<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark one)
/X/ Quarterly Report Under Section 13 or 15(d) of the Securities
Exchange Act of 1934
For Quarter Ended July 31, 1998
or
/ / Transition Report Under Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number: 33-23460-LA
AQUASEARCH, INC.
(Exact name of Registrant as specified in its charter)
Colorado 33-0034535
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization
73-4460 QUEEN KA'AHUMANU HIGHWAY, SUITE 110
KAILUA-KONA, HAWAII 96740
(Address of principal executive offices)
(808) 326-9301
Registrant's telephone number, including area code
Not Applicable
--------------
Former Name, Former Address and Former Fiscal
Year, if Changes Since Last Report
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter periods as the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
--- ---
The number of shares outstanding of Registrant's Common Stock, $0.0001 par value
at July 31, 1998 was 65,358,885 shares.
<PAGE>
AQUASEARCH, INC.
FORM 10-QSB FOR THE
QUARTER ENDED JULY 31, 1998
CONTENTS
<TABLE>
<S> <C>
PART I - FINANCIAL INFORMATION Page
ITEM 1: FINANCIAL STATEMENTS
BALANCE SHEETS 3
STATEMENTS OF LOSS AND ACCUMULATED DEFICIT 4,5
STATEMENTS OF CASH FLOWS 6
NOTES TO FINANCIAL STATEMENTS 7
ITEM 2: MANAGEMENT'S PLAN OF OPERATION
OVERVIEW 8
MANAGEMENT'S PLAN OF OPERATION FOR THE NEXT TWELVE MONTHS 12
RESULTS OF OPERATIONS -- COMPARISON OF QUARTERS AND
NINE MONTHS ENDED JULY 31, 1997 AND 1998 14
LIQUIDITY AND CAPITAL RESOURCES 14
PART II - OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS 15
ITEM 2: CHANGES IN SECURITIES 15
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 16
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 16
ITEM 5: OTHER INFORMATION 16
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K 16
SIGNATURE 17
</TABLE>
2
<PAGE>
Aquasearch, Inc.
(A Development Stage Enterprise)
Balance Sheets
<TABLE>
<CAPTION>
October 31, July 31,
1997 1998
(Audited) (Unaudited)
----------------------------
<S> <C> <C>
Assets
Current assets:
Cash $ 47,006 $ 666,025
Accounts receivable 1,219 -
Prepaid expenses 24,439 66,216
Refundable deposits 4,570 7,325
----------------------------
Total current assets 77,234 739,566
----------------------------
Notes receivable 30,516 109,696
Plant and equipment:
Plant 738,889 1,156,285
Equipment 173,052 202,595
Less accumulated depreciation (104,894) (173,383)
----------------------------
Net plant and equipment 807,047 1,185,497
----------------------------
Total assets $ 914,797 $ 2,034,759
----------------------------
----------------------------
Liabilities and Stockholders' Equity (Deficit)
Current liabilities:
Accounts payable $ 446,344 $ 502,215
Notes payable 575,000 265,000
----------------------------
Total current liabilities 1,021,344 767,215
----------------------------
Stockholders' Equity (Deficit)
Preferred stock (5,000,000 shares authorized) - -
Common stock ($0.0001 par value, 100,000,000
shares authorized, 47,819,881and 65,358,885,
shares outstanding at October 31, 1997, and
July 31,1998) 5,904 7,657
Additional paid-in capital 4,699,470 7,689,735
Deficit accumulated during the development stage (4,811,921) (6,429,848)
----------------------------
Total stockholders' equity (deficit) (106,547) 1,270,772
----------------------------
Total liabilities and stockholders' equity
(deficit) $ 914,797 $ 2,034,759
----------------------------
----------------------------
</TABLE>
3
<PAGE>
Aquasearch, Inc.
