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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2001
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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Commission file number 0-23634
KFX INC.
(Exact name of Registrant as specified in its charter)
Delaware 84-1079971
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) Identification number)
3300 EAST FIRST AVENUE, SUITE 290, DENVER, COLORADO USA 80206
(Address of principal executive offices)
(303) 293-2992
(Registrant's telephone number including area code)
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, and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
On August 10, 2001 there were 26,745,505 shares of the Registrant's common
stock, $.001 par value, outstanding.
KFX INC.
FORM 10-Q QUARTERLY REPORT
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2001
TABLE OF CONTENTS
PAGE NO.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS:
Consolidated Balance Sheets - June 30, 2001
and December 31, 2000 (Unaudited)..................... 3
Consolidated Statements of Operations - Three Months
Ended June 30, 2001 and 2000 (Unaudited).............. 4
Consolidated Statements of Operations - Six Months Ended
June 30, 2001 and 2000 (Unaudited).................... 5
Consolidated Statements of Cash Flows - Six Months Ended
June 30, 2001 and 2000 (Unaudited).................... 6
Notes to Consolidated Financial Statements (Unaudited).. 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF
OPERATIONS......................................... 15
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK.................................. 19
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.................................. 20
ITEM 2 CHANGES IN SECURITIES AND USE OF PROCEEDS.......... 21
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS. 21
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................... 22
SIGNATURES....................................................... 23
KFX INC.
CONSOLIDATED BALANCE SHEETS
UNAUDITED
JUNE DECEMBER
30, 2001 31, 2000
----------------- -------------
ASSETS
Current assets
Cash and cash equivalents ............................. $ 392,496 $ 348,955
Trade accounts receivable.............................. 685,959 351,909
Unbilled revenue....................................... 95,284 118,103
Other receivables...................................... 292,743 224,853
Prepaid expenses....................................... 33,161 34,459
Deferred job costs..................................... 476,122 216,152
-------------- -------------
Total current assets.................................. 1,975,765 1,294,431
Property, plant and equipment, net.......................... 825,747 1,360,430
Patents, net................................................ 1,772,341 1,951,567
Investment in K-Fuel, LLC................................... 555,924 694,135
Goodwill, net............................................... 1,477,874 1,817,731
Debt issue costs, net....................................... 432,089 679,046
Prepaid royalty............................................. 498,000 498,000
Other assets................................................ 169,054 176,030
-------------- -------------
TOTAL ASSETS................................................ 7,706,794 $ 8,471,370
============== =============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities
Accounts payable ...................................... 2,029,221 $ 1,817,533
Accrued expenses ...................................... 559,331 625,523
Interest payable....................................... 491,284 458,265
Liability to issue stock and warrants.................. 23,810 134,458
Deferred sale of Pegasus common
stock ............................................. -- 1,000,000
Deferred revenue....................................... 1,216,863 523,552
Short term notes payable to directors.................. 1,050,000 827,551
Obligations to repurchase Pegasus preferred stock, net 1,148,279 -
Current maturities of long-term debt................... 733,294 873,476
-------------- -------------
Total current liabilities.......................... 7,252,082 6,260,358
Deferred income............................................. 358,088 499,309
Deferred revenue, less current portion...................... 364,403 200,000
Long-term debt, less current maturities..................... 160,000 331,150
Convertible debentures...................................... 15,162,526 16,339,444
-------------- -------------
Total liabilities.................................. 23,297,099 23,630,261
-------------- -------------
Minority interest........................................... 4,094,738 2,275,040
-------------- -------------
Stockholders' deficit
Preferred stock, $.001 par value, 20,000,000 shares
authorized; none issued............................. -- --
Common stock, $.001 par value, 80,000,000 shares
authorized; and 25,710,505 and 25,196,280 shares
issued and outstanding.............................. 25,710 25,196
Additional paid-in capital.................................. 57,200,768 53,632,177
Accumulated deficit......................................... (76,911,521) (71,091,304)
Total stockholders' deficit........................ (19,685,043) (17,433,931)
-------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT................. 7,706,794 $ 8,471,370
The accompanying notes are an integral part
of these consolidated financial statement
KFX INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
UNAUDITED
THREE MONTHS ENDED JUNE 30,
2001 2000
---------------- -------------
OPERATING REVENUES
Pegasus software licenses and services.................... $ 529,004 $ 760,554
K-Fuel demonstration plant and laboratory contract revenue -- 99,976
---------------- -------------
Total operating revenues............................. 529,004 860,530
---------------- -------------
OPERATING COSTS & EXPENSES
Costs of Pegasus software licenses and services........... 379,244 425,041
Marketing, general and administrative expenses............ 1,085,600 1,291,116
Pegasus software research and development................. 212,121 144,590
K-Fuel demonstration plant and laboratory ................ 36,376 90,653
Depreciation and amortization............................. 662,663 706,091
---------------- -------------
Total operating costs and expenses................... 2,376,004 2,657,491
---------------- -------------
OPERATING LOSS............................................ (1,847,000) (1,796,961)
Interest and other income (expense)....................... (12,189) (39,947)
Interest expense (including accrual of maturity premiums). (1,144,744) (1,268,494)
Equity in income of unconsolidated affiliates............. 438 55,887
---------------- -------------
NET LOSS.................................................. $ (3,003,495) $(3,049,515)
================ =============
BASIC AND DILUTED NET LOSS PER COMMON SHARE............... $ (.12) $ (.12)
================ =============
Weighted-average common shares outstanding................ 25,389,000 24,940,000
=============== =============
The accompanying notes are an integral part
of these consolidated financial statements
KFX INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
UNAUDITED
SIX MONTHS ENDED JUNE 30,
2001 2000
---------------- -------------
OPERATING REVENUES
Pegasus software licenses and services.................... $ 776,954 $ 1,226,192
K-Fuel demonstration plant and laboratory contract revenue -- 99,976
---------------- --------------
Total operating revenues............................. 776,954 1,326,168
---------------- --------------
OPERATING COSTS & EXPENSES
Costs of Pegasus software licenses and services........... 608,764 798,291
Marketing, general and administrative expenses............ 2,239,440 2,488,696
Pegasus software research and development................. 352,857 265,833
K-Fuel demonstration plant and laboratory operations...... 89,778 176,760
Depreciation and amortization............................. 1,377,188 1,422,163
---------------- --------------
Total operating costs and expenses................... 4,668,027 5,151,743
---------------- --------------
OPERATING LOSS............................................ (3,891,073) (3,825,575)
Interest and other income (expense)....................... (37,923) (38,294)
Interest expense (including accrual of maturity premiums). (1,894,229) (1,554,631)
Equity in income of unconsolidated affiliates............. 3,009 46,230
---------------- --------------
NET LOSS.................................................. $ (5,820,216) $ (5,372,270)
================ ==============
BASIC AND DILUTED NET LOSS PER COMMON SHARE............... $ (.23) $ (.22)
================ ==============
Weighted-average common shares outstanding................ 25,336,000 24,747,000
================ ==============
The accompanying notes are an integral part
of these consolidated financial statements
KFX INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
UNAUDITED
SIX MONTHS ENDED JUNE 30,
2001 2000
---------------- --------------
OPERATING ACTIVITIES
Net loss................................................ $(5,820,216) $(5,372,270)
Adjustments to reconcile net loss to cash
used in operating activities
Depreciation and amortization.................... 1,377,188 1,422,163
Equity in loss of unconsolidated affiliates...... (3,009) (46,230)
