As filed with the Securities and Exchange Commission on June 9, 2005
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM S-1
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
Delaware EarthShell Corporation 77-0322379
(State or Other Jurisdiction of Incorporation (Name of Registrant in Our Charter) (I.R.S. Employer Identification No.)
or Organization)
Simon K. Hodson
3916 State Street, Suite 110 3916 State Street, Suite 110
Santa Barbara, California 93105 Santa Barbara, California 93105
(805) 563-7590 2650 (805) 563-7590
(Address and telephone number of Principal (Primary Standard Industrial (Name, address and telephone number
Executive Offices and Principal Place of Business) Classification Code Number) of agent for service)
Copies to:
Clayton E. Parker, Esq. Jacqueline G. Hodes, Esq.
Kirkpatrick & Lockhart Nicholson Graham LLP Kirkpatrick & Lockhart Nicholson Graham LLP
201 S. Biscayne Boulevard, Suite 2000 201 S. Biscayne Boulevard, Suite 2000
Miami, Florida 33131 Miami, Florida 33131
Telephone: (305)539-3300 Telephone: (305)539-3300
Telecopier: (305)358-7095 Telecopier: (305)358-7095
Approximate date of commencement of proposed sale to the public: As soon
as practicable after this registration statement becomes effective.
If any of the securities being registered on this Form are to be offered
on a delayed or continuous basis pursuant to Rule 415 under the Securities Act
of 1933 check the following box. |X|
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. |_|
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. |_|
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. |_|
CALCULATION OF REGISTRATION FEE
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Proposed Maximum
Proposed Maximum Aggregate Amount Of
Title Of Each Class Of Amount To Be Offering Price Offering Registration
Securities To Be Registered Registered Per Share (1) Price (1) Fee
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Common Stock, par value $0.01 per share 4,476,927 shares (2) $2.00 $8,953,854 $1,054.00
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TOTAL 4,476,927 shares (2) $2.00 $8,953,854 $1,054.00
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(1) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(c) under the Securities Act of 1933. For the purposes
of this table, we have used the average of the closing bid and asked
prices as of a recent date.
(2) Of these shares, 2,000,000 are being registered under the Standby Equity
Distribution Agreement, 143,550 shares were received as a commitment fee
under the Standby Equity Distribution Agreement, 6,450 shares were
received as a placement agent fee, 1,016,310 are being registered under
warrants, 791,667 are being registered pursuant to a settlement
arrangement, and 518,950 are being registered pursuant to private
placement transaction agreements.
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The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant shall
file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until this Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
PROSPECTUS
Subject to completion, dated June 9, 2005
EARTHSHELL CORPORATION
4,476,927 shares of Common Stock
This prospectus relates to the sale of up to 4,476,927 shares of
EarthShell Corporation ("EarthShell" or the "Company") common stock by certain
persons who are stockholders of the Company including Cornell Capital Partners,
LP ("Cornell Capital Partners"). Please refer to "Selling Stockholders"
beginning on page 16. EarthShell is not selling any shares of common stock in
this offering and therefore will not receive any proceeds from this offering.
All costs associated with this registration will be borne by the Company.
The shares of common stock are being offered for sale by the selling
stockholders at prices established on the Over-the-Counter Bulletin Board during
the term of this offering. On June 7, 2005, the last reported sale price of our
common stock was $1.98 per share. Our common stock is quoted on the
Over-the-Counter Bulletin Board under the symbol "ERTH.OB." These prices will
fluctuate based on the demand for the shares of common stock.
The selling stockholders consists of Cornell Capital Partners, who may
sell up to 2,768,550 shares of common stock, 2,000,000 of which are under the
Standby Equity Distribution Agreement if the Company determined to make advances
under the Standby Equity Distribution Agreement, 143,550 shares of common stock
received from the Company on March 23, 2005 as a fee under the Standby Equity
Distribution Agreement and 625,000 shares of common stock underlying a warrant,
Sloan Securities Corporation, who may sell up to 6,450 shares of common stock
received by the Company on March 23, 2005 as a placement agent fee under the
Standby Equity Distribution Agreement, SF Capital Partners Ltd., who may sell up
to 791,667 shares of common stock upon the conversion of existing debt, other
selling shareholders who may sell up to 518,940 shares of common stock
previously issued by the Company and other selling stockholders, who may sell up
to 391,310 shares of common stock underlying warrants.
Cornell Capital Partners is an "underwriter" within the meaning of the
Securities Act of 1933 in connection with the sale of common stock under the
Standby Equity Distribution Agreement. Cornell Capital Partners will pay
EarthShell 98% of, or a 2% discount to, the lowest volume weighted average price
of the common stock during the five consecutive trading day period immediately
following the notice date. In addition, Cornell Capital Partners will retain 5%
of each advance under the Standby Equity Distribution Agreement. Cornell Capital
Partners also received a one-time commitment fee in the form of 143,550 shares
of common stock on March 23, 2005. The 2% discount, the 5% retainage fee, and
the 143,550 compensation shares previously issued are underwriting discounts
payable to Cornell Capital Partners.
EarthShell has engaged Sloan Securities Corporation, an unaffiliated
registered broker-dealer, to advise it in connection with the Standby Equity
Distribution Agreement. Sloan Securities Corporation was paid a fee of 6,450
shares of the Company's common stock on March 23, 2005.
Brokers or dealers effecting transactions in these shares should confirm
that the shares are registered under the applicable state law or that an
exemption from registration is available.
These securities are speculative and involve a high degree of risk.
Please refer to "Risk Factors" beginning on page 7.
With the exception of Cornell Capital Partners, which is an "underwriter"
within the meaning of the Securities Act of 1933, no other underwriter or person
has been engaged to facilitate the sale of shares of common stock in this
offering. This offering will terminate twenty-four months after the accompanying
registration statement is declared effective by the Securities and Exchange
Commission. None of the proceeds from the sale of stock by the selling
stockholders will be placed in escrow, trust or any similar account.
The information in this prospectus is not complete and may be changed. The
selling stockholders may not sell these securities until the registration
statement filed with the Securities and Exchange Commission is effective. This
prospectus is not an offer to buy these securities in any state where the offer
or sale is not permitted.
The Securities and Exchange Commission and state securities regulators
have not approved or disapproved of these securities, or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
1
The date of this prospectus is June __, 2005
2
TABLE OF CONTENTS
PROSPECTUS SUMMARY....................................................................1
THE OFFERING..........................................................................2
SUMMARY FINANCIAL DATA................................................................4
SUPPLEMENTARY FINANCIAL INFORMATION...................................................5
CAPITALIZATION........................................................................6
RISK FACTORS..........................................................................7
FORWARD-LOOKING STATEMENTS...........................................................15
SELLING STOCKHOLDERS.................................................................16
USE OF PROCEEDS......................................................................20
DILUTION.............................................................................21
STANDBY EQUITY DISTRIBUTION AGREEMENT................................................22
PLAN OF DISTRIBUTION.................................................................24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.....................................................................26
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.....................................................................37
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...........................38
DESCRIPTION OF BUSINESS..............................................................39
MANAGEMENT...........................................................................47
STOCK PERFORMANCE GRAPH..............................................................56
PRINCIPAL STOCKHOLDERS...............................................................57
MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND OTHER
STOCKHOLDER MATTERS............................................................59
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.......................................60
DESCRIPTION OF CAPITAL STOCK.........................................................61
EXPERTS..............................................................................64
VALIDITY OF SECURITIES...............................................................64
INTERESTS OF NAMED EXPERT AND COUNSEL LEGAL MATTERS..................................64
HOW TO GET MORE INFORMATION..........................................................64
PART II............................................................................II-2
EXHIBIT 5.1.......................................................................5.1-1
EXHIBIT 23.2.....................................................................23.2-1
FINANCIAL STATEMENTS................................................................F-1
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i
PROSPECTUS SUMMARY
The following is only a summary of the information, financial statements
and the notes included in this prospectus. You should read the entire prospectus
carefully, including "Risk Factors" and our Financial Statements and the notes
to the Financial Statements before making any investment decision.
Our Company
EarthShell(R) Corporation ("EarthShell" or the "Company") was organized in
November 1992 to engage in the commercialization of a proprietary composite
material technology, designed with the environment in mind, for the manufacture
of disposable packaging to be used in the foodservice industry. Current and
future products include hinged-lid containers, plates, bowls, foodservice wraps,
cups, and cutlery ("EarthShell Packaging"). The EarthShell composite material is
primarily made from abundantly available and low cost natural raw materials such
as limestone and starch from annually renewable crops such as corn and potatoes.
The Company has defined that foodservice disposables made of this material will
offer certain significant environmental benefits, will have comparable or
superior performance characteristics, such as greater strength and rigidity, and
can be commercially produced and sold at prices that are competitive with
comparable conventional paper and plastic foodservice disposables.
The Company's objective is to establish EarthShell Packaging(R) as the
preferred disposable packaging material for the foodservice industry throughout
the world based on comparable performance, environmental superiority and
competitive pricing. EarthShell's approach for achieving this objective has been
to: (i) license the EarthShell technology to strategically selected
manufacturing or operating partners to manufacture, market, distribute and sell
EarthShell Packaging; (ii) demonstrate customer acceptance and demand for
EarthShell Packaging through key market leaders and environmental groups; and
(iii) demonstrate the manufacturability and improved economics with initial
strategic partners.
Going Concern
The condensed 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. The Company has
incurred significant losses since inception, has minimal revenues and has a
working capital deficit of $8,426,070 at March 31, 2005. 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, 2005. 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 March 2005,
the Company secured a $1.15 million loan and also entered into a Standby Equity
Distribution Agreement where the Company has the right, upon registration of
shares of its common stock, to require an institutional investor to purchase
shares of the Company's common stock from time to time at the Company's sole
discretion. In addition, the Company expects to receive additional technology
fee payments in 2005 in connection with both existing and new sublicense
agreements for its technology in various territories and fields of use. However,
the Company cannot assure that additional financing will be available to it, or,
if available, that the terms will be satisfactory, that it will receive any
further technology fee payments in 2005 pursuant to the Sublicense Agreement.
Management also plans to continue in its efforts to minimize expenses, but
cannot assure that it will be able to reduce expenses below current levels. The
condensed 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.
About Us
Our principal executive offices are located at 3916 State Street, Suite
110, Santa Barbara, California 93105. Our telephone number is (805) 563-7590.
1
THE OFFERING
This offering relates to the sale of common stock by certain persons who
are the selling stockholders consists of Cornell Capital Partners, who may sell
up to 2,768,550 shares of common stock, 2,000,000 of which are under the Standby
Equity Distribution Agreement if the Company determines to make advances under
the Standby Equity Distribution Agreement and 143,550 shares of common stock
received from EarthShell on March 23, 2005, as a fee under the Standby Equity
Distribution Agreement and 625,000 shares of common stock underlying warrants,
Sloan Securities Corporation, who intends to sell up to 6,450 shares of common
stock, which were received on March 23, 2005 under the Standby Equity
Distribution Agreement, SF Capital Partners Ltd., who may sell up to 791,667
shares of common stock upon the conversion of existing debt, other selling
shareholders who intend to sell up to 1,418,950 shares of common stock
previously issued by the Company and other selling stockholders, who intend to
sell up to 391,310 shares of common stock underlying warrants.
The commitment amount of the Standby Equity Distribution Agreement is
$10.0 million, and at an assumed price of $2.254 per share, the Company would be
able to receive gross proceeds of $4,508,000 million using the 2,000,000 shares
being registered in this registration statement. The Company would be required
to register 2,436,558 additional shares at this assumed price to obtain the
entire $10.0 million available under the Standby Equity Distribution Agreement.
Pursuant to the Standby Equity Distribution Agreement, we may, at our
discretion, periodically register, issue and sell to Cornell Capital Partners
shares of common stock for a total purchase price of $10.0 million. Whether we
choose to issue and sell stock is entirely at our discretion. We may choose to
not sell any shares hereunder, or we could decide to sell a small portion of
shares or a large amount of shares. The amount of each advance is subject to a
maximum advance amount of $500,000, and we may not submit any advance within
five trading days of a prior advance. Cornell Capital Partners will pay the
Company 98% of, or a 2% discount to, the lowest volume weighted average price of
the common stock during the five consecutive trading day period immediately
following the notice date. Of each advance made by EarthShell, Cornell Capital
Partners shall retain 5% of each advance. In addition, Cornell Capital Partners
received a one-time commitment fee in the form of 143,550 shares of the
Company's common stock on March 23, 2005. Cornell Capital Partners intends to
sell any shares purchased under the Standby Equity Distribution Agreement at the
then prevailing market price. Among other things, this prospectus relates to the
shares of common stock to be issued under the Standby Equity Distribution
Agreement. There are substantial risks to investors as a result of the issuance
of shares of common stock under the Standby Equity Distribution Agreement. These
risks include dilution of shareholders, significant decline in the Company's
stock price and the inability of the Company to draw sufficient funds when
needed.
There is an inverse relationship between our stock price and the number of
shares to be issued under the Standby Equity Distribution Agreement. That is, as
our stock price declines, we would be required to issue a greater number of
shares under the Standby Equity Distribution Agreement for a given advance. This
inverse relationship is demonstrated by the following table, which shows the
number of shares to be issued under the Standby Equity Distribution Agreement at
a recent price of $2.30 per share and 25%, 50% and 75% discounts to the recent
price.
Purchase Price: $ 2.2540 $ 1.6905 $ 1.1270 $ 0.5635
No. of Shares(1): 2,000,000 2,000,000 2,000,000 2,000,000
Total Outstanding (2): 20,435,452 20,435,452 20,435,452 20,435,452
Percent Outstanding (3): 9.8% 9.8% 9.8% 9.8%
Net Cash to EarthShell:(4) $ 4,197,600 $ 3,126,950 $ 2,056,300 $ 985,650
(1) Represents the number of shares of common stock to be issued to Cornell
Capital Partners under the Standby Equity Distribution Agreement at the
prices set forth in the table, assuming sufficient authorized shares are
available.
(2) Represents the total number of shares of common stock outstanding after
the issuance of the shares to Cornell Capital Partners under the Standby
Equity Distribution Agreement.
(3) Represents the shares of common stock to be issued as a percentage of the
total number shares outstanding.
(4) Net cash equals gross proceeds minus the 5% retainage and minus an
assumption of $85,000 in expenses.
We have engaged Sloan Securities Corporation, an unaffiliated registered
broker-dealer, to advise us in connection with the Standby Equity Distribution
Agreement. Sloan Securities Corporation was paid a fee of 6,450 shares of
EarthShell's common stock on March 23, 2005, under the Standby Equity
Distribution Agreement. Sloan Securities Corporation is not participating as an
underwriter in this offering.
2
Common Stock Offered 4,476,927 shares by selling stockholders
Offering Price Market price
Common Stock Outstanding 18,435,452 shares as of June 9, 2005
Before the Offering(1)
Use of Proceeds We will not receive any proceeds of the
shares offered by the selling
stockholders. Any proceeds we receive
from the sale of common stock under the
Standby Equity Distribution Agreement and
under the warrants will be used for
general working capital purposes. See
"Use of Proceeds."
Risk Factors The securities offered hereby involve a
high degree of risk and immediate
substantial dilution. See "Risk Factors"
and "Dilution."
Over-the-Counter Bulletin
Board Symbol ERTH.OB
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1 Excludes up to 2,000,000 shares of common stock to be issued under the
Standby Equity Distribution Agreement, up to 2,456,786 shares upon the
exercise of warrants, up to 1,083,334 shares issuable upon the conversion
of debt and up to 947,767 shares upon the exercise of options.
3
SUMMARY FINANCIAL DATA
The following selected financial data have been derived from the Company's
and its predecessor's consolidated financial statements which have been audited
by Farber & Hass LLP as of and for the years ended December 31, 2004, 2003 and
2002 and Deloitte & Touche LLP for the year ended December 31, 2001. The
financial data as of and for the three months ended March 31, 2005 is derived
from our unaudited consolidated financials included elsewhere in this
prospectus. The following data should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in
this Prospectus and the Consolidated Financial Statements and notes thereto
included in this Prospectus.
(Dollars in thousands, except per share data)
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For the Three
Months Ended
March 31,
Statement of Operations Data 2005 2004 2003 2002 2001 2000
---------------------------- --------- --------- --------- --------- --------- ---------
Revenues $ 75 $ 138 -- -- -- --
Research and development expenses 104 1,170 $ 9,547 $ 26,890 $ 47,148 $ 37,265
General and administrative expenses 1,032 3,749 5,786 9,590 9,634 6,843
Depreciation and amortization 1 42 380 3,099 5,874 5,704
Gain on sale of property and
equipment (7) (168) (452) (441) -- --
Interest expenses (income), net 22 1,068 1,791 132 (356) (1,264)
Related party patent expenses -- -- -- -- -- 362
Debenture conversion cost -- -- 166 321 -- --
Net loss 1,078 7,257 18,517 39,591 62,302 48,912
Average shares outstanding 18,250 15,047 13,267 11,277 9,353 8,452
For the Three
Months Ended
March 31,
Balance Sheet Data 2005 2004 2003 2002 2001 2000
------------------ --------- --------- --------- --------- --------- ---------
Cash and cash equivalents $ 328 $ 272 $ 1,902 $ 111 $ 828 $ 7,792
Working capital (deficit) (8,426) (7,289) (9,761) (8,315) (6,941) 2,107
Total assets 479 483 2,287 18,024 19,886 48,474
Total long-term obligations 1,316 1,475 4,408 -- -- --
Deficit accumulated during
development stage (322,685) (321,607) (314,351) (295,834) (256,243) (193,941)
Stockholders' equity (deficit) (9,733) (8,755) (12,269) (3,473) 11,536 42,296
Shares outstanding 18,391 18,235 14,129 12,055 9,860 8,709
Per Common Share
Basic and diluted loss per share $ 0.06 $ 0.48 $ 1.40 $ 3.51 $ 6.66 $ 5.79
4
SUPPLEMENTARY FINANCIAL INFORMATION
The following tables present EarthShell Corporation and Subsidiaries
condensed operating results for each of the eight fiscal quarters for the period
ended March 31, 2005. The information for each of these quarters is unaudited.
In the opinion of management, all necessary adjustments, which consist only of
normal and recurring accruals, have been included to fairly present the
unaudited quarterly results. This data should be read together with EarthShell
Corporation and Subsidiaries consolidated financial statements and the notes
thereto, the Independent Auditors Report and Management's Discussions and
Analysis of Financial Condition and Results of Operations.
THREE MONTHS ENDED (IN THOUSANDS)
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MAR 31, DEC 31, SEP 30, JUN 30, MAR 31, DEC 31, SEP 30, JUN 30,
2005 2004 2004 2004 2004 2003 2003 2003
------ ------ ------ ------ -------- -------- -------- --------
Revenues $ 75 $ 63 $ 50 $ 25 -- -- -- --
Net income (loss) (1,078) (1,280) (1,646) (2,264) $ (2,067) $ (5,217) $ (2,921) $ (3,608)
Net income (loss)
per share:
Basic 0.06 0.07 0.12 0.16 0.15 0.37 0.21 0.28
Diluted 0.06 0.07 0.12 0.16 0.15 0.37 0.21 0.28
Shares used in
computing per
share amounts:
Basic 18,250 17,659 14,233 14,128 14,129 14,014 13,596 13,013
Diluted 18,250 17,659 14,233 14,128 14,129 14,014 13,596 13,013
5
CAPITALIZATION
The following table sets forth as of March 31, 2005, EarthShell's actual
capitalization and pro forma capitalization after giving effect to the issuance
of 2,000,000 shares of common stock under the Standby Equity Distribution
Agreement. This information assumes a purchase price under the Standby Equity
Distribution Agreement of $2.30 per share resulting in gross proceeds of
$4,508,000; less estimated offering expenses of $85,000 and a retention of
$225,400, for net proceeds of $4,197,600. This table should be read in
conjunction with the information contained in "Management's Discussion and
Analysis or Plan of Operation" and the consolidated financial statements and the
notes thereto included elsewhere in this prospectus.
March 31, 2005
----------------------------
Actual Proforma
------------ ------------
Total Liabilities 10,212,633 10,212,633
------------ ------------
Stockholders' equity:
Common stock, $0.01 par value, 40,000,000 authorized, 18,391,065 shares
issued and outstanding as of March 31,2005(1) 183,911 203,911
Additional paid-in capital: 313,283,689 317,461,289
Accumulated deficit (322,685,339) (322,685,339)
Less note receivable for stock (475,000) (475,000)
------------ ------------
Accumulated other comprehensive loss (40,751) (40,751)
------------ ------------
Total stockholders' deficit (9,733,490) (5,535,890)
------------ ------------
(1) Total pro forma shares outstanding, as of March 31, 2005, equals
20,391,065, which includes 2,000,000 shares of common stock to be issued
under the Standby Equity Distribution Agreement.
6
RISK FACTORS
We are subject to various risks that may materially harm our business,
financial condition and results of operations. You should carefully consider the
risks and uncertainties described below and the other information in this filing
before deciding to purchase our common stock. If any of these risks or
uncertainties actually occurs, our business, financial condition or operating
results could be materially harmed. In that case, the trading price of our
common stock could decline and you could lose all or part of your investment.
Risks Related To Our Business
The Company Has Been The Subject Of A Going Concern Opinion From Its Independent
Auditors
The condensed 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. The Company has
incurred significant losses since inception, has minimal revenues and has a
working capital deficit of $8,426,070 at March 31, 2005. 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, 2005. 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 March 2005,
the Company secured a $1.15 million loan and also entered into a Standby Equity
Distribution Agreement where the Company has the right, upon registration of
shares of its common stock, to require an institutional investor to purchase
shares of the Company's common stock from time to time at the Company's sole
discretion. In addition, the Company expects to receive additional technology
fee payments in 2005 in connection with both existing and new sublicense
agreements for its technology in various territories and fields of use.
Additional financing may not be available to it, or, if available, the terms may
not be satisfactory, and we may not receive any further technology fee payments
in 2005 pursuant to the Sublicense Agreement. Management also plans to continue
in its efforts to minimize expenses, but we may not be able to reduce expenses
below current levels. The condensed 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.
We Have A Working Capital Deficit, Which Means That Our Current Assets On
December 31, 2004 Were Not Sufficient To Satisfy Our Current Liabilities On That
Date
We had a working capital deficit of $8,426,070 at March 31, 2005, which
means that our current liabilities exceeded our current assets on March 31, 2005
by that amount. Current assets are assets that are expected to be converted into
cash within one year and, therefore, may be used to pay current liabilities as
they become due. Our working capital deficit means that our current assets on
March 31, 2005 were not sufficient to satisfy all of our current liabilities on
that date.
We Have A Limited Operating History Upon Which You Can Evaluate Our Business
Although the Company earned its first revenues in 2004 and is no longer
classified as a "developmental stage company", it has limited operating history,
therefore, it remains subject to the inherent challenges and risks of
establishing a new business enterprise. The Company may not be successful in
addressing such risks. The limited operating history of the Company makes the
prediction of future results of operations difficult or impossible. To date,
production volumes of EarthShell Packaging products have been low relative to
intended and necessary capacity of the manufacturing lines. The success of
future operations depends upon the ability of licensees to manufacture products
made with EarthShell Packaging in sufficient quantities so as to be commercially
feasible and then to distribute and sell those products at competitive costs.
Consistent commercially feasible production volumes had not been achieved and
assured competitive cost figures had not yet been proven as of March 31, 2005.
As a result of the foregoing factors, the Company expects to incur losses for at
least the next twelve months and, depending on the success of the Company's
products and services in the marketplace, for potentially an even longer period.
We Need Additional Capital to Finance Growth and Capital Requirements, Which
Could Adversely Affect The Company's Business, Financial Condition and Results
of Operations
7
As of December 31, 2004, the Company had reported operating revenues of
$.1 million and aggregate net losses of approximately $7.3 million for this
year. In addition, as of March 31, 2005, the Company had reported operating
revenues of $75,000 and an aggregate net loss of approximately $1.1 million for
this quarter. Although the Company hopes to achieve break-even cash flow by the
end of the year, the Company does not expect to operate profitably during fiscal
year 2005. Although the Company is actively seeking third party financing to
meet its operating and capital needs, additional funding may not be available to
the Company, and, even if it is available, such financing may be (i) extremely
costly, (ii) dilutive to existing stockholders and/or (iii) restrictive to the
Company's ongoing operations. If the Company is unable to obtain such additional
capital, the Company may be required to reduce the scope of its anticipated
expansion, which could adversely affect the Company's business, financial
condition and results of operations or cease operations.
Our Obligations Under The Secured Promissory Note Are Secured By All of Our
Assets Which Cause Our Operations To Cease If We Default
Our obligations under the promissory note, issued to Cornell Capital
Partners are secured by all of our assets. As a result, if we default under the
terms of the promissory note, Cornell Capital Partners could foreclose its
security interest and liquidate all of our assets. This would cease operations.
Fluctuations Or Decreases In The Trading Price Of Our Common Stock May Adversely
Affect The Liquidity Of The Stock's Trading Market And Our Ability To Raise
Capital Through Future Offerings Of Capital Stock
The stock market from time to time experiences extreme price and volume
fluctuations which are often unrelated to the operating performance of
particular companies. Since our initial public offering in March 1998, the
market price of our common stock has been volatile, and it may continue to be
volatile in the future. Fluctuations or decreases in the trading price of our
common stock may adversely affect the liquidity of the stock's trading market
and our ability to raise capital through future offerings of capital stock.
Recently, when the market price of a stock has been volatile, holders of that
stock have often instituted securities class action litigation against the
company that issued the stock. If any of our stockholders brought such a class
action lawsuit against us, we could incur substantial costs defending the
lawsuit. Such a lawsuit could also divert the time and attention of our
management.
The Company's Assessment Of Its Internal Control Over Financial Reporting
Identified Certain Material Weaknesses, Which Could Have A Material Adverse
Effect On Our Business And Stock Price
The Company's assessment of its internal control over financial reporting
identified the following material weaknesses:
o The Company has inadequate segregation of critical duties within each of
its accounting processes and a lack of sufficient monitoring controls over
these processes to mitigate this risk. The responsibilities assigned to
one employee include maintaining the vendor master file, processing
payables, creating and voiding checks, reconciling bank accounts, making
bank deposits and processing payroll.
o The departure of the Company's Controller in November 2004 resulted in the
accounting and reporting functions being centralized under the Chief
Financial Officer, with no additional personnel in the Company having an
adequate knowledge of accounting principles and practices. As a result,
certain transactions had not been recorded in a timely manner and several
adjustments to the financial statements that were considered material to
the financial position at December 31, 2004 and results of operations for
the year then ended were recorded.
o There are weaknesses in the Company's information technology controls
which makes the Company's financial data vulnerable to error or fraud.
Specifically, there is a lack of documentation regarding the roles and
responsibilities of the IT function, lack of security management and
monitoring and inadequate segregation of duties involving IT functions.
Additionally, at the conclusion of our independent auditor's examination
of the Company's internal control over financial reporting, our independent
auditor noted several other areas of operations which could be improved. Our
auditors did not believe these items constituted material weaknesses. The
Company has begun taking remediation steps to enhance its internal control over
financial reporting and reduce control deficiencies in general, including the
material weaknesses enumerated above. However, should these remediation steps
not be effective, these material weaknesses could have a material adverse effect
on our business and stock price.
8
We Are Dependent On Our Licensees Which Could Have An Adverse Affect On Our
Business
The Company's current business model is to license the manufacturing and
distribution of EarthShell Packaging foodservice disposables to licensees.
Agreements with the licensees permit them to manufacture and sell other
foodservice disposable packaging products that are not based on EarthShell
Packaging. The licensees may also manufacture paper or polystyrene packaging
which could compete with EarthShell products, and they may not devote sufficient
resources or otherwise be able successfully to manufacture, distribute or market
EarthShell Packaging. Their failure to do so would be grounds for termination of
exclusivity provisions in their license agreement, but might also delay the
rollout of EarthShell Packaging into the marketplace, which could have an
adverse affect on our business.
We Have Not Yet Fully Evaluated All Of The Earthshell Packaging Products And It
Is Possible That Some Of The Products May Not Perform As Well As Conventional
Packaging Products
Although we believe that we can engineer EarthShell Packaging products to
meet many of the critical performance requirements for specific applications,
individual products may not perform as well as conventional foodservice
disposables; for example, some consumers may prefer clear cups and clear lids on
take-home containers which are not available with our foam technology. We are
still developing many of our EarthShell Packaging products and we have not yet
evaluated the performance of all of them. If we fail to develop EarthShell
Packaging products that perform comparably to conventional foodservice
disposables, this could cause consumers to prefer our competitors' products.
Our Charter Documents And Delaware Law Include Provisions That May Discourage A
Potential Takeover, Even If It Would Be Beneficial To Our Stockholders
Our Certificate of Incorporation and Bylaws and the Delaware General
Corporation Law include provisions that may discourage persons from pursuing a
non-negotiated takeover of EarthShell and prevent changes of control under some
circumstances, even if doing so would be beneficial to our stockholders.
Established Manufacturers In The Foodservice Disposables Industry Could Improve
The Ability To Recycle Their Existing Products Or Develop New Environmentally
Preferable, Disposable Foodservice Containers Which Could Render Our Technology
Obsolete And Could Negatively Impact Our Ability To Compete
Competition among existing food and beverage container manufacturers in
the foodservice industry is intense. Virtually all of the key participants in
the industry have substantially greater financial and marketing resources at
their disposal than we do, and many have well-established supply, production and
distribution relationships and channels. Companies producing competitive
products utilizing competitive materials may reduce their prices or engage in
advertising or marketing campaigns designed to protect their respective market
shares and impede market acceptance of EarthShell Packaging products. In
addition, some of the Company's licensees and joint venture partners manufacture
paper, plastic or foil packaging that may compete with EarthShell Packaging
products. Several paper and plastic disposable packaging manufacturers and
converters and others have made efforts to increase the recycling of these
products. Increased recycling of paper and plastic products could lessen their
harmful environmental impact, one major basis upon which the Company intends to
compete. A number of companies have introduced or are attempting to develop
biodegradable starch-based materials, plastics, or other materials that may be
positioned as potential environmentally superior packaging alternatives. We
expect that many existing packaging manufacturers may actively seek competitive
alternatives to our products and processes. The development of competitive,
environmentally attractive, disposable foodservice packaging, whether or not
based on our products and technology, could render our technology obsolete and
could impair our ability to compete, which would have an adverse effect on our
business, financial condition and results of operations.
Our Projected International Revenues Are Subject To Risks Inherent In
International Business Activities
We expect sales of our products and services in foreign countries to
account for a material portion of our revenues. These sales are subject to risks
inherent in international business activities, including:
o any adverse change in the political or economic environments in
these countries;
o economic instability;
o any adverse change in tax, tariff and trade or other regulations;
o the absence or significant lack of legal protection for intellectual
property rights;
o exposure to exchange rate risk for revenues which are denominated in
currencies other than U.S. dollars; and
9
o difficulties in managing joint venture businesses spread over
various jurisdictions.
Our revenues could be substantially less than we expect if these risks
affect our ability to successfully sell our products in the international
market.
Our Products May Be Perceived Poorly By Consumers And/Or Environmental Groups
Which Could Have An Adverse Affect On Our Business
Our success depends substantially on our ability to design and develop
foodservice disposables that are not as harmful to the environment as
conventional disposable foodservice containers made from paper, plastic and
polystyrene. EarthShell has used a life cycle inventory methodology in its
environmental assessment of EarthShell Packaging products and in the development
of associated environmental claims, and we have received support for the
EarthShell concept from a number of environmental groups. Although we believe
that EarthShell Packaging products offer several environmental advantages over
conventional packaging products, our products may also possess characteristics
that consumers or some environmental groups could perceive as negative for the
environment. In particular, EarthShell Packaging products may result in more
solid waste by weight and, in a dry environment, by volume, and manufacturing
them may release greater amounts of some pollutants and lesser amounts of other
pollutants than occurs with conventional packaging. Whether, on balance,
EarthShell Packaging products are better for the environment than conventional
packaging products is a somewhat subjective judgment. Environmental groups,
regulators, customers or consumers may not agree that present and future
EarthShell Packaging products have an environmental advantage over conventional
packaging.
Third Parties May Infringe Our Patents, New Products That We Develop May Not Be
Covered By Our Existing Patents And We Could Suffer An Adverse Determination In
A Patent Infringement Proceeding, Which Could Allow Our Competitors To Duplicate
Our Products Without Having Had To Incur The Research And Development Costs We
Have Incurred And Therefore Allow Them To Produce And Market Those Products More
Profitably Than Earthshell
Our ability to compete effectively with conventional packaging will
depend, in part, on our ability to protect our proprietary rights to the
licensed technology. Although EKI and EarthShell endeavor to protect the
licensed technology through, among other things, U.S. and foreign patents, the
duration of these patents is limited and the patents and patent applications
licensed to us may not be sufficient to protect our technology. The patents that
EKI obtains and licenses to us may not be validly held and others may try to
circumvent or infringe those patents. We also rely on trade secrets and
proprietary know-how that we try to protect in part by confidentiality
agreements with our licensee manufacturers, proposed joint venture partners,
employees and consultants. These agreements have limited terms and these
agreements may be breached, we may not have adequate remedies for any breach and
our competitors may learn our trade secrets or independently develop them. It is
necessary for us to litigate from time to time to enforce patents issued or
licensed to us, to protect our trade secrets or know-how and to determine the
enforceability, scope and validity of the proprietary rights of others.
We believe that we own or have the rights to use all of the technology
that we expect to incorporate into EarthShell Packaging products, but an adverse
determination in litigation or infringement proceedings to which we are or may
become a party could subject us to significant liabilities and costs to third
parties or require us to seek licenses from third parties. Although patent and
intellectual property disputes are often settled through licensing or similar
arrangements, costs associated with those arrangements could be substantial and
could include ongoing royalties. Furthermore, we may not obtain the necessary
licenses on satisfactory terms or at all. We could incur substantial costs
attempting to enforce our licensed patents against third party infringement, or
the unauthorized use of our trade secrets and proprietary know-how or in
defending ourselves against claims of infringement by others. Accordingly, if we
suffered an adverse determination in a judicial or administrative proceeding or
failed to obtain necessary licenses, it would prevent us from manufacturing or
licensing others to manufacture some of our products.
Failure Of Our Licensees And Joint Venture Partners To Produce Earthshell
Packaging Products Profitably On A Commercial Scale Would Adversely Affect Our
Ability To Compete With Conventional Disposable Foodservice Packagers.
