-----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, JgkUwtYIG8olZltAcF+pdFhi4NydhYqzBISiy/MzlQMuyC4LfDWxs4L3v+paE1j7 XV0DM0IAlArgkoYWxNJECg== 0001038838-99-000044.txt : 19990217 0001038838-99-000044.hdr.sgml : 19990217 ACCESSION NUMBER: 0001038838-99-000044 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990216 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-Q SEC ACT: SEC FILE NUMBER: 000-27808 FILM NUMBER: 99542475 BUSINESS ADDRESS: STREET 1: 3280 N FRONTAGE RD CITY: LEHI STATE: UT ZIP: 84043 BUSINESS PHONE: 8017684481 10-Q 1 FIRST QUARTER FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended December 31, 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 Identification No.) incorporation or organization) 3280 North Frontage Road Lehi, Utah 84043 (Address of principal executive offices) (Zip Code) (801) 768-4481 (Registrant's telephone number, including area code) Not applicable (Former name, former address and former fiscal year, if changed since last report) 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 ____ The number of shares outstanding of the Registrant's common stock as of February 12, 1999 was 12,494,029. COVOL TECHNOLOGIES, INC. TABLE OF CONTENTS Page No. PART I - FINANCIAL INFORMATION ITEM 1. CONSOLIDATED FINANCIAL INFORMATION (Unaudited) Consolidated Balance Sheets - As of September 30, 1998 and December 31, 1998.................................... 3 Consolidated Statements of Operations - For the three months ended December 31, 1997 and 1998.................. 5 Consolidated Statement of Changes in Stockholders' Equity - For the three months ended December 31, 1998............. 6 Consolidated Statements of Cash Flows - For the three months ended December 31, 1997 and 1998.................. 7 Notes to Consolidated Financial Statements.................... 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.....................................17 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS.............................................20 ITEM 2. CHANGES IN SECURITIES.........................................21 ITEM 3. DEFAULTS UPON SENIOR SECURITIES...............................22 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...........22 ITEM 5. OTHER INFORMATION.............................................22 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K..............................23 SIGNATURES.................................................................24 Statements in this Report, including those concerning the Registrant's expectations regarding its business, and certain of the other 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 certain of the factors that could cause actual results to differ from expectations, please see the caption entitled "Forward Looking Statements" in ITEM 2 hereof. There can be no assurance that the Registrant's results of operations will not be adversely affected by such factors. The 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
ITEM 1. CONSOLIDATED FINANCIAL INFORMATION (Unaudited) COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Unaudited) As of As of September 30, December 31, (thousands of dollars) 1998 1998 - ------------------------------------------------------------------------------------------- ---------------- ----------------- ASSETS Current assets: Cash and cash equivalents $ 727 $ 675 Receivables 2,879 2,891 Due from related party 1,012 1,337 Inventories 1,645 1,805 Advances on inventories, current 2,522 990 Notes receivable - related parties, current 229 235 Facilities held for sale 28,405 28,415 Prepaid expenses and other current assets 682 811 ---------------- ----------------- Total current assets 38,101 37,159 ---------------- ----------------- Property, plant and equipment, net of accumulated depreciation 14,902 14,976 ---------------- ----------------- Other assets: Restricted investments 748 891 Advances on inventories, non-current --- 1,914 Notes and accrued interest receivable, non-current 7,646 7,829 Notes receivable - related parties, non-current 2,869 2,809 Intangible assets, net of accumulated amortization 3,118 3,617 Deposits and other assets 525 846 ---------------- ----------------- Total other assets 14,906 17,906 ---------------- ----------------- Total assets $67,909 $70,041 ================ =================
(continued) The accompanying notes are an integral part of the consolidated financial statements 3
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS, continued (Unaudited) As of As of September 30, December 31, (thousands of dollars and shares) 1998 1998 - -------------------------------------------------------------------------------------------- --------------- ---------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $3,036 $3,366 Due to related party 1,609 1,870 Accrued liabilities 2,858 3,310 Notes payable, current 22,049 23,065 --------------- ---------------- Total current liabilities 29,552 31,611 --------------- ---------------- Long-term liabilities: Notes payable, non-current 13,930 13,973 Notes and accrued interest payable - related parties, non-current 147 69 Accrued interest payable, non-current 566 157 Deferred revenues from advance license fees 1,400 1,400 Deferred compensation 236 239 --------------- ---------------- Total long-term liabilities 16,279 15,838 --------------- ---------------- Total liabilities 45,831 47,449 --------------- ---------------- Minority interest in consolidated subsidiaries 507 109 --------------- ---------------- Commitments and contingencies (Note 7) Stockholders' equity: Convertible preferred stock, $0.001 par value; authorized 10,000 shares, issued and outstanding 316 shares at September 30, 1998 and 30 shares at December 31, 1998 (aggregate liquidation preference of $3,454 at December 31, 1998) 1 1 Common stock, $0.001 par value; authorized 25,000 shares, issued and outstanding 11,272 shares at September 30, 1998 and 12,494 shares at December 31, 1998 11 12 Capital in excess of par value - preferred 5,184 3,184 Capital in excess of par value - common 64,100 71,174 Accumulated deficit (36,177) (41,073) Notes and interest receivable - related parties, from issuance of, or collateralized by, common stock, net of allowance (7,773) (7,202) Deferred compensation from stock options (3,775) (3,613) --------------- ---------------- Total stockholders' equity 21,571 22,483 --------------- ---------------- Total liabilities and stockholders' equity $67,909 $70,041 =============== ================
The accompanying notes are an integral part of the consolidated financial statements 4
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) Three Months Ended December 31, (thousands of dollars, except per-share amounts) 1997 1998 - ---------------------------------------------------------------------------------- --------------------- --------------------- Revenues: License fees $1,000 $ 474 Binder sales -- 533 Binder and coal fine sales - related party 7 141 Other 34 7 --------------------- --------------------- Total revenues 1,041 1,155 --------------------- --------------------- Operating costs and expenses: Cost of coal briquetting operations 457 3,520 Cost of binder -- 376 Selling, general and administrative 741 929 Research and development 156 153 Compensation expense on stock options, stock warrants and issuance of common stock 207 162 --------------------- --------------------- Total operating costs and expenses 1,561 5,140 --------------------- --------------------- Operating loss (520) (3,985) --------------------- --------------------- Other income (expense): Interest income 122 831 Interest expense (1,112) (1,036) Minority interest in net losses of consolidated subsidiaries 86 -- Write-up (write-down) of notes receivable - related parties, collateralized by common stock 293 (571) Other 15 24 --------------------- --------------------- Total other income (expense) (596) (752) --------------------- --------------------- Net loss $(1,116) $(4,737) ===================== ===================== Basic and diluted net loss per common share $(.13) $(.40) ===================== =====================
The accompanying notes are an integral part of the consolidated financial statements 5
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited) Notes and interest receivable - related parties, Convertible Preferred Stock Common Stock from issuance of, -------------------------------- ---------------------------- or collater- Deferred Capital in Capital in alized compensation (thousands of excess of excess of Accumulated by, common from stock dollars and shares) Shares Amount par value Shares Amount par value deficit stock options - --------------------- ------ --------- --------- -------- ------- ---------- ----------- --------- ----------- Balances at September 30, 1998 316 $1 $5,184 11,272 $11 $64,100 $(36,177) $(7,773) $(3,775) Common stock issued to purchase minority interests in 92 -- 519 subsidiaries Common stock issued for cash, including exercise of 776 1 3,774 stock options Value of common stock warrants issued under terms of existing debt agreement -- -- 247 Common stock issued for rights to certain technology 60 -- 375 Common stock issued on conversion of preferred stock and accrued but undeclared dividends (286) -- (2,000) 308 -- 2,159 (159) Return of previously issued common stock by a director (14) -- -- Write-down of notes receivable - related parties 571 Amortization of deferred compensation from stock options 162 Net loss for the quarter ended December 31, 1998 (4,737) ------ --------- --------- -------- ------- ---------- ----------- --------- ----------- Balances at December 31, 1998 30 $1 $3,184 12,494 $12 $71,174 $(41,073) $(7,202) $(3,613) ====== ========= ========= ======== ======= ========== =========== ========= -----------
The accompanying notes are an integral part of the consolidated financial statements 6
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Three Months Ended December 31, (thousands of dollars) 1997 1998 - ----------------------------------------------------------------------------------------- ------------------- ------------------- Cash flows from operating activities: Net loss $(1,116) $(4,737) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 65 436 Write-down (write-up) of notes receivable - related parties (293) 571 Interest expense related to amortization of value of common stock warrants -- 82 Interest expense based upon issuance of convertible debt and warrants at a 1,112 -- discount Amortization of deferred compensation from stock options 207 162 Losses applicable to minority interests in subsidiaries (86) -- Decrease from changes in assets and liabilities, net of effects from investing and financing activities (858) (660) ------------------- ------------------- Net cash used in operating activities (969) (4,146) ------------------- ------------------- Cash flows from investing activities: Purchase of property, plant and equipment and facilities held for sale (4,978) (410) Purchase of rights to technology -- (100) Issuance of notes receivable (812) -- Payments on notes receivable - related parties, current -- 54 Purchase of restricted investment -- (143) ------------------- ------------------- Net cash used in investing activities (5,790) (599) ------------------- ------------------- Cash flows from financing activities: Proceeds from issuance of notes payable 3,095 1,049 Payments on notes payable - related parties (56) (78) Proceeds from issuance of preferred stock, net 90 -- Proceeds from issuance of common stock, net 836 3,774 Proceeds from receivable - stock subscriptions 577 -- Other 2 (52) ------------------- ------------------- Net cash provided by financing activities 4,544 4,693 ------------------- ------------------- Net decrease in cash and cash equivalents (2,215) (52) Total cash and cash equivalents, beginning of period 4,780 727 ------------------- ------------------- Total cash and cash equivalents, end of period $2,565 $ 675 =================== =================== Supplemental schedule of non-cash investing and financing activities: Common stock issued for purchase of minority interests in subsidiaries $ -- $ 519 Common stock issued on conversion of preferred stock and accrued but undeclared dividends -- 2,159 Common stock issued for rights to technology -- 375 Note payable issued for inventory 400 -- Note payable issued for equipment 1,971 --
