-----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, O+FF3WJkkLUr/pjGWQMboCbwQxzFCKWb47rialGP7mW10sqo4im19Zr6jHTtKf9x 5Cc0hV8bDTJBS4IU3mjucA== 0001038838-99-000127.txt : 19990517 0001038838-99-000127.hdr.sgml : 19990517 ACCESSION NUMBER: 0001038838-99-000127 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990514 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: 99624559 BUSINESS ADDRESS: STREET 1: 3280 N FRONTAGE RD CITY: LEHI STATE: UT ZIP: 84043 BUSINESS PHONE: 8017684481 10-Q 1 SECOND QUARTER 1999 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 March 31, 1999 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 May 14, 1999 was 12,471,985. 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 March 31, 1999........................................... 3 Consolidated Statements of Operations - For the three months ended March 31, 1998 and 1999 and the six months ended March 31, 1998 and 1999................................ 5 Consolidated Statement of Changes in Stockholders' Equity - For the six months ended March 31, 1999...................... 6 Consolidated Statements of Cash Flows - For the six months ended March 31, 1998 and 1999................................ 7 Notes to Consolidated Financial Statements..................... 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS...................................... 19 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS................................................ 25 ITEM 2. CHANGES IN SECURITIES............................................ 25 ITEM 3. DEFAULTS UPON SENIOR SECURITIES.................................. 26 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............. 26 ITEM 5. OTHER INFORMATION................................................ 26 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................. 27 SIGNATURES.................................................................. 28 Certain statements 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 current expectations. For a discussion of certain of the factors that could cause actual results to differ from expectations, please see the information set forth under the caption entitled "Forward Looking Statements" in ITEM 2 hereof. There can be no assurance that Covol's results of operations will not be adversely affected by such factors. Covol 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) September 30, March 31, (thousands of dollars) 1998 1999 - ------------------------------------------------------------------------------------------- ---------------- ----------------- ASSETS Current assets: Cash and cash equivalents $ 727 $6,879 Receivables 2,879 2,707 Due from related party 1,012 1,706 Inventories 1,645 2,039 Advances on inventories, current 2,522 473 Notes receivable - related parties, current 229 239 Facilities held for sale 28,405 28,389 Prepaid expenses and other current assets 682 664 ---------------- ----------------- Total current assets 38,101 43,096 ---------------- ----------------- Property, plant and equipment, net of accumulated depreciation 14,902 14,499 ---------------- ----------------- Other assets: Restricted investments 748 698 Advances on inventories, non-current -- 2,825 Notes and accrued interest receivable, non-current 7,646 7,859 Notes receivable - related parties, non-current 2,869 2,746 Intangible assets, net of accumulated amortization 3,118 3,976 Deposits and other assets 525 1,678 ---------------- ----------------- Total other assets 14,906 19,782 ---------------- ----------------- Total assets $67,909 $77,377 ================ =================
(continued) The accompanying notes are an integral part of the consolidated financial statements 3
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS, continued (Unaudited) September 30, March 31, (thousands of dollars and shares) 1998 1999 - -------------------------------------------------------------------------------------------- --------------- ---------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $3,036 $2,616 Due to related party 1,609 2,029 Accrued liabilities 2,858 2,544 Notes payable, current 22,049 16,689 --------------- ---------------- Total current liabilities 29,552 23,878 --------------- ---------------- Long-term liabilities: Notes payable, non-current 13,930 25,612 Accrued interest payable, non-current 566 206 Notes and accrued interest payable - related parties, non-current 147 69 Deferred revenues from advance license fees 1,400 1,400 Deferred compensation 236 202 --------------- ---------------- Total long-term liabilities 16,279 27,489 --------------- ---------------- Total liabilities 45,831 51,367 --------------- ---------------- Minority interest in consolidated subsidiaries 507 109 --------------- ---------------- Commitments and contingencies (Note 8) Redeemable convertible preferred stock, $.001 par value, issued and outstanding 0 shares at September 30, 1998 and 60 shares at March 31, 1999 (aggregate liquidation preference of $6,016 at March 31, 1999) (Note 6) -- 4,354 --------------- ---------------- Stockholders' equity: Convertible preferred stock, $0.001 par value; authorized 10,000 shares, issued and outstanding 316 shares at September 30, 1998 and 31 shares at March 31, 1999 (aggregate liquidation preference of $4,514 at March 31, 1999) 1 1 Common stock, $0.001 par value; authorized 25,000 shares, issued and outstanding 11,272 shares at September 30, 1998 and 12,472 shares at March 31, 1999 11 12 Capital in excess of par value 69,284 77,763 Accumulated deficit (36,177) (45,755) Notes and interest receivable - related parties, from issuance of, or collateralized by, common stock, net of allowance (7,773) (7,024) Deferred compensation from stock options (3,775) (3,450) --------------- ---------------- Total stockholders' equity 21,571 21,547 --------------- ---------------- Total liabilities and stockholders' equity $67,909 $77,377 =============== ================
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 March 31, Six Months Ended March 31, (thousands of dollars, except per-share amounts) 1998 1999 1998 1999 - -------------------------------------------------------------- ---------------- ---------------- ---------------- --------------- Revenues: License fees $3,586 $ 320 $4,586 $ 794 Binder sales -- 423 -- 956 Binder and coal fine sales - related party 1,989 42 1,996 183 Other 36 132 70 139 ---------------- ---------------- ---------------- --------------- Total revenues 5,611 917 6,652 2,072 ---------------- ---------------- ---------------- --------------- Operating costs and expenses: Cost of coal briquetting operations 670 2,380 1,119 5,875 Cost of binder -- 274 -- 650 Cost of binder and coal fines - related party 1,964 10 1,972 35 Selling, general and administrative 1,150 1,233 1,891 2,162 Research and development 72 190 228 343 Compensation expense from stock options, stock warrants and issuance of common stock 239 163 446 325 ---------------- ---------------- ---------------- --------------- Total operating costs and expenses 4,095 4,250 5,656 9,390 ---------------- ---------------- ---------------- --------------- Operating income (loss) 1,516 (3,333) 996 (7,318) ---------------- ---------------- ---------------- --------------- Other income (expense): Interest income 181 306 303 1,137 Interest expense (1,180) (1,377) (2,292) (2,413) Minority interest in net losses of consolidated subsidiaries 52 -- 138 -- Write-up (write-down) of notes receivable - related parties, collateralized by common stock 270 (178) 563 (749) Other 93 (100) 107 (76) ---------------- ---------------- ---------------- --------------- Total other income (expense) (584) (1,349) (1,181) (2,101) ---------------- ---------------- ---------------- --------------- Net income (loss) $ 932 $(4,682) $ (185) $(9,419) ================ ================ ================ =============== Basic income (loss) per common share $.09 $(.38) $(.03) $(.78) ================ ================ ================ =============== Diluted income (loss) per common share $.07 $(.38) $(.03) $(.78) ================ ================ ================ ===============
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 For the Six Months Ended March 31, 1999 (Unaudited) Notes and interest receivable -related parties, from Convertible Preferred Common Stock issuance of, Stock or Deferred -------------------------------------------- Capital in collateralized compensation (thousands of excess of par Accumulated by, common from stock dollars and shares) Shares Amount Shares Amount value deficit stock options - --------------------- ------- -------- --------- --------- ------------- ------------ ------------- ------------- Balances at September 30, 1998 316 $1 11,272 $11 $69,284 $(36,177) $(7,773) $(3,775) Common stock issued to purchase minority interests in 70 -- 519 subsidiaries Common stock issued for cash, including exercise of stock options 776 1 3,774 Value of common stock warrants issued under terms of existing debt agreement -- -- 247 Common stock issued for rights to technology 60 -- 375 Common stock issued on conversion of preferred stock and in payment of accrued but undeclared dividends (286) -- 308 -- 159 (159) Return of previously issued common stock by a director (14) -- -- Value of common stock options issued in connection with debt -- -- 175 financing Preferred stock issued for cash, net of offering costs 1 -- 899 Value of common stock warrants issued in connection with redeemable convertible preferred stock and convertible debt 2,331 Write-down of notes receivable - related parties 749 Amortization of deferred compensation from stock options 325 Net loss for the six months ended March 31, 1999 (9,419) ---------------------------------------------------------------------------------------------------------- Balances at March 31, 1999 31 $1 12,472 $12 $77,763 $(45,755) $(7,024) $(3,450) ==========================================================================================================
The accompanying notes are an integral part of the consolidated financial statements 6
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Six Months Ended March 31, (thousands of dollars) 1998 1999 - ------------------------------------------------------------------------------------------------- ----------------- ------------- Cash flows from operating activities: Net loss $(185) $(9,419) Adjustments to reconcile net loss to net cash from operating activities: Depreciation and amortization 178 901 Write-down (write-up) of notes receivable - related parties (563) 749 Interest expense related to amortization of debt discount and debt issuance costs 2,266 326 Amortization of deferred compensation from stock options 446 325 Minority interest in net losses of consolidated subsidiaries (138) -- Loss (gain) on disposition of equipment (78) 103 Decrease from changes in assets and liabilities, net of effects from investing and financing activities (1,918) (2,688) ----------------- ------------- Net cash provided by (used in) operating activities 8 (9,703) ----------------- ------------- Cash flows from investing activities: Purchase of property, plant and equipment and facilities held for sale (21,916) (323) Proceeds from sale of equipment -- 170 Purchase of rights to technology -- (128) Issuance of notes receivable (1,257) -- Proceeds from notes receivable - related parties 119 112 Advances on binder facility 791 -- Decrease in restricted investment -- 50 ----------------- ------------- Net cash used in investing activities (22,263) (119) ----------------- ------------- Cash flows from financing activities: Proceeds from issuance of notes payable and warrants 16,338 10,498 Payments on notes payable -- (4,602) Payments on notes payable - related parties (342) (90) Proceeds from issuance of preferred stock and warrants, net 90 6,394 Proceeds from issuance of common stock, net 1,072 3,774 Proceeds from receivable - stock subscriptions 577 -- Proceeds from notes receivable - related parties, collateralized by common stock 302 -- Other (3) -- ----------------- ------------- Net cash provided by financing activities 18,034 15,974 ----------------- ------------- Net increase (decrease) in cash and cash equivalents (4,221) 6,152 Total cash and cash equivalents, beginning of period 4,780 727 ----------------- ------------- Total cash and cash equivalents, end of period $ 559 $ 6,879 ================= ============= 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 undeclared dividends -- 2,159 Common stock issued for rights to technology -- 375 Notes payable issued for rights to technology -- 427 Notes payable issued for equipment 1,153 213 Common stock issued on conversion of notes payable and related accrued interest 7,000 -- Common stock issued for notes receivable - related parties 45 -- Notes receivable issued for sale of synthetic fuel facility 6,500 -- Preferred stock dividends not accrued or paid 155 126