Production volumes of EarthShell Packaging products to date have been low
relative to the intended capacity of the various manufacturing lines, and, until
production volumes approach design capacity levels, actual costs and
profitability will not be certain. Since the actual cost of manufacturing
EarthShell Packaging products on a commercial scale has not been fully
demonstrated, they may not be manufactured at a competitive cost. As our
10
licensees and joint venture partners begin to commercially produce EarthShell
Packaging products, they may encounter unexpected difficulties that cause
production costs to exceed current estimates. The failure to manufacture
EarthShell Packaging products at commercially competitive costs would make it
difficult to compete with other foodservice disposable manufacturers.
Unavailability Of Raw Materials Used To Manufacture Our Products, Increases In
The Price Of The Raw Materials, Or The Necessity Of Finding Alternative Raw
Materials To Use In Our Products Could Delay The Introduction And Market
Acceptance Of Our Products
Although we believe that sufficient quantities of all raw materials used
in EarthShell Packaging products are generally available, if any raw materials
become unavailable, it could delay the commercial introduction and hinder market
acceptance of EarthShell Packaging products. In addition, our licensees and
joint venture partners may become significant consumers of certain key raw
materials such as starch, and if such consumption is substantial in relation to
the available resources, raw material prices may increase which in turn may
increase the cost of EarthShell Packaging products and impair our profitability.
In addition, we may need to seek alternative sources of raw materials or modify
our product formulations if the cost or availability of the raw materials that
we currently use become prohibitive.
If Initial Purchasers Of Our Products Do Not Purchase Significant Quantities, It
Could Delay The Introduction And Market Acceptance Of Our Products.
It will be important for our licensees and joint venture partners to
identify and obtain contractual commitments from major customers for substantial
quantities of product. If initial purchasers of our products do not ultimately
purchase significant quantities, it will delay our ability to realize meaningful
royalty revenues from sales of those products.
We Do Not Own The Technology Necessary To Manufacture EarthShell Packaging
EarthShell Packaging is based on a patented composite material technology
licensed on an exclusive worldwide basis from E. Khashoggi Industries LLC, the
largest stockholder of the Company, and, on a limited exclusive, worldwide
basis, from its wholly-owned subsidiaries (collectively "EKI"). The Company does
not own the technology necessary to manufacture EarthShell Packaging and is
dependent upon the License Agreement to use that technology. The licensed
technology is limited to the development, manufacture and sale of specified
foodservice disposables for use in the foodservice industry, and there is no
right to exploit opportunities to apply this technology or improve it outside
this field of use. If EKI were to file for or be declared bankrupt, the Company
would likely be able to retain its rights under the License Agreement with
respect to U.S. patents; however, it is possible that steps could be taken to
terminate its rights under the License Agreement with respect to international
patents. EKI is the controlling stockholder of the Company, and conflicts could
arise with regard to performance under the license agreement, corporate
opportunities or time devoted to the business of the Company by officers and
directors who are common to both EKI and the Company.
Our Operations Are Subject To Regulation By The U.S. Food and Drug
Administration
The manufacture, sale and use of EarthShell Packaging are subject to
regulation by the U.S. Food and Drug Administration (the "FDA"). The FDA's
regulations are concerned with substances used in food packaging materials, not
with specific finished food packaging products. Thus, food and beverage
containers are in compliance with FDA regulations if the components used in the
food and beverage containers: (i) are approved by the FDA as indirect food
additives for their intended uses and comply with the applicable FDA indirect
food additive regulations; or (ii) are generally recognized as safe for their
intended uses and are of suitable purity for those intended uses. The Company
believes that EarthShell Packaging plates, bowls and hinged-lid containers and
all other current and prototype EarthShell Packaging products of the Company are
in compliance with all requirements of the FDA and do not require additional FDA
approval. However, the FDA may not agree with these conclusions, which could
have a material adverse affect on our business operations.
11
Risks Related To This Offering
Future Sales By Our Stockholders May Adversely Affect Our Stock Price And Our
Ability To Raise Funds In New Stock Offerings
Sales of our common stock in the public market following this offering
could lower the market price of our common stock. Sales may also make it more
difficult for us to sell equity securities or equity-related securities in the
future at a time and price that our management deems acceptable or at all. Of
the 18,435,452 shares of common stock outstanding as of June 9, 2005, 6,571,222
shares are, or will be, freely tradable without restriction, unless held by our
"affiliates." The remaining 11,864,230 shares of common stock, which will be
held by existing stockholders, including the officers and directors, are
"restricted securities" and may be resold in the public market only if
registered or pursuant to an exemption from registration. Some of these shares
may be resold under Rule 144.
Existing Shareholders Will Experience Significant Dilution From Our Sale Of
Shares Under The Standby Equity Distribution Agreement
The sale of shares pursuant to the Standby Equity Distribution Agreement
will have a dilutive impact on our stockholders. For example, if the offering
occurred on March 31, 2005 at an assumed offering price of $2.254 per share (98%
of a recent closing bid price of $2.30 per share), the new stockholders would
experience an immediate dilution in the net tangible book value of $2.5255 per
share. Dilution per share at prices of $1.6905, $1.1270 and $0.5635 per share
would be $2.0145, $1.5035 and $0.9925, respectively.
As a result, our net income per share could decrease in future periods,
and the market price of our common stock could decline. In addition, the lower
our stock price, the more shares of common stock we will have to issue under the
Standby Equity Distribution Agreement to draw down the full amount. If our stock
price is lower, then our existing stockholders would experience greater
dilution.
Under The Standby Equity Distribution Agreement Cornell Capital Partners Will
Pay Less Than The Then-Prevailing Market Price Of Our Common Stock
The common stock to be issued under the Standby Equity Distribution
Agreement will be issued at a 2% discount to the lowest closing bid price for
the five days immediately following the notice date of an advance. In addition,
Cornell Capital Partners will retain 5% from each advance. Based on this
discount, Cornell Capital Partners will have an incentive to sell immediately to
realize the gain on the 2% discount. These discounted sales could cause the
price of our common stock to decline, based on increased selling of EarthShell's
common stock.
The Selling Stockholders May Sell Their Shares Of Common Stock In The Market,
Which Sales May Cause Our Stock Price To Decline
The selling stockholders may sell in the public market up to 4,476,927
shares of common stock being registered in this offering. That means that up to
4,476,927 shares may be sold pursuant to this registration statement. Such sales
may cause our stock price to decline. The officers and directors of the Company
and those shareholders who are significant shareholders as defined by the SEC
will continue to be subject to the provisions of various insider trading and
rule 144 regulations.
The Sale Of Our Stock Under Our Standby Equity Distribution Agreement Could
Encourage Short Sales By Third Parties, Which Could Contribute To The Future
Decline Of Our Stock Price
In many circumstances the provision of a Standby Equity Distribution
Agreement for companies that are traded on the Over-the-Counter Bulletin Board
has the potential to cause a significant downward pressure on the price of
common stock. This is especially the case if the shares being placed into the
market exceed the market's ability to take up the increased stock or if
EarthShell has not performed in such a manner to show that the equity funds
raised will be used to grow the Company. Such an event could place further
downward pressure on the price of common stock. Under the terms of our Standby
Equity Distribution Agreement, EarthShell may request numerous draw downs
pursuant to the terms of the Standby Equity Distribution Agreement. Even if the
Company uses the Standby Equity Distribution Agreement to grow its revenues and
profits or invest in assets which are materially beneficial to EarthShell the
opportunity exists for short sellers and others to contribute to the future
12
decline of EarthShell's stock price. If there are significant short sales of
stock, the price decline that would result from this activity will cause the
share price to decline more so which in turn may cause long holders of the stock
to sell their shares thereby contributing to sales of stock in the market. If
there is an imbalance on the sell side of the market for the stock the price
will decline.
It is not possible to predict those circumstances whereby short sales
could materialize or to what the share price could drop. In some companies that
have been subjected to short sales the stock price has dropped to near zero.
This could happen to the Company's stock price.
The Price You Pay In This Offering Will Fluctuate And May Be Higher Or Lower
Than The Prices Paid By Other People Participating In This Offering
The price in this offering will fluctuate based on the prevailing market
price of the common stock on the Over-the-Counter Bulletin Board. Accordingly,
the price you pay in this offering may be higher or lower than the prices paid
by other people participating in this offering.
Upon The Receipt Of An Advance Notice, Cornell Capital Partners Is Permitted To
Sell Shares To Be Issued To Cornell Capital Partners Pursuant To The Advance
Notice During The Applicable Pricing Period, Which Could Have A Negative Affect
On Our Stock Price
The Company has agreed that, upon receipt of an advance notice, Cornell
Capital Partners is permitted to sell the shares to be issued to Cornell Capital
Partners pursuant to the advance notice during the applicable pricing period.
This could have a negative affect on our stock price, which, in turn, would
require the Company to issue additional shares to Cornell Capital Partners
pursuant to any given advance.
We May Not Be Able To Access Sufficient Funds Under The Standby Equity
Distribution Agreement When Needed
We are to some extent dependent on external financing to fund our
operations. Our financing needs are expected to be partially provided from the
Standby Equity Distribution Agreement. No assurances can be given that such
financing will be available in sufficient amounts or at all when needed, in
part, because we are limited to a maximum draw down of $500,000 during any five
trading day period. In addition, the number of shares being registered may not
be sufficient to draw all funds available to us under the Standby Equity
Distribution Agreement. Based on the assumed offering price of $2.254 and the
2,000,000 shares we have registered, we would not be able to draw the entire
$10.0 million available under the Standby Equity Distribution Agreement. At this
assumed price, we will be able to draw $4,508,000 with the 2,000,000 shares
being registered. The Company would be required to register 2,436,558 additional
shares at this assumed price to obtain the entire $10.0 million available under
the Standby Equity Distribution Agreement.
We May Not Be Able To Draw Down Under The Standby Equity Distribution Agreement
If The Investor Holds More Than 9.9% Of Our Common Stock
In the event Cornell Capital Partners holds more than 9.9% of the
then-outstanding common stock of the Company, we will be unable to draw down on
the Standby Equity Distribution Agreement. Currently, Cornell Capital Partners
has beneficial ownership of 4.03% of our common stock and therefore we would be
able to draw down on the Standby Equity Distribution Agreement so long as
Cornell Capital Partners' beneficial ownership remains below 9.9%. If Cornell
Capital Partners' beneficial ownership increases to 9.9%, we would be unable to
draw down on the Standby Equity Distribution Agreement. A possibility exists
that Cornell Capital Partners may own more than 9.9% of EarthShell's outstanding
common stock at a time when we would otherwise plan to make an advance under the
Standby Equity Distribution Agreement.
Our Common Stock Is Deemed To Be "Penny Stock," Which May Make It More Difficult
For Investors To Sell Their Shares Due To Suitability Requirements
Our common stock is deemed to be "penny stock" as that term is defined in
Rule 3a51-1 promulgated under the Securities Exchange Act of 1934. Penny stocks
are stock:
o With a price of less than $5.00 per share;
o That are not traded on a "recognized" national exchange;
13
o Whose prices are not quoted on the Nasdaq automated quotation system
o (Nasdaq listed stock must still have a price of not less than $5.00 per
share); or
o In issuers with net tangible assets less than $2.0 million (if the issuer
has been in continuous operation for at least three years) or $5.0 million
(if in continuous operation for less than three years), or with average
revenues of less than $6.0 million for the last three years.
Broker/dealers dealing in penny stocks are required to provide potential
investors with a document disclosing the risks of penny stocks. Moreover,
broker/dealers are required to determine whether an investment in a penny stock
is a suitable investment for a prospective investor. These requirements may
reduce the potential market for our common stock by reducing the number of
potential investors. This may make it more difficult for investors in our common
stock to sell shares to third parties or to otherwise dispose of them. This
could cause our stock price to decline.
14
FORWARD-LOOKING STATEMENTS
Information included or incorporated by reference in this prospectus may
contain forward-looking statements. This information may involve known and
unknown risks, uncertainties and other factors which may cause our actual
results, performance or achievements to be materially different from the future
results, performance or achievements expressed or implied by any forward-looking
statements. Forward-looking statements, which involve assumptions and describe
our future plans, strategies and expectations, are generally identifiable by use
of the words "may," "should," "expect," "anticipate," "estimate," "believe,"
"intend" or "project" or the negative of these words or other variations on
these words or comparable terminology.
This prospectus contains forward-looking statements, including statements
regarding, among other things, (a) our projected sales and profitability, (b)
our growth strategies, (c) anticipated trends in our industry, (d) our future
financing plans and (e) our anticipated needs for working capital. These
statements may be found under "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Description of Business," as well as
in this prospectus generally. Actual events or results may differ materially
from those discussed in forward-looking statements as a result of various
factors, including, without limitation, the risks outlined under "Risk Factors"
and matters described in this prospectus generally. In light of these risks and
uncertainties, there can be no assurance that the forward-looking statements
contained in this prospectus will in fact occur.
15
SELLING STOCKHOLDERS
The following table presents information regarding the selling
stockholders. The selling shareholders are the entities who have assisted in or
provided financing to EarthShell. A description of each selling shareholder's
relationship to EarthShell and how each selling shareholder acquired the shares
to be sold in this offering is detailed in the information immediately following
this table.
Percentage
of
Percentage Outstanding
of Shares to be Shares to Be
Outstanding Acquired Acquired Percentage
Shares Shares under the under the of Shares
Beneficially Beneficially Standby Standby Beneficially
Owned Owned Equity Equity Shares to be Owned
Before Before Distribution Distribution Sold in the After
Selling Stockholder Offering Offering (1) Agreement Agreement Offering Offering (1)
--------------------- -------- ------------ --------- --------- -------- ------------
Shares Acquired in Financing Transactions with EarthShell
------------------------------------------------------------------------------------------------------------------------------
Cornell Capital
Partners, LP 768,550(2) 4.03% 2,000,000 9.8% 2,768,550(3) 0%
------------------------------------------------------------------------------------------------------------------------------
Debt Restructuring Transactions with EarthShell
------------------------------------------------------------------------------------------------------------------------------
Islandia, Ltd. 100,000 * -- -- 100,000 0%
Midsummer Investment,
Ltd. 150,000 * -- -- 150,000 0%
Omicron Master Trust(4) 187,500 1.02% -- -- 187,500 0%
Roth Capital Partners,
LP 246,310(5) 1.33% -- -- 246,310(5) 0%
SF Capital Partners Ltd. 867,134 4.70% -- -- 791,667 *
Straus - GEPT L.P. 36,250 * -- -- 26,250 *
Straus Partners L.P. (6) 63,750 * -- -- 48,750 *
------------------------------------------------------------------------------------------------------------------------------
Consultants and Others
------------------------------------------------------------------------------------------------------------------------------
Crown Investment
Banking, Inc. 6,450 * -- -- 6,450 0%
Sloan Securities
Corporation 6,450 * -- -- 6,450 0%
Benton Wilcoxon 65,000(7) * -- -- 65,000(7) 0%
Douglas Metz 81,000(8) * -- -- 80,000(9)) *
---------- ---------- ---------- ---------- ---------- ----------
Total 2,578,394 13.86% 2,000,000 9.8% 4,476,927 *
========== ========== ========== ========== ========== ==========
----------
* Less than 1%.
(1) Applicable percentage of ownership is based on 18,435,452 shares of common
stock outstanding as of June 9, 2005, together with securities exercisable
or convertible into shares of common stock within 60 days of June 9, 2005,
for each stockholder. Beneficial ownership is determined in accordance
with the rules of the Securities and Exchange Commission and generally
includes voting or investment power with respect to securities. Shares of
common stock subject to securities exercisable or convertible into shares
of common stock that are currently exercisable or exercisable within 60
days of June 9, 2005 are deemed to be beneficially owned by the person
holding such securities for the purpose of computing the percentage of
ownership of such person, but are not treated as outstanding for the
purpose of computing the percentage ownership of any other person. Note
that affiliates are subject to Rule 144 and Insider trading regulations -
percentage computation is for form purposes only.
(2) Represents shares of common stock received by Cornell Capital Partners as
a one-time commitment fee under the Standby Equity Distribution Agreement
and the shares of common stock underlying the warrant.
(3) Includes the shares that may be acquired by Cornell Capital Partners under
the Standby Equity Distribution Agreement, the 143,550 shares of common
stock received as a one-time commitment fee under the Standby Equity
Distribution Agreement and the 625,000 shares underlying a warrant that
may be converted into common stock of the Company.
(4) Omicron Capital, L.P., a Delaware limited partnership ("Omicron Capital"),
serves as investment manager to Omicron Master Trust, a trust formed under
the laws of Bermuda ("Omicron"), Omicron Capital, Inc., a Delaware
corporation ("OCI"), serves as general partner of Omicron Capital, and
Winchester Global Trust Company Limited ("Winchester") serves as the
trustee of Omicron. By reason of such relationships, Omicron Capital and
16
OCI may be deemed to share dispositive power over the shares of our common
stock owned by Omicron, and Winchester may be deemed to share voting and
dispositive power over the shares of our common stock owned by Omicron.
Omicron Capital, OCI and Winchester disclaim beneficial ownership of such
shares of our common stock. Omicron Capital has delegated authority from
the board of directors of Winchester regarding the portfolio management
decisions with respect to the shares of common stock owned by Omicron and,
as of June 9, 2005, Mr. Olivier H. Morali and Mr. Bruce T. Bernstein,
officers of OCI, have delegated authority from the board of directors of
OCI regarding the portfolio management decisions of Omicron Capital with
respect to the shares of common stock owned by Omicron. By reason of such
delegated authority, Messrs. Morali and Bernstein may be deemed to share
dispositive power over the shares of our common stock owned by Omicron.
Messrs. Morali and Bernstein disclaim beneficial ownership of such shares
of our common stock and neither of such persons has any legal right to
maintain such delegated authority. No other person has sole or shared
voting or dispositive power with respect to the shares of our common stock
being offered by Omicron, as those terms are used for purposes under
Regulation 13D-G of the Securities Exchange Act of 1934, as amended.
Omicron and Winchester are not "affiliates" of one another, as that term
is used for purposes of the Securities Exchange Act of 1934, as amended,
or of any other person named in this prospectus as a selling stockholder.
No person or "group" (as that term is used in Section 13(d) of the
Securities Exchange Act of 1934, as amended, or the SEC's Regulation
13D-G) controls Omicron and Winchester.
(5) Consists of 246,310 shares of common stock underlying warrants.
(6) Straus Partners L.P. is an entity under common control with Straus - GEPT
L.P. and its shares may be aggregated with Straus GEPT L.P. for purposes
of determining beneficial ownership.
(7) Consists of 65,000 shares of common stock underlying warrants.
(8) Consists of 80,000 shares of common stock underlying warrants and 1,000
shares of common stock.
(9) Consists of 80,000 shares of common stock underlying warrants.
The following information contains a description of each selling
shareholder's relationship to EarthShell and how each selling shareholder
acquired the shares to be sold in this offering is detailed below. None of the
selling stockholders have held a position or office, or had any other material
relationship, with the Company, except as follows:
Shares Acquired In Financing Transactions With EarthShell
Cornell Capital Partners, LP. Cornell Capital Partners is the investor
under the Standby Equity Distribution Agreement and a holder of a warrant. All
investment decisions of, and control of, Cornell Capital Partners are held by
its general partner, Yorkville Advisors, LLC. Mark Angelo, the managing member
of Yorkville Advisors, makes the investment decisions on behalf of and controls
Yorkville Advisors. Cornell Capital Partners acquired all shares being
registered in this offering in financing transactions with EarthShell. Those
transactions are explained below:
o Standby Equity Distribution Agreement. On March 23, 2005, we entered
into a Standby Equity Distribution Agreement with Cornell Capital
Partners. Pursuant to the Standby Equity Distribution Agreement, we
may, at our discretion, periodically sell to Cornell Capital
Partners shares of common stock for a total purchase price of up to
$10.0 million. For each share of common stock purchased under the
Standby Equity Distribution Agreement, Cornell Capital Partners will
pay EarthShell 98% of, or a 2% discount to, the lowest volume
weighted average price of our common stock on the Over-the-Counter
Bulletin Board or other principal market on which our common stock
is traded for the five days immediately following the notice date.
Further, Cornell Capital Partners will retain 5% of each advance
under the Standby Equity Distribution Agreement. In connection with
the Standby Equity Distribution Agreement, Cornell Capital Partners
received a one-time commitment fee in the form of 143,550 shares of
common stock. We are registering 2,000,000 shares in this offering
which may be issued under the Standby Equity Distribution Agreement.
For the Company to receive gross proceeds of $10.0 million using the
2,000,000 shares being registered in this prospectus, the price of
our common stock would need to average $5.00 per share.
o Warrant. On May 26, 2005, the Company issued a warrant to Cornell
Capital Partners to purchase 625,000 shares of common stock of the
Company. The warrant expires on the later of: (a) May 26, 2005 or
(b) the date sixty days after the date the $2,500,000 in promissory
notes issued to Cornell Capital Partners are fully repaid. The
warrant has an exercise price of $4.00 per share of common stock.
There are certain risks related to sales by Cornell Capital Partners,
including:
o The outstanding shares will be issued based on discount to the
market rate. As a result, the lower the stock price around the time
Cornell Capital Partners is issued shares, the greater chance that
Cornell Capital Partners gets more shares. This could result in
substantial dilution to the interests of other holders of common
stock.
o To the extent Cornell Capital Partners sells its common stock, the
common stock price may decrease due to the additional shares in the
market. This could allow Cornell Capital Partners to sell greater
amounts of common stock, the sales of which would further depress
the stock price.
o The significant downward pressure on the price of the common stock
as Cornell Capital Partners sells material amounts of common stocks
could encourage short sales by third parties. This could place
further downward pressure on the price of the common stock.
17
Other Selling Shareholders
Islandia, L.P. Pursuant to an Amended and Restated Debenture Purchase
Agreement dated September 29, 2004, in connection with the restructuring of its
debt and settlement of $400,000 in convertible debentures issued to Islandia,
L.P. in July, 2004, the Company issued 100,000 shares of its unregistered common
stock to Islandia, L.P. in settlement of the Company's default under the
debentures. These shares are being registered in this offering. All investment
decisions of, and control of, Islandia, L.P. are held by its parent, John Lang,
Inc. Richard O. Berner makes the investment decisions on behalf of and controls
John Lang, Inc.
Midsummer Investment, Ltd. Pursuant to an Amended and Restated Debenture
Purchase Agreement dated September 29, 2004, in connection with the
restructuring of its debt and settlement of $600,000 in convertible debentures
issued to Midsummer Investment, Ltd. in July 2004, the Company issued 150,000
shares of its unregistered common stock to Midsummer Investment, Ltd in
settlement of the Company's default under the debentures. These shares are being
registered in this offering. Michel A. Amsalem and Scott Kaufman make the
investment decisions on behalf of and control Midsummer Investment, Ltd.
Omicron Master Trust. Pursuant to an Amended and Restated Debenture
Purchase Agreement dated September 29, 2004, in connection with the
restructuring of its debt and settlement of $750,000 in convertible debentures
issued to Omicron Master Trust in July, 2004, the Company issued 187,500 shares
of its unregistered common stock to Omicron Master Trust in settlement of the
Company's default under the debentures. These shares are being registered in
this offering.
Roth Capital Partners, LLC. Pursuant to a Convertible Debenture and Common
Stock Warrant and a Common Stock Warrant, both dated March 3, 2003, the Company
issued 246,310 warrants (post-split) to Roth Capital Partners, LLC to purchase
the Company's common stock. 217,500 of these warrants expire on March 5, 2006
and have an exercise price of $7.20 and 28,810 of these warrants expire on March
5, 2006 and have an exercise price of $10.08. The shares underlying these
warrants are being registered in this offering. Gordon Roth and Byron Roth make
the investment decisions on behalf of and control Roth Capital Partners, LLC.
SF Capital Partners Ltd. Pursuant to an Amended and Restated Debenture
Purchase Agreement dated September 30, 2004, in connection with the
restructuring of its debt and settlement of $4,500,000 in debentures issued to
SF Capital Partners Ltd. in July, 2004, the Company agreed to a settlement
resulting in a $2,375,000 debenture outstanding to be converted, at SF Capital
Partners' option, into 791,667 shares of the Company's unregistered common stock
at $3.00 per share. The shares underlying this conversion right are being
registered in this offering. Michael A. Roth and Brian J. Stark make the
investment decisions on behalf of SF Capital Partners Ltd.
Straus - GEPT L.P. Pursuant to an Amended and Restated Debenture Purchase
Agreement dated September 30, 2004, in connection with the restructuring of its
debt and settlement of $105,000 in debentures issued to Straus - GEPT L.P. in
July, 2004, the Company issued 26,250 shares of its unregistered common stock to
Straus - GEPT L.P. in settlement of the Company's default under the debentures.
These shares are being registered in this offering. Mickey Straus makes the
investment decisions on behalf of and controls Straus - GEPT L.P.
Straus Partners L.P. Pursuant to an Amended and Restated Debenture
Purchase Agreement dated September 30, 2004, in connection with the
restructuring of its debt and settlement of $195,000 in debentures issued to
Straus Partners L.P. in July, 2004, the Company issued 48,750 shares of its
unregistered common stock to Straus Partners L.P. in settlement of the Company's
default under the debentures. These shares are being registered in this
offering. Mickey Straus makes the investment decisions on behalf of and controls
Straus Partners L.P.
Crown Investment Banking, Inc. Pursuant to an engagement letter entered
into with Crown Investment Banking, Inc., on March 31, 2005, the Company issued
6,450 shares of the Company's unregistered common stock in consideration for the
services rendered by Crown in connection with the Company obtaining financing.
These shares are being registered in this offering. Todd K. West and William
Breece make the investment decisions on behalf of and control Crown Investment
Banking, Inc.
18
Sloan Securities Corporation. Sloan Securities Corporation is an
unaffiliated registered broker-dealer that has been retained by us. James C.
Ackerman, Sloan Securities Corporation's President, makes the investment
decisions on behalf of and controls Sloan Securities Corporation. For its
services in connection with the Standby Equity Distribution Agreement between
EarthShell and Cornell Capital Partners, Sloan Securities Corporation received a
fee of 6,450 shares of unregistered common stock, on March 23, 2005. These
shares are being registered in this offering.
Benton Wilcoxon. In consideration for Benton Wilcoxon pledging his
personal shares in Composite Technology Corporation as a guaranty for the
Security Agreement entered into by the Company with Cornell Capital Partners,
the Company issued a warrant to Benton Wilcoxon to purchase 65,000 shares of
common stock of the Company at an exercise price of $3.00 per share. The warrant
expires on March 23, 2008.
Douglas Metz. In consideration for consulting services rendered by Douglas
Metz in connection with the Company obtaining financing, the Company issued a
warrant to Douglas Metz to purchase 80,000 shares of common stock of the Company
at an exercise price of $3.00 per share. The warrant expires on March 23, 2008.
With respect to the sale of unregistered securities referenced above, all
transactions were exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933 (the "1933 Act"), and Regulation D promulgated under the
1933 Act. In each instance, the purchaser had access to sufficient information
regarding the Company so as to make an informed investment decision. More
specifically, we had a reasonable basis to believe that each purchaser was an
"accredited investor" as defined in Regulation D of the 1933 Act and otherwise
had the requisite sophistication to make an investment in our securities.
19
USE OF PROCEEDS
This prospectus relates to shares of our common stock that may be offered
and sold from time to time by certain selling stockholders. There will be no
proceeds to us from the sale of shares of common stock in this offering.
However, we will receive the proceeds from the sale of shares of common stock to
Cornell Capital Partners under the Standby Equity Distribution Agreement. The
purchase price of the shares purchased under the Standby Equity Distribution
Agreement will be equal to 98% of the lowest volume weighted average price of
our common stock on the Over-the-Counter Bulletin Board for the five days
immediately following the notice date. The Company will pay Cornell Capital
Partners 5% of each advance as an additional fee.
Pursuant to the Standby Equity Distribution Agreement, EarthShell cannot
draw more than $500,000 every five trading days or more than $10.0 million over
twenty-four months.
For illustrative purposes only, we have set forth below our intended use
of proceeds for the range of net proceeds indicated below to be received under
the Standby Equity Distribution Agreement. The table assumes estimated offering
expenses of $85,000, plus 5% retainage payable to Cornell Capital Partners under
the Standby Equity Distribution Agreement. The figures below are estimates only,
and may be changed due to various factors, including the timing of the receipt
of the proceeds.
Gross proceeds $ 1,000,000 $ 3,000,000 $ 5,000,000 $10,000,000
Net proceeds $ 865,000 $ 2,765,000 $ 4,665,000 $ 9,415,000
No. of shares issued under the Equity
Distribution Agreement at an assumed
offering price of $2.254 443,656 1,330,968 2,218,779 4,436,558(1)
USE OF PROCEEDS: AMOUNT AMOUNT AMOUNT AMOUNT
-----------------------------------------------------------------------------------------------------------
General Working Capital $ 865,000 $ 2,765,000 $ 4,665,000 $ 9,415,000
----------- ----------- ----------- -----------
Total $ 865,000 $ 2,765,000 $ 4,665,000 $ 9,415,000
=========== =========== =========== ===========
(1) EarthShell would need to register additional shares of common stock to
access this amount of proceeds under the Standby Equity Distribution Agreement
at an assumed offering price of $2.254. EarthShell would be required to register
2,436,558 additional shares at this price to obtain the entire $10.0 million
available under the Standby Equity Distribution Agreement.
The Standby Equity Distribution Agreement limits EarthShell's use of
proceeds to general corporate purposes and prohibits the use of proceeds to pay
any judgment or liability incurred by any officer, director or employee of the
Company, except under certain limited circumstances.
20
DILUTION
The net tangible book value of EarthShell as of March 31, 2005 was a
deficit of $9,733,490 or $(0.5293) per share of common stock. Net tangible book
value per share is determined by dividing the tangible book value of the Company
(total tangible assets less total liabilities) by the number of outstanding
shares of our common stock. Since this offering is being made solely by the
selling stockholders and none of the proceeds will be paid to EarthShell, our
net tangible book value will be unaffected by this offering. Our net tangible
book value and our net tangible book value per share, however, will be impacted
by the common stock to be issued under the Standby Equity Distribution
Agreement. The amount of dilution will depend on the offering price and number
of shares to be issued under the Standby Equity Distribution Agreement. The
following example shows the dilution to new investors at an offering price of
$2.254 per share which is in the range of the recent share price.
If we assume that EarthShell had issued 2,000,000 shares of common stock
under the Standby Equity Distribution Agreement at an assumed offering price of
$2.254 per share (i.e., the number of shares registered in this offering under
the Standby Equity Distribution Agreement), less retention fees of $225,400 and
offering expenses of $85,000, our net tangible book value as of March 31, 2005
would have been a deficit $(5,535,890) or $(0.2715) per share. Note that at an
offering price of $2.254 per share, we would receive net proceeds of $4,197,600
of the $10,000,000 available under the Standby Equity Distribution Agreement. At
an assumed offering price of $2.254, Cornell Capital Partners would receive a
discount of $225,400 on the purchase of 2,000,000 shares of common stock. Such
an offering would represent an immediate increase in net tangible book value to
existing stockholders of $0.2578 per share and an immediate dilution to new
stockholders of $2.5255 per share. The following table illustrates the per share
dilution:
Assumed public offering price per share $ 2.2540
Net tangible book value per share before this offering $(0.5293)
Increase attributable to new investors $ 0.2578
--------
Net tangible book value per share after this offering $(0.2715)
--------
Dilution per share to new stockholders $ 2.5255
========
The offering price of our common stock is based on the then-existing
market price. In order to give prospective investors an idea of the dilution per
share they may experience, we have prepared the following table showing the
dilution per share at various assumed offering prices:
DILUTION
ASSUMED NO. OF SHARES PER SHARE
OFFERING PRICE TO BE ISSUED TO NEW INVESTORS
-------------- ------------ ----------------
$2.2540 2,000,000(1) $2.5255
$1.6905 2,000,000 $2.0145
$1.1270 2,000,000 $1.5035
$0.5635 2,000,000 $0.9925
(1) This represents the maximum number of shares of common stock that are
being registered under the Standby Equity Distribution Agreement at this
time.
21
STANDBY EQUITY DISTRIBUTION AGREEMENT
Summary
On March 23, 2005, we entered into a Standby Equity Distribution Agreement
with Cornell Capital Partners. Pursuant to the Standby Equity Distribution
Agreement, we may, at our discretion, periodically sell to Cornell Capital
Partners shares of common stock for a total purchase price of up to $10.0
million. For each share of common stock purchased under the Standby Equity
Distribution Agreement, Cornell Capital Partners will pay 98% of, or a 2%
discount to, the lowest volume weighted average price of our common stock on the
Over-the-Counter Bulletin Board or other principal market on which our common
stock is traded for the five days immediately following the notice date. The
number of shares purchased by Cornell Capital Partners for each advance is
determined by dividing the amount of each advance by the purchase price for the
shares of common stock. Further, Cornell Capital Partners will retain 5% of each
advance under the Standby Equity Distribution Agreement. Cornell Capital
Partners is a private limited partnership whose business operations are
conducted through its general partner, Yorkville Advisors, LLC. In addition, we
engaged Sloan Securities Corporation, a registered broker-dealer, to advise us
in connection with the Standby Equity Distribution Agreement. For its services,
Sloan Securities Corporation received 6,450 shares of our common stock on March
23, 2005. The effectiveness of the sale of the shares under the Standby Equity
Distribution Agreement is conditioned upon us registering the shares of common
stock with the Securities and Exchange Commission, among other things. The costs
associated with this registration will be borne by us. There are no other
significant closing conditions to draws under the Standby Equity Distribution
Agreement.
Standby Equity Distribution Agreement Explained
Pursuant to the Standby Equity Distribution Agreement, we may periodically
sell shares of common stock to Cornell Capital Partners to raise capital to fund
our working capital needs. The periodic sale of shares is known as an advance.
