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EVERGREEN ENERGY INC - 10-Q/A - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) In this Form 10-Q, we use the terms "Evergreen Energy," "Evergreen," "we," "our," "us" and "Company" to refer to Evergreen Energy Inc. and its subsidiaries. C-Lock refers to our subsidiary C-Lock Technology, Inc. Buckeye refers to our subsidiary Bimco Inc. (previously known as Buckeye Industrial Mining Co.) and referred to as "Buckeye" herein. All references to K-Fuel, K-Fuel®, K-Fuel process, K-Fuel refined coal, K-Fuel refineries, K-Direct®, K-Fuel Plants, K-Fuel facilities, K-Direct facilities, K-Direct® plants, C-Lock®, and GreenCert™, refer to our technologies and patented processes explained in detail in this Form 10-Q or in our Annual Report on Form 10-K for the year ended December 31, 2010 filed on March 14, 2011. As further described in Note 5 - Temporary Capital and Stockholders' Equity, effective August 20, 2010, we effected a 1 for 12 reverse stock split and all shares and per share amounts have been restated as if the reverse stock split occurred in the applicable periods. Forward-Looking Information May Prove Inaccurate Some of the information presented in this Quarterly Report on Form 10-Q constitutes "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements that include terms such as "may," "will," "intend," "anticipate," "estimate," "expect," "continue," "believe," "plan," or the like, as well as all statements that are not historical facts. Forward-looking statements are inherently subject to risks and uncertainties that could cause actual results to differ materially from current expectations. Our ability to execute our business plan and develop our K-Fuel technology, and the successful development and operation of our Southern Coal Holdings ("SCH") venture with WPG Resources and other acquisition, joint venture or strategic opportunities may be adversely impacted by unfavorable decisions in pending litigation, the inability of Green Bridge Holdings to make future payments under the terms of the sale of the Landrica Development Company assets and our Ft. Union Plant, the inability to raise sufficient additional capital in a timely manner to pursue the development of the technology or the development and operation of SCH, the inability to successfully apply the K-Fuel technology to SCH's coal deposits, the inability of SCH to obtain regulatory approval for its activities, and/or adverse conditions for the marketing and sale of coal or upgraded coal. Although we believe our expectations are based on reasonable assumptions within the bounds of our knowledge of our business and operations, there can be no assurance that actual results will not differ materially from expectations. For additional factors that could affect the validity of our forward-looking statements, you should read the risk factors set forth in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2010 and the Consolidated Financial Statements contained therein. 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 us. 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. Business Update and Overview We were founded in 1984 and are a cleaner coal technology company that offers environmental solutions for the energy production and generation industries, primarily through our patented clean coal process and technology, K-Fuel. K-Fuel significantly improves the performance of low-rank sub-bituminous and brown coals and lignite. The process yields higher efficiency levels, which are variable depending on the type of coal processed, by applying heat and pressure to low-rank coals to reduce moisture. The increase is variable depending on the type of coal we process. Our GreenCert software suite focuses on providing power generators with operational intelligence, analytics to identify operational efficiencies. Through August 2011, we have executed on a number of our strategic objectives, the most significant of which relate to realigning our business focus towards K-Fuel and improving our balance sheet. In realigning the business focus towards K-Fuel, we attained two important milestones: (i) re-opened the K-Fuel test facility in Wyoming; and (ii) formed a joint venture with WPG Resources ("WPG"). Further, we completed an equity offering and entered into a settlement agreement with certain holders of our 2007 Notes and 2009 Notes, which not only resolved outstanding litigation but also resulted in the settlement of $17.3 million of our 2007 Notes. Both of these events served to improve our balance sheet. Southern Coal Holdings. On June 9, 2011, we completed the formation of our venture with WPG, an Australian listed mineral resources company, to jointly develop and produce K-Fuel throughout Australia. The venture, SCH is 50% owned by WPG Resources and 50% by us, and was incorporated in Australia in 2010 as a private limited liability company. WPG has contributed all of its sub-bituminous coal and lignite resources located in Australia to SCH and we have contributed a license for the K-Fuel technology and technical knowledge regarding the K-Fuel process. We believe that this joint venture is strategically located in the Asia Pacific region where demand for coal from countries such as India, China, Japan and Korea highlight the need for coal upgrading technologies. 