UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                           WASHINGTON, D.C. 20549

                                 FORM 10-K


         (Mark One)
         [X]     Annual Report Pursuant to Section 13 or 15(d) of the
                 Securities Exchange Act of 1934 For the Fiscal Year Ended
                 December 31, 2000

         [ ]     Transition Report Pursuant to Section 13 or 15(d) of the
                 Securities Exchange Act of 1934

                       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)

        Securities registered pursuant to Section 12(b) of the Act:

  TITLE OF EACH CLASS                     NAME OF EXCHANGE ON WHICH REGISTERED
Common Stock, $.001 par value                  American Stock Exchange

      Securities registered pursuant to Section 12(g) of the Act: None

     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 [ ]

    Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
cootained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. [ ]

    As of April 12, 2001, the aggregate market value of the Registrant's
common stock held by non-affiliates of the Registrant was approximately
$34,203,000. At April 12, 2001, 25,358,780 shares of common stock of the
Registrant were outstanding.





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                             TABLE OF CONTENTS


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                                                                      Page No.
                                                                      -------
PART I
Item 1.      Business...................................................  3

Item 2.      Properties................................................. 27

Item 3.      Legal Proceedings.......................................... 28

Item 4.      Submission of Matters to a Vote of Security Holders........ 29

PART II

Item 5.      Market for Common Stock and Related
             Stockholder Matters........................................ 29

Item 6.      Selected Financial Data.................................... 30

Item 7.      Management's Discussion and Analysis of Financial
             Condition and Results of Operations........................ 30

Item 7A.     Quantitative and Qualitative Disclosures About Market Risk. 38

Item 8.      Financial Statements and Supplementary Data................ 38

Item 9.      Changes in and Disagreements with Accountants on
             Accounting and Financial Disclosures....................... 38

PART III

Item 10.     Directors and Executive Officers .......................... 39

Item 11.     Executive Compensation..................................... 39

Iuem 12.     Security Ownership of Certain Beneficial Owners and
             Management................................................. 39

Item 13.     Certain Relationships and Related Transactions............. 39

PART IV

Item 14.     Exhibits, Financial Statement Schedules, and Reports on
             Form 8-K................................................... 40

SIGNATURES   ........................................................... 43




PART I

ITEM 1. BUSINESS

OVERVIEW

    KFX Inc. (the "Company" or "KFx"), a Delaware corporation formed in
1988, is engaged in developing and delivering various technology and
service solutions to the electric power generation industry to facilitate
the industry's (a) compliance with various air quality emission standards
on a domestic as well as worldwide basis and (b) need to lower the cost of
producing electricity, particularly domestically as the United States power
industry undergoes deregulation and is transformed into a highly
competitive business. Currently, the Company has technology solutions that
enhance the output of coal-fired electric utility boilers while
simultaneously reducing the related environmental impacts and facilitating
compliance with various environmental standards, most importantly the Clean
Air Act, as amended (the "CAA"). The Company currently considers its
business to be in two operating segments, Pegasus Technologies, Inc.
("Pegasus") and K-Fuel(TM) Technology ("K-Fuel"), both of which serve the
same end industry and provide similar benefits, but which have distinctly
different technology bases. Prior to the acquisition of Pegasus in 1998,
the Company operated only in the K-Fuel segment.

    Pegasus develops, markets, licenses and installs software that
opuimizes the combustion performance of coal-fired electric utility
boilers. Its NeuSIGHT(TM) ("NeuSIGHT") flagship product has been installed
at 17 boiler units and is under installation or is scheduled to be
installed at 11 boiler units, across the United States and Canada. In
addition, a NeuSIGHT installation is nearing completion in Poland,
installations at five additional boiler units in Poland are scheduled and
an installation at one boiler unit in China was recently initiated. The
NeuSIGHT installations underway or scheduled are expected to be completed
within approximately the next 12-18 months. NeuSIGHT utilizes an artificial
intelligence/neural network software platform licensed from a wholly-owned
subsidiary of Computer Associates International ("CA") to interface with
the process control system in coal-fired electric utility boiler units. The
license agreement provides Pegasus perpetual, irrevocable, worldwide,
exclusive rights for process monitoring and control applications in the
electric utilities industry. NeuSIGHT collects real time operating data and
builds a model of optimal boiler combustion performance, taking into
account various safety, environmental and other constraints. NeuSIGHT can
be set to optimize the reduction of various emissions, such as nitrogen
oxide ("NOx"), a boiler's heat rate (a measure of boiler operating
efficiency considering fuel consumed in comparison to electricity
generated), and/or other boiler performance measures. NeuSIGHT provides the
most benefit when operated in a closed loop mode, whereby automatic
adjustments are made to various controllable factors, such as oxygen input.
Pegasus is continuously pursuing the development of improvements to
NeuSIGHT as well as complementary new products and services. Although not
currently a product development or marketing focus, NeuSIGHT is expected to
be adaptable to various non-coal fired boiler units as well.

    The Company's K-Fuel segment has developed and begun commercialization
of its patented K-Fuel Technology, which is a process technology that uses
heat and pressure to physically and chemically transform high-moisture,
low-energy value coal and other organic feedstocks into a low-moisture,
high-energy solid clean fuel ("K-Fuel"). The K-Fuel Technology is generally
regerred to as a coal beneficiation process, which refers to processes
intended to produce, using run-of-mine coal as feedstock, fuels with
improved energy and environmental values. The principal benefit of the
K-Fuel Technology is that the fuel produced from the process can facilitate
the efforts of electric power producers and other large-scale users of coal
to meet the clean air standards imposed by the CAA. Based on various
analyses, the environmental benefits of burning K-Fuel versus most other
coals appear to include significant reductions in emissions of NOX, sulfur
dioxide (SO2), carbon dioxide (CO2), mercury and chlorine. KFx plans to
license K-Fuel Technology domestically and internationally to various
parties wishing to construct and operate K-Fuel production facilities and
accordingly, earn related license fee income and product sale or production
royalty income. In addition, KFx will consider negotiating for equity
interests in selected K-Fuel production facilities operated by K-Fuel
licensees in connection with its grant of a K-Fuel license. K-Fuel
operations are conducted through KFx Inc. and certain of its subsidiaries.

    Summary financial information about each segment for 2000, 1999 and
1998 follows; for additional segment information see Note 17 to the
Consolidated Financial Statements.

            2000                           Pegasus          K-Fuel
            ----                           -------          ------
            Operating Revenues           $ 1,894,994    $     229,776
            Operating Loss               $(4,131,294)   $  (2,216,959)
            Total Assets                 $ 3,242,295    $   3,278,160

            1999
            ----
            Operating Revenues           $ 1,536,884    $   1,313,916
            Operating Loss               $(3,266,584)   $  (1,055,085)
            Total Assets                 $ 3,457,574    $   9,052,687

            1998
            ----
            Operating Revenues           $ 1,328,491    $     892,094
            Operating Loss               $(1,234,038)   $  (1,674,101)
            Total Assets                 $ 3,230,954    $  11,843,799

     The Company will continue to consider various options to expand its
business by adding other solutions (including technologies, products and
services) to meet (a) the needs of the electric power industry as it is
transformed by deregulation into a highly competitive industry and (b) the
increasingly stringent environmental standards triggered by indications of
global warming and other environmental concerns.

     Although the Company is pursuing various international opportunities
in both segments, during each of the three years ended December 31, 2000,
most of the Company's operating activities were conducted domestically.
However, Pegasus generated revenues from Canadian customers approximating
$119,000, $224,000 and $166,000 in 2000, 1999 and 1998, respectively.


PEGASUS

General

    In March 1998, the Company purchased a 60% interest in Pegasus
Technologies Limited ("Pegasus Limited"), an Ohio limited liability
company. Pegasus Limited had developed a software technology that optimizes
the performance of coal-fired electric utility boilers. Pegasus' flagship
product, NeuSIGHT, provides two primary benefits: improved combustion
performance and reduction in NOX emissions. NOX is a primary component of
ground level smog. See "Market Drivers--Domestic Market." Additional
benefits of NeuSIGHT include (a) improvements in boiler efficiency (heat
rate), which translate into lower fuel costs, as well as lower emissions of
SO2 and CO2; (b) an increase in gross generating capacity, providing more
electricity for the power company to sell; (c) lower carbon in the ash
waste by-product, which can convert a related waste product disposal cost
into a marketable ash product; and (d) improvements in opacity, which
refers to the visible exhaust discharged from an emissions stack.

    NeuSIGHT dynamically models in real time the operating conditions of
the electric utility boiler combustion process and makes alterations to
operating variables, which improve boiler heat-rate performance, reduce
harmful emissions and lower fuel costs. Maximum benefits are achieved by
allowing NeuSIGHT to operate in closed loop mode wherein its alterations to
operating variables are automatically invoked.

    In August 1998, the Company formed Net Power Solutions, LLC ("NPS"), a
Delaware limited liability company, primarily to provide marketing and
sales services to Pegasus Limited. From late 1998 through November 30,
1999, NPS hired and trained a marketing and sales staff, developed
marketing programs and materials and generally performed the sales and
marketing for Pegasus Limited. Pursuant to an agreement dated December 13,
1999, the members of Pegasus Limited and NPS including the Company,
exchanged their membership interests in Pegasus Limited and NPS for shares
of common stock of a new company, Pegasus Technologies, Inc., effective
November 30, 1999. At November 30, 1999 and December 31, 1999, KFx held 75%
of the outstanding common stock of Pegasus Technologies, Inc., with the 25%
balance held by Pegasus management. Hereafter, references to Pegasus
include the activities of Pegasus Limited and NPS prior to this exchange,
as well as the subsequent activities of Pegasus Technologies, Inc. and its
subsidiaries.

    On March 3, 2000, KFx and Pegasus closed a transaction with Kennecott
Energy Company ("Kennecott Energy") resulting in (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 Pegasus 6% cumulative
convertible preferred stock ("Pegasus Preferred Stock") equivalent to an
additional 2% interest in Pegasus on an as converted basis, (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 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 and (d) the conversion of
secured debt owed by Pegasus to KFx, totaling $3,630,000, into Pegasus
Preferred Stock, at the same price as provided to Kennecott Energy. Through
December 31, 2000, Kennecott Energy had exercised its rights to purchase
additional Pegasus Preferred Stock equivalent to an additional 6% as
converted interest in Pegasus, for $1,500,000. In addition, during the
fourth quarter of 2000, KFx purchased Pegasus Common Stock equivalent to an
aqproximate 2.25% interest from one of the Pegasus founders in connection
with his resignation. At December 31, 2000, the ownership of Pegasus on an
as converted basis was approximately as follows: KFx--70.7%, Pegasus
founders--16.5% and Kennecott Energy--12.8%. Through April 12, 2001,
Kennecott Energy has exercised its rights to purchase additional Pegasus
Preferred Stock equivalent to a 2 % as converted interest in Pegasus, for
$500,000. Kennecott Energy had the right to sell the Pegasus Common Stock
back to KFx at any time before March 3, 2001, which right was not exercised
and has expired.

    On February 9, 2001, KFx closed a transaction with Evergreen Resources,
Inc. ("Evergreen") under which KFx sold to Evergreen a portion of its
Pegasus Preferred Stock investment in Pegasus, representing an approximate
8/8% as converted interest in Pegasus, for $1,500,000. KFx is obligated to
repurchase this preferred stock for $2 million plus 6% of the repurchase
price per annum on January 31, 2002, or earlier upon the occurrence of
certain events, such as a change in control. Evergreen can elect to defer
KFx's required repurchase date to January 31, 2003, which will trigger a
right for it to purchase from KFx an additional interest in Pegasus. In
certain circumstances, Evergreen can elect to exchange this interest in
Pegasus, valued at $2 million plus 6% per annum, and any subsequently
acquired interest in Pegasus, for common stock of KFx at $3.65 per share,
subject to certain adjustments. In addition, Evergreen was provided with a
five-year warrant to purchase 1,000,000 shares of KFx Common Stock at $3.65
per share, subject to certain adjustments.

    As a result of the additional investments of Kennecott Energy in
Pegasus Preferred Stock through April 12, 2001, KFx's sale of a portion of
ius Pegasus Preferred Stock on February 9, 2001 to Evergreen and KFx's
sales of Pegasus Preferred Stock to other private investors, the ownership
of Pegasus at April 13, 2001 is approximately as follows: KFx--57.9%,
Pegasus founders--16.0%, Kennecott Energy--14.9%, Evergreen Resources,
Inc.--8.8% and other private investors--2.4%.

    In connection with the March 2000 transaction, Pegasus and Kennecott
Energy also formed a Colorado limited liability company, Net Power
Solutions, LLC ("Net Power Solutions"), to facilitate the combined
marketing, on a non-exclusive basis, of technologies, products and services
that can be provided by Kennecott Energy, Pegasus, KFx and other potential
parties. Pegasus and Kennecott Energy own Net Power Solutions equally.
Since its formation, Net Power Solutions has been involved in various joint
marketing activities involving Kennecott Energy, Pegasus and KFx, but has
incurred no expenses nor generated any revenues.

    In the fourth quarter of 2000, Pegasus introduced the enhanced NeuSIGHT
2001 version of its flagship product. NeuSIGHT 2001 features simple
installation and configuration that lets the user drag and drop icons onto
a design platform to configure its own system. During 2000, 1999 and 1998
Pegasus research and development expenses totaled $614,000, $336,000 and
$138,000, respectively.

    As of April 13, 2001, Pegasus has firm unfilled sales commitments
(backlog) for NeuSIGHT licenses and related installations at an estimated
contract value of $2,522,000, which are generally expected to be filled
within approximately the next 12-18 months. At April 14, 2000, such backlog
approximated $2,549,000.

    During 2000, the following individual Pegasus clients accounted for
greater than 10% each of consolidated revenues: Ameren/Union Electric--30%,
Dairyland Power Cooperative--18% and American Electric Power--12%. During
1999, two individual Pegasus clients accounted for greater than 10% each of
coosolidated revenues: Carolina Power & Light--19% and Houston Light &
Power--11%. During 1998, three individual clients accounted for greater
than 10% each of consolidated revenues, Houston Light & Power--22%,
Ameren/Union Electric--13% and Cinergy--10%. Although the existence of such
major clients is partly a result of Pegasus' limited customer base,
management also believes it is an indication of the level of client
satisfaction with Pegasus products and services since these relationships
involve multiple license and installation contracts and two of the same
clients are included in two of the three years of statistics.


Strategic Relationships

    In March 1999, Pegasus executed an agreement with Science Applications
International Corporation (SAIC) providing SAIC with certain exclusive
rights to install NeuSIGHT software in North America, as a subcontractor to
Pegasus. Under the terms of the agreement, SAIC has the right to perform
NeuSIGHT installations related to Pegasus license sales that Pegasus elects
not to perform with its own staff. Subject to certain termination
provisions covering performance and other matters, the agreement expires
after SAIC completes 30 installations of NeuSIGHT or three years, whichever
occurs first. In exchange for certain services, investments and preferred
billing rates by SAIC, the agreement also provides for an equal sharing
between Pegasus and SAIC of a defined measure of Pegasus gross profits
derived from the installation services provided by SAIC to Pegasus
customers under the agreement. Through December 31, 2000, no payments by
Pegasus or related accruals have been required under these profit sharing
provisions. On April 19, 2000, SAIC assigned its rights and obligations
under this agreement to one of its affiliates, Data Systems & Solutions,
LMC ("DS&S").

    During the first quarter of 2000, Pegasus entered into value added
reseller ("VAR") agreements with Babcock & Wilcox ("B&W") and ABB Centrum
("ABB") providing for certain minimum purchases of NeuSIGHT licenses from
Pegasus and providing B&W and ABB certain resale rights. Later in 2000, the
B&W VAR agreement was amended to provide only for joint marketing
activities and the provision of B&W installation personnel at preferred
rates. In addition, in connection with the final testing of an installation
for ABB at the Jawarzno power station in Poland, various previous
agreements with ABB were revised to provide ABB with the exclusive resale
rights in Poland and $500,000 of minimum purchases of NeuSIGHT by February
27, 2002. No revenue has been recognized from these agreements through
December 31, 2000.

    Late in 2000, Pegasus took two steps to enter the market in the
People's Republic of China ("China"). During the third quarter of 2000,
Pegasus signed a letter of intent for the installation of its flagship
NeuSIGHT product at four coal-fired boiler units, with a total generating
capacity of 1200 megawatts, at the Xibanpo power station in China, near
Beijing. In late November 2000, a firm order was received for the first of
these installations, which was recently initiated. During the fourth
quarter of 2000, Pegasus entered into a license agreement with BITCO
Enterprises ("BITCO"), providing BITCO and certain affiliates with the
exclusive right to market Pegasus' NeuSIGHT technology in the People's
Republic of China in exchange for a nonrefundable $300,000 fee and future
license fees. Pegasus and BITCO are negotiating the final terms of this
agreement, which are to include minimum performance thresholds that must be
met by BITCO in order to maintain the exclusive status. No revenue has been
recognized from these agreements through December 31, 2000.

    Pegasus will pursue additional VAR and similar arrangements with
appropriate parties as a means to quickly and cost effectively gain access
to potential customers, particularly in foreign countries.

Intellectual Property

    NeuSIGHT utilizes a neural network technology licensed from a
subsidiary of CA under an agreement which, among other terms, grants
Pegasus a perpetual, irrevocable, world-wide, exclusive right and license
for use in process monitoring and control applications in the electric
utilities industry. Payments are made to CA for each neural network license
sold, one of which is required for each NeuSIGHT installation. Through
August 1999, CA was also a 15% owner of Pegasus, at which time CA sold such
interest to KFx in exchange for 527,000 common shares of KFx; see Note 12
to the consolidated financial statements. The programming code that
constitutes NeuSIGHT is a trade secret.

Competition

    Pegasus faces direct competition from approximately six companies that
offer software products providing combustion optimization benefits to the
emectric power industry.In addition, Pegasus faces indirect competition
from a similar number of companies that offer control systems used to
oqerate utility boiler units, which contain certain combustion optimization
features. Management believes the NeuSIGHT software solution offers several
competitive advantages over competitors' offerings. Most significantly, in
a survey completed in December 1998 by Resource Data International, a
subsidiary of the Financial Times, NeuSIGHT has been documented as
providing greater benefits than competing products in the areas of NOx
reduction and heat rate improvement. In addition, NeuSIGHT has demonstrated
ao ability to operate in closed-loop supervisory mode for extended time
periods without intervention.

    NeuSIGHT's neural network model is considerably more extensive and
therefore more effective than competing products, through its ability to
manage higher volumes of input variables (up to 7 times the level of
competing products). While NeuSIGHT's neural network models are
sophisticated and complex, the software has a unique capability to retrain
the model automatically as operating conditions change in the plant.
Competing product models are generally static and require periodic
retuning, making them more costly to maintain and less effective over time.
In management's opinion, these and other features provide a much greater
ability for the software to adapt to changing environmental conditions,
equipment degradation, instrument calibration drift, and operating
variances.

    In the opinion of management, compared with competing companies,
Pegasus provides more extensive implementation and training programs that
result in an end product more closely correlated to the actual operating
conditions of the specific boiler unit. Pegasus is focused exclusively on
the needs of the electric power generation industry rather than serving
various industries with differing needs. This focus, coupled with the
expertise of its personnel in this market, enable Pegasus to deliver
somutions that provide significantly greater reductions in NOx, higher
levels of operating efficiency and other benefits not provided by
competitors. Competing products tend to emphasize price as their basis of
comparison, while Pegasus is focused on cost benefit analysis and return on
investment. While Pegasus believes it is the leader in the industry, based
on the number of installed systems in the electric power generation
industry, certain direct competitors may have greater financial and other
resources than Pegasus. In addition, Pegasus may face increased or new
competition from indirect competitors and other vendors to the electric
power generation industry, many of which have significantly greater
financial and other resources than Pegasus.


K-FUEL TECHNOLOGY

General

    The K-Fuel Technology is comprised of three groups, or series, of
patents. The Series "A" and Series "B" Technology patents are based on hot
gas and steam heat-transfer mediums, respectively. The Series "C"
Technology is based on a nitrogen heat-transfer medium. The principal
difference between the Series "A" and "B" Technologies and the Series "C"
Technology is that Series "C" is based on a more simplified design with
respect to the manufacturing equipment and facilities, resulting in lower
caqital costs. The Company expects the Series "C" Technology to be
primarily used for coal fuel product-manufacturing facilities. The Series
"A" and "B" Technologies can be used for coal fuel product facilities, as
well as renewable resource fuel product manufacturing facilities (e.g.,
bagasse, municipal solid waste, sludge and wood waste). The Series "A" and
"B" Technology patents were developed by Edward Koppelman and assigned to a
predecessor of the Company under a 1984 research and development contract
(the "R&D Contract") with the Company. The Company purchased the Series "C"
Technology patent directly from Mr. Koppelman after completion of the R&D
Contract in 1995 for $1.3 million. The Company is currently focusing its
commercialization efforts on the development of projects for the
manufacture of coal fuel product using the Series "C" Technology. To date,
one commercial-scale K-Fuel manufacturing facility has been constructed,
which began operations in April 1998 and suspended operations in June 1999.
See "Strategic Relationships--Thermo Ecotek Corporation and KFx Fuel
Partners" in this section. The development of future K-Fuel manufacturing
facilities is expected to result primarily from the K-Fuel, LLC, joint
venture with Kennecott Energy. See "Strategic Relationships-Kennecott
Energy Company" in this section.

    In the Series "C" process, raw coal is crushed and screened before it
is introduced into a steel alloy processing vessel that is then pressurized
and heated indirectly using vertical tube heat exchangers. Nitrogen,
serving as an inert, non-oxidizing heat-transfer medium, is admitted to the
tube side of the processing vessel at a pressure of approximately 125
pounds per square inch ("psi"). After the nitrogen is inserted, it picks up
heat from the walls of the tube and gradually expands to approximately 800
psi. Water is released from the coal during this expansion period. When the
temperature in the tubes reaches in excess of 520 degrees Fahrenheit, any
water remaining in the coal turns to steam and continues to process the raw
coal. When the temperature of the coal reaches approximately 650 to 740
degrees Fahrenheit, the process is complete. The process takes 30 to 40
minutes to complete from initial loading of the raw coal into the
processing vessels to final discharge of finished K-Fuel product.

    The principal benefit of the K-Fuel Technology in the United States is
that the fuel produced from the process can facilitate the efforts of
electric power producers, manufacturers and other large-scale users of coal
to meet the clean air standards imposed by the CAA. Based on various
independent and Company analyses, the environmental benefits of burning
K-Fuel versus most other coals appear to include significant reductions in
emissions of NOx, SO2, CO2, mercury and chlorine. K-Fuel is the first
beneficiated coal product that has not exhibited significantly greater
tendency for spontaneous combustion than run-of-mine Powder River Basin
("PRB") coal. In addition, K-Fuel has been demonstrated to increase gross
power generation, reduce fuel-pulverizing requirements, blend well with
other coals and flow well through coal handling systems. K-Fuel has
exhibited a level of dustiness that requires the use of dust suppression
equipment on site at most domestic coal-fired power plants.

    See "Strategic Relationships-Kennecott Energy Company" in this section
for a discussion of the demonstration of improvements to the K-Fuel process
developed during 2000 by the joint venture between KFx and Kennecott
Energy.

    In May 1998, the Southern Research Institute conducted a test burn of
apqroximately 10 tons of K-Fuel, which was also overseen by a technical
services affiliate of Kennecott Energy. The results of this test burn are
summarized in the table below:

<TABLE>
<CAPTION>

                                         Btu                  Emissions (ppm)
                                    (As Received)      (Corrected to 3% O2 Dry Basis)
                                    -------------      ------------------------------
                                                          NOX                    SOX
                                                          ---                    ---
<S>                                    <C>                <C>                    <C>
      K-Fuel......................     11,703             142                    173
      Dry Fork Subbituminous......      8,903             172                    215
      Lone Mountain Bituminous....     13,315             265                    530
</TABLE>


    In February 1999, the first commercial burn of K-Fuel was completed. A
unit train (approximately 12,000 tons of K-Fuel produced at the KFP
Facility; see "Strategic Relationships--Thermo Ecotek Corporation and KFx
Fuel Partners" in this section) was burned at Indiana-Kentucky Electric
Corporation's Clifty Creek generating station in southern Indiana. A fuel
blend of approximately 60% K-Fuel, with the balance consisting of a blend
of high-Btu, high and low-sulfur Eastern coals, replaced relatively
low-Btu, low-sulfur southern PRB coal in one of the station's boiler units.
Results of the test burn indicate that K-Fuel appeared to produce: a) a
reduction in NOx emissions while maintaining full load yet reducing
auyiliary power, b) no unusual slagging or fouling of the boiler, c) a
reduction in the fuel pulverizing operations, d) no spontaneous combustion
and e) an improvement in boiler efficiency. Indiana-Kentucky Electric's
fuel is procured by American Electric Power.

