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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------
FORM 10-K
For Annual and Transition Reports
Pursuant to Sections 13 or 15(d)
of the Securities Exchange Act of 1934
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
[NO FEE REQUIRED]
For the fiscal year ended September 30, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
[NO FEE REQUIRED]
For the transition period from .............. to ..............
Commission file number 0-27803
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COVOL TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 87-0547337
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3280 North Frontage Road
Lehi, Utah 84043
(Address of principal executive offices) (Zip Code)
(801) 768-4481
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Covol Technologies, Inc. Common Stock, $.001 par value
(Securities are traded on the OTC Bulletin Board under the symbol "CVOL")
Indicate by check mark whether the registrant: (1) has filed
all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days. Yes X No ___
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K [ ].
The aggregate market value of the voting stock held by non-
affiliates of the registrant on December 1, 1996 was $101,167,500.
The number of shares outstanding of each of the registrant's
classes of common stock as of December 1, 1996 was 8,895,542.
-----------------------------------
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following documents are incorporated herein by reference:
None.
TABLE OF CONTENTS
Page
PART I
ITEM 1. BUSINESS................................................. 1
ITEM 2. PROPERTIES............................................... 14
ITEM 3. LEGAL PROCEEDINGS........................................ 15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...... 17
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS..................................... 17
ITEM 6. SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA......... 20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.................... 23
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA............. 28
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE................. 28
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT...... 28
ITEM 11. EXECUTIVE COMPENSATION.................................. 31
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT.......................................... 38
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.......... 41
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, AND REPORTS ON
FORM 8-K................................................ 43
2
PART I
ITEM 1. BUSINESS
The Company
The primary business of Covol Technologies, Inc. (the
"Company") is to commercialize patented and proprietary technologies used to
recycle waste by-products from the coal and steel industries into a marketable
source of fuel and revert materials in the form of briquettes (the "Briquetting
Technology"). The Company has three plants, consisting of one prototype
briquetting plant and two commercial plants. The prototype briquetting plant,
located in Price, Utah, was built in 1992 and has produced commercial quantities
of coal, coke and revert material briquettes. The Company has two commercial
briquetting plants, one coke and revert material plant which produces coal, coke
and revert material products, located in Vineyard, Utah (referred to herein as
the "Geneva Plant"), and one synthetic coal plant, located in Price, Utah
(referred to herein as the "Utah Plant"). The Geneva Plant is operational,
however the primary contract for the sale of briquettes expired on December 31,
1996. See "BUSINESS--Business of Company--Geneva Plant. The Utah Plant is also
operational, and commenced commercial operations in December of 1996. The
Company is in the process of attempting to secure financing for additional
plants which will utilize the Briquetting Technology. See "BUSINESS--PacifiCorp"
and "BUSINESS--Gallagher."
The Company was originally incorporated in Nevada in 1987
under the name Cynsulo, Inc. In 1988 the Company consummated an initial public
offering of its common stock in Nevada in which the Company sold 200,000 shares
for $20,000. At the time of such public offering, the Company was engaged in no
material business activities. In December 1988, the Company acquired all of the
issued and outstanding shares of McParkland Corporation ("McParkland") and
changed its name to McParkland Properties, Inc. McParkland invested in
discounted notes and contracts through the Federal Deposit Insurance
Corporation. In 1989, management became aware of certain irregularities relating
to the original purchase of two loan packages. As a result of an investigation
conducted by management, the purchase of McParkland was rescinded in February
1990, and the Company's name was changed to Riverbed Enterprises, Inc. In
August, 1990, the Company's focus was changed to the growing and marketing of
certain agricultural products, primarily alfalfa. In 1991, the Company acquired
technology regarding binding agents used to make briquettes. The Company shifted
its focus to the research and development of better and stronger binding agents
which resulted in patenting the Briquetting Technology. The Company then changed
its focus from its agricultural business and devoted its primary efforts to the
development and commercialization of the Briquetting Technology. The Company's
name was changed to Enviro-Fuels Technology, Inc. in July 1991, to Environmental
Technologies Group International in 1994, and to Covol Technologies, Inc. in
August 1995, at which time the Company was reincorporated in Delaware.
In order to generate cash flow to support research and
development for the Briquetting Technology, in 1993, the Company acquired three
construction companies engaged in providing contracting and construction
services to the steel, copper and other heavy industries. The companies were
Industrial Management and Engineering, Inc. ("IME"), State Incorporated
("State") and Central Industrial Construction, Inc. ("CIC"). Additionally, in
1994, the Company acquired Larson Limestone Company, Inc. ("Larson"), which
mines, produces and markets limestone products for industrial applications. IME,
State, CIC and Larson are collectively referred to as the "Subsidiaries."
In September 1995, the Company made a strategic decision to
focus its efforts exclusively on commercializing the Briquetting Technology and
to divest itself of its Subsidiaries. Accordingly, on February 1, 1996, the
3
Company entered into a Share Purchase Agreement ( the "Agreement") with Michael
McEwan and Gerald Larson, former principals of the Subsidiaries (the "Buyers"),
to sell all of the common shares of the Subsidiaries to Buyers for a $5,000,000
promissory note (the "Note"). Mr. McEwan is the son of Lloyd C. McEwan, a former
director of the Company. The Note is collateralized by 100,000 shares of stock
of the Company owned by Buyers and is payable together with interest at 6% per
annum as follows: interest only for the first year payable on or before January
31, 1997; principal and interest are payable annually with the Note amortized
over a fifteen year period commencing February 1, 1997 with the first payment
due January 31, 1998; and all unpaid principal and interest payable January 31,
2000. The Company will have voting control over the shares securing the Note
until the Note has been paid. The Company agreed to make a capital contribution
to the Subsidiaries in the amount of approximately $3,500,000 to pay down
accounts payable, accrued liabilities and lines of credit of the Subsidiaries.
The Company paid the $3,500,000 required to close under the Agreement and closed
on September 26, 1996. There have been continuing discussions regarding accounts
payable in an amount estimated at between $300,000 and $650,000 that were not
apparent at the time the Agreement was entered into. The Company has accrued
$650,000 in the September 30, 1996 financial statements. In addition, the Buyers
have verbally committed to pledge an additional 100,000 shares of stock of the
Company owned by Buyers to secure payment of the Note. The Company expects to
reach final settlement with the Buyers by January 31, 1997. There is no
assurance that the Company will be able to finalize all matters relating to the
sale by January 31, 1997. The terms of the Agreement were arrived at by arm's
length negotiations between the parties and approved by the nonaffiliated
members of the Board of Directors and the stockholders of the Company.
Effective January 1, 1994, the Company changed its fiscal
year-end from December 31 to September 30. Effective June 14, 1995, the Company
implemented a one-for-twenty reverse stock split. Effective January 23, 1996 the
Company implemented a two-for-one forward stock split. Except as otherwise
indicated, all information set forth herein has been adjusted to give effect to
such stock splits.
The Company is dependent on raising sufficient capital to
finance its expansion plans and working capital requirements until October 1997.
The Company intends to finance its capital needs through the receipt of down
payments on the sale of future plants, license fees and royalties from the sale
of its first full scale briquetting facility and from commercial loans and
equity placements. No assurances can be made that the Company will be able to
raise sufficient capital or operate profitably.
Business of Company
The Company has developed the Briquetting Technology to
recycle waste by-products from the steel and coal industries into a marketable
source of fuel and revert material in the form of briquettes. During the
steel-making process, steel mills produce, among other waste by-products, revert
materials (small particles containing iron-rich materials). Coke breeze is a
very fine residue resulting from the production and storage of coke, a coal
derivative used in the steel making process. During the coal mining process,
coal fines (small coal particles ranging from dust size to less than 1/4" in
diameter) are produced. These waste materials have historically presented a
disposal problem for steel and coal producers, who may incur substantial costs
in complying with federal and state environmental laws and regulations relating
to their storage and disposal.
The Briquetting Technology employs pressure and chemical
agents to bind coke breeze, coal fines and other revert materials into
briquettes. The coke and coal briquettes produced through use of the Briquetting
Technology are suitable for industrial and commercial use and are comparable to
high grade newly-mined coal and formed coke. The revert material briquettes
4
produced through use of the Briquetting Technology are further processed in
reducing furnaces to reclaim iron and other materials. The revert processed
through use of the Briquetting Technology is comparable to scrap iron, a common
form of raw material used by the United States steel-making industry (as opposed
to newly-mined iron ore). The Company believes that its coke and coal briquettes
and reclaimed iron can be produced and marketed at prices which are competitive
with newly-mined coal, formed coke and other sources of scrap iron. Moreover,
the Company believes that the Briquetting Technology will be attractive to steel
and coal producers in addressing the environmental issues surrounding the
disposal of waste by-products generated in the production process.
The Company's fundamental business strategy has been to
commercialize the Briquetting Technology through joint ventures, licenses and
collaborative arrangements with steel, coke and coal producers or investors to
build and equip briquetting plants on-site at the producers' facilities.
Geneva Plant. In May 1995, the Company entered into a
collaborative agreement with Geneva Steel Company ("Geneva") to build and
operate a commercial briquetting plant in Vineyard, Utah defined above as the
Geneva Plant. That agreement was amended and restated in May, 1996. Pursuant to
the Amended and Restated Briquetting Services Agreement and Lease Agreement with
Geneva (collectively, the "Geneva Agreements") Geneva has provided the Company
with a building containing approximately 9,000 square feet. The Company equipped
the building to serve as a coal, coke and revert material briquetting plant. The
Company estimated that the Geneva Plant's initial capacity was 15 tons of
briquettes per hour or approximately 100,000 tons per year. Geneva provided the
Company with revert materials and the Company was obligated to produce and
deliver to Geneva briquettes conforming to agreed-upon specifications and in
agreed to quantities. Geneva bears all transportation costs with respect to
delivery of revert materials to the Geneva Plant and the shipment of briquettes.
Pursuant to the Geneva Agreements, the Company began producing briquettes in May
1996, and produced approximately 24,600 tons of revert briquettes by December
31, 1996 at the Geneva Plant. The Company has made various adjustments and
improvements to the plant to satisfy emissions and air quality standards
administered by the Utah State Division of Air Quality. Although the Geneva
Agreements expired on December 31, 1996, the Company continues to produce
briquettes for purchase by Geneva. Upon the expiration of the Geneva Agreements,
the lease of the building housing the plant also expired resulting in a
tenancy-at-will between the parties.
Limited Partnerships. In June 1996, the Company formed Utah
Synfuel #1, Ltd. ("Utah Synfuel #1") and Alabama Synfuel #1, Ltd. ("Alabama
Synfuel #1"), each a Delaware limited partnership (collectively the
"Partnerships"). The respective Partnerships are intended to (i) purchase a
nonexclusive license from the Company for the Briquetting Technology, (ii)
purchase a coal briquetting facility from the Company and (iii) sell such
facility to a third party purchaser. Utah Synfuel #1 intends to purchase the
coal briquetting Utah Plant and Alabama Synfuel #1 intends to purchase the coal
briquetting Birmingham, Alabama plant (the "Alabama Plant"). The Company will
grant to each of the Partnerships a non-exclusive license to use the Briquetting
Technology with respect to coal for a fee of $500,000 (totalling to $1,000,000).
The Company intends to retain at least a 60% interest in Utah Synfuel #1 and up
to an 83% interest in Alabama Synfuel #1. The Company has privately placed the
remaining partnership interests in the Partnerships. Specifically, the Company
received $3,277,500 ($3,080,000 at September 30, 1996) for the remaining
partnership interests in Utah Synfuel #1 and $1,762,500 ($1,305,000 at September
30, 1996) for the remaining partnership interests in Alabama Synfuel #1.
Notably, the Company is currently analyzing whether the original disclosure
provided to investors should be supplemented. The Company may decide to revise
the information in the original private placement memorandums for those
offerings, and may offer to such investors the opportunity to rescind their
purchases. If all such investors rescind, the Company would be required to pay
up to $5,040,000 ($4,385,000 at September 30, 1996) plus applicable interest
less the amount of income received thereon.
5
The Company has used a portion of the funds raised in the
Partnerships to purchase equipment for each of the plants. The Utah Plant has
been completed and commenced commercial operations in December of 1996. The
Alabama Plant is expected to be completed by June 1997. However, no assurances
can be made that the completion date for the Alabama Plant will be met.
The Company, as general partner for the Partnerships, is
currently negotiating transactions with potential buyers of the Utah Plant and
Alabama Plant, which is yet to be constructed or acquired. The Company believes
that the sale of the Utah Plant and Alabama Plant would include (i) a $500,000
sublicensing fee (which would be paid by the buyer to the Partnership in
exchange for the license of the Briquetting Technology), (ii) a royalty payment
to the Partnership based on per ton amount to be agreed on with the buyer, and
(iii) a promissory note delivered by the buyer in payment of the purchase price,
which would be payable to the Partnership from the cash flow of such plant. The
Company and Alabama Synfuel #1 have entered into a letter of intent with an
unregulated subsidiary of PacifiCorp, a large low-cost electric and telephone
utility, to sell the Alabama Plant to be constructed or acquired by Alabama
Synfuel #1, on substantially the terms listed above. See "BUSINESS--PacifiCorp"
for more information regarding the terms of the PacifiCorp letter of intent. The
PacifiCorp purchase transaction is subject to various conditions and no binding
agreement has been entered into. The Company and Utah Synfuel #1 have also
entered into a letter of intent with Arthur J. Gallagher & Co., an international
insurance brokerage and risk management services firm, to sell the Utah Plant,
to be acquired by Utah Synfuel #1 on substantially the terms listed above. See
"BUSINESS--Gallagher" for more information regarding the terms of the Gallagher
letter of intent. The Gallagher purchase transaction is also subject to various
conditions and no binding agreement has been entered into. No assurances can be
made that any of the plants being constructed or acquired by the Partnerships
will be sold.
Under the organizational documents of the Partnerships, the
Company is entitled to distributions from the Partnerships according to the
Company's percentage interest in the net distributable cash flow of the
Partnerships. The Company may also enter into loading agreements and operating
and maintenance agreements that would provide for payments directly from the
buyer of a plant. The binder materials used to produce the briquettes will
likely be sold to the buyer of a plant by the Company based on the Company's
cost plus an agreed upon percentage profit.
Greystone Joint Venture. In June 1995, the Company entered
into a license agreement (the "Greystone Joint Venture Agreement") with
Greystone Environmental Technologies, Inc. ("Greystone") to form a 50/50 joint
venture (the "Greystone Joint Venture") to commercialize and exploit the
Briquetting Technology for the production of coke and revert material
briquettes. The Greystone Joint Venture Agreement was amended on January 3,
1996. The Greystone Joint Venture has an exclusive world-wide license to
commercialize and exploit the Briquetting Technology for the production of coke
briquettes and a license to commercialize and exploit the Briquetting Technology
for the production of revert material briquettes in the Alabama and Gary,
Indiana regions. The Geneva Plant is not a part of the Greystone Joint Venture
or the Greystone Joint Venture Agreement.
The Greystone Joint Venture will be on a 50/50 basis, except
in the Gary, Indiana region where Greystone has a 12% interest in the entity
with an opportunity to increase its interest to a maximum of 20%. Greystone will
manage the Greystone Joint Venture on a day-to-day basis and the parties have
agreed to contribute the necessary capital to the Greystone Joint Venture in
proportion to their respective interests therein. The Greystone Joint Venture
will purchase all of its requirements for binding agents used in the Briquetting
Technology from the Company. Greystone is a newly-formed company, although its
principals have significant experience in the steel and coke production
industries.
6
In accordance with the Greystone Joint Venture Agreement,
Greystone made an initial payment of $100,000 to the Company, and was required
to make additional payments out of profits or capital of the Greystone Joint
Venture until a total aggregate of $500,000 had been paid to the Company for the
license. Greystone has failed to make the additional payments required under the
Greystone Joint Venture Agreement and, accordingly, has received notice that an
event of default has occurred thereunder. The Company believes that an uncured
event of default under the Greystone Joint Venture Agreement results in a
termination of the license.
As of December 1996, the Greystone Joint Venture has not
secured funding to proceed with the development and operation of any plants. The
Company believes that Greystone is continuing to seek funding.
Coal Venture. On January 30 1996, the Company entered into a
letter of understanding with CoBon Energy, L.L.C. ("CE"), a Utah professional
services company based in Salt Lake City, Utah, to form five entities to
commercialize and exploit the Briquetting Technology for the production of coal
briquettes (the "Coal Venture"). In August 1996, CE and the Company modified the
letter of understanding. Under the modified letter of understanding, the Company
has agreed to give CE a 1.6% interest in Alabama Synfuel #1, plus a license to
use the Briquetting Technology for specified plant locations up to an aggregate
capacity of 1.5 million tons of coal per year for each plant location. In
consideration for the interest in Alabama Synfuel #1 and the license, CE is
required to make a one-time payment of (i) $2.00 per ton for the production of
coal in the range of 500,001 to 1,000,000 tons and (ii) $2.50 per ton for the
production in the range of 1,000,001 to 1,500,000 tons. CE has not yet built any
plants which utilize the Briquetting Technology.
Business Strategy
Coke and Revert Material Briquettes. Subject to possible
termination of the license under the Greystone Joint Venture Agreement (as
explained above), the Company has agreed to exclusively market through the
Greystone Joint Venture the Briquetting Technology as it applies to coke. The
Greystone Joint Venture intends to market such technology to steel and coke
producers for the production of coke briquettes. The Company has also agreed to
exclusively market through the Greystone Joint Venture the Briquetting
Technology as it applies to revert material in the Gary, Indiana and Alabama
regions of the United States. With respect to the revert briquettes, the Company
may market the Briquetting Technology in other regions directly or through other
joint ventures or other arrangements. The Company, directly or through the
Greystone Joint Venture, will seek to enter into collaborative arrangements with
steel and coke producers to build, equip and operate briquetting plants on-site
at the producers' facilities. The Company believes that such arrangements will
benefit both the Company and steel and coke producers because they will (i)
provide the Company with an ongoing supply of inexpensive coke breeze and revert
materials while ensuring a ready customer for the briquettes produced, (ii)
provide the steel or coke producer with an economical means to dispose of waste
materials while providing a ready source of briquettes and/or iron feedstock,
and (iii) minimize transportation costs for waste by-products, raw materials and
briquettes, thereby increasing the economic competitiveness of the Company's
products.
The operations of the Geneva Plant will allow the Company to
show an operating on-site plant to assist in the establishment of other similar
sites throughout the United States. There is no assurance that such plant will
be profitable or that the Company, either directly or through the Greystone
Joint Venture, will be able to enter into comparable arrangements with other
steel and coke producers or to obtain the funding necessary to construct such
plants.
7
Coal Briquettes. The Company intends to build and place in
service plants which utilize the Briquetting Technology at or near coal fine
deposits. The Company intends to sell such plants to third parties. The Company
will license to each plant the use of the Briquetting Technology for a royalty
payment and will provide to each plant the binding agents. The contract will
provide that the payment for the binding agents will be at cost plus a mark up
to be negotiated between the plant owner and the Company. There is no assurance
the Company will be successful in funding the construction of the plants or in
operating any plants.
In June 1996, the Company formed Utah Synfuel #1 and Alabama
Synfuel #1, the Partnerships, which are intended to purchase, manage and sell
the coal briquetting Utah Plant and Alabama Plant. As described above, the
Company is conducting negotiations for the sale of these facilities by the
Partnerships. See "BUSINESS--Business of Company--Limited Partnerships." The
Company has retained brokers to locate potential buyers for plants that may be
constructed by the Company or its subsidiaries. See "BUSINESS--AGTC Brokerage
Disagreement." The Company has not entered into any binding agreements to sell
either the Utah Plant or the Alabama Plant.
The Company will not sell the Briquetting Technology but will
license it for use at each plant and contract with each plant to supply the
binding agents. The Company intends to contract with third party chemical
companies for the mixing and production of the binding agent. At the point at
which the Company has sufficient volume demand it intends to manufacture the
binding agent at a facility or facilities to be established.
Construction Agreements
In December 1995, the Company entered into a design and
construction agreement with Lockwood Greene Engineers, Inc. ("Lockwood") to
design and build the Utah Plant. The Company paid Lockwood an advance payment of
$500,000 on the facility on February 9, 1996. The total cost of the Utah Plant
to the Company is expected to be $3,600,000. Lockwood and the Company have
agreed to cooperate with each other in future projects by either party in the
field of coal agglomeration or metallic recovery. Also in December 1995, the
Company entered into additional contracts to design and build additional
facilities with Lockwood, each of which were subsequently terminated by the
Company in 1996 with all applicable cancellation charges either satisfied or
settled.
In December 1996, the Company entered into a total of thirteen
design and construction agreements (the "1996 Construction Agreements") for the
design and construction of eleven new coal fines agglomeration facilities and
the retrofiting of two existing facilities (the Utah Plant and Geneva Plant).
Depending upon the specific agreement, the contractor is either TIC The
Industrial Company, CEntry Constructors, L.C. or Centerline Engineering
Corporation, a Lockwood Greene Company. Under two of the 1996 Construction
Agreements, the Company is a joint owner with Ferro Resources, L.L.C. The 1996
Construction Agreements are subject to numerous conditions and no assurances can
be given that the Company will be successful in financing or constructing any of
the thirteen facilities. The 1996 Construction Agreements generally require that
a notice to proceed be issued by the Company (and its co-owner, if any) on or
before September 30, 1997 and that the plant be placed in service by June 30,
1998. An advance payment of $250,000 is due at the time a notice to proceed is
issued by the Company (and its co-owner, if any). The 1996 Construction
Agreements may be terminated at the Company's (and co-owner's, if any) option
with a penalty of 6% of the total contract price, if established, or the
guaranteed maximum price if the total contract price is not established. If the
Company is unsuccessful in obtaining financing or otherwise fails to construct a
facility, a penalty would be owed to the contractor. If this were to occur on
all thirteen facilities, the Company would be required to pay an aggregate
penalty of $3,012,000.
8
Indemnification to Lockwood
In December 1996, the Company entered into six indemnification
agreements with Lockwood whereby the Company agreed to indemnify Lockwood should
it be required to pay liquidated damages to certain third party owners under
various design and construction agreements for six coal agglomeration
facilities. Under the various design and construction agreements, if the
facilities are not completed by June 1, 1998 then $750,000 in liquidated damages
would be due and payable. The indemnification agreement will only apply if the
third party owners actually decide to build the facilities with Lockwood as the
design/builder. The maximum amount of contingent liability to the Company under
the indemnification agreements is $4,500,000 ($750,000 per design and
construction agreement). If triggered, the payments under the indemnification
agreements would not be due and owing until June 2, 1998.
PacifiCorp
In September 1996, the Company and Alabama Synfuel #1 entered
into a letter of intent with an unregulated subsidiary of PacifiCorp, a large,
low-cost electric and telephone utility, to purchase the coal briquetting
Alabama Plant that will be built and/or acquired by Alabama Synfuels #1. The
letter of intent generally provides for an entity designated by PacifiCorp to
purchase the Alabama Plant from Alabama Synfuel #1 (or to purchase Alabama
Synfuel #1's right to acquire the Alabama Plant) for a one-time $500,000
licensing fee, a promissory note in the amount of $3,400,000, that will be
payable out of the cash flow of the plant, and a per ton royalty fee. The
Company may retain up to an 83% interest in Alabama Synfuel #1 and would be
entitled to its percentage share of all cash distributed by Alabama Synfuel #1.
The letter of intent also provides for a convertible loan from
PacifiCorp to the Company in an amount up to $5,000,000. PacifiCorp would retain
a security interest in all of the assets related to the Alabama Plant. The loan
if made, may be convertible into Company common stock. The Company common stock
received upon conversion would be subject to piggy-back and demand registration
rights.
The obligations of PacifiCorp and its affiliates are subject
to PacifiCorp, the Company and Alabama Synfuel #1 entering into definitive
agreements. PacifiCorp will also require favorable tax rulings from the IRS and
completion of the Alabama Plant prior to consummating the purchase of the Plant.
The funding of the loan is subject to entering into the definitive agreements
and the filing of a request for tax rulings from the IRS, which the Company
believes will be complete by approximately January 31, 1997.
In December 1996, PacifiCorp and the Company entered into an
additional agreement for the construction of six additional facilities beyond
the Alabama Plant. Pursuant to this agreement, PacifiCorp has entered into
binding agreements with a third-party for the construction of the additional
facilities. Additionally, PacifiCorp has committed $250,000 per plant for a
total of $1.5 million to the entities through which PacifiCorp will build the
facilities. The commitment was made to facilitate the construction of the
facilities with the third-party. All of the facilities will utilize the
Briquetting Technology under license agreements with the Company. See
"BUSINESS--Recent Licensing Agreements."