(A Development Stage Enterprise)
Statements of Loss and Accumulated Deficit
<TABLE>
<CAPTION>
For the Period For the Three For the Nine
From Inception Months Ended Months Ended
To July 31, July 31, July 31,
1998 1998 1998
(Unaudited) (Unaudited) (Unaudited)
-------------------------------------------
<S> <C> <C> <C>
Sales $ 11,077 $ - $ -
Cost of sales 23,464 - -
-------------------------------------------
Gross profit (loss) (12,387) - -
Research and development costs 2,752,740 320,514 866,204
General and administrative
expenses 3,339,694 218,562 634,446
-------------------------------------------
Loss from operations (6,104,821) (539,076) (1,500,650)
Other Income (Expense)
Interest (119,844) (79,322) (114,662)
Other (9,317) (2,291) (2,615)
Investment in joint venture (147,096) - -
-------------------------------------------
Total other income (expense) (276,257) (81,613) (117,277)
-------------------------------------------
Loss before income taxes and
extraordinary item (6,381,078) (620,689) (1,617,927)
Extraordinary item - loss on write
down of assets to liquidation
basis (14,502) - -
-------------------------------------------
Loss before income taxes (6,395,580) (620,689) (1,617,927)
Federal and State income taxes - - -
-------------------------------------------
Net loss (6,395,580) (620,689) (1,617,927)
Accumulated Deficit
Balance, beginning of period (34,268) (5,809,159) (4,811,921)
-------------------------------------------
Balance, end of period $(6,429,848) $(6,429,848) $(6,429,848)
-------------------------------------------
-------------------------------------------
Loss per share $ (0.28) $ (0.01) $ (0.03)
-------------------------------------------
-------------------------------------------
Weighted average shares outstanding 22,936,599 45,713,543 44,159,602
-------------------------------------------
-------------------------------------------
</TABLE>
4
<PAGE>
Aquasearch, Inc.
(A Development Stage Enterprise)
Statements of Loss and Accumulated Deficit
<TABLE>
<CAPTION>
For the Period For the Three For the Nine
From Inception Months Ended Months Ended
To July 31, July 31, July 31,
1998 1997 1997
(Unaudited) (Unaudited) (Unaudited)
------------------------------------------
<S> <C> <C> <C>
Sales $ 1,077 $ 146 $ 1,077
Cost of sales 23,464 - -
------------------------------------------
Gross profit (loss) (12,387) - 1,077
Research and development costs 2,752,740 152,717 551,543
General and administrative
expenses 3,339,694 297,231 644,878
------------------------------------------
Loss from operations (6,104,821) (449,802) (1,195,344)
Other Income (Expense)
Interest (119,844) 223 4,448
Other (9,317) 411 217
Investment in joint venture (147,096) - -
------------------------------------------
Total other income (expense) (276,257) 634 4,665
------------------------------------------
Loss before income taxes and
extraordinary item (6,381,078) (449,168) (1,190,679)
Extraordinary item - loss on write
down of assets to liquidation
basis (14,502) (464) (464)
------------------------------------------
Loss before income taxes (6,395,580) (449,632) (1,191,143)
Federal and State income taxes - - -
------------------------------------------
Net loss (6,395,580) (449,632) (1,191,143)
Accumulated Deficit
Balance, beginning of period (34,268) (3,690,229) (2,948,718)
------------------------------------------
Balance, end of period $(6,429,848) $(4,139,861) $(4,139,861)
------------------------------------------
------------------------------------------
Loss per share $ (0.28) $ (0.01) $ (0.03)
------------------------------------------
------------------------------------------
Weighted average shares outstanding 22,936,599 45,713,543 44,159,602
------------------------------------------
------------------------------------------
</TABLE>
5
<PAGE>
Aquasearch, Inc.
