As filed with the Securities and Exchange Commission on February 14, 2006
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM S-1
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933, AS AMENDED
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Delaware EarthShell Corporation 77-0322379
(State or Other Jurisdiction of (Name of Registrant in (I.R.S. Employer
Incorporation Our Charter) Identification No.)
or Organization)
VINCENT J. TRUANT
1301 YORK ROAD, SUITE 200 1301 YORK ROAD, SUITE 200
LUTHERVILLE, MARYLAND 21093 LUTHERVILLE, MARYLAND 21093
(410) 847-9420 2650 (410) 847-9420
(Address and telephone number (Primary Standard Industrial (Name, address and telephone
of Principal Executive Offices Classification Code Number) number of agent for service)
and Principal Place of Business)
Copies to:
Clayton E. Parker, Esq. Matthew L. Ogurick, 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 1933 Act check the
following box. |X|
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the 1933 Act, please check the following box and
list the 1933 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 1933 Act, check the following box and list the 1933 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
======================================================================================================================
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 10,327,844 shares (2) $1.76 $18,177,005 $1,945
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TOTAL 10,327,844 shares (2) $1.76 18,177,005 $1,945
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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, as amended. For
the purposes of this table, we have used a recent closing price at January
17, 2006.
(2) These shares consist of: (i) 6,700,000 shares which are being registered
pursuant to the Purchase Agreement, dated December 30, 2005, with Cornell
Capital Partners, (ii) 143,550 shares which have been issued to Cornell
Capital Partners and 6,450 shares which have been issued to each of Sloan
Securities Corporation and Crown Capital Investment, Inc. on or about March
23, 2005, in connection with a financing transaction, (iii) 1,295,000
shares underlying warrants, (iv) 1,909,727 shares being registered pursuant
to various settlement arrangements, (v) 266,667 shares in connection with
the EarthShell Asia Transaction..
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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, as amended, 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 February 14, 2006
EARTHSHELL CORPORATION
10,327,844 shares of Common Stock
This prospectus (this "Prospectus") relates to the registration of
10,327,844 shares of common stock of EarthShell Corporation ("EarthShell" or the
"Company") by certain persons who are stockholders of the Company. The selling
shareholders may not choose to sell all of the shares covered by this
registration statement, or, under certain market conditions, may not be entitled
to convert and sell all of the shares covered by their respective registration
or conversion agreements. 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 associated with this offering are being offered
for sale by certain persons who are selling stockholders at prices established
on the Over-the-Counter Bulletin Board during the term of this offering. On
February 10, 2006, the last reported market sale price of our common stock was
$1.76 per share. Our common stock is quoted on the Over-the-Counter Bulletin
Board under the symbol "ERTH.OB". The price of our common stock will fluctuate
based on the demand for the shares of common stock.
The selling stockholders consist of: (a) Cornell Capital Partners, who may
sell up to 7,504,050 shares of common stock, consisting of: (i) 6,700,000 shares
which may be issued from time to time upon the conversion of secured convertible
debentures (the "December Debentures") acquired by Cornell Capital Partners
pursuant to the Securities Purchase Agreement, dated December 30, 2005 (the
"Purchase Agreement"), (ii) 143,550 shares which have been issued to Cornell
Capital Partners on or about March 23, 2005, in connection with a financing
transaction and (iii) 660,500 shares of common stock which may be issued upon
the exercise of warrants issued on May 26, 2005, August 26, 2005 and December
30, 2005; (b) Sloan Securities Corporation, who may sell up to 6,450 shares of
common stock which the Company issued on or about March 23, 2005, in connection
with a financing transaction; (c) Highgate House Funds, Ltd., who may sell up to
364,500 shares of common stock which may be issued upon the exercise of a
warrant issued on December 30, 2005; (d) SF Capital Partners Ltd., who may sell
up to 1,000,000 shares of common stock upon the conversion of existing debt
pursuant to a settlement arrangement; (e) 266,667 shares in connection with the
EarthShell Asia Transaction, (f) other selling shareholders who may sell up to
916,177 shares of common stock previously issued by the Company and (g)
additional selling stockholders, who may sell up to 270,000 shares of common
stock upon the exercise of warrants previously issued by the Company.
Pursuant to the Purchase Agreement, the Company issued to Cornell Capital
Partners the December Debentures, which shall be convertible into shares of the
Company's common stock as set forth herein. The Company received proceeds equal
to $4,500,000 from the sale of the December Debentures on January 6, 2006. The
December Debentures are secured by (i) a Pledge and Escrow Agreement, by and
among the Company, Cornell Capital Partners, and David Gonzalez, Esq., (ii) an
Insider Pledge Agreement and Escrow Agreement (the "IPEA"), by and among the
Company, Cornell Capital Partners, David Gonzalez, Esq. and Mr. Benton Wilcoxon
and (iii) an Amended and Restated Security Agreement, by and between the Company
and Cornell Capital Partners. The December Debentures are secured by
substantially all of the Company's assets, have a three (3) year term and accrue
interest at twelve percent (12%) per annum. Beginning 60 days after the
Securities and Exchange Commission ("SEC") declares the accompanying
registration statement effective, Cornell Capital Partners is entitled, at its
option, to convert and sell up to $250,000 of the principal amount of the
December Debentures, plus accrued interest, into shares of the Company's common
stock, within any 30 day period at the lesser of (i) a price equal to $3.00 or
(ii) eighty-eight percent (88%) of the average of the two (2) lowest volume
weighted average prices of the common stock during the ten (10) trading days
immediately preceding the conversion date, as quoted by Bloomberg, LP. The
conversion limitation of $250,000 per month does not apply if the market price
is greater than $3.00 per share.
The holder of the December Debentures may not convert the December
Debentures or receive shares of the Company's common stock as payment of
interest thereunder to the extent such conversion or receipt of such interest
payment would result in the holder, together with any affiliate thereof,
beneficially owning (as determined in accordance with Section 13(d) of the
Securities Exchange Act of 1934, as amended, and the rules promulgated
thereunder) in excess of 4.9% of the then issued and outstanding shares of
common stock, including shares issuable upon conversion of, and payment of
interest on, the December Debentures held by such holder after application of
this 4.9% restriction. This 4.9% restriction may be waived by the holder (but
only as to itself and not to any other holder) upon not less than sixty-five
(65) days prior notice to the Company.
The Company may redeem, with three (3) business days advance written notice
to Cornell Capital Partners, a portion or all amounts outstanding under the
December Debentures prior to the maturity date provided that the closing bid
price of the of the Company's common stock, as reported by Bloomberg, LP, is
less than $3.00 at the time of the redemption notice. The Company shall pay an
amount equal to the principal amount being redeemed plus a redemption premium
equal to ten percent (10%) of the principal amount being redeemed, and accrued
interest, to be delivered to the Cornell Capital Partners on the third (3rd)
business day after the redemption notice, provided, however, this redemption
premium does not apply until the outstanding principal balance of the December
Debentures has been reduced by $2.5 million. The amount that Cornell may convert
in any 30 day period will be reduced by the amount that the Company redeems.
In connection with the Purchase Agreement, on December 30, 2005, the
Company issued to Cornell Capital Partners the December Warrant to purchase up
to 350,000 shares of common stock. This December Warrant has an exercise price
of $4.00 per share, which may be adjusted under certain conditions to as low as
$3 per share and expires two (2) years from the date it was issued. Furthermore,
in connection with the Company's sale of December Debentures, the Company issued
to Mr. Benton Wilcoxon, in consideration of his pledge of shares of common stock
of Composite Technology Corporation pursuant to the terms of the IPEA, a warrant
to purchase up to 125,000 shares of common stock. This warrant has an exercise
price of $4.00 per share and expires three (3) years from the date it was
issued.
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 8.
No underwriter or person has been engaged to facilitate the sale of shares
of common stock in this offering. This offering will terminate twenty-four (24)
months after the accompanying registration statement (the "Registration
Statement") is declared effective by the "SEC". 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 SEC is effective. This Prospectus is not an offer to
buy these securities in any state where the offer or sale is not permitted.
The SEC 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.
2
TABLE OF CONTENTS
PROSPECTUS SUMMARY......................................................................................................1
THE OFFERING............................................................................................................4
SUMMARY FINANCIAL DATA..................................................................................................6
SUPPLEMENTARY FINANCIAL INFORMATION.....................................................................................7
RISK FACTORS............................................................................................................8
FORWARD-LOOKING STATEMENTS.............................................................................................15
SELLING STOCKHOLDERS...................................................................................................16
USE OF PROCEEDS........................................................................................................22
DILUTION...............................................................................................................23
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..................................44
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.............................................................45
DESCRIPTION OF BUSINESS................................................................................................46
MANAGEMENT.............................................................................................................55
STOCK PERFORMANCE GRAPH................................................................................................69
PRINCIPAL STOCKHOLDERS.................................................................................................70
MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND OTHER STOCKHOLDER MATTERS..........................72
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.........................................................................73
DESCRIPTION OF CAPITAL STOCK...........................................................................................75
EXPERTS................................................................................................................79
VALIDITY OF SECURITIES.................................................................................................79
INTERESTS OF NAMED EXPERT AND COUNSEL LEGAL MATTERS....................................................................79
HOW TO GET MORE INFORMATION............................................................................................79
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES*..........................................................................F-i
PART II ............................................................................................................II-1
SIGNATURES..........................................................................................................II-11
EXHIBIT 5.1.........................................................................................................5.1-1
EXHIBIT 23.2.......................................................................................................23.2-1
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 was organized in November 1992 to engage in the
commercialization of 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 (collectively,
"EarthShell Packaging(R)"). 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
determined that foodservice disposables made of this material should offer
certain environmental benefits, will have performance characteristics, such as
strength and rigidity, and it believes that it should be able to commercially
produce and sell these products 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(R); (ii) demonstrate customer acceptance and demand for
EarthShell Packaging(R) through key market leaders and environmental groups; and
(iii) demonstrate the manufacturability and improved economics with initial
strategic partners.
To date, the Company has licensed the technology to a number of carefully
selected partners and has required certain minimum performance. The Company has
terminated its license arrangements with certain of its licensed partners
wherever the relationship was not progressing as planned. The Company currently
has one (1) active licensee in the United States, one (1) in Mexico and one (1)
in Asia. In cooperation with its licensing partners, more than 50,000,000 units
of EarthShell Packaging(R), including plates, bowls and sandwich containers have
been manufactured and sold to key customers within a variety of market segments
in order to demonstrate commercial product quality, customer acceptance and
demand. In support of its environmental claims, the Company has received
endorsements from a number of governmental and non-environmental organizations.
In addition, the Company has worked with a machinery manufacturer who has
developed a turn-key manufacturing line for EarthShell plates and bowls. The
Company's primary focus is now on supporting its licensee in the United States
who has put in place a commercial production facility and is commencing
manufacturing and distribution operations. In addition, the Company will be
seeking to support its Mexican licensee in acquiring and putting into service
manufacturing capacity to serve the Mexican market. Finally, the Company has
entered into various license agreements with EarthShell Asia, an Asian licensee,
to demonstrate and to exploit a new embodiment of the EarthShell technology.
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 $11,576,360 at September 30, 2005. These factors,
along with others, may indicate that the Company will be unable to continue as a
going concern for a period of twelve (12) months or less. The Company will have
to raise additional funds to meet its current obligations and to cover operating
expenses through the year ending December 31, 2006. 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.
Recent Developments
On August 22, 2005, the Company entered into a letter agreement with EA to
grant sub-licenses to use EarthShell Technology for various applications in
certain Asian territories (the "EA License"). Shortly after executing a letter
agreement, both the Company and EA entered into negotiations to restructure the
transaction and ultimately entered into an amended and restated letter agreement
dated December 9, 2005. By its terms, the amended and restated letter agreement
was not to become effective until all conditions to the transactions described
therein were satisfied. Per the transaction as restructured in accordance with
the amended and restated letter agreement, the Company may receive a total of up
to $2.6 million from a combination of (i) prepaid technology fees (up to
$1.7 million), (ii) the sale of up to 266,667 shares of its common stock and
(iii) the issuance of warrants to purchase one million thirty three thousand
three hundred thirty three (1,033,333) shares of the Company's common stock at
$3.90 per share (which, if the Company does not file with the Securities and
Exchange Commission a registration statement for the resale of such shares by
January 31, 2006, may be adjusted to an excercise price of not less than $3 per
share). Subsequent to the execution of the amended and restated letter
agreement, EA agreed to change the deadline for filing the resale registration
statement to [February 15, 2006]. Realization of the full potential of the
transaction is dependent on the Company successfully demonstrating the
commercial viability of its technology in certain new applications
The Company received $500,000 from EA in August 2005 as an initial partial
payment and issued 166,667 shares of its common stock in connection with this
payment. The Company received an additional $300,000 in December 2005 and the
final payment, of approximately $61,000 on February 10, 2006. The remainder was
retained by EA as compensation for various costs and fees. Upon receipt of the
final payment, the Company issued a total of 266,667 shares and the warrants to
purchase the 1,033,333 shares
1
On October 11, 2005, the Company issued a promissory note (the "EKI Loan")
to E. Khashoggi Industries, Inc., LLC ("EKI"), pursuant to which EKI advanced
$1,000,000 to the Company. Also on October 11, 2005, the Company entered into a
debt conversion and mutual release agreement (the "Debt Conversion Agreement")
with EKI. Pursuant to the Debt Conversion Agreement, the Company and EKI agreed
that a receivable in an amount equal to $837,145.69 (previously owed to bio-Tec
Biologische Naturverpackunger GmbH & Co.KG, but which receivable was
subsequently assigned to EKI) be converted into 279,048 shares of common stock
of the Company. The conversion price equals $3.00 per share. Pursuant to the
Debt Conversion Agreement, the Company and EKI released each other from any and
all claims in connection with the receivable.
On December 30, 2005, the Company entered into a Purchase Agreement with
Cornell Capital Partners, whereby the Company received gross proceeds equal to
$4,500,000 on January 6, 2006 from the sale of the December Debentures.
Approximately $2.6 million of these proceeds were used to restructure and retire
the $2.5 million in notes payable to Cornell. In addition, the Company expects
to receive additional technology fee payments in 2006 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
or that it will receive any further technology fee payments in 2006 pursuant to
its sublicense agreements. 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.
In consultation with its independent auditors, as of September 30, 2005,
the Company has begun taking the following remediation steps, among others, to
enhance its internal control over financial reporting and reduce control
deficiencies in general:
o Management has interviewed multiple qualified candidates to perform
the Controller responsibilities, and as of October 31, 2005 has hired
a new controller.
o Management has engaged an outside accounting firm to perform certain
Internal Audit functions. This outside firm reports to the Audit
Committee of the Board of Directors on a quarterly basis.
o Management employs an outside firm, to monitor and maintain the
Company's information systems. This group was been directed to develop
and implement Company-wide information management control procedures
in response to the control weaknesses noted by the Company's auditors
and in consultation with the Company's internal auditors. In
connection with the recent move of its corporate offices to Maryland,
a new group was retained to perform a similar function. It is expected
that a final information technology controls policy and procedures
document will be finalized and implemented 2006.
To date, the Company has expended approximately $60,000 towards remediation
of these material weaknesses.
Simon Hodson, chairman of the Board of Directors of the Company, resigned
in January 2006, and Vincent J. Truant, Chief Executive Officer of the Company,
was elected as chairman of the Board of Directors as of Feb 2, 2006.
2
About Us
Our principal executive offices are located at 1301 York Road, Suite 200,
Lutherville, Maryland 21093. Our telephone number is (410) 847-9420. The address
of our website is www.earthshell.com. Information on our website is not part of
this Prospectus.
3
THE OFFERING
(a) Cornell Capital Partners, who may sell up to 7,504,050 shares of
common stock, consisting of: (i) 6,700,000 shares which may be issued from time
to time upon the conversion of secured convertible debentures (the "December
Debentures") acquired by Cornell Capital Partners pursuant to the Securities
Purchase Agreement, dated December 30, 2005 (the "Purchase Agreement"), (ii)
143,550 shares which have been issued to Cornell Capital Partners on or about
March 23, 2005, in connection with a financing transaction and (iii) 660,500
shares of common stock which may be issued upon the exercise of warrants issued
on May 26, 2005, August 26, 2005 and December 30, 2005; (b) Sloan Securities
Corporation, who may sell up to 6,450 shares of common stock which the Company
issued on or about March 23, 2005, in connection with a financing transaction;
(c) Highgate House Funds, Ltd., who may sell up to 364,500 shares of common
stock which may be issued upon the exercise of a warrant issued on December 30,
2005; (d) SF Capital Partners Ltd., who may sell up to 1,000,000 shares of
common stock upon the conversion of existing debt pursuant to a settlement
arrangement; (e) 266,667 shares in connection with the EarthShell Asia
Transaction, (f) other selling shareholders who may sell up to 916,177 shares of
common stock previously issued by the Company and (g) additional selling
stockholders, who may sell up to 270,000 shares of common stock upon the
exercise of warrants previously issued by the Company.
Pursuant to the Purchase Agreement, the Company issued to Cornell Capital
Partners the December Debentures, which shall be convertible into shares of the
Company's common stock as set forth herein. The Company received proceeds equal
to $4,500,000 from the sale of the December Debentures on January 6, 2006. The
December Debentures are secured by (i) a Pledge and Escrow Agreement, by and
among the Company, Cornell Capital Partners, and David Gonzalez, Esq., (ii) an
Insider Pledge Agreement and Escrow Agreement (the "IPEA"), by and among the
Company, Cornell Capital Partners, David Gonzalez, Esq. and Mr. Benton Wilcoxon
and (iii) an Amended and Restated Security Agreement, by and between the Company
and Cornell Capital Partners. The December Debentures are secured by
substantially all of the Company's assets, have a three (3) year term and accrue
interest at twelve percent (12%) per annum. Beginning 60 days after the
Securities and Exchange Commission ("SEC") declares the accompanying
registration statement effective, Cornell Capital Partners is entitled, at its
option, to convert and sell up to $250,000 of the principal amount of the
December Debentures, plus accrued interest, into shares of the Company's common
stock, within any 30 day period at the lesser of (i) a price equal to $3.00 or
(ii) eighty-eight percent (88%) of the average of the two (2) lowest volume
weighted average prices of the common stock during the ten (10) trading days
immediately preceding the conversion date, as quoted by Bloomberg, LP. The
conversion limitation of $250,000 per month does not apply if the market price
is greater than $3.00 per share.
The holder of the December Debentures may not convert the December
Debentures or receive shares of the Company's common stock as payment of
interest thereunder to the extent such conversion or receipt of such interest
payment would result in the holder, together with any affiliate thereof,
beneficially owning (as determined in accordance with Section 13(d) of the
Securities Exchange Act of 1934, as amended, and the rules promulgated
thereunder) in excess of 4.9% of the then issued and outstanding shares of
common stock, including shares issuable upon conversion of, and payment of
interest on, the December Debentures held by such holder after application of
this 4.9% restriction. This 4.9% restriction may be waived by the holder (but
only as to itself and not to any other holder) upon not less than sixty-five
(65) days prior notice to the Company.
The Company may redeem, with three (3) business days advance written notice
to Cornell Capital Partners, a portion or all amounts outstanding under the
December Debentures prior to the maturity date provided that the closing bid
price of the of the Company's common stock, as reported by Bloomberg, LP, is
less than $3.00 at the time of the redemption notice. The Company shall pay an
amount equal to the principal amount being redeemed plus a redemption premium
equal to ten percent (10%) of the principal amount being redeemed, and accrued
interest, to be delivered to the Cornell Capital Partners on the third (3rd)
business day after the redemption notice, provided, however, this redemption
premium does not apply until the outstanding principal balance of the December
Debentures has been reduced by $2.5 million. The amount that Cornell may convert
in any 30 day period will be reduced by the amount that the Company redeems.
In connection with the Purchase Agreement, on December 30, 2005, the
Company issued to Cornell Capital Partners the December Warrant to purchase up
to 350,000 shares of common stock. This December Warrant has an exercise price
of $4.00 per share, which may be adjusted under certain conditions to as low as
$3 per share and expires two (2) years from the date it was issued. Furthermore,
in connection with the Company's sale of December Debentures, the Company issued
to Mr. Benton Wilcoxon, in consideration of his pledge of shares of common stock
of Composite Technology Corporation pursuant to the terms of the IPEA, a warrant
to purchase up to 125,000 shares of common stock. This warrant has an exercise
price of $4.00 per share and expires three (3) years from the date it was
issued.
4
Common Stock Offered 10,119,511 shares by the selling stockholders
Offering Price Market price
Common Stock Outstanding
Before the Offering(1) 19,315,188 shares as of February 14, 2006
Use of Proceeds We will not receive any proceeds of the shares
offered by the selling stockholders. We did,
however, receive proceeds on January 6, 2006
equal to $4,500,000 from the sale of the
December Debentures pursuant to the Purchase
Agreement with Cornell Capital Partners. Any
proceeds we receive from the sale of common
stock 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
---------------
(1) Excludes up to 6,700,000 which may be issued to Cornell Capital Partners
upon the conversion of the December Debentures pursuant to the Purchase
Agreement, 143,550 shares which have been issued to Cornell Capital
Partners and 6,450 shares which have been issued to each of Sloan
Securities Corporation and Crown Capital Investment, Inc. on or about
March 23, 2005, pursuant to a financing transaction, up to 1,295,000
shares issuable upon the exercise of warrants, and 1,000,000 shares being
registered pursuant to a settlement arrangement.
5
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 by Deloitte & Touche LLP for the year ended December 31, 2001. The
financial data as of and for the nine (9) months ended September 30, 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 in the Consolidated Financial Statements and Notes thereto
included in this Prospectus.
(Dollars in thousands, except per share data)
--------------------------------------------------------------------------------
For the
Nine (9) For the Years For the Years For the Years For the Years
Months Ended Ended Ended December Ended Ended
September 30, December 31, 31, December 31, December 31,
--------------- --------------- ---------------- -------------- -------------
Statement of Operations
Data 2005 2004 2003 2002 2001
------------------------- --------------- --------------- ---------------- -------------- -------------
Revenues $ 158 $ 138 $ -- $ -- $ --
Research and development
expenses 333 1,170 9,547 26,890 47,148
General and
administrative expenses 4,208 3,749 5,786 9,590 9,634
Depreciation and
amortization 2 42 380 3,099 5,874
Gain on sale of property
and equipment 23 (168) (452) (441) --
Interest expenses
(income), net 470 1,068 1,791 132 (356)
Related party patent
expenses -- -- -- -- --
Debenture conversion cost -- -- 166 321 --
Net loss 4,833 7,257 18,517 39,591 62,302
Average shares
outstanding 18,385 15,047 13,267 11,277 9,353
Per Common Share
Basic and diluted
loss per share $ 0.26 $ 0.48 $ 1.40 $ 3.51 $ 6.66
(Dollars in thousands, except per share data)
---------------------------------------------------------------------------------
For the Nine (9) For the Years For the Years For the Years For the Years
Months Ended Ended Ended Ended Ended
September 30, December 31, December 31, December 31, December 31,
----------------- -------------- --------------- ------------- --------------
Balance Sheet Data 2005 2004 2003 2002 2001
------------------------- --------------- --------------- ---------------- -------------- -------------
Cash and cash equivalents $ 41 $ 272 $ 1,902 $ 111 $ 828
Working capital (deficit) (11,576) (7,289) (9,761) (8,315) (6,941)
Total assets 143 483 2,287 18,024 19,886
Total long-term
obligations 986 1,475 4,408 -- --
Deficit accumulated
during development
stage (326,441) (321,607) (314,351) (295,834) (256,243)
Stockholders' equity
(deficit) (12,562) (8,755) (12,269) (3,473) 11,536
Shares outstanding 18,602 18,235 14,129 12,055 9,860
6
SUPPLEMENTARY FINANCIAL INFORMATION
The following table presents EarthShell Corporation and Subsidiaries
condensed operating results for each of the ten (10) fiscal quarters through the
period ended September 30, 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, and Management's Discussions and Analysis of Financial
Condition and Results of Operations.
THREE (3) MONTHS ENDED (IN THOUSANDS)
------------------------------------------------------------------------------------------------------
SEPT 30, JUN 30, MAR 31, DEC 31, SEP 30, JUN 30, MAR 31, DEC 31, SEP 30, JUN 30,
2005 2005 2005 2004 2004 2004 2004 2003 2003 2003
---------- --------- --------- --------- ----------- -------- --------- ---------- --------- ---------
Revenues $ 25 $ 58 $ 75 $ 63 $ 50 $ 25 $ -- $ -- $ -- $ --
Net income (loss) (1,894) (1,861) (1,078) (1,280) (1,646) (2,264) (2,067) (5,217) (2,921) (3,608)
Net income (loss) per
share:
Basic 0.10 0.10 0.06 0.07 0.12 0.16 0.15 0.37 0.21 0.28
Diluted 0.10 0.10 0.06 0.07 0.12 0.16 0.15 0.37 0.21 0.28
Shares used in
computing per share
amounts:
Basic 18,508 18,395 18,250 17,659 14,233 14,128 14,129 14,014 13,596 13,013
Diluted 18,508 18,395 18,250 17,659 14,233 14,128 14,129 14,014 13,596 13,013
7
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
OUR OBLIGATIONS UNDER THE DECEMBER DEBENTURES ARE SECURED BY SUBSTANTIALLY ALL
OF OUR ASSETS WHICH COULD CAUSE OUR OPERATIONS TO CEASE IF WE DEFAULT
Our obligations under the December Debentures, issued to Cornell Capital
Partners on December 30, 2005 pursuant to the Purchase Agreement, are secured by
substantially all of our assets. As a result, if we default under the terms of
the December Debentures, Cornell Capital Partners could foreclose its security
interest and liquidate substantially all of our assets. This would cause us to
cease operations.
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 $11,576,360 at September 30, 2005. These factors,
along with others, may indicate that the Company will be unable to continue as a
going concern for a period of twelve (12) months or less. The Company will have
to raise additional funds to meet its current obligations and to cover operating
expenses through the year ending December 31, 2006. If the Company is not
successful in raising additional capital, it may not be able to continue as a
going concern for a period of twelve (12) months or less.
On August 22, 2005, the Company entered into a letter agreement with EA to
grant sub-licenses to use EarthShell Technology for various applications in
certain Asian territories (the "EA License"). Shortly after executing a letter
agreement, both the Company and EA entered into negotiations to restructure the
transaction and ultimately entered into an amended and restated letter agreement
dated December 9, 2005. By its terms, the amended and restated letter agreement
was not to become effective until all conditions to the transactions described
therein were satisfied. Per the transaction as restructured in accordance with
the amended and restated letter agreement, the Company may receive a total of up
to $2.6 million from a combination of (i) prepaid technology fees (up to $1.7
million), (ii) the sale of up to 266,667 shares of its common stock and (iii)
the issuance of warrants to purchase one million thirty three thousand three
hundred thirty three (1,033,333) shares of the Company's common stock at $3.90
per share (which, if the Company does not file with the Securities and Exchange
Commission a registration statement for the resale of such shares by January 31,
2006, may be adjusted to an excercise price of not less than $3 per share).
Subsequent to the execution of the amended and restated letter agreement, EA
agreed to change the deadline for filing the resale registration statement to
February 15, 2006. Realization of the full potential of the transaction is
dependent on the Company successfully demonstrating the commercial viability of
its technology in certain new applications.
The Company received $500,000 from EA in August 2005 as an initial partial
payment and issued 166,667 shares of its common stock in connection with this
payment. The Company received an additional $300,000 in December 2005 and the
final payment, of approximately $61,000 on February 10, 2006. The remainder was
retained by EA as compensation for various costs and fees. Upon receipt of the
final payment, the Company issued a total of 266,667 shares and the warrants to
purchase the 1,033,333 shares
On October 11, 2005, the Company issued a promissory note (the "EKI Loan")
to E. Khashoggi Industries, Inc., LLC ("EKI"), pursuant to which EKI advanced to
the Company $1,000,000 under the EKI Loan. On December 30, 2005, the Company
entered into a Purchase Agreement with Cornell Capital Partners whereby the
Company received proceeds equal to $4,500,000 on January 6, 2006 from the sale
of the December Debentures. Additional financing may not be available to the
Company, or, if available, the terms may not be satisfactory or if we may not
receive any further technology fee payments in 2006 pursuant to its sublicense
agreements. Management also plans to continue in its efforts to minimize
expenses, but it 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.
8
WE HAVE A WORKING CAPITAL DEFICIT, WHICH MEANS THAT OUR CURRENT ASSETS ON
SEPTEMBER 30, 2005 WERE NOT SUFFICIENT TO SATISFY OUR CURRENT LIABILITIES ON
THAT DATE
We had a working capital deficit of $11,576,360 at September 30, 2005,
which means that our current liabilities exceeded our current assets on
September 30, 2005 by that amount. Current assets are assets that are expected
to be converted into cash within one (1) year and, therefore, may be used to pay
current liabilities as they become due. Our working capital deficit means that
our current assets on September 30, 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(R) products have been low relative to
intended and necessary capacity of the manufacturing lines.