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 Technologies, Inc. and Subsidiaries ("Covol") primary business is to commercialize its binder technologies which are 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 March 31, 1999, Covol and its licensees were operating 28 facilities in ten states at various levels of production, including four facilities which are using a technology that Covol acquired during the six months ended March 31, 1999. 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. Funds received by Covol from these activities are not expected to be sufficient to cover Covol's operating costs and expenses until late 1999. Any extended delay in the sale of facilities held for sale may require Covol to seek additional debt or equity financing. To provide funding for Covol's operations and debt repayment requirements until late 1999, Covol expects to utilize existing working capital 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. During March 1999, Covol issued convertible secured debt, convertible redeemable preferred stock and common stock warrants for total net proceeds of approximately $14,800,000. Covol believes current working capital, excess proceeds from the sale of facilities, payments for license fees and binder sales, and funds raised in additional financings, if necessary, will be sufficient to fund Covol's operations until its operating activities begin producing positive cash flow. The ability of Covol to repay its debt as it matures is dependent primarily upon Covol's ability to sell the facilities which are held for sale. Covol believes the sale of facilities or extensions of existing debt repayment terms will enable it to meet these debt requirements. 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 and in Covol's Quarterly Report on Form 10-Q for the quarter ended December 31, 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 and any differences could be material. Certain prior period amounts have been reclassified to conform to the March 31, 1999 presentation. 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 March 31, 1999 has made payments totaling approximately $3,520,000, of which $222,000 has been transferred to cost of coal briquetting operations. The net amount paid has been recorded as advances on inventories. Covol expects to either utilize or sell these coal fines, 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 and six months ended March 31, 1999, Covol increased the allowance on the $5,000,000 face value note receivable from a stockholder by approximately $178,000 and $749,000, respectively, resulting in an adjusted carrying value of $860,000 as of March 31, 1999. During the three and six months ended March 31, 1998, Covol decreased the allowance by approximately $270,000 and $563,000, respectively. 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 personally guaranteed by the buyer of certain construction companies sold by Covol to him in 1996, and is collateralized by 150,000 shares of Covol's common stock held by Covol, and also by options expiring in January 2006 to acquire 25,000 shares of Covol's common stock at $1.50 per share. The allowance is subject to future fluctuations in the value of Covol's common stock. During the three months ended March 31 1999, Covol received interest payments totaling $225,000 from the Note holder. 4. Notes Payable
Notes payable consist of the following: September 30, March 31, 1999 (thousands of dollars) 1998 -------------------------------------------------------------------------------------------- ----------------- --------------- Note payable to a corporation, bearing interest at 15%, collateralized by a synthetic fuel facility in Pennsylvania, held for sale, with all unpaid principal and interest 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 prime (7.75% at March 31, 1999) 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 January 2000, collateralized by a coal wash plant in Utah. 4,263 4,288
9 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (Unaudited) ----------
4. Notes Payable, continued September 30, March 31, 1999 (thousands of dollars) 1998 -------------------------------------------------------------------------------------------- ----------------- --------------- Notes payable to the same corporation referred to in the preceding paragraphs, bearing interest at 6%. 50% of accrued interest due February 2000 with remaining accrued interest and principal due February 2001. Collateralized by a synthetic fuel facility in West Virginia, held for sale. $6,680 $6,500 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. 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 in June 2000. Alternatively, if Covol sells the facility before the loan repayment date, Covol must repay the loan from sale proceeds. 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 9,191 Convertible secured note payable to an investment company issued at a discount, bearing a stated interest rate of 2.5% on the $20,000 face amount. The note is due March 2004 if not earlier redeemed or converted into common stock. Interest is payable semiannually on January 1 and July 1, beginning July 1, 1999. The note is collateralized by license fees payable to Covol from the production and sale of synthetic fuel from four synthetic fuel facilities located in Virginia and West Virginia. See Note 6. -- 8,921 Note payable to a corporation originally 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 originally had an exercise price of $7.44 per share, expired in October 2000 and were valued at approximately $247. The terms of this note were amended in May 1999 to provide that $1,000 of principal is due in December 1999 and $3,000 of principal is due in April 2000. Accordingly, $3,000 has been classified as long-term in the balance sheet. Interest is payable at a rate of 22% through the original due date of June 12, 1999. Thereafter interest is payable monthly at a rate of 14%. The terms of existing warrants for the purchase of 185,713 shares of common stock were amended to extend the exercise periods for one year and to lower the exercise prices to market value of Covol's common stock. A member of Covol's Board of Directors is affiliated with this corporation. 4,000 4,000
10 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (Unaudited) ----------
4. Notes Payable, continued September 30, March 31, 1999 (thousands of dollars) 1998 -------------------------------------------------------------------------------------------- ----------------- --------------- Note payable to the same corporation referred to in the preceding paragraph, bearing interest at 14%. Principal and accrued interest were paid in March 1999. $ 4,000 $ -- Other 94 701 ----------------- --------------- 35,979 42,301 Less: current portion 22,049 16,689 ================= =============== Total non-current $13,930 $25,612 ================= ===============
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 16.8% at March 31, 1999. Interest Costs During the six months ended March 31, 1999, Covol incurred total interest cost of approximately $2,413,000 (including approximately $326,000 of amortization of debt discount and debt issuance costs, none of which was capitalized. During the six months ended March 31, 1998, Covol incurred total interest cost of approximately $2,983,000 (including approximately $2,266,000 of non-cash interest expense resulting from issuance of convertible debt and warrants at a discount), of which approximately $691,000 was capitalized. 5. Basic and Diluted Loss per Share
Three Months Ended March 31, Six Months Ended March 31, (thousands of dollars and shares, except per-share data) 1998 1999 1998 1999 ---------------------------------------------------------- -------------- --------------- ---------------- --------------- Numerator: Net income (loss) $932 $(4,682) $(185) $(9,419) Preferred stock dividends (undeclared) (85) (77) (85) (137) Imputed preferred stock dividends -- (40) -- (40) -------------- --------------- ---------------- --------------- Net income (loss) attributable to common stockholders $847 $(4,799) $(270) $(9,596) ============== =============== ================ =============== Denominator: Denominator for basic income (loss) per share - weighted-average shares outstanding 9,574 12,472 9,382 12,224 -------------- --------------- ---------------- --------------- Effect of dilutive securities: Common stock options 1,216 Common stock warrants 500 Convertible preferred stock 741 -------------- --------------- ---------------- --------------- Dilutive potential common shares 2,457 -- -- -- -------------- --------------- ---------------- --------------- Denominator for diluted income (loss) per share - adjusted weighted-average shares and assumed conversions $12,031 $12,472 $9,382 $12,224 ============== =============== ================ =============== Basic income (loss) per common share $.09 $(.38) $(.03) $(.78) ============== =============== ================ =============== Diluted income (loss) per common share $.07 $(.38) $(.03) $(.78) ============== =============== ================ ===============
11 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (Unaudited) ---------- 6. Financing Transaction On March 17, 1999, Covol completed a financing transaction (the "Financing") with OZ Master Fund, Ltd., an affiliate of the Och-Ziff Capital Management Group. The Financing consisted of the issuance of $20,000,000 face value of convertible secured debt, issued at a 50% discount, and the issuance of $6,000,000 of cumulative convertible preferred stock, for total gross proceeds of $16,000,000. Costs related to the Financing totaled approximately $1,200,000, and consisted of private placement fees of $800,000, legal expenses of approximately $350,000 and other expenses of approximately $50,000. Warrants for the purchase of common stock were also issued as part of the Financing. Covol received net cash proceeds of approximately $14,800,000, which are being used to retire maturing short-term debt and related accrued interest of approximately $4,900,000, for working capital uses and other general corporate purposes. So long as any debt or preferred stock issued in connection with this Financing is outstanding, the holders have the right, as a group, to elect one director to Covol's Board of Directors. Convertible Secured Note Payable The convertible secured debt has a five-year term and bears interest at a stated rate of 2.5% per annum on the $20,000,000 face amount, with interest payable semiannually on January 1 and July 1, beginning July 1, 1999. After consideration of the 50% discount and the value assigned to warrants, the imputed interest rate is approximately 38%. The debt is redeemable by Covol at any time prior to September 17, 2001 for an amount equal to the face amount of the debt. The debt is redeemable by Covol from September 18, 2001 and prior to March 17, 2002 for an amount equal to 109.85% of the face amount of the debt. The debt is convertible into common stock of Covol at the option of the noteholder at a discount to the market price at the time of conversion as