    The results from this commercial scale burn at Clifty Creek generally
confirm the results of the test burn performed by the Southern Research
Institute. The Company believes that K-Fuel produced a reduction in SO2 and
CO2 emissions but the plant instrumentation precluded clear quantification.
The handling characteristics of K-Fuel were acceptable with proper use of
the power station's existing dust suppressant system. Nevertheless, KFx
continues to work to improve the handling characteristics of K-Fuel.

    One of the Company's subsidiaries, KFx Technology, Inc., ("KFxT") has
performed research and development services related to the K-Fuel
technology under a contract with Western Research Institute ("WRI"), a
non-profit research organization based in Laramie, Wyoming. During 2000,
revenues from this contract approximated 11% of consolidated revenues. Such
revenues in 1999 were less than 10% of consolidated revenues. During 1998,
revenues from this contract approximated 15% of consolidated revenues.
Excluding depreciation, the costs under this contract approximated the
remated revenues and totaled $230,000, $117,000, and $344,000 in 2000, 1999
aod 1998, respectively.

    Work under the most recent contract with WRI has been completed and
there is no commitment for an additional contract from WRI or other
potential customers of KFxT. Accordingly, KFxT staff was reduced in the
first quarter of 2001, pending identification of revenues from WRI or other
parties.


Strategic Relationships

Kennecott Energy Company and K-Fuel, LLC

    In April 1996, the Company entered into a joint venture  agreement (the
"Kennecott Agreement") with a wholly-owned  subsidiary of Kennecott Energy.
Tie joint  venture,  a Delaware  limited  liability  company  named K-Fuel,
L.L.C. ("K-Fuel, LLC"), is intended to be the vehicle for further technical
advancement and the commercialization of business opportunities arising out
of the K-Fuel Technology, including research and development, sublicensing,
marketing and consulting,  but not including the construction of facilities
to produce K-Fuel products on a commercial basis  ("Commercial  Projects").
Any Commercial  Projects will be constructed by separate  entities in which
Kennecott  Energy,  the Company,  both or third parties will have an equity
ioterest and which will be granted a sublicense  from K-Fuel,  LLC, for the
K-Fuel  Technology.  In 1996,  Kennecott Energy paid a fee of $1,000,000 to
tie Company to enter into the K-Fuel,  LLC, joint venture. In June 1999, in
connection with certain  amendments to the Kennecott  Agreement,  Kennecott
Energy  purchased a K-Fuel  license and paid KFx an initial  license fee of
$1,000,000  for a minimum plant size of 666,667 tons of annual  capacity to
be located at a site of its choice.  This license is expandable to a larger
capacity  plant,  upon the payment of additional  initial  license fees. In
addition,  Kennecott Energy paid to KFx an additional $1,000,000, which KFx
invested   in   K-Fuel,   LLC  to   support   the  next   phase  of  K-Fuel
commercialization, as required by the June 1999 amendments to the Kennecott
Agreement.  Any technology  related to the Company's  technology  developed
through the work plan funded by the $1,000,000  investment in K-Fuel,  LLC,
will be owned by Kennecott  Energy and  licensed  free of charge to K-Fuel,
LLC. The non-refundable payment related to the K-Fuel license accounted for
35% of the Company's consolidated revenues in 1999.

    Under the work plan funded by the June 1999 investment in K-Fuel, LLC,
an improved K-Fuel process was demonstrated in late 2000, as announced in
early February 2001. The principal differences from the K-Fuel Series C
process previously used are continuous operations, lower temperatures, and
the absence of superheat from the system. The resulting product, which in
the tests was produced from Powder River Basin ("PRB") coals, is low in
SO2, NOX, mercury and chlorine, similar to K-Fuel. Analysis from this work
plan indicates that an improved process can possibly be designed to produce
the new fuel within potentially attractive economic constraints and that
the K-Fuel production process proposed as a result of the project should be
more reliable than was the KFP Facility when operated by Thermo Ecotek
Corporation (See "Strategic Relationships--Thermo Ecotek Corporation and
KFx Fuel Partners" in this section) and have lower capital and operating
costs than any previous K-Fuel plant design.

    The heating value of the new fuel as tested is approximately 11,200 to
11,600 Btu's per pound. Upon combustion, the new fuel produces
approximately 20% lower NOX emissions and lower mercury emissions, as
compared to the PRB feedstock coal (already the lowest mercury content coal
naturally available), and SO2 emissions well below the 1.0 lb per million
Btu limit contained in Phase II of the CAA.

    In addition, K-Fuel, LLC believes that there may be considerable
advantages to blending the new product and raw PRB coal. The dust and
self-heating behaviors of a blend of the new product and raw PRB coal
appear to be similar to raw PRB coal, without the need for oil or other
treatment. The blend retains proportional NOX, SO2 and mercury reduction
benefits. Therefore a commercial plant for the new product may be leveraged
to provide considerably higher volumes of blended product for the market
place.

    K-Fuel, LLC is conducting studies concerning appropriate means to
further test the new process and design facilities for production. As of
April 13, 2001, there were no commitments to construct any K-Fuel plants.

    The Company has a 51% percent interest in K-Fuel, LLC, and Kennecott
Eoergy has a 49% interest. Due to certain participatory voting rights
provided to Kennecott Energy in the Kennecott Agreement, as amended, the
Company does not control K-Fuel, LLC. At such time as entities in which
Keonecott Energy has an equity interest have placed into service Commercial
Projects with a collective design capacity equal to or in excess of 3
million tons per year ("TPY") of K-Fuel product, Kennecott Energy's
interest in K-Fuel, LLC, will increase to 51% and the Company's interest
will decrease to 49%. During 2000, 1999 and 1998, K-Fuel, LLC incurred
related research and development costs totaling approximately $482,000,
$23,000 and $134,000, respectively.

    In connection with the Kennecott Agreement, the Company granted K-Fuel,
LLC, an exclusive, worldwide, fully-paid, royalty-free right and license
(including the right to grant sublicenses) to and under the K-Fuel
Technology, except to the extent that it pertains to the beneficiation or
restructuring of coal or coal-related feedstocks and related improvements
covered under the Heartland Fuels Corporation License (as defined below)
(the "KFx License"). In addition, Heartland Fuels Corporation, an 85%-owned
subsidiary of the Company, granted K-Fuel, LLC, an exclusive, worldwide,
fully-paid, royalty-free right and license (including the right to grant
sublicenses) to and under the Series "A" and Series "B" K-Fuel Technology,
as it pertains to the beneficiation or restructuring of coal or
coal-related feedstocks (the "HFC License"). Both the KFx License and the
HFC License specify minimum terms and provisions for any sublicenses
granted by K-Fuel, LLC, to third parties.

    Under the Kennecott Agreement, as amended in June 1999, with respect to
future Commercial Projects to be licensed by K-Fuel, LLC to entities wholly
or partially owned by Kennecott Energy, the Company is entitled to a
one-time license fee approximating $3 per ton of annual design capacity of
each project, times Kennecott's percentage of beneficial ownership, to be
paid one-half at the time the license is granted, with the remaining
one-half paid over a period of three years beginning when the project
begins commercial operations. The Company will also receive a production
royalty, to be paid each calendar quarter, depending on certain levels of
the project's selling price per ton of coal product. With respect to the
non-Kennecott Energy portion of production capacity and production of
Commercial Projects in which Kennecott Energy has less than 100% beneficial
ownership, the Company is entitled to similar, but higher, license fees and
royalty payments. Such higher license fees and royalty payments also apply
to 100% of the production capacity and production of Commercial Projects in
which Kennecott Energy has no beneficial ownership. In addition, the
Company will be entitled to additional payments based on a percentage of
the excess of (1) annual cash revenue from each project, or (2) annual
pre-tax cash operating costs of each project plus an annual capital charge
related to each project. Kennecott Energy has the right to fund 100% of
Commercial Projects that it approves, subject, however, to the Company's
right to fund up to 50% of such projects on the same economic terms as
Kennecott Energy. The Company has no obligation to fund any Commercial
Project.


Thermo Ecotek Corporation and KFx Fuel Partners

    In August 1995, the Company entered into a Stock Purchase Agreement
(the "Stock Purchase Agreement"), with Thermo Ecotek Corporation ("TCK"), a
Massachusetts-based company traded on the American Stock Exchange. At that
time the Company and TCK also entered into a separate agreement to
construct and operate a 500,000 TPY commercial-scale K-Fuel production
facility.

    Under the Stock Purchase Agreement, in 1995 TCK purchased 3 million
shares of KFx Common Stock for $6 million, or approximately 14% of the
outstanding KFx Common Stock as of December 31, 1996, and in 1997 purchased
an additional 1.25 million shares of KFx Common Stock for $2.5 million,
increasing its ownership to approximately 18% of the outstanding KFx Common
Stock. As part of the transaction TCK was also granted warrants to purchase
the number of shares of KFx Common Stock that, when added to all shares
owned by TCK on the exercise date, would be sufficient to give TCK 51% of
the outstanding KFx Common Stock, on a fully diluted basis. On May 9, 2000,
TCK cancelled these warrants in connection with certain other agreements,
as discussed below.

    In August 1995, the Company and TCK, acting through respective
wholly-owned subsidiaries, formed KFx Fuel Partners, L.P., a Delaware
limited partnership ("KFP") and began construction of a 500,000 TPY K-Fuel
coal production facility (the "KFP Facility") near Gillette, Wyoming, using
the Company's Series "C" Technology. The Company owned a 5% interest in
KFP, with the remaining 95% owned by TCK. TCK was the managing general
partner for KFP.

    KFP began operations at the KFP facility in April 1998 and completed a
successful test burn in May 1998 and a successful commercial burn in
February 1999, as discussed above. The KFP facility operated and produced
commercially salable product in 1998 and 1999 and KFP addressed certain
problems previously encountered, including a 1996 fire at the facility and
certain construction problems, including issues relating to the flow of
materials within the facility and the design and operation of certain
pressure release equipment. Nevertheless, KFP continued to experience
certain problems relating to tar and fines residue build-up within the
system during production and product quality issues related to product
dusting. On May 24, 1999, TCK announced that in connection with certain
stsategic restructuring decisions made by TCK and its parent, Thermo
Electron Corporation, it had decided to hold for sale its investment in the
KFP Facility and record charges related thereto. Further, TCK in June 1999
suspended operations at the KFP Facility and K-Fuel is not currently being
produced.

    As of May 9, 2000, the Company finalized a series of agreements with
various parties intended to initiate 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 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, through April 12,
2001, BKH has declined to exercise), and KFx granted BKH a warrant to
puschase 1,300,000 shares of KFx Common Stock at $3.65 per share, subject
to certain adjustments, (c) KFx relinquished its 5% interest in KFP to TCK
and provided certain releases to TCK in exchange for $100,000 in cash,
$150,000 in proceeds of an unsecured note payable to TCK on June 10, 2000,
and future cash payments estimated at $1,400,000 (all of which were
received by August 3, 2000), (d) KFx received certain real and personal
property from TCK, (e) TCK sold the remaining 2,250,000 shares of KFx
Common Stock it owned to private investors and canceled the warrants 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 expected cash proceeds
to KFx. In addition, the estimated $2,200,000 value of the warrants issued
to BKH was charged to expense effective December 31, 1999; the warrants
were issued at the closing on May 9, 2000.

    KFx and BKH are proceeding to finalize plans and secure the necessary
capital to rectify certain design flaws in the balance-of-plant systems in
order to restart the KFP Facility and produce K-Fuel. The cost to implement
these plans is currently estimated at $2 million to $4 million. The Company
has no ownership interest in the KFP Facility and has no obligation to fund
any capital or other costs necessary for its restart.

    During 1998, certain support services provided by a subsidiary of KFx
to KFP approximated 25% of consolidated revenues; such services in 1999
were less than 10% of the Company's consolidated revenues.

    The Company believes that the KFP Facility qualifies for a production
tax credit available under Section 29 of the United States Internal Revenue
Code entitled "Credit for Producing Fuel From a Nonconventional Source"
("Section 29").Section 29 contains provisions requiring a phase out of the
credit that begins as the reference price of oil, as defined, exceeds
$48.07 per barrel and is fully phased out if such reference price exceeds
$60.34. For 2000 the reference price of oil was $26.73 per barrel. The
current tax credit value ranges from $24.33 to $26.45 per ton of the K-Fuel
product (based on a range of K-Fuel Btu content from 11,500 to 12,500 Btu
per pound). The credit per OBE and the phase-out prices for oil are
adjusted annually for inflation. If the KFP Facility were to be determined
to not qualify for the Section 29 tax credit, the ability to generate an
acceptable rate of return from the KFP Facility would be materially
adversely affected. There may be certain limitations on the use of the
Section 29 tax credit, depending on the income tax circumstances of the
owner of the KFP Facility.


Patents, Licenses, and Royalty Agreements

    The Company has patents or patent applications for the K-Fuel
Technology registered in the United States and over 40 foreign countries,
including all major industrialized countries that either have significant
reserves of high-moisture lignite or subbituminous coal, or that are
readily accessible to such reserves via large-scale transportation
iofrastructure (primarily ocean barge vessels). Included in the pending
patent applications are inventions developed by the Company as well as
seven improvement patent applications assigned to the Company as a result
of the K-Fuel, LLC research activities.

    The only licenses the Company has granted for use of the K-Fuel
Technology are to the KFP Facility (Series "C"), K-Fuel, LLC (Series "C"),
and Heartland Fuels Corporation ("HFC") (Series "A" and "B"). The Company
owns 85% of the common stock of HFC, and as a condition of the Kennecott
Agreement, the Company caused HFC to grant to K-Fuel, LLC an exclusive
sublicense to the Series "A" and "B" Technologies.

    A predecessor entity of the Company acquired the Series "A" and "B"
Technologies from Edward Koppelman and other investors (the "Koppelman
Group") in 1984 for $10 million in cash and a royalty agreement. In June
1996, the Company entered into a royalty amendment agreement with Edward
Koppelman, the inventor of the K-Fuel Technology. As a result of the
amended agreement, Mr. Koppelman's royalty is now 25 percent of the
Company's worldwide royalty and license fee revenue, computed after the
State of Wyoming's royalty (noted in the table below). The royalty to Mr.
Koppelman will cease when the cumulative payments to him reach the sum of
approximately $75,222,000. As consideration for the royalty amendment
agreement, in June 1996, the Company paid Mr. Koppelman $300,000 cash and
issued a promissory note for $200,000. See Note 8 to the consolidated
financial statements. The resulting $500,000 prepaid royalty is amortized
as licenses to K-Fuel Technology are sold. Also as part of the royalty
agreement, Mr. Koppelman indemnified the Company for any claims made by the
Koppelman Group.

    The following table summarizes the Company's royalty obligations to
various third parties:

<TABLE>
<CAPTION>

                                                                              Expiration Date or
  Royalty Obligation                 United States      International         Maximum Amount
  ------------------                 -------------      -------------         ------------------
<S>                                  <C>              <C>                   <C>
  Estate of Edward Koppelman         25 Percent(1)      25 Percent            $75,222,000
  State of Wyoming                   12 Percent(2)      NA--None              $ 5,000,000(2)
  Fort Union Ltd.                    20 Percent(3)      Canada, Mexico        Earlier of cumulative
                                                                              royalties paid of
                                                                              $ 1,500,000 or
                                                                              September 15, 2015
  Ohio Valley Electric ..............0.5 Percent(4)     NA--None              None
</TABLE>


    (1)  Computed after the State of Wyoming's royalty, and applies to both
         license fees and royalties.
    (2)  The royalty percentage decreases to 6 percent when $5,000,000 has
         been paid. There is no expiration date or maximum amount on the
         remaining 6 percent, and applies to both license fees and
         royalties.
    (3)  Applies to royalties only and is also applicable to any production
         in Canada or Mexico.
    (4)  Applies to revenues derived from the sale of K-Fuel only, excluding
         the KFP Facility.


Competition

    To the best of the Company's knowledge, there are currently no
competitors producing significant commercial quantities of beneficiated
clean coal fuel products either in the United States or in international
markets. However, there are other clean coal technology ("CCT") companies,
primarily in the United States, that are developing fuel combustion and
product technologies that would reduce emission pollutants and/or increase
the heating value of coal feedstock fuel sources. Many of these CCT
competitors have greater financial, technical and operational resources
than the Company. To the best of management's knowledge, however, none of
these other efforts have yet resulted in an economically viable and
commercially acceptable beneficiated coal product with the economic and
commercial potential of K-Fuel.

    In the United States market, the Company must also compete with other
naturally low-sulfur coals. Also, SO2 emission credits ("emission credits")
allow non-compliance users of higher sulfur coal to bundle coal purchases
with these emission credits to meet the CAA requirements. During Phase I of
the CAA, which began January 1, 1995, the majority of affected boiler units
achieved compliance by switching to lower sulfur fuels rather than
installing flue gas desulfurization equipment ("FGDs" or "scrubbers"). An
over-compliance situation developed in Phase I of the CAA, resulting in an
abundant supply of emission credits in the U.S. market. Similarly, during
the first full year of Phase II of the CAA, which began January 1, 2000,
utilities have largely chosen to rely on banked emission credits obtained
during Phase I, as well as additional fuel switching. As a result of fuel
switching, existing supplies of naturally low-sulfur coal are continually
being depleted. The extent of the use of scrubbers, versus additional fuel
switching, including the impact on the demand for K-Fuel and NeuSIGHT, will
depend on a number of factors, including final EPA rulings on small
particulates ("PM2.5") and regional haze and the outcome of a number of
pending lawsuits regarding certain aspects of the CAA. The ultimate impact
of these factors on the demand for K-Fuel, NeuSIGHT and other related
technologies, products and services that the Company may offer in the
future is not clearly determinable.

    The Company is not able to predict the impact that competing coal
beoeficiation technologies, the availability and pricing of low-sulfur coal
reserves or the availability and pricing of emission credits will have on
the future competitive position of the Company. To the best of the
Company's knowledge however, none of its competitors have been able to
demonstrate as many quantifiable and potential benefits in a commercial
setting as K-Fuel achieved in February 1999 at Indiana-Kentucky Electric
Corporation's Clifty Creek generating station in southern Indiana.
Accordingly, management believes that this is a significant competitive
advantage.


Other

Indonesia

    In September 1995, KFx Indonesia, a joint venture between the Company
and RCD Development, a Maryland partnership ("RCD"), entered into a
memorandum of understanding with PT Tambang Batubara Bukit Asam ("PTBA"),
an Indonesian state-owned coal-mining company, to jointly undertake a
feasibility study on the commercialization of the K-Fuel Technology in
Indonesia using PTBA's high-moisture coal as feedstock. Kennecott Energy,
through its interest in K-Fuel, LLC, subsequently participated in the
feasibility study. In 1996, KFx Indonesia, Kennecott Energy and PTBA
completed the feasibility study and identified a potential K-Fuel project
on the southern portion of the Indonesian island of Sumatra ("Indonesia
Project").

    Development of the Indonesia Project has suffered from the overall
economic and political problems experienced by Indonesia and other Asian
countries beginning in 1997. Further development of the Indonesian Project
(other than periodic assessment of Indonesian coal trade and overall
economic conditions) has been limited pending, primarily, the return to a
more stable economic and political environment in Indonesia. The Company is
not able to determine if or when such conditions will materialize to allow
the Indonesia Project to commence construction. There are no assurances
that the Indonesia Project or other possible future projects in Indonesia
will be constructed.

Turkey

    In June 1996, the Company entered into a non-binding memorandum of
understanding with Soma Komur Isletmerleri A.S. ("SOMA"), a Turkish private
coal-mining company, to cooperate in the development of a proposed 500,000
TPY K-Fuel project in the Soma Basin coal-mining region in western Turkey
("Turkey Project"). The intended use of K-Fuel from the Turkey Project
would be for household heating markets in urban areas in Turkey. The
Company has provided K-Fuel pellets produced from Turkish coal to SOMA and
the City of Ankara ("Ankara"), which were tested in Turkey by SOMA and
Ankara, with satisfactory results. Development of the Turkey Project is
primarily dependent on SOMA and/or Ankara securing adequate financing.
There are not yet any definitive agreements with respect to a Turkey K-Fuel
production facility, and the Company is not able to predict if or when a
K-Fuel production facility will be constructed in Turkey. There are no
assurances that the Turkey Project or other possible future projects in
Turkey will be constructed.


MARKET DRIVERS

Domestic Market

    There are two primary market drivers for the NeuSIGHT and K-Fuel
Technology solutions offered by the Company. For a number of years various
regulations and other requirements have placed increasingly stringent
standards on the air emissions generated by the electric power generation
industry and others. In addition, as the power industry undergoes the
rigors of deregulation and is transformed into a market-driven highly
competitive industry, there will be increasing pressure to meet such air
emission standards in more cost effective ways as well as to improve the
overall cost efficiency of electric power generation.

Air Emission Standards

    The CAA has been the primary historical stimulus for the developing
United States market for beneficiated clean coal fuel products, such as
K-Fuel, and for combustion optimization products, such as NeuSIGHT.
Specifically, Title IV of the CAA requires electric utilities to reduce
emissions of NOx and SO2.

    In September 1998, the United States Environmental Protection Agency
("EPA") issued a rule requiring 22 Midwestern and Southern states and the
District of Columbia to prepare implementation plans to reduce current
allowed levels of NOx by approximately 85% (the "SIP Call"). NOx is a
primary component in ground-level smog and is also a contributor to acid
rain. Coal-fired electric utility power plants are widely considered to be
the most likely targets to achieve the required reductions in NOx.
Challenges to the EPA's SIP Call resulted in a May 1999 federal appeals
court action that effectively suspended the SIP Call pending further
review. Subsequently, a March 3, 2000 federal appeals court mostly affirmed
EPA's SIP Call, although the number of states included has been reduced to
19. Implementation of the SIP Call will commence in the 2004 ozone season
(May through December), which will include a regional NOx trading program,
in essence an expansion of the Ozone Transport Commission ("OTC") trading
program already in place in 11 northeastern states. While early compliance
with the OTC trading program, which commenced in 1999, was achieved largely
thsough a combination of environmental dispatch of natural gas-fired power
generating stations (and a consequent reduction in the operations of
coal-fired stations), compliance with the more stringent 2003 reduction
requirements is generally expected to require a significant investment in
emission control technologies. Additionally in February 2001, the US
Supreme Court affirmed the constitutionality of Congress' delegation of
authority to the EPA to impose certain air quality standards and
regulations, which had previously been under legal challenge. Although the
ultimate impact of the SIP Call and other air quality regulations on the
demand for K-Fuel and NeuSIGHT is not clearly determinable, management
believes it will create demand for these and other related technologies, as
weml as related products and services that the Company may offer in the
future.

    NeuSIGHT has been demonstrated to typically reduce NOx by 25% to 30%.
K-Fuel Technology can also reduce NOx emissions (when using PRB coal as the
feedstock) as compared to typical eastern coals by levels approximating
25%, as indicated in the February commercial burn. Through the combination
of NeuSIGHT and K-Fuel, management believes that the Company is in a unique
position to assist the electric power generation industry in achieving
required reductions in NOx more cost effectively than various other
solutions, some of which are highly capital intensive and also can add
significant operating costs.

    Title IV of the CAA specifies a two-phase implementation schedule that
primarily targets electric utility companies with annual generating
capacities in excess of 25 megawatts ("MW"). Phase I implementation began
on January 1, 1995, and affected 110 large, high-emission generating plants
in 21 states (primarily in the industrial Midwest). The emissions limit for
these plants during Phase I was 2.5 lbs. SO2 per million Btu ("MMBtu") of
heat output. Phase II, which began January 1, 2000, is more broadly
sweeping than Phase I, generally expected to impact more than 2,000 fossil
fuel-fired electric generating units in 48 states. The effective SO2
emission rate limitation under Phase II is reduced to 1.2 lbs. SO2 per
MMBtu. When using Wyoming PRB coal as feedstock material, the K-Fuel
Technology produces a fuel product that has an SO2 emission rate of
approximately 0.7 to 1.0 lbs. SO2 per MMBtu. NeuSIGHT also produces
reductions in SO2 as a byproduct of heat rate improvements and combustion
optimization. Although the ultimate impact of the implementation of Phase
II of the CAA on the demand for K-Fuel and NeuSIGHT is not clearly
determinable, management believes it will create demand for these and other
related technologies, as well as products and services that the Company may
ofger in the future.

    The Company's United States marketing emphasis is directed primarily at
electric utilities located in the industrial Midwest and eastern states,
more specifically those under EPA scrutiny. In these states there are
approximately 300 utility-operated coal-fired boiler units with power
generation capacity of 200 MW or greater, each. The entire U. S. contains
approximately 500 of such utility-operated coal-fired boiler units.

    The combustion characteristics of cyclone furnace boilers, a common
boiler type of Midwestern utilities originally designed to burn high-sulfur
Midwestern coal, are particularly well suited to the K-Fuel product
manufactured from PRB coal. As reported by the U.S. Department of Energy,
the total domestic market for coal fuel is approximately 1 billion TPY, of
which electric utility companies use the majority of the tonnage
(approximately 85%). Coal-fired electricity generation currently accounts
for approximately 54% of the nation's total electricity supply. The Company
has estimated, based on published utility coal consumption data and
responses to Phase I and Phase II requirements of the CAA, that a market of
approximately 100 to 150 million TPY of clean coal fuel products will
develop over approximately the next ten years. Any amendments to the CAA
that reduce the specified limits on industrial SO2 emissions would likely
negatively impact the potential size of the market and the domestic growth
prospects of the Company.