We may request an advance every five trading days. A closing will be held six
trading days after such written notice at which time we will deliver shares of
common stock and Cornell Capital Partners will pay the advance amount. There are
no closing conditions imposed on the Company for any of the draws other than
that the Company has filed its periodic and other reports with the Securities
and Exchange Commission, has delivered the stock for an advance, the trading of
the Company's common stock has not been suspended, and the Company has given
written notice and associated correspondence to Cornell Capital Partners. We are
limited however, on our ability to request advances under the Standby Equity
Distribution Agreement based on the number of shares we have registered on this
registration statement. For example, at an assumed offering price of $0.2.2540,
we would not be able to draw the entire gross proceeds of $10,000,000 available
under the Standby Equity Distribution Agreement with the 2,000,000 shares we are
registering. EarthShell would be required to register 2,436,558 additional
shares at this assumed price to obtain the entire $10.0 million available under
the Standby Equity Distribution Agreement. Based on the limited number of
available authorized shares of common stock, Intrepid would need to obtain
shareholder approval to increase the authorized shares of common stock to access
additional amounts under the Standby Equity Distribution Agreement. In order to
access all funds available to us under the Standby Equity Distribution Agreement
with the 2,000,000 shares being registered in this offering, the average price
of shares issued under the Standby Equity Distribution Agreement would need to
be $5.00.
We may request advances under the Standby Equity Distribution Agreement
once the underlying shares are registered with the Securities and Exchange
Commission. Thereafter, we may continue to request advances until Cornell
Capital Partners has advanced $10.0 million or 24 months after the effective
date of the this registration statement, whichever occurs first.
The amount of each advance is subject to a maximum amount of $500,000, and
we may not submit an advance within five trading days of a prior advance. The
amount available under the Standby Equity Distribution Agreement is not
dependent on the price or volume of our common stock. Our ability to request
advances is conditioned upon us registering the shares of common stock with the
SEC. In addition, we may not request advances if the shares to be issued in
connection with such advances would result in Cornell Capital Partners owning
more than 9.9% of our outstanding common stock. Cornell Capital Partners'
beneficial ownership of EarthShell common stock is 4.03% and therefore we would
be permitted to make draws on the Standby Equity Distribution Agreement so long
as Cornell Capital Partners' beneficial ownership of our common stock remains
lower than 9.9%. A possibility exists that Cornell Capital Partners may own more
than 9.9% of the Company's outstanding common stock at a time when we would
otherwise plan to make an advance under the Standby Equity Distribution
Agreement.
22
We do not have any agreements with Cornell Capital Partners regarding the
distribution of such stock, although Cornell Capital Partners has indicated that
intends to promptly sell any stock received under the Standby Equity
Distribution Agreement.
We cannot predict the actual number of shares of common stock that will be
issued pursuant to the Standby Equity Distribution Agreement, in part, because
the purchase price of the shares will fluctuate based on prevailing market
conditions and we have not determined the total amount of advances we intend to
draw. Nonetheless, we can estimate the number of shares of our common stock that
will be issued using certain assumptions. Assuming we issued the number of
shares of common stock being registered in the accompanying registration
statement at a recent price of $2.30 per share, we would issue 2,000,000 shares
of common stock to Cornell Capital Partners for gross proceeds of $4,508,000.
These shares would represent 9.8% of our outstanding common stock upon issuance.
We will need to register additional shares of common stock in order to fully
utilize the $10.0 million available under the Standby Equity Distribution
Agreement if the average price at which we sell shares under the Standby Equity
Distribution Agreement is equal to $2.254 per share.
There is an inverse relationship between our stock price and the number of
shares to be issued under the Standby Equity Distribution Agreement. That is, as
our stock price declines, we would be required to issue a greater number of
shares under the Standby Equity Distribution Agreement for a given advance. This
inverse relationship is demonstrated by the following table, which shows the
number of shares to be issued under the Standby Equity Distribution Agreement at
a recent price of $2.30 per share and 25%, 50% and 75% discounts to the recent
price.
Purchase Price: $ 2.2540 $ 1.6905 $ 1.1270 $ 0.5635
No. of Shares(1): 2,000,000 2,000,000 2,000,000 2,000,000
Total Outstanding (2): 20,435,452 20,435,452 20,435,452 20,435,452
Percent Outstanding (3): 9.8% 9.8% 9.8% 9.8%
Net Cash to EarthShell:(4) $ 4,197,600 $ 3,126,950 $ 2,056,300 $ 985,650
(1) Represents the number of shares of common stock to be issued to Cornell
Capital Partners under the Standby Equity Distribution Agreement at the
prices set forth in the table, assuming sufficient authorized shares are
available.
(2) Represents the total number of shares of common stock outstanding after
the issuance of the shares to Cornell Capital Partners under the Standby
Equity Distribution Agreement.
(3) Represents the shares of common stock to be issued as a percentage of the
total number shares outstanding.
(4) Net cash equals gross proceeds minus the 5% retainage and minus an
assumption of $85,000 in expenses.
Proceeds used under the Standby Equity Distribution Agreement will be used
in the manner set forth in the "Use of Proceeds" section of this prospectus. We
cannot predict the total amount of proceeds to be raised in this transaction
because we have not determined the total amount of the advances we intend to
draw. Cornell Capital Partners has the ability to permanently terminate its
obligation to purchase shares of common stock from the Company under the Standby
Equity Distribution Agreement if there shall occur any stop order or suspension
of the effectiveness of this registration statement for an aggregate of fifty
(50) trading days other than due to acts by Cornell Capital Partners or if the
Company fails materially to comply with certain terms of the Standby Equity
Distribution Agreement, which remain uncured for thirty (30) days after notice
from Cornell Capital Partners.
All fees and expenses under the Standby Equity Distribution Agreement will
be borne by EarthShell. We expect to incur expenses of approximately $85,000 in
connection with this registration, consisting primarily of professional fees. In
connection with the Standby Equity Distribution Agreement, Cornell Capital
Partners received a one-time commitment fee in the form of 143,550 shares of
common stock on March 23, 2005. In addition, we issued 6,450 shares of common
stock to Sloan Securities Corporation, an unaffiliated registered broker-dealer,
on March 23, 2005, as compensation for its services as a placement agent for
this transaction.
23
PLAN OF DISTRIBUTION
The selling stockholders have advised us that the sale or distribution of
our common stock owned by the selling stockholders may be effected directly to
purchasers by the selling stockholders as principals or through one or more
underwriters, brokers, dealers or agents from time to time in one or more
transactions (which may involve crosses or block transactions) (i) on the on the
Over-the-Counter Bulletin Board or in any other market on which the price of our
shares of common stock are quoted or (ii) in transactions otherwise than on the
Over-the-Counter Bulletin Board or in any other market on which the price of our
shares of common stock are quoted. Any of such transactions may be effected at
market prices prevailing at the time of sale, at prices related to such
prevailing market prices, at varying prices determined at the time of sale or at
negotiated or fixed prices, in each case as determined by the selling
stockholders or by agreement between the selling stockholders and underwriters,
brokers, dealers or agents, or purchasers. If the selling stockholders effect
such transactions by selling their shares of common stock to or through
underwriters, brokers, dealers or agents, such underwriters, brokers, dealers or
agents may receive compensation in the form of discounts, concessions or
commissions from the selling stockholders or commissions from purchasers of
common stock for whom they may act as agent (which discounts, concessions or
commissions as to particular underwriters, brokers, dealers or agents may be in
excess of those customary in the types of transactions involved). The Company
has agreed that upon receipt of an advance notice, Cornell Capital Partners is
permitted to sell the shares to be issued to Cornell Capital Partners pursuant
to the advance notice during the applicable pricing period.
Cornell Capital Partners is an "underwriter" within the meaning of the
Securities Act of 1933 in connection with the sale of common stock under the
Standby Equity Distribution Agreement. Cornell Capital Partners will pay us 98%
of, or a 2% discount to, the lowest closing bid price of our common stock on the
Over-the-Counter Bulletin Board or other principal trading market on which our
common stock is traded for the five days immediately following the advance date.
In addition, Cornell Capital Partners will retain 5% of the proceeds received by
us under the Standby Equity Distribution Agreement, and received a one-time
commitment fee in the form of 143,550 shares of common stock on March 23, 2005.
The 2% discount, the 5% retainage and the 143,550 shares of common stock are
underwriting discounts. In addition, we engaged Sloan Securities Corporation, an
unaffiliated registered broker-dealer, to advise us in connection with the
Standby Equity Distribution Agreement. Sloan Securities Corporation has entered
into a placement agent agreement with EarthShell pursuant to which Sloan
Securities Corporation has reviewed the terms of the Standby Equity Distribution
Agreement and has advised the Company concerning these terms. Sloan Securities
Corporation, to the Company's knowledge, will not be participating in the
distribution of shares that may be issued under the Standby Equity Distribution
Agreement. For its services in regard to the Standby Equity Distribution
Agreement, Sloan Securities Corporation received 6,450 shares of our common
stock, on March 23, 2005.
Cornell Capital Partners was formed in February 2000 as a Delaware limited
partnership. Cornell Capital Partners is a domestic hedge fund in the business
of investing in and financing public companies. Cornell Capital Partners does
not intend to make a market in our stock or to otherwise engage in stabilizing
or other transactions intended to help support the stock price. Prospective
investors should take these factors into consideration before purchasing our
common stock.
Under the securities laws of certain states, the shares of common stock
may be sold in such states only through registered or licensed brokers or
dealers. The selling stockholders are advised to ensure that any underwriters,
brokers, dealers or agents effecting transactions on behalf of the selling
stockholders are registered to sell securities in all fifty states. In addition,
in certain states the shares of common stock may not be sold unless the shares
have been registered or qualified for sale in such state or an exemption from
registration or qualification is available and is complied with.
We will pay all the expenses incident to the registration, offering and
sale of the shares of common stock to the public hereunder other than
commissions, fees and discounts of underwriters, brokers, dealers and agents. If
any of these other expenses exists, EarthShell expects the selling stockholders
to pay these expenses. We have agreed to indemnify Cornell Capital Partners and
its controlling persons against certain liabilities, including liabilities under
the Securities Act. We estimate that the expenses of the offering to be borne by
us will be approximately $85,000. For its services, Sloan Securities Corporation
received 6,450 shares of our common stock, on March 23, 2005. The estimated
offering expenses consist of: a SEC registration fee of $1,054, printing
expenses of $2,500, accounting fees of $15,000, legal fees of $50,000 and
miscellaneous expenses of $16,446. We will not receive any proceeds from the
sale of any of the shares of common stock by the selling stockholders. We will,
however, receive proceeds from the sale of common stock under the Standby Equity
Distribution Agreement.
The selling stockholders are subject to applicable provisions of the
Securities Exchange Act of 1934, as amended, and its regulations, including,
Regulation M. Under Registration M, the selling stockholders or their agents may
not bid for, purchase, or attempt to induce any person to bid for or purchase,
shares of our common stock while such selling stockholders are distributing
24
shares covered by this prospectus. Pursuant to the requirements of Item 512 of
Regulation S-B and as stated in Part II of this Registration Statement, the
Company must file a post-effective amendment to the accompanying Registration
Statement once informed of a material change from the information set forth with
respect to the Plan of Distribution.
25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Management's discussion and analysis of results of operations and
financial condition are based on our financial statements. These statements have
been prepared in accordance with accounting principles generally accepted in the
United States of America. These principles require management to make certain
estimates, judgments and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, we evaluate our estimates based on
historical experience and various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions. The following discussion
should be read in conjunction with the Company's Financial Statements and Notes
thereto, included elsewhere within this registration statement.
Overview
Organized in November 1992 as a Delaware corporation, EarthShell
Corporation (the "Company") 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.
EarthShell was a development stage enterprise through the first quarter of
2004. With the recognition of the Company's first revenues resulting from the
receipt of $500,000 in technology fees in connection with granting a license to
a strategic partner in the second quarter of 2004, the Company was no longer a
development stage enterprise.
Critical Accounting Assumptions
Going Concern Basis. The condensed 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. The
Company has incurred significant losses since inception, has minimal revenues
and has a working capital deficit of $8,426,070 at March 31, 2005. 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, 2005. 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 March 2005, the Company secured a $1.15 million loan and also entered into a
Standby Equity Distribution Agreement where the Company has the right, upon
registration of shares of its common stock, to require an institutional investor
to purchase shares of the Company's common stock from time to time at the
Company's sole discretion. In addition, the Company expects to receive
additional technology fee payments in 2005 in connection with both existing and
new sublicense agreements for its technology in various territories and fields
of use. However, the Company cannot assure that additional financing will be
available to it, or, if available, that the terms will be satisfactory, that it
will receive any further technology fee payments in 2005 pursuant to the
Sublicense Agreement. Management also plans to continue in its efforts to
minimize expenses, but cannot assure that it will be able to reduce expenses
below current levels. The condensed 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
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
26
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.
At one time, the Company had been engaged in the development of manufacturing
equipment to validate acceptance of EarthShell products and their pricing. To
this end, the Company previously developed manufacturing lines in Owings Mills,
Maryland, Goleta, California and in Goettingen, Germany. The Company recognized
impairment charges on its equipment amounting to $4.0 million and $9.8 million
in 2003 and 2002, respectively.
Revenue Recognition. The Company recognizes revenue when persuasive
evidence of an arrangement exists, the price is fixed or readily determinable
and collectibility is probable. The Company recognizes revenue in accordance
with Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements" (SAB 101). EarthShell's revenues consist of technology fees that are
recognized ratably over the life of the related agreements and royalties based
on product sales by licensees that are recognized in the quarter that the
licensee reports the sales.
Results Of Operations
Three Months Ended March 31, 2005 Compared With The Three Months Ended
March 31, 2004
The Company's net loss decreased by approximately $1.0 million to
approximately $1.1 million from approximately $2.1 million for the three months
ended March 31, 2005 compared to the three months ended March 31, 2004,
respectively.
Revenues. The Company recorded revenues of approximately $0.08 million for
the three months ended March 31, 2005 as compared to $0 for the three months
ended March 31, 2004. These revenues reflect amortization of the $2.0 million
technology fee payable under the sublicense agreement that was entered into in
the second quarter of 2004 and the $1 million technology fee payable under the
sublicense agreement entered into in December of 2004. The amortization of these
technology fees will result in the recognition of $0.3 million in revenues per
year during the life of the agreements.
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 approximately
$0.4 million to approximately $0.1 million from approximately $0.5 million for
the three months ended March 31, 2005 compared to the three months ended March
31, 2004, respectively.
o Related party license fee and research and development expenses were
comprised in 2004 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 an agreement entered into by the EKI entities in connection with
debt restructuring and settlement of the convertible debenture financing
concluded in October of 2004. Related party license fee and research and
development expenses decreased approximately $0.3 million to $0 from
approximately $0.3 million for the three months ended March 31, 2005, compared
to the three months ended March 31, 2004, respectively. The decrease was due
primarily to the elimination of the monthly licensing fee in September 2004, as
noted above.
o Other research and development expenses are comprised of personnel
costs, travel and direct overhead for development and demonstration production.
Other research and development expenses decreased approximately $0.1 million to
approximately $0.01 million from approximately $0.2 million for the three months
ended March 31, 2005, compared to the three months ended March 31, 2004,
respectively. The reduction was due to the outsourcing of technical personnel
and the outsourcing of technical support activities during 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 by approximately $0.14 million to
approximately $1.13 million from approximately $1.17 million for the three
months ended March 31, 2005, compared to the three months ended March 31, 2004,
respectively. The largest reductions were in legal, business insurance, currency
translation losses, and personnel costs (approximately $0.3 million). These
reductions were partially offset by an accrual for potential damages related to
a legal settlement.
Interest Expense. Interest expense is comprised of related party interest
expense and other interest expense.
o Related party interest expense decreased by approximately $0.13 million
to $0 from approximately $0.13 million for the three months ended March 31,
2005, compared to the three months ended March 31, 2004. In 2004, related party
interest expense included interest accrued on outstanding loans made to the
27
Company by EKI under the Loan Agreement (see "Related Party Transactions"),
accretion of the discount related to the warrants issued to EKI 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").
In the fourth quarter of 2004, all of the EKI loans and accrued but unpaid
interest were converted into common stock of the Company, as were the unpaid
licensing fees under the Biotec License Agreement. Also in the fourth quarter of
2004, the March 2006 debentures were retired, so the accretion of the discount
related to the warrants issued to EKI have been written off. Therefore, there
was no related party interest expense for these items in the first quarter of
2005.
o Other interest expense decreased by approximately $0.19 million to
approximately $0.02 million from approximately $0.21 million for the three
months ended March 31, 2005, compared to the three months ended March 31, 2004,
respectively. Other interest expense in 2004 was primarily composed of accretion
of the discount and interest accrued on the 2006 Debentures. However, in the
fourth quarter of 2004 the Company settled with the remaining holders of the
March 2006 Debentures and the all of the outstanding debentures were retired.
Therefore, there will be no other interest expense for the 2006 Debentures
subsequent to December 31, 2004.
Other Income. Other income increased by approximately seven thousand
dollars for the three months ended March 31, 2005, compared to $0 for the three
months ended March 31, 2004. This other income was the result of a gain on the
sale of certain minor pieces of equipment which had previously been scrapped and
consigned to an equipment dealer.
Year Ended December 31, 2004 Compared with the Year Ended December 31,
2003
The Company's net loss decreased $11.2 million to $7.3 million from $18.5
million for the year ended December 31, 2004 compared to the year ended December
31, 2003, respectively.
Revenues. The Company recorded revenues of $0.1 million for the year ended
December 31, 2004. These revenues reflect amortization of the $3.0 million of
technology fees payable under the sublicense agreements that were entered into
with MBS and with EarthShell Hidalgo S.A. de C.V. ("ESH") in the second and
fourth quarters of 2004 over the ten years of the agreements. The amortization
of the technology fees will result in the recognition of $0.3 million in
revenues per year during the lives of the agreements. Prior to this, the Company
had no recognized revenue as it was a development stage company.
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
expenditures for the development of EarthShell Packaging(R) decreased $8.3
million to $1.2 million from $9.5 million for the year ended December 31, 2004
compared to the year ended December 31, 2003, respectively.
o Related party license fee and research and development expenses are
comprised of the $.1 million minimum monthly licensing fee for the
use of the EarthShell technology and for technical services, both of
which were payable to EKI, a stockholder of the Company, or Biotec,
a wholly-owned subsidiary of EKI. Related party license fee and
research and development expenses decreased $0.5 million to $0.8
million from $1.3 million for the year ended December 31, 2004
compared to the year ended December 31, 2003, respectively. The
decrease was primarily due to a decrease in the license fee as a
result of an agreement with Biotec to eliminate the $0.1 million per
month minimum licensing fee from September 2004 through August 2006.
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 $7.8 million to
$0.4 million from $8.2 million for the year ended December 31, 2004
compared to the year ended December 31, 2003, respectively. The
reduction was due to the non-recurrence of the following 2003
activities: the winding down of on-going demonstration manufacturing
in Goleta, California in the first quarter of 2003, the start-up in
mid-May of a new manufacturing line for plates and bowls built and
financed by Detroit Tool and Engineering Company (DTE) at their
Lebanon, Missouri facility, expenses incurred to vacate the
Company's demonstration manufacturing facility in Goleta at the
expiration of the lease on May 31, 2003, costs incurred in
connection with testing of the Goettingen, Germany manufacturing
equipment during the third quarter, the write down of the Goettingen
manufacturing equipment to
28
$1 as of December 31, 2003 due to the uncertainty of the proceeds to
be realized upon sale of the equipment, and the losses of the
Company's joint venture. In early August 2003, the Company
discontinued its day-to-day support of manufacturing activities at
DTE. In keeping with its business model, in 2004 the Company
primarily focused on the licensing of its foam analog material and
other technologies to new licensees, and these licensees and future
licensees will install and run equipment to produce EarthShell
Packaging(R) in their own facilities.
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 $2.0 million to $3.8 million from $5.8 million
for the year ended December 31, 2004 compared to the year ended December 31,
2003, respectively. This was primarily the result of efforts to significantly
reduce general and administrative expenses throughout 2003 and 2004, which
resulted in reductions in the following expenses: personnel costs by $0.7
million (due to a reduction in headcount from 14 employees at December 31, 2003
to 9 employees at December 31, 2004), professional fees and services by $0.8
million, facility and support costs by $0.3 million, business insurance costs by
$0.2 million, travel and entertainment expenses by $0.1 million and franchise
taxes by $0.1 million. In addition, the Company was able to reduce previously
provided expense accruals by approximately $0.6 million due to their favorable
resolution in the third quarter of 2004. Most of the credit to general and
administrative expenses related to the favorable resolution of property tax
disputes within the states of California and Maryland. The expense reductions
were partially offset by approximately $0.8 million of accounts payable
settlement gains in 2003. The settlement gains were the result of a program
began by the Company in the second quarter of 2003 to satisfy vendors for
outstanding aged invoices.
Depreciation and Amortization Expense. Depreciation and amortization
expense decreased $0.34 million to $0.04 million from $0.38 million for the year
ended December 31, 2004 compared to the year ended December 31, 2003,
respectively. The decrease in depreciation expense is primarily attributable to
taking the remainder of EarthShell's manufacturing and development assets out of
service as of the end of 2003.
Interest Expense. Interest expense is comprised of Related party interest
expense and Other interest expense.
o Related party interest expense was $0.4 million for both the year
ended December 31, 2004 and the year ended December 31, 2003.
Related party interest expense includes interest accrued on
outstanding loans made to the Company by EKI under the Loan
Agreement, accretion of the discount related to the warrants issued
to EKI in conjunction with the March 2003 financing transactions,
plus accrued interest payable on amounts owed to EKI for monthly
licensing fees that were accrued rather than being paid in
accordance with the terms of the subordination agreements entered
into in connection with the issuance of secured convertible
debentures in March 2006 (the "2006 Debentures") (see "Related Party
Transactions"). During the third quarter of 2004, agreements were
negotiated with EKI to convert all outstanding loans and accrued but
unpaid interest into common stock of the Company and to restructure
the unpaid licensing fees under the Biotec License Agreement.
Therefore, there will be no Related party interest expense for these
items subsequent to December 31, 2004.
o Other interest expense decreased $0.7 million to $0.7 million from
$1.4 million for the year ended December 31, 2004 compared to the
year ended December 31, 2003, respectively. Other interest expense
for 2004 is primarily comprised of accretion of the discount and
interest accrued on the 2006 Debentures. Other interest expense for
2003 was primarily comprised of accretion of discount on the 2006
Debentures and a beneficial conversion charge in the amount of $0.4
million due to a change in the 2007 Debentures conversion price. In
addition, 0ther interest expense for 2003 also included accretion of
the discount on the 2007 Debentures and accrued interest payable on
the 2006 and 2007 Debentures.
Gain on Sale of Property and Equipment. Gain on the sale of property and
equipment decreased $0.3 million to $0.2 million from $0.5 million for the year
ended December 31, 2004 compared to the year ended December 31, 2003,
respectively. The gains in both 2004 and 2003 were realized due to the sale of
non-essential machine shop equipment and excess office furniture and equipment
over their net book value, most of which was fully depreciated. In addition,
2003 also included proceeds received from the sale of production line equipment
that was previously impaired and therefore had a net book value of zero.
Premium due to Debenture Default. At December 31, 2004, the Company was in
non-compliance with certain covenants of the 2006 Debentures. Two of the
debenture holders, including the debenture holder with the largest ownership
position, notified the Company in writing that the Company was in default and
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. The debenture contains a provision for repurchase of the
debenture at a premium if the repurchase is due to an event of default, and the
Company accrued the amount of the premium specified in the debenture.
29
Other Income. Other income for the year ended December 31, 2004 was zero
compared to $0.4 million for the year ended December 31, 2003. The 2003 other
income represents the net gain realized in the third quarter of 2003 from
reducing the balance of the warrant obligation to its estimated fair value of
zero. The warrant obligation was initially recorded in connection with the March
2003 financing transactions.
(Gain) Loss on Extinguishment of Debentures. There was a gain on
extinguishment of debentures of $.1 million for the year ended December 31, 2004
compared to a loss on extinguishment of debentures was $1.7 million for the year
ended December 31, 2003. The $0.1 million gain for the year ended December 31,
2004 relates to interest payable on the 2006 Debentures that was not paid by the
Company upon conversion of the Debentures. 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 Cost. Debenture Conversion Cost was $0.2 million for
the year ended December 31, 2003. The expense represents the prorated portion of
the original discount attributed to the 2007 Debentures whose conversion was
forced by the Company in the respective periods.
Year Ended December 31, 2003 Compared with the Year Ended December 31,
2002
The Company's net loss decreased $21.1 million to $18.5 million from $39.6
million for the year ended December 31, 2003 compared to the year ended December
31, 2002, respectively.
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
expenditures for the development of EarthShell Packaging(R) decreased $17.4
million to $9.5 million from $26.9 million for the year ended December 31, 2003
compared to the year ended December 31, 2002, respectively.
o Related party license fee and research and development expenses are
comprised of the $100,000 minimum monthly licensing fee for the use
of the EarthShell technology and for 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 of 2003. Related party license fee and research and
development expenses decreased $0.2 million to $1.3 million from
$1.5 million for the year ended December 31, 2003 compared to the
year ended December 31, 2002, respectively. The 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 $17.2 million to
$8.2 million from $25.4 million for the year ended December 31, 2003
compared to the year ended December 31, 2002, respectively. The
decrease in other research and development expenses was primarily
due to concluding the demonstration manufacturing of hinged-lid
containers in Owings Mills, Maryland at the end of the second
quarter of 2002. While the majority of the expenses incurred in 2002
related to the Owings Mills demonstration manufacturing, it also
included expenses related to the commencement of demonstration
manufacturing of bowls and plates in Goleta, California. Other
research and development expenses incurred in 2003 primarily related
to the ongoing demonstration manufacturing in Goleta through
mid-April and to the start-up in mid-May of a new manufacturing line
for plates and bowls built and financed by Detroit Tool and
30
Engineering Company (DTE) at their Lebanon, Missouri facility. In
early August 2003, the company discontinued its day-to-day support
of manufacturing activities at DTE. In keeping with its business
model, the Company will hereafter focus primarily on the licensing
of its foam analog material and other technologies, and all future
manufacturing and production will be the responsibility of current
or new licensees as they install and run equipment to produce
EarthShell Packaging(R) in their own facilities. The decrease in
other research and development expenses was also due to a $5.8
million reduction in property and equipment impairment charges, to
$4.0 million in 2003 from $9.8 million in 2002.
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 $3.8 million to $5.8 million from $9.6 million
for the year ended December 31, 2003 compared to the year ended December 31,
2002, respectively. This was primarily the result of efforts to significantly
reduce general and administrative expenses in 2003, which resulted in reductions
in the following expense categories: legal fees, including patent prosecution
and maintenance fees, by $0.9 million, personnel costs by $0.7 million,
professional fees and services by $0.4 million, travel costs by $0.3 million,
facility costs by $0.3 million and business insurance costs by $0.2 million. In
addition, in the second quarter of 2003 the Company began a program to satisfy
vendors for outstanding invoices and recognized gains from settling various old
trade accounts payable at a discount. As a result of negotiations, in 2003 the
Company settled and paid outstanding accounts payable of approximately $1.5
million at a discount of approximately $0.8 million.
Depreciation and Amortization Expense. Depreciation and amortization
expense decreased $2.7 million to $0.4 million from $3.1 million for the year
ended December 31, 2003 compared to the year ended December 31, 2002,
respectively. The decrease in depreciation expense is primarily attributable to
the decrease in property and equipment as a result of the impairment of
demonstration manufacturing property and equipment in 2002.
Interest Income. Interest income totaled $0.1 million for each of the
years ended December 31, 2003 and December 31, 2002.
Interest Expense. Interest expense is comprised of Related party interest
expense and Other interest expense.
o Related party interest expense increased $0.3 million to $0.4
million from $0.1 million for the year ended December 31, 2003
compared to the year ended December 31, 2002, respectively. The
increase was due to an increase in accrued interest payable on
outstanding loans made to the Company by EKI from September 2002
through January 2003 that were outstanding throughout all of 2003,
accretion in 2003 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).
o 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 increased $1.2 million to $1.4 million from
$0.2 million for the year ended December 31, 2003 compared to the
year ended December 31, 2002, respectively. Other interest expense
for 2003 is primarily comprised of accretion of the discount on the
2006 Debentures and a beneficial conversion charge in the amount of
$0.4 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. Other interest
expense for 2002 was comprised of accretion of the discount and
accrued interest payable on the 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
they are repaid or are converted into common stock.
Other Income. Other income was $0.4 million for the year ended December
31, 2003. This represents the net gain realized in the third quarter of 2003
from reducing the balance of the warrant obligation to its estimated fair value
of zero. Management believes the estimated fair value of the warrant at December
31, 2003 is zero. The warrant obligation was initially recorded in connection
with the March 2003 financing transactions.
31
Loss on Extinguishment of Debentures. Loss on extinguishment of debentures
was $1.7 million for the year ended December 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.
Gain on Sale of Property and Equipment. Gain on the sale of property and
equipment increased $0.1 million to $0.5 million from $0.4 million for the year
ended December 31, 2003 compared to the year ended December 31, 2002,
respectively. The gain in both 2003 and 2002 represents the excess of proceeds
received from the sale of non-essential machine shop equipment and excess office
furniture and equipment over their net book value. In addition, 2003 also
includes proceeds received from the sale of production line equipment that was
previously impaired and therefore had a net book value of zero.
Debenture Conversion Cost. Debenture Conversion Cost decreased $0.1
million to $0.2 million from $0.3 million for the year ended December 31, 2003
compared to the year ended December 31, 2002, respectively. The expense
represents the prorated portion of the original discount attributed to the 2007
Debentures whose conversion was forced by the Company in the respective periods.
32
Liquidity and Capital Resources
Cash Flow - March 31, 2005. The Company's principal use of cash for the
three months ended March 31, 2005 was to fund operations. Net cash used in
operations was approximately $0.8 million for the three months ended March 31,
2005, compared to $1.2 million for the three months ended March 31, 2004. As of
March 31, 2005 the Company had cash and cash equivalents totaling approximately
$0.3 million and a working capital deficit of approximately $8.4 million. 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.
Cash Flow - December 31, 2004. The Company's principal uses of cash for
the year ended December 31, 2004 were to fund operations, repay convertible
debentures, and pay accounts payable and accrued expenses. Net cash used in
operations was $2.7 million and $15.7 million for the years ended December 31,
2004 and 2003, respectively. Net cash provided by investing activities was $.2
million and $4.0 million for the years ended December 31, 2004 and 2003,
respectively. Net cash provided by financing activities was $.9 million and
$13.5 million for the years ended December 31, 2004 and 2003, respectively. As
of December 31, 2004, the Company had cash and related cash equivalents totaling
$.3 million.
Capital Requirements. Due to the fact that construction of the initial
commercial production lines was largely completed in 2002 and the Company
decided to discontinue all demonstration manufacturing activities in 2003, the
Company only made one minor capital expenditure during the year ended December
31, 2004. The Company made no capital expenditures during the three months ended
March 31, 2005, and the Company does not expect to make significant capital
expenditures in the remaining part of 2005.
Contractual Obligations. The following table summarizes the Company's
known obligations to make future payments pursuant to certain contracts as of
December 31, 2004, as well as an estimate of the timing in which these
obligations are expected to be satisfied:
Payments due by period (in thousands)
Contractual Total Less than 1 year 1-3 years
----------- ----- ---------------- ---------
Obligations
Long-term debt - principal
payments only
Capital leases -- -- --
Operating leases -- -- --
Payable to related party $875 $875 --
Other long-term liability $726 $314 $412
------ ------ ----
Totals $1,601 $1,189 $412
====== ====== ====
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 1,250,000
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 $30.6 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 an additional 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. 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. 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. During the year ended December 31, 2003, the Company issued 432,974
shares for the conversion of $1.8 million of 2007 Debentures. The remainder of
the 2007 Debentures were prepaid or exchanged for 2006 Debentures during 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, for which the Company
received proceeds of approximately $9.0 million, net of financing costs of
approximately $1.5 million. 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. (See Stock Warrants) In 2003, $5.75 million
principal amount of the 2006 Debentures was converted into 958,334 shares of
common stock. At December 31, 2003, the outstanding principal balance of 2006
Debentures was $6.8 million. The remaining shares under the December 2001 shelf
registration described above were used to secure shares potentially issuable
upon conversion of the 2006 Debentures.
33
Although the Company was in compliance with all covenants of the 2006
Debentures at December 31, 2003, 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 for continued
listing. In addition, the Company did not make interest payments related to the
2006 Debentures as required on January 31, 2004. These actions put the Company
in non-compliance with its covenants under the 2006 Debentures. During 2004, the
Company sold $2.7 million of its common stock in a private equity transaction,
received $1.5 million in prepaid technology fees related to the granting of new
licenses, and worked to negotiate settlements with each of the remaining holders
of its 2006 debentures to retire the debentures, to resolve the defaults, and to
restructure its long-term debt as follows.
Debenture Purchase Agreements. As of September 30, 2004, the Company
entered into agreements with each of the holders (collectively, the "Holders")
of the 2006 Debentures due March 5, 2006 to amend and restate the Debenture
Purchase Agreements entered into in July 2004 by EarthShell and the Holders (as
amended and restated, the "Debenture Purchase Agreements" and the transactions
contemplated therein, collectively, the "Debenture Transactions"). The 2006
Debentures were in default and their outstanding principal balance totaled $6.5
million prior to their repurchase. Collectively, the Debenture Purchase
Agreements required (i) E. Khashoggi Industries, LLC ("EKI") to pay $1 million
cash (EarthShell was obligated to reimburse EKI for this cash payment as
discussed below), (ii) the Holders to convert the 2006 Debentures in accordance
with their terms, resulting in the issuance by EarthShell of 1,091,666 shares of
its common stock, which shares were previously registered for resale by the
Company in connection with the issuance of the 2006 Debentures, (iii) EarthShell
to issue to the Holders an aggregate of 512,500 additional shares EarthShell
common stock and (iv) EarthShell to pay $2.3 million to one of the Holders from
33% of any equity funding received by the Company (excluding the first $2.7
million funded by MBS) or 50% of the royalties received by EarthShell in excess
of $250,000 per month (determined on a cumulative basis commencing July 1,
2004). EarthShell has the right to convert the unpaid portion of the $2.3
million into shares of the Company's common stock at a price equal to the lesser
of $3.00 per share or the price per share price that EarthShell subsequently
receives upon the issuance of its common stock (or other convertible security)
during the three year period commencing September 30, 2004. The 512,500 shares
of common stock issued to the Holders on October 6, 2004 were not registered for
resale under the Securities Act of 1933, as amended (the "Securities Act"),, but
are being registered as part of this registration statement on form S-1. The
consideration for the repurchase of the Debentures has been paid or issued, and
the 2006 Debentures have been retired by EarthShell.
