UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2004
[ ] TRANSITION REPORT PURSUANT SECTION 13 OR 15 (d)
OF SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From ______to_________
Commission File Number 333-13287
EARTHSHELL CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 77-0322379
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6740 CORTONA DRIVE, SANTA BARBARA, CALIFORNIA 93117
(Address of principal executive office) (Zip Code)
(805) 571-8232
(Registrant's telephone number,
including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ ] No [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [X] No [ ]
The number of shares outstanding of the Registrant's Common Stock as of May 5,
2004 is 14,128,966.
EARTHSHELL CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2004
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements Page
a) Consolidated Balance Sheets as of March 31, 2004 (unaudited) and December
31, 2003........................................................................... 1
b) Consolidated Statements of Operations for the three months ended March 31,
2004 and March 31, 2003 (unaudited) and for the period from November 1, 1992
(inception) through March 31, 2004 (unaudited)..................................... 2
c) Consolidated Statements of Stockholders' (Deficit) Equity for the period
from November 1, 1992 (inception) to March 31, 2004 (unaudited).................... 3
d) Consolidated Statements of Cash Flows for the three months ended March 31, 2004
and March 31, 2003 (unaudited) and for the period from November 1, 1992
(inception) through March 31, 2004 (unaudited)..................................... 5
e) Notes to Consolidated Financial Statements (unaudited)............................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................................ 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk............................ 16
Item 4. Controls and Procedures .............................................................. 17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..................................................................... 17
Item 2. Changes in Securities and Use of Proceeds and Issuer Repurchases of
Equity Securities..................................................................... 17
Item 3. Defaults Upon Senior Securities....................................................... 17
Item 4. Submission of Matters to a Vote of Security Holders................................... 17
Item 5. Other Information..................................................................... 17
Item 6. Exhibits and Reports on Form 8-K...................................................... 17
SIGNATURE................................................................................................ 19
EARTHSHELL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31,
2004 2003
------------- -------------
(UNAUDITED)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 654,436 $ 1,901,639
Prepaid expenses and other current assets 140,123 323,680
------------- -------------
Total current assets 794,559 2,225,319
PROPERTY AND EQUIPMENT, NET 34,453 61,794
EQUIPMENT HELD FOR SALE 1 1
------------- -------------
TOTALS 829,013 $ 2,287,114
============= =============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 4,837,908 $ 4,853,413
Convertible debentures, net of discount of $1,332,014 and $1,505,755
as of March 31, 2004 and December 31, 2003, respectively 5,467,986 5,294,245
------------- -------------
Total current liabilities 10,305,894 10,147,658
PAYABLES TO RELATED PARTY 2,247,997 1,839,108
NOTES PAYABLE TO RELATED PARTY, NET OF DISCOUNT OF $193,917 AND $219,210 AS
OF MARCH 31, 2004 AND DECEMBER 31, 2003, RESPECTIVELY 2,561,083 2,535,790
OTHER LONG-TERM LIABILITY 20,833 33,333
------------- -------------
Total liabilities 15,135,807 14,555,889
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' DEFICIT
Preferred stock, $.01 par value, 10,000,000 shares authorized; 9,170,000 Series
A shares designated; no shares issued and outstanding as of
March 31, 2004 and December 31, 2003 -- --
Common stock, $.01 par value, 25,000,000 shares authorized; 14,128,966
shares issued and outstanding as of March 31, 2004 and December 31,
2003 141,290 141,290
Additional paid-in common capital 302,033,746 302,033,746
Deficit accumulated during the development stage (316,417,538) (314,350,681)
Accumulated other comprehensive loss (64,292) (93,130)
------------- -------------
Total stockholders' deficit (14,306,794) (12,268,775)
------------- -------------
TOTALS $ 829,013 $ 2,287,114
============= =============
See Notes to Consolidated Financial Statements.
1
EARTHSHELL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NOVEMBER 1,
THREE MONTHS 1992
ENDED MARCH 31, (INCEPTION)
------------------------------ THROUGH MARCH
2004 2003 31, 2004
------------- ------------- -------------
Operating Expenses
Related party license fee and research
and development expenses $ 300,000 $ 353,800 $ 71,491,282
Other research and development expenses 222,538 1,896,986 142,734,609
Related party general and administrative
expenses (reimbursements) -- (4,074) 2,187,540
Other general and administrative expenses 1,173,855 1,853,702 69,387,013
Depreciation and amortization 27,341 112,640 22,868,720
Related party patent expenses -- -- 8,693,105
------------- ------------- -------------
Total operating expenses 1,723,734 4,213,054 317,362,269
Other (Income) Expenses
Interest income (1,234) (39,952) (10,906,043)
Related party interest expense 134,182 75,302 5,417,140
Other interest expense 209,375 577,767 3,638,111
Gain on sales of property and equipment -- (56,000) (893,353)
Other (income) expense -- 196,529 (399,701)
Loss on extinguishment of debentures -- 1,697,380 1,697,380
Debenture conversion costs -- 105,847 487,464
------------- ------------- -------------
Loss Before Income Taxes 2,066,057 6,769,927 316,403,267
Income Taxes 800 800 14,271
------------- ------------- -------------
Net Loss 2,066,857 6,770,727 316,417,538
Preferred Dividends -- -- 9,926,703
------------- ------------- -------------
Net Loss Available to Common
Stockholders $ 2,066,857 $ 6,770,727 $ 326,344,241
============= ============= =============
Basic and Diluted Loss Per Common
Share $ 0.15 $ 0.55 $ 38.13
Weighted Average Number of Common
Shares Outstanding 14,128,966 12,358,967 8,559,798
See Notes to Consolidated Financial Statements.
2
EARTHSHELL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY
(UNAUDITED)
CUMULATIVE
CONVERTIBLE
PREFERRED STOCK ADDITIONAL ADDITIONAL
SERIES A PAID-IN COMMON STOCK PAID-IN
------------------------------ PREFERRED ----------------------------- COMMON
SHARES AMOUNT CAPITAL SHARES AMOUNT CAPITAL
------------- ------------- ------------- ------------- ------------- -------------
ISSUANCE OF COMMON STOCK AT
INCEPTION ................ -- -- -- 6,877,500 $ 3,150 $ 6,850
Sale of preferred stock, net 6,988,850 $ 267 $ 24,472,734 -- -- --
Net loss .................... -- -- -- -- -- --
------------- ------------- ------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 1993 .. 6,988,850 267 24,472,734 6,877,500 3,150 6,850
Net loss .................... -- -- -- -- -- --
------------- ------------- ------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 1994 .. 6,988,850 267 24,472,734 6,877,500 3,150 6,850
Contribution to equity ...... -- -- -- -- -- 1,117,723
Net loss .................... -- -- -- -- -- --
------------- ------------- ------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 1995 .. 6,988,850 267 24,472,734 6,877,500 3,150 1,124,573
Contribution to equity ...... -- -- -- -- -- 650,000
Issuance of stock warrants .. -- -- -- -- -- 246,270
Net loss .................... -- -- -- -- -- --
------------- ------------- ------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 1996 .. 6,988,850 267 24,472,734 6,877,500 3,150 2,020,843
Compensation related to
stock options, warrants
and stock grants ......... -- -- -- -- -- 3,156,659
Net loss .................... -- -- -- -- -- --
------------- ------------- ------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 1997 .. 6,988,850 267 24,472,734 6,877,500 3,150 5,177,502
262 to 1 stock split ........ -- 5,557 (5,557) -- 65,625 (65,625)
Conversion of preferred
stock into common stock .. (6,988,850 (5,824) (24,467,177 582,404 5,824 24,467,177
Issuance of common stock .... -- -- -- 877,193 8,772 205,979,984
Preferred stock dividends ... -- -- -- -- -- (9,926,703)
Net loss .................... -- -- -- -- -- --
------------- ------------- ------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 1998 ... -- -- -- 8,337,097 83,371 225,632,335
Net loss .................... -- -- -- -- -- --
------------- ------------- ------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 1999 .. -- -- -- 8,337,097 83,371 225,632,335
Issuance of common stock .... -- -- -- 371,431 3,714 10,518,074
Net loss .................... -- -- -- -- -- --
------------- ------------- ------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 2000 .. -- -- -- 8,708,528 87,085 236,150,409
Issuance of common stock .... -- -- -- 1,126,727 11,267 30,542,773
Compensation related to
stock options, warrants
and stock grants ......... -- -- -- 25,000 250 986,869
Net loss .................... -- -- -- -- -- --
------------- ------------- ------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 2001 .. -- -- -- 9,860,255 98,602 267,680,051
Issuance of common stock .... -- -- -- 2,025,686 20,257 21,881,459
Common stock warrants issued
in connection with
convertible debentures ... -- -- -- -- -- 1,521,046
Conversion of convertible
debentures to common stock -- -- -- 168,696 1,687 998,313
Debentures conversion costs . -- -- -- -- -- 176,471
Net loss ....................