Gallagher
In November 1996, the Company and Utah Synfuel #1 entered into
a letter of intent with Arthur J. Gallagher & Co., an international insurance
brokerage and risk management services firm, to purchase the Utah Plant that
will be acquired by Utah Synfuels #1. The letter of intent generally provides
9
for an entity designated by Gallagher to purchase the Utah Plant from Utah
Synfuel #1 (or to purchase Utah Synfuel #1's right to acquire the Utah Plant)
for $2,500,000 (payable upon the satisfaction of certain performance
conditions), a one-time $500,000 licensing fee and a per ton royalty fee that
will be payable out of the cash flow of the Utah Plant. The Company may retain
approximately a 60% interest in Utah Synfuel #1 and would be entitled to its
percentage share of all cash distributed by Utah Synfuel #1.
The obligations of Gallagher and its affiliates are subject to
Gallagher, the Company and Utah Synfuel #1 entering into a definitive agreement.
In December 1996, Gallagher and the Company entered into an additional
agreement to construct four additional facilities beyond the two plants
contemplated by the letter of intent. Pursuant to this additional agreement,
Gallagher entered into binding agreements with a third-party to construct the
additional facilities. All of the facilities will utilize the Briquetting
Technology under license agreements with the Company. See "BUSINESS--Recent
Licensing Agreements."
In December 1996, the Company entered into a Debenture
Agreement and Security Agreement with AJG Financial Services, Inc., an affiliate
of Gallagher, whereby the Company borrowed $1,100,000, and may, under certain
circumstances, draw down an additional amount of up to $2,900,000 (for a total
borrowed amount of $4,000,000). In consideration for the loan of $1,100,000, the
Company issued a Convertible Subordinated Debenture accruing interest at 6% per
annum and maturing three years from its date of issuance (the "Subordinated
Debenture"). The interest and principal of the Subordinated Debenture is payable
on maturity. The Company does not have the right to prepay any portion of the
principal of the Subordinated Debenture, and the Company is required to prepay
the Subordinated Debenture if a change in control of the Company occurs. All or
a portion of the unpaid principal due on the Subordinated Debenture is
convertible into Company common stock. The Subordinated Debenture is
subordinated and junior in right to all other existing indebtedness of the
Company which is not expressly pari passu with or subordinated to the
Subordinated Debenture. Finally, the Company has granted piggy-back and demand
registration rights to AJG Financial Services, Inc. for the Company common stock
issued upon conversion of the Subordinated Debenture.
On January 2, 1997, the Company borrowed $588,683 of the
$2,900,000 draw down amount described above. In consideration for the amount
drawn down, the Company issued a Senior Debenture in such amount accruing
interest at prime plus two percent (2%) and maturing three years from the date
of issuance (the "Senior Debenture"). The Senior Debenture is collateralized by
all real and personal property purchased by the Company with the proceeds of the
Senior Debenture. The proceeds of the Subordinated Debenture and the Senior
Debenture may be used to satisfy contractual obligations of the Company, for
working capital and to purchase equipment to be used to construct coal
briquetting facilities to be managed and/or sold by the Company or affiliates of
the Company.
Alabama Power Company
In April 1996, the Company entered into a sale and purchase
agreement for coal with Alabama Power Company. Under the agreement, the Company
has agreed to process coal into coal briquettes and to sell such briquettes to
Alabama Power Company at a base price per ton, plus or minus certain
adjustments, for a period of five years commencing on January 1, 1997. According
to the agreement, Alabama Power Company is required to purchase a base tonnage
of 250,000 tons per year until December 31, 1999. There are numerous conditions
and obligations to be performed by both parties prior to January 1, 1997 and on
an ongoing basis before coal briquettes are required to be purchased by Alabama
10
Power Company. Given the delays associated with the financing and construction
of the Alabama Plant, the Company is now in technical default under the
agreement. It is uncertain what actions Alabama Power Company will take, if any,
in response to the default.
Port Hodder
In September 1996, the Company entered into a purchase
agreement with E. J. Hodder and Associates, Inc. for the purchase of a certain
land leasehold interest and equipment consisting of a barge loading facility
servicing the Warrior River located at the Alabama Plant. The total purchase
price for the facility is $927,000 consisting of $342,000 in cash and $585,000
of Company common stock. The land lease commenced on September 1, 1996 and
expires on May 23, 1998 with rights to extend to May 23, 2006. The Company
intends to use the facility in connection with the operations of the Alabama
Plant.
K-Lee Supply Agreement
In September 1996, the Company entered into a supply agreement
with K-Lee Processing, Inc. and Concord Coal Recovery Limited Partnership for a
continuous supply of coal fines to the Alabama Plant. Under this agreement, the
Company is obligated to purchase a minimum of 20,000 tons of coal fines per
month, commencing upon the completion of the Alabama Plant and expiring on
December 1, 2001, at a fixed price per ton during the first year (subject to
adjustment for moisture and ash content) with an escalating price thereafter.
AGTC Brokerage Disagreement
In accordance with an April 1996 letter agreement between the
Company and AGTC, a partnership formed by AGTC, Inc., Alpine Coal Company, Inc.
and E. J. Hodder & Associates, Inc., AGTC was engaged by the Company on a best
efforts basis, to investigate, identify and participate in the selection of (i)
project sites for the construction of suitable coal extrusion manufacturing
facilities for the Company, (ii) suitable coal fines reserves and (iii) suitable
users or consumers of the coal product produced. The compensation for such
services consisted of a monthly retainer of $35,000 and a commission of 8% on
the gross sales or monetized price of a project. In the fourth month following
the execution of the letter agreement a dispute arose among the parties
regarding AGTC's performance and compensation due under the agreement.
Accordingly, the Company terminated the agreement pursuant to its terms. AGTC
subsequently claimed that it was entitled to a commission on the proposed sale
of the Alabama Plant. The Company, on the advice of counsel, believes that
AGTC's claim has no merit.
Savage Mojave
In November 1996, the Company signed a primary contract with
Savage Industries, Inc. ("Savage") to form up to two limited liability companies
("LLCs") to be owned 50% by Savage and 50% by the Company, with each LLC
entering into a contract with Savage, the Company and a qualified third party
contractor for the design, construction, start-up and certification of a coal
fines agglomeration facility. All profits and losses of the respective LLCs
shall be borne by Savage and the Company according to their respective ownership
interest. Savage has the right but not the duty to operate the facilities and to
provide transportation of the raw materials and the briquettes. The Company in
turn will (i) provide its license to the binding process (at no cost) and (ii)
provide the binder required to produce the briquettes on a cost plus basis.
Performance under the agreement is subject to numerous conditions, including,
but not limited to establishing a criteria for the design of such facilities and
satisfaction of the Section 29 Tax Credit provisions of the Internal Revenue
Code of 1986, as amended.
11
In November 1996, the Company also entered into an agreement
with Savage whereby the Company agreed (i) to license the Briquetting Technology
to a limited liability company, to be formed by Savage and Flyash Haulers, Inc.,
for a monthly licensing fee based upon each ton of qualified fuel produced, all
relating to a briquetting facility to be located in Laughlin, Nevada, (ii) to
provide, upon request, coal fines to the limited liability company, (iii) to
provide technical assistance to the limited liability company, and (iv) to
reimburse to Savage, from the monthly license fees, an amount equal to 16% of
the cash capital required to upgrade the Laughlin, Nevada facility. The Company
does not expect to receive monthly license fees until mid 1997. No assurances
can be made that Savage will be successful in the production and sale of
synthetic coal. The agreement expires by its terms on December 31, 2009.
Recent Licensing Agreements
In December 1996, the Company entered into agreements with
various third parties for the licensing of the Briquetting Technology. Such
third parties are not expected to construct the facilities utilizing the
Briquetting Technology until late calendar year 1997. While the Company may
receive some advance license fees,the Company does not expect to receive the
majority of the licensing fees from such agreements until the facilities have
been placed into operation. In addition, the Company will receive royalty
payments based on production and sales at the facilities.
The Briquetting Technology
The Company has developed a special binding formula, which
allows for the production of high-grade briquettes which withstand degradation
both during shipment and the burn cycle. In simplified terms, in the briquetting
process, the material to be briquetted may be washed to remove impurities. The
material is then mixed with the binding agent and fed into a briquetter, which
utilizes indirect pressure to combine the feed material into a briquette having
the desired shape, size and density. Briquettes are then air-cured to achieve
maximum strength. Waste coke breeze, coal fines and other revert material
discharged from the briquetter are also recaptured and recycled. Cured
briquettes are expelled onto a continuous belt for handling. The briquetting
process takes approximately two hours to complete.
Substantially all the equipment and machinery used in the
briquetting process are commercially available. The Company has arrangements
with certain manufacturers for the supply of a portion of the equipment and
machinery but there can be no assurance that the Company will be able to acquire
all necessary equipment and machinery on terms acceptable to the Company.
Proprietary Protection
The Company has received three United States patents and has
two United States patent applications pending (one of which received a notice of
allowance in October 1996) and two international patent applications under the
Patent Cooperation Treaty covering certain aspects of the Briquetting
Technology. There can be no assurance as to the scope of protection afforded by
the patents. Moreover, there are other industrial waste recycling technologies
in use and others may subsequently be developed, which do (or will) not utilize
processes covered by the pending patents. There can be no assurance that any
patent issued will not be infringed or challenged by other parties, infringe
against patents held by other parties or that the Company will have the
resources to enforce any proprietary protection afforded by the patent or defend
against an infringement claim.
In addition to patent protection, the Company also relies on
trade secrets and know-how and employs various methods to protect the
Briquetting Technology. However, such methods may not afford complete protection
12
and there can be no assurance that others will not independently develop such
know-how or obtain access to the Company's know-how, concepts, ideas and
documentation. Since the Company's proprietary information is important to its
business, failure to protect its trade secrets may have a material adverse
effect on the Company.
Research and Development
The Company has devoted significant research and development
efforts to the refinement and commercialization of the Briquetting Technology.
The Company's research and development expenses were approximately $387,000,
$1,265,000 and $1,044,000, respectively, in the nine months ended September 30,
1994, and the years ended September 30, 1995 and September 30, 1996. The Company
at the present time is developing other related technologies to implement in
steel mills and other mineral industries. In addition, the Briquetting
Technology is being refined to apply to the commercial operations in the Geneva
Plant.
Construction and Limestone Businesses
In order to generate cash flow to support research and
development for the Briquetting Technology, in 1993 the Company acquired IME,
State and CIC, three construction companies engaged in providing contracting and
construction services to heavy industry. In addition to the foregoing, in 1994
the Company acquired Larson, which provides limestone products for industrial
applications. The Company believes that the relationships between its
Subsidiaries and their customers assisted the Company in exploring and
developing relationships with steel producers in connection with the
commercialization of the Briquetting Technology.
The Company's construction and limestone businesses accounted
for substantially all of its revenues and cash flow during the nine months ended
September 30, 1994 and the year ended September 30, 1995.
In September 1995, the Company made a strategic decision to
focus its efforts exclusively on commercializing the Briquetting Technology and
to divest itself of its Subsidiaries. On September 26, 1996, the Company
substantially completed the divestiture of its Subsidiaries. See
"BUSINESS--Business of Company--General".
Government Regulation
General. The Company's present and proposed briquetting
operations are subject to federal, state and local environmental regulations
that impose limitations on the discharge of pollutants into the air and water
and establish standards for the treatment, storage and disposal of waste
products. In order to establish and operate its briquetting plants, the Company
will be required to obtain various state and local permits. The Company has
obtained all permits required to date, believes that it will be able to obtain
future permits without inordinate difficulty or expense and that it is in
substantial compliance with all material laws and regulations governing the
briquetting operations. The Company believes that environmental compliance for
its new briquetting plant at the Geneva facility will not entail significant
costs. However, the Company's briquetting operations may entail risk of
environmental damage and the Company may incur liabilities in the future arising
from the discharge of pollutants into the environment or its waste disposal
practices. See "ITEM 3--LEGAL PROCEEDINGS--Utah Division of Air Quality."
Failure to obtain necessary permits to construct and operate
future briquetting plants could have a material adverse effect on the Company,
and other developments, such as the enactment of more stringent environmental
13
laws and regulations, could require the Company to incur significant capital
expenditures. If the Company does not have the financial resources or is
otherwise unable to comply with such laws and regulations, such failure could
also have a material adverse effect on the Company.
The Company's construction and limestone products businesses
were also governed by extensive environmental and occupational safety laws and
regulations. The Company believes that it was in substantial compliance with all
such material laws and regulations while it owned the Subsidiaries. There can be
no assurance that failure to comply with applicable laws and regulations,
whether in existence or subsequently enacted would not have a material adverse
effect on the Company.
Tax Credit
Section 29 of the Internal Revenue Code of 1986, as amended
(the "Code") provides a credit (the "Section 29 Credit") against the regular
federal income tax, measured by unrelated party sales by a taxpayer of qualified
fuels, including solid synthetic fuel produced in the United States from coal,
the production of which is attributable to the taxpayer. Where more than one
person has an interest in a production facility, the Code provides generally
that the attributable production is determined by allocation among the
interested persons in proportion to their interests in gross sales.
In order to be a solid synthetic fuel produced from coal for
purposes of the Section 29 Credit, the produced fuel must differ significantly
in chemical composition, as opposed to physical composition, from the
alternative substance used to produce it. The Company has received a private
letter ruling from the Internal Revenue Service (the "Service") in which the
Service, based on representations made to it, agrees that the Briquetting
Technology, as explained to the Service, results in a significant chemical
change to waste coal fines and transforms them into a solid synthetic fuel, and
accordingly the Service concludes, based on the facts presented to it, that (i)
the Company, with the use of its patented process, produces a "qualified fuel"
within the meaning of Section 29(c)(1)(C) of the Code, and (ii) assuming the
other requirements of Section 29 are met, the sale of the "qualified fuel" will
entitle the Company to claim the Section 29 Credit in the taxable year of sale.
In its ruling, the Service noted that no temporary or final regulations
pertaining to one or more of the issues addressed in the ruling have been
adopted and that the ruling will be modified or revoked by the adoption of
temporary or final regulations to the extent the regulations are inconsistent
with any conclusions in the ruling. The Service notes, however, that a private
letter ruling from the Service is not revoked or modified retroactively, except
in rare and unusual circumstances, provided certain criteria are satisfied,
including that (i) there has been no misstatement or omission of material facts,
(ii) the facts at the time of the transaction are not materially different from
the facts on which the letter ruling was based, (iii) there has been no change
in the applicable law, (iv) the letter ruling was originally issued for a
proposed transaction and (v) the taxpayer directly involved in the letter ruling
acted in good faith in relying on the letter ruling, and revoking the letter
ruling retroactively would be to the taxpayer's detriment.
The Section 29 Credit is also subject to the passive activity
rules of Section 469, and therefore will generally not be available to
individuals and closely held corporations.
The Section 29 Credit is equal to $3.00 in 1979 dollars (or
$5.83 in 1995 dollars) for each oil barrel equivalent ("OBE") of the qualifying
fuel produced and sold. This equates to approximately $25.00 per ton of coal
briquettes. The OBE is defined generally as an amount of fuel having a 5.8
million Btu content. The Section 29 Credit allowed may not exceed the taxpayer's
regular tax liability reduced by certain other credits. The credit cannot be
utilized to offset the Alternative Minimum Tax.
14
The Section 29 Credit was designed to provide protection for
qualifying fuels against market price declines, and it is therefore subject to a
phaseout (under an annually adjusted formula) after the unregulated oil price
reaches specified levels. In 1994 dollars, the credit would have phased out had
the reference price for oil exceeded $45.14 per barrel, but the reference price
determined for 1994 was $13.19, and no phaseout occurred. In 1995 dollars, the
credit would have phased out had the reference price for oil exceeded $46.00,
but the reference price determined for 1995 was $14.62 and no phaseout occurred.
There presently is no reference price for 1996. The credit is also subject to by
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.
During 1996, the time periods applicable to Section 29 tax
credits were extended. The Section 29 Credit will, under present law, be
available for sales completed by December 31, 2007 to the extent attributable to
production from facilities placed in service by June 30, 1998, provided that
such facilities are constructed pursuant to a binding written contract in effect
by December 31, 1996. Unless the Section 29 credit is extended, the Company will
be limited to the 1996 Construction Agreements which were entered into by
December 31, 1996. See "BUSINESS--Construction Agreements."
Section 29 of the Code contains no provision for carryback or
carryforward of Section 29 Credits. Once earned, however, the nonconventional
fuel 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.
Competition
The Company may experience substantial competition from other
alternative fuel technology companies, as well as companies that specialize in
the disposal and recycling of waste products generated by steel, coal and coke
production. Many of these companies have greater financial, technical,
management and other resources than does the Company. The Company believes that
key factors in its ability to compete will be the quality of its briquettes and
their pricing compared to other sources of coal, coke and scrap iron. The
Company anticipates that it will be able to compete favorably in these regards
although there can be no assurance that it will do so successfully.
Employees
The Company currently employs approximately 28 persons
full-time. Approximately 9 of such persons are in corporate administration, and
19 are in briquetting operations, including research, development and marketing.
None of such employees are covered by a collective bargaining agreement. In
connection with the establishment and operation of each briquetting plant, the
Company will seek to hire between eight to ten persons, principally in
operations.
The discontinuation of the limestone and construction business
has resulted in a material decrease in the number of persons employed since
November, 1995. Since that time, there has been a reduction of approximately 200
employees in the discontinued limestone and construction business due to layoffs
and seasonal reductions.
Confidentiality Provisions
As part of its business, the Company typically enters into
agreements concerning its projects which contain confidentiality provisions. The
Company is, on occasion, required to disclose such agreements to the Securities
15
Exchange Commission as part of its ongoing reporting requirements under the
Securities Exchange Act of 1934. Moreover, disclosure of such agreements may be
required in connection with the Company's private placement of securities.
Notably, some of the agreements do not contain the standard exceptions for the
disclosure of information which is required to be disclosed under law.
Accordingly, no assurances can be given that the Company has not inadvertently
disclosed information regarding its various projects in violation of
confidentiality covenants entered into by the Company.
Forward Looking Statements
Statements regarding the Company's expectations as to the
financing, development and construction of facilities utilizing its Briquetting
Technology, the receipt of licensing fees and certain other information
presented in this report constitute forward looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. Although the
Company believes that its expectations are based on reasonable assumptions
within the bounds of its knowledge of its business and operations, there can be
no assurance that actual results will not differ materially from its
expectations. In addition to matters affecting the economy and the Company's
industry generally, factors which could cause actual results to differ from
expectations include the following:
(i) The commercial success of the Briquetting Technology.
(ii) Procurement of necessary equipment to place facilities into
operation.
(iii) Securing of necessary sites and raw materials for facilities
to be constructed and operated.
(iv) Timely construction and completion of facilities.
(v) Ability to obtain needed additional capital on terms acceptable
to the Company.
(vi) Changes in governmental regulation or failure to comply with
existing regulation could result in operational shutdowns of
its facilities.
(vii) The continuance of the Section 29 Tax Credit.
(viii) Ability to meet financial commitments under existing
contractual arrangements.
ITEM 2. PROPERTIES
The Company owns a 5,000 square-foot building in Lehi, Utah,
which houses its executive offices. The building is mortgaged with a
non-affiliated party pursuant to an adjustable rate mortgage with an original
principal balance of $275,000 due in 2002. The mortgage is adjustable quarterly
and the total monthly payment was $3,711 on the remaining $175,383 balance as of
December 31, 1996. The mortgage, which was originally an obligation of IME, has
been assumed by the Company as a result of the sale of IME. This assumption has
not been approved by the lender and therefore may cause the lender to accelerate
the note. The Company has taken no formal steps to obtain the consent of the
lender, other than verbal discussions. In the event the lender accelerates the
note, the Company believes that it will be able to refinance the building on
comparable terms prior to any foreclosure action. However, there is no assurance
that the Company will be able to obtain such financing in a timely manner, which
would force the Company to relocate its executive offices.
In June 1996, the Company purchased an 8,000 square-foot site
located in Price, Utah, on which the Company's prototype briquetting plant is
located, for $150,000. Included in the purchase was a 1,400 square-foot office
building which houses equipment.
16
In May 1995, the Company entered into a lease with Geneva
Steel Company for a 9,000 square foot building in Vineyard, Utah as part of the
Geneva Agreements described in "ITEM 1--BUSINESS--Business of Company--Geneva.
The Company pays no cash rent on these facilities. The purpose of the lease is
to allow the Company to apply the Briquetting Technology to Geneva's coke breeze
and steel revert materials. Upon the execution of the Geneva Agreements, the
lease with Geneva expired resulting in a tenancy-at-will between the parties.
As part of the acquisition of the Port Hodder facility, the
Company entered into a land lease of approximately 15.45 acres with a
non-affiliated party for the Alabama Plant for an annual rental of $1. See "ITEM
1--BUSINESS--Port Hodder." In June 1996, the Company entered into a land lease
of approximately 12 acres in Price, Utah with a non-affiliated party at a
monthly rental of $600.00. The lease term commenced on June 20, 1996 and expires
on December 31, 2007.
ITEM 3. LEGAL PROCEEDINGS
CoalPlex Litigation
On October 31, 1995, the Company as plaintiff filed a
complaint in the United States District Court for the District of Utah, Central
Division against CoalPlex International, Inc., a Nevada corporation ("CoalPlex")
and Daniel J. Longworth (collectively, the "Defendants"). The suit alleged that
the Defendants breached a nondisclosure agreement dated October 3, 1995 pursuant
to which the Company had given the Defendants confidential information; that the
Defendants intentionally interfered with the Company in its acquisition of the
option on the Wellington, Utah property; that the Defendants had commercially
disparaged the Company and that common law fraud was committed on the Company.
The Company sought an injunction against the Defendants and damages of
$1,000,000. The Company recently withdrew the suit without prejudice based upon
assurances from CoalPlex that it would refrain from any further breaches of the
non-disclosure agreement and from contacting the Company's customers, employees
or contacts.
Farrell Larson Litigation
In May 1995 the Company's wholly owned subsidiary, Larson,
filed a complaint in the Fourth Judicial District Court in and for the County of
Utah, State of Utah against Farrell Larson, Larson's former president and
director. In January, 1996 the complaint was amended to add the Company as a
plaintiff. In addition Irene Larson, Gary Burningham d/b/a Burningham and
Company, and Burningham Enterprises, Inc. were added as defendants. The
plaintiffs alleged that the defendants misrepresented facts and made material
omissions in connection with the sale of 50% of Larson to the Company in 1994.
Furthermore, the plaintiffs alleged that the share purchase agreement was
breached by defendant Farrell Larson and that state securities laws were
violated. The complaint sought to enjoin Farrell Larson from harassing the
Company and sought an order releasing all collateral held to secure plaintiff's
performance including the 50% of Larson held in escrow as security for the note
given by the Company in the purchase of Larson, and damages of not less than
$325,000, treble damages in accordance with Utah securities laws, punitive
damages of $1,000,000 and costs. In February 1996, Farrell Larson and Irene
Larson filed counterclaims against the Company asserting breach of contract by
the Company and Larson in respect to the agreements through which the Company
purchased Farrell Larson's 50% interest in Larson; breach of the covenant of
good faith and fair dealing with respect to the same contracts; interference
with contractual and economic relations; defamation, which relates to alleged
statements by the Company concerning the litigation, either just prior to or
during the litigation; breach of fiduciary duty, alleging that the Company owed
Farrell Larson a fiduciary duty with respect to the conduct of business of
Larson; and violation of Larson's bylaws. In their counterclaim, Farrell Larson
17
and Irene Larson ask for the forfeiture of the shares of Larson acquired by the
Company, for management of Larson to be reinstated as directed by Farrell
Larson, for reimbursement of all attorney fees and costs incurred by Farrell
Larson, for an order allowing Farrell Larson to foreclose on collateral held
under the Share Purchase Agreement with the Company, for final payment of
$325,000 under other contracts between the Company and Farrell Larson, and other
unspecified amounts of actual and punitive damages.
In connection with the facts at issue in the Company's action
against Farrell Larson; in January 1996 Farrell Larson and his wife, Irene
Larson, filed a new lawsuit in the Fourth Judicial District Court in and for
Utah County, State of Utah against, among other defendants, Michael Midgley (the
then Chief Financial Officer of the Company and then President and director of
Larson), Mark Hardman (a Vice-President and director of Larson), and Kenneth M.
Young (the Company's then Chairman of the Board and former President). This
complaint included three causes of action: (i) interference with Larson's
business relations, (ii) defamation, and (iii) breach of fiduciary duty. The
factual basis for these claims for relief are substantially the same as the
facts at issue in the Company's action against Farrell Larson. Accordingly, the
Court consolidated these two cases at the Company's request so that all of the
related issues will be resolved together. The Company believes that all acts
alleged as basis for liability against Messrs. Midgley, Hardman and Young were
performed by them in the course and scope of their employment for the Company
and Larson.
As part of the sale of the Subsidiaries, the Company has
agreed to fund all legal proceedings with Farrell Larson and indemnify the
Buyers from any liability.