The initial production volumes of product that was actually sold were
produced on lab equipment, pilot machinery, or first generation commercial
equipment. Although we have produced and sold 40-50 million pieces, the
commercial equipment envisioned by the Company that will allow for the
manufacturing to be done profitably has to be operated at higher speeds and good
part throughput rates than was experienced during the early stages of
production. In fact, ultimately the Company shut down production completely to
allow Detroit Tool and Engineering Company ("DTE") to finish the machinery
development to achieve the commercial levels of quality and throughput.
At this point in time, the first modules of DTE equipment have been
purchased by ReNewable Products, Inc. ("RPI"), as EarthShell's U.S. licensee,
and are operational at commercial throughput rates. Production and distribution
has begun and commercial quality product is beginning to be re-introduced.
The success of future operations depends upon the ability of licensees to
manufacture and sell products made with EarthShell Packaging(R) in sufficient
quantities so as to be commercially feasible and then to distribute and sell
those products at competitive prices. Consistent commercially feasible
production volumes had not been achieved and assured competitive price figures
had not yet been fully proven as of September 30, 2005. As a result of the
foregoing factors, the Company may incur losses for at least the next twelve
(12) 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
For the year ended December 31, 2004, the Company had reported operating
revenues of $0.1 million and aggregate net losses of approximately $7.3 million.
In addition, for the nine (9) months ended September 30, 2005, the Company had
reported operating revenues of $0.2 million and an aggregate net loss of
approximately $4.8 million. Although the Company hopes to achieve break-even
cash flow by the end of 2006, the Company does not expect to operate profitably
during this fiscal year. Although the Company is actively seeking equity
financing to restructure the debt on its balance sheets and 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.
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.
9
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 ("IT")
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.
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(R) 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(R). 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(R). 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(R) into the marketplace, which could have an
adverse affect on our business.
WE HAVE NOT YET FULLY EVALUATED ALL OF THE EARTHSHELL PACKAGING(R) 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(R) 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(R) products and we have not
yet evaluated the performance of all of them. If we fail to develop EarthShell
Packaging(R) products that perform comparably to conventional foodservice
disposables, this could cause consumers to prefer our competitors' products.
10
OUR CHARTER DOCUMENTS AND DELAWARE LAW INCLUDE PROVISIONS MAY DISCOURAGE A
POTENTIAL TAKEOVER, EVEN IF IT WOULD BE BENEFICIAL TO OUR STOCKHOLDERS
Our Certificate of Incorporation, 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(R) 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(R)
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
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
11
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(R) 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(R) 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(R) 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(R) 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(R) 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, the largest stockholder of the Company, 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(R) 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(R) PRODUCTS PROFITABLY ON A COMMERCIAL SCALE WOULD ADVERSELY AFFECT
OUR ABILITY TO COMPETE WITH CONVENTIONAL DISPOSABLE FOODSERVICE PACKAGERS
Production volumes of EarthShell Packaging(R) 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(R) products on a commercial scale has not been fully
demonstrated, they may not be manufactured at a competitive cost. As our
licensees and joint venture partners begin to commercially produce EarthShell
Packaging(R) products, they may encounter unexpected difficulties that cause
production costs to exceed current estimates. The failure to manufacture
EarthShell Packaging(R) 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(R) products are generally available, if any raw materials
become unavailable, it could delay the commercial introduction and hinder market
acceptance of EarthShell Packaging(R) 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(R) 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.
12
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 or continue to purchase on a repeat basis, 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(R)
EarthShell Packaging(R) is based primarily on patented composite material
technology licensed on an exclusive worldwide basis from EKI, the largest
stockholder of the Company, and to a lesser extent, on a limited exclusive,
worldwide basis from the Biotec Group. The Company does not own the technology
necessary to manufacture EarthShell Packaging(R) and is dependent upon a license
agreement with EKI (the "Licensing 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 largest 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 employees of EKI.
OUR OPERATIONS ARE SUBJECT TO REGULATION BY THE U.S. FOOD AND DRUG
ADMINISTRATION
The manufacture, sale and use of EarthShell Packaging(R) 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(R) plates, bowls and hinged-lid containers
and all other current and prototype EarthShell Packaging(R) 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.
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 19,315,188 shares of common stock outstanding as of February 14, 2006,
11,050,307 shares are, or will be, freely tradable without restriction, unless
held by our "affiliates". The remaining 8,264,881 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 PURSUANT TO THE PURCHASE AGREEMENT
The sale of shares pursuant to the Purchase Agreement with Cornell Capital
Partners will have a dilutive impact on our stockholders. For example, if the
offering occurred on September 30, 2005 at an assumed conversion price of
$1.6456 per share (eighty-eight percent (88%) of the average of the two (2)
lowest volume weighted average prices during the ten (10) days immediately
preceding a recent trading date), the new stockholders would experience an
immediate dilution in the net tangible book value of $1.7097 per share. Dilution
per share at prices of $1.2342, $0.8228 and $0.4114 per share would be $1.4072,
$1.1048 and $0.8023, 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 convert under the Purchase Agreement. If our stock price is
lower, then our existing stockholders would experience greater dilution.
13
UNDER THE PURCHASE AGREEMENT CORNELL CAPITAL PARTNERS WILL PAY LESS THAN THE
THEN-PREVAILING MARKET PRICE OF OUR COMMON STOCK
Pursuant to the Purchase Agreement, Cornell Capital Partners will convert
the December Debentures into shares of EarthShell's common stock at a discount
equal to eighty-eight percent (88%) of the average of the two (2) lowest volume
weighted average prices during the ten (10) days immediately preceding the date
of conversion. The common stock to be issued will be at a twelve percent (12%)
discount to the two (2) lowest volume weighted average prices during the ten
(10) days immediately preceding the date of conversion. Based on this discount,
Cornell Capital Partners will have an incentive to convert immediately to
realize the gain on the twelve percent (12%) discount. These discounted sales
could cause the price of our common stock to decline, based on increased selling
of the Company'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 10,327,844
shares of common stock being registered in this offering. That means that up to
10,327,844 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 stockholders 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 PRICE YOU PAY IN THIS OFFERING WILL FLUCTUATE AND MAY BE HIGHER OR LOWER
THAN THE PRICES PAID BY OTHER PERSONS 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 persons participating in this offering.
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, as amended
(the "Exchange Act"). 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;
o Whose prices are not quoted on the Nasdaq automated quotation system
(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 (3) years)
or $5.0 million (if in continuous operation for less than three (3)
years), or with average revenues of less than $6.0 million for the
last three (3) 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
This Prospectus contains certain forward-looking statements regarding
management's plans and objectives for future operations including plans and
objectives relating to our planned marketing efforts and future economic
performance. The forward-looking statements and associated risks set forth in
this Prospectus include or relate to, among other things, (a) our projected
sales and profitability, (b) our growth strategies, (c) anticipated trends in
our industry, (d) our ability to obtain and retain sufficient capital for future
operations, 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.
The forward-looking statements herein are based on current expectations
that involve a number of risks and uncertainties. Such forward-looking
statements are based on assumptions that there will be no material adverse
competitive or technological change in conditions in our business, that demand
for our products will significantly increase, that our Chief Executive Officer
and Chief Financial Officer will remain employed as such, that our forecasts
accurately anticipate market demand, and that there will be no material adverse
change in our operations or business or in governmental regulations affecting us
or our manufacturers and/or suppliers. The foregoing assumptions are based on
judgments with respect to, among other things, future economic, competitive and
market conditions, and future business decisions, all of which are difficult or
impossible to predict accurately and many of which are beyond our control.
Accordingly, although we believe that the assumptions underlying the
forward-looking statements are reasonable, any such assumption could prove to be
inaccurate and therefore there can be no assurance that the results contemplated
in forward-looking statements will be realized. In addition, as disclosed
elsewhere in the "Risk Factors" section of this Prospectus, there are a number
of other risks inherent in our business and operations which could cause our
operating results to vary markedly and adversely from prior results or the
results contemplated by the forward-looking statements. Growth in absolute and
relative amounts of cost of goods sold and selling, general and administrative
expenses or the occurrence of extraordinary events could cause actual results to
vary materially from the results contemplated by the forward-looking statements.
Management decisions, including budgeting, are subjective in many respects and
periodic revisions must be made to reflect actual conditions and business
developments, the impact of which may cause us to alter marketing, capital
investment and other expenditures, which may also materially adversely affect
our results of operations. In light of significant uncertainties inherent in the
forward-looking information included in this Prospectus, the inclusion of such
information should not be regarded as a representation by us or any other person
that our objectives or plans will be achieved.
Some of the information in this Prospectus contains forward-looking
statements that involve substantial risks and uncertainties. Any statement in
this Prospectus and in the documents incorporated by reference into this
Prospectus that is not a statement of an historical fact constitutes a
"forward-looking statement". Further, when we use the words "may", "expect",
"anticipate", "plan", "believe", "seek", "estimate", "internal" and similar
words, we intend to identify statements and expressions that may be forward-
looking statements. We believe it is important to communicate certain of our
expectations to our investors. Forward-looking statements are not guarantees of
future performance. They involve risks, uncertainties and assumptions that could
cause our future results to differ materially from those expressed in any
forward-looking statements. Many factors are beyond our ability to control or
predict. You are accordingly cautioned not to place undue reliance on such
forward-looking statements. Important factors that may cause our actual results
to differ from such forward-looking statements include, but are not limited to,
the risk factors discussed below. Before you invest in our common stock, you
should be aware that the occurrence of any of the events described under "Risk
Factors" below or elsewhere in this Prospectus could have a material adverse
effect on our business, financial condition and results of operation. In such a
case, the trading price of our common stock could decline and you could lose all
or part of your investment.
15
SELLING STOCKHOLDERS
The following table presents information regarding the selling
stockholders. The selling stockholders are the entities who have assisted in or
provided financing to EarthShell. A description of each selling stockholder's
relationship to EarthShell and how each selling stockholder acquired the shares
to be sold in this offering is detailed in the information immediately following
this table.
The selling shareholders may not choose to sell all of the shares covered
by this registration statement, or, under certain market conditions, may not be
entitled to convert and sell all of the shares covered by their respective
registration or conversion agreements.
PERCENTAGE
PERCENTAGE OF
OF MAXIMUM OUTSTANDING
OUTSTANDING NUMBER OF SHARES WHICH PERCENTAGE
SHARES SHARES SHARES TO BE MAY BE OF SHARES
BENEFICIALLY BENEFICIALLY ACQUIRED ACQUIRED BENEFICIALLY
OWNED OWNED PURSUANT TO PURSUANT TO SHARES TO BE OWNED
BEFORE BEFORE THE PURCHASE THE PURCHASE 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 804,050(2) 4.16% 6,700,000(4) 34.69% 7,504,050(4) 38.85%
Highgate House Funds,
Ltd. 364,500(3) 1.89% -- -- 364,500 1.89%
DEBT RESTRUCTURING AND SETTLEMENT TRANSACTIONS WITH EARTHSHELL
Islandia, L.P. 100,000 * -- -- 100,000 *
Midsummer Investment,
Ltd. (5) 175,000 * -- -- 175,000 *
Omicron Master Trust(6) 187,500 * -- -- 187,500 *
Roth Capital Partners,
LLC 246,310(7) 1.28% -- -- 246,310(7) 1.28%
SF Capital Partners Ltd. 1,000,000 5.18% -- -- 1,000,000 5.18%
Straus - GEPT L.P. 36,250 * -- -- 26,250 *
Straus Partners L.P. (8) 63,750 * -- -- 48,750 *
Vam Dam Machine Corp. 75,000 * -- -- 75,000 *
Alcalde & Fay 50,917 * -- -- 50,917 *
EARTHSHELL ASIA TRANSACTION
Ying Wang 83,333 o* -- -- 83,333 *
Monty Waltz 38,333 o* -- -- 33,333 *
Greg C. Hoffman 1,231,535(9) 6.39% -- -- 66,668 *
Steven L. Galvanoni 746,799(10) 3.87% -- -- 83,333 *
Trust
CONSULTANTS AND OTHERS
Crown Investment
Banking, Inc. 6,450 * -- -- 6,450 *
Sloan Securities
Corporation 6,450 * -- -- 6,450 *
Mr. Benton Wilcoxon 190,000(11) * -- -- 190,000(11) *
Mr. Douglas Metz 81,000(12) * -- -- 80,000 *
---------- ---------- ---------- ---------- ---------- ----------
Total 5,487,177 28.41% 6,700,000 34.69% 10,327,844 53.47%
========== ========== ========== ========== ========== ==========
--------------------------------------
* Less than one percent (1%).
(1) Applicable percentage of ownership is based on 19,315,188 shares of common
stock outstanding as of February 14, 2006, together with securities
exercisable or convertible into shares of common stock within sixty (60)
days of February 14, 2006, 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 sixty (60) days of February 14, 2006 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.
16
(2) Represents 143,550 shares of common stock issued to Cornell Capital
Partners on or about March 23, 2005, in connection with a financing
transaction and 660,500 shares of common stock underlying warrants.
(3) Represents 364,500 shares of common stock underlying warrants.
(4) Includes 6,700,000 shares that may be acquired by Cornell Capital Partners
pursuant to the Purchase Agreement, 143,550 shares issued to Cornell
Capital Partners, on or about March 23, 2005, in connection with financing
transaction and 660,500 shares of common stock underlying warrants. Under
the purchase agreement, Cornell has the right to convert up to $4.5
million, plus accrued interest, into shares of EarthShell common stock over
a period of time. Assuming the market price for EarthShell common stock is
at or above $3 per share at the time of conversion, EarthShell will need to
deliver approximately 1.65 million shares. In the event that the market
price for EarthShell common stock is less than $3 per share at the time of
the conversion, the conversion price will be adjusted to 88% of the fair
market value of EarthShell common stock at the time of the conversion.
Because of the potentially variable nature of the future conversion price,
pursuant to the Purchase Agreement, EarthShell has agreed to register a
number of shares equal to 4 times the number of shares that would be
required to convert the full $4.5 million, plus accrued interest, at $3 per
share.
(5) Midsummer Capital, LLC is the investment manager to Midsummer Investment
Ltd. By virtue of such relationship, Midsummer Capital, LLC may be deemed
to have dispositive power over the shares owned by Midsummer Investment
Ltd. Midsummer Capital, LLC disclaims beneficial ownership of such shares.
Mr. Michel Amsalem and Mr. Scott Kaufman have delegated authority from the
members of Midsummer Capital, LLC with respect to the shares of common
stock owned by Midsummer Investment Ltd. Messrs. Amsalem and Kaufman may be
deemd to share dispositive power over the shares of our common stock owned
by Midsummer Investment Ltd. Messrs. Amsalem and Kaufman disclaim
beneficial ownership of such shares of our common stock and neither person
has any legal right to maintain such delegated authority.
(6) 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
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.
(7) Consists of 246,310 shares of common stock underlying warrants.
(8) 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.
(9) Includes 66,668 shares of common stock to be registered in this offering
and 664,867 shares underlying warrants to purchase common stock. Also
includes 500,000 shares of common stock regarding which shares it is
possible that a third party may assert disputed competing claims to some or
all such stock.
(10) Includes warrants to purchase 363,466 shares of the Company's common stock
and 83,333 shares that will be registered as part of this offering.
(11) Consists of 65,000 shares of common stock underlying warrants at $3.00 per
share and 125,000 shares of common stock underlying warrants at $4.00 per
share.
(12) Consists of 80,000 shares of common stock underlying warrants and 1,000
shares of common stock.
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 TO BE ACQUIRED IN FINANCING TRANSACTIONS WITH EARTHSHELL
Cornell Capital Partners, LP. Cornell Capital Partners is the investor
pursuant to the Purchase Agreement and a holder of the May Warrant, the August
Warrant and the December Warrant. All investment decisions of, and control of,
Cornell Capital Partners are held by its general partner, Yorkville Advisors,
LLC ("Yorkville"). Mark Angelo, the managing member of Yorkville, makes the
investment decisions on behalf of and controls Yorkville. Cornell Capital
Partners has acquired or will acquire all shares being registered in this
offering in financing transactions with EarthShell. Those transactions are
explained below:
o Purchase Agreement. On December 30, 2005, the Company entered into a
Purchase Agreement with Cornell Capital Partners. Pursuant to the
Purchase Agreement, the Company issued to Cornell Capital Partners
the December Debentures. The December Debentures shall be
convertible into shares of the Company's common stock, and the
Company received proceeds from the sale of the December Debentures
equal to $4,500,000 on January 6, 2006. The selling shareholders may
not choose to sell all of the shares covered by this registration
statement, or, under certain market conditions, may not be entitled
to convert and sell all of the shares provided covered by their
respective registration or conversion agreements.
17
The December Debentures are secured by (i) a Pledge and Escrow
Agreement, by and among the Company, Cornell Capital Partners and
David Gonzalez, Esq., (ii) an Insider Pledge and Escrow Agreement (the
"IPEA"), by and among the Company, Cornell Capital Partners, David
Gonzalez, Esq. and Mr. Benton Wilcoxon and (iii) an Amended and
Restated Security Agreement, by and between the Company and Cornell
Capital Partners. The December Debentures are secured by substantially
all of the Company's assets, have a three (3) year term and accrue
interest at twelve percent (12%) per annum. Beginning 60 days after
the Securities and Exchange Commission ("SEC") declares the
accompanying registration statement effective, Cornell Capital
Partners is entitled, at its option, to convert and sell up to
$250,000 of the principal amount of the December Debentures, plus
accrued interest, into shares of the Company's common stock, within
any 30 day period at the lesser of (i) a price equal to $3.00 or (ii)
eighty-eight percent (88%) of the average of the two (2) lowest volume
weighted average prices of the common stock during the ten (10)
trading days immediately preceding the conversion date, as quoted by
Bloomberg, LP. The conversion limitation of $250,000 per month does
not apply if the market price is greater than $3.00 per share. The
holder of the December Debentures may not convert the December
Debentures or receive shares of the Company's common stock as payment
of interest thereunder to the extent such conversion or receipt of
such interest payment would result in the holder, together with any
affiliate thereof, beneficially owning (as determined in accordance
with Section 13(d) of the Exchange Act, and the rules promulgated
thereunder) in excess of 4.9% of the then issued and outstanding
shares of common stock, including shares issuable upon conversion of,
and payment of interest on, the December Debenture held by such holder
after application of this 4.9% restriction. This 4.9% restriction may
be waived by a holder (but only as to itself and not to any other
holder) upon not less than sixty-five (65) days prior notice to the
Company.
The Company may redeem, with three (3) business days advance written
notice to Cornell Capital Partners, a portion or all amounts
outstanding under the December Debentures prior to the maturity date
provided that the closing bid price of the Company's common stock, as
reported by Bloomberg, LP, is less than $3.00 at the time of the
redemption notice. The Company shall pay an amount equal to the
principal amount being redeemed plus a redemption premium equal to ten
percent (10%) of the principal amount being redeemed, and accrued
interest, to be delivered to the Cornell Capital Partners on the third
(3rd) business day after the redemption notice, provided, however,
this redemption premium does not apply until the outstanding principal
balance of the December Debentures have been reduced by $2.5 million.
The amount that Cornell may convert in any 30 day period will be
reduced by the amount that the Company redeems.
Under the purchase agreement, Cornell has the right to convert up to
$4.5 million, plus accrued interest, into shares of EarthShell common
stock over a period of time. Assuming the market price for EarthShell
common stock is at or above $3 per share at the time of conversion,
EarthShell will need to deliver approximately 1.65 million shares. In
the event that the market price for EarthShell common stock is less
than $3 per share at the time of the conversion, the conversion price
will be adjusted to 88% of the fair market value of EarthShell common
stock at the time of the conversion. Because of the potentially
variable nature of the future conversion price, pursuant to the
Purchase Agreement, EarthShell has agreed to register a number of
shares equal to 4 times the number of shares that would be required to
convert the full $4.5 million, plus accrued interest, at $3 per share.
o May Warrant. On May 26, 2005, the Company issued a common stock
purchase warrant to Cornell Capital Partners to purchase 625,000
shares of common stock of the Company. This May Warrant expires the
earlier of one (1) year or the date that 2,500,000 is repaid, has an
exercise price that was adjusted to $3.00 per share of common stock as
of December 30, 2005 and has "piggy back" and demand registration
rights. These shares are being registered in this offering.
o August Warrant. In August 2005, the Company issued a common stock
purchase warrant to Cornell Capital Partners to purchase 50,000 shares
of common stock of the Company as consideration for consolidating two
(2) promissory notes (the "CCP Notes") and extending the date upon
which amortization and repayment of the CCP Notes is to begin. This
August Warrant expires two (2) years from the date of issuance, has an
exercise price of $3.00 per share of common stock and has "piggy back"
registration and demand rights. These shares are being registered in
this offering.
o December Warrant. On December 30, 2005, the Company issued to Cornell
Capital Partners a common stock purchase warrant to purchase up to
350,000 shares of common stock of the Company. This December Warrant
has an exercise price of $4.00 per share, expires two (2) years from
the date it was issued and has "piggy back" and demand registration
rights. Under certain circumstances, the $4.00 exercise price is
subject to adjustment downward to a price not less than $3.00 per
share. These shares are being registered in this offering.
18
There are certain risks related to sales by Cornell Capital Partners,
including:
o The outstanding shares will be issued upon conversion of the December
Debentures based on a twelve percent (12%) discount to the market
price. As a result, the lower the stock price around the time Cornell
Capital Partners is issued shares, the greater chance that Cornell
Capital Partners will receive 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.
Highgate House Funds, Ltd. All of the investment decisions for Hightgate
House Funds are made by its portfolio manager, Mark Angelo. Control of Highgate
House Funds is 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. Highgate House Funds has
acquired all of the shares being registered in this offering in financing
transactions with EarthShell.
SHARES ACQUIRED IN DEBT RESTRUCTURING AND SETTLEMENT TRANSACTIONS WITH
EARTHSHELL
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 the Company's 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. In February 2006, the
Company issued to Midsummer an additional 25,000 shares of its unregistered
common stock in settlement of certain claims relating to the settlement. 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 the Company's 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. Bruce Bernstein makes the investment decisions on
behalf of Omicron Master Trust.
Roth Capital Partners, LLC. Pursuant to a convertible and common stock
warrant and an additional 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 the Company's debt and settlement of $4,500,000 in debentures
issued to SF Capital Partners Ltd. ("SF Capital Partners") 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, subject to
a price protection clause, of the Company's unregistered common stock at $3.00
per share. In January 2006, SF Capital Partners converted a portion of the
settlement balance into unregistered shares of the Company's common stock. In
addition, the Company has agreed to register on behalf of SF Capital partners
1,000,000 shares of the Company's common stock to be available for the
conversion of the remaining balance owed to SF Capital and to pay damages
stemming from the Company's non-performance under the reigistration right clause
of the settlement agreement. The shares underlying this conversion right and
settlement of claims are being registered in this offering. Michael A. Roth and
Brian J. Stark make the investment decisions on behalf of SF Capital Partners.
19
Straus - GEPT L.P. Pursuant to an amended and restated debenture purchase
agreement, dated September 30, 2004, in connection with the restructuring of the
Company's 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 the
Company's 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.
Van Dam Machine Corp. In December 2005, in connection with the settlement
of litigation between the Company and Van Dam Machine Company ("Van Dam") the
Company agreed to issue 75,000 shares of its unregistered common stock. These
shares are being registered in this offering. John Sari makes the investment
decisions on behalf of Van Dam..
Alcalde & Fay. In November 2003 and December 2005, the Company agreed to
issue 2, 917 and 48,000 shares of its unregistered common stock, respectively,
in settlement of certain accounts payable to Alcalde & Fay, a consultant to the
Company. These shares are being registered in this offering. Kevin Fay makes the
investment decisions on behalf of Alcalde & Fay.
EARTHSHELL ASIA TRANSACTION
In December 2005, in connection with a stock purchase agreement with
EarthShell Asia dated August 22 which was subsequently amended and restated, the
Company received approximately $800,000 and issued 266,667 shares of its
unregistered common stock. All of these shares are to be registered in this
offering. The shares were issued to and are held by various principals of
EarthShell Asia as follows:
Ying Wang. Mr. Ying Wang received 83,333 shares of the Company's
unregistered common stock.
Monty Waltz. Mr. Monty Waltz received 33,333 shares of the Company's
unregistered common stock.
Greg C. Hoffman. Mr. Greg C. Hoffman received 66,668 shares of the
Company's unregistered common stock.
Steven L. Galvanoni Trust. The Steven L. Galvanoni Trust received 83,333
shares of the Company's unregistered common stock. Mr. Steven Galvanoni makes
the investment decisions with respect to these shares.
CONSULTANTS AND OTHER SHAREHOLDERS
Crown Investment Banking, Inc. Pursuant to an engagement letter entered
into with Crown Investment Banking, Inc. ("Crown") 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.
Sloan Securities Corporation. Sloan Securities Corporation is an
unaffiliated registered broker-dealer that has been retained by us in connection
with services provided pursuant to a financing transaction with Cornell Capital
Partners. James C. Ackerman, Sloan Securities Corporation's President, makes the
investment decisions on behalf of and controls Sloan Securities Corporation.
Sloan Securities Corporation received a fee of 6,450 shares of unregistered
common stock on or about March 23, 2005. These shares have "piggy back"
registration and demand rights and are being registered in this offering.
20
Mr. Benton Wilcoxon. In consideration for Mr. Benton Wilcoxon pledging his
personal shares in Composite Technology Corporation as a guaranty for a security
agreement entered into by the Company with Cornell Capital Partners in
connection with a financing transaction, the Company issued a warrant to Mr.
Wilcoxon to purchase 65,000 shares of common stock of the Company at an exercise
price of $3.00 per share. This warrant expires on March 23, 2008. In addition,
in connection with the Company's issuance and sale to Cornell Capital Partners
of the December Debentures, the Company issued to Mr. Wilcoxon, in consideration
of his pledge of shares of common stock of Composite Technology Corporation
pursuant to the terms of the IPEA, a warrant to purchase up to 125,000 shares of
common stock. This warrant has an exercise price of $4.00 per share and expires
three (3) years from the date it was issued. The shares underlying these
warrants are being registered in this offering. The Company also granted to Mr.
Wilcoxon a right of refusal to enter into a license agreement for certain of the
Company's technology in certain Asian territories.
Mr. Douglas Metz. In consideration for consulting services rendered by Mr.
Douglas Metz in connection with the Company obtaining financing, the Company
issued a warrant to Mr. Metz to purchase 80,000 shares of common stock of the
Company at an exercise price of $3.00 per share. This warrant expires on March
23, 2008. The shares underlying this warrant are being registered in this
offering.
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, as amended (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.
21
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 did receive proceeds from the sale and issuance to Cornell Capital
Partners of the December Debentures pursuant to the Purchase Agreement equal to
$4,500,000 which the Company received on January 6, 2006, of which approximately
$2.6 million was used to payoff the existing $2.5 million promissory note to
Cornell and Highgate. We received $800,000 from the sale of common stock to
EarthShell Asia. We will also receive proceeds upon the exercise of warrants
held by our several selling stockholders in this offering.
22
DILUTION
The net tangible book value of EarthShell as of September 30, 2005 was
$(12,562,225) or $(0.6753) 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 from time to time to Cornell Capital Partners
upon conversion of the December Debentures pursuant to the Purchase Agreement.
The amount of dilution will depend on the conversion price (eighty-eight percent
(88%) of the average of the two (2) lowest volume weighted average prices of the
common stock during the ten (10) trading days immediately preceding the date of
conversion) and number of shares to be issued pursuant to the Purchase
Agreement. The following example shows the dilution to new investors at an
assumed conversion price of $1.6456 per share.
If we assume that EarthShell issued 6,700,000 shares of common stock to
Cornell Capital Partners (i.e., the number of shares registered in this offering
pursuant to the Purchase Agreement) upon conversion of the December Debentures
pursuant to the Purchase Agreement at an assumed conversion price of $1.6456 per
share (eighty-eight percent (88%) of the average of the two (2) lowest volume
weighted average market prices of the common stock during the ten (10) trading
days immediately preceding a recent trading date) less offering expenses of
$85,000, our net tangible book value as of September 30, 2005 would have been
($8,147,225) or ($.3818) per share. Such an offering would represent an
immediate increase in net tangible book value to existing stockholders of
$0.6112 per share and an immediate dilution to new stockholders of $1.7097 per
share. The following table illustrates the per share dilution:
Assumed conversion price per share $1.6456
Net tangible book value per share before this offering ($0.6753)
Increase attributable to new investors $0.2935
----------
Net tangible book value per share after this offering ($0.3818)
-----------
Dilution per share to new stockholders $2.0274
===========
The conversion 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 conversion prices:
DILUTION
ASSUMED CONVERSION NO. OF SHARES TO BE PER SHARE
PRICE ISSUED TO NEW INVESTORS
-------------------- ------------------------ ---------------------
$1.6456 2,734,565(1) $2.0274
$1.2342 3,646,087 $1.6004
$0.8228 5,469,130 $1.1613
$0.4114 6,700,000 $0.8023
(1) This represents the maximum number of shares of common stock that are being
registered pursuant to the Purchase Agreement.