Foreign currency translation
adjustment ............... -- -- -- -- -- --
Comprehensive loss .......... -- -- -- -- -- --
------------- ------------- ------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 2002 .. -- -- -- 12,054,637 120,546 292,257,340
Issuance of common stock .... -- -- -- 137,264 1,373 811,267
Common stock and common
stock warrants issued in
connection with issuance
of convertible debentures -- -- -- 624,747 6,248 2,921,594
Conversion of convertible
debentures to common stock -- -- -- 1,312,318 13,123 7,536,877
Debenture conversion
costs .................... -- -- -- -- -- (1,493,332)
Net loss ....................
Foreign currency translation
adjustment ............... -- -- -- -- -- --
Comprehensive loss .......... -- -- -- -- -- --
------------- ------------- ------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 2003 .. -- -- -- 14,128,966 141,290 302,033,746
Net loss .................... -- -- -- -- -- --
Foreign currency translation
adjustment ............... -- -- -- -- -- --
Comprehensive loss .......... -- -- -- -- -- --
------------- ------------- ------------- ------------- ------------- -------------
BALANCE, MARCH 31, 2004 ..... -- $ -- $ -- 14,128,966 $ 141,290 $ 302,033,746
============= ============= ============= ============= ============= =============
3
DEFICIT
ACCUMULATED ACCUMULATED
DURING OTHER
DEVELOPMENT COMPREHENSIVE
STAGE LOSS TOTALS
------------- ------------- -------------
ISSUANCE OF COMMON STOCK AT
INCEPTION ................ -- -- $ 10,000
Sale of preferred stock, net -- -- 24,473,001
Net loss .................... $ (7,782,551) -- (7,782,551)
------------- ------------- -------------
BALANCE, DECEMBER 31, 1993 .. (7,782,551) -- 16,700,450
Net loss .................... (16,582,080) -- (16,582,080)
------------- ------------- -------------
BALANCE, DECEMBER 31, 1994 .. (24,364,631) -- 118,370
Contribution to equity ...... -- -- 1,117,723
Net loss .................... (13,914,194) -- (13,914,194)
------------- ------------- -------------
BALANCE, DECEMBER 31, 1995 .. (38,278,825) -- (12,678,101)
Contribution to equity ...... -- -- 650,000
Issuance of stock warrants .. -- -- 246,270
Net loss .................... (16,950,137) -- (16,950,137)
------------- ------------- -------------
BALANCE, DECEMBER 31, 1996 .. (55,228,962) -- (28,731,968)
Compensation related to
stock options, warrants
and stock grants ......... -- -- 3,156,659
Net loss .................... (18,992,023) -- (18,992,023)
------------- ------------- -------------
BALANCE, DECEMBER 31, 1997 .. (74,220,985) -- (44,567,332)
262 to 1 stock split ........ -- -- --
Conversion of preferred
stock into common stock .. -- -- --
Issuance of common stock .... -- -- 205,988,756
Preferred stock dividends ... -- -- (9,926,703)
Net loss .................... (26,620,052) -- (26,620,052)
------------- ------------- -------------
BALANCE, DECEMBER 31, 1998 ... (100,841,037) -- 124,874,669
Net loss .................... (44,188,443) -- (44,188,443)
------------- ------------- -------------
BALANCE, DECEMBER 31, 1999 .. (145,029,480) -- 80,686,226
Issuance of common stock .... -- -- 10,521,788
Net loss .................... (48,911,605) -- (48,911,605)
------------- ------------- -------------
BALANCE, DECEMBER 31, 2000 .. (193,941,085) -- 42,296,409
Issuance of common stock .... -- -- 30,554,040
Compensation related to
stock options, warrants
and stock grants ......... -- -- 987,119
Net loss .................... (62,301,511) -- (62,301,511)
------------- ------------- -------------
BALANCE, DECEMBER 31, 2001 .. (256,242,596) -- 11,536,057
Issuance of common stock .... -- -- 21,901,716
Common stock warrants issued
in connection with
convertible debentures ... -- -- 1,521,046
Conversion of convertible
debentures to common stock -- -- 1,000,000
Debentures conversion costs . -- -- 176,471
Net loss .................... (39,591,344) (39,591,344)
Foreign currency translation
adjustment ............... -- $ (16,632) (16,632)
-------------
Comprehensive loss .......... -- -- (39,607,976)
------------- ------------- -------------
BALANCE, DECEMBER 31, 2002 .. (295,833,940 (16,632) (3,472,686)
Issuance of common stock .... -- -- 812,640
Common stock and common
stock warrants issued in
connection with issuance
of convertible debentures -- -- 2,927,842
Conversion of convertible
debentures to common stock -- -- 7,550,000
Debenture conversion
costs .................... -- -- (1,493,332)
Net loss .................... (18,516,741) (18,516,741)
Foreign currency translation
adjustment ............... -- (76,498) (76,498)
-------------
Comprehensive loss .......... -- -- (18,593,239)
------------- ------------- -------------
BALANCE, DECEMBER 31, 2003 .. (314,350,681) (93,130) (12,268,775)
Net loss .................... (2,066,857) -- (2,066,857)
Foreign currency translation
adjustment ............... -- 28,838 28,838
-------------
Comprehensive loss .......... -- -- (2,038,019)
------------- ------------- -------------
BALANCE, MARCH 31, 2004 ..... $(316,417,538) $ (64,292) $ (14,306,794)
============= ============= =============
See Notes to Consolidated Financial Statements
4
EARTHSHELL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NOVEMBER 1,
THREE MONTHS ENDED 1992
MARCH 31, (INCEPTION)
------------------------------ THROUGH
2004 2003 MARCH 31, 2004
------------- ------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss ...................................................... $ (2,066,857) $ (6,770,727) $(316,417,538)
Adjustments to reconcile net loss to net cash used in operating
activities
Depreciation and amortization ............................... 27,341 112,640 22,868,720
Amortization and accretion of debenture issue costs ......... 199,034 175,806 1,570,385
Debenture conversion costs .................................. -- 105,847 487,464
(Gain) Loss on change in fair value of warrant obligation ... -- 196,529 (399,701)
Loss on extinguishment of debentures ........................ -- 1,697,380 1,697,380
Beneficial conversion value due to change in debentures
conversion price ......................................... -- 360,000 360,000
(Gain) Loss on sale, disposal, or impairment of property and
equipment ................................................ -- (56,000) 50,761,599
Equity in the losses of joint venture ....................... -- 123,288 541,542
Accrued purchase commitment ................................. -- -- 1,645,000
Compensation related to issuance of stock, stock options and
warrants to directors, consultants and officers .......... -- -- 4,848,641
Net loss on sale of investments ............................. -- -- 32,496
Accretion of discounts on investments ....................... -- -- (410,084)
Other non-cash items ........................................ (7,691) -- 42,507
Changes in operating assets and liabilities
Prepaid expenses and other current assets ................... 182,608 (369,750) (124,041)
Accounts payable and accrued expenses ....................... 25,248 (1,031,453) 4,777,845
Payable to related party .................................... 408,889 (65,358) 2,202,351
Accrued purchase commitment ................................. -- -- (1,645,000)
Other long term liability ................................... (12,500) -- 20,833
------------- ------------- -------------
Net cash used in operating activities .................... (1,243,928) (5,521,798) (227,139,601)
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of restricted time deposit in connection with
purchase commitment ........................................ -- -- (3,500,000)
Proceeds from release of restricted time deposit upon
settlement of purchase commitment .......................... -- -- 3,500,000
Purchase of investments in U.S. government securities ......... -- -- (52,419,820)
Proceeds from sales and redemption of investments ............. -- -- 52,797,408
Proceeds from sales of property and equipment ................. -- 56,000 1,262,927
Investment in joint venture ................................... -- -- (541,542)
Purchases of property and equipment ........................... -- -- (75,799,435)
------------- ------------- -------------
Net cash provided by (used in) investing activities ...... -- 56,000 (74,700,462)
------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock ........................ -- -- 284,852,820
Common stock issuance costs ................................... -- -- (15,178,641)
Proceeds from issuance of common stock and convertible
debentures, net of issuance costs and discounts
amounting to approximately $3.4 million .................... -- 8,671,712 8,711,844
Proceeds from issuance of convertible debentures .............. -- -- 10,000,000
Purchase of restricted time deposit in connection with
issuance of convertible debentures ......................... -- -- (10,000,000)