In September of 1996, the plaintiffs and defendants entered
into a settlement agreement whereby: (i) Farrell Larson and Irene Larson
(collectively, the "Larsons") released any claims on the amounts held in escrow
securing the note given by the Company in purchase of Larson, (ii) the Larsons
released all liens caused to be filed or recorded against the real property and
personal property of the plaintiffs, (iii) Burningham was required to pay off or
refinance its loans relating to two Beall trailers and remove Larson as a
guarantor on such lease, (iv) the Larsons agreed to the Company's sale of Larson
to any third party, (v) Burningham and Larson agreed not to purchase any stock
of the Company and (vi) the parties agree to a dismissal of the suits with
prejudice.
Notices of Violation--Utah Division of Air Quality
In April 1996, the Company and Nevada Electric Investment
Company ("NEICO") received a Notice of Violation under Utah Administrative Code
R 307-10-1 and R307-1-8 regarding asbestos in Carbon County, Utah occurring on
January 11, 1996. In August 1996, the Company agreed to pay a negotiated
settlement amount of $11,000 over the next two years to the Utah Division of Air
Quality. The Company believes the asbestos problem has been corrected.
In August 1996, the Company received a Notice of Violation
regarding numerous dust complaints received by the Utah Division of Air Quality
regarding the Geneva Plant. The Company notified the Utah Division of Air
Quality in September of 1996 regarding the corrective actions taken by the
Company.
AGTC Brokerage Disagreement
See "ITEM 1--BUSINESS--AGTC Brokerage Disagreement."
18
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Pursuant to a written consent of stockholders, the following
matters were approved by stockholder consent on approximately January 22, 1996:
1. The sale of the Subsidiaries was approved by
Stockholders owning 1,909,558 shares of common stock,
or approximately 54.72% of the outstanding common
stock on that date.
2. The amendment of the Company's 1995 Stock Option Plan
(the "Option Plan") to increase the number of shares
of common stock available under the plan from 450,000
shares to 1,200,000 shares was approved by
Stockholders owning 1,909,558 shares of common stock,
or approximately 54.72% of the outstanding common
stock on that date.
3. The amendment of the Company's Certificate of
Incorporation to provide for a 2 for 1 common stock
split and to maintain the authorized common stock of
the Company at 25,000,000 shares, $.001 par value,
was approved by Stockholders owning 2,051,014 shares
of common stock, or approximately 58.77% of the
outstanding common stock on that date.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The shares of common stock of the Company are listed for
trading on the OTC Bulletin Board under the symbol "CVOL." The following table
sets forth, for the periods presented, the high and low bid quotations for the
common stock as reported by National Quotation Bureau, Inc. during the three
most recent calendar years. The quotations do not reflect adjustments for retail
markups, markdowns or commissions and may not necessarily represent actual
transactions. Since the Company has several market makers, the bid prices among
the different market makers will generally vary. Accordingly, the low bid price
may represent a bid price substantially below the inside bid and be less
representative of actual trades than the high bid price. 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.
19
Low Bid High Bid
------- --------
Calendar 1994
- - --------------
First Quarter $ 2.50 $ 4.375
Second Quarter $ 1.875 $ 4.375
Third Quarter $ 1.875 $ 3.43
Fourth Quarter $ 1.875 $ 3.20
Calendar 1995
- - -------------
First Quarter $ 1.25 $ 3.75
Second Quarter $ 1.25 $ 3.875
Third Quarter $ 3.00 $ 7.50
Fourth Quarter $ 5.00 $21.25
Calendar 1996
- - -------------
First Quarter $18.00 $31.50
Second Quarter $ 9.50 $22.25
Third Quarter $ 6.50 $10.75
Fourth Quarter $ 7.50 $14.375
The Company implemented a two-for-one stock split effective
January 23, 1996. The bid prices set forth above have been adjusted to reflect
the effect of that stock split.
As of December 1, 1996, there are approximately 2,103 record
holders of the Company's outstanding shares of common stock.
The Company has not paid dividends to date and does not intend
to pay dividends in the foreseeable future. The Company intends to retain
earnings, if any, to finance the development and expansion of its business.
Payment of dividends in the future will depend, among other things, upon the
Company's ability to generate earnings, its need for capital and its overall
financial condition.
Recent Sales of Unregistered Securities
The following sets forth all securities issued by the Company
within the past fiscal year without registering the securities under the
Securities Act. No underwriters were involved in any stock issuances nor were
any commissions or similar fees paid in connection therewith.
The issuance of qualified options is required to be based on
market value. Accordingly, the exercise price is set based on the market price
of the Company's common stock, even though the options convert into restricted
stock.
The Company believes that the following issuances of shares of
common stock and debentures were exempt from the registration requirements of
the Securities Act of 1993 pursuant to the exemption set forth in Section 4(2)
thereof and the certificate for each of such security bears a restrict legend:
20
Commencing September of 1995 and ending January 1996 the
Company issued 629,021 shares of common stock in exchange for $2,280,172 cash
and 20,979 shares of common stock in exchange for $157,342.50 in services to
fifty four purchasers. Each of the purchasers was an individual or institution
whom the Company believed was an "accredited investor" within the meaning of
Rule 501(a) of Regulation D under the Securities Act of 1933.
In November 1995 the Company issued 69,334 shares of common
stock to Mr. George Browne in exchange for $260,000, received in fiscal year
1995. The Company also issued 50,000 shares of common stock to Mr. Alan
Summerhaays in exchange for consulting services valued at $322,000, received in
fiscal year 1995.
In December 1995, the Company issued 900,000 shares of common
stock to 17 employees in connection with the exercise of options granted under
the Option Plan. The aggregate exercise price, in excess of the par value of the
stock issued, 450,000 of which were issued in October 1995 to officers,
directors and employees, was paid by the 17 employees in the form of notes
receivable of approximately $6,159,000. The Notes are due and payable by the
employees on December 1, 2005, bear interest at 5.7% and are collateralized by
the stock issued upon exercise of the options. The interest rate on the Notes
reflects the cost to the Company to borrow money at the time the notes were
issued.
In December 1995, the Company issued 2,000 shares of common
stock to Mr. Anthony Pilotte in exchange for $4,000 and 3,000 shares to Mr. Mark
Hardman in exchange for services rendered valued at $11,250.
In December 1995, the Company issued 25,000 shares of common
stock to Mr. Clayton Timothy for $37,500 in cash and 10,000 shares of common
stock to Mr. Ted Strong for $15,000, both pursuant to exercises of stock
options.
In January 1996, the Company issued 10,000 shares of common
stock to Mr. Maury Shefftel for consulting services valued at $72,500 and 250
shares of common stock to Mr. Michael Buhman in exchange for $500.
On January 1, 1996, the Company granted options to purchase
120,000 shares of Common Stock at a price of $1.50 per share to certain
officers, employees and consultants. Of these options, 20,000 were exercised and
35,000 were canceled. At September 30, 1996, 65,000 of the options remain
unexercised. On this same date, the Company granted options to purchase 124,000
shares of Common Stock at prices between $2.50 and $3.50 per share to certain
consultants. These options remain unexercised at September 30, 1996.
In February 1996, the Company issued 227,115 shares of the
Company's common stock to accredited investors in connection with the sale of
units in a private placement transaction. A unit consists of five shares of
restricted common stock and one Class A warrant with an exercise price of
$25.00, one Class B warrant with an exercise price of $30.00 and one Class C
warrant with an exercise price of $35.00. The Company approximately raised
$3,244,000 through this private placement.
In March 1996, the Company issued 8,417 shares of common stock
to Mr. Jay Rice for professional services valued at $120,363.
In April 1996, Mr. Ken Young purchased 7,000 shares of Common
Stock for $100,100.
21
In April 1996, Mr. Sidney Borenstein, Mr. Eric Bashford and
Mr. Robert Schneider purchased 8,126, 14,900 and 15,074 shares of common stock
in exercise of warrants respectively for $12,189, $22,350 and $22,611,
respectively. In connection with the purchase, the Company granted certain
registration rights to the purchasers. In the event the purchased stock is not
timely registered, the Company will be required to issue additional stock to the
Purchasers. In addition, in the event that the market value of the stock is less
than $21.00 per share at the time the stock is registered, the Company will be
required to issue additional shares to the purchasers so that the purchaser may
realize the equivalent of $21.00 per share.
In June 1996, the Company issued 750 and 1,000 shares, to Mr.
Milton Young and Mr. Golden Murry, respectively, for professional service valued
at $1,500 and $3,000, respectively.
On June 3, 1996, the Company granted options to purchase
100,000 shares and 40,000 shares of Common Stock for $1.50 per share to an
Officer of the Company as part of compensation related to an employment
agreement. At September 30, 1996, these options remain unexercised.
In July, August and September of 1996, Mr. Ray Weller, Mr.
Joe Johnson, Ms. Lois Shapiro and Ribalta, Inc. purchased 32,115, 150,000,
14,900 and 43,750 shares of common stock for $459,250, $1,000,000, $22,350 and
$350,000, respectively. The Ribalta, Inc. shares were unissued at September
30,1996. Also the Shapiro share were the exercise of options.
On August 13, 1996, the Company granted 777,500 options to
purchase shares of Common Stock to certain employees, officers and directors for
$1.50 per share. Prior to September 30, 1996, 312,500 of these options were
canceled. At September 30, 1996, 465,000 shares remain unexercised.
In September 1996, the Company issued 100,000 shares for a
note receivable to George Ford for $1.00 per share pursuant to the exercise
of an option. In addition, the Company issued 1,350 shares to Ted Harker at a
price of $1.00 per share, 20,000 shares to Roger Huber at $2.50 per share and
30,000 shares to Maynard Moe at $2.50 per share. The stock issuances to Mr.
Harker, Mr. Huber and Mr. Moe were pursuant to exercises of option, which
exercise price was paid by a combination of cash and services.
In November 1996, the Company issued convertible subordinated
debentures in the aggregate principal amount of $1,000,000. See "ITEM
7--MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS--Liquidity and Capital Resources."
In December 1996, the Company issued the Subordinated
Debenture in the principal amount of $1,100,000. See "ITEM
1--BUSINESS--Gallagher."
In January 1997, the Company issued the Senior Debenture in
the principal amount of $588,683. See "ITEM 1--BUSINESS--Gallagher."
ITEM 6. SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
The following table sets forth the Company's selected
historical consolidated financial data as of and for the years ended December
31, 1992 and 1993; the nine months ended September 30, 1994 and the years ended
September 30, 1995 and 1996. The selected consolidated financial data as of and
for the years ended December 31, 1992 and 1993 are derived from the financial
statements of the Company which have been audited by Jones, Jensen, Orton &
Company. The selected consolidated financial data as of and for the nine months
ended September 30, 1994 and as of and for the years ended September 30, 1995
and 1996 were derived from the financial statements of the Company which have
been audited by Coopers & Lybrand, L.L.P. The information below should be read
in conjunction with the Consolidated Financial Statements and notes thereto and
appearing elsewhere in this document.
22
COVOL TECHNOLOGIES, INC.
(FORMERLY ENVIRONMENTAL TECHNOLOGIES GROUP INTERNATIONAL)
AND SUBSIDIARIES
Year Ended Nine
December 31, Months Ended Year Ended Year Ended
September 30, September 30, September 30,
--------------------------------
1992 1993 1994 1995 1996
-------------------------------------------------------------------------
Statement of Operations Data:
Revenues:
License fees $ -- $ -- $ -- $ 100,000 $ 100,000
Briquette sales 12,447 12,688 19,867 29,310 195,165
-------------------------------------------------------------------------
Total revenues 12,447 12,688 19,867 129,310 295,165
Operating costs and expenses:
Cost of coal briquettes 8,314 22,977 32,386 37,165 859,574
Research and development 319,907 393,300 387,128 1,265,072 1,044,192
Selling, general and 266,914 426,512 393,109 1,494,270 3,796,569
administrative
Compensation expense on -- -- -- 703,527 4,772,959
stock options
Compensation expense on -- -- -- 104,000 --
stock warrants
Compensation expense on -- -- -- 148,446 100,360
issuance of common stock
Write off of purchased -- -- -- 344,900 --
technology and trade
secrets
Write-down of note receivable -- -- -- -- 2,699,575
Minority interest in net -- -- -- -- (4,456)
losses of consolidated
subsidiaries
-------------------------------------------------------------------------
Total operating costs and 595,135 842,789 812,623 4,097,380 12,268,773
expenses
-------------------------------------------------------------------------
Operating loss (582,688) (830,101) (792,756) (3,968,070) (12,973,608)
Other income (expense): -- -- -- 9,663 302,565
Interest income
Interest expense (2,091) (30,870) (21,158) (113,137) (94,706)
Other income -- -- 3,200 35,169 (166,066)
-------------------------------------------------------------------------
Total other income (expense) (2,091) (30,870) (17,958) (68,305) 41,793
-------------------------------------------------------------------------
Loss from continuing operations (584,779) (860,971) (810,714) (4,036,375) (12,931,815)
before income tax benefit
(provision)
Income tax benefit (provision) -- -- 313,100 (488,000) (23,000)
-------------------------------------------------------------------------
Loss from continuing operations (584,779) (860,971) (497,614) (4,524,375) (12,954,815)
23
Year Ended Nine
December 31, Months Ended Year Ended Year Ended
------------------- September 30, September 30, September 30,
1992 1993 1994 1995 1996
-----------------------------------------------------------------------
Discontinued operations
(Note 14):
Income (loss) from 10,050 145,965 609,354 (351,782) (590,480)
discontinued
operations (less
applicable income tax
(provision) benefit of $0.
$0. $0. $(297,800),
$253,000, and $0,
respectively)
Loss on disposal of -- -- -- (777,394) (291,025)
discontinued
operations (less
applicable income tax
benefit of $562,000 in
1995 and $0 in 1996)
-------------------------------------------------------------------------
Income (loss) from 10,050 145,965 609,354 (1,129,176) (881,505)
discontinued
operations
-------------------------------------------------------------------------
Income (loss) before cumulative (574,729) (715,006) 111,740 (5,653,551) (13,836,320)
effect of change in
accounting principle
Cumulative effect of change in -- -- 31,302 -- --
accounting principle (less
applicable income tax
provision of $15,300 in 1994)
-------------------------------------------------------------------------
Net income (loss) ($574,729) ($715,006) $143,042 ($5,653,551) ($13,836,320)
-------------------------------------------------------------------------
Net income (loss) per common share
Loss per share from continuing ($0.38) ($0.36) ($0.13) ($1.00) ($1.86)
operations
Income (loss) per share from 0.01 0.06 0.16 (0.25) (0.13)
discontinued operations
-------------------------------------------------------------------------
Income (loss) per share before (0.37) (0.30) 0.03 (1.25) (1.99)
cumulative effect of change
in accounting principle
-------------------------------------------------------------------------
Income per share of cumulative 0.00 0.00 0.01 0.00 0.00
effect of change in
accounting principle
-------------------------------------------------------------------------
Net income (loss) per share ($0.37) ($0.30) $0.04 ($1.25) ($1.99)
-------------------------------------------------------------------------
Weighted average shares outstanding 1,525,258 2,417,568 3,789,996 4,524,056 6,941,424
-------------------------------------------------------------------------
December 31, September 30,
-------------------------------------------------------------------------
1992 1993 1994 1995 1996
-------------------------------------------------------------------------
Balance Sheet Data:
Working capital ($198,944) ($423,570) ($619,907) ($480,420) ($3,482,227)
Net property and equipment 272,942 341,455 747,952 1,330,300 7,125,245
Total assets 725,596 2,129,885 4,852,637 2,659,977 8,772,072
Long-term debt 46,700 511,193 852,081 176,601 150,980
Total Stockholders' equity 451,182 1,107,915 2,989,529 1,182,768 (233,364)
24
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 HISTORICAL CONSOLIDATED FINANCIAL DATA" and the financial
statements and notes thereto for the Company included elsewhere herein.
Year Ended September 30, 1996 Compared to Year Ended September 30, 1995
The information set forth below compares the Company's
operating results for fiscal year 1996 with its operating results
for fiscal year 1995.
Continuing Operations
Revenues. Revenues from the sales of briquettes increased to
$195,165 for the year ended September 30, 1996 from $29,310 recognized for the
year ended September 30, 1995. A substantial portion of the sale of briquettes
is attributable to production from the Geneva Plant. Fees from the licensing of
the Briquetting Technology were $100,000 for the year ended September 30, 1996,
and for the year ended September 30, 1995.
Operating Costs and Expenses. The operating costs of producing
briquettes increased to $859,574 for the year ended September 30, 1996 from
$37,165 for the year ended September 30, 1995. The increase is reflective of the
phase of development and operation the Company was in for fiscal year 1996 as
compared to fiscal 1995. In 1996, the Company incurred substantial material and
labor costs in implementing and improving the briquetting product and process,
the costs for which were currently expensed rather than capitalized.
Research and development expenditures decreased $220,880 or
17.5% during the year ended September 30, 1996 from $1,265,072 for the year
ended September 30, 1995. During the year ended September 30, 1996, the Company
received a notice of allowance on one of the patent applications which it filed
in 1993. The Company also continued the prosecution of two previously filed
patent applications relating to the Briquetting Technology during fiscal year
1996.
Selling, general and administrative expenses increased
$2,302,299 or 154% for the year ended September 30, 1996 from $1,494,270 for the
year ended September 30, 1995. During this period the Company was increasing
staff and other operating costs, in order to accommodate the licensing and
implementation of the Briquetting Technology, including extensive activity in
the development of the Utah Plant and Alabama Plant.
25
In fiscal year 1996, the Company recognized compensation
expense on the issuance of stock options at below market price, compensation
expense on the issuance of warrants at below market price, and compensation
expense on the issuance of common stock for services in the total amount of
$4,873,319, which represents an increase of $3,917,346 over the prior year
expense of $955,973. The Company issued stock options at below market price to
consultants who provided and will continue to provide services relating to the
exploitation of Company technology, identification of users of such technology,
finance of the Company and its projects, marketing, and general business
strategy. The options vest over ten years. The Company has expensed the total
value of such options (current stock value less strike price) in fiscal 1996 in
the amount of $2,305,000. During fiscal 1996 and for the period through the date
of filing of this document, the Company has undergone significant management
changes. The increase in this expense reflects the acceleration of the expense
for options held by prior management and other former employees as settlement in
their termination in the amount of $832,500. As an enticement to a key
executive, the Company granted 100,000 options valued at $1,163,000. This
executive signed an employment contract with the Company through May 31, 1999.
The balance of the expense related principally to the amortization of the value
of stock options, based on the vesting of such options.
Also in fiscal year 1996, the Company recognized an expense in
the form of a write-down of the Note received from the Buyers of the
Subsidiaries in the amount of $2,699,575. Under generally accepted accounting
principles, the Company is required to write down the carrying cost of the note
to the ascertainable value of the collateral securing the note. There has been
no events of default or past due payments occur on the note. See "ITEM
1--BUSINESS--The Company." See iscussion below for discontinued
operations.
Loss From Continuing Operations. For the year ended September
30, 1996, the Company had a loss from continuing operations of $(12,954,815) as
compared to $(4,524,375) for the year ended September 30, 1995. The increased
loss is primarily due to the compensation expense from the stock options, write
down of Buyers' note from the sale of the Subsidiaries, and the expenses related
to the initial production of briquettes discussed above.
Discontinued Operations
For the year ended September 30, 1996 the discontinued
operations had a net loss of $590,480 as compared to a net loss of $351,782 for
the year ended September 30, 1995. The Company also recognized an additional net
loss on the disposal of the discontinued operations in the amount of $291,025.
The Company agreed to pay certain liabilities associated with the Subsidiaries
as a condition of the sale. The actual amount of the liabilities was greater
26
than originally estimated, resulting in an additional loss from discontinued
operations in 1996. The Company is currently negotiating an increase in the
notes receivable proportional to the additional liabilities actually paid.
Year Ended September 30, 1995 Compared to the Nine Months Ended September 30,
1994
As a result of the change in the Company's fiscal year, the
comparisons of results of operations for the year ended September 30, 1995
reflect twelve months of activity as compared to nine months of activity for the
period ended September 30, 1994.
Continuing Operations
Revenues. Revenues from "Clean Coal" sales increased $9,443
or 48% for the year ended September 30, 1995 from the $19,867 recognized in the
nine months ended September 30, 1994 primarily due to closing out of the "Clean
Coal" inventory. Licensing revenues of $100,000 for the year ended September 30,
1995 represent cash received from Greystone Environmental Technology, Inc. for
the initial payment on the purchase of their coke license. See Note 15 of the
Financial Statements.
Operating Cost and Expenses. During the year ended September
30, 1995, the Company received a notice of allowance on the patent application
which it filed in 1993. The Company also filed two additional patent
applications relating to the Briquetting Technology during this time period and
built and tested a reduction furnace and installed an electric arc furnace in
Price, Utah, which was put into production to demonstrate the feasibility of the
Briquetting Technology to produce iron from waste materials. During 1995, the
Company also developed two new binders, which are more cost effective with
better thermal stability than the binders acquired in 1991 and 1992. As a result
of this activity, research and development expenditures increased $877,944 or
227% during the year ended September 30, 1995. As a result of these
developments, the Company wrote off the purchased technology and trade secrets
in the amount of $344,900.
Selling, general and administrative expenses increased
$1,101,161 in 1995 from $393,109 for the nine months ended September 30, 1994.
During this period the Company was increasing staff and other operating costs,
in order to accommodate the licensing and exploitation of the Briquetting
Technology, including starting up the Geneva plant.
In 1995, the Company recognized compensation expense on the
issuance of stock options at below market price in the amount of $703,527,
$104,000 as compensation expense on the issuance of warrants at below market
price, and compensation expense on the issuance of common stock for services in
the amount of $148,446.
27
Loss From Continuing Operations. For the year ended September
30, 1995, the Company had a loss from continuing operations of $(4,524,375) as
compared to $(497,614) for the nine months ended September 30, 1994. The
increased loss is primarily due to increased operating costs and expenses
discussed above and the recognition of tax expense of $(488,000) in 1995
compared to a benefit of $313,100 in 1994. The expense in 1995 is due to the
Company's inability to offset its net loss against discontinued operations
taxable income, while the benefit in 1994 is due to the Company's ability to
offset its net operating loss against discontinued operations income.
Discontinued Operations
For the year ended September 30, 1995 the discontinued
operations had a net loss of $351,782 as compared to net income of $609,354 in
1994. The Company also recognized a net loss on the disposal of the discontinued
operations in the amount of $777,394 in 1995, which includes a reserve of
$330,000 for operating losses during the disposal period, offset by a tax
benefit of $562,000. The loss in 1995 is due to the increased focus on the
Briquetting Technology and the Company's efforts to scale down the Subsidiaries
activities until a buyer could be found.
Nine Months Ended September 30, 1994 Compared to the Year Ended December 31,
1993
As a result of the change in the Company's fiscal year the
comparisons of results of operations for the nine months ended September 30,
1994 reflect nine months of activity as compared to twelve months of activity
for the period ended December 31, 1993.
Continuing Operations
Revenues. Total revenues of $19,867 for the nine months ended
September 30, 1994 were generated by the sale of the Company's "Clean Coal"
product as compared to $12,688 for the year ended December 31, 1993 primarily as
a result of the Company's efforts to reduce its inventory.
Operating Costs and Expenses. During the nine months ended
September 30, 1994 the Company was phasing out its "Clean Coal" product line,
which resulted in a negative gross margin of $12,519 for the period as compared
to a negative gross margin of $10,289 for the year ended December 31, 1993. The
Company had determined during 1994 that the home heating market for "Clean Coal"
was not going to produce the gross margins that had been anticipated and the
Company made the decision to pursue the industrial application of the
Briquetting Technology.
Research and development expenditures decreased to $387,128
for the nine months ended September 30, 1994 from $393,300 for the year ended
December 31, 1993, a decrease of $6,172 or 2%. Expenditures in 1994 were related
to improvements made to the binding process and the Company's efforts to expand
28
the application of the Briquetting Technology to steel making waste by-products.
The Company also produced test run materials for several steel plants and filed
one patent application during this period.
Selling, general and administrative expenses were $393,109 for
the nine months ended September 30, 1994 compared to $426,512 for the year ended
December 31, 1993, a decrease of $33,403 or 8%.
Loss From Continuing Operations. For the nine months ended
September 30, 1994, the Company had a loss from continuing operations of
$(497,614) before the cumulative effect of a change in accounting principle
related to the Company's method of depreciating its property, plant and
equipment, compared to a loss from continuing operations of $(860,971) for the
year ended December 31, 1993. In 1994 the Company had a tax benefit from
continuing operations of $313,100 (due to the use of net operating losses to
offset income of the discontinued operations), while in 1993 no tax benefit was
recognized.
Discontinued Operations
Net income for the discontinued operations increased to
$609,354 for the nine months ended September 30, 1994 from $145,965 for the
previous period. It was during this period that CIC started two large
construction contracts with a large mining company in Utah, which accounted for
the increase.