Accrual of maturity premiums and amortization of
debt discount................................................ 1,265,327 1,000,000
Common stock granted for services................ 247,135 --
Other............................................ 69,698 --
Changes in operating assets and liabilities:
Accounts receivable, unbilled revenue
and deferred job costs............................. (639,092) 19,947
Deferred revenue.................................... 857,714 (256,727)
Accounts payable and accrued expenses............... 145,493 722,608
Interest payable.................................... 33,019 (103,598)
Other assets........................................ 6,899 19,118
---------------- --------------
Cash used in operating activities............................ (2,459,844) (2,594,989)
---------------- --------------
INVESTING ACTIVITIES
Purchases of equipment.................................. (60,721) (35,381)
Pending patent applications............................. (46,893) (107,644)
Deferred sale of subsidiary stock....................... -- 1,000,000
Cash recovery of investment in KFx Fuel Partners LP..... -- 200,000
---------------- --------------
Cash (used in) provided by investing activities.............. (107,614) 1,056,975
---------------- --------------
FINANCING ACTIVITIES
Issuance of preferred stock in subsidiary............... 750,000 1,000,000
Proceeds from sale of Pegasus preferred stock........... 1,972,331 -
Short term note issued to director...................... 300,000 550,000
Payments on note payable to director.................... (100,000)
Payments on notes payable............................... (311,332) (546,167)
---------------- --------------
Cash provided by financing activities........................ 2,610,999 1,003,833
---------------- --------------
Increase (decrease) in cash and cash equivalents............. 43,541 (534,181)
Cash and cash equivalents, beginning of period............... 348,955 654,429
---------------- --------------
Cash and cash equivalents, end of period..................... $ 392,496 $ 120,248
================ ==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest.................................. $ 624,165 $ 658,114
================ ==============
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Six Months Ended June 30, 2001:
The Company issued 174,500 shares of stock in exchange for consulting
services during the six months and to satisfy an obligation at December 31,
2000; a total of approximately $358,000 was charged to expense and to
reduce a corresponding liability. In connection with the sales of Pegasus
preferred stock, subject to KFx's obligation to repurchase, a debt discount
of $1,780,256 was recorded, which is being amortized to interest expense
over the one-year term of the repurchase obligation. On March 3, 2001,
Kennecott Energy's put option relative to its Pegasus common stock expired,
accordingly, the $1,000,000 sales price has been included in minority
interest as of June 30, 2001. Convertible Debentures with a face value of
$1,240,000 were converted, under the stated terms of $3.65 per share, into
339,726 shares of the Company's common stock resulting in an addition to
stockholders' equity approximating $1,206,130, net of a pro rata portion of
unamortized debt issue costs. Warrants to purchase 285,000 shares of
Pegasus common stock were issued in the second quarter of 2001, resulting
in debt discount of $102,348, which was recognized as interest expense on
the issuance date.
Six Months Ended June 30, 2000:
Convertible Debentures with a face value of $1,750,000 were converted,
under the stated terms of $3.65 per share, into 479,445 shares of the
Company's common stock resulting in an addition to stockholders' equity
approximating $1,637,000, net of a pro rata portion of unamortized debt
issue costs. Warrants valued at $2,200,000 to purchase 1.3 million shares
of KFx common stock at $3.65 per share, subject to certain adjustments, were
issued in the second quarter of 2000; see Note 3.
KFX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The accompanying financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. The Company
has incurred net losses of approximately $12,290,000, $12,730,000 and
$6,784,000 and negative cash flow from operations of $5,151,000, $3,458,000
and $4,642,000 in the years ended December 31, 2000, 1999 and 1998,
respectively, and an additional net loss of $5,820,000 and negative cash
flow from operations of $2,460,000 in the six months ended June 30, 2001
and had an accumulated deficit of approximately $76,912,000 as of June 30,
2001. These factors, coupled with the need for additional financing to fund
planned growth in the business, raise substantial doubt about whether the
Company can continue as a going concern. The Report of Independent
Accountants dated April 13, 2001 covering the Company's consolidated
financial statements for the year ended December 31, 2000 included an
explanatory paragraph discussing this going concern uncertainty.
In order to mitigate this uncertainty, the Company intends to seek
further capital through various means which may include the sale of all or
a portion of its interest in Pegasus, additional sales of debt or equity
securities, a business combination or other means and to further reduce
expenditures as necessary. Should the Company not be successful in
achieving one or more of these actions, it is possible that the Company may
not be able to continue as a going concern. The consolidated financial
statements do not include any adjustments that might result from the
outcome of this uncertainty.
The accompanying unaudited consolidated financial statements include
the accounts of KFX Inc. ("KFx" or the "Company"), its wholly owned
subsidiary, KFX Wyoming Inc., and its majority-owned subsidiaries, Pegasus
Technologies, Inc. ("Pegasus"), KFX Technology, Inc. ("KFxT"), and
Heartland Fuels Corporation. The Company's 51% interest in K-Fuel, L.L.C.
("K-Fuel, LLC") is accounted for as an equity investment since the 49%
partner, Kennecott Energy, has certain participative rights; accordingly,
the Company does not control K-Fuel, LLC. Until May 2000, the Company's 5%
interest in KFx Fuel Partners, L.P. ("KFP") was accounted for as equity
investment since the Company was a non-controlling investor in KFP. In May
2000, the Company sold its 5% interest in KFP to Black Hills Corporation,
see Note 3.
The consolidated financial statements at June 30, 2001 and for the
three and six month periods ended June 30, 2001 and 2000 are unaudited. In
the opinion of the Company's management, all adjustments, consisting of
only normal recurring adjustments, necessary for a fair statement of the
results for the interim periods have been made. Certain reclassifications
have been made to the 2000 financial statements to conform to the current
year presentation.
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted. These financial
statements should be read in conjunction with the audited financial
statements and notes to financial statements for the year ended December
31, 2000 included in the Company's Form 10-K. The accounting policies used
in the preparation of these unaudited quarterly financial statements are
the same as those policies used in the preparation of the audited annual
financial statements. The results of operations for the three and six
months ended June 30, 2001 are not necessarily indicative of the results of
operations expected for the year ended December 31, 2001.
Net loss per common share for the three and six month periods ended
June 30, 2001 and 2000 are based on the weighted-average number of shares
of common stock outstanding during the period, and excludes approximately
9,946,000 and 8,425,000 of potentially issuable common shares from common
stock options, warrants and convertible debt, as the effect on the
Company's net loss would be anti-dilutive.
NOTE 2. DEFERRED SALE OF PEGASUS COMMON STOCK, ISSUANCES OF PEGASUS
PREFERRED STOCK AND SALES OF PEGASUS PREFERRED STOCK
On March 3, 2000, KFx and Pegasus closed a transaction with Kennecott
Energy Company ("Kennecott Energy") that included, among various other
elements, (a) the sale of 4% of the common stock of Pegasus, held by KFx,
("Pegasus Common Stock") to Kennecott Energy for $1,000,000, (b) the
issuance by Pegasus to Kennecott Energy, in exchange for $500,000, of newly
authorized 6% cumulative convertible preferred stock ("Pegasus Preferred
Stock") equivalent to an additional 2% interest in Pegasus on an as
converted basis, and (c) the joint development by KFx, Pegasus and
Kennecott Energy of a work plan for enhancements to NeuSIGHT, new product
development and the completion of other tasks designed to improve the
performance of Pegasus and trigger additional purchases of Pegasus
Preferred Stock by Kennecott Energy at its discretion of up to $3,500,000,
for an additional interest in Pegasus up to 14%, on an as converted basis,
by December 31, 2004 or earlier. Through June 30, 2001, Kennecott Energy
has purchased $2,250,000 of additional Pegasus Preferred Stock, $750,000 of
which was purchased during the six months ended June 30, 2001. Through
March 3, 2001, Kennecott Energy had the right to sell the Pegasus Common
Stock back to KFx at a price equal to the greater of $1,000,000 or fair
market value; such right was not exercised and expired on March 3, 2001.