Proceeds from release of restricted time deposit upon
conversion of convertible debentures into common stock ..... -- 800,000 2,800,000
Proceeds from release of restricted time deposit upon
exchange of convertible debentures ......................... -- 2,000,000 2,000,000
Proceeds from release of restricted time deposit for
repayment of convertible debentures ........................ -- 5,200,000 5,200,000
Repayment of convertible debentures ........................... -- (5,200,000) (5,200,000)
Proceeds from issuance of notes payable to related party ...... -- 1,010,000 20,105,000
Repayment of notes payable to related party ................... -- -- (15,325,651)
Proceeds from drawings on line of credit with bank ............ -- -- 14,000,000
Repayment of line of credit with bank ......................... -- -- (14,000,000)
Preferred dividends paid ...................................... -- -- (9,926,703)
Proceeds from issuance of preferred stock ..................... -- -- 25,675,000
Preferred stock issuance costs ................................ -- -- (1,201,999)
------------- ------------- -------------
Net cash provided by financing activities ................ -- 12,481,712 302,511,670
------------- ------------- -------------
Effect of exchange rate changes on cash and cash equivalents .. (3,275) 406 (17,171)
------------- ------------- -------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS .............. (1,247,203) 7,016,320 654,436
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ................ 1,901,639 111,015 --
------------- ------------- -------------
CASH AND CASH EQUIVALENTS, END OF PERIOD ...................... $ 654,436 $ 7,127,335 $ 654,436
============= ============= =============
NOVEMBER 1,
THREE MONTHS ENDED 1992
MARCH 31, (INCEPTION)
------------------------------ THROUGH
2004 2003 MARCH 31, 2004
------------- ------------- --------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for
Income taxes ............................................... $ -- $ -- $ 12,671
Interest ................................................... 1,256 4,492 3,161,907
Common stock warrants issued in connection with convertible
debentures ................................................. -- 745,562 2,572,776
Conversion of convertible debentures into common stock ........ -- 1,464,907 8,550,000
Transfer of property from EKI ................................. -- -- 28,745
Conversion of preferred stock to common stock ................. -- -- 69,888
Interest paid in common stock ................................. -- 74,867 95,339
Commission paid in common stock ............................... -- 29,500 29,500
Common stock issued to service providers in connection with
the March 2003 financing ................................... -- 484,500 484,500
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
In March 2003, warrants for the purchase of $1.055 million in aggregate
principal amount of convertible debentures and 70,477 shares of common stock
were issued in connection with the issuance of convertible debentures. The
estimated fair value of the warrants of $442,040, based upon the Black-Scholes
method of valuation, was recorded as an original issue discount thereby reducing
the carrying value of the convertible debentures and as an increase in
additional paid-in common capital.
In March 2003, warrants for the purchase of 83,333 shares of common stock were
issued to EKI, in connection with the issuance of convertible debentures, in
consideration for its willingness to subordinate amounts owed to it. The
estimated fair value of the warrants of $303,522, based upon the Black-Scholes
method of valuation, was recorded as an original issue discount thereby reducing
the carrying value of the notes payable to EKI and as an increase in additional
paid-in common capital.
See Notes to Consolidated Financial Statements.
5
EARTHSHELL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
MARCH 31, 2004
--------------------------------------------------------------------------------
OVERVIEW OF OPERATIONS
Organized in November 1992 as a Delaware corporation, EarthShell Corporation is
engaged in the commercialization of composite material technology for the
manufacture of foodservice disposable packaging designed with the environment in
mind. EarthShell Packaging(R) is based on patented composite material technology
(collectively, the "EarthShell Technology"), licensed on an exclusive, worldwide
basis from E. Khashoggi Industries LLC and its wholly owned subsidiaries.
The EarthShell Technology has been developed over many years in consultation
with leading material scientists and environmental experts to reduce the
environmental burdens of foodservice disposable packaging through the careful
selection of raw materials, processes, and suppliers. EarthShell Packaging(R),
including hinged-lid sandwich containers, plates, bowls, foodservice wraps, and
cups, is primarily made from commonly available natural raw materials such as
natural ground limestone and potato starch. EarthShell believes that EarthShell
Packaging(R) has comparable or superior performance characteristics and can be
commercially produced and sold at prices that are competitive with comparable
paper and plastic foodservice disposables.
PRESENTATION OF FINANCIAL INFORMATION
The foregoing interim financial information is unaudited and has been prepared
from the books and records of EarthShell Corporation. EarthShell Corporation's
consolidated financial statements include the accounts of its wholly-owned
subsidiary, EarthShell GmbH. All significant intercompany balances and
transactions have been eliminated in consolidation. Both EarthShell Corporation
and its subsidiary (collectively "EarthShell" or the "Company") are development
stage enterprises. In the opinion of management, the financial information
reflects all adjustments necessary for a fair presentation of the financial
condition, results of operations and cash flows of the Company in conformity
with generally accepted accounting principles. All such adjustments were of a
normal recurring nature for interim financial reporting. Certain
reclassifications have been made to the 2003 financial statements to conform to
the 2004 presentation.
The accompanying unaudited consolidated financial statements and these notes do
not include certain information and footnote disclosures required by accounting
principles generally accepted in the United States, which were included in the
Company's consolidated financial statements for the year ended December 31,
2003. The information included in this Form 10-Q should be read in conjunction
with Management's Discussion and Analysis of Financial Condition and Results of
Operations and the Company's consolidated financial statements and notes thereto
for the year ended December 31, 2003 included in the Company's Annual Report on
Form 10-K.
The accompanying consolidated 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. During the period from November
1, 1992 (inception) to March 31, 2004, the Company has incurred a cumulative net
loss of $316,417,538 and has a stockholders' deficit of $14,306,794 at March 31,
2004. These factors among others may indicate that the Company will be unable to
continue as a going concern for a reasonable period of time.
The consolidated financial statements do not include any adjustments relating to
the recoverability and classification of recorded asset amounts or the amounts
and classification of liabilities that might be necessary should the Company be
unable to continue as a going concern. The Company's continuation as a going
concern is dependent upon its ability to generate sufficient cash flow to meet
its obligations on a timely basis, to obtain additional financing or refinancing
as may be required, and ultimately to attain successful operations.
6
Basic loss per common share is computed by dividing net loss available to common
stockholders by the weighted-average number of common shares outstanding during
the period. Diluted loss per common share is computed by dividing net loss
available to common stockholders by the weighted-average number of common shares
outstanding plus an assumed increase in common shares outstanding for
potentially dilutive securities, which consist of options and warrants to
acquire common stock and convertible debentures. Potentially dilutive shares are
excluded from the computation in loss periods, as their effect would be
anti-dilutive. The dilutive effect of options and warrants to acquire common
stock is measured using the treasury stock method. The dilutive effect of
convertible debentures is measured using the if-converted method. Basic and
diluted loss per common share is the same for all periods presented because the
impact of potentially dilutive securities is anti-dilutive.