Liquidity and Capital Resources
While the Company continued its commitment to research and
development during fiscal 1996, the Company made significant progress toward the
commercialization of its technology and movement from a development company to
an operating company. The increase in cash used by the Company in operating
activities from $237,023 in fiscal 1995 to $2,574,713 during 1996 was largely
due to the increase in staff and the start up and operation of the Geneva Plant.
The increase in staff was necessitated by the increased planning, marketing and
development activities of the Company. The Company was able to fund this growth
principally through the issuance of common stock.
The Company made a strategic decision to focus its efforts
exclusively on commercializing the Briquetting Technology and to divest itself
of its construction and limestone businesses. Accordingly in February, 1996, the
Company entered into a share purchase agreement with Mike McEwan and Gerald
Larson, former principals of the Subsidiaries, to sell all of the common stock
of the Subsidiaries. The divestiture was substantially complete on September 28,
1996 resulting in an additional loss to the Company of $881,505 during fiscal
year 1996. See "ITEM 1--BUSINESS--The Company."
29
During fiscal year 1996, the Company produced revert briquettes
at the Geneva Plant for Geneva according to specifications supplied by Geneva.
Revenues from the production of revert briquettes at the Geneva Plant amounted
to $191,427. Although the Geneva Agreements expired in December 31, 1996, the
Geneva facility has continued to produce briquettes for purchase by Geneva
Steel.
The Company anticipates that cash flow from (i) operations,
including fees for the operation of facilities owned by third parties,
(ii licensing and royalty fees from new plants utilizing the Briquetting
Technology, (iii) the sale of chemical binder to new plants utilizing the
Briquetting Technology, (iv) sale of synthetic coal products, (v) fees from port
operations and loading (vi) cash distributions from Utah Synfuel #1 and Alabama
Synfuel #1 and (vii) payments on notes receivable will be used to fund working
capital and other operating needs. See "ITEM 1--BUSINESS--Business Strategy." In
September 1996, the Company entered into a letter of intent with an unregulated
subsidiary of PacifiCorp to purchase the Alabama Plant from Alabama Synfuel #1
for a one time $500,000 licensing fee, a promissory note in the amount of
$3,400,000 that will be payable out of the cash flow of the plant, and a per ton
royalty fee. See "ITEM 1--BUSINESS--PacifiCorp." In November 1996, the Company
entered into a letter of intent with Arthur J. Gallagher & Co., to purchase the
Utah plant from Utah Synfuel #1 for $2,500,000 cash and a promissory note, a one
time $500,000 licensing fee and a per ton royalty fee payable out of the cash
flow of the Utah plant. See "ITEM 1--BUSINESS--Gallagher." The Company completed
construction of the Utah plant in connection with Utah Synfuel #1, and commenced
commercial operations in December, 1996, producing and selling more than 5,000
tons of coal briquettes prior to the end of calendar year 1996. However, the
Company has not yet closed on the sale of such plants, and there can be no
assurance that the Company will receive the anticipated cash payments from the
sale of such plants. Moreover, most of the cash flow from the above sources will
not occur until late 1997 and in subsequent years.
In May 1995, the Company secured financing in the form of an
$825,000 master equipment lease funded by a commercial bank to equip its initial
briquetting plant at Geneva's facilities. The Company has the option to purchase
the equipment from the bank at the end of the lease term.
In December 1996, the Company entered into the 1996
Construction Agreements. In order to assure the agreements would be considered
binding on the Company, the Company agreed to penalty clauses in the aggregate
amount of $3,012,000 if they failed to build the facilities. See "Item
1--BUSINESS--Construction Agreements."
In December 1996, the Company entered into indemnity
agreements with Lockwood which may result in a contingent liability of
$4,500,000 on or after June 2, 1998. See "ITEM 1--BUSINESS-- Indemnification to
Lockwood."
30
In December 1996, the Company entered into a Debenture
Agreement and Security Agreement with AJG Financial Services, Inc. to borrow
$4,000,000. In December 1996, $1,100,000 in convertible debentures was issued
and funded with an additional $2,900,000 in credit available for future draw
downs pursuant to Senior Debentures to be issued by the Company. On January 2,
1997, the Company drew down $588,683 of the available $2,900,000. See "ITEM 1 --
BUSINESS -- Gallagher." The balance of the $2.9 million loan will be used for
working capital and for the construction and development of the coal
agglomeration facilities.
In October 1996, as part of the PacifiCorp letter of intent,
PacifiCorp agreed to a convertible loan from PacifiCorp to the Company in an
amount up to $5,000,000. See "ITEM 1--BUSINESS-- PacifiCorp."
In November of 1996, the Company issued convertible
subordinated debentures in the principal amounts of $300,000, $200,000 and
$500,000 to Mr. Douglas M. Kinney, Mr. Gordon, L. Deane and the Douglas M.
Kinney 1999 Retained Annuity Trust, respectively. The convertible subordinated
debentures accrue interest at prime plus two percent (2%) with interest and
principal payable in full on June 30, 1998. All or a portion of the unpaid
principal due on the convertible subordinated debenture is convertible into
Company common stock. Through a separate subscription agreement, the Company has
granted piggy-back registration rights to the investors for Company common stock
issued upon conversion of the convertible subordinated debentures. The Company
has the right to prepay the principal of the convertible subordinated
debentures. Finally, the investors have represented to the Company that they are
"Accredited Investors" as defined under Rule 501 of the Securities Act of 1933,
as amended.
The Company has had significant discussions with RAS Securities
Corp. to act as placement agent on a "best efforts" offering of a minimum
aggregate principal amount of $1,000,000 ($3,000,000 maximum) of 8% Convertible
Subordinated Debentures of the Company to accredited investors. Such debentures
would have an established floor and ceiling conversion price, and the shares
issued upon conversion would be entitled to piggy-back and demand registration
rights. No assurances can be given that RAS Securities Corp. will act as
placement agent or that the minimum offering will be successfully placed. Such
offering will be made only by means of a private offering memorandum and
statements relating to such offering herein are neither offers to sell nor
solicitations of offers to buy.
The Company believes that the resources desribed above will be
adequate to meet its obligations in fiscal year 1997, notwithstanding its
working capital deficit at September 30, 1996.
31
Impact of Recently Issued Accounting Standards
In March 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of".
The Statement requires that long-lived assets and certain identifiable
intangibles to be held and used by an entity be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. The Statement is effective for financial statements for
fiscal years beginning after December 15, 1995. The impact of the Statement on
the Company is not expected to be material.
In October 1995, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting
for Stock-Based Compensation". This Statement defines a fair value method of
32
accounting for an employee stock option or similar equity instrument and
encourages adoption of that method. The Statement also requires that an
employer's financial statements include certain disclosures about stock-based
compensation arrangements regardless of the method used to account for them. The
Statement is effective for financial statements for fiscal years that begin
after December 15, 1995. The Company has determined that it will adopt the
disclosure requirement of SFAS No. 123 and will continue to account for
stock-based compensation as permitted under the provision of Accounting
Principles Board Statement No. 25.
Impact of Inflation
During fiscal year 1996, cost increases to the Company were
not materially impacted by inflation.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary financial data
required by this Item 8 are set forth in Item 14 of this Form 10-K. All
information which has been omitted is either inapplicable or not required.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On April 17, 1994, the Company's Board of Directors voted that
the accounting firm then employed by the Company was to be dismissed.
There were no adverse opinions or disclaimers of opinion, nor
were there any modifications as to uncertainty, audit scope, or accounting
principles with the former accountant. There were no disagreements with the
former accountant on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure.
On October 17, 1994, the accounting firm of Coopers & Lybrand,
L.L.P. was engaged to perform the annual audit as of September 30, 1994. Coopers
& Lybrand, L.L.P. was also engaged to perform the annual audit for fiscal year
ended September 30, 1995, and 1996.
There are no other changes in and disagreements on accounting
and financial statement disclosure.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The directors and executive officers of the Company as of
January 1, 1997 are as follows:
33
Name Age Position
- - --------------------- ------------- -----------------------------------
Brent M. Cook 36 President and Chief Executive Officer
Russ Madsen 50 Interim Chairman of the Board, Vice
President-Operations and Director
Stanley M. Kimball 42 Chief Financial Officer, Treasurer
and Director
Alan D. Ayers 39 Chief Operating Officer and Director
George W. Ford 51 Vice President-Research and
Development and Director
Steven Brown 38 Vice President of Engineering and
Construction and Director
Asael T. Sorensen, Jr. 42 Secretary and General Counsel
Richard Lambert 51 Vice President of Sales and Marketing
Raymond J. Weller 50 Director
DeLance Squire 77 Director
- - -----------------------
Brent M. Cook has served as President and Chief Executive Officer since October
1996, and Chief Financial Officer from June 1996 until December 1996. Mr. Cook
is a Certified Public Accountant. Prior to joining the Company, 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. PacifiCorp is
not affiliated with the Company.
Russ Madsen has served as Interim Chairman since November 1996 and Vice
President of Operations and a Director of the Company since August 1992. Mr.
Madsen is responsible for the Company's prototype briquetting plant in Price,
Utah. Between 1981 and 1992, Mr. Madsen was employed as an accounting manager by
Coastal States Energy, a subsidiary of Coastal Corporation. From 1984 to 1991,
Mr. Madsen also was a Vice President and Director of Specialized Mining
Services, Inc., a mine support service company from whom the Briquetting
Technology was acquired. Mr. Madsen graduated from Utah State University with a
B.S. degree in Agricultural Economics and a minor in Business Management.
Stanley M. Kimball has served as Chief Financial Officer, Treasurer and Director
since January 1, 1997. Prior to joining the Company, 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 Masters
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.
34
Alan D. Ayers has served as Chief Operating Officer and Director since June
1996. Mr. Ayers joined the Company in August of 1995 as manager of the Company's
investor relations department. From 1993 to 1995, Mr. Ayers was the General
Manager for Taylor Maid Beauty Supply, responsible for the operations of the
regional supply company. From 1987 to 1993, he was Director of Operations for
Knighton Optical, Inc. Mr. Ayers received his M.B.A. from the University of
Utah.
George W. Ford has served as Vice President of Research and Development and a
Director of the Company since August 1993. From 1982 to 1993, Mr. Ford was
employed at Ballard Medical Products, Inc. in research and development,
principally in the biomedical field. He 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 Brown has served as Vice President of Engineering and Construction of the
Company since February 1995. He was elected to the Board of Directors in
September of 1995. Mr. Brown was responsible for the management of the
construction companies and the limestone quarry. He is currently responsible for
the design and construction of the Company's production facilities. 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. Mr. Brown
obtained a B.S. degree in Civil Engineering and a Master of Business
Administration from Brigham Young University.
Asael T. Sorensen, Jr. joined the Company as its General Counsel in September
1995. From 1982 to 1995, Mr. Sorensen practiced law primarily in the area of
contract negotiations and administration. Since 1987, Mr. Sorensen has been a
consultant with the American Management Association, a business seminar and
consulting non-profit organization headquartered in New York. Mr. Sorensen
graduated from Brigham Young University with a joint Juris Doctor and Masters of
Business Administration. He is admitted to practice law in the State of Utah.
Raymond J. Weller has served as a director of the Company since July 1991. Since
1991, Mr. Weller has been Vice President of HMO Benefits of Utah, a Utah based
insurance brokerage firm. From 1985 to 1991, Mr. Weller was an agent with the
insurance brokerage of Galbraith, Benson, and McKay.
DeLance Squire has served as a director of the Company since December 13, 1996.
Mr. Squire was the founder of Squire & Co., Orem, Utah and retired in 1986.
Since 1986, Mr. Squire has been the Executive Director for the Commission for
Economic Development, Orem, UT. In addition, Mr. Squire is a member of the
Impact Fees Committee and the Strategic Plan Committee to the City of Orem. He
also serves as a member of the board of trustees for Mountain View Hospital,
Payson, UT. Mr. Squire received his B.S. degree in Accounting from Brigham Young
University in 1947 and became a Certified Public Accountant in 1950.
The Company's executive officers are elected annually by the
Board of Directors and serve at the discretion of the Board. The Company's
directors hold office until the next annual meeting of stockholders and until
their successors have been duly elected and qualified. Officers serve at the
will of the Board of Directors.
Pursuant to an amendment to the Bylaws of the Company adopted
on January 31, 1996, the Board of Directors will be divided into three classes
after the first annual meeting of stockholders (scheduled to be held in 1997).
35
The three classes will be as nearly equal in number as possible with the term of
the office of directors of the first class, second class and third class to
expire at the first, second and third annual meeting of stockholders after their
election, respectively. At each annual meeting following such classification and
division of the members of the Board of Directors, a number of directors equal
to the number of directorships in the class whose term expires at the time of
such meeting shall be elected to hold office until the third succeeding annual
meeting of stockholders of the Company. The salaried employees of the Company
serving as directors are not compensated as directors. The Board of Directors
has granted stock options to directors of the Company not otherwise employed by
the Company. Such directors also receive reimbursement of out-of-pocket
expenses.
Compliance with Section 16(a) of the Exchange Act
Section 16(a) of the Securities Exchange Act of 1934 requires
the Company's officers and directors, and persons who own more than ten percent
of a registered class of the Company's equity securities, to file reports of
ownership and changes in ownership with the Securities and Exchange Commission
and the National Association of Securities Dealers. Officers, directors and
greater than ten-percent shareholders are required by Securities and Exchange
Commission regulations to furnish the Company with copies of all Section 16(a)
forms they file. Based solely on review of the copies of such forms furnished to
the Company since it became subject to the Securities Exchange Act of 1934 to
December 31, 1996, year-end reports furnished to the Company after December 31,
1996 and representations by current officers and directors that no other reports
were required, the Company has determined that during the 1996 fiscal year all
applicable 16(a) filing requirements for the current officers and directors were
met; provided, however, that the Company has been unable to reconcile year-end
balances for certain officers and directors.
ITEM 11. EXECUTIVE COMPENSATION
The following sets forth the compensation paid by the Company
for services rendered by Kenneth M. Young, the Company's Chairman of the Board
and Chief Executive Officer during the nine-month fiscal period ended September
30, 1994, the fiscal years ended September 30, 1995 and September 30, 1996 and
to each of the other executive officer whose compensation exceeded $100,000
during the most recently completed fiscal year.
Summary Compensation Table
Annual Compensation Long-Term Compensation
- - ----------------------- ----------------------
Other Restricted All Other
Name and Salary Bonus ($) Annual Stock Stock Compensation
Principal Position Year ($) Compensation Awards ($) Options (#) ($)
($)
======================= -------- ---------- -------------- ------------- ------------- -------------- ==============
Kenneth M. Young(1) 1996 $88,700 - - (1) - - 84,500(2) -
======================= -------- ---------- -------------- ------------- ------------- -------------- ==============
CEO and Chairman of 1995 $70,000 $36,812 - (2) - - 306,250(3) -
the Board
======================= -------- ---------- -------------- ------------- ------------- -------------- ==============
1994(4) $60,000 - - - - -
======================= ======== ========== ============== ============= ============= ============== ==============
Brent M. Cook (5) 1996 $23,335 $ 60,000 $1,163,000(6) 40,000(6)
Executive Vice
President and CFO
36
(1) Mr. Young resigned as Chairman of the Board effective November 12, 1996.
This action has resulted in further compensation being owed to Mr. Young
and payable over fiscal year 1997 pursuant to the terms of a settlement
agreement. See "ITEM 13 -- CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS."
(2) Includes (A) an option to acquire 34,500 shares of common stock at $8.38
($16.76 presplit) per share, granted on October 17, 1995, of which all were
exercised on October 17, 1995 at a market price equal to exercise price and
(B) an option to acquire 62,500 shares of common stock at $1.50 per share,
granted on August 13, 1996, of which 12,500 were canceled pursuant to a
settlement agreement between Mr. Young and the Company. See "ITEM 13 --
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS."
(3) Includes an option to acquire 250,000 shares of common stock at $1.50 per
share and an option to acquire 56,250 shares of common stock at $5.315 per
share under the Company's 1995 Stock Option Plan.
(4) Represents nine-month period ended September 30, 1994.
(5) Mr. Cook entered into an employment agreement dated June 1, 1996 to act as
Executive Vice President and Chief Financial Officer. Mr. Cook was
appointed as President and Chief Executive Officer in October of 1996.
(6) Upon the execution of his Employment Agreement with the Company, Mr. Cook
received immediately exercisable options to acquire 100,000 shares of the
Company's common stock at a price of $1.50 per share. This amount
represents $1,163,000 of the compensation recorded by the Company as a
result of the option grant to Mr. Cook. Mr. Cook also received an option to
acquire 40,000 shares of the Company's common stock at a price of $1.50 per
share, which vests over 10 years.
Other than the Company's 1995 Stock Option Plan, there are no
retirement, pension, or profit sharing plans for the benefit of the Company's
officers, directors and employees. The Company does provide health insurance
coverage for its employees. The Board of Directors may recommend and adopt
additional programs in the future for the benefit of officers, directors and
employees.
Information concerning grants of options to the named
executive officer is reflected in the table below. The amounts shown for the
named executive officer as potential realizable values are based on arbitrarily
assumed annualized rates of stock price appreciation of zero percent, five
percent and ten percent over the full term of the options. These potential
realizable values are based solely on arbitrarily assumed rates of price
appreciation required by applicable SEC regulations. Actual gains, if any, on
option exercises and common stockholdings are dependent on the future
performance of the Company and overall stock market conditions. There can be no
assurance that the potential realizable values shown in this table will be
achieved.
37
Option Grants in Fiscal Year 1996
====================================================================================================================
Potential Realizable Value at
Assumed Annual Rates of Stock
Price Appreciation
Individual Grants for Option Term
======================== ----------------------------
% of Total
Options
Options Granted
Name Granted to Employees Exercise Market Price Expiration Date (0%) ($) (5%) ($) ( 10%) ($)
(#) in Fiscal Year Price on Date
1996 of Grant
======================== ---------- ---------------- --------- -------------- ----------------- ----------- ---------- --------
Kenneth M. Young(1) 34,500 2.1% $8.38 $16.75 October 16, 2005 $ 288,765 $ 470,585 $ 749,532
---------- ---------------- --------- -------------- ----------------- ----------- ---------- -----------
50,000 3.1% $1.50 $10.25 August 12, 2006 $ 43,750 $ 48,467 $ 55,703
======================== ========== ================ ========= =============== ================= =========== ========== ===========
Brent M. Cook 100,000 6.2% $1.50 $13.125 June 1, 2006 $1,162,500 $1,256,834 $1,401,561
40,000 2.5% $1.50 $13.125 June 1, 2007 $ 465,000 507,020 576,187
====================================================================================================================================
(1) Includes (A) an option to acquire 34,500 shares of common stock at
$8.38 ($16.76 presplit) per share, granted on October 17, 1995, of
which all were exercised on October 17, 1995 at a market price equal to
exercise price and (B) an option to acquire 62,500 shares of common
stock at $1.50 per share, granted on August 13, 1996, of which 12,500
were canceled pursuant to a settlement agreement between Mr. Young and
the Company. See "ITEM 13 -- CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS."
Aggregated Option Exercises and Year-End Option Values in 1996
The following table summarizes for the named executive officer
of the Company the number of stock options, if any, exercised during Fiscal Year
1996, the aggregate dollar value realized upon exercise, the total number of
unexercised options held at September 30, 1996 and the aggregate dollar value of
in-the-money unexercised options held at September 30, 1996. Value realized upon
exercise is the difference between the fair market value of the underlying stock
on the exercise date and the exercise price of the option. The value of
unexercised, in-the-money options at September 30, 1996 is the difference
between its exercise price and the fair market value of the underlying stock on
September 30, 1996 which was $8.00 per share based on the closing bid price of
the common stock on September 30, 1996. The underlying options have not been
and, may never be exercised; and actual gains, if any, on exercise will depend
on the value of the common stock on the actual date of exercise. There can be no
assurance that these values will be realized.
38
Aggregated Option Exercises in Fiscal Year 1996
and Year-End Option Values
====================================================================================================================
Number of Value of Unexercised
Unexercised Options In-the-Money Options
at 9/30/96(#) at 9/30/96($)
- - --------------------------------------------------------------------------------------------------------------------
Shares Acquired Value
Name on Exercise(#) Realized($) Exercisable Unexercisable Exercisable Unexercisable
===================== ----------------- --------------- ------------ -------------- ------------- ==================
Kenneth M. Young 34,500 $-0-(1) -0- 100,000(2) $ -0- $ 650,000
===================== ================= =============== ============ ============== ============= ==================
Brent M. Cook -0- $-0- 100,000 40,000 $ 650,000 $ 260,000
====================================================================================================================
(1) The option to acquire 34,500 shares of common stock at $8.38 ($16.76
presplit) per share was granted and exercised on October 17, 1995 at a
market price equal to the exercise price.
(2) In accordance with Mr. Young's settlement agreement, options to acquire
100,000 shares of common stock became fully vested on January 1, 1997. See
"ITEM 13 -- CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS."
Long-Term Incentive Plan Awards in Fiscal Year 1996
The Company has no "long-term incentive plan".
Future Benefits of Pension Plan Disclosure in Fiscal Year 1996
The Company has no such benefit plans.
Employment Agreements
Kenneth Young. The Company entered into an employment
agreement dated as of January 1, 1992, with Kenneth M. Young. The employment
agreement provides for an annual base salary of $72,000. An annual bonus may be
paid as determined by the Company's Board of Directors. Mr. Young is entitled to
all other fringe benefits provided to other similar employees of the Company.
The agreement is terminable at will at anytime by either party. Upon termination
of the employment agreement, Mr. Young is subject to a 48-month covenant not to
compete, during which time Mr. Young has agreed not to compete with the Company.
The Company has agreed to pay Mr. Young a payment equal to 80% of his annual
compensation (exclusive of bonus and benefits) within 30 days after the
termination of his employment in exchange for his covenant not to compete.
Effective November 12, 1996, Kenneth Young resigned as Chairman of the Board and
Chief Executive Officer of the Company. The Company and Kenneth Young have
entered into a settlement agreement. See "ITEM 13 -- CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS."
Brent M. Cook. The Company entered into an employment
agreement dated June 1, 1996, with Brent M. Cook to act as Executive Vice
President and Chief Financial Officer. Mr. Cook was appointed as President and
Chief Executive Officer in October of 1996. The employment agreement provides
for an annual base salary of $80,000. An annual bonus may be paid as determined
by the Company's Board of Directors. Mr. Cook is entitled to all other fringe
benefits provided to other similar employees of the Company. The term of the
employment agreement commenced on June 1, 1996 and will terminate on May 31,
1999. If Mr. Cook does not continue in the employ of the Company after
39
termination of the agreement (whether or not Mr. Cook is offered employment by
the Company) the Company shall pay Mr. Cook the sum of one year's annual wages
no later than July 1, 1999. Effective June 1, 1997, Mr. Cook's annual salary
shall increase to $100,000 in accordance with the employment agreement.
Director Compensation
The salaried employees of the Company serving as directors are
not compensated as directors. The Board of Directors has granted stock options
to directors of the Company not otherwise employed by the Company. Such
directors also receive reimbursement of out-of-pocket expenses.
Officer Compensation
In September 1995, the Company's Board of Directors approved a
new compensation structure for management. The structure was to become effective
on October 1, 1995 but has been deferred until such time as the board determines
the Company's cash flow is sufficient to support the new compensation structure.
The Company no longer intends to implement that structure. The Company's Board
of Directors is currently considering other compensation structures.
Stock Option Plans
1995 Stock Option Plan. Under the Company's 1995 Stock Option
Plan, as amended (the "Option Plan"), 2,400,000 shares of common stock are
reserved for issuance upon the exercise of stock options. The Option Plan is
designed to serve as an incentive for retaining qualified and competent
employees, directors and consultants. As of September 30, 1996, options to
purchase an aggregate of approximately 900,000 shares of Common Stock were
issued under the Option Plan, all of which have been exercised.
A committee of the Company's Board of Directors, or in its
absence, the Board (the "Committee") administers and interprets the Option Plan
and is authorized to grant options and other awards thereunder to all eligible
employees of the Company, including officers and directors (whether or not
employees) of the Company. The Option Plan provides for the granting of both
"incentive stock options" (as defined in Section 422 of the Code) and
non-statutory stock options. Options can be granted under the Option Plan on
such terms and at such prices as determined by the Committee, except for the per
share exercise price of incentive stock options which will not be less than the
fair market value of the common stock on the date of grant and, in the case of
an incentive stock option granted to a 10% stockholder, the per share exercise
price will not be less than 110% of such fair market value. The aggregate fair
market value of the shares of common stock covered by incentive stock options
granted under the Option Plan that become exercisable by a grantee for the first
time in any calendar year is subject to a $100,000 limit.
Options granted under the Option Plan will be exercisable
after the period or periods specified in the option agreement. Options granted
under the Option Plan are not exercisable after the expiration of ten years from
the date of grant and are not transferable other than by will or by the laws of
descent and distribution.
