agreement with this party. Substantially all of
the fines purchased by Covol have now been sold so sales of coal fines are not
expected to be material during 1999. Covol sold six binder mixing plants to
licensees during 1998 for $1,088,000, generating a gross profit of $200,000.
Covol does not expect sales of binder mixing plants during 1999. Covol provides
binder material to its licensees either at a fixed price or at Covol's cost plus
a contracted markup. Covol purchases the binder materials under a long-term
contract with a large chemical company. Total binder sales during 1998 were
$994,000 with a corresponding direct cost to Covol of $642,000. Covol expects a
significant increase during 1999 of production of synthetic fuel by its
licensees as licensees move toward full production levels with a corresponding
increase in earned license fees or royalty payments and sales of binder
products. However, Covol cannot assure increases in license fees, royalty
payments, and binder sales because Covol licensees must successfully obtain
adequate feedstock coal fines, process fines into synthetic fuel, and develop
markets for synthetic fuel, now and in the future. Covol believes that its
licensees have made significant progress in these areas, but continued success
cannot be assured.
Operating Costs and Expenses. Operating costs and expenses increased by
$4,205,000 or 38% to $15,310,000 during 1998 from $11,105,000 during 1997. Cost
of coal briquetting operations increased $4,492,000 from $4,803,000 during 1997
to $9,295,000 during 1998. This increase included $4,121,000 relating to the
costs associated with binder plant sales, binder sales and coal fine sales as
discussed above. During 1997, Covol recorded an expense for $1,477,000 relating
to construction penalties for failure to proceed under several contracts Covol
had entered into. There was no similar expense in 1998. However, during 1998
Covol incurred significantly higher operating expenses in connection with the
continued refinement and implementation of the briquetting process, and the
commercialization of this process in connection with the 24 facilities placed in
service during 1998, including the four facilities held for sale. Covol expects
to continue incurring losses into 1999 until these facilities are sold. Covol
expects to realize a gain when the facilities are sold. These expenses related
in part to the construction and operation of four synthetic fuel facilities
built by Covol that are currently held for sale, costs incurred in providing
assistance to Covol's licensees during the ramp-up of their synthetic fuel
facilities, and increased personnel costs. These increases during 1998
effectively offset the 1997 construction penalty expenses. Covol operates one of
the synthetic fuel facilities for Coaltech, a partnership for which Covol is the
general partner. Under this operating agreement, Covol is contractually
obligated to purchase all of the synthetic fuel produced at cost plus $1 per
ton. Production of synthetic fuel from this facility during 1998 was not
significant and accordingly, the cost per ton is significantly in excess of the
current market value. These costs and the corresponding write-down of this
inventory
26
to its market value are included in the cost of coal briquetting operations. The
write-down was approximately $1,400,000 during 1998 and $1,548,000 during 1997.
Covol expects the excess cost per ton to decrease in 1999 as production volumes
increase.
Research and development costs decreased during 1998 as a result of
Covol's continued focus on the commercialization of the synthetic fuel
technology and the utilization of certain research and development resources in
this endeavor. Covol expects that research and development costs will increase
in 1999 as Covol focuses resources on further refinement of its technology
relative to the synthetic fuel / coal industry and the application of the
technology into other areas.
Selling, general and administrative expenses increased $1,438,000 or
48% to $4,436,000 during 1998 from $2,998,000 for 1997. Approximately $500,000
of this increase related to a substantial increase in travel and related costs
as Covol's employees spent a significantly greater amount of time at Covol and
licensee-owned facilities. Covol believes that travel and related expenses will
decrease during 1999, but will continue to run at levels higher than 1997 due to
the ongoing activities that will be required at the 24 synthetic fuel facilities
utilizing Covol's patented technology. The balance of the increase in expenses
relates to approximately $250,000 of commissions incurred in connection with the
placement of synthetic fuel license agreements, $175,000 in increased
professional fees and a $500,000 increase in payroll and related costs,
resulting from additional employees hired.
Compensation expense on stock options, stock warrants, or issuance of
common stock decreased $1,119,000 or 54% to $939,000 for 1998 from $2,058,000
for 1997. This decrease is attributable to a change in policy to only grant
stock options at strike prices that are not "in-the-money", for the purpose of
providing an incentive to the recipient of the options to create shareholder
value. The majority of the 1998 expense relates to options granted in prior
years that vest over several years and the compensation value that is being
recognized as an expense over the vesting period.
In 1998, Covol sold the facility owned by Alabama Synfuel #1 Ltd. for
$6,500,000, in exchange for a note receivable due February 2003. A loss of
$218,000 was incurred from the sale of this facility. In 1997, Utah Synfuel #1
sold its facility to Coaltech for $3,500,000, evidenced by a promissory note
payable in 44 quarterly installments of $130,000 starting March 31, 1997. The
actual cost to construct the Utah Synfuel #1 facility was $4,082,000.
Accordingly, a loss was incurred from the sale of the Utah Synfuel #1 facility
in the amount of $582,000.
During 1996, Covol sold certain construction companies and received as
consideration a $5,000,000 note receivable ("Note") with interest at 6% payable
over five years. It was determined that the Note should be discounted to an
appropriate market rate and accordingly, the Note was discounted at 10.25%
resulting in a discount of $1,281,000. The Note is collateralized by stock and
stock options of Covol and is reflected in the balance sheet at the underlying
value of the collateral. Accordingly, the Note is "marked to market" each
quarter based upon the market value of Covol's common stock. This adjustment
resu