Accordingly, the $1,000,000 sale price has been included in minority
interest as of June 30, 2001.
During the six months ended June 30, 2001, KFx closed transactions with
various parties pursuant to which KFx sold a portion of its Pegasus
preferred stock investment in Pegasus, representing an approximate 11.6% as
converted interest in Pegasus, for $1,972,331. Included in these sales of
Pegasus preferred stock were sales to two directors of KFx and KFx's
Chairman, Theodore Venners, for $222,331 in exchange for an as converted
interest in Pegasus of 1.3%. KFx is obligated to repurchase this preferred
stock, or any other security issued with respect to this preferred stock,
for $2,787,561 at dates varying from January 31, 2002 to May 25, 2002, or
earlier upon the occurrence of certain events, such as a change in control.
In certain circumstances, the parties can individually elect to exchange
their interest in Pegasus, with an aggregate value of $2,787,561, and any
interest in Pegasus subsequently acquired by Evergreen Resources, Inc.
("Evergreen"), for common stock of KFx at $3.65 per share, subject to
certain adjustments, including a reduction to the then current market value
upon the conversion or satisfaction of the Company's 6% Convertible
Debentures due July 31, 2002 ("Debentures"). In addition, the parties were
provided with warrants, expiring five years after their issue, to purchase
an aggregate amount of 1,314,888 shares of KFx common stock at $3.65 per
share, subject to certain adjustments including a reduction to a
weighted-average price of $2.34 per share upon the conversion or
satisfaction of the Company's Debentures. The terms of these agreements are
substantially the same except that Evergreen, which paid $1,500,000 for an
approximate 8.8% as converted interest, can elect to defer the repurchase
date to January 31, 2003, in which case it will receive the right to
purchase from KFx an additional interest in Pegasus on similar terms,
excluding any additional warrants to purchase KFx common stock. Evergreen's
Chairman is a member of the Board of Directors of KFx.
Based on the terms and characteristics of the preferred stock sales as
discussed above, the instruments have been classified as debt in the June
30, 2001 balance sheet. Accordingly, the Company valued the related
warrants using a Black-Scholes option pricing model and recorded $843,247
as debt discount. In addition, the difference between the accounting
conversion price of the preferred stock and the fair value of KFx's common
stock on the dates of the transactions resulted in a beneficial conversion
feature in the amount of $937,009, which was calculated in accordance with
EITF 98-5, Accounting for Convertible Securities with Beneficial Conversion
Features or Contingently Adjustable Conversion Ratios and EITF 00-27,
Application of Issue No. 98-5 to Certain Convertible Instruments. The
beneficial conversion feature is reflected as additional debt discount in
the balance sheet at June 30, 2001. In the six months and quarter ended
June 30, 2001, the Company recorded $955,814 and $654,260, respectively, in
interest expense related to the amortization of the debt discount and the
accretion to redemption value.
At June 30, 2001, as a result of these additional investments of
Kennecott Energy in Pegasus Preferred Stock and KFx's sale of a portion of
its Pegasus Preferred Stock, the ownership, on an as converted basis, of
Pegasus is approximately as follows: KFx--56.7%, Pegasus founders--15.8%,
Kennecott Energy--15.9%, Evergreen Resources, Inc.--8.8% and other private
investors--2.8%.
NOTE 3. INVESTMENT IN KFP
On April 12, 2000, the Company executed agreements with various parties
that initiated the redevelopment of the KFP Facility. Pursuant to the
agreements (a) a subsidiary of Black Hills Corporation ("BKH") purchased
the KFP Facility and received 2 million shares of KFx common stock
previously held by Thermo Ecoteck Corporation ("TCK") in exchange for the
assumption of the reclamation liability associated with the KFP Facility,
(b) BKH was given the right to one seat on KFx's board of directors (which
to date it has declined to exercise), (c) KFx granted BKH a
fully-exercisable warrant, which expires April 30, 2005, to purchase 1.3
million shares of KFx common stock at $3.65 per share, subject to certain
adjustments including a reduction to a price of $3.48 per share upon the
conversion or satisfaction of the Company's Debentures, (d) KFx
relinquished its 5% interest in KFP to TCK and provided certain releases to
TCK in exchange for cash proceeds approximating $1.5 million and certain
real and personal property, and (e) TCK sold the remaining 2.25 million
common shares of KFx it owned to private investors and canceled the
warrant it held to purchase a control position in KFx's common stock. The
carrying value of the Company's investment in KFP was written down
effective December 31, 1999 by $1,800,000, to the $1,500,000 estimated cash
proceeds to KFx from these transactions. In addition, the estimated $2.2
million value of the warrant issued to BKH, using the Black-Scholes
method, was charged to expense in 1999.
NOTE 4. NOTES PAYABLE TO THE STATE OF WYOMING
Principal and interest under a promissory note ("Note") to the State of
Wyoming ("Wyoming") in the amount of $500,000 was due March 1, 2001, but
not paid. The Company initiated discussions with Wyoming in advance of the
maturity date and paid the interest due under the Note on April 10, 2001.
Substantially identical circumstances arose relative to a promissory note
("Chairman's Note") for $819,000 due to Wyoming by KFx's Chairman and one
of his affiliates. The Company agreed in 1994 to indemnify its Chairman and
his affiliate for any payments due under such note. In exchange for current
interest payments, Wyoming had previously granted the Company an extension
to August 1, 2001. On July 20, 2001, the Company made the final payment to
Wyoming in the amount of $1,161,583 for all principal and interest
outstanding at that date under the Note and the Chairman's Note. At the
time of the final payment, which fulfilled all obligations to Wyoming under
the Note and the Chairman's Note, Wyoming returned its 12% interest in the
K-Fuel process to the Company.
NOTE 5. SEGMENT INFORMATION
KFx's reportable segments are based on its principal products and
services, which are optimization software and related services, through its
Pegasus subsidiary ("Pegasus" segment), and clean fuels technology, through
certain activities of KFx and certain of its subsidiaries ("K-Fuel"
segment). The accounting policies of these segments are the same as
described in the Company's Annual Report on Form 10-K for the year ended
December 31, 2000. In addition, the goodwill and related amortization
resulting from the acquisition of Pegasus is included in the Pegasus
segment. KFx evaluates the performance of its segments and allocates
resources to them primarily based on its view of the potential for net
income and operating cash flow. There are no intersegment revenues;
however, KFx's corporate office charges management and related fees to the
Pegasus segment based on actual costs and estimated time and other
resources devoted to assist with and support the activities of Pegasus.