(A Development Stage Enterprise)
Statements of Cash Flows
<TABLE>
<CAPTION>
For the Period For the Nine For the Nine
From Inception Months Ended Months Ended
To July 31, July 31, July 31,
1998 1997 1998
(Unaudited) (Unaudited) (Unaudited)
-----------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows from Operating Activities
Net loss $ (6,395,580) $ (1,191,143) $ (1,617,927)
Adjustments to reconcile net loss
to net cash used in operating
activities:
Amortization 3,527 - -
Depreciation 179,091 42,057 68,490
Expenses paid with common stock 901,643 - -
Loss on write down of assets to
liquidation basis 5,392 - -
Changes in:
Other current assets (73,340) (66,959) (44,532)
Receivables - 414 1,219
Accounts payable 272,178 (3,783) (90,453)
Deposits held - (460,980) -
-----------------------------------------------------------------
Cash used in operating activities (5,107,089) (1,680,394) (1,536,879)
Cash Flows from Investing Activities
Purchase of fixed assets (1,268,464) (98,728) (446,939)
-----------------------------------------------------------------
Cash used in investing activities (1,268,464) (98,728) (446,939)
Cash Flows from Financing Activities
Cash (held in) released from escrow - 460,980 -
Increase in notes receivable (109,696) - (79,180)
Issuance of common stock 7,128,340 1,264,695 2,992,018
Increase (decrease) in notes payable 294,800 100,000 310,000
Offering costs (271,919) (156,213) -
-----------------------------------------------------------------
Cash provided by financing activities 7,041,525 1,669,462 2,602,838
-----------------------------------------------------------------
Net increase (decrease) in cash 665,972 (109,660) 619,020
Cash, beginning of the period 54 187,166 47,006
-----------------------------------------------------------------
Cash, end of the period $ 666,026 $ 77,506 $ 666,026
-----------------------------------------------------------------
-----------------------------------------------------------------
</TABLE>
6
<PAGE>
Aquasearch, Inc.
(A Development Stage Enterprise)
NOTES TO FINANCIAL STATEMENTS
July 31, 1998
(Unaudited)
1. COMMON STOCK AND STOCK PURCHASE WARRANTS
As of July 31, 1998, there were a total of 8,291,931 Common Stock Purchase
Warrants (the "Warrants") issued and outstanding, of which 5,347,244 Warrants
had an exercise price of $1.00 per share, 25,974 Warrants had an exercise
price of $0.21 per share, and 2,918,713 Warrants had an exercise price of $0.50
per share. No Warrants were exercised during the three months ended July 31,
1998. The $1.00 per share Warrants are redeemable by the Company at $.01 per
Warrant during their three-year exercise period upon 30 days' notice anytime
that the closing bid price per share of the Common Stock exceeds $1.50 per share
for 20 trading days out of 30 consecutive trading days ending on the third day
prior to the date of the notice of redemption.
An analysis of the changes in stockholders' equity is as follows:
<TABLE>
<CAPTION>
Shares of Additional Total
Common Common Paid-In Accumulated Stockholders'
Description Stock Stock Capital Deficit Equity (Deficit)
-----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance, April 30, 1998 47,819,881 $ 5,904 $ 4,699,470 $ (5,809,159) $ (1,103,785)
Conversion of convertible
notes to common stock
($0.173 per share) 16,870,520 1,686 2,915,274 2,916,961
Stock issued for services
($0.25 per share) 201,622 20 45,859 45,879
Exercise of options for
stock ($0.625 per share) 466,862 47 29,132 29,179
Loss for the three months
ended July 31, 1998 -- -- -- (620,689) (620,689)
-----------------------------------------------------------------------------------------
Balance, July 31, 1998 65,358,885 $ 7,657 $ 7,689,735 $ (6,429,848) $ 1,270,772
-----------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------
</TABLE>
On November 14, 1996, the Company executed a Letter of Intent with C.
Brewer and Company, Limited ("C. Brewer") with respect to the acquisition by the
Company of between 80 and 90 acres of property in the Ka'u region of the Big
Island of Hawaii valued at between $900,000 and $1,000,000 in exchange for the
issuance to C. Brewer of between 2,570,000 and 2,850,000 shares of Common Stock
of the Company (the "C. Brewer Common Stock") at a purchase price of $0.35 per
share. In addition, C. Brewer acquired a three-year warrant (the "C. Brewer
Warrant") to purchase up to 500,000 shares of Common Stock at a purchase price
of $1.25 per share. The stockholders' equity at July 31, 1998 does not reflect
the issuance of the C. Brewer Common Stock or the C. Brewer Warrant. The
Company does not yet wish to finalize its agreement with C. Brewer. Aquasearch
initially intended to complete the C. Brewer transaction in order to have
sufficient property on which to expand its production capability to 40 kg
astaxanthin per month. However, improvements in productivity of astaxanthin
have rendered the Brewer land acquisition unnecessary at present.
