-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, POK2pxHFmHW1GA3V0nHktb7wyGHfnUk7svf0L43DDFcsCBZU2LgmqeGawTv+2umi ss6dpx3PDCdHayd/QojufA== 0001038838-99-000003.txt : 19990114 0001038838-99-000003.hdr.sgml : 19990114 ACCESSION NUMBER: 0001038838-99-000003 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 16 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19990113 FILER: COMPANY DATA: COMPANY CONFORMED NAME: COVOL TECHNOLOGIES INC CENTRAL INDEX KEY: 0001003344 STANDARD INDUSTRIAL CLASSIFICATION: BITUMINOUS COAL & LIGNITE MINING [1220] IRS NUMBER: 870547337 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-27808 FILM NUMBER: 99505749 BUSINESS ADDRESS: STREET 1: 3280 N FRONTAGE RD CITY: LEHI STATE: UT ZIP: 84043 BUSINESS PHONE: 8017684481 10-K 1 YEAR ENDED SEPTEMBER 30, 1998 RESULTS UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended September 30, 1998, or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____ to _____ Commission file number 0-27803 COVOL TECHNOLOGIES, INC. (Exact name of registrant as specified in its charter) Delaware 87-0547337 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 3280 North Frontage Road Lehi, Utah 84043 (Address of principal executive offices) (Zip Code) (801) 768-4481 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.001 par value Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No __ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting stock held by non-affiliates of the registrant as of December 17, 1998 was $59,671,125 based upon the closing price on the Nasdaq National Market(R) reported for such date. This calculation does not reflect a determination that persons whose shares are excluded from the computation are affiliates for any other purpose. The number of shares outstanding of the registrant's common stock as of December 17, 1998 was 12,494,029. --------------------------- DOCUMENTS INCORPORATED BY REFERENCE Portions of the following document are incorporated herein by reference: Portions of the registrant's definitive proxy statement to be issued in connection with registrant's annual stockholders' meeting to be held in 1999. TABLE OF CONTENTS Page PART I ITEM 1. BUSINESS...................................................... 3 ITEM 2. PROPERTIES.................................................... 18 ITEM 3. LEGAL PROCEEDINGS............................................. 19 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........... 20 EXECUTIVE OFFICERS OF THE REGISTRANT.......................... 20 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS........................................... 23 ITEM 6. SELECTED FINANCIAL DATA....................................... 25 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS..................................... 26 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK..... 32 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................... 32 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE............................32 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............ 32 ITEM 11. EXECUTIVE COMPENSATION........................................ 32 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.................................................... 32 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................ 32 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K................................................... 33 SIGNATURES.............................................................. 42 Forward-Looking Statements Statements in this Form 10-K, including those concerning the Registrant's expectations regarding its business, and certain of the information presented in this report, constitute forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. As such, actual results may vary materially from such expectations. For a discussion of the factors that could cause actual results to differ from expectations, please see the caption entitled "Forward Looking Statements" in Item 1 and 7 hereof. There can be no assurance that the Registrant's results of operations will not be adversely affected by such factors. Registrant undertakes no obligation to revise or publicly release the results of any revision to these forward looking statements. Readers are cautioned not to place undue reliance on these forward looking statements, which reflect management's opinion only as of the date hereof. 2 PART I ITEM 1. BUSINESS The Company Covol Technologies Inc. is a technology development company focused on "Recycling Yesterday's Waste into Tomorrow's Resources."(TM) Company History Covol was originally incorporated in Nevada in 1987 under the name Cynsulo, Inc. Subsequently, the company acquired all of the issued and outstanding shares of McParkland Corporation and changed its name to McParkland Properties, Inc. The purchase of McParkland was rescinded in February 1989, and the company's name was changed to Riverbed Enterprises, Inc. In 1991, the company acquired technology consisting of binding agents used to make briquettes. From 1991 to 1995 the company focused on the research and development of binding agents principally for iron, coal and coke waste particles. The company's name was changed to Enviro-Fuels Technology in 1991, to Environmental Technologies Group International in 1994, and to Covol Technologies, Inc. in 1995, at which time the company was reincorporated in Delaware. In 1995, management of Covol recognized the applicability of its technology to the production of synthetic fuel. Since 1996, the primary focus of Covol has been on developing and commercializing the synthetic fuel technology. Background As a result of efforts by government and business to balance environmental concerns with the needs of business and recognize the need to efficiently use diminishing resources, the recycling industry has developed and pursued many endeavors to recycle, recover and/or enhance the usefulness of wastes and by-products. Covol has developed a family of binder technologies used to form fine materials from wastes and by-products into briquettes to capture their inherent resource value. Coal mines, ferrous and non-ferrous metals producers, and other industries produce waste and other by-products. Cost-effective processes have not been implemented generally to capture and use many such wastes, despite their potential usefulness and potential value. Storage and disposal of many of these by-products is costly and can be environmentally harmful. Covol's binder technologies are designed to enable the conversion of by-products from the coal and metals industries into valuable fuels and resources. Covol's primary focus over the past two years has been the commercialization of the application of its binder technologies to coal fines. Covol's binder technologies are being used to transform coal fines into a usable fuel. Coal fines are small particles of coal produced as a waste by-product of coal production. Coal fines can be found throughout coal producing regions of the United States and the world. A recent study of the coal industry estimated that there are more than 2 billion tons of coal fines residing in waste ponds and landfills in the United States alone. Millions of tons are added to this amount each year. Although coal fines have inherent fuel value, they present recovery and handling challenges that make it difficult to capture that value. Covol's binder technologies molecularly bond the coal fines into a formed fuel. Because this process is accomplished through a significant chemical reaction, the resulting product has been classified as a "synthetic fuel" within the meaning of Section 29 of the U.S. Internal Revenue Code. Sales of the fuel therefore qualify for a significant tax credit. The resulting fuel is more easily handled and transported than are coal fines. The composition of the resulting fuel varies in its potential heat, ash and sulfur content and other characteristics, depending primarily upon the composition of the coal fines used as feedstock, and secondarily on the processing of the feedstock. The possible end markets for the resulting synthetic fuel are as diverse as the markets for coal. Different end users have different requirements for fuel type and quality, 3 whether the fuel be synthetic or coal. The application of Covol's binder technologies can be customized to address the specific needs of prospective customers. The Covol binder technologies can also be used to transform coke dust into formed coke. Coke, which is processed metallurgical coal, is primarily used in the iron making process as a reducing agent and also as an economical fuel source. Coke dust, also known as "coke breeze," is a fine residue by-product resulting from the production, handling and storage of coke and is marketable in its "dust" state because of its high carbon and energy content. In tests, Covol has succeeded in aggregating coke dust into hard briquettes designed to withstand the weight, heat and other environmental factors inside of metal making furnaces, which appear potentially marketable at prices above briquette production costs. The Covol binder technologies can also be used to convert iron rich wastes into usable iron. Mill scale, bag-house dust, furnace sludge, blast furnace dust and other iron rich materials, are all waste by-products created by steel producers. These by-products present environmental problems for the steel industry. Because of their high iron content, they also have high potential value. Approximately 775 million tons of finished steel are consumed annually in the world with the U.S. producing approximately 100 million tons. The capture of even a fraction of the waste and other by-products of this steel production in the U.S. alone could provide millions of tons of feedstock material for processing. On a test basis, the Covol binder technologies have been demonstrated to be capable of producing briquettes from such steel production wastes. Such briquettes can be further processed in metal reducing furnaces to form high grade pig iron, a common form of feed material used in the steel industry. Additional fuel or resource by-products to which the Covol binder technologies appear applicable after initial testing include: molybdenum, silicon carbide, grinding swarf, lead dross, zinc oxide, titanium dioxide, phosphorous, and charcoal. Briquettes containing these by-products appear potentially marketable to ferrous and non-ferrous metals producers and to other industrial consumers. Except for synthetic fuel production, the Covol binder technologies listed above have not been commercially applied. No assurance can be given that Covol will be able to implement these applications profitably. Covol Binder Technologies The Covol binder technologies are designed to aggregate and process wastes and other by-products that are in a fine particulate state into usable fuels and resources in the form of briquettes, pellets or extrusions. These technologies also provide a way to "engineer" fuels or resources with value-added qualities, such as moisture reduction, elimination or neutralization of pollutants such as sulfur dioxide and nitric oxide, improvement of handling strength, reduction of impurities, and formation into uniform shapes and sizes to maximize efficiencies in combustion or in processing. The resulting products manufactured using the Covol binder technologies are broadly categorized as "engineered fuels" and "engineered resources" and can be marketed to utilities, ferrous and nonferrous metal producers, and other major industrial users. The Covol binder technologies chemically bond together fines, sludge, and dust such as coal fines, iron production wastes and coke dust that up to now have been considered by-products and waste materials. The process, in simplified terms, mixes the resource-rich wastes or other by-products with a chemical formula. The mixed materials are conveyed into a briquetter, a pelletizer or an extruder which utilizes pressure together with a chemical reaction to bond and shape the materials into the desired size and density required for the specific application. The materials may be processed further to meet specific market requirements. Covol has licensed its technology to other parties to produce and sell the products manufactured with the Covol binder technologies. Covol has contracted with Dow Chemical Company to produce chemical binder materials for the production of synthetic fuel made from coal fines. Substantially all of the equipment and machinery used for producing synthetic fuel is considered standard or "off-the-shelf" and is commercially available both domestically and internationally. 4 Covol has been issued seven U.S. patents and four foreign patents and has other U.S. and foreign patents pending. The patented technology principally relates to the application of Covol's binder technologies to iron production wastes, coke, coal and other carbon based materials. Covol is in the process of expanding the existing patents and applying for new patents related to waste recovery applications. See "ITEM 1. BUSINESS - Proprietary Protection" for a discussion of Covol's patents, trademarks and other intellectual property. Business Strategy The Covol binder technologies represent the foundation for Covol's business strategy. Covol believes that its success depends upon its ability to engineer industrial wastes and other by-products into value-added fuels and resources. Covol has divided its strategy into four general approaches: engineered fuels, engineered resources, licensing and technology transfers and strategic acquisitions. Engineered Fuels. Engineered fuels include fuels recovered or enhanced primarily from carbon based materials. The Covol binder technologies provides a use for fuel-rich wastes and by-products by aggregating them into a solid form for improved handling and processing, and by making such modifications as may be required for a given application of the resulting fuel, for example, reduced moisture, increased hardness or enhanced energy content. Covol's engineered fuels include the production of fuel from briquetted coal fines, coke dust and silicon carbide. For the past two years Covol's business strategy has been focused almost exclusively upon synthetic fuel from coal fines. There are currently 24 synthetic fuel facilities located in 8 states that are utilizing Covol's synthetic fuel technology. Twenty of the facilities are owned by unaffiliated third parties and four are currently owned by Covol. Two of the four facilities owned by Covol are under options to sell to licensees that would be expected to pay royalties to Covol. Covol does not expect one of the options to be exercised. Covol is actively pursuing the sale of the four facilities. Covol intends to sell all or part of each facility that Covol owns. Covol has no current ability to use the potential tax benefits that Covol's facilities can produce. Most of the synthetic fuel facilities were initially placed into operation in the second calendar quarter of 1998 and Covol and its licensees are currently in the process of ramping up production and entering into contracts for product sales. Covol is working with its licensees to secure coal fines feedstock, improve production and refine its chemical formulas. Covol and its licensees are also negotiating sales and marketing contracts for the synthetic fuel. Several of the owners of facilities are building or contemplating building wash plants to wash the coal fines which are then processed into synthetic fuel. Feedstock supply, production and product quality and the marketing of the synthetic fuel all directly affect the amount and timing of royalties to be received by Covol from the synthetic fuel facilities. Accordingly, assisting licensees to optimize the production from these facilities is currently Covol's highest priority. Covol has received one-time advance license fees with respect to most of the synthetic fuel facilities. In the future, most of the revenues related to such facilities are expected to come from royalties that are tied to production and sale of synthetic fuel pursuant to licensing agreements in place. Covol also expects to generate net revenues from the sale of binder materials to the facilities. Covol believes that the Covol binder technologies may also be applied profitably without the benefit of a tax credit. There are millions of tons of coal fines in the U.S. and internationally that could be washed and briquetted, and, in the opinion of Covol, sold at a reasonable profit above the fines purchase and processing costs. Additionally, the Covol binder technologies are well-adapted to the processing of "ultra fines," the face powder sized coal fines created in preparing coal for industrial use. Ultra fines can be recovered by equipping coal preparation facilities with modern float cell technology. These ultra fines have historically been slurried into waste ponds and, depending upon the preparation facility, might constitute as much as 10% of the processed coal. The Covol binder technologies allow for the recovery of such fines by removing the high levels of moisture they contain and forming them into a solid product that can be handled and sold. Finally, there are certain coals with high inherent moisture levels, such as Powder River Basin coals. The processing of these coals with the Covol binder technologies may reduce the moisture levels, thus increasing heat content, improving combustion efficiencies, and 5 reducing transportation costs because of the reduced weight. Covol intends to aggressively pursue these and other similar synthetic fuel applications. Another engineered fuel application Covol is pursuing is coke. Coke is processed metallurgical coal which serves as both a fuel and a reducing agent in iron and steel making. The production and handling of coke produces fine particles of coke dust. The aggregation of coke dust into briquettes that are designed to withstand the rigors of handling, heat and weight in metal making furnaces results in a useable fuel. Covol has patented technology and is in the process of patenting additional technology related to coke dust processing. Covol has acquired property where coke and coke dust has been landfilled. Covol intends to recover this coke and to briquette a portion of it for use as a fuel as described above. Silicon carbide is a product manufactured from a blend of carbon based materials and high silica sand. In addition to its principle use in the abrasives industry, silicon carbide is also used as an alloy and a high-quality fuel in specialized metal making applications. This application is covered under existing and applied-for patents. Covol has not yet applied the aggregation of silicon carbide in a full-scale operation. Engineered Resources. Steel mills, nonferrous metal producers and other mineral industries produce wastes and other by-products that may contain valuable unrecovered resources. These wastes often create environmental compliance, storage and disposal problems. The Covol binder technologies provide a way to solve disposal problems, extract the inherent resources, process the materials with current industrial methods, and enhance the materials with qualities that add value and that customize the materials for alternative uses. The resulting products are collectively referred to as "engineered resources." Covol has not yet commercially applied the Covol binder technologies in engineered resources. However, Covol has devoted significant research and development resources to improving and perfecting its technology for these applications, particularly in the processing of iron production wastes. During the steel-making process, steel mills produce, among other waste by-products, small particles of iron-rich materials. The Covol binder technologies are able to bind such particles into briquettes which can be further processed in reducing furnaces to reclaim the iron and other materials. Covol believes that products produced from such wastes could be marketed at prices which are competitive with other sources of iron and that this technology will be attractive in addressing the environmental issues surrounding the disposal of waste by-products generated in the steel making process. Covol will seek to enter into collaborative arrangements with steel and iron producers to build, equip and operate briquetting and processing plants at the producers' facilities. Covol believes that such arrangements will benefit both Covol and the metal producers because they will: o provide Covol with an ongoing supply of inexpensive iron tailing materials while ensuring a ready customer for the briquettes produced; o provide the steel producer with an economical means to dispose of waste materials while providing a ready source of briquettes and/or iron feedstock; and o minimize transportation costs for waste by-products, raw materials and briquettes, thereby increasing the economic competitiveness of Covol's products. Covol has developed and tested its technologies with other fine particulate wastes and other by-products, including: molybdenum, titanium dioxide, grinding swarf, lead dross, zinc oxide and phosphorous. Covol intends to continue to evaluate these and other engineered resource applications. Licensing and Technology Transfer. Covol believes that the Covol binder technologies include valuable intangible properties in the form of patents, processes, formulations and know-how. Covol intends to devote significant human and capital resources in the continued development and refinement of various applications of these technologies. Covol hopes to augment its own efforts with technical support from major suppliers of binding 6 materials. Covol has entered into licensing agreements with third parties for the use of its synthetic fuel technology. Covol intends to actively pursue additional licensing, joint venture and other collaborative arrangements with coal, coke, ferrous and non-ferrous metals producers and other resource producers to utilize Covol's technologies in recycling, recovering or enhancing fuels and resources from wastes and other by-products, both domestically and worldwide. Strategic Acquisitions. Covol believes that it has a unique opportunity to pursue acquisitions that are synergistic with Covol's financial and environmental objectives and initiatives. The Covol binder technologies may be applied to waste streams that are otherwise of little or no value. Covol intends to pursue possible acquisitions of businesses aligned to the industries in which the Covol binder technologies may be applied. Covol intends to broaden its position in the synthetic fuel industry and other resource industries through the acquisition or licensing of technologies that are complementary to the Covol binder technologies. Subsidiaries Covol has organized various special purpose entities to facilitate some of the transactions relating to the 24 synthetic fuel facilities. The entities are listed with Covol's position and interest in the entity as of December 31, 1998 described as follows: o Alabama Synfuel #1 Ltd., a Delaware limited partnership of which Covol serves as general partner and owns 98% o Utah Synfuel #1 Ltd., a Delaware limited partnership of which Covol serves as general partner and owns 100% o Flat Ridge Corporation, a Utah corporation, a wholly-owned subsidiary of Covol o Commonwealth Synfuel, L.L.C., a Utah limited liability company of which Covol is managing member and owns 100% The following chart illustrates Covol's corporate structure. Covol's ownership of each subsidiary is 100% unless otherwise indicated. [CHART OMITTED DESCRIBED AS FOLLOWS] [Chart with box centered containing the word "Covol." A line is drawn proceeding down from that box which divides into four branches, each of which terminates in one of four boxes, all aligned horizontally, labeled respectively as follows: o Alabama Synfuel #1 Ltd. (98% owned) o Utah Synfuel #1 Ltd. o Flat Ridge Corporation o Commonwealth Synfuel, L.L.C.] Tax Credits Section 29 of the U.S. Internal Revenue Code provides a credit against regular federal income tax with respect to sales of qualified fuel to an unrelated party. Where more than one person has an interest in a qualified facility, the Section 29 Credits generated by the facility are allocated pursuant to the proportional interests of such persons in the facility. 7 In order to qualify as a solid synthetic fuel produced from coal for purposes of the Section 29 credit, the fuel produced must differ significantly in chemical composition, as opposed to physical composition, from the raw material used to produce it. Covol has received a Private Letter Ruling, or PLR, from the IRS in which the IRS, based on representations made to it by Covol, ruled that the synthetic fuel technology produces a significant chemical change compared to coal fines and this qualifies the end product as a solid synthetic fuel. Accordingly the IRS has ruled, based on the facts presented to it, that: o Covol, with the use of its patented process, produces a "qualified fuel" within the meaning of Section 29 of the tax code; and o assuming the other requirements of Section 29 are met, the sale of the "qualified fuel" will entitle Covol to claim the Section 29 credit in the taxable year of sale. In its ruling, the IRS noted that no temporary or final regulations pertaining to one or more of the issues addressed in the PLR have been adopted and that the PLR would be modified or revoked by the adoption of temporary or final regulations to the extent the regulations are inconsistent with any conclusions in the PLR. The IRS notes, however, that a PLR is not revoked or modified retroactively, except in rare and unusual circumstances, provided that: o there has been no misstatement or omission of material facts, o the facts at the time of the transaction are not materially different from the facts on which the PLR was based, o there has been no change in the applicable law, o the PLR was originally issued for a proposed transaction and o the taxpayer directly involved in the PLR acted in good faith in relying on the PLR, and revoking the PLR retroactively would be to the taxpayer's detriment. Covol received its PLR in September 1995. At least six other PLRs covering twelve of the synthetic fuel facilities have been obtained by third parties in connection with licenses of Covol's synthetic fuel technology. However, all PLRs are only binding with respect to the specific projects addressed in the PLR and may only be relied on by the party that has obtained the PLR. The Section 29 credit is subject to the passive activity rules of Section 469, and therefore may not be available to individuals and closely held corporations. The Section 29 credit is equal to approximately $6.10 in 1997 dollars for each oil barrel equivalent of the qualifying fuel produced and sold. This equates to approximately $20.00-$28.00 per ton of synthetic fuel briquettes, depending upon the recoverable heat content. The oil barrel equivalent is defined generally as an amount of fuel having a recoverable heat content of 5.8 million Btu's. The Section 29 credit allowed may not exceed the taxpayer's regular tax liability reduced by certain other credits. The credit cannot be utilized to offset the Alternative Minimum Tax. The Section 29 credit was designed to provide protection for qualifying fuels against market price declines, and it is therefore subject to a phase out after the unregulated oil price reaches specified levels under an annually adjusted formula. In 1997 dollars, the credit would have phased out had the reference price for oil exceeded $47.78 per barrel, but the reference price determined for 1997 was $18.92 and no phase out occurred. There presently is no reference price for 1998. However, the average price of oil in the U.S. was lower in 1998 than 1997. The credit is also subject to reduction insofar as an otherwise qualifying facility benefits from grants or subsidized financing provided by federal, state or local governments, or from tax-exempt bond financing. 8 Section 29 of the tax code contains no provision for carryback or carryforward of Section 29 credits. Once earned, the credits are not subject to subsequent recapture. By virtue of the various limitations and other factors described above, there can be no assurances that any particular amount of Section 29 credit will be allowable and usable. During 1996, certain of the time periods applicable to the Section 29 credit were extended. The Section 29 credit will, under present law, be available for sales of qualified fuels completed before January 1, 2008. The qualified fuels sold must be produced at facilities placed in service by June 30, 1998. The synthetic fuel facilities must have been constructed pursuant to a binding written contract in effect as of December 31, 1996. Synthetic Fuel Manufacturing Facilities The following table represents a summary of the 24 synthetic fuel manufacturing facilities constructed and placed in operation before June 30, 1998 by Covol and its licensees.
SYNTHETIC FUEL MANUFACTURING FACILITIES No. of Annual Rated Name of Facility Plants1 Location Owner/Licensee2 Operator Capacity (tons)3 ---------------- ------- -------- --------------- -------- ---------------- Utah Synfuel #1 1 Price, Utah Coaltech No. 1 Company 360,000 L.P.4 Carbon Synfuel 1 Price, Utah Company5 Company 360,000 Mohave Synfuels 1 Laughlin, Savage Industries Flyash Haulers, 280,000 Nevada Inc. Inc. Birmingport 1 Mulga, Birmingham Syn Birmingham Syn 360,000 Alabama Fuel, L.L.C.7 Fuel, L.L.C. Brookwood 1 Brookwood, PacifiCorp Syn PacifiCorp Syn 360,000 Alabama Fuel, L.L.C8 Fuel, L.L.C. Pumpkin Center 2 Flat Creek, PacifiCorp Syn PacifiCorp Syn 720,000 #1 & #2 Alabama Fuel, L.L.C. Fuel, L.L.C. Norton 1 Norton, PC Virginia Constellation 600,000 Virginia Synthetic Fuel #1, L.L.C. Chelyan 1 Chelyan, West PC West Virginia Constellation 600,000 Virginia Synthetic Fuel #1, L.L.C. Muddlety 1 Muddlety, West PC West Virginia Constellation 600,000 Virginia Synthetic Fuel #2, L.L.C. Eckman 1 Eckman, West PC West Virginia Constellation 600,000 Virginia Synthetic Fuel #3, L.L.C. Appalachian 2 Peccus, West Appalachian AT Massey 720,000 Synfuel Virginia Synfuel, L.L.C. Mountaineer 1 Tallmansville, Company6 Savage 360,000 Synfuel West Virginia Industries Inc. Pocahontas 1 North Fork, Company Company 360,000 Synfuel West Virginia 9 Ginger Hill 1 Ginger Hill, Ginger Hill Maple Creek 300,000 Pennsylvania Synfuels, L.L.C. Mining Robena 1 Paisley, Robena, L.L.C. Consolidation 580,000 Pennsylvania Coal Commonwealth 1 Karthaus, Company River Hill Coal 360,000 Synfuel Pennsylvania Pennsylvania 1 Somerset, Somerset Fuels, Somerset Fuels, 600,000 Synfuel Project Pennsylvania L.L.C. L.L.C. USA Coal, #1, 4 Pawnee, Illinois A.J.G. Financial USA Coal 1,440,000 #2, #3, & #4 Services, Inc. Pleasant Ridge 1 Alledonia, Ohio Pleasant Ridge Ohio Valley 340,000 --- ---------- Synfuels, L.L.C. Coal Total 24 9,900,000 ==== =========
1 A plant is a finished synthetic fuel manufacturing facility constructed pursuant to a binding construction agreement entered into on or before December 31, 1996. 2 Most owners/licensees are special purpose entities owned by one or more other companies. 3 This is an amount as engineered and determined by equipment manufacturers. Most facilities are not yet operating at rated capacity. There is no assurance that the facilities will operate at rated capacity in the future. 4 Coaltech No. 1 L.P. consists of AJG Financial Services, Inc., a wholly-owned subsidiary of Arthur J. Gallagher & Co., and Square D Company, a wholly-owned subsidiary of Groupe Schneider, as limited partners, and Covol as 1% general partner. Covol has entered into an operating agreement with Coaltech to operate the Utah Synfuel #1 facility. 5 Covol granted Coaltech an option to purchase the facility, but does not expect the option to be exercised. 6 Covol granted Mountaineer Synfuel, L.L.C. an option to purchase the facility, which option expires in January 1999. The purchase option transaction for the Mountaineer facility provides that Covol is the managing member of Mountaineer Synfuel, L.L.C. 7 Birmingham Syn Fuel, L.L.C. is an affiliate of PacifiCorp Financial Services, Inc. 8 PacifiCorp Syn Fuel, L.L.C. is an affiliate of PacifiCorp Financial Services, Inc. Covol Contracts. Consistent with the requirements for obtaining Section 29 tax credits, in December 1996 Covol entered into fourteen design and construction agreements for the design and construction of new synthetic fuel manufacturing facilities each having capacity of approximately 360,000 tons per year. Depending upon the specific agreement, the contractor was either TIC, CEntry Constructors & Engineers, PICOR or Centerline Engineering Corporation. The PICOR contracts were part of a joint venture with Savage Industries. The construction agreements, among other things, required that the plants be placed in service no later than June 30, 1998. Covol obtained financing and successfully constructed five facilities from its construction agreements. Of these, one was built by TIC for Covol and sold to Birmingham Syn Fuel, L.L.C., a special purpose entity owned by PacifiCorp Financial Services, Inc., two were built for Covol by Centerline and are under option for sale to Mountaineer Synfuel, L.L.C. and to Coaltech No. 1 L.P., and two were built by TIC and are held for sale by Covol. 10 Covol assigned four other construction agreements to licensees and those licensees successfully constructed four facilities as follows: Fluor Corporation. Covol assigned two of its fourteen construction agreements to Appalachian Synfuel L.L.C., a wholly owned subsidiary of Fluor Corporation. The facilities were built at A.T. Massey Coal Company, Inc.'s Marfork Prep Plant Site near Peccus, in Boone County, West Virginia. In conjunction with the assignment of the two contracts, Covol entered into a license agreement with Appalachian for the use of the Covol binder technologies. Under the agreement, Covol was paid an advance license fee. A quarterly license fee is also to be paid based upon the Btu of product produced and sold up to a prescribed amount of production per year. Covol also granted Appalachian the right to pay a lump sum payment for the facilities, in lieu of quarterly license fees over the term of the agreement. Covol will provide binder to the facility on a cost plus basis. Pelletco Corporation. Covol assigned two of its construction agreements with Centerline to affiliates of Pelletco Corporation. One contract was assigned to Pleasant Ridge Synfuels, L.L.C. which constructed a facility in Alledonia, Ohio. One contract was assigned to Ginger Hill Synfuels, L.L.C. which constructed a facility at Ginger Hill, Pennsylvania. In connection with these two facilities, Covol entered into technology license and agreements to supply Covol's chemical binder, providing Covol with advanced license fees and quarterly license fees equal to 50% of the licensees' net cash flow. Covol will provide binder to the two facilities on a cost plus basis. Unused Contracts. Covol did not build facilities under five of its fourteen construction agreements, including the two PICOR contracts as part of a joint venture with Savage Industries. The construction agreements provided for penalties if the construction was not pursued by Covol. Covol accrued this liability during the fiscal year ended September 30, 1997, of which the remaining liability at September 30, 1998 is $755,000. Covol believes that construction under any of the five unused contracts is not likely. Additional Licensed Facilities. In addition to the nine facilities constructed under Covol's construction agreements, Covol licensed its technology to eight licensees for use at fifteen facilities constructed by these licensees. In total, Covol has licensed or constructed plants using the Covol binder technologies at 24 synthetic fuel facilities that operate at 18 locations in the Rocky Mountain region, Southern Appalachia, Central Appalachia, Northeast Appalachia, Northwest Appalachia, and the Illinois Basin, which are the primary coal supply regions of the United States. A facility generally consists of a conditioner and binder additive and mixing system, briquetting or aggregating equipment, a product dryer, and other supporting systems. However, each facility was individually engineered and constructed, including systems and components specially selected by the respective owners, so that there is variation in features from facility to facility. Covol has manufactured and sold binder mixing plants for installation at synthetic fuel manufacturing facilities. Six such plants were manufactured and sold in 1998. License and Binder Supply Agreements. All non-Covol entities that have constructed or own facilities using the Covol binder technologies have entered into a technology license and binder supply agreement with Covol. Most license agreements provide for an advance license fee of $1.39 per ton of rated capacity, payable upon reaching project milestones. Covol has received most of the advance license fees related to these facilities. In addition, pursuant to the license agreement, the licensee pays a quarterly earned license fee at a prescribed dollar amount multiplied by the recoverable heat denominated in Btu's in the product produced and sold during the calendar quarter. The prescribed dollar amount is subject to adjustment based upon the "inflation adjustment factor" as set forth in Section 29 of the tax code. In some cases, the amount to be paid is subject to adjustment to the extent that licensees incur an operating loss on the production and sale of synthetic fuel, exclusive of the amount licensees pay as a license fee for the use of the technology. Some license agreements also provide for a goal fee based on time schedules and production amounts. The license agreements generally have a term until the later of January 1, 2008 or the corresponding date after which tax credits may not be claimed or are not otherwise available under Section 29 of the tax code. 11 Covol also agreed, pursuant to the binder supply agreements, to provide binder material to licensees for the manufacture and production of synthetic fuel. The price for the binder sold to the licensees falls into two categories: o a fixed price, or o an amount equal to Covol's cost plus a prescribed mark-up. In some cases, the mark-up may be reduced to the extent the licensee incurs a loss on the production and sale of synthetic fuel, but not below Covol's cost for such binder materials. The binder is currently manufactured by Dow Chemical Corporation for Covol utilizing Covol's patented and proprietary technology. Covol arranges with Dow for shipping of the binder directly to the facilities. Pace Loan. In December of 1996 Covol entered into license agreements with affiliates of Pace Carbon Fuels, L.L.C. (collectively "Pace") for the use of the Covol binder technologies at four synthetic fuel manufacturing facilities owned by Pace. In 1998 Pace requested a reduction in the license fees payable to Covol under the license agreements. Upon condition of immediate payment by Pace of advance license fees, Covol agreed to a reduction in future license fees. This reduction was accomplished by a ten year loan agreement whereby Covol would loan to Pace up to $750,000 each quarter beginning in November 1998. Covol's loan to Pace will be repaid at the end of the ten years only if the Pace projects have accumulated sufficient prescribed earnings. Pace has requested a loan of $750,000 for the November 1998 quarter. Covol believes that its current loan obligation to Pace is limited to the earned license fees payable to Covol for the quarter ended September 30, 1998, which is believed to be approximately $300,000. Pace and Covol are negotiating in an attempt to resolve their differences. Covol Synthetic Fuel Facility Operations Covol is the operator at three facilities: Utah Synfuel #1, Carbon Synfuel, and Pocahontas Synfuel. Of these facilities, Utah Synfuel #1 is not owned by Covol, and Covol operates the facility under agreement with the owner, Coaltech. The operating agreement provides that Covol will act as operator of the facility for a quarterly fee based upon the amount of synthetic fuel produced and sold per year. Covol cannot predict with any certainty the amount of fees that may be generated under its operating agreement. Covol has contracts with independent operators to operate Covol's Commonwealth Synfuel and Mountaineer Synfuel facilities. River Hill Coal Company operates the Commonwealth facility and Savage Industries Inc. operates the Mountaineer facility. Both operating contracts compensate the operator with a prescribed fee plus reimbursement of costs. Supply of Raw Materials The synthetic fuel manufacturing facilities use coal fines as the primary feedstock to produce synthetic fuel. Accordingly, a supply of coal fines is essential to the feasibility of a synthetic fuel manufacturing facility. Historically, lower quality coal and mining refuse and fine particles of coal were discarded into refuse piles or impoundments. Today, coal preparation and material handling technologies have reduced the amount of coal that is discarded, but coal fines generated by coal mining and preparation are still problematic for the industry. With some variation, most consumers of coal only purchase coal with an ash content of 12% or less. Discarded coal fines are typically too high in ash content to be used as-is in making marketable synthetic fuel. To make use of fine coal refuse, owners of synthetic fuel plants must either blend the refuse with "clean" coal in appropriate proportions to yield an acceptable ash content, and/or clean the coal refuse itself. Clean coal can be purchased from traditional coal marketers and is available to all synthetic fuel facility owners that have a clean coal/coal refuse blending strategy. Covol's strategy at all of the facilities it owns or operates includes clean coal/coal refuse blending. Coal fines cleaning is a distinct technology and to implement it successfully requires analysis of the particular coal refuse to determine appropriate plant design and to determine whether feedstock can be economically produced. Capital requirements for coal cleaning or preparation plants adequate to supply a synthetic fuel plant can 12 be in excess of $4 million. Coal cleaning plants require six months or more to design and construct. A feasibility analysis must be performed to determine whether the savings achieved by the plant justify the capital costs of construction together with operational costs, which can vary between approximately $5-10 per ton. The costs of a cleaning plant are compared to the alternative of purchasing clean coal for blending. The decision to construct a coal cleaning plant does not delay delivery of synthetic fuel to market because in all cases clean blending coal is available to purchase as an immediate alternative. The decision to construct a coal cleaning plant is based on how a facility most economically obtains clean feedstock. Covol constructed a coal cleaning plant to supply Utah Synfuel #1 and Carbon Synfuel and is reviewing the feasibility of coal cleaning plants at two other synthetic fuel facilities. In facilities owned and operated by licensees, the licensee secures its own supply of coal fines. Licensees that are also coal producers utilize their own feedstock sources. Nonproducer licensees secure deposits of coal fines to supply their facilities. Covol has arranged for the supply of coal fines for the following facilities it owns or operates: Utah Synfuel #1 and Carbon Synfuel. In February 1997, Covol entered into a contract with a non-affiliated party, Earthco, to acquire coal fines and to lease property to conduct fines recovery and preparation activities at a location near Wellington, Utah, approximately six miles from the Utah Synfuel plant site. Covol paid an initial amount to Earthco upon execution of the lease agreement to acquire the fines and lease the associated land and will continue to make quarterly payments through May 2000. Covol constructed a preparation plant at the site which became operational in May 1998 and which produces feedstock from the acquired raw fines for the Utah Synfuel #1 and Carbon Synfuel facilities. The estimated quantity of coal fines at this site is in excess of 2 million tons although the recoverable amount may be less. Additional fines will be required to supply the longer term requirements of Utah Synfuel #1 and Carbon Synfuel. Pocahontas Synfuel. In May 1997, Covol entered into a joint venture with Black Diamond Enterprises, Inc. under which Black Diamond has certain rights to market the synthetic fuel produced at the facility and to a percentage of the net proceeds received by Covol from the project. In addition, Black Diamond is to provide coal fines to the Pocahontas Synfuel facility. Black Diamond owns the land in McDowell County, West Virginia upon which the Pocahontas facility is located and which land includes a fines pond and other coal refuse containing an estimated 1.2 million tons of recoverable clean fines. Black Diamond and Covol plan to construct a preparation plant to clean the raw Black Diamond fines. To date, neither Covol nor Black Diamond have begun construction of a preparation plant. In addition to the fines at the Pocahontas site, an affiliate of Black Diamond operates a waste coal recovery operation with an estimated 350,000 tons of recoverable clean fines. Covol has also acquired waste coal on a site near the project with an estimated 500,000 tons of recoverable clean fines. After cleaning, the coal fines from these reserves are high in recoverable heat, low in ash, and low in sulfur. Until a preparation plant can be permitted, financed and constructed at Pocahontas, Covol is purchasing coal fines from local sources for processing at the facility. Commonwealth. The Commonwealth Synfuel facility is located on property owned by River Hill Coal Company, Inc. River Hill has approximately 6 million tons of leased and permitted coal reserves which it actively mines. River Hill has agreed to provide up to 400,000 tons per year of coal fines from its mining and preparation plant operations to the Commonwealth facility. Covol intends to assign this supply agreement to the entity that acquires this facility, which is currently being offered for sale. Mountaineer. The Mountaineer Synfuel facility is located on property owned by Upshur Property, Inc., an affiliate of Anker Energy Corporation. Anker has agreed to provide the feedstock requirements of Mountaineer Synfuel, L.C. for a period of ten years, up to 480,000 tons of feedstock per year. Anker will supply the feedstock from various sources owned or controlled by Anker, including preparation plant operations and fines ponds. The price for the feedstock varies based upon the source of the coal fines and the costs of recovery. The site contains a fines refuse pond which is serving as a partial source for feedstock and a preparation plant is planned to increase the quality and amount of feedstock coming from the site refuse pond. Covol does not yet have financing for the preparation plant. If Mountaineer Synfuel, L.L.C. exercises its option to purchase the Mountaineer facility, Covol proposes to assign this supply agreement to Mountaineer. 13 Alabama Inventory. In March of 1997 Covol entered into a coal fines supply agreement (the Supply Agreement") with K-Lee Processing Inc. and Concord Coal Recovery Limited Partnership (collectively "K-Lee"). Covol purchased coal fines under the Supply Agreement through February of 1998 at which time Covol sold its inventory of coal fines and assigned the Supply Agreement to Birmingham Syn Fuel, L.L.C. Birmingham Syn Fuel removed the coal fines inventory and asserted that the inventory was approximately 11,000 tons less than K-Lee had invoiced and received payment from Covol. Covol is currently in negotiations attempting to resolve the dispute. Supply of Binder. Covol purchases its patented and proprietary binder from Dow Chemical Company under a ten year agreement under which Covol pays a prescribed price per pound of binder. Covol arranges with Dow for the delivery of the binder from Dow's manufacturing plants to each of the synthetic fuel facilities owned, operated, or licensed by Covol. Sale of Facilities Covol and its affiliates have developed and sold or have granted an option to sell four synthetic fuel facilities. The following is a summary of each option or sale: Utah Synfuel #1. On March 10, 1997, Utah Synfuel #1 Ltd., a Delaware limited partnership in which Covol was at the time a 64% owner and general partner, sold the Utah synthetic fuel facility for $3.5 million, in the form of a nonrecourse promissory note bearing interest at 9.6552% per annum and payable in 44 equal quarterly installments, all in accordance with the Utah Project Purchase Agreement, dated as of March 7, 1997, between Covol, Utah Synfuel #1 and Coaltech No. 1 L.P. The sale of the Utah facility resulted in a loss of approximately $581,000 to Utah Synfuel #1. The promissory note is collateralized by a security interest in the Utah facility, and in the event of a default under the promissory note, Covol's and Utah Synfuel #1's sole right to recovery is limited to the Utah facility without recourse against Coaltech. Covol granted Coaltech a put option to require Covol to purchase the Utah facility from Coaltech if: 1. all of the Coaltech limited partners are unable to utilize the federal income tax credits under Section 29 of the tax code, 2. the economic benefits accruing to or experienced by all of the Coaltech limited partners differ significantly from what was initially projected, or 3. there is a permanent force majeure or material damage or destruction of the Utah facility. If the put option is exercised prior to the third anniversary date of the facility sale, the option price will be equal to the fair market value of the limited partnership interests of the optionees on a going concern basis, but in no event will the option price exceed 50% of the capital contributions made by the optionees to fund payments due under the promissory note, the Utah License Agreement and broker fees. If the put option is exercised on or after the third anniversary date, the option price will be $10 and the optionees will not be entitled to any other payments. As part of the sale of the Utah facility, Covol and Utah Synfuel #1 entered into a Supply and Purchase Agreement with Coaltech. Under the agreement, Covol agreed to provide coal fines to the Utah facility for processing into synthetic fuel at an amount equal to Covol's per ton costs, including any wash costs. Utah Synfuel #1 also agreed to purchase from Coaltech the synthetic fuel produced at Coaltech's cost plus one dollar per ton. Coaltech has the right to market its synthetic fuel to a third party, with Utah Synfuel #1 having a right of first refusal to purchase such synthetic fuel. Covol has incurred a loss each quarter in connection with this agreement and expects that these losses will continue into the foreseeable future. Carbon Synfuel. In connection with the Utah Project Purchase Agreement, dated March 10, 1997 Covol entered into an option agreement with Coaltech to sell a second facility, identified as Carbon Synfuel and located at the Utah Synfuel #1 facility. If Coaltech exercises its option, Covol will sell the second line of synthetic fuel manufacturing equipment including the building, binder plant, and other equipment that were not part of the Utah 14 Synfuel #1 facility sale. The terms of the option provide that Coaltech would purchase Carbon Synfuel on the same terms as Coaltech's purchase of Utah Synfuel #1 facility. Covol does not expect the option to be exercised. Covol is actively seeking an alternative buyer for the Carbon Synfuel facility, however there is no assurance that a sale will be completed. Since the Utah Synfuel #1 facility and Carbon Synfuel facility were first placed in service they have experienced several problems, including inadequate clean coal fines as feedstock, inadequate end product strength, and inability to market to end-consumers the synthetic fuel product produced from the feedstock. Covol continues to improve the synthetic fuel product quality and believes that the improvements will achieve the results necessary for successful marketing. Covol also has begun to see some success in marketing the product from these two facilities to a power plant and an industrial manufacturer. Covol is seeking a long term purchase commitment from these consumers. The Utah Synfuel #1 and Carbon Synfuel facility are currently operating at well below their rated capacity. Covol and its licensee have incurred a loss on the production of synthetic fuel at the Utah Synfuel #1 and Carbon Synfuel facilities. In order to provide coal fines to the Utah Synfuel #1 facility, Covol entered into a purchase agreement with Earthco to acquire the coal fines located at Wellington, Utah. The estimated amount of coal fines at the Wellington site is in excess of 2 million tons. The Wellington fines require washing. Covol has constructed a wash plant at the Wellington site which supplies coal fines to Utah Synfuel #1 and Carbon Synfuel. The cost for the plant was approximately $8 million. The financing for the construction of the wash plant was provided in part by AJG Financial Services, Inc., and is evidenced by a debenture of Covol to AJG which is collateralized by the wash plant assets. The debenture bears interest at 6% per annum with principal and interest being due and payable in October 1999. As additional consideration to AJG for financing the wash plant, Covol, in October 1997, agreed to grant to AJG warrants to purchase approximately 430,000 shares of Covol common stock, with fifty percent of the shares having a purchase price of $10 per share and fifty percent of the shares having a purchase price of $20 per share. The warrants expire two years from issuance. Birmingham Syn Fuel. Alabama Synfuel #1 Ltd., a Delaware limited partnership in which Covol was at the time a 74% owner and general partner, sold the Birmingham Syn Fuel/Birmingport facility to Birmingham Syn Fuel, L.L.C., a wholly-owned subsidiary of PacifiCorp Financial Services, Inc., on March 6, 1998. The purchase price for the Birmingport facility was $6,500,000 payable in the form of a nonrecourse promissory note collateralized by certain portions of the Birmingport facility. Mountaineer Synfuel. On May 5, 1998 Covol entered into a purchase agreement to sell the Mountaineer synthetic fuel facility to Mountaineer Synfuel, L.L.C., a Delaware limited liability company. The agreement is subject to numerous conditions, including but not limited to, the obtaining of a PLR from the IRS, and the production of product meeting certain specifications. There is no assurance that Mountaineer will exercise its option with respect to the purchase of this facility. Covol also entered into a financing agreement with Mountaineer to finance up to $9.75 million for project construction and operations working capital. Covol's obligation to repay the financing will be extinguished if Mountaineer exercises its purchase option; otherwise, Covol will be required to repay the loan with ten percent interest in monthly installments of interest only payments for the months January through June 1999 and monthly installments thereafter of $350,000 and a balloon payment on June 30, 2000. Covol's obligation to repay the amounts borrowed is collateralized by the assets of the project, and income streams from the Ginger Hill and Pleasant Ridge facilities. Under a license agreement, Covol will provide use of its technology and Mountaineer will pay a quarterly license fee based upon the synthetic fuel product produced and sold during the quarter. Covol will also supply binder material to the project on a cost plus basis. In addition to the four facilities discussed above, Covol owns and operates two synthetic fuel manufacturing facilities that Covol has for sale. One facility is referred to as Commonwealth Synfuel, located near Karthaus, Pennsylvania. The other Covol-owned facility for sale is referred to as Pocahontas Synfuel located near North Fork, West Virginia. Several entities have expressed interest in purchasing the facilities and Covol expects the facilities to be sold in early 1999. However, Covol cannot give assurance that it will successfully sell either or both facilities. 15 Research and Development Covol has devoted and continues to commit significant human and capital resources to the development, refinement and commercialization of the Covol binder technologies in the engineered fuel and engineered resource applications. Covol is currently focusing its research and development efforts principally on the synthetic fuel technology, including refinements to the chemical formula and process, enhancements to the base binder formulations to address product quality issues, and continued testing and development of other binder materials for the production of synthetic fuel. Covol is also currently conducting research and development related to application of the Covol binder technologies to iron tailing materials, coke breeze, silicon carbide and other waste product or resource materials. Covol's intellectual property base consists of seven U.S. and four international patents relating to the Covol binder technologies as applied to coal, iron tailings, coke and other carbon based materials. Covol's research and development efforts will be directed toward perfecting and expanding these technologies and the filing for patents for proprietary intangible property developed. See "ITEM 1. BUSINESS - Proprietary Protection" for a discussion of Covol's patents, trademarks and other intellectual property. Proprietary Protection Covol has the following trade names and patents covering certain aspects of Covol's technology: Trade names: Covol Technologies, Inc., Alabama Synfuel #1 Ltd., Utah Synfuel #1 Ltd., Flat Ridge Corporation and Engineered Fuel Technologies, Inc. Trademarks and Service Marks: United States Trademark Registration No. 2,038,742 for licensing services identified by "Covol", "Recycling Yesterday's Waste Into Tomorrow's Resources." United States Patents: United States Patent No. 5,453,103, which issued 26 September 1995. United States Patent No. 5,487,764, which issued 30 January 1996. United States Patent No. 5,589,118, which issued 31 December 1996. United States Patent No. 5,599,361, which issued 4 February 1997. United States Patent No. 5,738,694, which issued 14 April 1998. United States Patent No. 5,752,993, which issued 19 May 1998. United States Patent No. 5,807,420, which issued 15 September 1998. Foreign Patents: European Patent Office # 96905442.8-2307 filed May 1, 1998. Australian #686624 filed on January 21, 1994; filed with U.S. Patent Office as No. 184099 on May 28, 1998. New Zealand #266060 filed on April 7, 1994; filed with U.S. Patent Office on February 20, 1998. Republic of Trinidad and Tobago #960038 filed on July 1, 1996 and #970147 filed under PCT/US96/01798 on February 8, 1996. Other United States, Patent Cooperative Treaty, and Foreign Patent Applications are pending. 16 Covol's U.S. and foreign patents expire on January 21, 2014. There can be no assurance as to the scope of protection afforded by the patents. In addition, there are other industrial waste recycling technologies in use and others may subsequently be developed, which do not, or will not utilize processes covered by the patents or pending patents. There can be no assurance that any patent issued will not be infringed or challenged by other parties, infringe on patents held by other parties or that Covol will have the resources to enforce any proprietary protection afforded by the patent or defend against an infringement claim. In addition to patent protection, Covol also relies on trade secrets, know-how and confidentiality agreements to protect the Covol binder technologies. However, such methods may not afford complete protection and there can be no assurance that others will not independently develop such know-how or obtain access to Covol's know-how, concepts, ideas, and documentation. Since Covol's proprietary information is important to its business, failure to protect ownership of its proprietary information would likely have a material adverse effect on Covol. Covol's current and expected revenues are dependent upon license agreements by which licensees use the Covol binder technologies to manufacture synthetic fuel and then pay license fees to Covol. Covol expects that revenues will continue to be tied to future licensing agreements in the application of Covol binder technologies to iron rich wastes, coke dust, and other potentially useful wastes and by-products. Covol believes that its patents, trade secrets, know-how and confidential information are the basis upon which Covol is able to obtain licensing agreements. Confidentiality Provisions As part of its business, Covol typically enters into agreements concerning its projects which contain confidentiality provisions. Covol is, on occasion, required to disclose such agreements to the Securities and Exchange Commission as part of its ongoing reporting requirements under the Securities Exchange Act of 1934. In addition, disclosure of such agreements may be required in connection with Covol's private placement of securities. Some of the agreements do not contain the standard exceptions for the disclosure of information which is required to be disclosed under law. Consequently, no assurances can be given that Covol has not inadvertently disclosed information regarding its various projects in violation of confidentiality covenants entered into by Covol. Government Regulation Covol's and its licensees' synthetic fuel operations are subject to federal, state and local environmental regulations that impose limitations on the discharge of pollutants into the air and water and establish standards for the treatment, storage and disposal of waste products. In order to establish and operate the synthetic fuel plants, Covol and its licensees obtained various state and local permits. Covol believes that it or its licensees have obtained all required permits to construct and operate synthetic fuel facilities, and that they are in substantial compliance with all relevant laws and regulations governing the synthetic fuel operations. However, Covol's and its licensees' synthetic fuel operations entail risk of environmental damage and Covol or its licensees may incur liabilities in the future arising from the discharge of pollutants into the environment or from waste disposal practices. Failure by Covol or its licensees to maintain necessary permits to operate synthetic fuel plants and to comply with permit requirements could have a material adverse effect on Covol or its licensees. Other developments, such as the enactment of more stringent environmental laws and regulations, could require Covol or its licensees to incur significant capital expenditures. If Covol or its licensees do not have the financial resources or is otherwise unable to comply with such laws and regulations, such failure could also have a material adverse effect on Covol. Covol's goal is to establish itself as the provider of technologies that will assist others in the processing and reclamation of their wastes and by-products, and Covol seeks for itself and its licensees to avoid creating waste streams or compounding environmental reclamation problems. Covol has not assumed responsibility for environmental reclamation of coal refuse impoundments from which Covol or its licensees obtain refuse for feedstock. Such liabilities are and remain the responsibility of the impoundment owners or operators. In the manufacture of synthetic fuel from coal refuse using Covol's binder technologies, the synthetic fuel produced effectively completely consumes the refuse. The synthetic fuel manufacturing process does not contribute to environmental reclamation liabilities with respect to the coal refuse. However, the synthetic fuel manufacturing process using Covol binder technologies typically uses dilute acids. Covol and its licensees must comply with hazardous material handling and storage regulations related to acid solutions and stored concentrates. Covol's and its licensees' synthetic fuel operations are also subject to federal and state safety and health standards. Covol is committed to providing effective management of worker safety and health protection. Covol periodically contracts with independent safety and industrial hygiene inspectors in order to measure a facility's regulatory compliance. In addition, Covol has developed a safety policy designed to raise and maintain a high level of safety awareness by both management and employees. Compliance to applicable safety and health standards is verified through periodic inspections by regulatory agencies. Failure to comply with safety and health standards could have a material adverse affect on Covol, for example, a regulatory inspector could close the operation until Covol meets the required standards. 