The accompanying notes are an integral part of the consolidated financial statements 7 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) ---------- 1. Nature of Operations and Basis of Presentation Covol's primary business is to commercialize its binder technologies used to recycle waste by-products from the coal, steel and other industries into marketable fuel and resources. Through June 30, 1998, Covol's focus was on the construction of facilities and the licensing of its binder technologies to companies that constructed facilities that convert coal fines into synthetic fuel briquettes. At December 31, 1998, Covol and its licensees were operating 24 of these facilities in eight states at various levels of production. The four Covol-owned facilities are expected to be sold in 1999. Covol has no current plans to construct additional synthetic fuel facilities. Covol anticipates that earned license fees or royalties from the production and sale of synthetic fuel will continue to increase during 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. 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 anticipates that these operating activities will be producing 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 financing transactions and excess proceeds from the sale of facilities. During November 1998, Covol issued common stock and common stock warrants for total net proceeds of approximately $3,729,000. During January 1999, Covol issued convertible preferred stock and warrants for total net proceeds of approximately $900,000. Covol is presently negotiating and finalizing definitive agreements with respect to previously negotiated term sheets for the sale of up to $16,000,000 of additional convertible preferred stock, which financing is expected to close in February 1999. Covol believes the funds raised in these financings and others, if necessary, excess proceeds from the sale of facilities, and payments for license fees and binder sales will be sufficient to fund Covol's operations and debt repayment requirements until its operating activities begin producing positive cash flow. The accompanying unaudited consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. The results of operations for the periods presented are not necessarily indicative of the results to be expected for the full year. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. It is suggested that these financial statements be read in conjunction with the consolidated financial statements and notes thereto included in Covol's Annual Report on Form 10-K for the year ended September 30, 1998. 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. Certain prior period amounts have been reclassified to conform to the December 31, 1998 presentation. These reclassifications had no effect on net loss or total assets. 8 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (Unaudited) ---------- 2. Advances on Inventories During 1997, Covol entered into an agreement to purchase coal fines and through December 31, 1998 has made payments totaling approximately $3,125,000, of which $221,000 has been transferred to cost of coal briquetting operations. The net amount paid has been recorded as advances on inventories. Covol expects to utilize some of these coal fines during 1999, at which time the related costs will be expensed. Under the agreement, Covol 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. Change in Carrying Value of Note Receivable During the three months ended December 31, 1998, Covol increased the allowance on the $5,000,000 face value note receivable from a stockholder received from the 1996 sale of certain construction companies by approximately $571,000, which adjusted the carrying value to $1,038,000 as of December 31, 1998. During the three months ended December 31, 1997, Covol decreased the allowance by approximately $293,000. The changes in the allowance were based solely on changes in the market value of Covol's common stock and common stock options held as collateral for the note receivable. The note is guaranteed by the buyer, who is the sole stockholder of the construction companies, by 150,625 shares of Covol's common stock held by Covol, and by options expiring in January 2006 to acquire 25,000 shares of Covol's common stock committed by the stockholder to be provided to Covol. The allowance is subject to future fluctuations in the value of Covol's common stock. In February 1999, Covol received an interest payment of $75,000 from the Note holder. 4. Notes Payable
Notes payable consist of the following: September 30, December 31, (thousands of dollars) 1998 1998 ---------------------------------------------------------------------------------------- ------------------ ------------------ Note payable to a corporation bearing interest at prime (7.75% at December 31, 1998) plus 2%, collateralized by plant and equipment, principal and interest due December 1999. $ 2,900 $2,900 Note payable to the same corporation referred to in the preceding paragraph, bearing interest at 6%, principal and interest due October 1999, collateralized by a coal wash plant in Utah. 4,263 4,276 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 6,680
9 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (Unaudited) ---------- 4. Notes Payable, continued
September 30, December 31, 1998 (thousands of dollars, except per-share data) 1998 ------------------------------------------------------------------------------------- ------------------ ------------------- 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. In December 1998, this entity modified the terms of the note and agreed to loan to Covol additional amounts up to $1,500. This entity had an option to purchase the facility, which expired unexercised in January 1999 (see Note 8). Covol agreed to pay interest on all outstanding amounts at a rate of 10%, payable monthly 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, Covol granted additional collateral to the corporation in the form of certain license fees receivable by Covol from other synthetic fuel facilities. 8,242 8,895 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 August 1999. 5,800 5,800 Note payable to a corporation bearing interest at 22%, due June 1999, collateralized by a promissory note receivable and by certain future license fees receivable by Covol. Warrants to purchase 100,000 shares of common stock were granted in October 1998 based on the outstanding principal balance. The warrants have an exercise price of $7.44 per share, expire in October 2000 and were valued at approximately $247,000. A member of Covol's Board of Directors is affiliated with this corporation. 4,000 4,000 Note payable to the same corporation referred to in the preceding paragraph, bearing interest at 14%. Principal and accrued interest due March 1999, collateralized by certain future license fees receivable by Covol. 4,000 4,000 Other 94 487 ------------------- ------------------ 35,979 37,038 Less: current portion 22,049 23,065 =================== ================== Total non-current $13,930 $13,973 =================== ==================
Substantially all of Covol's property, plant and equipment and facilities held for sale are collateral for the notes payable. The weighted average interest rate on notes payable was 8.5% at September 30, 1998 and 11.4% at December 31, 1998. 10 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (Unaudited) ---------- 4. Notes Payable, continued Interest Costs During the three months ended December 31, 1998, Covol incurred total interest costs of approximately $1,036,000 (including approximately $82,000 of amortization of value of common stock warrants issued under terms of an existing agreement), none of which were capitalized. During the three months ended December 31, 1997, Covol incurred total interest costs of approximately $1,397,000 (including approximately $1,112,000 of non-cash interest expense resulting from issuance of convertible debt at a discount), of which approximately $285,000 was capitalized. 5. Basic and Diluted Loss per Share
(thousands of dollars and shares, except per-share data) 1997 1998 ----------------------------------------------------------------------------------- ------------------- ------------------ Numerator: Net loss $(1,116) $(4,737) Preferred stock dividends (undeclared) (88) (60) =================== ================== Net loss attributable to common stockholders $(1,204) $(4,797) =================== ================== Denominator - weighted average shares outstanding 9,194 11,976 =================== ================== Basic and diluted net loss per share $(.13) $(.40) =================== ==================
6. Equity Transactions Purchase of Limited Partners' Interests in Subsidiaries 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. In September 1998, Covol offered the limited partners in Alabama Synfuel #1 and Utah 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 partnerships' assets and other factors including but not limited to current and future expected cash flows of the partnerships and the market value of Covol's common stock at the date of the offer, which was $9.00 per share. 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. Covol recorded this exchange using the market values of Covol's common stock on the dates the limited partners tendered acceptance of Covol's offer. These market values ranged from $6.75 to $11.13 per share. The excess of the value of the consideration paid for the purchase of the limited partners' interests in subsidiaries over the fair values of the related assets, which fair values approximated their carrying cost, was recorded as an intangible asset. 11 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (Unaudited) ---------- 6. Equity Transactions, continued Sale of Common Stock During November and December 1998, Covol completed a sale of 745,875 units at $5.00 per unit, for total proceeds of approximately $3,729,000. Each unit consisted 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 per share. The warrants expire in November 1999 if not exercised. Covol provided piggyback registration rights for the restricted common shares and the shares issuable upon exercise of the warrants. Technology Acquisition Effective in November 1998, Covol acquired a coal-based synthetic fuel technology, and related licensing and patent rights for $100,000 in cash, 60,000 shares of restricted common stock valued at $375,000 and a commitment to make installment payments of $5,000 per month for 60 months if certain events occur. This acquisition transferred to Covol patent ownership and licensor rights and obligations to existing license agreements with a company that sublicensed the technology to a developer of four synthetic fuel facilities. In connection with the acquisition of the technology, Covol entered into a consulting agreement with the previous owner of the patent rights to provide consulting services related to iron revert, coke, charcoal, waste recycling, and other related applications. The consulting agreement provides for monthly payments of $7,500 through November 2001. The total cost of $475,000 is being amortized on a straight-line basis over approximately nine years. Preferred Stock Conversion In October 1998, a total of approximately 308,000 shares of the common stock were issued on conversion of approximately 286,000 shares of series B preferred stock and related accrued but unpaid dividends. Return of Stock Issued to Director Covol previously issued 34,000 shares of common stock to a director as compensation for services and financial assistance. Following negotiations between Covol and this director, 14,000 shares of stock were cancelled in December 1998. Reference is made to paragraph 7 in "Recent Sales of Unregistered Securities" in Part II, Item 1. for a more detailed description of this transaction. Stock Options During the quarter ended December 31, 1998, Covol granted options for the purchase of a total of 322,000 shares of common stock. Options for the purchase of 150,000 shares of common stock were granted to three officers and options for the purchase of 172,000 shares were granted to four independent directors. In addition to these grants, in January 1999, Covol granted options for the purchase of 60,000 shares of common stock to four individuals for services rendered in connection with the financing of a synthetic fuel facility pursuant to a consulting arrangement originally entered into in 1997 and revised in August 1998. In December 1998, three officers exercised options for the purchase of 30,000 shares of common stock, for which Covol received proceeds of $45,000. 