The tables below presents information about revenues, certain income
and expense categories, net loss, cash used in operating activities,
segment assets and certain other information used by KFx's Chairman and
CEO, its chief operating decision maker, as of June 30, 2001 and 2000 and
for the three and six month periods then ended:
RECONCILING
THREE MONTHS ENDED PEGASUS K-FUEL ITEMS (a) CONSOLIDATED
------------------ ------- ------ ----------------- ------------
June 30, 2001
Operating Revenues.............. $ 529,004 $ -- $ -- $ 529,004
Net Loss........................ $ (941,583) $ (352,072) $ (1,709,840) $ (3,003,495)
Cash Provided by (Used in)
Operating Activities............ $ (640,791) $ 216,457 $ (132,094) $ (556,428)
Total Assets $ 3,522,496 $ 2,573,601 $ 1,610,697 $ 7,706,794
June 30, 2000
-------------
Operating Revenues.............. $ 760,554 $ 99,976 $ -- $ 860,530
Net Loss........................ $ (844,423) $ (379,857) $ (1,825,235) $ (3,049,515)
Cash Provided by (Used in)
Operating Activities............ $ (741,034) $ 88,041 $ (409,379) $ (1,062,372)
Total Assets $ 3,009,305 $ 8,252,855 $ 691,378 $ 11,953,538
RECONCILING
SIX MONTHS ENDED PEGASUS K-FUEL ITEMS (a) CONSOLIDATED
---------------- ------- ------ ----------------- ------------
June 30, 2001
Operating Revenues.............. $ 776,954 $ -- $ -- $ 776,954
Net Loss........................ $ (1,959,832) $ (809,520) $ (3,050,864) $ (5,820,216)
Cash Provided by (Used in)
Operating Activities............ $ (1,200,555) $ 222,644 $ (1,481,933) $ (2,459,844)
Total Assets $ 3,522,496 $ 2,573,601 $ 1,610,697 $ 7,706,794
June 30, 2000
-------------
Operating Revenues.............. $ 1,226,192 $ 99,976 $ -- $ 1,326,168
Net Loss........................ $ (1,803,216) $ (880,328) $(2,688,726) $ (5,372,270)
Cash Provided by (Used in)
Operating Activities............ $(1,135,773) $ 75,433 $(1,534,649) $ (2,594,989)
Total Assets.................... $ 3,009,305 $ 8,252,855 $ 691,378 $ 11,953,538
(a) Consists primarily of KFx corporate office activities and consolidating entries.
NOTE 6. NOTES PAYABLE TO DIRECTORS
During the six months ended June 30, 2001, Pegasus borrowed $300,000
under an unsecured note payable to a director bearing interest at prime
plus 2%, due on demand. The terms of the agreement include a warrant to
purchase common stock of Pegasus equivalent to 1.5% of its then currently
outstanding common stock. The Company valued the warrant using a
Black-Scholes option pricing model and recorded $102,348 as debt discount,
which was immediately amortized to interest expense on the issuance date.
At June 30, 2001, the unpaid balance of this note was $300,000.
During the six months ended June 30, 2000, the Company borrowed
$550,000 under an unsecured note payable to a director bearing interest at
11.5% and personally guaranteed by the Company's Chairman. At June 30, 2001
the unpaid balance of these notes was $150,000.
In addition, at June 30, 2001, Pegasus had an unpaid balance of
$400,000 payable to another of the Company's directors under an unsecured
note, bearing interest at prime plus 2%, due on demand. The terms of the
agreement include a warrant to purchase common stock of Pegasus equivalent
to 1.5% of its then currently outstanding common stock.
NOTE 7. DEBENTURE PREMIUM
At June 30, 2000 the Company recorded a cumulative charge of $1,000,000
to correct previously unrecorded accretion of the 12% premium on its
Debentures. The Company cannot provide any assurance that the Debentures
will be converted prior to maturity on July 31, 2002; accordingly,
accretion of this premium is required under generally accepted accounting
principles. The impact of this correction on each of the quarters since the
Debentures were issued in July 1997 was not material. Accordingly, the
correction was recorded in the second quarter of 2000.
NOTE 8. CONTINGENCIES
On September 8, 2000, Pavilion Technologies, Inc. ("Pavilion"), a
competitor of Pegasus, served Pegasus with a complaint that it had filed on
August 14, 2000, in the United States District Court for the Southern
District of Texas, asserting that Pegasus infringed 26 patents allegedly
issued to or licensed by Pavilion (the "Pavilion Lawsuit"). The Pavilion
Lawsuit was subsequently transferred to the United States District Court
for the Northern District of Ohio. The Pavilion Lawsuit seeks injunctive
relief, compensatory and treble damages, as well as attorney's fees, costs
and expenses. Pegasus' products employ its own proprietary computer code as
well as computer code exclusively licensed to Pegasus. On September 15,
2000, the licensor agreed to defend Pegasus in the Pavilion Lawsuit
pursuant to an indemnification provision of the parties' license agreement.
On October 27, 2000, Pegasus filed an answer to the Pavilion Lawsuit
denying the patent infringement claims ("Pegasus Answer"). The Pegasus
Answer also asserted various counterclaims against Pavilion alleging unfair
competition, deceptive trade practices, defamation, tortuous interference
with business relationships and attempted monopolization in violation of
Section 2 of the Sherman Antitrust Act ("Pegasus Counterclaims"). After
consultation with counsel, KFx and Pegasus management believe that the
infringement allegations in the Pavilion Lawsuit are objectively baseless
and without merit. On April 11, 2001, Pegasus and Pavilion agreed to
dismiss the Pavilion Lawsuit, the Pegasus Answer and the Pegasus
Counterclaim, without prejudice, in order to explore possible business
combinations, cooperative relationships and other alternatives. On August
1, 2001, Pegasus purchased certain assets of Pavilion, see Note 10.
On November 4, 1999, Link Resources, Inc., a Georgia corporation,
("Link") and its two shareholders, Linda E. Kobel ("Kobel") and Gary A.
Sanden ("Sanden"), filed a complaint against the Company in US District
Court for the District of Colorado. The complaint alleges that KFX, Link,
Kobel and Sanden had entered into an agreement requiring KFX to acquire
Link and that KFX breached such agreement. The complaint seeks damages in
excess of $5.3 million. Although the ultimate resolution of this matter
cannot be predicted with certainty, based on a review of the underlying
facts and discussions with counsel, management believes that this complaint
is without merit. KFX intends to contest this complaint vigorously.
Accordingly, management does not believe that its ultimate outcome will
have a material adverse effect on the Company's consolidated financial
position, its results of operations or its cash flows.
As part of the restructured bond agreement with the State of Wyoming
("Wyoming") in 1994, Energy Brothers Holding, Inc., an affiliate of the
Company's Chairman; and the Company's Chairman, Theodore Venners, executed
a promissory note to Wyoming for $819,000, with annual interest at 6
percent. The Company agreed in 1994 to indemnify its Chairman and his
affiliate for any payments made under such note, upon his demand, since
their obligation stemmed from their personal guarantee of certain
obligations of the Company that were renegotiated in 1994. During 2000, the
Company made related principal and interest payments on behalf of its
Chairman totaling $82,150. In addition, similar payments totaling $158,587
were made during the six months ended June 30, 2001. The Company's Chairman
and his affiliate have agreed to waive their indemnification rights for
2001, triggering a 10-day cure period. On June 29, 2001, Wyoming agreed to
forebear from collection activities under this note until August 1, 2001.
In connection with the 1994 restructured bond agreement, the Company
entered into an agreement that requires the Company to pay Wyoming 12% of
its domestic license and royalty revenue. The rate decreases to 6% when
cumulative payments under this agreement total $5 million. On July 20,
2001, the Company made a final payment to Wyoming to satisfy these
commitments, see Note 10.
The Company is contingently liable to Ohio Valley Electric Corporation
("OVEC") for an overriding royalty of 0.5% to OVEC on the gross revenues
generated by the sale of fuel produced from any production plant (other
than the current facility owned by BKH) located in the United States in
which the feedstock is coal and which uses the Company's proprietary Series
"C" K-Fuel technology to produce fuel. The Company is contingently liable
to Fort Union for 20% of the Company's North American royalty proceeds. No
payments or accruals have been required through June 30, 2001 under these
agreements.