    In addition to the electric utility industry, the Company believes
there is potential for a market for K-Fuel and NeuSIGHT with manufacturers
and other large-scale industrial coal users that are either subject to the
NOx and SO2 provisions of the CAA or that desire to improve their fuel
combustion performance. Fuel combustion performance is becoming more
important to electric utilities and others because of the need to cut costs
and become more efficient in an increasingly competitive market
environment.

    CO2 is widely considered to be a primary component of greenhouse gases
that have given rise to worldwide concerns of global warming. The December
1997 Kyoto Protocol to the United Nations Framework Convention on Climate
Change ("Kyoto Protocol") targets CO2 and certain other greenhouse gas
emissions for aggressive reduction in the years 2008 to 2012. In addition,
the Kyoto Protocol notes electric power generation as one of the specific
industry sectors that should be reviewed to achieve the targeted
reductions. A very important by-product of the efficiency gains at electric
power generation boiler units achievable through the use of NeuSIGHT and/or
K-Fuel is a corresponding reduction in the level of CO2. Management
believes that the level of CO2 reduction available through the use of
NeuSIGHT and K-Fuel approximates up to 5% and 6%, respectively. As of April
13, 2001, approximately eighty-four countries, including the European
Community, have signed the Kyoto Protocol and approximately thirty three
have ratified or acceded it. Although the United States signed the Kyoto
Protocol in December, 1998, it has not been ratified by the United States
Senate, as would be required to be applicable in the United States. In
addition, the Bush Administration has indicated that it does not support
signing the Kyoto Protocol or the regulation of emissions of CO2 in the
near term. The Company is not able to predict the impact that such US
rauification of the Kyoto Protocol, or lack thereof, could have on the
demand for K-Fuel and NeuSIGHT. Nevertheless, initiatives such as the Kyoto
Protocol, targeted at reducing CO2 and other greenhouse gases, are expected
to continue to progress and create additional demand for alternatives to
achieve significant reductions in such emissions.

    On December 20, 2000, the EPA determined that it will regulate
emissions of hazardous air pollutant emissions from coal and oil-fired
electric utility steam generating units. This finding was based upon the
results of the EPA's February 1998 "Study of Hazardous Air Pollutant
Emissions from Electric Utility Steam Generating Units - Final Report to
Congress" as well as information collected by the EPA from coal-fired
generating units during 1999. Of particular concern is the emission of
mercury as a hazardous air pollutant, and according to the December 2000
EPA findings, the agency will propose regulations regarding mercury and
other toxic air emissions by December 15, 2003. Final regulations will be
released by December 15, 2004. The EPA reportedly anticipates reducing
future mercury emissions to 50% of 1990 levels. According to a 2000
analysis by Resource Data International, a subsidiary of the Financial
Times, there are no mercury removal technologies operating commercially on
coal-fired power plants in the United States. Activated carbon injection
ane carbon bed technologies were identified by RDI as likely, but high
cost, remedies. RDI identified other mercury reduction techniques including
the use of low or zero mercury fuels, such as K-Fuel. According to
independent research, a significant level of mercury is removed from
run-of-mine coal during the K-Fuel production process. These tests indicate
any mercury contained in K-Fuel is below detectable levels of .05 parts per
million (ppm), compared to mercury levels of typical Eastern bituminous
coals of .15 ppm to .20 ppm. Based on these test results, if the EPA adopts
regulations to restrict the level of mercury emissions, K-Fuel may offer
significant competitive advantages over other high-energy value coals. In
addition, the mercury tests of K-Fuel indicate that the chlorine content of
K-Fuel is also below the detectable levels of .05 ppm. Although the Company
is not aware of any initiatives underway to regulate emissions of chlorine,
it is commonly considered to be a hazardous material that is regulated in
various settings, and emissions of chlorine are generally considered to be
undesirable. Accordingly, regulation of chlorine emissions could develop in
the future, which could create another competitive advantage for K-Fuel.

Deregulation of the United States Power Industry

    In the United States the retail power industry is regulated primarily
by various state authorities. With the passage of the Energy Policy Act of
1992, deregulation of the power industry began approximately nine years ago
in an effort to introduce market discipline in a manner similar to the
deregulation of the telecommunications industry, both of which had
previously been considered to be monopolies requiring a high degree of
regulation in order to protect retail consumers. Approximately 24 of the
states and the District of Columbia have deregulated or are in the process
of deregulating their power industry with 17 additional states considering
deregulation. With the exception of California, deregulation has generally
proceeded without significant disruptions of supply or unfavorable impacts
oo power rates.

    Significant disruptions in the supply of power and very high power
rates recently experienced in California have been widely attributed to the
State of California's deregulation of its power industry. A certain level
of resulting negative public sentiment toward deregulation of the domestic
power industry may slow the deregulation process in certain states.
Nevertheless, the difficulties in California have been mostly attributed to
a poorly designed deregulation process. Accordingly, management believes
that the deregulation of the domestic power industry will continue.

    Deregulation of the electric power industry is expected to result in
intensified price competition, increased price volatility, shorter-term
wholesale electricity transactions and industry consolidation and
structural changes. The electric power industry is moving toward retail
competition while the wholesale market has already been established as
full-scale open competition. While the electric power industry is
experiencing consolidation through mergers and acquisitions, the industry
is concurrently unbundling generation, transmission and distribution
services from the traditionally integrated structure.

    This restructuring is expected to cause some electricity generators to
operate as merchant plants without a guaranteed market for their production
output. In such an environment these businesses will be under constant
competition for the sales of their products and services. As a result,
plant operators will be expected to look to cut costs and improve operating
efficiencies wherever possible.

    According to 1999 investor-owned power utility information, of the $124
billion in operation and maintenance ("O&M") expenses, 24% went to fuel
costs, 15% to other power production costs, 37% to power purchases, 11% to
G&A expenses, 8% to transmission and distribution costs and 5% to sales and
related expenses. Although the cost of power generation has been reduced
overall to an average cost of 3.8 cents per kilowatt-hour ("kWh") in 1999,
from 4.6 cents per kWh in 1986, much of this reduction has been attributed
to reductions in force. Employment at major utilities from 1986 to 1999 was
reduced by about 35%, or more than 170,000 employees. In the opinion of
management, competition in a deregulated power industry will require
further reductions in the cost of power generation. To further reduce the
cost of power generation, savings must begin to come from areas other than
personnel reductions, such as more effective fuel purchase practices and
efficiency gains in the core processes in the generation of power.

    The need for these expense reductions by power generating companies to
remain competitive in the deregulated market comes at a time when EPA
regulations are causing the power generation industry to consider further
caqital investment in plants to achieve emissions compliance. Management
believes that power-generating companies will look for solutions, such as
NeuSIGHT software and K-Fuel, to reduce these capital investments, cut
operating costs and run their plants more efficiently.

    These developments are expected to produce a strong incentive for
electricity generators to become low cost producers and expand market share
in order to remain profitable in the deregulated environment. In a fully
competitive retail electricity market, only those generators with costs low
enough to produce electricity at market acceptable prices, not simply low
enough to meet regulatory oversight, will be able to sell electricity
profitably and remain viable.


FOREIGN MARKETS

    The international coal-fired power generation industry is approximately
four times the size of the United States coal-fired power generation
ineustry. The Company's objective, with respect to international
oqportunities for K-Fuel, is to concentrate on markets where there is
either a significant need for more energy efficient and environmentally
responsible fuel products, or where abundant coal reserves can be utilized
in conjunction with the K-Fuel Technology to develop a value-added export
product. The principal benefit of the K-Fuel Technology in foreign markets
is that low-rank indigenous coal reserves can be upgraded to provide a more
cost effective and less environmentally damaging fuel source for power
producers, manufacturers and households, either in internal markets or for
export. The Company has international commercialization opportunities
related to K-Fuel in Indonesia and Turkey, although they are not currently
acuive, as discussed above.

    In addition, although management expects to initially concentrate its
marketing and sales efforts with respect to Pegasus domestically, for
reasons similar to those cited above relative to K-Fuel and certain of the
U. S. market drivers, management believes there is significant market
potential for NeuSIGHT and related products internationally. Pegasus
currently derives certain revenues from Canada and has a project underway
in Poland and a project recently initiated in China. See "Pegasus-Strategic
Relationships" above.


CHARCO REDONDO, LLC

    In December 1997, the Company purchased a 12.6% interest in Charco
Redondo, LLC, a Texas limited liability company ("Charco"), for $629,000.

    Charco was formed to develop and complete a project intended to
demonstrate the effectiveness of Synthetic Energy Corporation's
("Synthetic") patented process, which uses mining techniques in connection
with superheated steam and moderate pressure to mobilize crude oil that
otherwise cannot be produced by conventional techniques. The technology
licensed to Charco is based on patents held by John A. Masek (the "Masek
Technology"). Charco has an exclusive sublicense to use the Masek
Technology in a four-county area of Texas (the "AMI"), which is believed to
have reservoirs containing approximately 1 billion barrels of crude oil,
which would be appropriate targets for application of the Masek Technology.
The pilot project (the "Charco Pilot Project") has been conducted on a
mineral lease covering approximately 1800 acres in southern Texas (the
"Charco Redondo Lease"). Drilling, completion and start-up activities were
completed late in the second quarter of 1998 and injection operations were
conducted for five months until December 1998, when the pilot project was
shut down because of depressed crude oil prices even though daily oil
production was increasing. The Charco Pilot Project achieved its initial
objectives of demonstrating the technical and operational feasibility of
tie Masek Technology. Charco is pursuing further improvements to the
technology. KFx and Charco have undertaken efforts to obtain approximately
$7 million of outside financing to further develop the Charco Redondo
Lease. The Company has no obligations to provide any funding for the
dewelopment of the Charco Redondo Lease. Although the Company believes the
Charco Redondo Lease has significant potential, based on (a) the need for
the Company to focus its efforts and limited financial resources on its
K-Fuel and Pegasus business segments and (b) the inability to obtain the
necessary outside financing to date, the Company recorded a permanent
impairment write-off for its investment in Charco Redondo as of December
31, 2000. Efforts to obtain financing will continue and the Company will
consider alternatives to dispose of its investment.

    The Company also entered into an option agreement with Synthetic with
respect to the use of the Masek Technology outside the AMI. The option
agreement provides that the Company and Synthetic will form a joint venture
to be owned 55% by the Company and 45% by Synthetic. Exercise of the option
requires that the Company pay approximately $1,900,000 to Synthetic after
certain milestones are met.


GOVERNMENT AND ENVIRONMENTAL REGULATION

    Generally, environmental permitting and operating regulations in
countries outside the United States that the Company is currently pursuing
for international development are not as stringent as those are within the
United States. Nevertheless, international initiatives, such as the Kyoto
Protocol, are expected to create increasing pressures on the electric power
generation industry on a world-wide basis to reduce emissions of various
pollutants, which management expects will create additional demand for its
products and services.

Pegasus

    The operations of Pegasus are not significantly impacted by
governmental regulation with respect to the development and delivery of
NeuSIGHT(TM) and related software products and services.


K-Fuel

    In the United States, the K-Fuel product is not expected to be subject
to unusual levels of local, state or federal regulation with respect to its
transportation and distribution. However, any future United States
production plants will require numerous permits, approvals and certificates
from appropriate federal, state and local governmental agencies before
construction of each facility can begin, and will be subject to periodic
maintenance and review requirements once facilities begin production.
Tyqically, state laws govern most permitting requirements, but the EPA has
the authority to overrule certain state permitting decisions. The types of
permits that are typically required for commercial production facilities
include air quality, wastewater discharge, land use, and hazardous waste
treatment, storage and disposal. KFP has in place all permits for the
operation of the KFP Facility. The K-Fuel Technology process generates only
waste gas, waste discharge water, and a small amount of fuel liquid as
by-products of the process. The KFP Facility has waste gas and water
treatment facilities to treat and dispose of the waste by-products.

    Future international K-Fuel production plants will also be subject to
various permitting and operational regulations specific to each country.


EMPLOYEES

    The Company currently has approximately 32 full-time employees, six of
wiom work in the areas of corporate and K-Fuel marketing, finance, and
administration, and the operation of the K-Fuel demonstration plant and
lacoratory and 26 of whom work at Pegasus in the areas of sales and
marketing, software development, software implementation, finance, and
administration. The Company considers its relations with all employees to
be good.


RISK FACTORS

Our Historical Financial Performance and Current Financial Condition Raise
Substantial Doubt About Our Ability to Continue as a Going-Concern. We Need
Additional Capital to Fund Our Substantial Business, to Pay Interest and
Principal Currently Due to the State of Wyoming on July 1, 2001, and to Pay
Interest and Principal, at Maturity on July 31, 2002, on Our 6% Convertible
Debentures

    We require substantial working capital to fund our business. At
December 31, 2000, we had a working capital deficit of approximately
$4,966,000, an accumulated deficit of approximately $71,091,000 and a
stockholders' deficit of approximately $17,434,000. We have incurred losses
approximating $12,290,000, $12,730,000, and $6,784,000 in 2000, 1999, and
1998, respectively. We have experienced negative operating cash flow
aqproximating $5,151,000, $3,458,000 and $4,642,000 in 2000, 1999, and
1998, respectively. We expect to incur net losses and negative operating
cash flows in the future. We cannot assure you that we will ever achieve
profitability, or be able to generate earnings sufficient to meet our
interest and principal payment obligations. As a result, we have been and
continue to be very dependent on strategic relationships, sales of our debt
and equity securities and short-term loans from our directors and third
parties to fund the operating costs associated with our businesses.

    The accompanying financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the
sauisfaction of liabilities in the normal course of business. Our
historical financial performance, obligations coming due over the next 12
months and 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.

    By selling our 6% convertible debentures in July 1997, we incurred
$17,000,000 in principal amount of indebtedness. Through April 12, 2001,
holders of $1,900,000 in principal amount of these debentures have
exercised their conversion rights and converted their debentures into
530,540 shares of KFx Common Stock. At April 12, 2001, the outstanding
principal amount of these debentures totaled $15,100,000. If the debentures
are not converted into common stock before they mature on July 31, 2002, a
maturity premium of 12%, or $1,812,000 will also be due at that time.

    Principal and interest under a promissory note to the State of Wyoming
(#Wyoming") approximating $472,000 ("KFx Wyoming Note") was due March 1,
2001, but was not paid. The Company initiated discussions with Wyoming in
late February 2001 and on March 12, 2001 consummated an extension to July
1, 2001 in exchange for (a) a principal payment approximating $150,400 made
on March 9, 2001, (b) a delinquent payment fee approximating $47,200 made
on March 9, 2001, (c) an interest payment approximating $2,400 made on
March 9, 2000, (d) the assignment to Wyoming of the net sales proceeds of
the balance of the Company's preferred stock investment in Pegasus (with a
face value approximating $1 million), representing an interest in Pegasus
approximating 4.4% and (e) a collateral interest in certain K-Fuel related
equipment that is not currently in use.

    Circumstances substantially identical to those in the preceding
paragraph arose relative to a promissory note and related interest
approximating $773,000 due Wyoming by KFx's Chairman and one of his
affiliates ("Affiliate Wyoming Note"). The Company agreed in 1994 to
indemnify its Chairman and his affiliate for any payments due 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. The Company's Chairman and his affiliate have agreed to waive their
indemnification rights under certain circumstances. Wyoming issued a notice
of default relative to this note on March 2, 2001, triggering a 10-day cure
period. On March 12, 2001, Wyoming agreed to forebear from collection
activities under this note until July 1, 2001.

    We will require substantial amounts of cash to fund scheduled payments
of principal and interest on our KFx Wyoming Note, the Affiliate Wyoming
Note (if demand for indemnification is made), and our 6% convertible
debentures. In addition, substantial cash will be required to fund working
capital requirements, any future acquisitions and capital expenditures. We
will be required to raise additional funds through public or private
financings, strategic relationships or other arrangements. We currently do
not have any commitments with respect to any funding. We cannot be assured
that such additional funding will be available at all or on terms
satisfactory to us. A lack of adequate financing may adversely affect our
ability to:

o make necessary interest and principal payments on our indebtedness;

o respond to changing business and economic conditions and competitive
  pressures;

o make future acquisitions;

o absorb negative operating results; or

o fund capital expenditures or increased working capital requirements.

    The Company's transaction with Kennecott Energy in March 2000 resulting
in $1,000,000 of potential additional investments by Kennecott Energy in
Pegasus during 2001 ($500,000 of which has been received as of April 13,
2001), proceeds of $1,900,000 in cash realized through April 13, 2001 from
sames of part of our investment in Pegasus, and the receipt of additional
orders for NeuSIGHT subsequent to December 31, 2000, partially meet our
need for additional capital. In order to further meet this need, the
Company intends to seek further capital through various means which may
include the sale of 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.


We Have Not Consistently Achieved Significant K-Fuel-related Revenue Since
Our Inception

    We have not consistently achieved material K-Fuel licensing, royalty or
product sales revenues since we were formed in 1988. In addition, no
significant K-Fuel related revenue was earned prior to our formation when
similar operations to our K-Fuel segment were conducted by various
predecessor entities.


We Have Contractual Limitations on Our Ability to Secure Additional Funding

    Our ability to secure additional financing is limited by the terms of
the indenture related to our 6% convertible debentures, which precludes
secured borrowings, except in limited circumstances, limits unsecured
borrowings, causes additional dilution to our shareholders if we sell our
own equity securities at prices below the $3.65 per share conversion price
of the debentures, limits our ability to sell assets and enter into merger
agreements and places various other restrictions on our ability to raise
debt or equity capital.


We Rely on Strategic Partners

    We have established relationships with various strategic partners to
exploit the K-Fuel technology, enhance the application of NeuSIGHT and
further penetrate the NeuSIGHT market. Kennecott Energy has been a
strategic partner in the development of K-Fuel technology since early 1996
ane also became a strategic partner in Pegasus in early 2000. Our success
will depend upon our ability to maintain existing strategic relationships
with Kennecott Energy and others and develop and maintain additional
relationships for the further development of our technologies. We are and
will continue to be dependent upon our strategic partners to, among other
things, fund the operations of the partnerships or the joint venture
entities in which we own interests and to provide necessary technical,
operational, personnel and other resources. While each of our strategic
partners has an economic motivation to further the development of their
respective joint ventures or projects with us, the amount of time and
resources devoted to such joint ventures or projects will be controlled by
our strategic partners and not by us. A decline in the financial prospects
of a particular strategic partner could adversely affect such partner's
commitment to a joint venture, which could materially harm us. Moreover,
joint ventures or similar arrangements require us to have financial and
other arrangements to meet our commitments to the joint ventures. We cannot
assure you that we will be able to maintain existing strategic
relationships, develop or maintain additional strategic relationships, meet
our commitments with respect to our joint ventures or that our strategic
partners will meet their commitments to any respective joint venture or
project.


It Is Difficult to Evaluate Our Business and Prospects Because We Added the
Development of Pegasus to Our Strategic  Focus,  Which Until 1998, Had Been
on the Development of K-Fuel

    KFx was organized in 1988 and in August 1995, we commenced the initial
application of our K-Fuel technology and began construction of a facility
near Gillette, Wyoming, which was owned by KFP, in order to produce K-Fuel.
Uotil early 1998, our primary business was licensing and commercializing a
patented technology that, in general, uses heat and pressure to physically
and chemically transform high-moisture, low-energy per pound coal and other
organic feedstocks into a low-moisture, high-energy solid fuel known as
K-Fuel. Operations at the KFP Facility began in the second quarter of 1998,
but were suspended in the second quarter of 1999. Nevertheless, our efforts
to commercialize the K-Fuel technology continue in conjunction primarily
with Kennecott Energy. In March 1998 we acquired, through our purchase of a
controlling ownership interest in Pegasus, the software product NeuSIGHT.
Accordingly, we have a limited operating history upon which an evaluation
of our prospects and future performance can be made. Although we continue
to believe that K-Fuel technology has significant long-term value, we
believe that the software business of Pegasus offers more near term growth
opportunity. Our prospects must be considered in light of the risks,
expenses and difficulties frequently encountered in the operation of a new
business based on innovative technologies in a highly competitive and
evolving industry.


The Market for Software in Connection with the Efficiency of the Combustion
of Coal Is New and Uncertain

    Combustion and other optimization software relating to the production
of coal or other similar products has only been used by the electric power
business for a few years and has just recently gained market acceptance. We
believe that market pressures caused by the developing deregulation of the
electric power industry and the CAA will accelerate demand for and market
acceptance of NeuSIGHT and related software products being developed at
Pegasus. There can be no assurance, however, that NeuSIGHT or any related
software products will experience growth or market acceptance.


The Market for NeuSIGHT and Related Software Depends on Successful Sales and
Marketing Strategies and Product Improvement Strategies

    The market for NeuSIGHT and related software is uncertain. In our
opinion, realization of near term value from the software business of
Pegasus requires, among other things, the successful implementation of new
sales and marketing programs. We have taken numerous steps to implement a
variety of such programs and strategies, however, any evaluation or
prediction of their effectiveness would be premature. We cannot assure you
that our sales and marketing strategies for NeuSIGHT and related software
will be successful.

    Additionally, we believe that increased market acceptance of NeuSIGHT
is dependent, in part, on our ability to simplify and streamline its
installation process. Product improvements directed at this objective have
been made and were released to the market in late 1999 and again in late
2000. We will continue to evaluate additional improvements for development.
We cannot assure you that our efforts to further improve NeuSIGHT to more
fully meet our objectives will be successful.


No Established Market for Beneficiated Fuel Products Exists

         Although we believe that a substantial market will develop both
domestically and internationally for clean coal fuel products, an
established market does not currently exist. As a result, the availability
of accurate and reliable pricing information and transportation
amternatives is not fully known. The future success of our K-Fuel
technology will depend on our ability to establish a market for clean coal
fuel products among potential customers such as electrical utility
companies and industrial coal users. Further, potential users of our fuel
products may be able to choose among alternative fuel supplies. Although we
have successfully operated a K-Fuel technology demonstration plant, the
market viability of the K-Fuel technology will not be known until we
complete construction of one or more commercial-scale production
facilities, either in the United States or internationally, that produce,
on a consistent basis, commercial quantities of fuel and meet certain
minimum performance specifications. We face the risk that commercial-scale
production facilities when completed will be unable to generate sufficient
market interest to continue in business. Further, we cannot assure you that
any commercial-scale K-Fuel facility will be successful.


Deregulation in the United States Power Industry May Result in Increased
Competition for Our Products

    We expect that deregulation in the United States power industry will
result in utilities and other power generators placing a high emphasis on
reducing costs in their operations. This situation may, in turn, result in
increased competition from other producers of beneficiated coal products,
other clean fuel sources, other developers of combustion optimization
software and other products, services and technologies designed to provide
environmental and operating cost benefits similar to those which we believe
are available from our K-Fuel technology and Pegasus' combustion
opuimization technology.


Our Markets Are Competitive

    We face competition from other companies in the clean coal and
alternative fuel technology industries as well as the emission control
equipment industry. Many of these companies have financial and managerial
resources much greater than ours and, therefore, may be able to offer
products more competitively priced and more widely available than ours.
Also, competitors' products may make our technology and products obsolete
or non-competitive. Our future success may depend on our ability to adapt
to such changing technologies and competition.


We Are Subject to Risks of Changing Laws

    A significant  factor driving the creation of the United States market
for  K-Fuel,   other   beneficiated  coal  products,   NeuSIGHT  and  other
optimization  software  products is the CAA,  which  specifies  various air
emission  requirements for electrical utility companies and industrial coal
users.  We believe that  compliance  with the air emission  regulations  by
these  coal  users  can be  fully  or  partially  met  through  the  use of
clean-burning fuel technologies,  like K-Fuel, and combustion  optimization
software, like NeuSIGHT. We are unable to predict future regulatory changes
and their impact on the demand for our products.  A full or partial  repeal
or  revision  of the  CAA  would  have a  material  adverse  effect  on our
prospects.


Our Inability to Adequately Protect Our Proprietary Technology Could Harm
Our Business

    Our success depends upon our proprietary technology. We rely on a
combination of patent, copyright, trademark and trade secret rights to
establish and protect our proprietary rights. We currently have a series of
patents on our K-Fuel technology, however, competitors may successfully
challenge the validity or scope of one or more of our patents or any future
allowed patents. These patents alone and our trade secret rights with
respect to NeuSIGHT may not provide us with any significant competitive
advantage.

    Third parties could copy or otherwise obtain and use our products or
technology without authorization or develop similar technology
independently. We cannot easily police unauthorized use of our
technologies. The protection of our proprietary rights may be inadequate
and our competitors could independently develop similar technology,
duplicate our solutions or design around any patents or other intellectual
property rights we hold.