Since March 8, 2004, the Company's common stock has been listed through the Pink
Sheets published by the National Quotation Bureau, Inc. The Company's common
stock trades under the symbol "ERTH.PK."
RELATED PARTY TRANSACTIONS
E. Khashoggi Industries LLC and its wholly owned subsidiaries ("EKI") own
approximately 35% of the Company's outstanding shares, and may be deemed to be a
controlling stockholder. In connection with the formation of the Company, the
Company entered into a Master License Agreement with EKI (the "EKI License
Agreement"), pursuant to which the Company has an exclusive, worldwide,
royalty-free license to use and license the EKI technology to manufacture and
sell disposable, single-use containers for packaging or serving food or
beverages intended for consumption within a short period of time (less than 24
hours). Effective January 1, 2001, EKI granted to the Company priority rights to
license certain product applications on an exclusive basis from Biotec, a wholly
owned subsidiary of EKI, in consideration for payment by the Company of a
$100,000 minimum monthly licensing fee to Biotec. In addition, Biotec agreed to
render technical services to the Company, as required, at Biotec's cost plus 5%.
Effective July 29, 2002, the Company restated its agreements with Biotec in a
definitive License & Information Transfer Agreement with Biotec to utilize the
Biotec technology for foodservice applications, including food wraps used in
foodservice applications (the "Biotec License Agreement"). Under the terms of
the Biotec License Agreement, the Company paid or accrued $300,000 and $353,800
during the three months ended March 31, 2004 and 2003, respectively, consisting
of the $100,000 per month minimum licensing fee plus materials and services
provided by EKI, which vary based upon the Company's requirements. As part of
the new convertible debenture financing ("2006 Debentures") completed in March
2003 (see Convertible Debentures), payment of this licensing fee was
subordinated to the new debentures with strict covenants governing payment.
In September 2002, the Company entered into a Loan Agreement with EKI whereby
EKI agreed to extend certain loans to the Company at EKI's sole discretion, at
interest rates of 7% to 10%. As of December 31, 2002 the outstanding principal
amount of outstanding loans was $1,745,000. In January 2003, the Company
borrowed an additional $1,010,000 from EKI under the Loan Agreement, bringing
the total outstanding principal amount of the loans to $2,755,000. As part of
the 2006 Debentures (see Convertible Debentures), repayment of these loans and
related interest was subordinated to the new debentures with strict covenants
governing their repayment. Therefore, at March 31, 2004, the loans totaling
$2,755,000 and related interest of $392,602 are classified as noncurrent
liabilities. In March 2003, the Company issued to EKI a warrant, which was
immediately exercisable, to purchase 83,333 shares of the Company's common stock
at $6.00 per share in connection with the subordination of the loans totaling
$2,755,000. The fair value of the warrant was estimated to be approximately
$303,522 using the Black-Scholes option pricing model and was recorded as a
discount on the outstanding loans.
CONVERTIBLE DEBENTURES
On March 5, 2003, the Company received proceeds of approximately $9.0 million,
net of financing costs of approximately $1.5 million, from the issuance to a
group of institutional investors of 416,667 shares of common stock and $10.55
million in aggregate principal amount of secured convertible debentures due in
2006 (the "2006 Debentures"). The 2006 Debentures bear interest at a rate of
2.0% per annum, payable quarterly in arrears on each January 31, April 30, July
31 and October 31. The holders of the 2006 Debentures have the right to convert
such debentures into the Company's common stock at a conversion price of $6.00
per share. While the 2006 Debentures are outstanding, the conversion price is
subject to adjustment in certain instances, such as a result of stock dividends
7
and splits, distributions of property to common stockholders, the sale of
substantially all of the Company's assets, the consummation of a merger, or
sales of common stock or common stock equivalents for per share prices lower
than the conversion price in effect. In addition to the holders' conversion
option, the Company has the right to force conversion of all or a portion of the
outstanding principal amount of the 2006 Debentures if certain conditions are
met, including a requirement that the closing price of the common stock has been
equal to or greater than 300% of the conversion price for at least the 10
consecutive days immediately preceding the conversion. The principal amount of
the 2006 Debentures is due and payable on March 5, 2006; however, earlier
repayment may occur if the Company receives cash proceeds in excess of $2.65
million (the "Excess Amount") from the sale of debt or equity securities,
equipment sales to unrelated third parties, or operating revenues. If the Excess
Amount arises, the Company can elect to distribute one-third of such Excess
Amount to EKI in payment of amounts due to EKI under the License Agreement or
the Biotec Agreement that have been subordinated to the 2006 Debentures, and
one-third of such Excess Amount, with the consent of each applicable debenture
holder, as a 102% prepayment of principal and interest of the 2006 Debentures.
In accordance with Accounting Principles Board Opinion No. 14, "Accounting for
Convertible Debt and Debt Issued with Stock Purchase Warrants," the Company
allocated the net proceeds of $9.0 million to the 2006 Debentures and the common
stock based their relative fair values. A discount on the 2006 Debentures of
$3.4 million and a discount on the common stock of $604,000 resulted from the
fair value allocation. Based on the conversion price of the 2006 Debentures
relative to the fair market value for a share of the Company's common stock at
the date of issue, the conversion feature of the 2006 Debentures was determined
to have no intrinsic value to the holders. If subsequent to the issuance date
the conversion price of the 2006 Debentures is adjusted downward, the value of
the conversion feature will be re-measured to determine if any beneficial
conversion value should be recorded as of the date the conversion price is
adjusted. The principal amount of the 2006 Debentures of $10.55 million was
recorded as a noncurrent liability, net of a $3.4 million discount. The total
discount on the 2006 Debentures of $3.4 million, which is being amortized to
interest expense over the 36-month term of the 2006 Debentures using the
effective interest method, may be subject to downward adjustments to the extent
partial conversions of the 2006 Debentures occur. These adjustments, if
required, would reduce the discount and reduce additional paid-in capital.
In addition to the $1.5 million of financing costs, the Company also incurred
approximately $646,000 of non-cash costs attributable to 54,167 shares of common
stock issued to the lead purchaser of the 2006 Debentures and two warrants
issued to a placement agent, both of whom received the instruments as
compensation for their services rendered in connection with the transaction. The
fair value of the 54,167 shares of common stock issued to the lead purchaser was
determined to be $247,000, based on the closing price of $4.56 per share of the
Company's common stock on the NASDAQ SmallCap Market on March 5, 2003. The fair
value of approximately $42,000 of the first of the two warrants issued to the
placement agent, which expires in March 2006 and is immediately exercisable by
the placement agent to purchase 28,810 shares of the Company's common stock for
$10.08 per share, was estimated using the Black Scholes option-pricing model and
is reflected in the accompanying financial statements as an increase in
additional paid-in capital and as a component of the $4.0 million aggregate
discount on the 2006 Debentures and common stock issued in the March 2003
transaction. The second of the two warrants issued to the placement agent, which
expires in March 2006, is immediately exercisable by the placement agent to
purchase $1.055 million in aggregate principal amount of the 2006 Debentures and
416,667 shares of the Company's common stock, except if, prior to exercise of
the warrant, all of the 2006 Debentures have been redeemed, repurchased or
converted, in which case the portion of the warrant exercisable into the 2006
Debentures becomes exercisable into common stock as if the 2006 Debentures
included in the warrant had been converted to common stock. The exercise price
of the convertible debenture portion of the warrant is $1,200 for each $1,000 of
principal and is subject to adjustment consistent with the provisions of the
2006 Debentures. The exercise price of the common stock portion of the warrant
is $7.20 per share. The estimated fair value of this warrant was reflected in
the financial statements as a warrant obligation and as a component of the $4.0
million aggregate discount on the 2006 Debentures and common stock issued in the
March 2003 financing transaction. At September 30, 2003, the Company evaluated
the current value of this warrant, considering its current cash flow
projections, continued operating losses, the prospects of raising additional
equity capital, the significant excess of the conversion price to the current
stock price and the volatility in the Company's stock price. Based upon these
factors, the Company determined that the likelihood of the warrant being
8
exercised was remote and wrote off the balance of the warrant obligation as of
September 30, 2003, resulting in a $0.5 million gain in the three months ended
September 30, 2003.
