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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2003

Commission File Number 0-23634

KFX INC.

(Exact Name of Registrant as specified in its Charter)

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

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

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

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

Yes x No ¨

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

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

Yes x No ¨

The aggregate market value of the voting and non-voting common equity held by non-affiliates of KFx Inc. as of June 30, 2003, the last business day of KFx Inc.’s most recently completed second fiscal quarter was $145,962,000 computed by reference to the price at which KFx Inc.’s common stock was last traded on that date, as reported on the American Stock Exchange.

At March 8, 2004, 54,428,153 shares of common stock of the Registrant were outstanding.

Documents Incorporated by Reference:

Portions of the definitive Proxy Statement for the 2004 Annual Meeting of Stockholders are incorporated by reference in Part III of this Report on Form 10-K.

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TABLE OF CONTENTS

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PART I

CAUTIONS ABOUT FORWARD LOOKING STATEMENTS

This Annual Report on Form 10-K includes forward-looking statements about events, products or financial performance that may not exist, or may not have occurred. For example, statements like we “expect,” we “believe,” we “plan,” we “intend” or we “anticipate” are forward-looking statements. Investors should be aware that our actual operating results and financial performance may differ materially from our expressed expectations because of risks and uncertainties about the future including risks related to economic and competitive conditions. In addition, we will not necessarily update the information in this Annual Report on Form 10-K if any forward-looking statement later turns out to be inaccurate. Details about risks affecting various aspects of our business are included throughout this Form 10-K. Investors should read all of these risks carefully, and should pay particular attention to risks affecting the following areas: competition issues discussed on page 11; government regulation discussed on pages 11 to 12; intellectual property and proprietary rights discussed on pages 8 to 11; specific risk factors discussed on pages 12 to 16; and commitments and contingent liabilities described in Note 13 to the financial statements included in this Form 10-K.

AVAILABLE INFORMATION

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

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

FREQUENTLY USED TERMS

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

OVERVIEW

We are a “clean energy” technology company with a patented process, which we refer to as K-Fuel^™ technology, that uses heat and pressure to physically and chemically transform low grade (or low BTU), high moisture content coal into high grade (or high BTU), low moisture content solid clean fuel. Our technology adds value to coal producers and the electric power generation industry by significantly improving the quality of low-grade coal and facilitating the industry’s compliance with air emission standards. We operate a research, development, and demonstration facility near Gillette, Wyoming that includes a Class A laboratory and pilot plants capable of processing all types of source coal into K-Fuel^™ using our proprietary technology. We maintain this facility to provide complex technological data and other similar information to our potential customers and governmental agencies in assessing the benefits of the K-Fuel^™ process.

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In the future, we plan to own and operate K-Fuel^™ production facilities both domestically and internationally, as well as to license the K-Fuel^™ technology to third parties. In January 2003, we announced a preliminary agreement with Arch Mineral Corporation (“Arch”) to develop a 750,000 ton-per-year K-Fuel^™ plant at Arch’s Black Thunder mine. In about June 2003, Arch and KFx began evaluating alternative sites because of the difficulty of integrating our initial smaller sized plant into Black Thunder’s 70 million ton per year mining operations and the likelihood of more favorable locations available to Arch and/or KFx. In July 2003 we began the design, engineering, and equipment fabrication for a 750,000 ton-per-year K-Fuel^™ plant to be constructed in the Powder River Basin of Wyoming. Since then we have filed and continue to file for the long lead-time permits for the most likely sites under consideration for the first plant. We expect to complete our evaluation of the alternative sites and to announce our selection for the initial K-Fuel^™ plant after the end of the first quarter of 2004.

Recent Developments

Equity Exchange of Pegasus Technologies and K-Fuel LLC

On November 26, 2003 we completed an equity exchange transaction with Kennecott Energy Company (“Kennecott”). In accordance with terms contained in the Equity Exchange Agreement, Kennecott transferred to KFx its 49% membership interest in K-Fuel LLC and the full ownership of all related technology developed by Kennecott. Prior to the consummation of this transaction, KFx owned a 51% membership interest in K-Fuel LLC. K-Fuel LLC was a joint venture between KFx and Kennecott which was intended to be the vehicle for further technical advancement and the commercialization of business opportunities arising out of the K-Fuel^™ technology, including research and development, sublicensing, marketing and consulting, but not including the construction of facilities to produce K-Fuel^™ products on a commercial basis. In exchange, KFx transferred its ownership interests in Pegasus Technologies, Inc. (“Pegasus”) to Kennecott. KFx had previously held approximately 65% ownership in Pegasus. Pegasus’ primary business is to provide software solutions for electric utilities, which improved coal-fired boiler efficiency and air emissions. KFx retained no ownership interest in Pegasus.