Receipt of Proceeds from Sale of Common Stock to MBS. On August 5, 2004,
EarthShell and Meridian Business Solutions, LLC ("MBS") entered into a Stock
Purchase Agreement (the "Stock Purchase Agreement") pursuant to which MBS agreed
to fund $5 million to EarthShell in exchange for EarthShell's issuance of a
total of 1,666,666 shares of common stock at a price of $3.00 per share. On
August 20, 2004, EarthShell received $500,000 from MBS, for which the Company
issued 166,666 shares of its common stock to MBS. On October 1, 2004, EarthShell
received an additional $1.2 million of the $5 million committed by MBS, and the
Company issued 400,000 shares of its common stock to MBS. On October 11, 2004,
MBS purchased an additional 333,333 shares for $1.0 million, of which it had
paid $.5 million as of December 31, 2004 and $.5 million was still due.
Subsequent to December 31, 2004, MBS paid an additional $25,000 leaving the
balance due at March 31, 2005 of $.475 million. The shares of common stock
issued to MBS were not registered for resale under the Securities Act, but are
being registered as part of this registration statement on Form S-1. The cash
received from MBS was used, in part, to fund the repurchase of the 2006
Debentures (as defined below) and to restructure the Company's long-term debt.
EKI Agreements. In connection with its purchase of the 2006 Debentures
from the Holders, on September 30, 2004, EKI entered into an agreement with
EarthShell to sell the 2006 Debentures it purchased back to the Company for $1
million cash, the cash price paid by EKI for the purchased 2006 Debentures (the
"EKI Debenture Purchase Agreement"). In connection therewith, immediately after
its acquisition, EKI sold the purchased 2006 Debentures to the Company and, as
discussed above, the Company retired the 2006 Debentures shortly thereafter.In
addition, on September 30, 2004, the Company and EKI agreed to convert certain
existing loans from EKI to the Company into shares of EarthShell's common stock
(the "EKI Conversion Agreement"). This transaction closed after the closing of
the Debenture Transactions and, pursuant to the EKI Conversion Agreement, EKI
converted the $2,755,000 principal amount of such debt into shares of
EarthShell's common stock at a conversion price of $3 per share. In addition,
under the terms of the EKI Conversion Agreement, EKI converted the accrued and
unpaid interest on such loans into shares of EarthShell's common stock at a
conversion price equal to the greater of (i) $3 per share, and (ii) the maximum
per share price (not to exceed $4 per share) obtained by the Company upon the
sale of its common stock to any investor during the three month period following
the closing. In May of 2005, an additional 44,387 shares were issued to EKI
pursuant to a 90 day price protection clause, which provided for an adjustment
in the effective conversion price of the interest portions of the EKI loans from
$4 per share to $3 per share. The 1,051,494 shares of common stock issued to EKI
as a result of this conversion agreement will not be registered for resale under
the Securities Act.
34
Biotec Agreement. EarthShell also reached agreement to amend its existing
agreements with its affiliates, bio-tec Biologische Naturverpackungen GmbH & Co.
and bio-tec Biologische Naturverpackungen Forschungs und Entwicklungs GmbH
(collectively, "Biotec"; and such agreement, the "Biotec Amendment"). Under the
terms of the Biotec Amendment, EarthShell has agreed to satisfy the approximate
$2.5 million in indebtedness owed to Biotec by (i) paying $750,000 in various
installements to Biotec in 2004 (ii) converting approximately $1.47 million
principal amount of the Biotec debt into shares of EarthShell's common stock at
a conversion price of $3 per share and (iii) at EarthShell's option, on the
first anniversary of the closing, pay $250,000 to Biotec or convert the
remaining $250,000 Biotec debt into 133,333 shares of EarthShell's common stock
at a conversion price of $3 per share. In consideration for the above, Biotec
also agreed to suspend the monthly license fees payable by EarthShell for two
years after the date of the closing. The common stock to be issued pursuant to
the Biotec Amendment will not be registered for resale under the Securities Act.
As of December 31, 2004, the Company had paid to Biotec $125,000 in cash and
converted approximately $1.48 million into 491,778 shares of unregistered
commons stock, and the balance owing to Biotec as of December 31, 2004 was
$875,000 (see Relationship with and Reliance on EKI).
In connection with the settlement of the 2006 Debentures and the related
restructuring of the Company's debt, the Company provided registration rights
with respect to newly issued unregistered shares of its common stock. Such
registration rights required the Company to, among other things, file a
registration statement with the SEC in December 2004 registering the resale of
such shares of common stock. Under certain of the agreements, the Company's not
filing such a registration statement (or the registration statement not being
declared effective) within the required timeframe provides the holders of the
registrable securities with a right to liquidated damages which, in the
aggregate, may amount to approximately $50,000 per month until the registration
statement is filed. If the Company fails to pay such liquidated damages, the
Company must also pay interest on such amount at a rate of 10% per year (or such
lesser amount as is permitted by law).
Because this registration statement was not filed as planned, in December
2004 the Company became obligated on the direct financial obligation described
above. In light of the Company's current liquidity and financial position any
such claim could have a negative effect on the Company. While none of the
holders of registrable securities have made a formal claim for liquidated
damages to date, there can be no assurance that such holders will not do so in
the future.
During 2002 and 2003, the Company's largest shareholder, EKI, made various
simple interest working capital loans to the Company. These loans were interest
bearing at a rate of 7% or 10% per annum, and were payable on demand. As of
December 31, 2003, the outstanding principal balance of these loans was
$2,755,000. In connection with the sale of the March 2006 Debentures,
subordinated the payments and advances that were owed to it, and in
consideration, the Company issued to EKI a warrant in March 2003, expiring in
ten years, to acquire 83,333 shares of the Company's common stock for $6.00 per
share. As disclosed above, as part of the settlement of the March 2006
Debentures in October of 2004, EKI agreed to convert all of its outstanding
loans to EarthShell ($2,755,000) into unregistered common stock at $3 per share
and $532,644 of accumulated interest into unregistered common stock at $4 per
share for a total of 1,051,494 shares received by EKI. As of December 31, 2004,
the loans from EKI were paid in full. In May of 2005, the Company issued an
additional 44,387 shares of unregistered common stock to EKI pursuant to a
provision of the EKI conversion agreement which provided for the issuance of
these additional shares if the Company did not sell equity to a third party
within 90 days of the initial conversion at a price of at least $4 per share.
During 2004, the Company entered into license agreements for which it
received a total of $1.5 million in technology fees. In May 2004, the Company
entered into its license agreement with MBS, which calls for a total of $2.0
million in technology fees payable in $.5 million increments based on certain
milestones during the startup of manufacturing operations and prior to the
beginning of royalty generation. To date the Company has received $.5 million.
In November of 2004, the Company entered into a license agreement with ESH and
received technology fees of $1 million.
Subsequent to December 31, 2004, on March 23, 2005, the Company entered
into a promissory note and Security Agreement with Cornell Capital Partners.
Pursuant to the Security Agreement, the Company issued promissory notes to
Cornell Capital Partners in the original principal amount of $2,500,000. The
$2,500,000 was disbursed as follows: $1,150,000 on March 28, 2005 and the
remaining $1,350,000 was disbursed on May 27, 2005. The promissory notes are
secured by the assets of the Company and shares of stock of another entity
pledged by an affiliate of that entity. The promissory notes have a one-year
term and accrue interest at 12% per year. In connection with the financing with
Cornell Capital Partners, the Company issued a warrant to Cornell Capital
Partners to purchase 625,000 shares of common stock of the Company. The warrant
expires on the later of: (a) May 26, 2005 or (b) the date sixty days after the
date the $2,500,000 in promissory notes issued to Cornell Capital Partners are
fully repaid. The warrant has an exercise price of $4.00 per share of common
stock.
35
Subsequent to December 31, 2004 and on March 23, 2005, EarthShell entered
into a Standby Equity Distribution Agreement with Cornell Capital Partners.
Pursuant to the Standby Equity Distribution Agreement, the Company may, at its
discretion, periodically sell to Cornell Capital Partners shares of common stock
for a total purchase price of up to $10.0 million. For each share of common
stock purchased under the Standby Equity Distribution Agreement, Cornell Capital
Partners will pay the Company 98% of the lowest volume weighted average price of
the Company's common stock as quoted by Bloomberg, LP on the Over-the-Counter
Bulletin Board or other principal market on which the Company's common stock is
traded for the 5 days immediately following the notice date. The price paid by
Cornell Capital Partners for the Company's stock shall be determined as of the
date of each individual request for an advance under the Standby Equity
Distribution Agreement. Cornell Capital Partners will also retain 5% of each
advance under the Standby Equity Distribution Agreement. Cornell Capital
Partners' obligation to purchase shares of the Company's common stock under the
Standby Equity Distribution Agreement is subject to certain conditions,
including the Company obtaining an effective registration statement for shares
of common stock sold under the Standby Equity Distribution Agreement and is
limited to $500,000 per weekly advance.
The Company also expects to generate cash in the remaining part of 2005
through technology fees and royalty payments from licensees and through the
issuance of debt or equity securities. During 2004, the Company entered into
license agreements for which it received a total of $1.5 million cash in
technology fees. The Company expects to receive additional technology fees in
connection with the granting of additional new licenses during the year. In
addition, the Company expects to begin generating royalty revenues later in the
year.
The Company expects to generate additional cash in 2005 through royalty
payments from licensees. The Company believes that the cash from this borrowing,
combined with projected revenues, will be sufficient to fund its operations
through the year ending December 31, 2005. If the Company is not successful at
generating license revenues during the year, the Company will have to raise
additional funds to meet its current obligations and to cover operating
expenses. 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. However, the Company cannot assure that
it will receive any royalty payments in 2005, that additional financing will be
available to it, or, if available, that the terms will be satisfactory.
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.
Off-Balance Sheet Arrangements. The Company does not have any off-balance
sheet arrangements as of March 31, 2005 and has not entered into any
transactions involving unconsolidated, limited purpose entities.
Subsequent Events. In February of 2005, an option of 1,000,000 shares with
an exercise price of $2.30 per share was issued to a board member in connection
with considerable financial support of the Company. The option was subsequently
rescinded by the Company in May of 2005.
36
CHANGES IN AND DISAGREEMENTS
WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
37
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.
The Company has significantly reduced its long-term debt obligations.
Currently, there remain a few settlements of accounts payable obligations that
will be paid out over terms from 18 months to 36 months, the long term portion
of which may be exposed to interest rate risk. In addition, the Company is
exposed to interest rate risk on its fixed rate long-term working capital loans.
Currently, the principal amount of these long-term fixed rate debt obligations
totaled approximately $1.15 million. The working capital loans bear interest at
a fixed rate of 12% 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.
38
DESCRIPTION OF BUSINESS
The Company
EarthShell(R) Corporation ("EarthShell" or the "Company") was organized in
November 1992 to engage in the commercialization of a proprietary composite
material technology, designed with the environment in mind, for the manufacture
of disposable packaging to be used in the foodservice industry. Current and
future products include hinged-lid containers, plates, bowls, foodservice wraps,
cups, and cutlery ("EarthShell Packaging").
The EarthShell composite material is primarily made from abundantly
available and low cost natural raw materials such as limestone and starch from
annually renewable crops such as corn and potatoes. The Company believes that
foodservice disposables made of this material will offer certain significant
environmental benefits, will have comparable or superior performance
characteristics, such as greater strength and rigidity, and can be commercially
produced and sold at prices that are competitive with comparable conventional
paper and plastic foodservice disposables.
The Company's objective is to establish EarthShell Packaging(R) as the
preferred disposable packaging material for the foodservice industry throughout
the world based on comparable performance, environmental superiority and
competitive pricing. EarthShell's approach for achieving this objective has been
to: (i) license the EarthShell technology to strategically selected
manufacturing or operating partners to manufacture, market, distribute and sell
EarthShell Packaging; (ii) demonstrate customer acceptance and demand for
EarthShell Packaging through key market leaders and environmental groups; and
(iii) demonstrate the manufacturability and improved economics with initial
strategic partners.
Industry Overview
Based on industry studies, the Company believes that the annual spending
on foodservice disposable packaging is approximately $12 billion in the U.S. and
over $28 billion globally. According to industry studies of the U.S. market,
approximately 54% of the total foodservice disposable packaging is purchased by
quick-service restaurants and 46% by other institutions such as hospitals,
stadiums, airlines, schools, restaurants (other than quick-service restaurants),
and retail stores. The Company believes that of the foodservice disposables
purchased in the U.S. by quick-service restaurants and other institutions,
approximately 45% are made of coated or plastic laminated paper and 55% are made
of non-paper materials such as plastic, polystyrene or foil. A breakdown of the
various components of the global market for foodservice disposables is as
follows:
Market Size
$ %
----------------------------------------
($ in millions)
Commercial Products
Plates, Bowls $4,500 16%
Hinged-Lid Containers 1,750 6
Commercial Prototypes
Wraps 2,000 7
Hot Cups 3,000 11
Concept Prototypes
Cold Cups 5,500 20
Containers, Trays 4,000 14
Straws, Cup Lids 3,000 11
Pizza Boxes 2,250 8
Cutlery 2,000 7
------- ---
Total $28,000 100%
======= ===
39
In addition to the U.S., the Company believes the market opportunity for
EarthShell Packaging is particularly strong in Europe and parts of Asia due to
heightened environmental concerns and government regulations. In Europe,
environmental legislation, such as the so-called "Green Dot" laws have created
an opportunity for environmentally preferable products. Meanwhile, new
regulations in many Asian countries have mandated a reduction in polystyrene
production stimulating an increased demand for foodservice packaging
manufactured from acceptable alternative materials. Furthermore, improvements in
the Asian and European composting and recycling infrastructure are expected to
facilitate the use of environmentally preferable products.
Products
EarthShell Packaging is based on a patented composite material technology
licensed on an exclusive worldwide basis from E. Khashoggi Industries LLC, the
largest stockholder of the Company, and, on a limited exclusive, worldwide
basis, from its wholly-owned subsidiaries (collectively "EKI"). The Company's
licensed field of use of the technology is for the development, manufacture and
sale of disposable packaging for use in the foodservice industry and for certain
specific food packaging applications.
Traditional foodservice disposables, wraps, and paperboard are currently
manufactured from a variety of materials, including paper and plastic. The
Company believes that none of these materials fully addresses three of the
principal challenges facing the foodservice industry; namely performance, price,
and environmental impact. The Company believes that EarthShell Packaging
addresses the combination of these challenges better than traditional
alternatives and therefore will be able to achieve a significant share of the
foodservice disposable packaging market.
EarthShell Packaging can be categorized into four types: laminated foamed
products, flexible wraps, injection-molded products and paperboard substitutes.
To date, the EarthShell technology has been used to produce limited commercial
quantities of plates, bowls, and hinged-lid containers intended for use by all
segments of the foodservice disposable packaging market, including quick-service
restaurants, food and facilities management companies, the U.S. government,
universities/colleges, and retail operations. These products were developed
using detailed environmental assessments and carefully selected raw materials
and processes to minimize the harmful impact on the environment without
sacrificing competitive price or performance.
Environment
EarthShell's foodservice disposable products were developed over many
years based on environmental models to reduce the environmental concerns of
foodservice disposable packaging through the careful selection of raw materials,
manufacturing processes and suppliers. For example, EarthShell Packaging reduces
risk to wildlife compared to polystyrene foam packaging because it biodegrades
when exposed to moisture in nature and can be composted in a commercial facility
(where available) or even in consumers' backyards. EarthShell Packaging and the
designs approach for its manufacture and disposal has received support from many
governmental and non-governmental organizations.
Performance
The Company believes that it has demonstrated that its laminated foam
products, including hinged-lid containers, plates and bowls meet the critical
performance requirements of the marketplace, including strength, graphic
capabilities, insulation, shipping, handling and packaging. The Company believes
its foodservice wraps also meet critical performance requirements of the
marketplace, including flexibility, folding characteristics, graphic
capabilities, insulation, shipping, handling and packaging. Finally, the Company
believes that its paperboard substitute product, which is currently under
development, may be manufactured using the same basic raw materials as the foam
laminate disposables and wraps and will be readily accepted by the market when
available.
40
Some examples of where EarthShell Packaging plates, bowls, and hinged-lid
containers have been used include:
Quick-Service Restaurants McDonald's Corporation ("McDonalds")
Wendy's
Facilities Management Sodexho
Bon Appetit
Aramark
Government U.S. Department of the Interior
U.S. Department of Defense
Environmental Protection Agency
Universities University of California, Davis
Hampshire College
Allegheny College
Retail Wal-Mart Stores
Green Earth Office Supply
Cost
Since EarthShell Packaging is uniquely engineered from readily available,
low-cost natural raw materials such as limestone and starch, the Company
believes EarthShell products can be manufactured cost-effectively at commercial
production levels.
Business Strategy
The Company' objective is to establish EarthShell Packaging as the
preferred foodservice disposable packaging in the foodservice industry. The
Company's strategies to achieve this objective are to:
o Develop products which deliver comparable or greater performance,
are competitively priced and offer environmental advantages as compared to
traditional packaging alternatives
o Demonstrate customer demand as well as product performance and
positioning
o Educate the market and build awareness for the EarthShell brand
o Prove manufacturability and economics of EarthShell Packaging
o License the EarthShell technology to strategic manufacturing
partners to manufacture, market, distribute and sell EarthShell Packaging
o Expand the business by replicating the EarthShell model across
multiple operating partners to increase capacity
The Company believes that the use of EarthShell Packaging by key
foodservice operators will accelerate the acceptance of the products by other
users. To this end, the Company has worked with major purchasers of foodservice
disposables in the development and testing of products in order to demonstrate
superior product performance, highlight cost-benefit and build demand for
EarthShell Packaging. The Company also expects that the EarthShell Packaging
brand name will appear on EarthShell products.
41
The Company's strategy includes licensing the EarthShell technology to, or
joint venturing with, strategically selected manufacturing or operating partners
for the manufacture, marketing, distribution and sale of EarthShell Packaging.
During 2004, the Company terminated its license agreements with Sweetheart/Solo
and with Huhtamaki as those relationships had not progressed as planned. The
Company entered into three new license agreements -- with Meridian Business
Solutions ("MBS") for the U.S. market another with EarthShell Hidalgo S.A. de
C.V. for a segment of the Mexican market, and with Hood Packaging ("Hood") to be
the exclusive manufacturer of EarthShell food wraps for the North American
market. The Company is seeking additional qualified licensees and will provide
each of its licensees with technical and ongoing support to facilitate the
application of the EarthShell technology, further refine the manufacturing
processes and reduce production costs. The Company will monitor product quality
at licensee operations.
Over the past several years, the Company has garnered support and achieved
commercial validation for EarthShell Packaging from key environmental groups and
foodservice purchasers. The Company has also devoted resources to the
optimization of product design and the development of cost-effective
manufacturing processes. In cooperation with former manufacturing partners, the
Company financed and built initial commercial demonstration production capacity
and sold limited quantities of plates, bowls, and hinged-lid containers. Having
demonstrated the manufacturability of EarthShell foam products, the Company has
now ceased commercial demonstration production activities and is relying on its
equipment manufacturing partners to demonstrate and guarantee the long-term
manufacturability of EarthShell Packaging(R).
EarthShell believes it has a high quality and cost-effective product and a
profitable business model necessary to take advantage of a significant market
opportunity. With the introduction of commercial production capacity by its
licensees and commercial sales of its products in 2005, EarthShell expects its
products to continue to gain acceptance in the marketplace and believes it is
well-poised to support capacity expansion and market penetration by its
licensees leading to growth of the Company's royalty revenue.
Licensing Business Model
The licensing business model enables the Company to concentrate on the
continuing development of quality food service packaging products with reduced
impact on the environment. This approach contemplates that manufacturing,
marketing, distribution and sale of EarthShell Packaging will be the
responsibility of the Company's manufacturing licensees. EarthShell believes
that its licensing business model will enable it to generate a sustainable
royalty revenue stream. Beyond the revenue opportunities, the Company believes
the licensing business model has positive implications for the Company's cost
structure. As the Company has moved from product and process development toward
product commercialization phase and has reduced its investment in demonstration
manufacturing operations, it has been able to significantly reduce monthly
operating costs and reposition itself to take advantage of the operating
leverage provided by the licensing model.
EarthShell Packaging will be exclusively manufactured by licensed
manufacturing partners. Given the low cost of the raw materials required, these
strategic manufacturing partners should have a financial incentive to produce
EarthShell Packaging rather than comparable traditional paperboard/polystyrene
products even after making the required royalty payments to EarthShell. As the
first turnkey commercial manufacturing equipment is successfully placed in
service by its first licensee, the Company expects that other licensees will
then move quickly to invest to build additional new manufacturing capacity.
While the Company believes it will be successful in developing cost
competitive products with its partners, delays in developing such products could
adversely impact the introduction and market acceptance of EarthShell Packaging
and could have an adverse effect on the Company's business, financial condition
and results of operations.
Strategic Manufacturing and Distribution Relationships
The Company believes that it has demonstrated that the performance of
EarthShell plates, bowls and hinged-lid containers is commercially competitive
and that there is a customer base that is willing to buy them. The critical task
for 2005 is the installation and start-up of commercial manufacturing capacity
by the Company's licensees to supply EarthShell products to the marketplace. The
Company's current licensees are committing capital to purchase equipment to
provide EarthShell Packaging products or otherwise develop the EarthShell
products or production capacity. The Company intends to proliferate the use of
EarthShell Packaging in the U.S. and international markets through agreements
with additional licensed partners.
Meridian Business Solutions. In May 2004, the Company entered into a ten
year license agreement with MBS for the United States and granted to MBS a
priority license to supply certain retail and government market segments. MBS
has paid EarthShell $500,000 in technology fees to date. Under the terms of the
license agreement, in order to retain its priority in its market segments, MBS
must acquire manufacturing capacity to supply its market segments and meet other
minimum performance criteria. As the machinery orders are finalized and the
manufacturing equipment is built and put into service, MBS will pay an
additional $1.5 million in technology fees. All of the technology fees thus paid
will be credited against future royalties. At present, since EarthShell has a
limited number of initial licensees, MBS potentially represents more than 10% of
EarthShell's current revenue base. Once MBS is in production and paying
royalties to EarthShell, loss of MBS as a licensee could have a material adverse
consequence.
42
EarthShell Hidalgo. In November of 2004, the Company entered into a ten
year license agreement with ESH as the Company's exclusive licensee for the
country of Mexico. To date, they have paid the Company a $1,000,000 technology
fee that will be credited against future royalty obligations. Under the terms of
the license agreement, in order to retain its priority in its market segments,
ESH must acquire manufacturing capacity to supply its market segments and meet
other minimum performance criteria. At present, since EarthShell has a limited
number of initial licensees, ESH potentially represents more than 10% of
EarthShell's revenue base. Once ESH is in production and paying royalties to
EarthShell, loss of ESH as a licensee could have a material adverse consequence.
Hood Packaging. In February 2004, the Company entered into a definitive
license agreement with Hood Packaging under which Hood became the exclusive
manufacturer/distributor of EarthShell food wraps for the North American market,
subject to maintaining certain monthly and annual performance targets. Hood is
currently working on refining the manufacturing process prior to introducing
wraps into selected markets.
Manufacturing
The current EarthShell manufacturing process for laminated foamed products
consists of blending the component ingredients of a proprietary composite
material in a mixer, depositing the mixture into heated cavity molds, heating
the molded mixture for approximately one minute, removing the product, trimming
excess material, and applying functional coatings with desired graphics.
EarthShell Packaging uses readily available natural raw materials, such as
limestone, potato or corn starch, as well as natural fiber and functional
coatings. The Company believes that these raw materials are currently available
from multiple existing suppliers in quantities sufficient to satisfy projected
demand.
Over the past several years, the Company has devoted resources to develop
manufacturing machinery and to demonstrate the commercial viability of its
manufacturing processes to enable its operating partners to compete effectively
with conventional disposable foodservice packaging and to transfer the
operational and financial responsibility of its production lines to its
operating partners. In cooperation with former manufacturing partners, the
Company financed and built initial commercial production capacity. To date, the
Company has produced limited amounts of EarthShell Packaging bowls, plates and
hinged-lid containers at production volumes that are low relative to the
intended and necessary capacities of the manufacturing lines that are required
to achieve efficiencies and cost effectiveness. Although the manufacturing
processes currently being used to manufacture EarthShell Packaging are based on
generally available methods and equipment, it has taken much longer and has cost
much more than anticipated to integrate the machinery in an automated fashion
and to refine the manufacturing processes and equipment to operate at
commercially viable levels. Having demonstrated the manufacturability of
EarthShell foam products, the Company has now ceased commercial demonstration
production activities and is relying on its equipment manufacturing partners to
demonstrate and guarantee the long-term manufacturability of EarthShell
Packaging(R).
Detroit Tool & Engineering ("DTE"). DTE was one of the initial equipment
manufacturers to work with EarthShell in developing its first generation
commercial manufacturing equipment. In 2002, EarthShell granted a license to DTE
to become an approved EarthShell equipment supplier. In early 2005, the Company
extended the license through 2007 with exclusivity to manufacture equipment for
production of shallow draw products. Building on previous experience with
EarthShell manufacturing, DTE designed and built a modular and integrated,
turn-key manufacturing line for the production of EarthShell plates and bowls,
comprising four plate and four bowl manufacturing modules and has demonstrated
to EarthShell's satisfaction that this equipment is fully capable of continuous
commercial service. This equipment was planned for delivery, installation and
start-up in early 2004 with one of EarthShell's licensees. However, due to a
change in EarthShell licensees, as well as a reorganization of DTE that was
completed in late 2004, the placement of this equipment was delayed. As of early
2005, these first eight commercial modules have been moved from DTE's
fabrication floor and partially installed in a manufacturing hall owned by DTE
and in close proximity to the fabrication facility. The Company is negotiating a
license agreement with a new licensee which has expressed an interest in
acquiring this equipment from DTE and beginning manufacturing operations.
Currently, the Company expects that this equipment will be placed in service
during the remaining part of 2005.
Patents, Proprietary Rights and Trademarks
The technology that the Company licenses from EKI is the subject of
numerous issued and pending patents in the U.S. and internationally. The Company
believes the patents and pending patent applications provide broad protection
covering foam laminate EarthShell Packaging, material composition and the
manufacturing processes. Currently, EKI has over 130 U.S. and international
patents and has pending patent applications relating to the compositions,
products and manufacturing processes used to produce EarthShell Packaging(R)
food and beverage containers. Patents currently issued do not begin to expire
until 2012 and provide some protection until 2020. Pending patents, if granted,
would extend protection through 2022. Sixteen of the issued U.S. patents and
43
five of the pending U.S. patents relate specifically to molded food and beverage
containers manufactured from the new composite material, the formulation of the
new composite material used in virtually all of the EarthShell Packaging are
currently under development. The Company and EKI will continue to seek domestic
and international patent protection for further developments in the technology
and will vigorously enforce rights against any person infringing on the
technology.
The Company owns the EarthShell trademark and certain other trademarks,
and has been licensed by EKI to use the trademark ALI-ITE for the composite
material.
Relationship with and Reliance on EKI
The Company has an exclusive, worldwide, royalty-free license in
perpetuity 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).
On July 29, 2002, the Company entered into an amendment to its Amended and
Restated License Agreement with EKI (the "License Agreement") expanding the
field of use for the EarthShell technology to include noodle bowls used for
packaging instant noodles, a worldwide market that the Company estimates to be
approximately $1 billion. Because the noodle bowl development was made at no
cost to EarthShell and is an incremental field of use, EarthShell will pay to
EKI 50% of any royalty or other consideration it receives in connection with the
sale of products within this particular field of use.
In addition, on July 29, 2002 the Company entered into a License &
Information Transfer Agreement with bio-tec Biologische Naturverpackungen GmbH &
Co. KG and bio-tec Biologische Naturverpackungen Forschungs und Entwicklungs
GmbH, together known as "Biotec", a wholly owned subsidiary of EKI, to utilize
the Biotec technology for foodservice disposable packaging applications,
including food wraps and cutlery applications (the "Biotec Agreement"). EKI had
previously granted to the Company priority rights to license certain product
applications on an exclusive basis from Biotec in consideration for the
Company's payment of a $100,000 minimum monthly payment to Biotec. In addition,
in consideration of the monthly payment, Biotec agreed to render technical
services to the Company at Biotec's cost plus 5%. The licensing fee and services
arrangements were continued in the Biotec Agreement. Under the terms of the
Biotec Agreement, Biotec is entitled to receive 25% of any royalties or other
consideration that the Company receives in connection with the sale of products
utilizing the Biotec technology, after applying a credit for all minimum monthly
payments received to date. In connection with the issuance of EarthShell's 2006
Convertible Debentures, Biotec agreed to subordinate the licensee fee payments
due from EarthShell until the debentures were retired. During this period, the
license fees due to Biotec were accrued. In September of 2004, as part of an
overall restructuring of its debt, EarthShell and Biotec entered into an
agreement to convert $1.475 million of the $2.475 million of accrued license
fees as of September 1, 2004, plus accrued interest into 491,778 shares of
EarthShell common stock and to eliminate, for two years, the $100,000 per month
minimum license fee. In December of 2004, the agreement was amended and
EarthShell paid to Biotec $125,000, leaving a balance owing of $875,000.
During 2002 and January 2003, EKI made a series of loans to the Company
totaling approximately $5.8 million. In connection with the issuance and sale in
March 2003 of the Company's 2% secured convertible debentures due in 2006 (the
"2006 Debentures") to a group of institutional investors, EKI agreed to
subordinate the repayment of these loans to the payment in full of the Company's
obligations under the 2006 Debentures. In addition, EKI and Biotec agreed to
subordinate certain payments referenced above to which they were otherwise
entitled under the License Agreement and the Biotec Agreement to the
satisfaction in full of the Company's obligations under the 2006 Debentures.
They further agreed not to assert any claims against the Company for breaches of
the License Agreement or the Biotec Agreement until such time as the Company's
obligations under the 2006 Debentures were satisfied in full. EKI and Biotec
also agreed to allow the Company to pledge its interest in the License Agreement
to secure its 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 License Agreement and the Biotec
Agreement to third parties in an insolvency context. These rights terminated
upon the satisfaction in full of the obligations under the 2006 Debentures in
October of 2004. In consideration for its willingness to subordinate the
payments and advances that were owed to it, the Company issued to EKI in March
2003 a warrant to acquire 83,333 shares of the Company's common stock at a price
of $6.00 per share with a ten year term.
44
In October 2004, in connection with the settlement of the March 2006
Debentures, EKI converted all of its outstanding loans to EarthShell
($2,755,000) into unregistered common stock at $3 per share and $532,644 of
accumulated interest at $4 per share for a total of 1,051,494 shares received by
EKI. As of December 31, 2004, the loans from EKI to EarthShell had all been
retired. In May of 2005, an additional 44,387 shares were issued to EKI pursuant
to a 90 day price protection clause, which provided for an adjustment in the
effective conversion price of the interest portions of the EKI loans from $4 per
share to $3 per share.
In May of 2005, the Company granted a 10-year warrant to EKI to purchase
one million shares of the Company's common stock at $3 per share in
consideration of EKI's continued support of the Company since its inception,
including providing bridge loans at below market terms from time to time.
Also in May of 2005, the Company issued an additional 44,387 shares of
unregistered common stock to EKI pursuant to a provision of the EKI conversion
agreement which provided for the issuance of these additional shares if the
Company did not sell equity to a third party within 90 days of the initial
conversion at a price of at least $4 per share.
Under the terms of the License Agreement and the Amended and Restated
Patent Agreement for the Allocation of Patent Costs between the Company and EKI,
any patents granted in connection with the EarthShell technology are the
property of EKI, and EKI may obtain a benefit therefrom, including the
utilization and/or licensing of the patents and related technology in a manner
or for uses unrelated to the license granted to the Company in the foodservice
disposables field of use. Effective January 1, 2001, EarthShell assumed direct
responsibility to manage and maintain the patent portfolio underlying the
License Agreement with EKI and continues to pay directly all relevant costs.
Competition
Competition among food and beverage container manufacturers in the
foodservice industry is intense. Virtually all of these competitors have greater
financial and marketing resources at their disposal than does the Company, and
many have established supply, production and distribution relationships and
channels. Companies producing competitive products may reduce their prices or
engage in advertising or marketing campaigns designed to protect their
respective market shares and impede market acceptance of EarthShell Packaging.
In addition, some of the Company's licensees and joint venture partners
manufacture paper, plastic or foil packaging that may compete with EarthShell
Packaging.
Several paper and plastic disposable packaging manufacturers and
converters and others have made efforts to increase the recycling of these
products. Increased recycling of paper and plastic products could lessen their
harmful environmental impact, one major basis upon which the Company intends to
compete. A number of companies have introduced or are attempting to develop
biodegradable starch-based materials, plastics, or other materials that may be
positioned as potential environmentally superior packaging alternatives. It is
expected that many existing packaging manufacturers may actively seek to develop
competitive alternatives to the Company's products and processes. While the
Company believes its patents uniquely position it to incorporate a proportion of
low cost, inorganic fillers with its material, which, relative to other
starch-based or specialty polymers, will result in lower material costs, the
development of competitive, environmentally attractive, disposable foodservice
packaging could render the Company's technology obsolete and could have an
adverse effect on the business, financial condition and results of operations of
the Company.
Government Regulation
The manufacture, sale and use of EarthShell Packaging are subject to
regulation by the U.S. Food and Drug Administration (the "FDA"). The FDA's
regulations are concerned with substances used in food packaging materials, not
with specific finished food packaging products. Thus, food and beverage
containers are in compliance with FDA regulations if the components used in the
food and beverage containers: (i) are approved by the FDA as indirect food
additives for their intended uses and comply with the applicable FDA indirect
food additive regulations; or (ii) are generally recognized as safe for their
intended uses and are of suitable purity for those intended uses.
The Company believes that EarthShell Packaging plates, bowls and
hinged-lid containers and all other current and prototype EarthShell Packaging
products of the Company are in compliance with all requirements of the FDA and
do not require additional FDA approval. The Company cannot be certain, however,
that the FDA will agree with these conclusions.
Management And Employees
Currently, the Company has 8 employees. The Company's employees are not
represented by a labor union, and the Company believes it has a good
relationship with its employees.
The Company established a qualified 401(k) plan for all of its employees
in 1998. The 401(k) plan allows employees to contribute, on a tax-deferred
basis, up to fifteen percent of their annual base compensation subject to
certain regulatory and plan limitations. The Company uses a discretionary
matching formula that matches one half of the employee's 401(k) deferral up to a
maximum of six percent of annual base compensation. The 401(k) employer match
was $24,311 in 2004, $44,057 in 2003, and $74,853 in 2002.