In 1996, the Company entered into a royalty amendment agreement with
Edward Koppelman, the inventor of the K-Fuel Technology. As a result of the
agreement, Mr. Koppelman's royalty is now 25% of the Company's worldwide
royalty and license fee revenue, computed after a State of Wyoming royalty.
The royalty to Mr. Koppelman will cease when the cumulative payments to him
reach the sum of approximately $75,222,000. Mr. Koppelman is now deceased
and his estate holds all royalty rights. The total amount paid under this
agreement through June 30, 2001 was $250,000.
Pegasus is contingently liable to certain of its founding stockholders
for a royalty equivalent to 2% of the license fee revenues derived from the
sale of its NeuSIGHT product through November 30, 2004. This obligation is
limited to the extent of pretax income without regard to such royalty,
subject to a maximum of $2.5 million and subject to certain other
limitations. Pegasus has made no payments or accruals through June 30, 2001
under this agreement.
NOTE 9. RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 141, "Business Combinations"
("FAS 141") and Statement of Financial Accounting Standard No. 142,
"Goodwill and Other Intangible Assets" ("FAS 142").
FAS 141 requires that all purchase business combinations must be
accounted for using the purchase method. Under this method, the purchase
price of an acquired business is allocated to the individual tangible and
intangible assets acquired and liabilities assumed based on the estimated
fair values at the date of acquisition. If the purchase price exceeds the
amounts assigned to assets acquired and liabilities assumed, the excess is
recognized as goodwill. Acquired intangible assets that do not meet certain
criteria for recognition apart from goodwill are included in the amount
initially recognized as goodwill. After initial recognition, goodwill and
intangible assets acquired in the business combination must be accounted
for under FAS 142. FAS 141 is effective for the Company for all business
combinations initiated after June 30, 2001, including the acquisition of
certain assets of Pavilion, see Note 10.
FAS 142 requires that after a company allocates the purchase price in
accordance with FAS 141, the assets acquired, liabilities assumed and
goodwill must be assigned to one or more reporting units based on certain
criteria outlined in FAS 142. In addition, goodwill will no longer be
amortized. Companies must perform transitional, annual, and, in certain
situations, interim impairment testing of their recorded goodwill, as well
as of their indefinite-lived intangible assets. Indefinite-lived intangible
assets would be tested for impairment by comparing the fair value of the
intangible asset with its carrying amount. FAS 142 is effective for the
Company for any goodwill acquired in a business combination entered into
after June 30, 2001, including the acquisition of certain assets of
Pavilion, see Note 10. The remaining provisions of the Statement are
effective for the year ending December 31, 2002.
The Company has not yet determined the effect of adoption of FAS 141 or
FAS 142, as applicable on its financial position or results of operations.
NOTE 10. SUBSEQUENT EVENTS
In July 2001, the Company issued 1 million shares of common stock at a
price of $3.65 per share and a warrant, expiring three years after the date
of issue, exercisable for 500,000 shares of KFx common stock, at a price of
$3.65 per share, subject to certain adjustments, to an institutional
investor, resulting in proceeds to the Company of $3.65 million.
On July 20, 2001, the Company made the final payment of $1,161,583 to
Wyoming for all principal and interest outstanding at that date under the
Note and the Chairman's Note (defined above in Note 4), for a clean coal
technology loan to develop the K-Fuel process. Until the final payment was
made, Wyoming owned a 12% interest in the K-Fuel process patents. Upon
final payment, which fulfilled all obligations under the Note and the
Chairman's Note, Wyoming returned its 12% interest to the Company in
accordance with the terms of the agreement between KFx and Wyoming.
On July 25, 2001, Cinergy Corp. ("Cinergy) advanced $3.5 million to
Pegasus against the existing contract between Pegasus and Cinergy. The
advance bears interest at 7% per annum. Cinergy may elect to apply future
Pegasus invoices against the advance or may choose to convert the balance
of the advance into KFx common stock, at a price of $3.65 per share, or
Pegasus common stock, at a price of $2.10 per share, subject to certain
adjustments. Cinergy also received a warrant, expiring three years after
the date of issue, exercisable 200,000 at $3.65 per share, subject to
certain adjustments.
On August 1, 2001, Pegasus and Pavilion entered into an agreement
providing for: (i) the purchase by Pegasus of certain Pavilion assets
relating to Process optimization for the utility based boiler, gas turbine
and power production and process steam turbine (the "Segment"); (ii)
Pegasus' rights and access to certain Pavilion assets, personnel and
services relating to the Segment; and, (iii) the licensing to Pegasus of
certain Pavilion intellectual property related to the Segment in a limited
field of use. Pegasus will pay: (i) a base price of $9,500,000 in
installments through July 31, 2003; and (ii) royalties of up to $5,500,000
over the next 51 months based on software licenses sold. Accordingly, the
Pavilion Lawsuit has been resolved and no accruals are recorded relating to
the Pavilion Lawsuit.
KFX INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This quarterly report includes forward-looking statements. We have
based these forward-looking statements on our current expectations and
projections about future events based on our knowledge of facts as of the
date of this quarterly report and our assumptions about future events.
These forward-looking statements are subject to various risks and
uncertainties that may be outside of our control, including, but not
limited to:
o the ability of the Company to continue to as a going concern;
o adverse market and various other condition that could impair the
Company's ability to obtain needed financing;
o actions or the inaction of the Company's strategic partners;
o the breadth or degree of protection available to the Company's
intellectual property;
o availability of key management and skilled personnel;
o competition and technological developments by competitors;
o lack of market interest in the Company's existing products and
any new products or services;
o changes in environmental, electric utility and other governmental
regulations;
o unanticipated problems that could arise in research and development
activities;
o cost overruns, delays and other problems that may occur in
developing, permitting, financing or constructing K-Fuel
production facilities;
o the availability of Section 29 or similar tax credits related to
any future K-Fuel production facilities; and o domestic and
international economic and political developments.
We use words like "believe," "expect," "anticipate," "will,"
"estimate," "project," "plan," and similar expressions to help identify
forward-looking statements in this annual report.
For additional factors that could affect the validity of our
forward-looking statements, you should read "Risk Factors" contained in
Part I, Item 1 of our annual report on Form 10-K for the year ended
December 31, 2000, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" contained in Part II, Item 7 of our
annual report on Form 10-K for the year ended December 31, 2000 and "Notes
to Consolidated Financial Statements" contained in Part II, Item 8 of our
annual report on Form 10-K for the year ended December 31, 2000. The
forward-looking statements included in this quarterly report are subject to
additional risks and uncertainties not disclosed in this quarterly report,
some of which are not known or capable of being known by the Company. The
information contained in this quarterly report is subject to change without
notice. Readers should review future reports that we file with the
Securities and Exchange Commission. In light of these and other risks,
uncertainties and assumptions, actual events or results may be very
different from those expressed or implied in the forward-looking statements
in this quarterly report or may not occur. We have no obligation to
publicly update or revise any forward-looking statement, whether as a
result of new information, future events or otherwise.
OVERVIEW
During the past several months, the Company has been able to establish
a platform to develop and implement a strategic plan to begin to realize
the potential growth of its two energy technology bases.
A 16-month project of its K-Fuel LLC joint venture with Kennecott
Energy culminated in the demonstration of an improved design for a K-Fuel
plant that was announced in February 2001. K-Fuel LLC is conducting studies
concerning appropriate means to further test the new process and design
facilities for production. In April 2001, Pegasus and Pavilion entered into
an agreement to dismiss the litigation pending between the two companies,
without prejudice, in order to explore possible combinations.