32 -------------------------------------------------------------------------------- Table of Contents In July 2011, SCH released its preliminary estimate of resources in the Penrhyn Deposit, which is sub-bituminous coal, located in Penrhyn, Australia. The report, which is Joint Ore Reserves Committee ("JORC") compliant, and based upon a series of drilling and exploration efforts, established an estimated 350 million metric tonnes of coal deposits at Penrhyn, 92% of which are estimated to be in the "measured and indicated" mineral resources category. Further, the JORC compliant resource report also estimated "inferred" resources of 270 million metric tonnes of lignite in the Lochiel North Deposit. SCH continues exploratory and testing activities with respect to the identified coal deposits and we understand that SCH anticipates that additional resources will be identified in this process. As further described below under K-Fuel Testing Facility, we have begun testing samples from the Penhryn Deposit for suitability for upgrading through our K-Fuel process at our testing facility in Gillette, Wyoming and anticipate testing samples from the Lochiel North Deposit later in 2011. Depending upon the results of K-Fuel testing and coal market conditions, including the price of coal and other information, we anticipate that SCH will evaluate opportunities to maximize its profitability, including potentially selling coal directly into the market as a traditional mine, upgrading the deposits through the K-Fuel process for sale or a combination thereof. In addition to its coal resources, SCH benefits from port access at Port Pirie and other infrastructure owned or leased by WPG. There are further potential opportunities for SCH to partner with WPG by supplying its magnetite and pig iron operations in the region with coal. Future development of SCH is subject to the permitting, construction and completion of mining and K-Fuel upgrading facilities. Further, development of SCH and our continued participation in SCH is subject to obtaining sufficient financing to conduct these activities. Previously, we disclosed that our business strategy included the potential construction of a K-Fuel demonstration plant. As the SCH joint venture develops, we plan to further evaluate the propriety of a demonstration plant and may determine that it is most appropriate to focus our resources on the development and construction of a commercial K-Fuel plant at SCH. K-Fuel Testing Facility. Concurrent with the sale of our Fort Union site, we entered into a lease agreement to provide access to and use of our K-Fuel testing facility and certain equipment located on the Fort Union site for a period of five years at nominal cost to us. During the first quarter of 2011, we re-opened our testing facility in Gillette, Wyoming and have successfully completed coal upgrading tests using our K-Fuel process. In conjunction with our renewed focus on K-Fuel and concurrent re-start of the Gillette Test Facility, we began actively testing various partner and client coal resources to assess their suitability as feedstock for the K-Fuel process. To accommodate the increased interest in our coal upgrading process and deliver larger quantities of K-Fuel product to resource owners for their own evaluations, we implemented a project in Gillette that expands our testing capabilities by 100 kilograms per day of maximum capacity. This project is in the commissioning phase and is expected to become operational during the third quarter of 2011. Prior to this expansion, producing 100 kilograms of K-Fuel product required at least two full work weeks, without expanded personnel or additional shifts. The backlog for testing in our K-Fuel Test Facility is growing rapidly and the facility is expected to operate at its capacity for the duration of the year, subject to other equipment and human resource limitations. Coals from SCH and coals from North American and Asian companies are on-site and awaiting processing. The results from this testing will be used to further develop and evaluate our future business opportunities. Balance Sheet Improvements. On February 1, 2011, we completed a private placement of 6.2 million shares of our common stock and 12.0 million warrants to purchase our common stock, resulting in $14.5 million of net proceeds, after offering costs. Also on February 1, 2011, we executed an agreement to settle an aggregate of $17.3 million of our 2007 Notes and the associated litigation (the "Settlement Agreement"). The Settlement Agreement, among other things, required us to make a series of payments totaling $6.76 million, as further described in Note 6 - Debt and Note 10 - Commitments and Contingencies, which were partially funded by the private placement. On May 17, 2011, as a result of us satisfying all conditions under the Settlement Agreement, we redeemed $17.3 million of the 2007 Notes and issued a new convertible note with a principal amount of $1.55 million. See further discussion in Note 6 - Debt. Further, on February 14, 2011, we entered into an agreement with other existing 2007 Noteholders and exchanged $1.4 million in aggregate principal amount of 2007 Notes for an aggregate of 238,000 shares of our common stock. These two transactions reduced the principal balance of our outstanding 2007 Notes from $21.6 million as of December 31, 2010 to $2.8 million as of June 30, 2011. Other Recent Developments Through August 2011, we have taken other steps to improve our financial position, summarized as follows: † On March 29, 2011, we closed the sale of the assets of our subsidiary, Landrica Development Company, including the Fort Union plant and associated property located near Gillette, Wyoming for total consideration of $2.0 million in addition to the replacement of $5.2 million of reclamation bonds. See Note 12-Discontinued operations for further discussion. 