45
Description Of Property
In November 2004, the Company relocated its offices to its current
location at 3916 State Street in Santa Barbara, California. The office space is
shared with EKI under a month to month sublease. The Company's monthly lease
payment for approximately 2,000 square foor of office space and is approximately
$4,000. In addition, the Company leases 3,353 square feet of office space in
Lutherville, Maryland, on a month to month basis. The Company's monthly lease
payment with respect to this space is $5,780.
The Company believes it will be able to lease comparable space at a
comparable price when these leases expire.
Legal Proceedings
The Company is engaged in litigation with two equipment suppliers seeking
to collect a total of approximately $600,000 for manufacturing equipment in
connection with the Company's former Goettingen, Germany manufacturing line that
is no longer in service. The entire amount claimed in the litigation has already
been accrued as part of the Company's accounts payable. The Company believes
that it has good defenses and counterclaims inasmuch as the equipment did not
reach the performance requirements specified in the purchase contracts, and
expects to settle the respective matters soon.
46
MANAGEMENT
Executive Officers
The following table sets forth the names, ages and positions of each of
the Company's executive officers. Subject to rights under any employment
agreements, officers of the Company serve at the pleasure of the Board of
Directors.
Name Age Position Officer Since
------------------------- --------- ------------------------------------------------------ ------------
Simon K. Hodson.......... 50 Vice Chairman of the Board and Chief Executive Officer 1992
D. Scott Houston......... 50 Chief Financial Officer and Secretary 1993
Vincent J. Truant........ 57 President and Chief Operating Officer 1998
----------
The following is a biographical summary of the experience of each of
the executive officers:
Simon K. Hodson has served as Vice Chairman of the Board and Chief
Executive Officer of the Company since its organization in November 1992.
Additionally, Mr. Hodson served as President of the Company from May 1999 until
May 2002, and previously from December 1995 until May 1996. Mr. Hodson has also
served as President and Vice Chairman of EKI and its predecessor entity since
their organization in October 1997 and June 1991, respectively, and as President
and Vice Chairman of Concrete Technology Corporation ("CTC") since August 1987.
Mr. Hodson was President of National Cement & Ceramics Laboratories, Inc., a
company previously engaged in materials science research, from June 1990 through
1995. He is a co-inventor of a number of U.S. and foreign patented inventions,
all belonging to EKI.
D. Scott Houston has served as the Company's Chief Financial Officer since
October 1999, and the Company's Secretary since December 1999. From January to
October 1999, Mr. Houston served as Senior Vice President of Corporate Planning
and Assistant Secretary. From July 1993 until January 1999, Mr. Houston served
as Chief Financial Officer. From August 1986 until joining the Company, he held
various positions with EKI and its affiliates, including Chief Financial Officer
and Vice President of CTC from 1986 to 1990. From 1984 to 1986, Mr. Houston
operated Houston & Associates, a consulting firm. From July 1980 until September
1983, Mr. Houston held various positions with the Management Information
Consulting Division of Arthur Andersen & Co., an international accounting and
consulting firm.
Vincent J. Truant has served as the Company's President and Chief
Operating Officer since May 15, 2002. From March 2001 to May 2002, Mr. Truant
served as Senior Vice President and Chief Marketing Officer. From October 1999
to March 2001, and from March 1999 to October 1999, respectively, he served as
Senior Vice President and as Vice President of Marketing, Environmental Affairs
and Public Relations, and from April 1998 to March 1999 as Vice President of
Marketing and Sales. During a prior 15-year tenure at Sweetheart Cup Company
("Sweetheart"), Mr. Truant served as Vice President and General Manager for the
National Accounts Group and the McDonald's Corporation Strategic Business Units.
Before joining Sweetheart, Mr. Truant was engaged in both domestic and
international marketing assignments for Philip Morris Inc. and its subsidiary,
Miller Brewing Company, as well as Eli Lilly & Company.
Directors
The Board of Directors of the Company is currently comprised of six
members. All directors are elected each year at the annual meeting of
stockholders. The following table sets forth the name and age of each director
nominated for reelection at this year's annual meeting of shareholders, the year
the director was first elected and his or her position with the Company:
Name Age Position Director Since
------------------------- --------- ------------------------------------------------------ --------------
Essam Khashoggi.......... 65 Chairman of the Board 1992
Simon K. Hodson.......... 50 Vice Chairman of the Board and Chief Executive Officer 1992
John Daoud............... 69 Director 1992
Layla Khashoggi.......... 47 Director 1992
Hamlin M. Jennings....... 57 Director 2003
Walker Rast.............. 69 Director 2003
----------
47
The following is a biographical summary of the experience of each of the
directors. For a biographical summary of the experience of Mr. Hodson, kindly
refer to the summaries of Executive Officers' experience provided above:
Essam Khashoggi has served as Chairman of the Board of the Company since
its organization in November 1992. Mr. Khashoggi has also served as Chairman of
the Management Committee and Chief Executive Officer of E. Khashoggi Industries,
LLC ("EKI") and its predecessor entity, E. Khashoggi Industries, since their
organization in October 1997 and June 1991, respectively. Mr. Khashoggi has
served as a director and officer of a number of domestic and foreign companies
engaged in licensing, manufacturing, real estate, marketing and design and he
has served as a Trustee for the University of California Santa Barbara
Foundation.
John Daoud has served as a Director of the Company since its organization
in November 1992. Mr. Daoud served as Secretary of the Company from October 1996
through December 1999 and as the Assistant Secretary of the Company from June
1993 until October 1996. Mr. Daoud has also served as the Chief Financial
Officer and Secretary of EKI and its predecessor entity since their organization
in October 1997 and June 1991, respectively, and as the Manager and Principal
Officer of Condas International, LLC and its predecessor from 1987 through
October 2003. Since 1972, Mr. Daoud has advised Mr. Khashoggi and his affiliated
entities on certain financial matters both in an individual capacity as well as
Manager and Principal Officer of Condas International, LLC and its predecessor.
From 1970 to 1972, Mr. Daoud was a Senior Auditor with PricewaterhouseCoopers.
Layla Khashoggi has served as a Director of the Company since its
organization in November 1992. Mrs. Khashoggi has also been a member of the
Management Committee of EKI since its organization in October 1997 and a
Director of CTC for the past five years. Mrs. Khashoggi has served as Chairman
of the Development Committee and as an Executive Committee member of the Board
of Laguna Blanca School, Site Council Member and Co-Chairman of the Budget
Committee of San Marcos High School, Executive Committee member and Chairman of
the Marketing Committee of the Santa Barbara Zoo Board, and member of the Board
of Trustees of the Santa Barbara Public Education Foundation. Mrs. Khashoggi is
Essam Khashoggi's spouse.
Hamlin M. Jennings has served as a Director of the Company since January
1, 2003. Since 1987, Dr. Jennings has been a Professor in the Civil and
Environmental Engineering Department and the Materials Sciences and Engineering
Department at Northwestern University. In 2002, he assumed the Chairmanship of
the Civil and Environmental Engineering Department. Prior to his appointment at
Northwestern, Dr. Jennings worked at the National Institute of Standards and
Technology, Imperial College London, and the University of Cape Town. He is a
fellow of the Institute of Materials in the United Kingdom and Fellow of the
American Ceramic Society. Dr. Jennings received a Ph.D. in materials science
from Brown University in 1975, and a Bachelor of Science in Physics from Tufts
University in 1969. Additionally, Dr. Jennings is owner and President of
Evanston Materials Consulting Corporation, founded in 1997, which specializes in
cement-based materials and coatings. Dr. Jennings holds 12 patents, is the
associate editor of two journals and has published over 120 scientific papers.
Walker Rast has served as a Director of the Company since September 2003,
when he was appointed to fill the vacancy created by the resignation of Mr. Bert
Moyer from the Board in August 2003. Mr. Rast is currently a business consultant
and a member of the Educational Foundation Board of the University of South
Carolina and a member of the Advisory Board of the College of Engineering and
Information Technology. From 1987 to 1994, Mr. Rast was a member of the
Executive Board of Directors of Royal Packaging Industries Van Leer, a worldwide
packaging company based in the Netherlands. From 1979 to 1987, Mr. Rast was
President of Keyes Fibre Company (now know as The Chinet Company), first an
operating group of Arcata Corporation and then of Royal Packaging Industries Van
Leer. Mr. Rast held various executive positions with Arcata Corporation for over
ten years, and was previously with U.S. Gypsum Corporation for over ten years.
Committees of the Board of Directors
The Board maintains five standing committees: the Executive Committee of
the Board of Directors, the Audit Committee, the Compensation Committee, the
Stock Option Committee and the Conflicts Committee. The Company does not have a
standing Nominating Committee, as the Board believes that the process is best
conducted by the entire Board of Directors. Therefore, the Board performs the
functions of the nominating committee and the Company does not have a written
charter for such a committee.
48
Executive Committee
The primary function of the Executive Committee is to perform all of the
duties otherwise vested in the Board of Directors when the Board is not in
session, except for the following matters which have not been delegated to the
Executive Committee: (1) declaring cash or stock dividends or distributions to
stockholders of the Company; (2) taking action on matters otherwise specifically
delegated to other committees of the Board of Directors; (3) amending or
repealing the Certificate of Incorporation or Bylaws of the Company, or adopting
new ones; (4) approving a plan of merger, acquisition or divestiture or sale,
lease or exchange of substantially all of the business, properties or assets of
the Company; (5) authorizing or approving the issuance or sale of shares of
stock of the Company; (6) authorizing the Company to perform or make a contract
or commitment that is not contemplated by, or that requires a financial
commitment by the Company exceeding the applicable amount budgeted under the
operating Budget or capital Budget approved by the Board of Directors, if such
contract or commitment, together with any other such contract or commitment,
involves a payment by the Company of more than $1 million in the aggregate; and
(7) electing or removing officers, directors or members of any committee of the
Board of Directors.
Compensation Committee
The functions of the Compensation Committee include: (1) reviewing and
recommending to the Board of Directors the annual base salary, bonus and other
benefits for each of the senior executive officers of the Company; (2) reviewing
and commenting upon new executive compensation programs that the Company
proposes to adopt; (3) periodically reviewing the results of the Company's
executive compensation and perquisite programs to ensure that they are properly
coordinated to yield payments and benefits that are reasonably related to
executive performance; (4) ensuring that a significant portion of executive
compensation is reasonably related to the long-term interests of the
stockholders; (5) participating in the preparation of certain portions of the
Company's annual proxy statement; (6) hiring a compensation expert to provide
independent advice on compensation levels, if necessary; and (7) ensuring that
the Company undertakes appropriate planning for management succession and
advancement.
Audit Committee
The Company's Board of Directors has adopted a written charter for the
Audit Committee. The Audit Committee charter, revised on March 26, 2003,
outlines the functions of the Audit Committee, which include: (1) recommending
the engagement of an accounting firm to act as the Company's independent
external auditor (the "Auditor"); (2) reviewing the Auditor's compensation, the
proposed terms of its engagement, its independence from the Company and its
performance during each year of its engagement; (3) reviewing the Company's
annual financial statements and significant disputes, if any, between management
of the Company and the Auditor that arise in connection with the preparation of
those financial statements; (4) reviewing the results of each external audit;
(5) reviewing the procedures employed by the Company in preparing published
quarterly financial statements and related management commentaries; (6)
reviewing any major changes proposed to be made in auditing and accounting
principles and practices in connection with the Company's financial statements;
(7) reviewing the adequacy of the Company's internal financial controls; and (8)
if the Company appoints a Director of Internal Audit, meeting periodically with
that person to evaluate compliance with the foregoing duties. The members of the
audit committee are all independent within the meaning of the National
Association of Securities Dealers' listing standards. The Board of Directors has
determined that Dr. Roland qualifies as the "audit committee financial expert"
as that term is defined in Item 401(h)(2) of Regulation S-K in the Securities
Exchange Act of 1934.
Stock Option Committee
The Stock Option Committee is responsible for administering the Company's
1995 Stock Incentive Plan (the "Plan") including, without limitation, the
following: (1) adopting, amending and rescinding rules relating to the Plan; (2)
determining who may participate in the Plan and what awards may be granted to
such participants; (3) granting awards to participants and determining the terms
and conditions thereof, including the number of shares of Common Stock issuable
pursuant to the awards; (4) determining the terms and conditions of options
automatically granted to directors pursuant to the Plan; (5) determining whether
and the extent to which adjustments are required pursuant to the anti-dilution
provisions of the Plan; and (6) interpreting and construing the Plan and the
terms and conditions of any awards granted thereunder.
49
Conflicts Committee
The functions of the Conflicts Committee include: (1) reviewing proposed
transactions between the Company and (a) interested directors, (b) the
controlling stockholder, which is the parent of the Company and (c) other
similar transactions that involve possible questions of conflicts of interest or
self-dealing; (2) reviewing transactions or conduct involving the Company and an
interested director to determine whether each transaction is on at least as
favorable terms to the Company as might be available from other third parties;
(3) reviewing the fairness of transactions having self-dealing elements to
determine whether each is reasonably likely to further the Company's business
activities and interests; (4) reviewing the fairness of each transaction having
self-dealing elements to determine whether the process by which the decision to
enter into such a transaction was approved or ratified is fair; (5) ensuring
that minority public stockholders affected by a proposal are treated fairly; (6)
ensuring that all conflict-of-interest transactions are disclosed in the
Company's filings with the Securities and Exchange Commission; and (7) if
necessary, retaining an independent expert to determine the advisability of the
Company's entering into transactions involving a possible conflicts of interest,
and to determine fair terms for such proposed transactions.
Compensation of Directors
Under a compensation plan based on a study conducted by SCA Consulting
LLC, the Board pays to each non-employee director an annual retainer fee of
$20,000, payable quarterly, plus a fee of $1,000 for each regular meeting
attended in person. Committee chairpersons receive an additional $1,000 per
year. All of the directors, except for Mr. Hodson, are currently considered to
be non-employee directors of the Company.
The 1995 Stock Incentive Plan, as amended, provides that each non-employee
director automatically be granted options to purchase 2,083 shares of the
Company's Common Stock, effective at the conclusion of each annual meeting. All
such stock options (i) vest ratably at 25% at the end of each calendar quarter
following the grant, provided the director holding the options continues to
serve as a director at the end of each such quarter, and (ii) have an exercise
price equal to the "fair market value" of the underlying shares, which is
defined in the 1995 Stock Incentive Plan as the closing trading price on the day
before such annual meeting.
In April 2004, based on the financial condition of the Company, the Board
of Directors unanimously agreed to defer the payment of the Director fees
discussed above until such time as the financial condition of the Company
improves. As of March 31, 2005, the Company had accrued approximately $140,000
in Director's fees payable.
Code of Ethics
The Company has adopted a Code of Ethics that applies to all Directors,
officers and employees, including the chief executive officer, chief financial
officer and principal accounting officer of the Company.
50
Executive Compensation
The following table sets forth certain information with respect to the
compensation of the Named Executive Officers. The "Named Executive Officers"
include, (i) the Company's Chief Executive Officer (ii) the Company's executive
officers as of December 31, 2004 (iii) two additional individuals who were not
executive officers as of the year ended December 31, 2004. The Company did not
grant any restricted stock awards or stock appreciation rights or make any
long-term incentive plan payouts during the periods set forth below.
Summary Compensation Table
Long Term
Compensation
Annual Compensation Awards
----------------------------------------------------------------------------------------
Fiscal year Other Annual
Name and Ended Compensation Securities Underlying
Principal Position December 31 Salary ($)* Bonus ($) ($) Options (#)
Simon K. Hodson 2004 $500,000 (2) $ -- 2,750 (1) 400,000
Vice Chairman of the Board 2003 500,000 -- 2,250 (1) 41,667
and Chief Executive Officer 2002 500,000 -- 2,500 (1) 41,667
Vincent J. Truant 2004 350,000 -- 2,625 (1) 50,000
President and Chief 2003 350,000 -- 3,063 (1) 20,833
Operating Officer 2002 321,875 (3) -- 2,844 (1) 29,167
D. Scott Houston 2004 327,200 (4) -- 3,590 (1) 50,000
Chief Financial Officer 2003 327,200 (4) -- 2,454 (1) 20,833
and Secretary 2002 327,200 (4) -- 2,419 (1) 26,667
John B. Nevling (5) 2004 116,363 -- 2,677 (1) 50,000 (6)
V.P. Product Management 2003 104,565 -- 3,135 (1) --
and Environmental Affairs 2002 101,000 -- 3,030 (1) --
Michael P. Hawks (7) 2004 110,000 -- -- 35,000 (9)
Principal Accounting Officer 2003 60,849 (8) -- -- 4,167 (9)
2002 -- -- -- --
----------
*The Company provides various perquisites to its executives which, in accordance
with SEC regulations, are not itemized because their value is less than 10% of
the executive's salary.
(1) Reflects payments under the Company's 401(k) plan.
(2) Includes $141,667 deferred salary.
(3) Reflects a mid-year salary adjustment effective May 16, 2002 as a result of
Mr. Truant becoming President of the Company on that date. Mr. Truant's current
salary is $350,000.
(4) Includes $142,222 deferred salary and $7,200 in car allowance payments made
to Mr. Houston.
(5) Mr. Nevling is not and was not as of December 31, 2004 an executive officer
of the Company. Mr. Nevling resigned from his position with the Company March
2005.
(6) Options expired April 24, 2004 due to Mr. Nevling's resignation.
(7) Mr. Hawks resigned from his position with the Company in October 2004.
(8) Mr. Hawks was a temporary employee through an agency. In addition to Mr.
Hawks' salary for the remainder of 2003, the Company paid the agency $68,547 in
fees for his services from
(9) Options were not exercisable at December 31, 2004 due to Mr. Hawks
resignation.
51
Stock Option Grants in 2004
The following table sets forth information with respect to options to
purchase shares of the Company's Common Stock granted in 2004 to the Named
Executive Officers:
Potential Realizable Value at
Assumed Rates of Stock
Individual Grants Appreciation for Option Term (1)
------------------------------------------------------ ----------------------------------
Number of % of Total
Shares Options
Underlying Granted to Exercise
Name and Options Employees Price Expiration
Principal Position Granted (2) in 2004 (per share) Date 5% 10%
---------------------------- ----------- ----------- ----------- ----------- ----------- -----------
Simon K. Hodson............. 400,000 52.5% $0.75 6/25/2014 $488,668 $778,123
Vice Chairman of the
Board and Chief
Executive Officer
Vincent J. Truant........... 50,000 6.6% $0.75 6/25/2014 $61,084 $97,265
President and Chief
Operating Officer
D. Scott Houston............ 50,000 (3) 6.6% $0.75 6/25/2014 $61,084 $97,265
Chief Financial
Officer
and Secretary
John Nevling................ 50,000 6.6% $0.75 6/25/2014 $61,084 $97,265
Vice President of
Product
Management and
Environmental Affairs
Michael Hawks............... 35,000 4.6% $0.75 6/25/2014 $42,758 $68,086
Principal Accounting
Officer
----------
(1) The 5% and 10% assumed rates of appreciation are mandated by the rules of
the Securities and Exchange Commission and do not represent the Company's
estimate or projection of the future Common Stock price. In each case, the
Company would use the market price of the Common Stock on the date of
grant to compute the potential realizable values.
(2) Except for Mr. Houtson, the options granted to executives in 2004 become
vested and exercisable upon the completion by the Company of certain key
milestones, including 1) that EarthShell plates and bowls are supplied by
a licensee to a customer at a level equivalent to 1,500 Wal Mart stores
for a consecutive period of no less than three months, and 2) the product
supply economics must be consistent with the License Agreement between
EarthShell and the Licensee including royalty structure.
(3) The options granted to Mr. Houston become vested and exercisable upon 1)
resolution of all past due payables for not more than $800,000, 2) a
resolution of all pending litigation related to payables, and 3)
successful proxy solicitation for the re-scheduled Annual Meeting on July
26, 2004.
52
Aggregated Option Exercises In 2004 and 2004 Year End Option Values
The following table sets forth for the Named Executive Officers
information with respect to options exercised, unexercised options and year-end
option values, in each case with respect to options to purchase shares of the
Company's Common Stock.
Number of Securities Value of Unexercised
Underlying Unexercised In-The-Money Options at
Options at Fiscal Year End Fiscal
2004 Year End 2004 (1)
-------------------------- --------------------------
Shares
Name and Acquired on Value
Principal Position Exercise Realized Unexercisable Exercisable Unexercisable Exercisable
------------------ ------------ -------- ------------- ----------- ------------- -----------
Simon K. Hodson............. -- -- 483,334 -- $680,000 --
Vice Chairman of the
Board and Chief
Executive Officer
Vincent J. Truant........... -- -- 100,000 32,917 85,000 --
President and Chief
Operating Officer
D. Scott Houston............ -- -- 97,500 42,037 85,000 --
Chief Financial Officer
and Secretary
John Nevling................ -- -- 50,000 2,916 85,000 --
Vice President of Product
Management and
Environmental Affairs
Michael Hawks............... -- -- -- -- -- --
Principal Accounting
Officer
(1) The market price of the Company's common stock at December 31, 2004 was
$2.45.
Employment Agreements and Arrangements
Simon Hodson currently does not have a written employment agreement with
the Company. His previous employment agreement expired on September 30, 2001.
Mr. Hodson receives an annual salary of $500,000, subject to annual review and
increase at the discretion of the Board of Directors. He may also be entitled to
receive (i) an annual bonus, the amount of which is determined by the
Compensation Committee, and (ii) options or other rights to acquire Common
Stock, under terms and conditions determined by the Stock Option Committee. Mr.
Hodson may be terminated at any time with or without cause. In order to conserve
cash until the Company is able to establish its royalty revenue stream, Mr.
Hodson agreed to a 40% deferral of base salary resulting in cash compensation of
$300,000 per year effective April 16, 2004 resulting in the deferral of $141,667
for the year ended December 31, 2004.
D. Scott Houston entered into a written employment agreement with the
Company on October 19, 1993. Mr. Houston receives an annual salary of $320,000,
subject to annual review and increase at the discretion of the Board of
Directors. He may also be entitled to receive (i) an annual bonus, the amount of
which is determined by the Compensation Committee, and (ii) options or other
rights to acquire the Common Stock, under terms and conditions determined by the
Stock Option Committee. Mr. Houston may be terminated at any time, with or
without cause, upon thirty (30) days notice. In order to conserve cash until the
Company is able to establish its royalty revenue stream, Mr. Houston agreed to a
75% deferral of base salary resulting in cash compensation of $80,000 per year
effective April 16, 2004. As of October 16, 2004, the cash portion of Mr.
Houston's salary was adjusted to $213,333 per year. Total deferred compensation
for the year ended December 31, 2004 was $142,222.
53
Vincent J. Truant entered into an employment agreement with the Company
with a commencement date of May 1, 1998. From time to time, Mr. Truant has
received salary increases and incentive stock options as determined by the
Compensation and Options Commitees of the Board of Directors. Effective May 15,
2002, the Board increased Mr. Truant's salary to $350,000 in connection with his
new responsibilities as President and Chief Operating Officer. Mr. Truant may
also be entitled to receive (i) an annual bonus in an amount equal to one year's
base salary, provided certain financial and other milestones determined by Mr.
Truant and the Compensation Committee are met by Mr. Truant and the Company,
and, in the event such milestones are not met, or are significantly exceeded,
such other lesser or greater bonus as the Compensation Committee shall
determine, and (ii) options or other rights to acquire Common Stock, under terms
and conditions determined by the Stock Option Committee. Pursuant to the terms
of his employment agreement, Mr. Truant may be terminated at any time, with or
without cause, upon thirty (30) days written notice, provided that, if the
Company terminates Mr. Truant's employment for other than cause, he will be
entitled to receive a one-time severance payment equal to 100% of his
then-current annual base salary.
Compensation Committee Interlocks and Insider Participation
All decisions relating to executive compensation during 2004 were made by
the Company's Compensation Committee, which was comprised of Mr. Khashoggi, Mrs.
Khashoggi and Dr. Roland. None of the members of the Compensation Committee were
officers of the Company in 2004. Mr. Khashoggi is the controlling stockholder of
EKI, the Company's principal stockholder with whom the Company has certain
relationships and related transactions described below. Mr. Khashoggi is the
beneficial owner of 39.25% of the Common Stock of the Company.
The Company has an exclusive, worldwide, royalty-free license to use and
license EKI technology to manufacture and sell disposable, single-use containers
for packaging or serving food and beverages intended for consumption within a
short period of time (less than 24 hours).
On July 29, 2002, the Company entered into an amendment to its Amended and
Restated License Agreement with EKI (the "License Agreement") expanding the
field of use for the EarthShell technology to include noodle bowls used for
packaging instant noodles. Because the noodle bowl development was made at no
cost to EarthShell and is an incremental field of use, EarthShell will pay to
EKI 50% of any royalty or other consideration it receives in connection with the
sale of products within this field of use.
In addition, on July 29, 2002 the Company entered into a License &
Information Transfer Agreement with bio-tec Biologische Naturverpackungen GmbH &
Co. KG and bio-tec Biologische Naturverpackungen Forschungs und Entwicklungs
GmbH, together known as "Biotec", a wholly owned subsidiary of EKI, to utilize
the Biotec technology for foodservice disposable packaging applications,
including food wraps and cutlery (the "Biotec Agreement"). EKI had previously
granted to the Company priority rights to license certain product applications
on an exclusive basis from Biotec in consideration for the Company's payment of
a $100,000 minimum monthly payment to Biotec. In addition, in consideration of
the monthly payment, Biotec agreed to render technical services to the Company
at Biotec's cost plus 5%. The licensing fee and services arrangements were
continued in the Biotec Agreement. Under the terms of the Biotec Agreement,
Biotec is entitled to receive 25% of any royalties or other consideration that
the Company receives in connection with the sale of products utilizing the
Biotec technology, after applying a credit for all minimum monthly payments
received to date. In connection with the issuance of EarthShell's 2006
Convertible Debentures, Biotec agreed to subordinate the licensee fee payments
due from EarthShell until the debentures were retired. During this period, the
license fees due to Biotec were accrued. In September of 2004, as part of an
overall restructuring of its debt, EarthShell and Biotec entered into an
agreement to convert $1.475 million of the $2.475 million of accrued license
fees as of September 1, 2004, plus accrued interest into 491,778 shares of
EarthShell common stock and to eliminate, for two years, the $100,000 per month
minimum license fee. In December of 2004, the agreement was amended and
EarthShell paid to Biotec $125,000, leaving a balance owing of $875,000.
During 2002, and January 2003, EKI made a series of loans to the Company
totaling approximately $5.8 million. These loans were used to pay operating
costs, and accrued interest at 7% or 10% per annum. In connection with the
issuance and sale in March 2003 of the Company's 2% secured convertible
debentures due in 2006 (the "2006 Debentures") to a group of institutional
investors, EKI agreed to subordinate the repayment of these loans to the payment
in full of the Company's obligations under the 2006 Debentures. In addition, EKI
and Biotec agreed to subordinate certain payments to which they were otherwise
entitled under the License Agreement and the Biotec Agreement referenced above
(other than their respective percentages of any royalties received by the
Company) to the satisfaction in full of the Company's obligations under the 2006
Debentures. They further agreed to not assert any claims against the Company for
breaches of the License Agreement or the Biotec 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 its interest in the License Agreement to
secure its 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 License Agreement and the Biotec
Agreement 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, the Company issued to EKI in March 2003 an immediately vested
warrant to acquire 83,333 shares of the Company's common stock at a price of
$6.00 per share with a ten year term.
54
In October 2004, in connection with the settlement of the March 2006
Debentures, EKI converted all of its outstanding loans to EarthShell
($2,755,000) into unregistered common stock at $3 per share and $532,644 of
accumulated interest at $4 per share for a total of 1,051,494 shares received by
EKI. As of December 31, 2004, the loans from EKI to EarthShell had all been
retired. In May of 2005, an additional 44,387 shares were issued to EKI pursuant
to a 90 day price protection clause, which provided for an adjustment in the
effective conversion price of the interest portions of the EKI loans from $4 per
share to $3 per share.
Under the terms of the License Agreement and the Amended and Restated
Patent Agreement for the Allocation of Patent Costs between the Company and EKI,
any patents granted in connection with the EarthShell technology are the
property of EKI, and EKI may obtain a benefit therefrom, including the
utilization and/or licensing of the patents and related technology in a manner
or for uses unrelated to the license granted to the Company in the foodservice
disposables field of use. Effective January 1, 2001, EarthShell assumed direct
responsibility to manage and maintain the patent portfolio underlying the
License Agreement with EKI and continues to pay directly all relevant costs.
In July 2002, the Company extended a loan in the amount of $55,000 to Mr.
Vincent Truant, President and Chief Operating Officer. The loan, which bears
interest at 7% per annum and is evidenced by a promissory note in favor of the
Company, is due upon demand by the Company. In May of 2005, the Compensation
Committee of the Board of Directors approved a bonus to Mr. Truant equal to the
principle and accrued interest, and the note was cancelled.
In 2003, the Company paid Mr. Rast, a Director, a $4,000 consulting fee
for doing a detailed evaluation of its demonstration equipment in Europe.
In May of 2005, the Company granted a warrant to EKI to purchase one
million shares of the Company's common stock at $3 per share in consideration of
EKI's continued support of the Company since its inception, including providing
bridge loans at below market terms from time to time. The warrant expires in May
of 2015.
55
STOCK PERFORMANCE GRAPH
The graph below compares the cumulative total return on the Company's
Common Stock for the last five fiscal years to the total cumulative return on
the S&P 500 Index and the Dow Jones Containers & Packaging Industry Group Index
(USA). The comparison assumes $100 was invested in the Company's common stock
and the indexes on December 31, 1999 and assumes reinvestment of dividends
before consideration of income taxes.
The stock performance depicted in the graph below is not necessarily
indicative of future performance. The Stock Performance Graph shall not be
deemed to be "soliciting material" or to be "filed" with the Securities and
Exchange Commission or subject to Regulations 14A or 14C or to the liabilities
of Section 18 of the Exchange Act, except to the extent that the Company
specifically requests that such information be treated as soliciting material or
specifically incorporates it by reference into a filing under the Securities Act
or Exchange Act.
Comparison of Cumulative Total Shareholder Return
Since December 31, 1999
[TABLE BELOW REPRESENTS A LINE CHART IN THE ORIGINAL DOCUMENT.]
Indexed Total Return
EarthShell S&P 500 Dow Jones
Close Index Index CTR
-------------------------------------------------------
12/31/1999 100.0 100.0 100.0
12/31/2000 31.1 89.9 63.9
12/31/2001 48.5 78.1 79.3
12/31/2002 14.1 59.9 84.5
12/31/2003 3.6 75.7 99.6
12/31/2004 4.9 82.5 117.5
56
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information with respect to the
beneficial ownership of each class of the Company's voting securities as of June
9, 2005, by (i) each person or company known by the Company to be the beneficial
owner of more than 5% of the Company's outstanding shares, (ii) each director of
the Company or any nominee for directorship, (iii) the Chief Executive Officer
of the Company and each of the other Named Executive Officers and (iv) all
directors and Named Executive Officers of the Company as a group.
Percentage of Shares
Number of Shares of of Common Stock
Name and address (1) Common Stock Outstanding(2)
-------------------------------------------- ------------------- --------------------
Essam Khashoggi (3)......................... 7,664,449 39.25%
Simon K. Hodson (4)......................... 4,500 *
John Daoud (5).............................. 37,077 *
Layla Khashoggi (6)......................... 9,894 *
Hamlin Jennings (7)......................... 4,513 *
Walker Rast (8)............................. 1,562 *
Vincent J. Truant (9)....................... 37,083 *
D. Scott Houston (10)....................... 44,120 *
John Nevling................................ 2,916 *
Directors and Named Executive Officers
as agroup (11)........................... 7,806,114 39.70%
E. Khashoggi Industries, LLC(12)............ 6,720,891 34.43%
----------
* Indicates ownership of less than 1%.
(1) The address of all individuals, entities and stockholder groups listed in
the table is c/o EarthShell Corporation, 3916 State St. Suite 110, Santa
Barbara, California 93105.
(2) Applicable percentage of ownership is based on 18,435,452 shares of common
stock outstanding as of June 9, 2005, together with securities exercisable
or convertible into shares of common stock within 60 days of June 9, 2005,
for each stockholder. Beneficial ownership is determined in accordance
with the rules of the Securities and Exchange Commission and generally
includes voting or investment power with respect to securities. Shares of
common stock subject to securities exercisable or convertible into shares
of common stock that are currently exercisable or exercisable within 60
days of June 9, 2005 are deemed to be beneficially owned by the person
holding such securities for the purpose of computing the percentage of
ownership of such person, but are not treated as outstanding for the
purpose of computing the percentage ownership of any other person. Note
that affiliates are subject to Rule 144 and Insider trading regulations -
percentage computation is for form purposes only.
(3) Includes 5,637,558 shares held by E. Khashoggi Industries, LLC ("EKI"),
and 715,436 shares held by EKINVESCO, the controlling owner of each being
Mr. Khashoggi. Includes 218,228 shares held by other entities, including
CTC, in which Mr. Khashoggi also has a controlling ownership interest.
Also includes fully exercisable options to purchase 9,894 shares of Common
Stock issued by the Company to Mr. Khashoogi and warrants held by EKI to
purchase 1,083,333 shares of Common Stock of the Company. Mr. Khashoggi
has sole voting and dispositive power with respect to all shares referred
to in this note, and is therefore deemed to be the beneficial owner of
such shares.
(4) Mr. Hodson holds a minority ownership interest in EKI and CTC. This does
not include any of the shares held by EKI, or the 71,739 shares held by
CTC.
(5) Includes options to purchase 25,000 shares of Common Stock from EKI which
were issued to Mr. Daoud in his capacity as an officer of EKI, and options
to purchase 12,077 shares of Common Stock issued under the 1995 Stock
Incentive Plan, all of which are fully vested and exercisable.
(6) Includes options to purchase 9,894 shares of Common Stock issued under the
1995 Stock Incentive Plan, which are fully vested and exercisable.
(7) Includes options to purchase 4,513 shares of Common Stock issued under the
1995 Stock Incentive Plan, which are fully vested and exercisable.
(8) Includes options to purchase 1,562 shares of Common Stock issued under the
1995 Stock Incentive Plan, which are fully vested and exercisable.
(9) Includes options to purchase 32,917 shares of Common Stock issued under
the 1995 Stock Incentive Plan, which are fully vested and exercisable.
(10) Includes options to purchase 42,037 shares of Common Stock issued under
the 1995 Stock Incentive Plan which are fully vested and exercisable.