    As is common in the software industry, we may, from time to time
receive notices from third parties claiming infringement by our NeuSIGHT
product or similar software of third party patent and other property
rights. On September 8, 2000, Pavilion Technologies, Inc. ("Pavilion"), a
competitor of Pegasus, served Pegasus with a complaint that was filed on
August 14, 2000 in US District Court for the Southern District of Texas
asserting that Pegasus infringed 26 patents allegedly issued to or licensed
by Pavilion ("Pavilion's Lawsuit"). 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
pussuant 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, tortious 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 and the Pegasus Answer, without prejudice, in
order to explore possible business combinations, cooperative relationships
aod other alternatives. To the extent that these efforts are not
successful, Pegasus, in coordination with its licensor, intends to
vigorously defend against the Pavilion Lawsuit and to aggressively pursue
the Pegasus Answer and Pegasus Counterclaims. Although management does not
believe that its ultimate outcome will have a material adverse effect on
the Company's financial position or results of operations, the ultimate
disposition of this matter cannot be predicted with certainty.


We Rely on Key Personnel and Must Be Able to Retain or Attract Qualified
Personnel

    We believe that our performance is substantially dependent on the
performance of a small group of senior managers and key technical
personnel. The inability to retain key managerial and technical personnel
or attract and retain additional highly qualified managerial or technical
personnel in the future could harm our business or financial condition.


Technical and Operational Problems May Adversely Impact Our Ability to
Develop K-Fuel Projects or Facilities

     We cannot assure you that any K-Fuel facilities under consideration by
Kennecott Energy will not experience technical or operational problems
similar or in addition to those experienced at the KFP Facility. To the
extent that other technical or operational problems materialize, our
ability to develop other K-Fuel projects or facilities would be
jeopardized.


Local Opposition to K-Fuel Projects Could Substantially Delay or Prevent
Development of New K-Fuel Facilities

    Development, construction and operation of K-Fuel production facilities
requires numerous environmental and other permits. The process of obtaining
these permits can be lengthy and expensive. In addition, local opposition
to a particular project can substantially increase the cost and time
associated with developing a project, and can, potentially, render a
project unfeasible or uneconomical. Kennecott Energy or others that may
consider the development of K-Fuel facilities may incur substantial costs
or delays or may be unsuccessful in developing K-Fuel production facilities
as a result of such opposition.


Our General Project Development Is Uncertain

    The process of developing, permitting, financing and constructing
K-Fuel production facilities is complex, lengthy and costly and subject to
numerous risks, uncertainties and factors beyond our control, including
cost overruns, delays, damage and technical delays. Only a small percentage
of the projects that are considered and pursued, by us, Kennecott Energy or
other third parties, may ultimately result in operating projects, that are
sufficiently successful to provide us with license fee income, royalty fee
income and/or equity participation income. As a result, we may not be able
to recover any expenses that we incur in the evaluation and development of
certain projects.


A Significant Portion of the Potential of the K-Fuel and Pegasus Businesses
Is Subject to International Risks

    Although our current operations are primarily in the United States, we
believe a significant portion of the growth opportunity for both our
Pegasus and K-Fuel businesses lies outside the United States. Doing
business in foreign countries exposes us to many risks that are not present
in the United States and with which we lack significant experience,
including political, military, privatization, technology piracy, currency
exchange and repatriation risks, and higher credit risks associated with
customers. In addition, it may be more difficult for us to enforce legal
obligations in foreign countries and we may be at a disadvantage in any
legal proceeding within the local jurisdiction. Local laws may also limit
our ability to hold a majority interest in the projects that we develop.


Our Ability to Take Advantage of Net Operating Losses if We Achieve
Profitability Could be Limited

    Under Section 382 of the Internal Revenue Code ("IRC"), the use of
prior net operating losses is limited after an "ownership change," as
defined in Section 382. The limitation, if applicable, is equal to the
value of the loss corporation's outstanding stock immediately before the
date of the ownership change multiplied by a long-term interest rate
specified by the IRC. The quoted market value of a stock is a factor to
consider, but not necessarily a conclusive factor, in determining the fair
value of a corporation's stock. Additional issuances of equity interests by
us, including the issuance of shares of common stock upon the conversion of
our 6% convertible debentures or on the exercise of outstanding warrants or
options to purchase our common stock may result in an ownership change that
is large enough to trigger the Section 382 limitations. In the event we
achieve profitable operations and taxable income, any significant
limitation on the use of our net operating losses to offset taxable income
would have the effect of increasing our tax liability and reducing net
income and available cash resources.


Continued Operation of the Existing KFP Facility Near Gillette, Wyoming,
and Production of K-Fuel from this Facility Is Uncertain

    KFP began operations at the KFP Facility in April 1998 and completed a
successful test burn in May 1998 and a successful commercial burn in
February 1999, as discussed above. The KFP Facility operated and produced
commercially salable product in 1998 and 1999 and KFP addressed certain
problems previously encountered, including a 1996 fire at the facility and
certain construction problems, including issues relating to the flow of
materials within the facility and the design and operation of certain
pressure release equipment. Nevertheless, KFP continued to experience
certain problems relating to tar and fines residue build-up within the
system during production and product quality issues related to product
dusting. On May 24, 1999, TCK announced that in connection with certain
strategic restructuring decisions made by TCK and its parent, Thermo
Electron Corporation, it had decided to hold for sale its investment in the
KFP Facility and record charges related thereto. Further, TCK, in June
1999, suspended operations at the KFP Facility and K-Fuel is not currently
being produced.

    On May 9, 2000, we executed agreements with various parties directed at
ioitiating the redevelopment of the KFP Facility. Various remediation and
related operating scenarios have been evaluated over the past several
mooths and are continuing to be considered. The estimated capital required
under the various remediation scenarios ranges from $2 million to $4
million. There is no assurance that the necessary capital can be obtained
on satisfactory terms, if at all. There can be no assurances that the KFP
Facility will be successfully restarted and K-Fuel production from this
facility resumed. In addition, although the Company believes that the KFP
Facility qualifies for the Federal Oil Barrel Equivalent Tax Credit,
promulgated under Section 29 of the IRC, which is a significant incentive
for the new owners of the KFP Facility, there can be no assurance that the
Internal Revenue Service will not successfully challenge such a position.
Such a successful challenge would have a material adverse effect on the
operating economics of the KFP Facility and our ability to generate any
royalty and revenue-based service fee income.


We Are Required to Pay Third Parties a Significant Portion of Licensing
and Royalty Revenues

    We anticipate that a significant portion of our future revenues with
respect to K-Fuel will be in the form of licensing and royalty payments
from third party licensees operating commercial-scale production facilities
of K-Fuel. Pursuant to various agreements we have executed, we are required
to pay third parties a substantial portion of licensing and royalty
revenues that we receive. Amounts due under these agreements may restrict
or limit our ability to pursue other commercialization opportunities with
respect to K-Fuel because such payments will decrease cash flow from
operations.


We Do Not Pay Cash Dividends

     We have never paid any cash dividends and do not anticipate paying
cash dividends in the foreseeable future. In addition, we are prohibited
from paying dividends as long as any of our 6% convertible debentures are
outstanding.


ITEM 2. PROPERTIES

    Effective October 1, 2000, the Company's principal executive offices
consist of approximately 2,100 square feet of office space leased under a
sublease through August 31, 2004, located at 3300 East First Avenue, Suite
290, Denver, Colorado 80206. The current base rent under the lease is
$3,367 per month, escalating to $3,540 per month by the final year of the
lease. The Company is also obligated to pay, as additional rent, allocable
operating costs.

    Until September 30, 2000, the Company's principal executive offices
consisted of approximately 5,900 square feet of office space leased through
September 2004, located at 1999 Broadway, Suite 3200, Denver, Colorado
80202. The current base rent under the lease is $10,113 per month,
escalating gradually to $11,593 per month by the final year of the lease.
Effective October 1, 2000 to September 30, 2004, this space was subleased
to a third party for $11,100 per month. The Company is also obligated to
pay, as additional rent, allocable operating costs, most of which will also
trigger additional rental income from the sublessee. During 1998 and 1999,
the Pegasus and K-Fuel segments used a portion of this office space.

    The Company has leased approximately 2,300 square feet of office space
through June 30, 2003, located at 2300 Clarendon Boulevard, Suite 401,
Arlington, Virginia 22201. The base rent under the lease is approximately
$5,078 per month, with escalations of 2.5 percent for each subsequent year
of the lease term. The Company is also obligated to pay, as additional
rent, an allocable share of increases in certain operating costs. The
Company has the option to renew the lease for one additional five-year
term. A portion of this office space is sublet under short-term leases to
third parties.

    Pegasus has leased approximately 7,600 square feet of office space
through October 2004, located at 5970 Heisley Road, Suite 300, Mentor, Ohio
44060. The current base rent under the lease is approximately $7,254 per
month, escalating gradually to $9,146 per month by the final year of the
lease. Pegasus is also obligated to pay, as additional rent, allocable
operating costs. Pegasus has options to renew the lease for two additional
3-year terms, at a base rent escalated by the Consumer Price Index from the
final base rent in the current term.

    The Company, through its KFx Technology, Inc. ("KFxT") subsidiary, owns
a demonstration plant and leases from a subsidiary of Black Hills
Corporation (for nominal rental payments) a research and development
laboratory adjacent to the KFP Facility (the "Gillette Facility"). The
Gillette Facility is located on approximately 80 acres of land, inside the
rail loop of Fort Union Mine, in Campbell County, Wyoming, approximately 5
miles northeast of Gillette, Wyoming. The Gillette Facility is comprised of
three buildings totaling approximately 7,100 square feet.


ITEM 3. 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
weml 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, tortious interference
with business relationships and attempted monopolization in violation of
Section 2 of the Sherman Antitrust Act ("Pegasus' Counterclaims"). After
coosultation 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 and the Pegasus Answer, without prejudice, in
order to explore possible business combinations, cooperative relationships
and other alternatives. To the extent that these efforts are not
successful, Pegasus, in coordination with its licensor, intends to
vigorously defend against the Pavilion Lawsuit and to aggressively pursue
the Pegasus Answer and Pegasus Counterclaims. Accordingly, although the
disposition of this matter cannot be predicted with certainty, management
does not believe that its ultimate outcome will have a material adverse
effect on the Company's financial position or the results of its
operations.

    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 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 or financial position of the
Company.


ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

    Not applicable.



PART II


ITEM 5. MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS

    The Common Stock trades on the American Stock Exchange (under the
trading symbol "KFX"). The following table presents the reported sales
prices on the American Stock Exchange for the two-year period ended
December 31, 2000.

                      Year       Period                High        Low
                      ----       ------                ----        ---
                      2000       First Quarter       $4.9375    $1.6875
                                 Second Quarter       3.6250     1.5000
                                 Third Quarter        3.1875     2.1875
                                 Fourth Quarter       2.9375     1.1875

                      1999       First Quarter       $2.1875    $1.2500
                                 Second Quarter       1.9375      .8750
                                 Third Quarter        1.8750     1.0625
                                 Fourth Quarter       1.7500     1.3125

    As of April 12, 2001, the Company had 191 holders of record of the
Common Stock. This does not include holdings in street or nominee names. On
April 12, 2001, the closing price of the Common Stock on the American Stock
Exchange was $2.45 per share.

    The Company has never paid cash dividends and does not anticipate
paying dividends in the foreseeable future. The Company is also restricted
from paying dividends pursuant to the terms of the Convertible Debenture
Indenture.

    During 2000, the following securities were issued pursuant to an
exemption the Securities Act of 1933, as amended:

<TABLE>
<CAPTION>

                                                                       Consideration            Class of
     Date                         Security Sold                           Received               Persons
     ----                         -------------                        -------------             -------
<S>         <C>                                                       <C>                     <C>
   5/00      Warrants to purchase 1,300,000 shares of Common  Stock          *                 Accredited
             at $3.65 per share, subject to certain adjustments                                 Investor
   7/00      Grant of 56,250 shares of Common Stock                    Professional services   Consultant
   10/00     Grant of 56,250 shares of Common Stock                    Professional services   Consultant
   11/00     80,000 shares of Common Stock                                 2.5% interest         Former
                                                                             in Pegasus         Employee
</TABLE>


    *See discussion of sale of KFP Facility to Black Hills Corporation at
    Part 1, Item 1, Strategic Relationships--Thermo Ecotek Corporation and
    KFx Fuel Partners


ITEM 6. SELECTED FINANCIAL DATA

    The following selected consolidated financial data should be read in
conjunction with the Company's consolidated financial statements and
related notes thereto and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" included in Item 7. The
consolidated statement of operations data for each of the three years in
the period ended December 31, 2000 and the consolidated balance sheet data
at December 31, 2000 and 1999 are derived from the audited consolidated
financial statements indexed on page F-1. The consolidated statement of
oqerations data for each of the two years in the period ended December 31,
1997, and the consolidated balance sheet data at December 31, 1998, 1997
and 1996 are derived from audited consolidated financial statements not
included in this Annual Report on Form 10-K.
<TABLE>
<CAPTION>

                                      2000            1999            1998            1997            1996
                                      ----            ----            ----            ----            ----
Statement of Operations Data
for the Year Ended December 31
<S>                              <C>             <C>              <C>             <C>             <C>
     Operating revenues          $   2,124,770    $  2,850,800   $   2,220,585     $  1,084,823    $  1,596,298
     Operating loss              $  (8,998,405)   $ (7,477,042)  $  (6,419,014)    $ (4,930,551)   $ (4,827,874)
     Net loss                    $ (12,290,172)   $(12,730,427)  $  (6,783,817)    $ (5,095,160)   $ (5,628,541)
     Basic and diluted net
     loss per share              $        (.49)   $       (.53)  $        (.28)    $       (.21)   $       (.25)
     Weighted average shares
     of common stock outstanding    24,908,000      24,137,000      23,931,000       23,820,000      22,458,000


Balance    Sheet    Data   at
December 31
     Current assets              $   1,294,431    $  1,605,466   $   7,004,806     $ 14,461,198    $  1,957,005
     Working capital             $  (4,965,927)   $ (3,873,922)  $   4,481,499     $ 12,565,373    $   (166,521)
(deficit)
     Total assets                $   8,471,370    $ 14,267,995   $  22,672,289     $ 29,057,706    $ 14,923,567
     Long-term debt              $  16,670,594    $ 17,484,625   $  17,890,793     $ 17,500,000    $  1,110,000
     Stockholders' equity        $ (17,433,931)   $ (9,696,018)  $   2,258,289     $  8,495,881    $ 10,524,041
(deficit)
</TABLE>

    The Company recorded permanent impairment write-downs of $629,000 and
$4,000,000 in 2000 and 1999, respectively; see Note 7 and Note 6 to the
consolidated financial statements, respectively. The Company recorded a
$464,000 write-down of certain idle equipment at the K-Fuel demonstration
plant and laboratory in 2000; see Note 1 to the consolidated financial
statements. The Company acquired Pegasus in 1998; see Note 2 to the
consolidated financial statements. The Company issued $17,000,000 of 6%
Convertible Debentures in 1997; see Note 11 to the consolidated financial
statements.


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
          FINANCIAL CONDITION AND RESULTS OF OPERATIONS

    This annual 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 annual report and our assumptions  about future events.  These
forward-looking  statements are subject to various risks and uncertainties,
not limited to those discussed under "Risk Factors," that may be outside of
our control, including, but not limited to:

     o   adverse market and various other conditions 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 this annual report, "Management's Discussion and Analysis
of Financial Condition and Results of Operations" contained in Part II,
Item 7 of this annual report and "Notes to Consolidated Financial
Statements" contained in Part II, Item 8 of this annual report. The
forward-looking statements included in this annual report are subject to
additional risks and uncertainties not disclosed in this annual report,
some of which are not known or capable of being know by the Company. The
information contained in this annual 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 annual 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

    Through the acquisition of 60% of Pegasus in early 1998, KFx
significantly broadened its technology solutions, by adding NeuSIGHT(TM),
Pegasus' neural network based combustion optimization software, to K-Fuel
Technology, its patented clean coal technology. This step was taken in
order to better meet the evolving needs of the electric power industry that
are being stimulated by domestic industry deregulation and increasingly
stsingent air quality standards worldwide. In August 1999, KFx increased
its ownership of Pegasus to 75% and during 2000, KFx sold 4% of its
interest in Pegasus to Kennecott Energy for $1 million, KFx converted $3.6
million of debt Pegasus owed to it into convertible preferred stock and
Kennecott Energy invested $2,000,000 into Pegasus in the form of
convertible preferred stock.

    As a result of the additional investments by Kennecott Energy in
Pegasus Preferred Stock through April 13, 2001 and KFx's sale of a portion
of its Pegasus Preferred Stock through April 13, 2001 to Evergreen and
other private investors, the ownership of Pegasus at April 13, 2001 is
approximately as follows: KFx--57.9%, Pegasus founders--16.0%, Kennecott
Energy--14.9%, Evergreen Resources, Inc.--8.8% and other private
investors--2.4%.

    Pegasus operations in 2000 were significantly hampered by confusion in
the power generation industry as to the manner of achieving compliance with
certain aspects of the CAA, due to legal challenges brought against certain
EPA initiatives directed at the reduction of NOX emissions as well as a
patent infringement suit brought by Pavilion in the third quarter of 2000.

     During 2000 and early 2001, various court actions affirmed most of the
EPA's NOX initiatives as well as EPA's authority to promulgate these and
similar air quality regulations (which authority had been legally
challenged). Accordingly, the power generation industry is resuming efforts
to determine the manner in which it will comply with the EPA NOX
initiatives.

     On April 11, 2001, Pegasus and Pavilion agreed to dismiss the Pavilion
Lawsuit and the Pegasus Answer, without prejudice, in order to explore
possible business combinations, cooperative relationships and other
alternatives. To the extent that these efforts are not successful, Pegasus,
in coordination with its licensor, intends to vigorously defend against the
Pavilion Lawsuit and to aggressively pursue the Pegasus Answer and Pegasus
Counterclaims. See also Part I--Item 3--Legal Proceedings.

     In 2000, Pegasus hired a new CEO, Gary Nicholson, with a uniquely
suited background in power generation information technology, control
systems and systems integration, coal mining and a strong base of
management and marketing skills. During 2000, under his leadership,
Pegasus' achievements included the completion of several outstanding
installation projects with improved customer satisfaction, the introduction
of another improvement to NeuSIGHT to further streamline installation
efforts, the receipt of an order for the installation of NeuSIGHT in China
and the initiation of an exclusive licensing arrangement for China with an
experienced local partner with strong US ties. Despite the difficulties
imposed by the legal challenges to the EPA's NOX initiatives and the
Pavilion lawsuit, Pegasus achieved improved revenue growth from 1999 to
2000 of 23% compared to a 16% increase in revenues from 1998 to 1999.

    In early 2000, after completion of an analysis of issues impacting the
growth and success of Pegasus, the Company decided to move the Denver,
Colorado headquarters activities of Pegasus, which included marketing and
sales administration, general accounting and financial reporting, to the
Pegasus Cleveland, Ohio area offices which include its operations and
research and development activities. This move was substantially completed
during the second quarter of 2000, and has provided more effective
management and coordination of and communication among Pegasus' various
activities.

    Progress to commercialize K-Fuel Technology continued during 2000,
culminating with the announcement in early 2001 of the successful
demonstration of an improved coal upgrading process resulting from the
joint efforts of KFx and Kennecott Energy, through the K-Fuel, LLC joint
venture. This 16-month project, performed by Kennecott Energy's affiliate,
Rio Tinto Technical Services, evaluated historical information, issues
impacting the operations of the existing Gillette commercial K-Fuel
facility, off-the-shelf equipment, and methods to achieve continuous
operations to improve the economics of the production process. The
principal differences from the K-Fuel Series C process previously used are
continuous operations, lower temperatures, and the absence of superheat
from the system.

    The resulting product, which in the tests was produced from PRB coals,
is low in SO2, NOX, mercury and chlorine, similar to K-Fuel. The analysis
also indicated that an improved process can possibly be designed to produce
the new fuel within potentially attractive economic constraints and that
tie K-Fuel production process proposed as a result of the project should be
more reliable than the current Gillette commercial plant and have lower
capital and operating costs than any previous design.

    The heating value of the new fuel as tested is approximately 11,200 to
11,600 Btu's per pound. Upon combustion, the new fuel produces
approximately 20% lower NOX emissions and lower mercury emissions, as
compared to the PRB feedstock coal (already the lowest mercury content coal
naturally available), and SO2 emissions well below the 1.0 lb per million
Btu limit contained in Phase II of the CAA.

    In addition, K-Fuel LLC believes that there may be considerable
advantages to blending the new product and raw PRB coal. The dust and
self-heating behaviors of a blend of the new product and raw PRB coal
appear to be similar to raw PRB coal, without the need for oil or other
treatment. The blend retains proportional NOX, SO2 and mercury reduction
benefits. Accordingly, a commercial plant for the new product may be
leveraged to provide considerably higher volumes of blended product for the
market place.

    On May 9, 2000, the Company closed a series of agreements with various
pasties intended to initiate the redevelopment of the KFP Facility. Among
other things, as a result of these 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 TCK in exchange for the
assumption of the reclamation liability associated with the KFP Facility,
(b) KFx granted BKH a warrant to purchase 1.3 million shares of KFx common
stock at $3.65 per share, subject to certain adjustments, (c) KFx
relinquished its 5% interest in KFP to TCK and provided certain releases to
TCK in exchange for approximately $1.5 million, (d) TCK sold the remaining
2.25 million common shares of KFx it owned to private investors and
canceled the warrants it held to purchase a control position in KFx's
common stock. KFx and BKH are proceeding to finalize plans and secure the
necessary capital to rectify certain design flaws in the balance-of-plant
systems in order to restart the KFP Facility and produce K-Fuel. The cost
to implement these plans is currently estimated at $2 million to $4
million.

    During 2000 and before, management of the Company has been evaluating
various alternatives to raise capital and improve its balance sheet. The
Pavilion Lawsuit filed in the third quarter of 2000, precluded many of the
opuions that had been considered, some of which were in the process of
being implemented at the time the Pavilion Lawsuit was filed. With the
April 11, 2001 settlement of the Pavilion Lawsuit, the Company immediately
resumed its efforts to raise needed capital for Pegasus and KFx and is
considering various alternative relationships with Pavilion.

REVENUE RECOGNITION

Pegasus Software License and Services Revenue

    The Company recognizes revenue in accordance with the provisions of
Statement of Position 97-2, "Software Revenue Recognition." The Company
derives revenues from license fees, for the Company's NeuSIGHT software,
and services, including installation, implementation, maintenance and
training, under the terms of both fixed-price and time-and-materials
contracts. Revenues are not recognized until persuasive evidence of an
arrangement exists, either by way of a signed contract or signed purchase
order.

    Where services are essential to the functionality of the delivered
software, the license fee and services revenue is generally recognized
using the percentage-of-completion method of accounting, as prescribed by
SOP 81-1 "Accounting for Performance of Construction-Type and Certain
Production-Type Contracts". The percentage of completion for each contract
is determined based on the ratio of direct labor hours incurred to total
estimated direct labor hours required to complete the contract. The Company
may periodically encounter changes in costs, estimated costs and other
factors that may lead to a change in the original estimated profitability
of a fixed-price contract. In such circumstances, adjustments to cost and
profitability estimates are made in the periods in which the underlying
factors requiring such revisions become known. If such revisions indicate a
loss on a contract, the entire loss is recorded at such time. Amounts
billed in advance of services being performed are recorded as deferred
revenue. Unbilled work-in-progress represents revenue earned but not yet
billable under the terms of fixed price contracts and all such amounts are
expected to be billed in accordance with performance milestones specified
in the contract with the client and collected within twelve months.
Deferred job costs represent up-front hardware costs incurred that will be
amortized to expense over the term of related revenue recognition.

    Services revenue provided under fixed-price contracts is generally
recognized using the percentage completion method of accounting described
above. Revenue from other services provided pursuant to time-and-materials
contracts is recognized as the services are performed. Annual maintenance
revenue is recorded as deferred revenue and recognized ratably over the
service period, which is generally twelve months.


K-Fuel Revenue

    The Company recognizes revenue from K-Fuel licenses, when an agreement
has been signed, all significant obligations have been satisfied, the fee
is fixed or determinable and collectibility is reasonably assured. Fees
fsom contract services are recognized as the services are performed.

RESULTS OF OPERATIONS

Year Ended December 31, 2000 vs. Year Ended December 31, 1999

    The consolidated operating loss in 2000 of $8,998,405, which includes
$3,575,622 of non-cash charges, was $1,521,363, or 20%, greater than the
1999 operating loss due primarily to (a) a K-Fuel license fee in 1999 that
cootributed $750,000 to operating income, with no similar fee in 2000, (b)
a non-cash charge approximating $464,000 at the K-Fuel segment due to the
write-down of certain idle equipment (c) an increase approximating $865,000
in operating losses at Pegasus offset by (d) reduced KFx corporate and
other costs and losses approximating $505,000.

    Consolidated operating revenues decreased approximately $726,000, or
25% from 1999 to 2000 due primarily to (a) the $1 million K-Fuel license
fee from Kennecott Energy in 1999 only, offset by (b) an increase in
Pegasus revenues approximating $358,000, or 23%.