33 -------------------------------------------------------------------------------- Table of Contents † On February 14, 2011, we entered into an amendment to the original warrant agreement with a holder of 2009 Convertible Preferred Stock, which resulted in net proceeds to us of $1.0 million. See further discussion in Note 5 - Temporary Capital and Stockholders' Equity. GreenCert We have been evaluating strategic alternatives related to GreenCert, including but not limited to evaluation of its relationship to and integration with our K-Fuel technology, potential sale, or joint venture of this business. We have completed the first part of the GreenCert evaluation and have determined that the K-Fuel and GreenCert technologies share only limited synergies and market overlap. In July 2011, GreenCert executed an agreement with a third party to implement its product, pursuant to which we anticipate will recognizing approximately $85,000 in revenue over the next six months. While we complete the evaluation to determine the propriety of a sale or joint venture of the GreenCert business and market conditions, we have taken steps to reduce losses incurred related to this segment. We believe these developments enable us to not only develop a business where we license our technology to coal companies, but may also enable us to jointly develop a traditional mine through SCH that utilizes our coal beneficiation process. Further, we believe these transactions have better positioned us to refocus our resources and continue to more clearly define objectives and clarify our strategic positioning. To this end, we expect to evaluate several alternatives, including but not limited to: (i) the development of a commercial K-Fuel plant through SCH rather than the K-Fuel demonstration plant previously disclosed; (ii) the evaluation of acquisition, joint venture and other strategic opportunities, domestically and internationally, where we could own or have access to coal assets for upgrading or where coal might be produced as a traditional coal mine operation; and (iii) the continued assessment of the GreenCert business. Significant Trends For the last several years, our operations have been focused on developing our two technologies, K-Fuel and GreenCert, and the construction of the Fort Union plant. To date, we have not yet generated significant revenues from either of these technologies or from the plant. Historically, most of our expenses are related to general and administrative expenses and plant costs. With the addition of Buckeye, we generated revenue and incurred more substantial mining costs. As a result of the sale of Buckeye and our Fort Union assets, the results of operations for the mining segment and plant segment are shown as discontinued operations and prior year comparative information is also restated and reflected in discontinued operations. See our Annual Report on Form 10-K for the year ended December 31, 2010 for further discussion related to our anticipated revenue and expense trends. RESULTS OF OPERATIONS Our business lines include the Technology segment and the GreenCert segment. The Technology segment is comprised of all operations that use, apply, own or otherwise advance our proprietary, patented K-Fuel process, including our headquarters and related operations, our testing facility in Gillette, Wyoming, activities of our SCH investment, and activities of Evergreen Energy Asia Pacific Corp. and KFx Technology, LLC, which holds the licenses to our technology. Corporate costs within our Technology segment are allocated to our GreenCert segment, generally on a percentage based on the number of employees, total segment operating expenses, or segment operating expenses plus segment capital expenditures. Our GreenCert software suite focuses on providing the owners and operators of the power generation companies' collaborative tools and business analytics to improve profitability and efficiencies throughout their energy fleets. Our operations are principally conducted in the United States. Data through segment operating (loss)/ income is what is provided to our Chief Operating Decision Maker. As a result of the sale of Buckeye and the signing of a definitive agreement for the sale of our Fort Union assets, the Mining and the Plant segments were reclassified to discontinued operations for our condensed consolidated financial statements. We will continue to evaluate how we manage our business and, as necessary, adjust our segment reporting accordingly. Revenue Revenues for the three and six months ended June 30, 2011 were $100,000 and $200,000, respectively, compared to $103,000 and $203,000 for the same periods ended June 30, 2010, respectively. General and Administrative Corporate costs within our Technology segment are allocated to our other segment, generally on a percentage, based on the number of employees, total segment operating expenses or segment operating expenses plus segment capital expenditures. As a result of the sale of Buckeye and our Fort Union assets, the results of operations for the mining segment and plant segment are shown as discontinued operations and prior year comparative information is also restated and reflected in discontinued operations. 