12 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (Unaudited) ---------- 7. Commitments and Contingencies Commitments and contingencies as of December 31, 1998 not disclosed elsewhere, are as follows: Letters of Credit During fiscal 1998, Covol entered into letter of credit arrangements with a bank that provide for the issuance of letters of credit totaling up to $938,000. As of December 31, 1998, there was $698,000 of outstanding letters of credit. Certificates of deposit totaling $698,000 that are included in restricted investments in the accompanying balance sheet collateralize these arrangements. Legal or Contractual Matters Included in accrued liabilities at September 30, 1998 and December 31, 1998 is $755,000 related to construction contracts that contain a "failure to proceed" liability clause. In December 1996, Covol entered into indemnification agreements in connection with construction contracts for certain synthetic fuel facilities entered into between the construction contractor and independent third parties. These contracts call for liquidated damages of $750,000 per contract if construction of the facilities were not completed by June 1, 1998. Covol indemnified the contractor for these potential liabilities. The maximum contingent liability Covol may have under these indemnification agreements would be $2,250,000. The contractor and the contracting party have initiated arbitration against each other including claims for liquidated damages. Covol is closely monitoring the arbitration and believes that payment of a material amount by Covol is unlikely. In March 1997, Covol sold the Utah Synfuel #1 facility to Coaltech. In connection with this sale, Utah Synfuel #1 licensed Coaltech to use Covol's binder technologies for an advance license fee of $1,400,000 and an earned license fee that is payable quarterly and is based upon briquette production and sales from the Utah Synfuel #1 facility. Covol contracted with Coaltech to operate the facility for which Covol receives a quarterly fee, which is also based upon briquettes produced and sold. Coaltech has an option wherein they can require Covol to purchase this facility under certain conditions for a price equal to fair market value, but not to exceed 50% of the amounts paid to Covol by Coaltech. Additionally, Covol entered into a supply and purchase agreement wherein Covol agreed to provide coal fines to Coaltech for processing into synthetic fuel at a price equal to its cost. Covol 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, Covol expects to incur a loss under this supply and purchase agreement which will reduce the earned license fees received. Covol believes that in total the earned license fees will exceed the losses incurred under the supply and purchase agreement. Because of the initial expected losses under this supply and purchase agreement, revenue recognition of the advance license fee has been deferred as of September 30, 1998 and December 31, 1998. In June 1996, Covol formed Alabama Synfuel #1 to construct a synthetic fuel facility. In connection with the construction of this facility, Covol entered into a supply agreement for coal fines to be used at the facility, under which Covol was obligated to purchase a minimum of 20,000 tons of coal fines per month through December 2001. Covol assigned this agreement to the purchaser of the facility and accordingly, has no ongoing obligation. Covol has a dispute with the provider of the coal fines, the resolution of which is not expected to have a material impact on Covol. In May 1995, Covol entered into an agreement with Geneva Steel Company to build and operate a commercial briquetting plant. The facility is not currently operational and is expected to be moved from the Geneva site in the near future. Covol may use this equipment for the production of synthetic fuel or for testing purposes. 13 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (Unaudited) ---------- 7. Commitments and Contingencies, continued Legal or Contractual Matters, continued In December 1996, Covol entered into license agreements with affiliates of Pace Carbon Fuels, L.L.C. (collectively "Pace") for the use of Covol's binder technologies at four synthetic fuel manufacturing facilities developed 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 earned 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. Revenues from earned license fees will be recognized by Covol only to the extent that amounts exceed the loan commitment. Pace has requested two quarterly loans totaling $1,500,000. Covol believes that its current loan obligation to Pace is limited to the earned license fees receivable by Covol for the quarters ended September 30, 1998 and December 31, 1998, which amounts are believed to be approximately $612,000 in total. 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 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 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 the resolution of this matter will have a material adverse effect on Covol. As of September 30, 1998 and December 31, 1998, Covol has recorded liabilities to The Industrial Company ("TIC") totaling approximately $735,000. In November 1998, Covol was served with liens from TIC in amounts totaling approximately $1,150,000 for construction payments TIC claims are due for certain synfuel facilities. Covol 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 Covol is unlikely. In September 1996, Covol entered into an agreement with Coalco Corporation whereby Coalco was to advise Covol with respect to the financing and sale of certain synthetic fuel manufacturing facilities. To date, Covol has paid Coalco approximately $347,000 pursuant to the agreement. A dispute has arisen between Covol and Coalco about services rendered or to be rendered by Coalco and the amount and timing for payment for such services. Covol and Coalco are negotiating to attempt to resolve their differences. The potential liability to Covol, if any, is not known. While Covol's management believes the dispute will be resolved and will not have a significant financial impact, it can give no assurance as to the ultimate effect on Covol. Pelletco, an affiliate of Coalco, is a licensee of Covol. Covol is also involved in several legal proceedings that have arisen out of the normal course of business. Covol 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 Covol. 14 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (Unaudited) ---------- 7. Commitments and Contingencies, continued Employment Contract In January 1999, Covol entered into an employment agreement with an officer. This agreement has a term of three years and provides for annual salaries and benefits ranging from approximately $107,000 to $142,000. The agreement provides for termination benefits under specific conditions of an amount equal to one year's annual base salary. 8. Events Subsequent to December 31, 1998 Events subsequent to December 31, 1998 not disclosed elsewhere are as follows: Sale of Series C Convertible Preferred Stock During January 1999, Covol completed a financing transaction with a stockholder that consisted of the sale of 1,000 shares of a new series of non-voting preferred stock, designated as Series C 7% Convertible Preferred Stock. Covol received $900,000 in net proceeds from the issuance of this preferred stock, which has the following rights and privileges: o Dividends on the preferred stock are cumulative and accrue whether or not they have been declared or whether Covol has any profits. The dividend rate is 7% per year of the liquidation value of $1,000 per share. o The preferred stock is convertible into common shares in incremental stages beginning April 1999 through July 1999, at which time all of the outstanding shares may be converted to common stock. The number of common shares to be received upon conversion is determined by multiplying the number of preferred shares by $1,000 and dividing that number by the conversion price (currently $5.50 per share, subject to adjustment). Upon conversion, all accrued and unpaid dividends will be paid or converted into shares of common stock. o Covol may at its option redeem the outstanding preferred stock beginning July 1999 for a redemption price equal to 125% of the liquidation value plus any accrued and unpaid dividends thereon. Warrants for the purchase of 72,727 shares of common stock were issued in conjunction with this preferred stock. These warrants are exercisable from April 1999 through July 2001 at an exercise price of $6.88 per share, subject to adjustment. The exercise deadline for certain other warrants with an exercise price of $7.00 per share held by this stockholder were extended to June 2000 and certain additional warrants with an exercise price of $30.00 per share were relinquished and have been cancelled. Covol granted registration rights for the restricted common shares issuable upon conversion of the preferred stock or upon exercise of the common stock warrants. 15 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (Unaudited) ---------- 7. Commitments and Contingencies, continued Other Covol is presently finalizing definitive agreements with respect to previously negotiated term sheets for the sale of up to $16,000,000 of additional convertible preferred stock, which financing is expected to close in February 1999. In May 1998, Covol entered into a construction and operation financing agreement and a purchase option agreement to sell the Mountaineer synthetic fuel facility to Mountaineer Synfuel, L.L.C., a Delaware limited liability company. The purchase option expired unexercised on January 29, 1999. Under the financing agreement, Covol is obligated to repay the loan (approximately $8,895,000 at December 31, 1998 and $9,191,000 at January 29, 1999) with ten percent interest in monthly interest only installments through June 1999 and monthly principal and interest installments thereafter of $350,000, with a balloon payment on June 30, 2000. Alternatively, if Covol sells the facility before the loan repayment date, Covol must repay the loan from sale proceeds. Covol continues to operate the project under contract with Savage Industries Inc. Anker Energy Corporation supplies the facility with feedstock and provides marketing services for the synthetic fuel produced. Covol is actively seeking a purchaser for the Mountaineer facility and expects the facility to be sold in its fiscal year 1999. However, Covol cannot give assurance that it will successfully sell the facility. 16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following Management's Discussion and Analysis should be read in conjunction with the accompanying unaudited consolidated financial statements and notes thereto. Three Months Ended December 31, 1998 Compared to Three Months Ended December 31, 1997 Revenues. Total revenues for the three months ended December 31, 1998 ("1998") increased by $114,000 to $1,155,000 as compared to $1,041,000 for the three months ended December 31, 1997 ("1997"). During 1998, Covol recognized license fees totaling $474,000 while license fees of $1,000,000 were recognized during 1997. The license fees in 1998 consisted solely of earned license fees or royalty payments, substantially all of which were from a single licensee, while the license fees in 1997 consisted solely of one-time advance license fees. Earned license fees or royalty payments are due quarterly based upon synthetic fuel produced and sold as reported to Covol by its licensees. 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 specified 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 two of the synthetic fuel facilities. Earned license fees or royalty payments are expected to increase at a moderate level in the near term with significant increases expected during mid to late 1999. Covol provides binder material to its licensees either at a fixed price or at Covol's cost plus a contracted markup. Covol purchases binder material under a long-term contract with a large chemical company. Total binder sales during 1998 were $533,000 with a corresponding direct cost to Covol of $376,000. Covol had sales of binder and coal fines to a related party during 1998 totaling $141,000 compared to $7,000 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. Covol expects an increase during 1999 of production of synthetic fuel by its licensees as licensees improve production capability and establish marketing agreements for end product. This will result in 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. Covol believes that its licensees have made significant progress in these areas during the quarter ended December 31, 1998, but continued success cannot be assured. Operating Costs and Expenses. Operating costs and expenses increased by $3,579,000 to $5,140,000 during 1998 from $1,561,000 during 1997. Cost of coal briquetting operations accounted for most of this variance as these costs increased $3,063,000 from $457,000 during 1997 to $3,520,000 during 1998. During 1998, Covol incurred significantly higher operating expenses in connection with the continued refinement and commercialization of the briquetting process in connection with the 24 facilities placed in service during 1998, and in particular the four facilities owned by Covol which are currently held for sale. These expenses primarily related to labor and operating expenses at the four Covol synthetic fuel facilities and the wash plant and synthetic fuel plant located in Utah, discussed below, costs incurred in providing assistance to Covol's licensees during the ramp-up of their synthetic fuel facilities, and increased personnel costs. Covol expects to continue incurring losses into 1999 until the four facilities which it owns are sold, but expects to realize a gain from these sales. 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 by Coaltech 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 well in excess of the current market value. These costs and the corresponding write-down of this inventory to its market value are included in the cost of coal briquetting operations. The write-down was approximately $1,150,000 during 1998 and $240,000 during 1997. Covol expects the excess cost per ton to decrease in 1999 as production volumes increase. 17 Selling, general and administrative expenses increased $188,000 or 25% to $929,000 during 1998 from $741,000 for 1997. The largest components of selling, general and administrative expenses for both periods were payroll, professional services and travel expenses. Payroll costs increased approximately $45,000 and professional services increased approximately $172,000, while travel costs decreased approximately $37,000. Most of the increase in professional services was due to increased legal costs. Research and development costs decreased marginally during 1998. Covol expects that research and development costs will increase in 1999 as Covol focuses resources on further refinement of its binder technologies relative to the synthetic fuel industry and the application of its binder technologies into other areas. Compensation expense on stock options, stock warrants, and issuance of common stock decreased $45,000 to $162,000 for 1998 from $207,000 for 1997. This expense relates to options granted in prior periods that vest over several years and the compensation value that is being recognized as an expense over the vesting period. This amount is expected to remain relatively level. Other Income and Expense. During 1998, Covol had net other expenses of $752,000 compared to $596,000 for 1997. This increase of $156,000 relates primarily to a change between periods of $864,000 in the mark-to-market adjustment of the carrying value of related party notes receivable collateralized by common stock, offset in part by an increase in interest income of $709,000. 