(11) Includes warrants to purchase 1,083,833 shares of Common Stock of the
Company and options to purchase 137,894 shares of Common Stock.
(12) Includes warrants to purchase 1,083,833 shares of Common Stock of the
Company.
57
Securities Authorized for Issuance Under Equity Compensation Plans
The following table provides information with respect to compensation
plans (including individual compensation arrangements) under which equity
securities of the Company are authorized for issuance to employees or
non-employees (such as directors, consultants, advisors, vendors, customers,
suppliers or lenders), as of December 31, 2004.
Equity Compensation Plan Information
Number
Of Securities
Remaining
Available
Number For Future
Of Securities Issuance
To Be Issued Weighted-Average Under Equity
Upon Exercise Exercise Price Compensation Plans
Of Outstanding Of Outstanding (Excluding
Options, Options, Securities
Warrants And Warrants And Reflected
Rights Rights In Column (a))
-------------- ---------------- ------------------
(a) (b) (c)
---------------------------------------------------------- -------------- ---------------- ------------------
Equity compensation plans approved by security holders 1,043,245 12.58 206,755
Equity compensation plans not approved by security holders -- -- --
========= ===== =======
TOTAL 1,043,245 12.58 206,755
========= ===== =======
58
MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S
COMMON EQUITY AND OTHER STOCKHOLDER MATTERS
The Company's common stock is currently listed on the Bulletin Board
published by the National Quotation Bureau, Inc., and prior to March 8, 2004
traded on the Nasdaq SmallCap Market. The Company's common stock trades under
the symbol "ERTH.OB." For the periods indicated, the following table presents
the range of high and low closing sale prices for the Company's common stock.
High Low
($) ($)
----------------------------------------------------------------
Year ended December 31, 2005:
First Quarter 2.45 1.48
Year ended December 31, 2004:
First Quarter 2.52 1.49
Second Quarter 2.03 0.45
Third Quarter 3.75 1.75
Fourth Quarter 2.97 1.95
Total Year 3.75 0.45
Year ended December 31, 2003:
First Quarter 7.80 4.20
Second Quarter 7.08 4.32
Third Quarter 5.64 3.72
Fourth Quarter 4.56 1.33
Total Year 7.80 1.33
The Company's common stock sales prices have been restated, where
applicable, to reflect the one-for-twelve reverse split of the Company's common
stock effective as of October 31, 2003. Quotations since the Company's stock
began trading on the Over-the-Counter Bulletin Board may reflect inter-dealer
prices, without retail mark-up, mark-down or commission and may not necessarily
represent actual transactions.
The number of stockholders of record of the Company's common stock at June
9, 2005 was 1,179. At June 9, 2005, Mr. Essam Khashoggi, directly or indirectly,
owned approximately 39.25% of the outstanding common stock of the Company.
Dividends
The Company does not intend to declare or pay cash dividends on its common
stock in the foreseeable future nor has it paid dividends in the past two years.
59
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
All relationships and related transactions reported in this Prospectus are
described under the caption "Compensation Committee Interlocks and Insider
Participation."
60
DESCRIPTION OF CAPITAL STOCK
Common Stock
EarthShell is authorized to issue 40,000,000 shares of Common Stock $0.01
par value, of which 18,435,452 were issued and outstanding at June 9, 2005. The
securities being offered hereby are common stock, with one vote per share on all
matters to be voted on by shareholders, without any right to accumulate their
votes. Shareholders have no preemptive rights and have no liability for further
calls or assessments on their shares. The shares of common stock are not subject
to repurchase by the Company or conversion into any other security. All
outstanding shares of common stock are, and those issued pursuant to the Standby
Equity Distribution Agreement and the warrants will be fully paid and non
assessable.
Shareholders are entitled to receive such dividends as may be declared by
the Board of Directors of the EarthShell out of funds legally available
therefore and, upon the liquidation, dissolution or winding up of the Company,
are entitled to share ratably in all net assets available for distribution to
such holders after satisfaction of all of our obligations, including stock
preferences. It is not anticipated that we will pay any dividends in the
foreseeable future since we intend to follow the policy of retaining its
earnings to finance the growth of its business. Future dividend policies will
depend upon the Company's earnings, financial needs and other pertinent factors.
Preferred Stock
The Board of Directors has the authority, without further action by
stockholders, to issue up to 10,000,000 shares of Preferred Stock in one or more
series and to fix the powers, designations, rights, preferences, privileges,
qualifications and restrictions thereof, including dividend rights, conversion
rights, voting rights, rights and terms of redemption, liquidation preferences
and sinking fund terms, any or all of which may be greater than the rights of
the common stock. The Board of Directors, without stockholder approval, can
issue Preferred Stock with voting, conversion, and other rights which could
adversely affect the voting power and other rights of the holders of Common
Stock. The issuance of Preferred Stock in certain circumstances may have the
effect of delaying, deferring or preventing a change of control of the Company
without further action by the stockholders, may discourage bids for the
Company's Common Stock at a premium over the market price of the Common Stock,
and may adversely affect the market price of the Common Stock.
Series A Preferred Stock
In 1993, the Company issued Series A Preferred Stock in connection with
the funding of the early development stage of the Company. In 1998, the entire
Series A Preferred Stock was converted to common stock in connection with the
Company's Initial Public Offering. As of June 9, 2005, there were no shares of
Series A Preferred Stock issued and outstanding.
Series B Convertible Preferred Stock
As of June 9, 2005, there were 100 shares of Series B Convertible
Preferred Stock, par value $0.01 per share, designated. The 100 shares of Series
B Convertible Preferred Stock have been pledged to secure the promissory notes
issued to Cornell Capital Partners and have been placed in escrow to be issued
to Cornell Capital Partners in the event of default. The shares will be released
to the Company from escrow upon (i) repayment of $1,350,000 of principal under
the promissory notes; (ii) in the event the shares pledged pursuant to that
certain Amended and Restated Pledge and Escrow Agreement by and among Benton
Wilcoxon, Cornell Capital Partners and David Gonzalez, Esq. is equal to or
exceeds 3 times the amount of principal then outstanding under the promissory
notes; (iii) a registration statement has been declared effective by the SEC
relating to the shares to be issued pursuant to the Standby Equity Distribution
Agreement; and (iv) the 100 shares of Series B Convertible Preferred Stock have
been redeemed pursuant the Certificate of Designation. Pursuant to the
Certificate of Designation, the Series B Convertible Preferred Stock is senior
to the Company's common stock with respect to the distribution of the assets of
the Company upon liquidation and junior to all other series of preferred stock.
The holders of the Series B Convertible Preferred Stock are not entitled to
dividends or distributions. Each share of Series B Convertible Preferred Stock
is convertible, at the option of the holder, at any time upon an event of
default under the promissory notes, into 33,333 shares of fully paid and
non-assessable common stock of the Company. The Series B Convertible Preferred
Stock has no voting rights, except as required under Delaware law. After full
repayment of the notes, the Company has the absolute right to redeem (unless
otherwise prevented by law) any outstanding shares of Series B Convertible
Preferred Stock at an amount equal to $0.01 per share.
61
Warrants
In connection with the issuance of the convertible debentures on August
12, 2002, the Company issued to the debenture holders warrants to purchase
208,333 shares of the Company's common stock at $14.40 per share. The exercise
price and number of common shares issuable upon exercise of the warrants are
subject to adjustment under certain circumstances, such as the occurrence of
stock dividends and splits, distributions of property or securities other than
common stock, equity issuances for less than the warrant exercise price and a
change in control of the Company. In March 2003, in connection with the issuance
of the 2006 Debentures, the exercise price of the warrants was reduced to $6.00
per share, but the number of shares of common stock issuable upon exercise
remained fixed at 357,143. At the same time, the warrant agreement was amended
such that any subsequent reduction in the exercise price of the warrants will
not result in any increase in the number of shares of common stock issuable
under the warrants. The warrants expire on August 12, 2007.
In connection with the issuance of the convertible debentures in March
2003, the Company issued to the placement agent warrants to purchase $1.055
million in aggregate principal amount of the 2006 Debentures at $1,200 per
$1,000 of principal amount, 28,810 shares of the Company's common stock at
$10.08 per share, and 41,667 shares of the Company's common stock at $7.20 per
share. When the 2006 Debentures were retired in 2004, the warrant to purchase
$1,055 million in the aggregate principal amount of the 2006 Debentures
converted to a warrant to purchase 175,833 shares of common stock. Therefore,
the total number of warrants held by Roth Capital Partners, LLC is 246,310. The
exercise price and number of common shares issuable upon exercise of the
warrants are subject to adjustment under certain circumstances, such as the
occurrence of stock dividends and splits, distributions of property or
securities other than common stock and a change in control of the Company. The
warrants expire in March 2006.
On March 5, 2003, the Company issued to EKI a warrant to purchase 83,333
shares at $6.00 per share in connection with the subordination of loans of
$2.755 million made to the Company and the elimination of the conversion
feature. The warrants expire on March 5, 2013.
In February of 2005, the independent members of the Board of Directors
approved the grant of a ten year option to Mr. Essam Khashoggi, the Chairman of
the Board of Directors, under the Company's 1995 Stock Option plan to purchase 1
million shares of EarthShell common stock at $2.30 per share.in consideration
for his long term support of the Company in providing timely and low cost
financial support of the Company during difficult times in the Company's
history. Upon review of the transaction, the option was rescinded in May of
2005, and a warrant was issued to EKI, which is the largest shareholder of the
Company and is beneficially owned by Mr. Khashoggi, as more fully described
below.
In March 2005, in consideration for Benton Wilcoxon pledging his personal
shares in Composite Technology Corporation as a guaranty for the Security
Agreement entered into by the Company with Cornell Capital Partners, the Company
issued a warrant to Benton Wilcoxon to purchase 65,000 shares of common stock of
the Company at an exercise price of $3.00 per share. The warrant expires on
March 23, 2008.
In consideration for consulting services rendered by Douglas Metz in
connection with the Company obtaining financing, the Company issued a warrant to
Douglas Metz to purchase 80,000 shares of common stock of the Company at an
exercise price of $3.00 per share. The warrant expires on March 23, 2008.
In May of 2005, the Company granted to EKI a warrant to purchase one
million shares of the Company's common stock at $3 per share in consideration of
EKI's continued support of the Company since its inception, including providing
bridge loans on good terms from time-to-time during the Company's history. This
warrant expires on May 3, 2015.
On May 26, 2005, the Company issued a warrant to Cornell Capital Partners
to purchase 625,000 shares of common stock of the Company. The warrant expires
on the later of: (a) May 26, 2005 or (b) the date sixty days after the date the
$2,500,000 in promissory notes issued to Cornell Capital Partners are fully
repaid and has an exercise price of $4.00 per share of common stock.
Options
In 1995, the Company established the EarthShell Corporation 1995 Stock
Incentive Plan (the "1995 Plan"). The 1995 Plan provides that the Company may
grant an aggregate number of options for up to 1,250,000 shares of common stock
to employees, directors and other eligible persons as defined by the 1995 Plan.
Options issued to date under the 1995 Plan generally vest over varying periods
from 0 to 5 years and generally expire 5-10 years from the date of grant.
The Company currently has 947,767 options outstanding to purchase common
stock of EarthShell. The exercise prices range from $0.75-$252.00 per share.
62
Transfer Agent
The transfer agent for EarthShell common stock is U.S. Stock Transfer
Corporation. Its address is 1745 Gardena Avenue, Suite 200, Glendale, California
91204 and its telephone number is (800) 835-8778.
Reports To Shareholders
We intend to furnish our shareholders with annual reports which will
describe the nature and scope of our business and operations for the prior year
and will contain a copy of the Company's audited financial statements for its
most recent fiscal year.
Limitation Of Liability: Indemnification
The Company's Certificate of Incorporation limits the liability of
directors to the maximum extent permitted by Delaware law. Delaware law provides
that directors of a company will not be personally liable for monetary damages
for breach of their fiduciary duties as directors, except for liability for (i)
any breach of their duty of loyalty to the company or its stockholders, (ii)
acts or omissions not in good faith or involving intentional misconduct or a
knowing violation of law, (iii) unlawful payment of dividends or unlawful stock
repurchases or redemptions as provided in Section 174 of the Delaware General
Corporation Law, or (iv) any transaction from which the director derived an
improper personal benefit.
The Company's Bylaws provide that the Company shall indemnify its
officers, directors, employees and other agents to the maximum extent permitted
by Delaware law. The Company's Bylaws also permit it to secure insurance on
behalf of any officer, director, employee or other agent for any liability
arising out of his or her actions in such capacity, regardless of whether the
Bylaws would permit indemnification.
The Company believes that the provisions in its Certificate of
Incorporation and its Bylaws are necessary to attract and retain qualified
persons as officers and directors.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
EarthShell pursuant to the foregoing, or otherwise, the Company has been advised
that in the opinion of the SEC such indemnification is against public policy as
expressed in the Securities Act of 1933 and is, therefore, unenforceable.
Anti-Takeover Effects Of Provisions Of The Articles Of Incorporation
The Company is subject to Section 203 of the Delaware General Corporation
Law ("Section 203"), which restricts certain transactions and business
combinations between a corporation and an "Interested Stockholder" owning 15% or
more of the corporation's outstanding voting stock, for a period of three years
from the date the stockholder becomes an Interested Stockholder. Subject to
certain exceptions, unless the transaction is approved by the board of directors
and the holders of at least 66 2/3% of the outstanding voting stock of the
corporation (excluding shares held by the Interested Stockholder), Section 203
prohibits significant business transactions such as a merger with, disposition
of assets to, or receipt of disproportionate financial benefits by the
Interested Stockholder, or any other transaction that would increase the
Interested Stockholder's proportionate ownership of any class or series of the
corporation's stock. The statutory ban does not apply if, upon consummation of
the transaction in which any person becomes an Interested Stockholder, the
Interested Stockholder owns at least 85% of the outstanding voting stock of the
corporation (excluding shares held by persons who are both directors and
officers or by certain employee stock plans).
The Company's Certificate of Incorporation and Bylaws include a number of
provisions which may have the effect of discouraging persons from pursuing
non-negotiated takeover attempts. These provisions include limitations on
stockholder action initiated by Interested Stockholders, a prohibition on the
call of special meetings of stockholders by persons other than the Board of
Directors, and a requirement of advance notice for the submission of stockholder
proposals or director nominees.
63
EXPERTS
The audited financial statements included in this prospectus and elsewhere
in the registration statement for the fiscal years ended December 31, 2004,
December 31, 2003 and December 31, 2002 have been audited by Farber & Hass LLP.
The reports of Farber & Hass LLP are included in this prospectus in reliance
upon the authority of this firm as experts in accounting and auditing. The
report of Farber & Hass LLP contained elsewhere in this prospectus contain an
explanatory paragraph regarding its ability to continue as a going concern.
VALIDITY OF SECURITIES
The validity of the shares offered herein will be opined on for us by
Kirkpatrick & Lockhart Nicholson Graham LLP, which has acted as our outside
legal counsel in relation to certain, restricted tasks.
INTERESTS OF NAMED EXPERT AND COUNSEL
LEGAL MATTERS
The validity of the shares of common stock offered hereby as to their
being fully paid, legally issued and non-assessable will be passed upon for us
by Kirkpatrick & Lockhart Nicholson Graham LLP, Miami, Florida. Kirkpatrick &
Lockhart Nicholson Graham LLP does not have any interests in EarthShell and has
never been employed by EarthShell on a contingent basis.
The audited consolidated financial statements of the Company for the years
ended December 31, 2004, December 31, 2003 and December 31, 2002 have been
audited by Farber & Hass LLP. Farber & Hass LLP does not have any interests in
EarthShell and have never been employed by EarthShell on a contingent basis.
HOW TO GET MORE INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1 under the Securities Act with respect to the securities
offered by this prospectus. This prospectus, which forms a part of the
registration statement, does not contain all the information set forth in the
registration statement, as permitted by the rules and regulations of the
Commission. For further information with respect to us and the securities
offered by this prospectus, reference is made to the registration statement.
Statements contained in this prospectus as to the contents of any contract or
other document that we have filed as an exhibit to the registration statement
are qualified in their entirety by reference to the to the exhibits for a
complete statement of their terms and conditions. The registration statement and
other information may be read and copied at the Commission's Public Reference
Room at 450 Fifth Street N.W., Washington, D.C. 20549. The public may obtain
information on the operation of the Public Reference Room by calling the
Commission at 1-800-SEC-0330. The Commission maintains a web site at
http://www.sec.gov that contains reports, proxy and information statements, and
other information regarding issuers that file electronically with the
Commission.
64
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
Index to Consolidated Financial Statements and Schedules F-1
Condensed Consolidated Balance Sheets as of March 31, 2005
(unaudited) and December 31, 2004 F-2
Condensed Consolidated Statements of Operations for the three months ended
March 31, 2005 and March 31, 2004 (unaudited) F-3
Condensed Consolidated Statements of Cash Flows for the three months ended
March 31, 2005 and March 31, 2004 (unaudited) F-4 - F-5
Notes to Condensed Consolidated Financial Statements (unaudited) F-6 - F-8
Reports of Independent Registered Public Accounting Firm F-9 - F-10
Consolidated Balance Sheets as of December 31, 2004 and 2003 F-11
Consolidated Statements of Operations for the years ended December
31, 2004, 2003, and 2002 F-12
Consolidated Statements of Stockholders' Equity (Deficit) for the
years ended December 31, 2004, 2003, and 2002 F-13
Consolidated Statements of Cash Flows for the years ended December
31, 2004, 2003, and 2002 F-14 - F-16
Notes to Consolidated Financial Statements F-17 - F-30
Consolidated Financial Statement Schedules:
None.
All schedules have been omitted because they are not required, not applicable,
or the information required to be set forth therein is included in the Company's
Consolidated Financial Statements or the Notes therein.
F-1
EARTHSHELL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31,
2005 2004
------------- -------------
(UNAUDITED)
ASSETS
CURRENT ASSETS
Cash and cash equivalents ................ $ 327,858 $ 272,371
Prepaid expenses and other current assets 143,085 201,467
------------- -------------
Total current assets ................ 470,943 473,838
PROPERTY AND EQUIPMENT, NET .................... 8,199 9,037
EQUIPMENT HELD FOR SALE ........................ 1 1
------------- -------------
TOTALS ......................................... $ 479,143 $ 482,876
============= =============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Accounts payable and accrued expenses .... $ 3,910,552 $ 3,899,526
Short-term notes payable to related party 1,000 --
Current portion of settlements ........... 304,888 313,743
Current portion of deferred revenues ..... 550,000 300,000
Contingent settlement .................... 2,375,000 2,375,000
Note payable ............................. 880,573 --
Payable to a related party ............... 875,000 875,000
------------- -------------
Total current liabilities ..... 8,897,013 7,763,269
LONG-TERM PORTION OF DEFERRED REVENUES ......... 987,500 1,062,500
OTHER LONG-TERM LIABILITIES .................... 328,120 412,192
------------- -------------
Total liabilities ................... 10,212,633 9,237,961
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 March 31, 2005 and
December 31 2004
Common Stock, $.01 par value, 40,000,000
shares authorizee: 18,391,065 and
18,234,615 shares issued and outstanding
as of March 31, 2005 and December 31
2004, respectively............................ 183,911 182,346
Additional paid-in common capital .............. 313,283,689 313,196,905
Accumulated deficit (322,685,339) (321,607,782)
Less note receivable for stock ................. (475,000) (500,000)
Accumulated other comprehensive loss ........... (40,751) (26,554)
------------- -------------
Total stockholders' deficit .............. (9,733,490) (8,755,085)
------------- -------------
TOTALS ......................................... $ 479,143 $ 482,876
============= =============
See Notes to Condensed Consolidated Financial Statements.
F-2
EARTHSHELL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
FOR THE
THREE MONTHS
ENDED MARCH 31,
----------------------------
2005 2004
------------ ------------
Revenues ............................................ $ 75,000 $ --
Operating Expenses
Related party research and development .......... -- 300,000
Other research and development expenses ......... 103,595 222,538
Related party general and administrative expenses -- 578
Other general and administrative expenses ....... 1,032,313 1,173,855
Depreciation and amortization ................... 837 27,341
------------ ------------
Total operating expenses .................... 1,137,323 1,723,734
Operating Loss ...................................... 1,062,323 1,723,734
Other (Income) Expense
Interest income ................................. (478) (1,234)
Related party interest expense .................. 556 134,182
Other interest expense .......................... 21,461 209,375
Gain on sales of property and equipment ......... (7,105)
------------ ------------
Loss Before Income Taxes ............................ 1,076,757 2,066,057
Income taxes ........................................ 800 800
------------ ------------
Net Loss ............................................ $ 1,077,557 $ 2,066,857
============ ============
Basic and Diluted Loss Per Common Share ............. $ 0.06 $ 0.15
Weighted Average Number of Common Shares ............ 18,250,260 14,128,966
See Notes to Condensed Consolidated Financial Statements.
F-3
EARTHSHELL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
--------------------------
2005 2004
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss ................................................................. $(1,077,557) $(2,066,857)
Adjustments to reconcile net loss to net cash used in operating activities
Depreciation and amortization .......................................... 838 27,341
Amortization and accretion of debenture issue costs .................... 5,922 199,034
(Gain) Loss on sale, disposal, or impairment of property and equipment . (7,105) --
Deferred revenues ...................................................... 175,000
Other non-cash expense items ........................................... (89,354) (7,691)
Changes in operating assets and liabilities
Prepaid expenses and other current assets .............................. 58,382 182,608
Accounts payable and accrued expenses .................................. 90,869 25,248
Payables to related party .............................................. -- 408,889
Other long-term liabilities ............................................ 485 (12,500)
----------- -----------
Net cash used in operating activities ............................... (842,520) (1,243,928)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of property and equipment ............................ 7,105 --
----------- -----------
Net cash provided by investing activities ........................... 7,105 --
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock ................................... 25,000 --
Proceeds from issuance of notes payable to related party ................. 251,000
Repayment of notes payable to related party .............................. (250,000)
Principal payments on settlements ........................................ (93,412)
Proceeds from issuance of note payable ................................... 1,150,000
Note payable issuance costs .............................................. (187,000)
----------- -----------
Net cash provided by financing activities ........................... 895,588 --
----------- -----------
Effect of exchange rate changes on cash and cash equivalents ............. (4,686) (3,275)
----------- -----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ......................... 55,487 (1,247,203)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ........................... 272,371 1,901,639
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD ................................. $ 327,858 $ 654,436
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
F-4
THREEE MONTHS ENDED
MARCH 31,
2005 2004
---------- ----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for
Income taxes ................................. $ 800 $ --
Interest ..................................... $ 3,657 $ 1,256
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
In March of 2005, in consideration for a loan guarantee, the Company issued
warrants to purchase 65,000 shares of common stock of the Company at an exercise
price of $3.00 per share. The warrant expires on March 23, 2008.
Also in March of 2005, in consideration for consulting services rendered in
connection with the Company obtaining financing, the Company issued a warrant
for 80,000 shares of common stock of the Company at an exercise price of $3.00
per share. The warrant expires on March 23, 2008.
See Notes to Condensed Consolidated Financial Statements.
F-5
EARTHSHELL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
MARCH 31, 2005
OVERVIEW OF OPERATIONS
Organized in November 1992 as a Delaware corporation, EarthShell Corporation
(the "Company") 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.
EarthShell was a development stage enterprise through the first quarter of 2004.
With the recognition of the Company's first revenues in the second quarter of
2004, the Company was no longer a development stage enterprise.
BASIS OF PRESENTATION OF FINANCIAL INFORMATION
The foregoing financial information 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, PolarCup
EarthShell GmbH. All significant intercompany balances and transactions have
been eliminated in consolidation. 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.
The accompanying unaudited 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, 2004. 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, 2004 included in the Company's Annual Report on
form 10-K, including Form 10-K/A - Amendment No. 2.
The accompanying unaudited financial 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
significant losses since inception, has minimal revenues and has a working
capital deficit of $8,426,070 at March 31, 2005. These factors, along with
others, may indicate substantial doubt that the Company will be unable to
continue as a going concern for a reasonable period of time (see "Critical
Accounting Policies - Going Concern Basis").
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.
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, including Common stock to be issued. Diluted loss per common share
is computed by dividing net loss available to common stockholders by the
weighted-average number of common shares outstanding (including Common stock to
be issued) 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.
F-6
Since June 21, 2004, the Company's common stock has been listed through the OTC
Bulletin Board. The Company's common stock trades under the symbol "ERTH.OB."
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, 2005 were as follows:
MARCH 31, DECEMBER 31,
2005 2004
----------- -----------
Total office furniture and equipment ............. 245,274 245,274
Less: Accumulated depreciation and amortization (237,035) (236,237)
Property and equipment - net ..................... $ 8,199 $ 9,037
=========== ===========
Equipment held for sale .......................... $ 1 $ 1
=========== ===========
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,
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,
2005 2004
----------- -----------
Net Loss as reported ............................ $ 1,077,557 $ 2,066,857
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
$ 5,275 $ 13,015
----------- -----------
Pro forma net loss .............................. $ 1,082,832 $ 2,079,872
Basic diluted loss per common share
As reported .................................. $ 0.06 $ 0.15
Pro forma .................................... $ 0.06 $ 0.15
FINANCING
In March 2005, the Company entered into a promissory note and Security Agreement
with Cornell Capital Partners, LP ("Cornell Capital Partners"). Pursuant to the
Security Agreement, the Company shall issue promissory notes to Cornell Capital
Partners in the original principal amount of $2,500,000. The $2,500,000 will be
disbursed as follows: $1,150,000 was disbursed on March 28, 2005. The remaining
F-7
$1,350,000 will be issued in a second closing, expected to occur during the 2nd
quarter of 2005, after the filing of a registration statement related to the
Standby Equity Distribution Agreement, described below. The promissory notes are
secured by the assets of the Company and shares of stock of another entity
pledged by an affiliate of that entity. The promissory notes have a one-year
term and accrue interest at 12% per year. As of March 31, 2005, the Company had
executed on the first phase of the transaction and received net proceeds of
approximately $1,000,000.
In connection with the first disbursement, the Company recorded an original
issue discount of $275,348. The discount includes cash fees and expenses related
to the origination of the loan, issuance of 6,450 shares of the Company's common
stock to a broker, valued at the market value on the closing date of the
transaction, and issuance of warrants to purchase 145,000 shares of the
Company's stock at $3 per share valued at $78,028 using the Black Sholles
valuation model, all of which will be amortized over the 12 month life of the
note at a rate of $39,389 per month.
In March 2005, EarthShell entered into a Standby Equity Distribution Agreement
with Cornell Capital Partners. Pursuant to the Standby Equity Distribution
Agreement, the Company may, at its discretion, periodically sell to Cornell
Capital Partners shares of common stock for a total purchase price of up to
$10.0 million. For each share of common stock purchased under the Standby Equity
Distribution Agreement, Cornell Capital Partners will pay the Company 98% of the
lowest volume weighted average price of the Company's common stock as quoted by
Bloomberg, LP on the Over-the-Counter Bulletin Board or other principal market
on which the Company's common stock is traded for the 5 days immediately
following the notice date. The price paid by Cornell Capital Partners for the
Company's stock shall be determined as of the date of each individual request
for an advance under the Standby Equity Distribution Agreement. Cornell Capital
Partners will also retain 5% of each advance under the Standby Equity
Distribution Agreement. Cornell Capital Partners' obligation to purchase shares
of the Company's common stock under the Standby Equity Distribution Agreement is
subject to certain conditions, including the Company's registration statement
for shares of common stock sold under the Standby Equity Distribution Agreement
being declared effective by the Securities and Exchange Commission and is
limited to $500,000 per weekly advance.
Subsequent Events
In February of 2005, an option of 1 million shares with an exercise price of
$2.30 per share was issued to a board member in connection with considerable
financial support of the Company. The option was subsequently rescinded by the
Company in May of 2005.
F-8
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of EarthShell Corporation:
We have audited the accompanying consolidated balance sheets of EarthShell
Corporation (the "Company") as of December 31, 2004 and 2003, and the related
consolidated statements of operations, stockholders' (deficit) equity, and cash
flows for the years ended December 31, 2004, 2003 and 2002. 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 in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit 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. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, based on our audits, such consolidated financial statements
present fairly, in all material respects, the financial position of the Company
as of December 31, 2004 and 2003, and the results of its operations and its cash
flows for the years ended December 31, 2004, 2003 and 2002, in conformity with
accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in the notes to
the consolidated financial statements, the Company has incurred significant
losses, has minimal revenues and has a working capital deficit of approximately
$7,289,000 at December 31, 2004. These matters raise substantial doubt about the
Company's ability to continue as a going concern. Management's plans concerning
these matters are also described in the notes to the consolidated financial
statements. The consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
/s/ Farber & Hass LLP
---------------------
Camarillo, California
March 4, 2005
F-9
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of EarthShell Corporation:
We have audited management's assessment, included in the accompanying
"Management's Annual Report on Internal Controls over Financial Reporting," that
EarthShell Corporation (the "Company") did not maintain effective internal
control over financial reporting as of December 31 ,2004, because of the effect
of pervasive material weaknesses in the design and operation of the Company's
system of internal controls, based on criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring Organization
of the Treadway Commission (COSO). The Company's management is responsible for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting.
Our responsibility is to express an opinion on management's assessment and an
opinion on the effectiveness of the company's internal control over financial
reporting based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management's assessment, testing
and evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinion.
A company's internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company's internal
control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
A material weakness is a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected. The Company has pervasive material weaknesses in the design and
operation of its system of internal controls over financial reporting. The
following material weaknesses have been identified and included in management's
assessment:
(1) Inadequate segregation of duties involving the authorization,
recording, custody, and periodic reconciliation of accounting transactions.
(2) Insufficient staffing of accounting personnel with adequate knowledge
of accounting principles generally accepted in the United States. This
inadequate staffing in the accounting department resulted in transactions not
being recorded in a timely manner. In addition, there was inadequate application
of accounting principles generally accepted in the United States in relation to
the valuation of the gain on settlements of debt obligations in 2004, the
classification of certain debts in the financial statements and the proper
recording of liabilities as of December 31, 2004. This weakness resulted in the
recording of several adjustments to the financial statements that were
considered material to the financial position at December 31, 2004 and results
of operations for the year then ended.
(3) A pervasive lack of general controls over the information technology
system which could have a material effect on the financial statements.
These material weaknesses were considered in determining the nature,
timing, and extent of audit tests applied in our audit of the 2004 financial
statements, and this report does not affect our report dated March 4, 2005 on
those financial statements.
In our opinion, management's assessment that EarthShell Corporation did
not maintain effective internal control over financial reporting as of December
31, 2004, is fairly stated, in all material respects, based on criteria
established in Internal Control--Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). Also, in our
opinion, because of the effect of the material weakness described above on the
achievement of the objectives of the control criteria, EarthShell Corporation
has not maintained effective internal control over financial reporting as of
December 31, 2004 based on criteria established in Internal Control--Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
We do not express an opinion or any other form of assurance on
management's statements referring to the corrective actions taken by the Company
after the date of management's assessment.
/s/ Farber & Hass LLP
---------------------
April 26, 2005
Camarillo, California
F-10
EARTHSHELL CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31,
------------------------------
2004 2003
------------------------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents ................................................... $ 272,371 $ 1,901,639
Prepaid expenses and other current assets ................................... 201,467 323,680
------------------------------
Total current assets ...................................................... 473,838 2,225,319
PROPERTY AND EQUIPMENT, NET ................................................... 9,037 61,794
EQUIPMENT HELD FOR SALE ....................................................... 1 1
------------------------------
TOTALS ........................................................................ $ 482,876 $ 2,287,114
==============================
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Accounts payable and accrued expenses ....................................... $ 3,899,526 $ 4,853,413
Current portion of settlements .............................................. 313,743 --
Current portion of deferred revenues ........................................ 300,000 --
Payable to related party, current............................................ 875,000 --
Debenture settlement ........................................................ 2,375,000 --
Convertible debentures, net of discount of $1,505,755 ....................... -- 5,294,245
------------------------------
Total current liabilities ................................................. 7,763,269 10,147,658
DEFERRED REVENUES, LESS CURRENT PORTION........................................ 1,062,500 --
PAYABLE TO RELATED PARTY, LONG TERM............................................ 1,839,108
NOTES PAYABLE TO RELATED PARTY NET OF DISCOUNT................. 2,535,790
OTHER LONG-TERM LIABILITIES ................................................... 412,192 33,333
------------------------------
Total liabilities ......................................................... 9,237,961 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 December
31, 2004 and 2003 ......................................................... -- --
Common stock, $.01 par value, 40,000,000 shares authorized;
18,234,615 and 14,128,966 shares issued and outstanding as
of December 31, 2004 and 2003, respectively ............................... 182,346 141,290
Additional paid-in common capital ........................................... 313,196,905 302,033,746
Accumulated deficit ......................................................... (321,607,782) (314,350,681)
Less note receivable for stock .............................................. (500,000) --
Accumulated other comprehensive loss ........................................ (26,554) (93,130)
------------------------------
Total stockholders' deficit ............................................... (8,755,085) (12,268,775)
------------------------------
TOTALS ........................................................................ $ 482,876 $ 2,287,114
==============================
See Notes to Consolidated Financial Statements.
F-11
EARTHSHELL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31,
2004 2003 2002
------------ ------------ ------------
Revenues .................................... $ 137,500 $ -- $ --
Operating Expenses
Related party license fee and
research and development
expenses ................................ 800,000 1,312,374 1,488,070
Other research and development
expenses ................................ 370,163 8,234,416 25,401,869
Related party general and
administrative (reimbursements) ......... (4,875) (4,074) (24,444)
Other general and administrative
expenses ................................ 3,753,902 5,790,473 9,614,037
Depreciation and amortization ............. 42,236 379,949 3,099,367
------------ ------------ ------------
Total operating expenses ................ 4,961,426 15,713,138 39,578,899
Operating Loss .............................. 4,823,926 15,713,138 39,578,899
Other (Income) Expenses
Interest income ........................... (4,606) (95,176) (134,391)
Related party interest expense ............ 410,965 445,628 66,599
Other interest expense .................... 661,721 1,440,118 199,880
Gain on sales of property and
equipment ............................... (168,458) (451,940) (441,413)
Premium due to debenture default .......... 1,672,426 -- --
Other income .............................. -- (399,701) --
(Gain) Loss on extinguishment of
debentures .............................. (139,673) 1,697,380 --
Debenture conversion costs ................ -- 166,494 320,970
------------ ------------ ------------
Loss Before Income Taxes .................... 7,256,301 18,515,941 39,590,544
Income Taxes ................................ 800 800 800
------------ ------------ ------------
Net Loss .................................. $ 7,257,101 $ 18,516,741 $ 39,591,344
============ ============ ============
Basic and Diluted Loss Per Common Share ..... $ 0.48 $ 1.40 $ 3.51
Weighted Average Number of Common
Shares Outstanding ........................ 15,046,726 13,266,668 11,277,170
See Notes to Consolidated Financial Statements.