Under the terms of this transaction, an intercompany working capital loan from KFx to Pegasus with an outstanding balance of approximately $9.4 million was exchanged for a contingent earn-out agreement of up to $9.4 million in the aggregate, plus accrued interest (prime rate plus 500 basis points), payable out of a portion of future cash flows generated by Pegasus. Due to the contingent nature of this potential stream of future cash flows the Company has not recognized an asset or any associated income. Pursuant to the terms of the Agreement, Kennecott repaid KFx approximately $1 million, plus accrued interest, that KFx had loaned to Pegasus during the first nine months of 2003, under a working capital line of credit. Kennecott also paid to the Chairman and CEO of KFx $184,595 to retire indebtedness owed by Pegasus and $301,138 to a director of KFx and his company to retire indebtedness owed by Pegasus.

In connection with the Equity Exchange Agreement, KFx paid $500,000 to Pavilion Technologies, Inc. (“Pavilion”) to obtain agreement from Pavilion to waive their right to demand acceleration of royalty obligations due to Pavilion from Pegasus upon the change in control of Pegasus. KFx is to be repaid 50% of this amount as part of a note receivable from Pegasus and the remaining 50% was added to the contingent obligations due from Pegasus. The Company recognized an additional $250,000 in the note receivable from Pegasus as a result (See Note 3 to the consolidated financial statements). Kennecott also received a license and all necessary rights to build and operate up to three commercial K-Fuel^™ plants (1 domestic and 2 outside the Western Hemisphere except in India) and to market K-Fuel^™ or other production from those plants. Each plant can have annual capacity of up to three million tons and Kennecott will pay applicable royalty and license fees.

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Summary Financial Information

In previous periods we reported financial information about our Pegasus and K-Fuel^™ as segments. We are now reporting the discontinued operations of Pegasus separately in the financial statements in Note 2. Summary information for our consolidated operations for 2003, 2002 and 2001 follow:

During each of the three years ending December 31, substantially all of our operating activities were conducted domestically.

Industry Overview

Domestic Market

As reported by the U.S. Department of Energy (“DOE”), the total domestic market for coal fuel is approximately 1.1 billion tons per year, of which electric utility companies use the majority of the tonnage (approximately 91%). Coal-fired electricity generation currently accounts for approximately 51% of the nation’s total electricity supply. At the 1.1 billion tons per year consumption rate, DOE estimates that there are over 250 years of proven recoverable coal reserves in the US. Our K-Fuel^™ technology is marketed to coal producers and the electric power generation industry to beneficiate lower grade coal production and facilitate compliance with air emission standards. For a number of years various regulations and other requirements have placed increasingly stringent standards on the air emissions generated by the electric power generation industry and others. In addition, there will be increasing pressure from regulatory agencies and competitive market forces to meet such air emission standards in more cost effective ways and to improve the overall efficiency of electric power generation. A discussion of the regulations and standards affecting air emissions which could create potential market opportunities for KFx is provided below:

Air Emission Standards. The Clean Air Act of 1970, as amended in 1990 (the “Clean Air Act”), has been the primary historical stimulus for the developing United States market for beneficiated clean coal fuel products, such as K-Fuel^™. A number of regulations issued under the Clean Air Act have the potential for driving the demand for our products. Among other things, the Clean Air Act requires reductions in acid rain precursor emissions (sulfur dioxide (“SO₂”) and nitrogen oxide (“NOx”)) from existing sources, particularly large, older power plants that were exempted from certain requirements of the Clean Air Act. Specifically, beginning January 1, 2000, NOx emissions from utilities are to be reduced by an additional 15% or 900,000 tons per year beyond the 1.2 million tons per year required by EPA in its 1995 rule. According to EPA, electric utilities are a major contributor to NOx emissions nationwide and approximately 90% of electric utility NOx is from coal-fired plants. EPA’s 2000 rule targets dry bottom wall-fired burners, wet bottom boilers, cyclones, cell burner boilers, and vertically fired boilers. The SO₂ requirements were structured in two phases, with Phase I beginning in 1995 and Phase II, which began in 2000. As in the case of NOx emissions, the SO₂ rules have tightened the annual limits on the large plants, and set restrictions on smaller, cleaner plants and all new plants. In addition, the SO₂ rules provide for stringent caps on emissions, but permit trading SO₂ emissions.