On May 9, 2001, KFx retained Raymond James & Associates to assist in
all aspects of strategic and financial planning to take advantage of the
rapidly growing energy market opportunities and determine an optimal course
of action for KFx's shareholders. In addition, it is management's belief
there is a far better understanding in Washington, D.C. today of the
importance of coal-fired power to meet the nation's energy needs, which it
believes will facilitate the Company's development and implementation of a
strategic plan to capitalize on the growth potential of its technologies.
In May 2001, Cinergy Corp. ("Cinergy"), a Cincinnati, Ohio based energy
company, selected Pegasus to install its NeuSIGHT optimization software on
a system-wide basis. Phase 1 of the Cinergy contract calls for
performance-based incentives measured by actual NOx reductions and is
expected to generate approximately $5-$8 million in revenues through May
2004, including potential revenues from performance provisions in the
contract of up to approximately $3 million. On July 25, 2001, Cinergy Corp.
("Cinergy) advanced $3.5 million to Pegasus against the existing contract
between Pegasus and Cinergy. The advance bears interest at 7% per annum.
Cinergy may elect to apply future Pegasus invoices against the advance or
may choose to convert the balance of the advance into KFx common stock, at
a price of $3.65 per share, or Pegasus common stock, at a price of $2.10
per share, subject to certain adjustments. Cinergy also received a warrant,
expiring three years after the date of issue, exercisable for 200,000 at
shares of KFx common stock, $3.65 per share, subject to certain
adjustments.
In July 2001, the Company issued 1 million shares of common stock at a
price of $3.65 per share and 500,000 shares of KFx common stock, at a price
of $3.65 per share, subject to certain adjustments, to an institutional
investor, resulting in proceeds to the Company of $3.65 million.
On August 1, 2001, Pegasus and Pavilion entered into an agreement
providing for: (i) the purchase by Pegasus of certain Pavilion assets
relating to Process optimization for the utility based boiler, gas turbine
and power production and process steam turbine (the "Segment"); (ii)
Pegasus' rights and access to certain Pavilion assets, personnel and
services relating to the Segment; and, (iii) the licensing to Pegasus of
certain Pavilion intellectual property related to the Segment in a limited
field of use. This agreement increases the Pegasus customer and installed
bases, allows Pegasus to offer additional solutions to customers and will
accelerate development of new products.
As disclosed in Note 7 to the Consolidated Financial Statements, the
second quarter of 2000 includes a $1,000,000 non cash, non operational
cumulative charge to correct the previously unrecorded accretion of the 12%
premium on its 6% Convertible Debentures. This maturity premium will only
be paid if the Debentures are not converted prior to their maturity in July
2002.
Pegasus' firm backlog of software license and installation contracts as
of June 30, 2001 was approximately $8,200,000, compared to approximately
$2,022,000 at June 30, 2000, an increase of 306%.
RESULTS OF OPERATIONS-THREE MONTHS ENDED JUNE 30, 2001 VS. THREE MONTHS ENDED
JUNE 30, 2000
Consolidated revenues in the second quarter of 2001 declined as
compared to the second quarter of 2000 by $331,526 (39%) due to a $99,976
decline in K-Fuel contract revenues in 2001 because of the suspension of
certain contract activities and decrease in Pegasus revenues of $231,550
(30%). The decrease in Pegasus revenues results from a decrease in the
level of software installation activity due to the lack of new orders prior
to the Cinergy order received in May 2001. Due to the recent increase in
the Pegasus backlog, mainly due to the Cinergy order as noted above, we
expect the trend of declining revenue to narrow and ultimately reverse in
future quarters.
Consolidated operating costs and expenses in the second quarter of 2001
declined as compared to the second quarter of 2000 by $281,487 (11%) due
primarily to the net effect of (a) a $45,797 (11%) decrease in Pegasus'
cost of software licenses and services triggered by the corresponding
revenue decrease, (b) a decrease of $54,277 (60%) in the costs at the
K-Fuel demonstration plant due to the suspension of certain contract
activities, (c) a decline in marketing, general and administrative expense
of $205,516 (16%) due to corporate level general and administrative cost
reductions at KFx as well as a decrease of approximately $260,000 at
Pegasus mainly due to the realization of a full quarter of staff reductions
that occurred during the second quarter of 2000, offset by an increase of
$67,531 (47%) in Pegasus' research and development costs.
The factors discussed above combined in the second quarter of 2001 to
produce an operating loss of $1,847,000, which was $50,039 greater than for
the second quarter of 2000. Pegasus' portion of the operating loss for the
second quarter of 2001 was $803,616, which approximates the corresponding
$785,700 operating loss for the second quarter of 2000. The combined K-Fuel
segment and corporate cost portion of the operating loss for the second
quarter of 2001 was $1,043,384 compared to $1,011,261 in 2000.
Non-operating items added $1,156,495 of net expense in the second
quarter of 2001, compared to $1,252,554 in the second quarter of 2000, for
a decrease of $96,059 (8%), largely due to a decrease in interest expense
of $123,750 (10%). The decrease in interest expense is due mainly to a
decrease of $910,431 in the accrual for the maturity premium on the
Convertible Debentures (accrual was $1 million for the second quarter of
2000) offset by an increase of $654,260 in accruals for the maturity
premium, debt discount and beneficial conversion charges related to the
second quarter 2001 sales to third parties of Pegasus Preferred Stock held
by KFx and KFx's related obligation to repurchase and debt discount of
$102,348, which was recognized as interest expense on the issuance date of
warrants for Pegasus common stock.
As a result of the above factors, the consolidated net loss of
$3,003,495 ($0.12 per share) for the second quarter of 2001 was $46,020
less than the net loss for the second quarter of 2000. Included in the
second quarter net losses were non-cash charges approximating $1,691,000
and $1,696,000, respectively.
RESULTS OF OPERATIONS-SIX MONTHS ENDED JUNE 30, 2001 VS. SIX MONTHS ENDED
JUNE 30, 2000
Consolidated revenues in the first half of 2001 declined as compared to
the first half of 2000 by $549,214 (41%) due to (a) a $99,976 decline in
K-Fuel contract revenues in 2001 because of the suspension of certain
contract activities, and (b) a decrease in Pegasus revenues of $449,238
(37%) due to the lack of new orders late in 2000 and during the first
quarter of 2001. Due to the recent increase in the Pegasus backlog, mainly
due to the Cinergy order as noted above, we expect the trend of declining
revenue to narrow and ultimately reverse in future quarters.
Consolidated operating costs and expenses in the first half of 2001
decreased as compared to the first half of 2000 by $483,716 (9%) due
primarily to the net effect of (a) a $189,527 (24%) decrease in Pegasus'
cost of software licenses and services triggered by the corresponding
revenue decrease, (b) a decrease of $86,982 (49%) in the costs at the
K-Fuel demonstration plant due to the suspension of certain contract
activities, (c) a decline in marketing, general and administrative expense
of $249,256 (10%), due to corporate level general and administrative cost
reductions at KFx of approximately $32,000, as well as a decrease of
approximately $353,000 at Pegasus mainly due to the realization of a full
six months of staff reductions that occurred during the second quarter of
2000, offset by an increase of $87,024 (33%) in Pegasus' research and
development costs.
The factors discussed above combined in the first half of 2001 to
produce an operating loss of $3,891,073, which was $65,498 greater than for
the first half of 2000. Pegasus' portion of the operating loss for the
first half of 2001 was $1,771,591, which approximates the corresponding
$1,744,919 operating loss for the first half of 2000. The combined K-Fuel
segment and corporate cost portion of the operating loss for the first half
of 2001 was $2,119,482 compared to $2,080,656 in 2000.