described below. The debt is not convertible by the holder until after March 17, 2002 except upon the occurrence of an event of default. If converted, the number of shares into which the debt can be converted would be calculated based on a price per share of common stock equal to 33% of the then market price at the time of conversion, but not less than $6.67 per share nor more than $10.00 per share. Covol's present intent is to redeem the debt prior to March 17, 2002, assuming sufficient cash from operations or future equity or debt financing is available. A deferred asset was recorded for the portion of financing costs allocated to the debt. This asset is being amortized over 30 months, the most likely period of time over which the debt is expected to remain outstanding. Amortization is computed using the straight-line method. Paid-in capital was credited for the relative value of the warrants directly related to the issuance of debt and the warrants allocated to the issuance of debt, as compared to the total combined fair values of the warrants and debt. A liability was recorded for $20,000,000, the face value of the debt. Debt discount was recorded so as to yield a level interest rate on the net amount of debt outstanding between the issue date and 30 months from the issue date. Each period, interest expense is recorded consisting of the total of 1) interest expense based on the stated interest rate and the face value of the debt; 2) amortization of debt discount; and 3) amortization of debt issue costs. Covol will be in default of the provisions of the debt agreement if certain events occur. These events include, in addition to events commonly considered defaults, incurring one or more judgments in excess of $5,000,000, which judgments are not discharged, stayed or otherwise satisfied within 30 days of the judgments, and the failure to meet certain earnings targets. The earnings targets apply initially to the quarter ending December 31, 1999, and then to subsequent quarterly periods. Consolidated earnings of $5,000,000 or more before interest, taxes, depreciation, and amortization, and certain other adjustments as defined in the applicable agreement, are required for the quarter ending December 31, 1999. In subsequent quarters, earnings targets increase incrementally up to $6,500,000 for the quarter ending December 31, 2001 and subsequent quarters. There are provisions for the carryover of earnings which exceed the targets to subsequent quarters, if necessary, subject to certain limitations. The debt is collateralized by license fees payable to Covol from the production and sale of synthetic fuel from 12 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (Unaudited) ---------- 6. Financing Transaction, continued Convertible Secured Note Payable, continued four synthetic fuel facilities located in Virginia and West Virginia. The owner of these facilities has entered into licensing agreements to use Covol's technologies in return for a royalty based on the production and sale of synthetic fuel, subject to prescribed adjustments. In the event of default, the interest rate on the debt increases immediately by 1% and increases automatically by 1% at the end of each succeeding 90-day period, to the extent permitted by law, until the event is cured. Depending on the nature of the event of default, in most instances, either 1) all unpaid principal and interest become immediately due and payable; or 2) the note and accrued interest become immediately convertible into common stock and the conversion price is subject to adjustment, based on the market price of Covol's common stock and other factors, as provided for in the loan agreement. Redeemable Cumulative Convertible Preferred Stock The preferred stock consists of 60,000 shares of a new series of preferred stock, Series D Cumulative Convertible Preferred Stock, with a liquidation value of $100 per share. This series of preferred stock is senior, with respect to dividend rights, payments upon liquidation, or redemption, to all other capital stock of Covol, including the other series of preferred stock which are outstanding or which may be issued in the future. Dividends accrue at a rate of 7% per annum whether or not declared or paid. At Covol's option, dividends can be paid in additional shares of preferred stock in lieu of cash. Dividends are payable quarterly beginning July 1, 1999. Holders of the preferred stock have voting rights as to all matters voted on by the holders of common stock and are entitled to one vote for each share of common stock issuable upon conversion of the preferred stock. In addition, holders of the preferred stock and debt vote as a group for one director. The preferred stock is redeemable at Covol's option through March 17, 2002 at 125% of its liquidation value, subject to adjustment for changes in the value of Covol's common stock. The preferred stock is redeemable at the option of the preferred stockholder only upon occurrence of a change in control. The preferred stock is convertible at the option of the stockholders beginning June 15, 1999, up to a maximum of 20% of the outstanding shares of preferred stock. Each month thereafter, the amount of preferred stock that can be converted increases by 20% until October 13, 1999, at which time all of the preferred stock can be converted into common stock. On March 17, 2002, all outstanding preferred stock automatically converts to common stock. The number of shares of common stock into which the preferred stock is convertible is determined by multiplying the number of preferred shares by $100 and dividing by the lesser of $5.25 or 90% of the market value of Covol's common stock on the date of conversion. The portion of financing costs allocated to the preferred stock were netted against proceeds. Paid-in capital was credited for the relative value of the warrants directly related to the issuance of preferred stock and the warrants allocated to the issuance of preferred stock, as compared to the total combined fair values of the warrants and preferred stock. Because the preferred stock can be redeemed by the preferred stock holders (only upon the occurrence of a change in control), it has been classified outside the equity section in the balance sheet. Because the conversion price of the preferred stock was less than the fair market value of Covol's common stock on the date of issuance, an imputed dividend will affect the earnings per share calculation as it is amortized over the period from issue date to date of first conversion. 13 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (Unaudited) ---------- 6. Financing Transaction, continued Warrants Warrants for the purchase of a total of approximately 1,300,000 shares of common stock were issued in connection with the Financing. The number of shares issuable upon exercise of the warrants is subject to certain antidilution provisions including but not limited to the issuance of common stock at prices below the market price of Covol's common stock. Warrants to purchase 400,000 shares of common stock are initially exercisable at prices of $5.00 per share for 200,000 shares and $10.00 per share for 200,000 shares, for the period of time beginning on March 17, 2002 through March 17, 2004, subject to adjustment upon the occurrence of certain events. Warrants to purchase 883,626 shares of common stock are initially exercisable at prices ranging from $5.25 to $6.56 per share for the period of time beginning on September 13, 1999 through March 17, 2002, subject to adjustment upon the occurrence of certain events. The warrants issued in this transaction were valued at approximately $3,000,000 using the Black-Scholes option valuation model. Some warrants were issued in connection with the convertible debt, some were issued in connection with the convertible preferred stock and some were issued in connection with both the debt and equity securities. The value of the warrants issued in connection with both the debt and equity securities was allocated between debt and preferred stock on a pro-rata basis, based on the debt and equity portions of the total financing. Registration Rights The restricted common stock issuable pursuant to the conversion of the convertible secured debt and related interest, convertible preferred stock, preferred stock dividends, and exercise of approximately 971,000 warrant shares have been provided demand and piggyback registration rights. The remaining warrants have been provided piggyback registration rights. Other Significant Obligations or Restrictions Terms of the agreements entered into by Covol in connection with the Financing provide for limits and restrictions common to such financing arrangements, as well as certain additional specific limitations or restrictions. 7. Equity Transactions Technology Acquisition Effective in November 1998, Covol acquired a coal-based synthetic fuel technology, and related licensing and patent rights for $128,000 in cash, 60,000 shares of restricted common stock valued at $375,000 and a commitment to make installment payments ranging from $5,000 to $12,500 per month for 60 months with interest imputed at 15%. 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. The total cost of approximately $930,000 is being amortized on a straight-line basis over approximately nine years. 14 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (Unaudited) ---------- 7. Equity Transactions, continued Sale of Series C Convertible Preferred Stock During January 1999, Covol completed a financing transaction with a previous 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. The new and extended warrants were valued at approximately $500,000. Issuance costs were netted against proceeds and paid-in capital was credited for the relative value of the warrants, as compared to the total combined fair values of the warrants and preferred stock. Stock Options During the six months ended March 31, 1999, Covol granted options for the purchase of a total of 382,000 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. Covol also 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. These options were assigned a value of approximately $175,000 which is being amortized over the life of the related financing. 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. 15 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (Unaudited) ---------- 8. Commitments and Contingencies Commitments and contingencies as of March 31, 1999 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 March 31, 1999, there were $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 March 31, 1999 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 called 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 had under these indemnification agreements would have been $2,250,000. The contractor and the contracting party initiated claims in arbitration against each other but have settled their claims, including a release of claims against Covol for liquidated damages. 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 synthetic fuel produced and sold at the Utah facility by Coaltech. Covol contracted with Coaltech to operate the facility for which Covol receives a quarterly fee, which is also based upon synthetic fuel 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 to Coaltech coal fines for processing into synthetic fuel at a price equal to Covol's 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 of $1,400,000 has been deferred as of September 30, 1998 and March 31, 1999. In June 1996, Covol formed Alabama Synfuel #1, Ltd. 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 been paid for most of the coal fines purchased but has a dispute with the provider of the coal fines for a portion of the coal fines Covol paid for. The resolution of this dispute is not expected to have a material impact on Covol. 