17 Competition Products made using the Covol binder technologies compete with other synthetic products as well as traditional source materials. Competitive factors include price, quality, delivery cost and waste handling costs. Covol may experience competition from other alternative fuel technology companies and their licensees, particularly those companies with technologies to produce coal based solid synthetic fuels. Competition may come in the form of the licensing of the competing technologies to process coal fines or in the marketing of end products qualifying as synthetic fuel. Competition includes, for example, Carbontec, Krystal Bond, KFx Inc. and Startec Inc. Covol will also experience competition from traditional coal and fuel suppliers and natural resource producers in addition to those companies that specialize in the disposal and recycling of waste products generated by coal, coke, steel and other resource production. Many of these companies have greater financial, management and other resources than Covol. Covol believes that it will be able to compete effectively although there can be no assurance that it will do so successfully. Employees Covol currently employs approximately 80 persons full-time. Approximately 30 of such persons are in corporate administration including research, development and marketing, and 50 are in synthetic fuel and coal washing operations. None of these employees are covered by a collective bargaining agreement. Forward Looking Statements Statements regarding Covol's expectations as to the financing, development, construction and operation of facilities utilizing the Covol binder technologies, the marketing of products, the receipt of licensing fees and other information presented in this Annual Report on Form 10-K that are not purely historical by nature, including those statements regarding Covol's future business plans, the operation of facilities, the estimated capacity of facilities, the availability of coal fines, the marketability of the synthetic fuel and other briquettes and the financial viability of the proposed facilities, constitute forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although Covol believes that its expectations are based on reasonable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results will not differ materially from its expectations. In addition to matters affecting Covol's industry or the coal industry or the economy generally, factors which could cause actual results to differ from expectations stated in these forward looking statements include, among others, the following: (1) The commercial success of the Covol binder technologies. (2) Procurement of necessary equipment to maintain facilities' operations. (3) Securing of necessary sites, including permits and raw materials, for facilities to be constructed and operated. (4) Completion of facilities, in particular the synthetic fuel manufacturing facilities, by the placed in service date. (5) Ability to obtain needed additional capital on terms acceptable to Covol. (6) Changes in governmental regulations or failure to comply with existing regulations which may result in operational shutdowns of Covol or licensee facilities. (7) The availability of tax credits under Section 29 of the tax code. (8) The commercial feasibility of the Covol binder technologies upon the expiration of Section 29 tax credits. (9) Ability to meet financial commitments under existing contractual arrangements. (10) Ability to commercialize the non-synthetic fuel related Covol binder technologies which have only been tested in the laboratory and not in full-scale operations. (11) Dependence on licensees to successfully implement Covol binder technologies. (12) The market acceptance of products manufactured with Covol binder technologies in the face of competition from traditional products. (13) Ability to produce products with Covol binder technologies with acceptable hardness, moisture level, and other characteristics. (14) Success in the face of competition by others producing synthetic fuel and other recycled products. (15) Sufficiency of intellectual property protections. ITEM 2. PROPERTIES Covol leases an approximately 5,000 square-foot building in Lehi, Utah, which houses its executive offices ("Corporate Headquarters"). In August 1997, Covol entered into a triple-net lease dated August 1, 1997 (the "Headquarters Lease"). The Headquarters Lease provides for a monthly rent of $5,000 during the initial term which expires on July 31, 2000. Thereafter, the Headquarters Lease will automatically extend indefinitely for successive one-year periods at the sole option of Covol, and the monthly rent will increase by 5% per year. 18 In October 1997, Covol purchased an 8,000 square-foot site located in Price, Utah, on which Covol's prototype briquetting plant is located, for $150,000. Included in the purchase was a 1,400 square-foot office and warehouse building which houses equipment. The property is subject to a 10-year $100,000 mortgage held by the seller. The equity in the property was pledged as part of the collateral for a $2.9 million loan to Covol from AJG Financial Services, Inc. In May 1995, Covol entered into a lease with Geneva Steel Company for a 9,000 square foot building in Vineyard, Utah. Covol pays no cash rent on these facilities. Subsequent to the execution of the Geneva Agreements, the lease with Geneva expired resulting in a tenancy-at-will between the parties. Covol may use the Geneva briquetting facility in the manufacture of synthetic fuel or for testing purposes at the Geneva site or some other location. In June 1996, Covol entered into a land lease of approximately 12 acres in Price, Utah with a non-affiliated party at a monthly rental of $600. The lease term commenced on June 20, 1996 and expires on December 31, 2007 but may be extended. In 1996 Covol constructed a 22,000 square-foot building to house the Utah Synfuel #1 and Carbon Synfuel facilities. In March 1997, this building was subleased by Covol to Coaltech as part of the sale of the Utah Synfuel #1 facility. However, Covol retained responsibility for operations of the property pursuant to an Operations and Maintenance Agreement between Covol and Coaltech. Covol has constructed an ancillary building, a 1,650 square-foot binder plant. Coaltech has an option to purchase the Carbon Synfuel facility, and if exercised, Coaltech will take ownership of the buildings. In February 1997, Covol entered into a lease agreement with Earthco for two contiguous parcels located in Wellington, Utah (approximately 6 miles from the Utah Synfuel #1 site). The first parcel covers approximately 30 acres and has a lease term of 15 years. On this parcel, Covol constructed a 3,400 square-foot wash plant. The second parcel covers approximately 357 acres and has a lease term of 5 years. On this parcel, Covol conducts fines recovery operations. Covol has the option to extend or purchase either or both parcels upon the satisfaction of certain conditions. Total obligations to lease the parcels and acquire the associated fines are approximately $5.5 million, of which $700,000 was paid at the time of lease execution and Covol has and will make payments 4 times each year until May of 2002 for the balance. In 1997, Covol entered into a 5 year, $850 per month sublease with Combustion Resources, Inc. for approximately 2,400 square feet of building space in Provo, Utah. In 1997, Covol entered into a one year, $9,000 lease with Stephen Mallory for approximately 2,000 square feet of office and residential space in Dunbar, West Virginia. This property serves as Covol's Eastern Region office. In 1998, Covol entered into a one year, $1,500 per month lease with Mobile Auto & Storage for approximately 4,000 square feet of building space in Lehi, Utah. This property provides office and laboratory facilities for some of Covol's research and development personnel. In May 1998, Covol entered into a 10 year, $1,000 per year lease with Upshur Property, Inc., for approximately 10 acres of property in Tallmansville, Upshur County, West Virginia. The property is the site of the Mountaineer Synfuel facility. The lease is assignable to Mountaineer Synfuel, L.L.C., in connection with its facility purchase option. In May 1998, Covol purchased approximately 80 acres of undeveloped property near Sunnyside, Utah for $100,000. In June of 1998 Covol entered into a five year lease with an option to purchase approximately 40 acres of property with office and warehouse improvements. The lease payments are $2,000 per month, escalating to $3,500 per month over time. The leased property is adjacent to the purchased property. Covol plans to conduct some operations on the two properties in the future. None of Covol's subsidiaries have interests in real property. ITEM 3. LEGAL PROCEEDINGS Asbestos Investigation. In January 1996, a manager of Covol entered property owned by Nevada Electric Investment Company, a subsidiary of Nevada Power Corporation, in connection with an offer by Covol to purchase the property, and with certain other employees of Covol, removed some asbestos over a two-day period. In May of 1996 Covol received a notice of violation and order for compliance from the State of Utah, Division of Air Quality alleging that asbestos was improperly handled, removed, and disposed of. Covol complied with the order and in September of 1996 entered into a settlement agreement with the State of Utah and paid a fine in the amount of $11,000. In late 1997 the U.S. Environmental Protection Agency began its own investigation, referring the matter to the U.S. Attorney's office which proceeded with a grand jury inquiry. Covol was served in September 1998 with a grand jury subpoena for records, with which Covol has complied. Covol does not know the results of the grand jury inquiry or whether the inquiry is completed. Covol does not believe that its resolution will have a material adverse effect on Covol. 19 Indemnification to Centerline. In December 1996, Covol entered into six indemnification agreements with Centerline whereby Covol agreed to indemnify Centerline should it be required to pay liquidated damages to PacifiCorp under various design and construction agreements for six synthetic fuel facilities. Under the original terms of the various design and construction agreements, if the facilities were not completed by June 1, 1998 then $750,000 in liquidated damages for each facility would be due and payable by Centerline. The indemnification agreement only applied if PacifiCorp actually decided to build the facilities with Centerline as the design/builder. PacifiCorp elected to not build three of the projects, and therefore the indemnity agreement with respect to those facilities no longer applies. Accordingly, the maximum amount of contingent liability to Covol under the indemnification agreements is $2,250,000 ($750,000 per design and construction agreement). Counsel for Centerline has notified Covol that a dispute exists between Centerline and PacifiCorp which may require indemnification by Covol. Covol has been advised that the dispute is proceeding to arbitration. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Covol held its Annual Meeting of Stockholders on August 27, 1998. At the meeting, the following actions were approved by the stockholders: James A. Herickhoff was elected a director of Covol for a three year term to expire in 2001, by a vote of 7,703,272 in favor and 50,992 against. John P. Hill was elected a director of Covol for a three year term to expire in 2001, by a vote of 7,694,872 in favor and 58,992 against. Selection by the Board of Directors of PricewaterhouseCoopers LLP as independent auditors of Covol for the 1998 fiscal year was ratified by a vote of 7,690,463 in favor, 15,610 opposed and 43,938 abstaining. EXECUTIVE OFFICERS OF THE REGISTRANT NAME AGE POSITION Brent M. Cook 38 Chief Executive Officer and Director Stanley M. Kimball 44 President and Director Steven G. Stewart 50 Chief Financial Officer George W. Ford, Jr. 53 Principal Scientist and Vice President of Science and Technology Steven R. Brown 40 Senior Vice President of Engineering and Development Max E. Sorenson 49 Senior Vice President of Engineered Resources Dee J. ("D.J.") Priano 53 Senior Vice President of Synfuel Engineered Fuels Asael T. Sorensen, Jr. 44 Secretary and Corporate Counsel Harlan M. Hatfield 38 Vice President and General Counsel Kenneth R. Frailey 45 Vice President of Operations Stephanie R. Black 36 Vice President of Research and Development 20 Brent M. Cook has served as Chief Executive Officer and Director since November 1996, as President from October 1996 until July 1998, and served as Chief Financial Officer from June 1996 until December 1996. Mr. Cook is a Certified Public Accountant. Prior to joining Covol, Mr. Cook was Director of Strategic Accounts-Utah Operations, for PacifiCorp, Inc. ("PacifiCorp"). His responsibilities included the management of revenues of approximately $128 million per year, and seeking out and evaluating strategic growth opportunities for PacifiCorp, including joint ventures and other transactions. Mr. Cook spent more than 12 years with PacifiCorp. Stanley M. Kimball was appointed President in July 1998 and has been a Director since January 1997. He served as Chief Financial Officer from January 1997 to July 1998. Prior to joining Covol, Mr. Kimball was employed by Huntsman Corporation ("HC"). From 1989 to early 1995, Mr. Kimball served as the Director of Tax for Huntsman Chemical Corporation ("HCC"). In May 1995, Mr. Kimball was appointed as an officer of HCC, serving as Vice President, Tax. In July 1995, Mr. Kimball was appointed as Vice President, Administration for HC. In this position, he had numerous responsibilities, both for HC and for Mr. Jon M. Huntsman personally, which included financial accounting, tax and estate planning, and cash and investment management. In this position, Mr. Kimball also served as Mr. Huntsman's Chief of Staff. In 1980, Mr. Kimball received a Master of Accountancy, with emphasis in taxation, from Brigham Young University and is a Certified Public Accountant. Between 1980 and 1989, he was employed by Arthur Andersen & Co., and was serving as a Senior Tax Manager prior to his employment with HCC. Steven G. Stewart was appointed Chief Financial Officer of Covol in July 1998, and served as Vice President of Finance and Treasurer from April 1998 through July 1998. Prior to joining Covol, Mr. Stewart was a partner for 11 years with a "Big Five" accounting firm, an audit partner with Ernst & Young (formerly Arthur Young) and was the Salt Lake City office Director of High Technology and Entrepreneurial Services. From January 1994 through September 1996, Mr. Stewart was self-employed and provided consulting services to high technology companies, established strategic alliances, advised companies on alternative valuation methods applicable to acquisition targets and negotiated acquisition/sale transactions. From October 1996 through March 1998, Mr. Stewart was a business assurance partner at PricewaterhouseCoopers, LLP (formerly Coopers & Lybrand LLP), with primary responsibility for public companies operating in the high technology, mining and extractive industries. Mr. Stewart is a Certified Public Accountant. George W. Ford, Jr. has served as Vice President of Research and Development of Covol since August 1993. From August 1993 to February 1997, Mr. Ford served as a Director of Covol. From 1982 to 1993, Mr. Ford was employed at Ballard Medical Products, Inc. in research and development, principally in the biomedical field. Mr. Ford holds 17 national and international patents covering a wide variety of technologies. Mr. Ford has functioned as an independent consultant working on projects in computer programming, medical product device design and process polymer chemistry design for the energy industry. Mr. Ford is a member of the American Association for the Advancement of Science and the Iron and Steel Society. Steven R. Brown was appointed Senior Vice President of Engineering and Development in December 1998. Since July 1998 he served as Vice President - Synfuel Operations. Previously he served as Vice President of Engineering and Construction of Covol since February 1995. Mr. Brown served as a Director of Covol from September 1995 to March 1997. From 1993 to 1995, Mr. Brown was President of Construction Management Service, Inc. Mr. Brown is a licensed professional engineer and a licensed general contractor. Max E. Sorenson was appointed Senior Vice President of Engineered Resources in December 1998. He served as Vice President of Covol since April 1997. Prior to Mr. Sorenson's employment with Covol, Mr. Sorenson was Senior Vice President of Operations, Engineering and Technology of Geneva Steel Company. Mr. Sorenson began his employment with Geneva Steel Company in October 1989. During his employment with Geneva Steel Company, Mr. Sorenson also had responsibility for raw materials, transportation contracts and information systems and also served as Chief Engineer of Coke, Iron and Steel, and Vice President of Engineering. Prior to joining Geneva Steel Company, Mr. Sorenson worked for 16 years for Inland Steel, Inc., one of the largest steel companies in the United States, where he served in various operational and technology management positions in ironmaking and steelmaking. Mr. Sorenson obtained a B.S. degree in Metallurgical Engineering from the University of Utah in 1973 and a Master of Science degree in Industrial Management from Purdue University in 1978. 21 Dee J. "DJ" Priano was appointed Senior Vice President of Synfuel Engineered Fuels in December 1998. Prior thereto, he served as Vice President of Covol since August 1997. Mr. Priano had been employed by Kennecott Corporation for more than 32 years prior to that time. Mr. Priano worked in several different positions at Kennecott including Principal Planning Engineer for Kennecott's Bingham Canyon mine, Manager of Operations Analysis, Controller of Kennecott's Bingham Canyon mine as well as the Controller of Kennecott's U.S. Mines Division. In addition to managing general accounting and financial reporting activities, he was responsible for the administration of purchasing, MIS and land and water management functions. Mr. Priano received a BS degree and Master of Business Administration from the University of Utah. Asael T. Sorensen, Jr. joined Covol as its legal Counsel in September 1995. He has also served as Corporate Secretary since June 1996. From 1982 to 1995, Mr. Sorensen was an in-house attorney for the Church of Jesus Christ of Latter-Day Saints in Salt Lake City, Utah and practiced law primarily in the area of contract negotiations and administration. Mr. Sorensen graduated from Brigham Young University with a joint Juris Doctor and Master of Business Administration. He is admitted to practice law in the State of Utah. Harlan M. Hatfield has served as Vice President and General Counsel since July 1998 and Corporate Counsel since October 1996. His primary activities with Covol have been the development of synthetic fuel projects, including licensing, financing, permitting, construction, feedstocks, site selection, and other aspects of project development. As General Counsel he oversees the legal staff and outside legal counsel, litigation, regulatory disputes, contracts, and other legal matters. Prior to his employment with Covol, he was in private practice at the Seattle law firm of Oles, Morrison and Rinker for more than nine years where he was a partner. Kenneth R. Frailey joined Covol in August 1998, and in December 1998, was appointed Vice President of Operations. Until August 1998, Mr. Frailey was employed by Kennecott Corporation and General Electric for a total of approximately 20 years. Mr. Frailey's Kennecott experience related to mining and electrical power generation, and particularly managerial assignments in plant operations and engineering. Stephanie E. Black joined Covol in March of 1998 as Director of Research and Development, and in December 1998, was appointed Vice President of Research and Development. She was employed as a Strategic Account Manager with PacifiCorp from June of 1995 until joining Covol. For the approximately 11 years prior to June 1995, Ms. Black was employed with Hercules, Inc. (now Alliant Techsystems). While with Hercules, Ms. Black acted at various times as engineer, analyst, supervisor, and subcontract manager. Covol's Executive Officers are elected annually by the Board of Directors and serve at the discretion of the Board. 22 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The shares of common stock of Covol trade on The Nasdaq National(R) Market under the symbol "CVOL". The following table sets forth, for the periods presented, the high and low trading prices of Covol's common stock as reported by Nasdaq from April 1998, to September 1998, and bid quotations as reported by National Quotation Bureau, Inc. from October 1996 through March 1998. The quotations do not reflect adjustments for retail mark-ups, mark-downs or commissions and may not necessarily represent actual transactions. Since Covol has several market makers, the bid prices among the different market makers will generally vary. Accordingly, the bid price may not be representative of actual trades. The following prices may not be considered valid indications of market value due to the limited and sporadic trading in the shares of common stock. Low High Fiscal 1997 Quarter ended December 31, 1996 $7.50 $14.38 Quarter ended March 31, 1997 7.88 15.75 Quarter ended June 30, 1997 6.75 8.88 Quarter ended September 30, 1997 6.25 10.13 Fiscal 1998 Quarter ended December 31, 1997 $8.88 $13.94 Quarter ended March 31, 1998 10.50 14.06 Quarter ended June 30, 1998 12.25 17.44 Quarter ended September 30, 1998 9.00 17.25 As of December 17, 1998, there were approximately 625 shareholders of record of Covol's common stock. Covol has not paid dividends on its common stock to date and does not intend to pay dividends on its common stock in the foreseeable future. Covol intends to retain earnings, if any, to finance the development and expansion of its business and to pay debt service and dividends on preferred stock. Payment of common stock dividends in the future will depend, among other things, upon Covol's ability to generate earnings, its need for capital and its overall financial condition. Recent Sales of Unregistered Securities The following sets forth all securities issued by Covol within the past fiscal year without registration under the Securities Act of 1933, as amended. No underwriters were involved in any stock issuances nor were any commissions paid in connection therewith. However, Covol did pay finders fees in the form of cash, stock or warrants in connection with various securities issuances. The issuance of qualified options is required to be based on market value. Accordingly, the exercise price is set based on the market price of Covol's common stock, even though the options convert into restricted stock. Covol believes that the following issuances of shares of common stock, notes, debentures and other securities were exempt from the registration requirements of the Securities Act of 1933, as amended, pursuant to the exemption set forth in Section 4(2) thereof. Each security was issued subject to transfer restrictions. Each certificate for each security bears a restricted legend. Each investor made representations to Covol that it was accredited as that term is defined in Regulation D and that the security was acquired for investment purposes. In September and October 1997, Covol accepted subscriptions from 49 accredited investors for the purchase of 119,557 units (the "Units") pursuant to a Confidential Private Placement Memorandum, dated August 28, 1997 (the "Memorandum"), at a price of $35.00 per Unit, with an aggregate purchase price of approximately 23 $4,200,000. Each Unit consisted of five shares of common stock of Covol together with a warrant to purchase one additional share of common stock at the price of $8.00, expiring April 30, 1998. Pursuant to the terms of the Memorandum, Covol granted to purchasers of the Units piggyback registration rights on the shares of common stock included in the Units and the shares of common stock which were issuable upon the exercise of the warrants. A total of 597,850 shares of common stock and 119,557 warrants were issued in the offering. Of the 119,557 warrants issued to investors, 96,357 were exercised and 23,300 expired. In connection with the sale of the Units under the Memorandum, Covol issued to three accredited investors finder fees in the form of warrants to acquire an aggregate of up to 199,262 shares of Covol's common stock at a purchase price of $8.00 per share at any time prior to October 31, 1999, none of which had been exercised as of September 30, 1998. On November 25, 1997, Covol issued 1,500 shares of Covol common stock to a single investor upon exercise of warrants at $8.00 per share, paid in cash. The warrants were originally issued with Units privately placed in September and October 1997. On December 8, 1997, Covol issued 1,500 shares of Covol common stock to a single investor upon exercise of warrants at $8.00 per share, paid in cash. The warrants were originally issued with Units privately placed in September and October 1997. On January 9, 1998 Covol issued warrants for 216,272 shares of Covol common stock at a per share exercise price of $10.00 to AJG Financial Services, Inc. ("AJG"). Also, on January 9, 1998 Covol issued warrants for 216,272 shares of Covol common stock at a per share exercise price of $20.00 to AJG. Covol issued these warrants as partial consideration for AJG's loan to Covol of $4,367,351 under Covol's debenture to AJG dated January 9, 1998. On March 4, 1998 Covol issued 1,000,000 shares of Covol common stock to PacifiCorp Financial Services, Inc., pursuant to PacifiCorp Financial's conversion of its Convertible Loan and Security Agreement dated March 20, 1997 ("Agreement"). On April 7, 1998 Covol issued an additional 27,000 shares of Covol common stock to PacifiCorp Financial as satisfaction of the adjustment provisions of the Agreement. In 1996, Covol formed two limited partnerships, Alabama Synfuel #1 Ltd. and Utah Synfuel #1 Ltd., to assist with the financing of construction at two synthetic fuel manufacturing facilities. These two facilities have been sold and are now owned by Birmingham Syn Fuel, L.L.C. and Coaltech No. 1 L.P. On September 9, 1998 Covol offered the limited partners in Utah Synfuel #1 and Alabama Synfuel #1 an exchange of Covol's common stock for their limited partnership interests. The exchange ratio was based in part on an independent valuation of the limited partnership's assets and other factors including but not limited to current and future expected cash flow of the partnerships and current market values of Covol's common stock as quoted on NASDAQ. The exchange ratio for Utah Synfuel #1 was 112.828 shares of common stock per each limited partnership unit and 125.97 shares for each Alabama Synfuel #1 limited partnership unit. The limited partnership's units originally sold for $1,000 per unit. As of November 10, 1998, all of the limited partners in Utah Synfuel #1 and all but one of the limited partners in Alabama Synfuel #1 had agreed to exchange their limited partnership interests for shares of Covol's Common Stock, and accordingly Utah Synfuel #1 became a wholly-owned subsidiary of Covol and Alabama Synfuel #1 became a 98%-owned subsidiary of Covol. During September 1998 Covol completed a financing of $1,500,000 that consisted of the sale of 55,555 units at $27.00 per unit to an investor. A unit consisted of three shares of restricted common stock of Covol plus one warrant to purchase one share of restricted common stock at a price of $12.00. The warrants expire September 16, 2000 if not exercised. During November 1998, Covol completed a financing transaction that consisted of $400,000 of debt and approximately $3,500,000 of equity issued to 28 investors. The debt had a term of twelve months, bears interest at 15% per annum, with an interest only payment due in six months and with the balance of interest and principal due at maturity. The debt is collateralized by certain assets of Covol and is due prior to maturity upon the placement of 24 long-term financing by Covol. The equity transaction consisted of the sale of a unit at a price of $5.00. A unit consisted of one share of restricted common stock of Covol plus a warrant to purchase one additional share of restricted common stock at an exercise price of $7.50. The warrants expire in twelve months if not exercised. The stock and shares issuable pursuant to the related warrants bear "piggyback" registration rights. ITEM 6. SELECTED FINANCIAL DATA The following selected financial data are derived from the consolidated financial statements of Covol. This information should be read in conjunction with the consolidated financial statements, related notes and other financial information included herein. As more fully described in Note 15 to the consolidated financial statements, Covol sold its construction subsidiaries in 1996. All construction - related operations have been reflected as discontinued operations in the 1996, 1995 and 1994 financial statements. The construction subsidiaries include one business which was acquired on September 30, 1994 and therefore is included in discontinued operations in 1996 and 1995 only. The note receivable received by Covol as consideration for the sale is "marked to market" each quarter based on the market value of Covol's stock held as collateral, and the resulting adjustments are reflected in Covol's statement of operations. The selected financial data as of and for the nine months ended September 30, 1994, as of and for the year ended September 30, 1995 and as of September 30, 1996 are derived from audited financial statements not included herein. The selected financial data for the year ended September 30, 1996, and as of and for the years ended September 30, 1997 and 1998 were derived from the financial statements of Covol which have been audited by PricewaterhouseCoopers LLP included elsewhere herein.
Nine Months Ended Year Ended September 30, September 30, --------------------------------------------------- (thousands of dollars, except per-share data) 1998 1997 1996 1995 1994 - ----------------------------------------------- ------------ --------------- --------------- -------------- ------------- OPERATING DATA: Total revenues $12,699 $ 251 $ 295 $ 129 $ 20 Loss from continuing operations (3,986) (10,995) (12,955) (4,524) (498) Net loss (3,986) (10,995) (13,836) (5,654) (143) Basic and diluted net income (loss) per common share: Loss per share from continuing operations (.43) (1.38) (1.86) (1.00) (.13) Net income (loss) per share (.43) (1.38) (1.99) (1.25) 0.04 Purchase of property, plant and equipment and facilities held for sale 36,963 7,194 5,055 694 100 September 30, ------------------------------------------------------------------------ (thousands of dollars) 1998 1997 1996 1995 1994 - ------------------------------------------------ ----------- --------------- --------------- -------------- ------------ BALANCE SHEET DATA: Working capital $ 8,549 $ 4,960 $(3,482) $ (480) $ (620) Net property, plant and equipment 14,902 5,464 7,125 1,330 748 Total assets 66,897 26,361 8,772 2,660 4,853 Long-term obligations 16,279 5,467 364 177 852 Total stockholders' equity (deficit) 21,571 5,929 (233) 1,183 2,990
25 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the information set forth under the caption entitled "ITEM 6. SELECTED FINANCIAL DATA" and the financial statements and notes thereto for Covol included elsewhere herein. Year Ended September 30, 1998 Compared to Year Ended September 30, 1997 The information set forth below compares Covol's operating results for 1998 with its operating results for 1997. Revenues. Total revenues for the year ended September 30, 1998 increased by $12,448,000 to $12,699,000 as compared to $251,000 for 1997. During 1998 Covol recognized license fees totaling $7,942,000 while no license fees were recognized during 1997. These fees consisted of one-time advance license fees of $7,736,000 and earned license fees or royalty payments of $206,000. Advance license fees are normally due when construction of the related synthetic fuel facility begins, when construction is completed, or when certain construction milestones or other conditions are met. Covol expects to receive approximately $4,000,000 of additional advance license fees during 1999 upon the sale of certain synthetic fuel facilities currently owned by Covol and upon the achievement of certain production levels at one of the synthetic fuel facilities. Earned license fees or royalty payments are due quarterly based upon synthetic fuel produced and sold as reported to Covol by its licensees. Covol had sales of binder and coal fines to a related party during 1998 totaling $2,543,000 compared to $209,000 during 1997. These revenues resulted primarily from coal fines that were sold to the related party at Covol's cost as provided for under the binder and license agreement with this party. Substantially all of the fines purchased by Covol have now been sold so sales of coal fines are not expected to be material during 1999. Covol sold six binder mixing plants to licensees during 1998 for $1,088,000, generating a gross profit of $200,000. Covol does not expect sales of binder mixing plants during 1999. Covol provides binder material to its licensees either at a fixed price or at Covol's cost plus a contracted markup. Covol purchases the binder materials under a long-term contract with a large chemical company. Total binder sales during 1998 were $994,000 with a corresponding direct cost to Covol of $642,000. Covol expects a significant increase during 1999 of production of synthetic fuel by its licensees as licensees move toward full production levels with a corresponding increase in earned license fees or royalty payments and sales of binder products. However, Covol cannot assure increases in license fees, royalty payments, and binder sales because Covol licensees must successfully obtain adequate feedstock coal fines, process fines into synthetic fuel, and develop markets for synthetic fuel, now and in the future. Covol believes that its licensees have made significant progress in these areas, but continued success cannot be assured. Operating Costs and Expenses. Operating costs and expenses increased by $4,205,000 or 38% to $15,310,000 during 1998 from $11,105,000 during 1997. Cost of coal briquetting operations increased $4,492,000 from $4,803,000 during 1997 to $9,295,000 during 1998. This increase included $4,121,000 relating to the costs associated with binder plant sales, binder sales and coal fine sales as discussed above. During 1997, Covol recorded an expense for $1,477,000 relating to construction penalties for failure to proceed under several contracts Covol had entered into. There was no similar expense in 1998. However, during 1998 Covol incurred significantly higher operating expenses in connection with the continued refinement and implementation of the briquetting process, and the commercialization of this process in connection with the 24 facilities placed in service during 1998, including the four facilities held for sale. Covol expects to continue incurring losses into 1999 until these facilities are sold. Covol expects to realize a gain when the facilities are sold. These expenses related in part to the construction and operation of four synthetic fuel facilities built by Covol that are currently held for sale, costs incurred in providing assistance to Covol's licensees during the ramp-up of their synthetic fuel facilities, and increased personnel costs. These increases during 1998 effectively offset the 1997 construction penalty expenses. Covol operates one of the synthetic fuel facilities for Coaltech, a partnership for which Covol is the general partner. Under this operating agreement, Covol is contractually obligated to purchase all of the synthetic fuel produced at cost plus $1 per ton. Production of synthetic fuel from this facility during 1998 was not significant and accordingly, the cost per ton is significantly in excess of the current market value. These costs and the corresponding write-down of this inventory 26 to its market value are included in the cost of coal briquetting operations. The write-down was approximately $1,400,000 during 1998 and $1,548,000 during 1997. Covol expects the excess cost per ton to decrease in 1999 as production volumes increase. Research and development costs decreased during 1998 as a result of Covol's continued focus on the commercialization of the synthetic fuel technology and the utilization of certain research and development resources in this endeavor. Covol expects that research and development costs will increase in 1999 as Covol focuses resources on further refinement of its technology relative to the synthetic fuel / coal industry and the application of the technology into other areas. Selling, general and administrative expenses increased $1,438,000 or 48% to $4,436,000 during 1998 from $2,998,000 for 1997. Approximately $500,000 of this increase related to a substantial increase in travel and related costs as Covol's employees spent a significantly greater amount of time at Covol and licensee-owned facilities. Covol believes that travel and related expenses will decrease during 1999, but will continue to run at levels higher than 1997 due to the ongoing activities that will be required at the 24 synthetic fuel facilities utilizing Covol's patented technology. The balance of the increase in expenses relates to approximately $250,000 of commissions incurred in connection with the placement of synthetic fuel license agreements, $175,000 in increased professional fees and a $500,000 increase in payroll and related costs, resulting from additional employees hired. Compensation expense on stock options, stock warrants, or issuance of common stock decreased $1,119,000 or 54% to $939,000 for 1998 from $2,058,000 for 1997. This decrease is attributable to a change in policy to only grant stock options at strike prices that are not "in-the-money", for the purpose of providing an incentive to the recipient of the options to create shareholder value. The majority of the 1998 expense relates to options granted in prior years that vest over several years and the compensation value that is being recognized as an expense over the vesting period. In 1998, Covol sold the facility owned by Alabama Synfuel #1 Ltd. for $6,500,000, in exchange for a note receivable due February 2003. A loss of $218,000 was incurred from the sale of this facility. In 1997, Utah Synfuel #1 sold its facility to Coaltech for $3,500,000, evidenced by a promissory note payable in 44 quarterly installments of $130,000 starting March 31, 1997. The actual cost to construct the Utah Synfuel #1 facility was $4,082,000. Accordingly, a loss was incurred from the sale of the Utah Synfuel #1 facility in the amount of $582,000. During 1996, Covol sold certain construction companies and received as consideration a $5,000,000 note receivable ("Note") with interest at 6% payable over five years. It was determined that the Note should be discounted to an appropriate market rate and accordingly, the Note was discounted at 10.25% resulting in a discount of $1,281,000. The Note is collateralized by stock and stock options of Covol and is reflected in the balance sheet at the underlying value of the collateral. Accordingly, the Note is "marked to market" each quarter based upon the market value of Covol's common stock. This adjustment resulted in income of $19,000 being recognized during 1998, compared to an expense of $60,000 recognized during 1997. The Note is guaranteed by the buyer of the construction companies and there has been no event of default or past due payment on the Note. Covol is scheduled to receive a $515,000 payment on the Note in January 1999. Covol does not accrue interest on this Note and as of September 30, 1998 the Note has a carrying value of $1,609,000 in Covol's balance sheet. Other Income and Expense. During 1998, Covol had net other expenses of $1,375,000 compared to $141,000 for 1997. This increase of $1,234,000 relates primarily to an increase of $487,000 in net interest expense and a decrease of $853,000 in minority interest in the net losses of consolidated subsidiaries (Utah Synfuel #1 and Alabama Synfuel #1). Interest expense in 1999 is expected to decrease after the repayment of debt related to facilities held for sale. During September 1998, Covol offered the limited partners of Utah Synfuel #1 and Alabama Synfuel #1 an exchange of their limited partnership interests for common stock of Covol. These exchanges, most of which were accounted for in September 1998, were substantially completed in November 1998, at which time Utah Synfuel #1 became a wholly-owned subsidiary of Covol and Alabama Synfuel #1 became a 98%-owned subsidiary of Covol. Covol believes the combined operations of these partnerships will result in operating losses in the near-term future which will be included in Covol's statement of operations. 27 Loss from Continuing Operations. For 1998, the loss from continuing operations decreased by $7,009,000 from $10,995,000 for 1997 to $3,986,000. The decrease is primarily due to the significant increase in total revenues, which was partially offset by increased operating costs and other expenses as discussed previously. Covol did not recognize any income tax benefit in 1998 or 1997 since the realization of its deferred tax assets, consisting primarily of net operating loss carryforwards, depends on generation of future taxable income. Year Ended September 30, 1997 Compared to Year Ended September 30, 1996 The information set forth below compares Covol's operating results for 1997 with its operating results for 1996. Continuing Operations Revenues. For 1997, total revenues decreased by $44,000 to $251,000 from $295,000 for 1996. There were no license fees recognized in 1997 as compared to $100,000 recognized in 1996. Covol received payment for related party license fees in fiscal 1997 which were attributable to a one-time advance license fee paid by Coaltech, a partnership for which Covol serves as the general partner, upon the sale of the Utah Synfuel #1 facility. Covol also received a $250,000 payment in fiscal 1997 of a one-time advance license fee from Birmingham Syn Fuel, L.L.C. upon the issuance of a private letter ruling to Birmingham Syn Fuel by the Internal Revenue Service. Because Covol is obligated to render future services to Coaltech and Birmingham Syn Fuel, the advance license fees are recorded as deferred revenue and will be recognized as income in future periods when its obligations are met. Net proceeds from the sale of briquettes decreased in 1997 by $153,000 to $42,000 from $195,000 in 1996. Notwithstanding the Utah Synfuel #1 facility having been placed in service in early 1997, its production and sales of synthetic fuel were significantly curtailed due to the lack of adequate quality feed stock for production. Covol did produce approximately 18,000 tons of synthetic fuel during 1997; however, due to high levels of ash in the feedstock and hence in the end product, the synthetic fuel was difficult to market. Covol received revenues from binder sales in the amount of $209,000 in 1997. No sales of binder were made in 1996. Operating Costs and Expenses. Operating costs and expenses increased $532,000 to $11,105,000 for 1997 from $10,573,000 for 1996. Operating costs and expenses attributable to briquetting operations increased $3,943,000 to $4,803,000 for 1997 from $860,000 for 1996. On or before December 31, 1996, Covol entered into several contracts to construct synthetic fuel facilities. In order for the contracts to be binding for purposes of qualification for Section 29 treatment, Covol agreed to pay a penalty of 6% of the expected contract price for the facilities if Covol did not proceed with construction. As of September 30, 1997, there were several contracts that were not expected to be completed by June 30, 1998. Accordingly, Covol recorded the liability for the penalty for these facilities in 1997 in the amount of $1,477,000. Covol also incurred costs of $1,548,000 which were attributable to the start-up and operation of the Utah Synfuel #1 facility for Coaltech, a partnership for which Covol is the general partner. When Utah Synfuel #1 and Covol sold the Utah Synfuel #1 facility to Coaltech, Utah Synfuel #1 entered into an agreement to purchase synthetic fuel produced at the Utah Synfuel #1 facility for costs incurred plus $1 per ton. The Utah Synfuel #1 facility incurred significant costs for coal fines, labor, binder materials, repairs and maintenance, equipment rental and other costs to work through various operational issues. These costs are included in the synthetic fuel purchase commitment and therefore are included in the cost of coal briquetting operations. The remaining costs for briquetting operations in 1997 were more than in 1996 due to material and labor costs for the continuing refinement and implementation of the briquetting process and is reflective of the phase of commercialization and operation Covol was in for 1997 as compared to 1996. Research and development costs decreased $380,000 or 36% during 1997 from $1,044,000 for 1996. This decrease is due to Covol's focus of resources and efforts on the commercialization of its synthetic fuel technology through: the construction and start-up of its first full scale briquetting facilities, the Utah and Birmingport plants; the licensing of the Briquetting Technology to other licensees; and the development of other projects that will utilize the Briquetting Technology in the manufacture of synthetic fuels. The majority of the 1997 costs were principally attributable to research and development efforts related to Covol's synthetic fuels technology. 28 Selling, general and administrative expense decreased $798,000 or 21% to $2,998,000 for 1997 from $3,796,000 for 1996. The decrease related principally to reductions in costs for administrative labor, outside professional services and travel expenses. The reduction in these expenses is due to Covol's use of personnel, resources and efforts on the commercialization of the Covol binder technologies. Compensation expense on stock options, stock warrants and issuance of common stock decreased $2,815,000 or 58% to $2,058,000 for 1997 from $4,873,000 for 1996. The decrease is attributable to reduction in the use of stock options in compensating employees and consultants of Covol. The reduction is also reflective of a general change in Covol philosophy regarding the strike price for options granted. Generally, fewer stock options granted by Covol have been "in-the-money", thus serving as an incentive to the recipient of the options to add value to Covol. In 1997, Utah Synfuel #1 sold its facility to Coaltech for $3,500,000, evidenced by a promissory note payable in 44 quarterly installments of $130,000 starting March 31, 1997. The actual cost of Utah Synfuel #1 to construct the facility was $4,082,000. Accordingly, a loss was incurred from the sale of the Utah Synfuel #1 facility in the amount of $582,000. Other Income and Expense. In 1996, Covol had net other expense of $2,654,000 and in 1997 had net other expense of $141,000 for a net decrease in other expense of $2,513,000. In 1996, Covol was required, under generally accepted accounting principles, to write down the discounted $5,000,000 6% promissory note (the "Note") from the sale of the construction companies to the ascertainable value of the property collateralizing the Note. This accounting treatment resulted in a write-down of $2,700,000 in 1996. The additional write-down in 1997 of $60,000 resulted from the change in the value of the property collateralizing the Note. The Note is guaranteed by the buyer of the construction companies and there has been no event of default or past due payment on the Note. The remaining difference in net other expense is made up principally of interest expense of $1,645,000, of which $1,438,000 was booked as a result of the transaction Covol entered into with PacifiCorp with respect to the $5,000,000 convertible debt instrument (see discussion below). This expense is partially offset by the net change in the addback for minority interest in net losses of consolidated subsidiaries of $1,241,000 ($4,000 in 1996 compared to $1,245,000 in 1997). The increase is attributable to the minority interest in the loss incurred by Utah Synfuel #1 in 1997. The current period represents the first full year of operations of Utah Synfuel #1. Utah Synfuel #1 incurred losses in 1997 due to: the sale of the Utah Synfuel #1 facility at an amount less than its cost (after adjustment for the installation of the new dryer), start-up costs for the facility, expense incurred for license fees, and the obligation to purchase synthetic fuels produced at a price equal to cost plus $1 per ton. In July 1996, Covol negotiated with PacifiCorp the general terms of the sale of the Birmingport facility, including an arrangement for convertible debt in the amount of up to $5,000,000 to fund working capital and construction costs needed to complete the Birmingport facility. At the time of these negotiations, Covol agreed to a conversion price of $7 per share, the trading price of Covol's stock at the time the deal was initially negotiated. The actual documents completing this agreement were not finalized until March 20, 1997, at which time the bid price of the common stock of Covol was approximately $9 per share. Notwithstanding the fact that at the time Covol initially negotiated the conversion price there was no discount, because there was a discount as of the date the documents for the transaction were completed and signed, Covol was required to reflect as interest expense the deemed discounted value, the difference at the date of issue of the convertible debt security between the conversion price and the fair market value of the common stock into which the security is convertible, multiplied by the number of shares into which the security is convertible. The expense did not require an actual cash payment nor did it impact the net equity of Covol. This accounting treatment is consistent with guidance issued by the Securities and Exchange Commission and with guidance issued as of March 13, 1997 by the Emerging Issues Task Force of the AICPA (Statement EITF D-60: Accounting for the Issuance of Convertible Preferred Stock and Debt Securities with a Nondetachable Conversion Feature). Loss from Continuing Operations. For 1997, Covol had a net decrease of $1,960,000 in loss from continuing operations. The decrease is principally due to: reductions in research and development costs and selling, general and administrative costs; reductions in expenses for compensation expense from stock options, stock warrants and issuance of common stock; and reduction in the write-down of notes receivable. These reductions 29 were partially offset by: increases in costs for briquetting operations, including losses attributable to the Utah Synfuel #1 facility and penalties for failure to proceed with construction contracts; loss from the sale of the Utah Synfuel #1 facility, and interest expense booked on the PacifiCorp convertible debt. Covol did not recognize any income tax benefit in 1997 or 1996 related to net operating loss carryforwards since the realization of the deferred tax assets depends on generation of future taxable income. Discontinued Operations For 1996, Covol incurred losses from discontinued operations in the total amount of $881,000. No additional losses were recorded from discontinued operations in subsequent years. Liquidity and Capital Resources Liquidity. During 1998, Covol and its licensees completed the construction of and began operations at 24 synthetic fuel facilities. Covol currently owns four facilities which it constructed that are either under option to purchase or are being offered for sale. Covol anticipates sale of these facilities during the year ending September 30, 1999. The majority of the funds received from sale of these facilities will be used to retire debt that was incurred principally in connection with the construction and operation of these facilities and activities relative to the completion of the other synthetic fuel facilities. Net cash used in operating activities increased by $840,000 to $5,042,000 during 1998 from $4,202,000 during 1997. Covol was able to fund its operating activities, including the continued refinement and commercialization of it patented briquetting technology, through the incurrence of debt and the issuance of convertible preferred stock, common stock and related common stock warrants. Capital Resources. During 1998, Covol used net cash in its investing activities totaling $38,388,000 compared to $7,181,000 for 1997. These uses consisted principally of purchases of property, plant and equipment, a major portion of which related to the four facilities currently held for sale. During 1998, proceeds from the issuance of notes payable and convertible debentures totaled $35,454,000 and issuance of common stock totaled $3,257,000. Covol believes that funds required for investing activities will be significantly less during 1999 because the construction of facilities that produce synthetic fuel that qualifies for federal income tax credits under Section 29 of the IRC were completed during 1998. Covol anticipates that earned license fees or royalties from the production and sale of synthetic fuel will continue to increase during 1999. Covol believes that most of the synthetic fuel facilities will reach production levels approaching capacity by the end of 1999. As production levels increase, sales of the binder materials by Covol to its licensees are expected to increase proportionately. Covol also anticipates receiving the final amounts of advance license fees totaling approximately $4,000,000 during 1999. While funds received by Covol from these activities are not expected to be sufficient to cover Covol's operating costs and expenses until the third quarter of 1999, Covol does expect that these operating activities will be producing significant operating cash flow by the end of 1999. To provide funding for Covol's operations and debt repayment requirements during early 1999, Covol will utilize proceeds from the issuance of debt and equity securities and excess proceeds from the sale of facilities. During November 1998, Covol issued common stock and common stock warrants for total proceeds of approximately $3,500,000 and incurred debt totaling $400,000. Covol has received term sheets for the sale of up to $10,000,000 of convertible preferred stock. This financing is expected to close in January 1999. Covol has received correspondence from the lender holding notes payable due March 1999 and June 1999 indicating a willingness to extend the due dates for 90 days if so requested by the Company. If such a request is made, Covol has agreed to issue warrants for the purchase of common stock to the lender as consideration for the extension. Covol believes the funds raised in this financing will be sufficient to fund Covol's operations and debt repayment requirements until its operating activities begin producing positive cash flow. 30 Forward Looking Statements Statements in this Item 7 regarding Covol's expectations as to the financing, development and construction of facilities utilizing Covol's binder technologies, the receipt of licensing and royalty fees, revenues, the receipt of operation and maintenance fees, the receipt of fees for sale of binder materials, and other information presented herein that are not purely historical by nature, constitute forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although Covol believes that its expectations are based on reasonable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results will not differ materially from its expectations. In addition to matters affecting Covol's industry or the coal industry or the economy generally, factors which could cause actual results to differ from expectations set forth in the above-identified forward looking statements include in part, the following: o the ability of licensees to produce and sell synthetic fuel at or near the rated capacity of the synthetic fuel facilities; o ability to obtain needed additional capital on terms acceptable to Covol; o changes in governmental regulation or failure to comply with existing regulation which may result in operational shutdowns of its facilities; and o the availability of tax credits under Section 29 of the tax code. See "ITEM 1. BUSINESS--Forward Looking Statements" for a description of additional factors which could cause actual results to differ from expectations. Year 2000 Issues The year 2000 issue results from computer programs and electronic circuitry that do not differentiate between the year 1900 and year 2000 because they are written using two-digit rather than four-digit dates to define the applicable year. Many computer applications and date-sensitive devices could fail or produce erroneous results when processing data after December 31, 1999. Covol does not have any computer applications that it believes are mission critical to the operation of synthetic fuel facilities that it operates. While Covol has not formally verified Year 2000 compliance with licensees that utilize Covol's technology in their synthetic fuel facilities, it is believed that the computer applications used in the operations of these facilities are not mission critical. Accordingly, it is believed that Year 2000 issues will not be significant to these computer applications and accordingly, upgrading or modifications to these applications to make them Year 2000 compliant will not be significant. During 1998 Covol upgraded its network operating system and believes that system is Year 2000 compliant and that any additional upgrading to that system will not be significant. Covol utilizes computer applications in the finance and accounting departments and in the corporate office that utilize a two-digit date that will need to be upgraded in order to be Year 2000 compliant. Covol has contacted the providers of this software and they have indicated that Year 2000 compliant software will be available in early 1999. Covol believes the cost to purchase this upgraded software and to convert the applicable applications to this new software will be less than $50,000. Covol anticipates that this conversion will be completed by June 30, 1999. The costs incurred during 1998 to upgrade the network operating systems was approximately $25,000 and is included in selling, general and administrative expenses. 31 Impact of Inflation During 1998, cost increases to Covol were not materially impacted by inflation. Other Items Covol has reviewed all recently issued, but not yet adopted, accounting standards in order to determine their effects, if any, on the results of operations or financial position of Covol. Based on that review, Covol believes that none of these pronouncements will have any significant effects on current or future financial position or results of operations. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK None. 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 There are no changes in or disagreements with Accountants on accounting or financial statement disclosure. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information to be set forth under the caption "Item 1: Election of Directors" in Covol's Proxy Statement dated on or about January 25, 1999, for the Annual Meeting of Shareholders to be held on or about March 18, 1999 (the "Proxy Statement"), and the information to be set forth under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement are incorporated herein by reference. The information set forth under "Executive Officers of Covol" in Part I hereof is also incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information to be set forth under the caption "Executive Compensation" in the Proxy Statement is incorporated herein by reference; provided, however, that Covol specifically excludes from such incorporation by reference any information set forth under the captions "Compensation Committee Report on Executive Compensation" and "Stock Price Performance Graph" in the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Security ownership of certain beneficial owners and management to be set forth under the caption "Security Ownership of Directors, Nominees and Principal Stockholders" in the Proxy Statement is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information to be set forth under the caption "Transaction with Related Parties" in the Proxy Statement is incorporated herein by reference. 32 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) 1. Financial Statements Consolidated Financial Statements of Covol Technologies, Inc. Report of Independent Accountants...................................... F-1 Consolidated Balance Sheets as of September 30, 1998 and 1997.......... F-2 Consolidated Statements of Operations for the years ended September 30, 1998, 1997 and 1996......... F-4 Consolidated Statements of Changes in Stockholders' Equity for the years ended September 30, 1998, 1997 and 1996......... F-5 Consolidated Statements of Cash Flows for the years ended September 30, 1998, 1997 and 1996......... F-9 Notes to Consolidated Financial Statements............................. F-11 2. Financial Statement Schedules All financial statement 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. 3. Listing of Exhibits 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 Covol and its subsidiaries on a consolidated basis and Covol agrees to furnish a copy of any such instrument to the Commission upon request. There is included a Restated Financial Data Schedule for the years ended September 30, 1997 and 1996. 33 Exhibit No. Description Location 2.1 Agreement and Plan of Reorganization, dated July 1, (1) 1993 between Covol and the Stockholders of R1001 2.2 Agreement and Plan of Merger dated August 14, 1995 between Covol and Covol (1) Technologies, Inc., a Delaware corporation 2.3 Stock Purchase Agreement, dated July 1, 1993, (1) among Covol, 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. 2.4 Stock Sale Transaction Documentation, effective (1) as of September 30, 1994, between Covol and Farrell F. Larson regarding Larson Limestone Company, Inc. 2.5 Stock Purchase Agreement dated February 1, 1996 (1) by and among Covol, Michael McEwan and Gerald Larson regarding the sale of State, Inc., Industrial Engineering & Management, Inc., Central Industrial Construction, Inc., and Larson Limestone Company, Inc. 2.5.1 Amendment to Share Purchase Agreement regarding (1) the sale of the Construction Companies 2.5.2 Amendment No. 2 to Share Purchase Agreement (2) regarding the sale of the Construction Companies 3.1 Certificate of Incorporation of Covol (1) 3.1.1 Certificate of Amendment of the Certificate of (1) Incorporation of Covol dated January 22, 1996 3.1.2 Certificate of Amendment of the Certificate of (6) Incorporation dated June 25, 1997 3.1.3 Certificate of Designation, Number, Voting Powers, (7) Preferences and Rights of Covol's Series A 6% Convertible Preferred Stock (Originally designated as Exhibit No. 3.1.2) 3.1.4 Certificate of Designation, Number, Voting Powers, (8) Preferences and Rights of Covol's Series B Convertible Preferred Stock (Originally designated as Exhibit No. 3.1.3) 3.2 By-Laws of Covol (1) 3.2.1 Certificate of Amendment to Bylaws of Covol dated January 31, 1996 (1) 3.2.2 Certificate of Amendment to the Bylaws dated May (6) 20, 1997 (Originally designated as Exhibit No. 3.2.1) 3.2.3 Certificate of Amendment to the Bylaws dated June 25, (6) 1997 (Originally designated as Exhibit No. 3.2.2) 4.1 Promissory Note between Covol and Mountaineer (12) Synfuel, L.L.C. dated May 5, 1998 (filed as Exhibit 10.52.2 hereto) 34 Exhibit No. Description Location 4.2 Promissory Note dated December 8, 1998 of Covol to * Mountaineer Synfuel, L.L.C.(filed as Exhibit 10.52.4 hereto) 4.3 Security Agreement dated December 8, 1998 between * Mountaineer Synfuel, L.L.C. and Covol (filed as Exhibit 10.52.5 hereto) 9.1 Special Powers of Attorney Coupled With an Interest (1) dated February 1, 1996 between Covol, Gerald Larson and Michael McEwan 10.1 License Agreement, dated June 30, 1995, between (1) Covol and Greystone Environmental Technologies, relating to the Greystone Joint Venture 10.1.1 First Amendment dated January 3, 1996 to the (1) License Agreement dated June 30, 1995 between Covol and Greystone Environment Technologies 10.2 Briquetting Services Agreement, dated May 5, 1995, (1) between Geneva Steel Company and Covol 10.2.1 Amended and Restated Briquetting Service (3) Agreement, dated May 14, 1996, between Covol and Geneva Steel Company 10.3 Lease Agreement, dated May 5, 1995 between (1) Geneva Steel Company, as landlord, and Covol, as tenant 10.3.1 First Amendment to Lease Agreement, dated May (3) 14, 1996 between Geneva Steel Company, as landlord, and Covol, as tenant 10.4 Master Equipment Lease Agreement, dated May (1) 4, 1995, between Keycorp Leasing Ltd. and Covol 10.5 1995 Stock Option Plan (1) 10.5.1 First Amendment to the 1995 Stock Option Plan (1) 10.6 Employment Agreement, dated January 1, 1992, with (1) Kenneth M. Young 10.7 Employment Agreement, dated July 1, 1992, with (1) Russell Madsen 10.8 Lease Agreement, dated May 31, 1994, between (1) Covol and Byrleen Hanson regarding Carbon County, Utah 10.9 Standard Form of Agreement between Owner and (1) Design Builder dated December 28, 1995 between Covol and Lockwood Greene Engineers, Inc. 10.9.1 Notice to Proceed from Covol to Lockwood Greene (1) Engineers, Inc. dated January 14, 1996 10.9.2 Letter Agreement with Lockwood Greene Engineers, (1) Inc. to extend notice dates. 