In connection with the March 2003 financing transactions, the Company prepaid
$5.2 million of the $8.2 million principal amount outstanding of the convertible
debentures due in 2007 (the "2007 Debentures"), resulting in a prepayment
penalty of $208,000. The Company also issued to the holders of the 2007
Debentures 52,083 shares of common stock, valued at $237,500 based upon the
closing price of the Company's common stock on the NASDAQ SmallCap Market of
$4.56 per share on March 5, 2003. In addition, one of the holders of the 2007
Debentures exchanged $2.0 million aggregate principal amount of 2007 Debentures
for $2.0 million aggregate principal amount of 2006 Debentures and 78,989 shares
of common stock valued at approximately $360,000 based upon the closing price of
the Company's common stock of $4.56 per share on March 5, 2003. In connection
with the prepayment and exchange transactions, the Company incurred cash
transaction costs of approximately $296,000, excluding the prepayment penalty.
The Company recognized a $1.7 million loss upon extinguishment of the 2007
Debentures through the prepayment and exchange. The prepayment of the 2007
Debentures and the debenture exchange resulted in the release to the Company of
$2.0 million of restricted cash.
The issuance of the 2006 Debentures, prepayment of the 2007 Debentures (from
restricted cash) and the debenture exchange provided the Company with aggregate
net proceeds of approximately $11.0 million.
During 2003, $5.75 million principal amount of the 2006 Debentures was converted
into 958,334 shares of common stock, resulting in the approximately $4.4 million
carrying amount of the 2006 Debentures being transferred to common stock.
At March 31, 2004, the outstanding principal balance of 2006 Debentures was $6.8
million, which is reflected on the accompanying balance sheet net of an
unamortized discount of approximately $1.3 million.
In October 2003, $575,000 principal amount of the 2006 Debenture was converted
into 95,833 shares of common stock, reducing the outstanding principal balance
of 2006 Debentures to $6.8 million.
In 2003, the Company forced the conversion of $1.3 million principal amount of
the 2007 Debentures and debenture holders voluntarily converted $0.5 million
principal amount of the 2007 Debentures for a total of 353,985 shares of common
stock, resulting in the release to the Company of $1.8 million of restricted
cash.
On March 8, 2004, the Company's common stock was delisted from the Nasdaq
Smallcap Market because the Company's market capitalization failed to meet the
minimum required standard. In addition, the Company did not make interest
payments related to the 2006 Debentures as required on January 31, 2004 and
April 30, 2004. These actions put the Company in non-compliance with its
covenants under the 2006 Debentures. Management is currently negotiating with
the debenture holders for appropriate relief or waiver of these covenants. One
of the debenture holders has notified the Company in writing that they are in
default and has requested that the Company repurchase the entire principal
amount of the 2006 Debentures that they hold at the price specified in the
debenture, along with any accrued and unpaid interest. Because the Company can
not assure that it will be able to negotiate appropriate relief or a waiver of
the applicable covenants, the entire outstanding principal amount of the 2006
Debentures has been classified as a current liability as of March 31, 2004 and
December 31, 2003.
In connection with the March 2003 financing transactions, EKI agreed to
subordinate the repayment of its outstanding loans totaling $2,755,000 to the
Company's payment obligations under the 2006 Debentures. In addition, EKI and
Biotec agreed to subordinate certain payments to which they were otherwise
entitled under the Biotec License Agreement (other than their respective
percentages of any royalties received by the Company) to the satisfaction of the
Company's payment obligations under the 2006 Debentures. They further agreed not
to assert any claims against the Company for breaches of the Biotec License
Agreement (other than the assertion of certain equitable remedies to enjoin the
Company from, for example, selling products outside its field of use) until such
time as the Company's obligations under the 2006 Debentures are satisfied in
full. EKI and Biotec also agreed to allow the Company to pledge their respective
interests in the EKI and Biotec License Agreements to secure the Company's
9
obligations under the 2006 Debentures, and certain additional concessions were
made by EKI and Biotec to permit the Company greater flexibility in selling its
rights under the EKI and Biotec License Agreements to third parties in an
insolvency context. These rights terminate upon the satisfaction in full of the
obligations under the 2006 Debentures. In consideration for its willingness to
subordinate the payments and advances that are owed to it, in March 2003 the
Company issued to EKI a warrant, expiring in ten years, to acquire 83,333 shares
of the Company's common stock for $6.00 per share. The fair value of the warrant
was estimated to be approximately $303,522 using the Black-Scholes option
pricing model and was recorded as a discount on the outstanding loans.
COMMITMENTS
During 1998, EKI entered into certain agreements with an equipment manufacturer
providing for the purchase by EKI of certain technology applicable to
starch-based disposable packaging. EKI licenses such technology to the Company
on a royalty-free basis pursuant to the License Agreement. In connection with
the purchase, the Company would be required to pay the seller $3.0 million over
the five-year period commencing January 1, 2004 if EKI, the Company or their
respective licensees make active use of the technology and have not purchased,
by December 31, 2003, at least $35.0 million of equipment from the seller. As of
March 31, 2004, the Company and its respective licensees have neither actively
used the technology nor purchased equipment from the seller. The Company does
not plan to make active use of the technology during the year ending December
31, 2004. EKI has agreed to indemnify the Company to the extent the Company is
required to pay any portion of this $3.0 million obligation solely as a result
of EKI's or its licensees' active use of such patents and related technology
(other than use by the Company or its sublicenses). The $3.0 million obligation
to the seller of the technology is subject to reduction in an amount equal to 5%
of the purchase price of any equipment purchased from the seller by EKI, the
Company or their sublicenses during the five-year period commencing January 1,
2004.
PROPERTY AND EQUIPMENT AND EQUIPMENT HELD FOR SALE
The cost and accumulated depreciation of property and equipment and equipment
held for sale at March 31, 2004 and December 31, 2003 were as follows:
MARCH 31, DECEMBER 31,
2004 2003
----------- -----------
Property and Equipment
Product development center ................ $ 1,175,394 $ 1,175,394
Office furniture and equipment ............ 356,339 356,339
----------- -----------
Total cost ..................................... 1,531,733 1,531,733
Less: Accumulated depreciation and amortization (1,497,280) (1,469,939)
----------- -----------
Property and equipment - net ................... $ 34,453 $ 61,794
=========== ===========
Equipment held for sale ........................ $ 1 $ 1
=========== ===========
A commercial production line in Goettingen, Germany was financed and constructed
by the Company. Because the Company is unable to determine with certainty the
proceeds that will be realized upon sale of the equipment, the Company wrote the
line down to $1 as of December 31, 2003 and reclassified it to the long-term
asset account "Equipment held for sale." If the equipment is sold, the Company
will recognize a gain equal to the proceeds received for the equipment.
10
STOCK OPTIONS
The Company accounts for stock options in accordance with the provisions of
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees," and complies with the disclosure provisions of Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation." Under APB Opinion No. 25, compensation expense is based on the
difference, if any, on the date of grant, between the fair value of the
Company's common stock and the exercise price of the option. For disclosure
purposes, to measure stock-based compensation in accordance with SFAS No. 123,
"Accounting for Stock-Based Compensation," the fair value of each option grant
is estimated on the date of grant using the Black-Scholes option-pricing model.
The fair value of each option grant is then amortized as pro forma compensation
expense over the vesting period of the options. The following table sets forth
the pro forma net loss and loss per share resulting from applying SFAS No. 123.