34 -------------------------------------------------------------------------------- Table of Contents The following table summarizes our general and administrative costs for the three and six months ended June 30, 2011 and 2010. Three Months Ended Six Months Ended June 30, June 30, 2011 2010 2011 2010 (in thousands) Employee non-cash, share-based compensation $ 210 $ 257 $ 1,177 $ 2,262 Employee-related costs 934 1,213 2,029 2,686 Professional fees 1,908 817 3,261 1,739 Office and travel costs 462 370 956 848 Insurance and other 816 517 1,379 1,137 Total general and administrative $ 4,330 $ 3,174 $ 8,802 $ 8,672 Employee non-cash, share-based compensation expenses were $210,000 and $257,000 for the three months ended June 30, 2011 and 2010, respectively. Employee non-cash, share-based compensation expenses were $1.2 million and $2.3 million for the six months ended June 30, 2011 and 2010, respectively. The decrease for the six months ended June 30, 2011 compared to the same period ended in 2010 was primarily due to a transition agreement we entered into with a former officer in our Technology segment. Pursuant to that agreement, we accelerated vesting of a restricted stock grant and recorded $1.6 million of non-cash compensation for the six months ended June 30, 2010 in our Technology segment. Partially offsetting this reduction are the impacts of new grants made to various employees, principally in the Technology segment, during the last half of 2010 and first quarter of 2011. Employee-related costs primarily include salaries and wages, bonuses, benefits, employer payroll taxes and education and training. The following table summarizes our employee-related costs associated with each of our segments for the three and six months ended June 30, 2011 and 2010. Three Months Ended Six Months Ended June 30, June 30, 2011 2010 2011 2010 (in thousands) Technology $ 710 $ 703 $ 1,267 $ 1,602 GreenCert 224 510 762 1,084 Total employee-related $ 934 $ 1,213 $ 2,029 $ 2,686 Employee-related costs decreased for the three months ended June 30, 2011 compared to the three months ended June 30, 2010 because of lower head-count in our GreenCert segment. The decrease for the six months ended June 30, 2011 in comparison to the same period in 2010 was due to lower head-count in both our GreenCert and Technology segments. Professional fees include legal, audit and accounting, public relations, governmental relations and similar costs. The following table summarizes our professional fees related to each of our segments for the three and six months ended June 30, 2011 and 2010. Three Months Ended Six Months Ended June 30, June 30, 2011 2010 2011 2010 (in thousands) Technology $ 434 $ 730 $ 787 $ 1,571 GreenCert 1,474 87 2,474 168 Total professional fees $ 1,908 $ 817 $ 3,261 $ 1,739 The increase in professional fees for the three and six months ended June 30, 2011 in our GreenCert segment primarily relates to litigation costs and an accrual for a pending litigation settlement offer when compared to the same periods ended 2010. The decrease for the three and six months ended June 30, 2011 in our Technology segment relates to costs incurred during the three and six months ended June 30, 2010 related to our 2007 Notes litigation. See Note 10-Commitments and Contingencies for further details. 35 -------------------------------------------------------------------------------- Table of Contents Office and travel costs include airfare, lodging, meals, office rent, marketing, office supplies, phone, publications, subscriptions and utilities. The following table summarizes our office and travel costs related to each of our segments for the three and six months ended June 30, 2011 and 2010. Three Months Ended Six Months Ended June 30, June 30, 2011 2010 2011 2010 (in thousands) Technology $ 366 $ 205 $ 726 $ 524 GreenCert 96 165 230 324 Total office and travel $ 462 $ 370 $ 956 $ 848 Insurance and other costs primarily include costs related to our property, commercial liability, and other insurance and all costs that cannot be categorized elsewhere and include, among other costs, various business and franchise taxes, licensing fees, repair and maintenance, engineering and technical services and director expenses. The following table summarizes our insurance and other costs related to each of our segments for the three and six months ended June 30, 2011 and 2010. Three Months Ended Six Months Ended June 30, June 30, 2011 2010 2011 2010 (in thousands) Technology $ 783 $ 362 $ 1,315 $ 846 