16 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (Unaudited) ---------- 8. Commitments and Contingencies, continued Legal or Contractual Matters, continued In May 1995, Covol entered into an agreement with Geneva Steel Company to build and operate a commercial briquetting plant. The facility never reached commercial operating levels and the equipment has been moved from the Geneva site. Covol intends to use this equipment for the production of synthetic fuel, for testing purposes, or other potential applications of Covol's technology. 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. This loan will be repaid to Covol 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 three quarterly loans totaling $2,250,000. 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 through March 31, 1999, which amounts are estimated at $854,000 in total. Pace and Covol are renegotiating their license agreements, which negotiations could result in a reduction and/or deferral of the receipt of future license royalty payments. Covol expects revised agreements to replace the ten-year loan arrangements. 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 had recorded liabilities to The Industrial Company ("TIC") totaling approximately $735,000. In November 1998, Covol was served with two liens from TIC in amounts totaling approximately $1,150,000 for construction payments TIC claimed were due for certain synfuel facilities. Covol increased the recorded liability to TIC to $945,000 as of March 31, 1999, which amount was paid in April 1999 for the settlement and release of both liens. 17 COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (Unaudited) ---------- 8. Commitments and Contingencies, continued Legal or Contractual Matters, continued 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. There have been ongoing discussions between Covol and Coalco in an 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. 18 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 March 31, 1999 Compared to Three Months Ended March 31, 1998 Revenues. Total revenues for the three months ended March 31, 1999 ("1999") decreased by $4,694,000 to $917,000 as compared to $5,611,000 for the three months ended March 31, 1998 ("1998"). During 1999, Covol recognized license fees totaling $320,000 while license fees of $3,586,000 were recognized during 1998. The license fees in 1999 consisted solely of earned license fees or royalty payments, while the license fees in 1998 consisted solely of one-time advance license fees from several licensees. 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 additional advance license fees during 1999 upon the sale of synthetic fuel facilities currently owned by Covol and upon the achievement of certain production levels at two other synthetic fuel facilities. Earned license fees or royalty payments are expected to increase at a moderate level in the near term with increases expected in 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 to non-related parties during 1999 were $423,000, with a corresponding direct cost to Covol of $274,000, excluding related labor and overhead. In 1998, Covol had no binder sales to non-related parties. Covol had sales of binder and coal fines to related parties during 1999 totaling $42,000 compared to $1,989,000 during 1998. These revenues resulted primarily from coal fines that were sold to a related party under a non-recurring contractual obligation at Covol's cost, as provided for under the binder and license agreement with this entity. Covol expects an increase during 1999 of production and sales of synthetic fuel by its licensees as they improve production capability and establish marketing agreements for the synthetic fuel produced. 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's licensees must successfully obtain adequate feedstock or coal fines, process fines into synthetic fuel, and develop markets for synthetic fuel. Covol believes that its licensees have made progress in these areas during the quarter ended March 31, 1999, but significant improvement is still needed and continued progress and eventual success cannot be assured. Operating Costs and Expenses. Operating costs and expenses increased by $155,000 to $4,250,000 during 1999 from $4,095,000 during 1998. Cost of coal briquetting operations increased $1,710,000 from $670,000 during 1998 to $2,380,000 during 1999, and cost of binder and coal fines - related parties decreased $1,954,000 from $1,964,000 during 1998 to $10,000 during 1999. During 1999, 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 located in Utah, losses related to the write-down of Coaltech inventory, and costs incurred in providing assistance to Covol's licensees in resolving ramp-up issues at their synthetic fuel facilities. Covol expects to continue incurring operating losses during 1999 until the four facilities held for sale are sold, even though it 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 the synthetic fuel produced by Coaltech at cost plus $1 per ton. Production of synthetic fuel from this facility during 1999 and 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 19 operations. The write-down was approximately $650,000 during 1999 and $250,000 during 1998. The excess cost per ton should decrease in the remainder of 1999 as production volumes at the Coaltech facility increase. Selling, general and administrative expenses increased $83,000 or 7% to $1,233,000 during 1999 from $1,150,000 for 1998. Except for amortization of intangible assets in 1999 and commissions in 1998, the largest components of selling, general and administrative expenses for 1999 and 1998 were payroll, professional services, and travel expenses. Payroll costs increased approximately $115,000 from 1998 to 1999 due to increased headcount. Amortization of intangible assets increased approximately $96,000 related to the late 1998 exchange of common stock of Covol for limited partnership interests. Commission expense decreased $250,000 due to a nonrecurring commission in 1998 related to a licensee relationship. Changes in the other categories from year to year were not material. Research and development costs increased $118,000 to $190,000 from 1998 to 1999 primarily because Covol has focused additional resources on further refinement of its binder technologies relative to the synthetic fuel industry and to a lesser extent as a result of the application of its binder technologies into other areas. Compensation expense from stock options, stock warrants, and issuance of common stock decreased $76,000 to $163,000 for 1999 from $239,000 for 1998. 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 for the remainder of 1999. Other Income and Expense. During 1999, Covol had net other expenses of $1,349,000 compared to $584,000 for 1998. This increase of $765,000 relates primarily to a change between periods of $448,000 in the mark-to-market adjustment of the carrying value of the related party note receivable collateralized by common stock, an increase in interest expense of $197,000; and a loss on disposition of equipment in 1999 of $103,000. During 1996, Covol sold certain construction companies and received as consideration a $5,000,000 note receivable ("Note"). 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 $178,000 during 1999, compared to a write-up of $270,000 during 1998 for a net change of $448,000. As of March 31, 1999, the Note had a carrying value of $860,000. Interest expense in 1998 of $1,180,000 consisted primarily of expense based upon the issuance of convertible debt and warrants at a discount. Interest expense of $1,377,000 in 1999 consisted of interest accrued on notes payable used to finance the construction of synthetic fuel facilities held for sale and for operating needs and includes only $121,000 of amortization of debt discount. Interest expense is expected to increase by approximately $900,000 per quarter as a result of the debt issued in March 1999, which increase will be offset by reduced interest as a result of any future repayments of debt related to facilities held for sale. Net loss. For 1999, the net loss of $4,682,000 represented a change of $5,614,000 from net income of $932,000 reported for 1998. This is primarily due to the significant decrease in one-time advance license fee revenues and the increase in cost of briquetting operations. Covol did not recognize any income tax benefit in 1999 or 1998 since the realization of its deferred tax asset of approximately $14,000,000, consisting primarily of net operating loss carryforwards, is dependent on generation of future taxable income. Six Months Ended March 31, 1999 Compared to Six Months Ended March 31, 1998 Revenues. Total revenues for the six months ended March 31, 1999 ("1999") decreased by $4,580,000 to $2,072,000 as compared to $6,652,000 for the six months ended March 31, 1998 ("1998"). During 1999, Covol recognized license fees totaling $794,000 while license fees of $4,586,000 were recognized during 1998. The license fees in 1999 consisted solely of earned license fees or royalty payments, while the license fees in 1998 consisted solely of one-time advance license fees from several licensees. Total binder sales to non-related parties during 1999 were $956,000, with a corresponding direct cost to Covol of $650,000. In 1998, Covol had no binder sales to non-related parties. Covol had sales of binder and coal fines to related parties during 1999 totaling $183,000 compared to $1,996,000 during 1998. These revenues resulted 20 primarily from coal fines that were sold to a related party under a non-recurring contractual obligation at Covol's cost as provided for under the binder and license agreement with this entity. Operating Costs and Expenses. Operating costs and expenses increased by $3,734,000 to $9,390,000 during 1999 from $5,656,000 during 1998. Cost of coal briquetting operations increased $4,756,000 from $1,119,000 during 1998 to $5,875,000 during 1999, and cost of binder and coal fines - related parties decreased $1,937,000 from $1,972,000 during 1998 to $35,000 during 1999. During 1999, 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 operating costs of 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 located in Utah, losses related to the writedown of Coaltech inventory, and costs incurred in providing assistance to Covol's licensees in resolving ramp-up issues at their synthetic fuel facilities. Covol is contractually obligated to purchase the synthetic fuel produced by Coaltech at cost plus $1 per ton. Production of synthetic fuel from this facility during 1999 and 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 $1,800,000 during 1999 and $500,000 during 1998. The excess cost per ton should decrease as 1999 production volumes at the Coaltech facility increase. Selling, general and administrative expenses increased $271,000 or 14% to $2,162,000 during 1999 from $1,891,000 for 1998. Except for amortization of intangible assets during 1999 and commissions in 1998, the largest components of selling, general and administrative expenses for 1999 and 1998 were payroll, professional services, and travel expenses. Payroll costs and professional services each increased approximately $150,000 from 1998 to 1999 due to increased headcount and higher legal costs, respectively. Amortization of intangible assets increased approximately $192,000 related to the 1998 exchange of common stock of Covol for limited partnership interests. Commission expense decreased approximately $305,000 due primarily to a nonrecurring commission in 1998 related to a licensee relationship. Changes in the other categories from year to year were not material. Research and development costs increased $115,000 to $343,000 from 1998 to 1999 primarily because Covol has focused additional resources on further refinement of its binder technologies relative to the synthetic fuel industry and to a lesser extent as a result of the application of its binder technologies into other areas. Compensation expense from stock options, stock warrants, and issuance of common stock decreased $121,000 to $325,000 for 1999 from $446,000 for 1998. 