THREE MONTHS
ENDED MARCH 31,
-----------------------
2004 2003
---------- ----------
Net Loss as reported ........................................ $2,066,857 $6,770,727
Deduct: Stock-based employee compensation expense
included in reported net loss, net of tax ................ -- --
Add: Total stock-based employee compensation determined under
fair value based method for all awards, net of tax ....... 13,015 79,390
---------- ----------
Pro forma net loss .......................................... $2,079,872 $6,850,117
Net loss per common share
As reported .............................................. $ 0.15 $ .55
Pro forma ................................................ 0.15 0.55
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD LOOKING STATEMENTS
Information contained in this Quarterly Report on Form 10-Q, including but not
limited to "Management's Discussion and Analysis of Financial Condition and
Results of Operations," contains forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995, as amended. These
statements may be identified by the use of forward-looking terminology such as
"may," "will," "expect," "anticipate," "estimate," or "continue," or the
negative thereof or other comparable terminology. Any one factor or combination
of factors could cause the Company's actual operating performance or financial
results to differ substantially from those anticipated by management that are
described herein. Investors should carefully review the risk factors set forth
in other Company reports or documents filed with the Securities and Exchange
Commission, including Forms 10-Q, 10-K, 10-K/A and 8-K. Factors influencing the
Company's operating performance and financial results include, but are not
limited to, changes in the general economy, the availability of financing,
governmental regulations concerning, but not limited to, environmental issues,
and other risks and unforeseen circumstances affecting the Company's business.
This Quarterly Report on Form 10-Q should be read in conjunction with the
Company's Annual Report on Form 10-K for the fiscal year ended December 31,
2003.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements and related disclosures in conformity
with generally accepted accounting principles requires management to make
judgments, assumptions and estimates that affect the amounts reported in the
Company's financial statements and the accompanying notes. The amounts of assets
and liabilities reported in the Company's balance sheet and the amounts of
expenses reported for each fiscal period are affected by estimates and
assumptions which are used for, but not limited to, the accounting for asset
impairments. Actual results could differ from these estimates. The following
critical accounting policies are significantly affected by judgments,
assumptions and estimates used in the preparation of the consolidated financial
statements.
11
Going Concern Basis. The consolidated 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. During the period
from November 1, 1992 (inception) to March 31, 2004, the Company has incurred a
cumulative net loss of $316,417,538 and has a working capital deficit of
$9,511,335 at March 31, 2004. These factors, along with others, may indicate
that the Company will be unable to continue as a going concern for a reasonable
period of time. The Company will have to raise additional funds to meet its
current obligations and to cover operating expenses through the year ending
December 31, 2004. If the Company is not successful in raising additional
capital it may not be able to continue as a going concern for a reasonable
period of time. Management plans to address this need by raising cash through
either the issuance of debt or equity securities. In addition, the Company
expects cash to be generated in 2004 through royalty payments from licensees.
Another possible source of funds is the sale or transfer of the commercial
production line in Goettingen, Germany to an operating partner. However, the
Company can not assure that additional financing will be available to it, or, if
available, that the terms will be satisfactory, that it will receive any royalty
payments in 2004, or that it will be able to negotiate mutually agreeable terms
for the transfer of its commercial production line to an operating partner.
Management will also continue in its efforts to reduce expenses, but can not
assure that it will be able to reduce expenses below current levels. The
consolidated financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the amounts and
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern.
Estimated Net Realizable Value of Property and Equipment. The Company has been
engaged in the development of manufacturing equipment to validate acceptance of
EarthShell products and their pricing. To this end the Company constructed
manufacturing lines in Owings Mills, Maryland, Goleta, California and
Goettingen, Germany. The Company evaluates the recoverability of property and
equipment whenever events or changes in circumstances indicate that the carrying
value of an asset may not be recoverable. If there is an indication that the
carrying value of an asset may not be recoverable and the estimated future cash
flows (undiscounted and without interest charges) from the use of the asset are
less than the carrying value, a write-down is recorded to reduce the related
asset to its estimated fair value.
The commercial production line in Goettingen, Germany was originally financed
and constructed by the Company for the Company's joint venture with Huhtamaki.
During 2001, $1.2 million of the Goettingen line was written off to reflect
equipment that had no further application in the product development cycle.
During the third quarter of 2002 the Company concluded, after obtaining
quotations from various machinery suppliers for an identical line, that $1.7
million of the cost of the line would not be recoverable and therefore the
carrying value of the line was written down by this amount, of which $1.6
million was recorded in the third quarter of 2002 and the remaining $0.1 million
was recorded in the fourth quarter of 2002. With the conclusion of the joint
venture with Huhtamaki in 2003, the Company is seeking other operating partners
to purchase the production line. However, because the Company is unable to
determine with certainty the proceeds that will be realized upon sale of the
equipment, the Company wrote the line down to $1 as of December 31, 2003 and
reclassified it to the long-term asset account "Equipment held for sale."
The key accounting estimates and policies are reviewed with the Audit Committee
of the Board of Directors.
THREE MONTHS ENDED MARCH 31, 2004 COMPARED WITH THE THREE MONTHS ENDED MARCH 31,
2003.
The Company's net loss decreased $4.7 million to $2.1 million from $6.8 million
for the three months ended March 31, 2004 compared to the three months ended
March 31, 2003, respectively. The most significant reasons for the net loss
decrease are set forth below
RESEARCH AND DEVELOPMENT EXPENSES. Total research and development expenses are
comprised of Related party license fee and research and development expenses and
Other research and development expenses. Total research and development expenses
for the development of EarthShell Packaging(R) decreased $1.8 million to $0.5
million from $2.3 million for the three months ended March 31, 2004 compared to
the three months ended March 31, 2003, respectively.
12
o Related party license fee and research and development expenses are
comprised of the $100,000 monthly licensing fee for the use of the
EarthShell Technology and technical services, both of which were
payable to EKI, a stockholder of the Company, or Biotec, a wholly
owned subsidiary of EKI. It should be noted that payment of these
related party expenses has been deferred pursuant to subordination
agreements entered into by the EKI entities in connection with the
convertible debenture financing concluded in March 2003. Related party
license fee and research and development expenses decreased $0.1
million to $0.3 million from $0.4 million for the three months ended
March 31, 2004 compared to the three months ended March 31, 2003,
respectively. This decrease was entirely due to a decrease in
technical services provided to the Company by Biotec.
o Other research and development expenses are comprised of personnel
costs, travel and direct overhead for development and demonstration
production, as well as impairment charges on manufacturing property
and equipment constructed for demonstration production purposes. Other
research and development expenses decreased $1.7 million to $0.2
million from $1.9 million for the three months ended March 31, 2004
compared to the three months ended March 31, 2003, respectively. The
decrease in other research and development expenses was primarily due
to the winding down of on-going demonstration manufacturing in Goleta
in the first quarter of 2003. In addition, the Company's expense
reduction efforts resulted in reduced personnel and other costs in
2004.
OTHER GENERAL AND ADMINISTRATIVE EXPENSES. Other general and administrative
expenses are comprised of personnel costs, travel and direct overhead for
marketing, finance and administration. Total general and administrative expenses
decreased $0.6 million to $1.2 million from $1.8 million for the three months
ended March 31, 2004 compared to the three months ended March 31, 2003,
respectively as a result of efforts to significantly reduce general and
administrative expenses in 2003 including reductions in the following expenses:
personnel costs by $0.3 million, facility and support costs by $0.1 million,
professional fees and services by $0.1 million, and business insurance costs by
$0.1 million.
INTEREST EXPENSE. Interest expense is comprised of Related party interest
expense and Other interest expense.
o Related party interest expense was $0.1 million in both the three
months ended March 31, 2004 and the three months ended March 31, 2003.
Related party interest expense includes interest accrued on
outstanding loans made to the Company by EKI under the Loan Agreement
(see Related Party Transactions), accretion of the discount related to
the warrants issued in conjunction with the March 2003 financing
transactions, plus accrued interest payable on amounts owed to EKI for
monthly licensing fees that were not paid in accordance with the terms
of the subordination agreements entered into in connection with the
2006 Debentures (see Related Party Transactions).
Although the outstanding loans and monthly licensing fees will accrue
approximately $0.4 million in annual interest expense, payment of the
interest is subordinated to the 2006 Debentures. Therefore, the
related party interest expense will continue to accrue but will not be
paid in cash until the 2006 Debentures have been converted or the
obligation satisfied in full.
o Other interest expense decreased $0.4 million to $0.2 million from
$0.6 million for the three months ended March 31, 2004 compared to the
three months ended March 31, 2003, respectively. Other interest
expense for the three months ended March 31, 2004 is primarily
composed of accretion of the discount and interest accrued on the 2006
Debentures. Other interest expense for the three months ended March
31, 2003 was primarily composed of the accretion of the discount on
the 2007 Debentures and a beneficial conversion charge in the amount
of $.04 million due to a change in the 2007 Debentures conversion
price. In addition, Other interest expense for 2003 also included
accretion of the discount on the 2007 debentures and accrued interest
payable on the 2006 and 2007 Debentures. Interest expense from
accretion of the discount and accrued interest payable for the 2006
Debentures will be approximately $0.8 million per year until the are
repaid or are converted into common stock.