GreenCert 33 155 64 291Total insurance and other $ 816 $ 517 $ 1,379 $ 1,137 Insurance and other costs increased in our Technology segment for the three and six months ended June 30, 2011 compared to the same periods ended in 2010 primarily due to warrants that were issued to Stanhill Special Situations Fund related to our professional services agreement (see Note 9 - Related Parties for further detail.) Included in our Technology segment is non-cash compensation expense for our Board of Directors, of which we recorded $210,000 and $39,000 for the six months ended June 30, 2011 and 2010, respectively. Impairment We are required to test our GreenCert capitalized software development costs for recoverability at each reporting period. Due to the unlikelihood that Green House Gas legislation will be passed in the United States in the near-term for energy-related companies, we believe there is uncertainty for us to generate revenue from the GreenCert Energy System and to recover our costs from the creation and sale of carbon credits. As a result of this recoverability test, we impaired capitalized costs related to our GreenCert energy software module by $2.5 million, of which $2.4 million was previously reflected in construction in progress and $100,000 in property plant and equipment in our condensed consolidated balance sheet. During the three months and six months ended June 30, 2011, we recorded $64,000 and $1.0 million of impairment expense related to the abandonment of certain patents and write off of certain furniture and fixtures at our corporate location. Other Interest expense Interest expense for the quarter ended June 30, 2011 was $46,000 compared to $459,000 for the quarter ended June 30, 2010. Interest expense for the six months ended June 30, 2011 was $224,000 compared to $1.5 million for the same period ended 2010. The decrease for the three and six months is primarily due to the reduction of the principal balance of our 2007 Notes. See further details in Note 10- Commitments and Contingencies. Gain (loss) on fair value derivatives We are required to evaluate the fair value of the embedded derivatives at the end of each reporting period. We recognized a $3.1 million and $2.3 million gain on the fair value adjustments for our embedded derivatives for the quarters ended June 30, 2011and 2010, respectively. We recognized a $2.5 million loss and a $4.9 million gain for the six months ended June 30, 2011 and 2010, 36 -------------------------------------------------------------------------------- Table of Contents respectively. These fair value adjustments are non-cash items, and each quarter's estimations are impacted, in part, by our stock price. See Note 6 - Debt and Note 10 - Commitments and Contingencies for further discussion related to the 2007 Notes. 37 -------------------------------------------------------------------------------- Table of Contents Loss on warrant modification and exercise On February 14, 2011, one share of the 2009 Preferred Stock was converted into 139 shares of our common stock. Additionally, we entered into an amendment to the original warrant agreement with the holder, in which we gave cash consideration of $1.5 million paid contemporaneously with the exercise of 321,502 warrants. Upon the exercise of the warrants we received $1.0 million, net of the cash consideration we paid. We recorded $1.0 million of other expense during the six month period ended June 30, 2011 related to this transaction. See Note 5 - Temporary Capital and Stockholders' Equity for further details. Gain (loss) on early extinguishment of debt We recorded a $10.2 million gain on the 2007 Note settlement during the three months ended June 30, 2011. We recorded a $6.7 million gain on the 2007 Note settlement during the six months ended June 30, 2011. See Note 10 - Commitments and Contingencies for further details. During the three and six months ended June 30, 2010, we recorded a $2.3 million loss on the early extinguishment of the 2009 notes primarily related to the acceleration of debt issuances costs, the acceleration of exit fees and the write-off of the derivatives associated with these notes. Discontinued Mining and Plant Operations Discontinued Mining Operations Discontinued Mining Operations is comprised of the following: Six Months Ended June 30, 2011 2010 (in thousands) Mining revenue $ - $ 12,619 Coal mining operating costs - (12,058 ) General and administrative - (1,426 ) Depreciation, depletion & amortization - (1,281 ) Other loss - (2,733 ) Loss from discontinued mining operations $ - $ (4,879 ) Discontinued Plant Operations Discontinued Plant Operations is comprised of the following: Six Months Ended June 30, 2011 2010 (in thousands) Revenue $ - $ - Plant costs (172 ) (254 ) General and administrative - - Gain on sale of assets 3,895 689Income from discontinued plant operations $ 3,723 $ 435 Liquidity and Capital Resources We have decreased our cash flow used in operations by $1.6 million when comparing the six months ended June 30, 2011 to the same period in 2010. Our cash used in operating activities from continuing operations increased by $2.3 million when compared to the prior year period. The increase in cash used in continuing operations is primarily due to the $1.45 million forbearance fee paid to the Settling 2007 Noteholders, its related settlement advisory and restructuring fees, an increase in overall professional fees, primarily related to higher litigation costs, and an increase in research and development costs. These factors offset our reductions in other general and administrative costs during the second quarter of 2011. Our cash used in discontinued operating activities decreased by $4.0 million when compared to the prior year period, primarily due to the cessation of operations in our Mining and Plant segments. During the six months ended June 30, 2011, we did not have any activity in our Mining segment and had substantially discontinued our Plant operations by March 31, 2011. 