F-12
EARTHSHELL CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY
Common Stock
----------------------------- Additional Accumulated
Paid-In Stock Other
Common Accumulated Purchase Comprehensive
Shares Amount Capital Deficit Receivable Loss Totals
------------- ------------- ------------- ------------- ------------- ------------- -------------
BALANCE, DECEMBER 31,
2001 .................. 9,860,255 $ 98,602 $ 267,680,051 $(256,242,596) $ -- $ -- $ 11,536,057
Issuance of common
stock ................. 2,025,686 20,257 21,881,459 -- -- -- 21,901,716
Common stock warrants ... --
issued in connection
with convertible
debentures ............ -- 1,521,046 -- -- -- 1,521,046
Conversion of convertible
debentures to
common stock .......... 168,696 1,687 998,313 -- -- -- 1,000,000
Debenture conversion
costs ................. -- -- 176,471 -- -- -- 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 .................. 12,054,637 120,546 292,257,340 (295,833,940) -- (16,632) (3,472,686)
Issuance of common
stock ................. 137,264 1,373 811,267 -- -- -- 812,640
Common stock and common
stock warrants issued
in connection with
issuance of convertible
debentures ............ 624,747 6,248 2,921,594 -- -- -- 2,927,842
Conversion of convertible
debentures to common
stock ................. 1,312,318 13,123 7,536,877 -- -- -- 7,550,000
Debenture conversion .... --
costs ................. -- (1,493,332) -- -- -- (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 .................. 14,128,966 141,290 302,033,746 (314,350,681) -- (93,130) (12,268,775)
Issuance of common
stock ................. 2,443,272 24,432 7,181,970 -- (500,000) -- 6,706,402
Conversion of convertible
debentures to common
stock ................. 1,662,377 16,624 4,970,508 -- -- -- 4,987,132
Debenture conversion .... --
costs ................. -- (989,319) -- -- -- (989,319)
Net loss ................ --
............... -- -- (7,257,101) -- -- (7,257,101)
Foreign currency
translation
adjustment ............ -- -- -- -- -- 66,576 66,576
Comprehensive loss ...... -- -- -- -- -- -- (7,190,525)
------------- ------------- ------------- ------------- ------------- ------------- -------------
BALANCE, DECEMBER 31,
2004 .................. 18,234,615 $ 182,346 $ 313,196,905 $(321,607,782) $ (500,000) $ (26,554) $ (8,755,085)
============= ============= ============= ============= ============= ============= =============
See Notes to Consolidated Financial Statements.
F-13
EARTHSHELL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
----------------------------------------------
2004 2003 2002
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss ................................................................ $ (7,257,101) $(18,516,741) $(39,591,344)
Adjustments to reconcile net loss to net cash used in operating
activities
Depreciation and amortization ......................................... 42,236 379,949 3,099,367
Amortization and accretion of debenture issue costs ................... 592,316 955,574 144,500
Premium due to debenture default ...................................... 1,672,426 -- --
Debenture issuance and conversion costs ............................... -- 166,494 320,970
Gain on change in fair value of warrant obligation .................... -- (399,701) --
(Gain) Loss on extinguishment of debentures ........................... (139,673) 1,697,380 --
Beneficial conversion value due to change in debentures conversion
price ............................................................... -- 360,000 --
(Gain) Loss on sale, disposal or impairment of property and
equipment ........................................................... (168,458) 3,548,059 9,340,375
Equity in the losses of joint venture ................................. -- 392,116 20,263
Accrued purchase commitment ........................................... -- (1,855,000) 3,500,000
Other non-cash expense items .......................................... 180,171 50,198 --
Changes in operating assets and liabilities
Prepaid expenses and other current assets ............................. 120,549 264,153 9,670
Accounts payable and accrued expenses ................................. (553,710) (2,339,720) (444,851)
Payable to related party .............................................. 1,043,869 1,214,683 578,779
Deferred revenues ..................................................... 1,362,500 -- --
Accrued purchase commitment ........................................... -- (1,645,000) --
Other long-term liabilities ........................................... 378,859 33,333 --
------------ ------------ ------------
Net cash used in operating activities ............................... (2,726,016) (15,694,223) (23,022,271)
============ ============ ============
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from release of restricted time deposit upon settlement of
purchase commitment ................................................... -- 3,500,000 --
Proceeds from sales of property and equipment ........................... 187,708 487,691 477,566
Investment in joint venture ............................................. -- (26,104) --
Purchases of property and equipment ..................................... (8,729) (1,320) (2,802,371)
------------ ------------ ------------
Net cash provided by (used in) investing activities ................... 178,979 3,960,267 (2,324,805)
============ ============ ============
See Notes to Consolidated Financial Statements.
F-14
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock .................................. 2,086,755 -- 21,901,716
Proceeds from issuance of common stock and convertible debentures,
net of issuance costs and discounts amounting to
approximately $3.4 million ............................................ -- 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 .............................. -- 1,800,000 1,000,000
Proceeds from release of restricted time deposit upon exchange of
convertible debentures ................................................ -- 2,000,000 --
Proceeds from release of restricted time deposit for repayment of
convertible debentures ................................................ -- 5,200,000 --
Repayment of convertible debentures ..................................... (1,110,294) (5,200,000) --
Principal payments on settlements ....................................... (66,387) -- --
Proceeds from issuance of notes payable to related party ................ -- 1,010,000 4,825,000
Repayment of notes payable to related party ............................. -- -- (3,080,000)
------------ ------------ ------------
Net cash provided by financing activities ............................. 910,074 13,521,844 24,646,716
Effect of exchange rate changes on cash and cash equivalents .......... 7,695 2,736 (16,632)
------------ ------------ ------------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS .......................... (1,629,268) 1,790,624 (716,992)
CASH AND CASH EQUIVALENTS, BEGINNING OF
PERIOD .................................................................. 1,901,639 111,015 828,007
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF
PERIOD .................................................................. $ 272,371 $ 1,901,639 $ 111,015
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for
Income taxes .......................................................... $ 800 $ 800 $ 800
Interest .............................................................. 111,353 21,058
Common stock warrants issued in connection with convertible
debentures .......................................................... -- 745,562 1,521,046
Conversion of convertible debentures into common stock ................ 6,800,000 7,550,000 1,000,000
Transfer of property from EKI ......................................... -- -- --
Conversion of preferred stock into common stock ....................... -- -- --
Interest paid in common stock ......................................... 532,644 95,339 --
Commission paid in common stock ....................................... -- 29,500 --
Common stock issued to service providers in connection with the
March 2003 financing ................................................ -- 484,500 --
See Notes to Consolidated Financial Statements.
F-15
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
In 2004, no warrants were issued.
In 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 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.
In 2003, 137,264 shares of common stock were issued to satisfy accounts
payable and accrued interest payable of $812,640.
In 2002, warrants for the purchase of 208,333 shares of common stock were
issued in connection with the issuance of convertible debentures. The estimated
fair value of the warrants of $1,521,046, 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.
See Notes to Consolidated Financial Statements.
F-16
EARTHSHELL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Overview of Operations
Organized in November 1992 as a Delaware corporation, EarthShell
Corporation (the "Company") 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.
EarthShell was a development stage enterprise through the first quarter of
2004. With the recognition of the Company's first revenues in the second quarter
of 2004, the Company was no longer a development stage enterprise.
BASIS OF PRESENTATION OF FINANCIAL INFORMATION
The foregoing financial information 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,
PolarCup EarthShell GmbH. All significant intercompany balances and transactions
have been eliminated in consolidation. 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.
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. The Company has
incurred significant losses since inception, has minimal revenues and has a
working capital deficit of $7,289,431 at December 31, 2004. These factors, along
with others, may indicate substantial doubt that the Company will be unable to
continue as a going concern for a reasonable period of time.
Subsequent to December 31, 2004 the Company entered into a financing
transaction to borrow $2.5 million (See Subsequent Events). On March 28, 2005,
the Company received $1.15 million of this funding. The Company expects to
receive the remaining $1.35 million prior to April 30, 2005. The Company expects
to generate additional cash in 2005 through royalty payments from licensees. The
Company believes that the cash from this borrowing, combined with projected
revenues, will be sufficient to fund its operations through the year ending
December 31, 2005. If the Company is not successful at generating license
revenues during the year, the Company will have to raise additional funds to
meet its current obligations and to cover operating expenses. 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.
However, the Company cannot assure that it will receive any royalty payments in
2005, that additional financing will be available to it, or, if available, that
the terms will be satisfactory. Management will also continue in its efforts to
reduce expenses, but cannot 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. 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.
In January 2004, the Company announced that it was not in compliance with
a Nasdaq SmallCap Market minimum requirement. On March 8, 2004 the Company's
common stock was de-listed by the Nasdaq SmallCap Market and trading was moved
to the over-the-counter (OTC) [Pink Sheets Electronic Quotation Service]. Since
June 21, 2004, the Company's common stock has been listed through the OTC
Bulletin Board. The Company's common stock trades under the symbol "ERTH.OB."
F-17
Operations and Financing
The Company was engaged in initial concept development from 1993 to 1998.
During this period, the Company focused on enhancing the material science
technology licensed from EKI, initial development of the Company's foam
packaging products (primarily, its hinged-lid sandwich containers, which are
referred to as "hinged-lid containers"), and the development of relationships
with key licensees and end-users.
Since 1998, the Company has been primarily engaged in commercial
validation of EarthShell Packaging for plates, bowls, hinged-lid containers, and
sandwich wraps, and other market development activities. During this stage, the
Company has worked to demonstrate the commercial viability of its business model
by optimizing product design, garnering support from key members of the
environmental community, expanding validation of the environmental profile
through third party evaluations, developing commercially viable manufacturing
processes, establishing and refining licensing arrangements with the Company's
licensees, and validating product performance and price acceptance through
commercial contracts with influential purchasers in key segments of the
foodservice market. In cooperation with its operating partners, the Company
financed and built initial commercial demonstration production capacity and has
sold limited quantities of plates, bowls, and hinged-lid containers. In 2003,
the Company ceased commercial demonstration production activity and is relying
on its equipment and manufacturing partners to demonstrate and to guarantee the
long-term manufacturability of EarthShell Packaging(R).
As demonstration of the business fundamentals to licensees is
accomplished, the Company expects that its operating partners will build
production capacity. The Company intends to expand the use of EarthShell
Packaging in the U.S. and in international markets through agreements with
additional licensees. By leveraging the infrastructure of its licensees, the
Company believes the go-to-market strategy will accelerate the market
penetration of EarthShell Packaging.
Currently, the Company's strategic relationships include Detroit Tool and
Equipment ("DTE"),Hood Packaging Corporation ("Hood"), and Meridian Business
Solutions ("MBS") all in the U.S., as well as EarthShell Hidalgo ("ESH") in
Mexico. During 2004, the Company received technology fees from MBS and ESH, and
recorded it first revenues since its inception. During prior years, proceeds
from initial sales of plates, bowls and hinged-lid containers were not
significant and were recorded as an offset to the costs of its demonstration
manufacturing operations.
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 S-3 shelf registration statements for 416,667 and 1,250,000 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 under such registration statements and
received net proceeds from such sales of approximately $2.3 million, $30.6
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 an additional 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 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 $10.0 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 (see Convertible
Debenture). 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 (see Restricted Cash). In 2002 and
2003, $2.8 million of the debentures were converted to common stock. In March
2003, the Company issued $10.55 million in aggregate principal amount of
convertible debentures, due March 2006 (the "2006 Debentures"), and 0.5 million
shares of common stock to a group of institutional investors for net proceeds of
approximately $9.0 million. In connection with this transaction, the Company
repaid $5.2 million of the remaining balance of the 2007 Debentures, and
exchanged $2.0 million of the 2007 Debentures for the 2006 Debentures.
F-18
This transaction provided the Company with net proceeds of approximately
$11.0 million. The Company's use of these proceeds was subject to a number of
restrictions. In 2003, $5.75 million of the 2006 Debentures were converted to
common stock. The remaining shares under the December 2001 shelf registration
described above have been used to secure shares potentially issuable upon
conversion of the remainder of the 2006 Debentures.
During 2004, as a result of its stock price dropping below $3 per share
for an extended period of time, the Company was de-listed from NASDAQ.
Consequently, it became in default on its 2006 Debentures. In the 4th quarter of
2004, the Company sold $2.7 million of unregistered stock, negotiated a
settlement with each of its debenture holders, and retired all of the
outstanding debentures.
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 December 31,
2003, 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 October 2004, these related party
loans, including accrued interest were converted to unregistered shares of
EarthShell common stock. (See Related Party Transactions).
Recent Accounting Pronouncements
The FASB recently issued the following statements:
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs-an
amendment of ARB. No. 43, Chapter 4". This Statement amends the guidance in ARB
No. 43, Chapter 4, "Inventory Pricing," to clarify the accounting for abnormal
amounts of idle facility expense, freight, handling costs, and wasted material
(spoilage). Paragraph 5 of ARB 43, Chapter 4, previously stated that "... under
some circumstances, items such as idle facility expense, excessive spoilage,
double freight, and rehandling costs may be so abnormal as to require treatment
as current period charges...." This Statement requires that those items be
recognized as current-period charges regardless of whether they meet the
criterion of "so abnormal." In addition, this Statement requires that allocation
of fixed production overheads to the costs of conversion be based on the normal
capacity of the production facilities. The Company does not believe that this
recent accounting pronouncement has had or will have a material impact on their
financial position or results of operations.
In December 2004, the FASB issued SFAS No. 152, "Accounting for Real
Estate Time-Sharing Transactions - an amendment of FASB statements no. 66 and
67". This Statement amends FASB Statement No. 66, Accounting for Sales of Real
Estate, to reference the financial accounting and reporting guidance for real
estate time-sharing transactions that is provided in AICPA Statement of Position
(SOP) 04-2, Accounting for Real Estate Time-Sharing Transactions. This Statement
also amends FASB Statement No. 67, Accounting for Costs and Initial Rental
Operations of Real Estate Projects, to state that the guidance for (a)
incidental operations and (b) costs incurred to sell real estate projects does
not apply to real estate time-sharing transactions. The accounting for those
operations and costs is subject to the guidance in SOP 04-2. The Company does
not believe that this recent accounting pronouncement has had or will have a
material impact on their financial position or results of operations.
F-19
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Non-monetary
assets - an amendment of APB Opinion No. 29". This Statement amends APB Opinion
29 to eliminate the exception for non-monetary exchanges of similar productive
assets and replaces it with a general exception for exchanges of non-monetary
assets that do not have commercial substance. A non-monetary exchange has
commercial substance if the future cash flows of the entity are expected to
change significantly as a result of the exchange. The Company does not believe
that this recent accounting pronouncement has had or will have a material impact
on their financial position or results of operations.
In December 2004, the FASB issued SFAS No. 123R, "Share Based Payment".
This Statement is a revision of FASB Statement No. 123, Accounting for
Stock-Based Compensation. This Statement supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees, and its related implementation
guidance. This Statement establishes standards for the accounting for
transactions in which an entity exchanges its equity instruments for goods or
services. It also addresses transactions in which an entity incurs liabilities
in exchange for goods or services that are based on the fair value of the
entity's equity instruments or that may be settled by the issuance of those
equity instruments. This Statement focuses primarily on accounting for
transactions in which an entity obtains employee services in share-based payment
transactions. This Statement does not change the accounting guidance for
share-based payment transactions with parties other than employees provided in
Statement 123 as originally issued and EITF Issue No. 96-18, "Accounting for
Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services." This Statement does not address
the accounting for employee share ownership plans, which are subject to AICPA
Statement of Position 93-6, Employers' Accounting for Employee Stock Ownership
Plans. This statement will require the Company to recognize the fair value of
employee services received in exchange for awards of equity instruments in
current earnings. The Company will adopt this pronouncement July 1, 2005 as
required.
Other Comprehensive Income
The Company has reflected the provisions of SFAS No. 130, "Reporting
Comprehensive Income", in the accompanying consolidated financial statements for
all periods presented. The accumulated comprehensive loss and other
comprehensive loss as reflected in the accompanying consolidated financial
statements, respectively, consists of foreign currency translation adjustments,
which historically have been insignificant to the Company's operations.
Foreign Currency Translation
Assets and liabilities of the Company's foreign subsidiary, PolarCup
EarthShell GmbH, are translated into United States dollars at the exchange rate
in effect at the close of the period, and revenues and expenses are translated
at the weighted average exchange rate during the period. The aggregate effect of
translating the financial statements of PolarCup EarthShell GmbH is included as
a separate component of stockholders' equity. Foreign exchange gains/losses have
been insignificant.
Reverse Stock Split
Effective as of October 31, 2003, the Company's Board of Directors
("Board") approved an amendment to the Company's Certificate of Incorporation to
effect a reverse split of the Company's common stock. This action by the Board
followed approval by 88% of the stockholders of a proposal at the 2003 Annual
Meeting of the Company that authorized the Board to take such action. The
decision by the Board was prompted by the need to maintain compliance with
certain covenants of the Company's 2006 Debentures that require the Company to
retain its listing on a national market.
After careful analysis, the Board approved the final ratio for the split
at one-for-twelve (1:12), whereby each twelve shares of the company's issued and
outstanding common stock was automatically converted into one share of new
common stock. The percentage of the Company's stock owned by each shareholder
remained the same. No fractional shares were issued, and instead, the Company's
transfer agent aggregated and sold any fractional shares on the open market and
distributed the pro rata share of the cash proceeds to the holders of fractional
share interests.
The reverse split has been retroactively reflected in these financial
statements.
In conjunction with the reverse split, the authorized shares of common
stock were reduced from 200 million to 25 million as of October 31, 2003.
Increase in authorized shares of common stock in conjunction with the annual
meeting of the shareholders held on June 26, 2004. The authorized shares of
common stock were increased from 25 million to 40 million.
Disclosure About Fair Value of Financial Instruments
The Company has financial instruments, none of which are held for trading
purposes. The Company estimates that the fair value of all financial instruments
at December 31, 2004 and 2003, as defined in FASB 107, does not differ
materially from the aggregate carrying values of its financial instruments
recorded in the accompanying balance sheet. The estimated fair value amounts
have been determined by the Company using available market information and
appropriate valuation methodologies. However, the fair value of payables to
related parties and notes payable to related party cannot be determined due to
their related party nature. In addition, it is impractical for the Company to
estimate the fair value of the convertible debentures because a market for such
debentures does not readily exist. Considerable judgment is required in
interpreting market data to develop the estimates of fair value, and
accordingly, the estimates are not necessarily indicative of the amounts that
the Company could realize in a current market exchange.
Concentration of Risk - Financial Instruments
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of Cash and Cash Equivalents.
The Company places its excess cash in reputable federally insured financial
institutions and in high quality money market fund deposits. Money market fund
deposits ($210,428 on deposit with one bank at December 31, 2004) are subject to
market fluctuations and there is no guarantee as to their ultimate value.
F-20
Reclassifications
Certain items in the 2002 and 2003 financial statements have been
reclassified to conform to the 2004 presentation.
Cash and Cash Equivalents
Cash and cash equivalents include cash, funds invested in money market
funds and cash invested temporarily in various instruments with maturities of
three months or less at the time of purchase. The money market fund deposits
have an investment objective to provide high current income to the extent
consistent with the preservation of capital and the maintenance of liquidity
and, therefore, are subject to minimal risk.
Restricted Cash
As of December 31, 2004, the Company had no restrictions on its cash.
Prepaid Expenses and Other Current Assets
The following is a summary of prepaid expenses and other current assets at
December 31:
2004 2003
-------- --------
Recoverable foreign taxes - VAT ............... $ -0- $158,491
Prepaid expenses and other current assets ..... 83,583 165,189
Receivable on sale of
equipment ..................................... 78,009 -0-
Related party
receivable .................................... 12,875 -0-
Retainer for
financing ..................................... 27,000 -0-
-------- --------
Total Prepaid Expenses and Other Current Assets $201,467 $323,680
======== ========
Evaluation of Long-Lived Assets
The Company evaluates the recoverability of long-lived assets 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 a
long-lived 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 (see Property and Equipment).
Property and Equipment and Equipment Held for Sale
Property and equipment are carried at cost. Depreciation and amortization
is provided for using the straight-line method for financial reporting purposes
based upon the estimated useful lives of the assets, which range from three to
seven years. The cost of assets sold or retired and the related amounts of
accumulated depreciation are eliminated from the accounts and the resulting gain
or loss is included in income. As described further below, the Company wrote
down property and equipment related to commercialization of the EarthShell
Packaging products technology by $4.0 million in 2003 and $9.8 million in 2002.
The impairment charges were expensed to "Other research and development" in the
accompanying Statements of Operations.
F-21
The cost and accumulated depreciation of property and equipment and
equipment held for sale at December 31, 2004 were as follows:
2004 2003
----------- -----------
Property and Equipment
Product Development Center .................. $ -0- $ 1,175,394
Office Furniture and Equipment .............. 245,274 356,339
----------- -----------
Total cost .................................... 245,274 1,531,733
Less: accumulated depreciation and amortization (236,237) (1,469,939)
----------- -----------
Property and equipment--net ................... $ 9,037 $ 61,794
=========== ===========
Equipment held for sale ....................... $ 1 $ 1
=========== ===========
The Company has fully depreciated equipment (original cost of $893,657)
and a commercial production line which are being held for sale. The commercial
production line in Goettingen, Germany was financed and constructed by the
Company for the Company's joint venture (see Investment in 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 will 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. At December 31, 2003, the Company
was negotiating to sell the line to a party who would become a licensee with
rights to produce foodservice disposables. However, because the Company was
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 $4.0 million impairment charge was expensed to "Other research and
development" in the accompanying Statements of Operations. If the equipment is
sold, the Company will record a gain equal to the proceeds received for the
equipment.
As the Company sold non-essential machine shop equipment and excess office
furniture and equipment in 2003 and 2004, the related cost and accumulated
depreciation were removed from the applicable asset account and accumulated
depreciation, respectively.
Investment in Joint Venture
On May 24, 1999, the Company entered into a joint venture agreement with
Huhtamaki to commercialize EarthShell Packaging throughout Europe, Australia,
New Zealand, and, on a country by country basis, Asia. The Company and Huhtamaki
formed PolarCup EarthShell ApS ("PolarCup"), a Danish holding company, for the
purpose of establishing operating companies to manufacture, market, sell and
distribute EarthShell Packaging.
The Company contributed approximately 10,000 Euros as nominal share
capital and 500,000 Euros for start-up capital. The Company paid for the
development of the initial commercial production line to be located at the
Huhtamaki facility at Goettingen, Germany (see Property and Equipment). In
January 2004, the Company announced the conclusion of its joint venture
structure with Huhtamaki. During 2003 and 2002 the Company recorded its equity
in the losses of the joint venture of $392,117 and $20,263 respectively,
including the write off of its remaining investment as of December 31, 2003.
Related Party Transactions
In connection with the formation of the Company, the Company entered into
a License Agreement (the "License Agreement") with EKI, a stockholder of the
Company. Pursuant to the license agreement, as amended, 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) and to use certain trademarks owned by EKI in connection
F-22
with the products covered under the License Agreement. The license continues to
be in effect during the life of the patents licensed under the License Agreement
covering the technologies. Patents currently issued do not begin to expire until
2012 and provide some protection through 2020. Pending patents, if granted,
would extend protection through 2022. On July 29, 2002, the License Agreement
was amended to expand the field of use for the EarthShell technology to include
noodle bowls used for packaging instant noodles. The Company will pay to EKI 50%
of any royalty or other consideration it receives in connection with the sale of
products within this particular field of use. In addition, on July 29, 2002 the
Company entered into a License & Information Transfer Agreement with Biotec, a
wholly owned subsidiary of EKI, to utilize the Biotec technology for foodservice
applications, including the food wraps used in foodservice applications (the
"Biotec Agreement"). Effective January 1, 2001, EKI had previously granted to
the Company priority rights to license certain product applications on an
exclusive basis from Biotec in consideration for the Company's payment of a
$100,000 monthly licensing fee to Biotec. In addition, in consideration of the
monthly payment, Biotec agreed to render technical services to the Company at
Biotec's cost plus 5%. The licensing fee and services arrangements were
continued in the Biotec Agreement. Under the terms of the Biotec Agreement,
Biotec is entitled to receive 25% of any royalties or other consideration that
the Company receives in connection with the sale of products utilizing the
Biotec technology. As part of the convertible debenture financing completed in
March 2003 (see Convertible Debentures), payment of amounts due to EKI under the
License Agreement or the Biotec Agreement were subordinated to the 2006
Debentures with strict covenants governing their repayment. However, any amounts
deferred pursuant to this subordination requirement shall accrue interest at the
rate of 10% per annum until paid. For the years ended December 31, 2004, 2003,
and 2002, the Company paid or accrued to EKI $800,000, $1,312,374, and
$1,488,070 , respectively, under the License Agreement and Biotec Agreement,
consisting of the $100,000 per month licensing fee, materials and services
provided by EKI, which vary based on the Company's given requirements, and
interest payable on outstanding balances.
In September of 2004, as part of an overall restructuring of its debt,
EarthShell entered into an agreement with Biotec to convert $1.475 million of
the $2.475 million of accrued license fees owing to Biotec as of September 1,
2004, plus accrued interest into 491,778 shares of EarthShell common stock and
to eliminate, for two years, the $100,000 per month minimum license fee. In
December of 2004, EarthShell paid to Biotec $125,000, leaving a balance of
$875,000 as of December 31, 2004.
In connection with the settlement of the March 2006 Debentures in October
of 2004, EKI converted all of its outstanding loans to EarthShell ($2,755,000)
into unregistered common stock at $3 per share and converted $532,644 of
accumulated interest into unregistered common stock at $4 per share for a total
of 1,051,494 shares received by EKI.
In September 2004, the Company hired an executive assistant who supports
both EKI and Company executives. The Company pays the salary and benefits of the
executive assistant and charges EKI for the portion of her time that was spent
supporting EKI executives. Through December 31, 2004, the Company invoiced EKI
$12,875 for such support services.
In May 2004, the Company sold non-essential machine shop equipment and
excess office furniture and equipment with a net book value of approximately
$19,122 to EKI for $78,409.
On September 22, 2004, Simon K. Hodson, Chief Executive Officer of the
Company, loaned $50,000 to the Company on a short-term basis at an annual
interest rate of 7%, and on September 29, 2004 Mr. Hodson loaned the Company an
additional $86,000. During the fourth quarter of 2004, the Company repaid both
short-term loans.
Accounts Payable and Accrued Expenses
The following is a summary of accounts payable and accrued expenses at December
31:
2004 2003
---------- ----------
Accounts payable and other accrued expenses ... $2,830,204 $3,516,736
Deferred officer compensation ................. 298,194 -0-
Accrued property taxes ........................ 112,159 655,000
Accrued salaries, wages and benefits .......... 258,691 338,402
Accrued legal fees ............................ 400,278 343,275
---------- ----------
Total Accounts Payable and Accrued Expenses ... $3,899,526 $4,853,413
========== ==========
F-23
Convertible Debentures
On August 12, 2002, the Company issued $10.0 million in aggregate
principal amount of the 2007 Debentures to institutional investors. These
debentures bore interest at a rate of 1.5% per annum, payable quarterly in
arrears on each January 31, April 30, July 31 and October 31. 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 $8.40 per share in November 2002 and then to $6.00 per share in March
2003 as a result of anti-dilution adjustments. Based on the conversion price
relative to the fair market value of the common stock at the date of issue, the
debentures were deemed to have no beneficial conversion feature. In March 2003,
the conversion price of the 2007 Debentures was adjusted downward, resulting in
a beneficial conversion charge of $360,000 that is included in Other interest
expense in the Statements of Operations. 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. During 2003, 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 connection with the issuance of the 2007 Debentures, the Company issued
to the debenture holders warrants to purchase 208,333 shares of the Company's
common stock at $14.40 per share. A value of $1,521,046 was ascribed to the
warrants and recorded as an original issue discount based on the Black-Scholes
method of valuation. During 2002, non-cash interest expense of $144,500 and
debenture conversion costs of $320,970 were recognized in the Statements of
Operations to reflect amortization of the original issue discount associated
with the warrants and to reflect the 15% discount to the market price of the
Company's common stock resulting from the forced conversions of the 2007
Debentures. During 2003, non-cash interest expense of $74,927 was recognized in
the Statements of Operations to reflect amortization of the original issue
discount associated with the warrants. In addition, $59,747 of the original
issue discount associated with the debentures voluntarily converted was charged
to additional paid in common capital.
In March 2003, as part of a new convertible debenture financing, the
Company prepaid $5.2 million principal amount of 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
exchange of $2.0 million of the 2007 Debentures for 2006 Debentures resulted in
the release to the Company of $2.0 million of restricted 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 bore interest
at a rate of 2.0% per annum, payable quarterly in arrears on each January 31,
April 30, July 31 and October 31.
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 upon 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 2006 Debentures were deemed to have no beneficial
conversion feature.
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 would expire in March 2006 and was 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 would expire in March 2006, was immediately exercisable by the
placement agent to purchase $1.055 million in aggregate principal amount of the
F-24
2006 Debentures and 41,667 shares of the Company's common stock. At September
30, 2003, the Company evaluated the current value of this warrant, considering
the Company's 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 warrant
had no value as of September 31, 2003 and December 31, 2003 and therefore
reduced the balance of the warrant obligation to zero as of September 30, 2003,
resulting in a $0.5 million gain that is reflected in "Other (income) expense"
in the Statements of Operations.
In 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 December 31, 2003, the Company was in compliance with all covenants of
the 2006 Debentures. However, 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. These actions put the Company in non-compliance
with its covenants under the 2006 Debentures. The Company negotiated with the
various debenture holders to resolve the defaults. From July through October
2004, the Company reach settlements with each of the remaining debenture holders
to retire the entire $6.8 million outstanding at the end of 2003. Taken
together, the debenture holders converted their debenture holdings into
1,149,877 shares of registered stock, received a total of $1.11 million in cash
payments, and received an additional 512,500 shares of unregistered common
stock. One of the debenture holders also received a settlement payable of $2.375
million, which may be converted to common stock at the option of the holder at
$3 per share. This holder also has the right to elect be paid from up to 1/3 of
the proceeds of future equity capital transactions or from up to 1/3 of future
revenues until he has received a total of $2.375 million, less any portion that
has already been converted. As of December 31, 2004, 100% of the outstanding
debentures had been retired, the security interest held by the 2006 Debenture
Holders had been released, and any and all defaults under these debentures had
been waived. Because the $2.375 million settlement payable is payable only from
future proceeds, it is classified on the balance sheet under Current Liabilities
as a Debenture Settlement.
In connection with the March 2003 financing transactions, EKI agreed to
subordinate the repayment of its outstanding loans totaling $2.755 million 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. 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.
Other Long Term Liabilites
The Company has negotiated settlements with a number of its trade payable
vendors comprised of payment plans of up to 36 months. These settlements have
been reclassified on the balance sheet from trade payables to Current Portion of
Settlements for payments due within the current reporting year and Other Long
Term Liabilities for payments due after December 31, 2005. Payments on such
settlements due in 2006 and 2007 total $275,786 and 136,406, respectively.
Commitments
In September 2003, the Company leased 4,000 square feet of office and
research and development space in Santa Barbara, California, under a lease that
expired on December 31, 2003. In January 2004, the lease was extended through
April 2004, and thereafter on a month-to-month basis. The Company's monthly
lease payment with respect to this space was $5,000. In November 2004, the
Company relocated to its current location that it sublets from and shares with
EKI. The Company pays to EKI approximately $4,000 per month for its share of the
rent and common area costs. In addition, the Company leases 3,353 square feet of
office space in Lutherville, Maryland, on a month-to-month basis. The Company's
monthly lease payment with respect to this space is $5,780. Future minimum lease
payments required under these leases as of December 31, 2004 are $0. Rental
expenses for the years ended December 31, 2004, 2003 and 2002 amounted to
165,382, $558,195, and $927,386 respectively.
The Company is periodically involved in litigation and administrative
proceedings primarily arising in the normal course of its business. In the
opinion of management, the Company's gross liability, if any, and without any
consideration given to the availability of indemnification or insurance
coverage, under any pending or existing litigation or administrative
proceedings, other than those separately addressed above, would not have a
material adverse impact upon the Company's financial statements.
F-25
Retirement Benefits
The Company established a qualified 401(k) plan for all of its employees
in 1998. The 401(k) plan allows employees to contribute, on a tax-deferred
basis, up to fifteen percent of their annual base compensation subject to
certain regulatory and plan limitations. The Company uses a discretionary
matching formula that matches one half of the employee's 401(k) deferral up to a
maximum of six percent of annual base compensation. The 401(k) employer match
was $24,311 in 2004, $44,057 in 2003, and $74,853 in 2002.
Stock Options
In 1994 the Company established the EarthShell Corporation 1994 Stock
Option Plan (the "1994 Plan"). In 1995 the Company subsequently established the
EarthShell Corporation 1995 Stock Incentive Plan (the "1995 Plan") which
effectively superseded the 1994 Plan for options issued on or after the date of
the 1995 Plan's adoption. The 1994 and 1995 Plans as amended (the "Plans")
provide that the Company may grant an aggregate number of options for up to
1,250,000 shares of common stock to employees, directors and other eligible
persons as defined by the Plans. Options issued to date under the Plans
generally vest over varying periods from 0 to 5 years and generally expire 10
years from the date of grant.