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 for the remainder of 1999. Other Income and Expense. During 1999, Covol had net other expenses of $2,101,000 compared to $1,181,000 for 1998. This increase of $920,000 relates primarily to a change between periods of $1,312,000 in the mark-to-market adjustment of the carrying value of the related party note receivable collateralized by common stock, partially offset by an increase in interest income of $834,000. Also contributing to the net increase in other expenses was an increase in interest expense of $121,000, a decrease in minority interest in losses of consolidated subsidiaries of $138,000, and a loss on disposition of equipment in 1999 of $103,000. During 1996, Covol sold certain construction companies and received as consideration a $5,000,000 note receivable ("Note"). 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 $749,000 during 1999, compared to a write-up of $563,000 during 1998 for a net change of $1,312,000. A $515,000 payment on the Note was due in January 1999, of which $225,000 has been received. The balance of the January payment is expected to be received in the quarter ending June 30, 1999. Included in interest income for 1999 is $515,000 related to this Note. 21 Interest expense in 1998 of $2,292,000 consisted primarily of expense based upon the issuance of convertible debt and warrants at a discount. Interest expense of $2,413,000 in 1999 consisted of interest accrued on notes payable used to finance the construction of synthetic fuel facilities held for sale and for operating needs and includes only $203,000 of amortization of debt discount. Interest expense is expected to increase by approximately $900,000 per quarter as a result of the debt issued in March 1999, which increase will be offset by reduced interest as a result of any future repayments 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 $138,000 in 1998 to approximately $0 in 1999. 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. Net loss. For 1999, the net loss increased $9,234,000 from $185,000 to $9,419,000. The increase is primarily due to the significant decrease in one-time advance license fee revenues and the increase in cost of briquetting operations. Covol did not recognize any income tax benefit in 1999 or 1998 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 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. Operating expenses associated with the owned facilities currently cost approximately $600,000 per month. Net cash used in operating activities for the six months ended March 31, 1999 ("1999") was $9,703,000. During the six months ended March 31, 1998 ("1998"), net cash of $8,000 was provided by operations. Substantially all of this change in cash flow from operations is attributable to the increase in net loss from $185,000 in 1998 to $9,419,000 in 1999. 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 common stock warrants. During 1999, proceeds from the issuance of notes payable totaled approximately $10,498,000, proceeds from the issuance of preferred stock totaled $6,394,000 and proceeds from the issuance of common stock totaled $3,774,000. Capital Resources. During 1999, Covol's investing activities were not significant. Investing activities in 1998 consisted primarily of the purchase of property, plant and equipment and the four facilities held for resale, with most of the funds for these activities coming from the issuance of notes payable ($16,338,000) and from working capital. Covol believes that funds required for investing activities will continue to be significantly lower during 1999 as compared to 1998 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. In order to receive tax credits under IRC Section 29, the synthetic fuel sold must be produced at facilities placed in service by June 30, 1998. Covol's long term existence depends on the ability of Covol's licensees to produce and sell synthetic fuel which will generate license fees to Covol. There are 24 synthetic fuel plants that utilize Covol's patented technology and from which Covol intends to earn license fees. These facilities do not presently operate at levels needed to generate significant revenues to Covol. Improved operations at each of these plants depend on the ability of the plant owner to produce synthetic fuel that meets market specifications in order for the plant owner to market the 22 synthetic fuel. Covol is assisting the plant owners in their efforts to overcome production and marketing problems. 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. Funds received by Covol from these activities are not expected to be sufficient to cover Covol's operating costs and expenses until late 1999. Any extended delay in the sale of facilities held for sale may require Covol to seek additional debt or equity financing. To provide funding for Covol's operations and debt repayment requirements until late 1999, Covol expects to utilize existing working capital 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. During March 1999, Covol issued convertible secured debt, convertible redeemable preferred stock and common stock warrants for total net proceeds of approximately $14,800,000. Covol believes current working capital, excess proceeds from the sale of facilities, payments for license fees and binder sales, and funds raised in additional financings, if necessary, will be sufficient to fund Covol's operations until its operating activities begin producing positive cash flow. The ability of Covol to pay its debt as it matures is dependent primarily upon Covol's ability to sell the facilities which are held for sale. Covol believes the sale of facilities or extensions of existing debt repayment terms will enable it to meet these debt requirements. Covol has agreed to certain covenants contained in the recently completed financing documents. One covenant requires Covol to meet earnings targets for the quarter ending December 31, 1999 and for subsequent quarters. Consolidated earnings before interest, taxes, depreciation and amortization, and certain other adjustments, of $5,000,000 or more are required for the quarter ending December 31, 1999. The earnings target increases in subsequent quarters. Non-compliance could result in penalty charges, acceleration of repayment, increased interest or the assignment of royalty payments from related collateral. There are other terms and conditions in these loan documents that will restrict or prohibit certain activities. Covol May Be Adversely Affected By Year 2000 Non-Compliance of Computer Applications The Year 2000 issue is the result of computer programs being written to define the applicable year using two digits rather than four digits. Thus, programs that are date sensitive may recognize a date using "00" as the year 1900 rather than 2000. This could result in a systems failure or miscalculations causing disruptions of operations including a temporary inability to engage in normal business activities. This systems issue creates risk for Covol from unforseen problems in its own computer systems and electronic equipment and from third parties with which Covol conducts business. Such failures of Covol's and third parties' computer systems could potentially have a material adverse impact on Covol's business and results of operations. While the risks discussed in this section have a possible material impact, management believes the actions and contingency plans that are being developed and implemented will significantly reduce the probability and potential impact of these identified risks. The information systems and electronic equipment utilized in Covol's business include a computer network system utilized for intra-company communication and Internet access and an accounting software package utilized for billing, procurement, payroll and accounting. Non-information technology electronic equipment includes programmable logic controllers, micro-controllers, specialized software packages for operations activities and miscellaneous systems for lab equipment. As a part of the information technology systems mentioned above, Covol's computer network system was upgraded in 1998 with year 2000 compliant equipment. The provider of the accounting software has indicated that this software package is not currently compliant but can be upgraded at nominal cost. This work will be undertaken during the third quarter of fiscal 1999 and tested prior to the close of the fiscal year. All of the synthetic fuel facilities constructed by Covol and its licensees were completed and placed in service between December 1996 and June 30, 1998, with the majority being completed during 1998. As such, the electronic equipment utilized in the facilities is of recent vintage (within 18 months of the June 30 date) and is year 2000 compliant. Suppliers of the major electronic equipment for Covol's four owned synthetic fuel facilities 23 have notified Covol that their equipment is compliant. This includes critical programmable logic controllers, micro-controllers and software operating packages. Licensees utilize proprietary technology provided by Covol including flow sheets and equipment recommended by Covol in the construction of their facilities. These licensees have represented to Covol that equipment within these facilities is compliant or that operations will not be impacted in the event of an equipment failure due to the Year 2000 issue. Malfunctions occurring in the synthetic fuel operations could potentially have an adverse material effect to Covol by reducing the sale of binder formulation materials to the facilities by Covol and the collection by Covol of royalties on the production of synthetic fuel. Covol's relationships with its third-party suppliers and transportation providers is critical to the operation of the synthetic fuel facilities. Covol is also dependent upon its customers who purchase and consume the synthetic fuel produced. Covol's suppliers have represented to Covol that their computer systems and equipment are year 2000 compliant. The most reasonably likely worst case scenarios would be the extended inability of major suppliers to deliver binder formulation materials and other bulk materials required for the operation of the synthetic fuel facilities and the failure of customers to be able to receive synthetic fuel production due to unforseen shutdown due to non-compliant equipment. As a contingency plan for the reasonably likely worst case events, Covol intends to stock up on bulk materials in the last half of the fourth quarter of 1999 so that operations can continue for several days into the new year without interruption. Covol has designed its facilities to accommodate bulk deliveries. Electrical power suppliers have notified Covol that power interruptions are not anticipated but that additional crews will be on hand to respond to problems as they may occur at the change to the new year. Covol and its licensees are also prepared to bypass automated controls and operate facility systems manually if the automated control systems fail. As supply contracts are written for operating materials, Covol is striving to negotiate terms such that year 2000 issues are not an excuse for non-performance. Costs attributable to Year 2000 issues are expected to be minimal. The only cost anticipated to date is for the upgrade to Covol's accounting software package. This cost is estimated to be less than $5,000. Costs associated with increased levels of bulk materials simply redistributes normal operating costs but does not affect the ultimate financial performance of Covol. Covol plans to continue to monitor the Year 2000 issue throughout the remainder of 1999. Should this monitoring reveal other developments, whether they be internal or third party, or identify additional electronic equipment and software that may be at risk, Covol will assess the situation and take appropriate action. There can be no assurance that Covol will discover all Year 2000 issues in the course of the remainder of 1999 or that Covol will be able to remedy any or all discoveries in a timely or cost effective manner such that the Year 2000 issues will not have a material adverse impact on Covol's business, financial condition and results of operations. Forward Looking Statements Statements in this Item 2 regarding Covol's expectations that relate to future plans, financial results or performance and other information presented herein that are not purely historical in nature, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although Covol believes that its expectations are based on reasonable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results will not differ materially from its expectations. In addition to matters affecting Covol's industry or the coal industry or the economy generally, factors which could cause actual results to differ from expectations set forth in the above-identified forward looking statements include but are not limited to: Covol's ability to sell company-owned synthetic fuel facilities, the ability of Covol to conserve its capital through cost reductions until operating revenues exceed expenses, favorable IRS tax treatment, the ability of Covol to complete specific research and development projects, commercial viability of technologies, the availability of natural resources and suitable raw materials, ability of Covol's licensees to achieve expected production levels at the synthetic fuel and engineered resource facilities, ability to market synthetic fuel and engineered resources produced, market penetration by competing 24 technologies, the ability of Covol to meet performance criteria required in financing agreements, and the ability of Covol to continue to find suitable partners and licensees. 