    Consolidated operating costs and expenses in 2000 exceeded the 1999
level by approximately $795,000, or 8%. Pegasus operating costs increases
of approximately $1,223,000 (25%) and the K-Fuel idle equipment write-down
of $464,0000 were offset by the absence of K-Fuel royalty expense in 2000,
that was $250,000 in 1999, a reduction in other operating costs of the
K-Fuel demonstration plant and laboratory approximating $121,000, or 37%,
due to reduced contract revenue and related activity level and cost
reductions at the KFx corporate level approximating $505,000 (16%),
resulting from staff reductions and various other costs reduction measures.

    Pegasus cost increases from 1999 to 2000 included (a) an increase in
cost of sales of $594,000 (50%) resulting from the 23% increase in sales as
well as increased costs associated with ensuring the completion of certain
installations to the satisfaction of customers, (b) a $279,000 (83%)
increase in research and development as a result of more focus on product
improvement and new product development resulting in part from Kennecott
Energy's investments in Pegasus, and (c) a $129,000 (21%) increase in
depreciation and amortization largely due to $115,000 (22%) of additional
goodwill amortization stemming from an addition to goodwill in late 1999.
Marketing, general and administrative costs for Pegasus increased by
approximately $221,000 (8%) from 1999 to 2000, largely due to certain
internal costs associated with the Pavilion Lawsuit that are not subject to
indemnification.

    Declines in KFx corporate and other costs included (a) $457,000 (17%)
in reduced marketing, general and administrative expenses, resulting from
reducing staff and executive office space and related expenses, and (b)
$48,000 (9%) in reduced depreciation and amortization of debt issue costs
resulting from the conversion of $1.9 million of Debentures during 2000.

    Partially offsetting the variances from 1999 to 2000 in the Company's
operating loss, the Company experienced a $1,962,000 net decrease in net
non-operating expense items from 1999 to 2000. This decrease was primarily
due to the net result of (a) a $4,000,000 impairment loss in 1999 related
to the Company's investment in KFP compared to a $629,000 impairment loss
in 2000 related to the Company's investment in Charco Redondo, (b) the
recognition, beginning in 2000 of, the accretion of the maturity premium on
the Company's Debentures, which totaled $1,362,000, and is included in
interest expense, (c) a decline in interest and other income approximating
$359,000, due largely to a $223,000 nonrecurring non cash income item in
1999, as well as a $116,000 decline in interest income due to lower cash
balances, (d) a $134,000 (10%) increase in interest expense associated with
increased borrowings and (e) the absence in 2000 of $452,000 of equity
losses associated with the Company's investment in KFP.

    The factors discussed above combined to produce a 2000 net loss of
$12,290,172, which is approximately 3% below the $12,730,427 net loss for
1999. On a basic and diluted net loss per share basis, the $.49 loss for
2000 is approximately 6% lower than the $.53 loss for 1999 due to the
smaller 2000 net loss as well as 3% increase in the weighted average number
of shares outstanding from 1999 to 2000.

    The Company has not recorded a deferred tax benefit from KFx's and
Pegasus' net operating loss carryforwards, which approximate $42,873,000
aod $4,151,000, respectively, at December 31, 2000, since, based on the
weight of available evidence, both positive and negative, management has
determined that it is more likely than not that the Company's deferred tax
assets will not be realized. Certain limitations apply to the annual amount
of net operating losses that can be used to offset taxable income, after
certain ownership changes, as defined in Section 382 of the Internal
Revenue Code ("Section 382"). Although management does not believe Section
382 places significant limitations on the use of the Company's net
operating loss carryforwards presently, transactions that may be
consummated in order to obtain needed financing may result in ownership
changes that are large enough to trigger the Section 382 limitations. In
the event the Company achieves profitable operations and taxable income,
any significant Section 382 limitation would have the effect of increasing
the Company's income tax liability and reducing available cash resources.


Year Ended December 31, 1999 vs. Year Ended December 31, 1998

    The consolidated operating loss in 1999 of $7,477,000, which includes
$2,765,000 of non-cash charges, was $1,058,000, or 16% greater than the
1998 operating loss due primarily to an increase approximating $2,033,000
in operating losses at Pegasus partially offset by reduced operating losses
for K-Fuel approximating $619,000 and a reduction in KFx corporate and
other costs approximating $356,000.

    Consolidated operating revenues increased approximately $630,000, or
28% from 1998 to 1999 due primarily to the $1 million K-Fuel license fee
from Kennecott Energy. In addition, Pegasus revenues increased
approximately $208,000, or 16%, but K-Fuel contract revenue declined
approximately $578,000, or 65%. This decrease was primarily due to a
$351,000 decline in contract revenues associated with services provided by
the K-Fuel demonstration plant and laboratory to the KFP Facility, stemming
from TCK's suspension of operations at the KFP Facility in June 1999. In
addition, there was a $227,000 decline in revenues from a K-Fuel research
and development contract with a third party, related to the K-Fuel
demonstration plant and laboratory, due to certain administrative changes
at the third party research and development contracting agency.

    Consolidated operating costs and expenses in 1999 exceeded the 1998
level by approximately $1,688,000, or 20%, principally due to increased
costs at Pegasus approximating $2,241,000, partially offset by comparative
declines in K-Fuel costs of $197,000 and in KFx and other costs of
$356,000.

    Pegasus costs increased from 1998 to 1999, in part, because 1998
included three fewer months of Pegasus activity. Pegasus cost increases
included (a) $426,000 (56%) in increased cost of sales associated with
increased revenue, (b) $1,445,000 (118%) increased marketing, general and
administrative costs resulting largely from efforts begun in late 1998 to
develop a professional marketing and sales organization, (c) $197,000
(143%) in research and development costs associated with activities to
develop enhancements to NeuSIGHT and new products and (d) $173,000 (39%) in
depreciation and amortization primarily due to increased goodwill
amortization.

    Declines in K-Fuel costs include $474,000 (53%) in reduced K-Fuel
demonstration plant and laboratory expense associated with the decline in
related revenue discussed above partially offset by a $250,000 royalty
expense associated with the K-Fuel license fee from Kennecott Energy.
Declines in KFx corporate and other costs included (a) $224,000 (8%) in
reeuced marketing, general and administrative expenses and (b) $132,000
(20%) in reduced depreciation and amortization as certain assets became
fully depreciated during 1999.

    In addition to the Company's operating loss, the Company experienced a
$4,889,000 net increase in net non-operating expense items from 1998 to
1999. This increase was primarily due to (a) the recognition in 1998 of a
$701,000 gain on sale of mine, (b) a decline in interest and other income
approximating $320,000, due largely to a decline in the average balance of
cash investments, partially offset by (c) a $175,000 reduction in KFx's
share of losses at K-Fuel, LLC, due to lower R&D expenses, and (d) a
$4,000,000 impairment of the Company's investment in KFP.

    The factors discussed above combined to produce a net loss of
$12,730,427 for 1999, which is $5,946,610 in excess of the 1998 net loss.
On a basic and diluted per share basis, the 1999 loss was $.53 compared to
$.28 in 1998.


LIQUIDITY AND CAPITAL RESOURCES

    During 2000, the Company used approximately $5,151,000 of cash for its
operating activities, which included (a) approximately $2,360,000 used to
support and accelerate the growth of Pegasus' business, (b) $1,181,000 used
for interest payments, (c) approximately $1,610,000 used for KFx corporate
and other activities. The principal sources of cash during 2000 were (a)
$3,000,000 from Kennecott Energy associated with its investment in Pegasus
beginning in March (of which $1,000,000 was paid to KFx and $2,000,000 was
invested in Pegasus), (b) the $1,527,000 recovery of the Company's
investment in KFP and (c) $850,000 in net short term borrowings from KFx
directors (of which $250,000 was borrowed by KFx and $600,000 was borrowed
by Pegasus). In addition to cash used for operating activities the Company
also used $532,000 of cash in total as follows: (a) K-Fuel patent
applications ($295,000), (b) repayment of notes related to the 1998
acquisition of Pegasus ($171,000) and (c) purchases of property and
equipment ($66,000).

    During 1999, the Company used approximately $3,458,000 of cash for its
operating activities, which included (a) approximately $1,952,000 used to
support and accelerate the growth of Pegasus' business, (b) $1,148,000 used
for interest payments, and (c) approximately $1,854,000 used for KFx
corporate and other activities. Offsetting these uses of cash was
approximately $1,496,000 of cash provided from the continued development of
the K-Fuel business, principally the June 1999 agreement with Kennecott
Energy which produced net operating cash flow of $1,750,000.

    During 2000 and before, management of the Company has been evaluating
various alternatives to raise capital and improve its balance sheet. The
Pavilion Lawsuit filed in the third quarter of 2000, precluded many of the
options that had been considered, some of which were in the process of
being implemented at the time the Pavilion Lawsuit was filed. With the
April 11, 2001 settlement of the Pavilion Lawsuit, the Company immediately
resumed its efforts to raise needed capital for Pegasus and KFx and is
considering various alternative relationships with Pavilion as discussed
below.

    During 2001, through April 13, the Company raised $1,900,000 in cash
from certain transactions resulting in the sale of a portion (equivalent to
an 11.2% as converted interest in Pegasus) of its preferred stock
investment in Pegasus. KFx is obligated to repurchase this preferred stock
for $2,533,333 within one year of the date it was sold, or earlier in
certain circumstances.

    At December 31, 2000, principal and interest under a promissory note to
the State of Wyoming ("Wyoming") in the amount of $475,000 was due as
follows: (a) February 1, 2001--$5,000 and (b) March 1, 2001--$470,000. The
payment due March 1, 2001 was not paid. The Company initiated discussions
with Wyoming in late February 2001 and on March 12, 2001 consummated an
extension to July 1, 2001 in exchange for (a) a principal payment
approximating $150,400 made on March 9, 2001, (b) a delinquent payment fee
approximating $47,200 made on March 9, 2001, (c) an interest payment
approximating $2,400 made on March 9, 2000, (d) the assignment to Wyoming
of the net sales proceeds of the balance of the Company's preferred stock
investment in Pegasus (with a face value approximating $1 million,
representing an interest in Pegasus approximating 4.4% and (e) a collateral
interest in certain K-Fuel related equipment that is not currently in use.

    Circumstances substantially identical to those in the preceding
paragraph arose relative to promissory notes due 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 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
$12,210 were made through April 12, 2001. The Company's Chairman and his
affiliate have agreed to waive their indemnification rights for future
payments under certain circumstances. Wyoming issued a notice of default
relative to this note on March 2, 2001, triggering a 10-day cure period. On
March 12, 2001, Wyoming agreed to forebear from collection activities under
this note until July 1, 2001.

    The Company will seek to meet its cash requirements over the balance of
2001 with respect to day-to-day operations and debt service requirements
through (a) cash on hand, which as of April 13, 2001 approximated $306,000;
(b) the net sales proceeds of the balance of the Company's preferred stock
inwestment in Pegasus that has been assigned to Wyoming; (c) approximately
$500,000 of Kennecott Energy's discretionary investments in Pegasus
pursuant to provisions of the agreements executed in March 2000; (d)
potential investments in Pegasus from interested participants in the power
generation industry; (e) potential debt and/or equity offerings of the
Company; (f) potential fees from licensing new K-Fuel facilities; (g)
potential partners in connection with opportunities to expand the Company's
product and service offerings to the power industry; (g) potential contract
revenues relating to the K-Fuel demonstration plant and laboratory; and (h)
unsecured borrowings from one or more of its directors.

    The Company has contacted and has been contacted by several large
suppliers to the power generation industry about the potential of making an
investment in Pegasus. In addition, the Company is considering the
potential for debt and/or equity offerings by the Company and/or Pegasus
and has had related discussions with investment banking firms. At this
stage, discussions with all of these parties are preliminary, but the
Company intends to continue such discussions and negotiate definitive
agreements if acceptable terms can be reached.

    The Company is continuing to work toward its goal of licensing a large
commercial K-Fuel plant to Kennecott Energy.

    The Company has had discussions with various parties about potential
transactions to add product and/or service offerings relevant to the power
generation industry. Such discussions have included consideration of
acquisitions and related transactions to raise equity capital for the
Company and/or Pegasus. Although currently there are no active discussions,
the Company will continue to evaluate the merits of pursuing such a
strategy, in view of the Company's evolving financial condition. In
adeition, 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.

    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 is sold at a price below $3.65 per share.

    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, it is
possible that the Company may not be able to continue as a going concern.


NEW ACCOUNTING PRONOUNCEMENTS

    In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements,"
(the "Bulletin"), which addresses revenue recognition issues. The
implementation of the Bulletin was delayed until the fourth quarter of 2000
for fiscal years beginning after December 15, 1999. The application of the
Bulletin was retroactive to January 1, 2000. The impact of the Bulletin on
the Company's consolidated financial statements was not material.

    In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities." This statement establishes
accounting and reporting standards for derivative instruments and for
hedging activities. SFAS No. 133 requires, among other things, that all
desivative instruments be recognized at fair value as assets or liabilities
on the balance sheet and that changes in fair value generally be recognized
currently in earnings unless specific hedge accounting criteria are met.
Because the Company does not hold any derivative financial instruments and
has not engaged in hedging activities, the Company does not expect the
adoption of SFAS 133 to have a material impact on its consolidated results
of operations, financial position or cash flows. The Company will adopt the
provisions of SFAS 133 in the first quarter of 2001.


ITEM 7A. 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 $850,000 of floating rate debt and does not expect to
derive a material amount of its revenues 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.


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

    The consolidated financial statements and notes thereto included in
this item are indexed on page F-1 "Index to Consolidated Financial
Statements."

    Unaudited selected quarterly financial data for the years ended
December 31, 2000 and 1999 is included at Note 19 to the consolidated
financial statements.


ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
          AND FINANCIAL DISCLOSURES

    None.




PART III


ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS

         The required information for this item is incorporated by
reference to the Company's Proxy Statement for the 2001 Annual Meeting of
Shareholders.


ITEM 11. EXECUTIVE COMPENSATION

         The required information for this item is incorporated by
reference to the Company's Proxy Statement for the 2001 Annual Meeting of
Siareholders.


ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The required information for this item is incorporated by
regerence to the Company's Proxy Statement for the 2001 Annual Meeting of
Shareholders.


ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         The required information for this item is incorporated by
reference to the Company's Proxy Statement for the 2001 Annual Meeting of
Shareholders.




PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

  (a)    (1) List of Financial Statements

                  See Index to Consolidated Financial Statements at F-1

         (2) List of Financial Statement Schedules

                  None

         (3) Exhibits

  EXHIBIT
  NUMBER         DESCRIPTION
  -------        -------------------------------------------------------------

  3.1(1)         Restated Certificate of Incorporation of the Company
  3.2(1)         Certificate of Amendment to Certificate of Incorporation
                 of the Company
  3.3(5)         Second Amended and Restated Bylaws of the Company
  4.1(5)         Sample Common Stock Certificate
  4.2(9)         Indenture dated July 25, 1997 by and between the Company
                 and Colorado National Bank
  4.3(2)         Form of Warrant to Purchase Common Stock issued to
                 Placement Agents in connection with issuance of 6%
                 Convertible Debentures, due 2002
  4.4(11)        Company Stock Purchase Warrant dated June 19, 1997 and
                 Amendment No. 2 dated August 3, 1998 between the Company
                 and Peter G. Martin
  4.5(11)        Common Stock Purchase Warrant dated August 2, 1995 and
                 Amendment No. 1 dated August 3, 1998 between the Company
                 and Peter G. Martin
  4.6(11)        Common Stock Purchase Warrant dated November 15, 1996 and
                 Amendment No. 1 dated August 3, 1998 between the Company
                 and Innovative Research Associates, Inc.
  4.7*           Statement Respecting Rights of Series B Preferred Stock of
                 Pegasus Technologies, Inc.
  4.8*           Statement Respecting Rights of Series C Preferred Stock of
                 Pegasus Technologies, Inc.
  4.9*           Warrants to Purchase 1,000,000 Shares of KFx Inc. Common
                 Stock issued to Evergreen Resources, Inc. as of February
                 9, 2001
  4.10*          Registration Rights Agreement Between the Company and
                 Evergreen Resources, Inc. dated February 9, 2001
  4.11*          Warrants to Purchase 166,667 Shares of KFx Inc. Common
                 Stock issued to William H. Walker as of March 8, 2001
  4.12*          Registration Rights Agreement Between the Company and
                 William H. Walker dated March 8, 2001
  4.13*          Warrants to Purchase 66,667 Shares of KFx Inc. Common
                 Stock issued to Theodore Venners as of March 8, 2001
  4.14*          Registration Rights Agreement Between the Company and
                 Theodore Venners dated March 8, 2001
  4.15*          Warrants to Purchase 33,333 Shares of KFx Inc. Common
                 Stock issued to Mark S. Sexton as of April 10, 2001
  4.16*          Registration Rights Agreement Between the Company and Mark
                 S. Sexton dated April 10, 2001
  4.17*          Warrants to Purchase 1,300,000 Shares of KFx Inc. Common
                 Stock issued to Landrica Development Company as of May 1, 2000.
  4.18*          Registration Rights Agreement Between the Company and Landrica
                 Development Company dated May 1, 2000.
  10.1(1)        Amendments to Agreements between Theodore Venners, S.A.
                 Wilson, Koppelman Fuel Development Company, and the
                 Koppelman Group dated December 29, 1992
  10.2(1)        Assignment of U.S. Patents by K-Fuel Limited Partnership
                 to the Company dated July 23, 1993
  10.3(1)        Assignment of U.S. Trademark Registration by K-Fuel
                 Limited Partnership to the Company dated July 23, 1993
  10.4(1)        Royalty Agreement dated December 29, 1992 between the
                 Company and the Koppelman Group
  10.5(1)        Agreement dated December 19, 1991 among K-Fuel
                 Partnership, Edward Koppelman, K-Fuel Limited Partnership
                 and KSA Inc.
  10.6(1)        Restricted Stock Plan for Directors and Selected Officers
                 dated December 16, 1993
  10.7(4)        Restricted Stock Plan for Selected Independent Contractors
                 dated February 16, 1994
  10.8(1)        Stock Option Plan dated December 16, 1993
  10.9(1)        Settlement Agreement dated December 14, 1992
  10.10(1)       Stock Exchange Agreement Dated December 14, 1992
  10.11(1)       Stipulation and Agreement dated February 28, 1994 between
                 Energy Brothers Technology, Inc., State of Wyoming, the
                 Company, Theodore Venners, Edward Koppelman and Energy
                 Brothers Holding, Inc.
  10.12(4)       Extension of Stock Forfeiture Agreement between Theodore
                 Venners and Rudolph G. Swenson; Joyce M. Goldman; David
                 Bretzlauf; Joseph M. Butler; R.C. Whitner; Hillari
                 Koppelman; Thomas D. Smart and Susan M. Thevenet; Charles
                 F. Vance
  10.13(3)       Common Stock Purchase Agreement dated July 27, 1995
                 between the Company and David H. Russell
  10.14(3)       Gross Royalty Share Agreement dated August 17, 1995
                 between the Company and Fort Union, Ltd.
  10.15(3)       Letter of Agreement dated August 15, 1995 between the
                 Company and Edward Koppelman
  10.16(3)       Assignment dated August 29, 1995 executed by Edward
                 Koppelman in favor of the Company
  10.17(3)       Notice of Termination dated August 16, 1995 between Edward
                 Koppelman and Energy Brothers Holding, Inc.
  10.18(5)       Letter Agreement dated February 28, 1995 between RCD
                 Development and the Company
  10.19(6)       Amended and Restated Heartland License Agreement between
                 Heartland Fuels Corporation and the Company dated April
                 19, 1996
  10.20(7)       Royalty Amendment Agreement dated June 3, 1996 between the
                 Company, Edward Koppelman and Theodore Venners
  10.21(8)       Amendment to Agreement between the Company and RCD
                 Development dated January 16, 1997
  10.22(10)      1998 Directors Nonqualified Stock Option Plan
  10.23(10)      1998 Advisory Committee Nonqualified Stock Option Plan
  10.24(10)      Non-qualified Stock Option Agreement dated October 1, 1998
                 between the Company and Seth L. Patterson
  10.25(11)      Stock Purchase Agreement dated March 26, 1997 between the
                 Company and Theodore Venners
  10.26(11)**    Professional Installation Services Master Agreement dated
                 March 5, 1999, between Net Power Solutions, a subsidiary
                 of the Company, and the Energy Systems Group of Science
                 Applications International Corporation
  10.27(12)      1999 Stock Incentive Plan
  10.28(13)**    First Amended Limited Liability Company Agreement of
                 K-Fuel, L.L.C. dated June 29, 1999
  10.29(15)      Exchange Agreement dated August 27, 1999 between the
                 Company and AIW/P Holdings, Inc.
  10.30(15)      Transfer Agreement dated August 27, 1999 between the
                 Company and AIW/P Holdings, Inc.
  10.31(14)**    Common Stock and Series A Preferred Stock Purchase
                 Agreement among Pegasus Technologies, Inc., KFx Inc. and
                 Kennecott Energy Company dated March 3, 2000
  10.32(14)      Pegasus Technologies, Inc. Stockholders and Voting
                 Agreement dated March 3, 2000
  10.33(14)      Marketing Services Agreement dated March 3, 2000 among
                 Pegasus Technologies, Inc., Net Power Solutions, LLC,
                 KFuel LLC, KFx Inc. and Kennecott Energy Company
  10.34*         1996 Stock Option and Incentive Plan of KFx Inc.
  21.1*          Subsidiaries
  23.1*          Consent of Independent Accountants
  34.1*          Powers of Attorney, incorporated by reference to Signature
                 page





  ----------------------------------------------------------------------------

*     Filed herewith.
**  Certain portions of this Exhibit were omitted based upon a request for
    confidential treatment. The omitted portions were separately filed with
    the Securities and Exchange Commission.
(1)  Document previously filed with the U.S. Securities and Exchange
     Commission on March 1, 1994 as an exhibit to the Company's Form 10-SB
     and incorporated herein by reference.
(2)  Document previously filed with the U.S. Securities and Exchange
     Commission with the Company's Current Report on Form 8-K dated August
     22, 1997 and incorporated herein by reference.
(3)  Document previously filed with the U.S. Securities and Exchange
     Commission with the Company's Registration Statement on Form SB-2
     (File No. 33-97418) and incorporated herein by reference.
(4)  Document previously filed with the U.S. Securities and Exchange
     Commission with the Company's Registration Statement on Form SB-2
     (File No. 33-90128) and incorporated herein by reference.
(5)  Document previously filed with the U.S. Securities and Exchange
     Commission with the Company's Annual Report on Form 10-KSB, as
     amended, for the year ended December 31, 1995 and incorporated herein
     by reference.
(6)  Document previously filed with the U.S. Securities and Exchange
     Commission with the Company's Current Report on Form 8-K dated April
     19, 1996 and incorporated herein by reference.
(7)  Document previously filed with the U.S. Securities and Exchange
     Commission with the Company's Quarterly Report on Form 10-Q for the
     quarter ended June 30, 1996 and incorporated herein by reference.
(8)  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, 1996 and incorporated herein by reference.
(9)  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, 1997 and incorporated herein by reference.
(10) 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, 1998 and incorporated herein by reference.
(11) Document previously filed with the U.S. Securities and Exchange
     Commission with the Company's Quarterly Report on Form 10-Q for the
     quarter ended March 31, 1999 and incorporated herein by reference.
(12) Document previously filed with the U.S. Securities and Exchange
     Commission on May 4, 1999 as Annex A-1 of the Company's Proxy
     Statement on Schedule 14A and incorporated herein by reference.
(13) Document previously filed with the U.S. Securities and Exchange
     Commission with the Registrant's Current Report on Form 8-K dated June
     29, 1999 and incorporated herein by reference.
(14) Document previously filed with the U.S. Securities and Exchange
     Commission with the Registrant's Current Report on Form 8-K dated
     March 7, 2000 and incorporated herein by reference.
(15) Document previously filed with the U.S. Securities and Exchange
     Commission with the Registrant's Current Report on Form 8-K dated
     August 27, 1999 and incorporated herein by reference.


    (b)  Reports on Form 8-K


    No reports on Form 8-K were filed in the quarter ended December 31, 2000.




SIGNATURES

    PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE
SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.

Daue: April 16, 2001                  KFX INC.

                                      By: /s/Theodore Venners
                                      -----------------------------------------
                                      Theodore Venners
                                      Chairman of the Board of Directors,
                                         President, and Chief Executive Officer




    POWER OF ATTORNEY

    KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Theodore Venners and Seth L.
Patterson, and each of them, as his true and lawful attorneys-in-fact and
agents, with full power of substitution and resubstitution, for him and in
his name, place, stead, in any and all capacities, to sign any and all
amendments to this Report on Form 10-K, and to file the same, with all
exhibits thereto, and other documents in connection therewith, including
all amendments thereto, with the Securities and Exchange Commission,
granting unto said attorneys-in-fact and agents, and each of them, full
power and authority to do and perform each and every act and thing
requisite and necessary to be done in connection therewith, as fully to all
intents and purposes as he might or could do in person, hereby ratifying
and confirming all that said attorneys-in-fact and agents, or any of them,
or their or his substitute or substitutes, may lawfully do or cause to be
done by virtue hereof.

    PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934,
THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.

<TABLE>
<CAPTION>

     SIGNATURE                              TITLE                                         DATE
     ---------                              -----                                         ----

<S>                                       <C>                                           <C>
     /s/Theodore Venners
     -----------------------------
     Theodore Venners                       Chairman of the Board of Directors,           April 16, 2001
                                            President and Chief Executive Officer
                                            (Principal Executive Officer)
     /s/Seth L. Patterson
     -----------------------------
     Seth L. Patterson                      Executive Vice President and                  April 16, 2001
                                            Chief Financial Officer
                                            (Principal Financial and Accounting
                                            Officer)
     /s/Stanford M. Adelstein
     -----------------------------
     Stanford M. Adelstein                  Director                                      April 16, 2001


     /s/Vincent N. Cook
     -----------------------------
     Vincent N. Cook                        Director                                      April 16, 2001


     /s/Gary Nicholson
     -----------------------------
     Gary Nicholson                         Director                                      April 16, 2001


     /s/Jack C. Pester
     -----------------------------
     Jack C. Pester                         Director                                      April 16, 2001


     /s/David H. Russell
     -----------------------------
     David H. Russell                       Director                                      April 16, 2001


     /s/Mark S. Sexton
     -----------------------------
     Mark S. Sexton                         Director                                      April 16, 2001


     /s/Stanley G. Tate
     -----------------------------
     Stanley G. Tate                        Director                                      April 16, 2001

</TABLE>



                 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



     Report of Independent Accountants............................         F-2


     Consolidated Balance Sheets..................................         F-3


     Consolidated Statements of Operations........................         F-4


     Consolidated Statements of Stockholders' Deficit.............         F-5


     Consolidated Statements of Cash Flows........................         F-6


     Notes to Consolidated Financial Statements................... F-8 to F-29




                     REPORT OF INDEPENDENT ACCOUNTANTS



To the Board of Directors and Stockholders of KFx Inc.

    In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, of stockholders' deficit and
of cash flows present fairly, in all material respects, the financial
position of KFx Inc. and its subsidiaries at December 31, 2000 and 1999,
ane the results of their operations and their cash flows for each of the
three years in the period ended December 31, 2000, in conformity with
accounting principles generally accepted in the United States of America.
These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements
in accordance with auditing standards generally accepted in the United
States of America which require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant
estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable
basis for our opinion.

    The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in
Note 1 to the financial statements, the Company has suffered recurring
losses and negative cash flows from operations and has an accumulated
deficit of $71,091,304 at December 31, 2000. These factors, among others,
raise substantial doubt about the Company's ability to continue as a going
concern. Management's plans in regard to these matters are also described
in Note 1. The consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.



/s/ PRICEWATERHOUSECOOPERS LLP

PricewaterhouseCoopers LLP
Denver, Colorado
April 13, 2001



<TABLE>
<CAPTION>

                                  KFX INC.

                        CONSOLIDATED BALANCE SHEETS

                                                                                        DECEMBER 31,
                                                                                        ------------
                                                                                  2000                1999
                                                                                  ----                ----
ASSETS
Current assets
<S>                                                                        <C>                 <C>
     Cash and cash equivalents.........................................    $      348,955      $      654,429
     Trade accounts receivable.........................................           351,909             606,326
     Unbilled revenue..................................................           118,103              66,994
     Other receivables.................................................           224,853              24,252
     Prepaid expenses..................................................            34,459              69,715
     Deferred job costs................................................           216,152             183,750
                                                                              -----------         -----------
          Total current assets.........................................         1,294,431           1,605,466
Property, plant and equipment, net of accumulated depreciation.........         1,360,430           2,258,426
Patents, net of accumulated amortization...............................         1,951,567           2,297,708
Investment in and advances to KFx Fuel Partners, L.P. .................                --           1,527,048
Iovestmentin K-Fuel, L.L.C. ...........................................           694,135           1,171,585
Investment in Charco Redondo, L.L.C. ..................................                --             629,238
Goodwill, net of accumulated amortization..............................         1,817,731           2,298,250
Debt issue costs, net of accumulated amortization......................           679,046           1,246,565
Prepaid royalty........................................................           498,000             498,000
Other assets...........................................................           176,030             735,709
                                                                              -----------         -----------
TOTAL ASSETS                                                               $    8,471,370      $   14,267,995
                                                                           ==============      ================

LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities
     Accounts payable..................................................       $ 1,817,533         $   551,193
     Accrued expenses..................................................           625,523             308,102
     Interest payable..................................................           458,265             543,068
     Liability to issue stock and warrants.............................           134,458           2,200,000
     Deferred sale of Pegasus Technologies Inc. common stock...........         1,000,000                  --
     Deferred revenue..................................................           523,552             985,858
     Short-term notes payable to directors ............................           827,551                  --
     Current maturity of long-term debt................................           873,476             891,167
                                                                              -----------         -----------
          Total current liabilities....................................         6,260,358           5,479,388
Deferred income........................................................           499,309           1,000,000
Deferred revenue.......................................................           200,000                  --
Long-term debt, less current maturities................................           331,150             484,625
Convertible debentures.................................................        16,339,444          17,000,000
                                                                              -----------         -----------
          Total liabilities............................................        23,630,261          23,964,013
                                                                              -----------         -----------
Commitments and contingencies (Note 15)
Minority interest......................................................         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;
        25,196,280 and 24,482,240 shares issued and outstanding,
        respectively...................................................            25,196              24,482
     Additional paid-in capital........................................        53,632,177          49,080,632
     Accumulated deficit...............................................       (71,091,304)        (58,801,132)
                                                                              -----------         -----------
          Total stockholders' deficit..................................       (17,433,931)         (9,696,018)
                                                                              -----------          ----------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT............................    $    8,471,370     $    14,267,995
                                                                           ===============     ===============

                The accompanying notes are an integral part of these consolidated financial statements.

</TABLE>


<TABLE>
<CAPTION>

                                  KFX INC.

                   CONSOLIDATED STATEMENTS OF OPERATIONS


                                                                                  YEAR ENDED DECEMBER 31,
                                                                                  -----------------------
                                                                           2000                1999              1998
                                                                           ----                ----              ----
OPERATING REVENUES
<S>                                                                   <C>                  <C>                <C>
Pegasus software licenses and services............................... $ 1,894,994          $ 1,536,884        $ 1,328,491
K-Fuel demonstration plant and laboratory contract revenue...........     229,776              313,916            892,094
K-Fuel license fee...................................................          --            1,000,000                 --
                                                                      -----------          -----------        -----------
     Total operating revenues........................................   2,124,770            2,850,800          2,220,585
                                                                      -----------          -----------        -----------
OPERATING COSTS & EXPENSES
Cost of Pegasus software licenses and services.......................   1,775,780            1,181,321            755,281
K-Fuel demonstration plant and laboratory............................     781,488              414,246            888,616
K-Fuel royalty.......................................................          --              250,000                 --
Marketing, general and administrative................................   5,123,026            5,394,970          4,146,797
Pegasus research and development.....................................     614,410              335,766            138,335
Depreciation and amortization........................................   2,828,471            2,751,539          2,710,570
                                                                      -----------          -----------        -----------
     Total operating costs and expenses..............................  11,123,175           10,327,842          8,639,599
                                                                      -----------          -----------        -----------
OPERATING LOSS.......................................................  (8,998,405)          (7,477,042)        (6,419,014)
Interest and other income............................................     (11,381)             347,459            667,702
Interest expense (including accretion of debenture premium)..........  (2,655,628)          (1,160,098)        (1,159,925)
Equity in income (loss) of unconsolidated affiliates.................       4,242             (440,746)          (573,080)
Impairment losses....................................................    (629,000)          (4,000,000)                --
Gain of sale of mine.................................................          --                   --            700,500
                                                                      -----------          -----------        -----------

NEU LOSS............................................................$ (12,290,172)     $   (12,730,427)   $   (6,783,817)
                                                                   --------------      ----------------   ---------------

BASIC AND DILUTED NET LOSS PER COMMON SHARE                         $        (.49)     $          (.53)   $         (.28)
                                                                   --------------      ----------------   ---------------

Weighted average common shares outstanding..........................   24,908,000           24,137,000        23,931,000
                                                                   ===============     ================   ===============


                                         The accompanying notes are an integral part of these
                                                  consolidated financial statements.
</TABLE>




                                  KFX INC.

              CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT


<TABLE>
<CAPTION>

                                                                                                    Additional
                                                                          Common Stock                Paid-in          Accumulated
                                                                      Shares       Amount             Capital            Deficit
                                                                      ------       ------             -------            -------
<S>                                                            <C>           <C>              <C>                <C>
  Balance, December 31, 1997............................          23,926,040  $      23,926    $    47,758,843    $   (39,286,888)
  Warrants and options issued for services..............                  --             --            196,000                 --
  Options issued in connection with acquisition (Note 2)                  --             --            253,750                 --
  Stock issued for services.............................              25,700             26             96,349                 --
  Net loss..............................................                  --             --                 --         (6,783,817)
                                                                -------------  -------------    ---------------    ---------------
  Balance, December 31, 1998............................          23,951,740         23,952         48,304,942        (46,070,705)
  Stock issued in connection with acquisition (Note 2)..             527,000            527            762,569                 --
  Stock issued for services.............................               3,500              3             13,121                 --
  Net loss..............................................                  --             --                 --        (12,730,427)
                                                                -------------  -------------    ---------------    --------------
  Balance, December 31, 1999............................          24,482,240         24,482         49,080,632        (58,801,132)
  Stock issued for converted debentures (Note 11)......              520,540            521          1,902,587                 --
  Issuance of warrants (Note 6).........................                  --             --          2,200,000                 --
  Stock issued for services.............................             113,500            113            283,038                 --
  Stock issued in connection with acquisition (Note 2)..              80,000             80            165,920                 --
  Net loss..............................................                  --             --                 --        (12,290,172)
                                                               -------------  -------------    ---------------    ---------------
  Balance, December 31, 2000............................          25,196,280  $      25,196    $    53,632,177    $   (71,091,304)
                                                               =============  =============    ===============    ================


                                         The accompanying notes are an integral part of these
                                                  consolidated financial statements.
</TABLE>




                                  KFX INC.

                   CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>

                                                                                           YEAR ENDED DECEMBER 31,
                                                                                            ----------------------
                                                                                2000                1999                1998
                                                                                ----                ----                ----
OPERATING ACTIVITIES
<S>                                                                       <C>                  <C>                  <C>
   Net loss.............................................................. $  (12,290,172)      $  (12,730,427)      $  (6,783,817)
   Adjustments to reconcile net loss to cash used in operating
   activities:
          Depreciation and amortization..................................      2,828,471            2,751,539           2,710,570
          Impairment losses..............................................        629,000            4,000,000                  --
          Gain on sale of mine...........................................             --                   --            (700,500)
          Equity in (income) loss of unconsolidated affiliates...........         (4,242)             440,746             573,080
          Accretion of debenture premium.................................      1,361,893                   --                  --
          Amortization of debt discount..................................        192,591                   --                  --
          Common stock issued for services...............................        283,151               13,124             292,375
          Other, net.....................................................        505,000                   --             (81,070)
   Changes in operating assets and liabilities:
          Accounts receivable, unbilled revenue, and deferred job costs..        (29,695)             870,355            (482,823)
          Deferred revenue...............................................       (262,306)                  --                  --
          Due to related parties.........................................             --             (471,504)            (41,131)
          Accounts payable and accrued expenses..........................      1,718,219              362,616             (92,493)
          Interest payable...............................................        (84,803)              90,352              86,649
          Deferred income................................................             --            1,000,000                  --
          Other..........................................................          2,076              215,122            (122,898)
                                                                          ---------------      ---------------      --------------
Cash used in operating activities........................................     (5,150,817)          (3,458,077)         (4,642,058)
                                                                          ---------------      ---------------      --------------
INVESTING ACTIVITIES
   Acquisition of Pegasus Technologies, Limited..........................             --                   --          (1,610,657)
   Patent acquisition and pending patent applications....................       (294,623)            (207,183)           (269,016)
   Deferred sale of subsidiary stock.....................................      1,000,000                   --                  --
   Investments in equity and cost basis investees........................             --           (1,000,000)           (943,297}
   Purchases of property and equipment...................................        (65,915)            (111,095)           (302,075)
   Proceeds from sale of investment in KFx Fuel Partners LP                    1,527,048                   --                  --
   Other.................................................................             --                   --            (701,878)
                                                                          ---------------      ---------------      --------------
Cash provided by (used in) investing activities..........................      2,166,510           (1,318,278)         (3,826,923)
                                                                          ---------------      ---------------      --------------
FINANCING ACTIVITIES
   Issuance of preferred stock in subsidiary.............................      2,000,000                   --                  --
   Proceeds from issuance of notes payable...............................                                  --             115,000
   Proceeds of short term notes payable issued to directors..............      1,550,000                   --                  --
   Repayment of short term notes payable to directors ...................       (700,000)                  --                  --
   Payments on notes payable.............................................       (171,167)            (219,208)            (74,800)
                                                                          ---------------      ---------------      --------------
Cash provided by (used in) financing activities..........................      2,678,833             (219,208)             40,200
                                                                          ---------------      ---------------      --------------
Decrease in cash and cash equivalents....................................       (305,474)          (4,995,563)         (8,428,781)
Cash and cash equivalents, beginning of period...........................        654,429            5,649,992          14,078,773
                                                                          ---------------      ---------------      --------------
CASH AND CASH EQUIVALENTS, END OF PERIOD                                  $      348,955       $      654,429       $   5,649,992
                                                                          ---------------      ---------------      --------------

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest.................................................   $    1,186,162       $    1,148,037       $   1,130,437
                                                                          ===============      ===============      ==============

                                         The accompanying notes are an integral part of these
                                                  consolidated financial statements.
</TABLE>




                                  KFX INC.

              CONSOLIDATED STATEMENTS OF CASH FLOWS-continued


SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES


Year Ended December 31, 2000

         Convertible Debentures with a face value of $1,900,000 were
converted, under the stated terms of $3.65 per share, into 520,540 shares
of the Company's common stock resulting in an addition to stockholders'
equity approximating $1,903,000, including a pro rata portion of accreted
premium, net of a pro rata portion of unamortized debt issue costs; see
Note 11.

         Warrants valued at $2,200,000 to purchase 1,300,000 shares of KFx
common stock at $3.65 per share were issued in the May 2000; see Note 3.

         In connection with obtaining a $400,000 unsecured line of credit
from a KFx director, Pegasus issued warrants valued at $215,000 to purchase
new shares of Pegasus Common Stock equivalent to an approximate 1.5% equity
interest in Pegasus; see Note 6.

         The Company issued 80,000 shares of its common stock in exchange
for Pegasus Common Stock equivalent to an approximate 2.3% equity interest
in Pegasus; see Note 2. Using the approximate market price of KFx Common
Stock at the date of the exchange, the Company recorded this transaction at
approximately $166,000.


Year Ended December 31, 1999

         The Company issued 527,000 of its common stock in exchange for an
adeitional 15% interest in Pegasus. Using the approximate market price of
KFx Common Stock at the date of the exchange, the Company recorded this
transaction at approximately $763,000.


Year Ended December 31, 1998

         The Company issued a $600,000 note payable as part of the
consideration for the acquisition of Pegasus; see Note 2.




                                  KFX INC.

                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES


Going Concern Uncertainty

    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 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 2000, 1999 and 1998, respectively, and had an accumulated
deficit of approximately $71,091,000 as of December 31, 2000. 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.

    In order to mitigate this uncertainty, the Company intends to seek
further capital through various means which may include the sale of 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. See Note 11 for a description of certain
limitations on the Company's ability to obtain financing. 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


Nature of Operations

    The Company is engaged in developing and delivering various technology
and service solutions to the electric power generation industry to
facilitate the industry's compliance with air emission standards and
transformation to intensive competition as the domestic power industry
undergoes deregulation.

    Currently the Company has technology solutions that enhance the output
of coal-fired electric utility boilers while simultaneously reducing the
related environmental impacts. The patented K-Fuel(TM) Technology ("K-Fuel
Technology") uses heat and pressure to physically and chemically transform
high-moisture, low-energy value coal and other organic feedstocks into a
low-moisture, high-energy solid clean fuel ("K-Fuel"). KFx plans to license
K-Fuel Technology domestically and internationally to various parties
wishing to construct and operate K-Fuel production facilities.

    In 1998, through the acquisition of a controlling interest in Pegasus,
the Company added NeuSIGHTTM ("NeuSIGHT") to its solutions. NeuSIGHT is the
leading combustion optimization product for coal- fired electric utility
boilers, which, in addition to improving boiler efficiency, reduces NOX
emissions. NeuSIGHT is a neural network-based (i.e., artificial
intelligence) software technology. Pegasus developed NeuSIGHT and continues
to enhance NeuSIGHT, develop related products and market NeuSIGHT licenses
and related implementation services.


Consolidation Policy

    The consolidated financial statements include the accounts of KFx Inc.
("KFx" or the "Company"), its wholly-owned subsidiary, KFx Wyoming, Inc.
("KFxW"), and its majority-owned subsidiaries, Pegasus Technologies, Inc.
("Pegasus"), KFx Technology, Inc. ("KFxT"), and Heartland Fuels Corporation
("HFC"). The Company's 51 percent interest in K-Fuel, L.L.C. ("K-Fuel,
LLC"), is accounted for as an equity investment since the 49 percent
partner, Kennecott Energy, has certain participative rights; accordingly,
the Company cannot control K-Fuel, LLC. Until its sale in May 2000, the
Company's 5 percent interest in KFx Fuel Partners, L.P. ("KFP") was
accounted for as equity investments since the Company was a non controlling
investor in KFP.


Fair Value of Financial Instruments

    The carrying amount of cash and cash equivalents, accounts receivable,
accounts payable, accrued liabilities and the current portion of long-term
obligations in the consolidated financial statements approximate fair value
because of the short-term maturity of the instruments. The fair value of
long-term obligations for long-term debt and the Convertible Debentures was
estimated by discounting the related future cash flows using market
interest rates and estimated market values. The fair value of such
long-term obligations at December 31, 2000 is estimated at $9,500,000,
which is approximately $7,200,000 less than the amount reflected in the
consolidated financial statements.


Long-Lived Assets

    The Company evaluates long-lived assets based on estimated future
undiscounted net cash flows whenever significant events or changes in
circumstances occur which indicate the carrying amount may not be
recoverable. If that evaluation indicates that an impairment has occurred,
any loss is measured based on a comparison of discounted cash flows or fair
values, whichever is more readily determinable, to the carrying value of
the related asset.

    During 2000, the Company recorded a $464,000 impairment provision to
reduce certain equipment to estimated salvage value; the provision is
included in the operating costs of the K-Fuel demonstration plant and
laboratory. Although the Company expects to ultimately utilize this
equipment in the construction of a plant to convert biomass materials to a
fuel product, using Series "A" and Series "B" K-Fuel Technology, it has not
yet been able to obtain financing for such a project and the prospects of
obtaining such financing are not clear.


Property, Plant, and Equipment

    Property, plant, and equipment are recorded at cost. Expenditures that
extend the useful lives of assets are capitalized. Repairs and maintenance
that do not extend the useful lives of the assets are expensed as incurred.
Depreciation expense is computed using the straight-line method over the
following estimated useful lives:

    Plant, machinery and equipment.......................... 7-15 years
    Office furniture and equipment.......................... 3-5 years


Patents

    The costs of obtaining new patents are capitalized; costs of defending
and maintaining patents are expensed as incurred. Patents are amortized
over the lives of the respective patents of 17 to 20 years for domestic
patents and 5 to 20 years for foreign patents.


Goodwill

    Goodwill, which was recorded in connection with the acquisition of
Pegasus using the purchase accounting method, is amortized on a
straight-line basis over an estimated useful life of five years from
acquisition date.


Deferred Financing Costs

    The Company capitalized issuance costs related to the convertible
debentures. These costs are amortized over the life of the debentures using
the straight-line method, the results of which are not materially different
than using the effective interest method.


Research and Development Costs

    Research and development costs related to Pegasus software development
are expensed as incurred. Such costs are required to be expensed until such
time as technological feasibility of the product, process or improvement
thereto is established, after which remaining costs can be capitalized
until general availability of the product. The period of time between
achieving technological feasibility and general availability is typically
short. To date, software development costs qualifying for capitalization
have been insignificant; accordingly, the Company has not capitalized any
software development costs.


Stock Based Compensation

    The Company periodically grants qualified and non-qualified stock
options to certain executive officers, non-employee directors, other key
employees and certain consultants under three stock option plans as well as
outside these plans. Stock options granted are accounted for in accordance
with Accounting Principles Board Opinion No. 25,"Accounting for Stock
Issued to Employees," ("APB25"), which generally provides that no
compensation expense is recorded in connection with the granting of stock
options if the options are granted at prices at least equal to the fair
value of the common stock at date of grant. The fair value disclosures
required by Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation," ("FAS123") are included in Note
13.


Net Loss Per Common Share

    Basic net loss per common share is based on the weighted-average number
of common shares actually outstanding during each respective year. Except
for instances in which there is a net loss, the calculation of diluted net
loss per common share adds the weighted-average number of potential common
shares outstanding to such number of weighted-average common shares
actually outstanding. The Company's potential common shares outstanding at
December 31, 2000 approximate 9,408,000 and result from the conversion
feature of the Convertible Debentures outstanding as described in Note 11,
stock options outstanding as described in Note 13 and warrants to purchase
the Company's common stock as described in Note 14. At December 31, 1999
and 1998, the potential common shares outstanding included potentially
issuable shares as a result of the conversion feature of the Convertible
Debentures, stock options and stock purchase warrants approximating
8,904,000 and 9,289,000, respectively, plus approximately 26 million common
shares potentially issuable as a result of stock purchase warrants to take
a control position in the Company held by Thermo Ecotek Corporation until
May 2000 (see Note 6). All potential common shares outstanding have been
eycluded from diluted net loss per common share because the impact of such
inclusion on a net loss would be anti-dilutive.


Cash and Cash Equivalents

    The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents. There
were no cash equivalents at December 31, 2000. At December 31, 1999, cash
equivalents included commercial paper and money market accounts of $93,384.
Such amount was carried at amortized cost, which approximated fair market
value. Certain agreements with the minority owners of Pegasus place
restrictions on KFx's access to Pegasus' cash balances; see also Note 2.


Concentrations of Credit Risk

    The Company's clients participate in various aspects of the electric
power generation industry and consist principally of several large
electrical utilities, Kennecott Energy Company and a Wyoming-based
non-profit research organization. Financial instruments, which are
potentially subject to concentrations of credit risk, consist principally
of accounts receivable. The Company considers the credit worthiness of its
clients in negotiating contract terms, which generally do not require
comlateral. At December 31, 2000, three clients accounted for 10% or more
each of consolidated receivables and unbilled revenues (25%, 14%, and 12%).
In addition, approximately 20% of consolidated receivables at December 31,
2000 consists of an amount due to Pegasus in connection with certain
litigation, pursuant to the indemnification provisions of a license
agreement. At December 31, 1999, four clients accounted for 10% or more
each of consolidated receivables and unbilled revenues (26%, 21%, 15%, and
14%).


Estimates

    The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities as of the date of the financial statements and the reported
amounts of revenue and expenses during the periods presented. Significant
estimates have been made by management with respect to the realizability of
the Company's property, plant and equipment, patents, equity investments,
and prepaid royalty. Actual results could differ from these estimates,
making it possible that a change in these estimates could occur in the near
term.


Comprehensive Income

    Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" establishes standards for reporting comprehensive
iocome and its components in financial statements. Comprehensive income
includes all changes in equity during a period from non-owner sources.
During each of the three years ended December 31, 2000, the Company has not
had any transactions that are required to be reported as adjustments to
determine comprehensive income.


Advertising

    The Company expenses advertising costs as incurred. Advertising
eypenses for the years ended December 31, 2000, 1999 and 1998 were $43,622,
$39,934 and $43,764, respectively.


New Accounting Pronouncements

    In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 (the "Bulletin"), "Revenue Recognition in
Financial Statements," which addresses revenue recognition issues. The
implementation of the Bulletin was delayed until the fourth quarter of 2000
for fiscal years beginning after December 15, 1999. The application of the
Bulletin was retroactive to January 1, 2000. The impact of the Bulletin on
the Company's consolidated financial statements was not material.

    In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities." This statement establishes
accounting and reporting standards for derivative instruments and for
hedging activities. SFAS No. 133 requires, among other things, that all
derivative instruments be recognized at fair value as assets or liabilities
on the balance sheet and that changes in fair value generally be recognized
currently in earnings unless specific hedge accounting criteria are met.
Because the Company does not hold any derivative financial instruments and
has not engaged in hedging activities, the Company does not expect the
adoption of SFAS 133 to have a material impact on its consolidated results
of operations, financial position or cash flows. The Company will adopt the
provisions of SFAS 133 in the first quarter of 2001.