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 guaranteed by the buyer of the construction companies and is collateralized by stock and stock options of Covol. Accordingly, the Note is "marked to market" each quarter based upon the market value of Covol's common stock and is reflected in the balance sheet at the underlying value of the collateral. This adjustment resulted in a write-down of $571,000 during 1998, compared to a write-up of $293,000 during 1997. A $515,000 payment on the Note was due in January 1999, of which $75,000 was received. The balance of the January payment is expected to be received in the quarter ending March 31, 1999. As of December 31, 1998 the Note had a carrying value of $1,038,000. Included in interest income for 1998 is $515,000 related to this Note. Interest expense in 1997 consisted solely of expense based upon the issuance of convertible debt and warrants at a discount. During December 1997, Covol executed an amendment to a loan agreement with a licensee, which provided funding for completing construction of a synthetic fuel facility in Alabama and acquiring coal fines and for other purposes related to the facility. The modification increased the amount available for borrowing with a provision that borrowings were convertible into common stock under the same terms as the original agreement. Based on the revised terms, an expense of approximately $714,000 was recognized during the quarter for conversion rights issued at a price below market. In October 1997, Covol entered into an agreement with another licensee whereby the licensee agreed to finance a wash plant being constructed by Covol to provide washed coal fines to a synthetic fuel facility in Utah. As additional consideration to the licensee for the financing arrangement, Covol granted warrants to purchase Covol common stock, resulting in the recognition of approximately $398,000 of interest expense in that quarter. Interest expense in 1998 consists of interest accrued on notes payable used to finance the construction of synthetic fuel facilities held for sale and for operating needs and includes $82,000 of amortization of value of common stock warrants issued under terms of an existing debt agreement. Interest expense 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 common stock of Covol in exchange for their limited partnership interests. These exchanges, most of which were accounted for in September 1998, were substantially completed by 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. As a result of these exchanges, minority interest in the losses of consolidated subsidiaries decreased from approximately $86,000 in 1997 to approximately $0 in 1998. Covol believes the combined operations of these partnerships will result in operating losses in the near-term future, which losses will be included in Covol's statement of operations. 18 Net loss. For 1998, the net loss increased by $3,621,000 from $1,116,000 for 1997 to $4,737,000. The increase is primarily due to the significant increase in the cost of briquetting operations, which was partially offset by increased interest income as discussed previously. Covol did not recognize any income tax benefit in 1998 or 1997 since the realization of its deferred tax asset, consisting primarily of net operating loss carryforwards, depends on generation of future taxable income. Liquidity and Capital Resources Liquidity. During the fiscal year 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 and which 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 $3,177,000 to $4,146,000 during 1998 from $969,000 during 1997. Covol was able to fund its operating activities, including the continued refinement and commercialization of its patented binder technologies, through the incurrence of debt and the issuance of convertible preferred stock, common stock and related common stock warrants. During 1998, proceeds from the issuance of notes payable totaled approximately $1,049,000 and issuances of common stock totaled $3,774,000. Capital Resources. During the quarter ended December 31, 1998, Covol used net cash in its investing activities totaling $599,000 compared to $5,790,000 for 1997. These uses consisted principally of purchases of property, plant and equipment. In 1997, a major portion of the purchases related to the four facilities currently held for sale. 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 fiscal 1998. Covol anticipates that earned license fees or royalties from the production and sale of synthetic fuel will continue to increase during 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. 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 anticipates that these operating activities will be producing 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 financing transactions and excess proceeds from the sale of facilities. During November 1998, Covol issued common stock and common stock warrants for total net proceeds of approximately $3,729,000. During January 1999, Covol issued convertible preferred stock and warrants for total net proceeds of approximately $900,000. Covol is presently negotiating and finalizing definitive agreements with respect to previously negotiated term sheets for the sale of up to $16,000,000 of additional convertible preferred stock, which financing is expected to close in February 1999. Covol believes the funds raised in these financings and others, if necessary, excess proceeds from the sale of facilities, and payments for license fees and binder sales will be sufficient to fund Covol's operations and debt repayment requirements until its operating activities begin producing positive cash flow. Forward Looking Statements Statements in this Item 2 regarding Covol's expectations as to the financing, development and operation of facilities utilizing Covol's binder technologies, the receipt of licensing and royalty fees, revenues, 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 19 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 regulations 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" in Covol's Annual Report on Form 10-K for the year ended September 30, 1998 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 fiscal year 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. 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. PART II -- OTHER INFORMATION ITEM 1. 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 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 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. 20 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 the resolution of this matter will have a material adverse effect on Covol. 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 2. CHANGES IN SECURITIES Recent Sales of Unregistered Securities The following sets forth all securities issued by Covol within the past fiscal quarter and subsequent to December 31, 1998 without registering the securities under the Securities Act of 1933, as amended. No underwriters were involved in any stock 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 or securities for contingently issuable common stock were exempt from the registration requirements of the Securities Act of 1933, as amended, pursuant to the exemption set forth in Section 4(2) or 4(6) thereof or Regulation D promulgated thereunder and the certificate for each security bears a restrictive 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 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 Alabama Synfuel #1 and Utah 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 partnerships' 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 partnerships' 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 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 long-term 21 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. In March 1996, Raymond G. Weller made a personal loan of $459,250 to Covol at the request of Covol's then CEO and CFO at a time when Covol was in great financial need. This loan was repaid in 1996 through the issuance of Covol common stock to Mr. Weller. It appears that the then management committed Covol to issue to Mr. Weller up to 34,000 shares of Covol common stock as compensation for the personal risk taken by Mr. Weller. The CEO and CFO left Covol in October 1996 before the transaction was completed. Mr. Weller continued to support Covol and provided leadership and guidance as a director through the period of transition between prior and current management. After confirming the circumstances surrounding the transaction, Covol's current management negotiated a resolution of the matter with Mr. Weller, and approved the issuance of 20,000 shares of restricted stock in complete satisfaction of any obligation Covol may have to Mr. Weller with respect to this transaction. The Board has approved the resolution. On December 3, 1998, Covol issued 60,000 shares of Covol common stock to a single investor as partial consideration for the purchase of a patent and related intellectual property rights with respect to an alternative method of production of solid synthetic fuel. In January 1999, Covol issued to four accredited investors, pursuant to a consulting compensation agreement dated August 1998, options to purchase an aggregate of 60,000 shares of Covol common stock, at an exercise price of $12.75 per share. The exercise price will be reduced to $8.58 per share if a consulting fee is not paid to the accredited investors as set forth in the consulting compensation agreement. The options are nontransferable and include piggy-back registration rights, which may be exercised two times. The options are exercisable until August 2003, after which any unexercised options will expire. Reference is made to the sale of series C convertible preferred stock described in Note 8 to the consolidated financial statements. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION Technology Acquisition Effective as of November 10, 1998, Covol acquired a coal-based synthetic fuel technology known as Carbontite(R), along with related licensing and patent rights owned by Dr. James G. Davidson and Adtech, Inc., including U.S. Patent No. 5,238,692. This acquisition transferred to Covol, in exchange for $100,000 and the issuance of 60,000 shares of Covol common stock, patent ownership and licensor rights and obligations to existing license agreements with Carbontech Energy Corporation ("CEC"), which in turn has sublicensed the technology to Carbontronics, the developer of the following synthetic fuel facilities: Location Rated Annual Capacity Gibraltar, KY 600,000 tons Lynnville, IN 600,000 tons Metropolis, IL 1,200,000 tons 22 The Gibraltar, Kentucky and Lynnville, Indiana synthetic fuel facilities are located at Peabody coal mine sites and are operated by Peabody. The Metropolis facilities are located at the Cook coal terminal operated by American Electric Power. As the owner of the Carbontite(R) technology and related license rights, Covol is to receive from CEC a share of the license fees paid to Carbontec by sublicensees, plus a prescribed royalty per ton of the finished product sold in plants operated by CEC or its sublicensees. The existing assigned license agreements do not provide for sale of chemical binder to licensees. In connection with the acquisition of the Carbontite(R) technology, Covol entered into a consulting agreement with Dr. Davidson to provide consulting services related to iron revert, coke, charcoal, waste recycling, and other related applications. In addition, Dr. Davidson granted rights to Covol for implementation of other technologies related to the business activities of Covol. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) The following exhibits are included herein: 3.1.5 Certificate of Designation, Number, Voting Powers, Preferences and Rights of Covol's Series C 7% Convertible Preferred Stock. 10.56 Employment Agreement effective April 21, 1998 with Brent M. Cook. 10.57 Employment Agreement effective January 1, 1999 with Steven R. Brown. 27.1 Financial Data Schedule (b) No reports on Form 8-K were filed during the three months ended December 31, 1998. 