38 -------------------------------------------------------------------------------- Table of Contents On-going costs associated with corporate, K-Fuel and GreenCert operations required us to raise additional capital in 2010 and again in February 2011. As a result, we completed three financing transactions: (i) on March 16, 2010, we entered into a securities purchase agreement, and received gross proceeds of approximately $9.3 million; (ii) on January 26, 2010, we consummated a registered direct public offering and raised gross proceeds of approximately $8.7 million; and (iii) on February 1, 2011, we completed a private placement to sell 6.2 million shares of our common stock and 12.0 million warrants to purchase our common stock, resulting $14.5 million of net proceeds, after the offering expenses. See Note 5-Temporary Capital and Stockholders' Equity to the condensed consolidated financial statements included herein for further description of these financings. On March 30, 2011, we closed the sale of the assets of our subsidiary, Landrica Development Company, including the Fort Union plant and associated property located near Gillette, Wyoming, to Green Bridge Holdings, Inc. a subsidiary of Synthetic Fuels LLC. Concurrent with the sale, we and Green Bridge Holdings entered into a lease agreement to provide access to and use of the K-Fuel testing facility and certain equipment located on the Fort Union site for a period of five years at nominal cost to the company. The sale is expected to provide an aggregate of approximately $7.2 million of available cash comprised of: (i) cash payments of $2.0 million, of which $500,000 was paid at closing, $500,000 is to be paid on the first anniversary of closing and the remaining $1.0 million on the second anniversary of closing; and (ii) the payment for the transfer of the $5.2 million of reclamation bonds pertaining to the sold property, which will be paid pursuant to a note secured by a mortgage on the property and payable on or before the one year anniversary of the closing. Upon closing, Green Bridge Holdings assumed the environmental liabilities of the site. We paid $100,000 in exit costs upon closing. Further, we will be required to pay additional closing costs of $368,000 upon receipt of the $5.2 million due pursuant to the note. Proceeds from the sale will be used for general working capital purposes. See further discussion in Note 12 - Discontinued Operations to the condensed consolidated financial statements included herein. On February 14, 2011, we entered into an amendment to the original warrant agreement with a holder of 2009 Convertible Preferred Stock, which resulted in net proceeds to us of $1.0 million. See further discussion in Note 5 - Temporary Capital and Stockholders' Equity. As previously described, on February 1, 2011, we executed a Settlement Agreement that provided for, assuming the final settlement date was reached and the settlement was completed; (i) the settlement of an aggregate of $17.3 million of the 2007 Notes; (ii) the payment of $6.7 million to the Settling 2007 Noteholders; and (iii) the issuance of a new note for $1.55 million due on the one year anniversary of the final settlement date, that bears interest at 7% and is convertible into shares of our common stock at the market value of the shares on the date the exchange. This agreement also called for the dismissal of the litigation that was pending between us, Buckeye, the Settling 2007 Noteholders and the 2009 Noteholders. On May 17, 2011, as a result of us satisfying all conditions under the Settlement Agreement, this transaction closed. Further, on February 14, 2011, we entered into an agreement to exchange $1.4 million of face value of 2007 Notes for 237,500 shares of our common stock. These two transactions reduced the principal balance of our outstanding 2007 Notes from $21.6 million as of December 31, 2010 to $2.8 million as of June 30, 2011. This reduced outstanding balance will decrease interest incurred from $1.9 million for the year ended December 31, 2010 to an estimated $340,000, on an annualized basis, including interest related to the new $1.55 million note. We have a history of losses, deficits and negative operating cash flows and may continue to incur losses in the future. Any continued market disruptions associated with the economic downturn, lower demand for our technology or products, increased incidence of customers' inability to pay their accounts, or insolvency of our customers, could