7
<PAGE>
3. MANAGEMENT'S REPRESENTATIONS OF INTERIM FINANCIAL INFORMATION
These financial statements reflect all adjustments which are, in the
opinion of management, necessary to a fair statement of the results of
operations for the interim period presented. These adjustments are of a normal
and recurring nature.
ITEM 2. MANAGEMENT'S PLAN OF OPERATION
THE FOLLOWING DISCUSSION OF MANAGEMENT'S PLAN OF OPERATION CONTAINS CERTAIN
FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 21E OF THE SECURITIES
EXCHANGE ACT OF 1934, AS AMENDED, INCLUDING STATEMENTS THAT INDICATE WHAT THE
COMPANY "BELIEVES," "EXPECTS" AND "ANTICIPATES" OR SIMILAR EXPRESSIONS. THESE
STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS
WHICH MAY CAUSE ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS OF THE COMPANY TO
DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING
STATEMENTS. SUCH FACTORS INCLUDE, AMONG OTHERS, THE INFORMATION CONTAINED UNDER
THE CAPTION "FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS" IN THE COMPANY'S
ANNUAL REPORT ON FORM 10-KSB FOR THE FISCAL YEAR ENDED OCTOBER 31, 1997 (THE
"1997 FORM 10-KSB"). THE READER IS CAUTIONED NOT TO PLACE UNDUE RELIANCE ON
THESE FORWARD-LOOKING STATEMENTS, WHICH REFLECT MANAGEMENT'S ANALYSIS ONLY AS
OF THE DATE OF THIS QUARTERLY REPORT ON FORM 10-QSB. THE COMPANY UNDERTAKES NO
OBLIGATION TO PUBLICLY RELEASE THE RESULTS OF ANY REVISION OF THESE
FORWARD-LOOKING STATEMENTS. THE READER IS STRONGLY URGED TO READ THE
INFORMATION SET FORTH UNDER THE CAPTION "FACTORS THAT MAY AFFECT FUTURE
OPERATING RESULTS" IN THE 1997 FORM 10-KSB FOR A MORE DETAILED DESCRIPTION OF
THESE SIGNIFICANT RISKS AND UNCERTAINTIES.
OVERVIEW
INCEPTION THROUGH JULY 31, 1998. Aquasearch, Inc. ("Aquasearch" or the
"Company") has been engaged, since its inception in 1989, in the development of
proprietary photobioreactor technology for commercial cultivation of microalgae.
In 1994, the Company initiated discussions with Cultor Ltd. ("Cultor"), a
Helsinki-based foods conglomerate that is the second largest producer of salmon
and trout feed in the world, regarding the purchase of microalgae rich in
astaxanthin - the primary pigment used in salmon and trout feed. In early 1995,
Cultor completed a series of feeding trials with farmed salmon, using the
Company's microalgae product. In July 1995, the Company entered into a Supply
Agreement with Svenska Foder AB (the "Svenska Foder Supply Agreement"), then a
subsidiary of Cultor, pursuant to which Svenska Foder agreed to act as exclusive
distributor of the Company's natural astaxanthin product for animal feed and
animal nutrition applications in Sweden, Norway and Finland for poultry, pigs,
cattle and horses. The Svenska Foder Supply Agreement had a term of three
years, and target production of five kilograms of natural astaxanthin per month.
In October 1995, the Company completed construction of a one-acre research and
development/production facility in the HOST Business Park at Keahole Point,
Kailua-Kona, Hawaii.