Other Options. In general the Company issues restricted stock
at 65% of market in transactions with third parties that involve no
consideration other than the cash received. The non-qualified options described
below were issued within this general guideline with exercise prices based on
market value at the time the options were issued.
40
The following table sets forth information with respect to
options granted to the Company's executive officers and directors during the
last fiscal year.
Name Number of Exercise
Options Price
- - --------------------- ------------------ --------------------
Kenneth M. Young (1) 34,500 $ 8.38
25,000 $ 1.50
Brent M. Cook 140,000 $ 1.50
Kirby Cochran(1) 34,500 $ 8.38
Russ Madsen 30,000 $ 8.38
25,000 $ 1.50
Michael Midgley (1) 30,000 $ 8.38
25,000 $ 1.50
Alan Ayers 30,000 $ 8.38
10,000 $ 1.50
100,000 $ 1.50
Steve Brown 28,200 $ 8.38
100,000 $ 1.50
George W. Ford 28,200 $ 8.38
25,000 $ 1.50
Michael Bodon(1) 28,200 $ 8.38
Asael T. Sorensen, Jr. 28,200 $ 8.38
100,000 $ 1.50
Richard Lambert 28,200 $ 8.38
20,000 $ 1.50
Lloyd C. McEwan(1) 30,000 $ 8.38
Raymond Weller 30,000 $ 8.38
25,000 $ 1.50
- - --------------
(1) No longer with the Company.
(2) Mr. Bodon is a cousin of the spouse of Mr. Young.
Recipients of these options may exercise them at any time.
Shares related to exercised options are held in escrow and are made available as
the options vest. The options vest at different times based upon the terms
offered with some options vesting immediately and others over terms of up to 10
years. (In the event that an executive officer or employee terminates employment
with the Company, or a director ceases to be a director, prior to the specified
vesting period, the Company will cancel any of the shares in which the recipient
41
has not vested) When options are issued with terms considered compensatory, the
compensation expense related to these options is being amortized to expense over
the specified vesting period.
Board Meetings
The Board held a total of nine (9) regular meetings during
fiscal year 1996 and no special meetings during fiscal year 1996. All directors
attended over 75% of the aggregate number of the regular meetings of the Board.
Committees Of The Board
The Board of Directors has not established an Audit Committee
or a Compensation Committee.
Report of the Board of Directors on Executive Compensation
The Company does not have a Compensation Committee of the Board of Directors.
The Board of Directors is responsible for establishing and administering the
compensation policies applicable to the Company's officers and key personnel,
including the named executives. Due to past cash flow concerns of the Company,
the Board of Directors has not implemented changes in the Company's compensation
structure which were previously approved by the Board of Directors. Future
compensation polices will be dependent on the Company's cash flow.
There is no specific relationship of corporate performance to executive
compensation regarding the Chief Executive Officer's compensation. However, due
to prior cash flow concerns, the Chief Executive Officer has received stock
based compensation as a significant component of his compensation. The Company
will likely continue to use stock based compensation to more closely align the
interests of the Chief Executive Officer with the interests of the stockholders.
Comparisons of base salaries to the market should take into account the
development the Company has experienced in the past year, including the
contractual arrangements entered into by the Company for the building of
facilities and the licensing of the Briquetting Technology. Measurements of
corporate responsibility may, therefore, be less accessible to obvious
conclusions for comparison to executive compensation.
The Board of Directors continues to strive to ensure that the Company's
compensation plan attracts, retains and rewards both staff and management
personnel while continuing to operate in the best interests of the shareholders.
The Board of Directors
42
Stockholder Return Performance Graph
Federal regulation requires the inclusion of a line graph comparing cumulative
total shareholder return on Common Stock with the cumulative total return of (1)
NASDAQ Combined Index and (2) a published industry or line-of-business index.
The performance comparison appears below.
The Board of Directors recognize that the market price of stock is influenced by
many factors, only one of which is Company performance. The stock price
performance shown on the graph is not necessarily indicative of future price
performance.
Comparison of Cumulative Total Return
Total Returns Assume Reinvestment of Dividends
{Graphic]
Total Return Analysis 9/30/94 9/30/95 9/30/96
Covol Technologies, Inc. $100 $230 $265
S&P Energy Composite $100 $120 $150
Nasdaq Composite (US) $100 $137 $161
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information as of
December 1, 1996, regarding the beneficial ownership of all of the Company's
outstanding common stock, par value $.001 per share (the "common stock"),
including such ownership by (i) each of the stockholders of the Company who owns
more than 5% of the outstanding shares of common stock, (ii) each director of
the Company, and (iii) all directors and executive officers of the Company as a
group. As of December 1, 1996, there were 8,895,542 shares of common stock
outstanding. As of that date, there were outstanding options to acquire an
additional 1,366,500 shares of common stock from the Company, of which 612,750
were vested.
43
Name and Address of Amount and Nature of Beneficial
Beneficial Owner (1) Ownership (2) Percent of Class
-------------------- ------------- ----------------
Kenneth M. Young* 332,328(3) 3.50%
Brent M. Cook 100,000(12) 1.05
Kirby Cochran* 23,045(4) 0.24
Russ Madsen 518,151(5) 5.50
Michael Midgley* 158,500(7) 1.67
Alan Ayers 43,500(13) 0.46
Steven Brown 144,400(8) 1.52
George W. Ford 181,696(6) 1.91
Michael Bodon* 181,650(15) 1.91
Asael T. Sorensen, Jr. 74,608(11) 0.78
Richard Lambert 55,134(14) 0.57
Lloyd C. McEwan* 239,284(9) 2.51
Raymond J. Weller 231,900(10) 2.44
All directors and executive
officers as a group 2,324,196 24.50%
(thirteen persons)
- - ------------------
* no longer affliated with the Company
(1) The address of each person named in the table is c/o the Company, 3280
North Frontage Road, Lehi, Utah 84043.
(2) The persons named in this table have sole voting and investment power with
respect to all shares of common stock reflected as beneficially owned by
them. A person is deemed to be the beneficial owner of securities that can
be acquired by such person within sixty (60) days from the Record Date upon
the exercise of options. The record ownership of each beneficial owner is
determined by assuming that options that are held by such person and that
are exercisable within sixty (60) days from the Record Date have been
exercised. The total outstanding shares used to calculate each beneficial
owner's percentage includes such options.
(3) Consists of 1,150 shares owned by Mr. Young's spouse, 120,050 shares owned
jointly by Mr. Young and his spouse, 111,123 shares owned by Mr. Young and
options to purchase 100,000 shares held by Mr. Young, which are currently
exercisable pursuant to a settlement agreement entered into by Mr. Young
and the Company in November 1996.
(4) Consists of 23,045 shares owned by Mr. Cochran. Mr. Cochran held options to
purchase 100,000 shares and 500,000 shares, both of which were forfeited in
1996.
(5) Consists of 321 shares owned by Mr. Madsen's spouse, 14,789 shares owned by
Mr. Madsen and his spouse, 363,334 shares owned by Mr. Madsen, 139,698
shares owned by Mr. Madsen in a personal securities account, and options to
purchase 17,500 shares held by Mr. Madsen which are currently exercisable.
44
(6) Consists of 176,696 shares owned by Mr. Ford and options to purchase 5,000
shares held by Mr. Ford which are currently exercisable.
(7) Consists of 83,500 shares owned by Mr. Midgley and options to purchase
75,000 shares held by Mr. Midgley which are exercisable on January 1, 1997
pursuant to a settlement agreement entered into by Mr. Midgley and the
Company in November 1996.
(8) Consists of 131,900 shares owned by Mr. Brown and options to purchase
12,500 shares held by Mr. Brown which are currently exercisable.
(9) Consists of 235,784 shares owned by Mr. McEwan and options to purchase
3,500 shares held by Mr. McEwan which are currently exercisable.
(10) Consists of 229,400 shares owned by Mr. Weller and options to purchase
2,500 shares held by Mr. Weller which are currently exercisable.
(11) Consists of 44,500 shares owned by Mr. Sorensen, 8,721 shares owned by Mr.
Sorensen and his child in trust, 1,000 shares owned by Mr. Sorensen and his
spouse, 7,887 shares owned by the Sorensen family trust and options to
purchase 12,500 shares held by Mr. Sorensen which are currently
exercisable.
(12) Consists of options to purchase 100,000 shares.
(13) Consists of 30,000 shares owned by Mr. Ayers, 1,700 shares owned by Mr.
Ayers' individual retirement account, 800 shares owned by Mr. Ayers' spouse
and options to purchase 11,000 shares held by Mr. Ayers which are currently
exercisable.
(14) Consists of 49,584 shares owned by Mr. Lambert, 50 shares owned by Mr.
Lambert's spouse and options to purchase 4,500 shares held by Mr. Lambert
which are currently exercisable.
(15) Consists of 179,150 shares owned by Mr. Bodon and options to purchase 2,500
held by Mr. Bodon which are currently exercisable.
Changes in Control.
The Company knows of no arrangement, including the pledge by
any person of securities of the Company, which may at a subsequent date result
in change of control of the Company.
45
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company entered into an employment agreement dated June
1, 1996, with Brent M. Cook to act as Executive Vice President and Chief
Financial Officer. Mr. Cook was appointed as President and Chief Executive
Officer in October of 1996. The employment agreement provides for an annual
base salary of $80,000. An annual bonus may be paid as determined by the
Company's Board of Directors. Mr. Cook is entitled to all other fringe benefits
provided to other similar employees of the Company. The term of the employment
agreement commenced on June 1, 1996 and will terminate on May 31, 1999. If Mr.
Cook does not continue in the employ of the Company after termination of the
agreement (whether or not Mr. Cook is offered employment by the Company) the
Company shall pay Mr. Cook the sum of one year's annual wages no later than July
1, 1999. Effective June 1, 1997, Mr.Cook's annual salary shall increase to
$100,000 in accordance with the employment agreement.
In June of 1996, the Company formed Utah Synfuel #1, Ltd. and
Alabama Synfuel #1, Ltd., each a Delaware limited partnership, for the purpose
of facilitating the financing and construction of the Utah Plant and the Alabama
Plant, respectively. See "ITEM 1--BUSINESS--Business of the Company--Limited
Partnerships" and "--Business Strategy--Coal Briquettes." The Company is
expected to enter into various agreements and contracts with Utah Synfuel #1,
Ltd. and Alabama Synfuel #1, Ltd. which may not be structured on an arm's-length
basis.
In an effort to obtain capital for the construction of the
Utah Plant and the Alabama Plant, the Company borrowed $700,000 from Key Bank of
Utah ("Key Bank"). The loan accrues interest at Key Bank's prime rate plus 2%
per annum and was to be paid in full in October 1996. In November 1996 the
Company paid accrued interest plus principal of $100,000. The Company and Key
Bank have agreed to rollover the remaining $600,000 principal balance of the
loan for another 90 days, until January 29, 1997. As a condition to making the
loan, Key Bank required that certain officers, directors and employees of the
Company also sign as guarantors of the note evidencing the loan (the "Key Bank
Note"). To induce such officers, directors and employees to sign the Key Bank
Note, the Company further loaned $100,000 each to Mr. Russ Madsen, Mr. Dean
Young, Mr. Kenneth Young, Mr. Alan Ayers, Mr. Asael T. Sorensen, Jr., Mr. Steve
Brown and Mr. Michael Midgley (the "Individuals"). The loan to the Individuals
is on the same terms as the loan from Key Bank. The proceeds of the loan from
the Company to the Individuals, along with other money of the Individuals
aggregating $1,850,000, were invested in partnership interests in Utah Synfuel
#1 and Alabama Synfuel #1. Mr. Russ Madsen invested $50,000 of the loan in
Alabama Synfuel #1 and $50,000 of the loan in Utah Synfuel #1. The remaining
Individuals invested the full amount of their respective loans in Utah Synfuel
#1. The Company has not received any payments from the Individuals.
In November of 1996, the Company entered into a settlement
agreement with Kenneth M. Young. Pursuant to the settlement agreement, the
Company agreed: (i) to pay Mr. Young $4,000 twice a month through December 31,
1996, (ii) to pay $25,030 in deferred compensation over 24 semi-monthly
installments of $1,042 beginning January 1, 1997, (iii) to pay for Mr. Young's
medical insurance until December 31, 1997, (iv) to pay $2,500 semi-monthly for
24 payments beginning January 1, 1997 in consideration for consulting services
reasonably requested by the Company and Mr. Young's agreement to refrain from
any activities in competition with the Company, (v) to allow options
representing 50,000 shares of Company common stock at $1.50/share to become
fully vested on January 1, 1997 (these options were originally issued under a
stock option agreement dated January 1, 1995 relating to 250,000 shares) and
(vi) to allow options representing 50,000 shares of Company Common Stock at
$1.50/share to become fully vested on January 1, 1997 (these options were
originally issued under a stock option agreement dated January 1, 1995 relating
to 62,500 shares, of which the remaining 12,500 shares expired).
46
In November of 1996, the Company entered into a settlement
agreement with Michael Q. Midgley. Pursuant to the settlement agreement, the
Company agreed: (i) to pay $20,000 in November 1996 and $38,479 in salary,
deferred compensation and unused vacation pay over 24 semi-monthly installments
of $1,605 beginning November 15, 1996, (ii) to pay $2,500 semi-monthly for 24
payments beginning January 1, 1997 in consideration for consulting services
reasonably requested by the Company and Mr. Midgley's agreement to refrain from
any activities in competition with the Company, (iii) to allow options
representing 50,000 shares of Company Common Stock to become fully vested on
January 1, 1997 (these options were originally issued under a stock option
agreement dated January 1, 1995) and (iv) to allow options representing 25,000
shares of Company Common Stock at $1.50/share to become fully vested on January
1, 1997 (these options were originally issued under a stock option agreement
dated January 1, 1996 relating to 50,000 shares, of which the remaining 25,000
shares expired).
47
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, AND REPORTS ON FORM 8-K
Financial Statements
Consolidated Financial Statements of Covol Technologies, Inc.
Report of Independent Public Accountants............................... F-1
Consolidated Balance Sheets as of September 30, 1995 and
September 30, 1996.................................................. F-2
Consolidated Statements of Operations
for the nine months ended September 30, 1994
and the years ended September 30, 1995 and 1996.............. F-3
Consolidated Statements of Changes in Stockholders' Equity
for the nine months ended September 30, 1994, and
the years ended September 30, 1995 and 1996.................. F-5
Consolidated Statements of Cash Flow
for the nine months ended September 30, 1994 and
the years ended September 30, 1995 and 1996.................. F-7
Notes to Consolidated Financial Statements............................ F-10
All other schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable, and therefore have been omitted.
Exhibits
All exhibits listed hereunder, unless otherwise indicated,
have previously been filed as exhibits to the Company's Form 10 and Form 10/A.
Such exhibits have been filed with the Securities and Exchange Commission
("Commission") pursuant to the requirements of the Acts administered by the
Commission. Such exhibits are incorporated herein by reference under Rule 24 of
the Commission's Rules of Practice and Investigations. Certain other instruments
which would otherwise be required to be listed below have not been so listed
because such instruments do not authorize securities in an amount which exceeds
10% of the total assets of the Company and its subsidiaries on a consolidated
basis and the Company agrees to furnish a copy of any such instrument to the
Commission upon request.
48
Report of Independent Accountants
To the Board of Directors
Covol Technologies, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Covol
Technologies, Inc. and Subsidiaries as of September 30, 1995 and 1996, and the
consolidated statements of operations, changes in stockholders' equity
(deficit), and cash flows for the nine months ended September 30, 1994 and the
years ended September 30, 1995 and 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Covol
Technologies, Inc. and Subsidiaries as of September 30, 1995 and 1996, and the
consolidated results of their operations and their cash flows for the nine
months ended September 30, 1994 and the years ended September 30, 1995 and 1996,
in conformity with generally accepted accounting principles.
As discussed in Note 11 to the financial statements, the Company changed its
method of computing depreciation in 1994.
Salt Lake City, Utah
January 10, 1997
F-1
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
as of September 30, 1995 and 1996
ASSETS 1995 1996
---- ----
Current assets:
Cash and cash equivalents $ 583,757 $ 490,106
Receivables 22,005 77,744
Inventories - 162,757
Notes receivable - related parties, current - 3,733
Prepaid expenses and other current assets 12,525 44,733
------------ --------------
Total current assets 618,287 779,073
----------- -------------
Property, plant and equipment, net of accumulated depreciation 1,330,300 7,125,245
---------- ------------
Other assets:
Restricted cash 500,000 -
Cash surrender value of life insurance 139,612 152,112
Notes receivable - related parties, non-current - 700,000
Deferred tax asset 23,000 -
Deposits and other assets 39,463 15,642
------------ --------------
Total other assets 702,075 867,754
----------- -------------
Net assets - discontinued operations 9,315 -
------------- --------------
Total assets $ 2,659,977 $ 8,772,072
========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 747,137 $ 2,183,278
Accrued liabilities 286,451 333,936
Notes payable - current 26,084 958,086
Notes payable - related parties, current 39,035 786,000
------------ -------------
Total current liabilities 1,098,707 4,261,300
---------- ------------
Long-term liabilities:
Notes payable, non-current 176,601 150,980
Deferred compensation 201,901 212,612
----------- -------------
Total long-term liabilities 378,502 363,592
----------- -------------
Total liabilities 1,477,209 4,624,892
---------- ------------
Minority interest in consolidated subsidiaries - 4,380,544
---------------- ------------
Commitments (Notes 8, 14, 15, and 17)
Stockholders' equity (deficit):
Common stock, $0.001 par value; authorized: 25,000,000 shares
issued and outstanding: 5,260,042 at September 30, 1995 and
7,610,373 at September 30, 1996 5,260 7,610
Common stock to be issued, 119,334 shares at September 30, 1995
and 103,750 shares at September 30, 1996 119 104
Capital in excess of par value 9,617,512 32,780,515
Capital in excess of par value - common stock to be issued 581,881 934,896
Accumulated deficit (7,360,156) (21,196,476)
Notes and interest receivable - related parties from issuance of
or collateralized by common stock (net of allowance) (240,000) (7,580,071)
Deferred compensation from stock options (1,421,848) (5,179,942)
---------- ------------
Total stockholders' equity (deficit) 1,182,768 (233,364)
---------- -------------
Total liabilities and stockholders' equity (deficit) $ 2,659,977 $ 8,772,072
========== ============
The accompanying notes are an integral
part of the consolidated financial statements
F-2
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Nine months
ended Year ended Year ended
September 30, September 30, September 30,
1994 1995 1996
---------------- ---------------- ----------------
Revenues:
License fees - $ 100,000 $ 100,000
Coal briquette sales $ 19,867 29,310 195,165
------------- ------------ -------------
Total revenues 19,867 129,310 295,165
------------- ----------- -------------
Operating costs and expenses:
Cost of coal briquetting operation 32,386 37,165 859,574
Research and development 387,128 1,265,072 1,044,192
Selling, general and administrative 393,109 1,494,270 3,796,569
Compensation expense on stock options - 703,527 4,772,959
Compensation expenses on stock warrants - 104,000 -
Compensation expense on issuance of common stock - 148,446 100,360
Write-off of purchased technology and trade secrets - 344,900 -
Write-down of note receivable - - 2,699,575
Minority interest in net losses of consolidated
subsidiaries - - (4,456)
------------- ---------- ------------
Total operating costs and expenses 812,623 4,097,380 13,268,773
------------ ---------- -----------
Operating loss (792,756) (3,968,070) (12,973,608)
------------ ---------- -----------
Other income (expense):
Interest income - 9,663 302,565
Interest expense (21,158) (113,137) (94,706)
Other income (expense) 3,200 35,169 (166,066)
-------------- ------------ -------------
Total other income (expense) (17,958) (68,305) 41,793
------------- ------------ --------------
Loss from continuing operations before income tax
benefit (provision) (810,714) (4,036,375) (12,931,815)
Income tax benefit (provision) 313,100 (488,000) (23,000)
------------ ----------- --------------
Loss from continuing operations (497,614) (4,524,375) (12,954,815)
Discontinued operations (Note 14):
Income (loss) from discontinued operations including
provision of $330,000 in 1995 for estimated
operating losses during phase-out period (less
applicable income tax (provision) benefit of
$(297,800), $253,000 and $0 respectively) 609,354 (351,782) (590,480)
Loss on disposal of discontinued operations (less
applicable income tax benefit of $562,000 in
1995 and $0 in 1996) - (777,394) (291,025)
----------------- ----------- -------------
Income (loss) from discontinued operations 609,354 (1,129,176) (881,505)
------------ ---------- -------------
Income (loss) before cumulative effect of change in
accounting principle 111,740 (5,653,551) (13,836,320)
Cumulative effect of change in accounting principle
(less applicable income tax provision of $15,300 in 1994) 31,302 - -
------------- ----------- --------------
Net income (loss) $ 143,042 $(5,653,551) $(13,836,320)
============ ========== ===========
- Continued -
The accompanying notes are an integral
part of the consolidated financial statements
F-3
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS, Continued
Nine months
ended Year ended Year ended
September 30, September 30, September 30,
1994 1995 1996
---------------- ---------------- ----------
Net income (loss) per common share:
Loss per share from continuing operations $ (0.13) $ (1.00) $ (1.86)
Income (loss) per share from discontinued operations 0.16 (0.25) (0.13)
--------------- -------------- ---------------
Income (loss) per share before cumulative effect
of change in accounting principle 0.03 (1.25) (1.99)
Income per share of cumulative effect of change
in accounting principle 0.01 0.00 0.00
--------------- -------------- ---------------
Net income (loss) per share $ 0.04 $ (1.25) $ (1.99)
=============== ============== ===============
Weighted average shares outstanding 3,789,996 4,524,056 6,941,424
=========== ========== ===========
The accompanying notes are an integral
part of the consolidated financial statements
F-4
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
Notes and interest
receivable - Deferred
Common stock to be issued related parties compensa-
Capital in Capital in from issuance of, tion on
Common Stock excess of excess of Accumulated or collateralized stock
Shares Amount par value Shares Amount par value deficit by, common stock options
--------- ------- --------- ------ ------ ---------- ----------- ------------------ --------
Balance at January 1, 1994 3,239,502 $3,240 $2,954,322 $(1,849,647)
Common stock issued to repay
advances from officers and
directors, including shares
issued upon exercise of
stock options 478,848 479 796,125
Common stock issued to repay
note payable 40,000 40 99,960
Common stock issued for note
receivable upon exercise
of stock options 100,000 100 99,900 $(100,000)
Common stock issued for
services rendered by
officers and directors,
including shares issued
upon exercise of stock options 51,974 52 78,448
Common stock issued for services 7,554 8 16,700
Common stock issued to officers
for cash 2,306 2 5,758
Common stock issued for equipment 15,400 15 40,985
Common stock to be issued for
acquisition of subsidiary 175,000 $175 $699,825
Net income for the nine months
ended September 30, 1994 143,042
--------- ----- ---------- -------- ---- --------- -------- ----------- -------
Balance at September 30, 1994 3,935,584 3,936 4,092,198 175,000 175 699,825 (1,706,605) $(100,000) $0
- Continued -
The accompanying notes are an integral
part of the consolidated financial statements
F-5
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT), Continued
Notes and interest
receivable - Deferred
Common stock to be issued related parties compensa-
Capital in Capital in from issuance of, tion on
Common Stock excess of excess of Accumulated or collateralized stock
Shares Amount par value Shares Amount par value deficit by, common stock options
------- ------ ---------- ------ ------- ---------- ----------- ------------------ ---------
Common stock issued for
acquisition of subsidiary 175,000 $175 $699,825 (175,000) $(175) $(699,825)
Common stock issued to
repay notes payable 47,618 47 99,953
Common stock issued for
equipment 3,870 4 10,300
Common stock issued to
repay advances from
officers and directors,
including shares issued
upon exercise of stock
options 95,602 96 95,517
Common stock issued for
notes receivable 56,000 56 139,944 $(140,000)
Common stock issued for
services 60,690 61 114,638
Common stock issued for
services rendered by
officers and directors,
including shares issued
upon exercise of stock
options 24,000 24 23,976
Common stock to be issued
for services already
received 50,000 50 321,950
Common stock issued and
to be issued to officers,
directors and others, for
cash, including shares
issued upon exercise of
stock options 861,678 861 1,963,339 69,334 69 259,931
Deferred compensation
related to the issuance
of stock options at below
market value to officers
and directors 1,888,750 $(1,888,750)
- Continued -
The accompanying notes are an integral
part of the consolidated financial statements
F-6
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT), Continued
Notes and interest
receivable - Deferred
Common stock to be issued related parties compensa-
Capital in Capital in from issuance of, tion on
Common Stock excess of excess of Accumulated or collateralized stock
Shares Amount par value Shares Amount par value deficit by, common stock options
------ ------ --------- ------ ------- --------- ----------- ----------------- --------
Compensation expense related
to the issuance of stock for
services at below market value $148,447
Compensation expense related to
the issuance of stock options
at below market value 236,625
Compensation expense related to
the issuance of stock warrants
at below market value 104,000
Amortization of deferred
compensation on stock options $466,902
Net loss for the year ended
September 30, 1995 $(5,653,551)
-------- ------- -------- -------- ----- ---------- ----------- ------------ -----------
Balance at September 30, 1995 5,260,042 $5,260 9,617,512 119,334 $119 $581,881 (7,360,156) $(240,000) (1,421,848)
Common stock issued for services 114,517 114 769,191 (50,000) (50) (321,950)
Common stock issued for notes
receivable from related parties,
including exercise of stock
options 1,010,000 1,010 6,283,365 (6,284,375)