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 (1) 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).
On December 30, 2005, EarthShell entered into a Purchase Agreement with
Cornell Capital Partners pursuant to which the Company issued and sold to
Cornell Capital Partners the secured December Debentures. The December
Debentures shall be convertible into shares of the Company's common stock, and
the Company is registering 6,700,000 shares in connection with the Purchase
Agreement. The Company received proceeds equal to $4,500,000 from the sale of
the December Debentures on January 6, 2006, of which approximately $2.6 million
was used to payoff the existing $2.5 million promissory note to Cornell and
Highgate.
The December Debentures are secured by (i) a Pledge and Escrow Agreement,
by and among the Company, Cornell Capital Partners, and David Gonzalez, Esq.,
(ii) an Insider Pledge Agreement and Escrow Agreement (the "IPEA"), by and among
the Company, Cornell Capital Partners, David Gonzalez, Esq. and Mr. Benton
Wilcoxon and (iii) an Amended and Restated Security Agreement, by and between
the Company and Cornell Capital Partners. The December Debentures are secured by
substantially all of the Company's assets, have a three (3) year term and accrue
interest at twelve percent (12%) per annum. Beginning 60 days after the
Securities and Exchange Commission ("SEC") declares the accompanying
registration statement effective, Cornell Capital Partners is entitled, at its
option, to convert and sell up to $250,000 of the principal amount of the
December Debentures, plus accrued interest, into shares of the Company's common
stock, within any 30 day period at the lesser of (i) a price equal to $3.00 or
(ii) eighty-eight percent (88%) of the average of the two (2) lowest volume
weighted average prices of the common stock during the ten (10) trading days
immediately preceding the conversion date, as quoted by Bloomberg, LP. The
conversion limitation of $250,000 per month does not apply if the market price
is greater than $3.00 per share.
The holder of the December Debentures may not convert the December
Debentures or receive shares of the Company's common stock as payment of
interest thereunder to the extent such conversion or receipt of such interest
payment would result in the holder, together with any affiliate thereof,
beneficially owning (as determined in accordance with Section 13(d) of the
Securities Exchange Act of 1934, as amended, and the rules promulgated
thereunder) in excess of 4.9% of the then issued and outstanding shares of
common stock, including shares issuable upon conversion of, and payment of
interest on, the December Debentures held by such holder after application of
this 4.9% restriction. This 4.9% restriction may be waived by the holder (but
only as to itself and not to any other holder) upon not less than sixty-five
(65) days prior notice to the Company.
The Company may redeem, with three (3) business days advance written notice
to Cornell Capital Partners, a portion or all amounts outstanding under the
December Debentures prior to the maturity date provided that the closing bid
price of the of the Company's common stock, as reported by Bloomberg, LP, is
less than $3.00 at the time of the redemption notice. The Company shall pay an
amount equal to the principal amount being redeemed plus a redemption premium
equal to ten percent (10%) of the principal amount being redeemed, and accrued
interest, to be delivered to the Cornell Capital Partners on the third (3rd)
business day after the redemption notice, provided, however, this redemption
premium does not apply until the outstanding principal balance of the December
Debentures has been reduced by $2.5 million. The amount that Cornell may convert
in any 30 day period will be reduced by the amount that the Company redeems.
In connection with the Purchase Agreement, on December 30, 2005, the
Company issued to Cornell Capital Partners the December Warrant to purchase up
to 350,000 shares of common stock. This December Warrant has an exercise price
of $4.00 per share, which may be adjusted under certain conditions to as low as
$3 per share and expires two (2) years from the date it was issued. Furthermore,
in connection with the Company's sale of December Debentures, the Company issued
to Mr. Benton Wilcoxon, in consideration of his pledge of shares of common stock
of Composite Technology Corporation pursuant to the terms of the IPEA, a warrant
to purchase up to 125,000 shares of common stock. This warrant has an exercise
price of $4.00 per share and expires three (3) years from the date it was
issued.
24
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 (50) 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. Pursuant to the Purchase Agreement, we have agreed to
indemnify Cornell Capital Partners and its controlling persons against certain
liabilities, including liabilities under the 1933 Act. We estimate that the
expenses of the offering to be borne by us will be approximately $85,000. For
services rendered in connection with the Purchase Agreement, the Company paid to
Yorkville Advisors, LLC ("Yorkville") $200,000. The Company also paid to
Yorkville $10,000 as a structuring and due diligence fee. Both amounts were paid
directly from the gross proceeds of the closing. The estimated offering expenses
consist of: an SEC registration fee of $1,945 printing expenses of $2,500,
accounting fees of $15,000, legal fees of $50,000 and miscellaneous expenses of
$15,555. We will not receive any proceeds from the sale of any of the shares of
common stock by the selling stockholders. However, we did receive proceeds from
the issuance and sale to Cornell Capital Partners of the December Debentures
pursuant to the Purchase Agreement equal to $4,500,000, which the Company
received on January 6, 2006. We will also receive proceeds upon the exercise of
warrants held by our several selling stockholders in this offering.
The selling stockholders are subject to applicable provisions of the
Exchange Act, and its regulations, including, Regulation M. Under Regulation 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 shares covered by this Prospectus.
Pursuant to the requirements of Item 512 of Regulation S-K 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, which are included elsewhere within this Registration Statement.
OVERVIEW
Organized in November 1992 as a Delaware corporation, EarthShell 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 primarily on patented composite material
technology (collectively, the "EarthShell Technology"), licensed on an
exclusive, worldwide basis from EKI, the largest stockholder of the Company,
and, to a lesser extent, on a limited exclusive worldwide basis from the Biotec
Group.
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 the granting of
license to a strategic partner in the second quarter of 2004, management no
longer considered the Company a development stage enterprise.
CRITICAL ACCOUNTING POLICIES
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 $11,576,360 at September 30, 2005. These
factors, along with others, may indicate that the Company will be unable to
continue as a going concern for a period of twelve (12) months or less. The
Company will have to raise additional funds to meet its current obligations and
to cover operating expenses through the year ending December 31, 2006. 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.
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
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. These plants are no
longer operating. 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. 104, "Revenue Recognition in Financial
Statements" (SAB 104). 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.
26
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS FOR THE THREE (3) MONTHS ENDED SEPTEMBER 30, 2005
COMPARED TO THE THREE (3) MONTHS ENDED SEPTEMBER 30, 2004
The Company's net loss increased $0.2 million to $1.9 million from $1.7
million for the three (3) months ended September 30, 2005, compared to the three
(3) months ended September 30, 2004, respectively.
REVENUES. The Company's revenues decreased $0.02 million to $0.03 million
from $0.05 million for the three (3) months ended September 30, 2005, compared
to the three (3) months ended September 30, 2004. These revenues are a result of
the amortization of technology fees received during 2004 in connection with the
granting of certain license agreements. In the third (3rd) quarter of 2004,
$500,000 of a total of $2 million technology payable was received in connection
with a sublicense agreement granted to Meridian Business Solutions, Ltd.
("MBS"). In the fourth (4th) quarter of 2004, a technology fee of $1 million was
received in connection with a sublicense agreement granted to EarthShell Hidalgo
S.A. de C.V. ("ESH"). These technology fees have been amortized over the ten
(10) year term of the sublicense agreements. The decrease in revenues is due to
the termination of the sublicense to MBS. The MBS sublicense agreement was
terminated on June 8, 2005, and the unamortized portion of the technology fee
was returned to MBS. The amortization of the remaining ESH technology fee will
result in the recognition of $0.1 million in revenues per year during the life
of the agreement.
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 $0.15 million
to $0.11 million from $0.26 million for the three (3) months ended September 30,
2005, compared to the three (3) months ended September 30, 2004.
o Related party license fee and research and development expenses were
comprised, through September 1, 2004, of a $100,000 minimum monthly
payment to retain exclusive use of the Biotec Group technology for
food service disposable packaging as well as payment for technical
services, both of which are payable to EKI, a stockholder of the
Company, or affiliates of EKI. The accrual of the minimum monthly
payment was halted for two (2) years beginning in September 2004
pursuant to an amendment to the Company's Biotec License Agreement.
Subsequently, the minimum monthly payment to retain exclusivity was
completely eliminated pursuant to an Amended and Restated License
Agreement with the Biotec Group, dated August 31, 2005. the Biotec
Group is no longer an affiliate of EKI. Related party license fee and
research and development expenses decreased $0.2 million to zero
dollars ($0) for the three (3) months ended September 30, 2005
compared to $0.2 million for the three (3) months ended September 30,
2004, respectively.
o Other research and development expenses are comprised of personnel
costs, contract research with the USDA, travel and direct overhead for
development and/or demonstration production. Other research and
development expenses increased $0.05 million to $0.11 million from
$0.06 million for the three (3) months ended September 30, 2005,
compared to the three (3) months ended September 30, 2004,
respectively. The increase was due to an increase in the contract with
the USDA for research and development activities.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
are comprised of related party general and administrative expenses and other
general and administrative expenses. Total general and administrative expenses
increased $1.5 million to $1.6 million from $0.1 million for the three (3)
months ended September 30, 2005 compared to the three (3) months ended September
30, 2004, respectively.
o Related party general and administrative expenses are comprised
primarily of the sublease of office facilities payable to the
Company's largest stockholder, EKI. During 2005 to date, these
expenses have been offset by reimbursement by EKI for fifty percent
(50%) of the cost of one of EarthShell's administrative staff shared
by EKI. Related party general and administrative expenses were
negligible for the three (3) months ended September 30, 2005 and
September 30, 2004, respectively.
27
o Other general and administrative expenses are comprised of personnel
costs and directors' fees, travel and direct overhead for marketing,
finance and administration. Total general and administrative expenses
increased approximately $1.5 million to $1.6 million from $0.1 million
for the three (3) months ended September 30, 2005, compared to the
three (3) months ended September 30, 2004, respectively. The increase
was due primarily to the non-recurrence of a one time $0.5 million
credit in 2004 resulting from the settlement of a property tax
dispute. In addition, professional fees increased $0.6 million due to
the accrual of investor relations fees of $0.3 million and a $0.3
million increase in legal costs primarily associated with financing
transactions. In addition, the Company accrued a penalty in the
quarter of approximately $0.2 million as a result of the Company's
failure to timely file a registration statement related to settlements
reached with respect to the Company's then outstanding debentures in
late 2004. Also, salaries and wages increased $0.2 million due
primarily to the accrual of deferred compensation in 2005 for
executive salaries that were voluntarily reduced in 2004.
INTEREST EXPENSE. Interest expense is comprised of related party interest
expense and other interest expense.
o Related party interest expense decreased approximately $0.13 million
to zero dollars ($0) from $0.13 million for the three (3) months ended
September 30, 2005 to the three (3) months ended September 30, 2004.
In 2004, related party interest expense consisted primarily of
interest accruing on $2.7 million in notes advanced to the Company by
EKI. In the fourth (4th) quarter of 2004, these loans were converted
to EarthShell common stock at $3.00 per share and the accrued interest
was converted to common stock at $4.00 per share. As a result, in
2005, there has been no further accrual of related party interest. The
Company has begun to accrue related party interest in connection with
the EKI Loan which, as of the second week of January 2006, EKI
advanced $1,000,000 to the Company.
o Other interest expense remained constant at $0.2 million for the three
(3) months ended September 30, 2005 and September 30, 2004,
respectively. In 2004, other interest expense was comprised primarily
of interest accrued on the then outstanding debentures. In the fourth
(4th) quarter of 2004, these debentures were settled and retired and
interest ceased to accrue. Beginning in late 2004, the Company entered
into payment plans to settle a number of aged payable accounts.
Interest is accruing on these accounts at the rate of about $10,000
per quarter. On December 30, 2005, the Company issued to Cornell
Capital Partners $4,500,000 in convertible December Debentures. The
December Debentures have a three (3) year term and accrue interest at
twelve percent (12%) per annum.
GAIN ON SALES OF PROPERTY AND EQUIPMENT. The Company had a minor gain of
approximately $1,000 from the sales of property and equipment in the three (3)
months ended September 30, 2005 compared to a gain of approximately $15,000 in
the three (3) months ended September 30, 2004 upon the sale of non-essential
machine shop equipment and excess office furniture and equipment over their net
book value, all of which was fully depreciated.
RESULTS OF OPERATIONS FOR THE NINE (9) MONTHS ENDED SEPTEMBER 30, 2005
COMPARED TO THE NINE (9) MONTHS ENDED SEPTEMBER 30, 2004
The Company's net loss decreased approximately $1.2 million to $4.8 million
from $6.0 million for the nine (9) months ended September 30, 2005 compared to
the nine (9) months ended September 30, 2005, respectively.
REVENUES. The Company recorded an increase of revenues of approximately
$0.08 million to $0.16 million from $0.08 million for the nine (9) months ended
September 30, 2005 compared to the nine (9) months ended September 30, 2004,
respectively. These revenues are a result of the amortization of technology fees
received during 2004 in connection with the granting of certain license
agreements. In the second (2nd) quarter of 2004, $500,000 of a total of $2
million technology fees payable were received in connection with a sublicense
agreement granted to MBS. In the fourth (4th) quarter of 2004, a technology fee
of $1 million was received in connection with a sublicense agreement granted to
EHS. These technology fees have been amortized over the ten (10) year term of
the agreements. The MBS sublicense agreement was terminated on June 8, 2005, and
the unamortized portion of the technology fee was returned to MBS. The
amortization of the remaining EHS technology fee will result in the recognition
of $0.1 million in revenues per year during the life of the agreement.
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
$0.8 million to $0.3 million from $1.1 million for the nine (9) months ended
September 30, 2005 compared to the nine (9) months ended September 30, 2004,
respectively, primarily due to the termination of the related party minimum
monthly payment in September 2005.
28
o Related party license fee and research and development expenses were
primarily comprised, through September 1, 2004, of the payment of a
$100,000 minimum monthly payment to retain exclusive use of the Biotec
Group technology for food service disposable packaging as well as
payment for technical services, both of which are payable to EKI, the
largest stockholder of the Company, or affiliates of EKI. The accrual
of the minimum monthly payment was halted for two (2) years beginning
in September 2004 pursuant to an amendment to the Biotech License
Agreement. Subsequently, the minimum monthly payment to retain
exclusivity was completely eliminated pursuant to the Amended and
Restated Biotec License Agreement dated August 31, 2005. the Biotec
Group is no longer an affiliate of EKI.
o Related party license fee and research and development expenses
decreased $0.8 million to $0 for the nine (9) months ended September
30, 2005, compared to $0.8 million for the nine (9) months ended
September 30, 2004, respectively.
o Other research and development expenses are comprised of personnel
costs, contract research with the USDA, travel and direct overhead for
development and/or demonstration production, and consulting services
for development work. Other research and development expenses remained
constant at approximately $0.3 million for each of the nine (9) months
ended September 30, 2005 and September 30, 2004, respectively.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
are comprised of related party general and administrative expenses and other
general and administrative expenses. Total general and administrative expenses
increased approximately $1.9 million to $4.2 million from $2.3 million for the
nine (9) months ended September 30, 2005 compared to the nine (9) months ended
September 30, 2004, respectively.
o Related party general and administrative expenses are comprised
primarily of the sublease of office facilities from the Company's
largest shareholder, EKI. During 2005 to date, these expenses have
been offset by reimbursement by EKI for fifty percent (50%) of the
cost of one of EarthShell's administrative staff shared by EKI.
Related party general and administrative expenses have been negligible
for each of nine (9) months ended September 30, 2005 and 2004,
respectively.
o Other general and administrative expenses are comprised of personnel
costs and directors' fees, travel and direct overhead for marketing,
finance and administration. Total general and administrative expenses
increased $1.9 million to $4.2 million from $2.3 million for the nine
(9) months ended September 30, 2005 compared to the nine (9) months
ended September 30, 2004, respectively. The increase was due primarily
to the engagement of an investor relations firm in March 2005,
resulting in the accrual of investor relations fees of $0.6 million
through September 30, 2005. In addition, legal fees increased
approximately $0.3 million due primarily to the increase in licensing
and financing activities. Also, the Company has accrued a penalty of
approximately $0.35 million as a result of the Company's failure to
timely file a registration statement related to the debenture
settlements reached in late 2004 and the Company has incurred a
currency translation loss of $0.2 million related to its German
subsidiary. Furthermore, in June of 2005, the Company awarded the
Directors of the Company each 10,000 restricted shares of the
Company's common stock in recognition of the fact that the Directors'
cash compensation during the prior year had been deferred. The value
of these awards was determined to be approximately $0.15 million and
was deemed a non-cash expense. Salaries and wages increased
approximately $0.1 million due to accrual of deferred compensation
which was granted in March 2005 in consideration of reductions in
executive salaries in 2004.
INTEREST EXPENSE. Interest expense is comprised of related party interest
expense and other interest expense.
o Related party interest expense decreased $0.3 million to $0.1 million
from $0.4 million for the nine (9) months ended September 30, 2005
compared to the nine (9) months ended September 30, 2004,
respectively. In 2004, related party interest expense consisted
primarily of interest accruing on $2.7 million in notes advanced to
the Company by EKI. In the fourth (4th) quarter of 2004, these loans
were converted to EarthShell common stock at $3.00 per share and the
accrued interest was converted into common stock at $4.00 per share.
As a result, in 2005, there has been no further accrual of related
party interest. However, during the second (2nd) quarter, the Company
issued to EKI 44,387 additional shares of EarthShell common stock
pursuant to a conversion agreement entered into in the fourth (4th)
quarter 2004 wherein accrued but unpaid interest on loans advanced to
the Company were converted into stock at $4.00 per share. The
additional shares were issued to reduce the conversion price to $3.00
per share. The $0.1 million related party interest expense recorded in
second (2nd) quarter 2004 is the value of the additional shares which
was a non-cash item. The Company has begun to accrue related party
interest in connection with the EKI Loan which, as of the second week
of January 2006, EKI advanced the full $1,000,000 to the Company under
the EKI Loan.
29
o Other interest expense decreased $0.2 million to $0.4 million from
$0.6 million for the nine (9) months ended September 30, 2005 compared
to the nine (9) months ended September 30, 2004, respectively. Other
interest expense for the nine (9) months ended September 30, 2004 was
primarily composed of accretion of the discount on the 2006 Debentures
and interest accrued on the 2006 Debentures. During the fourth (4th)
quarter 2004, the Company entered into agreements with the holders of
all $6.8 million outstanding principal amount of its 2006 Debentures
to settle its obligations and converted and retired the 2006
Debentures and all accrued but unpaid interest, satisfying its
obligations in full. Subsequent to December 31, 2004, there is no
other interest expense for the 2006 Debentures. Other interest expense
for the nine (9) months ended September 30, 2005 was primarily
composed of interest and accretion of the discount on promissory notes
held by Cornell Capital Partners (the "CCP Notes"). As of December 30,
2005, the CCP Notes have been paid off in full. In addition, beginning
in late 2004, the Company entered into payment plans to settle a
number of aged payable accounts with interest accruing on these aged
payable accounts.
GAIN ON SALES OF PROPERTY AND EQUIPMENT. The Company realized a gain of
approximately $0.02 million in the nine (9) months ended September 30, 2005 upon
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. This
reflects a decrease of $0.15 million to $0.02 million from $0.17 million for the
nine (9) months ended September 30, 2005 compared to the nine (9) months ended
September 30, 2004, respectively. The decrease is due to the fact that the
Company was downsizing through 2004 and disposed of surplus equipment during
that period.
PREMIUM DUE TO 2006 DEBENTURE DEFAULT. At June 30, 2004, the Company was in
non-compliance with certain covenants under the terms of the convertible
debentures issued in March 2003 (the "2006 Debentures"). Two (2) of the 2006
Debenture holders, including the 2006 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 2006 Debentures, along
with any accrued and unpaid interest. The 2006 Debentures contained a provision
for repurchase of the 2006 Debentures at a premium if the repurchase was due to
an event of default. Therefore, through the third (3rd) quarter 2004, the
Company accrued approximately $1.7 million of the repurchase premium specified
in the 2006 Debentures. This amount was also included in the current liabilities
account "Convertible Debentures" of the September 30, 2004 balance sheet. The
2006 Debentures were retired in the fourth (4th) quarter of 2004 and no expense
was recorded in 2005.
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2004 COMPARED TO 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 ESH in the second (2nd) and fourth (4th) quarters of 2004 over
the ten (10) 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.
30
o Related party license fee and research and development expenses are
comprised of the $0.1 million minimum monthly licensing fee for the
use of the EarthShell Technology and for technical services, both of
which were payable to EKI, the largest stockholder of the Company, or
the Biotec Group. 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 the
Biotec Group 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 (1st) quarter of 2003, the start-up
in mid-May of a new manufacturing line for plates and bowls built and
financed by DTE at their Lebanon, Missouri facility, expenses incurred
to vacate the Company's demonstration manufacturing facility in
Goleta, California 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 (3rd) quarter, the write down
of the Goettingen manufacturing equipment to $1.00 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 fourteen (14) employees at December 31, 2003 to nine (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 (3rd) 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 (2nd) 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 a 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 the secured 2006 Debentures. During the third (3rd) 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.
31
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 conversion price of the convertible debentures
issued on August 12, 2002 (the "2007 Debentures"). In addition, other
interest expense for 2003 also included accretion of the discount on
the 2007 Debentures and accrued interest payable on the 2006
Debentures 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 dollars
($0).
PREMIUM DUE TO 2006 DEBENTURE DEFAULT. At December 31, 2004, the Company
was in non-compliance with certain covenants under the 2006 Debentures. Two (2)
of the holders, including the 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 2006 Debentures, along with any accrued and
unpaid interest. The 2006 Debentures contain a provision for repurchase of the
2006 Debentures 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 2006
Debentures.
Other Income. Other income for the year ended December 31, 2004 was zero
dollars ($0) compared to $0.4 million for the year ended December 31, 2003. The
2003 other income represents the net gain realized in the third (3rd) quarter of
2003 from reducing the balance of the warrant obligation to its estimated fair
value of zero dollars ($0). 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 $0.1 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 2006 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 the 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. The 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.
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2003 COMPARED TO 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.
32
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, the largest stockholder of the Company, or the
Biotec Group. 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 the Biotec Group.
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 (2nd) 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, California through mid-April
and to the start-up in mid-May of a new manufacturing line for plates
and bowls built and financed by 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
(2nd)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.
33
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 Debentures 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 (3rd) quarter of 2003
from reducing the balance of the warrant obligation to its estimated fair value
of zero dollars ($0). Management believes the estimated fair value of the
warrant at December 31, 2003 was zero dollars ($0). The warrant obligation was
initially recorded in connection with the March 2003 financing transactions.
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 dollars ($0).
DEBENTURE CONVERSION COST. The 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.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW. The Company's principal use of cash for the nine (9) months
ended September 30, 2005 was to fund operations. Net cash used in operations was
approximately $2.7 million for the nine (9) months ended September 30, 2005,
compared to $2.3 million for the nine (9) months ended September 30, 2004. As of
September 30, 2005, the Company had cash and cash equivalents totaling
approximately $0.04 million and a working capital deficit of $11,576,360. These
factors, along with others, indicate that the Company may be unable to continue
as a going concern for a reasonable period of time.
34
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 operating activities was $2.7 million and
$15.7 million for the years ended December 31, 2004 and 2003, respectively. This
significant reduction in cash required to fund operating activities was due
primarily to a reduction in net loss of approximately $11 million as the Company
scaled back its development activities. Further reductions were due to the
receipt of approximately $1.4 million in deferred revenues, the accrual of $1.6
million for a premium due to the default of the 2006 Debentures, and accrual of
approximately $1 million payable to a related party. These reductions were
partially offset by the non-recurrence of a one-time adjustment in 2003 of $3.5
million for the loss on the disposal of equipment and a $1.7 million loss on the
extinguishment in 2003 of the 2007 Debentures. Net cash provided by investing
activities was $0.2 million and $4.0 million for the years ended December 31,
2004 and 2003, respectively. The change was due primarily to a one time event
which was the release in 2003 of a $3.5 million time deposit being used as
collateral for a purchase commitment. About one-half (1/2) of the $3.5 million
time deposit was paid out to settle the purchase commitment. Net cash provided
by financing activities was $0.9 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 $0.3 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 (1) minor capital expenditure during the year ended
December 31, 2004. The Company made no capital expenditures during the nine (9)
months ended September 30, 2005. The Company expects to expend approximately
$10,000 in the first (1st) quarter of 2006 for computer equipment.
CONTRACTUAL OBLIGATIONS. The following table summarizes the Company's known
obligations to make future payments pursuant to certain contracts as of
September 30, 2005, as well as an estimate of the timing in which these
obligations are expected to be satisfied:
Payments Due By Period (In Thousands)
-----------------------------------------------
Less Than
Contractual Obligations Total 1 Year 1-3 Years
---------------------------------------------- --------------- -------------- -----------------
Long-term debt - principal payments only
Capital leases $ -- $ -- $ --
Operating leases -- -- --
Payable to related party 875 875 --
Other long-term liability 530 380 150
-------- --------- --------
Totals $ 1,405 $ 1,255 $ 150
======== ========= ========
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 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, respectively, in private
transactions under such shelf 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 shelf 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.
35
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 on March 5, 2006 (the "2006 Debentures"),
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 these 2006 Debentures and two (2) warrants to a placement
agent, both of whom received the instruments as compensation for their services
rendered in connection with the transaction. 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
statement described above were used to secure shares potentially issuable upon
conversion of the 2006 Debentures. 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 2006 Debentures, to
resolve the defaults, and to restructure its long-term debt as follows. On May
13, 2004, the Company entered into a ten (10) year license agreement with MBS
and granted to MBS a priority license to supply certain retail and government
market segments in the United States (the "MBS Sublicense"). MBS has paid
EarthShell $500,000 in technology fees to date. On June 8, 2005, the Company
terminated the MBS Sublicense as set forth herein below.
On August 5, 2004, EarthShell and MBS entered into a stock purchase
agreement (the "MBS SPA") pursuant to which MBS agreed to fund $5 million to
EarthShell in exchange for EarthShell's issuance of 1,666,666 shares of common
stock at $3.00 per share. On August 20, 2004, EarthShell received $500,000 from
MBS, for which the Company issued to MBS 166,666 shares of its common stock. On
October 1, 2004, EarthShell received an additional $1.2 million of the $5
million commitment, and the Company issued to MBS 400,000 shares of its common
stock. On October 11, 2004, MBS purchased an additional 333,333 shares for $1.0
million, of which it had paid $0.5 million as of December 31, 2004 and $0.5
million was still due. Subsequent to December 31, 2004, MBS paid to the Company
an additional $25,000, leaving the balance due at March 31, 2005 equal to $0.475
million. The shares of common stock issued to MBS were not registered for resale
under the 1933 Act. The cash received from MBS was used, in part, to fund the
repurchase of the 2006 Debentures and to restructure the Company's long-term
debt.
On March 23, 2005, the Company entered into a financing arrangement with
Cornell Capital Partners whereby the Company issued promissory notes to, and
entered into a security agreement with, Cornell Capital Partners. Pursuant to
the financing, the Company issued one (1) promissory note equal to $1,150,000 on
March 28, 2005 and a second note equal to $1,350,000 on May 27, 2005
(collectively, the "CCP Notes") to Cornell Capital Partners for a total
principal amount of $2.5 million. Upon entering into the Purchase Agreement with
Cornell Capital Partners on December 30, 2005, the CCP Notes and all accrued
interest thereon have been paid in full.
On March 23, 2005, the Company entered into a Standby Equity Distribution
Agreement (the "SEDA") with Cornell Capital Partners whereby the Company was
entitled to, at its sole discretion, periodically sell to Cornell Capital
Partners shares of its common stock for a total aggregate purchase price of up
to $10.0 million. On June 9, 2005, the Company filed a registration statement on
Form S-1 with the SEC to register shares of its common stock underlying the
SEDA. On September 27, 2005, the registration statement was withdrawn and, on
December 30, 2005, the parties terminated the SEDA.
On May 26, 2005, the Company issued a common stock purchase warrant to
Cornell Capital Partners to purchase 625,000 shares of common stock of the
Company. This May Warrant expires on May 26, 2006, has an exercise price of
$4.00 per share of common stock and has "piggy back" and demand registration
rights. In August 2005 Cornell Capital Partners agreed to consolidate the CCP
Notes and to defer the commencement of repayment installments until October 1,
2005. In consideration of this modification to CCP Notes, the Company issued a
warrant to Cornell Capital Partners to purchase 50,000 shares of common stock of
the Company. This August Warrant expires on May 26, 2006, has an exercise price
which was adjusted to $3.00 per share of common stock, as of December 30, 2005
and has "piggy back" and demand registration rights.