On May 14, 1996, the Company entered into a three-year Distribution
and Development Agreement with Cultor (the "Cultor Distribution and Development
Agreement"), which was approved by the shareholders of the Company on September
24, 1996, pursuant to which the Company will act as the exclusive worldwide
supplier of natural astaxanthin derived from microalgae to Cultor in the field
of
8
<PAGE>
animal feed and animal nutrition and Cultor will act as the exclusive
worldwide distributor of Aquasearch's natural astaxanthin product in the
field of animal feed and animal nutrition. The Cultor Distribution and
Development Agreement originally called for production targets of 40
kilograms per month by September 1997 and 120 kilograms per month by
September 1998. By mutual agreement, the initial Aquasearch production
targets were each extended one year and, in addition, the focus of both
parties' development efforts were shifted from achieving monthly production
targets to achieving long-term production economics. Since the Cultor
Distribution and Development Agreement was signed, Cultor has devoted
substantial resources to developing its Aquaxan-Registered Trademark- animal
feed and animal nutrition product (which incorporates Aquasearch's natural
astaxanthin), including conducting extensive product formulation research and
feeding trials. During the past several quarters, the Company has achieved
and sustained significant improvements in virtually every phase of its
production process. As a result of these developments, the Company is
expanding its existing one-acre facility to a three-acre facility and
increasing its production capacity. Based on the current production rate of
existing AGMs, the Company estimates that the expanded facility could produce
more than 80 kilograms of astaxanthin per month if sufficient space were
available for finishing ponds. However, since space for finishing ponds at
the Keahole Point site is constrained, the Company (with Cultor's approval)
expects to limit astaxanthin production to approximately 25 kilograms per
month at the expanded site. The extra module capacity at the expanded site
will be used for further optimization of the astaxanthin production process
and the development and scale-up of new microalgal products.
The Cultor Distribution and Development Agreement currently provides
that, in the event that Cultor exercises its option to create a joint venture
company with Aquasearch to produce natural astaxanthin, Aquasearch would
contribute a natural astaxanthin production facility to be constructed at a
later date in return for a 50% stake in the new company and Cultor would
contribute cash equal to the appraised value of Aquasearch's production
facility in return for a 50% stake. In addition, Cultor had the option to
increase its stake in the new company by purchasing from Aquasearch a further
25% of the new company (thus increasing Cultor's stake to 75%) for cash based
on a formula. In view of the recent advancements achieved in astaxanthin
production, and pending further discussions with Cultor, Aquasearch currently
plans to develop a second site for large-scale astaxanthin production that
would be larger than the site initially contemplated in the Cultor
Distribution and Development Agreement and would have a production capacity
significantly greater than 120 kilograms per month. There is currently no
agreement between Aquasearch and Cultor as to if, or when, a second site
would be constructed, what the size, location or production capacity of such
a site would be, or how the construction or scale-up of this facility would
be financed. There can be no assurances that Aquasearch and Cultor will
reach an agreement regarding the development, timing, location or financing
of a second site, whether the Cultor Distribution and Development Agreement
would need to be amended or terminated to accomodate these plans, or whether
Cultor would have any role in connection with this project. The expansion of
the Keahole Point site and the construction and scale-up of any additional
production site will involve various risks and uncertainties. See "Risk
Factors -- Risks Associated With Scale-Up of Production Facilities" in the
1997 Form 10-KSB.
On July 30, 1996 the Company was awarded U.S. Patent Number 5,541,056 for a
"Method of Control of Microorganism Growth Process," which claims certain
processes that operate in the Company's proprietary, closed-system
photobioreactor system, the Aquasearch Growth Module. The Company's U.S. filing
was made under the provisions of the Patent Cooperation Treaty, and the Company
is in the process of pursuing international patents pursuant thereto.
On September 24, 1996, the Company's shareholders approved: (i) the Cultor
Distribution and Development Agreement; (ii) a Stock Subscription Agreement with
Cultor pursuant to which Cultor agreed to purchase 400,000 shares of the
Company's Common Stock at a purchase price of $0.50 per
9
<PAGE>
share (the "Cultor Stock Subscription Agreement"); and (iii) an amendment to the
Company's Articles of Incorporation to increase the number of shares of Common
Stock that the Company is authorized to issue from 50,000,000 shares to
100,000,000 shares and authorized the creation and issuance from time to time of
up to 5,000,000 shares of Preferred Stock in one or more series with such
designations, rights, preferences, privileges and restrictions as the Board of
Directors may determine.
In October 1996, the Company's consultants completed the initial phase of
the design work for the Company's planned intermediate expansion from a one-acre
facility to a three-acre facility. Construction of expanded production
facilities began in the second quarter of 1998 and is expected to be completed
in November 1998. The construction of these expanded facilities is dependent
upon the timely performance of a variety of contractors and sub-contractors, the
availability of supplies and equipment, and the availability of requisite
capital. While the Company has certain plans to address all these requirements,
there can be no assurance that the Company will be able to complete its
expansion in a timely manner.