10.9.3 Letter dated July 26, 1996 from Lockwood Greene (3) Engineers, Inc. and the Memorandum of Understanding between Covol Technology, Inc. and Lockwood Greene Engineers, Inc. dated August 28, 1996 35 Exhibit No. Description Location 10.9.4 Amendment to Standard Form of Agreement between (3) Owner and Design/Builder dated December 28, 1995, dated September 16, 1996, between Covol and Lockwood Greene Engineers, Inc. 10.10 Engagement Letter dated December 18, 1995 by and (1) between Covol and Smith Barney 10.10.1 Termination Letter, dated July 8, 1996, from (3) Smith Barney 10.11 Letter of Understanding dated January 30, 1996 (1) between Covol and CoBon Energy, LLC 10.11.1 Modification of Letter of Understanding dated (3) August 20, 1996 between Covol and CoBon Energy, LLC 10.11.2 License Agreement dated September 10, 1996, between (3) Covol and CoBon Energy, LLC 10.11.3** Project Development Agreement, dated December 30, (9) 1996, between Covol and CoBon Energy LLC 10.11.4** Modification of Project Development Agreement, (9) dated December 31, 1996, between Covol and CoBon Energy, LLC 10.12 [Intentionally Omitted] 10.13 Promissory Note dated February 15, 1996 in favor (1) of Covol from Michael McEwan and Gerald Larson 10.14 [Intentionally Omitted] 10.15 Agreement between Alabama Power Company and (3) Covol for the Sale and Purchase of Coal, dated April 16, 1996, between Covol and the Alabama Power Company 10.16 Employment Agreement, dated June 1, 1996 with (3) Brent M. Cook 10.16.1 Stock Option Agreement dated June 1, 1996 with (3) Brent M. Cook 10.18 Letter dated July 19, 1996 from Covol canceling (3) the Site Identification Agreement 10.19 Term Sheet, dated August 22, 1996, from Covol (3) common stock to Byrleen Hanson regarding purchase of Price, Utah office building 10.20 Primary Agreement, dated November 6, 1996, between (3) Covol and Savage Industries Inc. 10.20.1 Mojave Agreement, dated November 6, 1996, between (3) Covol and Savage Industries Inc. 10.21 Release to all claims, dated September 13, 1996, (3) executed by Maynard Moe 36 Exhibit No. Description Location 10.22 Letter of Understanding, dated September 13, 1996, (3) between Covol and E.J. Hodder & Associates, Inc. regarding the sale of the Port Hodder facility to Covol 10.23 Sublease, dated September 9, 1996, between Covol (3) and Parker Towing Company, Inc. regarding the lease of approximately 16 acres located in Tuscaloosa County, Alabama 10.24 Supply Agreement, dated September 11, 1996, (3) among Covol, K-Lee Processing, Inc. and Concord Coal Recovery Limited Partnership 10.25 PacifiCorp Financial Services, Inc. Letter of (3) Intent (Covol Technologies) dated September 12, 1996 10.26 Exclusive Financial Advisor Agreement, dated (3) September 16, 1996, between Covol and Coalco Corporation 10.27 Settlement Agreement, dated September 17, 1996, (3) among Covol, 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. 10.28 Debenture Agreement and Security Agreement, dated (3) December 20, 1996, between AJG Financial Services, Inc. and Covol 10.29 Arthur J. Gallagher & Co. Letter of Intent, dated (3) November 13, 1996 10.30 Lease Agreement, dated December 12, 1996, between (3) Covol and UPC, Inc. regarding Price City, Utah property 10.31 1996 Standard Form of Agreement between Owner and (3) Design/Contractor 10.32 Form of Limited Partnership Agreements for Alabama (3) Synfuel #1, Ltd. ("AS #1") and Utah Synfuel #1, Ltd. ("US #1") 10.33 Utah Project Purchase Agreement, dated as of (4) March 7, 1997, by and among Covol, US #1, a Delaware limited partnership, and Coaltech No. 1, L.P., a Delaware limited partnership ("Coaltech") 10.34 License and Binder Purchase Agreement, dated as of (4) March 7, 1997, by and among Covol, US #1 and Coaltech 10.35 Operation and Maintenance Agreement, dated as of (4) March 7, 1997, by and between Covol and Coaltech 10.36 Purchase and Supply Agreement, dated as of March (4) 7, 1997, by and among Covol, US #1 and Coaltech 10.37 Abandonment Option Agreement, dated as of March 7, (4) 1997, by and among Covol and the limited partners of Coaltech 10.38 Convertible Loan and Security Agreement, dated as (5) of March 20, 1997, by and between Covol and PacifiCorp Financial Services, Inc. ("PacifiCorp") 37 Exhibit No. Description Location 10.38.1 Amendment to Convertible Loan and Security (9) Agreement, dated December 12, 1997 by and between Covol and PacifiCorp 10.39 Alabama Project Purchase Agreement ("Alabama (5) Agreement") dated as of March 20, 1997, by and among Covol, AS #1 and Birmingham Syn Fuel, L.L.C. 10.39.1 Letter Amendment, dated June 27, 1997, to (9) Alabama Agreement. 10.39.2 ** Letter Amendment, dated July 7, 1997, to (9) Alabama Agreement. 10.39.3 Letter Amendment, dated August 28, 1997, to (9) Alabama Agreement. 10.39.4 Letter Amendment, dated December 12, 1997, to (9) Alabama Agreement. 10.39.5 ** Amended and Restated License Agreement, and Binder (9) Purchase dated December 12, 1997, by and among Covol, AS #1 and Birmingham Syn Fuel. 10.39.6** Letter Amendment dated February 20, 1998, to the (10) Alabama Project Purchase Agreement dated as of March 20, 1997, by and among Covol, AS #1, and Birmingham Syn Fuel. 10.39.7 Call Option Agreement date February 20, 1998, (10) between Birmingham Syn Fuel and Covol. 10.39.8** Letter Amendment dated February 20, 1998, to the (10) Amended and Restated License and Binder Purchase Agreement dated as of December 12, 1997, by and among Covol. AS #1 and Birmingham Syn Fuel. 10.39.9** Non-negotiable Promissory Note dated February 20, (10) 1998, in favor of AS #1, executed by Birmingham Syn Fuel as debtor. 10.39.10 Security Agreement dated February 20, 1998, by and (10) among Covol, AS #1 and Birmingham Syn Fuel. 10.40 Conditional Option Agreement, dated as of March 20, (5) 1997, by and among Birmingham Syn Fuel I, Inc., Birmingham Syn Fuel II, Inc., PacifiCorp, AS #1 and Covol 10.41 Registration Rights Agreement, dated as of March 20, (5) 1997, by and between Covol and PacifiCorp 10.42** Amended and Restated Agreement Concerning (9) Additional Facilities, dated December 12, 1997, by and between PacifiCorp., Birmingham Syn Fuel, LLC and Covol 10.43 Lease Agreement between Industrial Management (9) Engineering, Inc. and Covol 10.44 Employment Agreement, dated January 1, 1997 (9) with Stanley M. Kimball 10.45** License and Binder Purchase Agreement, dated (9) December 14, 1997, between Appalachian Synfuel, LLC and Covol 38 Exhibit No. Description Location 10.46** Financing Agreement, dated November 14, 1997, (9) between Covol and CoBon Energy, L.L.C. 10.47** License Agreement, dated as of August 5, 1997, (9) by and between Pelletco Corporation and Covol 10.48** Preparation Plant and Find Ponds Lease (9) (Wellington, Utah), dated February 21, 1997, between Earthco and Covol 10.49** Agreement Concerning Additional Facilities, (9) dated December 27, 1996, between AJG Financial Services, Inc. and Covol 10.50** Form of Agreement for Technology Licensing of (9) Facilitation, dated December 31, 1996, between PC West Virginia Synthetic Fuel #1, LLC and Covol 10.50.1** Form of Amended and Restated License and Binder (11) Purchase Agreement dated February 3, 1998, between PC Virginia Synthetic Fuel #1, PC West Virginia synthetic Fuel #2, PC West Virginia Synthetic Fuel #3 and Covol. 10.50.2** Loan Agreement between C.C. Pace Capital, L.L.C. and (11) Carbon Resources, Inc. and Covol dated April 21, 1998. 10.50.3 Security Agreement between C.C. Pace Capital, L.L.C. (11) and Carbon Resources, Inc. and Covol dated April 21, 1998. 10.51 Employment Agreement, dated March 20, 1997 with (9) Max E. Sorenson 10.52** Technology License and Binder Purchase Agreement (12) between Mountaineer Synfuel, L.L.C., Licensee, and Covol, Licensor 10.52.1 Asset Purchase Agreement between Mountaineer Synfuel, (12) L.L.C. as Purchase and Covol as Seller dated May 5, 1998 10.52.2 Promissory Note between Covol and Mountaineer (12) Synfuel, L.L.C. dated May 5, 1998 10.52.3 Deed of Ground Lease between Upshur Property, (12) Inc. and Covol dated May 5, 1998 10.52.4 Promissory Note dated December 8, 1998 of Covol * Technologies, Inc. to Mountaineer Synfuel, L.L.C. 10.52.5 Security Agreement dated December 8, 1998 between * Mountaineer Synfuel, L.L.C. and Covol Technologies, Inc. 10.52.6 Leasehold Credit Line Deed of Trust and Security * Agreement dated December 8, 1998 by Covol Technologies, Inc. for Mountaineer Synfuel, L.L.C. as Beneficiary. 10.52.7 Amendment No. 1 to Deed of Ground Lease dated * December 8, 1998 between Upshur Property, Inc. and Covol Technologies, Inc. 10.53.1 Debenture Agreement and Security Agreement * dated as of January 9, 1998, between Covol and AJG Financial Services, Inc. 39 Exhibit No. Description Location 10.53.2 Debenture dated as of January 9, 1998 between * Covol and AJG Financial Services, Inc. 10.53.3 Warrant A dated as of January 9, 1998, issued by * Covol in favor of AJG Financial Services, Inc. 10.53.4 Warrant B dated as of January 9, 1998, issued by * Covol in favor of AJG Financial Services, Inc. 10.53.5 Registration Rights Agreement dated as of January * 9, 1998, between Covol and AJG Financial Services, Inc. 10.54 Employment Agreement effective May 1, 1998 with * Steven G. Stewart 10.55 Employment Agreement effective August 1, 1997 * with Dee J. Priano 16.1 Letter to Securities and Exchange Commission, (1) dated March 24, 1995, from Jones, Jensen & Orton & Company, certified public accountants 21.1 List of Subsidiaries of Covol * 23.1 Consent of PricewaterhouseCoopers LLP * 27.1 Financial Data Schedule for the fiscal year ended September 30, 1998 * 27.2 Restated Financial Data Schedule for the fiscal * years ended September 30, 1997 and 1996 - ------------------------ * Filed herewith. ** Confidential treatment has been granted to certain portions of this exhibit, which portions have been deleted and filed separately with the Securities and Exchange Commission. Unless another exhibit number is indicated as the exhibit number for the exhibit as "originally filed," the exhibit number in the filing in which any exhibit was originally filed and to which reference is made hereby is the same as the exhibit number assigned herein to the exhibit. (1) Incorporated by reference to the indicated exhibit filed with Covol's Registration Statement on Form 10, filed February 26, 1996. (2) Incorporated by reference to the indicated exhibit filed with Covol's Registration Statement on Form 10/A, Amendment No. 2, dated April 24, 1996. (3) Incorporated by reference to the indicated exhibit filed with Covol's Annual Report on Form 10-K for the fiscal year ended September 30, 1996. (4) Incorporated by reference to the indicated exhibit filed with Covol's Current Report on Form 8-K, dated March 10, 1997. (5) Incorporated by reference to the indicated exhibit filed with Covol's Quarterly Report on Form 10-Q, for the quarterly period ended March 31, 1997. (6) Incorporated by reference to the indicated exhibit filed with Covol's Quarterly Report on Form 10-Q, for the quarterly period ended June 30, 1997. 40 (7) Incorporated by reference to the indicated exhibit filed with Covol's Current Report on Form 8-K, dated August 19, 1997. (8) Incorporated by reference to the indicated exhibit filed with Covol's Current Report on Form 8-K, for event dated September 18, 1997, filed October 28, 1997. (9) Incorporated by reference to the indicated exhibit filed with Covol's Annual Report on Form 10-K for the fiscal year ended September 30, 1997. (10) Incorporated by reference to the indicated exhibit filed with Covol's Current Report on Form 8-K, for event dated March 3, 1998, filed March 23, 1998. (11) Incorporated by reference to the indicated exhibit filed with Covol's Quarterly Report on Form 10-Q, for the quarterly period ended March 31, 1998. (12) Incorporated by reference to the indicated exhibit filed with Covol's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998. Reports on Form 8-K No reports on Form 8-K were filed during the quarter ended September 30, 1998. Exhibits The response to this portion of Item 14 is submitted as a separate section of this report. See Item 14 (a) (3) above. Financial Statement Schedules The response to this portion of Item 14 is submitted as a separate section of this report. See Item 14 (a) (2) above. 41 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/ Steven G. Stewart Steven G. Stewart, Principal Financial Officer Date: January 13, 1999 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. SIGNATURE TITLE DATE /s/ Brent M. Cook Chief Executive Officer January 13, 1999 - ----------------------- Principal Executive Officer) and Brent M. Cook Director /s/ Steven G. Stewart Chief Financial Officer (principal January 13, 1999 - ----------------------- Financial and Accounting Steven G. Stewart Officer) /s/ Stanley M. Kimball President and Director January 13, 1999 - ------------------------- Stanley M. Kimball /s/ DeLance W. Squire Director January 13, 1999 - ------------------------- DeLance W. Squire /s/ James A. Herickhoff Director January 13, 1999 - ------------------------- James A. Herickhoff /s/ Raymond J. Weller Director January 13, 1999 - ------------------------- Raymond J. Weller /s/ John P. Hill, Jr. Director January 13, 1999 - ------------------------- John P. Hill, Jr. 42 Report of Independent Accountants To the Board of Directors Covol Technologies, Inc. and Subsidiaries In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, stockholders' equity, and cash flows present fairly, in all material respects, the consolidated financial position of Covol Technologies, Inc. and Subsidiaries (the "Company") as of September 30, 1998 and 1997, and the consolidated results of their operations and their cash flows for the years ended September 30, 1998, 1997 and 1996, in conformity with generally accepted accounting principles. 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 of these statements in accordance with generally accepted auditing standards, which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PRICEWATERHOUSECOOPERS LLP Salt Lake City, Utah December 22, 1998 F-1
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS As of September 30, (thousands of dollars) 1998 1997 - ----------------------------------------------------------------------------------- -------------- ---------------- ASSETS Current assets: Cash and cash equivalents $ 727 $4,780 Receivables 2,879 13 Receivable - stock subscriptions --- 577 Due from related party 1,012 509 Inventories 1,645 1,819 Advances on inventories 2,522 1,087 Notes receivable - related parties, current 229 276 Facilities held for sale 28,405 8,155 Prepaid expenses and other current assets 682 52 -------------- ---------------- Total current assets 38,101 17,268 -------------- ---------------- Property, plant and equipment, net of accumulated depreciation 14,902 5,464 -------------- ---------------- Other assets: Restricted investments 748 --- Note and accrued interest receivable, non-current 6,986 --- Notes receivable - related parties, non-current 2,869 3,817 Investment in licensee facility 1,000 --- Intangible assets 3,118 --- Deposits and other assets 185 321 -------------- ---------------- Total other assets 14,906 4,138 -------------- ---------------- Total assets $67,909 $26,870 ============== ================
continued The accompanying notes are an integral part of the consolidated financial statements F-2
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS, continued As of September 30, (thousands of dollars and shares) 1998 1997 - ------------------------------------------------------------------------------------ -------------- ---------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $3,036 $3,013 Due to related party 1,609 1,548 Accrued liabilities 2,858 2,500 Notes payable and convertible debentures, current 22,049 5,247 -------------- ---------------- Total current liabilities 29,552 12,308 -------------- ---------------- Long-term liabilities: Notes payable and convertible debentures, non-current 13,930 2,900 Notes payable - related parties, non-current 147 489 Accrued interest payable, non-current 566 204 Deferred revenues from advance license fees 1,400 1,650 Deferred compensation 236 224 -------------- ---------------- Total long-term liabilities 16,279 5,467 -------------- ---------------- Total liabilities 45,831 17,775 -------------- ---------------- Minority interest in consolidated subsidiaries 507 3,166 -------------- ---------------- Commitments and contingencies Stockholders' equity: Convertible preferred stock, $0.001 par value; authorized 10,000 shares, issued and outstanding 316 shares at September 30, 1998 and 303 shares at September 30, 1997 (aggregate liquidation preference of $5,465 at September 30, 1998) 1 1 Common stock, $0.001 par value; authorized 25,000 shares, issued and outstanding 11,272 shares at September 30, 1998 and 8,627 shares at September 30, 1997 11 9 Common stock to be issued, 0 shares at September 30, 1998 and 462 shares at September 30, 1997 --- 1 Capital in excess of par value - preferred 5,184 5,094 Capital in excess of par value - common 64,100 41,818 Capital in excess of par value - common stock to be issued --- 3,291 Accumulated deficit (36,177) (32,191) Notes and interest receivable -- related parties, from issuance of, or collateralized by, common stock, net of allowance (7,773) (7,411) Deferred compensation from stock options (3,775) (4,683) -------------- ---------------- Total stockholders' equity 21,571 5,929 -------------- ---------------- Total liabilities and stockholders' equity $67,909 $26,870 ============== ================
The accompanying notes are an integral part of the consolidated financial statements F-3
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Year ended September 30, (thousands of dollars and shares, except per-share data) 1998 1997 1996 - --------------------------------------------------------------------- ----------------- ------------------ ------------------ Revenues: License fees $7,942 $ --- $ 100 Binder and coal fine sales - related party 2,543 209 --- Binder sales 994 --- --- Binder plant sales 1,088 --- --- Synthetic fuel sales, net 32 42 195 Other 100 --- --- ----------------- ------------------ ------------------ Total revenues 12,699 251 295 ----------------- ------------------ ------------------ Operating costs and expenses: Cost of coal briquetting operations 9,295 4,803 860 Selling, general and administrative 4,436 2,998 3,796 Research and development 422 664 1,044 Compensation expense on stock options, stock warrants and issuance of common stock 939 2,058 4,873 Loss on sale of facility 218 582 --- ----------------- ------------------ ------------------ Total operating costs and expenses 15,310 11,105 10,573 ----------------- ------------------ ------------------ Operating loss (2,611) (10,854) (10,278) ----------------- ------------------ ------------------ Other income (expense): Interest income 899 286 302 Interest expense (2,745) (1,645) (94) Minority interest in net losses of consolidated subsidiaries 392 1,245 4 Write-up (write-down) of notes receivable - related parties, collateralized by common stock 19 (60) (2,700) Other 60 33 (166) ----------------- ------------------ ------------------ Total other income (expense) (1,375) (141) (2,654) ----------------- ------------------ ------------------ Loss from continuing operations before income taxes (3,986) (10,995) (12,932) Income tax provision --- --- (23) ----------------- ------------------ ------------------ Loss from continuing operations (3,986) (10,995) (12,955) ----------------- ------------------ ------------------ Discontinued operations (Note 15): Loss from discontinued operations --- --- (590) Loss on disposal of discontinued operations --- --- (291) ----------------- ------------------ ------------------ Loss from discontinued operations --- --- (881) ================= ================== ================== Net loss $(3,986) $(10,995) $(13,836) ================= ================== ================== Basic and diluted net loss per common share: Loss per share from continuing operations $(.43) $(1.38) $(1.86) Loss per share from discontinued operations --- --- (.13) ----------------- ------------------ ------------------ Basic and diluted net loss per common share $(.43) $(1.38) $(1.99) ================= ================== ==================
The accompanying notes are an integral part of the consolidated financial statements F-4
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Notes and interest receivable -related parties, from issuance Convertible Preferred Stock Common Stock Common Stock to be Issued of, or Deferred ---------------------------- ------------------------ ------------------------- collater- compen- Capital in Capital in Capital in Accum- alized sation (thousands of excess of excess of excess of lated by, common from stock dollars and shares) Shares Amount par value Shares Amount par value Shares Amount par value deficit stock options - ------------------- ------- ------ --------- ------ ------ --------- ------ ------ --------- ------- --------- --------- Balances at October 1, 1995 --- $--- $--- 5,260 $6 $9,617 119 $1 $582 $(7,360) $(240) $(1,422) Common stock issued for services 114 --- 769 (50) --- (322) Common stock issued for notes receivable from related parties, including exercise of stock options 1,010 1 6,283 (6,284) Common stock issued for cash, including exercise of stock options and warrants 1,226 1 7,479 (69) --- (260) Common stock to be issued for cash received 44 --- 350 Common stock to be issued for property acquired 60 --- 585 Payment on notes receivable - - related 171 parties Issuance of notes receivable - related parties, collateralized by common stock (net of $2,700 write-down and $650 imputed (1,650) interest) Services received in lieu of payments on notes receivable - - related parties 688 Compensation expense related to the issuance of stock options at below market value 3,863 value Deferred compensation related to the issuance of stock options at below market value to officers, directors, employees and consultants, net of cancellations 4,668 (4,668)
The accompanying notes are an integral part of the consolidated financial statements F-5
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY, continued Notes and interest receivable -related parties, from issuance Convertible Preferred Stock Common Stock Common Stock to be Issued of, or Deferred ---------------------------- ------------------------ ------------------------- collater- compen- Capital in Capital in Capital in Accum- alized sation (thousands of excess of excess of excess of lated by, common from stock dollars and shares) Shares Amount par value Shares Amount par value Shares Amount par value deficit stock options - ------------------- ------- ------ --------- ------ ------ --------- ------ ------ --------- ------- --------- --------- Amortization of deferred compensation from stock options 910 Interest earned on notes receivable - - related parties (265) Compensation expense related to the issuance of stock for services at below market value 101 Net loss for the year ended September 30, 1996 (13,836) - ------------------- ------- ------ --------- ------ ------ --------- ------ ------ --------- ------- --------- --------- Balances at September 30, 1996 --- --- --- 7,610 8 32,780 104 1 935 (21,196) (7,580) (5,180) - ------------------- ------- ------ --------- ------ ------ --------- ------ ------ --------- ------- --------- --------- Common stock issued for cash received in the prior period 104 --- 935 (104) (1) (935) Common stock issued for cash, including exercise of stock options and warrants 603 1 2,773 Deferred compensation related to the issuance of stock options at below market value to officers, directors and employees 1,178 (1,178) Common stock issued for services 98 --- 789 Inducement related to conversion of notes payable into common stock 323 Common stock issued to repay note payable - - related parties 21 --- 136
The accompanying notes are an integral part of the consolidated financial statements F-6
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY, continued Notes and interest receivable -related parties, from issuance Convertible Preferred Stock Common Stock Common Stock to be Issued of, or Deferred ---------------------------- ------------------------ ------------------------- collater- compen- Capital in Capital in Capital in Accum- alized sation (thousands of excess of excess of excess of lated by, common from stock dollars and shares) Shares Amount par value Shares Amount par value Shares Amount par value deficit stock options - ------------------- ------- ------ --------- ------ ------ --------- ------ ------ --------- ------- --------- --------- Common stock issued on conversion of note 141 --- 1,125 payable Common stock issued under a subscription 50 --- 350 agreement for cash received in October 1997 Common stock to be issued for cash received in the current period, including exercise 400 1 2,798 Common stock to be issued for distribution 30 -- 266 rights Common stock to be issued under subscription agreements for cash received 32 --- 227 in October 1997 Amortization of deferred compensation from 1,675 stock options Interest expense related to issuance of convertible debt at a discount 1,429 Payment on notes receivable - related 109 parties Write-down of notes receivable - related 60 parties Preferred stock issued for cash, net of offering costs 303 1 5,094 Net loss for the year ended September 30, 1997 (10,995) - ------------------- ------- ------ --------- ------ ------ --------- ------ ------ --------- ------- --------- --------- Balances at September 30, 1997 303 1 5,094 8,627 9 41,818 462 1 3,291 (32,191) (7,411) (4,683) - ------------------- ------- ------ --------- ------ ------ --------- ------ ------ --------- ------- --------- --------- Common stock issued for cash received in the previous period 462 -- 3,291 (462) (1) (3,291) Common stock issued to purchase minority interests in subsidiaries 540 1 5,383
The accompanying notes are an integral part of the consolidated financial statements F-7
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY, continued Notes and interest receivable -related parties, from issuance Convertible Preferred Stock Common Stock Common Stock to be Issued of, or Deferred ---------------------------- ------------------------ ------------------------- collater- compen- Capital in Capital in Capital in Accum- alized sation (thousands of excess of excess of excess of lated by, common from stock dollars and shares) Shares Amount par value Shares Amount par value Shares Amount par value deficit stock options - ------------------- ------- ------ --------- ------ ------ --------- ------ ------ --------- ------- --------- --------- Common stock issued for cash, including exercise of stock options 533 --- 3,257 Preferred stock issued for cash, net of offering costs 13 --- 90 Common stock issued on conversion of notes payable and accrued interest to common stock 1,107 1 8,178 Interest expense related to issuance of convertible debt at a discount 2,046 Payment received on notes receivable -- 329 related parties Amortization of deferred compensation from stock options 908 Write-up of notes receivable - -- related (19) parties Compensation expense related to issuance of stock options for services 3 -- 127 Reclassification of notes receivable - - related parties (672) Net loss for the year ended September 30, 1998 (3,986) ------- ------ --------- ------ ------ --------- ------ ------ --------- ------- --------- --------- Balances at September 30, 1998 316 $1 $5,184 11,272 $11 $64,100 0 $0 $0 $(36,177) (7,773) $(3,775) ======= ====== ======== ====== ===== ======== ====== ===== ======== ======== ======= ==========
The accompanying notes are an integral part of the consolidated financial statements F-8
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Year ended September 30, (thousands of dollars) 1998 1997 1996 - ---------------------------------------------------------------------------------------------- ----------- ------------ ------------ Cash flows from operating activities: Net loss $(3,986) $(10,995) $(13,836) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 607 193 187 Losses applicable to minority interests in subsidiaries (392) (1,245) (4) Loss on disposal of discontinued operations --- --- 291 Deferred income taxes --- --- 23 Loss on sale of facility 218 582 --- Interest expense related to issuance of convertible debt at a discount 2,046 1,429 --- Amortization of deferred compensation and compensation expense on stock options 908 1,675 4,773 Common stock issued or to be issued for services and distribution rights, and compensation expense related to stock options 127 1,055 547 Write-down (write-up) of notes receivable - related parties (19) 60 2,700 Inducement expense related to conversion of notes payable into common stock --- 323 --- Services received in lieu of payments on notes receivable issued for common stock --- --- 687 Interest earned on notes receivable - related parties --- --- (265) Notes payable issued for services --- --- 160 Increase (decrease) from changes in assets and liabilities, net of effects from investing and financing activities: Receivables (2,866) 65 (55) Due from related party (503) (509) --- Inventories 174 (61) (162) Advances on inventories (1,435) (1,087) --- Prepaid expenses and other current assets (630) (7) (32) Accrued interest receivable - non-current (486) --- --- Deposits and other assets 136 (121) 24 Accounts payable 23 (1,138) 1,436 Due to related party 61 1,548 --- Accrued liabilities 851 2,166 47 Accrued interest payable, non-current 362 204 --- Deferred revenues from advance license fees (250) 1,650 --- Deferred compensation 12 11 10 Discontinued operations non-cash charges and working capital changes --- --- 894 ----------- ------------ ------------ Net cash used in operating activities (5,042) (4,202) (2,575) ----------- ------------ ------------ Cash flows from investing activities: Purchase of property, plant and equipment and facilities held for sale (36,963) (7,194) (5,055) Investment in licensee facility (1,000) --- --- Increase in restricted investments (748) --- --- Issuance of notes receivable -- related parties --- --- (704) Proceeds from notes receivable - related parties 323 45 --- Increase in cash surrender value of life insurance --- (32) (13) ----------- ------------ ------------ Net cash used in investing activities (38,388) (7,181) (5,772) ----------- ------------ ------------
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 Year ended September 30, (thousands of dollars) 1998 1997 1996 - -------------------------------------------------------------------------------------------- ----------- ----------- ------------ Cash flows from financing activities: Proceeds from issuance of notes payable and convertible debentures $35,454 $6,070 $ 700 Payment on notes payable (330) (1,109) (159) Proceeds from issuance of notes payable -- related parties --- 595 --- Payment on notes payable -- related parties --- (756) (3,539) Proceeds from receivable -- stock subscriptions 577 --- --- Proceeds from issuance of common stock, net 3,257 5,573 7,570 Proceeds from issuance of preferred stock, net 90 5,095 --- Proceeds from notes receivable -- related parties, from issuance of, or collateralized by common stock 329 109 171 Proceeds from issuance of minority interests in subsidiaries --- 302 4,385 Allocation to minority interest limited partners --- (206) --- Financing activities of discontinued operations --- --- (1,582) ----------- ----------- ------------ Net cash provided by financing activities 39,377 15,673 7,546 ----------- ----------- ------------ Net increase (decrease) in cash and cash equivalents (4,053) 4,290 (801) Cash and cash equivalents, beginning of year 4,780 490 1,291 ----------- ----------- ------------ Cash and cash equivalents, end of year $ 727 $ 4,780 $ 490 =========== =========== ============ Supplemental schedule of non-cash investing and financing activities: Common stock issued on conversion of notes payable and accrued interest $8,179 $ --- $ --- Note receivable issued for sale of facility 6,500 3,500 --- Common stock issued for purchase of minority interests in subsidiaries 5,384 --- --- Note payable issued for inventory --- 1,595 --- Accounts payable for facilities held for sale 588 1,968 --- Common stock issued for notes receivable --- 577 6,284 Common stock issued to repay notes payable and accrued interest -- related party --- 1,261 --- Note payable issued for equipment --- 1,607 --- Distribution to minority limited partners offset against note receivable --- 66 --- Obligations assumed in connection with sale of subsidiaries --- --- 4,636 Note receivable received for subsidiaries (net of imputed interest) --- --- 4,350 Note payable issued and common stock to be issued to acquire land --- --- 927 Note payable issued for services --- --- 160 Supplemental disclosure of cash flow information: Cash paid for interest, net of amounts capitalized: Continuing operations $49 $208 $111 Discontinued operations --- --- 98
The accompanying notes are an integral part of the consolidated financial statements F-10 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS ---------- 1. Summary of Significant Accounting Policies Business Organization and Nature of Operations Covol Technologies, Inc. (the Company) was originally incorporated in Nevada in 1987 and was reincorporated in Delaware in August 1995. In 1991, the Company 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. 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 Company is both the general partner and a limited partner in the Partnerships (see Note 14). The Company's primary business is to commercialize the Briquetting Technology used to recycle waste by-products from the coal and steel industries into a marketable source of fuel and revert materials. Through June 30, 1998, the Company's focus was on the construction of facilities and the licensing of its Briquetting Technology to companies that constructed facilities that convert coal fines into synthetic fuel briquettes. At September 30, 1998, the Company and its licensees were operating 24 of these facilities in eight states at various levels of production. The four Company-owned facilities are expected to be sold in 1999. The Company has no current plans to construct additional synthetic fuel facilities. The Company anticipates that earned license fees or royalties from the production and sale of synthetic fuel will continue to increase during 1999. The Company believes that most of the synthetic fuel facilities will reach production levels approaching capacity by the end of 1999. As production levels increase, sales of the binder materials by the Company to its licensees are expected to increase proportionately. The Company also anticipates receiving the final amounts of advance license fees totaling approximately $4,000,000 during 1999. While funds received by the Company from these activities are not expected to be sufficient to cover the Company's operating costs and expenses until the third quarter of 1999, the Company does expect that these operating activities will be producing significant operating cash flow by the end of 1999. To provide funding for the Company's operations and debt repayment requirements during early 1999, the Company will utilize proceeds from the issuance of debt and equity securities and excess proceeds from the sale of facilities. During November 1998, the Company issued common stock and common stock warrants for total proceeds of approximately $3,500,000 and incurred debt totaling $400,000. The Company has received term sheets for the sale of up to $10,000,000 of convertible preferred stock. This financing is expected to close in January 1999. The Company has received correspondence from the lender holding notes payable due March 1999 and June 1999 indicating a willingness to extend the due dates for 90 days if so requested by the Company. If such a request is made, the Company has agreed to issue warrants for the purchase of common stock to the lender as consideration for the extension. The Company believes the funds raised in this financing will be sufficient to fund the Company's operations and debt repayment requirements until its operating activities begin producing positive cash flow. Construction Businesses In 1993 and 1994, the Company acquired four construction companies. In September 1995, the Company's Board of Directors approved a plan to discontinue the Company's construction businesses, which were sold effective February 1, 1996. (See Note 15, "Discontinued Operations"). Principles of Consolidation The 1996 consolidated financial statements include the accounts of the Company and its 100% owned construction company subsidiaries, until the time of their sale in February 1996. The consolidated financial statements for all years presented 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. F-11 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS, continued ---------- 1. Summary of Significant Accounting Policies, continued Principles of Consolidation, continued During 1997, the Company became a 1% general partner of Coaltech No. 1 L.P. ("Coaltech"), a Delaware limited partnership, for $10. Based upon the Company's lack of effective control over Coaltech and the limited partners' financial responsibility for its operations, the Company's investment in Coaltech is accounted for using the equity method of accounting with proportional elimination of intercompany revenues and expenses. Stock Split 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 this stock split. Revenue and Cost Recognition Revenues from the licensing of the Company's technology are recognized in the period when earned. Advance license fees are earned when certain synthetic fuel facility construction milestones are met or when the facilities are certified operational for their intended use. Advance license fees that require the Company to render services in the future are deferred and recognized when its obligations are met. Earned license fees or royalty payments are recognized in the period synthetic fuel is produced and sold by licensees. $3,336,000 of license fees in 1998 were from a single licensee and $1,500,000 were from a second licensee. Revenues from the sale of coal briquettes are recognized as product is shipped. Collateral is not required for receivables and allowances are provided for uncollectible accounts. 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 financial institutions located in Utah. Restricted Investments Restricted investments consist primarily of highly liquid interest bearing deposits held as collateral for certain Company obligations. Inventories Inventories are stated at the lower of cost or market with cost determined using an average cost method, and consist primarily of coal fines, available for sale. Covol has a lease arrangement that provides for the purchase and removal of coal fines which are used as feedstock for a synthetic fuel facility. Payments made under the lease arrangement prior to removal of the coal fines are recorded as advances on inventories (see Note 2). Facilities Held for Sale Facilities held for sale consist of four synthetic fuel facilities, and are stated at the lower of cost or estimated net realizable value. The facilities were constructed to be sold to licensees of the Company's technology at or slightly above their cost. Two of the four facilities are under option for purchase by the licensees of those facilities, and the Company is actively pursuing the sale of all four facilities. The Company anticipates completing the sale of these facilities in 1999. The Company recognizes a gain or loss on facilities held for sale when the sale is consummated. The gain or loss represents the difference between the carrying value and the sales price and is reflected as a component of operating costs and expenses. F-12 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 is recorded at cost, including interest on funds borrowed during the construction period, and is depreciated using the straight-line method over its estimated useful life. 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. Intangible Assets Intangible assets consist of the excess of the value of the consideration paid for the purchase of certain limited partners' interests in subsidiaries over the fair values of the related assets, which fair values approximated their carrying cost (see Note 14). They are being amortized on the straight-line method over approximately ten years. Valuation of Long-Lived Assets The Company periodically evaluates the carrying value of long-lived assets, including intangible assets, when events and circumstances warrant such a review. The carrying value of a long-lived asset is considered impaired when the anticipated cumulative undiscounted cash flow from that asset is less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair market value of the long-lived asset. No impairment-related losses have been recognized in the Company's financial statements for any period presented. Common Stock Issued for Services Common stock issued for services is accounted for using the fair value of the shares of common stock, determined at the time the shares are issued. Loss per Share Calculation In 1998, the Company adopted Statement of Financial Accounting Standards No. 128 "Earnings per Share" ("SFAS 128"). SFAS 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is similar to the previous fully diluted earnings per share. Loss per share amounts for all periods presented conform to SFAS 128 requirements and no restatements were necessary (see Note 9). For all periods presented, options, warrants and convertible securities (as disclosed in Notes 7 and 13) were not included in the calculation of loss per share because the effect would have been antidilutive. 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, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. F-13 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS, continued ---------- 1. Summary of Significant Accounting Policies, continued Reclassifications Certain prior year amounts have been reclassified to conform with the current year's presentation. These reclassifications had no effect on net loss or total assets. 2. Advances on Inventories During 1997, the Company entered into an agreement to purchase coal fines and made payments totaling approximately $1,146,000, of which $59,000 was transferred to cost of coal briquetting operations. During 1998, additional payments totaling approximately $1,583,000 were made, of which $148,000 was transferred to cost of coal briquetting operations. The net amount paid has been recorded as advances on inventories. The Company expects to utilize the majority of these coal fines during 1999, at which time the costs will be expensed. Under the agreement, the Company is obligated to pay a total of $5,500,000 between February 1997 and May 2000 for the removal of 2 million tons of coal fines (a price of $2.75 per ton) from the property. Quarterly payments of approximately $396,000 are required under the agreement. The agreement also provides for removal of an additional 500,000 tons at $2.75 per ton. No payment is required for removal of any coal fines in excess of 2.5 million tons. 3. Due From/To Related Party Due from related party consists of amounts receivable from Coaltech for operating expenses in 1998 and for operating expenses and interest in 1997. Due to related party represents amounts due to Coaltech for the purchase of synthetic fuel briquettes. 4. Notes Receivable
Notes receivable consist of the following at September 30: (thousands of dollars) 1998 1997 ---------------------------------------------------------------------------------------------- -------------- -------------- Notes and Accrued Interest Receivable, non-current Note receivable from a corporation, bearing interest at 12%, principal and interest due February 2003, collateralized by a synthetic fuel facility in Alabama, which was sold by the Company. $6,500 $--- Accrued interest receivable 486 --- -------------- -------------- Note and interest receivable $6,986 $--- ============== ============== Notes Receivable - Related Parties Note receivable from Coaltech, bearing interest at 9.7%, principal and interest payments of $130 due quarterly through December 2007, collateralized by a synthetic fuel facility in Utah, which was sold by the Company. $3,098 $3,421 Notes receivable from seven officers of the Company, bearing interest at prime (8.5% at September 30, 1997) plus 2%, principal and interest due August 2000, originally collateralized by interests in Utah Synfuel #1 and Alabama Synfuel #1. Reclassified in 1998 as notes receivable - related parties, collateralized by common stock. No interest income was recognized in 1998 or 1997. --- 672 -------------- -------------- 3,098 4,093 Less current portion 229 276 -------------- -------------- Notes receivable - related parties $2,869 $3,817 ============== ==============
F-14
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS, continued ---------- 5. Property, Plant and Equipment Property, plant and equipment consists of the following at September 30: (thousands of dollars) Range of estimated useful 1998 1997 lives --------------------------------------------------------------- ------------------------------- -------------- -------------- Land $ 153 $ --- Buildings and improvements 10 - 20 years 11,154 260 Machinery and equipment 5 - 10 years 4,749 2,102 Construction in progress --- 3,698 -------------- -------------- 16,056 6,060 Less accumulated depreciation 1,154 596 ============== ============== Net property, plant and equipment $14,902 $5,464 ============== ==============
Depreciation expense was $557,000 in 1998, $193,000 in 1997 and $187,000 in 1996. 6. Investment in Licensee Facility Investment in licensee facility represents payments made to the licensee of a synthetic fuel facility located in Pennsylvania in exchange for a 10% interest in the net cash flows from operation of the facility. The investment is being accounted for at cost. Cash received by the Company will first be applied as a reduction of the carrying amount of the investment. 7. Long-term Liabilities
Notes Payable and Convertible Debentures Notes payable and convertible debentures consist of the following at September 30: (thousands of dollars, except per-share data) 1998 1997 ------------------------------------------------------------------------------------------------- ------------- ------------- Note payable to a corporation bearing interest at prime (8.25% at September 30, 1998) plus 2%, collateralized by plant and equipment, principal and interest due December $ 2,900 $ 2,900 1999. Note payable to a corporation bearing interest at 6%, principal and interest due October 1999, collateralized by a coal wash plant in Utah. 4,263 945 Note payable to a limited liability company issued in conjunction with funds advanced for the construction of a synthetic fuel facility in West Virginia, held for sale. As of September 30, 1998, the loan was collateralized by the facility, bore no interest and was originally due at the earlier of the sale of the facility or January 1999. Subsequent to September 30, 1998, this entity modified the terms of the note and agreed to loan to the Company additional amounts up to $1,500. This entity has an option to purchase the facility. If it is not purchased, the Company has agreed to pay interest on all outstanding amounts at a rate of 10%, payable monthly beginning January 1999 through June 1999. Beginning July 1999 through May 2000, monthly payments of $350 will be required, with all unpaid principal and interest due June 2000. Also, subsequent to September 30, 1998 the Company granted additional collateral to the corporation 8,242 -- in the form of certain license fees receivable by the Company from other synthetic fuel facilities. Notes payable to a corporation, bearing interest at 6%. 50% of accrued interest due February 1999 and balance of accrued interest and principal due February 2001. Collateralized by a synthetic fuel facility in West Virginia, held for sale. 6,680 ---
F-15
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS, continued ---------- 7. Long-term Liabilities, continued (thousands of dollars, except per-share data) 1998 1997 ------------------------------------------------------------------------------------------------- ------------- ------------- Note payable to a corporation, bearing interest at 15%, collateralized by a synthetic fuel facility in Pennsylvania, held for sale, and due at the earlier of the sale of the facility or 5,800 --- August 1999. Note payable to a corporation bearing interest at 18% until October 1998, at which time it increased to 22%, due June 1999, collateralized by a promissory note receivable and by certain future license fees receivable by the Company. Warrants to purchase 100,000 shares of common stock were granted in October 1998 based on the outstanding principal balance. A member of the Company's Board of Directors is affiliated with this corporation. 4,000 --- Note payable to a corporation, bearing interest at 13% until December 1998, at which time it increases to 14%. Principal and accrued interest due March 1999, collateralized by certain future license fees receivable by the Company. A member of the Company's Board of Directors is affiliated with this corporation. 4,000 --- Convertible note payable to a corporation bearing interest at prime plus 2%. Principal of $6,686 plus accrued interest of $314 was converted to common stock at $7.00 per share in March --- 3,302 1998. Convertible debenture payable to two individuals and one trust bearing interest at prime plus 2%. Converted to common stock at $11.00 per share in June 1998. --- 1,000 Other 94 --- ------------- ------------- 35,979 8,147 Less: current portion 22,049 5,247 ============= ============= Total non-current $13,930 $2,900 ============= =============
Substantially all of the Company's property, plant and equipment and facilities held for sale are collateral for the notes payable. The weighted average interest rate on notes payable and convertible debentures was 8.5% at September 30, 1998 and 10.5% at September 30, 1997. Future maturities of notes payable at September 30, 1998 are as follows:
Year ending September 30, (thousands of dollars) --------------------------- --------------------- 1999 $22,049 2000 7,173 2001 6,757 ===================== Total $35,979 =====================
Notes Payable - Related Parties, Non-current Notes payable - related parties represents unsecured amounts due to two officers of the Company which bear interest at prime (8.25% at September 30, 1998) plus 2%. Principal and interest are due November 2002. Deferred Compensation In 1993, the Company assumed a liability to pay a current stockholder of the Company $40,000 per year for seven years beginning February 1999. The present value of this liability, discounted at approximately 5%, is reflected as deferred compensation in the consolidated balance sheet. F-16 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS, continued ---------- 7. Long-term Liabilities, continued Interest Costs During 1998, the Company incurred total interest costs of approximately $4,266,000 (including approximately $2,046,000 of non-cash interest expense resulting from issuance of convertible debt at a discount), of which approximately $1,521,000 was capitalized. During 1997, the Company incurred total interest costs of approximately $2,023,000 (including approximately $1,429,000 of non-cash interest expense resulting from issuance of convertible debt at a discount), of which approximately $378,000 was capitalized. During 1996, the Company incurred total interest costs of approximately $94,000, of which approximately $33,000 was capitalized. 8. 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 files a consolidated tax return with its 100% owned subsidiaries. Both majority-owned limited partnerships file separate tax returns, as required. As of September 30, 1998, the Company has net operating loss carryforwards of approximately $21,400,000 which can be used to offset future taxable income. The net operating loss carryforwards expire from 2005 to 2018. The Company also has approximately $190,000 in research and development tax credit carryforwards which can be used to offset future tax liabilities. The tax credit carryforwards expire from 2007 to 2013. The utilization of these carryforwards against future taxable income may become subject to an annual limitation due to changes in ownership of the Company's common stock. The provision for income taxes from continuing operations for the years ended September 30, 1998, 1997 and 1996, all of which represents deferred income taxes, differs from the statutory federal income tax rate due to the following:
(thousands of dollars) 1998 1997 1996 --------------------------------------------------------------------------- --------------- --------------- -------------- Tax benefit at statutory rates $1,355 $ 3,738 $3,810 Change in valuation allowance (1,377) (3,840) (4,007) State income taxes, net of federal tax effect 39 101 363 Other, including redetermination of prior years' tax estimates (17) 1 (189) --------------- --------------- -------------- Deferred federal income tax provision $ 0 $ 0 $ (23) =============== =============== ============== The components of the net deferred tax asset as of September 30, 1998 and 1997 are as follows: (thousands of dollars) 1998 1997 ------------------------------------------------------------------------------------------- -------------- --------------- Deferred tax assets (liabilities): Net operating loss carryforwards $7,995 $ 6,282 Research and development tax credit carryforwards 189 189 Compensation expense related to common stock options 2,084 2,003 License fee revenue recognition 315 104 Write-down of notes receivable 304 712 Estimated liabilities 356 551 Depreciation (88) (111) Other 40 88 -------------- --------------- Total deferred tax assets 11,195 9,818 Valuation allowance (11,195) (9,818) -------------- --------------- Net deferred tax asset $ 0 $ 0 ============== ===============
F-17 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS, continued ---------- 8. Income Taxes, continued The valuation allowance increased by $1,377,000 during 1998, representing the additional amount of deferred tax assets at September 30, 1998 not considered recoverable through the reversal of taxable temporary differences, or the generation of future taxable income. The valuation allowance increased by $3,840,000 during 1997 and by $4,007,000 during 1996. 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 $11,195,000 should be provided as of September 30, 1998. This estimate may change in the near term depending on the level of earned license fees received in 1999. 9. Basic and Diluted Loss per Share
(thousands of dollars and shares, except per-share data) 1998 1997 1996 --------------------------------------------------------------------------- ---------------- --------------- --------------- Numerator: Loss from continuing operations $(3,986) $(10,995) $(12,955) Loss from discontinued operations --- --- (881) ---------------- --------------- --------------- Net loss (3,986) (10,995) (13,836) Preferred stock dividends (337) (189) --- ================ =============== =============== Net loss attributable to common stockholders $(4,323) $(11,184) $(13,836) ================ =============== =============== Denominator - weighted average shares outstanding 9,969 8,080 6,941 ================ =============== =============== Loss per share from continuing operations $(.43) $(1.38) $(1.86) Loss per share from discontinued operations --- --- (.13) ================ =============== =============== Basic and diluted net loss per share $(.43) $(1.38) $(1.99) ================ =============== =============== For 1998 and 1997, the Company's loss per common share was determined after taking into account undeclared cumulative preferred stock dividends of $337,000 and $24,000, respectively and, in 1997 approximately $165,000 of preferred stock dividends imputed based upon the price of the Company's common stock at the date the convertible preferred shares were issued. 10. Notes and Interest Receivable -- Related Parties, Collateralized by Common Stock -------------------------------------------------------------------------------- Notes and interest receivable -- related parties, collateralized by common stock, consist of the following at September 30: (thousands of dollars and shares) 1998 1997 ---------------------------------------------------------------------------------------------- ------------- -------------- Note receivable from a shareholder, $5,000 face amount, bearing interest at 6% renegotiated in November 1997, principal and interest of $515 due in annual installments beginning January 1999 through January 2004, with remaining balance due January 2005, collateralized by 130 shares of the Company's common stock held by the Company, options expiring in January 2006 to acquire 50 shares of the Company's common stock committed by the shareholder to be provided to the Company, and a personal guarantee of the shareholder. The carrying value is equal to the fair value of the 130 shares and options to acquire 50 shares and is net of unamortized discount after renegotiation of $1,281 based upon an imputed rate of 10.25%, and an allowance for impairment of $2,110 in 1998 ($2,129 in 1997). No interest income was recognized during 1998, 1997 or 1996. $1,609 $1,590
F-18
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS, continued ---------- 10. Notes and Interest Receivable -- Related Parties, Collateralized by Common Stock, continued ---------------------------------------------------------------------------- Notes and interest receivable from 16 current and former officers and employees, issued upon exercise of options to purchase 450 shares of common stock at $5.31 to $8.38 per share, bearing interest at 5.7%, principal and interest due in December 2000, collateralized by 900 shares of the Company's common stock. No interest income was recognized during 1998 or 1997. 5,492 5,805 Notes receivable from seven officers of the Company, bearing interest at prime (8.25% at September 30, 1998) plus 2%, principal and interest due August 2000, originally collateralized by partnership interests which were subsequently exchanged for 79 shares of the Company's common stock (see Note 14). Reclassified from notes receivable - related parties in 1998. No interest income has been recognized for any period. 672 --- Other --- 16 ------------- -------------- $7,773 $7,411 ============= ==============
11. Fair Value of Financial Instruments 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 * Receivables * Notes receivable * Notes receivable - related parties * Notes payable and convertible debentures * Notes payable - related parties * Notes receivable - related parties, from issuance of, or collateralized by, common stock A substantial portion of the Company's financial instruments are of a short-term nature. Accordingly, while the fair values of some of the individual financial instruments vary somewhat from their carrying values, the aggregate carrying values as reflected in the financial statements approximate fair value. 12. Preferred and Common Stock Preferred Series A - Non-Voting As of September 30, 1998, there were 3,000 shares of Series A shares issued and outstanding. The Series A preferred shares are non-voting and have the following rights and privileges: 1. The holders of the shares are entitled to cumulative dividends at the rate of 6% per year of the liquidation value of $1,000 per share. These dividends accrue whether or not they have been declared or whether the Company has any profits. Additional shares of Series A preferred stock may be issued in lieu of cash to pay accrued dividends on these shares. 2. Upon the liquidation of the Company, the holders of the Series A preferred shares are entitled to receive $1,000 per share, together with all accrued and unpaid dividends, if any. 3. Each share of Series A preferred stock includes a warrant to purchase 28.571 shares of common stock or a total of 85,713 shares, at a price of $8.00 per share. These warrants expire on August 31, 1999. F-19 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS, continued ---------- 12. Preferred and Common Stock, continued Preferred Series A - Non-Voting, continued 4. The holders of the shares are entitled to convert their shares to common shares at any time. The number of common shares to be received upon conversion is determined by multiplying the number of preferred shares by $1,000 and dividing by the conversion price of $7.00 per share. At any time after August 31, 1999, the Company has the right to require any holder of the Series A preferred shares to convert their shares into common stock. 5. No dividends have been declared through September 30, 1998. Dividends in arrears at September 30, 1998 totaled approximately $200,000, or $67 per share. Preferred Series B - Non-Voting As of September 30, 1998, there were 312,882 shares of Series B shares issued and outstanding. The Series B preferred shares are non-voting and have the following rights and privileges: 1. The holders of the shares are entitled to cumulative dividends at the rate of approximately 7% per year of the liquidation value of $7 per share. These dividends accrue whether or not they have been declared or whether the Company has any profits. Additional shares of Series B preferred stock may be issued in lieu of cash to pay accrued dividends on these shares. 2. Upon the liquidation of the Company, the holders of the Series B preferred shares are entitled to receive $7 per share, together with all accrued and unpaid dividends, if any. 3. Each unit (comprising 3 shares) of Series B preferred stock includes a warrant to purchase one share of common stock at a price of $8.00 per share. These warrants expire on September 30, 1999. 4. The holders of the shares are entitled to convert their shares to the same number of shares of common stock at any time, subject to adjustment for dilution. Accrued dividends may be converted by the Company into common stock at the conversion price of $7.00 per share. 5. No dividends have been declared through September 30, 1998. Dividends in arrears at September 30, 1998 totaled approximately $162,000, or $.52 per share. Based upon the conversion price per share at the date of issuance, a non-cash dividend of approximately $165,000 was imputed upon issuance. 13. Stock Options and Warrants Stock Options At September 30, 1998, the Company had one stock option plan (the "Option Plan") under which 2,400,000 shares of common stock are reserved for ultimate issuance. A committee of the Company's Board of Directors, or in its absence, the Board (the "Committee") administers and interprets the Option Plan. This Committee is authorized to grant options and other awards both under the terms of the Option Plan and outside the Option Plan to eligible employees, officers, directors, and consultants of the Company. The Option Plan provides for the granting of both incentive stock options and non-statutory stock options. Terms of options granted under the Option Plan, including vesting requirements, are determined by the Committee. Options granted under the Option Plan vest over periods ranging from 0 to ten years, expire ten years from the date of grant and are not transferable other than by will or by the laws of descent and distribution. Incentive stock option grants must meet the requirements of the Internal Revenue Code. F-20 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS, continued ---------- 13. Stock Options and Warrants, continued Stock Options, continued The Company has elected to continue to apply Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and related interpretations in accounting for its Option Plan. The alternative fair value method of accounting prescribed by SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), requires the use of option valuation models that were not developed for use in valuing employee stock options, as discussed below. Accordingly, under APB 25, no compensation expense has been recognized for stock option grants to employees, officers and directors when the exercise price of stock options equals or exceeds the market price of the Company's common stock on the date of grant. When options are issued with terms considered compensatory, the related compensation expense is amortized to expense over the specified vesting period on a straight-line basis. Deferred compensation related to options issued in 1998, 1997 and 1996 that vest over time was approximately $0, $1,178,000 and $4,668,000, respectively. The amortized compensation expense related to these options was approximately $908,000, $1,572,000 and $910,000 for 1998, 1997 and 1996, respectively. Compensation expense related to options that vested immediately was approximately $127,000, $103,000 and $3,863,000 for 1998, 1997, and 1996, respectively. If the Company had elected to account for options granted in 1998, 1997 and 1996 based on their fair value, as prescribed by SFAS 123, net loss and net loss per share would have been increased to the pro forma amounts shown in the table below.