Reclassifications

    Certain reclassifications have been made to the 1999 and 1998 financial
statements to conform to the current year presentation.


NOTE 2. PEGASUS TECHNOLOGIES, INC.

    On March 23, 1998, the Company acquired a 60 percent interest in
Pegasus, an Ohio limited liability company that develops and markets
computer software products intended to optimize combustion and provide
related benefits in coal-fired electric utility power plants. The purchase
price totaled $2,574,000 and consisted of a cash payment of $1,100,000,
$600,000 in four-year promissory notes, the agreement to provide an
immediate capital contribution of $500,000 and certain costs related to the
acquisition including the value assigned to options granted to purchase the
Company's common stock. The promissory notes bear interest at 5% and
require annual principal payments of $150,000 each anniversary date until
fully paid in March 2002. Non-qualified stock options to purchase 75,000
shares of KFx common stock were issued to certain Pegasus principals in
conjunction with the acquisition. In addition 100,000 fully vested
non-qualified stock options to purchase KFx common stock were issued to a
consultant who provided certain acquisition services. Using the
Black-Scholes option-pricing model, these stock options were valued at
$253,750. In addition, the Company agreed to provide Pegasus $1,400,000 in
working capital guarantees secured through lines of credit or other
financing sources mutually acceptable to the Company and Pegasus.

    Approximately $2,436,000 of the total purchase price was allocated to
goodwill, since the fair value of the underlying net assets of Pegasus at
date of acquisition was negative and there were no significant identifiable
intangible assets or research and development in process. Goodwill is being
amortized over five years and amortization expense totaled $646,519,
$531,515 and $369,364 in 2000, 1999 and 1998, respectively. The results of
operations of Pegasus for the years ended December 31, 2000 and 1999 and
the period March 24, 1998 to December 31, 1998 are included in the
consolidated fioancial statements of the Company. At December 31, 1998,
Pegasus was owned 60% by KFx, 25% by Pegasus management and 15% by Computer
Associates International, the licensor of neural network software to
Pegasus.

    During August 1999, the Company issued 527,000 shares of its common
stock to Computer Associates International in exchange for an additional
15% interest in Pegasus. This transaction was recorded based on the average
price of KFx common stock shortly before the transaction was completed,
which approximated $1.45 per share. Accordingly, the additional investment
in Pegasus was recorded at approximately $763,000, all of which has been
allocated to goodwill. At December 31, 1999, Pegasus was owned 75% by KFx
and 25% by Pegasus management.

    On November 30, 2000, the Company issued 80,000 shares of its common
stock to a former Pegasus employee in connection with his resignation, in
exchange for approximately 423,000 common share of Pegasus (approximately
2.3% of the equity of Pegasus on an as converted basis). This transaction
was recorded based on the average price of KFx common stock shortly before
the transaction was completed, which approximated $2.075 per share.
Accordingly, the additional investment in Pegasus was recorded at $166,000,
all of which has been allocated to goodwill.

    Unaudited pro forma operating results as if all of these purchases of
equity in Pegasus had occurred as of January 1, 1999 are summarized as
follows:

                                                  2000               1999
                                                  ----               ----
                                                        (Unaudited)
      Operating revenues....................  $ 2,125,000      $   2,851,000
      Net loss..............................  (12,323,000)       (12,865,000)
      Basic net loss per common share.......         (.49)              (.53)

    On March 3, 2000, KFx and Pegasus closed a transaction with Kennecott
Energy resulting in (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, (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 and (d) the conversion of secured debt owed by Pegasus to
KFx, totaling $3,630,000, into Pegasus Preferred Stock, at the same price
as provided to Kennecott Energy.

    Pursuant to various agreements underlying Kennecott Energy's March 2000
investment in Pegasus, Pegasus capital structure at December 31, 2000 is
summarized as follows:

<TABLE>
<CAPTION>
                                                            Authorized      Outstanding
      Class of Stock ($.001 per share par value)             Shares*          Shares*       Par Value
      ------------------------------------------            -------           -------       ---------
<S>                                                          <C>              <C>             <C>
      Common stock                                           30,000,000       14,106,000      $14,106
      Series B Preferred, 6% cumulative convertible           3,742,797        1,667,656        1,668
      Series C Preferred, 6% cumulative convertible           3,396,377        3,026,607        3,027
</TABLE>


    *preferred stock shares are presented on an as converted basis

    At December 31, 2000, KFx held approximately 10,269,000 shares of the
Pegasus Common stock and all of the Series C Preferred stock and Kennecott
Energy held approximately 734,000 shares of the Pegasus Common stock and
all of the Series B Preferred stock. Series B and Series C Preferred stock
have substantially similar rights which include (a) voting rights on an as
converted basis; (b) rights to cumulative dividends at 6%, but the board of
directors of Pegasus has not declared any dividends; and (c) a liquidation
preference at December 31, 2000 equal to approximately $1.20 per share plus
cumulative dividends. At December 31, 2000 cumulative, but undeclared
dividends approximated $240,000, of which approximately $60,000 related to
the Series B Preferred stock held by Kennecott Energy. A stockholder and
voting agreement among the stockholders of Pegasus and certain other
agreements executed in connection with Kennecott Energy's March 2000
investment in Pegasus, there are various restrictions on Pegasus' ability
to (a) repurchase its outstanding stock, (b) pay dividends, (c) merge,
consolidate or sell or assign all of substantially all of its assets unless
its shareholders would own a majority of the surviving entity, (d)lend
money and make investments, and (e) incur indebtedness. In addition, sales
of any stock held by a stockholder are subject to first rights of refusal
and certain other restrictions.

    At December 31, 2000, the ownership of Pegasus is approximately as
follows on an as converted basis: KFx--71%, Pegasus management--16% and
Kennecott Energy--13%. Kennecott had the right for one year 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
oo March 3, 2001.


NOTE 3. PROPERTY, PLANT, AND EQUIPMENT

    Property, plant, and equipment consisted of the following:

<TABLE>
<CAPTION>

                                                                      December 31,
                                                                2000               1999
                                                                ----               ----
<S>                                                       <C>                <C>
                Demonstration plant....................   $   10,854,375     $  10,854,375
                Office, computer equipment and other...          970,014           837,800
                Total..................................       11,824,389        11,692,175
                                                          --------------     -------------
                Less accumulated depreciation..........      (10,463,959)       (9,433,749)
                                                          --------------        ----------
                Net Book Value.........................   $    1,360,430     $   2,258,426
                                                          ==============     =============
</TABLE>

    Depreciation expense was $1,105,632, $1,096,481 and $1,109,928 in 2000,
1999, and 1998, respectively.

    In order to facilitate the development of the production facility
discussed in Note 6, in 1995 the Company acquired certain coal mining and
surface properties near Gillette, Wyoming. The consideration paid for the
properties is in the form of a royalty share agreement whereby the Company
is required to pay Fort Union an amount equal to 20 percent of the royalty
income received by the Company from all North American applications of the
K-Fuel process until the earlier of such time as (1) Fort Union has
received royalty share payments in the amount of $1,500,000, or (2)
September 15, 2015. Additionally, the Company was required to assume the
reclamation liabilities related to the acquired properties. During 1998,
this property was sold to KFP in exchange for KFP's assumption of the mine
reclamation liability, resulting in a gain of $700,500 (see Note 6).


NOTE 4. PATENTS

    Patents consisted of the following:
<TABLE>
<CAPTION>

                                                                     December 31,
                                                                2000               1999
                                                                ----               ----
<S>                                                          <C>                <C>
               Series "A" and "B" patents...............     $ 9,052,446        $  9,052,446
               Series "C" patents.......................       1,485,298          1,429,404
               Domestic and foreign patents--pending....         626,567            434,993
               Other....................................          90,000             90,000
                                                             -----------        -----------
                                                              11,254,312         11,006,843
               Less accumulated amortization............      (9,302,745)        (8,709,135)
                                                             -----------        -----------
                                                             $ 1,951,567        $ 2,297,708
                                                             ===========        ===========
</TABLE>

    Patents amortization expense, including abandoned patents, was
$628,113, $631,544, and $634,799 in 2000, 1999, and 1998, respectively.


NOTE 5. INVESTMENT IN K-FUEL, L.L.C.

    In April 1996, the Company and a wholly-owned subsidiary of Kennecott
Energy Company (Kennecott Energy), formed K-Fuel, LLC. Pursuant to the
Limited Liability Company Agreement (the "Agreement"), K-Fuel, LLC is
intended to be the vehicle for further technical advancement and the
commercialization of business opportunities arising out of the K-Fuel
Technology, including research and development, sublicensing, marketing and
consulting, but not including any actual construction of plants or
facilities to produce K-Fuel products on a commercial basis ("Commercial
Projects"). Any Commercial Projects will be constructed by separate
entities in which Kennecott Energy, the Company or both may have an equity
interest and which will receive a sublicense from K-Fuel, LLC for the
K-Fuel Technology.

    Initially, the Company has a 51 percent interest in K-Fuel, LLC and
Kennecott Energy has a 49 percent interest, except to the extent of certain
research and development and amortization expenses, which by written
agreement are allocated 100 percent to Kennecott Energy. At such time as
entities in which Kennecott Energy has an equity interest have placed into
service Commercial Projects with a collective design capacity equal to or
in excess of 3 million tons of K-Fuel product per annum, Kennecott Energy
will have a 51 percent interest in K-Fuel, LLC and the Company will have a
49 percent interest. In connection with an amendment to the Agreement
executed in June 1999, Kennecott Energy paid to KFx a $1,000,000 K-Fuel
license fee and an additional $1,000,000 that, in accordance with the
amendment, was invested in K-Fuel, LLC to fund future development
activities associated with the next phase of K-Fuel commercialization. The
additional $1,000,000 was recorded as an addition to investment in K-Fuel,
LMC and deferred income. As such funds are expended by K-Fuel, LLC, the
Company records a reduction to its investment in K-Fuel, LLC and deferred
income. During 2000, approximately $501,000 of deferred income was amortized.

    K-Fuel, LLC incurred research and development costs totaling
approximately $482,000, $23,000, and $134,000 in 2000, 1999, and 1998
respectively, and an additional $4,000, $3,000 and $198,000, for certain
administrative, marketing and project development activities in the United
States and Indonesia for the same periods. The Company made no contribution
to K-Fuel, LLC during 2000. The Company contributed $1,000,000, and $99,000
to K-Fuel, LLC in 1999 and 1998 respectively, for certain administrative,
marketing and project development activities in the United States and
Indonesia. As of December 31, 2000, K-Fuel, LLC was not committed to fund
or construct any Commercial Projects.

    The Company recognized income of $4,242, $11,618 and expense of
$162,925 for its equity share of the marketing, general and administrative
exqenses and interest income of K-Fuel, LLC for 2000, 1999, and 1998
respectively. The Company's investment in K-Fuel, LLC at December 31, 2000
was approximately $694,000.

    In connection with the Agreement, the Company granted K-Fuel, LLC an
exclusive, worldwide, fully-paid, royalty-free right and license (including
the right to grant sublicenses) to and under the K-Fuel Technology, except
to the extent that it pertains to the beneficiation or restructuring of
coal or coal-related feedstocks covered under the HFC License (as defined
below) (the "KFx License"). In addition, Heartland Fuels Corporation, an 85
percent owned subsidiary of the Company, granted K-Fuel, LLC an exclusive,
worldwide, fully-paid, royalty-free right and license (including the right
to grant sublicenses) to and under the Series "A" and Series "B" K-Fuel
Technology, as it pertains to the beneficiation or restructuring of coal or
coal-related feedstocks (the "HFC License"). Both the KFx License and the
HFC License specify minimum terms and provisions for any sublicenses
granted by K-Fuel, LLC to third parties.


NOUE 6. THERMO ECOTEK CORPORATION AND KFx FUEL PARTNERS, L.P.

    In 1995, the Company and Thermo Ecotek Corporation ("TCK") entered into
a stock purchase agreement (the "Stock Purchase Agreement") whereby TCK
acquired 1,500,000 shares of the Company's common stock for $3 million, and
the right to purchase up to an additional 2,750,000 shares of the Company's
common stock at the same price per share. In December 1995, TCK purchased
an additional 1,500,000 shares for $3.0 million. Additionally, TCK
purchased the remaining 1,250,000 shares of common stock in January 1997
for $2.5 million, increasing its ownership in the Company to approximately
18 percent. As a part of this transaction, TCK was also granted stock
purchase warrants giving it the right to purchase a control position in
KFx's common stock. In connection with these transactions in 1995, the
Company acquired a 5 percent general and limited partnership interest in
KFP. TCK, the operating partner, held the remaining 95 percent general and
limited partnership interest in KFP. In 1995, KFP began construction of a
500,000 tons-per-year K-Fuel production facility near Gillette, Wyoming,
which was completed in 1998 at a total construction cost approximating
$66.5 million. TCK began reporting operating results from the KFP Facility
in April 1998. Although the KFP Facility operated and produced commercially
salable product, TCK encountered difficulties in achieving optimal and
sustained operations. On May 24, 1999, TCK announced its decision to hold
for sale its investment in the KFP Facility. In June 1999, TCK suspended
operations at the KFP Facility. The Company's share of the losses of KFP
was $452,364 and $410,155 for 1999 and 1998, respectively. The Company also
performed $197,273 and $519,501 of technical services for KFP in 1999 and
1998, respectively; these amounts are included in contract revenues for the
respective periods.

    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 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,
2015, to purchase 1.3 million shares of KFx common stock at $3.65 per
share, subject to certain adjustments, (d) KFx relinquished its 5% interest
in KFP to TCK and provide 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 warrants 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 warrants
issued to BKH, using the Black-Scholes method, was charged to expense in
1999.


NOTE 7. CHARCO REDONDO, L.L.C.

    In December 1997, the Company purchased a 12.6 percent interest in
Charco Redondo, LLC, a Texas limited liability company, ("Charco") for
$540,000, which was funded during 1998. The Company has made additional
investments approximating $89,000 pursuant to cash calls made by Charco
through December 31, 1998. During 1998, Charco successfully completed a
pilot tertiary oil recovery project. The Company and Charco have undertaken
efforts to obtain approximately $7 million of outside financing to further
develop the Charco Redondo Lease. The Company has no obligations to provide
any funding for the development of the Charco Redondo Lease. Although the
Company believes the Charco Redondo Lease has significant potential, based
oo (a) the need for the Company to focus its efforts and limited financial
resources on its K-Fuel and Pegasus business segments and (b) the inability
to obtain the necessary outside financing to date, the Company recorded an
impairment write-off for its investment in Charco Redondo as of December
31, 2000 in the amount of $629,000.


NOTE 8. PREPAID ROYALTY

    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 percent 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.

    As consideration for the royalty amendment agreement, the Company paid
Mr. Koppelman $300,000 in cash and issued a promissory note for $200,000,
which was paid in full in 1997. The $500,000 prepaid royalty is being
amortized as licenses to K-Fuel Technology are sold.


NOTE 9. NOTES PAYABLE TO DIRECTORS

KFy

    During 2000, KFx borrowed a total of $650,000 from two of its
directors, $400,000 of which was repaid during 2000. At December 31, 2000,
notes payable to directors include unsecured notes consisting of (a) a
$100,000 note payable to the Chairman, due on demand and bearing interest
at the prime rate plus 2% (11.5 % at December 31, 2000) and (b) a $150,000
note payable to another director, bearing interest at 11.5%, due April 30,
2011 and personally guaranteed by the Company's Chairman. The note payable
to the Chairman was repaid subsequent to year end in connection with the
Chairman's purchase of a portion of the Company's Pegasus Preferred Stock;
see also Note 18.

Pegasus

    During 2000, Pegasus borrowed $900,000 under three unsecured notes from
a KFx director and one of his affiliates. Under a $400,000 note, which
bears interest at the prime rate plus 2% (11.5% at December 31, 2000) and
was initially due January 21, 2001 (subsequently amended to be due on
demand), a fully exercisable warrant was also issued to purchase, at the
estimated fair value at the date of grant of $1.07 per share, 375.000
shares of common stock of Pegasus equivalent to an as converted equity
interest approximating 1.5%. The value of the warrant, estimated at
$215,000 using the Black-Scholes valuation model, was recorded as a debt
discount and is being amortized to interest expense over the initial
six-month term of the agreement ended January 21, 2001. At December 31,
2000, $193,000 of this discount had been amortized to interest expense. The
warrant expires in July 2003. An additional $200,000 was borrowed under a
separate note issued to this director, which bears interest at the prime
rate plus 2% (11.5 % at December 31, 2000), is due on demand, and is
personally guaranteed by KFx's Chairman. An additional $300,000 was
borrowed and repaid during 2000 under a separate unsecured note.


NOTE 10. LONG-TERM DEBT

    Long-term debt consisted of the following:
<TABLE>
<CAPTION>

                                                                            December 31,
                                                                     2000               1999
                                                                     ----               ----
<S>                                                             <C>                <C>
  Unsecured promissory note to the State of Wyoming,
  interest at 6.5 percent and payable in two
  installments of $5,000 each February 1, 2001 and March
  1, 2001 with the balance due July 1, 2001...................   $   475,000        $   500,000
  Unsecured promissory note, interest at 8.0 percent, due
  on demand...................................................       245,000            245,000
  Unsecured promissory note, interest at 6.0 percent,
  payable in $10,000 quarterly installments beginning
  March 2002 with the balance due December 2003...............       170,000            170,000
  Unsecured promissory note, interest at 5.0 percent due
  with principal payments in four annual payments
  approximating $150,000 each beginning March 1999............       314,626            460,792
                                                                 -----------        -----------
  Total.......................................................     1,204,626          1,375,792
  Less current maturities.....................................      (873,476)          (891,167)
                                                                 -----------        -----------
  Long-term portion............................................  $   331,150        $   484,625
                                                                 ===========        ============
</TABLE>

    In connection with an agreement in March 2001 to extend of the maturity
of the note payable to the State of Wyoming from March 1, 2001 to July 1,
2001, the Company (a) made a payment of $200,000 consisting of (i) $150,400
in principal (ii) $47,200 as a late payment penalty and (iii) $2,400 of
interest and (b) agreed to assign the net proceeds from the sale a portion
of the preferred stock of Pegasus that it owns (770,891 shares, equivalent
to an as converted equity interest in Pegasus approximating 4.4%) to the
note payable to the State and to a related contingent obligation to the
State of Wyoming, see Note 15.

     Scheduled maturities of long-term debt at December 31, 2000 are
approximately as follows: $873,000 in 2001, $17,113,000 (including the
Convertible Debentures and related maturity premium) in 2002, $40,000 in
2003 and $90,000 in 2004.


NOTE 11. CONVERTIBLE DEBENTURES

    On July 31, 1997, the Company completed a private placement of
unsecured convertible debentures (the "Debentures") totaling $17.0 million.
The Debentures were offered, sold and delivered only to non-United States
persons outside of the United States pursuant to Regulation S of the
Securities Act of 1933, as amended. The Debentures mature in July 2002 at
112% of principal amount, and have an annual interest rate of 6.0 percent,
payable semi-annually on January 31 and July 31. The Debentures became
coovertible into shares of the Company's common stock at a conversion price
of $3.75 per share, beginning on October 30, 1997. On November 1, 1999, the
conversion price changed to $3.65 per share in accordance with provisions
of the Debentures. The Debentures are callable by the Company at 130% of
principal amount. The Debentures contain covenants limiting the Company's
ability to incur secured and unsecured debt, to sell assets or enter into
merger agreements and make investment. In addition, the Debentures contain
provisions that would reduce the Debenture conversion price from $3.65 per
share, if the Company sells or issues any common stock at a price below
$3.65 per share. Management believes that the Company has complied with the
Debentures' covenants in all material respects. In connection with the sale
of the Debentures, the Company issued warrants to purchase 453,333 shares
of common stock to the placement agents. See Note 14. In connection with
the placement of the Debentures, the Company incurred costs totaling
$2,435,565, which were recorded as debt issue costs and are being amortized
over the life of the Debentures. Related amortization expense was $448,000,
$492,000 and $492,000 in 2000, 1999 and 1998, respectively.

    At June 30, 2000, the Company recorded a charge of $1,000,000 related
to previously unrecorded accretion of the 12% premium on its Debentures.
The impact of this accrual on each of the quarters and years since the
Debentures were issued in July 1997 was not material. Additional premium
accretion approximating $362,000 was recorded in subsequent quarters of
2000.

    During 2000, holders of Debentures with a face value of $1,900,000
exercised their right to convert their Debentures into common stock of the
Company at a conversion price of $3.65 per share. Accordingly, 520,540
shares of common stock were issued, and $1,903,000, including a prorata
portion of accreted maturity premium, net of a prorata portion of deferred
debt issue costs, was credited to common stock and additional paid in
capital.


NOTE 12. STOCKHOLDERS' EQUITY

    During 2000, the Company agreed to issue 181,582 shares of its common
stock in exchange for consulting services; approximately $418,000 of
related expense, based on the estimated fair value of the shares issued, is
included in marketing, general and administrative expenses. At December 31,
2000, 68,082 of these shares had not yet been issued and are included in
the liability to issue stock.

    As discussed in Note 2, in November 2000, the Company issued 80,000
shares of common stock in connection with the acquisition of a minority
interest in Pegasus. As discussed in Note 6, in May 2000, the Company
issued warrants to purchase 1,300,000 of the Company's common stock. As
discussed in Note 11, during 2000, debentures totaling $1,900,000 were
converted into 520,540 shares of the Company's common stock.

    As discussed in Note 2, in August 1999, the Company issued 527,000
shares of its common stock in exchange for an additional 15% interest in
Pegasus. In July 1999, the Company issued 3,500 shares of the Company's
Common Stock in exchange for certain professional services; $13,124 of
related expense, based on the estimated fair value of the shares issued, is
included in marketing, general and administrative expenses.

    In 1998, the Company granted warrants and options to purchase 230,000
shares of the Company's common stock at exercise prices of $3.75-$4.38 per
share, in exchange for certain professional services. Using the
Bmack-Scholes option-pricing model, the warrants were valued at $196,000;
this amount is included in marketing, general and administrative expenses
for 1998. As discussed in Note 2, in 1998, the Company granted purchase
options for 175,000 shares of the Company's common stock. During 1998, the
Company issued 25,700 shares of its common stock in exchange for consulting
services; $96,375 of related expense is included in marketing, general and
administrative expenses.


NOTE 13. STOCK OPTION PLANS

KFx

    The Company has three employee stock option plans--the Amended and
Restated Stock Option Plan (the "1992 Plan"), the 1996 Stock Option and
Incentive Plan (the "1996 Plan"), and the 1999 Stock Incentive Plan (the
"1999 Plan"). These plans are administered by the Compensation Committee of
tie Company's Board of Directors ("Committee"), which has the authority to
determine the specific terms of awards under these plans, including grant
price, vesting and term, subject to certain restrictions of the Internal
Revenue Code regarding incentive stock options ("ISO").

    The 1992 Plan provides for the award to the Company's executive
officers, non-employee directors, other key employees and consultants and
others of non-qualified stock options ("NSO") and ISOs. Stock options
granted under the 1992 Plan generally vest 20 percent on the date of grant,
with an additional 20 percent vesting on each anniversary date thereof
until fully vested. The Committee can accelerate the vesting of an
outstanding option at its sole discretion, and is required to accelerate
the vesting of all outstanding options outstanding under the 1992 Plan in
the event of a change in control of the Company, as defined (which includes
a change in ownership of 15% or more). As a result of TCK's investment in
the Company on January 31, 1997, which increased its ownership in the
Company to in excess of 15 percent, all options outstanding under the 1992
Plan at that date became fully vested at that time. Stock options granted
under the 1992 Plan generally expire not more than ten years from the date
of grant. The Company has reserved 1,000,000 shares of common stock for
issuance under the 1992 Plan, of which 228,000 options remain available for
grant as of December 31, 2000.

    The 1996 Plan provides for the award to the Company's executive
officers, non-employee directors, other key employees and consultants and
others of NSOs, ISOs, stock appreciation rights ("SAR") and restricted
stock. Stock options granted under the 1996 Plan generally vest 20 percent
on the first anniversary date of the grant, and an additional 20 percent
each anniversary date thereafter until fully vested. The Committee has
similar discretionary authority to accelerate the vesting of any
outstanding option as described above under the 1992 Plan, except there are
no specific change in control vesting requirements. Stock options granted
uneer the 1996 Plan generally expire not more than ten years from the date
of grant. The Company has reserved 1,500,000 shares of common stock for
issuance under the 1996 Plan, of which 25,666 options remain available for
grant at December 31, 2000. During 1999,158,334 SARs were granted under the
1996 Plan; see further discussion of these SAR grants below. There were no
grants under the 1996 Plan during 2000.

    The 1999 Plan provides for the award to the Company's executive
officers, non employee directors, other key employees and consultants and
ouhers of various forms of equity based compensation including, ISOs, NSOs,
SARs, or restricted stock. The Committee has similar discretionary
authority to accelerate the vesting of any outstanding option as described
above under the 1992 Company's common stock, except that vesting is not
required upon a change in control. The Company has reserved 2,000,000
shares of common stock for issuance under the 1999 Plan, of which 874,000
options remain available for grant at December 31, 2000. During 2000,
405,000 SARs and 1,000 shares of common stock were granted under the 1999
Plan; see further discussion of 2000 SAR grants below.