On October 22, 1996, Cultor acquired 400,000 shares of the Company's Common
Stock pursuant to the terms of the Cultor Stock Subscription Agreement.
In December 1996, Cultor sold its majority stake in Svenska Foder and
acquired all of Svenska Foder's rights under the Svenska Foder Supply Agreement.
In February 1997, the Company completed a private placement of a total of
5,044,570 Units, consisting of one share of Common Stock and one Common Stock
Purchase Warrant (the "Warrants"). The purchase price of the Units ranged from
$0.21 per Unit to $0.43 per Unit. The Warrants have a term of three years and
are exercisable at $1.00 per share, subject to adjustment. The Warrants are
redeemable by the Company at $.01 per Warrant upon 30 days' notice anytime that
the closing bid price per share of the Common Stock exceeds $1.50 per share for
20 trading days out of 30 consecutive trading days ending on the third day prior
to the date of the notice of redemption. The net proceeds from this offering,
net of placement agent fees and commissions, were $1,105,421.
On June 25, 1997 the Company was awarded a European Patent number 0494887
for the "Process and Apparatus for the Production of Photosynthetic Microbes"
which claims certain processes that operate in the Company's proprietary,
closed-system photobioreactor system, the Aquasearch Growth Module, and the
means for automated process control. The patent was awarded by the European
Patent Office, and applies in all member nations of the European Union.
In July 1997, Aquasearch agreed to become a charter member of the Marine
Bioprocess Engineering Center (MarBEC) initiative launched by the University of
Hawaii at Manoa. More than 160 universities -- including University of Hawaii
- -- competed nationwide for a total of five Engineering Research Centers to be
awarded by the National Science Foundation. In August 1998, the University of
Hawaii was notified by the National Science Foundation that it was one of the
five winners. Charter industry members (including Aquasearch, Merck, Monsanto,
Hoechst and Eastman Chemical) will have equal preferential rights to new
products from microalgae developed by MarBEC. Aquasearch believes that it is
the only charter member of MarBEC that has developed photobioreactor technology,
which is likely to be required for the commercial exploitation of any new
product from microalgae.
AUGUST 1, 1997 THROUGH JULY 31, 1998. The Company has experienced certain
significant developments over the past twelve months.
10
<PAGE>
Aquasearch placed great emphasis in the past nine months on optimizing the
Aquasearch Growth Module and its performance. The Company believes that it
has made significant advances in several key areas of it's production
technology during this period, including: (i) biology-based improvements;
(ii) advanced production procedures; (iii) significant increases in AGM size;
and (iv) production automation advancements. These improvements resulted in
a fifteen-fold increase in productivity (weight of Astaxanthin per unit of
production capacity) and sustained operation for a nine-month period of the
largest photobioreactor the Company has operated to date, and which the
Company believes to be the largest photobioreactor in existence.
During the past nine months the Company has increased the size of its
largest AGM from 1,000 gallons to 4,000 gallons. The larger AGM is not only
less costly, but requires less labor, operates for a longer period of time
and has significantly greater productivity than the smaller version. The
Company has conducted intensive engineering studies on an even larger model
AGM of more than 7,000 gallons that has now been designed, and is slated for
construction in the fall of 1998. Management anticipates replacing all
production capacity with the new, very large AGMs in 1998, contingent on
available capital. The Company believes that the use of these very large
AGMs will increase current total production capacity by a factor of more than
six with no increase in labor costs.
Aquasearch began replacing its computer control system with
state-of-the-art industrial process control in 1997. Improvements that are
still underway have already reduced labor and hardware costs, and have provided
significantly better quality control. The Company believes that its process
control system is already greatly advanced compared to the standard in
biology-based manufacturing. Aquasearch continues to develop certain
proprietary process control software that it believes will provide a
significant competitive advantage over other known systems.
The Company introduced in late 1997 certain changes in nutrient media
formulation, sterility procedures and other practices resulting from its
research that have significantly enhanced productivity.