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Acid Rain Program. Title IV of the Clean Air Act established an innovative emissions trading program (the “Acid Rain Program”) to achieve reductions of SO₂ from fossil-fuel fired electric utility boilers. Under this program, existing electric generating units subject to the program are allocated “allowances”; each allowance equals a right to emit one ton of SO₂. New units generally must acquire allowances from the market. Each year, facilities are required to hold allowances equal to their SO₂ emissions. The program now encompasses over 2,500 fossil-fuel fired electric generating units at 1,000 plants. Although the ultimate impact of the implementation of the Acid Rain Program on the demand for K-Fuel^™ technology is not clearly determinable, management believes the program will create demand for KFx’s technology.

Our United States marketing emphasis is directed primarily at electric utilities under EPA scrutiny located in the industrial Midwest and Eastern states. In these states there are approximately 300 utility-operated coal-fired boiler units with each having a power generation capacity of 200 MW or greater. The combustion characteristics of cyclone furnace boilers, a common boiler type used by Midwestern utilities, are particularly well suited to the K-Fuel^™ product manufactured from Powder River Basin (“PRB”) coal.

In addition to marketing our product to the electric utility industry, we believe K-Fuel^™ could be marketed to manufacturers and other large-scale industrial coal users that are either subject to the NOx and SO₂ provisions of the Clean Air Act or that desire to improve their fuel combustion performance. Fuel combustion performance is becoming more important because of the need to cut costs and become more efficient in an increasingly competitive market environment.

NOx SIP Call. In 1998, the United States Environmental Protection Agency (“EPA”) issued a final rule, as amended in 2000, requiring certain states and the District of Columbia to revise their state implementation plans in order to achieve a significant reduction in emissions of “NOx” (the “SIP Call”). NOx is a primary component in ground-level smog and is also a contributor to acid rain. State plans developed to date have relied on achieving significant reductions from coal-fired electric utility power plants and the use of emissions trading. Although the SIP Call has survived a number of legal challenges, its complete implementation remains uncertain. Regardless, because full implementation is highly likely, compliance with the SIP Call requirements is expected to require a significant investment in emission control technologies.

Based on the results of a February 1999 commercial burn, fuel made using K-Fuel^™ technology can reduce NOx emissions (when using PRB coal as the feedstock) as compared to typical eastern coals by levels approximating 25%. We believe we are in a unique position to assist the electric power

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generation industry in achieving required reductions in NOx more cost effectively than various other solutions, some of which are highly capital intensive and also can add significant operating costs.

Revised National Ambient Air Quality Standards. In 1997, the EPA adopted a new national ambient air quality standard (“NAAQS”) to address emissions of fine particulate matter and also tightened the NAAQS for ozone. Although the revised fine particulate matter and ozone NAAQS were ultimately upheld, legal challenges to the standards have delayed their implementation. Once these regulations are effective, states will be required to revise their implementation plans to achieve attainment with the revised standards, which plans are likely to require additional emission reductions from facilities that are significant emitters of ozone precursors (such as NOx) and fine particulates (including NOx and SO2).

Greenhouse Gases. Carbon dioxide (“CO2”) is widely considered to be a primary component of greenhouse gases that have given rise to worldwide concerns of global warming. Global warming continues to be a concern and remains a policy issue that is regularly considered for possible government regulation. A very important by-product of the efficiency gains at electric power generation boiler units achievable through the use of K-Fuel^™ is a corresponding reduction in the level of CO₂. While we are not able to predict the likelihood of potential regulation of greenhouse gases, the impact of continued initiatives in this area should be positive on the demand for K-Fuel^™.

Hazardous Air Pollutants. On December 20, 2000, the EPA determined that it would regulate emissions of hazardous air pollutant emissions from coal and oil-fired electric utility steam generating units by designating these units as a source category under Section 112 of the Clean Air Act. The EPA has proposed regulations regarding mercury and to the extent necessary, other hazardous air pollutant emissions from electric utility steam generating units. Final regulations are proposed to be effective by December 15, 2004. According to a March 2003 report by Black & Veatch, an engineering and consulting firm, K-Fuel^™ provides an effective pre-combustion mercury reduction technology. According to this independent research, a significant level of mercury is removed from run-of-mine coal during the K-Fuel^™ production process. Based on these test results, if the EPA adopts regulations to restrict the level of mercury emissions, K-Fuel^™ may offer significant competitive advantages over other high-energy value coals.