13
OTHER (INCOME) EXPENSE. Other expense of $0.2 million for the three months ended
March 31, 2003 represents the increase in the estimated fair value of the
warrant obligation from its issuance on March 5, 2003 through March 31. 2003.
LOSS ON EXTINGUISHMENT OF DEBENTURES. Loss on extinguishment of debentures was
$1.7 million for the three months ended March 31, 2003. In connection with the
March 2003 financing transactions, the Company prepaid $5.2 million aggregate
principal amount of the 2007 Debentures, resulting in a prepayment penalty of
approximately $0.2 million. The Company also issued to the holders of the
prepaid 2007 Debentures 52,083 shares of common stock, valued at approximately
$0.2 million based upon the closing price of the Company's common stock of $4.56
per share on March 5, 2003. In addition, one of the holders of the 2007
Debentures exchanged $2.0 million aggregate principal amount of 2007 Debentures
for $2.0 million aggregate principal amount of 2006 Debentures. In connection
with the prepayment and exchange transactions, the Company incurred cash
transaction costs of approximately $0.3 million, excluding the prepayment
penalty. In addition, the Company incurred a charge of approximately $0.9
million for the prorated portion of the original discount attributed to the $7.2
million of the 2007 Debentures repaid and exchanged. Therefore, the Company
recognized a $1.7 million loss upon extinguishment of the 2007 debentures
through the prepayment and exchange.
DEBENTURE CONVERSION COSTS. Debenture conversion costs of $0.1 million for the
three months ended March 31, 2003 represent the prorated portion of the original
discount attributed to the 2007 Debentures whose conversion was forced by
Company in the respective periods.
LIQUIDITY AND CAPITAL RESOURCES AT MARCH 31, 2004
Cash Flow. The Company's principal use of cash for the three months ended March
31, 2004 was to fund operations. Net cash used in operations was $1.2 million
for the three months ended March 31, 2004. As of March 31, 2004 the Company had
unrestricted cash and related cash equivalents totaling $0.7 million.
Capital Requirements. The Company made no capital expenditures during the three
months ended March 31, 2004, nor does the Company expect to make significant
capital expenditures in the year 2004.
Sources of Capital. As part of the Company's initial public offering on March
27, 1998, the Company issued 877,193 shares of common stock, for which it
received net proceeds of $206 million. On April 18, 2000 and January 4, 2001,
the Company filed shelf registrations statements for 416,667 and 1.25 million
shares, respectively, of the Company's common stock. During the years ended
December 31, 2002, 2001 and 2000 the Company sold approximately 0.1 million, 1.1
million and 0.4 million shares of common stock in private transactions under
such registration statements and received net proceeds from such sales of
approximately $2.3 million, $30.5 million and $10.5 million, respectively. All
shares available under such registration statements had been sold as of December
2002.
In December of 2001 the Company filed a shelf registration statement providing
for the sale of up to $50 million of securities, including secured or unsecured
debt securities, preferred stock, common stock, and warrants. These securities
could be offered, separately or together, in distinct series, and amounts, at
prices and on terms to be set forth in the prospectus contained in the
registration statement, and in subsequent supplements to the prospectus. During
the year ended December 31, 2002, the Company sold 1.9 million shares of common
stock under such registration statement and received net proceeds from such
sales of $19.6 million.
On August 12, 2002, the Company issued $10 million in aggregate principal amount
of convertible debentures, due August 2007 (the "2007 Debentures"), and warrants
to purchase 0.2 million shares of common stock, to institutional investors for
proceeds of $10.0 million. The terms of the debentures required the proceeds be
held in restricted cash accounts linked to irrevocable letters of credit in
favor of each debenture holder such that unrestricted access to the proceeds
from the sale of the debentures generally occurred only upon conversion of the
debentures into shares of the Company's common stock. These debentures bore
interest at a rate of 1.5% per annum. The holders of these debentures had the
right to convert the debentures into the Company's common stock at an initial
conversion price of $15.60 per share, which was reduced to $6.00 per share as a
result of anti-dilution adjustments. In addition to the holders' conversion
option, under certain circumstances, the Company had the right to force
14
conversion of up to $500,000 of the debentures per week at a 15% discount to the
market price of the Company's stock. Subject to certain conditions set forth in
the debentures, the debentures could be prepaid upon twenty business days notice
for 104% of the outstanding principal balance of the debentures. During the
third quarter of 2002, the Company forced conversion of $1.0 million principal
amount of the debentures for 168,696 shares of common stock, resulting in the
release to the Company of $1.0 million of restricted cash. Subsequent to
December 31, 2002, the Company forced conversion of an additional $1.3 million
principal amount of the debentures and debenture holders voluntarily converted
$0.5 million principal amount of the debentures, for a total of 353,985 shares
of common stock, resulting in the release to the company of $1.8 million of
restricted cash. In March 2003, as part of a new convertible debenture
financing, the Company prepaid $5.2 million principal amount of the debentures.
In addition, one of the holders of the debentures exchanged $2.0 million
aggregate principal amount of these debentures for $2.0 million aggregate
principal amount of 2006 Debentures and 78,989 shares of common stock. The
exchange resulted in the release to the Company of $2.0 million of restricted
cash, as the 2006 Debentures are not secured by cash. There were no outstanding
2007 Debentures as of December 31, 2003.
On March 5, 2003, the Company issued to a group of institutional investors
416,667 shares of common stock and $10.55 million in aggregate principal amount
of secured convertible debentures due in March 2006 (the "2006 Debentures"), for
which the Company received proceeds of approximately $9.0 million, net of
financing costs of approximately $1.5 million. The 2006 Debentures bear interest
at a rate of 2.0% per annum, payable quarterly in arrears on each January 31,
April 30, July 31 and October 31. The debentures are secured by the Company's
rights, title and interest to the technology and trademarks covered by the EKI
License Agreement, including all process and product improvements of the
Company, the Company's right to use and to sublicense the technology, and all
license fees, royalties and/or other forms of compensation due to the Company
from sublicenses under existing or future sublicenses. The holders of the 2006
Debentures have the right to convert such debentures into the Company's common
stock at a conversion price of $6.00 per share. While the 2006 Debentures are
outstanding, the conversion price is subject to adjustment in certain instances,
such as a result of stock dividends and splits, distributions of property to
common stockholders, the sale of substantially all of the Company's assets, the
consummation of a merger, or sales of common stock or common stock equivalents
for per share prices lower than the conversion price in effect. In addition to
the holders' conversion option, after the first anniversary of the issuance of
the 2006 Debentures the Company has the right to force conversion of all or a
portion of the outstanding principal amount of the 2006 Debentures if certain
conditions are met, including a requirement that the closing price of the common
stock has been equal to or greater than 300% of the conversion price for at
least the 10 consecutive days immediately preceding the conversion. The
principal amount of the 2006 Debentures is due and payable on March 5, 2006;
however, earlier repayment may occur if the Company receives cash proceeds in
excess of $2.65 million (the "Excess Amount") from the sale of debt or equity
securities, equipment sales to unrelated third parties, or operating revenues.
If the Excess Amount arises, the Company can elect to distribute one-third of
such Excess Amount to EKI in payment of amounts due to EKI under the License
Agreement or the Biotec Agreement that have been subordinated to the 2006
Debentures, and one-third of such Excess Amount, with the consent of each
applicable debenture holder, as a 102% prepayment of principal and interest of
the 2006 Debentures.