23 SIGNATURES Pursuant to the requirements 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. Date: February 12, 1999 By: /s/ Brent M. Cook -------------------------- Brent M. Cook, Chief Executive Officer and Principal Executive Officer Date: February 12, 1999 By: /s/ Steven G. Stewart -------------------------- Steven G. Stewart, Chief Financial Officer and Principal Financial Officer 24 EX-3.1.5 2 SERIES C 7% CONVERTIBLE PREFERRED STOCK Certificate of Designation, Number, Voting Powers, Preferences and Rights of the Series of the Preferred Stock of COVOL TECHNOLOGIES, INC. To be Designated Series C 7% Convertible Preferred Stock Covol Technologies, Inc., a Delaware corporation (the "Corporation"), pursuant to authority conferred on the Board of Directors of the Corporation by its Certificate of Incorporation, as amended, and in accordance with the provisions of Section 151 of the General Corporation Law of Delaware ("DGCL"), certifies that the Board of Directors of the Corporation, at a meeting duly called and held pursuant to Section 141 of the DGCL, duly adopted the following resolution providing for the establishment and issuance of a series of Preferred Stock to be designated as "Series C 7% Convertible Preferred Stock" and to consist of 1,500 shares as follows: RESOLVED, that, pursuant to the authority expressly granted and vested in the Board of Directors of this Corporation in accordance with the provisions of its Certificate of Incorporation, as amended, a series of Preferred Stock of the Corporation be and hereby is established, consisting of 1,500 shares, to be designated as "Series C 7% Convertible Preferred Stock" (the "Series C 7% Preferred"); the Board of Directors be and hereby is authorized to issue such shares of Series C 7% Preferred Stock from time to time and for such consideration and on such terms as the Board of Directors shall determine; and subject to the limitations provided by law and by the Certificate of Incorporation, as amended, the powers, designations, preferences and relative, participating, option or other special rights of, and the qualifications, limitations or restrictions upon, the Series C 7% Preferred shall be as follows: Section 1. Definitions. "Common Stock" means, collectively, the Corporation's common stock, par value $.001 per share. "Conversion Stock" means shares of the Corporation's Common Stock; provided that if there is a change such that the securities issuable upon conversion of the Series C 7% Preferred are issued by an entity other than the Corporation or there is a change in the class of securities so issuable, then the term "Conversion Stock" shall mean one share of the security issuable upon conversion of the Series C 7% Preferred if such security is issuable in shares, or shall mean the smallest unit in which such security is issuable if such security is not issuable in shares. "Junior Securities" means any of the Corporation's Common Stock. "Liquidation Value" of any Share (as defined in Section 2A hereof) as of any particular date shall be equal to One Thousand Dollars ($1,000.00). "Market Price" of any security means (i) the average of the closing prices of such security's sales on all securities exchanges on which such security may at the time be listed, or, if there has been no sales on any such exchange on any day, the average of the highest bid and lowest asked prices on all such exchanges at the end of such day, or, (ii) if on any day such security is not so listed, the reported closing price on the Nasdaq National Market ("NNM"), or, if the security is listed on the NNM but there has been no sales on such market on any day, the average of the highest bid and lowest asked prices on the NNM at the end of such day, or (iii) the average of the representative bid and asked prices quoted in the Nasdaq Smallcap Market as of 4:00 P.M., New York time, or, if on any day such security is not quoted in the Nasdaq SmallCap Market, the average of the highest bid and lowest asked prices on such day in the domestic over-the-counter market as reported by the National Quotation Bureau, Incorporated, or any similar successor organization. If at any time such security is not listed on any securities exchange, the NNM, or quoted in the Nasdaq Smallcap Market or the over-the-counter market, the "Market Price" shall be the fair value thereof determined jointly by the Corporation and the holders of a majority of the Series C 7% Preferred. If such parties are unable to reach agreement within a reasonable period of time, such fair value shall be determined by an independent appraiser experienced in valuing securities jointly selected by the Corporation and the holders of a majority of the Series C 7% Preferred. The determination of such appraiser shall be final and binding upon the parties, and the Corporation shall pay the fees and expenses of such appraiser. "Person" means an individual, a partnership, a corporation, an association, a joint stock company, a trust, a joint venture, an unincorporated organization and a governmental entity or any department, agency or political subdivision thereof. "Redemption Date" as to any Share means the date specified in the notice of any redemption at the Corporation's option or the applicable date specified herein in the case of any other redemption; provided that no such date shall be a Redemption Date unless the Liquidation Value of such Share (plus all accrued and unpaid dividends thereon) is actually paid in full on such date, and if not so paid in full, the Redemption Date shall be the date on which such amount is fully paid. Section 2. Dividends. 2A. General Obligation. When and as declared by the Corporation's Board of Directors and to the extent permitted under the General Corporation Law of Delaware, the Corporation shall pay preferential dividends monthly to the holders of the Series C 7% Preferred Stock as provided in this Section. Except as otherwise provided herein, dividends on each share of the Series C 7% Preferred (a "Share") shall accrue on a daily basis at the rate of 7% per annum of the sum of the Liquidation Value thereof, from and including the date of issuance of such Share to and including the date on which the Liquidation Value of 2 such Share is paid or the date on which such Share is converted into shares of Conversion Stock hereunder; provided, however, that no compounding of such dividends shall be authorized thereon. Such dividends shall accrue whether or not they have been declared and whether or not there are profits, surplus or other funds of the Corporation legally available for the payment of dividends. Such dividends shall be cumulative such that all accrued and unpaid dividends shall be fully paid or declared with funds irrevocably set apart for payment before any dividend, distribution or payment may be made with respect to any Junior Securities. The date on which the Corporation initially issues any Share shall be deemed to be its "date of issuance" regardless of the number of times transfer of such Share is made on the stock records maintained by or for the Corporation and regardless of the number of certificates which may be issued to evidence such Share. 2B. Dividend Reference Date. To the extent not paid monthly on the 22d day of the calendar month, commencing February 22, 1999, all dividends which have accrued on each Share outstanding during the month (or other period in the case of the initial Dividend Reference Date) ending upon each such Dividend Reference Date shall be accumulated and shall remain accumulated dividends with respect to such Share until paid. 2C. Distribution of Partial Dividend Payments. Except as otherwise provided herein, if at any time the Corporation pays less than the total amount of dividends then accrued with respect to the Series C 7% Preferred, such payment shall be distributed ratably among the holders thereof based upon the number of Shares held by each such holder. 2D. Payment of Stock Dividends. In the sole discretion of the Corporation, any dividends accruing on Shares of Series C 7% Preferred may be paid in lieu of cash dividends by the issuance of additional Shares of Series C 7% Preferred (including fractional Shares) having an aggregate Liquidation Value at the time of such payment equal to the amount of the dividend to be paid; provided that if the Corporation pays less than the total amount of dividends then accrued on the Series C 7% Preferred in the form of additional Shares, such payment in Shares shall be made pro rata to the holders of Series C 7% Preferred based upon the aggregate accrued but unpaid dividends on the Shares of Series C 7% Preferred held by each such holder. Section 3. Liquidation. Upon any liquidation, dissolution or winding up of the Corporation, each holder of Series C 7% Preferred shall be entitled to be paid, before any distribution or payment is made upon any Junior Securities, an amount in cash equal to the aggregate Liquidation Value (plus all accrued and unpaid dividends) of all Shares held by such holder, and the holders of Series C 7% Preferred shall not be entitled to any further payment. If at the time of such liquidation, dissolution or winding up, other series of the Corporation's preferred stock are outstanding, the Series C 7% Preferred will be considered to have the same priority to receive payments, pari passu, as all other series of preferred stock which are, by their terms, senior to the Junior Securities and which do not provide by their terms that they are senior to, or junior to, the Series C 7% Preferred. If upon any such liquidation, dissolution or winding up of the Corporation, the Corporation's assets to be distributed among the holders of the Series C 7% Preferred are insufficient to permit payment to such holders of the aggregate amount which they are entitled to be paid, then the entire assets to be so distributed shall be distributed ratably among such holders based upon the aggregate 3 Liquidation Value (plus all accrued and unpaid dividends) of the Series C 7% Preferred held by each such holder. Prior to the liquidation, dissolution or winding up of the Corporation, the Corporation shall declare for payment all accrued and unpaid dividends with respect to the Series C 7% Preferred. The Corporation shall mail written notice of such liquidation, dissolution or winding up, not less than 60 days prior to the payment date stated therein, to each record holder of Series C 7% Preferred. Neither the consolidation or merger of the Corporation into or with any other entity or entities, nor the sale or transfer by the Corporation of less than substantially all of its assets, nor the reduction of the capital stock of the Corporation, shall be deemed to be a liquidation, dissolution or winding up of the Corporation within the meaning of this Section. Section 4. Redemption. 4A. Optional Redemptions. The Corporation may at any time within 180 days after the date of initial issuance (as defined in Section 2A) redeem all or any portion of Series C 7% Preferred then outstanding. On any such redemption, the Corporation shall pay a price per Share equal to 125% of the Liquidation Value thereof, plus 100% of all accrued and unpaid dividends thereon. 4B. Redemption Payment. For each Share which is to be redeemed, the Corporation shall be obligated on the Redemption Date to pay to the holder thereof (upon surrender by such holder at the Corporation's principal office of the certificate representing such Share) an amount in immediately available funds equal to 125% of the Liquidation Value of such Share (plus 100% of all accrued and unpaid dividends thereon). If the funds of the Corporation legally available for redemption of Shares on any Redemption Date are insufficient to redeem the total number of Shares to be redeemed on such date, those funds which are legally available shall be used to redeem the maximum possible number of Shares ratably among the holders of the Shares to be redeemed based upon the aggregate Liquidation Value of such Shares (plus all accrued and unpaid dividends thereon) held by each such holder. At any time thereafter when additional funds of the Corporation are legally available for the redemption of Shares, such funds shall immediately be used to redeem the balance of the Shares which the Corporation has become obligated to redeem on any Redemption Date but which it has not redeemed. 4C. Notice of Redemption. The Corporation shall mail written notice of each redemption of any Series C 7% Preferred to each record holder thereof not less than 10 days prior to the date on which such redemption is to be made. If on the redemption date specified in the notice, the Corporation fails to pay the redemption payment on any Shares properly tendered for redemption, then as sole remedy to the holder whose redemption price was not paid (the "Defaulted Holder") the Corporation agrees that (i) the redemption notice shall be void with respect to such unpaid Shares of the Defaulted Holder, (ii) the Conversion Price of the Shares for which the redemption notice is void shall be reduced by 5%, (iii) the limitations on conversion contained in subparagraph 6A(ii) shall no longer apply to any Shares held by the Defaulted Holder, and (iv) any of the Corporation's warrants issued in connection with the initial issuance of the Series C 7% Preferred held by the Defaulted Holder shall be and become exercisable notwithstanding provisions therein restricting exercise thereof prior to stated dates. In case fewer than the total number of Shares represented by any certificate are redeemed, a new certificate representing the number of 4 unredeemed Shares shall be issued to the holder thereof without cost to such holder within ten (10) business days after surrender of the certificate representing the redeemed Shares. 4D. Determination of the Number of Each Holder's Shares to be Redeemed. Except as otherwise provided herein, the number of Shares of Series C 7% Preferred to be redeemed from each holder thereof in redemptions hereunder shall be the number of Shares determined by multiplying the total number of Shares to be redeemed times a fraction, the numerator of which shall be the total number of Shares then held by such holder and the denominator of which shall be the total number of Shares then outstanding. 