Clear Skies Act. The Clear Skies Act was introduced in both Houses of Congress in February 2003. In the United States, power generation is responsible for 63% of SO_2, 22% of NOx and 37% of mercury released to the environment by human activity. To more effectively address the problems caused by power generation, EPA asserts a need for a national program and Clear Skies is such a national program. If approved, the Clear Skies Act would impose new strict mandatory emissions caps on SO₂ , NOx and mercury. Significant provisions of the proposed Clear Skies Act include:

The impact that current and more stringent laws and regulations, such as the NOx SIP Call, more stringent particulate matter and ozone national ambient air quality standards, regulation of mercury emissions and further limitations on NOx and SO₂ emissions that are contemplated in potential amendments to the Clean Air Act may have on the demand for K-Fuel^™ is not clearly determinable. Although we believe that such regulations will create demand for this technology, it is also possible that

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such regulations may cause power generators or other industrial users of coal to switch to other fuels, thus reducing the potential size of our market and our domestic growth opportunities.

International Market

The international coal-fired power generation industry is approximately four times the size of the United States coal-fired power generation industry. Our objective, with respect to international opportunities for K-Fuel^™, is to concentrate on markets where there is either a significant need for more energy efficient and environmentally responsible fuel products, or where abundant lower grade coal reserves can be utilized in conjunction with the K-Fuel^™ technology to develop a value-added export product. The principal benefit of the K-Fuel^™ technology in foreign markets is that low-rank indigenous coal reserves can be upgraded to provide a more cost effective and less environmentally damaging fuel source for power producers, manufacturers and households, either for internal markets or for export.

The KFP Facility

In August 1995, we and Thermo Ecotek Corporation, acting through respective wholly-owned subsidiaries, formed KFx Fuel Partners, L.P., a Delaware limited partnership and began the construction of a 500,000 ton per year K-Fuel^™ production facility (the “KFP Facility”) near Gillette, Wyoming, using our Series “C” Technology. We owned a 5% interest in KFx Fuel Partners, with the remaining 95% owned by Thermo Ecotek. The KFP Facility operated and produced commercially salable K-Fuel^™ in 1998 and 1999. The KFP Facility experienced certain problems relating to tar and fines residue build-up within the system during production and product quality issues related to product dusting. On May 24, 1999, Thermo Ecotek announced that in connection with certain strategic restructuring decisions it had decided to sell its interest in the KFP Facility. In June 1999, Thermo Ecotek suspended all K-Fuel^™ production at the KFP Facility. We have sold our interest in the KFP facility to Thermo Ecotek Corporation and accordingly, we have no ownership interest in the KFP Facility and have no further obligation to fund any capital or other costs. In September 2002 the major equipment at the KFP Facility was purchased by a third party and removed from the site.

K-Fuel LLC

In April 1996, we entered into a joint venture agreement (the “K-Fuel LLC Agreement”) with a wholly-owned subsidiary of Kennecott. The joint venture, a Delaware limited liability company named K-Fuel LLC, was intended to be the vehicle for further technical advancement and the commercialization of business opportunities arising out of the K-Fuel technology, including research and development, sublicensing, marketing and consulting, but not including the construction of facilities to produce K-Fuel^™ products on a commercial basis (“Commercial Projects”). Worldwide exclusive licenses for all of the K-Fuel^™ technology were granted to K-Fuel LLC. Commercial Projects will be constructed by KFx or separate entities, which will be granted a sublicense from K-Fuel LLC for the K-Fuel^™ technology. Under the Equity Exchange of Pegasus and K-Fuel LLC, KFx now owns 100 percent of K-Fuel LLC and the related technologies.