(thousands of dollars, except per-share data) 1998 1997 1996 --------------------------------------------------------------------------- ---------------- --------------- --------------- Net loss attributed to common stockholders -- reported $(4,323) $(11,184) $(13,836) -- pro forma (7,245) (11,799) (14,530) Basic and diluted net loss per share - reported (.43) (1.38) (1.99) --pro forma (.73) (1.46) (2.09)
The fair value of each stock option grant was determined using the Black-Scholes option pricing model and the following assumptions: expected stock price volatility of .67 to .70, risk-free interest rate of 4.4% to 7.8%, weighted average expected option lives of 10 years, and no dividends. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including expected stock price volatility. Because the Company's stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value, in management's opinion the existing models do not necessarily provide a reliable single measure of the fair value of stock options. F-21 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS, continued ---------- 13. Stock Options and Warrants, continued Stock Options, continued The following table is a summary of activity for all of the Company's stock options for the years ended September 30:
1998 1997 1996 Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise (thousands of shares) Shares Price Shares Price Shares Price ------------------------------------------- ------------- ------------- ------------ ------------ ------------ ------------- Outstanding at beginning of year 1,614 $2.85 1,367 $1.62 2,030 $2.37 Granted 850 12.34 445 6.08 1,612 3.51 Exercised (94) 1.93 (73) 1.84 (1,085) 5.92 Canceled --- --- (125) 1.50 (1,190) 1.54 ============= ============= ============ ============ ============ ============= Outstanding at end of the year 2,370 $6.29 1,614 $2.85 1,367 $1.62 ============= ============= ============ ============ ============ ============= Exercisable at end of year 1,038 $5.23 712 $2.04 463 ============= ============= ============ ============ ============ ============= Weighted average fair value of options granted during the year below market $10.21 $9.53 $12.66 Weighted average fair value of options granted during the year at market $9.91 $5.57 $0 The following table summarizes information about all stock options outstanding at September 30, 1998: (thousands of shares) Options Outstanding Options Exercisable ------------------------ ------------------------------------------------------------- ------------------------------------ Weighted Number Average Weighted Number Weighted Outstanding at Remaining Average Exercisable at Average Range of Exercise September 30, Contractual Life Exercise September 30, Exercise Prices 1998 in Years Price 1998 Price ------------------------ ---------------------- ------------------- ------------------ ------------------ ----------------- $1.50 to $3.50 1,221 7.3 $1.58 602 $1.66 $7.00 to $9.00 397 8.5 8.22 257 8.20 $11.00 to $13.56 752 9.0 12.92 179 13.02 ---------------------- ------------------ 2,370 1,038 ====================== ==================
Stock Warrants As of September 30, 1998, there were warrants outstanding for the purchase of approximately 2,033,000 shares of common stock at prices ranging from $7.00 to $30.00 per share and with expiration dates from October 1998 to September 2000. All of these warrants were issued in connection with private placements of common and preferred stock or notes payable during the years 1996 through 1998. In October 1998, the Company issued warrants for the purchase of 100,000 shares of common stock in accordance with the terms of a note payable to a corporation (see Note 7). F-22 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS, continued ---------- 14. Purchase of Limited Partners' Interests in Subsidiaries In September 1998, the Company formally offered the limited partners in its two consolidated subsidiaries, Utah Synfuel #1, and Alabama Synfuel #1, an exchange of the Company's common stock for their limited partnership interests. The exchange ratio was based in part on an independent valuation of the limited partnerships' assets and other factors including but not limited to current and future expected cash flows of the partnerships and the market value of the Company's common stock at the date of the offer, $9.00 per share. As of September 30, 1998, substantially all of the limited partners had elected to exchange their limited partnership interests for shares of the Company's common stock. During October and November 1998, all but one of the other limited partners exchanged their interests and Utah Synfuel #1 became a wholly-owned subsidiary of the Company and Alabama Synfuel #1 became a 98%-owned subsidiary of the Company. The Company recorded this exchange using the market values of the Company's common stock on the dates the limited partners tendered acceptance of the Company's offer. These market values ranged from $6.75 to $11.13 per share. 15. 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 subsidiaries. In September 1995, the Board of Directors approved a plan to dispose of the construction-related operations and in February 1996 entered into a stock purchase agreement to sell all of the common shares of the subsidiaries for a $5,000,000 face value promissory note. The terms of the original agreement were clarified in November 1997 and the financial effect is included in the change in the allowance to reduce the promissory note to collateral value (discussed below). Because the note includes a favorable interest rate for the buyer, 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% was to reduce the note to approximately $3,719,000 as of the renegotiation date. The original discount on the note was included in the estimated loss on disposal of discontinued operations in 1996. Because the note is collateralized by the Company's common stock, it is reflected in the consolidated financial statements as a reduction of stockholders' equity. Additionally, the note is adjusted to reflect subsequent increases or decreases in the fair value of the Company's stock and stock options held as collateral. Subsequent changes in the value of the collateral will be reflected in the statement of operations and as an increase or decrease to the carrying value of the note. Under the terms of the agreement, the Company agreed to pay $3,500,000 of accounts payable and lines of credit outstanding in the subsidiaries. Subsequently, the buyer also received 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 buyer. The Company has reflected those obligations in the loss on discontinued operations in 1996. Revenues of the discontinued operations were approximately $1,397,000 for the four months ended February 1, 1996, the date of sale. F-23 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS, continued ---------- 16. Commitments and Contingencies Commitments and contingencies as of September 30, 1998 not disclosed elsewhere, are as follows: Leases Rental expense was approximately $473,000, $318,000, and $330,000 for 1998, 1997 and 1996, respectively. The Company has a noncancellable operating lease for equipment through the year 2000 and other operating leases for real estate. At September 30, 1998, minimum rental payments due under these leases, are as follows: Year ending September 30: (thousands of dollars) ----------------------------- ----------------------- 1999 $664 2000 496 2001 314 2002 113 2003 36 ======================= $1,623 ======================= Letters of Credit During 1998, the Company entered into letter of credit arrangements with a bank that provide for the issuance of letters of credit totaling up to $938,000. These arrangements are collateralized by certificates of deposit totaling $588,000 that are included in restricted investments in the accompanying balance sheet. As of September 30, 1998, there was approximately $560,000 of liabilities covered by these arrangements. Legal or Contractual Matters Included in accrued liabilities is $755,000 ($1,477,000 in 1997) related to construction contracts that contained a "failure to proceed" liability clause. In December 1996, the Company entered into indemnification agreements in connection with construction contracts for certain synthetic fuel facilities entered into by independent third parties. These contracts call for liquidated damages of $750,000 per contract if construction of the facilities is not completed by June 1, 1998. The Company indemnified the contractor for these potential liabilities. The contracting party did not construct three of the facilities. Accordingly, the maximum contingent liability under these indemnification agreements would be $2,250,000. The contractor and the owner have initiated arbitration claims against each other including owner claims for liquidated damages. The Company is closely monitoring the situation and believes that payment of a material amount by the Company is unlikely. In June 1997, the Company sold the Utah Synfuel #1 facility to Coaltech. In connection with this sale, Utah Synfuel #1 sold to Coaltech a license to use the Company's Briquetting Technology for an advance license fee of $1,400,000 and an earned license fee that is payable quarterly and is based upon briquettes manufactured and sold at the Utah Synfuel #1 facility. The Company contracted with Coaltech to operate the facility for which it receives a quarterly fee which is also based upon briquettes produced and sold. Coaltech has an option wherein they can require the Company to purchase this facility under certain conditions. The purchase price is equal to fair market value, not to exceed 50% of the amounts paid to Covol by Coaltech. Additionally, the Company entered into a supply and purchase agreement wherein the Company agreed to provide coal fines to Coaltech for processing into synthetic fuel at a price equal to its cost. The Company agreed to purchase from Coaltech the synthetic fuel produced at Coaltech's cost plus one dollar per ton. Based upon expected manufacturing costs and current coal prices, the Company expects to incur a loss under this supply and purchase agreement which will reduce the earned license fees received. The Company believes the earned license fees will exceed the losses incurred under the supply and purchase agreement. Because of the expected loss under this supply and purchase agreement, revenue recognition of the advance license fee has been deferred as of September 30, 1998 and 1997. F-24 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS, continued ---------- 16. Commitments and Contingencies, continued Legal or Contractual Matters, continued In June 1996, the Company formed Alabama Synfuel #1 to construct a synthetic fuel facility. In connection with the construction of this facility, the Company entered into a supply agreement for coal fines to be used at the facility, under which the Company was obligated to purchase a minimum of 20,000 tons of coal fines per month through December 2001. The Company assigned this agreement to the purchaser of the facility and accordingly, has no ongoing obligation. The Company has a dispute with the provider of coal fines, the resolution of which is not expected to have a material impact on the Company. In May 1995, the Company entered into an agreement with Geneva Steel Company to build and operate a commercial iron revert briquetting plant. The facility never reached commercial productivity levels and is not operational. The Company may use this equipment for the production of synthetic fuel or for testing purposes. The Company entered into a letter of intent with Innovative Technologies ("Innovative") in July 1995 to apply the Company's Briquetting Technology to certain metallic ores supplied by Innovative. The Company conducted numerous tests of the ore through the fall of 1995, and concluded from the results that the venture was not economically viable. Accordingly, final agreement to process the ore was never reached. In March 1997, Innovative Holding Company, Inc., filed a civil complaint against the Company alleging breach of the letter of intent and damages in excess of $500,000. The Company successfully defended this action which was dismissed with prejudice. In December 1996, the Company entered into license agreements with affiliates of Pace Carbon Fuels, L.L.C. (collectively "Pace") for the use of Company technologies at four synthetic fuel manufacturing facilities owned by Pace. In 1998 Pace requested a reduction in the license fees payable to the Company under the license agreements. Upon condition of immediate payment by Pace of advance license fees, the Company agreed to a reduction in future earned license fees. This reduction was accomplished by a ten-year loan agreement whereby the Company would loan to Pace up to $750,000 each quarter beginning in November 1998. The Company's loan to Pace will be repaid at the end of the ten years only if the Pace projects have accumulated sufficient prescribed earnings. Revenues from earned license fees will be recognized by the Company only to the extent that amounts exceed the loan commitment. Pace has requested a loan of $750,000 for the November 1998 quarter. The Company believes that its current loan obligation to Pace is limited to the earned license fee receivable by the Company for the quarter ended September 30, 1998, which is believed to be approximately $300,000. In January 1996, a manager of the Company entered property owned by Nevada Electric Investment Company, a subsidiary of Nevada Power Corporation, in connection with an offer by the Company to purchase the property, and with certain other employees of the Company, removed some asbestos over a two-day period. In May 1996, the Company received a notice of violation and order for compliance from the State of Utah, Division of Air Quality alleging that asbestos was improperly handled, removed, and disposed of. The Company complied with the order and in September 1996 entered into a settlement agreement with the State of Utah and paid a fine in the amount of $11,000. In late 1997, the U.S. Environmental Protection Agency began its own investigation, referring the matter to the U.S. Attorney's office which proceeded with a grand jury inquiry. The Company does not know the results of the grand jury inquiry or whether the inquiry is completed. The Company does not believe that the resolution of this matter will have a material adverse effect on the Company. As of September 30, 1998, the Company has recorded liabilities to The Industrial Company ("TIC") totaling approximately $735,000. In November 1998, the Company was served with liens from TIC in amounts totaling approximately $1,150,000 for construction payments TIC claims are due for certain synfuel facilities. The Company is negotiating with TIC for the settlement and release of the liens and believes that payment of a material amount beyond what has been accrued by the Company is unlikely. F-25 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS, continued ---------- 16. Commitments and Contingencies, continued Legal or Contractual Matters, continued The Company is also involved in several legal proceedings that have arisen out of the normal course of business. The Company believes that many of these claims are without merit and in all cases intends to vigorously defend their position. Management does not believe that the outcome of these activities will have a significant effect upon the operations or the financial position of the Company. Employment Contracts The Company has entered into employment agreements with the Chief Executive Officer, President, Chief Financial Officer and two vice presidents. The agreements, which are renewable by the Company, generally have a term of approximately three years and provide for annual salaries and benefits ranging from approximately $80,000 to $190,000 annually per officer, and currently totaling approximately $600,000 for all five officers combined. All agreements provide for termination benefits under specific conditions ranging up to 200% of the then current annual salaries. 17. Events Subsequent to September 30, 1998 Subsequent to September 30, 1998, a total of approximately 308,000 shares of the Company's common stock were issued on conversion of approximately 285,000 shares of Series B preferred stock and related accrued but unpaid dividends in arrears. During November and December 1998, the Company completed financing transactions that consisted of $400,000 of debt and approximately $3,500,000 of equity. The debt has a term of twelve months, bears interest at 15%, with an interest only payment due in six months and with the balance of interest and principal due at maturity. The debt is collateralized by certain assets of the Company and is due prior to maturity upon the placement of long-term financing by the Company. The equity transaction consisted of the sale of units at a price of $5.00 per unit. A unit consists of one share of restricted common stock plus a warrant to purchase one additional share of restricted common stock at an exercise price of $7.50. The warrants expire in twelve months if not exercised. The restricted stock and shares issuable pursuant to the related warrants have been provided piggyback registration rights. The Company has received term sheets for the sale of up to $10,000,000 of convertible preferred stock. This financing is expected to close in January 1999. F-26 EX-10.52.4 2 PROMISSORY NOTE TO MUNTAINEER SYNFUEL PROMISSORY NOTE $9,750,000 December 8, 1998 FOR VALUE RECEIVED, COVOL TECHNOLOGIES, INC., a Delaware corporation ("Maker"), hereby unconditionally promises to pay to the order of MOUNTAINEER SYNFUEL, L.L.C., a Delaware limited liability company ("Payee"), at such place as Payee may from time to time designate in writing to Maker, the principal sum of $9,750,000, or, if less, the sum of (i) $8,250,000 plus (ii) any additional amounts ("Additional Amounts") loaned on the date hereof or hereafter by or on behalf of Payee to Maker up to a maximum additional amount of $1,500,000 pursuant to the letter agreement of even date herewith among Maker, Payee, Fannie Mae and MSDW Synfuels II, Inc., together with all unpaid interest thereon, on June 30, 2000 (the "Maturity Date"), or sooner as hereafter provided. 1. Notation of Additional Amounts. Payee is authorized to record, on the schedule annexed hereto and made a part hereof, or on other appropriate records of Payee, the date and amount of each Additional Amount loaned by Payee to Maker, provided, however, that failure by Payee to make any recordation or other error therein shall not limit or otherwise affect the obligations of Maker hereunder. 2. Interest. The unpaid principal balance of this promissory note (as amended, modified or supplemented from time to time, this "Note") from time to time outstanding shall bear interest at a per annum rate equal to ten percent (10%), but in no event higher than the maximum lawful rate that may be contracted for, charged, taken, reserved or received by Payee in accordance with applicable law. Interest hereon shall be computed on the basis of a year of 365 or 366 days, as applicable, for the actual number of days elapsed. 3. Manner of Payment and Application of Funds. The principal and accrued interest on this Note shall be due and payable as follows: (a) Unless this Note has been accelerated pursuant to Section 6 hereof, commencing on January 31, 1999 and continuing on the last day of each month thereafter through June 30, 1999, the Maker shall pay accrued interest on the outstanding principal amount hereof; (b) Unless this Note has been accelerated pursuant to Section 6 hereof, commencing July 31, 1999 and continuing on the last day of each month thereafter through May 31, 2000, the Maker shall pay the amount of $350,000, such payment being applied first to the payment of accrued but unpaid interest and then to principal; and (c) All unpaid principal and accrued interest on this Note shall be due and payable on the earlier of the Maturity Date or acceleration pursuant to Section 6 hereof. -1- All sums payable hereunder will be payable by Maker to Payee in funds constituting lawful money of the United States of America and in immediately available funds. Maker's obligation to make payments hereunder is absolute and unconditional and shall not be subject to any defense, claim, counterclaim, setoff, recoupment, abatement or other right that Maker may now or hereafter have against Payee or any other person or entity. 4. Prepayment of Principal. From and after January 29, 1999, Maker shall be entitled to prepay at any time(s) the outstanding principal balance hereof, in whole or in part, plus accrued interest thereon without premium or penalty. All prepayments shall be applied first to accrued but unpaid interest and then to principal. This Note shall not be prepayable in whole or in part prior to January 15, 1999. 5. Security Agreement. This Note is secured by a Security Agreement (as amended, modified or supplemented from time to time, the "Security Agreement") and by a Leasehold Credit Line Deed of Trust and Security Agreement (the "Leasehold Deed of Trust and Security Agreement"), each of even date herewith executed by Maker in favor of Payee, to which reference is made for a statement of the rights and obligations of Maker and Payee in relation thereto. 6. Events of Default. Maker shall be in default under this Note upon the occurrence of any of the following events or conditions (each, an "Event of Default"): (a) Maker fails to pay any principal, interest or other amounts payable under this Note when due; (b) Maker commences or becomes the subject of any proceedings under any bankruptcy, reorganization, compromise, arrangement, insolvency, readjustment of debts, conservatorship, moratorium, dissolution, liquidation, or similar debtor relief laws of any jurisdiction, whether now or hereafter in effect, and, in the case of involuntary proceedings, such proceedings are not dismissed, discharged, stayed or restrained within 60 days of the commencement thereof, or makes an assignment for the benefit of its creditors, or fails to pay its debts generally as they become due; (c) Maker liquidates or dissolves itself (or suffers any liquidation or dissolution) or otherwise winds up or terminates its existence; (d) An "Event of Default" as specified and defined in the Security Agreement or the Leasehold Deed of Trust and Security Agreement shall have occurred. 7. Acceleration and Other Remedies. (a) If an Event of Default described in Section 6(b) above occurs, the aggregate unpaid principal balance of and any accrued interest on this Note shall thereupon become due and payable concurrently therewith, without any action by Payee or any subsequent holder of this Note, and without diligence, presentment, demand, protest, notice of protest or intent to accelerate, or notice of any other kind, all of which are hereby expressly waived (except to the extent waiver of the foregoing is not permitted by applicable law). If any other Event of Default occurs, Payee or any subsequent holder hereof may, upon written notice to Payee of such Event of Default (i) declare the unpaid principal balance of and any accrued interest -2- on this Note immediately due and payable, whereupon it will be due and payable without diligence, presentment, demand, or protest, all of which are hereby expressly waived (except to the extent waiver of the foregoing is not permitted by applicable law), and (ii) exercise all other rights and remedies available by agreement, at law or in equity. (b) Failure to exercise any of the foregoing options will not constitute a waiver of the right to exercise the same or any other option at any subsequent time in respect to any other event. The acceptance by Payee of any payment hereunder that is less than payment in full of all amounts due and payable at the time of such payment will not constitute a waiver of the right to exercise any of the foregoing options at that time or at any subsequent time or nullify any prior exercise of any such option without the express written consent of Payee. 8. Waivers. Maker and any endorsers, sureties or guarantors hereof severally waive presentment and demand for payment, notice of intent to accelerate maturity, notice of acceleration of maturity, protest and notice of protest and non-payment, other notice of any kind, bringing of suit and diligence in taking any action to collect any sums owing hereunder or in proceeding against any of the rights and properties securing payment hereof. Maker and any endorsers, sureties or guarantors hereof also severally waive any notice of or defense on account of any extensions, renewals, partial payments or changes in any manner of or in this Note or in any of its terms, provisions and covenants, or any delay, indulgence or other act of any trustee or any holder hereof, whether before or after maturity. 9. Legal Interest Limitations. It is the intent of Maker and Payee to conform strictly to all applicable state and federal usury laws. All agreements between Maker and Payee, whether now existing or hereafter arising and whether written or oral, are hereby expressly limited so that in no contingency or event whatsoever, whether by reason of acceleration of the maturity hereof or otherwise, shall the amount contracted for, charged or received by Payee for the use, forbearance, or detention of the money to be loaned hereunder or otherwise, or for the payment or performance of any covenant or obligation contained herein or in any other document evidencing, securing, or pertaining to the indebtedness evidenced hereby which may be legally deemed to be for the use, forbearance or detention of money, exceed the maximum amount which Payee is legally entitled to contract for, charge or collect under applicable state or federal law. If from any circumstance whatsoever fulfillment of any provision hereon or of such other documents, at the time performance of such provision is due, involves transcending the limit of validity prescribed by law, then the obligation to be fulfilled shall be automatically reduced to the limit of such validity, and if from any such circumstance Payee ever receives as interest or otherwise an amount in excess of the maximum that can be legally collected, then such amount which would be excessive interest shall be applied to the reduction of the principal indebtedness hereof and any other amounts due under any other instrument evidencing, securing or pertaining to the indebtedness evidenced hereby, but not to the payment of interest; and if such amount which would be excessive interest exceeds the unpaid balance of principal hereof and all other non-interest indebtedness described above, then such additional amount will be refunded to Maker. All sums paid or agreed to be paid by Maker for the use, forbearance or detention of the indebtedness of Maker to Payee shall, to the extent permitted by applicable law, be amortized, prorated, allocated, and spread throughout the full term of such indebtedness until payment in full so that the amount of interest on account of such indebtedness is uniform throughout the term thereof and does not exceed the maximum permitted by applicable law. -3- The terms and provisions of this paragraph shall control and supersede every other provision of all agreements between Maker and the Payee. 10. Severability. If any provision of this Note or any related documents is held to be illegal, invalid or unenforceable under present or future laws or regulations, that provision will be fully severable. The affected instrument, document or agreement shall be construed and enforced as if the severed provision had never been a part thereof, and the remaining provisions shall remain in full force and effect and shall not be affected by the severed provision or by its severance therefrom. In lieu of the severed provision, there shall be added automatically as a part of the affected instrument, document or agreement a provision that is legal, valid and enforceable, and as similar in terms to the severed provision as may be possible. 11. Notices. All notices, requests or communications required or permitted to be given hereunder shall be in writing and shall be deemed to have been properly given if (a) mailed by first-class United States mail, postage prepaid, registered or certified with return receipt requested, (b) delivered by a nationally recognized overnight delivery service with written confirmation of delivery, (c) delivered in person to the intended addressee, or (d) sent by facsimile transmission with confirmation of delivery. Any notice mailed as above provided will be effective upon its deposit in the custody of the U.S. Postal Service; all other notices will be effective upon receipt. All notices hereunder shall be given at the following addresses: if to Maker: Covol Technologies, Inc. 3280 North Frontage Road Lehi, Utah 84043 Facsimile: (801) 768-4483 Attention: Stanley M. Kimball if to Payee: Mountaineer Synfuel, L.L.C. 3280 North Frontage Road Lehi, Utah 84043 Facsimile: (801) 766-1979 Attention: Harlan M. Hatfield with copies to: MSDW Synfuels II, Inc. 1221 Avenue of the Americas 23rd Floor New York, New York 10020 Facsimile: (212) 762-6912 Attention: Debra M. Aaron and Fannie Mae 3900 Wisconsin Avenue, N.W. Washington, D.C. 20016-2892 Facsimile: (201) 752-6088 Attention: William E. Einstein -4- Any such entity may change its address for notice hereunder to any other location within the continental United States by giving 30 days prior notice thereof to each other such entity in accordance with this paragraph. 12. Assignment. This Note, the rights, powers and interests held by Payee hereunder and under the Security Agreement may be transferred and assigned by Payee, in whole or in part, at such time and upon such terms as Payee may deem advisable, without the consent of Maker. Maker will not assign any of its rights, powers or interests hereunder without the prior written consent of Payee. 13. Amendment/Modification/Consent. This Note may not be amended, supplemented or otherwise modified, except by express written consent of Maker and Payee. No consent of Payee hereunder shall be effective unless approved in writing by MSDW Synfuels II, Inc. and Fannie Mae. 14. Governing Law. This Note shall be governed by and construed and enforced in accordance with the laws of the State of New York, without giving effect to the principles of conflict of law of New York. 15. ENTIRE AGREEMENT. THIS WRITTEN AGREEMENT AND THE OTHER DOCUMENTS REFERENCED HEREIN OR CONTEMPLATED HEREBY REPRESENT THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES HERETO. THERE ARE NO UNWRITTEN ORAL AGREEMENTS AMONG THE PARTIES. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] -5- IN WITNESS WHEREOF, Maker hereby executes this Note on the date first above written. COVOL TECHNOLOGIES, INC. a Delaware corporation By: /Stanley M. Kimball/ ------------------------------ Printed Name: Stanley M. Kimball Its: President -6- Schedule of Additional Amounts Under Promissory Note of Covol Technologies, Inc. Dated December 8, 1998 Date of Additional Amount Loan Amount of Additional Amount Loan EX-10.52.5 3 SECURITY AGREEMENT W/ MOUNTAINEER SYNFUEL SECURITY AGREEMENT THIS SECURITY AGREEMENT (as amended, modified or supplemented from time to time, this "Security Agreement") is made and entered into as of December 8, 1998, by and between MOUNTAINEER SYNFUEL, L.L.C., a Delaware limited liability company ("Secured Party"), and COVOL TECHNOLOGIES, INC, a Delaware corporation ("Debtor"). 1. Indebtedness. The Security Interest (as defined below) is herein created to secure payment and performance of that certain promissory note (as amended, modified or supplemented from time to time, the "Note") of even date herewith executed by Debtor and payable to the order of Secured Party in the original principal sum of NINE MILLION SEVEN HUNDRED FIFTY THOUSAND and No/100 Dollars ($9,750,000), all renewals and extensions thereof (the "Indebtedness"). 2. Collateral. For value received, Debtor hereby grants to Secured Party a security interest ("Security Interest") in all of Debtor's rights to receivables and payments in respect of the "Maple Creek Mining, Inc., Ginger Hill, P.A." project and the "Ohio Valley Coal Company, Alledonia, OH" project under the Amended and Restated License and Binder Purchaser Agreement, made and entered into as of April 15, 1998, by and between Pelletco Corporation ("Pelletco") and Debtor, as the same may be amended from time to time together with the related Assignment of License Agreement, made and entered into as of April 15, 1998 between Pelletco and Ginger Hill Synfuels, L.L.C. and Assignment of License Agreement made and entered into as of April 15, 1998 between Pelletco and Pleasant Ridge Synfuels, L.L.C. (collectively, the "License Agreement"), including, but not limited to, (i) all substitutions and replacements therefor and (ii) all proceeds, products and increases thereof (other than receivables and payments arising under Section 4.2(i) of such License and Binder Purchase Agreement) (the "Collateral"). Notwithstanding such grant, the Secured Party is not assuming any liability or obligation under the License Agreement and Debtor shall remain solely responsible for performance of its obligations thereunder. Debtor from time to time may propose substitute collateral to replace and release the security interest created hereby in the Collateral. Secured Party will in good faith evaluate the proposed substitute collateral. 3. Debtor's Warranties, Covenants and Further Agreements. A. Organization and Authority. Debtor is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware. Debtor has the corporate power and authority to execute, deliver and perform the Note and this Security Agreement, and the execution, delivery and performance of the Note and this Security Agreement by Debtor have been duly authorized by all necessary corporate action on the part of Debtor and do not and will not violate any law, rule or regulation or the certificate of incorporation or bylaws of Debtor and do not and will not conflict with, result in a breach of, or constitute a default under, the provisions of any indenture, loan agreement, security agreement or other instrument or agreement pursuant to which Debtor or any of its property is bound. -1- B. Enforceable Obligation. The Note and this Security Agreement have been duly executed and delivered by Debtor and, assuming the due execution and delivery of this Security Agreement by Secured Party, each constitutes a legal, valid and binding obligation of Debtor enforceable in accordance with its terms. The License Agreement has been duly executed and delivered by the parties thereto and constitutes a legal, valid and binding obligation of the parties thereto enforceable in accordance with its terms. C. Consent, Approval or Other Action. No consent, approval or other action by, notice to or filing with any governmental body or other person or entity is required for the grant, perfection or exercise by Secured Party of its rights hereunder, except for the filing of the financing statement(s) being made in connection with this Security Agreement. D. Title. Debtor has title to the Collateral free from any lien, security interest, encumbrance or claim and Debtor will, during the term of this Security Agreement, at Debtor's cost, keep the Collateral free from other liens, security interests, encumbrances or claims, and defend any action which may affect the Security Interest or Debtor's title to the Collateral. This Security Agreement and any account, instrument or document which is, or shall be, included in the Collateral is and shall be, genuine and legally enforceable and free from any set off, counterclaim or defense. E. Perfection. No financing statement covering the Collateral or any part or proceeds thereof is on file in any public office and, at Secured Party's request, Debtor will join in executing all financing statements and other instruments deemed necessary by Secured Party to perfect the Security Interest under the laws of the United States or any State thereunder. This Security Agreement and the financing statements filed in connection herewith create a valid and perfected first priority security interest in the Collateral securing the Indebtedness. F. Disposition of Collateral. Notwithstanding any other provision hereof, Debtor will not amend, modify, sell, assign, transfer, pledge or otherwise dispose of all or part of the Collateral, whether voluntarily or by operation of law, except with the prior written consent of the Secured Party. G. Principal Place of Business. The principal place of business and chief executive office of Debtor, and the office where Debtor keeps its books and records, including records relating to the Collateral, is located at the address of Debtor listed in Section 10 below. H. Further Assurances. At any time and from time to time, upon the request of Secured Party, and at the sole expense of Debtor, Debtor shall promptly execute and deliver all such further instruments and documents and take such further action as Secured Party may deem necessary or desirable to preserve and perfect its Security Interest in the Collateral and carry out the provisions and purposes of this Security Agreement, including, without limitation, the execution and filing of such financing statements as Secured Party may require. A carbon, photographic, or other -2- reproduction of this Security Agreement or of any financing statement covering the Collateral or any part thereof shall be sufficient as a financing statement and may be filed as a financing statement. I. Obligations. Debtor shall duly and punctually pay and perform the obligations of Debtor under the Note, the License Agreement and this Security Agreement. J. Notification. Debtor shall promptly notify Secured Party of (i) any lien, security interest, encumbrance, or claim made or threatened against the Collateral, (ii) any material change in the Collateral, including, without limitation, any breaches by any party to the License Agreement, and (iii) the occurrence or existence of any Event of Default (as defined below) or the occurrence or existence of any condition or event that, with the giving of notice or lapse of time or both, would constitute an Event of Default. K. Corporate Changes. Debtor shall not change its name, identity, or corporate structure in any manner unless Debtor shall have given Secured Party thirty (30) days prior written notice thereof and shall have taken all action deemed necessary or desirable by Secured Party to make each financing statement filed in connection with this Security Agreement not seriously misleading. Debtor shall not change its principal place of business, chief executive office or the location(s) of the Collateral and/or the records pertaining to the Collateral (as described above) unless it shall have given Secured Party thirty (30) days prior written notice thereof and shall have taken all action deemed necessary or desirable by Secured Party to cause its security interest in the Collateral to be perfected with the priority required by this Security Agreement. L. Books and Records; Information. Debtor shall keep accurate and complete books and records of the Collateral including all payments and payables in respect thereof and Debtor's business and financial condition in accordance with generally accepted accounting principles consistently applied. Debtor shall from time to time at the request of Secured Party deliver to Secured Party such information regarding the Collateral and Debtor as Secured Party may request, including, without limitation, payments and payables in respect thereof, lists and descriptions of the Collateral and evidence of the identity and existence of the Collateral. Debtor shall mark its books and records to reflect the security interest of Secured Party under this Security Agreement. M. Compliance with Agreements. Debtor shall comply in all material respects with all mortgages, deeds of trust, instruments, and other agreements binding on it or affecting its properties or business. N. Compliance with Laws. Debtor shall comply with all applicable laws, rules, regulations, and orders of any court or governmental authority. 4. Rights of Secured Party. Debtor hereby appoints Secured Party as Debtor's attorney-in-fact to do any act which Debtor is obligated by this Security Agreement to do, to exercise -3- all rights of Debtor in the Collateral and to do all things deemed necessary by Secured Party to perfect the Security Interest and preserve, collect, enforce and protect the Collateral, all at Debtor's cost and without any obligation on Secured Party so to act. Secured Party shall not be liable for any act or omission on the part of Secured Party, its officers, agents or employees, except willful misconduct nor shall Secured Party be responsible for depreciation in value of the Collateral or for preservation of rights against prior parties. The foregoing rights and powers of Secured Party may be exercised before or after default and shall be in addition to, and not a limitation upon, any rights and powers of Secured Party given herein or by law, custom or otherwise, except as otherwise expressly provided herein. 5. Events of Default. Debtor shall be in default under this Security Agreement upon the occurrence and continuation of any of the following events or conditions (each, an "Event of Default"): (a) Default in the timely payment or performance of any obligation, covenant or agreement contained herein, secured hereby or otherwise made or owed to Secured Party; (b) A material breach of or default under the License Agreement by any party thereto; (c) Any party to the License Agreement commences or becomes the subject of any proceedings under any bankruptcy, reorganization, comprise, arrangement, insolvency, readjustment of debts, conservatorship, moratorium, dissolution, liquidation, or similar debtor relief laws of any jurisdiction, whether now or hereafter in effect, and, in the case of involuntary proceedings, such proceedings are not dismissed, discharged, stayed or restrained within 60 days of the commencement thereof, shall make an assignment for the benefit of its creditors, or shall fail to pay its debts generally as they become due; (d) Any warranty, representation or statement made to Secured Party by or in behalf of Debtor proves to have been false in any material respect when made; (e) Any material default in the payment or performance of any obligation of Debtor to others under any loan, indenture, agreement or undertaking in respect of borrowed money; (f) Sale, loss, theft, destruction, encumbrance or unauthorized transfer of any of the Collateral; (g) Levy or seizure, or attachment of any of the Collateral; (h) Judgment against Debtor in an amount greater than $50,000 which remains unpaid for thirty (30) days unless execution on such judgment is subject to a stay pending appeal; and (i) Any Event of Default as specified and defined in the Note. -4- 6. Remedies of Secured Party upon Default. When an Event of Default occurs, and at any time thereafter, Secured Party may declare all or a part of the Indebtedness immediately due and payable and may proceed to enforce payment of same and to exercise any and all of the rights and remedies provided by the Uniform Commercial Code ("Code") and any other applicable law, as well as all other rights and remedies possessed by Secured Party under this Security Agreement or otherwise at law or in equity, including, but not limited to, notifying the account debtor on the Collateral to make any and all payments in respect thereof to the Secured Party. Secured Party may also require Debtor to assemble the Collateral and make it available to Secured Party at any place to be designated by Secured Party which is reasonably convenient to both parties. For purposes of the notice requirements of the Code, Secured Party and Debtor agree that notice given at least five (5) calendar days prior to the related action hereunder is reasonable. Secured Party shall be entitled to immediate possession of the Collateral and all books and records evidencing same and shall have authority to enter upon any premises, upon which said items may be situated, and remove same therefrom. Expenses of retaking, holding, preparing for sale, selling, or the like, shall include, without limitation, Secured Party's reasonable attorneys' fees and all such expenses shall be recovered by Secured Party before applying the proceeds from the disposition of the Collateral toward the Indebtedness. To the extent allowed by the Code, Secured Party may use its discretion in applying the proceeds of any disposition of the Collateral and Debtor shall remain liable for any deficiency remaining after such disposition. All rights and remedies of Secured Party hereunder are cumulative and may be exercised singly or concurrently. The exercise of any right or remedy shall not be a waiver of any other. 7. Waiver by Secured Party. No waiver by Secured Party of any right hereunder or of any Event of Default by Debtor shall be binding upon Secured Party unless provided in a written consent executed by Secured Party. Failure or delay by Secured Party to exercise any right hereunder or waiver of any Event of Default of Debtor shall not operate as a waiver of any other right of further exercise of such right, or of any further default. 8. Parties Bound. Subject to Section 17 hereof, this Security Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective heirs, executors, administrators, legal representatives, successors, receivers, trustees and assigns. 9. Governing Law. This Security Agreement shall be governed by and construed and enforced in accordance with the Code (the definitions of which apply herein) and other applicable laws of the State of New York without giving effect to the principles of conflict of law of New York. 10. Notices. All notices, requests or communications required or permitted to be given hereunder shall be in writing and shall be deemed to have been properly given if (a) mailed by first-class United States mail, postage prepaid, registered or certified with return receipt requested, (b) delivered by a nationally recognized overnight delivery service with written confirmation of delivery, (c) delivered in person to the intended addressee, or (d) sent by facsimile transmission with confirmation of delivery. Any notice mailed as above provided will be effective upon its deposit in the custody of the U.S. Postal Service; all other notices will be effective upon receipt. All notices hereunder shall be given at the following addresses: -5- if to Debtor: Covol Technologies, Inc. 3280 North Frontage Road Lehi, Utah 84043 Facsimile: (801) 768-4483 Attention: Stanley M. Kimball if to Secured Party: Mountaineer Synfuel, L.L.C. 3280 North Frontage Road Lehi, Utah 84043 Facsimile: (801) 766-1979 Attention: Harlen M. Hatfield with copies to: MSDW Synfuels II, Inc. 1221 Avenue of the Americas 23rd Floor New York, New York 10020 Facsimile: (212) 762-6912 Attention: Debra M. Aaron and Fannie Mae 3900 Wisconsin Avenue, N.W. Washington, D.C. 20016-2892 Facsimile: (201) 752-6088 Attention: William E. Einstein Any such entity may change its address for notice hereunder to any other location within the continental United States by giving 30 days prior notice thereof to each other such entity in accordance with this Section 10. 11. Cumulative Rights. All rights of Secured Party under this Security Agreement and all related documents are cumulative of each other and of every other right which Secured Party may otherwise have at law or in equity or under any other contract or other writing for the enforcement of the security interest herein or the collection of the Indebtedness. The exercise of one or more rights shall not prejudice or impair the concurrent or subsequent exercise of other rights. 12. Continuing Security Interest; Obligations Absolute. This Security Agreement constitutes a continuing security interest in the Collateral, and shall remain in full force and effect until performance and indefeasible payment in full of the Indebtedness. The obligations of Debtor under this Security Agreement shall be absolute and unconditional and shall not be released, discharged, reduced or in any way impaired by any circumstance whatsoever, including without limitation any amendment, modification, extension or renewal of this Security Agreement, the Indebtedness or any document or instrument evidencing, securing or otherwise relating to the Indebtedness, or any release or subordination of collateral, or any waiver, consent, extension, indulgence, compromise, settlement or other action or inaction in respect of this Security Agreement, the Indebtedness or any document or instrument evidencing, securing or otherwise relating to the -6- Indebtedness or any exercise or failure to exercise any right, remedy, power or privilege in respect of the Indebtedness. 13. Amendment/Modification/Consent. This Security Agreement shall not be amended, supplemented, or otherwise modified, except by written consent signed by Secured Party and Debtor. No consent of Secured Party hereunder shall be effective unless approved in writing by MSDW Synfuels II, Inc. and Fannie Mae. 14. Severability. If any provision of this Security Agreement or any related documents is held to be illegal, invalid or unenforceable under present or future laws or regulations, that provision will be fully severable. The affected instrument, document or agreement shall be construed and enforced as if any the severed provision had never been a part thereof, and the remaining provisions shall remain in full force and effect and shall not be affected by the severed provision or by its severance therefrom. In lieu of the severed provision, there shall be added automatically as a part of the affected instrument, document or agreement a provision that is legal, valid and enforceable, and as similar in terms to the severed provision as may be possible. 15. Construction. If there is any conflict between the provisions hereof and the provisions of the Indebtedness, the latter shall control. The captions herein are for convenience of reference only and not for definition or interpretation. 16. Waiver of Debtor. Debtor hereby waives presentment, demand, notice of dishonor, protest, and notice of protest, and all other notices with respect to collection, or acceleration of maturity, of the Collateral and Indebtedness. 17. Assignment. This Security Agreement, the rights, powers and interests held by Secured Party hereunder may be transferred and assigned by Secured Party, in whole or in part, at such time and upon such terms as Secured Party may deem advisable, without the consent of Debtor. Debtor will not assign any of its rights, powers or interests hereunder without the prior written consent of Secured Party. 18. ENTIRE AGREEMENT. THIS WRITTEN AGREEMENT AND THE OTHER DOCUMENTS REFERENCED HEREIN OR CONTEMPLATED HEREBY REPRESENT THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES HERETO. THERE ARE NO UNWRITTEN ORAL AGREEMENTS AMONG THE PARTIES. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] -7- IN WITNESS WHEREOF, the parties hereby execute this Security Agreement effective as of the date first above written. DEBTOR: COVOL TECHNOLOGIES, INC., a Delaware corporation By:/Stanley M. Kimball/ ---------------------------------- Printed Name: Stanley M. Kimball Its: President SECURED PARTY: MOUNTAINEER SYNFUEL, L.L.C., a Delaware limited liability company By: /Harlan M. Hatfield/ ---------------------------------- Printed Name: Harlan M. Hatfield Its: Vice President -8- EX-10.52.6 4 LEASHOLD CREDIT LINE DEED OF TRUST Prepared by, and after recording return to: Michael S. Kosmas, Esquire Jones, Day, Reavis & Pogue 1450 G Street, N.W., Suite 600 Washington, D.C. 20005 LEASEHOLD CREDIT LINE DEED OF TRUST AND SECURITY AGREEMENT THIS LEASEHOLD CREDIT LINE DEED OF TRUST AND SECURITY AGREEMENT (this "Deed of Trust"), dated as of the 8th day of December, 1998, from COVOL TECHNOLOGIES, INC., a Delaware corporation, having an address at 3280 North Frontage Road, Lehi, Utah 84043 (the "Borrower"), to ________________ and ________________, each a resident of West Virginia, having an address at _____________________________________________________________ (collectively, together with their successors in such capacity, the "Trustee"), for the benefit of MOUNTAINEER SYNFUEL, L.L.C., a Delaware limited liability company, having an address at 3280 North Frontage Road, Lehi, Utah 84043 (the "Beneficiary"). WITNESSETH: WHEREAS, pursuant to a Deed of Ground Lease dated as of May 5, 1998 between Upshur Property, Inc. and the Borrower (the "Ground Lease"), the Borrower has acquired a leasehold estate in certain real property located in Upshur County, West Virginia, described on Exhibit A attached hereto (the "Real Property"). A Memorandum of Lease setting forth certain information with respect to the Ground Lease is recorded immediately prior hereto. WHEREAS, pursuant to a Promissory Note dated of even date herewith in an original maximum aggregate principal amount of NINE MILLION SEVEN HUNDRED FIFTY THOUSAND DOLLARS ($9,750,000.00) (the "Note"), the Borrower is indebted to the Beneficiary as more fully set forth therein. The amounts due from the Borrower to the Beneficiary pursuant to the Note are sometimes referred to hereinafter as the "Obligations". THIS IS A CREDIT LINE DEED OF TRUST SECURING THE PAYMENT OF THE MAXIMUM PRINCIPAL AMOUNT OF $9,750,000.00 WA: 1043170v4 197770-600002 Printed: 12-23-98 12:53 1 NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, and FOR THE PURPOSE OF SECURING the Obligations (the original maximum aggregate amount of principal to be secured at any one time by this Deed of Trust being $9,750,000.00), and the full and punctual performance and observance by the Borrower of all the covenants, agreements, terms and conditions set forth herein, the Borrower does hereby irrevocably grant, sell, release, convey, warrant, assign, transfer, mortgage, pledge, set over and confirm unto the Trustee, its successors and assigns, IN TRUST, WITH POWER OF SALE, for the benefit and security of the Beneficiary, under and subject to the terms and conditions hereinafter set forth, the following described property, to wit: All of the right, title and interest of the Borrower under the Ground Lease and in and to the Real Property (collectively, the "Property"); TOGETHER WITH all interests, estates or other claims, both in law and in equity, which the Borrower now has or may hereafter acquire in (i) the Property, (ii) all easements, rights-of-way and rights used in connection therewith or as a means of access thereto, and (iii) all tenements, hereditaments and appurtenances in any way belonging, relating or appertaining thereto; TOGETHER WITH all estate, right, title and interest of the Borrower now owned or hereafter acquired, in and to any land lying within the right-of-way of any street, open or proposed, adjoining to the Property, and any and all sidewalks, alleys, strips of land and gores adjacent to or used in connection therewith; TOGETHER WITH all estate, right, title and interest of the Borrower, now owned or hereafter acquired, in and to any and all buildings and other improvements now or hereafter erected on the Property (collectively, the "Improvements"); TOGETHER WITH all estate, right, title and interest of the Borrower now owned or hereafter acquired, in and to all inventory, machinery, apparatus, equipment, materials, supplies, goods, fittings, fixtures and articles of personal property now or hereafter located on or at the Property or used in connection therewith (including in connection with the construction, renovation, or improvement thereof) and all additions, and accessions thereto, replacements therefor and proceeds and profits thereof (collectively, the "Personal Property"); TOGETHER WITH all estate, claim, demand, right (including all rights to possession and use, all options and other rights to give consents, modify, amend, extend, renew, terminate or purchase or sell), title and interest of the Borrower under all contracts, agreements, understandings or arrangements, whether written or oral, now or hereafter in effect relating to the development, construction, reconstruction, repair, alteration, addition to, improvement, replacement, use, operation or management of the Property and as lessee or lessor under any leases or occupancy arrangements relating to the Property, whether oral or written, now or hereafter in effect (all of the foregoing, collectively, the "Agreements"), provided that any of the WA: 1043170v4 197770-600002 Printed: 12-23-98 12:53 2 Agreements that by their terms or by operation of law would become void, voidable or revocable if mortgaged, pledged or assigned hereunder or if a security interest therein were granted hereunder are expressly excepted and excluded from the lien of this Deed of Trust; TOGETHER WITH all right, claim, demand, title and interest of the Borrower in, to and under all permits, approvals, certificates, variances, orders, exemptions and other authorizations, including any condominium permits, approvals, certificates, variances, orders, assumptions and other authorizations now or hereafter issued, made or granted with respect to the development, construction, reconstruction, repair, alteration, addition, improvement, replacement, use, operation or management of the Property (collectively, the "Permits"), provided that any of the Permits that by their terms or by operation of law would become void, voidable or revocable if mortgaged, pledged or assigned hereunder or if a security interest therein were granted hereunder are expressly excepted and excluded from the lien of this Deed of Trust; TOGETHER WITH all reversion or reversions, remainder or remainders, rents, revenues, proceeds, issues, profits, royalties, income and other benefits of the Property, the Improvements, the Personal Property and the Agreements, and the Beneficiary is hereby authorized to collect and receive the same, to give proper receipts and acquittances therefor and to apply the same to the payment of the Obligations, notwithstanding the fact that the same may not then be due and payable; TOGETHER WITH all right, title and interest of the Borrower in and to (i) all proceeds of the insurance required to be maintained under section 1.04 of this Deed of Trust and (ii) all awards heretofore or hereafter made to the Borrower with respect to any part of the Property, the Improvements, the Agreements, or the Personal Property as the result of the exercise of the power of eminent domain, including any awards for changes of the grades of streets, or as the result of any other damage to any part of the Property, the Improvements, the Agreements or the Personal Property for which compensation shall be given by any governmental authority (a "Condemnation"), and the Trustee is hereby authorized to collect and receive the proceeds thereof to the extent of the right, title and interest of the Borrower, to give proper receipts and acquittances therefor, and, at the direction of the Beneficiary, to apply the same to the payment of the Obligations, notwithstanding the fact that the same may not then be due and payable; TOGETHER WITH any and all air rights, development rights, zoning rights or other similar rights or interests which benefit or are appurtenant to the Property or the Improvements or both and any proceeds arising therefrom; Permitting the said Borrower to use and occupy the Property and the Improvements, until an Event of Default shall have occurred and be continuing; All of the foregoing property is sometimes herein referred to as the "Trust Estate". WA: 1043170v4 197770-600002 Printed: 12-23-98 12:53 3 TO HAVE AND TO HOLD the Trust Estate, with all privileges and appurtenances thereunto belonging, to the Trustee and its successors in trust and, for the benefit of the Beneficiary and its successors and assigns forever. PROVIDED ALWAYS, if the Obligations shall be paid in full according to the terms and provisions hereof and of the Note, then this Deed of Trust and the lien and estate hereby granted shall cease, determine and be void. TO PROTECT THE SECURITY OF THIS DEED OF TRUST, THE BORROWER HEREBY COVENANTS AND AGREES AS FOLLOWS: ARTICLE I Particular Covenants and Agreements of the Borrower Section 1.01. Payment of the Obligations; Title, etc. The Borrower shall pay the Obligations according to the terms of the Note. The Borrower warrants and represents that the Borrower (i) is lawfully possessed of a leasehold estate in the Property and is lawfully possessed of a fee title estate in and to the Improvements and the Personal Property, subject to no liens or encumbrances, and (ii) has full power and lawful authority to grant, bargain, sell, release, convey, warrant, assign, transfer, mortgage, pledge, set over and confirm unto the Trustee and Beneficiary all right, title and interest of the Borrower in and to the Trust Estate. The Borrower also warrants and represents that this Deed of Trust is given to secure indebtedness incurred in connection with the carrying on of a commercial enterprise. Subject to the rights of the Borrower under this Deed of Trust, the Borrower shall forever defend the title to the Trustee in and to the Trust Estate and the validity of the lien and estate hereof against the claims and demands of all persons whomsoever. Section 1.02. Further Assurances. (a) The Borrower shall execute, acknowledge and deliver, from time to time, such further instruments as the Trustee or the Beneficiary may reasonably require to accomplish the purposes of this Deed of Trust. (b) The Borrower, immediately upon the execution and delivery of this Deed of Trust, and thereafter from time to time, shall cause this Deed of Trust, each supplement and amendment hereof (collectively, the "Recordable Document"), to be filed, registered or recorded and refiled, re-registered or re-recorded in such manner and in such places as may be required by any present or future law in order to publish notice of and perfect the lien and estate of this Deed of Trust upon the Trust Estate. The Borrower shall, from time to time, perform or cause to be performed any other act as required by law and shall execute or cause to be executed any and all WA: 1043170v4 197770-600002 Printed: 12-23-98 12:53 4 further instruments (including financing statements, continuation statements and similar statements with respect to any Recordable Document) (collectively, "UCC Documents") reasonably requested by the Trustee or the Beneficiary for such purposes. Without limiting the foregoing, not more than six months nor less than three months prior to the date on which any continuation statements are required to be filed with respect to any Recordable Document, the Borrower shall file all such continuation statements and send copies evidencing such filing to the Trustee and the Beneficiary. If the Borrower shall fail to execute any UCC Document by the date three (3) months prior to the date on which any continuation statement is required to be filed, the Beneficiary shall be and is hereby irrevocably appointed the agent and attorney-in-fact of the Borrower to execute such UCC Document. (c) The Borrower shall pay all filing, registration and recording fees, all refiling, re-registration and re-recording fees, and all expenses incident to the execution, acknowledgment and delivery of the Recordable Documents, and all Federal, State, county and municipal stamp taxes and other taxes, duties, imposts, assessments and charges arising out of or in connection with the execution, acknowledgment and delivery of the Recordable Documents. (d) The Borrower has not caused, accepted or permitted, and shall not cause, accept or knowingly permit, the disposal, release or threatened release on the Property of any hazardous substance, as that term is defined in the Comprehensive Environmental Response, Compensation and Liability Act of 1980, 42 U.S.C. ss. 9601, et seq., and to Borrower's knowledge no other owner, user or operator of the Property, past or present, has caused, accepted or permitted the disposal, release or threatened release of any hazardous substance on the Property. Section 1.03. Compliance with Legal Requirements. The Borrower shall comply with all laws, ordinances, regulations, covenants, conditions and restrictions now or hereafter affecting the Trust Estate or any part thereof (collectively, "Legal Requirements"); provided, however, that if the Borrower contests in good faith and by appropriate proceedings the validity or applicability of any Legal Requirement so that the enforcement thereof is stayed or provides the Beneficiary with security in such amount and in such form as the Beneficiary may require, in its reasonable discretion, then, in either such case, compliance with the Legal Requirement in question shall be suspended during the pendency of such contest. Section 1.04. Required Insurance. The Borrower shall at all times (i) keep the Trust Property insured for the benefit of Beneficiary, as its interests may appear, in an amount not less than one hundred percent (100%) of the full replacement cost of such Trust Property, (ii) carry and maintain or cause others to carry and maintain such liability and indemnity insurance as may be required from time to time by the Beneficiary, and (iii) carry and maintain or cause others to carry and maintain workers' compensation and disability insurance to the fullest extent required by law. Upon request of the Beneficiary, the originals of all such policies and renewals thereof, together with receipts satisfactory to the Beneficiary evidencing payment thereof, shall be delivered to and held by the Beneficiary. WA: 1043170v4 197770-600002 Printed: 12-23-98 12:53 5 Section 1.05. Insurance Proceeds. (a) After the happening of any casualty to the Property, the Improvements or the Personal Property or any part thereof, the Borrower shall give prompt notice thereof to the Beneficiary and the Trustee. (b) Any insurance proceeds shall be paid over promptly to the Beneficiary, and the Beneficiary, at its sole discretion, may apply such sums, in whole or in part, to the repair, restoration and replacement of the Property, the Improvements or the Personal Property, or to the payment of the indebtedness secured by this Deed of Trust in such order of priority as the Beneficiary shall determine. Section 1.06. Assignments of Policies Upon Foreclosure. In the event of foreclosure of this Deed of Trust or other transfer of title or assignment of the Trust Estate in extinguishment, in whole or in part, of the Obligations, to the extent permitted by the Borrower's policies of insurance, all right, title and interest of the Borrower in and to all policies of insurance shall inure to the benefit of and pass to the successors in interest to the Borrower or the purchaser or grantee of the Trust Estate or any part thereof. Section 1.07. Indemnification; Waiver of Offset. (a) If the Trustee or the Beneficiary is made a party defendant to any litigation concerning this Deed of Trust or the Trust Estate or any part thereof or interest therein, or concerning the occupancy thereof by the Borrower, and such litigation did not arise as a result of the gross negligence or willful misconduct of the Trustee or the Beneficiary, as the case may be, then the Borrower shall indemnify, defend and hold the Trustee or the Beneficiary, as the case may be, harmless from and against all liability by reason of said litigation, including reasonable attorneys' fees and expenses in any such litigation, whether or not any such litigation is prosecuted to judgment. If the Trustee or the Beneficiary in good faith commences an action against the Borrower to enforce any of the terms hereof or because of the breach by the Borrower of any of the terms hereof, or for the recovery of any of the Obligations, then the Borrower shall, to the extent permitted by law, pay to the Trustee or the Beneficiary, as the case may be, its reasonable attorneys' fees and expenses, and the right to such attorneys' fees and expenses shall be deemed to have accrued on the commencement of such action, and shall be enforceable whether or not such action is prosecuted to judgment, provided that the Borrower shall not be liable for any amounts to be paid in settlement unless Borrower has consented in writing to such settlement, which consent shall not be unreasonably withheld. If a Default shall occur and be continuing, the Trustee or the Beneficiary may employ an attorney or attorneys to protect its rights hereunder, and in the event of such employment following any Default by the Borrower, the Borrower shall, to the extent permitted by law, pay the reasonable attorneys' fees and expenses incurred by the Trustee or the Beneficiary, as the case may be, whether or not an action is actually commenced against the Borrower by reason of such Default. The Borrower will assume the defense of any action against the Trustee or the Beneficiary covered by the indemnification set forth in this Section, including the retaining of counsel selected by Borrower and the payment by the Borrower of reasonable counsel's fees and expenses relating to such defense and of the aggregate amount to be paid at settlement of any litigation if such settlement is effected with the written consent of the WA: 1043170v4 197770-600002 Printed: 12-23-98 12:53 6 Borrower. The Trustee and the Beneficiary shall have the right to retain separate counsel in any such action and to participate in the defense thereof, but the fees and expenses of such counsel shall be at the expense of the Trustee and/or the Beneficiary unless the retaining of such counsel has been specifically authorized in writing by the Borrower or the use of counsel chosen by the Borrower to represent the Trustee and/or the Beneficiary would present such counsel with a conflict of interest. (b) The Borrower hereby waives any and all right to claim or recover against the Trustee or the Beneficiary, or their respective officers, employees, agents and representatives, for loss of or damage to the Borrower, the Trust Estate, the property of the Borrower or the property of others under the control of the Borrower from any cause insured against or required to be insured against under this Deed of Trust unless arising from the gross negligence or willful misconduct of the Trustee or the Beneficiary. Section 1.08. Impositions. The Borrower shall pay, or, where a third party is responsible for payment, cause the payment by third parties, before any fine, penalty, interest or cost attaches thereto, all taxes, assessments, water and sewer rates, utility charges and all other governmental or nongovernmental charges or levies now or hereafter assessed or levied against the Property, the Improvements, the Personal Property or any other part of the Trust Estate or upon the lien or estate of the Trustee or the Beneficiary therein (collectively, "Impositions"), as well as all claims for labor, materials or supplies which, if unpaid, might by law become a prior lien thereon, and as soon as possible after request by the Trustee or the Beneficiary shall cause receipts showing payment of any of the foregoing to be exhibited; provided, however, that if by law any Imposition may be paid in installments (whether- or not interest shall accrue on the unpaid balance thereof), such Imposition may be paid in installments (together with accrued interest on the unpaid balance thereof) as the same respectively become due, before any fine, penalty or cost attaches thereto; provided further, however, that if the Borrower or other party responsible for payment contests in good faith and by appropriate proceedings the validity or applicability of any Imposition or claims for labor, materials or supplies and provides to the Beneficiary security in such amount and in such form as the Beneficiary may reasonably require, then, in either such case, compliance with the Imposition in question may be suspended during the pendency of such contest. Section 1.09. Limitations of Use. Without the consent of the Beneficiary, the Borrower shall not initiate, join in or consent to any change in any private restrictive covenant, zoning ordinance or other public or private restrictions limiting or defining the uses which may be made of the Property and the Improvements or any part thereof. Section 1.10. Encumbrances. The Borrower shall discharge all existing liens and encumbrances on the Property. Section 1.11. Estoppel Certificates. The Borrower shall upon request by the Beneficiary, but not more often than twice per calendar year, within twenty (20) days of such WA: 1043170v4 197770-600002 Printed: 12-23-98 12:53 7 request furnish to the Beneficiary a written statement, duly acknowledged, of the unpaid amount of the Obligations and whether any offsets or defenses exist against the Obligations. Section 1.12. Actions by Trustee and/or Beneficiary to Protect Trust Estate. If the Borrower shall fail to (i) perform and observe any of the terms, covenants or conditions required to be performed or observed by it; (ii) cause the insurance required by section 1.04 to be effected; (iii) make (or cause to be made) the payments required by section 1.02(c) or section 1.08; or (iv) perform or observe any other covenants or agreements to be performed or observed by the Borrower hereunder, the Trustee or the Beneficiary may, without obligation so to do, at any time after ten (10) days' written notice to the Borrower (except in any emergency) and for so long as such failure by the Borrower continues, effect, pay, perform or observe the same. Each sum, including reasonable attorneys' fees, so expended by the Trustee or Beneficiary or expended to sustain the lien and estate of this Deed of Trust or its priority, or to protect or enforce any of the rights of the Trustee or the Beneficiary under this Deed of Trust, shall (together with interest thereon from and including the date of expenditure of such sum until the same shall be paid in full at the rate of ten percent (10%) per annum (the "Default Rate")) be a lien on the Trust Estate, be deemed to be added to the Obligations, and be paid by the Borrower within ten (10) days after demand therefor. In any action or proceeding to enforce this Deed of Trust or to recover or collect the Obligations, the provisions of law respecting the recovery of costs, disbursements and allowances shall prevail unaffected by this covenant. Section 1.13. Condemnation. (a) If the Property, the Improvements or the Personal Property or any part thereof or interest therein, are taken or damaged by reason of any Condemnation, or if the Borrower receives any notice or other information regarding such proceeding, the Borrower shall give prompt notice thereof to the Beneficiary and the Trustee. (b) Subject to the rights of the landlord under the Ground Lease with respect to compensation in connection with any taking of all or part of the Property, all compensation, awards and other payments or relief in any condemnation (collectively, "Condemnation Proceeds") shall, at the option of the Beneficiary, be distributed first to the Beneficiary to be applied to the payment of the indebtedness secured by this Deed of Trust in such order of priority as the Beneficiary shall determine. The Beneficiary shall be entitled at its option to participate in any compromise or settlement in connection with such Condemnation, and the Borrower shall within ten (10) Business Days after request therefor, reimburse the Beneficiary for all out-of-pocket expenses (including reasonable attorneys' fees) incurred by the Beneficiary in connection with such participation. The Borrower shall not make any compromise or settlement in connection with any Condemnation without the approval of the Beneficiary. Section 1.14. Additional Security. If the Beneficiary at any time holds additional security for the Obligations, and if an Event of Default shall have occurred and be continuing, the Beneficiary may enforce the sale thereof or otherwise realize upon the same, at its option, either before or concurrently herewith or after a sale is made hereunder. WA: 1043170v4 197770-600002 Printed: 12-23-98 12:53 8 Section 1. 