Common stock issued for cash,
including exercise of stock
options and warrants 1,225,814 1,226 7,479,034 (69,334) (69) (259,931)
Common stock to be issued for
cash already received 43,750 44 349,956
Common stock to be issued for
property acquired 60,000 60 584,940
- Continued -
The accompanying notes are an integral
part of the consolidated financial statements
F-7
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT), Continued
Notes and interest
receivable -
Common stock to be issued related parties Deferred
Capital in Capital in from issuance of, compensation
Common Stock excess of excess of Accumulated or collateralized on stock
Shares Amount par value Shares Amount par value deficit by, common stock options
------ ------ --------- ------ ------- --------- ------------ ------------------- ----------
Cash received in payment
on notes receivable -
related parties from
issuance of common stock $171,393
Note receivable - related
parties, collateralized
by common stock (net of
$2,699,575 allowance and
$650,425 imputed interest) (1,650,000)
Services received in lieu
of payments on notes
receivable - related
parties from issuance
of common stock 687,766
Compensation expense related
to the issuance of stock
options at below market value $3,863,000
Deferred compensation related
to the issuance of stock
options at below market value to
officers, directors, employees and
consultants (net of cancellations) 4,668,053 $(4,668,053)
Amortization of deferred compensation
on stock options 909,959
Interest earned on notes receivable -
related parties from issuance of or
collateralized by common stock (264,855)
Compensation expense related to the
issuance of stock for services at
below market value 100,360
Net loss for the year ended
September 30, 1996 $(13,836,320)
-------- ------ ---------- -------- ----- --------- ----------- ----------- -----------
Balance at September 30, 1996 7,610,373 $7,610 $32,780,515 103,750 $104 $934,896 $(21,196,476) $(7,580,071) $(5,179,942)
========= ====== ========== ======= ==== ======== ============= ============ ===========
The accompanying notes are an integral
part of the consolidated financial statements
F-8
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine months Year Year
ended ended ended
September 30, September 30, September 30,
1994 1995 1996
Cash flows from operating activities:
Net income (loss) $ 143,042 $(5,653,551) $(13,836,320)
Adjustments to reconcile net income
(loss) to net cash used in operating
activities:
Cumulative effect of change in
accounting principle (31,302) - -
Depreciation and amortization 107,118 125,861 187,581
Loss on disposal of discontinued
subsidiaries - 777,394 291,025
Write off of purchased technology
and trade secrets - 344,900 -
Deferred income taxes (313,100) 488,000 23,000
Common stock issued for services 95,208 287,146 547,665
Common stock to be issued for services - 322,000 -
Compensation expense on stock options - 236,625 3,863,000
Compensation expense on stock warrants - 104,000 -
Interest earned on notes receivable -
related parties, issued for or
collateralized by common stock - - (264,855)
Write-down of note receivable - - 2,699,575
Services received in lieu of payments
on notes receivable issued for common stock - - 687,766
Amortization of deferred compensation on
stock options - 466,902 909,959
Loss on disposal of equipment - 3,359 -
Losses applicable to minority interests
in subsidiaries - - (4,456)
Notes payable issued for services - - 160,000
Increase (decrease) from changes in assets and
liabilities of continuing operations:
Receivables 35,686 (15,934) (55,739)
Inventories (13,277) 37,165 (162,757)
Prepaid expenses - (12,525) (32,208)
Deposits and other assets (2,702) (36,298) 23,821
Accounts payable 3,156 619,413 1,436,141
Accrued liabilities 69,036 171,541 47,485
Deferred compensation 7,178 9,943 10,711
Discontinued operations non-cash charges
and working capital changes (275,295) 1,487,036 893,893
---------- ---------- -------------
Net cash used in operating activities (175,252) (237,023) (2,574,713)
---------- ----------- ------------
- Continued -
The accompanying notes are an integral
part of the consolidated financial statements
F-9
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
Nine months Year Year
ended ended ended
September 30, September 30, September 30,
1994 1995 1996
Cash flows from investing activities:
Cash paid for property, plant and equipment $ (100,199) $ (693,609) $ (5,055,732)
Purchase of subsidiaries (10,000) - -
Increase in cash surrender value of life insurance (20,026) (29,240) (12,500)
Notes receivable from related parties - - (703,733)
Investing activities of discontinued operations (25,426) (485,361) -
----------- ----------- --------------
Net cash used in investing activities (155,651) (1,208,210) (5,771,965)
---------- ---------- ------------
Cash flows from financing activities:
Payment of capital lease obligations (22,806) (27,345) -
Borrowings on notes payable - - 700,000
Payment of notes payable (17,235) (19,530) (159,413)
Borrowings on notes payable - related parties 860,927 52,485 -
Payments on notes payable and other obligations -
related parties (190,677) (965,160) (3,539,035)
Proceeds from note receivable from issuance of
common stock - - 171,393
Proceeds from common stock to be issued - 260,000 -
Proceeds from issuance of common stock 5,760 1,964,200 7,570,260
Proceeds from issuance of limited partnership
interests in subsidiaries - - 4,385,000
Financing activities of discontinued operations (88,727) 1,199,816 (1,582,587)
----------- ---------- ------------
Net cash provided by financing activities 547,242 2,464,466 7,545,618
---------- ---------- ------------
Net increase (decrease) in cash 216,339 1,019,233 (801,060)
- Continued -
The accompanying notes are an integral
part of the consolidated financial statements
F-10
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
Nine months Year Year
ended ended ended
September 30, September 30, September 30,
1994 1995 1996
Total cash and cash equivalents,
beginning of period $ 55,544 $ 271,933 $ 1,291,166
----------- ----------- ------------
Total cash and cash equivalents,
end of period $ 271,883 $ 1,291,166 $ 490,106
========== ========== =============
Cash and cash equivalents, components
continuing operations:
Cash and cash equivalents $ 155,926 $ 583,757 $ 490,106
Restricted cash - 500,000 -
Discontinued operations 115,957 207,409 -
Supplemental schedule of noncash investing
and financing activities:
Common stock issued for notes receivable $ 100,000 $ 140,000 $ 6,284,375
Common stock issued to repay advances 796,604 112,613 -
Common stock issued, or to be issued for
purchase of subsidiaries 700,000 - -
Common stock issued for equipment 41,000 10,304 -
Common stock issued to repay notes payable 100,000 100,000 -
Discontinued operations - capital lease of equipment - 500,000 -
Notes payable issued to acquire subsidiaries 790,000 - -
Notes payable issued to acquire a building 325,000 - -
Note payable issued and common stock to be issued
to acquire land - - 926,794
Note payable issued for equipment 6,000 - -
Obligations assumed in connection with sale of
subsidiaries - - 4,636,435
Note payable issued for services - - 160,000
Note receivable received for subsidiaries (net
of imputed interest) - - 4,349,575
Supplemental disclosure of cash flow information:
Cash paid for interest:
Continuing operations $ 25,823 $ 112,171 $ 110,671
Discontinued operations 33,177 217,001 98,358
The accompanying notes are an integral
part of the consolidated financial statements
F-11
NOTES TO FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies:
Business Organization
Covol Technologies, Inc. (the Company) was incorporated in Delaware in
August, 1995. Effective August 14, 1995, the Company changed its name
to Covol Technologies, Inc. from Environmental Technologies Group
International. In 1991, the Company discontinued its agricultural
operations and acquired a coal briquetting technology (the Briquetting
Technology). In 1992, the Company constructed a pilot briquetting
plant in Price, Utah. During 1993, the Company refined the technology
to briquette waste by-products of the steel manufacturing industry.
The Company is developing and marketing the Briquetting Technology.
On June 30, 1993, the Company acquired three heavy construction
companies. Industrial Management and Engineering, Inc. (IME) is a
management company for two construction companies, R1001, Inc., DBA
State, Inc. (State) and Central Industries Construction, Inc. (CIC).
State is a union construction company and CIC is a non-union
construction company. The majority of the Company's construction
contracts are with industrial corporations located in Utah.
On September 30, 1994, the Company acquired Larson Limestone Company,
Inc. (Larson). Larson owns and operates a limestone quarry and sells
the processed quarry products primarily to construction projects
located in Utah.
On September 30, 1995, the Company's Board of Directors approved a
plan to discontinue the Company's construction and limestone
businesses. The construction and limestone businesses were sold,
effective February 1, 1996. (See Note 14, "Discontinued Operations").
In June 1996, the Company formed Utah Synfuel #1, Ltd. ("Utah Synfuel
#1") and Alabama Synfuel #1 ("Alabama Synfuel #1"), each a Delaware
limited partnership (collectively the "Partnerships"). The Company is
both the general partner and a limited partner in the Partnerships.
Continued
F-12
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
1. Summary of Significant Accounting Policies, Continued:
Principles of Consolidation
The 1995 consolidated financial statements include the accounts of the
Company and its 100% owned subsidiaries, IME, State, CIC and Larson,
until the time of their sale effective February 1, 1996. The 1996
consolidated financial statements include the accounts of the Company
and its two majority owned subsidiaries, Utah Synfuel #1 and Alabama
Synfuel #1 from their inception in 1996. All significant intercompany
transactions and accounts are eliminated in consolidation.
Change in Year End
Effective January 1, 1994, the Company changed its year end from
December 31 to a fiscal year end of September 30.
Stock Split
Effective June 14, 1995, the Company implemented a one-for-twenty
reverse stock split. In addition, the Company implemented a
two-for-one stock split, effective January 23, 1996. All information
set forth herein has been adjusted to give effect to these stock
splits.
Revenue and Cost Recognition
Revenues from the sale of coal briquettes are recognized as product is
shipped and invoiced. Revenues from the licensing of the Company's
technology is recognized as cash is received.
For the discontinued operations, revenues from fixed-price and
modified fixed-price construction contracts are recognized on the
percentage-of-completion method, measured by the percentage of labor
costs incurred to date to estimated total labor costs (the efforts
expended method) for each contract. This method is used because
management considers expended labor costs to be the best available
measure of progress on these contracts. Revenues from cost-plus-fee
contracts are recognized on the basis of costs incurred during the
period plus the fee earned.
Continued
F-13
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
1. Summary of Significant Accounting Policies, Continued:
Revenue and Cost Recognition, Continued
Construction costs include all direct material and labor costs and
those indirect costs related to contract performance, such as indirect
labor, supplies, tools, repairs and depreciation. Selling, general and
administrative costs are charged to expense as incurred. Provisions
for estimated losses on uncompleted contracts are made in the period
in which such losses are determined.
Changes in job performance, job conditions, and estimated
profitability, including those arising from contract penalty
provisions and final contract settlements, may result in revisions to
costs and income and are recognized in the period in which the
revisions are determined. Profit incentives are included in revenues
when their realization is reasonably assured. An amount equal to
contract costs attributable to claims is included in revenues when
realization is probable and the amount can be reliably estimated.
Cash and Cash Equivalents
The Company considers all highly liquid debt instruments with an
original maturity of three months or less to be cash equivalents. Cash
and cash equivalents are deposited with two financial institutions
located in Utah.
Restricted cash, reported at September 30, 1995, represents amounts
which are restricted in accordance with collateral requirements
related to a note payable included in discontinued operations.
Inventories
Inventories are stated at the lower of average cost or market, and
consist of coal fines available for sale and binder materials.
Continued
F-14
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
1. Summary of Significant Accounting Policies, Continued:
Property, Plant and Equipment
Property, plant and equipment are recorded at cost and are depreciated
using the straight-line method over their estimated useful lives of
five to ten years. Maintenance, repairs and minor replacements are
charged to expense as incurred. Upon the sale or retirement of
property, plant and equipment, any gain or loss on disposition is
reflected in the statement of operations and the related asset cost
and accumulated depreciation are removed from the respective accounts.
Technology and Trade Secrets
Prior to being written off in June, 1995, technology and trade secrets
related to the coal briquetting process were recorded at cost and were
being amortized using the straight-line method over 17 to 20 years.
The write-off in 1995 was based upon development of a new binder
system which replaced the technology and trade secrets purchased in
1991 and 1992.
Earnings (Loss) Per Share Calculation
Net income (loss) per common share is computed on the weighted average
number of common and common equivalent shares outstanding during the
period. Common stock equivalents consist of common stock options and
warrants. Common equivalent shares are excluded from the computation
when their effect is anti-dilutive.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
Continued
F-15
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
2. Notes Receivable - Related Parties
Notes receivable - related parties consist of the following:
September 30, September 30,
1995 1996
------------- -------------
Notes receivable from seven officers
of the Company, bearing interest
at prime (8.25% at September 30, 1996)
plus 2%, principal and interest due
on August 1, 2000, collateralized by a
7.9% interest, in Utah Synfuels #1. - $700,000
Other notes receivable - 3,733
------------- ---------
Total - 703,733
Less: current portion - (3,733)
------------- ---------
Total notes receivable, non-current $ - $700,000
============= =======
3. Property, Plant and Equipment:
Property, plant and equipment of continuing operations consists of the
following:
September 30, September 30,
1995 1996
Building and real estate $ 333,708 $ 1,265,028
Construction in progress - 4,457,939
Machinery and equipment 1,211,824 1,805,091
Accumulated depreciation (215,232) (402,813)
----------- -----------
Net property, plant and equipment $ 1,330,300 $ 7,125,245
========== ==========
Continued
F-16
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
3. Property, Plant and Equipment, Continued:
Property, plant and equipment of discontinued operations consists of
the following:
September 30, September 30,
1995 1996
Property, plant and equipment $2,947,505
Accumulated depreciation and depletion (402,038) -
---------- ------------
Net property, plant and equipment $2,545,467 $ -
========= ============
4. Notes Payable:
Notes payable of continuing operations consist of the following:
September 30, September 30,
1995 1996
Note payable to a bank, bearing
interest at prime (8.25% at
September 30, 1996) plus 2%,
principal and interest of $3,711
due monthly through October 2001,
collateralized by an office building,
property and equipment, and three
former officers of IME. $202,685 $179,249
Note payable to a bank, bearing
interest at prime (8.25% at
September 30, 1996) plus 2%, principal
and interest due January 29,
1997, personally guaranteed by seven
officers of Covol. - 700,000
Continued
F-17
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
4. Notes Payable, Continued:
September 30, September 30,
1995 1996
Note payable to a corporation, non-
interest bearing (interest imputed at
10.25%), due on demand. - $ 229,817
---------------- -----------
Total notes payable $ 202,685 1,109,066
Less: current portion (26,084) (958,086)
------------ ----------
Total notes payable, non-current $ 176,601 $ 150,980
=========== ==========
Year ending September 30, 1996
1997 $ 958,086
1998 32,220
1999 34,807
2000 37,603
2001 46,350
-----------
Total $1,109,066
Discontinued Operations
Notes payable relating to discontinued operations consist of the
following:
September 30, September 30,
1995 1996
Note payable, bearing interest at
10.6%, principal and interest of
$2,380 due monthly through June
1998, collateralized by equipment and
personal guarantees of three
former officers. $ 68,247 -
Continued
F-18
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
4. Notes Payable, Continued:
Discontinued Operations, Continued
September 30, September 30,
1995 1996
Note payable, bearing interest
at 9.25%, principal and interest of
$3,751 due monthly through June
1999, collateralized by
discontinued operations assets and
personal guarantees of three former
officers. $144,791 -
Note payable, bearing interest at 8%,
principal and interest payments
of $1,820 due monthly through September
2004, collateralized by discontinued
operations assets and personal guarantee
of a former officer of Larson. 140,674 -
Revolving lines of credit payable to
a bank, bearing interest at prime
(7.75% at September 30, 1995) plus 2%,
interest due monthly, principal due April
1996, collateralized by discontinued
operations accounts receivable. 950,000 -
Note payable to a bank, bearing
interest at 7%, principal and interest
due February 1996, collateralized by
certain cash deposits of the Company. 500,000 -
Continued
F-19
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
4. Notes Payable, Continued:
Discontinued Operations, Continued
September 30, September 30,
1995 1996
Revolving line of credit payable
to a bank, bearing interest at prime
(7.75% at September 30, 1995) plus
2%, interest payable monthly,
principal due February 29, 1996,
collateralized by discontinued
operations accounts receivable and
inventory, the guarantee of the
Company, and personal guarantees
of two officers of the Company. $ 200,000 -
Other notes payable 9,117 -
------------- -----------
Total notes payable 2,012,829 -
Less: current portion (1,967,262) -
---------- -----------
Total notes payable - non current $ 45,567 $ -
============ ==========
5. Notes Payable - Related Parties:
Continuing Operations
Note payable - related parties from continuing operations consist of
the following:
September 30, September 30,
1995 1996
Note payable, bearing interest at 6%,
collateralized by stock in a subsidiary. $34,840 -
Continued
F-20
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
5. Notes Payable - Related Parties, Continued:
Continuing Operations, Continued
September 30, September 30,
1995 1996
Notes payable, non-interest bearing,
due upon demand. $ 4,195 -
Note payable to a shareholder, non-
interest bearing, $4,000 due monthly
with all remaining principal and
interest due in January, 1997. - $ 136,000
Obligations to two former officers
and shareholders, non-interest bearing,
payable upon demand. - 650,000
---------- --------
Total notes payable and other
obligations - related parties,
current $39,035 $ 786,000
====== ========
Discontinued Operations
Notes payable - related parties, including officers, employees and
shareholders relating to discontinued operations consist of the
following:
September 30, September 30,
1995 1996
Note payable, interest imputed
at 8.5%, monthly principal and
interest payments of $2,000,
balance due October 1995,
collateralized by a building, paid
in full October 1995. $325,000 -
------- ---------
Total notes payable - related parties,
current $325,000 $ -
======= =========
Continued
F-21
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
6. Deferred Compensation Agreement
Upon the acquisition of two subsidiaries in 1993, the Company assumed
a liability to pay $40,000 per year for seven years beginning
February, 1999 to a current stockholder of the Company. The present
value of this liability, discounted at 5.18%, is reflected as deferred
compensation on the consolidated balance sheet.
7. Income Taxes
The Company accounts for income taxes using the asset and liability
approach in accordance with Statement of Financial Accounting
Standards (SFAS) No. 109, "Accounting for Income Taxes". The Company
filed a consolidated tax return with its 100% owned subsidiaries (IME,
State, CIC and Larson) through the time of their sale on February 1,
1996. Both majority owned limited partnerships file separate tax
returns, as required.
Continuing Operations
As of September 30, 1996, the Company has net operating loss
carryforwards from continuing operations of approximately $15,600,000
which can be used to offset future taxable income. The net operating
loss carryforwards expire from 2005 to 2011. The Company also has
approximately $141,000 in research and development tax credit
carryforwards which can be used to offset future tax liabilities. The
tax credits expire from 2007 to 2010.
The provision from income taxes for the years ended September 30, 1995
and 1996 differs from the statutory federal income tax rate due to the
following:
Year Ended Year Ended
September 30, September 30,
1995 1996
Tax benefit at statutory rates $ 1,372,000 $ 3,810,000
Change in valuation allowance (1,971,000) (4,007,000)
State income taxes, net of federal
tax effect 133,000 363,000
Other (22,000) (189,000)
------------ -----------
Tax provision $ (488,000) $ (23,000)
=========== ============
Continued
F-22
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
7. Income Taxes, Continued:
Continuing Operations, Continued
The types of temporary differences between the tax bases of assets and
liabilities and their financial reporting amounts that give rise to
the net deferred tax assets and liabilities relate primarily to the
use of accelerated depreciation for tax purposes and straight-line
depreciation for book purposes, and the recording of certain reserves
for book purposes.
The components of the net deferred tax asset related to continuing
operations as of September 30, 1995 and 1996 are as follows:
1995 1996
----------- -----------
Deferred tax assets (liabilities):
Net operating loss carryforwards $ 1,984,000 $ 5,830,000
Research and development tax credit
carryforwards 96,000 141,000
Amortization of trade and technology - 72,000
Reserve for bad debts 13,000 -
Depreciation (99,000) (65,000)
------------ ------------
Total deferred tax assets 1,994,000 5,978,000
Valuation allowance (1,971,000) (5,978,000)
---------- ----------
Net deferred tax asset $ 23,000 $ -
============ ==========
The valuation allowance changed by $4,007,000 during the year ended
September 30, 1996, representing the amount of deferred tax assets at
September 30, 1996 not considered recoverable through the reversal of
taxable temporary differences, or the generation of future taxable
income. SFAS No. 109 requires that a valuation allowance be provided
if it is more likely than not that some portion or all of a deferred
tax asset will not be realized. The Company's ability to realize the
benefit of its deferred tax assets will depend on the generation of
future taxable income through its continuing operations or through the
sale of assets. Because the Company has not generated significant
revenues to date relating to the Briquetting Technology, the Company
believes that a valuation allowance of $5,978,000 should be provided
as of September 30, 1996.
Continued
F-23
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
7. Income Taxes, Continued:
Discontinued Operations
As of September 30, 1995, the Company had net operating loss
carryforwards from discontinued operations of approximately $580,000
which can be used to offset future taxable income. The net operating
loss carryforwards expire from 2005 to 2008. The utilization of these
carryforwards against future taxable income may become subject to an
annual limitation due to a change in ownership of the discontinued
operations (see Note 14).
The types of temporary differences between the tax bases of assets and
liabilities and their financial reporting amounts that give rise to
the net deferred tax assets and liabilities relate primarily to the
use of accelerated depreciation for tax purposes and straight-line
depreciation for book purposes, and the recording of certain reserves
and writedowns for book purposes.
The components of the net deferred tax liability related to
discontinued operations as of September 30, are as follows:
1995 1996
------------ ----------
Deferred tax assets (liabilities):
Reserve for operating losses during
phase-out period $ 123,000 -
Book write-down of assets held for
disposal 382,000 -
Net operating loss carryforwards 220,000 -
Reserve for bad debts 27,000 -
Depreciation (775,000) -
-------- ---------
Total deferred tax liability $ (23,000) $ -
========= ========
Continued
F-24
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
8. Leases:
Continuing Operations
Rental expense charged to continuing operations was $5,913 for the
nine months ended September 30, 1994, $92,850 for the year ended
September 30, 1995 and $330,006 for the year ended September 30, 1996.
The Company has two noncancellable operating leases for equipment and
a building that are in effect through 2000. At September 30, 1995,
minimum rental payments due under these leases, are as follows:
Year Ending September 30,
1997 $217,740
1998 217,740
1999 217,740
2000 94,925
2001 7,200
---------
Total minimum payments due $755,345
Discontinued Operations
Rental expense charged to discontinued operations was $42,775 for the
nine months ended September 30, 1994 and $429,472 for the year ended
September 30, 1995.
Continued
F-25
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
9. Notes and Interest Receivable - Related Parties, Collateralized by
Common Stock:
September 30, September 30,
1995 1996
Note receivable from two shareholders,
$5,000,000 face amount bearing interest
at 6%, interest of $300,000 due in January
1997, principal and interest of $514,814
due in annual payments beginning January
1998, remaining principal and interest
due January 2000, collateralized by 100,000
shares of the Company's common stock held
by the Company and an additional 100,000
shares of the Company's common stock
committed by the shareholders to be
provided to the Company, and personal
guarantees of two shareholders (net of
unamortized discount of $650,425 based
upon imputed rate of 10.25%, and allowance
for impairment of $2,699,575 due to changes
in the Company's stock price) - $1,650,000
Notes and interest receivable from 11
current and former employees, issued in
exercise of 450,000 common stock
options at $5.31 per share, bearing
interest at 5.7%, principal and
interest due in December 2000,
collateralized by 450,000 shares of
common stock of the Company. - 2,191,157
Notes and interest receivable from 16
current and former employees, issued in
exercise of 450,000 common stock
options at $8.375 per share, bearing
interest at 5.7%, principal and
interest due in December 2000,
collateralized by 450,000 shares of
common stock of the Company. - 3,613,914
Continued
F-26
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
9. Notes and Interest Receivable - Related Parties, Collateralized by
Common Stock, Continued:
September 30, September 30,
1995 1996
Other notes receivable, collateralized
by common stock of the Company. $ 240,000 125,000
---------- ----------
Total notes and interest receivable -
related parties, collateralized by
common stock. $ 240,000 $7,580,071
========== =========
10. Stock Options and Warrants:
Non-Qualified Options
Options and warrants are granted at the discretion of the Board of
Directors.