Research and Development

Over the years KFx has obtained patents for several versions of the K-Fuel^™ technology using a variety of methods to apply heat and pressure to beneficiate high moisture coal feedstocks. We have three series of primary patents related to the K-Fuel^™ technology. The initial series, Series “A” and Series “B” Technology patents, were based on hot gas and steam heat-transfer media, respectively, in direct contact with the feedstock for heat transfer and beneficiation. The second series, the Series “C” Technology patents are based on a nitrogen gas atmosphere combined with an indirect hot-oil heat transfer system medium and use a simplified design with respect to the manufacturing equipment and facilities, resulting in lower capital costs. Our joint venture with Kennecott and K-Fuel LLC developed further improvements

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to coal beneficiation technology, including continuous operations and lower processing temperature and pressure during the process. We refer to the improvements made in the Series “C” Technology as K-Fuel Plus^™, our third series of primary patents, which is expected to be used in future K-Fuel^™ manufacturing facilities. Further research may result in viable improvements to one or more of the three patent series. We are currently focusing our commercialization efforts on the development of projects for the manufacture of coal fuel product using the Series “C” and K-Fuel^™ Plus technology. Although the Series “A” and “B” Technology patents are approaching expiration, because these patents covered earlier versions of the technology, we do not believe that expiration of the patents will have a material adverse effect on us or the value of the Series “C” Technology due to the superior performance observed by employing the Series “C” Technology and the K-Fuel LLC improvements.

We have patents or patent applications for the K-Fuel^™ technology registered in the United States and in over 40 foreign countries. These include applications for patents developed by us and seven patents and patent applications developed by K-Fuel LLC. We have assigned the seven United States counterparts to K-Fuel LLC. All licensing rights to the K-Fuel^™ technology are property of K-Fuel LLC.

In late 2000, we demonstrated the K-Fuel^™ process and K-Fuel Plus^™ technology using PRB coal, which typically has the lowest mercury content of any naturally available coal. Analysis of the K-Fuel Plus^™ product produced during the demonstration indicated that the K-Fuel Plus^™ process produced lower amounts of SO₂, NO_X, mercury and chlorine than was produced by untreated PRB coal. Analysis of this demonstration also indicates that an improved process could be designed to produce improved K-Fuel^™ within potentially attractive economic constraints, with improved reliability and have lower capital and operating costs than any previous K-Fuel^™ plant design. The BTU value of the K-Fuel Plus^™ product tested was approximately 11,200 to 11,600 BTU’s per pound. Upon combustion, the K-Fuel Plus^™ product produced approximately 20% lower NO_X emissions and lower mercury emissions, as compared to untreated PRB coal and SO₂ emissions, well below the 1.0 lb per million BTU limit contained in Phase II of the Clean Air Act.

We are pursuing the possible advantages of blending the K-Fuel Plus^™ product and untreated PRB coal. The dust and self-heating behaviors of this blend of K-Fuel Plus^™ and untreated PRB coal appear to be similar to untreated PRB coal, without the need for oil or other treatment, as was the case in the Series C product. The NO_X, SO₂ and mercury reduction benefits of this blend can be adjusted by moderating the amount of K-Fuel Plus^™ product added to the blend. Therefore, a commercial plant for the new product may be leveraged to provide considerably higher volumes of blended product for the market place.

During the years ended December 31, 2003, 2001 and 2000, our K-Fuel^™ Demonstration Plant research and development costs were approximately $321,000, $230,000 and $221,000, respectively. In addition, relating to the initial development of our K-Fuel^™ Production Plant and related processes, we incurred approximately $1,295,000 of general engineering and design costs during 2003.

Licenses and Royalty Agreements

We have granted certain rights and limited licenses for the use of different versions of the K-Fuel^™ technology to the following parties: (i) the party that purchased the KFP Facility (Series “C” Technology), (ii) K-Fuel LLC (Series “C” Technology and subsequent improvements), (iii) Kennecott (Series “C” Technology and subsequent improvements), (iv) Heartland Fuels Corporation (Series “A” and “B” Technologies), and (v) certain investors (the “Investors”) who entered into five separate transactions for common stock and warrants during the period March 28, 2002 through August 21, 2002 (Series “C” Technology and subsequent improvements).

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A predecessor entity of KFx acquired the Series “A” and “B” Technologies from Mr. Koppelman, the inventor of the K-Fuel^™ technology, and other investors (the “Koppelman Group”) in 1984 for $10 million in cash and a royalty agreement. In June 1996, we entered into a royalty amendment agreement with Mr. Edward Koppelman. As a result of the amended agreement, Mr. Koppelman’s estate is now entitled to a royalty of 25% of our worldwide royalty and license fee revenue. The royalty to Mr. Koppelman’s estate will cease when the cumulative payments to him reach the sum of approximately $75,222,000. As consideration for the royalty amendment agreement, in June 1996, we paid Mr. Koppelman $300,000 cash and issued a promissory note for $200,000; see Note 7 to the consolidated financial statements. The resulting $500,000 prepaid royalty is amortized as licenses to K-Fuel^™ technology are sold. Also as part of the royalty agreement, Mr. Koppelman indemnified us for any claims made by the Koppelman Group. During 2001, we reacquired the 12% patent interest held by the State of Wyoming for a cash payment approximating $1,162,000.