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. 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. 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 was $2,250,000 ($750,000 per design and construction agreement). Centerline and PacifiCorp initiated claims in arbitration against each other but have settled their claims, including a release of claims against Covol for liquidated damages. ITEM 2. CHANGES IN SECURITIES Recent Sales of Unregistered Securities The following sets forth all securities issued by Covol within the past fiscal quarter 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. 25 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 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 and common stock warrants described in Note 7 to the consolidated financial statements and to the sale of series D redeemable cumulative convertible preferred stock and common stock warrants described in Note 6 to the consolidated financial statements. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS An annual meeting of stockholders of Covol was held on March 17, 1999 for the following purposes: 1. To elect three class II directors of Covol to serve until the 2002 annual meeting of stockholders, or until their successors are duly elected and qualified; 2. To ratify a grant by the Board of options to purchase 250,000 shares of common stock to Brent M. Cook at $12.97 per share to vest pro rata over 60 months beginning on May 1, 1998; 3. To ratify the selection by the Board of PricewaterhouseCoopers LLP as independent auditors of Covol for the fiscal year ending September 30, 1999. A total of 8,648,365 shares were voted. The results of voting on these matters were as follows: 1. Mr. Raymond J. Weller as a class II director: for - 8,179,645; withheld authority - 468,720. Mr. DeLance W. Squire as a class II director: for - 8,098,345; withheld authority - 550,020. Mr. Kirk A. Benson as a class II director: for - 8,472,274; withheld authority 176,091. 2. To approve the 250,000 share option grant to Mr. Cook: for - 7,855,106, against - 434,199; abstain -- 359,060. 3. To ratify the selection of PricewaterhouseCoopers LLP as auditors for fiscal 1999: for - 8,334,938; against - 5,915, abstain - 307,512. ITEM 5. OTHER INFORMATION None. 26 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) The following exhibits are included herein: 10.59. Secured Draw Down Promissory Note dated June 12, 1998 executed by Covol in favor of Trans Pacific Stores, Ltd. 10.59.1 Loan and Security Agreement dated June 12, 1998 executed by Covol in favor of Trans Pacific Stores, Ltd. 10.59.2 Letter Amendment dated May 6, 1999 between Covol and Trans Pacific Stores, Ltd. 27.1 Financial Data Schedule (b) A report on Form 8-K was filed on March 24, 1999. 27 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: May 14, 1999 By: /s/ Kirk A. Benson ----------------------------------- Kirk A. Benson, Chief Executive Officer and Principal Executive Officer Date: May 14, 1999 By: /s/ Steven G. Stewart ----------------------------------- Steven G. Stewart, Chief Financial Officer and Principal Financial Officer 28 EX-10.59 2 SECURED DRAW DOWN PROMISSORY NOTE THIS NOTE MAY ONLY BE SOLD, ASSIGNED OR OTHERWISE TRANSFERRED TO AN "ACCREDITED INVESTOR," AS DEFINED IN RULE 501(a)(1), (2) OR (3) UNDER REGULATION D OF THE SECURITIES ACT OF 1933. NOTWITHSTANDING ANYTHING CONTAINED HEREIN TO THE CONTRARY, WITHOUT THE WRITTEN CONSENT OF THE COMPANY, THIS NOTE SHALL NOT BE HYPOTHECATED OR BROKEN UP INTO MORE THAN ONE NOTE AND THERE SHALL ONLY BE ONE NOTEHOLDER. SECURED DRAW DOWN PROMISSORY NOTE Not to Exceed $4,000,000.00 Lehi, Utah June 12, 1998 FOR VALUE RECEIVED, COVOL TECHNOLOGIES, INC., a Utah corporation (the "Company"), hereby promises to pay to the order of TRANS PACIFIC STORES, LTD., a Hawaiian corporation (the "Lender"), at 555 Zang Street, Suite 300, Lakewood, CO 80228, or at such other place as the Lender may designate in writing, in accordance with Section 2 of this Note, the maximum principal amount of Four Million Dollars ($4,000,000.00), or such lesser amount as is advanced, in lawful money of the United States, with interest thereon to accrue pursuant to Section of this Note. 1. Undefined Terms. All terms not defined in this Note are used as set forth in the Security Agreement of even date between the parties. 2. Maturity Date. Interest on the outstanding principal balance shall accrue at a rate equal to eighteen percent (18%) per annum (the "Interest Rate"). Interest shall be calculated on the basis of a 365-day year and the actual number of days elapsed. On the four-month anniversary of this Note, the Interest Rate shall be adjusted to twenty-two percent (22%) per annum, until the Loan, including all principal and interest has been paid in full. Interest shall accrue on the unadvanced portion of the maximum principal amount, including amounts paid by the Company as partial repayment of the Loan, at the rate of one percent (1%) per annum until the Loan is paid in full. The unpaid principal amount owing and any and all interest due hereunder shall be due and payable in full on or before twelve months following execution of this Note. Interest shall accrue on this Note as set forth in this Section until the principal is paid in full. 3. Payment of Interest. Interest due hereunder shall be paid on a quarterly basis. 4. Advances. Principal of this Note shall be increased incrementally as advances are made following Draw Requests (as defined below) submitted pursuant to the procedure set forth in the remainder of the section. The Company shall request each advance of principal with respect to this Note by delivering to the Lender a written draw request ("Draw Request") for advance, the form of which is attached as Exhibit A, not less than two (2) business days prior to the date on which the advance is requested to be made. No Draw Requests can be made by the Company after the four-month anniversary of this Note. Each Draw Request shall be signed by any one of the following officers of the Company: Brent M. Cook, Stanley M. Kimball, Steven G. Stewart, Asael T. Sorensen or Harlan M. Hatfield or such other person as the Company may designate from time to time. Each such request shall specify the proposed date of the advance and the amount thereof and shall contain a certification (i) that the Company is not in default under the Note or the Security Agreement and (ii) that no event which, with the passage of time or the giving of notice, or both, would give rise to a default has occurred and is continuing. The Lender shall fund, within such two (2) day period, the amounts requested in such Draw Request unless an uncured Event of Default exists. Each advance, the date thereof and the then outstanding principal amount of the Note, as evidenced by the Lender's signature, shall be recorded by the Lender in Schedule A attached hereto. 5. Prepayment. The Company shall have the right to prepay all or any portion of the Note prior to maturity without the payment of any prepayment penalty. Any payments made prior to the maturity date of the Note, as set forth in Section 3, shall be credited first against the unpaid interest due, with no payments being applied to principal until the accrued interest has been fully paid. 6. Security. As security for the obligations under the Note, the Company shall, pursuant to a separate Security Agreement, dated of even date herewith, (the "Security Agreement"), by and between the Lender and the Company, grant, convey, and assign to the Lender a security interest in the following: (i) For $2,200,000 outstanding at any time, the Collateral is a continuing interest in that certain promissory note as amended ("Promissory Note") dated August 1996, between the Company and Gerald M. Larson; and (ii) The Collateral for amounts in excess of $2,200,000 up to an additional $1,800,000 is a continuing interest in future cash flows payable to the Company pursuant to the agreement between A.T. Massey ("Massey") and the Company dated December 4, 1997 for the construction, operation and sale of two 360,000 ton synthetic fuel manufacturing facilities. The Company agrees to take any and all reasonable steps required by the Lender, to protect, evidence, give effect to or give notice of Lender's security interest, and shall pay all costs in connection therewith. Notwithstanding the foregoing, recourse by the Lender against the Company is not limited to the Collateral, and the Company will be responsible for the entire Loan obligation, including principal and interest. 7. Usury Laws. Notwithstanding anything to the contrary contained herein or in the Security Agreement, all agreements between the Company and the Lender are hereby expressly limited so that in no contingency or event whatsoever shall the total liability for payments in the nature of interest, additional interest, and other charges exceed the applicable limits imposed by the usury laws of the State of Utah. If any payments in the nature of interest, additional interest, or other charges made hereunder or under the Security Agreement are held to be in excess of the applicable limits imposed by the usury laws of the State of Utah, it is agreed that any such amount held to be in excess shall be considered payment of principal hereunder, and the indebtedness evidenced hereby shall ipso facto be reduced by such amount so that the total liability for payments in the nature of interest, additional interest, and other charges shall not exceed the applicable limits imposed by the usury laws of the State of Utah, in compliance with the desires of the Company and the Lender. This provision shall never be superseded or waived and shall control every other provision of this Note and all agreements between the Company and Lender or Lender's successors or assigns. 