On June 8, 2005, the Company entered into a letter agreement with MBS
terminating its sublicense agreement (the "MBS Sublicense"), dated as of May 13,
2004. At the time the letter agreement was executed, MBS had not yet implemented
the sublicense granted to it under the MBS Sublicense. The parties separately
agreed that the effectiveness of the termination would be conditioned upon the
effectiveness of the agreements with RPI as described herein below. The Company
entered into additional sublicense agreements with MBS covering non-competing
technologies in other markets and territories than those covered by the MBS
Sublicense and the present RPI Sublicense. The effectiveness of such sublicense
agreements was expressly conditioned upon the satisfaction of certain conditions
before July 31, 2005, including the receipt by the Company of $2.6 million in
technology fees and other payments. These agreements expired under their own
terms.
36
On June 17, 2005, EarthShell entered into a sublicense agreement with RPI
(the "RPI Sublicense"), a newly formed subsidiary of Thompson Street Capital
Partners ("Thompson Street"), pursuant to which the Company granted to RPI an
exclusive license to produce plates, bowls, and certain other EarthShell
products incorporating the Company's technology and to sell these products in
the retail and governmental market segments in the United States. The Company
has been advised that RPI has already received the full $12 million funding
commitment from Thompson Street in order to begin production of EarthShell
Packaging(R) products. The RPI Sublicense requires RPI to pay to the Company a
royalty fee equal to twenty percent (20%) of RPI's net sales, not to exceed
fifty percent (50%) of RPI's gross margin. The parties separately agreed that
the effectiveness of the RPI Sublicense would be conditioned upon the
effectiveness of the agreements with MBS as set forth herein above.
On June 17, 2005, the Company, RPI and RPI's sole stockholder, Renewable
Products, LLC ("RPI LLC"), entered into an agreement and plan of merger (the
"RPI Merger") which contemplates the Company's eventual acquisition of RPI in
exchange for 8 million shares of the Company's Series C Convertible Preferred
stock (the "Series C Preferred") at such time as the following conditions, among
others, are achieved: (i) RPI's procurement, installation and start-up of
sixteen (16) manufacturing modules for producing the Company's product, which
equipment is to be designed to produce an aggregate of approximately $16 million
of EarthShell products per year, (ii) RPI's establishment of plant facilities to
support the full commercial operations of such machines, (iii) RPI's receipt of
funding to support additional working capital needs of $1 million, (iv) RPI's
receipt of at least $12 million of capital to purchase the machines described
above, and (v) the twenty percent (20%) royalty described above having become
payable and either accrued or paid to the Company pursuant to the RPI
Sublicense. At such time as the conditions to the transactions contemplated by
the RPI Merger are met, RPI has the right, through March 31, 2006, to call for
the merger to occur. The parties have mutually agreed to extend RPI's call date
to December 31, 2006. At the time the merger is triggered,
a valuation of RPI will be obtained and the Company will
acquire RPI pursuant to the terms of the RPI Merger in exchange for 8 million
shares of Series C Preferred, as described above. The Series C Preferred will be
convertible on a share for share basis into 8 million shares of the Company's
common stock which will be subject to registration rights.
On August 22, 2005, the Company entered into a letter agreement with EA to
grant sub-licenses to use EarthShell Technology for various applications in
certain Asian territories (the"EA License"). Shortly after executing a letter
agreement, both the Company and EA entered into negotiations to restructure the
transaction and ultimately entered into an amended and restated letter agreement
dated December 9, 2005. By its terms, the amended and restated letter agreement
was not to become effective until all conditions to the transactions described
therein were satisfied. Per the transaction as restructured in accordance with
the amended and restated letter agreement, the Company may receive a total of up
to $2.6 million from a combination of (i) prepaid technology fees (up to $1.7
million), (ii) the sale of up to 266,667 shares of its common stock and (iii)
the issuance of warrants to purchase one million thirty three thousand three
hundred thirty three (1,033,333) shares of the Company's common stock at $3.90
per share (which, if the Company does not file with the Securities and Exchange
Commission a registration statement for the resale of such shares by January 31,
2006, may be adjusted to an excercise price of not less than $3 per share).
Subsequent to the execution of the amended and restated letter agreement, EA
agreed to change the deadline for filing the resale registration statement to
February 15, 2006. Realization of the full potential of the transaction is
dependent on the Company successfully demonstrating the commercial viability of
its technology in certain new applications.
The Company received $500,000 from EA in August 2005 as an initial partial
payment and issued 166,667 shares of its common stock in connection with this
payment. The Company received an additional $300,000 in December 2005 and the
final payment, of approximately $61,000 on February 10, 2006. The remainder was
retained by EA as compensation for various costs and fees. Upon receipt of the
final payment, the Company issued a total of 266,667 shares and the warrants to
purchase the 1,033,333 shares.
On October 11, 2005, the Company entered into the EKI Loan with EKI
pursuant to which the Company issued to EKI a promissory note in the principal
amount of $1,000,000. As of the second week of January 2006, EKI has advanced
$1,000,000 to the Company. Interest accrues on the principal balance of the EKI
Loan at a variable per annum rate, as of any date of determination, that is
equal to the rate published in the "Money Rates" section of The Wall Street
Journal as being the "Prime Rate", compounded monthly. All accrued but unpaid
interest and outstanding principal is due and payable on the earliest to occur
of the following: (i) the second (2nd) anniversary of the date of the EKI Loan;
(ii) five (5) days following the date the Company has received $3 million or
more in aggregate net cash proceeds from all financing transactions, equity
contributions, and transactions relating to the sale, licensing, sublicensing or
disposition of assets or the provision of services (including advance royalty
payments, proceeds from the sale of the Company's common stock and fees for
technological services rendered to third parties), measured from the date of the
EKI Loan and not taking into account the proceeds advanced under the EKI Loan;
or (iii) the occurrence of an Event of Default (as defined in the EKI Loan).
On October 11, 2005, the Company entered into a debt conversion and mutual
release agreement (the "Debt Conversion Agreement") with EKI. Pursuant to the
Debt Conversion Agreement, the Company and EKI agreed that a receivable in an
amount equal to $837,145.69 (previously owed to bio-Tec Biologische
Naturverpackunger GmbH & Co.KG, but which receivable was subsequently assigned
to EKI) be converted into 279,048 shares of common stock of the Company. The
conversion price equals $3.00 per share. Pursuant to the Debt Conversion
Agreement, the Company and EKI released each other from any and all claims in
connection with the receivable.
On December 30, 2005, EarthShell entered into a Purchase Agreement with
Cornell Capital Partners pursuant to which the Company issued and sold to
Cornell Capital Partners the secured December Debentures. The December
Debentures shall be convertible into shares of the Company's common stock, and
the Company is registering 6,700,000 shares in connection with the Purchase
Agreement. The Company received proceeds equal to $4,500,000 from the sale of
the December Debentures on January 6, 2006, of which approximately $2.6 million
was used to payoff the existing $2.5 million promissory note to Cornell and
Highgate.
37
The December Debentures are secured by (i) a Pledge and Escrow Agreement,
by and among the Company, Cornell Capital Partners, and David Gonzalez, Esq.,
(ii) an Insider Pledge Agreement and Escrow Agreement (the "IPEA"), by and among
the Company, Cornell Capital Partners, David Gonzalez, Esq. and Mr. Benton
Wilcoxon and (iii) an Amended and Restated Security Agreement, by and between
the Company and Cornell Capital Partners. The December Debentures are secured by
substantially all of the Company's assets, have a three (3) year term and accrue
interest at twelve percent (12%) per annum. Beginning 60 days after the
Securities and Exchange Commission ("SEC") declares the accompanying
registration statement effective, Cornell Capital Partners is entitled, at its
option, to convert and sell up to $250,000 of the principal amount of the
December Debentures, plus accrued interest, into shares of the Company's common
stock, within any 30 day period at the lesser of (i) a price equal to $3.00 or
(ii) eighty-eight percent (88%) of the average of the two (2) lowest volume
weighted average prices of the common stock during the ten (10) trading days
immediately preceding the conversion date, as quoted by Bloomberg, LP. The
conversion limitation of $250,000 per month does not apply if the market price
is greater than $3.00 per share.
The holder of the December Debentures may not convert the December
Debentures or receive shares of the Company's common stock as payment of
interest thereunder to the extent such conversion or receipt of such interest
payment would result in the holder, together with any affiliate thereof,
beneficially owning (as determined in accordance with Section 13(d) of the
Securities Exchange Act of 1934, as amended, and the rules promulgated
thereunder) in excess of 4.9% of the then issued and outstanding shares of
common stock, including shares issuable upon conversion of, and payment of
interest on, the December Debentures held by such holder after application of
this 4.9% restriction. This 4.9% restriction may be waived by the holder (but
only as to itself and not to any other holder) upon not less than sixty-five
(65) days prior notice to the Company.
The Company may redeem, with three (3) business days advance written notice
to Cornell Capital Partners, a portion or all amounts outstanding under the
December Debentures prior to the maturity date provided that the closing bid
price of the of the Company's common stock, as reported by Bloomberg, LP, is
less than $3.00 at the time of the redemption notice. The Company shall pay an
amount equal to the principal amount being redeemed plus a redemption premium
equal to ten percent (10%) of the principal amount being redeemed, and accrued
interest, to be delivered to the Cornell Capital Partners on the third (3rd)
business day after the redemption notice, provided, however, this redemption
premium does not apply until the outstanding principal balance of the December
Debentures has been reduced by $2.5 million. The amount that Cornell may convert
in any 30 day period will be reduced by the amount that the Company redeems.
In connection with the Purchase Agreement, on December 30, 2005, the
Company issued to Cornell Capital Partners the December Warrant to purchase up
to 350,000 shares of common stock. This December Warrant has an exercise price
of $4.00 per share, which may be adjusted under certain conditions to as low as
$3 per share and expires two (2) years from the date it was issued. Furthermore,
in connection with the Company's sale of December Debentures, the Company issued
to Mr. Benton Wilcoxon, in consideration of his pledge of shares of common stock
of Composite Technology Corporation pursuant to the terms of the IPEA, a warrant
to purchase up to 125,000 shares of common stock. This warrant has an exercise
price of $4.00 per share and expires three (3) years from the date it was
issued.
The Company believes that as a result of (a) the $900,000 received pursuant
to the EA agreements (b) the $1,000,000 received pursuant to the EKI Loan and
(c) the $4,500,000 in proceeds received in connection with the issuance and sale
to Cornell Capital Partners of the December Debentures, the Company has
sufficient capital to fund its operations through the first several months of
2006. The Company expects to receive additional technology fees in connection
with the granting of additional new licenses during 2006. In addition, the
Company expects to begin generating royalty revenues later in 2006. If the
Company is not successful at generating royalty payments technology fees during
2006, the Company may have to raise additional funds to meet its current
obligations and to cover operating expenses through December 31, 2006. If the
Company is not successful in raising additional capital it may not be able to
continue as a going concern for a reasonable amount of time. Management expects
to address this potential need in 2006 by generating cash through the issuance
of debt or equity securities. The Company expects to receive additional
technology fees in connection with the granting of additional new licenses
during 2006. In addition, the Company expects to begin generating royalty
revenues later in 2006. However, the Company cannot assure that additional
financing will be available to it, or, if available, that the terms will be
satisfactory to it. Management will also continue in its efforts to reduce
expenses, but cannot assure that it will be able to reduce expenses below
current levels. If the Company is not successful in raising additional capital
it may not be able to continue as a going concern.
38
OFF-BALANCE SHEET ARRANGEMENTS. The Company does not have any off-balance
sheet arrangements as of September 30, 2005, and has not entered into any
transactions involving unconsolidated, limited purpose entities.
SUMMARY OF THE 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 to amend and restate the secured debenture
purchase agreements entered into in July 2004 by and among 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) 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 of EarthShell common stock and (iv)
EarthShell to pay $2.3 million to SF Capital Partners from thirty-three percent
(33%) of any equity funding received by the Company (excluding the first $2.7
million funded by MBS) or fifty percent (50%) of the royalties received by
EarthShell in excess of $250,000 per month (as 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 that EarthShell shall
subsequently receive upon the issuance of its common stock (or other convertible
security) during the three (3) 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 1933 Act, but are being registered as part of
this Registration Statement. The consideration for the repurchase of the 2006
Debentures has been paid or issued, and the 2006 Debentures have been retired by
EarthShell.
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 and in December 2004 registering the resale
of such shares of common stock. Under certain agreements, the Company not filing
such a registration statement (or the registration statement not being declared
effective) within a required timeframe provided 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 a 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 ten percent (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.
SUMMARY OF THE EKI AGREEMENTS. During 2002 and 2003, EKI made various
simple interest working capital loans to the Company (the "Simple Interest
Loans"). These Simple Interest Loans were interest bearing at a rate of seven
percent (7%) or ten percent (10%) per annum, and were payable on demand. As of
December 31, 2003, the outstanding principal balance of the Simple Interest
Loans was $2,755,000. In connection with the sale of the 2006 Debentures, EKI
subordinated the payments and advances that were owed to it, and as
consideration, the Company issued to EKI a warrant in March 2003, expiring ten
(10) years thereafter, to acquire 83,333 shares of the Company's common stock at
$6.00 per share. As part of the settlement of the 2006 Debentures in October of
2004, EKI agreed to convert all of the outstanding Simple Interest Loans to
EarthShell ($2,755,000) into unregistered common stock at $3.00 per share and
$532,644 of accumulated interest into unregistered common stock at $4.00 per
share, for a total of 1,051,494 shares received by EKI. As of December 31, 2004,
the Simple Interest Loans were paid in full. In May 2005, an additional 44,387
shares were issued to EKI pursuant to a ninety (90) day price protection clause,
which provided for an adjustment in the effective conversion price of the
interest portions of the Simple Interest Loans from $4.00 per share to $3.00 per
share. The 1,051,494 shares of common stock issued to EKI as a result of the EKI
Conversion Agreement will not be registered for resale under the 1933 Act.
On September 30, 2004, EKI entered into an agreement with EarthShell to
sell back to the Company the 2006 Debentures it had purchased for $1 million in
cash, the cash price paid by EKI for the purchased 2006 Debentures (the "EKI
DPA"). In connection therewith, immediately after the acquisition, EKI sold the
2006 Debentures to the Company and, as discussed above, the Company retired the
2006 Debentures shortly thereafter.
In 2005, the Company also granted a ten (10) year warrant to Essam
Khashoggi to purchase one million (1,000,000) shares of the Company's common
stock at $3.00 per share in consideration of his continued support of the
Company since its inception, including providing bridge loans at below market
terms from time to time.
39
On October 11, 2005, the Company entered into the EKI Loan with EKI
pursuant to which the Company issued to EKI a promissory note to EKI in the
principal amount of $1,000,000. As of the second week of January 2006, EKI has
advanced the full $1,000,000 to the Company. Interest accrues on the principal
balance of the EKI Loan at a variable per annum rate, as of any date of
determination, that is equal to the rate published in the "Money Rates" section
of The Wall Street Journal as being the "Prime Rate", compounded monthly. All
accrued but unpaid interest and outstanding principal is due and payable on the
earliest to occur of the following: (i) the second (2nd) anniversary of the date
of the EKI Loan; (ii) five (5) days following the date the Company has received
$3 million or more in aggregate net cash proceeds from all financing
transactions, equity contributions, and transactions relating to the sale,
licensing, sublicensing or disposition of assets or the provision of services
(including advance royalty payments, proceeds from the sale of the Company's
common stock and fees for technological services rendered to third parties),
measured from the date of the EKI Loan and not taking into account the proceeds
advanced under the EKI Loan; or (iii) the occurrence of an Event of Default (as
defined in the EKI Loan).
On October 11, 2005, the Company entered into the Debt Conversion Agreement
with EKI, pursuant to which the Company and EKI agreed that a receivable in an
amount equal to $837,145.69 (previously owed to bio-Tec Biologische
Naturverpackunger GmbH & Co.KG), but which receivable was subsequently assigned
to EKI) be converted into 279,048 shares of common stock of the Company. The
conversion price equals $3.00 per share. Pursuant to the Debt Conversion
Agreement, the Company and EKI released each other from any and all claims in
connection with the receivable.
Biotec License Agreement. On July 29, 2002 the Company entered into a
license and information transfer agreement (the "Biotech License Agreement")
with bio-tec Biologische Naturverpackungen GmbH & Co. KG and bio-tec Biologische
Naturverpackungen Forschungs und Entwicklungs GmbH (the "Biotec Group") to
utilize the Biotec Group technology for foodservice disposable packaging
applications. EKI had previously granted to the Company priority rights to
license certain product applications on an exclusive basis from the Biotec Group
in consideration for the Company's payment of a $100,000 minimum monthly payment
to Biotec. In addition, in consideration for the monthly payment, the Biotec
Group agreed to render technical services to the Company at the Biotec Group's
cost plus five percent (5%). The licensing fee and services arrangements were
continued in the Biotec License Agreement. Under the terms of the Biotec License
Agreement, the Biotec Group was entitled to receive twenty-five percent (25%) of
any royalties or other consideration that the Company receives in connection
with the sale of products utilizing the Biotec Group technology, after applying
a credit for all minimum monthly payments received. In connection with the
issuance of the 2006 Debentures, the Biotec Group agreed to subordinate the
licensee fee payments due from EarthShell until the debentures were retired.
During this period, the license fees due to the Biotec Group 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 (2) years, the $100,000 per month minimum license fee. In December of 2004,
the amended Biotec License Agreement was further amended and EarthShell paid to
Biotech $125,000, leaving a balance owing of approximately $875,000, which was
subsequently reduced to approximately $837,000. On August 31, 2005, in
connection with the sale of Biotec by EKI, Biotec License Agreement was again
amended and restated (the "Amended and Restated Biotec License") and the minimum
monthly payment to retain exclusivity was completely eliminated and the balance
of approximately $837,000 owing to EarthShell was assigned by the Biotec Group
to EKI. Under the Amended and Restated Biotec License, the Company has a fully
paid up license to use the Biotec technology in the EarthShell fields of use,
with certain limited exclusions, exclusively through June 2008. The Company can
maintain its exclusivity provided it has been successful in commercializing the
Biotec technology and is making certain minimum royalty payments under the
license by June 2008. As of the date of this Prospectus, the Company has paid to
the Biotec Group $125,000 in cash, has converted approximately $1.475 million
into 491,778 shares of unregistered stock, and had assigned the balance owing to
the Biotec Group of $837,000 to EKI. The $837,000 balance was ultimately
converted by EKI in October 2005 into shares of EarthShell common stock at $3
per share.
SUMMARY OF LICENSE AGREEMENTS. On May 13, 2004, the Company entered into
the MBS Sublease, which called for a total of $2.0 million in technology fees
payable in $0.5 million increments based on certain milestones during the
startup of manufacturing operations and prior to the beginning of royalty
generation. On June 8, 2005, the Company entered into a letter agreement with
MBS terminating the MBS Sublicense. At the time the letter agreement was
executed, MBS had not yet implemented the sublicense granted to it under the MBS
Sublicense. The parties separately agreed that the effectiveness of the
termination would be conditioned upon the effectiveness of certain agreements
with RPI. The Company entered into additional sublicense agreements with MBS
covering non-competing technologies in other markets and territories than those
covered by the past MBS Sublicense and the present RPI Sublicense. However, the
effectiveness of such sublicense agreements was expressly conditioned upon the
satisfaction of certain conditions before July 31, 2005, including the receipt
by the Company of $2.6 million in technology fees and other payments. These
agreements expired under their own terms on July 31, 2005.
40
In November of 2004, the Company entered into a ten (10) year license
agreement with ESH (the "ESH License") as the Company's exclusive licensee for
the country of Mexico. To date, ESH has paid to the Company a $1,000,000
technology fee that will be credited against future royalty obligations. Under
the terms of the ESH License, 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 could potentially represent more than
ten percent (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. This risk factor is more applicable to the following
paragraph since RPI actually has equipment operating and is selling product. RPI
actually represents up to 100% of EC's revenue base until additional licensees
commit capital and build more machines.
On June 17, 2005, EarthShell entered into the RPI Sublicense, pursuant to
which the Company granted to RPI the exclusive rights in the U.S. to produce
EarthShell plates, bowls, and other shallow-draw products for certain
distribution channel including the retail and government sectors. In return, RPI
agreed to invest in excess of $14 million to purchase and install the initial
eight (8) commercial modules that had been built by DTE and to order an
additional eight (8) modules. Since RPI is controlled by the same shareholder
that owns DTE, RPI is uniquely positioned to obtain the full support of the
machine builder to make sure the EarthShell manufacturing equipment meets its
performance targets. The merger agreement gives RPI the right, ultimately, to
merge with EarthShell at such time as it has invested substantial capital in
building new EarthShell manufacturing capacity and the equipment is operating
profitably. Based on the success of this initiative, the Company believes that
it will be able to successfully resume its licensing strategy. Currently, RPI
has installed and placed into service eight (8) modules. The next eight (8)
modules are nearing completion. At this time, RPI is busy working to sell it
newly available manufacturing capacity. The RPI Sublicense requires RPI to pay
to the Company a royalty fee equal to twenty percent (20%) of RPI's net sales,
not to exceed fifty percent (50%) of RPI's gross margin.
On August 22, 2005, the Company entered into an agreement with EarthShell
Asia granting certain licenses to use a new embodiment of the EarthShell
Technology for various applications in certain Asian territories (the "EA
License"). Under the license agreements, the Company may receive a total of up
to $1.7 million from prepaid technology fees, plus an ongoing royalty. Prior to
receiving the prepaid technology fees, the Company must successfully demonstrate
the commercial viability of this new technology for certain applications.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
General
The Management of EarthShell is responsible for establishing and
maintaining adequate internal control over financial reporting and for the
assessment of the effectiveness of internal control over financial reporting. As
defined by the SEC, internal control over financial reporting is a process
designed by, or supervised by, the Company's principal executive and principal
financial officers, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements in accordance
with generally accepted accounting principles.
The Company's internal control over financial reporting is supported by
written 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 Company's assets; (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 the Company's management and directors; 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 significant deficiency (within the meaning of
PCAOB Auditing Standard No. 2), or a combination of significant deficiencies,
that results in there being more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected on a timely basis by employees in the normal course of their
assigned functions.
41
In making its assessment of internal control over financial reporting,
management used the framework set forth in the report entitled "Internal
Control--Integrated Framework" published by the Committee of Sponsoring
Organizations ("COSO") of the Treadway Commission to evaluate the effectiveness
of the Company's internal control over financial reporting. Because of the
material weaknesses described below, management believes that, as of December
31, 2004, the Company did not maintain effective internal control over financial
reporting based on those criteria.
The Company's independent auditors have issued an attestation report on
management's assessment of the Company's internal control over financial
reporting. Although the Company operated during 2004 with a significantly
reduced number of personnel compared to prior years, the Company's management
has implemented and documented internal control over financial reporting which
it believed would be considered sufficient, given the resources available to it.
However, during the fourth (4th) quarter of 2004, the Company's Controller
resigned, leaving the Company's Chief Financial Officer as the only accounting
professional employed by the Company. This resulted in the loss of segregation
of responsibilities that are typical to effective financial reporting control
methodology. The Company employed certain mitigating controls designed to offset
the inherent control weaknesses that resulted from a lack of segregation of
responsibilities.
We engaged an accounting firm in December 2004 to assist us in documenting
and testing our controls and procedures in compliance with the Sarbanes-Oxley
Act. This process was not completed until late in the first (1st) quarter 2005.
The testing and evaluation of our internal controls as of that time indicated
that our controls were considered effective.
Based on the timing of this work and the filing deadline for our Annual
Report on Form 10-K as an accelerated filer, our independent registered public
accounting firm was not able to perform its audit of management's assessment of
the effectiveness of its internal control over financial reporting as of
December 31, 2004, until subsequent to the filing of our Annual Report on Form
10-K. Their audit disclosed the material weaknesses. We reviewed the results of
their audit of our assessment and concurred with their conclusion. Accordingly,
we modified our assessment in Amendment No. 1 to the Company's Quarterly Report
on Form 10-Q for the quarter ended March 31, 2005 and in Amendment No. 1 to the
Company's Annual Report on Form 10-K.
MATERIAL WEAKNESSES IDENTIFIED
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 ("IT")
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.
42
REMEDIATION STEPS TO ADDRESS THE MATERIAL WEAKNESSES
In consultation with its independent auditors, as of September 30, 2005,
the Company has begun taking the following remediation steps, among others, to
enhance its internal control over financial reporting and reduce control
deficiencies in general, including the material weaknesses enumerated above:
o Management has interviewed multiple qualified candidates to perform
the Controller responsibilities, and as of October 31, 2005 hired a
new controller.
o Management has engaged an outside accounting firm, to perform certain
Internal Audit functions. This outside firm reports to the Audit
Committee of the Board of Directors on a quarterly basis.
o Management employs an outside firm, to monitor and maintain the
Company's information systems. This group was been directed to develop
and implement Company-wide information management control procedures
in response to the control weaknesses noted by the Company's auditors
and in consultation with the Company's internal auditors. A first
draft was completed in July 2005. In connection with the recent move
of its corporate offices to Maryland, a new group was retained to
perform a similar function. It is expected that a final information
technology controls policy and procedures document will be finalized
and implemented 2006.
To date, the Company has expended approximately $60,000 towards remediation
of these material weaknesses.
43
CHANGES IN AND DISAGREEMENTS
WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
44
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 is exposed to interest rate risk on its obligations pursuant to
the December Debentures and the EKI Loan. Currently, the principal amounts of
the December Debentures and the EKI Loan combined total approximately $5.5
million. The December Debentures bear interest on the principal balance of $4.5
million at a fixed rate of twelve percent (12%) per annum and the EKI Loan
accrues on the principal balance of $1,000,000 at a variable rate per annum, as
of any date of determination, that is equal to the rate published in the "Money
Rates" section of The Wall Street Journal as being the "Prime Rate", compounded
monthly. In addition, there remain a few settlements of accounts payable
obligations that will be paid out over terms from eighteen (18) months to
thirty-six (36) months, the long term portion of which may be exposed to
interest rate risk.
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.
45
DESCRIPTION OF BUSINESS
THE COMPANY
EarthShell was organized in November 1992 to engage in the
commercialization of 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 (collectively,
"EarthShell Packaging(R)").
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(R); (ii) demonstrate customer acceptance and demand for
EarthShell Packaging(R) 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 United
States and over $28 billion globally. According to industry studies of the
market, approximately fifty-four percent (54%) of the total foodservice
disposable packaging is purchased by quick-service restaurants and forty-six
percent (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 United
States by quick-service restaurants and other institutions, approximately
forty-five percent (45%) are made of coated or plastic laminated paper and
fifty-five percent (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
========== ===
46
In addition to the United States, the Company believes the market
opportunity for EarthShell Packaging(R) 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(R) is based on a patented composite material
technology licensed on an exclusive worldwide basis from EKI, the largest
stockholder of the Company, and, on a limited exclusive, worldwide basis, from
its wholly-owned subsidiaries. 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(R)
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(R) can be categorized into four (4) types: (i)
laminated foamed products, (ii) flexible wraps, (iii) injection-molded products
and (iv) 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 United States 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(R)
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(R) 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.
47
Some examples of where EarthShell Packaging(R) plates, bowls, and
hinged-lid containers have been used include:
QUICK-SERVICE RESTAURANTS
McDonald's Corporation ("McDonald's")
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
In 1997, the Company initially entered into a supply agreement with Perseco
to supply EarthShell sandwich containers for the entire U.S. McDonald's
restaurant chain. Although the Company was able to finally deliver a product
that was acceptable to Perseco and McDonald's from an environmental and
performance perspective, ultimately, the Company and its licensee, Sweetheart
Cup Company, were not able to ramp up commercial manufacturing capacity at the
throughput rates to sustain a continuous and economically viable commercial
supply of its containers to meet that contract. The manufacturing equipment
needed to be refined.
Until full commercial production capability is firmly established, it is
critical to the Company's success that all other aspects of the products are
demonstrated in a commercial setting. While the development and refinement of
commercial manufacturing capability and capacity is taking place, the Company
has successfully implemented a strategy that we call "controlled creation of
demand". The purpose has been to demonstrate the breadth and depth of the market
demand for EarthShell products. Some of the objectives have been to demonstrate
that:
o EarthShell Packaging(R) can be made in a variety of product families
(sandwich containers, plates, bowls);
o EarthShell has application in all of the major market segments (fast
food, institutional feeders, governmental, retail, etc);
o Key market segment leaders are willing to purchase EarthShell products
on a repeat basis;
o EarthShell product performance characteristics and product quality are
commercially acceptable to actual customers that act as market opinion
leaders; and
o EarthShell product positioning is competitive and price points are
realistic and sustainable.