Non-operating items added $1,929,143 of net expense in the first half
of 2001, compared to $1,546,695 in the first half of 2000, for an increase
of $382,448 (22%), largely due to an increase in interest expense of
$339,598 (22%). The increase in interest expense is due mainly to $955,814
in accruals for the maturity premium, debt discount and beneficial
conversion charges related to 2001 sales to third parties of Pegasus
Preferred Stock held by KFx and KFx's related obligation to repurchase,
debt discount of $102,348, which was recognized as interest expense on the
issuance date of warrants for Pegasus common stock, and an increase in
interest on outstanding debt of approximately $81,000 (15%), offset by a
decrease of $821,121 (18%) in the accrual for the maturity premium on the
Convertible Debentures (accrual was $1 million for the first half of 2000).
As a result of the above factors, the consolidated net loss of
$5,820,216 ($0.23 per share) for the first six months of 2001 was $447,946
($0.01 per share) greater than the net loss for the first six months of
2000. Included in the year to date net losses were non-cash charges
approximating $2,959,000 and $2,422,000, respectively.
LIQUIDITY AND CAPITAL RESOURCES
During the first half of 2001, the Company used $2,459,844 of cash for
its operating activities, compared to $2,594,989 in the first half of 2000,
a decrease of $135,145. Included in the 2001 amount is $624,126 of interest
payments ($48,844 by Pegasus and $575,282 by KFx), $1,151,711 for other
Pegasus operations and $684,007 for the K-Fuel segment and other KFx
corporate activities. Included in the 2000 amount is $658,114 of KFx
interest payments, $1,135,773 for Pegasus' operations, and $876,535 for
KFx's corporate activities, offset by $75,433 of cash provided by the
K-Fuel segment's demonstration plant and laboratory.
Sources of cash during the first half of 2001 included $1,972,331 in
proceeds from the sale of Pegasus preferred stock held by KFx, which the
Company is required to repurchase during the first half of 2002, subject to
certain provisions that could accelerate or defer the required repurchase
date. Due to KFx's repurchase obligation, these sales are accounted for as
debt, see Note 2 to the Consolidated Financial Statements. In addition,
Pegasus issued $750,000 of Pegasus preferred stock to Kennecott Energy
during the first half of 2001.
In early May 2001, Pegasus and Pavilion agreed to dismiss, without
prejudice, a lawsuit pending between the companies and began combination
discussions. In addition, the Company engaged Raymond James & Associates,
an investment banking firm, to assist in all aspects of strategic and
financial planning. This step was taken as a part of the Company's ongoing
efforts to restructure its balance sheet in an optimal manner for the
benefit of its shareholders and in view of the rapidly growing energy
market opportunities. The Company had begun a similar effort initially
focused on Pegasus in mid 2000, but the Pavilion Lawsuit, which was filed
in the third quarter of 2000, precluded many of the options that were under
consideration at that time. Prior to the filing of the Pavilion Lawsuit and
subsequent to its dismissal the Company has received strong interest from
numerous industry sources to participate in the acceleration and
development of its products. On August 1, 2001, Pegasus and Pavilion
entered into an agreement providing for: (i) the purchase by Pegasus of
certain Pavilion assets relating to Process optimization for the utility
based boiler, gas turbine and power production and process steam turbine
(the "Segment"); (ii) Pegasus' rights and access to certain Pavilion
assets, personnel and services relating to the Segment; and, (iii) the
licensing to Pegasus of certain Pavilion intellectual property related to
the Segment in a limited field of use. Pegasus will pay: (i) a base price
of $9,500,000 in installments through July 31, 2003; and (ii) royalties of
up to $5,500,000 over the next 51 months based on software licenses sold.
On July 25, 2001, Cinergy Corp. ("Cinergy) advanced $3.5 million to
Pegasus against the existing contract between Pegasus and Cinergy. The
advance bears interest at 7% per annum. Cinergy may elect to apply future
Pegasus invoices against the advance or may choose to convert the balance
of the advance into KFx common stock, at a price of $3.65 per share, or
Pegasus common stock, at a price of $2.10 per share, subject to certain
adjustments. Cinergy also received a warrant, expiring three years after the
date of issue, exercisable for 200,000 shares of KFx common stock, at $3.65
per share, subject to certain adjustments.
In July 2001, the Company issued 1 million shares of common stock at a
price of $3.65 per share and a warrant, expiring three years after the date
of issue, exercisable for 500,000 shares of KFx common stock, at a price of
$3.65 per share, subject to certain adjustments, to an institutional
investor, resulting in proceeds to the Company of $3.65 million.
The Company is continuing to work toward its goal of licensing a large
commercial K-Fuel plant to Kennecott Energy. Upon granting a license to
construct a commercial scale K-Fuel production facility, KFx expects to
generate significant K-Fuel license fees and net cash flows.
From time to time, directors of the Company have provided to the
Company short term unsecured financing and the Company expects that such
financing, on at least a short-term basis, will continue to be available if
needed.
The Company expects its cash requirements over the remainder of 2001
with respect to day-to-day operations and debt service requirements to be
satisfied by (a) cash on hand, which as of August 10, 2001 approximated
$3.4 million; (b) $250,000 of Kennecott Energy's discretionary investments
in Pegasus in connection with the achievement of milestones under the work
plan, pursuant to provisions of the agreements executed in March 2000; (c)
potential additional investments in Pegasus and/or KFx from interested
participants in the power generation industry; (d) potential debt and/or
equity offerings of the Company; (e) potential fees from licensing new
K-Fuel facilities; (f) potential partners in connection with opportunities
to expand the Company's product and service offerings to the power
industry; and (g) unsecured short term borrowings for the Company and/or
Pegasus from one or more of its directors and/or other parties.
Depending on the outcome of various uncertainties, including those
discussed herein, the Company may be required to seek additional debt
and/or equity financing for general operating purposes and/or to meet debt
service requirements. The timing of collection of accounts receivable and
payment of accounts payable could significantly alter the Company's need
for at least temporary financing. Should the Company be required to seek
any additional debt and/or equity financing, its ability to do so will be
affected by the terms of the Debentures, which contain a number of
restrictions including (a) limitations on the Company's ability to incur
secured and unsecured debt, (b) limitations on the Company's ability to
sell assets or enter into merger agreements, and (c) provisions that would
reduce the Debenture conversion price from $3.65 per share if the Company
sells KFx common stock at a price below $3.65 per share. In addition,
included in the agreements among KFx and the other shareholders of Pegasus
are provisions governing the terms of investments from any new investors in
Pegasus, limiting the borrowings of Pegasus, and limiting the payment of
dividends by Pegasus. See also Note 1 of the Consolidated Financial
Statements.
There are no assurances that any of these potential funding sources
will materialize, and the Company does not currently have any commitments
with respect to any such funding sources. If the overall outcome of the
various uncertainties affecting the Company is not favorable, the Company
may be forced to seek debt and/or equity financing on terms and conditions
that may be unfavorable to the Company, if available at all. If the Company
requires additional financing and cannot obtain it when needed, the Company
may default on payments when due. Should the Company not be successful in
achieving one or more of the financing alternatives discussed above, the
Company may not be able to continue as a going concern.