4E. Dividends After Redemption Date. No Share is entitled to any dividends accruing after the date on which 125% of the Liquidation Value of such Share (plus 100% of all accrued and unpaid dividends thereon) is paid to the holder thereof. On such date all rights of the holder of such Share shall cease, and such Share shall not be deemed to be outstanding. 4F. Redeemed or Otherwise Acquired Shares. Any Shares which are redeemed or otherwise acquired by the Corporation shall be cancelled and shall be deemed to be undesignated authorized and unissued preferred shares. 4G. Other Redemptions or Acquisitions. The Corporation shall not redeem or otherwise acquire any Series C 7% Preferred, except as expressly authorized herein or pursuant to a purchase offer made pro-rata to all holders of Series C 7% Preferred on the basis of the number of Shares owned by each such holder. Section 5. Voting Rights. The Series C 7% Preferred shall have no voting rights unless specifically authorized by the DGCL. Section 6. Conversion. 6A. Conversion Procedure. (i) Subject to and in compliance with the provisions of this Certificate of Designation, any holder of Series C 7% Preferred may convert all or any portion of the Series C 7% Preferred held by such holder into a number of shares of Conversion Stock computed by multiplying the number of Shares to be converted by $1,000 and dividing the result by the Conversion Price then in effect. (ii) The right of the holders to convert the Series C 7% Preferred shall be subject to the following limitations: (a) No Series C 7% Preferred may be converted on or before April 15, 1999. (b) Commencing April 16, 1999, each holder of the Series C 7% Preferred may convert up to 10% of the Shares held by him at April 15, 1999, plus any Shares or fractional Shares issued in payment of dividends. 5 (c) Commencing May 16, 1999, each holder of the Series C 7% Preferred may convert up to an additional 10% of the Shares held by him at April 15, 1999 (i.e. up to a total of 20% on a cumulative basis), plus any Shares or fractional Shares issued in payment of dividends. (d) Commencing June 16, 1999, each holder of the Series C 7% Preferred may convert up to an additional 10% of the Shares held by him at April 15, 1999 (i.e. up to a total of 30% on a cumulative basis), plus any Shares or fractional Shares issued in payment of dividends. (e) Commencing July 16, 1999, each holder of the Series C 7% Preferred may convert his Shares without regard to limitations under this subparagraph (ii). (iii) Each conversion of Series C 7% Preferred shall be deemed to have been effected as of the close of business on the date on which the certificate or certificates representing the Series C 7% Preferred to be converted have been surrendered at the principal office of the Corporation (the "Conversion Date"). At such time as such conversion has been effected, the rights of the holder of such Series C 7% Preferred as such holder shall cease and the Person or Persons in whose name or names any certificate or certificates for shares of Conversion Stock are to be issued upon such conversion shall be deemed to have become the holder or holders of record of the shares of Conversion Stock represented thereby. (iv) The conversion rights of any Share subject to redemption hereunder shall terminate on the Redemption Date for such Share unless the Corporation has failed to pay to the holder thereof 125% of Liquidation Value thereof (plus 100% of all accrued and unpaid dividends thereon). (v) Within two business days after a conversion has been effected, the Corporation shall make available to the converting holder at the Corporation's transfer agent: (a) a certificate or certificates representing the number of shares of Conversion Stock issuable by reason of such conversion in such name or names and such denomination or denominations as the converting holder has specified; (b) payment in an amount equal to all accrued dividends with respect to each Share converted, which have not been paid prior thereto, plus the amount payable under subparagraph (ix) below with respect to such conversion; provided, however, that such accrued dividends may, at the Corporation's option, be converted into an additional number of shares of Conversion Stock by dividing the amount of unpaid dividends by the Conversion Price; and (c) a certificate representing any Shares of Series C 7% Preferred which were represented by the certificate or certificates delivered to the Corporation in connection with such conversion but which were not converted. (vi) Upon conversion, the Corporation shall convert all accrued and unpaid dividends on the Series C 7% Preferred being converted into an additional number of shares of Conversion Stock (which will be delivered within ten (10) business days) determined by 6 dividing the amount of the unpaid dividends to be applied for such purpose, by the Conversion Price. (vii) The issuance of certificates for shares of Conversion Stock upon conversion of Series C 7% Preferred shall be made without charge to the holders of such Series C 7% Preferred for any issuance tax in respect thereof or other cost incurred by the Corporation in connection with such conversion and the related issuance of shares of Conversion Stock. Upon conversion of each Share of Series C 7% Preferred, the Corporation shall take all such actions as are necessary in order to insure that the Conversion Stock issuable with respect to such conversion shall be validly issued, fully paid and nonassessable. (viii) The Corporation shall assist and cooperate with any holder of Shares required to make any governmental filings or obtain any governmental approval prior to or in connection with any conversion of Shares hereunder (including, without limitation, making any filings required to be made by the Corporation). (ix) If any fractional interest in a share of Conversion Stock would, except for the provisions of this subparagraph, be deliverable upon any conversion of the Series C 7% Preferred, the Corporation, in lieu of delivering the fractional share therefor, shall pay an amount to the holder thereof equal to the Market Price of such fractional interest as of the date of conversion. (x) The Corporation shall at all times reserve and keep available out of its authorized but unissued shares of Conversion Stock, solely for the purpose of issuance upon the conversion of the Series C 7% Preferred, such number of shares of Conversion Stock issuable upon the conversion of all outstanding Series C 7% Preferred. All shares of Conversion Stock which are so issuable shall, when issued, be duly and validly issued, fully paid and nonassessable and free from all taxes, liens and charges. The Corporation shall take all such actions as may be necessary to assure that all such shares of Conversion Stock may be so issued without violation of any applicable law or governmental regulation or any requirements of any domestic securities exchange upon which shares of Conversion Stock may be listed (except for official notice of issuance which shall be immediately delivered by the Corporation upon each such issuance). (xi) If the shares of Conversion Stock issuable by reason of such conversion of Series C 7% Preferred are convertible into or exchangeable for any other stock or securities of the Corporation, the Corporation shall, at the converting holder's option, upon surrender of the Shares to be converted by such holder as provided above together with any notice, statement or payment required to effect such conversion or exchange of Conversion Stock, deliver to such holder or as otherwise specified by such holder a certificate or certificates representing the stock or securities into which the shares of Conversion Stock issuable by reason of such conversion are so convertible or exchangeable, registered in such name or names and in such denomination or denominations as such holder has specified. 6B. Conversion Price. The Conversion Price shall be $5.50, which price shall be subject to adjustment as set forth in Section 6D. 7 6C. Limitation on Conversion. Notwithstanding any other provisions hereof, no holder of Shares shall be entitled to exercise the conversion rights under this Section to acquire any share or shares of Common Stock if, as a result of such conversion, such holder and its affiliates, directly or indirectly, would own, control or have power to vote a greater quantity of securities of any kind issued by the Corporation than such holder and its affiliates would be permitted to own, control or have power to vote under any law or under any regulation, rules or other requirement of any governmental authority at any time applicable to such holder and its affiliates. For purposes of this paragraph, a written statement of the holder involved, to the effect that such holder is legally entitled to exercise its conversion rights under this Section to acquire shares of Common Stock and that such holder shall not violate the prohibitions set forth in the preceding sentence, shall be sufficient evidence of the legality thereof and shall obligate the Corporation to deliver certificates representing the shares of Common Stock so purchased in accordance with the other provisions hereof. 6D. Anti-Dilution Provisions. (a) If on the trading day immediately preceding the Conversion Date, the Market Price of the Common Stock is less than $5.50 per share (or an equivalent amount for Conversion Stock other than Common Stock), then the Conversion Price for conversions on such Conversion Date shall be adjusted to equal the average of the three lowest closing bid prices of the Conversion Stock (or the closing prices if the Conversion Stock is listed on an exchange) during the 15 trading days immediately preceding the Conversion Date. (b) If, at any time or from time to time after the date hereof, the Corporation shall distribute property or assets to all holders of Common Stock (excluding (x) dividends paid in, or distributions of, the Corporation's capital stock for which the number of Conversion Stock receivable hereunder shall have been adjusted pursuant to Subsection 4(b), and (y) dividends or distributions paid in cash if the Series C 7% Preferred is converted into Conversion Stock prior to the record date therefor) (any of the foregoing being hereinafter in this Subsection 4(a) called the "Property"), then, in each such case, the Corporation shall reserve sufficient Property for distribution upon conversion of Series C 7% Preferred so that, in addition to the Conversion Stock to which a person owning Series C 7% Preferred ("Holder") is entitled, the Holder will receive upon such conversion the amount and kind of such Property which such Holder would have received if the Holder had, immediately prior to the record date for the distribution of the Property, converted the Series C 7% Preferred to the Conversion Stock. Notice of each such distribution shall be given to the Holder concurrently with any notice given to the holders of Common Stock regarding such distribution. (c) In case the Corporation shall hereafter i) pay a dividend or make a distribution on its Common Stock payable in shares of capital stock, ii) subdivide its outstanding shares of Common Stock into a greater number of shares, iii) combine its outstanding shares of Common Stock into a smaller number of shares or iv) issue by reclassification of its Common Stock any shares of capital stock of the Corporation, then, in any such event, the Holder shall be entitled to receive the aggregate number and kind of shares which, if the Holder had converted the Series C 7% Preferred to the Conversion Stock immediately prior to the record date with respect to the dividend or distribution or the effective date of the subdivision, combination or reclassification, he would have been entitled to receive by virtue of such dividend, distribution, subdivision, combination or 8 reclassification, and the Conversion Price shall be appropriately adjusted. Such adjustment shall be made successively whenever any event listed above shall occur. An adjustment made pursuant to this subsection (b) shall become effective immediately after the record date in the case of a dividend or distribution and shall become effective immediately after the effective date in the case of a subdivision, combination or reclassification. If, as a result of an adjustment made pursuant to this subsection (b), the Holder shall become entitled to receive shares of two or more classes of capital stock or shares of Common Stock and other capital stock of the Corporation, then Series C 7% Preferred may thereafter be converted to units consisting of whole number multiples of each such securities, as designated by the Board of Directors. (d) In case of any of the following events (each of which shall be deemed a "Reorganization Event"): (i) any consolidation or merger to which the Corporation is a party, other than a merger or consolidation in which the Corporation is the continuing corporation, (ii) any sale or conveyance to another entity of all or substantially all of the assets of the Corporation (including a sale of all or substantially all of the assets of the Corporation for a consideration consisting primarily of securities) or (iii) any statutory exchange of securities with another corporation (including any exchange effected in connection with a merger of a third party into the Corporation), the Holder shall