adversely affect our results of operations, liquidity, cash flows, and financial condition. We continue to evaluate our cash position and cash utilization and may make additional adjustments to capital or certain operating expenditures. As stated above, we continue to require additional capital, primarily to fund the development of our K-Fuel process technology, and expect to investigate sources of additional capital. Further, as opportunities arise to accelerate the expansion of our K-Fuel technology, including the execution of any acquisition, joint venture or any other strategic transaction, or our anticipated operating cash outflows are greater than expected, we will likely need to obtain further funding. We believe we have the ability to raise additional capital from time to time as needed principally through: (i) equity offerings; (ii) debt or debt offerings; and (iii) partnering with third parties. While we believe we will obtain additional capital through one or more of the alternatives described, we can provide no assurance that any of the alternatives will be available or be on acceptable terms. We have been evaluating strategic alternatives related to GreenCert, including but not limited to evaluation of its relationship to and integration with our K-Fuel technology, potential sale, or joint venture of this business. We have completed the first part of this evaluation and have determined that the K-Fuel and GreenCert technologies share only limited synergies and market overlap. While we complete the evaluation to determine the propriety of a sale or joint venture of the GreenCert business and market conditions, we have taken steps to reduce losses incurred related to this segment. 39 -------------------------------------------------------------------------------- Table of Contents Historical View Cash Used in Operating Activities Cash used in operating activities of continuing operations was $10.1 million and $8.5 million for the six months ended June 30, 2011 and 2010, respectively. The majority of the cash used in continuing operations for the six months ended June 30, 2011 relates to cash used in our on-going operations adjusted for non-cash items, and changes in operating assets and liabilities the most significant being: † $(8.4) million non-cash gain from the 2007 Noteholders Settlement, † $1.0 million loss from exercise of warrants, † $1.6 million non-cash compensation, † $2.5 million from derivative fair value adjustments, † $400,000 from a debt-to-equity exchange transaction, † $2.5 million from the impairment of GreenCert energy software. The most significant adjustments for the six months ended June 30, 2010 were: † $2.3 million non-cash compensation, † $(3.2) million from derivative fair value adjustments and † $2.3 million related to the write-off of debt issuance costs on our 2009 Notes retirement. Cash Provided by (Used in) Investing Activities Cash provided by (used in) investing activities of continuing operations was $191,000 and $1.3 million for the six months ended June 30, 2011 and 2010, respectively. The majority of the uses of cash relate to the following: † We spent $200,000 and $1.3 million primarily relating to GreenCert development for the six months ended June 30, 2011 and 2010, respectively. † We received $400,000 in proceeds from the Ft. Union sale, net of selling costs, during the six months ended June 30, 2011. Cash Provided by (Used in) Financing Activities Cash provided by (used in) financing activities of continuing operations during the six months ended June 30, 2011 was $10.0 million compared to $(6.8) million for the six months ended June 30, 2010. The increase between the two periods principally relates to the exercise of warrants, and the financing activities further described in Note 5- Temporary Capital and Stockholders' Equity to the condensed consolidated financial statements included herein. This increase was offset by payments made to the Settling 2007 Noteholders as further described in Note 10-Commitments and Contingencies to the condensed consolidated financial statements included herein. Further, payments were made to the 2009 Noteholders during the six months ended June 30, 2010, which are further described in Note 6-Debt to the condensed consolidated financial statements included herein. Cash Used in Discontinued Operations Cash used in operating activities of discontinued operations was $(700,000) and $(4.6) million for the six months ended June 30, 2011 and 2010, respectively. The decrease in operating cash used was due to the cessation of operations in our Mining and Plant segments. Cash provided by investing activities of discontinued operations was $2.8 million and $23.5 million for the six months ended June 30, 2011 and 2010, respectively. During the quarter ended June 30, 2011, the escrow balance of $2.8 million related to the sale of certain Buckeye and Evergreen assets was released from restricted cash. During the six months ended June 30, 2010, we received $23 million in proceeds from the sale of certain of Buckeye and Evergreen assets, and we also received $500,000 in proceeds from the sale of a boiler. 40 -------------------------------------------------------------------------------- Table of Contents |