ITEM 3. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
The Company is not currently subject to a significant level of direct
market risk related to interest rates, foreign currency exchange rates,
commodity prices or equity prices. The Company has no derivative
instruments and only $1,050,000 of floating rate debt and does not expect
to derive a material amount of its revenues or income from interest bearing
securities. Currently the Company has no significant foreign operations. To
the extent that the Company establishes significant foreign operations in
the future, it will attempt to mitigate risks associated with foreign
currency exchange rates contractually and through the use of hedging
activities and other means considered appropriate. The Company is
indirectly exposed to fluctuations in fuel commodity prices. To the extent
that fuel prices rise, there may be a tendency for greater demand for
certain of the Company's products and services, since K-Fuel and NeuSIGHT
have been shown to result in lower usage of coal and coal beneficiated fuel
products when used to generate electric power. The Company's fuel-related
products provide various environmental benefits that management believes
significantly mitigate the fuel commodity risk associated with the
Company's business. The Company holds no equity market securities, but does
face equity market risk relative to its own equity securities.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On September 8, 2000, Pavilion Technologies, Inc. ("Pavilion"), a
competitor of Pegasus, served Pegasus with a complaint that it had filed on
August 14, 2000, in the United States District Court for the Southern
District of Texas asserting that Pegasus infringed 26 patents allegedly
issued to or licensed by Pavilion (the "Pavilion Lawsuit"). The Pavilion
Lawsuit was subsequently transferred to the United States District Court
for the Northern District of Ohio. The Pavilion Lawsuit seeks injunctive
relief, compensatory and treble damages, as well as attorney's fees, costs
and expenses. Pegasus' products employ its own proprietary computer code as
well as computer code exclusively licensed to Pegasus. On September 15,
2000, the licensor agreed to defend Pegasus in the Pavilion Lawsuit
pursuant to an indemnification provision of the parties' license agreement.
On October 27, 2000, Pegasus filed an answer to the Pavilion Lawsuit
denying the patent infringement claims ("Pegasus Answer"). The Pegasus
Answer also asserted various counterclaims against Pavilion alleging unfair
competition, deceptive trade practices, defamation, tortuous interference
with business relationships and attempted monopolization in violation of
Section 2 of the Sherman Antitrust Act ("Pegasus Counterclaims"). After
consultation with counsel, KFx and Pegasus management believe that the
infringement allegations in the Pavilion Lawsuit are objectively baseless
and without merit. On April 11, 2001, Pegasus and Pavilion agreed to
dismiss the Pavilion Lawsuit, the Pegasus Answer and the Pegasus
Counterclaims, without prejudice, in order to explore possible business
combinations, cooperative relationships and other alternatives. On August
1, 2001, Pegasus and Pavilion entered into an agreement providing for: (i)
the purchase by Pegasus of certain Pavilion assets relating to Process
optimization for the utility based boiler, gas turbine and power production
and process steam turbine (the "Segment"); (ii) Pegasus' rights and access
to certain Pavilion assets, personnel and services relating to the Segment;
and, (iii) the licensing to Pegasus of certain Pavilion intellectual
property related to the Segment in a limited field of use. Pegasus will
pay: (i) a base price of $9,500,000 in installments through July 31, 2003;
and (ii) royalties of up to $5,500,000 over the next 51 months based on
software licenses sold. Accordingly, this matter has been resolved and no
accruals are recorded relating to the Pavilion Lawsuit.
On November 4, 1999, Link Resources, Inc., a Georgia corporation,
("Link") and its two shareholders, Linda E. Kobel ("Kobel") and Gary A.
Sanden ("Sanden"), filed a complaint against the Company in US District
Court for the District of Colorado. The complaint alleges that KFX, Link,
Kobel and Sanden had entered into an agreement requiring KFX to acquire
Link and that KFX breached such agreement. The complaint seeks damages in
excess of $5.3 million. Although this matter is still in discovery and its
ultimate resolution cannot be predicted with certainty, based on a
preliminary review of the underlying facts and discussion with counsel,
management believes that this complaint is without merit. KFX intends to
contest this complaint vigorously. Accordingly, management does not believe
that this matter will have a material impact on the results of operation,
financial position or cash flows of the Company.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
During the three months ended June 30, 2001, KFx issued the following
securities in private transactions pursuant to an exemption from the
registration requirements of the Securities Act of 1933, as amended
("Securities Act") under Section 4(2) of the Securities Act:
Number Sold Consideration
Date Terms of Exercise, if Convertible Title of Security or Granted Received
---- --------------------------------- ----------------- ---------- -------------
April 2001 N/A Common Stock 56,250 Professional services
valued at $205,313
May 2001 N/A Common Stock 12,000 Professional services
valued at $43,800
April 10, 2001 Exercisable at Warrants exercisable 33,333 50,000 (1)
$3.65 per share, for Common Stock
subject to certain
adjustments.
Expires five years
after the date of
issue.
May 21, 2001 Exercisable at Warrants exercisable 14,888 22,331 (2)
$3.65 per share, for Common Stock
subject to certain
adjustments.
Expires five years
after the date of
issue.
May 25, 2001 Exercisable at Warrants exercisable 33,333 50,000 (3_
$3.65 per share, for Common Stock
subject to certain
adjustments.
Expires five years
after the date of
issue.
1. This sum includes payment for 896,630 shares of Series C Preferred Stock
of Pegasus Technologies, Inc.
2. This sum includes payment for 845,237 shares of Series C Preferred Stock
of Pegasus Technologies, Inc.
3. This sum includes payment for 822,284 shares of Series C Preferred Stock of
Pegasus Technologies, Inc.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders of the Company was held on June 21,
2001 for the principal purposes of (a) electing three directors to the
Board of Directors; and (b) ratifying the selection of PricewaterhouseCoopers
LLP as the Company's independent accountant for the year ending December 31,
2001.
The following votes were cast by stockholders with respect to the
election of directors named in the Company's Proxy Statement, dated April
30, 2001, for the Annual Meeting:
Nominee Shares Voted For Shares Voted Against Shares Abstained
------- ---------------- -------------------- ----------------
Stanford M. Adelstein 22,329,743 3,600 54,915
Gary Nicholson 22,229,910 103,433 54,915
Mark S. Sexton 22,329,743 3,600 54,915
The following votes were cast by stockholders with respect to the
ratification of PricewaterhouseCoopers LLP as the Company's independent
accountant for the year ending December 31, 2001:
Shares Voted For Shares Voted Against Shares Abstained
---------------- -------------------- ----------------
PricewaterhouseCoopers LLP 22,262,458 62,150 63,650
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------ -----------
4.1* Warrant to Purchase 33,333 Shares of KFx Inc. Common Stock
issued to Mark S. Sexton as of April 10, 2001
4.2* Registration Rights Agreement Between the Company and Mark S.
Sexton dated April 10, 2001
4.3 Warrant to Purchase 14,888 Shares of KFx Inc. Common Stock
issued to Stanley G. Tate as of May 21, 2001
4.4 Registration Rights Agreement Between the Company and Stanley
G. Tate dated May 21, 2001
4.5 Warrant to Purchase 33,333 Shares of KFx Inc. Common Stock
issued to Mark S. Sexton as of May 25, 2001
4.6 Registration Rights Agreement Between the Company and Mark S.
Sexton dated May 25, 2001
* Document previously filed with the U.S. Securities and
Exchange Commission with the Company's Annual Report on
Form 10-K for the year ended December 31, 2000 and
incorporated herein by reference.
(B) REPORTS ON FORM 8-K
During the quarter ended June 30, 2001, the Company filed a Current
Report on Form 8-K dated April 20, 2001, under Item 5, Other Events.
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.
KFX INC.
/s/ PATRICK S. FLAHERTY
-------------------------------------------
PATRICK S. FLAHERTY
VICE PRESIDENT & CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER)
DATE: AUGUST 14, 2001