have the right thereafter to receive upon conversion of the Series C 7% Preferred the kind and amount of securities, cash or other property which he would have owned or have been entitled to receive immediately after such Reorganization Event had such Series C 7% Preferred been converted immediately prior to the effective date of such Reorganization Event and in any such case, if necessary, appropriate adjustment shall be made in the application of the provisions set forth in this Section with respect to the rights and interests thereafter of the Holder to the end that the provisions set forth in this Section shall thereafter correspondingly be made applicable, as nearly as may reasonably be, in relation to any shares of stock or other securities or property thereafter deliverable on the exercise of this Warrant. The foregoing provisions of this Subsection shall similarly apply to successive Reorganization Events. Notice of any Reorganization Event and of said provisions so proposed to be made shall be mailed to the Holder not less than 30 days prior to the effective date of such event. (e) Notwithstanding any other provision of this Section, no adjustment in the Conversion Price shall be required unless such adjustment would require an increase or decrease of at least $0.05 per share of Common Stock and no adjustment in the number of Conversion Stock issuable shall be required if such adjustment would represent less than one percent of the number of Conversion Stock to be so delivered; provided, however, that any adjustments which by reason of this Subsection (d) are not required to be made shall be carried forward and taken into account in any subsequent adjustment, and provided further, however, that adjustments shall be required and made in accordance with the provisions of this Section (other than this Subsection (d)) not later than such time as may be required in order to preserve the tax-free nature of a distribution to the Holder. All calculations under this Section shall be made to the nearest cent or to the nearest 1/100th of a share, as the case may be. Anything in this Section to the contrary notwithstanding, the Corporation shall be entitled to make such reductions in the Conversion Stock, in addition to those required by this Section, as it in its discretion shall deem to be advisable in order that any stock dividend, subdivision of shares, or distribution of rights to purchase stock or securities convertible or exchangeable for stock hereafter made by the Corporation to its shareholders shall not be taxable. 9 (f) Whenever the Conversion Price is adjusted as provided in this Section and upon any modification of the rights of the Holder in accordance with this Section, the Corporation shall promptly prepare a certificate of the Corporation's Chief Financial Officer, setting forth the Conversion Price and the number of Conversion Stock after such adjustment or the effect or such modification, a brief statement of the facts requiring such adjustment or modification and the manner of computing the same and cause a copy of such certificate to be mailed to the Holder. (g) If the Board of Directors of the Corporation shall declare any dividend or other distribution in cash with respect to the Common Stock, other than out of earned surplus, the Corporation shall mail notice thereof to the Holder not less than 15 days prior to the record date fixed for determining shareholders entitled to participate in such dividend or other distribution. (h) The Corporation will, at its sole cost and expense, (subject to the holder bearing the costs of commissions and independent legal review) covenants that if at any time during the period in which the Series C 7% Preferred may be converted the Corporation should file a registration statement or offering statement pursuant to applicable federal and state securities laws for a public offering of securities, (except on Form S-4 or S- 8 or their successor forms) the Corporation will provide written notification to the holder at least 10 days but not more than 60 days prior to the filing date of such registration statement or offering statement and use its best efforts to seek to register or qualify or cause to be registered or qualified, at the option of the holder, the sale and resale of all, or such amounts as the Corporation may legally and lawfully cause to be registered or on a pro-rata basis if limited by the firm or persons underwriting such offering, of the Conversion Stock underlying the Series C 7% Preferred (which are deliverable upon conversion of the Series C 7% Preferred) and the Corporation will use its best efforts to seek to maintain such registration statement or offering statement effective for all periods during which the Series C 7% Preferred may be converted until such time as the Corporation receives an opinion of counsel to the effect that the underlying Conversion Stock may be publicly resold without registration. If no other registration statement is being filed registering the Conversion Stock underlying the Series C 7% Preferred, the Corporation will, at its sole cost and expense, (subject to the holder bearing the costs of commissions and independent legal review) cause a registration statement covering the Conversion Stock underlying the Series C 7% Preferred to be effective within 90 days after closing of the initial issuance of the Series C 7% Preferred. If a holder tenders Series C 7% Preferred for conversion at a time when the Conversion Stock underlying such Shares is not registered for sale, such failure of registration is hereinafter referred to as an "Event", and the date on which such Event occurs is hereinafter referred to as an "Event Date". If an Event has occurred and not been cured, the converting holder shall be entitled to receive from the Corporation on conversion of the Series C 7% Preferred so converted, as sole remedy for the failure to register, (i) on the Event Date, additional Conversion Stock equal to 10% of the Conversion Stock otherwise issuable on conversion of such tendered Shares based on the Conversion Price in effect on the Event Date, and (ii) every thirty calendar days following the Event Date until the Event is cured, additional Conversion Stock equal to 10% of the Conversion Stock otherwise issuable on conversion of such tendered Shares based on the Conversion Price in effect on the Event Date. For purposes of this paragraph, each determination of whether an Event has occurred will be independently determined for each conversion request. 10 Section 7. Registration of Transfer. The Corporation shall keep at its principal office a register for the registration of Series C 7% Preferred. Subject to compliance with applicable securities laws, upon the surrender of any certificate representing Series C 7% Preferred at such place, the Corporation shall, at the request of the record holder of such certificate, execute and deliver (at the holder's expense) a new certificate or certificates in exchange therefor representing in the aggregate the number of Shares represented by the surrendered certificate. Each such new certificate shall be registered in such name and shall represent such number of Shares as is requested by the holder of the surrendered certificate and shall be substantially identical in form to the surrendered certificate, and dividends shall accrue on the Series C 7% Preferred represented by such new certificate from the date to which dividends have been fully paid on such Series C 7% Preferred represented by the surrendered certificate. All transfers of Shares shall be subject to any restrictions imposed by applicable federal and state securities laws. Section 8. Replacement. Upon receipt of evidence reasonably satisfactory to the Corporation (an affidavit of the registered holder shall be satisfactory) of the ownership and the loss, theft, destruction or mutilation of any certificate evidencing Shares of any of the Series C 7% Preferred, and in the case of any such loss, theft or destruction, upon receipt of indemnity reasonably satisfactory to the Corporation, or, in the case of any such mutilation upon surrender of such certificate, the Corporation shall (at the holder's expense) execute and deliver in lieu of such certificate a new certificate of like kind representing the number of Shares of such class represented by such lost, stolen, destroyed or mutilated certificate and dated the date of such lost, stolen, destroyed or mutilated certificate, and dividends shall accrue on the Preferred Stock represented by such new certificate from the date to which dividends have been fully paid on such lost, stolen, destroyed or mutilated certificate. Section 9. Amendment and Waiver. No amendment, modification or waiver shall be binding or effective with respect to any provision of Sections 1 to 10 hereof without the prior written consent of the holders of at least 51% of the Series C 7% Preferred outstanding at the time such action is taken; provided that no such action shall change (a) the rate at which or the manner in which dividends on the Series C 7% Preferred accrue or the times at which such dividends become payable or the amount payable on redemption of the Series C 7% Preferred or the times at which redemption of Series C 7% Preferred is to occur, without the prior written consent of the holders of at least 80% of the Series C 7% Preferred then outstanding, (b) the Conversion Price of the Series C 7% Preferred or the number of shares or class of stock into which the Series C 7% Preferred is convertible, without the prior written consent of at least 80% of the Series C 7% Preferred then outstanding or (c) the percentage required to approve any change described in clauses (a) and (b) above, without the prior written consent of the holders of at least 80% of the Series C 7% Preferred then outstanding. Notwithstanding the above, Corporation, without the consent or approval of the holders, may amend the provisions hereof solely for the purpose of increasing the number of authorized Shares of Series C 7% Preferred. 11 Section 10. Notices. Except as otherwise expressly provided hereunder, all notices referred to herein shall be in writing and shall be delivered by registered or certified mail, return receipt requested and postage prepaid, or by reputable overnight courier service, charges prepaid, and shall be deemed to have been given when so mailed or sent (i) to the Corporation, at its principal executive offices and (ii) to any stockholder, at such holder's address as it appears in the stock records of the Corporation (unless otherwise indicated by any such holder). IN WITNESS WHEREOF, the Corporation has caused its corporate seal to be affixed hereto and this Certificate of Designation to be signed by its Chief Executive Officer and attested by its Secretary this 22d day of January, 1999. - ------------------------------------ Brent M. Cook President and Chief Executive Officer Covol Technologies, Inc. ATTEST: - ------------------------------------ Secretary 12 EX-10.56 3 BRENT M. COOK EMPLOYMENT AGREEMENT EMPLOYMENT AGREEMENT By and Between COVOL TECHNOLOGIES, INC. And BRENT M. COOK Dated as of April 21, 1998 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT ("this Agreement") is made and entered into as of the 21st day of April, 1998 (the "Effective Date") by and between COVOL TECHNOLOGIES, INC. a Delaware Corporation (the "Company"), and Brent M. Cook ("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: A. Employee is a certified public accountant and immediately prior to Effective date, was employed by Covol Technologies, Inc., as Executive Vice President and Chief Financial Officer. 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 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 employs Employee and Employee accepts employment by the Company as Chief Executive Officer and President of the Company for the Period of Employment specified in Paragraph 3 ("Period of Employment"). 2. Services to be Rendered. The Employee shall, during the Period of Employment, serve the Company in the positions set forth in Paragraph 1 ("Employment and Positions") diligently, competently, and in conformance with the corporate policies of the Company. Employee shall be free to conduct personal business and investment activities that do not conflict or interfere with the performance of his duties under this Agreement. 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 Board of Directors and shareholders of the Company. 3. Period of Employment. Employee's employment by the Company pursuant to this Agreement shall, unless sooner terminated, begin as of the 21st day of April, 1998 (the "Effective Date") and continue for a period of five (5) years from the Effective Date ("Period of Employment"). 4. Base Salary. At the commencement of the Period of Employment, Employee shall be paid a yearly base salary of an amount determined by the Board of Directors consistent with an annual compensation review of comparable positions of public companies. Base salary shall be paid in semi monthly installments during the Period of Employment. 5. Incentive Bonus. The Board of Directors and Management will determine any incentive bonus guidelines 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 bonus plans are dependent upon the Corporation income performance and general performance evaluations. 