From time to time, the Company has manufactured limited quantities of
commercial product using its pilot scale equipment, and in some cases,
commercial scale equipment operating at low throughput rates. Concurrent with
the further development of the manufacturing processes, this supply of product
has been sold to carefully selected customers. Except for McDonald's and
Wal-Mart, who are large customers that require nationwide supply capability, all
of the other customers were selected because they are representative of their
market segments and will take small quantities. Their volume demands could be
kept low (within EarthShell's capacity to supply without a licensee in full
commercial production.) At the same time, repeat purchases from these key
customers gives clear indications that there is a strong and sustainable demand
for EarthShell products as soon as they are commercially available on a
sustained basis.
48
None of the customers that have used EarthShell products have been large
contributors to our revenue yet.
COST
Since EarthShell Packaging(R) 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(R) 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(R);
o License the EarthShell Technology to strategic manufacturing partners
to manufacture, market, distribute and sell EarthShell Packaging(R);
and
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(R) 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(R). The Company also expects that the EarthShell
Packaging(R) brand name will appear on EarthShell products.
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(R). During 2004, the Company terminated its license agreements with
Sweetheart/Solo and with Huhtamaki as those relationships had not progressed as
planned. The Company has entered into new license agreements with (a) RPI in the
U.S. market and (b) ESH for a segment of the Mexican market. In addition, the
Company entered into an agreement with a new licensee, EarthShell Asia, granting
certain licenses to use a new embodiment of the EarthShell Technology for
various applications in certain Asian territories (the "EA License"). Under the
license agreements, the Company may receive a total of up to $1.7 million from
prepaid technology fees, plus an ongoing royalty. Prior to receiving the prepaid
technology fees, the Company must successfully demonstrate the commercial
viability of this new technology for certain applications.
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(R) 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).
49
Through the course of developing the manufacturing processes, the Company
worked with a machinery manufacturer, Detroit Tool and Engineering (DTE), which
has developed turn-key manufacturing lines for EarthShell plates and bowls. One
of the Company's more recent licensees, Renewable Products, Inc. (RPI), has
acquired 16 manufacturing modules and is in the process of obtaining orders and
ramping up its manufacturing and distribution operations. The Company's primary
focus is now on supporting its first licensees, both in the United States and
abroad.
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(R) 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(R) 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(R) 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(R) 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 2006 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(R) products or otherwise develop the EarthShell
products or production capacity. The Company intends to proliferate the use of
EarthShell Packaging(R) in the U.S. and international markets through agreements
with additional licensed partners.
RENEWABLE PRODUCTS, INC. (RPI) One of the Company's main objectives has
been to demonstrate in a commercial setting that the EarthShell Technology is
commercially viable. After working with several licensees that were either
unsuccessful or otherwise did not ultimately commit the resources necessary to
commercialize the EarthShell Technology, the Company decided to take further
steps to make sure the technology was adequately demonstrated to launch its
licensing business model. The Company entered into the RPI Sublicense coupled
with the RPI Merger Agreement on June 17, 2005. Essentially, EarthShell has
granted to RPI the exclusive rights in the U.S. to produce EarthShell plates,
bowls, and other shallow-draw products for certain distribution channel
including the retail and government sectors. In return, RPI agreed to invest in
excess of $12 million and purchase and install the initial eight (8) commercial
modules that had been built by DTE and to order an additional eight (8) modules.
Since RPI is controlled by the same shareholder that owns DTE, RPI is uniquely
positioned to obtain the full support of the machine builder to make sure the
EarthShell manufacturing equipment meets its performance targets. The merger
agreement gives RPI the right, ultimately, to merge with EarthShell at such time
as it has invested substantial capital in building new EarthShell manufacturing
capacity and the equipment is operating profitably. Based on the success of this
initiative, the Company believes that it will be able to successfully resume its
licensing strategy. Currently, RPI has installed and placed into service eight
(8) modules. The next eight (8) modules are nearing completion. At this time,
RPI is busy working to sell it newly available manufacturing capacity.
50
MERIDIAN BUSINESS SOLUTIONS, LTD. (MBS) On May 13, 2004, the Company
entered into a ten (10) year license agreement with MBS and granted to MBS a
priority license to supply certain retail and government market segments in the
United States (the "MBS Sublicense") and initially paid EarthShell $0.5 million
in technology fees as of the date of this Prospectus. On June 8, 2005, the
Company entered into a letter agreement with MBS terminating the MBS Sublicense.
At the time the letter agreement was executed, MBS had not yet implemented the
sublicense granted to it under the MBS Sublicense. The parties separately agreed
that the effectiveness of the termination would be conditioned upon the
effectiveness of certain agreements with RPI. The Company entered into
additional sublicense agreements with MBS covering non-competing technologies in
other markets and territories than those covered by the past MBS Sublicense and
the present RPI Sublicense. However, the effectiveness of such sublicense
agreements was expressly conditioned upon the satisfaction of certain conditions
before July 31, 2005, including the receipt by the Company of $2.6 million in
technology fees and other payments. These agreements expired under their own
terms on July 31, 2005.
EARTHSHELL HIDALGO S.A. DE C.V. (EHS) In November of 2004, the Company
entered into a ten (10) year license agreement with ESH as the Company's
exclusive licensee for the country of Mexico. To date, EHS has paid to the
Company a $1,000,000 technology fee that will be credited against future royalty
obligations. Under the terms of the EHS License, 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.
EARTHSHELL ASIA, LIMITED (EA). On August 22, 2005, the Company entered into
an agreement with EA in connection with the granting of certain licenses to use
a new embodiment of the EarthShell Technology for various applications in
certain Asian territories (the "EA License"). Shortly after executing a letter
agreement, both the Company and EA decided to restructure the transaction. As
part of such restructuring, the Company may receive a total of up to $2.6
million from a combination of (i) prepaid technology fees (up to $1.7 million),
(ii) $800,000 from the sale of 266,667 shares of its common stock and (iii)
$100,000 from the issuance of one million (1,033,333) warrants to purchase
shares of the Company's common stock at $4.00 per share. The realization of the
full potential of the transaction is dependent on the Company successfully
demonstrating the commercial viability of its technology in certain new
applications.
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(R) 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(R) 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(R) 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 (1st) 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 (8) commercial modules were sold to RPI and were moved
from DTE's fabrication floor and installed in an adjacent manufacturing and is
in close proximity to the fabrication facility. The Company granted a license
agreement to RPI as described above.
51
PATENTS, PROPRIETARY RIGHTS AND TRADEMARKS
The technology that the Company licenses from EKI is the subject of
numerous issued and pending patents in the United States and internationally.
The Company believes the patents and pending patent applications provide broad
protection covering foam laminate EarthShell Packaging(R), 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 (16) of the issued U.S.
patents and 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(R) 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 Packaging(R) trademark and certain other
associated 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 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 twenty-four (24) hours). Mr. Essam
Khashoggi, Chief Executive Officer of EKI, served as our Company's Chairman of
the Board of Directors since its organization in November 1992 through July 2005
when he retired and resigned from the Board of Directors. Mr. Khashoggi has
confirmed to the Company that his resignation does not reflect a lack of
confidence in the Company or its prospects. Current management of the Company
does not believe that Mr. Khashoggi's resignation will impact the Company's
licensing or other relationships with EKI.
On July 29, 2002, the Company entered into an amendment to its previously
Amended and Restate License Agreement with EKI 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 nominal cost to
EarthShell and is an incremental field of use, EarthShell will pay to EKI fifty
percent (50%) of any royalty or other consideration it receives in connection
with the sale of products within this particular field of use.
During 2002 and January 2003, EKI made a series of loans (the "EKI Simple
Loans") to the Company totaling approximately $5.8 million. In connection with
the issuance and sale in March 2003 of the Company's 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 the Biotec Group agreed to subordinate certain payments referenced above to
which they were otherwise entitled under the License Agreement and the Biotec
License 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 License Agreement
until such time as the Company's obligations under the 2006 Debentures were
satisfied in full. EKI and the Biotec Group also agreed to allow the Company to
pledge its interest in the EKI License Agreement to secure its obligations under
the 2006 Debentures, and certain additional concessions were made by EKI and the
Biotec Group to permit the Company greater flexibility in selling its rights
under the EKI License Agreement and the Biotec License 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 (10) year term.
On September 30, 2004, EKI entered into an agreement with EarthShell to
sell back to the Company the 2006 Debentures it had purchased for $1 million in
cash, the cash price paid by EKI for the purchased 2006 Debentures (the "EKI
DPA"). In connection therewith, immediately after the acquisition, EKI sold the
2006 Debentures to the Company and, as discussed above, the Company retired the
2006 Debentures shortly thereafter.
52
In October 2004, in connection with the settlement of the 2006 Debentures,
EKI converted all of its outstanding loans to EarthShell ($2,755,000) into
unregistered common stock at $3.00 per share and $532,644 of accumulated
interest at $4.00 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 ninety (90) day price protection in the clause, which provided for an
adjustment in the effective conversion price of the interest portions of the EKI
loans from $4.00 per share to $3.00 per share. The Company also granted a ten
(10) year warrant to EKI to purchase one million (1,000,000) shares of the
Company's common stock at $3.00 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. This warrant was cancelled and
subsequently a new warrant with similar terms was reissued in August 2005 to
Essam Khashoggi, beneficial owner of EKI.
On October 11, 2005, the Company entered into the EKI Loan with EKI
pursuant to which the Company issued to EKI a promissory note to EKI in the
principal amount of $1,000,000. As of the second week of January 2006, EKI has
advanced the full $1,000,000 to the Company. Interest accrues on the principal
balance of the EKI Loan at a variable per annum rate, as of any date of
determination, that is equal to the rate published in the "Money Rates" section
of The Wall Street Journal as being the "Prime Rate", compounded monthly. All
accrued but unpaid interest and outstanding principal is due and payable on the
earliest to occur of the following: (i) the second (2nd) anniversary of the date
of the EKI Loan; (ii) five (5) days following the date the Company has received
$3 million or more in aggregate net cash proceeds from all financing
transactions, equity contributions, and transactions relating to the sale,
licensing, sublicensing or disposition of assets or the provision of services
(including advance royalty payments, proceeds from the sale of the Company's
common stock and fees for technological services rendered to third parties),
measured from the date of the EKI Loan and not taking into account the proceeds
advanced under the EKI Loan; or (iii) the occurrence of an Event of Default (as
defined in the EKI Loan).
On October 11, 2005, the Company entered into the Debt Conversion Agreement
with EKI, pursuant to which the Company and EKI agreed that a receivable in an
amount equal to $837,145.69 (previously owed to bio-Tec Biologische
Naturverpackunger GmbH & Co.KG), but which receivable was subsequently assigned
to EKI) be converted into 279,048 shares of common stock of the Company. The
conversion price equals $3.00 per share. Pursuant to the Debt Conversion
Agreement, the Company and EKI released each other from any and all claims in
connection with the receivable.
Under the terms of the EKI License Agreement and an amended and restated
Patent Agreement for the Allocation of Patent Costs by and between the Company
and EKI, EarthShell has the obligation to pay the patent prosecution and
maintenance costs for those patents which i) "directly relate to" it's field of
use, and which ii) "primarily benefit" EarthShell. 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 EKI 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(R). In addition, some of the Company's licensees and joint venture
partners manufacture paper, plastic or foil packaging that may compete with
EarthShell Packaging(R).
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.
53
GOVERNMENT REGULATION
The manufacture, sale and use of EarthShell Packaging(R) 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(R) plates, bowls and
hinged-lid containers and all other current and prototype EarthShell
Packaging(R) 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 six (6) 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.
DESCRIPTION OF PROPERTY
In November 2005, the Company closed its California operations and
relocated its corporate headquarters to its current location at 1301 York Road,
Suite 200, Lutherville, Maryland 21393. The Company leases 3,353 square feet of
this office space on a month to month basis. The Company's monthly lease payment
with respect to this space is approximately $5,500.
The Company believes it will be able to lease comparable space at a
comparable price when this lease expires.
LEGAL PROCEEDINGS
The Company has been engaged in litigation with two (2) 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 is
negotiating settlements with both of the suppliers, which it expects to finalize
in early 2006.
54
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 (the
"Board").
Name Age Position Officer Since
------------------ ------ ------------------------------------------------------------- ---------------
Vincent J. Truant 57 Chief Executive Officer, President and Chairman of the Board 1998
D. Scott Houston 51 Chief Financial Officer, Secretary and Director 1993
The following is a biographical summary of the experience of each of the
executive officers:
VINCENT J. TRUANT has served as the Company's Chief Executive Officer since
August 26, 2005, as President since 2002 and as a Director since 2005. In
February 2005, Mr. Truant was also elected Chairman of the Board of EarthShell.
From May 15, 2002 to August 26, 2005, Mr. Truant served as the Company's
President and Chief Operating Officer. From March 2001 to May 2002, Mr. Truant
served as Senior Vice President and Chief Marketing Officer of the Company. 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 fifteen (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.
D. SCOTT HOUSTON has served as the Company's Chief Financial Officer since
October 1999, as the Company's Secretary since December 1999 and as a Director
since 2005. 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.
DIRECTORS
The Board of the Company is currently comprised of five (5) 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, the year the
Director was first elected and his position with the Company:
Name Age Position Director Since
------------------- ------ -------------------------------------------------- ----------------
Vincent J. Truant 57 Director, Chief Executive Officer and President 2005
D. Scott Houston 51 Director, Chief Financial Officer and Secretary 2005
Hamlin M. Jennings 57 Director 2003
Walker Rast 69 Director 2003
Michael C. Gordon 69 Director 2005
The following is a biographical summary of the experience of each of the
Company's Directors. For biographical summaries of the experience of Messrs.
Truant and Houston, kindly refer to the summaries of Executive Officers'
experience provided above:
55
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 twelve (12) patents, is
the associate editor of two (2) 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 (1st)
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
(10) years.
MICHAEL C. GORDON was appointed to the Board of Directors in June 2005. Mr.
Gordon is currently the Director of SEC Services for Gumbiner Savett Inc.,
Certified Public Accountants and Business Advisors. From 1990 through 2001, Mr.
Gordon was an audit partner with BDO Seidman, where he was in charge of the
audit department of the Los Angeles office. From 1977 to 1990, he was an audit
partner with Laventhol and Horwath where he was also in charge of the audit
department of the Los Angeles office. Prior to 1977, he was an audit partner
with Arthur Young & Company. Mr. Gordon has over forty years of public
accounting, SEC, and financial reporting experience. The Board of Directors has
determined that Mr. Gordon qualifies as an "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. Mr. Gordon is serving as Chairman of the Audit Committee.
COMMITTEES OF THE BOARD OF DIRECTORS
At the annual meeting of the Board in July 2005, the Company reorganized
the Committees of the Board, Currently, the Board maintains three (3) standing
committees: the Audit Committee, the Compensation Committee, the Corporate
Goveranance and Nominating Committee. The Board has written charters for each of
its committees.
Director nominees are recommended to the full Board by the Corporate
Governance and Nominating Committee with input from Management. The committees
are presently comprised of the following Directors:
Corporate Goverance & Nominating
Audit Committee Compensation Committee Committee
------------------- ------------------------- ---------------------------------
Mr. Gordon (Chair) Dr. Jennings (Chair) Mr. Rast (Chair)
Mr. Rast Mr. Gordon Dr. Jennings
Dr. Jennings Mr. Rast Mr. Gordon
EXECUTIVE COMMITTEE
The Executive Committee was dissolved at the July 2005 annual meeting of
the Board in connection with the reorganization of Board and the Board
committees. Prior to being dissolved, the Executive Committee held frequent
meetings in 2004 and in 2005, and at times took action by unanimous written
consent in lieu of meetings. The primary function of the Executive Committee was
to perform all of the duties otherwise vested in the Board when the Board is not
in session, except for the following matters which have not been delegated to
the Executive Committee: (a) declaring cash or stock dividends or distributions
to stockholders of the Company; (b) taking action on matters otherwise
specifically delegated to other committees of the Board of Directors; (c)
amending or repealing the Certificate of Incorporation or Bylaws of the Company,
or adopting new ones; (d) 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; (e) authorizing or approving the issuance or sale of
shares of stock of the Company; (f) authorizing the Company to perform or make a
contract or commitment that requires a financial commitment by the Company
exceeding the applicable amount budgeted under the operating budget or capital
budget approved by the Board, 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 (g) electing or removing officers,
directors or members of any committee of the Board. The Executive Committee
functioned according to a written charter.
56
COMPENSATION COMMITTEE
The Compensation Committee held two (2) meetings in 2004 and two (2)
meetings in 2005. At the annual meeting of the Board in July 2005, the Stock
Options Committee was dissolved and the functions of that committee were assumed
by the Compensation Committee.
Prior to August 2005, the functions of the Compensation Committee included:
(a) 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; (b) reviewing and commenting on new executive compensation programs
that the Company proposes to adopt; (c) 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; (d) helping to ensure that a significant
portion of executive compensation is reasonably related to the long-term
interests of the stockholders; (e) participating in the preparation of certain
portions of the Company's annual proxy statement; (f) hiring a compensation
expert to provide independent advice on compensation levels, if necessary; and
(g) helping to ensure that the Company undertakes appropriate planning for
management succession and advancement.
On August 11, 2005, a new charter was adopted for the Compensation
Committee. As outlined in the new charter, the functions of the Compensation
Committee include: (a) oversee the Company's overall compensation structure,
policies and programs, and assess whether the Company's compensation structure
establishes appropriate incentives for management and employees; (b) review and
approve corporate goals and objectives relevant to the compensation of the Chief
Executive Officer (the "CEO"), evaluate the CEO's performance in light of those
goals and objectives, and either as a committee or together with the other
independent directors (as directed by the Board), determine and approve the
CEO's compensation level based on this evaluation; (c) administer and make
recommendations to the Board with respect to non-CEO compensation and the
Company's incentive-compensation and equity-based compensation plans; (d) review
and recommend to the Board the annual base salary, bonus, and other benefits for
the executive officers of the Company with the goal of ensuring that a
significant portion of executive compensation is reasonably related to the
long-term interests of the stockholders; (e) approve stock option and other
stock incentive awards for executive officers; (f) review and approve the design
of other benefit plans pertaining to executive officers; (g) review and
recommend employment agreements and severance arrangements for executive
officers, including change-in-control provisions, plans or agreements; (h)
approve, amend or modify the terms of any compensation or benefit plan that does
not require shareholder approval; (i) review periodically succession plans
relating to positions held by executive officers, and make recommendations to
the Board regarding the selection of individuals to fill these positions; (j)
annually evaluate the performance of the Committee and the adequacy of the
committee's charter; and (k) produce a Committee report on executive
compensation as required by the Securities and Exchange Commission (the "SEC")
to be included in the company's annual proxy statement filed with the SEC.
AUDIT COMMITTEE
The Audit Committee held four (4) meetings in 2004 and four (4) meetings in
2005. Previous to August 11, 2005 the functions of the Audit Committee included:
(a) engaging an accounting firm to act as the Company's independent external
auditor (the "Auditor"); (b) determining the Auditor's compensation, the
proposed terms of its engagement, its independence from the Company and its
performance during each year of its engagement; (c) 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; (d) reviewing the results of each external audit;
(e) reviewing the procedures employed by the Company in preparing published
quarterly financial statements and related management commentaries; (f)
reviewing any major changes proposed to be made in auditing and accounting
principles and practices in connection with the Company's financial statements;
(g) reviewing the adequacy of the Company's internal financial controls; and (h)
if the Company appoints a Director of Internal Audit, meeting periodically with
that person to evaluate compliance with the foregoing duties.
On August 11, 2005, a new charter was adopted for the Audit Committee. As
outlined in the new charter, the functions of the Compensation Committee
include: a) oversee the Company's accounting and financial reporting processes
and the audits of the Company's financial statements; b) oversee the Company's
compliance with legal and regulatory requirements; c) oversee the outside
auditor's qualifications and independence; d) oversee the performance of the
company's internal audit function and outside auditor; e) oversee the Company's
system of disclosure controls and system of internal controls; and f) prepare
the report required by the rules of the SEC to be included in the Company's
annual proxy statement.
57
The Company's Audit Committee is to be comprised of at least three (3)
independent Directors. Mr. Gordon serves as Chairman of the Audit Committee. The
Board has determined that Mr. Gordon is an "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, as amended. The Committee is currently comprised of
Messrs. Gordon, Jennings and Rast, each of whom are independent Directors within
the meaning of the National Association of Securities Dealers' listing
standards.
STOCK OPTION COMMITTEE
The Stock Option Committee was dissolved in connection with the
reorganization of the Board and the committees of the Board at the annual
meeting of the Board in July 2005. The functions of the Stock Option Committee
are now carried out by the Compensation Committee, as outlined above. Previous
to being dissolved, the Stock Option Committee held two (2) meetings in 2004 and
one (1) meeting in 2005. The Stock Option Committee was responsible for
administering the Company's 1994 Stock Option Plan and 1995 Stock Incentive Plan
(collectively, the "Plans") including, without limitation, the following: (a)
adopting, amending and rescinding rules relating to the Plans; (b) determining
who may participate in the Plans and what awards may be granted to such
participants; (c) granting awards to participants and determining the terms and
conditions thereof, including the number of shares of common stock issuable
pursuant to the awards; (d) determining the terms and conditions of options
automatically granted to directors pursuant to the Plans; (e) determining
whether and the extent to which adjustments are required pursuant to the
anti-dilution provisions of the Plans; and (f) interpreting and construing the
Plans and the terms and conditions of any awards granted thereunder.
CONFLICTS COMMITTEE / CORPORATE GOVERNANCE & Nominating Committee
At the annual meeting of the Board in July 2005, the Conflicts Committee
was dissolved and a new Corporate Governance and Nominating Committee was
organized. The Conflicts Committee held two (2) meetings in 2004. The functions
of the Conflicts Committee included reviewing potential related party or
conflict of interest transactions to: (a) determine whether each such
transaction is on at least as favorable terms to the Company as might be
available from other third parties, (b) determine whether such transactions are
reasonably likely to further the Company's business activities and interests,
(c) determine whether the process by which the decision to enter into such
transactions was approved or ratified and is fair, (d) help ensure that all such
transactions are disclosed in the Company's filings with the SEC as necessary
and (e) if necessary, retain an independent expert to determine the advisability
of the Company's entering into such transactions, and to determine fair terms
for such transactions.
A charter for the Corporate Governance and Nominating Committee was adopted
on August 11, 2005. The functions of the Corporate Governance and Nominating
Committee include: a) identifying qualified individuals to become Board members;
b) determining the composition of the Board and its committees; c) considering
questions of possible conflicts of interest; d) developing and implementing the
Company's corporate governance guidelines; and e) monitoring a process to assess
Board effectiveness.
BOARD AND COMMITTEE ATTENDANCE
The Board of Directors held fourteen (14) meetings in 2004 and 12 meetings
in 2005. All Directors attended at least seventy-five percent (75%) of the Board
meetings and the meetings of the Committees on which they served in 2004 and at
least 75% in 2005.
INDEPENDENT AUDITORS
The Company initially engaged Farber Hass Hurley & McEwen, LLP (formerly
Farber & Hass, LLP) as its auditors in 2003, and has selected them to continue
as its auditors for the fiscal years 2004 and 2005.
The Audit Committee pre-approved the engagement of Farber Hass Hurley &
McEwen, LLP (formerly Farber & Hass, LLP) to perform the annual audit and tax
services for the fiscal year ended December 31, 2005 and the quarterly reviews
for the three (3) quarters of 2005 . Farber & Hass LLP provided no other audit
services, audit-related services, or permitted non-audit services for and during
the fiscal year ended December 31, 2004 except for the statutory audit of the
Company's benefit plan for the year ended December 31, 2003 and the analysis of
the Company's net operating loss carry forward. The Audit Committee adopted a
pre-approval policy relating to audit services for all audit-related services,
tax services and non-audit services to be performed by its auditors from 2004
onward.
58
During the fiscal years ended December 31, 2004 and 2003, the following
audit, audit-related, tax and other fees were incurred by the Company:
AUDIT FEES. For the year ended December 31, 2004, Farber Hass Hurley &
McEwen, LLP (formerly Farber & Hass, LLP) charged the Company an aggregate of
approximately $ 78,600 for professional services rendered for the 2004 audit of
the Company's financial statements and the review of the financial statements
included in the Company's quarterly reports on Form 10-Q for the three quarters
of 2004. For the year ended December 31, 2003, Farber & Hass LLP charged the
Company an aggregate of $59,710 for professional services rendered for the 2003
audit of the Company's financial statements and the review of the financial
statements included in the Company's quarterly reports on Form 10-Q for the
quarters ended June 30, 2003 and September 30, 2003. In addition, the Company
paid to Deloitte & Touche, LLP, the Company's prior independent public
accountants, an aggregate of approximately $16,800 for professional services
rendered in connection with the inclusion of their audit opinions related to the
2002 and 2001 audits in the Company's December 31, 2003 Form 10-K and the review
of the financial statements included in the Company's Quarterly Report on Form
10-Q for the quarter ended March 31, 2003.
AUDIT-RELATED FEES. During the year ended December 31, 2004, the Company
incurred no fees for services related to Farber Hass Hurley & McEwen, LLP
(formerly Farber & Hass, LLP.) review of the Company's financial statements
included in various SEC documents that are not included in "Audit Fees", and
Farber Hass Hurley & McEwen, LLP (formerly Farber & Hass, LLP) charged the
Company $4,500 for benefit plan statutory audits. During the year ended December
31, 2003, the Company incurred fees of $28,750 for assurance and related
services related to Deloitte & Touche, LLP's review of the Company's financial
statements included in various SEC documents that are not included in "Audit
Fees", and Farber & Hass LLP charged the Company $6,500 for benefit plan
statutory audits.
TAX FEES. During the year ended December 31, 2004, the Company incurred
fees of $6,400 for Farber Hass Hurley & McEwen, LLP (formerly Farber & Hass,
LLP) preparation of its tax returns. During the year ended December 31, 2003,
the Company incurred fees of $16,243 to Deloitte & Touche, LLP for tax return
preparation.
ALL OTHER FEES. During the year ended December 31, 2003, the Company
engaged Deloitte & Touche, LLP to analyze the performance of certain
manufacturing equipment the Company had installed in Germany for a fee of
$16,487.
AUDIT COMMITTEE REPORT
The Audit Committee reviews the Company's financial reporting process on
behalf of the Board. Management has the primary responsibility for the financial
statements and the reporting process including the internal control system. The
Company's independent auditors are responsible for expressing an opinion on the
conformity of our audited financial statements to generally accepted accounting
principles.
In this context, the Audit Committee has reviewed and discussed the audited
financial statements with management and the independent auditors, and has also
discussed with the independent auditors the matters required to be discussed by
Statement on Auditing Standards No. 61 (Communication with Audit Committees).
The Audit Committee also received from the independent auditors the written
disclosures required by Independence Standards Board Standard No. 1
(Independence Discussions with Audit Committees), and discussed with them their
independence from the Company and its management. The Audit Committee has
further considered whether, and determined that, the independent auditors'
provision of non-audit services to the Company is compatible with the firm's
independence.
In reliance on the reviews and discussions referred to above, the Audit
Committee recommended to the Board that the audited financial statements be
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2004 for filing with the SEC.
COMPENSATION OF DIRECTORS
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
quarter except for the chairman of the audit committee, who receives an
additional $3,000 per quarter. Three (3) of our Directors are currently
considered to be non-employee Directors of the Company.
59
The 1995 Stock Incentive Plan provides that each non-employee Director
automatically be granted options to purchase 25,000 shares of the Company's
common stock, effective at the conclusion of each annual meeting. All such stock
options 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
unanimously agreed to defer the payment of the Director fees discussed above
until such time as the financial condition of the Company improves. Certain of
the deferred Directors' fees have been paid subsequent to December 31, 2004. As
of December 31, 2005, the Company had outstanding accrued and unpaid Directors'
fees of approximately $136,417. In June 2005, the Board granted to each of the
Company's non-employee Directors who have served during the past year 10,000
restricted shares of the Company's common stock.
In June, 2005, Mr. Gordon was appointed to the Board to fill the vacancy
created by the resignation of Dr. Roland. Mr. Gordon received an initial grant
of 10,000 restricted shares of the Company's common stock.
CODE OF ETHICS
The Company has adopted a Code of Ethics that applies to all Directors,
officers and employees, including the Chief Executive Officer, Chief Financial
Officer and accounting officer of the Company.
EXECUTIVE COMPENSATION
The following table sets forth certain information with respect to the
compensation of the Named Executive Officers. The "Named Executive Officers"
include, (i) the Company's Chief Executive Officer, (ii) the Company's executive
officers as of December 31, 2004; and (iii) two (2) additional individuals who
were not executive officers as of the year ended December 31, 2004. The Company
did not grant any restricted stock awards or stock appreciation rights or make
any long-term incentive plan payouts during the periods set forth below.