Stock option activity for 2004, 2003 and 2002 is as follows:
2004 2003 2002
------------------------- ------------------------- ------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
---------- ---------- --------- ----------- --------- ----------
Outstanding at beginning of year ....... 384,912 $ 38.24 320,924 $ 50.49 231,333 $ 73.44
Granted .............................. 762,498 0.78 121,699 4.87 168,811 34.44
Cancelled ............................ (92,499) 15.00 (43,748) 34.02 (73,105) 74.52
Expired .............................. (11,666) 68.95 (13,963) 42.14 (6,115) 189.24
---------- ---------- --------- ----------- --------- ----------
Outstanding at end of year ............. 1,043,245 $ 12.58 384,912 $ 38.24 320,924 $ 50.49
========== ========== ========= ========== ========== ==========
Options exercisable at year-end ........ 141,162 $ 61.35 155,228 $ 61.70 162,476 $ 63.72
========== ========== ========= ========== ========== ==========
The following table summarizes information about stock options outstanding
at December 31, 2004:
Options Outstanding Options Exercisable
---------------------------------------------------- ----------------------------------
Number Weighted-Average
Outstanding at Remaining Weighted-Average Number Exercisable Weighted-Average
Exercise Prices 12/31/04 Contractual Life Exercise price At 12/31/04 Exercise Price
-------------- -------------- -------------- -------------- --------------
$ 0.75 715,000 9.46 $ 0.75 -- $ --
2.55 12,498 9.57 2.55 6,249 2.55
4.80 83,333 8.72 4.80 -- --
5.64 11,283 3.42 5.64 11,283 5.64
15.00 8,334 1.19 15.00 8,334 15.00
16.68 8,332 2.41 16.68 8,332 16.68
36.00 97,501 7.53 36.00 -- --
44.04 17,979 6.07 44.04 17,979 44.04
45.36 6,249 0.36 45.36 6,249 45.36
45.60 6,249 1.35 45.60 6,249 45.60
60.00 43,750 4.79 60.00 43,750 60.00
91.56 23,471 1.05 91.56 23,471 91.56
182.40 2,183 2.90 182.40 2,183 182.40
252.00 7,083 3.42 252.00 7,083 252.00
-------------- -------------- -------------- -------------- --------------
1,043,245 8.43 $ 12.58 141,162 $ 61.35
============== ============== ============== ============== ==============
F-26
The Company accounts for the Plans 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 will be amortized as pro forma compensation
expense over the vesting period of the options. The following table sets forth
the assumptions used and the pro forma net loss and loss per share resulting
from applying SFAS No. 123:
Year Ended, Year Ended, Year Ended,
December 31, December 31, December 31,
2004 2003 2002
-------------- -------------- --------------
Net Loss as reported ...................................................... $ 7,257,101 $ 18,516,741 $ 39,591,344
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 ........................... 472,267 776,018 2,136,323
-------------- -------------- --------------
Pro forma net loss ........................................................ $ 7,729,368 $ 19,292,759 $ 41,727,667
Net loss per common share
As reported ............................................................. $ 0.48 $ 1.40 $ 3.51
Pro forma ............................................................... 0.51 1.45 3.70
Weighted average risk-free interest rate .................................. 4.05% 4.53% 4.54%
Weighted average expected life in years ................................... 9.5 9.5 9.6
Volatility ................................................................ 80% 102% 182%
Weighted average fair value of options granted during the year ............ $ 0.64 $ 3.99 $ 11.91
Stock Warrants
In connection with the issuance of the convertible debentures on August
12, 2002 (see Convertible Debentures), the Company issued to the debenture
holders warrants to purchase 208,333 shares of the Company's common stock at
$14.40 per share. A value of $1,521,046 was ascribed to the warrants and
recorded as an original issue discount based on the Black-Scholes method of
valuation. The exercise price and number of common shares issuable upon exercise
of the warrants are subject to adjustment under certain circumstances, such as
the occurrence of stock dividends and splits, distributions of property or
securities other than common stock, equity issuances for less than the warrant
exercise price and a change in control of the Company. In March 2003, in
connection with the issuance of the 2006 Debentures, the exercise price of the
warrants was reduced to $6.00 per share, but the number of shares of common
stock issuable upon exercise remained fixed at 357,143. At the same time, the
warrant agreement was amended such that any subsequent reduction in the exercise
price of the warrants will not result in any increase in the number of shares of
common stock issuable under the warrants. The warrants expire on August 12,
2007.
In connection with the issuance of the convertible debentures in March
2003 (see Convertible Debentures), the Company issued to the placement agent
warrants to purchase $1.055 million in aggregate principal amount of the 2006
Debentures at $1,200 per $1,000 of principal amount, 28,810 shares of the
Company's common stock at $10.08 per share, and 41,667 shares of the Company's
common stock at $7.20 per share. When the 2006 Debentures were retired in 2004,
the warrant to purchase $1,055 million in the aggregate principal amount of the
2006 Debentures converted to a warrant to purchase 175,833 shares of common
stock at $7.20 per share. Therefore, the total number of warrants now held by
Roth Capital Partners, LLC is 246,310. The exercise price and number of common
shares issuable upon exercise of the warrants are subject to adjustment under
certain circumstances, such as the occurrence of stock dividends and splits,
distributions of property or securities other than common stock and a change in
control of the Company. The warrants expire in March 2006.
On March 5, 2003, the Company issued to EKI a warrant to purchase 83,333
shares at $6.00 per share in connection with the subordination of loans of
$2.755 million made to the Company and the elimination of the conversion
feature. The warrants expire on March 5, 2013.
F-27
Revenue Recognition Policy
The Company recognizes revenue when persuasive evidence of an arrangement
exists, the price is fixed or readily determinable and collectibility is
probable. The Company recognizes revenue in accordance with Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements," (SAB 101).
EarthShell's revenues consist of technology fees that are recognized ratably
over the life of the related agreements and royalties based on product sales by
licensees that are recognized in the quarter that the licensee reports the
sales.
Income Taxes
Deferred income tax assets and liabilities are computed annually for
differences between the financial statement and income tax bases of assets and
liabilities. Such deferred income tax asset and liability computations are based
on enacted tax laws and rates applicable to periods in which the differences are
expected to reverse. Valuation allowances are established, when necessary, to
reduce deferred income tax assets to the amounts expected to be realized. Income
tax expense is the tax payable or refundable for the period plus or minus the
change during the period in deferred income tax assets and liabilities.
Deferred income taxes result from temporary differences in the recognition
of revenues and expenses for financial and tax reporting purposes. At December
31, 2004 and 2003, deferred income tax assets, which are fully reserved, were
comprised primarily of the following:
2004 2003
------------ ------------
Federal:
Depreciation ......................... $ 1,375,770 $ 6,510,014
Deferred compensation ................ 101,386 1,091,917
Deferred contributions ............... 361,117 361,117
Accrued management fees .............. 272,000 --
Accrued vacation ..................... 87,955 110,415
Other reserves ....................... 22,258 20,945
Capitalized operating expenses ....... -- 3,198,684
Net operating loss carryforward ...... 99,808,790 92,580,034
------------ ------------
$102,029,276 $103,873,126
============ ============
The valuation allowance (decreased) increased by $(1,843,850), $8,810,963
and $20,523,501 during the years ended December 31, 2004, 2003, and 2002,
respectively, as a result of changes in the components of the deferred income
tax items.
F-28
For federal income tax purposes, the Company has net operating loss
carryforwards of $302,487,919 as of December 31, 2004 that expire through 2024.
For state income tax purposes, the Company has California net operating loss
carryforwards of $64,504,022 as of December 31, 2004 that expire through 2009,
and Maryland net operating loss carryforwards of $120,893,526 that follow the
federal treatment and expire through 2024. Additionally, the ultimate
realizability of net operating losses may be limited by change of control
provision under section 382 of the Internal Revenue Code.
Income tax expense for 2004, 2003, and 2002 consists of the minimum state
franchise tax.
Loss Per Common Share
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, including Common stock to be issued. Diluted loss per common
share is computed by dividing net loss available to common stockholders by the
weighted-average number of common shares outstanding (including Common stock to
be issued) 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.
The dilutive effect of potentially dilutive securities was approximately
3.0 million shares, 900,000 shares, and 39,000 shares for the years ended at
December 31, 2004, 2003 and 2002, respectively.
Subsequent Events
On March 23, 2005, EarthShell Corporation (the "Company"), entered into a
Standby Equity Distribution Agreement with Cornell Capital Partners, LP.
Pursuant to the Standby Equity Distribution Agreement, the Company may, at its
discretion, periodically sell to Cornell Capital Partners, LP shares of common
stock for a total purchase price of up to $10.0 million. For each share of
common stock purchased under the Standby Equity Distribution Agreement, Cornell
Capital Partners LP will pay the Company 98% of the lowest volume weighted
average price of the Company's common stock as quoted by Bloomberg, LP on the
Over-the-Counter Bulletin Board or other principal market on which the Company's
common stock is traded for the 5 days immediately following the notice date. The
price paid by Cornell Capital Partners, LP for the Company's stock shall be
determined as of the date of each individual request for an advance under the
Standby Equity Distribution Agreement. Cornell Capital Partners, LP will also
retain 5% of each advance under the Standby Equity Distribution Agreement.
Cornell Capital Partner's obligation to purchase shares of the Company's common
stock under the Standby Equity Distribution Agreement is subject to certain
conditions, including the Company obtaining an effective registration statement
for shares of common stock sold under the Standby Equity Distribution Agreement
and is limited to $500,000 per weekly advance.
On March 23, 2005, the Company entered into a Security Agreement with
Cornell Capital Partners, LP. Pursuant to the Security Agreement, the Company
shall issue promissory notes to Cornell Capital Partners, LP in the original
principal amount of $2,500,000. The $2,500,000 will be disbursed as follows:
$1,150,000, within three days of the closing of all the transaction documents
with Cornell Capital Partners, LP and $1,350,000, two days prior to the filing
of a registration statement related to Standby Equity Distribution Agreement.
The promissory notes are secured by the assets of the Company and shares of
stock of another entity pledged by an affiliate of that entity. The promissory
notes have a one-year term and accrue interest at 12% per year beginning on the
3rd month anniversary.
In connection with the ESH sub-license, ESH agreed to purchase shares of
the Company's stock, which is planned to occur in conjunction with their scale
up of manufacturing capacity.
In January 2005, the Company entered into an agreement with a non-US based
prospective licensee for a new product family. At such time as the Company
demonstrates the commercial manufacturability of this new product family, the
prospective licensee may take a license on terms substantially similar to its
other licenses.
In February of 2005, the Board of Directors of the Company granted to its
Chairman an option to purchase up to 1 million shares of common stock at $2.30
per share in consideration for his many contributions and support of the Company
since its inception.
F-29
QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
First Second Third Fourth Total Year
----------- ----------- ----------- ----------- -----------
2004
Revenues .................................... $ -- $ 25,000 $ 50,000 $ 62,500 $ 137,500
Related party research and development ...... 300,000 300,000 200,000 -- 800,000
Other research and development .............. 222,538 42,913 64,121 40,591 370,163
Other general and administrative ............ 1,173,855 1,071,116 99,162 1,409,769 3,753,902
Net loss common shareholders ................ $ 2,066,857 $ 2,264,383 $ 1,645,931 $ 1,279,930 $ 7,257,101
Basic and diluted loss per common share ..... $ 0.15 $ 0.16 $ 0.12 $ 0.07 $ 0.48
Weighted average common shares
outstanding ............................... 14,128,966 14,128,966 14,223,402 17,659,043 15,046,726
2003
Related party research and development ...... $ 353,800 $ 304,667 $ 353,907 $ 300,000 $ 1,312,374
Other research and development .............. 1,896,986 1,707,507 1,287,516 3,342,407 8,234,416
Other general and administrative ............ 1,853,702 1,193,342 1,361,900 1,381,529 5,790,473
Net loss common shareholders ................ $ 6,770,727 $ 3,608,184 $ 2,920,797 $ 5,217,033 $18,516,741
Basic and diluted loss per common share ..... $ 0.55 $ 0.28 $ 0.21 $ 0.37 $ 1.40
Weighted average common shares
outstanding ............................... 12,358,967 13,013,462 13,595,973 14,013,965 13,266,668
F-30
We have not authorized any dealer, salesperson or other person to provide any
information or make any representations about EarthShell Corporation except the
information or representations contained in this prospectus. You should not rely
on any additional information or representations if made.
-----------------------
This prospectus does not constitute an ----------------------
offer to sell, or a solicitation of an
offer to buy any securities: PROSPECTUS
|_| except the common stock offered ---------------------
by this prospectus;
|_| in any jurisdiction in which the
offer or solicitation is not
authorized; 4,476,927 Shares of Common Stock
|_| in any jurisdiction where the
dealer or other salesperson is
not qualified to make the offer EARTHSHELL CORPORATION
or solicitation;
|_| to any person to whom it is
unlawful to make the offer or
solicitation; or
______________, 2005
|_| to any person who is not a
United States resident or who is
outside the jurisdiction of the
United States.
The delivery of this prospectus or any accompanying sale does not imply that:
|_| there have been no changes in
the affairs of EarthShell
Corporation after the date
of this prospectus; or
|_| the information contained in
this prospectus is correct after
the date of this prospectus.
-----------------------
Until _________, 2005, all dealers
effecting transactions in the
registered securities, whether or
not participating in this
distribution, may be required to
deliver a prospectus. This is in
addition to the obligation of
dealers to deliver a prospectus when
acting as underwriters.
II-1
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS
The Company's Certificate of Incorporation limits the liability of
directors to the maximum extent permitted by Delaware law. Delaware law provides
that directors of a company will not be personally liable for monetary damages
for breach of their fiduciary duties as directors, except for liability for (i)
any breach of their duty of loyalty to the company or its stockholders, (ii)
acts or omissions not in good faith or involving intentional misconduct or a
knowing violation of law, (iii) unlawful payment of dividends or unlawful stock
repurchases or redemptions as provided in Section 174 of the Delaware General
Corporation Law, or (iv) any transaction from which the director derived an
improper personal benefit.
The Company's Bylaws provide that the Company shall indemnify its
officers, directors, employees and other agents to the maximum extent permitted
by Delaware law. The Company's Bylaws also permit it to secure insurance on
behalf of any officer, director, employee or other agent for any liability
arising out of his or her actions in such capacity, regardless of whether the
Bylaws would permit indemnification.
The Company believes that the provisions in its Certificate of
Incorporation and its Bylaws are necessary to attract and retain qualified
persons as officers and directors.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
EarthShell pursuant to the foregoing, or otherwise, the Company has been advised
that in the opinion of the SEC such indemnification is against public policy as
expressed in the Securities Act of 1933 and is, therefore, unenforceable.
ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth estimated expenses expected to be incurred
in connection with the issuance and distribution of the securities being
registered. EarthShell will pay all expenses in connection with this offering.
Securities and Exchange Commission $ 1,054.00
Registration Fee
Printing and Engraving Expenses $ 2,500.00
Accounting Fees and Expenses $ 15,000.00
Legal Fees and Expenses $ 50,000.00
Miscellaneous $ 16,446.00
TOTAL $ 85,000.00
ITEM 26. SALES OF UNREGISTERED SECURITIES
During the past three years the registrant has issued the following
securities without registration under the Securities Act of 1933:
(1) In connection with the issuance of the convertible debentures in March
2003, the Company issued to the placement agent warrants to purchase $1.055
million in aggregate principal amount of the 2006 Debentures at $1,200 per
$1,000 of principal amount, 28,810 shares of the Company's common stock at
$10.08 per share, and 41,667 shares of the Company's common stock at $7.20 per
share. When the 2006 Debentures were retired in 2004, the warrant to purchase
$1,055 million in the aggregate principal amount of the 2006 Debentures
converted to a warrant to purchase 175,833 shares of common stock. Therefore,
the total number of warrants held by Roth Capital Partners, LLC is 246,310. The
exercise price and number of common shares issuable upon exercise of the
warrants are subject to adjustment under certain circumstances, such as the
occurrence of stock dividends and splits, distributions of property or
securities other than common stock and a change in control of the Company. The
warrants expire in March 2006.
(2) On March 5, 2003, the Company issued to EKI a warrant to purchase
83,333 shares at $6.00 per share in connection with the subordination of loans
of $2.755 million made to the Company and the elimination of the conversion
feature. The warrants expire on March 5, 2013.
II-2
(3) Pursuant to an agreement entered into in September 2004, as part of an
overall restructuring of its debt, EarthShell issued an aggregate of 491,778
shares of its common stock in October 2004 to Biotec in exchange for the
cancellation of $1.475 million of accrued license fees EarthShell owed Biotec,
which transaction computed to a $3.00 per share conversion price.
(4) Pursuant to an agreement entered into in September 2004, in connection
with the restructuring of its debt and settlement of the 2006 Debentures, in
October 2004, EarthShell issued an aggregate of 1,051,494 shares of its common
stock to EKI of the 2006 Debentures in exchange for the cancellation of $3.288
million of principal and interest due under then outstanding loans.
(5) Pursuant to various agreements dated September 29 and September 30,
2004 in connection with the restructuring of its debt and settlement of the 2006
Debentures, EarthShell issued an aggregate of 512,500 additional shares of its
common stock to the holders of the 2006 Debentures in settlement of the
Company's default under the 2006 Debentures.
(6) In October 2004, as part of an overall restructuring of its debt,
EarthShell issued an aggregate of 900,000 shares of its common stock to MBS at
$3.00 per share for an aggregate offering price of $2.7 million.
(7) On March 23, 2005, the Company entered into a Standby Equity
Distribution Agreement with Cornell Capital Partners, LP. Pursuant to the
Standby Equity Distribution Agreement, EarthShell may, at its discretion,
periodically sell to Cornell Capital Partners shares of common stock for a total
purchase price of up to $10.0 million. For each share of common stock purchased
under the Standby Equity Distribution Agreement, Cornell Capital Partners will
pay EarthShell 98% of, or a 2% discount to, the lowest volume weighted average
price of our common stock on the Over-the-Counter Bulletin Board or other
principal market on which our common stock is traded for the five days
immediately following the notice date. Further, Cornell Capital Partners will
retain 5% of each advance under the Standby Equity Distribution Agreement. In
connection with the Standby Equity Distribution Agreement, Cornell Capital
Partners received a one-time commitment fee in the form of 143,550 shares of
common stock on March 23, 2005.
(8) For its services in connection with the Standby Equity Distribution
Agreement, Sloan Securities Corporation received 6,450 shares of common stock of
the Company on March 23, 2005.
(9) On March 31, 2005, the Company issued 6,450 shares of common stock to
Crown Investment Banking, Inc. in consideration for the services rendered by
Crown Investment Banking, Inc. in connection with the Company obtaining
financing.
(10) In consideration for Benton Wilcoxon pledging his personal shares in
Composite Technology Corporation as a guaranty for the Security Agreement
entered into by the Company with Cornell Capital Partners, the Company issued a
warrant to Benton Wilcoxon to purchase 65,000 shares of common stock of the
Company at an exercise price of $3.00 per share. The warrant expires on March
23, 2008.
(11) In consideration for consulting services rendered by Douglas Metz in
connection with the Company obtaining financing, the Company issued a warrant to
Douglas Metz to purchase 80,000 shares of common stock of the Company at an
exercise price of $3.00 per share. The warrant expires on March 23, 2008.
(12) In May of 2005, the Company granted a 10-year warrant to EKI to
purchase one million shares of the Company's common stock at $3 per share in
consideration of EKI's continued support of the Company since its inception,
including providing bridge loans at below market terms from time to time.
(13) In May of 2005, the Company issued 44,387 shares of unregistered
common stock to EKI pursuant to a provision of the EKI conversion agreement
which provided for the issuance of these additional shares if the Company did
not sell equity to a third party within 90 days of the initial conversion at a
price of at least $4 per share.
(14) On May 26, 2005, 100 shares of our Series B Convertible Preferred
Stock, par value $0.01 per share, were pledged to secure the promissory notes
issued to Cornell Capital Partners and were been placed in escrow to be issued
to Cornell Capital Partners in the event of default. The shares will be released
from escrow to the Company upon (i) repayment of $1,350,000 of principal under
the promissory notes; (ii) in the event the shares pledged pursuant to that
certain Amended and Restated Pledge and Escrow Agreement by and among Benton
Wilcoxon, Cornell Capital Partners and David Gonzalez, Esq. is equal to or
exceeds 3 times the amount of principal then outstanding under the promissory
notes; (iii) a registration statement has been declared effective by the SEC
relating to the shares to be issued pursuant to the Standby Equity Distribution
Agreement; and (iv) the 100 shares of Series B Convertible Preferred Stock have
been redeemed pursuant the Certificate of Designation. Pursuant to the
Certificate of Designation, the Series B Convertible Preferred Stock is senior
II-3
to the Company's common stock with respect to the distribution of the assets of
the Company upon liquidation and junior to all other series of preferred stock.
The holders of the Series B Convertible Preferred Stock are not entitled to
dividends or distributions. Each share of Series B Convertible Preferred Stock
is convertible, at the option of the holder, at any time upon an event of
default under the promissory notes, into 33,333 shares of fully paid and
non-assessable common stock of the Company. The Series B Convertible Preferred
Stock has no voting rights, except as required under Delaware law. After full
repayment of the notes, the Company has the absolute right to redeem (unless
otherwise prevented by law) any outstanding shares of Series B Convertible
Preferred Stock at an amount equal to $0.01 per share.
(15) On May 26, 2005, the Company issued a warrant to Cornell Capital
Partners to purchase 625,000 shares of common stock of the Company. The warrant
expires on the later of: (a) May 26, 2005 or (b) the date sixty days after the
date the $2,500,000 in promissory notes issued to Cornell Capital Partners are
fully repaid and has an exercise price of $4.00 per share of common stock.
EarthShell claimed an exemption from registration under the Securities Act
for the sales and issuance of its common stock in the transactions described in
paragraphs (1) through (15) above by virtue of Section 4(2) of the Securities
Act in that such sales and issuances did not involve a public offering.
EarthShell believed that the recipients of common stock in each of these
transactions intended to acquire the securities for investment only and not with
a view to or for sale in connection with any distribution thereof, and
appropriate legends were affixed to the share certificates and instruments
issued in such transactions. These sales and issuances were made without general
solicitation or advertising and each purchaser was a sophisticated investor. All
recipients had adequate access, through their relationships with the Company, to
information about the Company. There were no underwriters involved in any of
these sales and issuances.
ITEM 27. EXHIBITS
Exhibit No. Description
----------- -----------
3.1(1) Amended and Restated Certificate of Incorporation of the
Company
3.2(1) Amended and Restated Bylaws
3.3(1) Certificate of Designation, Preferences Relative,
Participating, Optional and Other Special Rights of the
Company's Series A Cumulative Senior Convertible Preferred
Stock
3.4(2) Certificate of Designation of the Company's Series B
Convertible Preferred Stock
4.1(1) Specimen certificate of Common Stock
4.2(3) Form of Warrant to purchase Common Stock dated August 12, 2002
4.3(4) Form of Note under Loan Agreement dated as of September 9,
2002 between the Company and E. Khashoggi Industries, LLC
4.4(5) Form of Secured Convertible Debenture due March 5, 2006
4.5(5) Intellectual Property Security Agreement dated as of March 5,
2003 among the Company, E. Khashoggi Industries, LLC and the
investors signatory thereto
4.6(5) Waiver and Amendment to Debentures and Warrants dated as of
March 5, 2003 among the Company and the purchasers identified
on the signature pages thereto
4.7(5) Exchange Agreement dated as of March 5, 2003 between the
Company and the institutional investor signatory thereto
5.1(6) Opinion of Counsel
10.1(1) Amended and Restated License Agreement dated February 28, 1995
by and between the Company and E. Khashoggi Industries
10.2(1) Registration Rights Agreement dated as of February 28, 1995 by
and between the Company and EKI, as amended
10.3(1) EarthShell Container Corporation 1994 Stock Option Plan
10.4(1) EarthShell Container Corporation 1995 Stock Incentive Plan
10.5(1) Form of Stock Option Agreement under the EarthShell Container
Corporation 1994 Stock Option Plan
10.6(1) Form of Stock Option Agreement under the EarthShell Container
Corporation 1995 Stock Incentive Plan
10.7(1) Warrant to Purchase Stock issued July 2, 1996 by the Company
to Imperial Bank
II-4
10.8(1) Amended and Restated Technical Services and Sublease Agreement
dated October 1, 1997 by and between the Company and EKI
10.9(1) Amended and Restated Agreement for Allocation of Patent Costs
dated October 1, 1997 by and between the Company and EKI
10.10(1) Warrant to Purchase Stock issued October 6, 1997 by the
Company to Imperial Bank
10.11(1) Warrant to Purchase Stock dated December 31, 1997 by the
Company to Imperial Bank
10.12(1) Letter Agreement re Haas/BIOPAC Technology dated February 17,
1998 by and between the Company and EKI
10.13(1) Second Amendment to 1995 Stock Incentive Plan of the Company
10.14(1) Amendment No. 2 to Registration Rights Agreement dated as of
September 16, 1993
10.15(1) Amendment No. 2 to Registration Rights Agreement dated
February 28, 1995
10.16(7) First Amendment dated June 2, 1998 to the Amended and Restated
License Agreement by and between the Company and E. Khashoggi
Industries
10.17(8) First Amendment to 1995 Stock Incentive Plan of the Company
10.18(9) Third Amendment to 1995 Stock Incentive Plan of the Company
10.19(9) Fourth Amendment to 1995 Stock Incentive Plan of the Company
10.20(10) Lease Agreement dated August 23, 2000 by and between the
Company and Heaver Properties, LLC
10.21(11) Settlement Agreement with Novamont dated August 3, 2001
10.22(11) Amendment to Common Stock Purchase Agreement dated March 28,
2001
10.23(12) Securities Purchase Agreement dated as of August 12, 2002
between the Company and the investors signatory thereto
10.24(13) Loan Agreement dated as of September 9, 2002 between the
Company and E. Khashoggi Industries, LLC
10.25(14) Second Amendment dated 29 July, 2002 to Amended and Restated
License Agreement between E. Khashoggi Industries, LLC and the
Company
10.26(14) License and Information Transfer Agreement dated 29 July, 2002
between the Biotec Group and the Company
10.27(15) Loan and Securities Purchase Agreement dated as of March 5,
2003 between the Company and the investors signatory thereto
10.28(16) Sublicense Agreement dated February 20, 2004 by and between
the Company and Hood Packaging Corporation
10.29(16) Operating and Sublicense Agreement dated October 3, 2002 by
and between the Company and Sweetheart Cup Company, Inc.
10.30(16) First Amendment to Operating and Sublicense Agreement dated
July 2003 by and between the Company and Sweetheart Cup
Company, Inc.
10.31(16) Lease Agreement dated July 2003 between the Company and
Sweetheart Cup Company, Inc.
10.32(16) First Amendment to Lease Agreement dated December 16, 2003
between the Company and Sweetheart Cup Company, Inc.
10.33(17) Sublicense Agreement dated November 11, 2004 by and between
the Company and EarthShell Hidalgo S.A. de C.V.
10.34(18) Standby Equity Distribution Agreement dated as of March 23,
2005 between the Company and Cornell Capital Partners, LP
II-5
10.35(18) Registration Rights Agreement dated as of March 23, 2005
between the Company and Cornell Capital Partners, LP
10.36(18) Placement Agent Agreement dated as of March 23, 2005 by and
among the Company, Cornell Capital Partners, LP and Sloan
Securities Corporation
10.37(18) Security Agreement dated as of March 23, 2005 between the
Company and Cornell Capital Partners, LP
10.38(18) Promissory Note dated as of March 23, 2005 issued to Cornell
Capital Partners, LP
10.39(2) Promissory Note dated as of May 26, 2005 issued to Cornell
Capital Partners, LP
10.40(2) Pledge and Escrow Agreement dated as of May 26, 2005 by and
among the Company, Cornell Capital Partners, LP and David
Gonzalez, Esq.
10.41(19) Meridian Business Solutions Sublicense Agreement dated May 13,
2004
10.42(19) Amended and Restated Debenture Purchase Agreement by and among
the Company, EKI and SF Capital Partners, Ltd. dated September
30, 2004
10.43(19) Amended and Restated Debenture Purchase Agreement by and among
the Company, EKI and Omicron Master Trust dated September 29,
2004
10.44(20) Amended and Restated Debenture Purchase Agreement by and among
the Company, EKI and Islandia, Ltd. dated September 29, 2004
10.45(20) Amended and Restated Debenture Purchase Agreement by and among
the Company, EKI and Midsummer Investment, Ltd. dated
September 29, 2004
10.46(20) Conversion Agreement by and among the Company, EKI and RHP
Master Fund, Ltd. dated July 20, 2004
10.47(20) Amended and Restated Debenture Purchase Agreement by and among
the Company, EKI and Straus-GEPT L.P. dated September 29, 2004
10.48(20) Amended and Restated Debenture Purchase Agreement by and among
the Company, EKI and Straus Partners L.P. dated September 29,
2004
10.49(20) Amended and Restated Debenture Purchase Agreement by and among
the Company and EKI dated September 30, 2004
10.50(20) Agreement with EKI dated July 16, 2004 to convert debt to
equity
10.51(20) Agreement dated September 1, 2004 for conversion of Biotec
indebtedness
10.52(20) Stock Purchase Agreement between the Company and Meridian
Business Solutions, LLC dated August 5, 2004
10.53(2) Warrant issued to Cornell Capital Partners, LP
14.1(16) EarthShell Corporation Code of Ethics for Directors, Officers
and Employees
23.1(20) Consent of Kirkpatrick & Lockhart Nicholson Graham LLP
23.2(21) Consent of Farber & Hass LLP
(1) Previously filed, as an exhibit to the Company's Registration Statement on
Form S-1 and amendments thereto, File No. 333-1327, and incorporated
herein by reference.
(2) Previously filed as an exhibit to the Company's current report on Form 8-K
dated May 27, 2005, and incorporated herein by reference.
(3) Previously filed as an exhibit to the Company's current report on Form 8-K
dated August 12, 2002, and incorporated herein by reference.
(4) Previously filed as an exhibit to the Company's current report on Form 8-K
dated September 17, 2002, and incorporated herein by reference.
(5) Previously filed as an exhibit to the Company's current report on Form 8-K
dated March 5, 2003, and incorporated herein by reference.
(6) Provided herewith.
(7) Previously filed as an exhibit to the Company's quarterly report on Form
10-Q, for the quarter ended September 30, 1998, and incorporated herein by
reference.
(8) Previously filed as an exhibit to the Company's annual report on Form
10-K, for the fiscal year ended December 31, 1998, and incorporated herein
by reference.
II-6
(9) Previously filed as part of the Company's definitive proxy statement on
Schedule 14A, file no. 000-23567, for its 1999 annual meeting of
stockholders, and incorporated herein by reference.
(10) Previously filed as an exhibit to the Company's annual report on Form
10-K, for the fiscal year ended December 31, 2000, and incorporated herein
by reference.
(11) Previously filed as an exhibit to the Company's quarterly report on Form
10-Q, for the quarter ended June 30, 2001, and incorporated herein.
(12) Previously filed as an exhibit to the Company's current report on Form 8-K
dated August 12, 2002, and incorporated herein by reference.
(13) Previously filed as an exhibit to the Company's current report on Form 8-K
dated September 17, 2002, and incorporated herein by reference.
(14) Previously filed as an exhibit to the Company's quarterly report on Form
10-Q for the quarter ended September 30, 2002, and incorporated herein by
reference.
(15) Previously filed as an exhibit to the Company's current report on Form 8-K
dated March 5, 2003, and incorporated herein by reference.
(16) Previously filed as an exhibit to the Company's annual report on Form
10-K, for the fiscal year ended December 31, 2003, and incorporated herein
by reference.
(17) Previously filed as an exhibit to the Company's annual report on Form
10-K, for the fiscal year ended December 31, 2004, and incorporated herein
by reference.
(18) Previously filed as an exhibit to the Company's current report on Form 8-K
dated March 29, 2005, and incorporated herein by reference.
(19) Previously filed as part of the Company's quarterly report on Form 10-Q
for the quarter ended September 30, 2004, and incorporated herein by
reference.
(20) Incorporated by reference to Exhibit 5.1
(21) Incorporated by reference to Exhibit 23-2.
II-7
Item 28. Undertakings
The undersigned registrant hereby undertakes:
(1) To file, during any period in which it offers or sells
securities, a post-effective amendment to this registration statement to:
(i) Include any prospectus required by Sections 10(a)(3) of
the Securities Act of 1933 (the "Act");
(ii) Reflect in the prospectus any facts or events arising
after the effective date of the Registration Statement (or the most recent
post-effective amendment thereof) which, individually or in the aggregate,
represent a fundamental change in the information set forth in the Registration
Statement. Notwithstanding the foregoing, any increase or decrease in volume of
securities offered (if the total dollar value of securities offered would not
exceed that which was registered) and any deviation from the low or high end of
the estimated maximum offering range may be reflected in the form of prospectus
filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the
changes in volume and price represent no more than 20 percent change in the
maximum aggregate offering price set forth in the "Calculation of Registration
Fee" table in the effective Registration Statement;
(iii) Include any additional or changed material information
on the plan of distribution;
(2) That, for the purpose of determining any liability under the
Act, each such post-effective amendment shall be deemed to be a new registration
statement relating to the securities offered therein, and the offering of such
securities at that time shall be deemed to be the bona fide offering thereof.
(3) To remove from registration by means of a post-effective
amendment any of the securities that remain unsold at the end of the offering.
Insofar as indemnification for liabilities arising under the Act may be
permitted to directors, officers and controlling persons of the small business
issuer pursuant to the foregoing provisions, or otherwise, the small business
issuer has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the small business issuer of
expenses incurred or paid by a director, officer or controlling person of the
small business issuer in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the small business issuer will,
unless in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the Act and
will be governed by the final adjudication of such issue.
II-8
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements for filing on Form S-1 and authorized this registration
statement to be signed on our behalf by the undersigned, on June 9, 2005.
EARTHSHELL CORPORATION
Date: June 9, 2005 By: /s/ Simon K. Hodson
---------------------------------
Name: Simon K. Hodson
Title: Vice Chairman of the Board and
Chief Executive Officer
Date: June 9, 2005 By: /s/ D. Scott Houston
---------------------------------
Name: D. Scott Houston
Title: Chief Financial Officer and
Secretary
In accordance with the Securities Exchange Act, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
/s/ Essam Khashoggi Date: June 9, 2005
-------------------------------------
Essam Khashoggi
Chairman of the Board
/s/ Simon K. Hodson Date: June 9, 2005
-------------------------------------
Simon K. Hodson
Vice Chairman of the Board and Chief
Executive Officer
/s/ D. Scott Houston Date: June 9, 2005
-------------------------------------
D. Scott Houston
Chief Financial Officer and Secretary
/s/ John Daoud Date: June 9, 2005
-------------------------------------
John Daoud
Director
/s/ Layla Khashoggi Date: June 9, 2005
-------------------------------------
Layla Khashoggi
Director
/s/ Hamlin Jennings Date: June 9, 2005
-------------------------------------
Hamlin Jennings
Director
/s/ Walker Rast Date: June 9, 2005
-------------------------------------
Walker Rast
Director
II-8