15. Disposition of Trust Estate. Notwithstanding any other provision hereof, and except with respect to the sale of inventory in the ordinary course of business, the Borrower shall not sell, assign, transfer, pledge or otherwise transfer or encumber or dispose of all or part of the Trust Estate, whether voluntary or by operation of law, except with the prior written consent of the Beneficiary. Section 1.16. Subordination of Leases. All leases or subleases entered into by the Borrower (or any other entity representing the Borrower or succeeding to the Borrower's position) in respect of the Property shall be subordinate to and subject to this Deed of Trust and shall contain a clause to that effect. Section 1.17. Hazardous Materials; Contamination. (a) The Borrower represents, warrants and covenants that (i) the Trust Estate and the business operations occurring thereon comply with all applicable federal, state and local environmental and hazardous waste laws and regulations; (ii) no enforcement actions are pending or threatened against the Trust Estate; (iii) to the best of its knowledge, during the period of its ownership of the Trust Estate, there has been no disposal, release or threatened release of hazardous substances, wastes or materials or environmental contaminants on, from or under the Trust Estate; (iv) it has no knowledge of (and has no reason to have knowledge of) any presence, disposal, release or threatened release of any hazardous substances, wastes or materials or environmental contaminants on, from or under the Trust Estate that may have occurred prior to the Borrower's acquisition of title to the Trust Estate; (v) neither it nor to the best of its knowledge any lessee under any lease has received any notice from any governmental agency of a violation of any environmental or hazardous waste law or regulation; (vi) it has not used and does not intend to use or to allow the Trust Estate to be used in a manner which would violate applicable federal, state and local environmental or hazardous waste laws or regulations; (vii) during the period of its ownership of the Trust Estate there has been no litigation or administrative enforcement actions or proceedings brought or, to its knowledge, threatened to be brought, nor has the Borrower reached any settlements with anyone alleging the presence, disposal, release or threatened release of any hazardous waste, substance or material or any environmental contaminant on, from or under the Trust Estate and (viii) it shall keep or cause the Trust Estate to be kept free of hazardous wastes. The terms "disposal", "release", "threatened release", "hazardous substances", "hazardous wastes" "hazardous materials" and "environmental contaminants" mean and include any hazardous, toxic or dangerous waste, substance, or material, or any disposal, discharge, release, or threatened release, or any term defined as such in (or for purposes of) the federal Comprehensive Environmental Response, Compensation, and Liability Act, as amended, the Resources Conservation and Recovery Act, as amended, the Federal Clean Water Act, as amended, the Federal Clean Air Act, as amended, the Emergency Planning and Community Right to Know Act, as amended, or any other federal, state or local statute, law, ordinance, code, rule, regulation, order or decree regulating, relating to, or imposing liability or standards of conduct concerning, any hazardous, toxic or dangerous waste, substance or material, as now or at any time hereafter may be in effect. WA: 1043170v4 197770-600002 Printed: 12-23-98 12:53 9 (b) The Borrower shall comply with all laws, ordinances, orders, rules and regulations of all federal, state, county and municipal governments and appropriate departments, commissions, boards and officers thereof which now are or at any time in the future may be (i) applicable to the Trust Estate or (ii) related to asbestos, radon, environmental conditions, environmental contaminants, toxic wastes, hazardous wastes, hazardous materials, solid wastes or similar matters (collectively, "Legal Requirements"). The Borrower shall indemnify and hold harmless the Trustee or the Beneficiary and their affiliates from and against all loss, cost, liability and expense. (x) in any manner arising out of or related to any violation of or failure to comply with any Legal Requirement, (y) imposed upon the Trustee or the Beneficiary, an affiliate of the Trustee or the Beneficiary or the Borrower by any Legal Requirement or (z) in any manner arising out of or related to the presence, use, storage, disposal or transport of any hazardous materials or environmental contaminants found in, on or under, or affixed to, or emanating from, the Trust Estate (including, without limitation, (i) all foreseeable and all unforeseeable damages, directly or indirectly arising out of the use, generation, storage or disposal of hazardous materials or environmental contaminant by the Borrower or any prior owner or operator of the Trust Estate, and (ii) all costs of any required or necessary repair, clean-up or detoxification and the preparation of any closure or other required plans), whether such action is required or necessary prior to or following transfer of title to the Trust Estate, to the full extent that such action is attributable, directly or indirectly, to the presence or use, generation, storage, release, threatened release or disposal of hazardous materials or environmental contaminants by any person on the Trust Estate; provided that this. sentence shall not apply to any loss, cost, liability or expense arising from the act of the Trustee or Beneficiary or the failure of the Trustee or the Beneficiary to act when legally required to do so. The foregoing indemnity shall survive the repayment in full of the Obligations. If any action or proceeding is brought against the Beneficiary in respect of or in connection with any of the foregoing indemnified matters, the Borrower shall upon notice from the Beneficiary defend such action or proceeding by counsel satisfactory to the Beneficiary. The Trust Estate shall at all times comply with all zoning, subdivision regulations, building restrictions and other Legal Requirements. (c) The Borrower, as promptly as possible upon request, but only if the Beneficiary has a good faith reason to believe that a problem exists, shall furnish to the Beneficiary a radon and/or other hazardous waste and/or other environmental contaminant inspection report, at the cost and expense of the Borrower, covering the Trust Estate (i) in form, scope and substance satisfactory to the Beneficiary and (ii) prepared by an inspector selected and commissioned by the Beneficiary. At the election of the Beneficiary, the Borrower shall remove, encapsulate or otherwise deal with any radon and/or other hazardous waste and/or other environmental contaminant on the Trust Estate at the Borrower's cost and expense in a manner reasonably satisfactory to the Beneficiary. Section 1.18. Deed of Trust Secures Future Advances. This Deed of Trust is a credit line deed of trust for the purposes of Section 38-1-14 of the West Virginia Code, and the aggregate principal amount of the loans or indebtedness secured by this Deed of Trust shall not exceed the maximum principal amount of $9,750,000.00, and this Deed of Trust is also security WA: 1043170v4 197770-600002 Printed: 12-23-98 12:53 10 for the payment of interest on such principal sums and for taxes, insurance premiums and other obligations, including interest thereon, undertaken by the Beneficiary or the Trustee (to the extent permitted by law) pursuant to the provisions of this Deed of Trust. THE INDEBTEDNESS SECURED HEREBY PROVIDES FOR NON-OBLIGATORY FUTURE ADVANCES PURSUANT TO THE TERMS OF THE NOTE NOT TO EXCEED THE MAXIMUM PRINCIPAL AMOUNT OF $9,750,000.00. ALL NOTICES OF LIENS, CLAIMS OR ENCUMBRANCES AGAINST THE PROPERTY COVERED HEREBY SHALL BE SENT TO THE BENEFICIARY AT THE ADDRESS SPECIFIED IN THE FIRST PARAGRAPH OF THIS DEED OF TRUST. ARTICLE II Security Agreement Section 2.01. Creation of Security Interest in the Trust Estate. The Borrower hereby grants to the Beneficiary a security interest in such portion of the Trust Estate that is not real property (including all of the Personal Property, the Agreements and the Permits) for the purpose of securing the Obligations. Section 2.02. Representations and Warranties of the Borrower. The Borrower hereby warrants, represents and covenants that: (a) the Personal Property is not used or bought for personal, family or household purposes; and (b) this Deed of Trust constitutes a Security Agreement as that term is used in the Uniform Commercial Code in effect in the State of West Virginia. Section 2.03. Fixture Fling. This instrument is to be filed for record in the real estate records of the County in which the Real Property is located so as to serve as a fixture filing pursuant to West Virginia Code Chapter 46, Article 9, Section 402. Section 2.04. Technology License. The Borrower hereby grants to the Beneficiary an irrevocable non-exclusive, royalty-free license to use the technology of the Borrower described on Exhibit B hereto at the Property at any and all times, but otherwise subject to the terms and conditions of the May 5, 1998 Technology License and Binder Purchase Agreement between the Borrower and the Beneficiary (i) during which an Event of Default has occurred and is continuing, or (ii) following a foreclosure pursuant to this Deed of Trust until such time as the Note and all obligations of the Borrower under the Deed of Trust and under any judgement obtained with respect to the Note or this Deed of Trust have been satisfied in full. WA: 1043170v4 197770-600002 Printed: 12-23-98 12:53 11 ARTICLE III Events of Default; Remedies; Etc. Section 3.01. Event of Default. Borrower shall be in default under this Agreement upon the occurrence and continuation of any of the following events or conditions (each, an "Event of Default"): (a) an "Event of Default" as specified and defined in the Note or in the Security Agreement of even date herewith between the Borrower and Mountaineer Synfuel, L.L.C. (b) any material default in the performance of any obligation of Borrower hereunder; and (c) levy or seizure, or attachment of any of the Trust Estate. Section 3.02. Remedies. (a) If an Event of Default shall have occurred and be continuing, this Deed of Trust may, to the extent permitted by law, be enforced as a deed of trust and the Trustee or the Beneficiary may exercise any right, power or remedy permitted to it hereunder or by law, and, without limiting the generality of the foregoing, the Trustee or the Beneficiary may, to the extent permitted by law: (i) enter and take possession of the Trust Estate or any part thereof, exclude the Borrower and all persons claiming under the Borrower whose claims are junior to this Deed of Trust, wholly or partly therefrom, and use, operate, manage and control the same as the Beneficiary shall deem best, and upon such entry, from time to time at the expense of the Trust Estate, make all such repairs, replacements, alterations, additions or improvements to the Trust Estate or any part thereof as the Beneficiary may deem proper; and (ii) personally or by agents, with or without entry, if the Beneficiary shall deem it advisable: (a) exercise THE POWER OF SALE granted by this Deed of Trust and sell all or any portion of the Trust Estate in accordance with applicable West Virginia law for cash in hand on the day of sale, unless otherwise WA: 1043170v4 197770-600002 Printed: 12-23-98 12:53 12 specified by the Beneficiary to the highest bidder at public auction at a sale or sales held at such place or places and time or times and upon such notice and otherwise in such manner as may be required by law, or in the absence of any such requirement, as the Beneficiary may deem appropriate and from time to time adjourn any such sale by announcement at the time and place specified for such sale or for such adjourned sale without further notice, except such as may be required by law; (b) proceed to protect and enforce its rights under this Deed of Trust, by suit for specific performance of any covenant contained herein, or in aid of the execution of any power granted herein, or for the foreclosure of this Deed of Trust and the sale of the Trust Estate under the judgment or decree of a court of competent jurisdiction, or for the enforcement of any other right as the Trustee or the Beneficiary shall deem most effectual for such purpose or; (c) exercise any or all of the remedies available to a secured party under the applicable Uniform Commercial Code, including: (1) either personally or by means of a court appointed receiver, take possession of all or any of the Trust Estate that is not real property and exclude therefrom the Borrower and all persons claiming under the Borrower and thereafter hold, store, use, operate, manage, maintain and control, make repairs, replacements, alterations, additions and improvements to and exercise all rights and powers of the Borrower in respect of all or any of the Trust Estate that is not real property. If the Beneficiary demands or attempts to take possession of all or any of the Trust Estate that is not real property in the exercise of any rights hereunder, the Borrower shall promptly turn over and deliver complete possession thereof to the Beneficiary; (2) without notice to or demand upon the Borrower make such payments and do such acts as the Beneficiary may deem necessary to protect its security interest in all or any of the Trust Estate that is not real property including paying, purchasing, contesting or compromising any encumbrance which is prior to or superior to the security interest granted hereunder, and in exercising any such powers or authority to pay all expenses incurred in connection therewith; (3) require the Borrower to assemble all or any of the Trust Estate that is not real property at a place designated by the WA: 1043170v4 197770-600002 Printed: 12-23-98 12:53 13 Beneficiary and convenient to both parties, and promptly to deliver it to the Beneficiary, or its designated agent or representative. The Beneficiary, and its agents and representatives, shall have the right to enter upon the premises and property of the Borrower to exercise the Beneficiary's rights hereunder; (4) sell, lease or otherwise dispose of all or any of the Trust Estate that is not real property at public sale, with or without having all or any of the Trust Estate that is not real property at the place of sale, and upon such terms and in such manner as the Beneficiary may reasonably determine (the Trustee or the Beneficiary may be a purchaser at any such sale); and (5) the Beneficiary shall give the Borrower at least ten (10) days' prior notice of the time and place of any public sale of all or any of the Trust Estate that is not real property or other intended disposition thereof. (b) If an Event of Default shall have occurred and be continuing, the Beneficiary, to the extent permitted by law, shall be entitled as a matter of right to the appointment of a receiver of the Trust Estate, without notice or demand, without the requirement for a bond, and without regard to the adequacy of the security for the Obligations or the solvency of the Borrower. The Borrower hereby irrevocably consents to such appointment and waives notice of any application therefor. Any such receiver or receivers shall have all the usual powers and duties of receivers in like or similar cases and all the powers and duties of the Beneficiary in case of entry as provided in section 3.01(a)(i) and shall continue as such and exercise all such powers until the date of confirmation of sale of the Trust Estate, unless such receivership is sooner terminated. (c) If an Event of Default shall have occurred and be continuing, the Borrower hereby also assents to the passage of a decree by a court of competent jurisdiction for the sale of the Trust Estate pursuant to the terms of this Deed of Trust and applicable West Virginia law. (d) In any sale under any provision of this Deed of Trust or pursuant to any judgment or decree of court, the Trust Estate, to the extent permitted by law, may be sold in one or more parcels or as an entirety and in such order as the Trustee or the Beneficiary may elect, without regard to the right of the Borrower, or any person claiming under the Borrower to the marshalling of assets. The purchaser at any such sale shall take title to the Trust Estate or the part thereof so sold free and discharged of the estate of the Borrower therein, the purchaser being hereby discharged from all liability to see to the application of the purchase money. Any person, including the Beneficiary and the Trustee, may purchase at any such sale. Upon the completion of any such sale made by the Trustee or the Beneficiary or by virtue of this Section 3.01, the Trustee shall execute and deliver to the purchaser an appropriate instrument which shall WA: 1043170v4 197770-600002 Printed: 12-23-98 12:53 14 effectively transfer all of the Borrower's and the Trustee's estate, right, title, interest, property, claim and demand in and to the Trust Estate or portion thereof so sold, but without any covenant or warranty, express or implied. The Trustee and the Beneficiary are hereby irrevocably appointed the attorneys-in-fact of the Borrower in its name and stead to make all appropriate transfers and deliveries of the Trust Estate or any portions thereof so sold and, for that purpose, the Beneficiary or the Trustee, or both, may execute all appropriate instruments of transfer, and may substitute one or more persons with like power, the Borrower hereby ratifying and confirming all that said attorneys or such substitute or substitutes shall lawfully do by virtue hereof. Any sale or sales made under or by virtue of this Deed of Trust, to the extent not prohibited by law, shall operate to divest all the estate, right, title, interest, property, claim and demand whatsoever, whether at law or in equity, of the Borrower in and to the Trust Estate, or any portions thereof so sold, and shall be a perpetual bar both at law and in equity against the Borrower and against any and all persons claiming or who may claim the same, or any part thereof, by through or under the Borrower. The powers and agency herein granted are coupled with an interest and are irrevocable. (e) In the event that foreclosure proceedings are instituted hereunder but are not completed, Trustee shall be reimbursed for all reasonable costs and expenses so incurred by Trustee, together with interest thereon until paid at the Default Rate. Section 3.03. Application of Proceeds. The proceeds of any enforcement of this Deed of Trust, including any sale made either under the power of sale hereby given or under a judgment, order or decree made in any action to foreclose or to enforce this Deed of Trust shall be applied as determined by the Beneficiary in a manner consistent with Section 38-1-7 of the Code of West Virginia, as from time to time amended. Section 3.04. Right to Sue. If an Event of Default has occurred and is continuing, the Trustee and the Beneficiary shall have the right from time to time to sue for any sums required to be paid by the Borrower under the terms of this Deed of Trust as the same become due, without regard to whether or not the Obligations shall be, or have become, due and without prejudice to the right of the Trustee or the Beneficiary thereafter to bring any action or proceeding of foreclosure or any other action upon the occurrence of any Event of Default existing at the time such earlier action was commenced. Section 3.05. Powers of the Trustee and the Beneficiary. (a) The Trustee or the Beneficiary may at any time or from time to time renew or extend this Deed of Trust, alter or modify the same in any way, or waive any of the terms, covenants or conditions hereof or thereof, in whole or in part, and may release or reconvey any portion of the Trust Estate or any other security, and grant such extensions and indulgences in relation to the Obligations, or release any person liable therefor as the Trustee or the Beneficiary may determine without the consent of any junior lien or WA: 1043170v4 197770-600002 Printed: 12-23-98 12:53 15 encumbrancer, without any obligation to give notice of any kind thereto, without in any manner affecting the priority of the lien and estate of this Deed of Trust on or in any part of the Trust Estate, and without affecting the liability of the Borrower or any other person liable for any of the Obligations; (b) No right or remedy herein conferred upon or reserved to the Trustee or the Beneficiary is intended to be exclusive of any other right or remedy, and each and every right and remedy shall be cumulative and in addition to any right or remedy under this Deed of Trust, and the failure of the Trustee or the Beneficiary to insist at any time upon the strict observance or performance of any of the provisions of this Deed of Trust, or to exercise any right or remedy provided for herein, shall not impair any such right or remedy nor be construed as a waiver or relinquishment thereof, and (c) The Trustee and the Beneficiary, and each of them, shall be entitled to enforce payment and performance of any of the Obligations and to exercise all rights and powers under this Deed of Trust or any laws now or hereafter in force, notwithstanding that some or all of the Obligations may now or hereafter be otherwise secured, whether by mortgage, deed of trust, pledge, lien, assignment or otherwise; neither the acceptance of this Deed of Trust nor its enforcement, whether by court action or pursuant to the power of sale or other powers herein contained, shall prejudice or in any manner affect the Trustee's or the Beneficiary's right to realize upon or enforce any other security now or hereafter held by the Trustee or the Beneficiary, it being stipulated that the Trustee and the Beneficiary, and each of them, shall be entitled to enforce this Deed of Trust and any other security now or hereafter held by the Trustee or the Beneficiary in such order and manner as they, in their sole discretion, may determine; every power or remedy given by this Deed of Trust to the Trustee or Beneficiary or to which either of them may be otherwise entitled, may be exercised, concurrently or independently, from time to time and as often as may be deemed expedient by the Beneficiary, and either of them may pursue inconsistent remedies. (d) The Trustee may act through its agent or attorney and it shall not be necessary for the Trustee to be present in person at any foreclosure sale under this Deed of Trust. Section 3.06. Waiver of Stay, Extension, Moratorium Laws; Equity of Redemption. To the extent permitted by law, the Borrower shall not at any time insist upon, or plead, or in any manner whatever claim or take any benefit or advantage of any applicable present or future stay, extension or moratorium law, which may affect observance or performance of any provision of this Deed of Trust; nor claim, take or insist upon any benefit or advantage of any present or future law providing for the valuation or appraisal of the Trust Estate or any portion thereof prior to any sale or sales thereof which may be made under or by virtue of Section 3.01; and the Borrower, to the extent that it lawfully may, hereby waives all benefit or advantage of any such law or laws. The Borrower for itself and all who may claim under it, hereby waives, to the extent permitted by applicable law, any and all rights and equities of redemption from sale WA: 1043170v4 197770-600002 Printed: 12-23-98 12:53 16 under the power of sale created hereunder or from sale under any order or decree of foreclosure of this Deed of Trust and (if an Event of Default shall have occurred and be continuing) all notice or notices of seizure, and all right to have the Trust Estate marshalled upon any foreclosure hereof. Neither the Trustee nor the Beneficiary shall be obligated to pursue or exhaust its rights or remedies as against any other part of the Trust Estate nor shall the Borrower have the right to have the Trustee or the Beneficiary proceed in any particular order. ARTICLE IV The Trustee Section 4.01. Acceptance by Trustee. The Trustee accepts this trust when this Deed of Trust, duly executed and acknowledged, is made a public record as provided by law. Section 4.02. Compensation. The Trustee waives any statutory fee and shall accept reasonable compensation from the Beneficiary in lieu thereof for any services rendered by it in accordance with the terms hereof. Section 4.03. Action in Accordance With Instructions. Upon receipt by the Trustee of instructions from the Beneficiary at any time or from time to time, the Trustee shall (a) give any notice or direction or exercise any right, remedy or power hereunder or in respect of any part or all of the Trust Estate as shall be specified in such instructions and (b) approve such direction or exercise as satisfactory to the Trustee or to the Beneficiary. The Trustee may, but need not, take any of such actions in the absence of such instructions. At any time or from time to time, upon request of the Beneficiary and presentation of this Deed of Trust for endorsement, and without affecting the liability of any person for payment of the Obligations, the Trustee shall reconvey all or any part of the Trust Estate, consent to the making of any map or plat thereof, join in granting any easement thereon, or join in any extension agreement or any agreement subordinating the lien and estate hereof. If there is at any time more than one person or entity serving as Trustee hereunder, either of them or any successor of either of them may act on behalf of the Trustee. Section 4.04. Resignation. The Trustee may resign at any time upon giving not less than 60 days' prior notice to the Beneficiary, but shall continue to act as trustee until its successor shall have been chosen and qualified. Section 4.05. Successor Trustee. In the event of the death, removal, resignation or refusal or inability of the Trustee to act, or for any reason at any time, the Beneficiary shall have the irrevocable power, with or without cause, without prior notice of any kind, and without applying to any court, to select and appoint a successor trustee. Each such appointment and substitution shall be made by notice to the Borrower, the Trustee and successor trustee and by recording notice of such in each office in which this Deed of Trust is recorded. Such notice shall WA: 1043170v4 197770-600002 Printed: 12-23-98 12:53 17 be executed and acknowledged by the Beneficiary and shall be conclusive proof of proper appointment of the successor trustee. Such successor shall not be required to give bond for the faithful performance of its duties unless required by the Beneficiary. ARTICLE V Miscellaneous Section 5.01. Release by Trustee. Upon payment by Borrower of the Obligations and the Trustee's expenses, the Trustee shall release this Deed of Trust by an instrument duly acknowledged, in form for recording. Section 5.02. Notices. All notices, requests, demands, consents, approvals or other communications to, upon or by any party hereto shall be sent to the parties at the addresses set forth in the first paragraph of this Deed of Trust or at such other address as may be specified in writing to the parties. The address of the Beneficiary as specified is the address for the party secured by this Deed of Trust. Section 5.03. Amendments, Waivers, Etc. This Deed of Trust cannot be modified, changed or discharged except by an agreement in writing, duly acknowledged in form for recording, signed by the party against whom enforcement of such modification, change or discharge is sought. No amendment shall be deemed approved by or consented to by or effective against the Beneficiary unless approved in writing by MSDW Synfuels II, Inc. and Fannie Mae. Section 5.04. Successors and Assigns. This Deed of Trust shall bind and inure to the benefit of the parties hereto and their respective successors and assigns and shall run with the Property, except that the Borrower may not assign its rights or delegate its obligation hereunder without the prior consent of the Beneficiary. Section 5.05. Severability. If any term or provision of this Deed of Trust or the application thereof to any person or circumstance shall to any extent be invalid or unenforceable, the remainder of this Deed of Trust, or the application of such term or provision to persons or circumstances other than those as to which it is invalid or unenforceable, shall not be affected thereby, and each term and provision of this Deed of Trust shall be valid and enforceable to the fullest extent permitted by law. Should this Deed of Trust be or become ineffective as a deed of trust, then it shall be construed and enforced as a realty mortgage with the Borrower being the mortgagor and the Beneficiary being the mortgagee. Section 5.06. No Merger. If both the lessor's and lessee's estates under any lease or any portion thereof which constitutes a part of the Trust Estate shall at any time become vested in one owner, this Deed of Trust and the lien and estate created hereby shall not be destroyed or terminated by application of the doctrine of merger and, in such event, the Beneficiary shall WA: 1043170v4 197770-600002 Printed: 12-23-98 12:53 18 continue to have and enjoy all of the rights and privileges of the Beneficiary as to the separate estates. In addition, upon foreclosure of this Deed of Trust, any such lease shall not be destroyed or terminated by application of the law of merger or as a matter of law or as a result of such foreclosure unless the Beneficiary or any purchaser at such foreclosure sale shall so elect. Section 5.07. Limitation of Interest. It is the intention of the Borrower and the Beneficiary in the execution of the Note to contract in strict compliance with all applicable usury laws. In furtherance thereof, the Beneficiary and the Borrower stipulate that none of the terms and provisions contained in the Note shall ever be construed to create a contract for the use, forbearance or detention of money requiring payment of interest at a rate in excess of the maximum interest rate permitted to be charged by applicable law. The Borrower shall never be liable for unearned interest on the Obligations and shall never be required to pay interest thereon at a rate in excess of the maximum interest which may be lawfully charged under applicable usury laws and this Section 5.07 shall control over all other provisions of the Note executed in connection herewith or therewith which may be in apparent conflict herewith. If the Beneficiary shall collect monies which are deemed to constitute interest which would otherwise increase the effective interest rate on the Obligations to a rate in excess of that permitted to be charged by applicable usury laws, all such sums deemed to constitute interest in excess of the legal rate shall be immediately returned to the Borrower upon such determination. Section 5.08. Trust is Irrevocable. The trust created hereby is irrevocable by the Borrower subject to defeasance in accordance with this Deed of Trust. Section 5.09. Governing Law. This Deed of Trust shall be governed by and interpreted in accordance with the law of the State of West Virginia. Section 5. 10. Beneficial Owner. The beneficial owner and holder of the Obligations at the time of execution and delivery hereof is the Beneficiary, whose resident address is stated in the first paragraph of this Deed of Trust. Section 5.11. Status of Parties. It is understood and agreed that the relationship of the Borrower and the Beneficiary is that of borrower and lender and that nothing herein or in the Note or any document evidencing or securing the same shall be construed to constitute a partnership, joint venture or co-tenancy among the Borrower or the Beneficiary. [Signatures begin on next page.] WA: 1043170v4 197770-600002 Printed: 12-23-98 12:53 19 IN WITNESS WHEREOF, this Deed of Trust has been duly executed, acknowledged and delivered by the Borrower as of the day and year first above written. COVOL TECHNOLOGIES, INC. [SEAL] By: /Stanley M. Kimball/ ------------------------ Name: Stanley M. Kimball Title: President State of _______Utah________) City/County of _Utah________________), to wit: On this _8th_ day of December, 1998, before me, __Asael T. Sorensen, Jr._, a notary public in and for the above-said jurisdiction, personally appeared ___________________, personally known to me (or proved to me on the basis of satisfactory evidence) to be the person whose name is subscribed to the within instrument as __President_________ of Covol Technologies, Inc., the company which executed and delivered the within instrument and acknowledged to me that, being informed of the contents thereof, he executed and delivered the same, voluntarily in his capacity as such, for the purposes therein stated, on behalf of said company as the free act and deed of said company. IN WITNESS WHEREOF, I have hereunto set my hand and affixed my official seal the day and year in this certificate first above written. [SEAL] /Asael T. Sorensen, Jr./ Notary Public This Deed of Trust was prepared by: Michael S. Kosmas, Esq. Jones, Day, Reavis & Pogue 1450 G Street, N.W., Suite 600 Washington, D.C. 20005 WA: 1043170v4 197770-600002 Printed: 12-23-98 12:53 20 EX-10.52.7 5 AMEND NO 1 TO DEED OF GROUD LEASE W/ UPSHUR AMENDMENT NO. 1 TO DEED OF GROUND LEASE THIS AMENDMENT NO. 1 TO DEED OF GROUND LEASE (this "Amendment"), dated as of the 8th day of December, 1998, by and between UPSHUR PROPERTY, INC., a Delaware corporation (the "Landlord") and COVOL TECHNOLOGIES, INC., a Delaware corporation (the "Tenant"). WHEREAS, the Landlord and the Tenant are parties to that certain Deed of Ground Lease dated as of May 5, 1998 (the "Lease"); and WHEREAS, the Landlord and the Tenant desire to amend the terms of the Lease as set forth herein. NOW, THEREFORE, in consideration for Ten Dollars ($10.00) cash in hand paid by Tenant to Landlord, the receipt and sufficiency of which is hereby acknowledged, the Landlord and the Tenant agree to amend the terms of the Lease as follows: 1. Section 6.1 of the Lease is hereby deleted in its entirety and replaced with the following: "Section 6.1 Right to Mortgage. Except for that certain Leasehold Credit Line Deed of Trust and Security Agreement, dated as of December 8, 1998, from Covol Technologies, Inc. to ______________________, as Trustee, for the Benefit of Mountaineer Synfuel, L.L.C. (the "Mountaineer Leasehold Deed of Trust"), the Tenant shall not grant, or cause to be created, any deed of trust or other lien, encumbrance or security interest on or in all or any part of this Lease or Tenant's interest in the Premises. Tenant hereby covenants and agrees that it will not agree to amend, change or alter the Mountaineer Leasehold Deed of Trust without first obtaining the express written consent of the Landlord, which consent may be withheld for any reason." 2. Section 9.1(f) of the Lease is hereby deleted in its entirety and replaced with the following: "(f) Mountaineer fails to exercise its option to purchase the Facility and to require Tenant to assign this Lease to Mountaineer prior to March 31, 1999." 3. Except as expressly set forth herein, all of the terms and conditions of the Lease shall remain in full force and effect. IN WITNESS WHEREOF, the parties have caused this Amendment to be executed by their duly authorized representatives as of the day and year first above written. UPSHUR PROPERTY, INC., a Delaware corporation By: /Michael M. Matesic/ ------------------------- Name: Michael M. Matesic Its: Treas. COVOL TECHNOLOGIES, INC., a Delaware corporation By: /Stanley M. Kimball/ ------------------------- Name: Stanley M. Kimball Its: President 2 EX-10.53.1 6 DEBENTURE AGREEMENT & SECURITY AGREEMENT COVOL TECHNOLOGIES, INC. DEBENTURE AGREEMENT AND SECURITY AGREEMENT January 9, 1998 TABLE OF CONTENTS Section Page 1. Loans; Terms and Conditions; Issuance of Debenture and Warrants..........1 1.1 Loans...........................................................1 1.2 Terms and Conditions............................................1 1.3 Issuance of Debenture and Warrants..............................1 2. Representations, Warranties and Covenants of the Company.................1 2.1 Corporate Existence; Compliance with Law........................1 2.2 Corporate Power; Authorization; Enforceable Obligations.........2 2.3 Authorization and Valid Issuance of Debenture and Warrants......2 2.4 Securities Laws.................................................3 2.5 Disclosure......................................................3 2.6 Authorized and Outstanding Shares of Capital Stock..............3 2.7 Ownership of Property; Liens....................................3 2.8 Patents, Trademarks, Copyrights and Licenses....................3 2.9 No Material Adverse Effect......................................3 2.10 Environmental Laws..............................................4 2.11 Use of Proceeds.................................................4 3. Representations, Warranties and Covenants of the Investor................4 3.1 Purchase Entirely for Own Account...............................4 3.2 Disclosure of Information.......................................4 3.3 Investment Experience...........................................4 3.4 Restricted Securities...........................................4 3.5 Legends.........................................................5 3.6 Accredited Investor.............................................5 4. Valuation of Warrants....................................................5 4.1 Value of Warrants...............................................5 4.2 Financial and Tax Reporting.....................................5 4.3 Issue Price.....................................................5 4.4 Interpretation..................................................5 5. Security Agreement.......................................................6 5.1 Security Interest...............................................6 5.2 Collateral......................................................6 5.3 Perfection and Priority.........................................6 5.4 Affirmative Covenants...........................................6 5.5 Negative Covenants..............................................7 5.6 Insurance; Payment of Premiums..................................7 i 5.7 Remedies Upon Default...........................................8 6. Conditions Precedent.....................................................9 6.1 Execution and Delivery of Agreement.............................9 6.2 Documents and Other Agreements..................................9 6.3 Absence of Material Adverse Change.............................10 6.4 Conditions to the Closing.....................................10 7. Miscellaneous...........................................................10 7.1 Survival of Warranties.........................................10 7.2 Successors and Assigns.........................................10 7.3 Governing Law..................................................11 7.4 Counterparts...................................................11 7.5 Titles and Subtitles...........................................11 7.6 Notices........................................................11 7.7 Expenses.......................................................11 7.8 Amendments and Waivers.........................................11 7.9 Severability...................................................11 7.10 Indemnity......................................................11 7.11 Waiver of Trial by Jury........................................12 7.12 Entire Agreement...............................................12 ii DEBENTURE AGREEMENT AND SECURITY AGREEMENT THIS DEBENTURE AGREEMENT AND SECURITY AGREEMENT is made as of the 9th day of January, 1998, by and among COVOL TECHNOLOGIES, INC., a Delaware corporation (the "Company"), and AJG FINANCIAL SERVICES, INC., a Delaware corporation ("Investor"). THE PARTIES HEREBY AGREE AS FOLLOWS: 1. Loans; Terms and Conditions; Issuance of Debenture and Warrants. 1.1 Loans. During the period July 17, 1997, to and including January 9, 1998, Investor provided debt financing in the form of loans ("Loans") to the Company for use by the Company in the construction of the Wash Plant at the Company's facility at Wellington, Utah. The aggregate principal amount of the Loans, together with accrued interest thereon, is $4,367,351.28. 1.2 Terms and Conditions. This Agreement confirms the terms and conditions upon which Investor made the Loans to the Company. 1.3 Issuance of Debenture and Warrants. To evidence the aggregate outstanding principal amount of the Loans made by Investor to the Company, together with interest thereon to the date hereof, the Company shall issue to Investor, concurrently with the execution and delivery of this Agreement (the "Closing"), the Company's Debenture in the form set forth in Exhibit A hereto, and the Company's Warrants (one designated Warrant A and the other designated Warrant B) evidencing rights to purchase initially up to an aggregate of 432,544 shares of Common Stock of the Company. The Debenture shall replace the Company's Promissory Note, dated January 9, 1998, payable to the order of Investor in the principal amount of $4,325,432.79, and such Promissory Note shall be marked "replaced by Debenture dated January 9, 1998", and delivered to the Company. 2. Representations, Warranties and Covenants of the Company. The Company hereby represents, warrants and covenants to Investor that: 2.1 Corporate Existence; Compliance with Law. The Company (i) is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware; (ii) is duly qualified as a foreign corporation and in good standing under the laws of each jurisdiction where its ownership or lease of property or the conduct of its business requires such qualification; (iii) has the requisite corporate power and authority and the legal right to own, pledge, mortgage or otherwise encumber and operate its properties, to lease the property it operates under lease, and to conduct its business as now, heretofore and proposed to be conducted; (iv) has all material licenses, permits, consents or approvals 1 from or by, and has or will have made all material filings with, and has or will have given all material notices to, all governmental authorities having jurisdiction, to the extent required for such ownership, operation and conduct; (v) is in compliance with its certificate of incorporation and by-laws; and (vi) is in compliance with all applicable provisions of law, including, without limitation, the Employee Retirement Income Security Act of 1974, as amended, those regarding the collection, payment and deposit of employees' income, unemployment and Social Security taxes, and those relating to environmental matters where the failure to comply could reasonably be expected to have a material adverse effect on the business of the Company. 2.2 Corporate Power; Authorization; Enforceable Obligations. The execution, delivery and performance by the Company of this Agreement and the Debenture (i) are within the Company's corporate power; (ii) have been duly authorized by all necessary or proper corporate action; (iii) are not in contravention of any provision of the Company's certificate of incorporation or by-laws; (iv) will not violate any law or regulation, or any order or decree of any court or governmental instrumentality; (v) will not conflict with or result in the breach or termination of, constitute a default under, or accelerate any performance required by, any indenture, mortgage, deed of trust, lease, agreement or other instrument to which the Company is a party or by which the Company or any of its property is bound (except such conflict, breach, termination, default or acceleration as could not reasonably be expected to have a material adverse effect on the business of the Company); (vi) will not result in the creation or imposition of any lien upon any of the property of the Company other than those in favor of the Investor; and (vii) do not require the consent or approval of any governmental body, agency, authority or any other Person. At or prior to the Closing, each of the documents to be delivered at such time shall have been duly executed and delivered for the benefit of or on behalf of the Company, and each shall then constitute a legal, valid and binding obligation of the Company to the extent it is a party thereto, enforceable against it in accordance with its terms, subject to the effects of laws governing creditors rights generally and general principles of equity. 2.3 Authorization and Valid Issuance of Debenture and Warrants. All corporate action on the part of the Company and its officers, directors and stockholders necessary for the authorization, issuance and delivery of the Debenture being issued hereunder and the reservation for issuance of shares of Common Stock issuable upon exercise of the Warrants have been taken or will be taken prior to the Closing, and this Agreement, the Debenture and the Warrants shall then constitute valid and legally binding obligations of the Company, each enforceable in accordance with its terms. The Debentures which are being acquired by the Investor, when issued and delivered in accordance with the terms hereof for the consideration expressed herein, will be duly and validly issued. The Common Stock issuable upon exercise of the Warrants has been duly and validly reserved for issuance and, upon issuance in accordance with the terms of the Warrants and the Company's Certificate of Incorporation, shall be duly and validly issued, fully paid and 2 nonassessable, and issued in compliance with all applicable federal and state securities laws, as currently in effect. 2.4 Securities Laws. In reliance on the investment representations contained in Section 3.1 hereof, the offer, issuance, sale and delivery of the Warrants, as provided in this Agreement, is exempt from the registration requirements of the Securities Act of 1933, as amended, and the rules and regulations thereunder, and all applicable state securities laws. 2.5 Disclosure. The Company's Form 10-K for the fiscal year ended September 30, 1997, and all other written information furnished to Investor did not, as of the date of such information, contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements therein not misleading. 2.6 Authorized and Outstanding Shares of Capital Stock. After giving effect to the Closing, the authorized capital stock of the Company consists of 50,000,000 shares of Common Stock, $0.001 par value, of which11,326,404 Shares are issued and outstanding. Except for (i) the Warrants and (ii) rights to acquire 5,104,518 Shares (a) no subscription, warrant, option or other right to purchase or acquire any shares of any class of capital stock is authorized or outstanding, and (b) there is no commitment of the Company to issue any such shares, warrants, options or other such rights or securities. 2.7 Ownership of Property; Liens. The Company owns good and merchantable title to, or valid leasehold interests in, all of its properties and assets; and the Company has received all deeds, assignments, waivers, consents, non-disturbance and recognition or similar agreements, bills of sale and other documents, and duly effected all recordings, filings and other actions necessary to establish, protect and perfect the Company's right, title and interest in and to all such property to the extent necessary to use such property in its ordinary business operations. 2.8 Patents, Trademarks, Copyrights and Licenses. The Company owns all material licenses, patents, patent applications, copyrights, service marks, trademarks, trade mark applications, and trade names necessary to continue to conduct its business as heretofore conducted by it, now conducted by it and proposed to be conducted by it, each of which is listed, together with Patent and Trademark Office application or registration numbers, where applicable, on Schedule 2.8 hereto. The Company conducts its businesses without infringement or claim of infringement of any license, patent, copyright, service mark, trademark, trade name, trade secret or other intellectual property right of others. To the best knowledge of the Company, there is no infringement or claim of infringement by others of any material, license, patent, copyright, service mark, trademark, trade name, trade secret or other intellectual property right of the Company. 3 2.9 No Material Adverse Effect. Except as disclosed on Schedule 2.9 hereto, no event has occurred since September 30, 1997, and is continuing which has had or could reasonably be expected to have a material adverse effect on the business, assets, properties, operations, prospects or financial or other condition of the Company. 2.10 Environmental Laws. All premises and facilities owned, leased, used or operated by the Company or, to the knowledge of any executive officer of the Company after a reasonable investigation, any predecessor in interest, have been, and continue to be, owned, leased, used or operated in compliance in all material respects with all applicable environmental laws. 2.11 Use of Proceeds. The proceeds of the loans by Investor to the Company were used for the construction of the Wash Plant at the Company's facility at Wellington, Utah. 3. Representations, Warranties and Covenants of the Investor. Investor hereby represents and warrants that: 3.1 Purchase Entirely for Own Account. Investor hereby confirms that the Debenture and the Warrants to be received by Investor hereunder and the Common Stock issuable upon exercise of the Warrants (collectively, the "Securities") will be acquired for Investor's own account and not with a view to the resale or distribution of any part thereof, and that Investor has no agreement or arrangement with regard to or present intention of selling, granting any participation in, or otherwise distributing the same; provided, however, notwithstanding the foregoing, Investor may effect transactions in reliance on Rule 144A promulgated under the Securities Act of 1933, as amended (the "Act"). 3.2 Disclosure of Information. Investor has received all the information it considers necessary or appropriate for deciding whether to purchase the Securities being issued hereunder. Investor further represents that it has had an opportunity to ask questions and receive answers from the Company regarding the terms and conditions of the sale of the Securities. 3.3 Investment Experience. Investor acknowledges that it is able to fend for itself, can bear the economic risk of its investment and has such knowledge and experience in financial or business matters that it is capable of evaluating the merits and risks of the investment in the Securities being issued hereunder. 3.4 Restricted Securities. Investor understands that the Debenture and the shares of Common Stock issuable upon exercise of the Warrants it is acquiring pursuant hereto are characterized as "restricted securities" under the federal securities laws inasmuch as each is being acquired from the Company in a transaction not involving a public offering and that under such laws and applicable regulations such securities may be resold without registration under the Act only in certain limited circumstances. In this connection, Investor represents 4 that it is familiar with Rule 144 under the Act, as presently in effect, and understands the resale limitations imposed thereby and by the Act. 3.5 Legends. It is understood that the Debenture and the Warrants being issued hereunder and the Common Stock issuable upon exercise of the Warrants will bear a legend substantially similar to the following: "THIS SECURITY HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), OR REGISTERED OR OTHERWISE QUALIFIED FOR SALE UNDER ANY APPLICABLE STATE SECURITIES LAWS AND MAY NOT BE TRANSFERRED OR SOLD OR OFFERED FOR SALE OR OTHERWISE TRANSFERRED, PLEDGED, HYPOTHECATED OR DISPOSED OF UNLESS IT HAS BEEN REGISTERED UNDER THE ACT AND REGISTERED OR OTHERWISE QUALIFIED FOR SALE UNDER SUCH STATE SECURITIES LAWS OR AN EXCEPTION FROM REGISTRATION THEREUNDER IS AVAILABLE." 3.6 Accredited Investor. Investor is an Accredited Investor within the definition set forth in Rule 501(a) under the Act. 4. Valuation of Warrants. 4.1 Value of Warrants. The fair market value of Warrant A as of the date hereof is $1,000.00 and the fair market value of Warrant B as of the date hereof is $100.00, and accordingly, of the $4,367,351.28 stated principal amount of the Debenture, $1,100.00 is to be provided by Investor to the Company for the Warrants. Said fair market value was determined by the parties based on comparisons with comparable warrants of other issuers and Investor's customary investment considerations for equity and debt financing of such kind. 4.2 Financial and Tax Reporting. The Company and Investor shall prepare their respective financial accounting statements, and shall prepare and file their respective Federal (as well as state and local) income tax returns, in a manner consistent with the foregoing allocation of the stated principal amount of the Debenture between the Debenture and the Warrants, including but not limited to Investor's tax basis in the Warrants and Debenture in accordance with Section 1.1012(d) of the Treasury Regulations. 4.3 Issue Price. The "issue price" (within the meaning of Section 1272(b) of the Internal Revenue Code of 1986 (the "Code")) of the Debenture shall be equal to $4,366,251.28. 5 4.4 Interpretation. No provision in this Agreement shall be interpreted, alone or in conjunction with any other agreement between or among Investor and the Company, or either of them (i) to alter the amount of the exercise price of the Warrants or to alter any rights granted to Investor in conjunction with the Warrants, or (ii) to limit or impair in any way the rights of Investor under the Warrants, this Agreement, the Debenture or any other agreement. 5. Security Agreement. Payment of the Debenture shall be secured to the extent described below: 5.1 Security Interest. The Company hereby grants to Investor a security interest in the property and its proceeds described in Section 5.2 herein to secure the Company's obligations under the Debenture (the "Security Interest"). 5.2 Collateral. The property in which the Security Interest is granted (the "Collateral") consists of a continuing interest in the following: the Wash Plant at the Company's facility at Farnum Road, Wellington, Utah, and all machinery and equipment which is a part thereof, including the machinery and equipment described on Schedule 5.2 hereto and all processing equipment, conveyors, data processing and computer equipment with software and peripheral equipment, tools, attachments, accessories, and other equipment of every kind and nature, whether now owned or hereafter acquired, together with all additions and accessions thereto, replacements therefor, all parts therefor, all substitutions for any of the foregoing, fuel therefor, and all manuals, drawings, instructions, warranties and rights with respect thereto, and all products and proceeds thereof and condemnation awards and insurance proceeds with respect thereto. 5.3 Perfection and Priority. The Security Interest grant herein shall be a first priority lien on the Collateral, subject to no other liens, claims or rights of others. 5.4 Affirmative Covenants. The Company covenants that it shall: (a) Keep and maintain all Collateral consisting of equipment and machinery in good operating condition and repair; make all necessary replacements thereof so that the value and operating efficiency thereof shall at all times be maintained and preserved; promptly inform Investor of any additions to or deletions from such equipment and machinery; and prevent any such equipment and machinery from becoming a fixture to real estate or accession to other personal property; (b) Promptly discharge any liens, encumbrances or other claims against the Collateral; (c) Maintain such insurance as may be required by law and such other insurance to such extent and against such hazards and liabilities as is customarily 6 maintained by companies similarly situated, and include Investor as an additional insured on all liability policies; and (d) Comply strictly and in all respects with all applicable environmental laws. 5.5 Negative Covenants. The Company covenants that it shall not, without Investor's prior written consent, which Investor may or may not in its sole discretion give: (a) Enter into any transaction which materially and adversely affects the Collateral or the Company's ability to repay the indebtedness under the Debenture; (b) Remove the Collateral from the Company's facility at Wellington, Utah, or keep the Collateral at any other location unless (i) the Company gives Investor written notice thereof and of the new location of the Collateral at least thirty (30) days prior thereto, and (ii) the other location is within the continental United States of America; or (c) Create or permit any lien on any of the Collateral, other than liens created hereunder. 5.6 Insurance; Payment of Premiums. The Company shall, at its sole cost and expense, keep and maintain the Collateral insured for its full insurable value against loss or damage by fire, theft, explosion, sprinklers and all other hazards and risks ordinarily insured against by other owners or users of such properties in similar businesses and notify Investor promptly of any occurrence causing a material loss or decline in value of the Collateral and the estimated (or actual, if available) amount of such loss or decline. All policies of insurance on the Collateral shall be in form and with insurers recognized as adequate by prudent business persons and all such policies shall be in such amounts as may be satisfactory to Investor. The Company shall deliver to Investor a certificate of insurance and, upon request, the original (or certified copy) of each policy of insurance, and evidence of payment of all premiums therefor. Such policies of insurance shall contain an endorsement, in form and substance acceptable to Investor, showing loss payable to Investor, as its interests may appear. Such endorsement, or an independent instrument furnished to Investor, shall provide that the insurance companies will give Investor at least thirty (30) days prior written notice before any such policy or policies of insurance shall be altered or canceled and that no act or default of the Company or any other person shall affect the right of Investor to recover under such policy or policies of insurance in case of loss or damage. The Company hereby directs all insurers under such policies of insurance to pay all proceeds payable thereunder directly to Investor, as its interests may appear. The Company irrevocably makes, constitutes and appoints Investor (and all officers, employees or agents designated by Investor) as the Company's true and lawful attorney (and agent-in-fact) for the purpose of making, settling and adjusting claims under such policies of insurance, endorsing the name 7 of the Company on any check, draft, instrument or other items of payment for the proceeds of such policies of insurance and for making all determinations and decisions with respect to such policies of insurance. In the event the Company, at any time hereafter, shall fail to obtain or maintain any of the policies of insurance required above or to pay any premium in whole or in part relating thereto, then Investor, without waiving or releasing any obligations or default by the Company hereunder, may at any time thereafter (but shall be under no obligation to) obtain and maintain such policies of insurance and pay such premium and take any other action with respect thereto which Investor deems advisable. All sums so disbursed by Investor, including reasonable attorneys' fees, court costs, expenses and other charges relating thereto, shall be payable on demand by the Company to Investor and shall be additional liabilities under the Debenture secured by the Collateral. 5.7 Remedies Upon Default. In the event of any Event of Default under the Debenture, Investor may do any one or more of the following: (a) Declare any indebtedness under the Debenture immediately due and payable; (b) Enforce the security interest given in this Agreement under the provisions of the Uniform Commercial Code of the applicable state or any other equivalent law; (c) Enter upon the premises of the Company, without any obligation to pay rent to the Company, through self-help and without judicial process, without first obtaining a final judgment or giving the Company notice and opportunity for a hearing on the validity of Investor's claim, or any other place or places where the Collateral is located and kept, and remove the Collateral therefrom to the premises of Investor or any agent of Investor, for such time as Investor may desire, in order to effectively collect or liquidate the Collateral, or (ii) require the Company to assemble the Collateral and make it available to Investor at a place to be designated by Investor, in its sole discretion; (d) Take possession of the Collateral or any part of it and of the records pertaining to the Collateral; (e) Sell or otherwise dispose of all or any Collateral at public or private sale or sales, with such notice as may be required by law, in lots or in bulk, for cash or on credit, all as Investor, in its sole discretion, may deem advisable; (ii) adjourn such sales from time to time with or without notice; (iii) conduct such sales on the Company's premises or elsewhere and use the Company's premises without charge for such sales for such time or times as Investor may see fit. Investor shall have the right to sell, lease or otherwise dispose of the Collateral, or any part thereof, for cash, credit or any combination thereof, and Investor may purchase all or any part of the 8 Collateral at public or, if permitted by law, private sale and, in lieu of actual payment of such purchase price, may setoff the amount of such price against the indebtedness under the Debenture. The proceeds realized from the sale of any Collateral shall be applied first to the reasonable costs, expenses and attorneys' fees and expenses incurred by Investor for collection and for acquisition, completion, protection, removal, storage, sale and delivery of the Collateral; second to interest due upon any of the indebtedness under the Debenture; and third to the principal of the indebtedness under the Debenture. If any deficiency shall arise, the Company shall remain liable to Investor therefor; and (f) Exercise any other rights and remedies of a secured party under the Uniform Commercial Code of the applicable state or other applicable law, all of which rights and remedies shall be cumulative and non-exclusive, to the extent permitted by law. 6. Conditions Precedent This Agreement shall become effective upon the satisfaction of the following conditions precedent: 6.1 Execution and Delivery of Agreement. This Agreement or counterparts thereof shall have been duly executed by, and delivered to, the Company and the Investor. 6.2 Documents and Other Agreements. The Investor shall have received all of the following, each in form and substance satisfactory to the Investor: (a) The Debenture; (b) The Warrants (the "Warrants"); (c) Registration Rights Agreement between the Company and the Investor (the "Registration Rights Agreement"); (d) A Certificate of the Secretary of the Company, together with true and correct copies of the Certificate of Incorporation and By-Laws of the Company, and all amendments thereto, true and correct copies of the resolutions of the Board of Directors of the Company authorizing or ratifying the execution, delivery and performance of this Agreement, the Debenture, the Warrants and the Registration Rights Agreement, and the names of the officer or officers of the Company authorized to sign this Agreement, the Debenture, the Warrants and the Registration Rights Agreement, together with a sample of the true signature of each such officer; 9 (e) Certified copies of all documents evidencing any other necessary corporate action, consents and governmental approvals (if any) with respect to this Agreement, the Debenture, the Warrants and the Registration Rights Agreement; (f) The favorable opinion of Callister Nebeker & McCullough, special counsel for the Company, addressed to the Investor with respect to such matters as may be reasonably requested by the Investor; (g) The favorable opinion of Harlan M. Hatfield, general counsel for the Company, addressed to the Investor with respect to such matters as may be reasonably requested by the Investor; (h) The Certificate of Incorporation of the Company certified by the Secretary of State of Delaware; (i) Good Standing Certificates for the Company from the Secretaries of State of Delaware, Alabama, Pennsylvania, Utah, Virginia and West Virginia; (j) UCC lien search reports of filings against the Company for such jurisdictions as the Investor deems appropriate; (k) UCC Financing Statements filed against the Company in respect to such jurisdictions as the Investor deems appropriate; and (l) Landlord's Waiver and Consent by Earthco; (m) Certificate of insurance, together with a properly executed Lender's Loss Payable Clause. 6.3 Absence of Material Adverse Change. No material adverse change in the business, operations or condition, financial or otherwise, of the Company shall have occurred or be continuing. 6.4 Conditions to the Closing. It shall be a condition to the Closing that the conditions contained in Sections 5.1, 5.2 and 5.3 shall have been fulfilled. 7. Miscellaneous. 7.1 Survival of Warranties. The warranties, representations and covenants of the Company and the Investor contained in or made pursuant to this Agreement shall survive the execution and delivery of this Agreement and the Closing and shall in no way be affected by any investigation of the subject matter thereof made by or on behalf of Investor or the Company. 10 7.2 Successors and Assigns. Except as otherwise provided herein, the terms and conditions of this Agreement shall inure to the benefit of and be binding upon the respective successors and assigns of the parties (including transferees of the Debenture issued hereunder or any Common Stock issued upon exercise of the Warrants). 7.3 Governing Law. This Agreement shall be governed by and construed under the laws of the State of Utah without regard to choice of law principles. 7.4 Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 7.5 Titles and Subtitles. The titles and subtitles used in this Agreement are used for convenience only and are not to be considered in construing or interpreting this Agreement. 7.6 Notices. Unless otherwise provided, any notice required or permitted under this Agreement shall be given in writing and shall be deemed effectively given upon personal delivery to the party to be notified or upon deposit with a reputable overnight courier or with the United States Post Office, by registered or certified mail, postage prepaid and addressed to the party to be notified at the address indicated for such party on the signature page hereof, or at such other address as such party may designate by ten (10) days advance written notice to the other parties. 7.7 Expenses. Each party shall bear its own expenses in connection with the transactions contemplated by this Agreement. 7.8 Amendments and Waivers. Any term of this Agreement may be amended and the observance of any term of this Agreement may be waived only with the written consent of the Company and the Investor. Any amendment or waiver effected in accordance with this Section shall be binding upon each holder of any securities purchased under this Agreement at the time outstanding, each future holder of all such securities, and the Company. 7.9 Severability. If one or more provisions of this Agreement are held to be unenforceable under applicable law, such provision shall be excluded from this Agreement and the balance of the Agreement shall be interpreted as if such provision were so exuded and shall be enforceable in accordance with its terms. 7.10 Indemnity. The Company hereby indemnifies the Investor, and its directors, officers, employees, affiliates and agents (collectively, "Indemnified Persons") against, and agrees to hold each such Indemnified Person harmless from, any and all losses, claims, damages and liabilities, including claims brought by any stockholder or former stockholder 11 of the Company, and related expenses, including reasonable counsel fees and expenses, incurred by such Indemnified Person arising out of any claim, litigation, investigation or proceeding (whether or not such Indemnified Person is a party thereto) relating to any transactions, services or matters that are the subject of this Agreement; provided, however, that such indemnity shall not apply to any such losses, claims, damages, or liabilities or related expenses determined by a court of competent jurisdiction to have arisen from the gross negligence or willful misconduct of such Indemnified Person. 7.11 Waiver of Trial by Jury. THE COMPANY AND THE INVESTOR HEREBY WAIVE TRIAL BY JURY IN ANY ACTION, SUIT, PROCEEDING OR COUNTERCLAIM OF ANY KIND DIRECTLY OR INDIRECTLY ARISING OUT OF OR RELATED TO THIS AGREEMENT OR THE DEBENTURE OR ANY ACT OR OMISSION WHICH EITHER PARTY ASSERTS RESULTED IN ANY LIABILITY TO THE COMPANY, THE INVESTOR OR THEIR RESPECTIVE OFFICERS, DIRECTORS, STOCKHOLDERS, PARTNERS, EMPLOYEES OR AGENTS, TO THE FULL EXTENT PERMITTED BY LAW. 7.12 Entire Agreement. This Agreement, the Debenture, and other documents delivered pursuant hereto constitute the full and entire understanding and agreement between the parties with regard to the subjects hereof and thereof. 7.13 Permissible Offset. To the extent the Company fails to make payment of principal or interest when due under the Debenture, Holder may setoff the amount of such deficiency against "Royalty Amounts" (net of any commission that the Company would be required to pay (e.g., Coalco)) due and owing to the Company from the Holder. For purposes of this Section 7.13, "Royalty Amounts" shall mean royalties and license fees due to the Company either from the Holder or from any of the Holder's assigns or transferees that may owe a royalty or license fee to the Company. THE SECURITIES ARE SUITABLE ONLY FOR SOPHISTICATED INVESTORS FOR WHOM AN INVESTMENT IN THE SECURITIES DOES NOT CONSTITUTE A COMPLETE INVESTMENT PROGRAM AND WHO FULLY UNDERSTAND AND ARE WILLING TO ASSUME THE RISK INVOLVED IN PURCHASE OF THE SECURITIES. NO OFFER TO SELL (OR SOLICITATION OF AN OFFER TO BUY) IS BEING MADE IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION WOULD BE UNLAWFUL. THERE WILL BE NO PUBLIC OFFERING OF THE SECURITIES. IN MAKING AN INVESTMENT DECISION INVESTORS MUST RELY ON THEIR OWN EXAMINATION OF THE COMPANY AND THE TERMS OF THE OFFERING, INCLUDING THE MERITS AND RISKS INVOLVED. THE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY ANY FEDERAL OR STATE SECURITIES COMMISSION OR REGULATORY AUTHORITY NOR HAS ANY SUCH FEDERAL OR STATE SECURITIES COMMISSION OR REGULATORY AUTHORITY PASSED UPON THE 12 ACCURACY OR ADEQUACY OF ANY INFORMATION PROVIDED HEREWITH. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. Address: 3280 North Frontage Road COVOL TECHNOLOGIES, INC. Lehi, Utah 84043 By: /Stanley M. Kimball/ ------------------------- Name: Stanley M. Kimball Title: President Address: The Gallagher Centre AJG FINANCIAL SERVICES, INC. Two Pierce Place Itasca, Illinois 60143-3141 By: /David R. Long/ ------------------------- Name: David R. Long Title: President 13 EX-10.53.2 7 DEBENTURE AGREEMENT THIS DEBENTURE HAS BEEN ACQUIRED FOR INVESTMENT AND HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), OR REGISTERED OR OTHERWISE QUALIFIED FOR SALE UNDER THE SECURITIES LAWS OF ANY STATE. THIS DEBENTURE MAY NOT BE TRANSFERRED OR SOLD OR OFFERED FOR SALE OR OTHERWISE TRANSFERRED, PLEDGED OR HYPOTHECATED IN THE ABSENCE OF SUCH REGISTRATION OR QUALIFICATION OR AN EXEMPTION THEREFROM UNDER SUCH ACT AND SUCH LAWS OR AN OPINION OF COUNSEL SATISFACTORY TO THE ISSUER HAS BEEN DELIVERED TO THE ISSUER TO THE EFFECT THAT SUCH REGISTRATION IS NOT REQUIRED. DEBENTURE DUE JANUARY 10, 2000 Salt Lake City, Utah $4,367,351.28 January 9, 1998 COVOL TECHNOLOGIES, INC., a Delaware corporation whose headquarters are located at 3280 North Frontage Road, Lehi, Utah 84043 (the "Company"), promises to pay to the order of AJG FINANCIAL SERVICES, INC., or its successors and assigns (the "Holder"), the aggregate principal sum of Four Million, Three Hundred Sixty-Seven Thousand, Three Hundred Fifty-One and 28/100 Dollars ($4,367,351.28) (the "Principal Amount"), in lawful money of the United States of America, together with interest thereon from the date hereof on the unpaid Principal Amount, on the terms and conditions as hereinafter specified, until the Principal Amount is repaid in full. 1. Identification of Debenture. This Debenture is the "Debenture" defined in that certain Debenture Agreement and Security Agreement of even date herewith between the Company and the Holder (the "Debenture Agreement") and the Holder is entitled to all of the benefits that arise under the Debenture Agreement from being the "Investor" and the holder of the "Debenture" thereunder. 2. Payment of Principal and Interest. (a) The Principal Amount shall be payable on January 10, 2000 ("Principal Repayment Date", also herein referred to as the "Maturity Date"). At the Maturity Date, any final Prepayment (as defined in Section 3 below), any acceleration of the Principal Amount pursuant to Section 8 1 below, any unpaid Principal Amount of this Debenture, all interest accrued thereon and other sums payable hereunder shall be due and payable in full, notwithstanding any other provision hereof. (b) From and after the date hereof, interest on the unpaid balance of the Principal Amount shall accrue at the per annum rate of six percent (6%) (the "Interest Rate") and shall be due and payable upon the Maturity Date, provided that upon any Prepayment and any acceleration of the Principal Amount pursuant to Section 8 below, all accrued and unpaid interest on the principal amount of the Prepayment or on the accelerated Principal Amount shall be immediately due and payable. Interest shall be calculated on the basis of a 365-day year and the actual number of days elapsed. In the event that all or any portion of the Principal Amount is not paid on the scheduled payment date of this Debenture or upon acceleration (regardless of the reason therefor), the portion of the Principal Amount not paid when due shall bear interest until paid at the "Default Rate" (as defined in Section 8 below). (c) All portions of the Principal Amount, all interest thereon and all other sums due hereunder, shall be payable, without set-off or deduction, at the offices of the Holder set forth above or at such other place as Holder, from time to time may designate to the Company in writing, in cash, certified check or check of the Company that the Holder has agreed in writing in advance to accept or a wire transfer to such account as Holder may have previously designated to the Company in writing. 3. Prepayment. The Company may prepay any portion of the Principal Amount without penalty or premium, upon five (5) days' written notice to Holder (a "Prepayment"). Any Prepayments shall be applied first to any overdue payments of principal or interest that bear interest at the "Default Rate", next to any other accrued but unpaid interest and then to reduction of principal of the Principal Amount. If a Change in Control (as hereinafter defined) occurs, the Holder may, by notice to the Company given not later than the date 10 days after the date the Company has notified the Holder of such Change in Control, require the prepayment of the entire unpaid Principal Amount of this Debenture and all accrued but unpaid interest thereon; whereupon the Company shall, on the date 10 days after the date such notice is given by the Holder, prepay this Debenture. The Company shall give the Holder notice of the occurrence of any Change in Control not later than 10 days after such Change in Control occurred. As used herein, "Change in Control" of the Company means: (a) any "person", as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), (other than the Company, any trustee or other fiduciary holding securities under an employee benefit plan of the Company, or any corporation owned, directly or indirectly, by the stockholders of the Company in substantially the same proportions as their ownership of stock of the Company), is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly 2 or indirectly, of securities of the Company representing 30% or more of the combined voting power of the Company's then outstanding securities; (b) during any period of two consecutive years (not including any period prior to the date of this Debenture), individuals who at the beginning of such period constitute the Board, and any new director (other than a director designated by a person who has entered into an agreement with the Company to effect a transaction described in paragraph (a), (c) or (d) of this Section) whose election by the Board of Directors or nomination for election by the Company's stockholders was approved by a vote of at least two-thirds (2/3) of the directors then still in office who either were directors at the beginning of the period or whose election or nomination for election was previously so approved, cease for any reason to constitute at least a majority thereof; (c) the stockholders of the Company approve a merger or consolidation of the Company with any other corporation, other than (I) a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) more than 80% of the combined voting power of the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation or (II) a merger or consolidation effected to implement a recapitalization of the Company (or similar transaction) in which no "person" (as hereinabove defined) acquires more than 30% of the combined voting power of the Company's then outstanding securities; or (d) the stockholders of the Company approve a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company of all or substantially all of the Company's assets. 4. Exchange of Debenture. At the option of the Holder, this Debenture may be exchanged for other Debentures in denominations of $1,000 and any integral multiple thereof and of a like aggregate principal amount and tenor. Upon surrender of this Debenture to the Company for exchange, the Company shall execute and deliver to the Holder the Debentures which the Holder is entitled to receive in exchange. 5. Ranking of Obligations. The obligations of the Company hereunder do rank and will rank at least pari passu in priority of payment with all other indebtedness of the Company. 6. Covenants. Until satisfaction in full of all obligations of the Company under this Debenture, the Company shall at all times comply with all of the covenants of the Company set forth herein or in the Debenture Agreement, which are hereby incorporated by reference herein as if each such covenant was set forth in full in this Debenture, together with any necessary defined terms from the Debenture Agreement. 3 7. Events of Default. The following events are hereby defined for all purposes of this Debenture as Events of Default: (a) Failure of the Company to pay any principal or interest hereunder when and as the same shall become due and payable, which failure shall have continued for a period of 5 days after receiving written notice of such late payment. (b) The breach by the Company of any of the other covenants set forth in this Debenture or in the Debenture Agreement if such breach is not cured within 30 days after written notice thereof is given by the Holder. (c) The institution by the Company of proceedings to be adjudicated a bankrupt or insolvent, or the consent by it to the institution of bankruptcy or insolvency proceedings against it, or the filing by it of a petition or answer or consent seeking relief under Title 11 of the United States Code, as now constituted or hereafter in effect, or any other applicable Federal or State bankruptcy, insolvency or other similar law, or the consent by it to the institution of proceedings thereunder or the filing of any such petition or to the appointment of a receiver, liquidator, assignee, trustee, custodian, sequestrator (or other similar official) of the Company or of any substantial part of its property, or the making by the Company of an assignment for the benefit of creditors, or the admission by the Company in writing of its inability to pay its debts generally as they become due; (d) The entry of a decree or order by a court having jurisdiction for relief in respect of the Company, or adjudging the Company a bankrupt or insolvent, or approving as properly filed a petition seeking reorganization, arrangement, adjustment or composition of or in respect of the Company under Title 11 of the United States Code, as now constituted or hereafter in effect, or any other applicable Federal or State bankruptcy, insolvency or other similar law, or appointing a receiver, liquidator, assignee, trustee (or other similar official) of the Company or of any substantial part of its property, or ordering the winding-up or liquidation of its affairs, and the continuance of any such decree or order unstayed and in effect for a period of 60 consecutive days; or (e) A default shall occur under any other agreement, document or instrument to which the Company is a party and such default is not cured within any applicable grace period or waived in writing, and such default (i) involves the failure to make any payment when due in respect of any indebtedness (other than the Principal Amount and interest thereon) of the Company in excess of Five Hundred Thousand Dollars ($500,000) in the aggregate, or (ii) causes such indebtedness or a portion thereof in excess of Five Hundred Thousand Dollars ($500,000) in the aggregate to become due prior to its stated maturity or prior to its regularly scheduled dates of payment, or (iii) permits any holder of such indebtedness or a trustee to cause such indebtedness or a portion thereof in excess of Five Hundred Thousand Dollars ($500,000) in the aggregate to become due prior to its stated 4 maturity or prior to the regularly scheduled dates of payment and such default is not cured or waived within 30 days after the occurrence thereof. If one or more Events of Default shall happen and be continuing, then, and in each and every such case, the Holder, at its option, by notice in writing to the Company, may declare the entire Principal Amount and all interest accrued thereon and any other sums due hereunder, if not already due and payable, to be immediately due and payable. If there shall occur an Event of Default described in Sections 8(c) or 8(d), the entire unpaid balance of the Principal Amount with interest accrued thereon and all other sums due under this Debenture shall be immediately due and payable without notice to the Company. If the entire unpaid balance with interest accrued thereon shall, as a result of either of the preceding two sentences, be immediately due and payable, the unpaid balance of the Principal Amount shall accrue interest at the Interest Rate compounded annually to the date of default and thereafter at a rate which shall be equal to the Interest Rate plus two percent (2%) (the "Default Rate") and all other sums due by the Company hereunder shall also be immediately due and payable; and payment thereof may be enforced and recovered in whole or in part at any time by one or more of the remedies provided to the Holder in this Debenture or under applicable law. In such case, the Holder may also recover all costs of suit and other expenses in connection therewith, together with reasonable attorney's fees for collection, together with the interest on any judgment obtained by the Holder at the Default Rate, including interest at that rate from and after the date of any execution, judicial or foreclosure sale until actual payment is made to the Holder of the full amount due the Holder. 8. Payment on Default. In the event that an Event of Default shall occur, then the Company shall pay to the Holder the whole amount which then shall have become due on the Debenture for principal and interest, and in addition thereto, such additional amount as shall be sufficient to cover the costs and expenses of collection. No delay or omission of the Holder to exercise any rights or powers accruing upon any default which shall not have been remedied shall impair any such right or power, or shall be construed to be a waiver of any such default or acquiescence therein; and every power and remedy given by this to the Holder may be exercised from time to time and as often as may be deemed expedient by the Holder. 9. Immunity of Incorporators, Stockholders, Officers, Directors and Employees. No recourse shall be had for the payment of the principal or interest on this Debenture or for any claim based thereon or otherwise in any manner in respect thereof, to or against any subsidiary, incorporator, stockholder, officer, director or employee, as such, past, present or future, of the Company or any respective subsidiary, incorporator, stockholder, officer, director or employees, as such, past, present or future, of any predecessor or successor corporation, either directly or through the Company or such predecessor or successor corporation, whether by virtue of any constitutional provision or statute or rule of law, or by the enforcement of any assessment or penalty, or in any other manner, all such liability being expressly waived and released by the acceptance of this Debenture and as part of the consideration for the issue thereof. 5 10. Notices. Unless otherwise provided, any notice required or permitted under this Debenture shall be given in writing and shall be deemed effectively given upon personal delivery to the party to be notified or upon deposit with a reputable overnight courier or with the United States Post Office, by registered or certified mail, postage prepaid and addressed to the party to be notified at the address indicated for such party in the Debenture Agreement, or at such other address as such party may designate by ten (10) days advance written notice to the other party. 11. Miscellaneous. (a) The Company hereby waives presentment, demand, protest, notice of demand, notice of nonpayment or dishonor, notice of protest and all other notices of any kind in connection with the delivery, acceptance, performance default or enforcement of the payment of this Debenture. No failure to exercise, and no delay in exercising any rights hereunder on the part of the Holder hereof shall operate as a waiver of such rights. (b) The Holder and the Company may from time to time enter into written agreements amending or changing any provisions of this Debenture or the Debenture Agreement or the rights of the Holder or the Company hereunder or thereunder, or may grant written waivers or consents to a departure from the due performance of the obligations of the Company hereunder or thereunder. (c) The Company agrees that its liability under this Debenture shall be unconditional, without regard to the liability of any other party, and shall not be affected in any manner by any indulgence, extension of time, renewal, waiver or modification granted or consented to by the Holder. No course of dealing and no delay or failure of the Holder in exercising any right, power, remedy or privilege under this Debenture or the Debenture Agreement shall affect any other or future exercise thereof or operate as a waiver thereof; nor shall any single or partial exercise thereof or any abandonment or discontinuance of steps to enforce such a right, power, remedy of privilege preclude any further exercise thereof or of any other right, power, remedy or privilege. The rights and remedies of the Holder under this Debenture and the Debenture Agreement are cumulative and not exclusive of any rights or remedies which they would otherwise have. Any waiver, permit, consent or approval of any kind or character on the part of the Holder of any breach or default under this Debenture or any such waiver of any provision or condition of this Debenture must be in writing and shall be effective only to the extent specifically set forth in such writing. (d) Whenever any payment or action to be made or taken hereunder shall be stated to be due on a day which is not a business day, such payment or action shall be made or taken on the next following business day, and such extension of time shall be included in computing interest or fees, if any, in connection with such payment or action. (e) All notices, requests, demands, directions and other communications (collectively, "notices") given to or made upon any party hereto under the provisions of this Debenture shall be in writing and shall be effective if given in accordance with the provisions of the Debenture Agreement. 6 (f) The provisions of this Debenture are intended to be severable. If any provision of this Debenture shall be held invalid or unenforceable in whole or in part in any jurisdiction such provision shall, as to such jurisdiction, be ineffective to the extent of such invalidity or unenforceability without in any manner affecting the validity or enforceability thereof in any other jurisdiction or the remaining provisions hereof in any jurisdiction. (g) This Debenture and the Debenture Agreement and other documents delivered in connection herewith and therewith supersede all prior understandings and agreements, whether written or oral, between the parties hereto and thereto relating to the transactions provided for herein and therein. Any Holder of this Debenture acknowledges that such Holder is bound by the applicable provisions of the Debenture Agreement and by the acceptance of this Debenture such Holder agrees to the terms thereof. (h) All representations and warranties of the Company contained herein or made in connection herewith shall survive and shall not be waived by the execution and delivery of this Debenture or by any investigation by the Holder, but shall terminate upon Company's full satisfaction and payment of all outstanding amounts in the Principal Amount of or interest on this Debenture. (i) This Debenture shall be binding upon and shall inure to the benefit of the Holder, the Company and their respective successors and assigns, except that the Company may not assign or transfer any of its rights and obligations hereunder or any interest herein. (j) Whenever the Holder's consent is required to be obtained under this Debenture or the Debenture Agreement as a condition to any action, inaction, condition or event, the Holder shall be authorized to give or withhold such consent in its sole and absolute discretion and to condition its consent upon the giving of additional collateral, the payment of money or any other matter. (k) The representations, warranties and covenants contained herein shall be independent of each other and no exception to any representation, warranty or covenant shall be deemed to be an exception to any other representation, warranty or covenant contained herein unless expressly provided, nor shall any such exceptions be deemed to permit any action or omission that would be in contravention of applicable law. (l) This Debenture shall be governed by, and construed in accordance with, the laws of the State of Utah, excluding, however, the rules relating to conflicts of law. (m) In no event shall the rate of interest payable under this Debenture exceed the maximum rate of interest permitted to be charged by applicable law (including the choice of law rules) and any interest paid in excess of the permitted rate shall be refunded to the Company. Such refund shall be made by application of the excessive amount of interest paid against any sums outstanding and shall be applied in such order as the Holder may determine. If the excessive amount of interest paid exceeds the sums outstanding, the portion exceeding the said sums outstanding shall 7 be refunded in cash by the Holder. Any such crediting or refund shall not cure or waive any default by the Company hereunder. The Company agrees, however, that in determining whether or not any interest payable under this Debenture exceeds the highest rate permitted by law, any non-principal payment, other than interest payments, including, without limitation, fees and late charges, shall be deemed, to the extent permitted by law, to be an expense, fee, premium or liquidated damages, rather than interest. (n) THE COMPANY AND THE HOLDER HEREBY WAIVE TRIAL BY JURY IN ANY ACTION, SUIT, PROCEEDING OR COUNTERCLAIM OF ANY KIND DIRECTLY OR INDIRECTLY ARISING OUT OF OR RELATED TO THIS DEBENTURE OR THE DEBENTURE AGREEMENT OR ANY ACT OR OMISSION WHICH EITHER PARTY ASSERTS RESULTED IN ANY LIABILITY TO THE COMPANY, THE HOLDER OR THEIR RESPECTIVE OFFICERS, DIRECTORS, STOCKHOLDERS, PARTNERS, EMPLOYEES OR AGENTS, TO THE FULL EXTENT PERMITTED BY LAW. (o) To the extent the Company fails to make payment of principal or interest when due under this Debenture, Holder may setoff the amount of such deficiency against "Royalty Amounts" (net of any commission that the Company would be required to pay (e.g., Coalco)) due and owing to the Company from the Holder. For purposes of this paragraph (o), "Royalty Amounts" shall mean royalties and license fees due to the Company either from the Holder or from any of the Holder's assigns or transferees that may owe a royalty or license fee to the Company. IN WITNESS WHEREOF, the Company, intending to be legally bound hereby, has caused this Debenture to be duly executed by its respective authorized officers on the day and year first above written. COVOL TECHNOLOGIES, INC. By: /Stanley M. Kimball/ ------------------------- Name: Stanley M. Kimball Title: President [Corporate Seal] Attest: /Asael T. Sorensen, Jr./ ---------------------------- Asael T. Sorensen, Jr., Secretary Accepted and Agreed to as of the first day referred to above AJG FINANCIAL SERVICES, INC. By:/David R. Long/ --------------------- Name: David R. Long Title: President 8 EX-10.53.3 8 WARRANT A WARRANT A Dated: January 9, 1998 Warrant No. WA-1997-245 **216,272** Shares NEITHER THESE WARRANTS NOR THE SHARES OF COMMON STOCK ISSUABLE UPON EXERCISE OF THESE WARRANTS HAVE BEEN REGISTERED WITH THE U.S. SECURITIES AND EXCHANGE COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON AN EXEMPTION FROM REGISTRATION UNDER REGULATION D PROMULGATED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"). THESE WARRANTS AND THE SHARES OF COMMON STOCK ISSUABLE UPON EXERCISE OF THESE WARRANTS ARE RESTRICTED AND MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO REGULATION D UNDER THE ACT, AN EFFECTIVE REGISTRATION STATEMENT UNDER THE ACT OR PURSUANT TO AN APPLICABLE EXEMPTION THEREFROM. These Warrants shall cease to be exercisable and shall be void after January 10, 2000, at 5:00 p.m., Salt Lake City, Utah time. COMMON STOCK PURCHASE WARRANTS OF COVOL TECHNOLOGIES, INC. FOR VALUE RECEIVED, Covol Technologies, Inc. (the "Company"), a Delaware corporation, hereby certifies that AJG Financial Services, Inc., or its permitted assigns, is entitled to purchase from the Company, subject to the conditions and upon the terms of this Warrant, at any time or from time to time after the date hereof and prior to 5:00 p.m. Salt Lake City, Utah time, on January 10, 2000, an aggregate of 216,272 fully paid and nonassessable shares of Common Stock, par value $.001, of the Company (subject to adjustment as provided herein), at a per share exercise price of $10.00 per share (subject to adjustment as provided herein). This Warrant is issued pursuant to the terms set forth in a letter agreement dated October 22, 1997, by and between the Holder (as defined below) and the Company (the "Letter Agreement"). 1. Definitions. As used in this Warrant, the following terms have the respective meanings set forth below: "Additional Shares of Common Stock" shall mean all shares of Common Stock issued by the Company after the Closing Date, other than Warrant Shares. 1 "Affiliate" of any Person shall mean a Person that directly or indirectly, through one or more intermediaries, controls or is controlled by or is under common control with, such Person. "Appraised Value" shall mean, in respect of any share of Common Stock on any date herein specified, the fair market value of such share of Common Stock (determined without giving effect to the discount for (i) a minority interest, or (ii) any lack of liquidity of the Common Stock or to the fact that the Company may have no class of equity registered under the Exchange Act, based on the quotient obtained by dividing (x) the value of the Company, as determined by an investment banking firm selected in accordance with the terms of Section 12, by (y) the number of Fully Diluted Outstanding shares of Common Stock. "Book Value" shall mean, in respect of any share of Common Stock on any date herein specified, the consolidated book value of the Company (with inventory valued on a first-in-first-out basis) applicable to Common Stock as of the last day of any month immediately preceding such date, divided by the number of Fully Diluted Outstanding shares of Common Stock as determined in accordance with GAAP by Price Waterhouse Coopers LLP or any other firm of independent certified public accountants of recognized national standing selected by the Company and reasonably acceptable to the Majority Holders, determined in any event without any adjustment or reduction for the amount, if any, that may, under modifications to GAAP adopted after the Closing Date, be required either as an offset to or reserve against earnings or retained earnings, or as a deduction from book value or net worth, in either event as a result of the exercise, issuance, anticipated exercise or anticipated cost to the Company of any stock option, right or convertible security or any provision of the Warrants or any other warrant issued by the Company. "Business Day" shall mean any day that is not a Saturday or Sunday or a day on which banks are required or permitted to be closed in the State of Utah or the State of Illinois. "Closing Date" shall mean January 9, 1998. "Commission" shall mean the Securities and Exchange Commission or any other federal agency then administering the Securities Act and other federal securities laws. "Common Stock" shall mean (except where the context otherwise indicates) the Common Stock, $0.001 par value, of the Company as constituted on the Closing Date, and any capital stock into which such Common Stock may thereafter be changed, and shall also include (i) capital stock of the Company of any other class (regardless of how denominated) issued to the holders of shares of Common Stock upon any reclassification thereof which is also not preferred as to dividends or assets over any other class of stock of the Company and which is not subject to redemption and (ii) shares of common stock of any successor or acquiring corporation (as defined in Section 4.8) received by or distributed to the holders of Common Stock of the Company in the circumstances contemplated by Section 4.8. 2 "Convertible Securities" shall mean evidences of indebtedness, shares of stock or other securities which are convertible into or exchangeable, with or without payment of additional consideration in cash or property, for Additional Shares of Common Stock, either immediately or upon the occurrence of a specified date or a specified event. "Current Market Price" shall mean, in respect of any share of Common Stock on any date herein specified, the highest of (a) the Book Value per share of Common Stock at such date, (b) the Appraised Value per share of Common Stock as of a date which is within 120 days of such date, (c) the fair market value thereof as determined in good faith by the Board of Directors of the Company as of a date which is within 15 days of such date, or (d) if there shall then be a public market for the Common Stock, the average of the daily market prices for the 30 consecutive Business Days immediately preceding such date. The daily market price for each such Business Day shall be (i) the last sale price on such day on the principal stock exchange on which such Common Stock is then listed or admitted to trading, (ii) if no sale takes place on such day on any such exchange, the last reported sale price as officially quoted on any such exchange, (iii) if the Common Stock is not then listed or admitted to trading on any stock exchange, the last sale price on such day in the over-the-counter market, as reported by the National Association of Securities Dealers Automatic Quotation System ("NASDAQ"), or if such sale price is not available on such date, the average of the closing bid and asked prices on such date as reported by NASDAQ, or if not so reported, then as reported by the National Quotation Bureau, Inc., (iv) if neither such firm at the time is engaged in the business of reporting such prices, as furnished by any similar firm then engaged in such business, or (v) if there is no such firm, as furnished by any member of the NASD selected mutually by the Majority Holders and the Company or, if they cannot agree upon such selection, as selected by two such members of the NASD, one of which shall be selected by the Majority Holders and one of which shall be selected by the Company. "Current Warrant Price" shall mean, in respect of a share of Common Stock at any date herein specified, the price at which a share of Common Stock may be purchased pursuant to this Warrant on such date. On the Closing Date, the Current Warrant Price is $10.00 per share of Common Stock. "Debenture Agreement" shall mean the Debenture Agreement and Security Agreement, dated as of January 9, 1998, between the Company and AJG Financial Services, Inc. "Default Rate" means eight percent (8%). "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended, or any similar federal statute, and the rules and regulations of the Commission thereunder, all as the same shall be in effect from time to time. "Exercise Period" shall mean the period during which this Warrant is exercisable pursuant to Section 2. 3 "Fully Diluted Outstanding" shall mean, when used with reference to Common Stock, at any date as of which the number of shares thereof is to be determined, all shares of Common Stock Outstanding at such date and all shares of Common Stock issuable in respect of this Warrant outstanding on such date and other options or warrants to purchase, or securities convertible into, shares of common stock outstanding on such date which would be deemed outstanding in accordance with GAAP for purposes of determining book value or net income per share. "GAAP" shall mean generally accepted accounting principles in the United States of America as from time to time in effect. "Holder" shall mean, as the context requires, the Person in whose name this Warrant or one of the other Warrants is registered on the books of the Company maintained for such purpose or the Person holding any Warrant Shares, and "Holders" shall mean two or more such Persons. "Independent Counsel" shall mean counsel to the Company, unless counsel to Holder disagrees in writing with the opinion or advice of such counsel with respect to the issue in question within fifteen (15) days after receipt of such opinion or advice, in which case the Company and Holder shall select another counsel, not the regular counsel of either, who is experienced in Securities Act matters, who shall render an opinion with respect to the issue in question. The legal fees and expenses of such other counsel incurred in connection with the rendering of such opinion shall be borne equally by Holder and the Company. "Letter Agreement" shall have the meaning set forth in the first paragraph of this Warrant. "Majority Holders" shall mean the Holders of Warrants exercisable for in excess of 50% of the aggregate number of shares of Common Stock then purchasable upon exercise of all Warrants, whether or not then exercisable. "NASD" shall mean the National Association of Securities Dealers, Inc., or any successor corporation thereto. "Other Property" shall have the meaning set forth in Section 4.8. "Outstanding" shall mean, when used with reference to Common Stock, at any date as of which the number of shares thereof is to be determined, all issued shares of Common Stock, except shares then owned or held by or for the account of the Company or any Subsidiary, and shall include all shares issuable in respect of outstanding scrip or any certificates representing fractional interests in shares of Common Stock. "Permitted Issuances" shall mean [(i) the issuance of up to 800,000 shares of Common Stock pursuant to certain outstanding warrants of the Company which are "out of the money" as of the Closing Date, (ii) the issuance of up to 1,500,000 shares of Common Stock pursuant to certain outstanding options, warrants or other securities of the Company convertible into Common Stock 4 which are "in the money" as of the Closing Date, (iii) the issuance of or granting of rights to acquire up to 790,000 shares of Common Stock to PacifiCorp Financial Services, inc. or any of its affiliates ('PacifiCorp"), or their respective assigns, pursuant to the Convertible Loan and Security Agreement, dated, between the Company and PacifiCorp, (iv) the issuance of or granting of rights to acquire up to 515,000 shares of Common Stock to be sold by the Company pursuant to a private Placement Memorandum, (v) the issuance of or granting of rights to acquire up to 100,000 shares of Common Stock to LKD Partnership or its assigns pursuant to a Convertible Debenture in the principal amount of approximately $1,000,000 issued in November, 1996, (vi) the issuance of or granting of rights to acquire up to 2,000,000 shares of Common Stock to officers, directors, consultants or employees of the Company, which rights vest over the next 8 to 9 years, (vii) the issuance of or granting of rights to acquire up to 400,000 additional shares of Common Stock to any third parties in transactions other than those referred to in the preceding clauses (i) through (vi)], and (viii) the issuance of shares of Common Stock upon exercise of the Warrants. "Person" shall mean any individual, sole proprietorship, partnership, joint venture, trust, incorporated organization, association, corporation, institution, public benefit corporation, entity or government (whether federal, state, county, city, municipal or otherwise, including, without limitation, any instrumentality, division, agency, body or department thereof). "Registration Rights Agreement" shall mean the Registration Rights Agreement, dated as of January 9, 1998, between the Company and AJG Financial Services, Inc. "Restricted Common Stock" shall mean shares of Common Stock which are, or which upon their issuance on the exercise of this Warrant would be, evidenced by a certificate bearing the restrictive legend set forth in Section 8.1. "Securities Act" shall mean the Securities Act of 1933, as amended, or any similar federal statute, and the rules and regulations of the Commission thereunder, all as the same shall be in effect at the time. "Subsidiary" shall mean any corporation of which an aggregate of more than 50% of the outstanding stock having ordinary voting power to elect a majority of the board of directors of such corporation (irrespective of whether, at the time, stock of any other class or classes of such corporation shall have or might have voting power by reason of the happening of any contingency) is at the time, directly or indirectly, owned legally or beneficially by the Company and/or one or more Subsidiaries of the Company. "Termination Date" shall have the meaning set forth in Section 2. "Transfer" shall mean any disposition of any Warrant or Warrant Shares or of any interest in either thereof, which would constitute a sale thereof within the meaning of the Securities Act. 5 "Warrant Price" shall mean an amount equal to (i) the number of shares of Common Stock being purchased upon exercise of this Warrant pursuant to Section 2, multiplied by (ii) the Current Warrant Price as of the date of such exercise. "Warrant Shares" shall mean the shares of Common Stock purchased by Holders of the Warrants upon the exercise thereof. "Warrants" shall mean the two Warrants (one designated Warrant A and the other designated Warrant B), each dated January 9, 1998, issued by the Company to AJG Financial Services, Inc. evidencing rights to purchase initially up to an aggregate of 432,544 shares of Common Stock, and all warrants issued upon transfer, division or combination of, or in substitution or exchange for, any thereof. 2. Exercise of Warrant. This Warrant may be exercised, in whole at any time or in part from time to time during the period (the "Exercise Period") commending on the date hereof, and ending on January 10, 2000, at 5:00 p.m. Salt Lake City, Utah time (the "Termination Date"), by the Holder of this Warrant by the surrender of this Warrant (with the exercise form at the end hereof duly executed) at the address set forth in Section 13 hereof, together with payment of the Warrant Price. Payment of the Warrant Price shall be made first by offset, in whole or in part, against any obligation of the Company to the Holder pursuant to the Debenture issued pursuant to the Debenture Agreement, and then any balance by wire transfer to an account in a bank located in the United States designated for such purpose by the Company or by certified or official bank check. The Warrant shall expire, and exercise shall no longer be allowed, to the extent the Warrant has not been exercised by the expiration of the Exercise Period. If this Warrant is exercised in part, this Warrant must be exercised for a minimum of 1,000 shares of Common Stock and if the Exercise Period has not expired the Holder is entitled to receive a new Warrant covering the number of Warrant Shares in respect of which this Warrant has not been exercised and setting forth the proportionate part of the Warrant Price applicable to such Warrant Shares. Upon such surrender of this Warrant, the Company will (a) issue a warrant or warrants in the name of the Holder for the largest number of whole shares of Common Stock to which the Holder shall be entitled and, if this Warrant is exercised in whole, in lieu of any fractional share of the Common Stock to which the Holder shall be entitled, cash equal to the fair value of such fractional share (determined in such reasonable manner as the Board of Directors of the Company shall determine), and (b) deliver the proportionate part thereof if this Warrant is exercised in part, pursuant to the provisions of this Warrant. The Warrant shall expire, and exercise shall no longer be allowed, to the extent the Warrant has not been exercised by the expiration of the Exercise Period. 3. Reservation of Warrant Shares. The Company will at all times during the Exercise Period have authorized and reserved, and will keep available, solely for issuance or delivery upon the exercise of this Warrant, the Warrant Shares. All shares of Common Stock which shall be so issuable, when issued upon exercise of any Warrant and payment therefor in accordance with the terms of such Warrant, shall be duly and validly issued, fully paid and nonassessable and free and 6 clear of any liens, claims and restrictions (other than as provided herein). No stockholder of the Company has or shall have any preemptive rights to subscribe for such shares of Common Stock. Before taking any action which would cause an adjustment reducing the Current Warrant Price below the then par value, if any, of the shares of Common Stock issuable upon exercise of the Warrants, the Company shall take any corporate action which may be necessary in order that the Company may validly and legally issue fully paid and nonassessable shares of such Common Stock at such adjusted Current Warrant Price. Before taking any action which would result in an adjustment in the number of shares of Common Stock for which this Warrant is exercisable or in the Current Warrant Price, the Company shall obtain all such authorizations or exemptions thereof, or consents thereto, as may be necessary from any public regulatory body or bodies having jurisdiction thereof. If any shares of Common Stock required to be reserved for issuance upon exercise of Warrants require registration or qualification with any governmental authority under any federal or state law (otherwise than as provided in Section 8) before such shares may be so issued, the Company will in good faith and as expeditiously as possible and at its expense endeavor to cause such shares to be duly registered. 4. Adjustments. The number of shares of Common Stock for which this Warrant is exercisable, or the price at which such shares may be purchased upon exercise of this Warrant, shall be subject to adjustment from time to time as set forth in this Section 4. The Company shall give Holder notice of any event described below which requires an adjustment pursuant to this Section 4 at the time of such event. 4.1 Stock Dividends, Subdivisions and Combinations. If at any time the Company shall: (a) take a record of the holders of its Common Stock for the purpose of entitling them to receive a dividend payable in, or other distribution of, Additional Shares of Common Stock, (b) subdivide its outstanding shares of Common Stock into a larger number of shares of Common Stock, or (c) combine its outstanding shares of Common Stock into a smaller number of shares of Common Stock, then (i) the number of shares of Common Stock for which this Warrant is exercisable immediately after the occurrence of any such event shall be adjusted to equal the number of shares of Common Stock which a record holder of the same number of shares of Common Stock for which this Warrant 7 is exercisable immediately prior to the occurrence of such event would own or be entitled to receive after the happening of such event, and (ii) the Current Warrant Price shall be adjusted to equal (a) the Current Warrant Price multiplied by the number of shares of Common Stock for which this Warrant is exercisable immediately prior to the adjustment divided by (b) the number of shares for which this Warrant is exercisable immediately after such adjustment. 4.2 Certain Other Distributions. If at any time the Company shall take a record of the holders of its Common Stock for the purpose of entitling them to receive any dividend or other distribution of: (a) cash; (b) any evidences of its indebtedness, any shares of its stock or any other securities or property of any nature whatsoever (other than cash, Convertible Securities or Additional Shares of Common Stock); or (c) any warrants or other rights to subscribe for or purchase any evidences of its indebtedness, any shares of its stock or any other securities or property of any nature whatsoever (other than cash, Convertible Securities or Additional Shares of Common Stock); then (i) the number of shares of Common Stock for which this Warrant is exercisable shall be adjusted to equal the product obtained by multiplying the number of shares of Common Stock for which this Warrant is exercisable immediately prior to such adjustment by a fraction (a) the numerator of which shall be the Current Market Price per share of Common Stock at the date of taking such record and (b) the denominator of which shall be such Current Market Price per share of Common Stock, minus the amount allocable to one share of Common Stock of (x) any such cash so distributable and (y) the fair value (as determined in good faith by the Board of Directors of the Company and supported by an opinion from an investment banking firm of recognized national standing acceptable to the Majority Holders) of any and all such evidences of indebtedness, shares of stock, other securities or property or warrants or other subscription or purchase rights so distributable, and (ii) the Current Warrant Price shall be adjusted to equal (a) the Current Warrant Price multiplied by the number of shares of Common Stock for which this Warrant is exercisable immediately prior to the adjustment divided by (b) the number of shares for which this Warrant is exercisable immediately after such adjustment. A reclassification of the Common Stock (other than a change in par value, or from par value to no par value or from no par value to par value) into shares of Common Stock and shares of any other class of stock shall be deemed a distribution by the Company to the holders of its Common Stock of such shares of such other class of stock within the meaning of this Section 4.2 and, if the outstanding shares of Common Stock shall be changed into a larger or smaller number of shares of Common Stock as a part of such reclassification, such change shall be deemed a subdivision or combination, as the case may be, of the outstanding shares of Common Stock within the meaning of Section 4.1. 8 4.3 Issuance of Additional Shares of Common Stock. (a) If at any time the Company shall (except as hereinafter provided in Sections 4.4 and 4.5) issue or sell any Additional Shares of Common Stock, other than Permitted Issuances, for consideration in an amount per Additional Share of Common Stock less than the greater of the Current Warrant Price or the Current Market Price, then: (i) the number of shares of Common Stock for which this Warrant is exercisable shall be adjusted to equal the product obtained by multiplying the number of shares of Common Stock for which this Warrant is exercisable immediately prior to such issue or sale by a fraction (W) the numerator of which is the number of shares of Common Stock Outstanding immediately after the issuance or sale of such Additional Shares of Common Stock, and (X) the denominator of which is number of shares of Common Stock Outstanding immediately prior to such issuance or sale; and (ii) the Current Warrant Price shall be adjusted to a price determined by dividing (a) an amount equal to the sum of (X) the number of shares of Common Stock Outstanding immediately prior to such issuance or sale multiplied by the then existing Current Warrant Price, plus (Y) the consideration, if any, received by the Company upon such issuance or sale, by (b) the total number of shares of Common Stock Outstanding immediately after such issuance or sale. (b) If at any time the Company shall (except as hereinafter provided in Sections 4.4 and 4.5) issue or sell any Additional Shares of Common Stock, other than Permitted Issuances, for consideration in an amount per Additional Share of Common Stock equal to or greater than the greater of the Current Warrant Price or the Current Market Price, then the number of shares for which this Warrant is exercisable shall not change, but the Company shall issue to Holder a new Warrant for the number of shares of Common Stock equal to (i) the product obtained by multiplying the number of shares of Common Stock for which this Warrant is exercisable immediately prior to such issuance or sale by a fraction (W) the numerator of which is the number of shares of Common Stock Outstanding immediately after the issuance or sale of such Additional Shares of Common Stock, and (X) the denominator of which is the number of shares of Common Stock Outstanding immediately prior to such issuance or sale, less (ii) the number of shares for which this Warrant is exercisable immediately prior to such issuance or sale. The new Warrant shall have the same terms and provisions as this Warrant except with respect to the number of shares for which it is exercisable and except that the Current Warrant Price (as defined in the new Warrant) for each share of Common Stock for which such new Warrant is exercisable shall be equal to the fair value of the consideration per Additional Share of Common Stock. 9 (c) The provisions of this Section 4.3 shall not apply to any issuance of Additional Shares of Common Stock for which an adjustment is provided under Section 4.1 or 4.2. No adjustment shall be made under this Section 4.3 upon the issuance of any Additional Shares of Common Stock which are issued pursuant to the exercise of any warrants or other subscription or purchase rights or pursuant to the exercise of any conversion or exchange rights in any Convertible Securities, if any such adjustment shall previously have been made upon the issuance of such warrants or other rights or upon the issuance of such Convertible Securities (or upon the issuance of any warrant or other rights therefor) pursuant to Section 4.4 or Section 4.5. 4.4 Issuance of Warrants or Other Rights. If at any time the Company shall take a record of the holders of its Common Stock for the purpose of entitling them to receive a distribution of, or shall in any manner (whether directly or by assumption in a merger in which the Company is the surviving corporation) issue or sell, any warrants (other than the Warrants) or other rights to subscribe for or purchase any Additional Shares of Common Stock or any Convertible Securities, whether or not the rights to exchange or convert thereunder are immediately exercisable, and the price per share for which Common Stock is issuable upon the exercise of such warrants or other rights or upon conversion or exchange of such Convertible Securities shall be less than the greater of the Current Warrant Price or the Current Market Price in effect immediately prior to the time of such distribution, issue or sale, then the number of shares of Common Stock for which this Warrant is exercisable and the Current Warrant Price shall be adjusted as provided in Section 4.3(a) on the basis that (i) the maximum number of Additional Shares of Common Stock issuable pursuant to all such warrants or other rights or necessary to effect the conversion or exchange of all such Convertible Securities shall be deemed to have been issued and outstanding, (ii) the price per share for such Additional Shares of Common Stock shall be deemed to be the lowest price per share at which such Additional Shares of Common Stock are available to such holders, and (iii) the Company shall have received all of the consideration, if any, payable for such warrants or other rights as of the date of the actual issuance thereof. No further adjustments of the number of shares of Common Stock for which this Warrant is exercisable or of the Current Warrant Price shall be made upon the actual issue of such Common Stock or of such Convertible Securities upon exercise of such warrants or other rights or upon the actual issue of such Common Stock upon such conversion or exchange of such Convertible Securities. 4.5 Issuance of Convertible Securities. If at any time the Company shall take a record of the holders of its Common Stock for the purpose of entitling them to receive a distribution of, or shall in any manner (whether directly or by assumption in a merger in which the Company is the surviving corporation) issue or sell, any Convertible Securities, whether or not the rights to exchange or convert thereunder are immediately exercisable, and the price per share for which Common Stock is issuable upon such conversion or exchange shall be less than the greater of the Current Warrant Price or the Current Market Price in effect immediately prior to the time of such issue or sale, then the number of shares of Common Stock for which this Warrant is exercisable and the Current Warrant Price shall be adjusted as provided in Section 4.3(a) on the basis that (i) the maximum 10 number of Additional Shares of Common Stock issuable upon the conversion or exchange of all such Convertible Securities shall be deemed to have been issued and outstanding, (ii) the price per share of such Additional Shares of Common Stock shall be deemed to be the lowest possible price in any range of prices at which such Additional Shares of Common Stock are available to such holders, and (iii) the Company shall have received all of the consideration payable therefor, if any, as of the date of actual issuance of such Convertible Securities. No further adjustment of the number of shares of Common Stock for which this Warrant is exercisable or of the Current Warrant Price shall be made under this Section 4.5 upon the issuance of any Convertible Securities which are issued pursuant to the exercise of any warrants or other subscription or purchase rights therefor, if any such adjustment shall previously have been made upon the issuance of such warrants or other rights pursuant to Section 4.4. No further adjustments of the number of shares of Common Stock for which this Warrant is exercisable or of the Current Warrant Price shall be made upon the actual issue of such Common Stock upon conversion or exchange of such Convertible Securities and, if any issue or sale of such Convertible Securities is made upon exercise of any warrant or other right to subscribe for or to purchase or any warrant or other right to purchase any such Convertible Securities for which adjustments thereof have been or are to be made pursuant to other provisions of this Section 4, no further adjustments shall be made by reason of such issue or sale. 4.6 Superseding Adjustment. If, at any time after any adjustment of the number of shares of Common Stock for which this Warrant is exercisable shall have been made pursuant to Section 4.4 or Section 4.5 as the result of any issuance of warrants, rights or Convertible Securities, and either (a) such warrants or rights, or the right of conversion or exchange in such other Convertible Securities, shall expire, and all or a portion of such warrants or rights, or the right of conversion or exchange with respect to all or a portion of such other Convertible Securities, as the case may be, shall not have been exercised, or (b) the consideration per share for which shares of Common Stock are issuable pursuant to such warrants or rights, or the terms of such other Convertible Securities, shall be increased solely by virtue of provisions therein contained for an automatic increase in such consideration per share upon the occurrence of a specified date or event, then such previous adjustment shall be rescinded and annulled and the Additional Shares of Common Stock which were deemed to have been issued by virtue of the computation made in connection with the adjustment so rescinded and annulled shall no longer be deemed to have been issued by virtue of such computation. Thereupon, a recomputation shall be made of the effect of such rights or options or other Convertible Securities on the then outstanding Warrants, but not on any then outstanding Warrant Shares, on the basis of 11 (c) treating the number of Additional Shares of Common Stock or other property, if any, theretofore actually issued or issuable pursuant to the previous exercise of any such warrants or rights or any such right of conversion or exchange, as having been issued on the date or dates of any such exercise and for the consideration actually received and receivable therefor, and (d) treating any such warrants or rights or any such other Convertible Securities which then remain outstanding as having been granted or issued immediately after the time of such increase of the consideration per share for which shares of Common Stock or other property are issuable under such warrants or rights or other Convertible Securities. 4.7 Other Provisions Applicable to Adjustments under this Section. The following provisions shall be applicable to the making of adjustments provided for in this Section 4: (a) Computation of Consideration. To the extent that any Additional Shares of Common Stock or any Convertible Securities or any warrants or other rights to subscribe for or purchase any Additional Shares of Common Stock or any Convertible Securities shall be issued for cash consideration, the consideration received by the Company therefor shall be the amount of the cash received by the Company therefor, or, if such Additional Shares of Common Stock or Convertible Securities are offered by the Company for subscription, the subscription price, or, if such Additional Shares of Common Stock or Convertible Securities are sold to underwriters or dealers for public offering without a subscription offering, the initial public offering price (in any such case subtracting any amounts paid or receivable for accrued interest or accrued dividends, but not subtracting any compensation, discounts or expenses paid or incurred by the Company for and in the underwriting of, or otherwise in connection with, the issuance thereof). To the extent that such issuance shall be for a consideration other than cash, then, except as herein otherwise expressly provided, the amount of such consideration shall be deemed to be the fair value of such consideration at the time of such issuance as determined in good faith by the Board of Directors of the Company. In case any Additional Shares of Common Stock or any Convertible Securities or any warrants or other rights to subscribe for or purchase such Additional Shares of Common Stock or Convertible Securities shall be issued in connection with any merger in which the Company issues any securities, the amount of consideration therefor shall be deemed to be the fair value, as determined in good faith by the Board of Directors of the Company, of such portion of the assets and business of the nonsurviving corporation as such Board in good faith shall determine to be attributable to such Additional Shares of Common Stock, Convertible Securities, warrants or other rights, as the case may be. The consideration for any Additional Shares of Common 12 Stock issuable pursuant to any warrants or other rights to subscribe for or purchase the same shall be the consideration received by the Company for issuing such warrants or other rights plus the additional consideration payable to the Company upon exercise of such warrants or other rights. The consideration for any Additional Shares of Common Stock issuable pursuant to the terms of any Convertible Securities shall be the consideration, if any, received by the Company for issuing warrants or other rights to subscribe for or purchase such Convertible Securities, plus the consideration paid or payable to the Company in respect of the subscription for or purchase of such Convertible Securities, plus the additional consideration, if any, payable to the Company upon the exercise of the right of conversion or exchange in such Convertible Securities. In case of the issuance at any time of any Additional Shares of Common Stock or Convertible Securities in payment or satisfaction of any dividends upon any class of stock other than Common Stock, the Company shall be deemed to have received for such Additional Shares of Common Stock or Convertible Securities a consideration equal to the amount of such dividend so paid or satisfied. (b) When Adjustments to Be Made. The adjustments required by this Section 4 shall be made whenever and as often as any specified event requiring an adjustment shall occur, except that any adjustment of the number of shares of Common Stock for which this Warrant is exercisable that would otherwise be required may be postponed (except in the case of a subdivision or combination of shares of the Common Stock, as provided for in Section 4.1) up to, but not beyond the date of exercise if such adjustment either by itself or with other adjustments not previously made adds or subtracts less than 1% of the shares of Common Stock for which this Warrant is exercisable immediately prior to the making of such adjustment. Any adjustment representing a change of less than such minimum amount (except as aforesaid) which is postponed shall be carried forward and made upon the earlier of (i) the date upon which such adjustment, together with other adjustments required by this Section 4 and not previously made, would result in a minimum adjustment, and (ii) the date of exercise. For the purpose of any adjustment, any specified event shall be deemed to have occurred at the close of business on the date of its occurrence. (c) Fractional Interests. In computing adjustments under this Section 4, fractional interests in Common Stock shall be taken into account to the nearest 1/10th of a share. (d) When Adjustment Not Required. If the Company shall take a record of the holders of its Common Stock for the purpose of entitling them to receive a dividend or distribution or subscription or purchase rights and shall, 13 thereafter and before the distribution to stockholders thereof, legally abandon its plan to pay or deliver such dividend, distribution, subscription or purchase rights, then thereafter no adjustment shall be required by reason of the taking of such record and any such adjustment previously made in respect thereof shall be rescinded and annulled. (e) Escrow of Warrant Shares. If after any property becomes distributable pursuant to this Section 4 by reason of the taking of any record of the holders of Common Stock, but prior to the occurrence of the event for which such record is taken, Holder exercises this Warrant, any Additional Shares of Common Stock issuable and other property distributable upon exercise by reason of such adjustment shall be held in escrow for Holder by the Company to be issued to Holder upon and to the extent that the event actually takes place, upon payment of the then Current Warrant Price. Notwithstanding any other provision to the contrary herein, if the event for which such record was taken fails to occur or is rescinded, then such escrowed shares shall be canceled by the Company and escrowed property returned. (f) Challenge to Good Faith Determination. Whenever the Board of Directors of the Company shall be required to make a determination in good faith of the fair value of any item under this Section 4, such determination may be challenged in good faith by Holder, and any dispute shall be resolved by an investment banking firm of recognized national standing selected by the Company and acceptable to such Holder. 4.8 Reorganization, Reclassification, Merger, Consolidation or Disposition of Assets. In case the Company shall reorganize its capital, reclassify its capital stock, consolidate or merge with or into another corporation (where the Company is not the surviving corporation or where there is a change in or distribution with respect to the Common Stock of the Company), or sell, transfer or otherwise dispose of all or substantially all its property, assets or business to another corporation (hereinafter, a "Reorganization") and, pursuant to the terms of such Reorganization, shares of common stock of the successor or acquiring corporation, or any cash, shares of stock or other securities or property of any nature whatsoever (including warrants or other subscription or purchase rights) in addition to or in lieu of common stock of the successor or acquiring corporation ("Other Property"), are to be received by or distributed to the holders of Common Stock of the Company, then each Holder shall have the right following the effectiveness of such Reorganization to receive, upon exercise of such Warrant, the number of shares of common stock of the successor or acquiring corporation or of the Company, if it is the surviving corporation, and Other Property receivable upon or as a result of such Reorganization by a holder of the number of shares of Common Stock for which this Warrant is exercisable immediately prior to such event. In case of any such Reorganization, the successor or acquiring corporation (if other than the Company) shall expressly assume the due and punctual observance and performance of each and every covenant and condition of this Warrant to be performed and observed by the Company and all the obligations and liabilities 14 hereunder, subject to such appropriate modifications as are satisfactory to the Majority Holders in order to provide for adjustments of shares of the Common Stock for which this Warrant is exercisable which shall be as nearly equivalent as practicable to the adjustments provided for in this Section 4. For purposes of this Section 4.8 "common stock of the successor or acquiring corporation" shall include stock of such corporation of any class which is not preferred as to dividends or assets over any other class of stock of such corporation and which is not subject to redemption and shall also include any evidences of indebtedness, shares of stock or other securities which are convertible into or exchangeable for any such stock, either immediately or upon the arrival of a specified date or the happening of a specified event and any warrants or other rights to subscribe for or purchase any such stock. The foregoing provisions of this Section 4.8 shall similarly apply to successive Reorganizations. 4.9 Other Action Affecting Common Stock. In case at any time or from time to time the Company shall take any action in respect of its Common Stock, other than the payment of dividends permitted by Section 4.2(a) or any other action described in this Section 4, then, unless such action will not have a materially adverse effect upon the rights of the Holders, the number of shares of Common Stock or other stock for which this Warrant is exercisable and/or the purchase price thereof shall be adjusted in such manner as may be equitable in the circumstances. 4.10 Certain Limitations. Notwithstanding anything herein to the contrary, the Company agrees not to enter into any transaction which, by reason of any adjustment hereunder, would cause the Current Warrant Price to be less than the par value per share of Common Stock. 5. Notices to Warrant Holders. 5.1 Notice of Adjustments. Whenever the number of shares of Common Stock for which this Warrant is exercisable, or whenever the price at which a share of such Common Stock may be purchased upon exercise of this Warrant, shall be adjusted pursuant to Section 4, the Company shall forthwith prepare a certificate to be executed by the chief financial officer of the Company setting forth, in reasonable detail, the event requiring the adjustment and the method by which such adjustment was calculated (including a description of the basis on which the Board of Directors of the Company determined the fair value of any evidences of indebtedness, shares of stock, other securities or property or warrants or other subscription or purchase rights referred to in Section 4.2 or 4.7(a)), specifying the number of shares of Common Stock for which this Warrant is exercisable and (if such adjustment was made pursuant to Section 4.8 or 4.9) describing the number and kind of any other shares of stock or Other Property for which this Warrant is exercisable, and any change in the purchase price or prices thereof, after giving effect to such adjustment or change. The Company shall promptly cause a signed copy of such certificate to be delivered to Holder in accordance with Section 13. The Company shall keep at its chief executive office copies of all such certificates and cause the same to be available for inspection at said office during normal business hours by Holder or any prospective purchaser of a Warrant designated by Holder. 15 5.2 Notice of Certain Corporate Action. Holder shall be entitled to the same rights to receive notice of corporate action as any holder of Common Stock. 6. No Impairment. The Company shall not by any action including, without limitation, amending its certificate of incorporation or through any reorganization, transfer of assets, consolidation, merger, dissolution, issue or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms of this Warrant, but will at all times in good faith assist in the carrying out of all such terms and in the taking of all such actions as may be necessary or appropriate to protect the rights of Holder against impairment. Without limiting the generality of the foregoing, the Company will (a) not increase the par value of any shares of Common Stock receivable upon the exercise of this Warrant above the amount payable therefor upon such exercise immediately prior to such increase in par value, (b) take all such action as may be necessary or appropriate in order that the Company may validly and legally issue fully paid and nonassessable shares of Common Stock, free and clear of any liens, claims, encumbrances and restrictions (other than as provided herein) upon the exercise of this Warrant, and (c) use its best efforts to obtain all such authorizations, exemptions or consents from any public regulatory body having jurisdiction thereof as may be necessary to enable the Company to perform its obligations under this Warrant. 7. Fully Paid Stock; Taxes. The shares of the Common Stock represented by each and every certificate for Warrant Shares delivered on the exercise of this Warrant shall, at the time of such delivery, be validly issued and outstanding, fully paid and non-assessable, and not subject to any pre-emptive rights. The Company shall pay all expenses in connection with, and all taxes and other governmental charges that may be imposed with respect to, the issue or delivery thereof, unless such tax or charge is imposed by law upon Holder, in which case such taxes or charges shall be paid by Holder. The Company shall not be required, however, to pay any tax or other charge imposed in connection with any transfer involved in the issue of any certificate for shares of Common Stock issuable upon exercise of this Warrant in any name other than that of Holder, and in such case the Company shall not be required to issue or deliver any stock certificate until such tax or other charge has been paid or it has been established to the satisfaction of the Company that no such tax or other charge is due. 8. Transfer. 8.1 Securities Laws. Neither this Warrant nor the Warrant Shares issuable upon the exercise hereof have been registered in reliance on Section 4(2) of the Securities Act or under any state securities laws and unless so registered may not be transferred, sold, pledged, hypothecated or otherwise disposed of unless an exemption from registration pursuant to Rule 144 of the Securities Act is available. Except as provided in Section 8.6, this Warrant shall bear the following legend: 16 NEITHER THESE WARRANTS NOR THE SHARES OF COMMON STOCK ISSUABLE UPON EXERCISE OF THESE WARRANTS HAVE BEEN REGISTERED WITH THE U.S. SECURITIES AND EXCHANGE COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON AN EXEMPTION FROM REGISTRATION UNDER REGULATION D PROMULGATED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"). THESE WARRANTS AND THE SHARES OF COMMON STOCK ISSUABLE UPON EXERCISE OF THESE WARRANTS ARE RESTRICTED AND MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE ACT OR PURSUANT TO AN APPLICABLE EXEMPTION THEREFROM. 8.2 Conditions to Transfer. In the event Holder desires to transfer this Warrant or any of the Warrant Shares issued (in the absence of registration under the Securities Act), the Holder must give the Company prior written notice of such proposed transfer including the name and address of the proposed transferee. Such transfer may be made only either (i) upon publication by the Commission of a ruling, interpretation, opinion or "no action letter" based upon facts presented to said Commission, or (ii) upon receipt by the Company of an opinion of Holder's counsel acceptable to the Company, in either case to the effect that the proposed transfer will not violate the provisions of the Securities Act, the Exchange Act, or the rules and regulations promulgated under either such act (collectively, the "Securities Laws"). Prior to any such proposed transfer, and as a condition thereto, if such transfer is not made pursuant to an effective registration statement under the Securities Act, the Holder will, if requested by the Company, deliver to the Company any representation or agreement reasonably requested to determine compliance with the Securities Laws. 8.3 Indemnity. The Holder acknowledges that the Holder understands the meaning and legal consequences of this Section 8 and the Holder hereby shall indemnify and hold harmless the Company, its representatives and each officer, director and control person thereof from and against any and all loss, damage or liability (including all attorneys' fees and costs incurred in enforcing this indemnity provision) due to or arising out of (i) any transfer of the Warrant or any of the Warrant Shares in violation of the Securities Act, the Exchange Act, or the rules and regulations promulgated under either of such acts, or (ii) any transfer of the Warrant or any of the Warrant Shares not in accordance with this Warrant or any of the Warrant Shares not in accordance with this Warrant. 