Summary Compensation Table
Long-Term
Compensation
Annual Compensation Awards
----------------------------------------------- ---------------
Securities
Fiscal year Other Annual Underlying
Name and Ended Salary Bonus Compensation Options
Principal Position December 31 ($) ($) ($)(1) (#)
------------------------------------- --------------- --------------- ------------ ----------------- ----------------
Simon K. Hodson 2004 $ 500,000 (2) $ -- $ 2,750 400,000
Former Vice Chairman of the Board 2003 500,000 -- 2,250 41,667 (4)
and Former Chief Executive Officer 2002 500,000 -- 2,500 41,667 (5)
Vincent J. Truant 2004 350,000 -- 2,625 50,000
Former President and 2003 350,000 -- 3,063 20,833 (4)
Current Chief Executive Officer 2002 321,875 (3) -- 2,844 29,167 (5)
D. Scott Houston (6) 2004 327,200 -- 3,590 50,000
Chief Financial Officer 2003 327,200 -- 2,454 20,833 (4)
and Secretary 2002 327,200 -- 2,419 26,667 (5)
John B. Nevling (7) 2004 116,363 -- 2,677 50,000
Former V.P. Product Management 2003 104,565 -- 3,135 --
and Environmental Affairs 2002 101,000 -- 3,030 --
Michael P. Hawks (8) 2004 110,000 -- -- 35,000
Principal Accounting Officer 2003 60,849 -- -- 4,167
2002 -- -- -- --
------------------------
(1) Reflects payments under the Company's 401(k) plan. The Company provides
various perquisites to its executives which, in accordance with SEC
regulations, are not itemized because their value is less than ten percent
(10% ) of an executive's salary.
(2) Includes $141,667 deferred salary.
(3) Reflects a mid-year salary adjustment effective May 16, 2002 as a result
of Mr. Truant's becoming President of the Company on that date.
(4) This option grant is only exercisable upon the successful completion of a
sale of the Company.
60
(5) This option grant is only exercisable at such time as the share price of
the volume weighted average price of the common stock of the Company shall
be at or above $36 per share for at least ninety (90) days.
(6) Includes $142,222 deferred salary in 2004 and $7,200 in car allowance made
to Mr. Houston in 2002, 2003, and 2004.
(7) Mr. Nevling was not considered to be an executive officer of the Company.
He resigned from his position with the Company in March 2005 and his
options expired thirty (30) days following his resignation.
(8) Mr. Hawks resigned from his position with the Company in October 2004 and
his options expired thirty (30) days following his resignation. He was a
temporary employee through an agency through June 30, 2003. In addition to
his salary for the remainder of 2003, the Company paid the agency $68,547
in fees for his services from January 1 through June 30, 2003.
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
Name and Principal Options Employees in Exercise Price Expiration
Position Granted(2) 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
Executive 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 (4) 6.6% $0.75 (4) -- --
Vice President of
Product
Management and
Environmental Affairs
Michael Hawks 35,000 (4) 4.6% $0.75 (4) -- --
Principal Accounting
Officer
--------------------
(1) The five percent (5%) and ten percent (10%) assumed rates of appreciation
are mandated by the rules of the SEC 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. All options granted in 2004
were granted at the then existing market price of $0.75 per share.
(2) Except for Mr. Houston, the options granted to executives in 2004 become
vested and exercisable upon the completion by the Company of certain key
milestones, including (i) that the Company's plates and bowls are supplied
by a licensee to a customer at a level equivalent to the level that would
be required by 1,500 Wal Mart stores for a consecutive period of no less
than three (3) months, and (ii) the product supply economics must be
consistent with a license agreement between EarthShell and the licensee
including royalty structure.
(3) The options granted to Mr. Houston become vested and exercisable upon (i)
resolution of all past due payables for not more than $800,000, and (ii) a
resolution of all pending litigation related to payables.
(4) When initially granted, these options had an expiration date of June 25,
2014, but expired early thirty (30) days following the date of resignation.
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.
61
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 ---------------------------- -----------------------------------
Acquired on
Name and Principal Position Exercise Value 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
Executive 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
Mr. Simon Hodson resigned as Chief Executive Officer of the Company on
August 31, 2005. Mr. Hodson received an annual salary of $500,000 and was
entitled to receive (i) an annual bonus and (ii) options or other rights to
acquire common stock prior to his resignation on August 31, 2005. Mr. Hodson had
previously agreed to a forty percent (40%) reduction of base salary (which was
later approved by the Board to be accrued as deferred compensation) effective
April 16, 2004. resulting in the deferral of $141,667 for the year ended
December 31, 2004, which was paid in full in June 2005. As of December 31, 2005,
the Company owed Mr. Hodson $216,569 in deferred compensation accrued during
2005, including interest at 8% and accrued vacation pay.
Mr. Vincent J. Truant was elected Chief Executive Officer of the Company as
of September 1, 2005. Mr. Truant has been employed by the Company pursuant to an
employment agreement since May 1, 1998. From time to time, Mr. Truant has
received salary increases and incentive stock options as determined by the
Compensation and Options Committees of the Board of Directors or the full Board,
as appropriate. Effective May 15, 2002, the Board increased Mr. Truant's salary
to $350,000 in connection with his added responsibilities as President and Chief
Operating Officer. In connection with his election as CEO, the Company entered
into a new employment agreement with Mr. Truant effective September 1, 2005,
Under this employment agreement, Mr. Truant receives a salary of $400,000 per
year and a car allowance of $1,000 per month and the other standard benefits
offered to employees of the Company. Mr. Truant received an option grant for
350,000 shares in connection with his election as CEO. He 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 or the full Board, as appropriate. 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 one hundred percent
(100%) of his then-current annual base salary.
Mr. 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. 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 or the full Board, as appropriate. 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 voluntarily agreed to a seventy-five percent (75%) reduction of base
salary (which was later approved by the Board to be accrued as deferred
compensation) 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 and as of December 31, 2005 was $268,704,
including interest at 8%.
62
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act requires the Company's officers and
Directors and persons who beneficially own more than ten percent (10%) of the
Company's Common Stock to file reports of ownership and changes in ownership on
Forms 3, 4 and 5 with the SEC. Officers, directors and greater than ten percent
(10%) beneficial owners are required by the SEC to furnish the Company with
copies of all Forms 3, 4 and 5 that they file. Based solely upon the Company's
review of the copies of such forms it has received, and certain other
information available to it, to the best of the Company's knowledge:
EKI, a ten percent (10%) beneficial owner, did not timely file one report
reporting three conversions of debt. The conversions of debt were reported on
November 15, 2004.
Mr. Khashoggi did not timely file one (1) report reporting the gift of
shares of common stock to each of his three (3) children and one (1) report
reporting three conversions of debt by EKI, an affiliate of Mr. Khashoggi,
described above. The gift was reported on May 20, 2005 and the conversions of
debt by EKI were reported on November 10, 2004.
Mrs. Khashoggi did not timely file one (1) report reporting her husband's
gift of shares of common stock reported above and one (1) report reporting three
(3) conversions of debt by EKI, an affiliate of Ms. Khashoggi, described above.
The gift was reported on May 20, 2005 and the conversions of debt by EKI were
reported on November 10, 2004.
Various stock options were granted to officers and directors during 2005
which have not yet been reported. The Company is working with these officers and
directors to file the requisite forms.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
As of July 21, 2005 when the Compensation Committee was reorganized, all
decision relating to executive compensation have been made by the Company's
Compensation Committee, which is comprised of Hamlin Jennings, chairman, Walker
Rast, and Michael Gordon. All members of the current Compensation Committee are
independent directors. All decisions relating to executive compensation during
2004 through July 21, 2005 were made by the Company's former Compensation
Committee, which was comprised of Mr. Khashoggi, Mrs. Khashoggi and, until
February 2, 2005 when he resigned, Dr. Roland or the Board, as appropriate. 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 largest
stockholder with whom the Company has certain relationships and related
transactions described below. Mr. Khashoggi is the beneficial owner of 33.29 of
the common stock of the Company.
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 twenty-four (24) hours).
On July 29, 2002, the Company agreed with EKI to further amend the amended
and restated license agreement with EKI described above (the "EKI 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 a nominal cost to EarthShell and is an incremental field
of use, EarthShell agreed to pay to EKI fifty percent (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 and
information transfer agreement (the "Biotech License Agreement") with bio-tec
Biologische Naturverpackungen GmbH & Co. KG and bio-tec Biologische
Naturverpackungen Forschungs und Entwicklungs GmbH (the "Biotec Group") to
utilize the Biotec Group technology for foodservice disposable packaging
applications. EKI had previously granted to the Company priority rights to
license certain product applications on an exclusive basis from the Biotec Group
in consideration for the Company's payment of a $100,000 minimum monthly payment
to Biotec. In addition, in consideration for the monthly payment, the Biotec
Group agreed to render technical services to the Company at the Biotec Group's
cost plus five percent (5%). The licensing fee and services arrangements were
continued in the Biotec License Agreement. Under the terms of the Biotec License
Agreement, the Biotec Group was entitled to receive twenty-five percent (25%) of
any royalties or other consideration that the Company receives in connection
with the sale of products utilizing the Biotec Group technology, after applying
a credit for all minimum monthly payments received. In connection with the
issuance of the 2006 Debentures, the Biotec Group agreed to subordinate the
licensee fee payments due from EarthShell until the debentures were retired.
During this period, the license fees due to the Biotec Group were accrued.
63
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 (2) years, the $100,000 per month minimum license fee. In December of 2004,
the amended Biotec License Agreement was further amended and EarthShell paid to
Biotech $125,000, leaving a balance owing of approximately $875,000, which was
subsequently reduced to approximately $837,000. On August 31, 2005, in
connection with the sale of Biotec by EKI, Biotec License Agreement was again
amended and restated (the "Amended and Restated Biotec License") and the minimum
monthly payment to retain exclusivity was completely eliminated and the balance
of approximately $837,000 owing to EarthShell was assigned by the Biotec Group
to EKI. Under the Amended and Restated Biotec License, the Company has a fully
paid up license to use the Biotec technology in the EarthShell fields of use,
with certain limited exclusions, exclusively through June 2008. The Company can
maintain its exclusivity provided it has been successful in commercializing the
Biotec technology and is making certain minimum royalty payments under the
license by June 2008. As of the date of this Prospectus, the Company has paid to
the Biotec Group $125,000 in cash, has converted approximately $1.475 million
into 491,778 shares of unregistered stock, and had assigned the balance owing to
the Biotec Group of $837,145.69 to EKI. On October 11, 2005, the Company entered
into the Debt Conversion Agreement with EKI, pursuant to which the Company and
EKI agreed that a receivable in an amount equal to $837,145.69 (previously owed
to bio-Tec Biologische Naturverpackunger GmbH & Co.KG), but which receivable was
subsequently assigned to EKI) be converted into 279,048 shares of common stock
of the Company. The conversion price equals $3.00 per share. Pursuant to the
Debt Conversion Agreement, the Company and EKI released each other from any and
all claims in connection with the receivable.
During 2002 and 2003, EKI made various simple interest working capital
loans to the Company (the "Simple Interest Loans"). These Simple Interest Loans
were interest bearing at a rate of seven percent (7%) or ten percent (10%) per
annum, and were payable on demand. As of December 31, 2003, the outstanding
principal balance of the Simple Interest Loans was $2,755,000. In connection
with the sale of the 2006 Debentures, EKI subordinated the payments and advances
that were owed to it, and as consideration, the Company issued to EKI a warrant
in March 2003, expiring ten (10) years thereafter, to acquire 83,333 shares of
the Company's common stock at $6.00 per share. As part of the settlement of the
2006 Debentures in October of 2004, EKI agreed to convert all of the outstanding
Simple Interest Loans to EarthShell ($2,755,000) into unregistered common stock
at $3.00 per share and $532,644 of accumulated interest into unregistered common
stock at $4.00 per share, for a total of 1,051,494 shares received by EKI. As of
December 31, 2004, the Simple Interest Loans were paid in full. In May 2005, an
additional 44,387 shares were issued to EKI pursuant to a ninety (90) day price
protection clause, which provided for an adjustment in the effective conversion
price of the interest portions of the Simple Interest Loans from $4.00 per share
to $3.00 per share. The 1,051,494 shares of common stock issued to EKI as a
result of the EKI Conversion Agreement will not be registered for resale under
the 1933 Act.
On September 30, 2004, EKI entered into an agreement with EarthShell to
sell back to the Company the 2006 Debentures it had purchased for $1 million in
cash, the cash price paid by EKI for the purchased 2006 Debentures (the "EKI
DPA"). In connection therewith, immediately after the acquisition, EKI sold the
2006 Debentures to the Company and, as discussed above, the Company retired the
2006 Debentures shortly thereafter.
In 2005, the Company also granted a ten (10) year warrant to Essam
Khashoggi to purchase one million (1,000,000) shares of the Company's common
stock at $3.00 per share in consideration of his continued support of the
Company since its inception, including providing bridge loans at below market
terms from time to time.
64
On October 11, 2005, the Company entered into the EKI Loan with EKI
pursuant to which the Company issued to EKI a promissory note to EKI in the
principal amount of $1,000,000. As of the second week of January 2006, EKI has
advanced the full $1,000,000 to the Company. Interest accrues on the principal
balance of the EKI Loan at a variable per annum rate, as of any date of
determination, that is equal to the rate published in the "Money Rates" section
of The Wall Street Journal as being the "Prime Rate", compounded monthly. All
accrued but unpaid interest and outstanding principal is due and payable on the
earliest to occur of the following: (i) the second (2nd) anniversary of the date
of the EKI Loan; (ii) five (5) days following the date the Company has received
$3 million or more in aggregate net cash proceeds from all financing
transactions, equity contributions, and transactions relating to the sale,
licensing, sublicensing or disposition of assets or the provision of services
(including advance royalty payments, proceeds from the sale of the Company's
common stock and fees for technological services rendered to third parties),
measured from the date of the EKI Loan and not taking into account the proceeds
advanced under the EKI Loan; or (iii) the occurrence of an Event of Default (as
defined in the EKI Loan).
Under the terms of the EKI License Agreement and an amended and restated
Agreement for the Allocation of Patent Costs by and between the Company and EKI,
EarthShell has the obligation to pay the patent prosecution and maintenance
costs for those patents which i) "directly relate to" it's field of use, and
which ii) "primarily benefit" EarthShell. Any patents granted in connection with
the EarthShell Technology are the property of EKI, and EKI may utilize and/or
license 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, rather than reimbursing EKI for patent costs,
EarthShell assumed direct responsibility to manage and maintain the patent
portfolio underlying the EKI 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, Chief Executive Officer. The loan, which bore interest at seven
percent (7%) per annum, was due upon demand by the Company. In May 2005, the
Compensation Committee of the Board approved a bonus to Mr. Truant equal to the
total principal amount and accrued interest, and the note was cancelled.
COMPENSATION COMMITTEE CHARTER
To fulfill its responsibilities and duties the Committee shall have direct
responsibility to:
o oversee the Company's overall compensation structure, policies and
programs, and assess whether the Company's compensation structure
establishes appropriate incentives for management and employees;
o review and approve corporate goals and objectives relevant to the
compensation of the Chief Executive Officer (the "CEO"), evaluate the
CEO's performance in light of those goals and objectives, and either as a
committee or together with the other independent directors (as directed by
the Board), determine and approve the CEO's compensation level based on
this evaluation;
o administer and make recommendations to the Board with respect to non-CEO
compensation and the Company's incentive-compensation and equity-based
compensation plans;
o review and recommend to the Board the annual base salary, bonus, and other
benefits for the executive officers of the Company with the goal of
ensuring that a significant portion of executive compensation is
reasonably related to the long-term interests of the stockholders;
o approve stock option and other stock incentive awards for executive
officers;
o review and approve the design of other benefit plans pertaining to
executive officers;
o review and recommend employment agreements and severance arrangements for
executive officers, including change-in-control provisions, plans or
agreements;
o approve, amend or modify the terms of any compensation or benefit plan
that does not require shareholder approval;
o review periodically succession plans relating to positions held by
executive officers, and make recommendations to the Board regarding the
selection of individuals to fill these positions;
o annually evaluate the performance of the Committee and the adequacy of the
committee's charter; and
o produce a Committee report on executive compensation as required by the
Securities and Exchange Commission (the "SEC") to be included in the
company's annual proxy statement filed with the SEC.
65
COMPENSATION COMPONENTS
The Company's executive compensation program consists of a mixture of base
salary, cash bonuses and stock options. In determining the mix and total amount
of compensation for each executive officer, the Compensation Committee
subjectively considers each executive's overall value to the Company including
past and expected contributions by the executive to the Company's goals. In
addition, the Compensation Committee strives to balance short-term and long-term
incentive compensation to achieve desired results.
The Compensation Committee periodically reviews each of the three
components of its executive compensation program to ensure that its compensation
practices are competitive and that the overall compensation package
appropriately attracts, motivates, rewards, and retains key employees with
outstanding abilities.
Base Salary. The Company has historically determined base salary for its
executives based on qualifications, job requirements and competitive market
salaries that such qualifications and job requirements command. As the Company
grows, it will continue to rely on peer group competitive compensation practices
to remain consistent and competitive in its compensation practices.
Salaries for executives are reviewed by the Compensation Committee on an
annual basis and may be adjusted based upon their assessment of the individual's
contribution to and financial growth of the Company as well as competitive pay
levels.
In order to conserve cash until the Company is able to establish its
royalty revenue stream, effective April 16, 2004, Mr. Hodson and Mr. Houston
agreed to a forty percent (40%) and seventy-five percent (75%) reduction of base
salary (which was later approved by the Board to be accrued as deferred
compensation), respectively. In October 2004, Mr. Houston's deferred salary
percentage was changed to thirty-three percent (33%). In March 2005, the Board
approved the accrual of deferred compensation for Mr. Hodson and Mr. Houston,
respectively, equal to the amount of their salary reductions. Mr. Hodson
resigned as CEO effective August 31, 2005.
As of December 31, 2005, the Company had paid Mr. Hodson a total of
$275,000 in cash compensation, and has accrued $145,417 in deferred compensation
accrued during 2005, including interest at 8%. The Company has also accrued
vacation pay for Mr. Hodson in the amount of $71,152.
The Company paid base compensation to Mr. Vincent Truant, Chief Executive
Officer, in the amount of $350,000 per year for his services as President and
Chief Operating Officer to the Company during 2004 and through August 31, 2005.
Beginning September 1, 2005, in connection with his election as Chief Executive
Officer, Mr. Truant's base compensation was established at the rate of $400,000
per year. Additionally, Mr. Truant receives a $1,000 per month car allowance.
Mr. D. Scott Houston, Chief Financial Officer and Secretary, received base
compensation during 2005 of $327,200, of which, Mr. Houston received $220,533 in
cash and $106,667 was accrued as deferred compensation, as described above. The
base salary figures for Mr. Houston includes a $7,200 car allowance.
Bonus. Bonuses may be granted for a fiscal year after the financial results
for that fiscal year become available. The Compensation Committee meets to
consider annual bonuses for each executive based on individual performance as
well as overall financial results of the Company for the year. There is no plan
requiring that bonuses be paid. However, pursuant to their employment
agreements, certain executive officers may be entitled to receive an annual
bonus, the actual amount of which is determined in the sole discretion of the
Compensation Committee.
The Compensation Committee also may consider bonus compensation in light of
the accomplishment of specific milestones developed by management in support of
the annual strategic plan.
In determining whether to grant management bonuses for 2004, the
Compensation Committee considered both individual performance as well as the
Company's overall performance. Although the Compensation Committee noted several
significant individual and Company achievements during the year, in light of the
delays the Company has experienced in commercializing the Company's technology
as well as the financial condition of the Company, the Compensation Committee
determined that no bonuses for 2004 would be granted. The Compensation Committee
has not met yet to consider bonuses for 2005.
Stock Options. The Stock Option Committee believes that significant equity
interests in the Company in the form of stock options held by the Company's
management serve to align the interests of the executive management team with
those of stockholders. The Stock Option Committee may grant stock options and
restricted stock to executives and other key employees of the Company pursuant
to the 1995 Stock Incentive Plan, or may recommend that the Board do so, as
appropriate. In March 2005, the Stock Option Committee granted the Named
Executive Officers fully vested stock options issued under the 1995 Stock
Incentive Plan at the then-current market price exercisable only upon successful
completion of certain milestones that are critical to the long-term success of
the Company.
66
The option grants to the named officers of the Company for 2004 and 2005
were as follows:
Stock Option Grants Stock Option Grants
2004 2005
--------------------- -----------------------
Simon K. Hodson 400,000 500,000
Vincent Truant 50,000 350,000
D. Scott Houston 50,000 375,000
Michael Hawks 35,000
John Nevling 35,000
Paul Susie 40,000
The stock options granted in 2004 are reflected in the Stock Options Grant
table.
The Stock Option Committee will continue to consider various methods to
provide additional incentives to management and employees of the Company,
including granting additional stock options and/or restricted stock or
recommending that the Board do so, as appropriate. In determining the grants of
stock options and restricted stock, the Stock Option Committee will take into
account, among other things, the respective scope of responsibility and the
anticipated performance requirements and contributions to the Company of each
proposed award recipient as well as the amounts of prior grants.
COMPENSATION TO CHIEF EXECUTIVE OFFICER
The Compensation Committee meets annually to evaluate the Chief Executive
Officer's performance and to review the Chief Executive Officer's compensation.
Simon K. Hodson, who served as the CEO of the Company since its inception,
resigned August 31, 2005. Mr. Vincent J. Truant was elected effective September
1, 2005.
In reviewing the CEO's compensation, the Compensation Committee considers
his principal responsibilities, which include providing overall vision and
strategic direction for EarthShell, attracting and retaining highly qualified
employees and developing and maintaining key customer and capital relationships.
Mr. Hodson received a base compensation of $500,000 during 2004, a portion
of which was deferred. This amount was based on the Compensation Committee's
assessment that Mr. Hodson is uniquely qualified to lead the Company through its
early development stages to initial commercialization. The Board determined that
his vision for the Company, both from a technical and business viewpoint,
continues to be pivotal in bringing the Company to the point of commercializing
its first product lines. Based in part on the foregoing, the Compensation
Committee concluded that the $500,000 base salary compensation was appropriate
for 2004.
In order to conserve cash until the Company is able to establish its
royalty revenue stream, Mr. Hodson agreed to a forty percent (40%) deferral of
his base salary, effective April 16, 2004. In June 2005, the portion of Mr.
Hodson's 2004 salary which had been deferred was paid. As of December 31, 2005,
the amount of deferred compensation, with accrued interest and accrued vacation
pay was $216,569.
In determining Mr. Hodson's 2004 annual bonus, the Compensation Committee
considered both Mr. Hodson's individual performance as well as that of the
Company overall. Although the Compensation Committee noted several significant
achievements during the year, in light of the delays the Company has experienced
in commercializing the Company's technology as well as the financial condition
of the Company, the Compensation Committee determined that no bonus for 2004
would be granted.
Mr. Hodson owns a minority profits interest in EKI, the Company's largest
stockholder.
Effective September 1, 2005 the Board of Directors elected Mr. Vincent J.
Truant as Chief Executive Officer of EarthShell Corporation. He receives base
compensation at the rate of $400,000 per year and has a bonus opportunity at the
discretion of the Compensation Committee of the Board. If connection with his
election as CEO, Mr. Truant received options to purchase 350,000 shares of the
Company's common stock at the fair market value on September 1, 2005.
67
DEDUCTIBILITY OF EXECUTIVE COMPENSATION
Section 162(m) of the Internal Revenue Code of 1986, as amended (the
"Code"), limits the deductibility of compensation over $1 million to certain
executive officers unless, in general, the compensation is paid pursuant to a
plan which is performance related, non-discretionary and has been approved by
the Company's stockholders. The Company did not pay any compensation in 2003
that would be subject to Code Section 162(m). The Compensation Committee intends
to establish policies regarding qualification of compensation under Section
162(m) of the Code to the extent it considers such policies appropriate.
68
STOCK PERFORMANCE GRAPH
The graph below compares the cumulative total return on the Company's
common stock for the last six (6) 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 SEC 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 1933 Act or Exchange Act.
[COMPARISON OF CUMULATIVE TOTAL SHAREHOLDER RETURN GRAPH]
69
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
January 20, 2006, by (i) each person or company known by the Company to be the
beneficial owner of more than five percent (5%) of the Company's outstanding
shares, (ii) each Director of the Company,(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
Number of Shares of
Shares of Common Stock
Name and address (1) Common Stock Outstanding(1)(2)
-------------------------------------------------------------- ---------------- -----------------
Mr. Hamlin Jennings (3) 30,034 *
Mr. Walker Rast (4) 28,603 *
Mr. Vincent J. Truant (5) 37,083 *
Mr. D. Scott Houston (6) 419,120 1.68%
Mr. Michael C. Gordon 25,000 *
Mr. Paul Susie 10,000 *
Directors and Named Executive Officers as a Group (5 Persons) 539,840 2.16%
Mr. Essam Khashoggi (7) 7,933,603 31.79%
E. Khashoggi Industries, LLC(8) 5,999,939 24.04%
---------------
* Indicates ownership of less than one percent (1%).
(1) The address of all individuals, entities and stockholder groups listed in
the table is c/o EarthShell Corporation, 1301 York Road, Suite 200,
Lutherville, Maryland 21093.
(2) Applicable percentage of ownership is based on 19,315,188 shares of common
stock outstanding at January 20, 2006, together with securities exercisable
or convertible into shares of common stock within sixty (60) days of
January 20, 2006, for each stockholder. Beneficial ownership is determined
in accordance with the rules of the SEC 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 sixty (60) days of January
20, 2006 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 options to purchase 30,034 shares of common stock issued under the
1995 Stock Incentive Plan, which shares are fully vested and exercisable.
(4) Includes options to purchase 28,603 shares of common stock issued under the
1995 Stock Incentive Plan, which shares are fully vested and exercisable.
(5) Includes options to purchase 32,917 shares of common stock issued under the
1995 Stock Incentive Plan, which shares are fully vested and exercisable.
(6) Includes options to purchase 417,037 shares of common stock issued under
the 1995 Stock Incentive Plan which are shares fully vested and
exercisable.
(7) Includes 5,916,606 shares held by 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 Composite Technology
Corporation, in which Mr. Khashoggi also has a controlling ownership
interest. Also includes warrants to purchase 1,000,000 shares of common
stock issued by the Company to Mr. Khashoggi and warrants held by EKI to
purchase 83,333 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.
(8) Includes warrants to purchase 1,083,833 shares of common stock of the
Company.
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.
70
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 1,629,425 7.29 (1) --
Equity compensation plans not approved by security holders -- -- --
---------------- ---------------- ---------------------
TOTAL 1,629,425 7.29 --
---------------- ---------------- ---------------------
(1) A portion of the options to be issued were granted in 2005 subject to
approval by the shareholders of an increase in the option pool reserve at
the next annual meeting of the shareholders.
71
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 (1st) Quarter 2.45 1.48
Second (2nd) Quarter 3.20 1.65
Third (3rd) Quarter 2.95 1.77
Fourth (4th) Quarter 2.50 1.74
YEAR ENDED DECEMBER 31, 2004:
First (1st) Quarter 2.52 1.49
Second (2nd) Quarter 2.03 0.45
Third (3rd) Quarter 3.75 1.75
Fourth (4th) Quarter 2.97 1.95
YEAR ENDED DECEMBER 31, 2003:
First (1st) Quarter 7.80 4.20
Second (2nd) Quarter 7.08 4.32
Third (3rd) Quarter 5.64 3.72
Fourth (4th) Quarter 4.56 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
February 9, 2006 was 1,195.
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 (2)
years.
72
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
As of July 21, 2005 when the Compensation Committee was reorganized, all
decision relating to executive compensation have been made by the Company's
Compensation Committee, which is comprised of Hamlin Jennings, chairman, Walker
Rast, and Michael Gordon. All members of the current Compensation Committee are
independent directors. All decisions relating to executive compensation during
2004 through July 21, 2005 were made by the Company's former Compensation
Committee, which was comprised of Mr. Khashoggi, Mrs. Khashoggi and, until
February 2, 2005 when he resigned, Dr. Roland or the Board, as appropriate. 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 largest
stockholder with whom the Company has certain relationships and related
transactions described below. Mr. Khashoggi is the beneficial owner of 33.29 of
the common stock of the Company.
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 twenty-four (24) hours).
On July 29, 2002, the Company EKI for the amended and restated license
agreement with EKI for the license described above (the "EKI 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
agreed to pay to EKI fifty percent (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 and
information transfer agreement (the "Biotech License Agreement") with bio-tec
Biologische Naturverpackungen GmbH & Co. KG and bio-tec Biologische
Naturverpackungen Forschungs und Entwicklungs GmbH (the "Biotec Group") to
utilize the Biotec Group technology for foodservice disposable packaging
applications. EKI had previously granted to the Company priority rights to
license certain product applications on an exclusive basis from the Biotec Group
in consideration for the Company's payment of a $100,000 minimum monthly payment
to Biotec. In addition, in consideration for the monthly payment, the Biotec
Group agreed to render technical services to the Company at the Biotec Group's
cost plus five percent (5%). The licensing fee and services arrangements were
continued in the Biotec License Agreement. Under the terms of the Biotec License
Agreement, the Biotec Group was entitled to receive twenty-five percent (25%) of
any royalties or other consideration that the Company receives in connection
with the sale of products utilizing the Biotec Group technology, after applying
a credit for all minimum monthly payments received. In connection with the
issuance of the 2006 Debentures, the Biotec Group agreed to subordinate the
licensee fee payments due from EarthShell until the debentures were retired.