8. Default. For purposes of this Note, the occurrence of the following shall constitute an "Event of Default" which shall permit the Lender to declare all principal of and interest on this Note to be immediately due and payable: (a) Any petition is filed by or against the Company under any law pertaining to reorganization, insolvency or rescheduling of debts which is not dismissed within thirty (30) days, or the Company makes an assignment for the benefit of creditors or admits in writing its inability to pay its debts generally as they become due; (b) Any material garnishment, attachment or levy is issued against the Collateral by any party other than Lender; or (c) Any default occurs in payment or performance of any obligations of the Company, or any breach of a representation or warranty of the Company, under the provisions of this Note or the Security Agreement, executed in connection herewith; provided, however, that any such default shall not be deemed an Event of Default until the Company receives written notice of such event and the Company fails to cure such default within thirty (30) days after receipt of such notice. 9. Acceleration, Waiver. Upon the occurrence of an uncured Event of Default, the Lender may declare this Note immediately due and payable. 10. Immunity of Officers, Directors and Employees. No recourse shall be had for the payment of the principal or interest on this Note or for any claim based thereon or otherwise in any manner in respect thereof, to or against any officer, director or employee of the Company, either directly or through the Company, whether by virtue of any constitutional provision or statute or rule of law, or by the enforcement of any assessment or penalty, or in any other manner, all such liability being expressly waived and released by the acceptance of this Note and as part of the consideration for the issue thereof. 11. Securities Laws. This Note has not been registered under the Securities Act of 1933, as amended (the "Act"), or registered or otherwise qualified for sale under the securities laws of any state. The Lender by receipt of this Note acknowledges that it and all of its equity owners are "accredited investors" within the meaning of Regulation D of the Act and that the Lender has reviewed the public filings with the Securities and Exchange Commission ("SEC") of the Company, and has otherwise had the opportunity to ask questions of the Company regarding its business activities. 12. Notices. All notices required to be given under this Note shall be in writing and shall be personally delivered or sent by regular, express or certified first-class mail or express mail, or by express courier, charges prepaid or incurred for the account of the sender. Such notices shall be addressed to the addresses as set forth in the Security Agreement. 13. Necessary Documents. Each of the parties agrees to execute and provide, at the request of the other parties, any and all other documents or other necessary written instruments as may be reasonable necessary to effectuate the purposes of this Note. 14. Governing Law. This Note shall be construed and enforced in accordance with, and the rights of the parties shall be governed by, the laws of the State of Utah. IN WITNESS WHEREOF, the Company has executed this Note as of the date first written above. COVOL TECHNOLOGIES, INC. By: /s/ Stanley M. Kimball --------------------------- Title: CFO Address: 3280 N. Frontage Road Lehi, Utah 84043 (801) 768-4481 ATTEST: By:/s/ Asael T. Sorensen, Jr. ----------------------------- Name: Asael T. Sorensen, Jr. Title: Secretary SCHEDULE A Draw Record ====================== ================ ===================== ================== Outstanding Principal Amount of Advance(1) Date of Advance Signature of Lender Amount ($) - ---------------------- ---------------- --------------------- ------------------ - ---------------------- ---------------- --------------------- ------------------ - ---------------------- ---------------- --------------------- ------------------ - ---------------------- ---------------- --------------------- ------------------ - ---------------------- ---------------- --------------------- ------------------ - ---------------------- ---------------- --------------------- ------------------ - ---------------------- ---------------- --------------------- ------------------ - ---------------------- ---------------- --------------------- ------------------ - ---------------------- ---------------- --------------------- ------------------ - ---------------------- ---------------- --------------------- ------------------ - ---------------------- ---------------- --------------------- ------------------ - ---------------------- ---------------- --------------------- ------------------ - ---------------------- ---------------- --------------------- ------------------ - ---------------------- ---------------- --------------------- ------------------ - ---------------------- ---------------- --------------------- ------------------ - ---------------------- ---------------- --------------------- ------------------ - ---------------------- ---------------- --------------------- ------------------ - ---------------------- ---------------- --------------------- ------------------ - ---------------------- ---------------- --------------------- ------------------ - ---------------------- ---------------- --------------------- ------------------ ====================== ================ ===================== ================== EXHIBIT "A" DRAW REQUEST NO. ___ NOT TO EXCEED $4,000,000.00 TO: TRANS PACIFIC STORES, LTD. (the "Lender") This Draw Request is made pursuant to Section 3 of that certain Secured Draw Down Promissory Note dated June 12, 1998 (the "Note"). Lender is hereby directed to advance funds for payment of the expenses and capital costs of the Company as defined in that certain Security Agreement dated June 12, 1998 between Lender and the undersigned (the "Security Agreement") as follows: - ------------------- -------------------------- -------------------------------- Company/Payee Purpose of Payment Amount - ------------------- -------------------------- -------------------------------- - ------------------- -------------------------- -------------------------------- - ------------------- -------------------------- -------------------------------- - ------------------- -------------------------- -------------------------------- - ------------------- -------------------------- -------------------------------- - ------------------- -------------------------- -------------------------------- - ------------------- -------------------------- -------------------------------- - ------------------- -------------------------- -------------------------------- TOTAL - ------------------- -------------------------- -------------------------------- The obligation for which such payment is requested was properly incurred, is a proper expense or capital cost of the Company and has not been the basis of a previous advance. Covol Technologies, Inc., is not on the date hereof in default of any of its representations, warranties and covenants contained in the Note or in the Security Agreement. COVOL TECHNOLOGIES, INC. Dated: __________, 1998 By:______________________________ EX-10.59.1 3 LOAN AND SECURITY AGREEMENT ------------------------------------------------------------------------------ LOAN AND SECURITY AGREEMENT By and Between Covol Technologies, Inc. and Trans Pacific Stores, Ltd. June 12, 1998 ------------------------------------------------------------------------------ TABLE OF CONTENTS Section Page 1. Loan..................................................................1 2. Warrants..............................................................1 3. Security Agreement.................................................. 1 3.1. Security Interest.......................................... 1 3.2. Collateral. ............................................... 1 3.3. Cash Flow From Collateral. ................................ 2 3.4. Release of Collateral. .................................... 2 3.5. Remedies Upon Default...................................... 2 4. Representations, Warranties and Covenants of Borrower............... 2 4.1. Corporate Existence; Compliance with Law................... 2 4.2. Corporate Power; Authorization; Enforceable Obligations.... 3 4.3. Environmental Laws......................................... 3 4.4. Priority................................................... 3 5. Representations, Warranties, and Covenants of the Lender............ 3 5.1. Disclosure of Information.................................. 3 5.2. Accredited Investor........................................ 3 6. Miscellaneous....................................................... 3 6.1. Survival of Warranties..................................... 3 6.2. Successors and Assigns..................................... 4 6.3. Governing Law.............................................. 4 6.4. Counterparts............................................... 4 6.5. Titles and Subtitles....................................... 4 6.6. Notices.................................................... 4 6.7. Expenses................................................... 4 6.8. Amendments and Waivers..................................... 4 6.9. Severability............................................... 4 6.10. Waiver of Trial by Jury.................................... 4 6.11. Entire Agreement........................................... 5 LOAN AND SECURITY AGREEMENT THIS LOAN AND SECURITY AGREEMENT (the "Agreement") is entered into as of the 12th day of June, 1998, by and between COVOL TECHNOLOGIES, INC., a Utah corporation, (the "the Company"), and TRANS PACIFIC STORES, LTD., a Delaware corporation ("Lender"), and evidences the obligation of Lender to loan the Company up to Four Million Dollars ($4,000,000.00), and Lender's acceptance of a Secured Draw Down Promissory Note of even date herewith (the "Note"). THE PARTIES HEREBY AGREE AS FOLLOWS: 1 Loan. Subject to the terms and conditions of this Agreement and the Secured Draw Down Promissory Note of even date herewith (the "Note"), Lender agrees to lend, and the Company agrees to borrow, the principal amount of up to Four Million Dollars ($4,000,000) (the "Loan"), such amounts to be advanced over time, by wire transfer or check payable to the order of the Company within two (2) business days of Lender's receipt of a draw request (a "Draw Request") in the form attached to the Note. No Draw Requests can be made by the Company after the four-month anniversary of the Note. The proceeds of the Loan shall be used for operational and other expenses of the Company. 2 Warrants. As partial consideration for the Loan, the Company grants to Lender warrants (the "Warrants") to purchase restricted common stock of the Company at an exercise price equal to the closing bid price on the four-month anniversary of the Loan ("Trigger Date"). The number of Warrants granted will be equal to the principal amount of the Loan outstanding on the Trigger Date divided by Four Million Dollars ($4,000,000) times 100,000. For example, if the outstanding balance of the Loan is $2,000,000 on the Trigger Date, the Company will grant to Lender 50,000 Warrants ($2,000,000/$4,000,000 x 100,000 = 50,000). If the Loan has been paid in full by the Trigger Date, the number of Warrants granted hereunder will be zero. Warrants granted, if any, may be exercised within two years of the date of issuance of such Warrants. The Warrants if unexercised will expire on the two-year anniversary of the date of issuance. 3 Security Agreement. Payment of the Loan shall be secured to the extent described below: 3.1. Security Interest. the Company hereby grants to Lender a security interest in the property and the proceeds described in Section 3.2 herein to secure the Company's obligations under the Loan (the "Security Interest"). 3.2. Collateral. The property in which the Security Interest is granted (the "Collateral") consists of the following: (i) For $2,200,000 outstanding at any time, the Collateral is a continuing interest in that certain promissory note as amended ("Promissory Note") dated August 1996, between the Company and Gerald M. Larson; and (ii) The Collateral for amounts in excess of $2,200,000 up to an additional $1,800,000 is a continuing interest in future cash flows payable to the Company pursuant to the agreement between A.T. Massey ("Massey") and the Company dated December 4, 1997 for the construction, operation and sale of two 360,000 ton synthetic fuel manufacturing facilities. Upon execution of this Agreement or at the time the Massey cash flows commence, the Company shall execute and deliver to Lender any documents, notices or instruments reasonably requested by Lender to protect, evidence, give effect to or give notice of Lender's security interest, and shall pay all costs in connection therewith. 