In connection with the March 2003 financing transactions, the Company issued
54,167 shares of common stock to the lead purchaser of the 2006 Debentures and
two warrants to a placement agent, both of whom received the instruments as
compensation for their services rendered in connection with the transaction. The
first of the two warrants is immediately exercisable by the placement agent to
purchase 28,810 shares of the Company's common stock for $10.08 per share and
expires in March 2006. The second of the two warrants is immediately exercisable
by the placement agent to purchase $1.055 million in aggregate principal amount
of the 2006 Debentures and 416,667 shares of the Company's common stock, except
if, prior to exercise of the warrant, all of the 2006 Debentures have been
redeemed, repurchased or converted, in which case the portion of the warrant
exercisable into the 2006 Debentures becomes exercisable into common stock as if
the 2006 Debentures included in the warrant had been converted to common stock.
The exercise price of the convertible debenture portion of the warrant is $1,200
for each $1,000 of principal and is subject to adjustment consistent with the
provisions of the 2006 Debentures. The exercise price of the common stock
portion of the warrant is $7.20 per share. This warrant also expires in March
2006.
15
In 2003, $5.75 million principal amount of the 2006 Debentures was converted
into 958,334 shares of common stock.
At March 31, 2004, the outstanding principal balance of 2006 Debentures was $6.8
million. The remaining shares under the December 2001 shelf registration
described above have been used to secure shares potentially issuable upon
conversion of the 2006 Debentures.
On March 8, 2004, the Company's common stock was delisted from the Nasdaq
Smallcap Market because the Company's market capitalization failed to meet the
minimum required standard and trading was moved to the OTC Bulletin Board and
then to the Pink Sheets Electronic Quotation Services. In addition, the Company
did not make interest payments related to the 2006 Debentures as required on
January 31, 2004 and April 30, 2004. These actions put the Company in
non-compliance with its covenants under the 2006 Debentures. Management is
currently negotiating with the debenture holders for appropriate relief or
waiver of these covenants. One of the debenture holders has notified the Company
in writing that they are in default and has requested that the Company
repurchase the entire principal amount of the 2006 Debentures that they hold at
the price specified in the debenture, along with any accrued and unpaid
interest. Because the Company can not assure that it will be able to negotiate
appropriate relief or a waiver of the applicable covenants, the entire
outstanding principal amount of the 2006 Debentures have been classified as
current liabilities as of March 31, 2004 and December 31, 2003.
During 2002 and 2003, the Company's largest shareholder, EKI, made various
simple interest working capital loans to the Company. These loans bear interest
at a rate of 7% or 10% per annum, and are payable on demand. As of March 31,
2004, the outstanding principal balance of these loans was $2,755,000. In
connection with the March 2003 convertible debenture financing, the remaining
outstanding balance of these loans was subordinated to the 2006 Debentures, with
strict covenants governing their repayment. In addition, EKI and Biotec agreed
to subordinate certain payments to which they were otherwise entitled under the
Biotec License Agreement (other than their respective percentages of any
royalties received by the Company) to the satisfaction of the Company's payment
obligations under the 2006 Debentures. They further agreed not to assert any
claims against the Company for breaches of the Biotec License Agreement (other
than the assertion of certain equitable remedies to enjoin the Company from, for
example, selling products outside its field of use) until such time as the
Company's obligations under the 2006 Debentures are satisfied in full. EKI and
Biotec also agreed to allow the Company to pledge their respective interests in
the EKI and Biotec License Agreements to secure the Company's obligations under
the 2006 Debentures, and certain additional concessions were made by EKI and
Biotec to permit the Company greater flexibility in selling its rights under the
EKI and Biotec License Agreements to third parties in an insolvency context.
These rights terminate upon the satisfaction in full of the obligations under
the 2006 Debentures. In consideration for its willingness to subordinate the
payments and advances that are owed to it, in March 2003 the Company issued to
EKI a warrant, expiring in ten years, to acquire 83,333 shares of the Company's
common stock for $6.00 per share.
The Company will have to raise additional funds to meet its current obligations
and to cover operating expenses through the year ending December 31, 2004. If
the Company is not successful in raising additional capital it may not be able
to continue as a going concern for a reasonable period of time. Management plans
to address this need by raising cash through either the issuance of debt or
equity securities. In addition, the Company expects cash to be generated in 2004
through royalty payments from licensees. Another possible source of funds is the
sale or transfer of the commercial production line in Goettingen, Germany to an
operating partner. However, the Company can not assure that additional financing
will be available to it, or, if available, that the terms will be satisfactory,
that it will receive any royalty payments in 2004, or that it will be able to
negotiate mutually agreeable terms for the transfer of its commercial production
line to an operating partner. Management will also continue in its efforts to
reduce expenses, but can not assure that it will be able to reduce expenses
below current levels.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's treasury function controls all decisions and commitments regarding
cash management and financing arrangements. Treasury operations are conducted
within a framework that has been authorized by the board of directors.
16
The Company is exposed to interest rate risk on its fixed rate long-term working
capital loans to EKI and its fixed rate long-term convertible debentures. As of
March 31, 2004, these long-term fixed rate debt obligations totaled
approximately $9.555 million. The working capital loans bear interest at a fixed
rate of 10% per annum. The convertible debentures bear interest at a fixed rate
of 2% per annum. While generally an increase in market interest rates will
decrease the value of this debt, and decreases in rates will have the opposite
effect, we are unable to estimate the impact that interest rate changes will
have on the value of the substantial majority of this debt as there is no active
public market for this debt.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures. The Company's Chief Executive
Officer and Chief Financial Officer have evaluated the effectiveness of the
Company's disclosure controls and procedures (as such term is defined in Rules
13a-15(e) and 15d-15(e) under the Exchange act) as of the end of the period
covered by this quarterly report on Form 10-Q (the "Evaluation Date"). Based on
such evaluation, such officers have concluded that, as of the Evaluation Date,
the Company's disclosure controls and procedures are effective in alerting them
on a timely basis to material information relating to the Company required to be
included in the Company's periodic filings under the Exchange Act.
Changes in internal control over financial reporting. No changes in the
Company's internal control over financial reporting have come to management's
attention during the Company's last fiscal quarter that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS AND ISSUER REPURCHASES OF
EQUITY SECURITIES
The Company has not purchased any of its equity securities in the period ended
March 31, 2004.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
The Company did not make required interest payments related to the 2006
Debentures on January 31, 2004 and April 30, 2004. In addition, on March 8,
2004, the Company's common stock was delisted from the Nasdaq Smallcap Market.
These actions put the Company in non-compliance with its covenants under the
2006 Debentures. Management is currently negotiating with the debenture holders
for appropriate relief or waiver of these covenants. One of the debenture
holders has notified the Company in writing that the Company is in default and
has requested that the Company repurchase the entire principal amount of the
2006 Debentures held at the price specified in the debenture, along with any
accrued and unpaid interest. Because the Company can not assure that it will be
able to negotiate appropriate relief or a waiver of the applicable covenants,
the entire outstanding principal amount of the 2006 Debentures totaling $6.8
million plus accrued interest have been classified as current liabilities as of
March 31, 2004 and December 31, 2003.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
ITEM 5. OTHER INFORMATION
Not applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
The Company filed one report on Form 8-K during the quarter ended March 31,
2004. Information regarding the item reported on is as follows:
17
DATE ITEM REPORTED ON
--------------- ------------------------------------------------------------
March 5, 2004 Press release of the Company dated March 5, 2004, regarding
the delisting of the Company's common stock from the Nasdaq
SmallCap Market effective March 8, 2004.
31.1 Certification of the CEO pursuant to Rules 13a-14 and 15d-14 under the
Exchange Act, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
31.2 Certification of the CFO pursuant to Rules 13a-14 and 15d-14 under the
Exchange Act, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned.
EarthShell Corporation
Date: May 10, 2004 By: /s/ D. Scott Houston
--------------------
D. Scott Houston
Chief Financial Officer
(PRINCIPAL FINANCIAL OFFICER AND DULY
AUTHORIZED OFFICER)
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