The third parties set forth in the table below are entitled to share in the royalty and licensing revenues received by KFX. These licensing and royalty revenues are a small percentage of the gross revenues received from the sale of K-Fuel production. The following table illustrates our royalty obligations with respect to these parties expressed as a percentage of the gross revenues from the sale of K-Fuel production (the percentages shown below assume a 3 percent royalty payment to KFx for K-Fuel production sales which is the typical percentage used in recent negotiations and agreements):

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Material Relationships

Effective January 2, 2003, we signed an exclusive business development and intellectual property rights agreement with Lurgi South Africa (Pty) Limited (“Lurgi”) to combine the K-Fuel^™ technology with Lurgi’s technical services and equipment to beneficiate low-grade coal into clean, high-BTU K-Fuel Plus^™. We expect this relationship to accelerate the commercialization of K-Fuel^™ and significantly improve the economics of future plants. Existing Lurgi gasification equipment will be modified using our proprietary technology to produce K-Fuel^™. We believe that Lurgi’s 50 plus years of experience in designing and building coal processing plants, including more than 450 process plants and equipment installations since the first unit was constructed in 1927, add significant expertise to the commercial implementation of the K-Fuel^™ process. Lurgi is providing, under a related professional services agreement, the engineering, design, and project management services for the process portion of the K-Fuel^™ plant currently being fabricated.

Competition

We believe that there are no competitors producing significant commercial quantities of beneficiated clean coal fuel products either in the United States or international markets. However, there are other clean coal technology (“CCT”) companies, primarily in the United States, that are developing fuel combustion and product technologies that would reduce emission pollutants and/or increase the heat value of coal feedstock fuel sources. Many of these CCT competitors have greater financial, technical and operational resources than us. We believe none of these other efforts have yet resulted in an economically viable and commercially acceptable beneficiated coal product with the economic and commercial potential of K-Fuel^™. Potential customers may choose to install pollution control equipment to reduce or remove the emissions from the coal supplies they are currently burning. This could include flue gas desulfurization and cleanup equipment (scrubbers), selective catalytic reduction, fabric filters and/or baghouses, electrostatic precipitators, and electro catalytic oxidation. K-Fuel^™ also competes with naturally occurring high-Btu coal and with other fuels for electrical generation, including oil, natural gas, nuclear power and wind. Most of the producers of these fuels are much larger than we are in terms of capital, revenue and access to financial markets. While current trends in prices for these competing energy sources improve the viability of our K-Fuel^™ product, there can be no assurance these trends will continue.

Government And Environmental Regulation

The activities involved in generating electricity from coal include mining, transport to power plants and burning of the coal in power plants. Initially, coal is extracted from surface or underground mines and, then is often cleaned or washed at the coal mine to remove impurities before it is transported to the power plant. Finally, at the power plant, coal is burned in boilers to produce steam and the steam is funneled through a turbine to generate electricity. The K-Fuel^™ technology may not be involved in all

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aspects of generating electricity from coal since the “beneficiating process” transforms already mined coal to low moisture content coal, thereby, reducing certain harmful emissions.

In the United States, the K-Fuel^™ product is not expected to be subject to unusual levels of local, state or federal regulation with respect to its transportation and distribution. However, any future United States production plants will require numerous permits, approvals and certificates from appropriate federal, state and local governmental agencies before construction of each facility can begin, and will be required to comply with applicable environmental laws and regulations (including obtaining operating permits) once facilities begin production. The types of permits that are typically required for commercial production facilities include an operating and construction permit under the Clean Air Act, a wastewater discharge permit under the Clean Water Act, and a treatment, storage and disposal permit under the Resource Conservation Act. Some of the federal programs have been delegated to the states and, as a result, facilities may be required to secure state permits. Finally, the construction of new facilities will likely trigger federal or state action and; therefore, will require review under the National Environmental Policy Act (NEPA) or a state equivalent.