3.3. Cash Flow From Collateral. If there is an outstanding balance under this Agreement as of the four month anniversary of the Agreement, the Company will assign payments to be paid thereafter under the Collateral directly to Lender. Such payments will apply first to interest and then to principal. 3.4. Release of Collateral. Notwithstanding anything in this Agreement to the contrary, Lender will release the Promissory Note Collateral any time the Loan amount is equal to or less than $1,800,000, provided the Massey agreement continues to be held as Collateral to maintain the Loan amount at less than or equal to $1,800,000. 3.5. Remedies Upon Default. In the event of any Event of Default under the Note, Lender may do any one or more of the following: 3.5.1. Declare any indebtedness under the Loan immediately due and payable; 3.5.2. Enforce the security interest given in this Agreement under the provisions of the Uniform Commercial Code of the applicable state or any other equivalent law (the "Uniform Commercial Code"); 3.5.3. Exercise any other rights and remedies of a secured party under the Uniform Commercial Code of the applicable state or other applicable law, all of which rights and remedies shall be cumulative and non-exclusive, to the extent permitted by law. 4 Representations, Warranties and Covenants of the Company. The Company hereby represents, warrants, and covenants to Lender that: 4.1. Existence; Compliance with Law. The Company (i) is a corporation duly organized, validly existing, and in good standing under the laws of the State of Delaware; (ii) is duly qualified as a foreign corporation and in good standing under the laws of each jurisdiction where its ownership or lease of property or the conduct of its business requires such qualification; (iii) has the requisite power and authority and the legal right under the laws of the state of Utah to own, pledge, mortgage, or otherwise encumber and operate its properties, to lease the property it operates under lease, and to conduct its business as now, heretofore and proposed to be conducted; (iv) has all material licenses, permits, consents, or approvals from or by, and has or will have made all material filings with, and has or will have given all material notices to, all governmental authorities having jurisdiction, to the extent required for such ownership, operation, and conduct; and (v) is in compliance with its articles of incorporation. 4.2. Power; Authorization; Enforceable Obligations. The execution, delivery, and performance by the Company of this Agreement and the Note (i) are within the Company's power under the laws of the state of Utah; (ii) have been duly authorized by all necessary or proper action under the laws of the state of Utah; (iii) are not in contravention of any provision of the Company articles of incorporation; (iv) to the Company's knowledge will not violate any law or regulation, or any order or decree of any court or governmental instrumentality; (v) will not conflict with or result in the breach or termination of, constitute a default under, or accelerate any performance required by, any indenture, mortgage, deed of trust, lease, agreement, or other instrument to which the Company is a party or by which the Company or any of its property is bound (except such conflict, breach, termination, default, or acceleration as could not reasonably be expected to have a material adverse effect on the business of the Company); (vi) will not result in the creation or imposition of any lien upon any of the property of the Company other than those in favor of the Lender; and (vii) do not require the consent or approval of any governmental body, agency, authority or any other person. At or prior to the funding of each Draw Request, each of the documents to be delivered at such time shall have been duly executed and delivered by or on behalf of the Company, and each shall then constitute a legal, valid, and binding obligation of the Company to the extent it is a party thereto, enforceable against it in accordance with its terms, subject to the effects of laws governing creditors rights generally and general principles of equity. 4.3. Environmental Laws. All premises and facilities owned, leased, used, or operated by the Company or, to the knowledge of any officer of the Company after a reasonable investigation, any predecessor in interest, have been, and continue to be, owned, leased, used, or operated in compliance in all material respects with all applicable environmental laws. 4.4. Priority. The Company has not granted a security interest in the Collateral which is on a parity or superior to the Security Interest of Lender. 5 Representations, Warranties, and Covenants of the Lender. Lender hereby represents, and warrants that: 5.1. Disclosure of Information. Lender has received all the information it considers necessary or appropriate for deciding whether to grant the Loan. Lender further represents that it has had an opportunity to ask questions and receive answers from the Company regarding the terms and conditions of the Loan. 5.2. Accredited Investor. Lender is an "accredited investor" within the definition set forth in Rule 501(a) under the Act. 6 Miscellaneous. 6.1. Survival of Warranties. The warranties, representations, and covenants of the Company and the Lender contained in or made pursuant to this Agreement shall survive the execution and delivery of this Agreement and the funding of any Draw Request and shall in no way be affected by any investigation of the subject matter thereof made by or on behalf of Lender or the Company. 6.2. Successors and Assigns. Except as otherwise provided herein, the terms and conditions of this Agreement shall inure to the benefit of and be binding upon the respective successors and assigns of the parties. 6.3. Governing Law. This Agreement shall be governed by and construed under the laws of the State of Utah without regard to choice of law principles. 6.4. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 6.5. Titles and Subtitles. The titles and subtitles used in this Agreement are used for convenience only and are not to be considered in construing or interpreting this Agreement. 6.6. Notices. Unless otherwise provided, any notice required or permitted under this Agreement shall be given in writing and shall be deemed effectively given upon personal delivery to the party to be notified or upon deposit with a reputable overnight courier or with the United States Post Office, by registered or certified mail, postage prepaid and addressed to the party to be notified at the address indicated for such party on the signature page hereof, or at such other address as such party may designate by ten (10) days advance written notice to the other parties. 6.7. Expenses. Each party shall bear its own expenses in connection with the transactions contemplated by this Agreement. 6.8. Amendments and Waivers. Any term of this Agreement may be amended and the observance of any term of this Agreement may be waived only with the written consent of the Company and the Lender. 6.9. Severability. If one or more provisions of this Agreement are held to be unenforceable under applicable law, such provision shall be excluded from this Agreement and the balance of the Agreement shall be interpreted as if such provision were so excluded and shall be enforceable in accordance with its terms. 6.10. Waiver of Trial by Jury. BORROWER AND THE LENDER HEREBY WAIVE TRIAL BY JURY IN ANY ACTION, SUIT, PROCEEDING OR COUNTERCLAIM OF ANY KIND DIRECTLY OR INDIRECTLY ARISING OUT OF OR RELATED TO THIS AGREEMENT OR THE LOAN OR ANY ACT OR OMISSION WHICH EITHER PARTY ASSERTS RESULTED IN ANY LIABILITY TO BORROWER, THE LENDER OR THEIR RESPECTIVE OFFICERS, DIRECTORS, STOCKHOLDERS, PARTNERS, EMPLOYEES, OR AGENTS, TO THE FULL EXTENT PERMITTED BY LAW. 6.11. Entire Agreement. This Agreement, the Note and other documents delivered pursuant hereto constitute the full and entire understanding and agreement between the parties with regard to the subjects hereof and thereof. IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. Address: 3280 North Frontage Road COVOL TECHNOLOGIES, INC. Lehi, Utah 84043 By: /s/Stanley M. Kimball ------------------------------ Name: Stanley M. Kimball ---------------------------- Title: CFO --------------------------- Address: 555 Zang Street, Suite 300 TRANS PACIFIC STORES, LTD. Lakewood, CO 80228 By: /s/John P. Hill, Jr. ----------------------------- Name: John P. Hill, Jr. --------------------------- Title: President -------------------------- EX-10.59.2 4 LETTER AMENDMENT Thursday, May 6, 1999 Trans Pacific Stores 555 Zang St., Suite 300 Lakewood, CO 80228 Re: Letter Amendment Gentlemen: Reference is made to (i) the Secured Draw Down Promissory Note, dated as of June 12, 1998 in the principal amount of $4 million ("Note") made by Covol Technologies, Inc. ("Covol") to Trans Pacific Stores, Ltd. ("Trans Pacific"), (ii) the Loan and Security Agreement, dated as of June 12, 1998 ("Security Agreement") by and between Covol and Trans Pacific, (iii) the Common Stock Purchase Warrants of Covol Technologies, Inc., certificate no. WA-1998-287, dated as of October 12, 1998, for 100,000 shares ("Trans Pacific Warrants") made by Covol to Trans Pacific, and (iv) the Common Stock Purchase Warrants of Covol Technologies, Inc., certificate no. WA-001, dated as of August 19, 1997, for 85, 713 shares ("Diamond Jay Warrants"), made by Covol to Diamond Jay Ltd. Co. The parties to the above referenced agreements and instruments hereby amend the terms there of as follows: Section 2 of the Note is amended to provide that $1 million of the principal shall be due and payable on or before December 31, 1999 and $3 million of the principal and any accrued but unpaid interest shall be due and payable on April 30, 2000. The entire $4 million shall bear interest at 14 percent per annum beginning June 13, 1999 and shall then be payable monthly in arrears beginning June 30, 1999. Section 3 of the Security Agreement is amended to provide that the August 1996 Larson Promissory Note and the interest in future quarterly earned royalties payable to Covol pursuant to section 3.4 of the License Agreement between Appalachian Synfuel, LLC and Covol dated December 4, 1997 shall each be held as collateral for the full amounts due under the Note until the Note, as amended herein, is repaid in full. The Trans Pacific Warrants and the Diamond Jay Warrants are both amended to provide that the Exercise Periods shall be extended for one year from the original Termination Dates and that the Per Share Warrant Prices (exercise prices) shall be the lower of the average closing share price of Covol common stock for the five days immediately before May 6, 1999 or June 12, 1999. 2 This letter agreement may be executed in one or more counterparts, all of which shall be considered one and the same letter agreement. Very truly yours, Covol Technologies, Inc. /s/ Steven G. Stewart ------------------------- Steven G. Stewart Chief Financial Officer Accepted and Agreed to as of the date first set forth above: Trans Pacific Stores, Ltd. By: /s/ Donald V. Berlanti ------------------------ Name: Donald V. Berlanti Title: Chairman EX-27.1 5 FDS --
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE SIX MONTHS ENDED MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 6-MOS SEP-30-1999 MAR-31-1999 6,879 0 4,413 0 2,039 43,096 16,314 1,815 77,377 23,878 25,681 0 1 12 21,534 77,377 1,139 2,072 6,560 6,560 668 0 2,413 (9,419) 0 (9,419) 0 0 0 (9,419) (0.78) (0.78)
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