In 1993 the Company issued non-qualified options to purchase 470,000
shares of common stock at $0.80 to $2.50 per share to seven
individuals, including certain officers and directors. Effective
September 30, 1994, 223,700 of these options had been exercised or
expired. During 1995, 176,300 were exercised and 25,000 expired
unexercised. Also, in May 1995, the Company reissued stock options to
purchase 75,000 at $1.00 to an officer for options that had previously
expired. The remaining 120,000 options were exercised during the year
ended September 30, 1996.
During 1993, non-qualified options to purchase 100,000 shares of
common stock were issued to a marketing firm at $1.00 per share. In
1994, these options were exercised in exchange for a note receivable.
The note receivable, which is non-interest bearing and had no fixed
repayment term, is reflected as a reduction to stockholders' equity in
1995. During 1996, the note was repaid in services to the Company.
Continued
F-27
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
10. Stock Options and Warrants, Continued:
Non-Qualified Options, Continued
On December 1, 1994, the Company granted options to purchase a
combined total of 50,000 shares of common stock to two persons, each a
consultant to the Company. Such options are exercisable through
December 1, 1996 at a price of $1.80 per share. At September 30, 1996,
all 50,000 options remain unexercised.
In 1994, the Company granted options to purchase 30,000 shares of
common stock to an officer of the Company. Options for 20,000 shares
of common stock were exercised in February 1995, at a price of $1.80
per share and the remaining 10,000 options expired unexercised during
1996.
On January 1, 1995, the Company granted options to purchase 1,280,000
shares of common stock to certain executive officers, employees and
directors of the Company. During the year ended September 30, 1996,
35,000 of these options were exercised and 722,500 were forfeited or
canceled. The remaining 522,500 shares remain exercisable through
December 31, 2004 at a price of $1.50 per share.
On January 25, 1995, the Company granted options to purchase 100,000
shares of common stock to an officer of the Company, exercisable
through January 25, 1997 at a price of $1.80 per share. These options
were canceled in 1996.
On May 1, 1995, the Company granted options to purchase 20,000 shares
of common stock to an individual who was a consultant to the Company.
Such options were exercisable through December 31, 1996 at a price of
$2.50 per share. Of these options, 10,000 were exercised during 1996
and 10,000 were canceled.
On January 1, 1996, the Company granted options to purchase 160,000
shares of common stock at a price of $1.50 per share to certain
officers, employees and consultants. Of these options, 20,000 were
exercised and 35,000 were canceled during 1996. At September 30, 1996,
105,000 of the options remain unexercised. On this same date, the
Company granted options to purchase 124,000 shares of common stock at
prices between $2.50 and
Continued
F-28
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
10. Stock Options and Warrants, Continued:
Non-Qualified Options, Continued
$3.50 per share to certain consultants. These options remain
unexercised at September 30, 1996.
On June 3, 1996 the Company granted options to purchase 100,000 shares
of common stock for $1.50 per share to an officer of the Company as
part of compensation related to an employment agreement. At September
30, 1996, all 100,000 options remain unexercised.
On August 13, 1996, the Company granted 777,500 options to purchase
shares of common stock to certain employees, officers and directors
for $1.50 per share. Prior to September 30, 1996, 312,500 of these
options were canceled. At September 30, 1996, 465,000 shares remain
unexercised.
Recipients of these options may exercise them at any time. Shares
related to exercised options are held in escrow and are made available
as the options vest. The options vest at different times based upon
the terms offered with some options vesting immediately and others
over terms of up to 10 years. In the event that an executive officer
or employee terminates employment with the Company, or a director
ceases to be a director, prior to the specified vesting period, the
Company will cancel any of the shares in which the recipient has not
vested. When options are issued with terms considered compensatory,
the compensation expense related to these options is being amortized
to expense over the specified vesting period. Compensation expense
related to options that vest immediately was $236,625 and $3,863,000
for 1995 and 1996, respectively. Deferred compensation related to
options that vest over time was $1,888,750 and $4,668,053 for 1995 and
1996, respectively. The amortized compensation expense related to
these options is $466,902 and $909,959 for 1995 and 1996,
respectively.
1995 Stock Option Plan
Under the Company's 1995 Stock Option Plan (the "Option Plan"), which
was adopted in June of 1995, 900,000 shares of common stock are
reserved for issuance upon the exercise of stock options. The Option
Plan is designed to serve as an incentive for retaining qualified and
competent employees, directors and consultants.
Continued
F-29
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
10. Stock Options and Warrants, Continued:
1995 Stock Option Plan, Continued
A committee of the Company's Board of Directors, or in its absence,
the Board (the "Committee") administers and interprets the Option Plan
and is authorized to grant options and other awards thereunder to all
eligible employees of the Company, including officers and directors
(whether or not employees) of the Company. The Option Plan provides
for the granting of both "incentive stock options" (as defined in
Section 422 of the Internal Revenue Code) and non-statutory stock
options. Options can be granted under the Option Plan on such terms
and at such prices as determined by the Committee, except for the per
share exercise price of incentive stock options which will not be less
than the fair market value of the common stock on the date of grant
and, in the case of an incentive stock option granted to a 10%
stockholder, the per share exercise price will not be less than 110%
of such fair market value. The aggregate fair market value of the
shares of common stock covered by incentive stock options granted
under the Option Plan that become exercisable by a grantee for the
first time in any calendar year is subject to a $100,000 limit.
Options granted under the Option Plan will be exercisable after the
period or periods specified in the option agreement. Options granted
under the Option Plan are not exercisable after the expiration of ten
years from the date of grant and are not transferable other than by
will or by the laws of descent and distribution.
The Option Plan provides each director who is not an employee of the
Company effective as of January 1 of each year commencing January 1,
1996, an option to purchase 10,000 shares of common stock, all of
which outside director options will be exercisable with respect to 20%
of the covered shares of common stock commencing on the first
anniversary of grant and be exercisable with respect to an additional
20% of the covered shares of common stock after each additional year
until fully exercisable on the fifth anniversary of grant. The per
share exercise price of all such outside director options will be
equal to the fair market value of the common stock on the date of
grant.
Continued
F-30
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
10. Stock Options and Warrants, Continued:
1995 Stock Option Plan, Continued
As of September 30, 1995, 450,000 options were outstanding under the
Option Plan. Such options are exercisable through September, 2005 at a
price of $5.31. These options were exercised for notes receivable in
November 1995.
In October, 1995 the Company issued the remaining 450,000 options
under the Option Plan. Such options are exercisable through November,
2005 at a price of $8.38. These options were exercised for notes
receivable in November 1995.
Warrants
In January 1995, the Company issued warrants to purchase 65,000 shares
of common stock to RAS Securities Corp. Such warrants are exercisable
through January 1999 at an exercise price of $1.50 per share.
Consulting fees of $84,500, related to these warrants, was recognized
in the year ended September 30, 1995. During 1996, 53,000 of these
warrants were exercised and 12,000 remain unexercised at September 30,
1996.
In February 1996, the Company issued warrants to purchase 164,967
shares of common stock at prices ranging from $25 to $35. In addition,
warrants to purchase 43,750 shares of common stock at $15 per share
were issued in July 1996. In both cases, the issuance of warrants was
made in connection with private placement of common stock. At
September 30, 1996 all of these warrants remain unexercised.
Continued
F-31
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
11. Change in Accounting Principle:
Depreciation of property, plant and equipment has been computed using
the straight line method for periods beginning after December 31,
1993. Depreciation in prior years was computed using a method which
approximated the double declining balance method. The new method of
depreciation was adopted to more accurately reflect the usage patterns
of the assets involved. The effect of this change, excluding the
cumulative effect on years prior to January 1, 1994 of $46,602
($31,302 after tax or $0.01 per share), was to increase net income for
the nine months ended September 30, 1994 by $54,840 ($33,640 after tax
or $0.01 per share).
12. Union Employee Benefit Plans:
Discontinued Operations
Union employees of State are covered by health, accident and pension
plans sponsored by the various unions. These plans cover substantially
all union employees of State. The Company's allocated expense
associated with the plans, which is determined by the union contracts,
was approximately $153,000 for the nine months ended September 30,
1994 and $165,000 for the year ended September 30, 1995.
13. Patents:
On September 29, 1995, the Company received patent number 5,453,103
from the United States Department of Commerce - Patent and Trademark
Office relating to the Company's technology in reclaiming and
utilizing discarded and newly formed coke breeze, coal fines, and
blast furnace revert materials.
On January 30, 1996, the Company received patent number 5,487,764 from
the United States Department of Commerce - Patent and Trademark Office
relating to the Company's technology for the recovery of iron from
iron-rich material. This patent is a continuation-in-part of the
previous patent issued.
Continued
F-32
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
14. Discontinued Operations:
In 1995, the Company made a strategic decision to focus its efforts
exclusively on commercializing the Briquetting Technology and to
divest itself of its construction and limestone subsidiaries. In
September 1995, the Board of Directors approved a plan to dispose of
the Company's construction and limestone businesses. Accordingly, on
February 1, 1996, the Company entered into a Stock Purchase Agreement
(the Agreement) with former principals of IME, State, CIC and Larson
(Buyers) to sell all of the common shares of the subsidiaries to the
Buyers for a $5,000,000 face value promissory note (the Note). One of
the Buyers is the son of a director of the Company at the time of the
transaction. The Note is collateralized by 100,000 shares of the
Company's common stock owned by the Buyers held by the Company,
100,000 shares of the Company's common stock committed by the Buyers
to be provided to the Company, and personal guarantees of the Buyers,
and is payable together with interest at 6% per annum (interest
imputed at 10.25%) as follows: interest only is payable through
January 31, 1997; principal and interest is payable annually with the
Note amortized over a 15 year period with the first payment due
January 31, 1998; and all unpaid principal and interest is payable
January 31, 2000. Because the Note includes a favorable interest rate
for the Buyers, the Company has calculated the present value of the
Note using a market rate of 10.25% over the term of the Note. The
effect of discounting the Note at 10.25% is to reduce the Note to
$4,349,575 as of the date of the Agreement. The discount on the Note
was included in the estimated loss on disposal of discontinued
operations.
Because the Note is collateralized by the Company's common stock, the
Note is reflected in the consolidated financial statements as a
reduction to stockholders' equity (deficit). Additionally, the Note is
adjusted to reflect subsequent increases or decreases in the fair
value of the Company's stock held as collateral. Because of a decrease
in the trading price of the Company's common stock subsequent to the
date of the Agreement, an allowance of approximately $2,700,000 is
reflected in the Company's consolidated financial statements as of
September 30, 1996. As of January 10, 1997, the trading price of the
Company's common stock had increased resulting in a recovery of
approximately $1,300,000 of the allowance existing at September 30,
1996. Subsequent changes in the value of the collateral will be
reflected in the consolidated statement of operations and as an
increase to the Note.
Continued
F-33
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
14. Discontinued Operations, Continued:
Under the terms of the Agreement, the Company agreed to pay off
$3,500,000 of accounts payable and lines of credit outstanding in the
subsidiaries. Subsequently, the Buyers have requested reimbursement
from the Company for approximately $650,000 of additional expenses
related to the discontinued operations during the wind-down period
which were paid by the Buyers. The Company has reflected those
obligations in the additional loss on the discontinued operations for
the year ended September 30, 1996.
The results for the construction and limestone operations have been
classified as discontinued operations for all periods presented in the
Consolidated Statements of Operations. The assets and liabilities of
the discontinued operations have been classified in the Consolidated
Balance Sheets as "Net assets - discontinued operations". Discontinued
operations have also been segregated for all periods presented in the
Consolidated Statements of Cash Flows.
Net assets of the Company's discontinued operations (excluding
intercompany balances which have been eliminated against the equity of
the discontinued operations) are as follows:
As of As of
September 30, September 30,
1995 1996
Assets:
Current assets:
Cash and cash equivalents $ 207,409 -
Accounts receivable 2,310,386 -
Inventories 220,396 -
Other 123,918 -
---------- -----------
Total current assets 2,862,109 -
Net property, plant and equipment 2,545,467 -
Other noncurrent assets 510,763 -
---------- ----------
Total assets $5,918,339 $ -
========= ==========
Continued
F-34
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
14. Discontinued Operations, Continued:
As of As of
September 30, September 30,
1995 1996
Liabilities:
Current liabilities $5,103,756 -
Notes payable - long term 45,567 -
Deferred income taxes 23,000 -
Other liabilities, including capital
lease obligations 736,301 -
---------- ----------
Total liabilities 5,909,024 -
--------- ----------
Net assets - discontinued operations $ 9,315 $ -
============ ==========
The net property, plant and equipment of discontinued operations is
presented in the table above, net of the expected loss on the sale of
the discontinued operations, which includes the discount on the note
receivable from the Buyers.
Revenues of the discontinued operations were $7,836,781, $14,681,032
and $1,396,641 for the nine months ended September 30, 1994, the year
ended September 30, 1995 and the four months ending January 31, 1996
(the date of sale), respectively.
15. Agreements:
Greystone Joint Venture
In June 1995, the Company entered into a license agreement (the
"Greystone Joint Venture Agreement") with Greystone Environmental
Technologies, Inc. ("Greystone") to form a 50/50 joint venture (the
"Greystone Joint Venture") to commercialize and exploit the
Briquetting Technology for the production of coke and revert material
briquettes. The Greystone Joint Venture Agreement was amended on
January 3, 1996. The Greystone Joint Venture has an exclusive
world-wide license to commercialize and exploit the Briquetting
Technology for the production of coke briquettes and a license to
commercialize and exploit the Briquetting Technology for the
Continued
F-35
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
15. Agreements, Continued:
Greystone Joint Venture, Continued
production of revert material briquettes in the Alabama and Gary,
Indiana regions. The Geneva Plant is not a part of the Greystone Joint
Venture or the Greystone Joint Venture Agreement.
The Greystone Joint Venture will be on a 50/50 basis, except in the
Gary, Indiana region where Greystone has a 12% interest in the entity
with an opportunity to increase its interest to a maximum of 20%.
Greystone will manage the Greystone Joint Venture on a day-to-day
basis and the parties have agreed to contribute the necessary capital
to the Greystone Joint Venture in proportion to their respective
interests therein. The Greystone Joint Venture will purchase all of
its requirements for binding agents used in the Briquetting Technology
from the Company. Greystone is a newly-formed company, although its
principals have significant experience in the steel and coke
production industries.
In accordance with the Greystone Joint Venture Agreement, Greystone
made an initial payment of $100,000 to the Company, and was required
to make additional payments out of profits or capital of the Greystone
Joint Venture until a total aggregate of $500,000 had been paid to the
Company for the license. Greystone has failed to make the additional
payments required under the Greystone Joint Venture Agreement and,
accordingly, has received notice that an event of default has occurred
thereunder. The Company believes that an uncured event of default
under the Greystone Joint Venture Agreement results in a termination
of the license.
As of December 1996, the Greystone Joint Venture has not secured
funding to proceed with the development and operation of any plants.
The Company believes that Greystone is continuing to seek funding.
Continued
F-36
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
15. Agreements, Continued:
Geneva Plant
In May 1995, the Company entered into a collaborative agreement with
Geneva Steel Company ("Geneva") to build and operate a commercial
briquetting plant in Vineyard, Utah defined above as the Geneva Plant.
That agreement was amended and restated in May, 1996. Pursuant to the
Amended and Restated Briquetting Services Agreement and Lease
Agreement with Geneva (collectively, the "Geneva Agreements") Geneva
has provided the Company with a building containing approximately
9,000 square feet. The Company equipped the building to serve as a
coal, coke and revert material briquetting plant. The Company
estimated that the Geneva Plant's initial capacity was 15 tons of
briquettes per hour or approximately 100,000 tons per year. Geneva
provided the Company with revert materials and the Company was
obligated to produce and deliver to Geneva briquettes conforming to
agreed-upon specifications and in agreed to quantities. Geneva bears
all transportation costs with respect to delivery of revert materials
to the Geneva Plant and the shipment of briquettes. Pursuant to the
Geneva Agreements, the Company began producing briquettes in May 1996,
and produced approximately 24,600 tons of revert briquettes by
December 31, 1996 at the Geneva Plant. The Company has made various
adjustments and improvements to the plant to satisfy emissions and air
quality standards administered by the Utah State Division of Air
Quality. Although the Geneva Agreements expired on December 31, 1996,
the Company continues to produce briquettes for purchase by Geneva.
Upon the expiration of the Geneva Agreements, the lease of the
building housing the plant also expired resulting in a tenancy-at-will
between the parties.
Limited Partnerships
In June 1996, the Company formed Utah Synfuel #1, Ltd. ("Utah Synfuel
#1") and Alabama Synfuel #1, Ltd. ("Alabama Synfuel #1"), each a
Delaware limited partnership (collectively the "Partnerships"). The
respective Partnerships are intended to (i) purchase a nonexclusive
license from the Company for the Briquetting Technology, (ii) purchase
a coal briquetting facility from the Company and (iii) sell such
facility to a third party purchaser. Utah Synfuel #1 intends to
purchase the coal briquetting Utah Plant and Alabama Synfuel #1
intends to purchase the coal briquetting Birmingham, Alabama plant
(the "Alabama Plant"). The Company will grant to each of the
Partnerships a
Continued
F-37
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
15. Agreements, Continued:
Limited Partnerships, Continued
non-exclusive license to use the Briquetting Technology with respect
to coal for a fee of $500,000 (totalling $1,000,000). The Company
intends to retain at least a 60% interest in Utah Synfuel #1 and up to
an 83% interest in Alabama Synfuel #1. The Company has privately
placed the remaining partnership interests in the Partnerships.
Specifically, the Company received $3,277,500 ($3,080,000 as of
September 30, 1996) for the remaining partnership interests in Utah
Synfuel #1 and $1,762,500 ($1,305,000 as of September 30, 1996) for
the remaining partnership interests in Alabama Synfuel #1. Notably,
the Company is currently analyzing whether the original disclosure
provided to investors should be supplemented. The Company may decide
to revise the information in the original private placement
memorandums for those offerings, and may offer to such investors the
opportunity to rescind their purchases. If all such investors rescind,
the Company would be required to pay up to $5,040,000 ($4,385,000 at
September 30, 1996) plus applicable interest less the amount of income
received thereon. Management believes the amount rescinded by
investors will be immaterial.
The Company has used a portion of the funds raised in the Partnerships
to purchase equipment for each of the plants. The Utah Plant has been
completed and commenced commercial operations in December of 1996. The
Alabama Plant is expected to be completed by June 1997. However, no
assurances can be made that the completion date for the Alabama Plant
will be met.
The Company, as general partner for the Partnerships, is currently
negotiating transactions with potential buyers of the Utah Plant and
Alabama Plant, which is yet to be constructed or acquired. The Company
believes that the sale of the Utah Plant and Alabama Plant would
include (i) a $500,000 sublicensing fee (which would be paid by the
buyer to the Partnership in exchange for the license of the
Briquetting Technology), (ii) a royalty payment to the Partnership
based on per ton amount to be agreed on with the buyer, and (iii) a
promissory note delivered by the buyer in payment of the purchase
price, which would be payable to the Partnership from the cash flow of
such plant. The Company and Alabama Synfuel #1 have entered into a
letter of intent with an unregulated subsidiary of PacifiCorp, a large
low-cost electric and telephone utility, to sell the Alabama Plant to
be constructed or acquired by Alabama
Continued
F-38
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
15. Agreements, Continued:
Limited Partnerships, Continued
Synfuel #1, on substantially the terms listed above. The PacifiCorp
transaction is subject to various conditions and no definitive
agreement has been entered into. The Company and Utah Synfuel #1 have
also entered into a letter of intent with Arthur J. Gallagher & Co.,
an international insurance brokerage and risk management services
firm, to sell the Utah Plant, to be acquired by Utah Synfuel #1 on
substantially the terms listed above. The Gallagher purchase of Utah
Synfuel #1 is also subject to various conditions and no definitive
agreement has been entered into. No assurances can be made that any of
the plants being constructed or acquired by the Partnerships will be
sold.
Under the organizational documents of the Partnerships, the Company is
entitled to distributions from the Partnerships according to the
Company's percentage interest in the net distributable cash flow of
the Partnerships. The Company may also enter into loading agreements
and operating and maintenance agreements that would provide for
payments directly from the buyer of a plant. The binder materials used
to produce the briquettes will likely be sold to the buyer of a plant
by the Company based on the Company's cost plus an agreed upon
percentage profit.
Coal Venture
On January 30 1996, the Company entered into a letter of understanding
with CoBon Energy, L.L.C. ("CE"), a Utah professional services company
based in Salt Lake City, Utah, to form five entities to commercialize
and exploit the Briquetting Technology for the production of coal
briquettes (the "Coal Venture"). In August 1996, CE and the Company
modified the letter of understanding. Under the modified letter of
understanding, the Company has agreed to give CE a 1.6% interest in
Alabama Synfuel #1, plus a license to use the Briquetting Technology
for specified plant locations up to an aggregate capacity of 1.5
million tons of coal per year for each plant location. In
consideration for the interest in Alabama Synfuel #1 and the license,
CE is required, to make a one-time payment of (i) $2.00 per ton for
the production of coal in the range of 500,001 to 1,000,000 tons and
(ii) $2.50 per ton for the production in the range of 1,000,001 to
1,500,000 tons. CE has not yet built any plants which utilize the
Briquetting Technology.
Continued
F-39
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
15. Agreements, Continued:
Construction Agreements
In December 1995, the Company entered into a design and construction
agreement with Lockwood Greene Engineers, Inc. ("Lockwood") to design
and build the Utah Plant. The Company paid Lockwood an advance payment
of $500,000 on the facility on February 9, 1996. The total cost of the
Utah Plant to the Company is expected to be $3,600,000. Lockwood and
the Company have agreed to cooperate with each other in future
projects by either party in the field of coal agglomeration or
metallic recovery. Also in December 1995, the Company entered into
additional contracts to design and build additional facilities with
Lockwood, each of which were subsequently terminated by the Company in
1996 with all applicable cancellation charges either satisfied or
settled.
Port Hodder
In September 1996, the Company entered into a purchase agreement with
E. J. Hodder and Associates, Inc. for the purchase of a certain land
leasehold interest and equipment consisting of a barge loading
facility servicing the Warrior River located at the Alabama Plant. The
total purchase price for the facility is $927,000 consisting of
$342,000 in cash and $585,000 of the Company's common stock. The land
lease commenced on September 1, 1996 and expires on May 23, 1998 with
rights to extend to May 23, 2006. The Company intends to use the
facility in connection with the operations of the Alabama Plant.
K-Lee Supply Agreement
In September 1996, the Company entered into a supply agreement with
K-Lee Processing, Inc. and Concord Coal Recovery Limited Partnership
for a continuous supply of coal fines to the Alabama Plant. Under this
agreement, the Company is obligated to purchase a minimum of 20,000
tons of coal fines per month, commencing upon the completion of the
Alabama Plant and expiring on December 1, 2001, at a fixed price per
ton during the first year (subject to adjustment for moisture and ash
content) with an escalating price thereafter.
Continued
F-40
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
15. Agreements, Continued:
AGTC Brokerage Disagreement
In accordance with an April 1996 letter agreement between the Company
and AGTC, a partnership formed by AGTC, Inc., Alpine Coal Company,
Inc. and E. J. Hodder & Associates, Inc., AGTC was engaged by the
Company on a best efforts basis, to investigate, identify and
participate in the selection of (i) project sites for the construction
of suitable coal extrusion manufacturing facilities for the Company,
(ii) suitable coal fines reserves and (iii) suitable users or
consumers of the coal product produced. The compensation for such
services consisted of a monthly retainer of $35,000 and a commission
of 8% on the gross sales or monetized price of a project. In the
fourth month following the execution of the letter agreement a dispute
arose among the parties regarding AGTC's performance and compensation
due under the agreement. Accordingly, the Company terminated the
agreement pursuant to its terms. AGTC subsequently claimed that it was
entitled to a commission on the proposed sale of the Alabama Plant.
The Company, on the advice of counsel, believes that AGTC's claim has
no merit.
Alabama Power Company
In April 1996, the Company entered into a sale and purchase agreement
for coal with Alabama Power Company. Under the agreement, the Company
has agreed to process coal into coal briquettes and to sell such
briquettes to Alabama Power Company at a base price per ton, plus or
minus certain adjustments, for a period of five years commencing on
January 1, 1997. According to the agreement, Alabama Power Company is
required to purchase a base tonnage of 250,000 tons per year until
December 31, 1999. There are numerous conditions and obligations to be
performed by both parties prior to January 1, 1997 and on an ongoing
basis before coal briquettes are required to be purchased by Alabama
Power Company. Given the delays associated with the financing and
construction of the Alabama Plant, the Company is now in technical
default under the agreement. It is uncertain what actions Alabama
Power Company will take, if any, in response to the default. The
Company's management believes this technical default can be resolved
satisfactorily, with no material liability to the Company.