During this period, the license fees due to the Biotec Group 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 (2) years, the $100,000 per month minimum license fee. In December of 2004,
the amended Biotec License Agreement was further amended and EarthShell paid to
Biotech $125,000, leaving a balance owing of approximately $875,000, which was
subsequently reduced to approximately $837,000. On August 31, 2005, in
connection with the sale of Biotec by EKI, Biotec License Agreement was again
amended and restated (the "Amended and Restated Biotec License") and the minimum
monthly payment to retain exclusivity was completely eliminated and the balance
of approximately $837,000 owing to EarthShell was assigned by the Biotec Group
to EKI. Under the Amended and Restated Biotec License, the Company has a fully
paid up license to use the Biotec technology in the EarthShell fields of use,
with certain limited exclusions, exclusively through June 2008. The Company can
maintain its exclusivity provided it has been successful in commercializing the
Biotec technology and is making certain minimum royalty payments under the
license by June 2008. As of the date of this Prospectus, the Company has paid to
the Biotec Group $125,000 in cash, has converted approximately $1.475 million
into 491,778 shares of unregistered stock, and had assigned the balance owing to
the Biotec Group of $837,145.69 to EKI. On October 11, 2005, the Company entered
into the Debt Conversion Agreement with EKI, pursuant to which the Company and
EKI agreed that a receivable in an amount equal to $837,145.69 (previously owed
to bio-Tec Biologische Naturverpackunger GmbH & Co.KG), but which receivable was
subsequently assigned to EKI) be converted into 279,048 shares of common stock
of the Company. The conversion price equals $3.00 per share. Pursuant to the
Debt Conversion Agreement, the Company and EKI released each other from any and
all claims in connection with the receivable.
73
During 2002 and 2003, EKI made various simple interest working capital
loans to the Company (the "Simple Interest Loans"). These Simple Interest Loans
were interest bearing at a rate of seven percent (7%) or ten percent (10%) per
annum, and were payable on demand. As of December 31, 2003, the outstanding
principal balance of the Simple Interest Loans was $2,755,000. In connection
with the sale of the 2006 Debentures, EKI subordinated the payments and advances
that were owed to it, and as consideration, the Company issued to EKI a warrant
in March 2003, expiring ten (10) years thereafter, to acquire 83,333 shares of
the Company's common stock at $6.00 per share. As part of the settlement of the
2006 Debentures in October of 2004, EKI agreed to convert all of the outstanding
Simple Interest Loans to EarthShell ($2,755,000) into unregistered common stock
at $3.00 per share and $532,644 of accumulated interest into unregistered common
stock at $4.00 per share, for a total of 1,051,494 shares received by EKI. As of
December 31, 2004, the Simple Interest Loans were paid in full. In May 2005, an
additional 44,387 shares were issued to EKI pursuant to a ninety (90) day price
protection clause, which provided for an adjustment in the effective conversion
price of the interest portions of the Simple Interest Loans from $4.00 per share
to $3.00 per share. The 1,051,494 shares of common stock issued to EKI as a
result of the EKI Conversion Agreement will not be registered for resale under
the 1933 Act.
On September 30, 2004, EKI entered into an agreement with EarthShell to
sell back to the Company the 2006 Debentures it had purchased for $1 million in
cash, the cash price paid by EKI for the purchased 2006 Debentures (the "EKI
DPA"). In connection therewith, immediately after the acquisition, EKI sold the
2006 Debentures to the Company and, as discussed above, the Company retired the
2006 Debentures shortly thereafter.
In 2005, the Company also granted a ten (10) year warrant to Essam
Khashoggi to purchase one million (1,000,000) shares of the Company's common
stock at $3.00 per share in consideration of his continued support of the
Company since its inception, including providing bridge loans at below market
terms from time to time.
On October 11, 2005, the Company entered into the EKI Loan with EKI
pursuant to which the Company issued to EKI a promissory note to EKI in the
principal amount of $1,000,000. As of the second week of January 2006, EKI has
advanced the full $1,000,000 to the Company. Interest accrues on the principal
balance of the EKI Loan at a variable per annum rate, as of any date of
determination, that is equal to the rate published in the "Money Rates" section
of The Wall Street Journal as being the "Prime Rate", compounded monthly. All
accrued but unpaid interest and outstanding principal is due and payable on the
earliest to occur of the following: (i) the second (2nd) anniversary of the date
of the EKI Loan; (ii) five (5) days following the date the Company has received
$3 million or more in aggregate net cash proceeds from all financing
transactions, equity contributions, and transactions relating to the sale,
licensing, sublicensing or disposition of assets or the provision of services
(including advance royalty payments, proceeds from the sale of the Company's
common stock and fees for technological services rendered to third parties),
measured from the date of the EKI Loan and not taking into account the proceeds
advanced under the EKI Loan; or (iii) the occurrence of an Event of Default (as
defined in the EKI Loan).
Under the terms of the EKI License Agreement and an amended and restated
Agreement for the Allocation of Patent Costs by and between the Company and EKI,
EarthShell has the obligation to pay the patent prosecution and maintenance
costs for those patents which i) "directly relate to" it's field of use, and
which ii) "primarily benefit" EarthShell.
any patents granted in connection with the EarthShell Technology are the
property of EKI, and EKI may utilize and/or license 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,
rather than reimbursing EKI for patent costs, EarthShell assumed direct
responsibility to manage and maintain the patent portfolio underlying the EKI
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, Chief Executive Officer. The loan, which bore interest at seven
percent (7%) per annum, was due upon demand by the Company. In May 2005, the
Compensation Committee of the Board approved a bonus to Mr. Truant equal to the
total principal amount and accrued interest, and the note was cancelled.
74
DESCRIPTION OF CAPITAL STOCK
COMMON STOCK
EarthShell is authorized to issue 40,000,000 shares of Common Stock $0.01
par value, of which 19,315,188 were issued and outstanding at January 20, 2006.
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
Purchase 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 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 has the authority, without further action by stockholders, to
issue up to 10,000,000 shares of preferred stock ("Preferred Stock") in one (1)
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, 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 September 16, 2005, there were no
shares of Series A Preferred Stock issued and outstanding.
SERIES B CONVERTIBLE PREFERRED STOCK
As of January 20, 2006, there were 100 shares of Series B Convertible
Preferred Stock, par value $0.01 per share, designated. The one hundred (100)
shares of Series B Convertible Preferred Stock have been pledged to secure the
CCP 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 Mr. 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 the Delaware
General Corporation 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.
75
WARRANTS
In connection with the issuance of the convertible debentures on August 12,
2002, the Company issued to the debenture holders, Cranshire Capital, L.P.,
Cleveland Overseas Ltd., and Beacon Equities, Inc, 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 approved the
grant of a ten (10) year option to Mr. Essam Khashoggi, the former Chairman of
the Board, 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. This warrant was cancelled as well and a
new warrant with the same terms was issued in August 2005 to Mr. Khashoggi.
In March 2005, in consideration for Mr. 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 Mr. 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. There is a business relationship between Composite
Technology Corporation and EKI.
In consideration for consulting services rendered by Mr. Douglas Metz in
connection with the Company obtaining financing, the Company issued a warrant to
Mr. 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.
On May 26, 2005, the Company issued a common stock purchase warrant to
Cornell Capital Partners to purchase 625,000 shares of common stock of the
Company. This May Warrant expires on May 26, 2005, has an adjusted exercise
price of $3.00 per share as of December 30, 2005 for common stock and has "piggy
back" and demand registration rights. These shares are being registered in this
offering.
In August 2005, the Company issued a common stock purchase warrant to
Cornell Capital Partners to purchase 50,000 shares of common stock of the
Company as consideration for consolidating two (2) promissory notes (the "CCP
Notes") and extending the date upon which amortization and repayment of the CCP
Notes is to begin. This August Warrant expires on May 26, 2006, has an adjusted
exercise price of $3.00 per shear of common stock and has "piggy back"
registration and demand rights. These shares are being registered in this
offering.
On December 30, 2005, the Company issued to Mr. Wilcoxon in consideration
of his pledge of shares of common stock of Composite Technology Corporation
pursuant to the terms of the IPEA a warrant to purchase up to 125,000 shares of
common stock. This warrant has an exercise price of $4.00 per share and expires
three (3) years from the date it was issued. The shares underlying these
warrants are being registered in this offering.
76
On December 30, 2005, the Company issued to Cornell Capital Partners a
common stock purchase warrant to purchase up to 350,000 shares of common stock
of the Company. This December Warrant has an exercise price of $4.00 per share,
expires two (2) years from the date it was issued and has "piggy back" and
demand registration rights. These shares are being registered in this offering.
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 zero (0) to five (5) years and generally expire five (5) to ten (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.
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 stockholders 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 Amended and Restated 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 1933 Act 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 1933 Act 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
fifteen percent (15%) or more of the corporation's outstanding voting stock, for
a period of three (3) 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 eighty-five percent (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).
77
The Company's Amended and Restated 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, and a requirement of advance notice for the submission of
stockholder proposals or Director nominees.
78
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 Hurley
& McEwen, LLP (formerly Farber & Hass, LLP). The reports of Farber Hass Hurley &
McEwen, LLP (formerly 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 SEC a Registration Statement on Form S-1 under the
1933 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 SEC. 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 SEC's Public
Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may
obtain information on the operation of the Public Reference Room by calling the
SEC at 1-800-SEC-0330. The SEC 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 SEC.
79
EARTHSHELL CORPORATION
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES*
PAGE
----
EARTHSHELL CORPORATION CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS FOR THE QUARTER ENDED SEPTEMBER 30, 2005
-------------------------------------------------------------------------------------------------------
Condensed Consolidated Balance Sheets as September 30, 2005 (unaudited) and
December 31, 2004 F-1
Condensed Consolidated Statements of Operations for the three (3) and nine (9) months ended September
30, 2005 and September 30, 2004 (unaudited) F-2
Condensed Consolidated Statements of Cash Flows for the three (3) and nine (9) months ended June 30,
2005 and September 30, 2004 (unaudited) F-3 - 4
Supplemental Disclosure of Non-Cash Investing and Financial Activities F-5
Notes to Consolidated Financial Statements (unaudited) F-6 - 9
EARTHSHELL CORPORATION FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2004, 2003 AND 2002
-------------------------------------------------------------------------------------------------------
Reports of Independent Registered Public Accounting Firm F-10 - 11
Consolidated Balance Sheets as of December 31, 2004 and 2003 F-12
Consolidated Statements of Operations for the years ended December 31, 2004, 2003 and 2002 F-13
Consolidated Statements of Stockholders' Equity (Deficit) for the years ended December 31, 2004, 2003
and 2002 F-14
Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002 F-15 - 16
Supplemental Disclosure of Non-Cash Investing and Financing Activities F-17
Notes to Consolidated Financial Statements F-18 - 30
Quarterly Financial Information for 2004 and 2003 (Unaudited) F-31
-------------------------------------------------------------------------------------------------------
*Consolidated Financial Statement 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-i
EARTHSHELL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------- -------------
(UNAUDITED)
ASSETS
CURRENT ASSETS
Cash and cash equivalents ................................................... $ 40,503 $ 272,371
Prepaid expenses and other current assets ................................... 102,607 201,467
------------- -------------
Total current assets ...................................................... 143,110 473,838
PROPERTY AND EQUIPMENT, NET ................................................... -- 9,037
EQUIPMENT HELD FOR SALE ....................................................... 1 1
------------- -------------
TOTALS .................................................................... $ 143,111 $ 482,876
------------- -------------
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Accounts payable and accrued expenses ....................................... $ 5,865,929 $ 3,899,526
Current portion of settlements .............................................. 344,845 313,743
Current portion of deferred revenues ........................................ 100,000 300,000
Contingent settlement ....................................................... 2,375,000 2,375,000
Note payable ................................................................ 2,196,550 --
Payable to a related party .................................................. 837,146 875,000
------------- -------------
Total current liabilities ................................................. 11,719,470 7,763,269
LONG-TERM PORTION OF DEFERRED REVENUES ........................................ 812,500 1,062,500
OTHER LONG-TERM LIABILITIES ................................................... 173,366 412,192
------------- -------------
Total liabilities ......................................................... 12,705,336 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 September
30, 2005 and December 31 2004; 100 Series B shares designated and issued as
of September 30, 2005 as collateral for Note payable.......................
Common Stock, $.01 par value, 40,000,000 shares authorized: 18,602,119 and
18,234,615 shares issued and outstanding as of September 30, 2005 and
December 31 2004, respectively ............................................ 186,021 182,346
Additional paid-in common capital ........................................... 313,933,470 313,196,905
Accumulated deficit ......................................................... (326,440,627) (321,607,782)
Less note receivable for stock .............................................. (183,333) (500,000)
Accumulated other comprehensive loss ........................................ (57,756) (26,554)
------------- -------------
Total stockholders' deficit ............................................... (12,562,225) (8,755,085)
------------- -------------
TOTALS .................................................................... $ 143,111 $ 482,876
============= =============
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
F-1
EARTHSHELL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
FOR THE FOR THE
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- --------------------------------
2005 2004 2005 2004
---------------- -------------- ---------------- ---------------
Revenues $ 25,000 $ 50,000 $ 158,333 $ 75,000
Operating Expenses
Related party license fee and research and
development expenses -- 200,000 -- 800,000
Other research and development expenses 110,628 64,121 333,406 329,572
Related party general and administrative expenses
(reimbursements), net (2,227) -- (5,867) --
Other general and administrative expenses 1,603,577 99,162 4,213,578 2,344,133
Depreciation and amortization 558 3,164 2,233 41,735
(Gain)/Loss on sales of property and equipment 803 (14,785) (22,902) (168,320)
------------ ------------ ------------ ------------
Total operating expenses 1,713,339 351,662 4,520,448 3,347,120
Operating Loss 1,688,339 301,662 4,362,115 3,272,120
Other (Income) Expenses
Interest income (1,112) (705) (3,864) (3,476)
Related party interest expense -- 131,030 101,314 406,895
Other interest expense 206,655 205,121 372,480 628,406
Premium due to debenture default -- 1,008,823 -- 1,672,426
------------ ------------ ------------ ------------
Loss Before Income Taxes 1,893,882 1,645,931 4,832,045 5,976,371
Income taxes -- -- 800 800
------------ ------------ ------------ ------------
Net Loss $ 1,893,882 $ 1,645,931 $ 4,832,845 $ 5,977,171
============ ============ ============ ============
Basic and Diluted Loss Per Common Share $ 0.10 $ 0.12 $ 0.26 $ 0.42
Weighted Average Number of Common Shares Outstanding 18,507,916 14,223,402 18,385,325 14,160,674
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
F-2
EARTHSHELL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------------
2005 2004
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss ........................................................................... $ (4,832,845) $ (5,977,171)
Adjustments to reconcile net loss to net cash used in operating activities
Depreciation and amortization .................................................... 2,233 41,736
Compensation related to issuance of stock, stock options, warrants, and restricted
stock to directors, consultants, and officers .................................. 251,692 --
Amortization and accretion of note issue costs ................................... 234,744 592,316
Premium due to debenture default.................................................. -- 1,672,426
(Gain) Loss on sales of property and equipment ................................... (22,902) (168,320)
Deferred revenues ................................................................ (158,333) 425,000
Other non-cash expense items ..................................................... (198,110) 19,865
Changes in operating assets and liabilities
Prepaid expenses and other current assets ...................................... 98,860 70,157
Accounts payable and accrued expenses .......................................... 1,990,416 (266,883)
Payables to related party ...................................................... (37,854) 1,131,014
Other long-term liabilities .................................................... -- 145,793
-------------- --------------
Net cash used in operating activities ........................................ (2,672,099) (2,314,067)
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of property and equipment ...................................... 29,706 187,570
Purchases of property and equipment ................................................ (8,729)
-------------- --------------
Net cash provided by investing activities ...................................... 29,706 178,841
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock ............................................. 528,788 504,097
Common stock issuance costs ........................................................ (117,342)
Repayment of convertible debentures ................................................ (110,294)
Proceeds from issuance of notes payable to related party ........................... 322,000 136,000
Repayment of notes payable to related party ........................................ (322,000) --
Principal payments on settlements .................................................. (207,724) --
Proceeds from issuance of note payable ............................................. 2,500,000 --
Note payable issuance costs ........................................................ (402,500) --
-------------- --------------
Net cash provided by financing activities ...................................... 2,418,564 412,461
-------------- --------------
Effect of exchange rate changes on cash and cash equivalents ....................... (8,039) 64
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ......................... (231,868) (1,722,701)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ..................................... 272,371 1,901,639
-------------- --------------
CASH AND CASH EQUIVALENTS, END OF PERIOD ........................................... $ 40,503 $ 178,938
============== ==============
F-3
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------------
2005 2004
-------------- --------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for
Income taxes ..................................................................... $ 800 $ 800
Interest ......................................................................... 12,619 9,220
Transfer of property to EKI ........................................................ -- 78,409
Conversion of convertible debentures into common stock.............................. -- 174,632
Interest paid in common stock ...................................................... -- 4,097
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
F-4
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
In March of 2005, in consideration for a loan guarantee, the Company issued
warrants to Benton Wilcoxon to purchase 65,000 shares of common stock of the
Company at an exercise price of $3.00 per share. The warrants expire on March
23, 2008. Using the Black-Scholes pricing model, the warrants are valued at
$34,980. In addition, the Company granted to Mr. Wilcoxon a right of first
refusal to enter into a license agreement for certain of its technology in
certain Asian territories.
Also in March of 2005, in consideration for consulting services rendered in
connection with the Company obtaining financing, the Company issued a warrant to
Mr. Douglas Metz 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. Using the
Black-Scholes pricing model, the warrant is valued at $43,048.
In May 2005, the Company issued a warrant to Cornell Capital Partners (CCP) to
purchase 625,000 shares of common stock of the Company. The warrant expires on
the later of: (a) May 26, 2006 or (b) the date sixty days after the date the
$2,500,000 in promissory notes issued to Cornell Capital are fully repaid. The
warrant has an exercise price of $4.00 per share of common stock. Using the
Black-Scholes pricing model, the warrant is valued at $47,345.
In August 2005, the Company issued a warrant to Cornell Capital Partners to
purchase 50,000 shares of common stock of the Company in consideration for
consolidating the two CCP promissory notes and extending the date upon which
amortization and repayment of the notes is to begin. The warrant expires on the
later of: (a) May 26, 2006 or (b) the date sixty days after the date the
$2,500,000 in promissory notes issued to Cornell Capital are fully repaid. The
warrant has an exercise price of $4.00 per share of common stock. Using the
Black-Scholes pricing model, the warrant is valued at $3,788.
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
F-5
EARTHSHELL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SEPTEMBER 30, 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 ("EKI").
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 (1st) quarter of
2004. With the recognition of the Company's first (1st) revenues in the second
quarter of 2004, the Company was no longer a development stage enterprise.
BASIS OF PRESENTATION OF FINANCIAL INFORMATION
The foregoing interim financial information is unaudited and has been prepared
from the books and records of EarthShell Corporation. EarthShell Corporation's
consolidated financial statements include the accounts of its wholly-owned
subsidiary, PolarCup EarthShell GmbH. All significant inter-company 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 accounting principles generally accepted
in the United States. All such adjustments were of a normal recurring nature for
interim financial reporting. Results of operations for the three and nine month
periods ended September 30, 2005 are not necessarily indicative of results that
will occur for the year ending December 31, 2005.
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/A - Amendment No. 3.
The accompanying unaudited 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 $ 11,576,360 at September 30, 2005. These factors, along with
others, indicate substantial doubt that the Company may 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 September 30, 2005 and December 31, 2004 were as follows:
SEPTEMBER 30, DECEMBER 31,
2005 2004
----------------- ---------------
Total office furniture and equipment 146,157 245,274
Less: Accumulated depreciation and amortization (146,157) (236,237)
--------- ---------
Property and equipment - net $ -- $ 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.
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------------------
2005 2004
----------------- ------------------
Net Loss as reported ..................................................... $ 4,832,845 $ 5,977,171
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
Relates primarily to warrants issued to executive officers
........................................................................ $ 2,327,367 $ 488,899
----------------- ------------------
Pro forma net loss ....................................................... $ 7,160,212 $ 6,466,070
Basic and diluted loss per common share
As reported ............................................................ $ 0.26 $ 0.42
Pro forma .............................................................. $ 0.39 $ 0.46
F-7
FINANCING
On March 23, 2005, the Company entered into a promissory note and Security
Agreement with Cornell Capital Partners, LP ("Cornell Capital Partners"). 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
Company also issued and placed in escrow for the benefit of the lender 100
shares of a newly designated Series B convertible preferred stock. In the event
the Company defaults on its obligation to repay the promissory notes to Cornell
Capital Partners, Cornell would have the right to receive the shares and to
convert each share into 33,333 shares of the Company's common stock. 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, 2006 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. The first (1st) installment payment on the
promissory notes was due on July 25, 2005. In August 2005 Cornell Capital
Partners agreed to consolidate the two notes and to defer the commencement of
repayment installments until October 1, 2005. In consideration of this
modification to the promissory notes, the Company issued a warrant to Cornell
Capital Partners to purchase 50,000 shares of common stock of the Company. The
warrant expires on the later of: (a) May 26, 2006 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.
In connection with the Cornell Capital Partners promissory notes, the Company
recorded an original issue discount of $312,693. 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, issuance of warrants to purchase 145,000 shares of the
Company's stock at $3 per share valued at $78,028 using the Black-Scholes
valuation model, and the issuance of warrants to the lender to purchase 625,000
shares of the Company's stock at $4 per share valued at $47,345 using the
Black-Scholes valuation model, all of which will be amortized over the 12 month
life of the note at a rate of $39,389 per month.
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 aggregate 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 to be 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 the offer and sale by Cornell Capital Partners of the
shares of common stock sold under the Standby Equity Distribution Agreement
becoming effective, and is limited to $500,000 per weekly advance. 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 June 9, 2005 the Company filed a registration statement on Form S-1
with the Securities and Exchange Commission to register the shares of EarthShell
common stock underlying this transaction, including the shares of common stock
received as a commitment fee. On September 27, 2005, the registration statement
was withdrawn. The Company continues to work with Cornell Capital Partners to
restructure the transactions.
In August 2005, the Company entered into an agreement with EarthShell Asia,
Limited, ("EA") in connection with the granting of certain licenses to use
EarthShell technology for various applications in certain ASEAN territories.
Shortly after executing this letter agreement, both the Company and EA decided
to restructure the transaction. As part of this transaction, the Company may
receive a total of up to $2.6 million from a combination of prepaid technology
fees (up to $1.7 million) and the sale of up to 300,000 shares of its common
stock and one million warrants to purchase shares of the Company's common stock
at $4 per share. The realization of the full potential of the transaction is
dependent on the Company successfully demonstrating the commercial viability of
its technology in certain new applications. The Company received $500,000 from
EA as an initial partial payment and has agreed to issue 166,667 shares of its
common stock in connection with this payment. Additional definitive agreements
have not yet been entered into.
F-8
Subsequent to September 30, 2005, EarthShell Corporation, a Delaware corporation
(the "Company") issued a Promissory Note (the "Note") to E. Khashoggi
Industries, Inc, LLC, a Delaware limited liability company ("EKI"), in the
principal amount of $1,000,000. Under the terms of the Note dated October 11,
2005, EKI will advance the Company the following sums on the following dates, or
a lesser amount as the Company requests in writing:
Amount Date of Funding
----------- -----------------------------------
$350,000 October 12, 2005
$250,000 October 31, 2005
$250,000 November 30, 2005
$150,000 December 31, 2005
Notwithstanding the funding schedule described above, if, on or before any of
the above funding dates, the Company receives a total of $3 million in aggregate
net cash proceeds from any combination of financing transaction, equity
contribution, sale, licensing or sublicensing of assets or the provision of
services (including, without limitation, advanced royalty payments, proceeds
from the sale of the Company's common stock and fees for technical services
rendered to third parties, but excluding any proceeds advanced under the Note),
EKI is not obligated to advance any additional funds to the Company, including
the funds that were to be advanced at the next funding date.
Interest accrues on the principal balance of the Note at a variable per annum
rate, as of any date of determination, that is equal to the rate published in
the "Money Rates" section of The Wall Street Journal as being the "Prime Rate",
compounded monthly. All accrued but unpaid interest and outstanding principal is
due and payable on the earliest to occur of the following: (i) the second (2nd)
anniversary of the date of the Note; (ii) five (5) days following the date the
Company has received $3 million or more in aggregate net cash proceeds from all
financing transactions, equity contributions, and transactions relating to the
sale, licensing, sublicensing or disposition of assets or the provision of
services (including advance royalty payments, proceeds from the sale of the
Company's common stock and fees for technological services rendered to third
parties), measured from the date of the Note and not taking into account the
proceeds advanced under the Note; or (iii) the occurrence of an Event of Default
(as defined in the Note).
On October 11, 2005, the Company entered into a Debt Conversion and Mutual
Release Agreement (the "Agreement") with EKI. Pursuant to the Agreement, the
Company and EKI agreed that a receivable in an amount equal to $837,145.69
(previously owed to bio-Tec Biologische Naturverpackunger GmbH & Co.KG, a
former, wholly-owned subsidiary of EKI ("Biotec"), which receivable amount was
subsequently assigned to EKI) will be converted into 279,048 shares of common
stock of the Company. The conversion price equals $3.00 per share. Pursuant to
this Agreement, the Company and EKI released each other from any and all claims
in connection with the receivable.
F-9
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-10
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-11
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-12
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-13
EARTHSHELL CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY
Common Stock
--------------------
Additional
Paid-In
Common Accumulated
Shares Amount Capital Deficit
------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 2001 .... 9,860,255 $ 98,602 $ 267,680,051 $(256,242,596)
Issuance of common
stock ....................... 2,025,686 20,257 21,881,459 --
Common stock warrants issued in
connection with convertible
debentures .................. -- -- 1,521,046 --
Conversion of convertible
debentures to
common stock ................ 168,696 1,687 998,313 --
Debenture conversion costs .... -- -- 176,471 --
Net loss ...................... -- -- -- (39,591,344)
Foreign currency translation
adjustment .................. -- -- -- --
Comprehensive loss ............ -- -- -- --
------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 2002 .... 12,054,637 120,546 292,257,340 (295,833,940)
Issuance of common
stock ....................... 137,264 1,373 811,267 --
Common stock and common stock
warrants issued in connection
with issuance of convertible
debentures .................. 624,747 6,248 2,921,594 --
Conversion of convertible
debentures to common stock .. 1,312,318 13,123 7,536,877 --
Debenture conversion
costs ....................... -- -- (1,493,332) --
Net loss ...................... -- -- -- (18,516,741)
Foreign currency translation
adjustment .................. -- -- -- --
Comprehensive loss ............ -- -- -- --
------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 2003 .... 14,128,966 141,290 302,033,746 (314,350,681)
Issuance of common
stock ....................... 2,443,272 24,432 7,181,970 --
Conversion of convertible
debentures to common stock...
1,662,377 16,624 4,970,508 --
Debenture conversion
costs ....................... -- -- (989,319) --
Net loss....................... -- -- -- (7,257,101)
Foreign currency translation
adjustment .................. -- -- -- --
Comprehensive loss ............ -- -- -- --
------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 2004 .... 18,234,615 $ 182,346 $ 313,196,905 $(321,607,782)
============= ============= ============= =============
Accumulated
Stock Other
Purchase Comprehensive
Receivable Loss Totals
------------- ------------- -------------
BALANCE, DECEMBER 31, 2001 .... $ -- $ -- $ 11,536,057
Issuance of common
stock ....................... -- -- 21,901,716
Common stock warrants issued in
connection with convertible
debentures .................. -- -- 1,521,046
Conversion of convertible
debentures to
common stock ................ -- -- 1,000,000
Debenture conversion costs .... -- -- 176,471
Net loss ...................... -- -- (39,591,344)
Foreign currency translation
adjustment .................. -- (16,632) (16,632)
Comprehensive loss ............ -- -- (39,607,976)
------------- ------------- -------------
BALANCE, DECEMBER 31, 2002 .... -- (16,632) (3,472,686)
Issuance of common
stock ....................... -- -- 812,640
Common stock and common stock
warrants issued in connection
with issuance of convertible
debentures .................. -- -- 2,927,842
Conversion of convertible
debentures to common stock .. -- -- 7,550,000
Debenture conversion
costs ....................... -- -- (1,493,332)
Net loss ...................... -- -- (18,516,741)
Foreign currency translation
adjustment .................. -- (76,498) (76,498)
Comprehensive loss ............ -- -- (18,593,239)
------------- ------------- -------------
BALANCE, DECEMBER 31, 2003 .... -- (93,130) (12,268,775)
Issuance of common
stock ....................... (500,000) -- 6,706,402
Conversion of convertible
debentures to common stock...