8.4 Transfer. Except as provided in this Section 8, this Warrant and the Warrant Shares issued may be transferred by the Holder in whole or in part at any time or from time to time. Upon surrender of this Warrant to the Company or at the office of its stock transfer agent, if any, with the Assignment Form annexed hereto duly executed and funds sufficient to pay any transfer tax, and upon compliance with the foregoing provisions, the Company shall, without charge, execute and deliver a new Warrant or Warrants in the name of the assignee or assignees named in such Assignment Form (and if the entire amount of the Warrant is not being transferred, in the name of the Holder), and this Warrant shall promptly be canceled. Any assignment, transfer, pledge, hypothecation or other disposition of this Warrant attempted contrary to the provisions of this 17 Warrant, or any levy of execution, attachment or other process attempted upon the Warrant, shall be null and void and without effect. 8.5 Registration. The Holders of Warrants and Warrant Shares shall have the right to request registration of such Warrant Shares pursuant to the Registration Rights Agreement. 8.6 Termination of Restrictions. Notwithstanding the foregoing provisions of Section 8, the restrictions imposed by this Section upon the transferability of the Warrants, the War rant Shares and the Restricted Common Stock (or Common Stock issuable upon the exercise of the Warrants) and the legend requirements of Section 8.1 shall terminate as to any particular Warrant or Warrant Share or Restricted Common Stock (or Common Stock issuable upon the exercise of the Warrants) (i) when and so long as such security shall have been effectively registered under the Securities Act and disposed of pursuant thereto, or (ii) when the Company shall have delivered to the Holder or Holders of Warrants, Warrant Shares or Restricted Common Stock the written opinion of Independent Counsel stating that such legend is not required in order to ensure compliance with the Securities Act. Whenever the restrictions imposed by Section 8 shall terminate as to this War rant, as hereinabove provided, the Holder hereof shall be entitled to receive from the Company, at the expense of the Company, a new Warrant bearing the following legend in place of the restrictive legend set forth hereon: "THE RESTRICTIONS ON TRANSFERABILITY OF THE WITHIN WARRANT CONTAINED IN SECTION 8 HEREOF TERMINATED ON ____________, 19__, AND ARE OF NO FURTHER FORCE AND EFFECT." All Warrants issued upon registration of transfer, division or combination of, or in substitution for, any Warrant or Warrants entitled to bear such legend shall have a similar legend endorsed thereon. Whenever the restrictions imposed by this Section shall terminate as to any share of Restricted Common Stock, as hereinabove provided, the Holder thereof shall be entitled to receive from the Company, at the Company's expense, a new certificate representing such Common Stock not bearing the restrictive legend set forth in Section 8.1. 9. Loss, etc. of Warrant. Upon receipt of evidence satisfactory to the Company of the loss, theft, destruction or mutilation of this Warrant, and of indemnity reasonably satisfactory to the Company (it being understood that the written indemnity agreement of AJG Financial Services, Inc. shall be sufficient indemnity), if lost, stolen or destroyed, and upon surrender and cancellation of this Warrant, if mutilated, the Company shall execute and deliver to the Holder a new Warrant of like date, tenor, and denomination. 10. Warrant Holder Not Shareholder. Except as otherwise provided here, this Warrant does not confer upon the Holder any right to vote or to consent to or receive notice as a shareholder of the Company, as such, in respect of any matters whatsoever, or any other rights or liabilities as a shareholder of the Company, either at law or in equity, and the rights of the Holder are limited to those expressed in this Warrant. 18 11. Liquidated Damages. In the event the Company fails to comply in all material respects with any provision of the Registration Rights Agreement, upon written request of the Holder of this Warrant or Warrant Shares, the Company shall promptly obtain from an independent investment banking firm acceptable to such Holder an opinion estimating the net proceeds which such Holder would have received (after deducting underwriting commissions and discounts and any other expenses that would have been solely attributable to the registration or qualification of such shares of Warrant Shares) upon the sale of shares of Warrant Shares proposed to be sold pursuant to such registration or qualification. Such opinion of the independent investment banking firm shall be (a) delivered in writing to the Company, with a copy to such Holder, within thirty (30) days after the date of the request of such Holder to the Company and (b) conclusive and binding on the Company and such Holder. Within 30 days of receipt by the Company of such estimate, the Company shall pay to such Holder an amount equal to (a) such estimated net proceeds minus (b) the aggregate Warrant Price paid or payable with respect to such shares of Warrant Shares. Payment of such amount shall be made by, at the option of such person, (i) wire transfer to an account in a bank located in the United States designated by such Holder for such purpose or (ii) a certified or official bank check drawn on a member of the Chicago or New York Clearing House payable to the order of such Holder. Upon payment to such Holder of such liquidated damages, such Holder shall assign to the Company this Warrant and the Warrant Shares proposed to be sold pursuant to the registration or qualification in question without any representation or warranty (other than that such Holder has good and marketable title thereto, free and clear of liens, claims, encumbrances and restrictions of any kind). If less than all of the shares of Common Stock issuable upon the exercise hereof were proposed to be sold pursuant to the registration or qualification in question, the Company shall cancel this Warrant and issue in the name of, and deliver to, the Holder, pursuant to Section 2, a new Warrant for the shares of Common Stock issuable upon the exercise hereof not required to be assigned to the Company pursuant to the provisions of the preceding sentence. The Company agrees that the amount of actual damages that would be sustained by such Holder as a result of the failure of the Company to comply with any provisions of the Registration Rights Agreement is not capable of ascertainment on any other basis. 12. Appraisal. The determination of the Appraised Value per share of Common Stock shall be made by an investment banking firm of nationally recognized standing selected by the Majority Holders and acceptable to the Company. If the investment banking firm selected by the Majority Holders is not acceptable to the Company and the Company and the Majority Holders cannot agree on a mutually acceptable investment banking firm, then the Majority Holders and the Company shall each choose one such investment banking firm and the respective chosen firms shall agree on another investment banking firm which shall make the determination. The Company shall, at its sole cost, pay all fees of such investment banking firm as may be necessary for the determination of Appraised Value required by the terms of this Warrant. 13. Communication. No notice or other communication under this Warrant shall be effective unless the same is in writing and is either (i) mailed by first-class mail, postage prepaid, 19 in which event the notice shall be deemed effective three days after deposit in the mails, or (ii) delivered by established delivery service which guarantees three business days or less delivery, in which event the notice shall be deemed effective on the date of guaranteed delivery. Regardless of the method of delivery, the notice or communication shall be addressed to: (a) the Company at 3280 North Frontage Road, Lehi, Utah 84043, Attention: Chief Executive Officer or such other address as the Company has designated in writing to the Holder, or (b) the Holder at the address indicated in the opening paragraph hereof, or such other address as the Holder has designated in writing to the Company. 14. Headings. The headings of this Warrant have been inserted as a matter of convenience and shall not affect the construction hereof. 15. Applicable Law. This Warrant shall be governed by and construed in accordance with the law of the State of Delaware without giving effect to the principles of conflicts of law thereof. 16. Warrant Register. The Company will register this Warrant in the Warrant Register in the name of the record holder to whom it has been distributed or assigned in accordance with the terms hereof. The Company may deem and treat the registered Holder of this Warrant as the absolute owner hereof (notwithstanding any notation of ownership or other writing hereon made by anyone) for the purpose of any exercise hereof or any distribution to the Holder and for all other purposes, and the Company shall not be affected by any notice to the contrary. 17. Successors. All of the provisions of this Warrant by or for the benefit of the Company or the Holder shall bind and inure to the benefit of their respective successors and assigns. IN WITNESS WHEREOF, Covol Technologies, Inc. has caused this Warrant to be signed by its President and its corporate seal to be hereunto affixed and attested by its Secretary this 9th day of January, 1998. ATTEST: COVOL TECHNOLOGIES, INC. /Asael T. Sorensen, Jr./ By: Stanley M. Kimball - ------------------------- --------------------- Secretary President 20 EXERCISE FORM To be executed by the Holder in Order to Exercise Warrants The undersigned Holder hereby irrevocably elects to exercise Warrants represented by this Warrant, and to purchase the securities issuable upon the exercise of such Warrants, and requests that certificates for such securities shall be issued in the Holder's name and be delivered to [please print or type address] and if such number of Warrants shall not be all the Warrants evidenced by this Warrant, that a new Warrant for the balance of such Warrants be registered in the name of, and delivered to, the Holder at the address stated above. The undersigned acknowledges that, if this Exercise Form is submitted prior to the Company having given notice that the issuance of the Warrant Shares has been registered under the Securities Act, the Warrant Shares issued on exercise will be "restricted securities" and will bear appropriate restrictive legends. Dated: Signature of Holder Signature Guaranteed 21 ASSIGNMENT To Be Executed by the Holder in Order to Assign Warrants THE WARRANTS REPRESENTED HEREBY HAVE NOT BEEN REGISTERED UNDER FEDERAL OR STATE SECURITIES LAWS AND TRANSFER THEREOF HAS BEEN RESTRICTED. ANY TRANSFER OR PURPORTED TRANSFER DESCRIBED IN THIS FORM OF ASSIGNMENT SHALL NOT BE EFFECTIVE UNTIL AND UNLESS THE PROPOSED TRANSFEREE COMPLIES WITH THE RESTRICTIONS ON TRANSFER DESCRIBED IN THE WARRANT CERTIFICATE. FOR VALUE RECEIVED, the undersigned hereby sells, assigns and transfers unto Name: [please print or type] Address: Social Security: or Taxpayer I.D. No. the undersigned's right to purchase up to ___________ Shares of Common Stock represented by this Warrant, and hereby irrevocably constitutes and appoints ____________________________________ attorney to transfer the same on the books of the Company, with full power of substitution in the premises. Dated: Signature Guaranteed 22 EX-10.53.4 9 WARRANT B WARRANT B Dated: January 9, 1998 Warrant No. WA-1997-246 **216,272** Shares NEITHER THESE WARRANTS NOR THE SHARES OF COMMON STOCK ISSUABLE UPON EXERCISE OF THESE WARRANTS HAVE BEEN REGISTERED WITH THE U.S. SECURITIES AND EXCHANGE COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON AN EXEMPTION FROM REGISTRATION UNDER REGULATION D PROMULGATED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"). THESE WARRANTS AND THE SHARES OF COMMON STOCK ISSUABLE UPON EXERCISE OF THESE WARRANTS ARE RESTRICTED AND MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO REGULATION D UNDER THE ACT, AN EFFECTIVE REGISTRATION STATEMENT UNDER THE ACT OR PURSUANT TO AN APPLICABLE EXEMPTION THEREFROM. These Warrants shall cease to be exercisable and shall be void after January 10, 2000, at 5:00 p.m., Salt Lake City, Utah time. COMMON STOCK PURCHASE WARRANTS OF COVOL TECHNOLOGIES, INC. FOR VALUE RECEIVED, Covol Technologies, Inc. (the "Company"), a Delaware corporation, hereby certifies that AJG Financial Services, Inc., or its permitted assigns, is entitled to purchase from the Company, subject to the conditions and upon the terms of this Warrant, at any time or from time to time after the date hereof and prior to 5:00 p.m. Salt Lake City, Utah time, on January 10, 2000, an aggregate of 216,272 fully paid and nonassessable shares of Common Stock, par value $.001, of the Company (subject to adjustment as provided herein), at a per share exercise price of $20.00 per share (subject to adjustment as provided herein). This Warrant is issued pursuant to the terms set forth in a letter agreement dated October 22, 1997, by and between the Holder (as defined below) and the Company (the "Letter Agreement"). 1. Definitions. As used in this Warrant, the following terms have the respective meanings set forth below: "Additional Shares of Common Stock" shall mean all shares of Common Stock issued by the Company after the Closing Date, other than Warrant Shares. 1 "Affiliate" of any Person shall mean a Person that directly or indirectly, through one or more intermediaries, controls or is controlled by or is under common control with, such Person. "Appraised Value" shall mean, in respect of any share of Common Stock on any date herein specified, the fair market value of such share of Common Stock (determined without giving effect to the discount for (i) a minority interest, or (ii) any lack of liquidity of the Common Stock or to the fact that the Company may have no class of equity registered under the Exchange Act, based on the quotient obtained by dividing (x) the value of the Company, as determined by an investment banking firm selected in accordance with the terms of Section 12, by (y) the number of Fully Diluted Outstanding shares of Common Stock. "Book Value" shall mean, in respect of any share of Common Stock on any date herein specified, the consolidated book value of the Company (with inventory valued on a first-in-first-out basis) applicable to Common Stock as of the last day of any month immediately preceding such date, divided by the number of Fully Diluted Outstanding shares of Common Stock as determined in accordance with GAAP by Price Waterhouse Coopers LLP or any other firm of independent certified public accountants of recognized national standing selected by the Company and reasonably acceptable to the Majority Holders, determined in any event without any adjustment or reduction for the amount, if any, that may, under modifications to GAAP adopted after the Closing Date, be required either as an offset to or reserve against earnings or retained earnings, or as a deduction from book value or net worth, in either event as a result of the exercise, issuance, anticipated exercise or anticipated cost to the Company of any stock option, right or convertible security or any provision of the Warrants or any other warrant issued by the Company. "Business Day" shall mean any day that is not a Saturday or Sunday or a day on which banks are required or permitted to be closed in the State of Utah or the State of Illinois. "Closing Date" shall mean January 9, 1998. "Commission" shall mean the Securities and Exchange Commission or any other federal agency then administering the Securities Act and other federal securities laws. "Common Stock" shall mean (except where the context otherwise indicates) the Common Stock, $0.001 par value, of the Company as constituted on the Closing Date, and any capital stock into which such Common Stock may thereafter be changed, and shall also include (i) capital stock of the Company of any other class (regardless of how denominated) issued to the holders of shares of Common Stock upon any reclassification thereof which is also not preferred as to dividends or assets over any other class of stock of the Company and which is not subject to redemption and (ii) shares of common stock of any successor or acquiring corporation (as defined in Section 4.8) received by or distributed to the holders of Common Stock of the Company in the circumstances contemplated by Section 4.8. 2 "Convertible Securities" shall mean evidences of indebtedness, shares of stock or other securities which are convertible into or exchangeable, with or without payment of additional consideration in cash or property, for Additional Shares of Common Stock, either immediately or upon the occurrence of a specified date or a specified event. "Current Market Price" shall mean, in respect of any share of Common Stock on any date herein specified, the highest of (a) the Book Value per share of Common Stock at such date, (b) the Appraised Value per share of Common Stock as of a date which is within 120 days of such date, (c) the fair market value thereof as determined in good faith by the Board of Directors of the Company as of a date which is within 15 days of such date, or (d) if there shall then be a public market for the Common Stock, the average of the daily market prices for the 30 consecutive Business Days immediately preceding such date. The daily market price for each such Business Day shall be (i) the last sale price on such day on the principal stock exchange on which such Common Stock is then listed or admitted to trading, (ii) if no sale takes place on such day on any such exchange, the last reported sale price as officially quoted on any such exchange, (iii) if the Common Stock is not then listed or admitted to trading on any stock exchange, the last sale price on such day in the over-the-counter market, as reported by the National Association of Securities Dealers Automatic Quotation System ("NASDAQ"), or if such sale price is not available on such date, the average of the closing bid and asked prices on such date as reported by NASDAQ, or if not so reported, then as reported by the National Quotation Bureau, Inc., (iv) if neither such firm at the time is engaged in the business of reporting such prices, as furnished by any similar firm then engaged in such business, or (v) if there is no such firm, as furnished by any member of the NASD selected mutually by the Majority Holders and the Company or, if they cannot agree upon such selection, as selected by two such members of the NASD, one of which shall be selected by the Majority Holders and one of which shall be selected by the Company. "Current Warrant Price" shall mean, in respect of a share of Common Stock at any date herein specified, the price at which a share of Common Stock may be purchased pursuant to this Warrant on such date. On the Closing Date, the Current Warrant Price is $10.00 per share of Common Stock. "Debenture Agreement" shall mean the Debenture Agreement and Security Agreement, dated as of January 9, 1998, between the Company and AJG Financial Services, Inc. "Default Rate" means eight percent (8%). "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended, or any similar federal statute, and the rules and regulations of the Commission thereunder, all as the same shall be in effect from time to time. "Exercise Period" shall mean the period during which this Warrant is exercisable pursuant to Section 2. 3 "Fully Diluted Outstanding" shall mean, when used with reference to Common Stock, at any date as of which the number of shares thereof is to be determined, all shares of Common Stock Outstanding at such date and all shares of Common Stock issuable in respect of this Warrant outstanding on such date and other options or warrants to purchase, or securities convertible into, shares of common stock outstanding on such date which would be deemed outstanding in accordance with GAAP for purposes of determining book value or net income per share. "GAAP" shall mean generally accepted accounting principles in the United States of America as from time to time in effect. "Holder" shall mean, as the context requires, the Person in whose name this Warrant or one of the other Warrants is registered on the books of the Company maintained for such purpose or the Person holding any Warrant Shares, and "Holders" shall mean two or more such Persons. "Independent Counsel" shall mean counsel to the Company, unless counsel to Holder disagrees in writing with the opinion or advice of such counsel with respect to the issue in question within fifteen (15) days after receipt of such opinion or advice, in which case the Company and Holder shall select another counsel, not the regular counsel of either, who is experienced in Securities Act matters, who shall render an opinion with respect to the issue in question. The legal fees and expenses of such other counsel incurred in connection with the rendering of such opinion shall be borne equally by Holder and the Company. "Letter Agreement" shall have the meaning set forth in the first paragraph of this Warrant. "Majority Holders" shall mean the Holders of Warrants exercisable for in excess of 50% of the aggregate number of shares of Common Stock then purchasable upon exercise of all Warrants, whether or not then exercisable. "NASD" shall mean the National Association of Securities Dealers, Inc., or any successor corporation thereto. "Other Property" shall have the meaning set forth in Section 4.8. "Outstanding" shall mean, when used with reference to Common Stock, at any date as of which the number of shares thereof is to be determined, all issued shares of Common Stock, except shares then owned or held by or for the account of the Company or any Subsidiary, and shall include all shares issuable in respect of outstanding scrip or any certificates representing fractional interests in shares of Common Stock. "Permitted Issuances" shall mean [(i) the issuance of up to 800,000 shares of Common Stock pursuant to certain outstanding warrants of the Company which are "out of the money" as of the Closing Date, (ii) the issuance of up to 1,500,000 shares of Common Stock pursuant to certain outstanding options, warrants or other securities of the Company convertible into Common Stock 4 which are "in the money" as of the Closing Date, (iii) the issuance of or granting of rights to acquire up to 790,000 shares of Common Stock to PacifiCorp Financial Services, inc. or any of its affiliates ('PacifiCorp"), or their respective assigns, pursuant to the Convertible Loan and Security Agreement, dated, between the Company and PacifiCorp, (iv) the issuance of or granting of rights to acquire up to 515,000 shares of Common Stock to be sold by the Company pursuant to a private Placement Memorandum, (v) the issuance of or granting of rights to acquire up to 100,000 shares of Common Stock to LKD Partnership or its assigns pursuant to a Convertible Debenture in the principal amount of approximately $1,000,000 issued in November, 1996, (vi) the issuance of or granting of rights to acquire up to 2,000,000 shares of Common Stock to officers, directors, consultants or employees of the Company, which rights vest over the next 8 to 9 years, (vii) the issuance of or granting of rights to acquire up to 400,000 additional shares of Common Stock to any third parties in transactions other than those referred to in the preceding clauses (i) through (vi)], and (viii) the issuance of shares of Common Stock upon exercise of the Warrants. "Person" shall mean any individual, sole proprietorship, partnership, joint venture, trust, incorporated organization, association, corporation, institution, public benefit corporation, entity or government (whether federal, state, county, city, municipal or otherwise, including, without limitation, any instrumentality, division, agency, body or department thereof). "Registration Rights Agreement" shall mean the Registration Rights Agreement, dated as of January 9, 1998, between the Company and AJG Financial Services, Inc. "Restricted Common Stock" shall mean shares of Common Stock which are, or which upon their issuance on the exercise of this Warrant would be, evidenced by a certificate bearing the restrictive legend set forth in Section 8.1. "Securities Act" shall mean the Securities Act of 1933, as amended, or any similar federal statute, and the rules and regulations of the Commission thereunder, all as the same shall be in effect at the time. "Subsidiary" shall mean any corporation of which an aggregate of more than 50% of the outstanding stock having ordinary voting power to elect a majority of the board of directors of such corporation (irrespective of whether, at the time, stock of any other class or classes of such corporation shall have or might have voting power by reason of the happening of any contingency) is at the time, directly or indirectly, owned legally or beneficially by the Company and/or one or more Subsidiaries of the Company. "Termination Date" shall have the meaning set forth in Section 2. "Transfer" shall mean any disposition of any Warrant or Warrant Shares or of any interest in either thereof, which would constitute a sale thereof within the meaning of the Securities Act. 5 "Warrant Price" shall mean an amount equal to (i) the number of shares of Common Stock being purchased upon exercise of this Warrant pursuant to Section 2, multiplied by (ii) the Current Warrant Price as of the date of such exercise. "Warrant Shares" shall mean the shares of Common Stock purchased by Holders of the Warrants upon the exercise thereof. "Warrants" shall mean the two Warrants (one designated Warrant A and the other designated Warrant B), each dated January 9, 1998, issued by the Company to AJG Financial Services, Inc. evidencing rights to purchase initially up to an aggregate of 432,544 shares of Common Stock, and all warrants issued upon transfer, division or combination of, or in substitution or exchange for, any thereof. 2. Exercise of Warrant. This Warrant may be exercised, in whole at any time or in part from time to time during the period (the "Exercise Period") commending on the date hereof, and ending on January 10, 2000, at 5:00 p.m. Salt Lake City, Utah time (the "Termination Date"), by the Holder of this Warrant by the surrender of this Warrant (with the exercise form at the end hereof duly executed) at the address set forth in Section 13 hereof, together with payment of the Warrant Price. Payment of the Warrant Price shall be made first by offset, in whole or in part, against any obligation of the Company to the Holder pursuant to the Debenture issued pursuant to the Debenture Agreement, and then any balance by wire transfer to an account in a bank located in the United States designated for such purpose by the Company or by certified or official bank check. The Warrant shall expire, and exercise shall no longer be allowed, to the extent the Warrant has not been exercised by the expiration of the Exercise Period. If this Warrant is exercised in part, this Warrant must be exercised for a minimum of 1,000 shares of Common Stock and if the Exercise Period has not expired the Holder is entitled to receive a new Warrant covering the number of Warrant Shares in respect of which this Warrant has not been exercised and setting forth the proportionate part of the Warrant Price applicable to such Warrant Shares. Upon such surrender of this Warrant, the Company will (a) issue a warrant or warrants in the name of the Holder for the largest number of whole shares of Common Stock to which the Holder shall be entitled and, if this Warrant is exercised in whole, in lieu of any fractional share of the Common Stock to which the Holder shall be entitled, cash equal to the fair value of such fractional share (determined in such reasonable manner as the Board of Directors of the Company shall determine), and (b) deliver the proportionate part thereof if this Warrant is exercised in part, pursuant to the provisions of this Warrant. The Warrant shall expire, and exercise shall no longer be allowed, to the extent the Warrant has not been exercised by the expiration of the Exercise Period. 3. Reservation of Warrant Shares. The Company will at all times during the Exercise Period have authorized and reserved, and will keep available, solely for issuance or delivery upon the exercise of this Warrant, the Warrant Shares. All shares of Common Stock which shall be so issuable, when issued upon exercise of any Warrant and payment therefor in accordance with the terms of such Warrant, shall be duly and validly issued, fully paid and nonassessable and free and 6 clear of any liens, claims and restrictions (other than as provided herein). No stockholder of the Company has or shall have any preemptive rights to subscribe for such shares of Common Stock. Before taking any action which would cause an adjustment reducing the Current Warrant Price below the then par value, if any, of the shares of Common Stock issuable upon exercise of the Warrants, the Company shall take any corporate action which may be necessary in order that the Company may validly and legally issue fully paid and nonassessable shares of such Common Stock at such adjusted Current Warrant Price. Before taking any action which would result in an adjustment in the number of shares of Common Stock for which this Warrant is exercisable or in the Current Warrant Price, the Company shall obtain all such authorizations or exemptions thereof, or consents thereto, as may be necessary from any public regulatory body or bodies having jurisdiction thereof. If any shares of Common Stock required to be reserved for issuance upon exercise of Warrants require registration or qualification with any governmental authority under any federal or state law (otherwise than as provided in Section 8) before such shares may be so issued, the Company will in good faith and as expeditiously as possible and at its expense endeavor to cause such shares to be duly registered. 4. Adjustments. The number of shares of Common Stock for which this Warrant is exercisable, or the price at which such shares may be purchased upon exercise of this Warrant, shall be subject to adjustment from time to time as set forth in this Section 4. The Company shall give Holder notice of any event described below which requires an adjustment pursuant to this Section 4 at the time of such event. 4.1 Stock Dividends, Subdivisions and Combinations. If at any time the Company shall: (a) take a record of the holders of its Common Stock for the purpose of entitling them to receive a dividend payable in, or other distribution of, Additional Shares of Common Stock, (b) subdivide its outstanding shares of Common Stock into a larger number of shares of Common Stock, or (c) combine its outstanding shares of Common Stock into a smaller number of shares of Common Stock, then (i) the number of shares of Common Stock for which this Warrant is exercisable immediately after the occurrence of any such event shall be adjusted to equal the number of shares of Common Stock which a record holder of the same number of shares of Common Stock for which this Warrant 7 is exercisable immediately prior to the occurrence of such event would own or be entitled to receive after the happening of such event, and (ii) the Current Warrant Price shall be adjusted to equal (a) the Current Warrant Price multiplied by the number of shares of Common Stock for which this Warrant is exercisable immediately prior to the adjustment divided by (b) the number of shares for which this Warrant is exercisable immediately after such adjustment. 4.2 Certain Other Distributions. If at any time the Company shall take a record of the holders of its Common Stock for the purpose of entitling them to receive any dividend or other distribution of: (a) cash; (b) any evidences of its indebtedness, any shares of its stock or any other securities or property of any nature whatsoever (other than cash, Convertible Securities or Additional Shares of Common Stock); or (c) any warrants or other rights to subscribe for or purchase any evidences of its indebtedness, any shares of its stock or any other securities or property of any nature whatsoever (other than cash, Convertible Securities or Additional Shares of Common Stock); then (i) the number of shares of Common Stock for which this Warrant is exercisable shall be adjusted to equal the product obtained by multiplying the number of shares of Common Stock for which this Warrant is exercisable immediately prior to such adjustment by a fraction (a) the numerator of which shall be the Current Market Price per share of Common Stock at the date of taking such record and (b) the denominator of which shall be such Current Market Price per share of Common Stock, minus the amount allocable to one share of Common Stock of (x) any such cash so distributable and (y) the fair value (as determined in good faith by the Board of Directors of the Company and supported by an opinion from an investment banking firm of recognized national standing acceptable to the Majority Holders) of any and all such evidences of indebtedness, shares of stock, other securities or property or warrants or other subscription or purchase rights so distributable, and (ii) the Current Warrant Price shall be adjusted to equal (a) the Current Warrant Price multiplied by the number of shares of Common Stock for which this Warrant is exercisable immediately prior to the adjustment divided by (b) the number of shares for which this Warrant is exercisable immediately after such adjustment. A reclassification of the Common Stock (other than a change in par value, or from par value to no par value or from no par value to par value) into shares of Common Stock and shares of any other class of stock shall be deemed a distribution by the Company to the holders of its Common Stock of such shares of such other class of stock within the meaning of this Section 4.2 and, if the outstanding shares of Common Stock shall be changed into a larger or smaller number of shares of Common Stock as a part of such reclassification, such change shall be deemed a subdivision or combination, as the case may be, of the outstanding shares of Common Stock within the meaning of Section 4.1. 8 4.3 Issuance of Additional Shares of Common Stock. (a) If at any time the Company shall (except as hereinafter provided in Sections 4.4 and 4.5) issue or sell any Additional Shares of Common Stock, other than Permitted Issuances, for consideration in an amount per Additional Share of Common Stock less than the greater of the Current Warrant Price or the Current Market Price, then: (i) the number of shares of Common Stock for which this Warrant is exercisable shall be adjusted to equal the product obtained by multiplying the number of shares of Common Stock for which this Warrant is exercisable immediately prior to such issue or sale by a fraction (W) the numerator of which is the number of shares of Common Stock Outstanding immediately after the issuance or sale of such Additional Shares of Common Stock, and (X) the denominator of which is number of shares of Common Stock Outstanding immediately prior to such issuance or sale; and (ii) the Current Warrant Price shall be adjusted to a price determined by dividing (a) an amount equal to the sum of (X) the number of shares of Common Stock Outstanding immediately prior to such issuance or sale multiplied by the then existing Current Warrant Price, plus (Y) the consideration, if any, received by the Company upon such issuance or sale, by (b) the total number of shares of Common Stock Outstanding immediately after such issuance or sale. (b) If at any time the Company shall (except as hereinafter provided in Sections 4.4 and 4.5) issue or sell any Additional Shares of Common Stock, other than Permitted Issuances, for consideration in an amount per Additional Share of Common Stock equal to or greater than the greater of the Current Warrant Price or the Current Market Price, then the number of shares for which this Warrant is exercisable shall not change, but the Company shall issue to Holder a new Warrant for the number of shares of Common Stock equal to (i) the product obtained by multiplying the number of shares of Common Stock for which this Warrant is exercisable immediately prior to such issuance or sale by a fraction (W) the numerator of which is the number of shares of Common Stock Outstanding immediately after the issuance or sale of such Additional Shares of Common Stock, and (X) the denominator of which is the number of shares of Common Stock Outstanding immediately prior to such issuance or sale, less (ii) the number of shares for which this Warrant is exercisable immediately prior to such issuance or sale. The new Warrant shall have the same terms and provisions as this Warrant except with respect to the number of shares for which it is exercisable and except that the Current Warrant Price (as defined in the new Warrant) for each share of Common Stock for which such new Warrant is exercisable shall be equal to the fair value of the consideration per Additional Share of Common Stock. 9 (c) The provisions of this Section 4.3 shall not apply to any issuance of Additional Shares of Common Stock for which an adjustment is provided under Section 4.1 or 4.2. No adjustment shall be made under this Section 4.3 upon the issuance of any Additional Shares of Common Stock which are issued pursuant to the exercise of any warrants or other subscription or purchase rights or pursuant to the exercise of any conversion or exchange rights in any Convertible Securities, if any such adjustment shall previously have been made upon the issuance of such warrants or other rights or upon the issuance of such Convertible Securities (or upon the issuance of any warrant or other rights therefor) pursuant to Section 4.4 or Section 4.5. 4.4 Issuance of Warrants or Other Rights. If at any time the Company shall take a record of the holders of its Common Stock for the purpose of entitling them to receive a distribution of, or shall in any manner (whether directly or by assumption in a merger in which the Company is the surviving corporation) issue or sell, any warrants (other than the Warrants) or other rights to subscribe for or purchase any Additional Shares of Common Stock or any Convertible Securities, whether or not the rights to exchange or convert thereunder are immediately exercisable, and the price per share for which Common Stock is issuable upon the exercise of such warrants or other rights or upon conversion or exchange of such Convertible Securities shall be less than the greater of the Current Warrant Price or the Current Market Price in effect immediately prior to the time of such distribution, issue or sale, then the number of shares of Common Stock for which this Warrant is exercisable and the Current Warrant Price shall be adjusted as provided in Section 4.3(a) on the basis that (i) the maximum number of Additional Shares of Common Stock issuable pursuant to all such warrants or other rights or necessary to effect the conversion or exchange of all such Convertible Securities shall be deemed to have been issued and outstanding, (ii) the price per share for such Additional Shares of Common Stock shall be deemed to be the lowest price per share at which such Additional Shares of Common Stock are available to such holders, and (iii) the Company shall have received all of the consideration, if any, payable for such warrants or other rights as of the date of the actual issuance thereof. No further adjustments of the number of shares of Common Stock for which this Warrant is exercisable or of the Current Warrant Price shall be made upon the actual issue of such Common Stock or of such Convertible Securities upon exercise of such warrants or other rights or upon the actual issue of such Common Stock upon such conversion or exchange of such Convertible Securities. 4.5 Issuance of Convertible Securities. If at any time the Company shall take a record of the holders of its Common Stock for the purpose of entitling them to receive a distribution of, or shall in any manner (whether directly or by assumption in a merger in which the Company is the surviving corporation) issue or sell, any Convertible Securities, whether or not the rights to exchange or convert thereunder are immediately exercisable, and the price per share for which Common Stock is issuable upon such conversion or exchange shall be less than the greater of the Current Warrant Price or the Current Market Price in effect immediately prior to the time of such issue or sale, then the number of shares of Common Stock for which this Warrant is exercisable and the Current Warrant Price shall be adjusted as provided in Section 4.3(a) on the basis that (i) the maximum 10 number of Additional Shares of Common Stock issuable upon the conversion or exchange of all such Convertible Securities shall be deemed to have been issued and outstanding, (ii) the price per share of such Additional Shares of Common Stock shall be deemed to be the lowest possible price in any range of prices at which such Additional Shares of Common Stock are available to such holders, and (iii) the Company shall have received all of the consideration payable therefor, if any, as of the date of actual issuance of such Convertible Securities. No further adjustment of the number of shares of Common Stock for which this Warrant is exercisable or of the Current Warrant Price shall be made under this Section 4.5 upon the issuance of any Convertible Securities which are issued pursuant to the exercise of any warrants or other subscription or purchase rights therefor, if any such adjustment shall previously have been made upon the issuance of such warrants or other rights pursuant to Section 4.4. No further adjustments of the number of shares of Common Stock for which this Warrant is exercisable or of the Current Warrant Price shall be made upon the actual issue of such Common Stock upon conversion or exchange of such Convertible Securities and, if any issue or sale of such Convertible Securities is made upon exercise of any warrant or other right to subscribe for or to purchase or any warrant or other right to purchase any such Convertible Securities for which adjustments thereof have been or are to be made pursuant to other provisions of this Section 4, no further adjustments shall be made by reason of such issue or sale. 4.6 Superseding Adjustment. If, at any time after any adjustment of the number of shares of Common Stock for which this Warrant is exercisable shall have been made pursuant to Section 4.4 or Section 4.5 as the result of any issuance of warrants, rights or Convertible Securities, and either (a) such warrants or rights, or the right of conversion or exchange in such other Convertible Securities, shall expire, and all or a portion of such warrants or rights, or the right of conversion or exchange with respect to all or a portion of such other Convertible Securities, as the case may be, shall not have been exercised, or (b) the consideration per share for which shares of Common Stock are issuable pursuant to such warrants or rights, or the terms of such other Convertible Securities, shall be increased solely by virtue of provisions therein contained for an automatic increase in such consideration per share upon the occurrence of a specified date or event, then such previous adjustment shall be rescinded and annulled and the Additional Shares of Common Stock which were deemed to have been issued by virtue of the computation made in connection with the adjustment so rescinded and annulled shall no longer be deemed to have been issued by virtue of such computation. Thereupon, a recomputation shall be made of the effect of such rights or options or other Convertible Securities on the then outstanding Warrants, but not on any then outstanding Warrant Shares, on the basis of 11 (c) treating the number of Additional Shares of Common Stock or other property, if any, theretofore actually issued or issuable pursuant to the previous exercise of any such warrants or rights or any such right of conversion or exchange, as having been issued on the date or dates of any such exercise and for the consideration actually received and receivable therefor, and (d) treating any such warrants or rights or any such other Convertible Securities which then remain outstanding as having been granted or issued immediately after the time of such increase of the consideration per share for which shares of Common Stock or other property are issuable under such warrants or rights or other Convertible Securities. 4.7 Other Provisions Applicable to Adjustments under this Section. The following provisions shall be applicable to the making of adjustments provided for in this Section 4: (a) Computation of Consideration. To the extent that any Additional Shares of Common Stock or any Convertible Securities or any warrants or other rights to subscribe for or purchase any Additional Shares of Common Stock or any Convertible Securities shall be issued for cash consideration, the consideration received by the Company therefor shall be the amount of the cash received by the Company therefor, or, if such Additional Shares of Common Stock or Convertible Securities are offered by the Company for subscription, the subscription price, or, if such Additional Shares of Common Stock or Convertible Securities are sold to underwriters or dealers for public offering without a subscription offering, the initial public offering price (in any such case subtracting any amounts paid or receivable for accrued interest or accrued dividends, but not subtracting any compensation, discounts or expenses paid or incurred by the Company for and in the underwriting of, or otherwise in connection with, the issuance thereof). To the extent that such issuance shall be for a consideration other than cash, then, except as herein otherwise expressly provided, the amount of such consideration shall be deemed to be the fair value of such consideration at the time of such issuance as determined in good faith by the Board of Directors of the Company. In case any Additional Shares of Common Stock or any Convertible Securities or any warrants or other rights to subscribe for or purchase such Additional Shares of Common Stock or Convertible Securities shall be issued in connection with any merger in which the Company issues any securities, the amount of consideration therefor shall be deemed to be the fair value, as determined in good faith by the Board of Directors of the Company, of such portion of the assets and business of the nonsurviving corporation as such Board in good faith shall determine to be attributable to such Additional Shares of Common Stock, Convertible Securities, warrants or other rights, as the case may be. The consideration for any Additional Shares of Common 12 Stock issuable pursuant to any warrants or other rights to subscribe for or purchase the same shall be the consideration received by the Company for issuing such warrants or other rights plus the additional consideration payable to the Company upon exercise of such warrants or other rights. The consideration for any Additional Shares of Common Stock issuable pursuant to the terms of any Convertible Securities shall be the consideration, if any, received by the Company for issuing warrants or other rights to subscribe for or purchase such Convertible Securities, plus the consideration paid or payable to the Company in respect of the subscription for or purchase of such Convertible Securities, plus the additional consideration, if any, payable to the Company upon the exercise of the right of conversion or exchange in such Convertible Securities. In case of the issuance at any time of any Additional Shares of Common Stock or Convertible Securities in payment or satisfaction of any dividends upon any class of stock other than Common Stock, the Company shall be deemed to have received for such Additional Shares of Common Stock or Convertible Securities a consideration equal to the amount of such dividend so paid or satisfied. (b) When Adjustments to Be Made. The adjustments required by this Section 4 shall be made whenever and as often as any specified event requiring an adjustment shall occur, except that any adjustment of the number of shares of Common Stock for which this Warrant is exercisable that would otherwise be required may be postponed (except in the case of a subdivision or combination of shares of the Common Stock, as provided for in Section 4.1) up to, but not beyond the date of exercise if such adjustment either by itself or with other adjustments not previously made adds or subtracts less than 1% of the shares of Common Stock for which this Warrant is exercisable immediately prior to the making of such adjustment. Any adjustment representing a change of less than such minimum amount (except as aforesaid) which is postponed shall be carried forward and made upon the earlier of (i) the date upon which such adjustment, together with other adjustments required by this Section 4 and not previously made, would result in a minimum adjustment, and (ii) the date of exercise. For the purpose of any adjustment, any specified event shall be deemed to have occurred at the close of business on the date of its occurrence. (c) Fractional Interests. In computing adjustments under this Section 4, fractional interests in Common Stock shall be taken into account to the nearest 1/10th of a share. (d) When Adjustment Not Required. If the Company shall take a record of the holders of its Common Stock for the purpose of entitling them to receive a dividend or distribution or subscription or purchase rights and shall, 13 thereafter and before the distribution to stockholders thereof, legally abandon its plan to pay or deliver such dividend, distribution, subscription or purchase rights, then thereafter no adjustment shall be required by reason of the taking of such record and any such adjustment previously made in respect thereof shall be rescinded and annulled. (e) Escrow of Warrant Shares. If after any property becomes distributable pursuant to this Section 4 by reason of the taking of any record of the holders of Common Stock, but prior to the occurrence of the event for which such record is taken, Holder exercises this Warrant, any Additional Shares of Common Stock issuable and other property distributable upon exercise by reason of such adjustment shall be held in escrow for Holder by the Company to be issued to Holder upon and to the extent that the event actually takes place, upon payment of the then Current Warrant Price. Notwithstanding any other provision to the contrary herein, if the event for which such record was taken fails to occur or is rescinded, then such escrowed shares shall be canceled by the Company and escrowed property returned. (f) Challenge to Good Faith Determination. Whenever the Board of Directors of the Company shall be required to make a determination in good faith of the fair value of any item under this Section 4, such determination may be challenged in good faith by Holder, and any dispute shall be resolved by an investment banking firm of recognized national standing selected by the Company and acceptable to such Holder. 4.8 Reorganization, Reclassification, Merger, Consolidation or Disposition of Assets. In case the Company shall reorganize its capital, reclassify its capital stock, consolidate or merge with or into another corporation (where the Company is not the surviving corporation or where there is a change in or distribution with respect to the Common Stock of the Company), or sell, transfer or otherwise dispose of all or substantially all its property, assets or business to another corporation (hereinafter, a "Reorganization") and, pursuant to the terms of such Reorganization, shares of common stock of the successor or acquiring corporation, or any cash, shares of stock or other securities or property of any nature whatsoever (including warrants or other subscription or purchase rights) in addition to or in lieu of common stock of the successor or acquiring corporation ("Other Property"), are to be received by or distributed to the holders of Common Stock of the Company, then each Holder shall have the right following the effectiveness of such Reorganization to receive, upon exercise of such Warrant, the number of shares of common stock of the successor or acquiring corporation or of the Company, if it is the surviving corporation, and Other Property receivable upon or as a result of such Reorganization by a holder of the number of shares of Common Stock for which this Warrant is exercisable immediately prior to such event. In case of any such Reorganization, the successor or acquiring corporation (if other than the Company) shall expressly assume the due and punctual observance and performance of each and every covenant and condition of this Warrant to be performed and observed by the Company and all the obligations and liabilities 14 hereunder, subject to such appropriate modifications as are satisfactory to the Majority Holders in order to provide for adjustments of shares of the Common Stock for which this Warrant is exercisable which shall be as nearly equivalent as practicable to the adjustments provided for in this Section 4. For purposes of this Section 4.8 "common stock of the successor or acquiring corporation" shall include stock of such corporation of any class which is not preferred as to dividends or assets over any other class of stock of such corporation and which is not subject to redemption and shall also include any evidences of indebtedness, shares of stock or other securities which are convertible into or exchangeable for any such stock, either immediately or upon the arrival of a specified date or the happening of a specified event and any warrants or other rights to subscribe for or purchase any such stock. The foregoing provisions of this Section 4.8 shall similarly apply to successive Reorganizations. 4.9 Other Action Affecting Common Stock. In case at any time or from time to time the Company shall take any action in respect of its Common Stock, other than the payment of dividends permitted by Section 4.2(a) or any other action described in this Section 4, then, unless such action will not have a materially adverse effect upon the rights of the Holders, the number of shares of Common Stock or other stock for which this Warrant is exercisable and/or the purchase price thereof shall be adjusted in such manner as may be equitable in the circumstances. 4.10 Certain Limitations. Notwithstanding anything herein to the contrary, the Company agrees not to enter into any transaction which, by reason of any adjustment hereunder, would cause the Current Warrant Price to be less than the par value per share of Common Stock. 5. Notices to Warrant Holders. 5.1 Notice of Adjustments. Whenever the number of shares of Common Stock for which this Warrant is exercisable, or whenever the price at which a share of such Common Stock may be purchased upon exercise of this Warrant, shall be adjusted pursuant to Section 4, the Company shall forthwith prepare a certificate to be executed by the chief financial officer of the Company setting forth, in reasonable detail, the event requiring the adjustment and the method by which such adjustment was calculated (including a description of the basis on which the Board of Directors of the Company determined the fair value of any evidences of indebtedness, shares of stock, other securities or property or warrants or other subscription or purchase rights referred to in Section 4.2 or 4.7(a)), specifying the number of shares of Common Stock for which this Warrant is exercisable and (if such adjustment was made pursuant to Section 4.8 or 4.9) describing the number and kind of any other shares of stock or Other Property for which this Warrant is exercisable, and any change in the purchase price or prices thereof, after giving effect to such adjustment or change. The Company shall promptly cause a signed copy of such certificate to be delivered to Holder in accordance with Section 13. The Company shall keep at its chief executive office copies of all such certificates and cause the same to be available for inspection at said office during normal business hours by Holder or any prospective purchaser of a Warrant designated by Holder. 15 5.2 Notice of Certain Corporate Action. Holder shall be entitled to the same rights to receive notice of corporate action as any holder of Common Stock. 6. No Impairment. The Company shall not by any action including, without limitation, amending its certificate of incorporation or through any reorganization, transfer of assets, consolidation, merger, dissolution, issue or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms of this Warrant, but will at all times in good faith assist in the carrying out of all such terms and in the taking of all such actions as may be necessary or appropriate to protect the rights of Holder against impairment. Without limiting the generality of the foregoing, the Company will (a) not increase the par value of any shares of Common Stock receivable upon the exercise of this Warrant above the amount payable therefor upon such exercise immediately prior to such increase in par value, (b) take all such action as may be necessary or appropriate in order that the Company may validly and legally issue fully paid and nonassessable shares of Common Stock, free and clear of any liens, claims, encumbrances and restrictions (other than as provided herein) upon the exercise of this Warrant, and (c) use its best efforts to obtain all such authorizations, exemptions or consents from any public regulatory body having jurisdiction thereof as may be necessary to enable the Company to perform its obligations under this Warrant. 7. Fully Paid Stock; Taxes. The shares of the Common Stock represented by each and every certificate for Warrant Shares delivered on the exercise of this Warrant shall, at the time of such delivery, be validly issued and outstanding, fully paid and non-assessable, and not subject to any pre-emptive rights. The Company shall pay all expenses in connection with, and all taxes and other governmental charges that may be imposed with respect to, the issue or delivery thereof, unless such tax or charge is imposed by law upon Holder, in which case such taxes or charges shall be paid by Holder. The Company shall not be required, however, to pay any tax or other charge imposed in connection with any transfer involved in the issue of any certificate for shares of Common Stock issuable upon exercise of this Warrant in any name other than that of Holder, and in such case the Company shall not be required to issue or deliver any stock certificate until such tax or other charge has been paid or it has been established to the satisfaction of the Company that no such tax or other charge is due. 8. Transfer. 8.1 Securities Laws. Neither this Warrant nor the Warrant Shares issuable upon the exercise hereof have been registered in reliance on Section 4(2) of the Securities Act or under any state securities laws and unless so registered may not be transferred, sold, pledged, hypothecated or otherwise disposed of unless an exemption from registration pursuant to Rule 144 of the Securities Act is available. Except as provided in Section 8.6, this Warrant shall bear the following legend: 16 NEITHER THESE WARRANTS NOR THE SHARES OF COMMON STOCK ISSUABLE UPON EXERCISE OF THESE WARRANTS HAVE BEEN REGISTERED WITH THE U.S. SECURITIES AND EXCHANGE COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON AN EXEMPTION FROM REGISTRATION UNDER REGULATION D PROMULGATED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"). THESE WARRANTS AND THE SHARES OF COMMON STOCK ISSUABLE UPON EXERCISE OF THESE WARRANTS ARE RESTRICTED AND MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE ACT OR PURSUANT TO AN APPLICABLE EXEMPTION THEREFROM. 8.2 Conditions to Transfer. In the event Holder desires to transfer this Warrant or any of the Warrant Shares issued (in the absence of registration under the Securities Act), the Holder must give the Company prior written notice of such proposed transfer including the name and address of the proposed transferee. Such transfer may be made only either (i) upon publication by the Commission of a ruling, interpretation, opinion or "no action letter" based upon facts presented to said Commission, or (ii) upon receipt by the Company of an opinion of Holder's counsel acceptable to the Company, in either case to the effect that the proposed transfer will not violate the provisions of the Securities Act, the Exchange Act, or the rules and regulations promulgated under either such act (collectively, the "Securities Laws"). Prior to any such proposed transfer, and as a condition thereto, if such transfer is not made pursuant to an effective registration statement under the Securities Act, the Holder will, if requested by the Company, deliver to the Company any representation or agreement reasonably requested to determine compliance with the Securities Laws. 8.3 Indemnity. The Holder acknowledges that the Holder understands the meaning and legal consequences of this Section 8 and the Holder hereby shall indemnify and hold harmless the Company, its representatives and each officer, director and control person thereof from and against any and all loss, damage or liability (including all attorneys' fees and costs incurred in enforcing this indemnity provision) due to or arising out of (i) any transfer of the Warrant or any of the Warrant Shares in violation of the Securities Act, the Exchange Act, or the rules and regulations promulgated under either of such acts, or (ii) any transfer of the Warrant or any of the Warrant Shares not in accordance with this Warrant or any of the Warrant Shares not in accordance with this Warrant. 8.4 Transfer. Except as provided in this Section 8, this Warrant and the Warrant Shares issued may be transferred by the Holder in whole or in part at any time or from time to time. Upon surrender of this Warrant to the Company or at the office of its stock transfer agent, if any, with the Assignment Form annexed hereto duly executed and funds sufficient to pay any transfer tax, and upon compliance with the foregoing provisions, the Company shall, without charge, execute and deliver a new Warrant or Warrants in the name of the assignee or assignees named in such Assignment Form (and if the entire amount of the Warrant is not being transferred, in the name of the Holder), and this Warrant shall promptly be canceled. Any assignment, transfer, pledge, hypothecation or other disposition of this Warrant attempted contrary to the provisions of this 17 Warrant, or any levy of execution, attachment or other process attempted upon the Warrant, shall be null and void and without effect. 8.5 Registration. The Holders of Warrants and Warrant Shares shall have the right to request registration of such Warrant Shares pursuant to the Registration Rights Agreement. 8.6 Termination of Restrictions. Notwithstanding the foregoing provisions of Section 8, the restrictions imposed by this Section upon the transferability of the Warrants, the War rant Shares and the Restricted Common Stock (or Common Stock issuable upon the exercise of the Warrants) and the legend requirements of Section 8.1 shall terminate as to any particular Warrant or Warrant Share or Restricted Common Stock (or Common Stock issuable upon the exercise of the Warrants) (i) when and so long as such security shall have been effectively registered under the Securities Act and disposed of pursuant thereto, or (ii) when the Company shall have delivered to the Holder or Holders of Warrants, Warrant Shares or Restricted Common Stock the written opinion of Independent Counsel stating that such legend is not required in order to ensure compliance with the Securities Act. Whenever the restrictions imposed by Section 8 shall terminate as to this War rant, as hereinabove provided, the Holder hereof shall be entitled to receive from the Company, at the expense of the Company, a new Warrant bearing the following legend in place of the restrictive legend set forth hereon: "THE RESTRICTIONS ON TRANSFERABILITY OF THE WITHIN WARRANT CONTAINED IN SECTION 8 HEREOF TERMINATED ON ____________, 19__, AND ARE OF NO FURTHER FORCE AND EFFECT." All Warrants issued upon registration of transfer, division or combination of, or in substitution for, any Warrant or Warrants entitled to bear such legend shall have a similar legend endorsed thereon. Whenever the restrictions imposed by this Section shall terminate as to any share of Restricted Common Stock, as hereinabove provided, the Holder thereof shall be entitled to receive from the Company, at the Company's expense, a new certificate representing such Common Stock not bearing the restrictive legend set forth in Section 8.1. 9. Loss, etc. of Warrant. Upon receipt of evidence satisfactory to the Company of the loss, theft, destruction or mutilation of this Warrant, and of indemnity reasonably satisfactory to the Company (it being understood that the written indemnity agreement of AJG Financial Services, Inc. shall be sufficient indemnity), if lost, stolen or destroyed, and upon surrender and cancellation of this Warrant, if mutilated, the Company shall execute and deliver to the Holder a new Warrant of like date, tenor, and denomination. 10. Warrant Holder Not Shareholder. Except as otherwise provided here, this Warrant does not confer upon the Holder any right to vote or to consent to or receive notice as a shareholder of the Company, as such, in respect of any matters whatsoever, or any other rights or liabilities as a shareholder of the Company, either at law or in equity, and the rights of the Holder are limited to those expressed in this Warrant. 18 11. Liquidated Damages. In the event the Company fails to comply in all material respects with any provision of the Registration Rights Agreement, upon written request of the Holder of this Warrant or Warrant Shares, the Company shall promptly obtain from an independent investment banking firm acceptable to such Holder an opinion estimating the net proceeds which such Holder would have received (after deducting underwriting commissions and discounts and any other expenses that would have been solely attributable to the registration or qualification of such shares of Warrant Shares) upon the sale of shares of Warrant Shares proposed to be sold pursuant to such registration or qualification. Such opinion of the independent investment banking firm shall be (a) delivered in writing to the Company, with a copy to such Holder, within thirty (30) days after the date of the request of such Holder to the Company and (b) conclusive and binding on the Company and such Holder. Within 30 days of receipt by the Company of such estimate, the Company shall pay to such Holder an amount equal to (a) such estimated net proceeds minus (b) the aggregate Warrant Price paid or payable with respect to such shares of Warrant Shares. Payment of such amount shall be made by, at the option of such person, (i) wire transfer to an account in a bank located in the United States designated by such Holder for such purpose or (ii) a certified or official bank check drawn on a member of the Chicago or New York Clearing House payable to the order of such Holder. Upon payment to such Holder of such liquidated damages, such Holder shall assign to the Company this Warrant and the Warrant Shares proposed to be sold pursuant to the registration or qualification in question without any representation or warranty (other than that such Holder has good and marketable title thereto, free and clear of liens, claims, encumbrances and restrictions of any kind). If less than all of the shares of Common Stock issuable upon the exercise hereof were proposed to be sold pursuant to the registration or qualification in question, the Company shall cancel this Warrant and issue in the name of, and deliver to, the Holder, pursuant to Section 2, a new Warrant for the shares of Common Stock issuable upon the exercise hereof not required to be assigned to the Company pursuant to the provisions of the preceding sentence. The Company agrees that the amount of actual damages that would be sustained by such Holder as a result of the failure of the Company to comply with any provisions of the Registration Rights Agreement is not capable of ascertainment on any other basis. 12. Appraisal. The determination of the Appraised Value per share of Common Stock shall be made by an investment banking firm of nationally recognized standing selected by the Majority Holders and acceptable to the Company. If the investment banking firm selected by the Majority Holders is not acceptable to the Company and the Company and the Majority Holders cannot agree on a mutually acceptable investment banking firm, then the Majority Holders and the Company shall each choose one such investment banking firm and the respective chosen firms shall agree on another investment banking firm which shall make the determination. The Company shall, at its sole cost, pay all fees of such investment banking firm as may be necessary for the determination of Appraised Value required by the terms of this Warrant. 13. Communication. No notice or other communication under this Warrant shall be effective unless the same is in writing and is either (i) mailed by first-class mail, postage prepaid, 19 in which event the notice shall be deemed effective three days after deposit in the mails, or (ii) delivered by established delivery service which guarantees three business days or less delivery, in which event the notice shall be deemed effective on the date of guaranteed delivery. Regardless of the method of delivery, the notice or communication shall be addressed to: (a) the Company at 3280 North Frontage Road, Lehi, Utah 84043, Attention: Chief Executive Officer or such other address as the Company has designated in writing to the Holder, or (b) the Holder at the address indicated in the opening paragraph hereof, or such other address as the Holder has designated in writing to the Company. 14. Headings. The headings of this Warrant have been inserted as a matter of convenience and shall not affect the construction hereof. 15. Applicable Law. This Warrant shall be governed by and construed in accordance with the law of the State of Delaware without giving effect to the principles of conflicts of law thereof. 16. Warrant Register. The Company will register this Warrant in the Warrant Register in the name of the record holder to whom it has been distributed or assigned in accordance with the terms hereof. The Company may deem and treat the registered Holder of this Warrant as the absolute owner hereof (notwithstanding any notation of ownership or other writing hereon made by anyone) for the purpose of any exercise hereof or any distribution to the Holder and for all other purposes, and the Company shall not be affected by any notice to the contrary. 