Future international K-Fuel^™ production plants will also be subject to various permitting and operational regulations specific to each country. Generally, environmental permitting and operating regulations in countries outside the United States that we are currently pursuing for international development are not as stringent as those that are within the United States. Nevertheless, international initiatives, such as the Kyoto Protocol, are expected to create increasing pressures on the electric power generation industry on a world-wide basis to reduce emissions of various pollutants, which management expects will create additional demand for its products and services.

Employees

At March 8, 2004, we had approximately 12 full-time employees. We consider our relations with all employees to be good.

Risk Factors

We have a history of losses, deficits, working capital deficits and negative operating cash flows.

At December 31, 2003, we had working capital of approximately $21.2 million and an accumulated deficit of approximately $118 million. At December 31, 2003 we had a stockholders’ equity of approximately $31.1 million. In prior years, the Company had significant accumulated deficits and working capital deficits. We incurred net losses from continuing operations of approximately $10.2 million, $18.4 million, and $11.1 million in 2003, 2002, and 2001, respectively. We have experienced negative operating cash flow of approximately $6.9 million, $4 million, and $6.7 million in 2003, 2002 and 2001, respectively. Further, the report from our former independent accountants for the year ended December 31, 2001 contained an explanatory paragraph regarding our ability to continue as a going concern. We have not yet achieved significant K-Fuel^™ licensing, royalty or product sale revenue.

We expect to incur significant additional operating losses and continued negative cash flows from operations at least through 2004. We have made, and will continue to make, very significant expenditures well before our revenues increase sufficiently to cover these additional costs. We are not able to estimate when, if ever, our revenue will increase sufficiently to cover these costs. Further, we may not achieve or maintain profitability or generate cash from operations in future periods.

As a result, we have been and continue to be very dependent on strategic relationships and sales of our debt and equity securities to fund the operating costs associated with our business. Our continuation is dependent on our ability to utilize existing resources and to generate sufficient cash flows to meet our obligations on a timely basis, to obtain financing or refinancing as may be required, to attain

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profitability, or a combination thereof. A lack of adequate financing may adversely affect our ability to respond to changing business and economic conditions and competitive pressures, absorb negative operating results, and fund capital expenditures or increased working capital requirements.

We have contractual limitations on our ability to secure additional funding.

Our ability to secure additional financing is limited by the terms of a common stock and warrant purchase agreement for the sale of 6.76 million shares of common stock in 2002. Under the terms of this agreement and a related investors rights agreement we are prohibited from selling and issuing any of our preferred stock until the investors no longer hold any shares of common stock or warrants, or obtain a waiver to sell and issue preferred stock from at least two-thirds of these investors. The terms of this agreement have subsequent dilutive offering protections that are triggered if we sell common stock at a price below $2.50 per share. The investors under this common stock and warrant purchase agreement also have the first right of purchase related to potential sales of our common stock until August 21, 2004.

Technical and operational problems may adversely impact our ability to develop K-Fuel^™ projects or facilities.

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

The K-Fuel^™ technology has not yet shown economic viability.

We have only recently finished the development of the current K-Fuel^™ technology. Our future success depends upon our ability to successfully construct and operate commercial K-Fuel^™ production facilities.

The process of developing, financing and constructing K-Fuel^™ production facilities, including obtaining necessary regulatory permits and approvals, is complex, lengthy and costly and subject to numerous risks, uncertainties and factors beyond our control, including cost overruns, delays, damage and technical delays. In addition, local opposition to a particular project can substantially increase the cost and time associated with developing the project, and can, potentially, render a project unfeasible or uneconomical. Future projects for the development of K-Fuel^™ production facilities may incur substantial costs or delays or may be unsuccessful as a result of such opposition.

Only a small percentage of the potential projects that are considered and pursued may ultimately result in operating plants that are sufficiently successful to provide us with project revenues and equity

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participation income, license fee income, and royalty fee income. As a result, we may not be able to recover any expenses that we incur in the evaluation and development of certain projects.

The market for the K-Fuel^™ technology and products is unclear.

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

Deregulation in the United States power industry may result in increased competition for our products.

We expect that deregulation in the United States power industry will result in utilities and other power generators placing a high emphasis on reducing costs in their operations. This situation may, in turn, result in increased competition from other producers of beneficiated coal products, other clean fuel sources, and other products, services and technologies designed to provide environme