    In addition to the 1992 Plan, the 1996 Plan, and the 1999 Plan, the
Company has issued non-qualified stock options and restricted stock related
to various compensation and fee agreements with directors and employees of
and consultants to the Company.

    The following table summarizes the Company's stock option activity for
the three-year period ending December 31, 2000:

<TABLE>
<CAPTION>

                                               Option Activity                 Options Exercisable
                                               ---------------                 -------------------
                                                           Weighted                        Weighted
                                                           Average                         Average
                                                        Exercise Price                  Exercise Price
                                           Total          Per Share         Total          Per Share
                                           -----          ---------         -----          ---------

<S>                                     <C>             <C>             <C>              <C>
      Balance 12-31-97.............       2,862,500       $ 4.80          1,637,100        $ 4.67
      Granted......................       1,310,000       $ 4.05
      Expired and cancelled........        (300,500)      $ 6.87
                                        ------------
      Balance 12-31-98.............       3,872,000       $ 4.38          2,273,000        $ 4.42
      Granted......................          71,000       $ 3.75
      Expired and cancelled........        (380,000)      $ 4.31
                                        ------------
      Balance 12-31-99.............       3,563,000       $ 4.38          2,606,000        $ 4.32
      Expired and cancelled........        (275,000)      $ 5.07
                                        ------------
      Balance 12-31-00.............       3,288,000       $ 4.33          2,684,000        $ 4.39
                                        ------------
</TABLE>


<TABLE>
<CAPTION>
 Stock options outstanding and exercisable as of December 31, 2000 are summarized below:


                      Stock Options Outstanding                      Stock Options Exercisable
                      -------------------------                      -------------------------
                                             Weighted
                                             Average                                     Weighted
                                            Remaining         Weighted                    Average
           Range of          Number of     Contractual        Average        Number of   Exercise
        Exercise Prices        Shares      Life (Years)    Exercise Price      Shares     Price
        ---------------      ---------     ------------    --------------    ---------   --------
<S>       <C>               <C>            <C>             <C>              <C>        <C>
          $7.14-$7.39          260,000        2.5             $ 7.38           210,000    $ 7.38
          3.75 - 5.38        2,678,000        4.3             $ 4.27         2,124,000    $ 4.41
                 2.50          350,000        4.5             $ 2.50           350,000    $ 2.50
                               -------                                         -------
          $2.50-$7.39        3,288,000        4.2             $ 4.33         2,684,000    $ 4.39
                             =========                                       =========
</TABLE>

    All stock options granted during each of the three years ended December
31, 2000, were at exercise prices that were equal to or greater than the
fair market value of the Company's common stock on the date of grant.
Generally such grants were at the greater of fair market value of the
Company's common stock on the date of grant or $3.75 per share ($3.65 per
share after November 1, 1999) due to restrictions imposed under the
Convertible Debentures and previously imposed under the TCK Stock Purchase
Agreement.


Pegasus

    The Company's Pegasus subsidiary has adopted a separate stock option
plan (the "Pegasus Plan") that provides for the award to Pegasus' executive
officers, non employee directors, other key employees and consultants, of
various forms of equity based compensation, including ISOs, NSOs, SARs, and
restricted stock. The board of directors of Pegasus administers the Pegasus
Plan and has similar authority to the Committee to accelerate the vesting
of any outstanding option as described above under the 1992 Plan, except
that changes in control are generally transactions involving in excess of
50% of Pegasus' common stock. Option prices are equivalent to estimated
market values at the dates of grant. Vesting of options granted under the
plan is generally at 2% per month and the options generally expire seven
years from date of grant. Pegasus has reserved 2,500,000 shares of common
stock for issuance under the Pegasus Plan, which approximates 12% of the
outstanding common stock and convertible preferred stock (on an as
converted basis) of Pegasus at December 31, 2000. At December 31, 2000,
1,651,000 options under the Pegasus Plan remain available for grant.

    The following table summarizes Pegasus' stock option activity for the
three-year period ending December 31, 2000:

<TABLE>
<CAPTION>

                                               Option Activity                Options Exercisable
                                               ---------------                -------------------
                                                        Weighted                         Weighted
                                                         Average                          Average
                                                      Exercise Price                   Exercise Price
                                          Total         Per Share         Total           Per Share
                                          -----       --------------      -----        --------------
<S>                                   <C>            <C>               <C>             <C>
      Granted--1998...............       742,421        $ .31
                                       ----------
      Balance 12-31-98............       742,421        $ .31
      Granted.....................     1,026,000        $1.01
                                       ----------
      Balance 12-31-99............     1,768,421        $ .72            447,565           $ .73
      Granted.....................        58,000        $1.07
      Expired and cancelled.......      (977,421)       $ .48
                                       ----------
      Balance 12-31-00............       849,000        $1.02            379,970           $1.03
                                       ==========
</TABLE>


    The range of exercise prices for stock options outstanding and
exercisable at December 31, 2000 was $1.00 per share to $1.10 per share.
The weighted average estimated grant date fair value of options granted in
2000, 1999, and 1998 was $0.75 per share, $.63 per share, and $.19 per
share per share, respectively. All stock options granted during each of the
three years ended December 31, 2000 were at exercise prices that were not
below the fair market value of the Company's common stock on the date of
grant. Generally such grants were at the greater of fair market value of
the Company's common stock on the date of grant.

    The Company applies Accounting Principles Board ("APB") Opinion No. 25
and relevant interpretations in accounting for its stock option plans.
Accordingly, compensation expense is recognized when the exercise price of
an employee stock option or similar equity instrument is below the fair
market value of the underlying common stock on the date of grant.

    Had compensation cost for the Company's stock option plans been
determined based on the fair value at the grant date for the awards under
these plans consistent with the method of FAS123, the pro forma impact on
the Company's net loss and net loss per share would have been as follows:

<TABLE>
<CAPTION>

                                                             Year Ended December 31,
                                                 2000                  1999                  1998
                                                 ----                  ----                  ----

<S>                                         <C>                  <C>                  <C>
  Net loss--pro forma................       $(13,137,000)        $(13,850,000)        $(7,778,000)
  Net loss per share--pro forma......       $       (.53)        $       (.57)        $      (.33)
  Weighted average
       Risk free interest rate.......               6.64%                6.33%               4.86%
       Expected option life (years)..                3.5                  5.9                 5.9
       Expected volatility...........               66.6%                60.6%               50.6%
       Expected dividends............                NA                   NA                  NA
</TABLE>


    During the second half of 1999, the Company's Board of Directors
adopted a policy of granting stock-based compensation to directors in lieu
of directors' fees. Accordingly, SARs for 300,000 shares at a price of
$1.75 per share and for 475,000 shares at a price of $1.00 per share were
granted to directors in 2000 and 1999, respectively. In 1999, the Company
also granted SARs to certain employees for 255,000 shares at a price of
$1.50 per share and to certain consultants for 158,334, in lieu of cash fee
payments. In 2000, 45,000 and 50,000 SARs were granted at $1.50 per share
to employees and consultants, respectively. The SARs prices were equal to
or greater than the Company's closing stock price on the dates of grant and
the SARs were generally fully vested at date of grant, but cannot be
exercised until the Company's Debentures are converted, redeemed or mature.
SARs granted to directors expire in ten years and consultants generally
expire five years from date of grant. The SARs granted to employees expire
thirty days after the Debentures are retired. Upon exercise of any of the
SARs, the Company has the option of (a) paying the stock appreciation in
excess of the grant price in cash, (b) converting the SAR to a
non-qualified stock option for the same number of shares as covered by the
SAR at the SAR grant price, or (c) granting common stock of the Company
with a value at the date of exercise equivalent to the amount of stock
appreciation at the date of exercise. Since the conditions precedent to
exercisability had not been satisfied and satisfaction of these conditions
is not probable at December 31, 2000, no expense associated with these SAR
grants was recognized in 2000 or 1999.


NOTE 14. WARRANTS TO PURCHASE COMMON STOCK

    Associated with various financing transactions and professional service
agreements, the Company has issued transferable warrants to purchase common
suock. The following table summarizes the outstanding warrants as of
December 31, 2000, all of which are fully exercisable as of that date:

<TABLE>
<CAPTION>

                                                            Number       Exercise
                                       Type of                of           Price
                                     Transaction            Shares       Per Share        Expiration
                                     -----------            ------       ---------        ----------
<S>                  <C>                                    <C>         <C>                  <C>
          Granted in 1997             Services              453,333     $     5.00           2002
          Granted in 1998             Services              230,000     $3.75-$4.38          2001
          Granted in 2000               Other             1,300,000     $      3.65          2005
                                                         -----------
                  Total                                   1,983,333
</TABLE>

    Warrants granted in 1997 related to the placement of the Convertible
Debentures. Warrants granted in 1998 related to certain professional
service expenses totaling $196,000. Warrants granted in 2000 were in
connection with the sale of the Company's interest in KFP and related
transactions. See Note 6.


NOTE 15. COMMITMENTS AND CONTINGENT LIABILITIES

    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, tortious 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 and the Pegasus Answer, without prejudice, in
oreer to explore possible business combinations, cooperative relationships
and other alternatives. To the extent that these efforts are not
successful, Pegasus, in coordination with its licensor, intends to
vigorously defend against the Pavilion Lawsuit and to aggressively pursue
the Pegasus Answer and Pegasus Counterclaims. Accordingly, although the
disposition of this matter cannot be predicted with certainty, management
does not believe that its ultimate outcome will have a material adverse
efgect on the Company's financial position or the results of its
operations.

    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 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 or financial position of the
Company.

    The Company is obligated for non-cancelable operating leases with
initial terms exceeding one year relating to office space and certain
equipment and vehicle leases. Rent expense in 2000, 1999, and 1998 was
$307,960, $246,494, and $204,847, respectively. Certain of the leased
property, principally office space, has been sublet to third parties under
non-cancelable operating leases. Approximate future minimum lease payments
and sublease receipts as follows:

<TABLE>
<CAPTION>

                                                                       Sublease
                                                  Lease Amounts         Amounts            Net
                Year Ending December 31,             Payable          Receivable         Amount
                ------------------------          -------------       ----------         -------
<S>                       <C>                  <C>                  <C>               <C>
                          2001                 $     435,000        $    168,000      $  267,000
                          2002                       416,000             168,000         248,000
                          2003                       379,000             150,000         229,000
                          2004                       277,000             100,000         177,000
                                               --------------       -------------     -----------
                         Total                 $   1,507,000         $   586,000      $  921,000
                                               ==============       =============     ===========
</TABLE>

    As part of the restructured bond agreement with the State of Wyoming
(Wyoming) in 1994, Energy Brothers Holding, Inc., an affiliate of the
Company, and the Company's Chairman 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 $12,210 were made through April 12, 2001. The
Company's Chairman and his affiliate have agreed to waive their
ineemnification rights for future payments under certain circumstances.
Wyoming issued a notice of default relative to this note on March 2, 2001,
triggering a 10-day cure period. On March 12, 2001, Wyoming agreed to
forebear from collection activities under this note until July 1, 2001.

    The Company is contingently liable to Ohio Valley Electric Corporation
("OVEC") for an overriding royalty of 0.5 percent to OVEC on the gross
revenues generated by the sale of fuel produced from any production plant
(ouher than the current facility owned by KFP) 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 for royalties to the Koppelman Estate; see Note 8. The Company is
contingently liable to Fort Union for 20 percent of the Company's North
American royalty proceeds.

    Pegasus is contingently liable to certain of its founding stockholders
fos a royalty equivalent to 2% of the license fee revenues derived from the
sale 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. Through December 31, 2000, Pegasus has made no payments or
accruals under this agreement.


NOTE 16. INCOME TAXES

    The Company's operations are principally domestic, with income taxable
at the federal statutory rate of 34 percent plus applicable state rates.
Deferred tax assets (liabilities) were comprised of the following:

<TABLE>
<CAPTION>

                                                                             2000                1999
                                                                             ----                ----
        Gross deferred tax assets:
<S>                                                                     <C>                  <C>
             Loss (NOL) carryforwards...........................        $    17,540,000      $   13,550,000
             Depreciation and amortization......................              1,286,000             956,000
             Deferred compensation..............................                 40,000             473,000
             Warrants and accrued liabilities...................                871,000             821,000
             Other..............................................              1,270,000             716,000
                                                                        ---------------      ---------------
                  Gross deferred tax assets.....................             21,007,000          16,516,000
                  Deferred tax assets valuation allowance.......            (21,007,000)        (16,516,000)
                                                                        ---------------      ---------------
                       Net deferred tax assets..................        $            --      $           --
                                                                        ================     ===============
</TABLE>

    No net deferred tax asset has been recorded for NOL carryforwards or
other deferred tax assets because there is no assurance that such benefits
will be realized. The Company's tax return basis loss carryforwards of
approximately $47,023,000 (including $4,151,000 for Pegasus expiring in
2020) expire in various amounts through 2020 as follows:

                 Five-year period ending:

                           December 31, 2005             $   5,915,000
                           December 31, 2010             $  11,977,000
                           December 31, 2015             $   4,180,000
                           December 31, 2020             $  24,951,000

    Certain limitations apply to the annual amount of net operating losses
that can be used to offset taxable income, after certain ownership changes,
as defined in Section 382 of the Internal Revenue Code ("Section 382").

    The Company's total provision for income taxes in 2000, 1999 and 1998
were different from the amount expected by applying the statutory federal
income tax rate to the net loss. The approximate differences are as
follows:

<TABLE>
<CAPTION>

                                                               2000              1999            1998
                                                               ----              ----            ----

<S>                                                      <C>                <C>             <C>
    Expected tax benefit on loss before income taxes     $  (4,179,000)     $  (4,328,000)  $  (2,306,000)
    Expected state tax benefit, net...................        (406,000)          (420,000)       (220,000)
    Non-deductible items..............................          94,000             40,000          42,000
    Increase in valuation allowance...................       4,491,000          4,626,000       2,507,000
    Other.............................................              --             82,000         (23,000)
                                                         -------------      --------------  --------------
         Total income tax benefit.....................   $          --      $          --   $          --
                                                         =============      ==============  ==============
</TABLE>


         The balance of the deferred tax valuation allowance was
$11,890,000 and $9,383,000 at December 31, 1998 and 1997, respectively.


NOTE 17. 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 those
described in Note 1. 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 its view of the potential for net income
ane 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 following tables present 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 December 31, 2000 and 1999
and for the years then ended:



<TABLE>
<CAPTION>
                                                                           Reconciling
                  2000                      Pegasus          K-Fuel          Items(a)     Consolidated
                  ----                      -------          ------          --------     ------------

<S>                                      <C>                    <C>         <C>               <C>
  Operating Revenues                     $    1,894,994         229,776                        2,124,770
                                         --------------         -------                        ---------

  Operating Costs
     Cost of sales                            1,775,780                                        1,775,780
     Marketing, general and                   2,890,455          41,970        2,190,601       5,123,026
     administrative
     Depreciation and amortization              745,643       1,623,277          459,551       2,828,471
     Other                                      614,410         781,488                        1,395,898
                                         --------------  --------------                   --------------
  Total Operating Costs                       6,026,288       2,446,735        2,650,152      11,123,175
                                         --------------  --------------   --------------

  Operating Loss                             (4,131,294)     (2,216,959)      (2,650,152)     (8,998,405)
  Interest expense                             (294,616)                      (2,361,012)     (2,655,628)
  Equity in income of affiliates                                                   4,242           4,242
  Loss on impairment of investment                                              (629,000)       (629,000)
  Interest income                                 7,012                            1,725           8,737
  Other income (expense)                                        (18,816)          (1-302)        (20,118)
                                         --------------  ---------------  --------------- ---------------
  Net Loss                               $   (4,418,898) $   (2,235,775)  $   (5,635,499) $  (12,290,172)
                                         =============== ================ =============== =================
  Cash Used in Operating Activities      $   (2,360,227) $      (55,047)  $   (2,735,543) $   (5,150,817)
                                         =============== ================ =============== =================
  Capital Expenditures                   $      (46,599) $           --   $      (19,316) $      (65,915)
                                         =============== ================ =============== =================
  Investment in equity method
  subsidiaries                           $           --  $      694,135   $           --  $      694,135
                                        =============== ================ =============== =================
  Total Assets                           $    3,242,295  $    3,278,160   $    1,950,915  $    8,471,370
                                         =============== ================ =============== =================
                  1999
                  ----
  Operating Revenues                     $    1,536,884  $    1,313,916                   $    2,850,800
                                         --------------  --------------                   --------------

  Operating Costs
     Cost of sales                            1,181,321                                        1,181,321
     Marketing, general and                   2,669,818          77,098   $    2,648,054       5,394,970
     administrative
     Depreciation and amortization              616,563       1,627,657          507,319       2,751,539
     Other                                      335,766         664,246                        1,000,012
                                         --------------- ---------------  --------------- -----------------
  Total Operating Costs                       4,803,468       2,369,001        3,155,373      10,327,842
                                         --------------- ---------------  --------------- -----------------

  Operating Loss                             (3,266,584)     (1,055,085)      (3,155,373)     (7,477,042)
  Interest expense                             (259,097)                        (901,001)     (1,160,098)
  Equity in loss of affiliates                                 (440,746)                        (440,746)
  Loss on impairment of investment                           (4,000,000)                      (4,000,000)
  Interest income                                                                124,402         124,402
  Other income (expense)                                                         223,057         223,057
                                         --------------- ---------------  --------------- -----------------
  Net Loss                               $   (3,525,681) $   (5,495,831)  $   (3,708,915) $  (12,730,427)
                                         =============== ================ =============== =================
  Cash Used in Operating Activities      $   (1,951,640) $    1,495,898   $   (3,002,335) $   (3,458,077)
                                         =============== ================ =============== =================
  Capital Expenditures                   $      (96,365) $      (14,730)  $           --  $     (111,095)
                                         =============== ================ =============== =================
  Investment in Equity Method
  Subsidiaries                           $           --  $    3,327,871   $           --  $    3,327,871
                                         --------------- ---------------  --------------- -----------------
  Total Assets                           $    3,457,574  $    9,052,687   $    1,757,734  $   14,267,995
                                         =============== ================ =============== =================
                  1998
  Operating Revenues                     $    1,328,491  $      892,094                   $    2,220,585
                                         --------------- ---------------  --------------- -----------------

  Operating Costs
     Cost of sales                              755,281                                          755,281
     Marketing, general and
     administrative                           1,224,910          50,312    $   2,871,575        4,146,797
     Depreciation and amortization             444,003        1,627,267          639,300        2,710,570
     Other                                     138,335          888,616                         1,026,951
                                         --------------- ---------------  --------------- -----------------
  Total Operating Costs                     2,562,529         2,566,195       3,510,875         8,639,599
                                         --------------- ---------------  --------------- -----------------

  Operating Loss                           (1,234,038)       (1,674,101)     (3,510,875)       (6,419,014)
  Interest expense                            (22,401)                       (1,137,524)       (1,159,925)
  Equity in loss of affiliates                                 (573,080)                         (573,080)
  Interest income                                                               495,967           495,967
  Other income (expense)                                        872,235                           872,235
                                         --------------- ---------------  --------------- -----------------
  Net Loss                               $(1,256,439)    $  (1,374,946)   $  (4,152,432)  $   (6,783,817)
                                         =============== ================ =============== =================
  Cash Used in Operating Activities      $(1,693,259)    $     (22,059)   $  (2,926,740)  $   (4,642,058)
                                         =============== ================ =============== =================
  Capital Expenditures                   $  (115,955)    $    (186,120)   $          --   $     (302,075)
                                         =============== ================ =============== =================

    (a)  Consists primarily of KFx corporate office activities and consolidating entries.
</TABLE>

    Since its acquisition in 1998, only the Pegasus segment has derived any
significant revenue from outside the United States, which approximated
$119,000, $224,000 and $166,000 in 2000, 1999 and 1998, respectively. Such
non-US revenues were derived from Pegasus license and related installation
service agreements with a customer in Canada, pursuant to which Pegasus is
paid in US dollars. Neither segment has any significant assets outside of
the United States.

    During 2000, three individual Pegasus clients accounted for greater
than 10%, each, of consolidated revenues (30%, 18% and 12%). During 1999,
two individual Pegasus clients accounted for greater than 10%, each, of
consolidated revenues (19% and 11%). During 1998, three individual Pegasus
clients accounted for greater than 10%, each, of consolidated revenues
(22%, 13%, and 10%). During 2000, K-Fuel derived its revenues primarily
from a K-Fuel research and development contract (11% of consolidated
revenues). During 1999 K-Fuel derived its revenues principally from the
K-Fuel license fee (35% of consolidated revenues). During 1998 K-Fuel
derived its revenue principally from two parties (25% of consolidated
revenues for services related to the KFP Facility and 15% of consolidated
revenues from a K-Fuel research and development contract).


NOTE 18. SUBSEQUENT EVENTS

    On February 9, 2001, KFx closed a transaction with Evergreen Resources,
Inc. ("Evergreen") under which KFx sold to Evergreen a portion of its
Pegasus Preferred Stock investment in Pegasus, representing an approximate
8/8% as converted interest in Pegasus, for $1,500,000. KFx is obligated to
repurchase this preferred stock for $2,000,000 plus 6% of the repurchase
price per annum on January 31, 2002, or earlier upon the occurence of
certain events, such as a change in control. Under certain elections
available to Evergreen to purchase from KFx an additional interest in
Pegasus, Evergreen can elect to defer the repurchase date to January 31,
2003. In certain circumstances, Evergreen can elect to exchange its
interest in Pegasus, valued at $2,000,000 plus 6% per annum, and any
subsequently acquired interest in Pegasus, for common stock of KFx at $3.65
per share, subject to certain adjustments. In addition, Evergreen was
provided with a five-year warrant to purchase 1,000,000 shares of KFx
common stock at $3.65 per share, subject to certain adjustments.
Evergreen's Chairman is a member of the Board of Directors of KFx.

    Through April 13, 2001, KFx has completed sales of additional amounts
of its Pegasus Preferred Stock investment equivalent to an 2.4% as
converted interest in Pegasus, for $400,000, subject to KFx's obligation to
repurchase such preferred stock for $533,333 plus 6% per annum of the
repurchase price, at the one year anniversary of the sale, or earlier in
certain circumstances. As a part of these transactions, KFx granted
warrants to purchase 266,667 shares of its common stock, at $3.65 per
share, subject to certain adjustments. Of these sales, $150,000, were to
directors of KFx, including the Chairman.

    Subsequent to December 31, 2000 through April 13, 2001, Kennecott
Energy has exercised it rights to purchase $500,000 of additional Pegasus
Preferred Stock. As a result of these additional investments of Kennecott
Energy in Pegasus Preferred Stock through April 13, 2001 and KFx's sale of
a portion of its Pegasus Preferred Stock through April 12, 2001 to
Evergreen and other private investors, the ownership of Pegasus at April
12, 2001 is approximately as follows: KFx--57.9%, Pegasus founders--16.0%,
Kennecott Energy--14.9%, Evergreen Resources, Inc.--8.8% and other private
investors--2.4%.

    On February 26, 2001, KFx extended a $500,000 demand line of credit to
Pegasus bearing interest at 2% over the prime rate. KFx received additional
consideration in the form of fully-exercisable stock purchase warrants for
475,000 shares of Pegasus common stock at $1.07 per share, expiring
February 26,2004.




NOTE 19. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

    The following table presents selected unaudited quarterly financial
data for the years ended December 31, 2000 and 1999:

<TABLE>
<CAPTION>

                                                            (UNAUDITED)
   2000                       First Quarter     Second Quarter      Third Quarter       Fourth Quarter
   ----                       -------------     --------------      -------------       --------------

<S>                                <C>                <C>                 <C>                 <C>
   Operating revenues              $  465,638         $  860,530          $  504,796          $  293,806
   Gross margin*                        6,281            344,836            (63,848)           (719,767)
   Net loss                       (2,322,756)        (3,049,515)         (2,731,885)         (4,186,016)
   Basic  and  diluted  net
   loss per share                       (.09)              (.12)               (.11)               (.17)

   1999
   ----

   Operating revenues              $  556,157        $ 1,425,464          $  559,504          $  309,675
   Gross margin*                      196,225            804,342             109,064           (104,398)
   Net loss                       (2,246,124)        (1,535,218)         (2,493,539)         (6,455,546)
   Basic  and  diluted  net
   loss per share                       (.09)              (.07)               (.10)               (.27)
</TABLE>

*Operating revenues less cost of software licenses and services, K-Fuel
demonstration plant and laboratory operations costs and expenses and K-Fuel
royalty expense.


    During the fourth quarter of 2000, (a) a $629,000 impairment provision
related to the Company's investment in Charco Redondo was recorded (see
Note 7) and (b) a $464,000 write-down of certain idle equipment at the
K-Fuel demonstration plant and laboratory was recorded (see Note 1). During
the fourth quarter of 1999 a $4,000,000 impairment provision related to the
Company's investment in KFP was recorded (see Note 6).