17. Successors. All of the provisions of this Warrant by or for the benefit of the Company or the Holder shall bind and inure to the benefit of their respective successors and assigns. IN WITNESS WHEREOF, Covol Technologies, Inc. has caused this Warrant to be signed by its President and its corporate seal to be hereunto affixed and attested by its Secretary this 9th day of January, 1998. ATTEST: COVOL TECHNOLOGIES, INC. /Asael T. Sorensen, Jr./ By: /Stanley M. Kimball/ - ------------------------ ---------------------- Secretary President 20 EXERCISE FORM To be executed by the Holder in Order to Exercise Warrants The undersigned Holder hereby irrevocably elects to exercise Warrants represented by this Warrant, and to purchase the securities issuable upon the exercise of such Warrants, and requests that certificates for such securities shall be issued in the Holder's name and be delivered to [please print or type address] and if such number of Warrants shall not be all the Warrants evidenced by this Warrant, that a new Warrant for the balance of such Warrants be registered in the name of, and delivered to, the Holder at the address stated above. The undersigned acknowledges that, if this Exercise Form is submitted prior to the Company having given notice that the issuance of the Warrant Shares has been registered under the Securities Act, the Warrant Shares issued on exercise will be "restricted securities" and will bear appropriate restrictive legends. Dated: Signature of Holder Signature Guaranteed 21 ASSIGNMENT To Be Executed by the Holder in Order to Assign Warrants THE WARRANTS REPRESENTED HEREBY HAVE NOT BEEN REGISTERED UNDER FEDERAL OR STATE SECURITIES LAWS AND TRANSFER THEREOF HAS BEEN RESTRICTED. ANY TRANSFER OR PURPORTED TRANSFER DESCRIBED IN THIS FORM OF ASSIGNMENT SHALL NOT BE EFFECTIVE UNTIL AND UNLESS THE PROPOSED TRANSFEREE COMPLIES WITH THE RESTRICTIONS ON TRANSFER DESCRIBED IN THE WARRANT CERTIFICATE. FOR VALUE RECEIVED, the undersigned hereby sells, assigns and transfers unto Name: [please print or type] Address: Social Security: or Taxpayer I.D. No. the undersigned's right to purchase up to ______________ Shares of Common Stock represented by this Warrant, and hereby irrevocably constitutes and appoints ______________________________________ attorney to transfer the same on the books of the Company, with full power of substitution in the premises. Dated: Signature Guaranteed 22 EX-10.53.5 10 REGISTRATION RIGHTS AGREEMENT REGISTRATION RIGHTS AGREEMENT THIS REGISTRATION RIGHTS AGREEMENT is made as of the 9th day of January, 1998, by and among COVOL TECHNOLOGIES, INC., a Delaware corporation (the "Company"), and AJG FINANCIAL SERVICES, INC. and its successors, assigns and transferees (herein referred to collectively as the "Holders" and individually as a "Holder"). W I T N E S S E T H: WHEREAS, on the date hereof, Holder is the holder of those certain Warrants To Purchase Common Stock of the Company, both issued January 9, 1998, to AJG Financial Services, Inc., one designated Warrant A for 216, 272 Shares of Common Stock, and the other designated Warrant B for 216, 272 Shares of Common Stock. WHEREAS, the Company has agreed to provide the Holders with certain registration rights as set forth herein. NOW, THEREFORE, in consideration of the mutual covenants and undertakings contained herein, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, and subject to and on the terms and conditions herein set forth, the parties hereto agree as follows: 1. Definitions. As used in this Agreement, the following capitalized defined terms shall have the following meanings: "Company" shall have the meaning set forth in the preamble and shall also include the Company's successors. "Company Common Stock" shall mean the shares of common stock, $.001 par value per share, of the Company. "Effective Date" shall mean the date of this Agreement. "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended from time to time. "Holder" or "Holders" shall have the meaning set forth in the preamble. "Person" shall mean an individual, partnership, corporation, trust, or unincorporated organization, or a government or agency or political subdivision thereof. 1 "Prospectus" shall mean the prospectus included in a Registration Statement, and any such prospectus as amended or supplemented by any prospectus supplement with respect to the terms of the offering of any portion of the Registrable Securities covered by a Registration Statement, and by all other amendments and supplements to such prospectus, including post-effective amendments, and in each case including all material incorporated by reference therein. "Public Sale" shall mean a public sale or distribution of Registrable Securities, including a sale pursuant to Rule 144 (or any similar provision then in effect) under the Securities Act. "Registrable Securities" shall mean the Shares, excluding (i) Shares for which a Registration Statement relating to the sale thereof by the Holder shall have become effective under the Securities Act and which have been disposed of by the Holder under such Registration Statement, and (ii) Shares sold or otherwise distributed pursuant to Rule 144 under the Securities Act. "Registration Expenses" shall mean any and all expenses incident to performance of or compliance with this Agreement, including, without limitation: (i) all SEC or National Association of Securities Dealers, Inc. ("NASD") registration and filing fees, (ii) all fees and expenses incurred in connection with compliance with state securities or blue sky laws (including reasonable fees and disbursements of counsel in connection with blue sky qualification of any of the Registrable Securities and the preparation of a Blue Sky Memorandum) and compliance with the rules of the NASD, (iii) all expenses of any Persons engaged by the Company in preparing or assisting in preparing, word processing, printing and distributing any Registration Statement, any Prospectus, certificates and other documents relating to the performance of and compliance with this Agreement, (iv) all fees and expenses incurred in connection with the listing, if any, of any of the Registrable Securities on any securities exchange or exchanges pursuant to Section 3(a)(vii) hereof, and (v) the fees and disbursements of counsel for the Company and of the independent public accountants of the Company, including the expenses of any special audits or "cold comfort" letters, if any, required by or incident to such performance and compliance. Registration Expenses shall specifically exclude the fees and disbursements of counsel representing a selling Holder and underwriting discounts and commissions, and transfer taxes, if any, relating to the sale or disposition of Registrable Securities by a selling Holder, all of which shall be borne by such Holder in all cases. "Registration Statement" shall mean a registration statement of the Company and any other entity required to be a registrant with respect to such registration statement pursuant to the requirements of the Securities Act which covers the Registrable Securities requested by Holders to be covered by such registration statement, and all amendments and supplements to such registration statement, including post-effective amendments, in each case including the Prospectus contained therein, all exhibits thereto and all materials incorporated by reference therein. "SEC" shall mean the Securities and Exchange Commission. "Securities Act" shall mean the Securities Act of 1933, as amended from time to time. 2 "Selling Holder" shall mean each Holder who elects to participate in an underwritten public offering of Company Common Stock. "Shares" shall mean Company Common Stock that is issued upon exercise of the Warrants. "Warrants" shall mean the two Warrants (one designated Warrant A and the other designated Warrant B), each dated January 9, 1998, issued by the Company to AJG Financial Services, Inc. evidencing rights to purchase initially up to an aggregate of 432,544 shares of Common Stock, and all warrants issued upon transfer, division or combination of, or in substitution or exchange for, any thereof. 2. Registration Under the Securities Act. (a) Filing of Registration Statement. As promptly as practicable after the date hereof, the Company intends, but is not obligated, to cause to be filed a Registration Statement providing for the issuance of the Shares to the Holder to the extent allowed by applicable regulations and the resale by the Holder of Registrable Securities then held by the Holder and intends to use its best efforts to cause such Registration Statement if filed to be declared effective by the SEC as soon as reasonably practicable. The Company agrees to use its best efforts to keep such Registration Statement continuously effective under the Securities Act for a period expiring on the date two (2) years from the date of the last issuance of any Shares and further agrees to supplement or amend the Registration Statement, if and as required by the rules, regulations or instructions applicable to the registration form used by the Company for such Registration Statement or by the Securities Act or by any other rules and regulations thereunder for such Registration Statement. (b) Demand Registration. In the event the Company has not caused to be filed a Registration Statement as provided in Section 2(a) within six (6) months from the date hereof, Holder shall have the right, at any time and from time to time after such six (6) month period, to demand that the Company cause to be filed a Registration Statement or an amendment to a Registration Statement providing for the registration under the Securities Act of the Shares to be issued to Holder to the extent allowed by applicable regulations and the resale by the Holder of all Registrable Securities, or, in the event the Company has filed a Registration Statement as provided in Section 2(a) within six (6) months from the date hereof, but such Registration Statement has not been declared effective by the SEC, Holder shall have the right at any time and from time to time after September 1, 1998, to demand that the Company cause to be filed a Registration Statement or an amendment to a Registration Statement providing for the registration under the Securities Act of the Shares to be issued to Holder and the resale by the Holder of all Registrable Securities; provided, however, if at the time of such demand, the Shares have been issued, such Registration Statement shall only relate to sales by Holder. The Company agrees to use its best efforts to keep such Registration Statement continuously effective under the Securities Act for a period expiring on the date two (2) years from the date of the last issuance of any Shares and further agrees to supplement or amend the Registration Statement, if and as required by the rules, regulations or instructions 3 applicable to the registration form used by the Company for such Registration Statement or by the Securities Act or by any other rules and regulations thereunder for such Registration Statement. (c) Cut-Back Registration. In the event that the Holder has requested the inclusion of Registrable Securities in a registration statement pursuant to Section 3(a) or Section 3(b) and all or a portion of the Registrable Securities with respect to which the Holder has requested registration are not registered by virtue of the provisions of said sections, Holder shall thereupon have the right to require the registration under the Securities Act of such Registrable Securities pursuant to the provisions of Section 2(b), irrespective of whether the date upon which Registration is requested is within six months of the date of this Agreement. (d) Expenses. The Company shall pay all Registration Expenses in connection with any Registration Statement filed pursuant to this Section 2. (e) Inclusion in Registration Statement. The Company may require each Holder of Registrable Securities to furnish to the Company in writing such information regarding the proposed offer or sale by such Holder of such Registrable Securities as the Company may from time to time reasonably request in writing. Any Holder who does not provide the information reasonably requested by the Company in connection with the Registration Statement as promptly as practicable after receipt of such request, but in no event later than ten (10) days thereafter, shall not be entitled to have its Registrable Securities included in the Registration Statement. (f) Underwritten Demand by Holder. If at the demand of Holder, the Company proposes to file a Registration Statement relating to an underwritten public offering of any Registerable Securities and the investment banking firm selected by Holder to act as lead underwriter in connection with such public offering of securities by Holder advises in writing that, in such firm's opinion, a registration of other securities of the Company at that time would materially and adversely affect the offering by Holder, no person (including the Company) shall have a right to have shares of common stock or other securities included in such Registration Statement; provided, however, that if an offering of some but not all of the shares requested to be registered by Holder would not adversely affect the offering by Holder, the aggregate number of shares requested to be included in such offering by the Company and each other person shall be reduced pro rata according to the total number of securities proposed to be sold by the Company and other Person taken as a whole; provided, in no event shall the shares requested by Holder to be included in the Registration Statement be reduced. (g) Rights to Subsequent Investors. The Company shall not grant any rights to any other person which shall diminish in any way the rights granted to the Holders hereunder. The Company may grant subsequent investors rights of registration (such as those provided in Section 2 hereof); provided, however, that (i) such rights are limited to shares of Common Stock (including, in the case of any underwritten offering, shares issuable upon the conversion of convertible securities or upon the exercise of warrants if such conversion or exercise is effected by the sellers or the 4 underwriters prior to sale to the public in such offering), (ii) such rights are not inconsistent with the provisions hereof; (iii) the instrument granting such rights specifically confirms the rights of the Holders of Registrable Shares hereunder; (iv) the rights of the Holder hereunder shall be the same as the rights of registration granted to the subsequent investors. 3. Incidental Registration. (a) If the Company proposes to register any shares of Company Common Stock ("Other Securities") for public sale by the Company pursuant to an underwritten offering under the Securities Act it will give prompt written notice to Holders of its intention to do so, and upon the written request of Holders delivered to the Company within fifteen (15) Business Days after the giving of any such notice which request shall specify the number of Registrable Securities intended to be disposed of by Holders and the Company shall include such Registrable Securities in such Registration Statement. The Company will not be required to effect any registration pursuant to this Section 3(a) if the Company shall have been advised in writing (with a copy to the Selling Holders) by a nationally recognized independent investment banking firm selected by the Company to act as lead underwriter in connection with the public offering of securities by the Company that, in such firm's opinion, a registration at that time by other holders would materially and adversely affect the Company's own scheduled offering; provided, however, that if an offering of some but not all of the shares requested to be registered by Holder and other holders would not adversely affect the Company's offering, the aggregate number of shares requested to be included in such offering by each selling holder shall be reduced pro rata according to the total number of securities proposed to be sold by the selling holders taken as a whole. (b) If at the demand of any other Person but the Holder ("Other Person"), the Company proposes to register Other Securities for public sale pursuant to an underwritten offering under the Securities Act it will give prompt written notice to Holder of its intention to do so, and upon the written request of Holders delivered to the Company within fifteen (15) Business Days after the giving of any such notice which request shall specify the number of Registrable Securities intended to be disposed of by Holder and the Company shall include such Registrable Securities in such Registration Statement. If the Other Person shall have been advised in writing (with a copy to the Selling Holders) by a nationally recognized independent investment banking firm acting as lead underwriter in connection with the public offering of securities by the Other Person that, in such firm's opinion, a registration by the Holders at that time would materially and adversely affect the offering by the Other Person, the Registrable Securities of the Holder shall not be included in such Registration, provided the number of shares requested to be included in such offering by the Holders and all other Persons shall be reduced pro rata according to the total number of securities proposed to be sold by the Holder and other selling holders taken as a whole; provided, however, notwithstanding the foregoing sentence, the shares requested by the Other Person demanding registration to be included in the Registration Statement shall not be reduced if required by an agreement between such Other Person and the Company. 5 (c) With respect to any proposed sale or sale by the Holder of Registrable Securities pursuant to this Section 3 the Company shall pay all Registration Expenses. (d) No registration of Registrable Securities effected under this Section 3 shall relieve the Company of its obligation (if any) to effect registrations of Registrable Securities pursuant to Section 2. 4. Registration Procedures. (a) Obligations of the Company. In connection with any Registration Statement pursuant to Sections 2 or 3 hereof, the Company shall: (i) cause the Registration Statement to be available for the sale of the Registrable Securities by Holders in one or more transactions, in negotiated transactions, through the writing of options of the Registrable Securities, or a combination of such methods of sale, and to comply as to form in all material respects with the requirements of the applicable form and include all financial statements required by the SEC to be filed therewith and in the event the Company is listed on the NASDAQ National Market System ("NMS") in one or more transactions on NMS or otherwise in special offerings, exchange distributions or secondary distribution pursuant to and in accordance with the rules of the NMS, in the over-the-counter market; (ii) (A) prepare and file with the SEC such amendments and post- effective amendments to any Registration Statement as may be necessary to keep each such Registration Statement effective for the applicable period; (B) cause the Prospectus included in each such Registration Statement to be supplemented by any required prospectus supplement, and as so supplemented to be filed pursuant to Rule 424 or any similar rule that may be adopted under the Securities Act; (C) respond promptly to any comments received from the SEC with respect to each Registration Statement, or any amendment, post-effective amendment or supplement relating thereto; and (D) comply with the provisions of the Securities Act with respect to the disposition of all securities covered by each Registration Statement; (iii) furnish to each Holder of Registrable Securities, without charge, as many copies of each Prospectus, and any amendment or supplement thereto and such other documents as they may reasonably request, in order to facilitate the public sale or other disposition of the Registrable Securities; the Company consents to the use of the 6 Prospectus, by each such Holder of Registrable Securities, in connection with the offering and sale of the Registrable Securities covered by the Prospectus; (iv) notify promptly each Holder of Registrable Securities and confirm such advice in writing (A) of the issuance by the SEC or any state securities authority of any stop order suspending the effectiveness of a Registration Statement or the initiation of any proceedings for that purpose, (B) if the Company receives any notification with respect to the suspension of the qualification of the Registrable Securities for sale in any jurisdiction or the initiation of any proceeding for such purpose, and (C) of the happening of any event during the period a Registration Statement is effective as a result of which such Registration Statement or the related Prospectus contains any untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made (in the case of the Prospectus), not misleading; (v) use its best effort to obtain the withdrawal of any order suspending the effectiveness of a Registration Statement at the earliest possible moment; (vi) use its best efforts to register or qualify the Registrable Securities by the time the applicable Registration Statement is declared effective by the SEC under all applicable state securities or "blue sky" laws of such jurisdictions as any Holder of Registrable Securities covered by a Registration Statement shall reasonably request in writing, keep each such registration or qualification effective during the period such Registration Statement is required to be kept effective or during the period offers or sales are being made by a Holder that has delivered a Registration Notice to the Company, whichever is shorter, and do any and all other acts and things which may be reasonably necessary or advisable to enable such Holder to consummate the disposition in each such jurisdiction of such Registrable Securities owned by such Holder; provided, however, that the Company shall not be required to (A) qualify generally to do business in any jurisdiction or to register as a broker or dealer in such jurisdiction where it would not otherwise be required to qualify but for this Section 4(a)(vi), (B) subject itself to taxation in any such jurisdiction, or (C) submit to the general service of process in any such jurisdiction; 7 (vii) upon the occurrence of any event contemplated by Section 4(a)(iv)(C) hereof, use its best efforts promptly to prepare and file a supplement or prepare, file and obtain effectiveness of a post-effective amendment to a Registration Statement or the related Prospectus or any document incorporated therein by reference or file any other required document so that, as thereafter delivered to the purchasers of the Registrable Securities, such Prospectus will not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading; (viii) use its best efforts to cause all Registrable Securities to be listed on any securities exchange on which similar securities issued by the Company are then listed; (ix) provide a CUSIP number for all Registrable Securities, not later than the effective date of the Registration Statement or amendment thereto relating to such Registrable Securities; (x) otherwise use its best efforts to comply with all applicable rules and regulations of the SEC and make available to its security holders, as soon as reasonably practicable, an earning statement covering at least twelve (12) months which shall satisfy the provisions of Section 11(a) of the Securities Act and Rule 158 thereunder; and (xi) use its best efforts to cause the Registrable Securities covered by a Registration Statement to be registered with or approved by such other governmental agencies or authorities as may be necessary by virtue of the business and operations of the Company to enable Holders to consummate the disposition of such Registrable Securities. (b) Obligations of Holders. In connection with and as a condition to the Company's obligations with respect to a Registration Statement pursuant to Section 2 hereof and this Section 4, each Holder agrees that (i) it will not offer or sell its Registrable Securities under the Registration Statement until it has received copies of the supplemental or amended Prospectus contemplated by Section 4(a)(ii) hereof and receives notice that any post-effective amendment has become effective; and (ii) upon receipt of any notice from the Company of the happening of any event of the kind described in Section 4(a)(iv)(C) hereof, such Holder will forthwith discontinue disposition of Registrable Securities pursuant to a Registration Statement until such Holder receives copies of the supplemented or amended Prospectus contemplated by Section 4(a)(vii) hereof and receives notice that any post-effective amendment has become effective, and, if so directed by the Company, such Holder will deliver to the Company (at the expense of the Company) all copies in 8 its possession, other than permanent file copies then in such Holder's possession, of the Prospectus covering such Registrable Securities current at the time of receipt of such notice. (c) Lockup. In the event the Company proposes to effect the distribution of its securities by the Company through an underwritten public offering, each Holder who then beneficially owns in excess of 100,000 shares agrees for a period of time, beginning seven (7) days prior to the effective date of the underwriting agreement pertaining to such offering and ending thirty (30) days after such effective date that such Holder will forthwith cease any sale or other disposition of any of the Registrable Securities or sale or other disposition of any of its Registrable Securities during such period of time, if requested in writing by the representatives of the underwriters for any such underwritten public offering; provided, however, that Holders shall not be subject to more than one Lockup Period during any twelve (12) month period. 5. Indemnification; Contribution. (a) Indemnification by the Company. The Company agrees to indemnify and hold harmless each Holder, each officer and director of such Holder, and each Person, if any, who controls any Holder within the meaning of Section 15 of the Securities Act as follows: (i) against any and all loss, liability, claim, damage and expense whatsoever, as incurred, arising out of any untrue statement or alleged untrue statement of a material fact contained in any Registration Statement (or any amendment thereto) pursuant to which Registrable Securities were registered under the Securities Act, including all documents incorporated therein by reference, or the omission or alleged omission therefrom of a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading; (ii) against any and all loss, liability, claim, damage and expense whatsoever, as incurred, to the extent of the aggregate amount paid in settlement of any litigation, or investigation or proceeding by any governmental agency or body, commenced or threatened, or of any claim whatsoever based upon any such untrue statement or omission, or any such alleged untrue statement or omission, if such settlement is effected with the written consent of the Company; and (iii) against any and all expense whatsoever, as incurred (including reasonable fees and disbursements of counsel), reasonably incurred in investigating, preparing or defending against any litigation, or investigation or proceeding by any governmental agency or body, commenced or threatened, in each case whether or not a party, or any claim whatsoever based upon any such untrue statement or omission, 9 or any such alleged untrue statement or omission, to the extent that any such expense is not paid under subparagraph (i) or (ii) above; provided, however, that the indemnity provided pursuant to this Section 4(a) does not apply to any Holder with respect to any loss, liability, claim, damage or expense to the extent arising out of any untrue statement or omission or alleged untrue statement or omission made in reliance upon and in conformity with written information furnished to the Company by such Holder expressly for use in a Registration Statement (or any amendment thereto) or any Prospectus (or any amendment or supplement thereto). (b) Indemnification by the Holders. Each Holder severally agrees to indemnify and hold harmless the Company and the other selling Holders, and each of their respective directors and officers (including each director and officer of the Company who signed the Registration Statement), and each Person, if any, who controls the Company or any other selling Holder within the meaning of Section 15 of the Securities Act, to the same extent as the indemnity contained in Section 5(a) hereof (except that any settlement described in Section 4(a)(ii) shall be effected only with the written consent of such Holder), but only insofar as such loss, liability, claim, damage or expense arises out of or is based upon (i) any untrue statement or omission, or alleged untrue statements or omissions, made in a Registration Statement (or any amendment thereto) or any Prospectus (or any amendment or supplement thereto) in reliance upon and in conformity with written information furnished to the Company by such selling Holder expressly for use in such Registration Statement (or any amendment thereto) or such Prospectus (or any amendment or supplement thereto), or (ii) such Holder's failure to deliver a Prospectus to any purchaser of Registrable Securities where such a delivery obligation was applicable to such Holder's sale of Registrable Securities and such Holder had been provided with sufficient copies of such Prospectus for the relevant deliveries thereof. In no event shall the liability of any Holder under this Section 4(b) be greater in amount than the dollar amount of the proceeds received by such Holder upon the sale of the Registrable Securities giving rise to such indemnification obligation. (c) Conduct of Indemnification Proceedings. Each indemnified party shall give reasonably prompt notice to each indemnifying party of any action or proceeding commenced against it in respect of which indemnity may be sought hereunder, but failure to so notify an indemnifying party (i) shall not relieve it from any liability which it may have under the indemnity agreement provided in Section 4(a) or (b) above, unless and to the extent it did not otherwise learn of such action and the lack of notice by the indemnified party results in the forfeiture by the indemnifying party of substantial rights and defenses and (ii) shall not, in any event, relieve the indemnifying party from any obligations to any indemnified party other than the indemnification obligation provided under Section 4(a) or (b) above. If the indemnifying party so elects within a reasonable time after receipt of such notice, the indemnifying party may assume the defense of such action or proceeding at such indemnifying party's own expense with counsel chosen by the indemnifying party and approved by the indemnified parties defendant in such action or proceeding, which approval shall not be unreasonably withheld; provided, however, that, if such indemnified party or parties reasonably determine that a conflict of interest exists where it is advisable for such indemnified party 10 or parties to be represented by separate counsel or that, upon advice of counsel, there may be legal defenses available to them which are different from or in addition to those available to the indemnifying party, then the indemnifying party shall not be entitled to assume such defense and the indemnified party or parties shall be entitled to one separate counsel at the indemnifying party's expense. If an indemnifying party is not entitled to assume the defense of such action or proceeding as a result of the proviso to the preceding sentence, such indemnifying party's counsel shall be entitled to conduct the defense of such indemnified party or parties, it being understood that both such counsel will cooperate with each other to conduct the defense of such action or proceeding as efficiently as possible. If an indemnifying party is not so entitled to assume the defense of such action or does not assume such defense, after having received the notice referred to in the first sentence of this paragraph, the indemnifying party or parties will pay the reasonable fees and expenses of counsel for the indemnified party or parties. In such event, however, no indemnifying party will be liable for any settlement effected without the written consent of such indemnifying party. If an indemnifying party is entitled to assume, and assumes, the defense of such action or proceeding in accordance with this paragraph, such indemnifying party shall not be liable for any fees and expenses of counsel for the indemnified parties incurred thereafter in connection with such action or proceeding. The indemnification obligations provided pursuant to Sections 4(a) and (b) hereof survive, with respect to a Holder, the transfer of Registrable Securities by such Holder, and with respect to a Holder or the Company, shall remain in full force and effect regardless of any investigation made by or on behalf of any indemnified party. (d) Contribution. (i) In order to provide for just and equitable contribution in circumstances in which the indemnity agreement provided for in this Section 4 is for any reason held to be unenforceable although applicable in accordance with its terms, the Company and the selling Holders shall contribute to the aggregate losses, liabilities, claims, damages and expenses of the nature contemplated by such indemnity agreement incurred by the Company and the selling Holders, in such proportion as is appropriate to reflect the relative fault of and benefits to the Company on the one hand and the selling Holders on the other (in such proportions that the selling Holders are severally, not jointly, responsible for the balance), in connection with the statements or omissions which resulted in such losses, claims, damages, liabilities or expenses, as well as any other relevant equitable considerations. The relative benefits to the indemnifying party and indemnified parties shall be determined by reference to, among other things, the total proceeds received by the indemnified party and indemnified parties in connection with the offering to which such losses, claims, damages, liabilities or expenses relate. The relative fault of the indemnifying party and indemnified parties shall be determined by reference to, among other things, whether the action in question, 11 including any untrue or alleged untrue statement of a material fact or omission or alleged omission to state a material fact, has been made by, or relates to information supplied by, such indemnifying party or the indemnified parties, and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such action. (ii) The Company and the Holders agree that it would not be just or equitable if contribution pursuant to this Section 4(d) were determined by pro rata allocation or by any other method of allocation which does not take account of the equitable considerations referred to in the immediately preceding paragraph. Notwithstanding the provisions of this Section 4(d), no selling Holder shall be required to contribute any amount in excess of the amount by which the total price at which the Registrable Securities of such selling Holder were offered to the public exceeds the amount of any damages which such selling Holder would otherwise have been required to pay by reason of such untrue statement or omission. (iii) Notwithstanding the foregoing, no Person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any Person who was not guilty of such fraudulent misrepresentation. For purposes of this Section 4(d), each Person, if any, who controls a Holder within the meaning of Section 15 of the Securities Act and directors and officers of a Holder shall have the same rights to contribution as such Holder, and each director of the Company, each officer of the Company who signed the Registration Statement and each Person, if any, who controls the Company within the meaning of Section 15 of the Securities Act shall have the same rights to contribution as the Company. (iv) The contribution provided for in this Section 4(d) shall survive, with respect to a Holder, the transfer of Registrable Securities by such Holder, and with respect to a Holder or the Company, shall remain in full force and effect regardless of any investigation made by or on behalf of any indemnified party. 6. Rule 144 Sales. (a) Reports. The Company covenants that it will file the reports required to be filed by the Company under the Securities Act and the Securities Exchange Act of 1934, as amended, and will take such further action as any Holder of Registrable Securities may reasonably request, all to 12 the extent required to enable such Holder to sell Registrable Securities pursuant to Rule 144 under the Securities Act. (b) Certificates. In connection with any sale, transfer or other disposition by any Holder of any Registrable Securities pursuant to Rule 144 under the Securities Act, the Company shall cooperate with such Holder to facilitate the timely preparation and delivery of certificates representing Registrable Securities to be sold and not bearing any Securities Act legend, and enable certificates for such Registrable Securities to be for such number of shares and registered in such names as the selling Holders may reasonably request at least two (2) business days prior to any sale of Registrable Securities. 7. Miscellaneous. (a) Amendments and Waivers. The provisions of this Agreement, including the provisions of this sentence, may not be amended, modified or supplemented, and waivers or consents to departures from the provisions hereof may not be given without the written consent of the Company and the Holders of a majority in amount of the outstanding Registrable Securities; provided, however, that no amendment, modification or supplement or waiver or consent to the departure with respect to the provisions of Sections 2, 3, 4, 5, 6 or 7 hereof shall be effective as against any Holder of Registrable Securities unless consented to in writing by such Holder of Registrable Securities, as the case may be. Notice of any amendment, modification or supplement to this Agreement adopted in accordance with this Section 6(a) shall be provided by the Company to each Holder of Registrable Securities at least thirty (30) days prior to the effective date of such amendment, modification or supplement. (b) Notices. All notices and other communications provided for or permitted hereunder shall be made in writing by hand-delivery, registered first-class mail, telex, telecopier, or any courier guaranteeing overnight delivery, (i) if to a Holder, at the most current address given by such Holder to the Company by means of a notice given in accordance with the provisions of this Section 6(b), which address initially is, with respect to each Holder, the address set forth next to such Holder's name on the books and records of the Company, or (ii) if to the Company, at: Covol Technologies, Inc., 3280 North Frontage Road, Lehi, Utah 84043; Facsimile: (801) 768-4483; Attn: General Counsel. All such notices and communications shall be deemed to have been duly given: at the time delivered by hand, if personally delivered; five (5) business days after being deposited in the mail, postage prepaid, if mailed; when answered back, if telexed; when receipt is acknowledged, if telecopied; or at the time delivered if delivered by an air courier guaranteeing overnight delivery. (c) Successors and Assigns. This Agreement shall inure to the benefit of and be binding upon the successors, assigns and transferees of each of the Company and the Holders, including without limitation and without the need for an express assignment, subsequent Holders. If any successor, assignee or transferee of any Holder shall acquire Registrable Securities, in any 13 manner, whether by operation of law or otherwise, such Registrable Securities, as the case may be, shall be held subject to all of the terms of this Agreement, and by taking and holding such Registrable Securities such Person shall be entitled to receive the benefits hereof and shall be conclusively deemed to have agreed to be bound by all of the terms and provisions hereof. (d) Headings. The headings in this Agreement are for the convenience of reference only and shall not limit or otherwise affect the meaning hereof. (e) GOVERNING LAW. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF DELAWARE WITHOUT GIVING EFFECT TO THE CONFLICTS OF LAW PROVISIONS THEREOF. (f) Specific Performance. The Company and the Holders hereto acknowledge that there would be no adequate remedy at law if any party fails to perform any of its obligations hereunder, and accordingly agree that each party, in addition to any other remedy to which it may be entitled at law or in equity, shall be entitled to compel specific performance of the obligations of any other party under this Agreement in accordance with the terms and conditions of this Agreement in any court of the United States or any State thereof having jurisdiction. (g) Entire Agreement. This Agreement is intended by the Company as a final expression of its agreement and intended to be a complete and exclusive statement of the agreement and understanding of the Company in respect of the subject matter contained herein. This Agreement supersedes all prior agreements and understandings of the Company with respect to such subject matter. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first written above. COVOL TECHNOLOGIES, INC. By:/Stanley M. Kimball/ --------------------------- Name:Stanley M. Kimball Title: President AJG FINANCIAL SERVICES, INC. By: /David R. Long/ --------------------------- Name: David R. Long Title: President 14 EX-10.54 11 EMPLOYMENT AGREEMENT W/STEVEN STEWART EMPLOYMENT AGREEMENT By and Between COVOL TECHNOLOGIES, INC. And Steven G. Stewart Effective as of May 1, 1998 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT (this Agreement@) is effective as of the 1st day of May, 1998 (the AEffective Date@) by and between COVOL TECHNOLOGIES, INC. a Delaware Corporation (the ACompany@), and Steven G. Stewart (AEmployee@). The Company and Employee are sometimes later in this Agreement collectively referred to as the AParties.@ RECITALS This Agreement is entered into with reference to the following facts, definitions, and objectives: A. Employee is a Certified Public Accountant and immediately prior to his employment by the Company, was employed by Coopers & Lybrand, LLP as a Business Assurance Partner. B. Employee=s services are deemed to be of value to the Company and it is recognized that inducements must be offered to Employee in order that the company may obtain and retain Employee=s services. NOW THEREFORE, in consideration of this Agreement and of the covenants and conditions contained in this Agreement, the Parties agree as follows: 1. Employment and Positions. (a) Positions. The Company employed Employee and Employee accepted employment by the Company as an officer of the Company with the title of AVice President of Finance and Treasurer@ for the Period of Employment specified in Paragraph 3 (APeriod of Employment@). Such position and title, including related duties and responsibilities, may be changed during the term of this contract provided that such Employee continues as an officer of the Company. Also, provided further that any new position would be of comparable or higher responsibility level with compensation for such services at a level at or above the Employees then current compensation level prior to such title and/or position change. 2. Services to be Rendered. The Employee shall, during the Period of Employment, serve the Company in the positions set forth in Paragraph 1 (AEmployment and Positions@) diligently, competently, and in conformance with the corporate policies of the Company. Employee shall have the responsibility to always act in the best interest of the Company and recognizes opportunities, ideas, and intellectual property relating to the business of the Company that are developed as an officer or employee of Covol Technologies, Inc. remain the property of Company. In fulfilling his duties and responsibilities under this Agreement, Employee shall report to the President and/or the Chief Executive Officer of the Company. 1 3. Period of Employment. Employee=s employment by the Company pursuant to this Agreement shall, began as of May 1, 1998 (the AEffective Date@). The period of employment continues for a period of three (3) years from the Effective Date (APeriod of Employment@) renewing annually on May 1st so as to result in a continuing effective period of three (3) years from the renewal date until normal retirement or resignation by the employee. 4. Base Salary. At the commencement of the Period of Employment, Employee shall be paid a yearly base salary of $80,000. Base salary shall be paid in semi monthly installments during the Period of Employment. The base salary will be increased effective May 1, 1999 by 25% to a yearly base salary of $100,000. The base salary will be increase effective May 1, 2000 by 25% to a yearly base salary of $125,000. It is recognized by the Company and Employee that a Salary Compensation Study has recently been conducted and the base salary of this Employee may be adjusted in the future as a result of this Salary Compensation Study. If and when the base salary is adjusted as a result of this study, the salary increases as provided in this paragraph will be adjusted so that the increase will not result in the percentage reflected herein but will instead result in the actual dollar amount increases set forth herein of $20,000 and $25,000 in the respective years. 5. Incentive Bonus. During the Period of Employment, Employee shall be entitled to receive a bonus pursuant to the Company=s bonus plan, if any, as in effect from time to time. It is recognized that a bonus plan, if any, is established at the discretion of the Company and may be subject to variables and conditions including income performance and general performance evaluations. 6. Expense Reimbursement. The Employee shall be entitled to prompt reimbursement for reasonable expenses incurred by the Employee in performing services for the Company. Employee shall be required to provide proof and documentation of such expenditures as required by the Company. 7. Grant of Options. The Company may grant from time to time to the Employee, in accordance with the terms of a stock option agreement, the right and option to purchase shares of the Company=s Common Stock . (a) Stock Options Pursuant to Stock Option Plan. Any Stock Options (AStock Option@) issued shall be issued pursuant and subject to the provisions of the Company Employee Stock Option Plan (the AStock Option Plan@) or as approved by the Board of Directors. Number of options, purchase price, exercise periods and vesting requirements shall be included in the stock option document. (b) Vesting of Options in Event of Full and Complete Disability or Death. In the event of full and complete disability or death of the employee any unvested Stock Options shall vest effective as of the date of the full and complete disability or the death of Employee. In the event of Employee=s full and complete disability or death, the Employee, heirs or estate of Employee, as the case may be, may exercise any unexecuted options at any time subject to the time limitations within which exercise of option must occur. 2 (c) Vesting of Options in Event of Ownership Change. In the event a change in control, all non-vested Stock Options shall vest immediately prior to such stock or asset purchase. A change in control shall be deemed to have taken place if, as the result of a tender offer, merger, consolidation, sale of substantially all assets, a third party purchase of a controlling interest of the total outstanding shares of the Company, or any combination of the foregoing transactions, the person s who were directors of the Company immediately before the transaction shall cease to constitute a majority of the board of directors of the Company or any successor to the Company. The intent of this section is to allow the Employee to exercise any unexercised options at the Employee=s discretion. (d) Options Granted. In connection with acceptance of employment as provided herein, Employee is granted qualified incentive stock options under the Company Employee Stock Option Plan to purchase 50,000 shares of the Company=s Common Stock at a price of $12.625. These options will vest on a pro-rata basis over 60 months beginning May 1, 1998 and are exercisable through April 30, 2008. 8. Other Benefits. In addition to the benefits previously set forth in this Agreement, Employee shall, during the Period of Employment, be entitled to the benefits described below, and as concerns all such benefit programs where years of service are a factor, to the extent permitted by law, Employee shall be given credit for his years of service with Covol Technologies, Inc. prior to the implementation of any benefit program. (a) Vacation. During the Period of Employment, Employee shall be entitled to not less than four weeks of paid vacation during each calendar year occurring during the Period of Employment. Any and all unused vacation will, at the Company's option, be paid for by the Company at the end of each calendar year, or will carry forward from year to year until taken by the Employee or paid the Employee by the Company. Upon termination of Employee=s employment under this Agreement, Employee shall be paid for any unused vacation in the year in which the termination occurred, and vacation will continue to accrue up to and including the termination date in proportionate to the amount of time employed during that year. (b) Sick Leave. Leave time will be granted to the Employee that is reasonable under the circumstances and that is consistent with the Company=s policies and procedures, as the same may be changed, modified or provided for other officers of the Company from time to time. (c) Insurance. Participation in the group insurance program of the Company as concerns life, disability, medical and dental insurance currently available to other employee=s as the same may be implemented, changed, modified or terminated for all participants from time to time. Employee shall be required to pay that portion of the premiums for coverage under such insurance that is payable by other officers of the Company for their insurance coverage. 3 (d) Retirement Plan. The Employee shall participate in the Company=s Retirement Plans in accordance with the terms and provision and applicable law as the same may be implemented, changed, amended, or terminated from time to time. Employee shall become eligible to participate in the Company=s Retirement Plans at date of hire or as of the effective date of the implementation of such plans, whichever is later. (e) Automobile Allowance. The Company will provide the Employee a monthly automobile allowance. This allowance is to compensate the Employee for the use of his personal automobile in the amount of $550 per month during the Employment Period (f) Other Miscellaneous Benefits. The Company shall pay or reimburse Employee for the following miscellaneous benefits: (i) Annual dues for association membership for relevant professional groups and organizations as deemed appropriate by the Employee. (ii) Subscription and purchase of books, journals, and publications which relate to job duties and responsibilities. Employee shall first obtain authorization for payment or purchases referred to in (i) and (ii) from the President of the Company before incurring such costs. 9. Terms of Employment. (a) Term. The Company hereby agrees to continue the Employee in its employ, and the Employee hereby agrees to remain in the employ of the Company, in accordance with the terms and provisions of paragraph 3 of this Agreement, for the Period of Employment, thus terminating upon the retirement of the Employee, upon resignation of the Employee, or upon thirty (30) days prior written notice from the Company to the Employee of termination for cause. (b) During the Period of Employment. The Employee=s services shall be performed at the location where the Employee was employed immediately preceding the Effective Date or at any office which is the headquarters of the Company. 10. Termination of Agreement. (a) Termination of Employment by Employer. Anything in this Agreement to the contrary notwithstanding, the Company shall have the following rights with respect to termination of Employee=s employment. (i) Disability. The Company may terminate Employee=s employment under this Agreement if Employee shall become unable to fulfill his duties under this Agreement, as measured by the Company=s usual business activities, by reason of any medically determinable physical and/or mental disability. (ii) Cause. Employee=s employment may be terminated for Cause. For purpose of the Agreement, ACause@ shall mean and refer to a determination made in good faith by the Company=s Board of Directors that: (1) Employee has been convicted of or has entered a plea of guilty or nolo contendere to a felony or to any other crime, which other crime is punishable by incarceration for a period of one (1) year or longer, or which is a crime involving moral turpitude; (2) there has been a theft, embezzlement, or other criminal misappropriation of funds by Employee, whether from Company or any other person; (3) Employee has willfully failed to follow reasonable written policies or directives established by the Board of Directors or the Chief Executive Officer of the Company. Additionally, the Employee has willfully failed to attend to material duties or obligations of Employee=s office (other than any such failure resulting from Employee=s incapacity due to physical or mental illness, which is a cause or manifestation of Employee=s disability), which failure or refusal continues for ninety (90) days following delivery of a written demand from the Company=s Chief Executive Officer for performance to Employee identifying the manner in which Employee has failed to follow such policies or directives or to perform such duties. (iii) Termination pursuant to this Paragraph 10 shall be effective as of the effective date of the notice by the Board of Directors, Chief Executive Officer, or President to Employee that it has made the required determination, or at such other subsequent date, if any specified in such notice. (iv) Death. If Employee dies during the Period of Employment, Employee=s employment shall be terminated effective as of the end of the calendar month during which Employee died. (b) Termination by Employee. (i) With Good Reason. Employee shall have the right to terminate his employment under this Agreement at any time for Good Reason, provided Employee has delivered written notice to the Company which briefly describes the facts underlying Employee=s belief that AGood Reason@ exist and the Company has failed to cure such situation within thirty (30) days after the effective date of such notice. For purposes of the Agreement, AGood Reason@ shall mean and consist of: (1) a material breach by the Company of its obligations under this Agreement; (2) the assignment to Employee of duties that are materially inconsistent with, or that constitute a material alteration in the status of his responsibilities set forth in Paragraph 1 of this Agreement, as an employee of the Company; (3) a reduction by the Company of Employee=s Base Salary below the Base Salary set forth in Paragraph 5 (ABase Salary@); (4) without Employee=s prior written consent, the transfer or relocation of Employee=s place of employment to any place other than the Salt Lake City/Provo metropolitan area, except for reasonable travel on the business of the Company; (5) upon a change of control as defiend in Paragraph 6(c) herein, or (6) upon the consummation of a third party purchase of a controlling interest of the total outstanding shares of the Company. 11. Confidential Information. The Employee shall hold in a fiduciary capacity for the benefit of the Company all secret or confidential information, knowledge or data relating to the Company or any of its affiliated companies and their respective businesses, which has been obtained by the Employee during the Employee=s employment by the Company or any of its affiliated companies and which shall not be or become public knowledge (other than by acts by the Employee or representatives of the Employee in violation of this Agreement). After termination of the Employee=s employment with the Company, the Employee shall not, without prior written consent of the Company or as may otherwise be required by law or legal process, communicate or divulge any such information, knowledge or data to anyone other than the Company and those designated by the Company. In no event shall an asserted violation of the provisions of this Section constitute a basis for deferring or withholding any amounts otherwise payable to the Employee under the provisions of this Agreement. 12. Inventions. (a) Assignment. Without further consideration, the Employee shall fully and promptly report to the Company all writings, ideas, concepts, inventions, discoveries, formulas, designs, and know-how conceived or produced by the Employee at any time during the Period of Employment relating to the Company=s trade or business, whether alone or with others and whether or not patentable or subject to copy or service rights or trademark or other property protections (collectively, AInventions@ pertaining directly or indirectly to the business of the Company as conducted by the Employee at any time during the Employment Period) and shall assign and hereby does assign to the Company or its nominee the Employee=s entire right, title and interest in and to all such Inventions. 4 (b) Cooperation. The Employee shall take all reasonable action requested by the Company to protect or obtain title to any and all United States and/or foreign patents on any such Inventions, including execution and delivery of all applications, assignments and other documents deemed necessary or desirable by the Company, provided the Company shall reimburse the Employee for all expenses incurred by the Employee in connection with such execution and delivery. 13. Non-Competition after Termination. (a) Acknowledgment. The Employee acknowledges that his services and responsibilities are of a particular significance to the Company and that his position with the Company does and will continue to give him an intimate knowledge of its business. Because of this, it is important to the Company that the Employee be restricted from competing with the Company in the event of the termination of his employment. (b) Agreement. The Employee agrees that, in addition to any other limitations, for a period of two (2) years after the termination of his employment under this Agreement, the Employee will not directly or indirectly compete with the Company or its business. 14. Severance Pay. Except for termination for Cause under Paragraph 10(a)(iii) herein, if the Employee does not continue in the employ of the Company during the Period of Employment as provided in this Agreement, whether or not the Employee is offered continued employment by the Company, Company shall pay to Employee, no later than 30 days following termination of employment, the sum of 200% of the then current year=s annual base salary. The Employee shall not be required to mitigate the amount of the payment provided for in this section by seeking other employment or otherwise; nor shall the amount of the payment be reduced by any compensation earned by the Employee as the result of employment by another employer after termination or otherwise. 15. Indemnification. Subject to the Company's Certificate of Incorporation, as amended, the Company shall release, indemnify and hold harmless the Employee against and from any and all loss, claims, actions or suits, including costs and attorney=s fees, both at trial and on appeal, resulting from, or arising out of or in any way connected with the Employee=s acts as an officer of the Company. 5 16. Miscellaneous. Any notice or other communications required or permitted to be given to the parties hereto shall be deemed to have been given when received, addressed as follows (or at such other address as the party addressed may have substituted by notice pursuant to this Section): (a) If to the Company: President and/or Chief Executive Officer 3280 North Frontage Road Lehi, Utah Attention: President and CEO (b) If to Employee: Steven G. Stewart 187 South 1225 East Bountiful, Utah 84010 17. Governing Law. This Agreement shall in all respects be interpreted, construed and governed by and in accordance with the laws of the State of Utah. Executed this 4th day of January, 1999: Covol Technologies, Inc.: Employee: By:______________________________ __________________________ Brent M. Cook Steven G. Stewart Chief Executive Officer 6 EX-10.55 12 EMPLOYMENT AGREEMENT W/ DEE PRIANO Employment Agreement THIS EMPLOYMENT AGREEMENT (this "Agreement") is effective as of the first day of August 1997 (the "Effective Date") by and between Covol Technologies, Inc., a Delaware corporation (the "Company") and Dee J. Priano ("Employee"). The Company and Employee are sometimes later in this Agreement collectively referred to as the "Parties". RECITALS This Agreement is entered into with reference to the following facts, definitions and objectives. NOW, THEREFORE, in Consideration of this Agreement and of the covenants contained in this Agreement, the Parties agree as follows: 1) Employment and Position. The Company employs Employee and the Employee accepts employment by the Company as Vice President of the Company or other mutually agreed senior position for the Company for the Period of Employment specified in Paragraph 3, Period of Employment. 2) Services to be Rendered. Employee shall, during the Period of Employment, serve the Company in the position set forth in Paragraph 1, Employment and Position, diligently, competently and in conformance with the corporate policies of the Company. Employee shall be free to conduct real estate investment activities that do not conflict or interfere with the performance of his duties under this Agreement. Employee may from time to time perform services for Kennecott Utah Copper Corporation as long as said services do not conflict or interfere with the performance of his duties under this Agreement. In fulfilling his duties and responsibilities under this Agreement, Employee shall report to the President or Chief Executive Officer of the Company. 3) Period of Employment. Employee's employment by the Company pursuant to this Agreement shall, unless sooner terminated as provided in this Agreement, be for a term of three (3) years, commencing as of the first day of August 1997, and ending with the close of "business" on the thirty-first day of July 2000 (the "Period of Employment"). 4) Base Salary. During the first twenty-four months of this Agreement, the Employee's regular salary, before all customary and proper taxes, shall be no less than $80,000 per year, payable bi-weekly. During the last twelve months of this Agreement, the Employee's regular salary, before all customary and proper taxes, shall be no less than $125,000 per year, payable bi-weekly. 1 5) Incentive Bonus. During the Period of Employment, Employee shall be entitled to receive bonuses pursuant to the Company's bonus plan as in effect from time to time. 6) Stock Options. Incentive Stock Options (as defined in Section 422 of the Internal Revenue Code) shall be issued pursuant and subject to the provisions outlined below or as otherwise mutually agreed to: a) Purchase Price. The purchase price per share for the shares subject to the Stock Option will be Eight Dollars and Twenty-five Cents ($8.25) per share. b) Number of Shares. The Stock Options will be for One Hundred Thousand (100,000) shares of the Company's Common Stock (the "Optioned Shares"). c) Exercise Periods. Four Thousand (4,000) Optioned Shares will be vested and exercisable on August 1, 1997 and Four Thousand (4,000) additional Optioned Shares will be vested and exercisable on the first day of each month following through September 1, 1999, at which time all One Hundred Thousand Optioned Shares will be fully vested and exercisable. d) Additional Stock Options. Employee shall also be eligible to receive additional stock options during the Period of Employment pursuant to a stock option bonus plan as may from time to time be in effect. e) Vesting of Options in Event of Disability or Death. In the event of disability or death of Employee, any nonvested Stock Options shall vest effective as of the date of the disability or the death of Employee. In the event of Employee's disability or death, the Employee, heirs or estate of Employee, as the case may be, may exercise any unexecuted options at any time. f) Vesting of Options in Event of Management Change. In the event of replacement of Brent M. Cook as Chief Executive Officer of the Company, all nonvested Stock Options and Additional Stock Options shall vest as of the date Brent M. Cook is released from the position of Chief Executive Officer of the Company. g) Vesting of Options in Event of Ownership Change. In the event a third party tenders to purchase all outstanding shares of the Company, or substantially all of the assets of the Company, all non-vested Stock Options shall vest as of the date the tender offer or asset sale is announced. The intent of this section is to allow the Employee to vote the shares represented by the Stock Options and at the Employee's discretion, exercise any unexecuted options. 2 7) Other Benefits. In addition to the benefits previously set forth in this Agreement, Employee shall, during the Period of Employment, be entitled to the benefits described below, and as concerns all such benefit programs where years of service are a factor, to the extent permitted by law, Employee shall be given credit for his years of service with Kennecott Corporation and/or any of its subsidiaries. a) Vacation. During the Period of Employment, Employee shall be entitled to not less than Five (5) weeks of paid vacation during each calendar year occurring during the Period of Employment and that amount of vacation provided to other senior executive officers of the Company. Upon termination of Employee's employment under this Agreement, Employee shall be paid for any unused vacation in the year in which the termination occurred. b) Sick Leave. Sick leave time will be granted to the Employee that is reasonable under the circumstances and that is consistent with the Company's policies and procedures, as the same may be changed, modified or terminated for all participants from time to time. c) Insurance. At the Employee's option, the Company shall pay the premium for and provide life, disability, medical, and dental benefits for the Employee and his family. d) Retirement Plan. The Employee shall participate in the Company's Retirement Plans in accordance with the terms and provisions and applicable law, as the same may be implemented, changed, amended, or terminated from time to time. Employee shall become eligible to participate in the Company's Retirement Plans as of August 1, 1997, or as the effective date of the implementation of such plans whichever is later. e) Other Miscellaneous Benefits. The Company shall pay or reimburse Employee for the following miscellaneous benefits: i) Annual dues for association membership for relevant professional groups. ii) Subscription and purchase of books, journals, and publications which relate to job duties and responsibilities. 8) Termination of Employment by the Company. Anytime in this Agreement to the contrary notwithstanding, the Company shall have the following rights with respect to termination of the Employee's employment: a) Cause. Employee's employment may be terminated for Cause. For purpose of this Agreement, "cause" shall mean and refer to a determination made in good faith by the Company's Board of Directors that: 3 i) Employee has been convicted of or has entered a plea of guilty or nolo contendre to a felony or to any other crime, which other crime is punishable by incarceration for a period of one (1) year or longer, or which is a crime involving moral turpitude. ii) There has been a theft, embezzlement, or other criminal misappropriation of funds by Employee, whether from Company or any other person. iii) Employee has willfully failed or refused to follow reasonable written policies or directives established by the Board of Directors or the Chief Executive Officer of the Company, or Employee has willfully failed to attend to material duties or obligations of his office (other than any such failure resulting from Employee's incapacity due to physical or mental illness which is a cause or manifestation of Employee's disability), which failure or refusal continues for thirty (30) days following delivery of a written demand from the Company's Chief Executive Officer for performance to Employee identifying the manner in which Employee has failed to follow such policies or directives or to perform such duties. Termination pursuant to this Paragraph shall be effective as of the effective date of the notice by the Board of Directors to Employee that it has made the required determination, or at such other subsequent date, if any, specified in such notice. b) Without Cause. Employee's employment may be terminated without cause provided that the Company pays Employee upon notice of termination, any unearned salary specified in Paragraph 4, Base Salary, the amount specified in Paragraph 10, Severance Pay, any earned Incentive Bonuses specified in Paragraph 5, Incentive Bonus, vests Employee in any Stock Options specified in Paragraph 6)b, Stock Options Number of Shares, which have not vested as of the date of termination and awards to and vests Employee, effective date of termination, any Additional Stock Options that Employee has received or is eligible to receive under Paragraph 6)d, Additional Stock Options. 9) Termination of Employment by Employee. Anytime in this Agreement to the contrary notwithstanding, the Employee shall have the following rights with respect to termination of the Employee's employment: a) With Good Reason. Employee shall have the right to terminate his employment under this Agreement at any time for Good Reason, provided Employee has delivered written notice to the Company which briefly describes the facts underlying Employee's belief that "Good Reason" exists and the Company has failed to cure such situation within thirty (30) days after effective date of such notice. If the employee terminates With Good Reason, the Company shall pay the 4 Employee on the date of termination, any unearned salary specified in Paragraph 4, Base Salary, the amount specified in Paragraph 10, Severance Pay, any earned Incentive Bonuses specified in Paragraph 5, Incentive Bonus, vests Employee in any Stock Options specified in Paragraph 6)b, Stock Options Number of Shares which have not vested as of the date of termination and awards to and vests Employee, effective the date of termination, any Additional Stock Options that Employee has received or is eligible to receive under Paragraph 6)d, Additional Stock Options. For purposes of this Agreement, "Good Reason" shall mean and consist of: i) A material breach by the Company of its obligations under this Agreement; without Employee's prior written consent, the assignment to Employee of duties that are materially inconsistent with, or that constitute a material alteration in the status of his responsibilities set forth in this Agreement, as a Vice President of the Company; without Employee's prior written consent, the transfer or relocation of Employee's place of employment to any place other than the Salt Lake City/Provo metropolitan area, except for reasonable travel on the business of the Company or; upon consummation of a sale of all or substantially all of the outstanding stock or assets of the Company in which sale the acquiring company did not assume all of the obligations of the Company under this Agreement. b) Without Good Reason. With not less than sixty (60) days prior written notice (which notice shall specify the date of termination), Employee shall have the right to terminate his employment under this Agreement without Good Reason. 10) Severance Pay. If this Agreement terminates and the Employee does not continue in the employment of the Company, whether or not the Employee is offered continued employment by the Company, the Company shall pay to the Employee an amount equal to two times the base annual salary in effect at the time of such termination. The Employee shall not be required to mitigate the amount of the payment provided for in this section by seeking other employment or otherwise, nor shall the amount of the payment be reduced by any compensation earned by the Employee as the result of employment by another employer after termination or otherwise. 5 11) Automobile Allowance. Commencing January 1, 1999 and continuing until this Agreement terminates, the Company shall pay the Employee an Automobile Allowance of no less than $550 per month. Accepted and Agreed to: /Dee J. Priano/ 4 January 1999 - ------------------------------------- ------------------------- Dee J. Priano Date Accepted and Agreed to for Covol Technologies: /Brent M. Cook/ 4 January 1999 - ------------------------------------- ------------------------- Brent M. Cook Date 6 EX-21.1 13 SUBSIDIARIES OF COVOL COVOL TECHNOLOGIES, INC. List of Subsidiaries Jurisdiction of Name Organization Utah Synfuel #1, Ltd. Delaware limited Partnership Alabama Synfuel #1, Ltd. Delaware limited Partnership Flat Ridge Corporation Utah corporation Commonwealth Synfuel, L.L.C. Utah limited liability company EX-23.1 14 CONSENT OF PRICEWATERHOUSECOOPERS CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the registration statement of Covol Technologies, Inc. on Form S-3 (File No. 333-67371) of our report dated December 22, 1998, on our audits of the consolidated financial statements of Covol Technologies, Inc. as of September 30, 1998 and 1997, and for the years ended September 30, 1998, 1997, and 1996, which report is included in this Annual Report on Form 10-K. /PricewaterhouseCoopers LLP/ Salt Lake City, Utah December 22, 1998 EX-27.1 15 FDS --
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEAR ENDED SEPTEMBER 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR SEP-30-1998 SEP-30-1998 727 0 3,891 0 1,645 38,101 16,056 1,154 67,909 29,552 14,077 0 1 11 21,559 67,909 3,569 12,699 9,295 9,295 1,579 0 2,745 (3,986) 0 (3,986) 0 0 0 (3,986) (0.43) (0.43)
EX-27.2 16 FDS --
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED SEPTEMBER 30, 1997 AND 1996 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR YEAR SEP-30-1997 SEP-30-1996 SEP-30-1997 SEP-30-1996 4,780 490 0 0 1,099 78 0 0 1,819 163 17,268 779 6,060 7,528 596 403 26,870 8,772 12,308 4,261 3,389 151 0 0 1 0 9 8 5,919 (241) 26,870 8,772 251 195 251 295 4,803 860 4,803 860 3,364 8,783 0 0 1,645 94 (10,995) (12,932) 0 23 (10,995) (12,955) 0 (881) 0 0 0 0 (10,995) (13,836) (1.38) (1.99) (1.38) (1.99)
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