Continued
F-41
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
16. Fair Value of Financial Instruments
Statement of Financial Accounting Standards (SFAS) No. 107 requires
that the fair market value of certain financial instruments be
disclosed in the financial statements. The Company has the following
financial instruments that are subject to the provisions of SFAS No.
107:
Cash and cash equivalents Notes receivable - related parties Notes
payable Notes payable - related parties
Notes receivable - related parties from issuance of common stock
For each of the financial instruments listed above, the carrying value
approximates fair value or the instruments is reflected in the
financial statements at fair market value.
17. Subsequent Events:
Stock Options and Warrants
In October 1996, the Company issued warrants to purchase 620,000
shares of common stock at prices ranging from $7 to $30 per share to a
stockholder of the Company in association with a private placement of
common stock.
Agreements
PacifiCorp
In October 1996, the Company and Alabama Synfuel #1 entered into
a letter of intent with an unregulated subsidiary of PacifiCorp,
a large, low-cost electric and telephone utility, to purchase the
coal briquetting Alabama Plant that will be built and/or acquired
by Alabama Synfuels #1. The letter of intent generally provides
for an entity designated by PacifiCorp to purchase the Alabama
Plant from Alabama Synfuel #1 (or to purchase Alabama Synfuel
#1's right to acquire the Alabama Plant) for a one-time $500,000
licensing fee, and a promissory note in the amount of $3,400,000
that will be payable out of the cash flow of the plant, and a per
ton royalty fee. The Company will retain up to an 83% interest in
Continued
F-42
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
17. Subsequent Events, Continued:
Agreements, Continued
PacifiCorp, continued
Alabama Synfuel #1 and will be entitled to its percentage share
of all cash distributed by Alabama Synfuel #1.
The letter of intent also provides for a convertible loan from
PacifiCorp to the Company in an amount up to $5,000,000.
PacifiCorp would retain a security interest in all of the assets
related to the Alabama Plant. The loan if made, may be
convertible into Company common stock at a conversion price of
$7.00 per share. The Company common stock received upon
conversion would be subject to piggyback and demand registration
rights.
The obligations of PacifiCorp and its affiliates are subject to
PacifiCorp, the Company and Alabama Synfuel #1 entering into
definitive agreements. PacifiCorp will also require favorable tax
rulings from the IRS and completion of the Alabama Plant prior to
consummating the purchase of the Plant. The funding of the loan
is subject to entering into the definitive agreements and the
filing of a request for tax rulings from the IRS, which the
Company believes will be complete by approximately January 31,
1997.
In December 1996, PacifiCorp and the Company entered into an
additional agreement for the construction of six additional
facilities beyond the Alabama Plant. Pursuant to this agreement,
PacifiCorp has entered into binding agreements with a third-party
for the construction of the additional facilities. Additionally,
PacifiCorp has committed $300,000 per plant for a total of $1.8
million to the entities through which PacifiCorp will build the
facilities. The commitment was made to facilitate the
construction of the facilities with the third- party. All of the
facilities will utilize the Briquetting Technology under license
agreements with the Company.
Continued
F-43
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
16. Subsequent Events, Continued:
Agreements, Continued
Gallagher
In November 1996, the Company and Utah Synfuel #1 entered into a
letter of intent with Arthur J. Gallagher & Co., an international
insurance brokerage and risk management services firm, to
purchase the Utah Plant that will be acquired by Utah Synfuels
#1. The letter of intent generally provides for an entity
designated by Gallagher to purchase the Utah Plant from Utah
Synfuel #1 (or to purchase Utah Synfuel #1's right to acquire the
Utah Plant) for $2,500,000 (payable upon the satisfaction of
certain performance conditions), a one-time $500,000 licensing
fee and a per ton royalty fee that will be payable out of the
cash flow of the Utah Plant. The Company will retain
approximately a 60% interest in Utah Synfuel #1 and will be
entitled to its percentage share of all cash distributed by Utah
Synfuel #1.
The obligations of Gallagher and its affiliates are subject to
Gallagher, the Company and Utah Synfuel #1 entering into a
definitive agreement.
In December 1996, Gallagher and the Company entered into an
additional agreement to construct four additional facilities
beyond the two plants contemplated by the letter of intent.
Pursuant to this expanded agreement, Gallagher entered into
binding agreements with a third-party to construct the additional
facilities. All of the facilities will utilize the Briquetting
Technology under license agreements with the Company.
In December 1996, the Company entered into a Debenture Agreement
and Security Agreement with AJG Financial Services, Inc., an
affiliate of Gallagher, whereby the Company borrowed $1,100,000,
and may, under certain circumstances, draw down an additional
amount of up to $2,900,000 (for a total borrowed amount of
$4,000,000). In consideration for the loan of $1,100,000, the
Company issued a Convertible Subordinated Debenture accruing
interest at 6% per annum and maturing three years from its date
of issuance (the "Subordinated Debenture"). The interest and
principal of the Subordinated Debenture is payable on maturity.
The Company does not have the right to prepay any portion of the
principal of the Subordinated Debenture, and the Company
Continued
F-44
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
17. Subsequent Events, Continued:
Agreements, Continued
Gallagher, continued
is required to prepay the Subordinated Debenture if a change in
control of the Company occurs. All or a portion of the unpaid
principal due on the Subordinated Debenture is convertible into
Company common stock at a conversion price of $11.00 per share
subject to certain adjustments. The Subordinated Debenture is
subordinated and junior in right to all other existing
indebtedness of the Company which is not expressly pari passu
with or subordinated to the Subordinated Debenture. Finally, the
Company has granted piggy-back and demand registration rights to
AJG Financial Services, Inc. for the Company common stock issued
upon conversion of the Subordinated Debenture.
On January 2, 1997, the Company borrowed $588,683 of the
$2,900,000 draw down amount described above. In consideration for
the amount drawn down, the Company issued a Senior Debenture in
such amount accruing interest at prime plus two percent (2%) and
maturing three years from the date of issuance (the "Senior
Debenture"). The Senior Debenture is collateralized by all real
and personal property purchased by the Company with the proceeds
of the Senior Debenture. The proceeds of the Subordinated
Debenture and the Senior Debenture may be used to satisfy
contractual obligations of the Company, for working capital and
to purchase equipment to be used to construct coal briquetting
facilities to be managed and/or sold by the Company or affiliates
of the Company.
Savage Mojave
In November 1996, the Company signed a primary contract with
Savage Industries, Inc. ("Savage") to form up to two limited
liability companies ("LLCs") to be owned 50% by Savage and 50% by
the Company, with each LLC entering into a contract with Savage,
the Company and a qualified third party contractor for the
design, construction, start-up and certification of a coal fines
agglomeration facility. All profits and losses of the respective
LLCs shall be borne by Savage and the Company according to their
respective ownership interest. Savage has the right but not the
Continued
F-45
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
17. Subsequent Events, Continued:
Agreements, Continued
Savage Mojave, continued
duty to operate the facilities and to provide transportation of
the raw materials and the briquettes. The Company in turn will
(i) provide its license to the binding process (at no cost) and
(ii) provide the binder required to produce the briquettes on a
cost plus basis. Performance under the agreement is subject to
numerous condition, including, but not limited to establishing a
criteria for the design of such facilities and satisfaction of
the Section 29 Tax Credit provisions of the Internal Revenue Code
of 1986, as amended.
In November 1996, the Company also entered into an agreement with
Savage whereby the Company agreed (i) to license the Briquetting
Technology to a limited liability company, to be formed by Savage
and Flyash Haulers, Inc., for a monthly licensing fee based upon
each ton of qualified fuel produced, all relating to a
briquetting facility to be located in Laughlin, Nevada, (ii) to
provide, upon request, coal fines to the limited liability
company, (iii) to provide technical assistance to the limited
liability company, and (iv) to reimburse to Savage, from the
monthly license fees, an amount equal to 16% of the cash capital
required to upgrade the Laughlin, Nevada facility. The Company
does not expect to receive monthly license fees until mid 1997.
No assurances can be made that Savage will be successful in the
production and sale of synthetic coal. The agreement expires by
its terms on December 31, 2009.
Construction Agreements
In December 1996, the Company entered into a total of thirteen design
and construction agreements (the "1996 Construction Agreements") for
the design and construction of eleven new coal fines agglomeration
facilities and the retrofiting of two existing facilities (the Utah
Plant and Geneva Plant). Depending upon the specific agreement, the
contractor is either TIC The Industrial Company, CEntry Constructors,
L.C. or Centerline Engineering Corporation, a Lockwood Greene Company.
Under two of the 1996 Construction Agreements, the Company is a joint
owner with Ferro Resources, L.L.C. The 1996 Construction Agreements
are subject to numerous con-
Continued
F-46
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
17. Subsequent Events, Continued:
Construction Agreements, Continued
ditions and no assurances can be given that the Company will be
successful in financing or constructing any of the thirteen
facilities. The 1996 Construction Agreements generally require that a
notice to proceed be issued by the Company (and its co-owner, if any)
on or before September 30, 1997 and that the plant be placed in
service by June 30, 1998. An advance payment of $250,000 is due at the
time a notice to proceed is issued by the Company (and its co-owner,
if any). The 1996 Construction Agreements may be terminated at the
Company's (and co-owner's, if any) option with a penalty of 6% of the
total contract price, if established, or the guaranteed maximum price
if the total contract price is not established. If the Company is
unsuccessful in obtaining financing or otherwise fails to construct a
facility, a penalty would be owed to the contractor. If this were to
occur on all thirteen facilities, the Company would be required to pay
an aggregate penalty of $3,012,000.
Indemnification to Lockwood
In December 1996, the Company entered into six agreements with
Lockwood whereby the Company agreed to indemnify Lockwood should it be
required to pay liquidated damages to certain third party owners under
various design and construction agreements for six coal agglomeration
facilities. Under the various design and construction agreements, if
the facilities are not completed by June 1, 1998 then $750,000 in
liquidated damages would be due and payable. The indemnification
agreement will only apply if the third party owners actually decide to
build the facilities with Lockwood as the design/builder. The maximum
amount of contingent liability to the Company under the
indemnification agreements is $4,500,000 ($750,000 per design and
construction agreement). If triggered, the payments under the
indemnification agreements would not be due and owing until June 2,
1998.
Continued
F-47
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
17. Subsequent Events, Continued:
Settlement Agreements
Kenneth Young
Effective November 12, 1996, Kenneth Young resigned as Chairman
of the Board and Chief Executive Officer of the Company. The
Company and Kenneth Young have entered into a settlement
agreement. Pursuant to the settlement agreement, the Company
agreed: (i) to pay Mr. Young $4,000 twice a month through
December 31, 1996, (ii) to pay $25,030 in deferred compensation
over 24 semi-monthly installments of $1,042 beginning January 1,
1997, (iii) to pay for Mr. Young's medical insurance until
December 31, 1997, (iv) to pay $2,500 semi-monthly for 24
payments beginning January 1, 1997 in consideration for
consulting services reasonably requested by the Company and Mr.
Young's agreement to refrain from any activities in competition
with the Company, (v) to allow options representing 50,000 shares
of Company common stock at $1.50/share to become fully vested on
January 1, 1997 (these options were originally issued under a
stock option agreement dated January 1, 1995 relating to 250,000
shares) and (vi) to allow options representing 50,000 shares of
Company common stock at $1.50/share to become fully vested on
January 1, 1997 (these options were originally issued under a
stock option agreement dated January 1, 1995 relating to 62,500
shares, of which the remaining 12,500 shares expired).
Michael Midgley
In November of 1996, the Company entered into a settlement
agreement with Michael Q. Midgley. Pursuant to the settlement
agreement, the Company agreed: (i) to pay $20,000 in November
1996 and $38,479 in salary, deferred compensation and unused
vacation pay over 24 semi-monthly installments of $1,605
beginning November 15, 1996, (ii) to pay $2,500 semi-monthly for
24 payments beginning January 1, 1997 in consideration for
consulting services reasonably requested by the Company and Mr.
Midgley's agreement to refrain from any activities in competition
with the Company, (iii) to allow options representing 50,000
shares of Company common stock to become fully vested on January
1, 1997 (these options were originally issued under a stock
option agreement dated January 1, 1995) and (iv) to allow options
representing 25,000 shares of
Continued
F-48
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, Continued
17. Subsequent Events, Continued:
Settlement Agreements, Continued
Michael Midgley, continued
Company common stock at $1.50/share to become fully vested on
January 1, 1997 (these options were originally issued under a
stock option agreement dated January 1, 1996 relating to 50,000
shares, of which the remaining 25,000 shares expired).
F-49
Section No. Exhibit No. Description Location
- - ----------- ----------- ------------ --------
2 2.1 Agreement and Plan of Reorganization, *
dated July 1, 1993 between the Company
and the Shareholders of R1001
2 2.2 Agreement and Plan of Merger dated *
August 14, 1995 between the Company
and Covol Technologies, Inc., a Delaware
corporation
2 2.3 Stock Purchase Agreement, dated July 1, *
1993, among the Company, Lloyd C. McEwan,
Michael McEwan, Dale F. Minnig and Ted C.
Strong regarding the purchase of Industrial
Management & Engineering, Inc. and Central
Industrial Construction, Inc.
2 2.4 Stock Sale Transaction Documentation, *
effective as of September 30, 1994,
between the Company and Farrell F. Larson
regarding Limestone Company, Inc.
2 2.5 Stock Purchase Agreement dated February *
1, 1996 by and among the Company, Michael
McEwan and Gerald Larson regarding the
sale of State, Inc., Industrial Engineering
& Management, Inc., Central Industrial
Construction, Inc., and Limestone
Company, Inc.
2 2.5.1 Amendment to Share Purchase Agreement *
regarding the sale of the Subsidiaries
2 2.5.2 Amendment No. 2 to Share Purchase **
Agreement regarding the sale of the
Subsidiaries
3 3.1 Certificate of Incorporation of the Company *
3 3.1.1 Certificate of Amendment of the Certificate *
of Incorporation of the Company dated
January 22, 1996
3 3.2 By-Laws of the Company *
3 3.2.1 Certificate of Amendment to Bylaws of the *
Company dated January 31, 1996
- - ---------------------------------
* Previously filed.
** Filed herewith.
49
Section No. Exhibt No. Description Location
- - ----------- ---------- ------------- --------
9 9.1 Special Powers of Attorney Coupled With *
an Interest dated February 1, 1996 between
the Company, Gerald Larson and Michael
McEwan
10 10.1 License Agreement, dated June 30, 1995, *
between the Company and Greystone
Environmental Technologies, relating to
the Greystone Joint Venture
10 10.1.1 First Amendment dated January 3, 1996 to *
the License Agreement dated June 30,
1995 between the Company and Greystone
Environment Technologies
10 10.2 Briquetting Services Agreement, dated *
May 5, 1995, between Geneva Steel Company
and the Company
10 10.2.1 Amended and Restated Briquetting Service *
Agreement, dated May 14, 1996, between
the Company and Geneva Steel Company
10 10.3 Lease Agreement, dated May 5, 1995 *
between Geneva Steel Company, as landlord,
and the Company, as tenant
10 10.3.1 First Amendment to Lease Agreement, dated **
May 14, 1996 between Geneva Steel Company,
as landlord, and the Company, as tenant
10 10.4 Master Equipment Lease Agreement, dated *
May 4, 1995, between Keycorp Leasing Ltd.
and the Company
10 10.5 1995 Stock Option Plan *
10 10.5.1 First Amendment to the 1995 Stock *
Option Plan
10 10.6 Employment Agreement, dated January 1, *
1992, with Kenneth M. Young
10 10.7 Employment Agreement, dated July 1, 1992, *
with Russ Madsen
- - ---------------------------------
* Previously filed.
** Filed herewith.
50
Section No. Exhibit No. Description Location
- - ----------- ----------- ------------- --------
10 10.8 Lease Agreement, dated May 31, 1994, *
between the Company and Byrleen Hanson
re Carbon County, Utah
10 10.9 Standard Form of Agreement between Owner *
and Design Builder dated December 28,
1995 between the Company and Lockwood
Greene Engineers, Inc.
10 10.9.1 Notice to Proceed from the Company to *
Lockwood Greene Engineers, Inc. dated
January 14, 1996
10 10.9.2 Letter Agreement with Lockwood Greene *
Engineers, Inc. to extend notice dates.
10 10.9.3 Letter dated July 26, 1996 from Lockwood **
Greene Engineers, Inc. and the Memorandum
of Understanding between Covol Technology,
Inc. and Lockwood Greene Engineers, Inc.
dated August 28, 1996
10 10.9.4 Amendment to Standard Form of Agreement **
between Owner and Design/Builder dated
December 28, 1995, dated September 16,
1996, between the Company and Lockwood
Greene Engineers, Inc.
10 10.10 Engagement Letter dated December 18, 1995 *
by and between the Company and Smith Barney
10 10.10.1 Termination Letter, dated July 8, 1996, **
from Smith Barney
10 10.11 Letter of Understanding dated January 30, *
1996 between the Company and CoBon
Energy, LLC
10 10.11.1 Modification of Letter of Understanding **
dated August 20, 1996 between the Company
and CoBon Energy, LLC
10 10.11.2 License Agreement, dated September 10, **
1996, between the Company and CoBon
Energy, LLC
- - ----------------------------------
* Previously Filed.
** Filed herewith.
51
Section No. Exhibit No. Description Location
- - ----------- ------------ -------------- --------
10 10.12 Mortgage Note with First Security Bank *
of Utah, N.A. as lender on the Company's
executive offices in Lehi, Utah dated
January 21, 1992.
10 10.12.1 Loan Authorization and Agreement (Guaranty *
Loan) from the U.S. Small Business
Administration.
10 10.13 Promissory Note dated February 15, 1996 *
in favor of the Company from Michael
McEwan and Gerald Larson
10.14 [Intentionally Omitted]
10 10.15 Agreement between Alabama Power Company **
and the Company for the Sale and Purchase
of Coal, dated April 16, 1996, between
the Company and the Alabama Power Company
10 10.16 Employment Agreement, dated June 1, 1996 **
with Brent M. Cook
10 10.16.1 Stock Option Agreement dated June 1, 1996 **
with Brent M. Cook
10 10.17 Letter Agreement, dated March 6, 1996, **
among the Company, AGTC, Inc., Alpine
Coal Company, Inc, and E.J. Hodder &
Associates, Inc. regarding services to
investigate, identify and participate in
site selection
10 10.18 Letter dated July 19, 1996 from the **
Company canceling the Site Identification
Agreement
10 10.19 Term Sheet, dated August 22, 1996, from **
Company to Byrleen Hanson regarding
purchase of Price, Utah office building
10 10.20 Primary Agreement, dated November 6, 1996, **
between the Company and Savage Industries,
Inc.
10 10.20.1 Mojave Agreement, dated November 6, 1996, **
between the Company and Savage Industries,
Inc.
- - ------------------------------------
* Previously filed.
** Filed herewith.
52
Section No. Exhibit No. Description Location
- - ----------- ----------- ------------ --------
10 10.21 Release to all claims, dated September 13, **
1996, executed by Maynard Moe
10 10.22 Letter of Understanding, dated September **
13, 1996, between the Company and E.J.
Hodder & Associates, Inc. regarding the
sale of the Port Hodder facility to the
Company
10 10.23 Sublease, dated September 9, 1996, between **
the Company and Parker Towing Company, Inc.
regarding the lease of approximately 16
acres located in Tuscaloosa County,
Alabama
10 10.24 Supply Agreement, dated September 11, 1996, **
among the Company, K-Lee Processing, Inc.
and Concord Coal Recovery Limited
Partnership
10 10.25 PacifiCorp Financial Services, Inc. Letter **
of Intent (Covol Technologies) dated
September 12, 1996
10 10.26 Exclusive Financial Advisor Agreement, **
dated September 16, 1996, between the
Company and Coalco Corporation
10 10.27 Settlement Agreement, dated September 17, **
1996, among the Company, Environmental
Technologies Group International, Inc.,
Larson Limestone Company, Inc., Michael
M. Midgley, Mark Hardman, Kenneth M.
Young, Irene Larson, Farrell Larson, Gary
Burningham and Burningham Enterprises,
Inc.
10 10.28 Debenture Agreement and Security Agreement, **
dated December 20, 1996, between AJG
Financial Services, Inc. and the Company
10 10.29 Arthur J. Gallagher & Co. Letter of Intent, **
dated November 13, 1996
10 10.30 Lease Agreement, dated December 12, 1996, **
between the Company and UPC, Inc.
regarding Price City, Utah property
10 10.31 1996 Standard Form of Agreement between **
Owner and Design/Contractor.
- - ---------------------------------
* Previously filed.
** Filed herewith.
53
Section No. Exhibit No. Description Location
- - ----------- ----------- -------------- --------
10 10.32 Form of Limited Partnership Agreements **
for Alabama Synfuel #1, Ltd. and Utah
Synfuel #1, Ltd.
16 16.1 Letter to Securities and Exchange *
Commission, dated March 24, 1995, from
Jones, Jensen & Orton & Company,
certified public accountants
21 21.1 List of Subsidiaries of the Company *
27 27.1 Financial Data Schedule **
- - --------------------
* Previously filed.
** Filed herewith.
Reports on Form 8-K
The Company filed a Form 8-K on June 3, 1996. The information
provided in Form 8-K was as follows:
New Officers Appointed
At the June 3, 1996 meeting of the Board of Directors of the Company, the
directors received and accepted the resignations of Kirby D. Cochran as
President, and Michael Bodon as Secretary of the Company. Both Mr. Cochran and
Mr. Bodon also resigned as directors of the Company, all effective as of June 3,
1996. Mr. Cochran's resignation was prompted by health reasons, and Mr. Bodon
resigned in order to pursue other career objectives. To fill the vacancies
created by the resignations of Mr. Cochran and Mr. Bodon, certain executive
officers were appointed to new positions effective June 3, 1996. The following
sets forth the new positions of executive officers of the Company with changed
positions:
Michael M. Midgley President
Alan D. Ayers Chief Operating Officer
Brent M. Cook Chief Financial Officer
Asael T. Sorensen, Jr. Secretary and General Counsel
In connection with the changes described above, Brent M. Cook was hired as
Chief Financial Officer of the Company. The following is summary biographical
information on Mr. Ayers and Mr. Cook:
Alan D. Ayers. Mr. Ayers joined the Company in August of 1995 as manager of
the Company's investor relations department. From 1993 to 1995, Mr. Ayers was
the General Manager for Taylor Maid Beauty Supply ("Taylor Maid"), responsible
54
for the operations of the regional supply company. From 1987 to 1993, he was
Director of Operations for Knighton Optical, Inc. ("Knighton"). Taylor Maid and
Knighton are not affiliated with the Company. Mr. Ayers received his M.B.A. from
the University of Utah.
Brent M. Cook. Mr. Cook is a Certified Public Accountant. Prior to joining
the Company, 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 acquisitions and other
transactions. Mr. Cook spent more than 12 years with PacifiCorp. PacifiCorp is
not affiliated with the Company.
New Directors Appointed
At the June 3, 1996 meeting of the Board of Directors of the Company Alan
D. Ayers and Brent M. Cook were appointed to fill the two vacant positions on
the Board of Directors created by the resignations of Mr. Cochran and Mr. Bodon.
Biographical information on Messrs. Ayers and Cook is set forth above.
55
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
COVOL TECHNOLOGIES, INC.
By: /s/ BRENT M. COOK
Brent M. Cook,
Chief Executive Officer and
Principal Executive Officer
By: /s/ STANLEY M. KIMBALL
Stanley M. Kimball,
Principal Financial Officer
Date: January 10, 1997
Pursuant to the requirements of the Securities Act of 1933, as
amended, this Registration Statement has been signed by the following persons in
the capacities and on the dates indicated.
Signature Title Date
/s/ BRENT M. COOK Chief Executive Officer (Principal January 10, 1997
- - --------------------- Executive Officer)
Brent M. Cook
/s/ RUSS MADSEN Interim Chairman of the Board and January 10, 1997
- - --------------------- Director
Russ Madsen
/s/ STANLEY M. KIMBALL Chief Financial Officer, Treasurer January 10, 1997
- - ----------------------- and Director (Principal Financial
Stanley M. Kimball and Accounting Officer)
/s/ ALAN D. AYERS Chief Operating Officer and January 10, 1997
- - ----------------------- Director
Alan D. Ayers
56
/s/ RUSS MADSEN Vice President Operation and January 10, 1997
- - ----------------------- Director
Russ Madsen
/s/ GEORGE W. FORD Vice President - Research and January 10, 1997
- - ----------------------- Development and Director
George W. Ford
/s/ RICHARD C. LAMBERT Vice President - Sales and January 10, 1997
- - ----------------------- Marketing
Richard C. Lambert
/s/ STEVEN BROWN Vice President of Engineering and January 10, 1997
- - ----------------------- Construction and Director
Steven Brown
/s/ DELANCE SQUIRE Director January 10, 1997
- - -----------------------
DeLance Squire
/s/ RAYMOND J. WELLER Director January 10, 1997
- - -----------------------
Raymond J. Weller