6. Expense Reimbursement. The Employee shall be entitled to prompt reimbursement for reasonable expense 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 shall grant to the Employee, in accordance with the terms and the Stock Option Agreement attached hereto as Exhibit A, the right and option to purchase shares of the Company's Common Stock. (a) Stock Options Pursuant to Stock Option Plan. The Stock Option ("Stock Option") shall be issued pursuant and subject to the provisions of the Company Employee Stock Option Plan (the "Stock Option Plan"). (b) Purchase Price. The purchase price per share for the shares subject to the Stock Option will be $12 31/32 per share. (c) Number of Shares. The Stock Options will be for 250,000 shares of the Company's Common Stock (the "Optioned Shares"). (d) Exercise Periods. The Optioned Shares will vest and be exercisable on the beginning of each month on a pro rata basis during the next five (5) years. Once vested, the Optioned Shares may be exercised in whole or in part at any time, subject to the limitations within which the exercise of the Options must occur. The Optioned Shares must be exercised in their entirety prior to April 21, 2008, also known as the expiration date. (e) Vesting of Options in Event of Full and Complete Disability or Death. In the event of 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. (f) Vesting of Options in Event of Ownership Change. In the event a third party purchases a controlling interest of the total 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 immediately prior to such stock or asset purchase. The intent of this section is to allow the Employee to vote the shares represented by the Stock Options and the Employee's discretion exercise any unexecuted options. (g) Additional Stock Options. Employee shall also be eligible to receive additional stock options during he Period of Employment pursuant to a stock options bonus plan as may from time to time be in effect. 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 six (6) weeks of paid vacation during each calendar year occurring during the Period of Employment. The vacation may be carried over from year to year. At the end of the term of this Agreement, the Employee shall be entitled to be paid for the pro rated portion of the accrued salary attributable to unused vacation. (b) 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 employee's of the Company for their insurance coverage. (c) 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 at date of hire or as 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 us of his personal automobile in the amount of $550.00 per month during the Employment Period. (f) Dental Expense. The Company will provide the Employee with an annual dental allowance of $4,500 or provide comparable coverage. (g) 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, publications which relate to job duties and responsibilities. 9. Terms of Employment (a) Term. The Company hereby agrees to continue the Employee in its employ, an 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 on the fifth anniversary of the Effective Date of this Agreement, upon thirty (30) days prior written notice from the Company to the Employee. If such written notice of termination is not given, then the Employee's employment under this Agreement shall continue under the terms of this Agreement, until the Employee is terminated by the Company upon thirty (30) days prior written notice. (b) During the Period of Employment. (i) The Employee's position, authority, duties and responsibilities shall be commensurate in all material respects with those held, exercised and assigned at any time during the ninety (90) day period immediately preceding the Effective Date or at any office which is the headquarters of the Company. (ii) 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, "Cause" 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 or refused to follow reasonable written policies or directives established by the Board of Directors of the Company, or 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 thirty (30) days following delivery of a written demand from the Company's Board of Directors for policies or directives or to perform such duties. (iii) Termination pursuant to this Paragraph 9 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. (iv) Death. If the Employee dies during the term of this Agreement, his personal representative or designated survivor shall be entitled to receive all the salary and benefits provided hereunder for the remaining term of this Agreement. (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 "Good Reason" exist and the Company has failed to cure such situation within thirty (30) days after effective date of such notice. For purposes of the Agreement, "Good 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 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 ("Base 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; or (5) upon the consummation of a sale of all or substantially all of the assets of the Company not in the usual or regular course of the business of the Company in which sale the acquiring company did not assume all of the obligations of the Company under this Agreement. 11. Confidential Information. The Employee shall hold in a fiduciary 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 have 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 ideas, concepts, inventions, discoveries, formulas, and designs 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 patentable or unpatentable (collectively, "Inventions" 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. (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. If the Employee does not continue in the employ of the Company after the termination of this Agreement, whether or not the Employee is offered continued employment by the Company, Company shall pay to Employee, no later than two months after termination, the sum of one year's annual base wages. 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. 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 Employees acts as an employee of the Company. 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: 3280 North Frontage Road Lehi, Utah Attention: President and CEO (b) If to Employee: Brent M. Cook 5733 West 10040 North Highland, UT 84003 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. IN WITNESS WHEREOF, the parties have executed this Agreement in duplicate as of the date written above. COVOL TECHNOLOGIES, INC.: EMPLOYEE: By: Raymong J. Weller Brent M. Cook ------------------------- ---------------------- Title: Chairman of the Board EX-10.57 4 STEVEN R. BROWN EMPLOYMENT AGREEMENT EMPLOYMENT AGREEMENT By and Between COVOL TECHNOLOGIES, INC. And Steven R. Brown Effective as of January 1, 1999 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT (this Agreement") is effective as of the first day of January, 1999 (the "Effective Date") by and between COVOL TECHNOLOGIES, INC. a Delaware Corporation (the "Company"), and Steven R. Brown ("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: A. Employee is Senior Vice President of Engineering and Development and immediately prior to Effective Date, was employed by the Company as a Vice President. 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 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. The Company employs Employee and Employee accepts employment by the Company as an officer of the Company with the title of "Senior Vice President of Engineering and Development" for the Period of Employment specified in Paragraph 3 ("Period 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 and provided further that compensation for services are not reduced due 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 ("Employment 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 of the Company. 2 3. Period of Employment. Employee's employment by the Company pursuant to this Agreement shall, unless sooner terminated, begin as of the Effective Date and continue for a period of three (3) years from the Effective Date ("Period of Employment"). 4. Base Salary. At the commencement of the Period of Employment, Employee shall be paid a base salary of $100,000 for the first year, $130,000 for the second year, and $135,000 for the third year, during the Period of Employment. Base salary shall be paid in equal semi monthly installments during the Period of Employment. 5. Incentive Bonus. During the Period of Employment, the 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 ("Stock Option") issued shall be issued pursuant and subject to the provisions of the Company Employee Stock Option Plan (the "Stock 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 the full and complete disability or the 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. (c) Vesting of Options in Event of Ownership Change. In the event of a 3 change in control, all non-vested Stock Options shall vest immediately prior to such change in control. 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, contested election, or any combination of the foregoing transactions, the persons 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 unexecuted options at the Employees discretion. 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 (4) weeks of paid vacation during each calendar year occurring during the Period of Employment. Any 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, proportionate to the amount of time employed 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 terminated for all participants 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 employees of the Company for their insurance coverage. (d) Retirement Plan. The Employee shall participate in the Company's Retirement Plans in accordance with the terms and provisions and 4 applicable laws 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 $550.00 per month during the Employment Period. (f) Disability Insurance. The Company shall reimburse the Employee for disability insurance that is currently being paid by the Employee until such time that the Company implements a disability insurance program for which the employee would be covered. (g) 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. Employee shall obtain authorization for payment or purchases referred to in (i) and (ii) above from the chief financial officer 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 on the third anniversary of the Effective Date of this Agreement, upon thirty (30) days prior written notice from the Company to the Employee. If such written notice of termination is not given, then the Employee's employment under this Agreement shall continue under the terms of this Agreement, until the Employee is terminated by the Company upon thirty (30) days prior written notice. (b) During the Period of Employment. The Employee's services shall be performed at the location where the Employee was employed immediately 5 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, "Cause" 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; or (2) there has been a theft, embezzlement, or other criminal misappropriation of funds by Employee, whether from Company or any other person; or (3) Employee has willfully failed or 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 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 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. 6 (iii) Termination pursuant to this Paragraph 10 shall be effective as of the effective date of the notice by the Board of Directors or Chief Executive Officer 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 "Good Reason" exists and the Company has failed to cure such situation within thirty (30) days after effective date of such notice. For purposes of the Agreement, "Good 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 ("Base 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; or (5) upon a change of control as defined in Paragraph 6(c) above. 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 7 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 ideas, writings, 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 (collectively, "Inventions" 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. (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 8 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)(ii) above, if the Employee does not continue in the employ of the Company after the termination of this Agreement, whether or not the Employee is offered continued employment by the Company, Company shall pay to Employee, no later than thirty (30) days, the sum of one year's annual base wages. 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 employee of the Company. 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: 3280 North Frontage Road Lehi, Utah 84043 Attention: President and CEO (b) If to Employee: Steven R. Brown 1681 North 400 East Orem, Utah 84097 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. 9 Effective the first day of January, 1999. Covol Technologies, Inc.: Employee - -------------------- ------------------- By: Steven R. Brown Title: Date: Date: 10 EX-27 5 FDS --
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE THREE MONTHS ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS SEP-30-1999 DEC-31-1998 675 0 4,228 0 1,805 37,159 16,456 1,480 70,041 31,611 14,042 0 1 12 22,470 70,041 674 1,155 3,896 3,896 315 0 1,036 (4,737) 0 (4,737) 0 0 0 (4,737) (0.40) (0.40)
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