-- -- 4,987,132
Debenture conversion
costs ....................... -- -- (989,319)
Net loss....................... -- -- (7,257,101)
Foreign currency translation
adjustment .................. -- 66,576 66,576
Comprehensive loss ............ -- -- (7,190,525)
------------- ------------- -------------
BALANCE, DECEMBER 31, 2004 .... $ (500,000) $ (26,554) $ (8,755,085)
============= ============= =============
See Notes to Consolidated Financial Statements.
F-14
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-15
EARTHSHELL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS -CONTINUED
Year Ended December 31,
-------------------------------------------------
2004 2003 2002
--------------- ----------------- ---------------
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-16
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-17
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 (1st) quarter of
2004. With the recognition of the Company's first (1st) 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) . 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-18
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, Ltd. ("MBS") all in the U.S., as well as EarthShell Hidalgo S.A. de
C.V. ("ESH") in Mexico. During 2004, the Company received technology fees from
MBS and ESH, and recorded it first (1st) 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-19
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.
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.
F-20
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-21
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-22
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
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 License 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 License Agreement. Under the terms of the Biotec License
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 License 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 License 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.
F-23
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-24
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 (1st) 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
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.
F-25
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 LIABILITIES
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-26
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-27
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-28
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.
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.
F-29
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-30
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-31
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
----------------------
o except the common stock offered by this
prospectus;
o in any jurisdiction in which the offer or
solicitation is not authorized;
o in any jurisdiction where the dealer or other 10,327,844 Shares of Common Stock
salesperson is not qualified to make the offer
or solicitation;
o to any person to whom it is unlawful to make the EARTHSHELL CORPORATION
offer or solicitation; or
o to any person who is not a United States
resident or who is outside the jurisdiction of
the United States.
______________, 2006
The delivery of this prospectus or any accompanying
sale does not imply that:
o there have been no changes in the affairs of
EarthShell Corporation after the date of
this prospectus; or
o the information contained in this prospectus
is correct after the date of this prospectus.
-----------------------
Until _________, 2006, 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.
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS
The Company's Amended and Restated 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 it's Amended and Restated
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 1933 Act 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 1933 Act 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 Registration Fee $ 1,945.00
Printing and Engraving Expenses $ 2,500.00
Accounting Fees and Expenses $ 15,000.00
Legal Fees and Expenses $ 50,000.00
Miscellaneous $ 15,555.00
---------------
TOTAL $ 85,000.00
ITEM 26. SALES OF UNREGISTERED SECURITIES
During the past three (3) years the registrant has issued the following
securities without registration under the 1933 Act:
(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.
II-1
(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.
(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 to the
Biotec Group, 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 (the "SEDA") with Cornell Capital Partners, LP. In
connection with the SEDA, Cornell Capital Partners received a one-time
commitment fee in the form of 143,550 shares of common stock on March 23, 2005.
On December 30, 2005, the parties terminated the SEDA; however Cornell Capital
Partners retained the commitment shares.
(8) For its services in connection with the SEDA, 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 Mr. 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 Mr. 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 Mr. Douglas
Metz in connection with the Company obtaining financing, the Company issued a
warrant to Mr. 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 ten (10) year warrant to EKI
to purchase one million shares of the Company's common stock at $3.00 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 ninety (90) days of the initial
conversion at a price of at least $4.00 per share.
(14) On May 26, 2005, one hundred (100) shares of our Series B
Convertible Preferred Stock, par value $0.01 per share, were pledged to secure
the CCP 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
were 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 Mr. 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.
II-2
(15) On May 26, 2005, the Company issued a common stock purchase
warrant to Cornell Capital Partners to purchase 625,000 shares of common stock
of the Company. This May Warrant expires on May 26, 2006, has an exercise price
of $4.00 per share of common stock and has "piggy back" and demand registration
rights. These shares are being registered in this offering.
(16) In August 2005, the Company issued a common stock purchase warrant
to Cornell Capital Partners to purchase 50,000 shares of common stock of the
Company as consideration for consolidating two (2) promissory notes (the "CCP
Notes") and extending the date upon which amortization and repayment of the CCP
Notes is to begin. This August Warrant expires on May 26, 2006, has an exercise
price of $4.00 per share of common stock and has "piggy back" registration and
demand rights. These shares are being registered in this offering.
(17) On October 11, 2005, the Company entered into a debt conversion
and mutual release agreement (the "Debt Conversion Agreement") with EK1.
Pursuant to the Debt Conversion Agreement, the Company and EK1 agreed that a
receivable in an amount equal to $837,145.69 (previously owed to bio-Tec
Biologische Naturverpackunger GmBH & Co.KG, but which receivable was
subsequently assigned to EKI) be converted into 279,048 shares of common stock
of the company. The conversion price equals $3.00 per share. Pursuant to the
Debt Conversion Agreement, the Company and EKI released each other from any and
all claims in connection with the receivable.
(18) On December 30, 2005, EarthShell entered into the Purchase
Agreement with Cornell Capital Partners, pursuant to which the Company issued
and sold to Cornell Capital Partners the December Debentures. The December
Debentures shall be convertible into shares of the Company's common stock and
the Company received proceeds equal to $4,500,000 from the sale of the December
Debentures on January 6, 2006. The December Debentures are secured by (i) a
Insider Pledge and Escrow Agreement by and among the Company, Cornell Capital
Partners, and David Gonzalez, Esq., (ii) an Insider Pledge and Escrow Agreement
(the "IPEA"), by and among the Company, Cornell Capital Partners, David
Gonzalez, Esq. and Mr. Benton Wilcoxon and (iii) an amended and restated
security agreement, by and between the Company and Cornell Capital Partners. The
December Debentures are secured by substantially all of the Company's assets,
have a three (3) year term and accrue interest at twelve percent (12%) per
annum. Cornell Capital Partners is entitled, at its option, to convert and sell
all or any part of the principal amount of the December Debentures, plus accrued
interest, into shares of the Company's common stock, at the lesser of (i) a
price equal to $3.00 or (ii) eighty-eight percent (88%) of the average of the
two (2) lowest volume weighted average prices of the common stock during the ten
(10) trading days immediately preceding the conversion date, as quoted by
Bloomberg, LP. The holder of the December Debentures may not convert the
December Debentures or receive shares of the Company's common stock as payment
of interest hereunder to the extent such conversion or receipt of such interest
payment would result in the holder, together with any affiliate thereof,
beneficially owning (as determined in accordance with Section 13(d) of the
Exchange Act and the rules promulgated thereunder) in excess of 4.9% of the then
issued and outstanding shares of common stock, including shares issuable upon
conversion of, and payment of interest on, the December Debentures held by such
holder after application of this 4.9% restriction. This 4.9% restriction may be
waived by the holder (but only as to itself and not to any other holder) upon
not less than sixty-five (65) days prior notice to the Company.
The Company may redeem, with three (3) business days advance written notice
to Cornell Capital Partners, a portion or all amounts outstanding under the
December Debentures prior to the maturity date provided that the closing bid
price of the Company's common stock, as reported by Bloomberg, LP, is less than
$3.00 at the time of the redemption notice. The Company shall pay an amount
equal to the principal amount being redeemed plus a redemption premium equal to
ten percent (10%) of the principal amount being redeemed, and accrued interest,
to be delivered to the Cornell Capital Partners on the third (3rd) business day
after the redemption notice, provided, however, this redemption premium does not
apply until the outstanding principal balance of the December Debentures has
been reduced by $2.5 million.
II-3
(19) On December 30, 2005, the Company issued to Cornell Capital
Partners a common stock purchase warrant to purchase up to 350,000 shares of
common stock of the Company. This December Warrant has an exercise price of
$4.00 per share, expires two (2) years from the date it was issued and has
"piggy back" and demand registration rights. These shares are being registered
in this offering.
(20) On December 30, 2005, the Company issued to Mr. Wilcoxon, in
consideration of his pledge of shares of common stock of Composite Technology
Corporation pursuant to the terms of the IPEA, a warrant to purchase up to
125,000 shares of common stock. This warrant has an exercise price of $4.00 per
share and expires three (3) years from the date it was issued. The shares
underlying these warrants are being registered in this offering.
(21) In December, 2005 the Company entered into various settlement
agreements to settle litigation or to retire obligations for services received.
The Company issued 48,000 shares of its unregistered common stock to Alcalde and
Fay, 75,000 shares to the Van Dam Machine Corp. and 25,000 shares to Midsummer
Capital. These shares of common stock are being registered in this offering.
(22) On August 22, 2005, the Company entered into a letter agreement
with EA to grant sub-licenses to use EarthShell Technology for various
applications in certain Asian territories (the "EA License"). Shortly after
executing a letter agreement, both the Company and EA entered into negotiations
to restructure the transaction and ultimately entered into an amended and
restated letter agreement dated December 9, 2005. By its terms, the amended and
restated letter agreement was not to become effective until all conditions to
the transactions described therein were satisfied. Per the transaction as
restructured in accordance with the amended and restated letter agreement, the
Company may receive a total of up to $2.6 million from a combination of (i)
prepaid technology fees (up to $1.7 million), (ii) the sale of up to 266,667
shares of its common stock and (iii) the issuance of warrants to purchase one
million thirty three thousand three hundred thirty three (1,033,333) shares of
the Company's common stock at $3.90 per share (which, if the Company does not
file with the Securities and Exchange Commission a registration statement for
the resale of such shares by January 31, 2006, may be adjusted to an excercise
price of not less than $3 per share). Subsequent to the execution of the
amended and restated letter agreement, EA agreed to change the deadline for
filing the resale registration statement to February 15, 2006. Realization of
the full potential of the transaction is dependent on the Company successfully
demonstrating the commercial viability of its technology in certain new
applications.
The Company received $500,000 from EA in August 2005 as an initial partial
payment and issued 166,667 shares of its common stock in connection with this
payment. The Company received an additional $300,000 in December 2005 and the
final payment, of approximately $61,000 on February 10, 2006. The remainder was
retained by EA as compensation for various costs and fees. Upon receipt of the
final payment, the Company issued a total of 266,667 shares and the warrants to
purchase the 1,033,333 shares.
EarthShell claimed an exemption from registration under the 1933 Act for
the sales and issuance of its common stock in the transactions described in
paragraphs (1) through (22) above by virtue of Section 4(2) of the 1933 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 LOCATION
----------- ---------------------------------------------- --------------------------------------------
3.1 Amended and Restated Certificate of Incorporated by reference to Exhibit 3.1(1) to
Incorporation of the Company the Company's Registration Statement on Form
S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
3.2 Amended and Restated Bylaws Incorporated by reference to Exhibit 3.2(1) to
the Company's Registration Statement on Form
S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
3.3 Certificate of Designation, Preferences Incorporated by reference to Exhibit 3.3(1) to
Relative, Participating, Optional and Other the Company's Registration Statement on Form
Special Rights of the Company's Series A S-1 and Amendments thereto, File No. 333-1327,
Cumulative Senior Convertible Preferred Stock as filed with the SEC on June 9, 2005
3.4 Certificate of Designation of the Company's Incorporated by reference to Exhibit 99.3 to
Series B Convertible Preferred Stock the Company's Current Report on Form 8-K, as
filed with the SEC on May 27, 2005
II-4
EXHIBIT NO. DESCRIPTION LOCATION
----------- ---------------------------------------------- --------------------------------------------
4.1 Specimen certificate of Common Stock Incorporated by reference to Exhibit 4.1(1) to
the Company's Registration Statement on Form
S-1 and Amendments thereto, File No. 333-1327
as filed with the SEC on June 9, 2005.
4.2 Form of Warrant to purchase Common Stock dated Incorporated by reference to Exhibit 4.3 to
August 12, 2002 the Company's Current Report on Form 8-K, as
filed with the SEC on August 12, 2002
4.3 Form of Note under Loan Agreement, dated as of Incorporated by reference to Exhibit 10.2 to
September 9, 2002, by and between the Company the Company's Current Report, as filed with the
and E. Khashoggi Industries, LLC SEC on September 26, 2002
4.4 Form of Secured Convertible Debenture due March Incorporated by reference to Exhibit 4.2 to
5, 2006 the Company's Current Report on Form 8-K, as
filed with the SEC on March 5, 2003
4.5 Intellectual Property Security Agreement, dated Incorporated by reference to Exhibit 4.3 to
as of March 5, 2003, by and among the Company, the Company's Current Report on Form 8-K, as
E. Khashoggi Industries, LLC and the investors filed with the SEC on March 5, 2003
listed therein
4.6 Waiver and Amendment to Debentures and Warrants Incorporated by reference to Exhibit 4.4 to
dated as of March 5, 2003 among the Company and the Company's Current Report on Form 8-K, as
the purchasers identified on the signature pages filed with the SEC on March 5, 2003
thereto
4.7 Exchange Agreement, dated as of March 5, 2003, Incorporated by reference to Exhibit 4.6 to
by and between the Company and the Institutional the Company's Current Report on Form 8-K, as
Investor signatory thereto filed with the SEC on March 5, 2003
5.1 Opinion of Counsel To be provided herewith by Amendment
10.1 Amended and Restated License Agreement, dated Incorporated by reference to Exhibit 10.1(1) to
February 28, 1995, by and between the Company the Company's Registration Statement on Form
and E. Khashoggi Industries, LLC S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.2 Registration Rights Agreement, dated as of Incorporated by reference to Exhibit 10.2(1) to
February 28, 1995, by and between the Company the Company's Registration Statement on Form
and E. Khashoggi Industries, LLC, as amended S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.3 1994 Stock Option Plan Incorporated by reference to Exhibit 10.3(1) to
the Company's Registration Statement on Form
S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.4 1995 Stock Incentive Plan Incorporated by reference to Exhibit 10.4(1) to
the Company's Registration Statement on Form
S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.5 Form of Stock Option Agreement under the Incorporated by reference to Exhibit 10.5(1) to
EarthShell Container Corporation 1994 Stock the Company's Registration Statement on Form
Option Plan S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.6 Form of Stock Option Agreement under the Incorporated by reference to Exhibit 10.6(1) to
EarthShell Container Corporation 1995 Stock the Company's Registration Statement on Form
Incentive Plan S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
II-5
EXHIBIT NO. DESCRIPTION LOCATION
----------- ---------------------------------------------- ---------------------------------------------
10.7 Warrant to Purchase Stock, issued July 2, 1996, Incorporated by reference to Exhibit 10.7(1) to
by the Company to Imperial Bank the Company's Registration Statement on Form
S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.8 Amended and Restated Technical Services and Incorporated by reference to Exhibit 10.8(1) to
Sublease Agreement, dated October 1, 1997, by the Company's Registration Statement on Form
and between the Company and E. Khashoggi S-1 and Amendments thereto, File No. 333-1327,
Industries, LLC as filed with the SEC on June 9, 2005
10.9 Amended and Restated Agreement for Allocation of Incorporated by reference to Exhibit 10.9(1) to
Patent Costs, dated October 1, 1997, by and the Company's Registration Statement on Form
between the Company and E. Khashoggi Industries, S-1 and Amendments thereto, File No. 333-1327,
LLC as filed with the SEC on June 9, 2005
10.10 Warrant to Purchase Stock, issued October 6, Incorporated by reference to Exhibit 10.10(1) to
1997, by the Company to Imperial Bank the Company's Registration Statement on Form
S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.11 Warrant to Purchase Stock, issued December 31, Incorporated by reference to Exhibit 10.11(1) to
1997, by the Company to Imperial Bank the Company's Registration Statement on Form
S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.12 Letter Agreement re Haas/BIOPAC Technology, Incorporated by reference to Exhibit 10.12(1) to
dated February 17, 1998, by and between the the Company's Registration Statement on Form
Company and E. Khashoggi Industries, LLC S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.13 Second Amendment to 1995 Stock Incentive Plan of Incorporated by reference to Exhibit 10.13(1) to
the Company the Company's Registration Statement on Form
S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.14 Amendment No. 2 to Registration Rights Incorporated by reference to Exhibit 10.14(1) to
Agreement, dated as of September 16, 1993, by the Company's Registration Statement on Form
and between the Company and the purchasers of S-1 and Amendments thereto, File No. 333-1327,
series A convertbile preferred stock. as filed with the SEC on June 9, 2005
10.15 Amendment No. 2 to Registration Rights Incorporated by reference to Exhibit 10.15(1) to
Agreement, dated February 28, 1995, by and the Company's Registration Statement on Form
between the Company and EKI S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.16 First Amendment to the Amended and Restated Incorporated by reference to Exhibit 10.8 to
License Agreement, dated June 2, 1998, by and the Company's Quarterly Report on Form 10-Q,
between the Company and E. Khashoggi Industries, for the quarter ended September 30, 1998, as
LLC filed with the SEC on Novermber 12, 1998
10.17 First Amendment to 1995 Stock Incentive Plan of Incorporated by reference to Exhibit 10.51 to
the Company the Company's Annual Report on Form 10-K, for
the fiscal year ended December 31, 1998, as
filed with the SEC on March 31, 1999
10.18 Third Amendment to 1995 Stock Incentive Plan of Incorporated by reference to Exhibit to
the Company the Company's Definitive Proxy Statement on
Schedule 14A, file No. 000-23567, as filed with
the SEC on April 22, 1999
II-6
EXHIBIT NO. DESCRIPTION LOCATION
----------- ---------------------------------------------- ---------------------------------------------
10.19 Fourth Amendment to 1995 Stock Incentive Plan of Incorporated by reference to the Company's
the Company Definitive Proxy Statement on Schedule 14A,
file No. 000-23567, as filed with the SEC on
April 22, 1999
10.20 Lease Agreement, dated August 23, 2000, by and Incorporated by reference to Exhibit 10.39 to
between the Company and Heaver Properties, LLC the Company's Annual Report on Form 10-K, for
the fiscal year ended December 31, 2000, as
filed with the SEC on April 2, 2001
10.21 Settlement Agreement, dated August 3, 2001, by Incorporated by reference to Exhibit 10.48 to
and between the Company and Novamont the Company's Quarterly Report on Form 10-Q,
for the quarter ended June 30, 2001, as filed
with the SEC on August 14, 2001
10.22 Amendment to Common Stock Purchase Agreement Incorporated by reference to Exhibit 10.49 to
dated March 28, 2001 the Company's Quarterly Report on Form 10-Q,
for the quarter ended June 30, 2001, as filed
with the SEC on August 14, 2001
10.23 Securities Purchase Agreement, dated as of Incorporated by reference to Exhibit 4.1 to
August 12, 2002, by and between the Company and the Company's Current Report on Form 8-K, as
the Investors listed therein filed with the SEC on August 12, 2002
10.24 Loan Agreement, dated as of September 9, 2002, Incorporated by reference to Exhibit 10.1 to
by and between the Company and E. Khashoggi the Company's Current Report on Form 8-K dated
Industries, LLC September 17, 2002
10.25 Second Amendment to the Amended and Restated Incorporated by reference to Exhibit 10.54 to
License Agreement, dated 29 July, 2002, by and the Company's Quarterly Report on Form 10-Q,
between the Company and E. Khashoggi Industries, for the quarter ended September 30, 2002, as
LLC filed with the SEC on November 15, 2002
10.26 License and Information Transfer Agreement, Incorporated by reference to Exhibit 10.55 to
dated 29 July, 2002, by and between the Biotec the Company's Quarterly Report on Form 10-Q,
Group and the Company for the quarter ended September 30, 2002, as
filed with the SEC on November 15, 2002
10.27 Loan and Securities Purchase Agreement, dated as Incorporated by reference to Exhibit 4.1 to
of March 5, 2003, by and between the Company and the Company's Current Report on Form 8-K, as
the Investors listed therein filed with the SEC on March 7, 2003
10.28 Sublicense Agreement, dated February 20, 2004, Incorporated by reference to Exhibit 10.30 to
by and between the Company and Hood Packaging the Company's Annual Report on Form 10-K, for
Corporation the fiscal year ended December 31, 2003, as
filed with the SEC on April 14, 2004
10.29 Operating and Sublicense Agreement, dated Incorporated by reference to Exhibit 10.31 to
October 3, 2002, by and between the Company and the Company's Annual Report on Form 10-K, for
Sweetheart Cup Company, Inc. the fiscal year ended December 31, 2003, as
filed with the SEC on April 14, 2004
10.30 First Amendment to Operating and Sublicense Incorporated by reference to Exhibit 10.32 to
Agreement, dated July 2003, by and between the the Company's Annual Report on Form 10-K, for
Company and Sweetheart Cup Company, Inc. the fiscal year ended December 31, 2003, as
filed with the SEC on April 14, 2004
10.31 Lease Agreement, dated July 2003, by and between Incorporated by reference to Exhibit 10.33 to
the Company and Sweetheart Cup Company, Inc. the Company's Annual Report on Form 10-K, for
the fiscal year ended December 31, 2003, as
filed with the SEC on April 14, 2004
II-7
EXHIBIT NO. DESCRIPTION LOCATION
----------- ---------------------------------------------- ---------------------------------------------
10.32 First Amendment to Lease Agreement, dated Incorporated by reference to Exhibit 10.34 to
December 16, 2003, by and between the Company the Company's Annual Report on Form 10-K, for
and Sweetheart Cup Company, Inc. the fiscal year ended December 31, 2003, as
filed with the SEC on April 14, 2004
10.33 Sublicense Agreement, dated November 11, 2004, Incorporated by reference to Exhibit 10.37 to
by and between the Company and EarthShell the Company's Annual Report on Form 10-K, for
Hidalgo S.A. de C.V. the fiscal year ended December 31, 2004, as
filed with the SEC on April 14, 2005
10.34 Standby Equity Distribution Agreement, dated as Incorporated by reference to Exhibit 99.1 to
of March 23, 2005, by and between the Company the Company's Current Report on Form 8-K, as
and Cornell Capital Partners, LP filed with the SEC on March 29, 2005
10.35 Registration Rights Agreement, dated as of March Incorporated by reference to Exhibit 99.2 to
23, 2005, by and between the Company and Cornell the Company's Current Report on Form 8-K, as
Capital Partners, LP filed with the SEC on March 29, 2005
10.36 Placement Agent Agreement, dated as of March 23, Incorporated by reference to Exhibit 99.3 to
2005, by and among the Company, Cornell Capital the Company's Current Report on Form 8-K, as
Partners, LP and Sloan Securities Corporation filed with the SEC on March 29, 2005
10.37 Security Agreement, dated as of March 23, 2005, Incorporated by reference to Exhibit 99.4 to
by and between the Company and Cornell Capital the Company's Current Report on Form 8-K, as
Partners, LP filed with the SEC on March 29, 2005
10.38 Promissory Note, dated as of March 23, 2005, Incorporated by reference to Exhibit 99.5 to
issued by the Company to Cornell Capital the Company's Current Report on Form 8-K, as
Partners, LP filed with the SEC on March 29, 2005
10.39 Promissory Note, dated as of May 26, 2005, Incorporated by reference to Exhibit 99.1 to
issued by the Company to Cornell Capital the Company's Current Report on Form 8-K, as
Partners, LP filed with the SEC on May 27, 2005
10.40 Pledge and Escrow Agreement, dated as of May 26, Incorporated by reference to Exhibit 99.2 to
2005, by and among the Company, Cornell Capital the Company's Current Report on Form 8-K, as
Partners, LP and David Gonzalez, Esq. filed with the SEC on May 27, 2005
10.41 Meridian Business Solutions, Ltd. Sublicense Incorporated by reference to Exhibit 10.1 to
Agreement, dated May 13, 2004, by and between the Company's Quarterly Report on Form 10-Q,
the Company and Meridian Business Solutions, Ltd. for the quarter ended September 30, 2004, as
filed with the SEC on November 9, 2004
10.42 Amended and Restated Debenture Purchase Incorporated by reference to Exhibit 10.2 to
Agreement, dated September 30, 2004, by and the Company's Quarterly Report on Form 10-Q,
among the Company, E. Khashoggi Industries, Inc. for the quarter ended September 30, 2004, as
and SF Capital Partners, Ltd. filed with the SEC on November 9, 2004
10.43 Amended and Restated Debenture Purchase Incorporated by reference to Exhibit 10.3 to
Agreement, dated September 29, 2004, by and the Company's Quarterly Report on Form 10-Q,
among the Company, E. Khashoggi Industries, LLC for the quarter ended September 30, 2004, as
and Omicron Master Trust filed with the SEC on November 9, 2004
10.44 Amended and Restated Debenture Purchase Incorporated by reference to Exhibit 10.44(20) to
Agreement, dated September 29, 2004, by and the Company's Registration Statement on Form S-1
among the Company, E. Khashoggi Industries, and Amendments thereto, File No. 333-1327,
LLC on and Islandia, Ltd. as filed with the SEC on June 9, 2005
II-8
EXHIBIT NO. DESCRIPTION LOCATION
----------- ----------- --------
10.45 Amended and Restated Debenture Purchase Incorporated by reference to Exhibit 10.45(20) to
Agreement, dated September 29, 2004, by and the Company's Registration Statement on Form S-1 and,
among the Company, E. Khashoggi Industries, LLC Amendments thereto, File No. 333-1327,
and Midsummer Investment as filed with the SEC on June 9, 2005
10.46 Conversion Agreement, dated July 20, 2004, by Incorporated by reference to Exhibit 10.46(20) to
and among the Company, E. Khashoggi Industries, the Company's Registration Statement on Form S-1 and,
LLC and RHP Master Fund, Ltd. Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.47 Amended and Restated Debenture Purchase Incorporated by reference to Exhibit 10.47(20) to
Agreement, dated September 29, 2004, by and the Company's Registration Statement on Form S-1 and,
among the Company, E. Khashoggi Industries, LLC Amendments thereto, File No. 333-1327,
and Straus-GEPT L.P. as filed with the SEC on June 9, 2005
10.48 Amended and Restated Debenture Purchase Incorporated by reference to Exhibit 10.48(20) to
Agreement, dated September 29, 2004, by and the Company's Registration Statement on Form S-1 and,
among the Company, E. Khashoggi Industries, Ltd. Amendments thereto, File No. 333-1327,
and Straus Partners, L.P. as filed with the SEC on June 9, 2005
10.49 Amended and Restated Debenture Purchase Incorporated by reference to Exhibit 10.49(20) to
Agreement, dated September 30, 2004, by and the Company's Registration Statement on Form S-1 and,
among the Company and E. Khashoggi Industries, Amendments thereto, File No. 333-1327,
LLC as filed with the SEC on June 9, 2005
10.50 Agreement To Convert Debt To Equity, dated Incorporated by reference to Exhibit 10.50 to
July 16, 2004, by and between the Company and E. the Company's Registration Statement on Form S-1 and,
Khashoggi Industries, LLC Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.51 Agreement dated September 1, 2004 for conversion Incorporated by reference to Exhibit 10.51(20) to
of Biotec indebtedness the Company's Registration Statement on Form S-1 and,
Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.52 Stock Purchase Agreement, dated August 5, 2004, Incorporated by reference to Exhibit 10.52(20) to
by and between the Company and Meridian Business the Company's Registration Statement on Form S-1 and,
Solutions, Ltd. Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.53 Warrant, dated issued by the Company to Incorporated by reference to Exhibit 99.4 to
Cornell Capital Partners, LP the Company's Current Report on Form 8-K dated
May 27, 2005
14.1 Code of Ethics Incorporated by reference to Exhibit 14.4 to
the Company's Annual Report on Form 10-K, for
the fiscal year ended December 31, 2003, as
filed with the SEC on April 4, 2004
23.1 Consent of Kirkpatrick & Lockhart Nicholson Provided herewith (included in Exhibit 5.1)
Graham LLP
23.2 Consent of Farber Hass Hurley & McEwen, Provided herewith
LLP (Formerly Farber & Hass, LLP
II-9
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 1933
Act (the "1933 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 SEC pursuant to Rule 424(b) if, in the aggregate, the changes in
volume and price represent no more than twenty percent (205) 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 1933
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 SEC such indemnification is
against public policy as expressed in the 1933 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 1933 Act and
will be governed by the final adjudication of such issue.
II-10
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, as
amended, 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
February 14, 2006.
EARTHSHELL CORPORATION
Date: February 14, 2006 By: /s/ Vincent J. Truant
----------------------
Name: Vincent J. Truant
Title: Chief Executive Officer
Date: February 14, 2006 By: /s/ D. Scott Houston
----------------------
Name: D. Scott Houston
Title: Chief Financial Officer and Secretary
In accordance with the Securities Exchange Act of 1934, as amended, 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/ Vincent J. Truant Date: February 14, 2006
--------------------------------------------
Vincent J. Truant
Chief Executive Officer and Director
/s/ D. Scott Houston Date: February 14, 2006
--------------------------------------------
D. Scott Houston
Chief Financial Officer, Secretary and Director
/s/ Hamlin Jennings Date: February 14, 2006
--------------------------------------------
Hamlin Jennings
Director
/s/ Walker Rast Date: February 14, 2006
--------------------------------------------
Walker Rast
Director
II-11