In September 1997, Aquasearch executed a Letter of Intent with Inflazyme
Pharmaceuticals, Limited ("Inflazyme") to enter into a ten-year drug development
and manufacturing agreement. Under the terms of the agreement, Aquasearch would
produce large-scale research quantities of several thousand different microalgae
in its AGM photobioreactors. Inflazyme would investigate each species for
therapeutic activity in the areas of inflammation, cancer, blood and
cardiovascular diseases. Aquasearch would receive cost-plus reimbursement of
all its research costs (including dedicated physical facilities); potential
milestone payments associated with steps in the U.S. Food and Drug
Administration drug approval process; and royalties on future net product sales.
The conversion of this Letter of Intent into a final Screeening and Drug
Development Agreement has been delayed due to management changes within
Inflazyme. Given the extended delay, there can be no assurances as to when or
if a final agreement will be consummated.
In July 1998, the holders of $2,805,000 aggregate principal amount of
Convertible Notes exercised their option to convert their Notes into shares
of Common Stock. The Company will issue 16,870,520 shares of Common Stock
upon conversion of the outstanding principal and interest on the Convertible
Notes. In addition, the Company will also issue 2,918,713 Warrants under
the provisions of the Convertible Notes. The Warrants have an exercise price
of $0.50 per share and term of three years. The financial statements as of
July 31, 1998 reflect the conversion of the Convertible Notes into shares of
Common Stock.
11
<PAGE>
The Company is currently in preliminary discussions with a major U.S.
chemical company and major Japanese food/pharmaceutical company with respect to
the development of certain human nutritional supplements or nutraceuticals. The
Company is also in late-stage discussions with (i) a smaller U.S. distribution
and extraction company with respect to the possible formation of a joint venture
to commercialize microalgae in the nutraceutical and/or pharmaceutical markets
and (ii) a possible strategic alliance with a U.S. biotechnology company for the
purpose of developing a library of microalgae-derived compounds for
pharmaceutical and/or agricultural biotechnology screening purposes. There can
be no assurances as to when or if these discussions will lead to the execution
of a letter of intent or final agreement, or whether the terms of such
arrangements will be attractive to the Company.
The Company has added three new members to its Scientific Advisory Board in
early 1998, increasing its expertise in genetics and microbiology. Aquasearch
has an active Scientific Advisory Board consisting of thirteen Ph.D.s with
expertise in the fields of aquaculture, marine biology, fluid dynamics, and the
chemistry, photobiology, physiology, genetics and mass culture of microalgae.
MANAGEMENT'S PLAN OF OPERATION FOR THE NEXT TWELVE MONTHS
During the next twelve months, Aquasearch intends to focus its efforts
on strengthening its intellectual property position, optimizing the
performance of its proprietary AGM technology, expanding its production
capacity, initiating a business in pharmaceutical drug development, and
improving productivity through employee incentives.
- - INTELLECTUAL PROPERTY: The Company is maintaining numerous international
patent applications under the aegis of the Patent Cooperation Treaty, and
contemplates new filings that will enhance its formal claims to
intellectual property. At the same time, Aquasearch continues to develop
certain trade secrets that management believes will enhance its
intellectual property position.
- - TECHNOLOGY IMPROVEMENT: Aquasearch intends to enlarge the size of its
proprietary AGM from 4,000 to 7,000 gallons during 1998. Furthermore, the
process control system is slated for hardware and software improvements,
which the Company believes will reduce capital and labor costs and improve
productivity.
- - EXPANSION OF PRODUCTION CAPACITY: Aquasearch began construction in early
1998 to increase the size of its Keahole Point research and
development/production facility from one acre to three acres. Construction
is expected to be completed in November 1998, and is anticipated to
augment its production capacity to approximately 25 kilograms per month
(given existing pond finishing constraints). Pending further discussions
with Cultor, the Company currently plans to develop a second site for
large-scale astaxanthin production. It is currently contemplated that this
second site would be larger than initially contemplated in the Cultor
Distribution and Development Agreement and would have a production
capacity significantly greater than 120 kilograms per month.
- - PHARMACEUTICAL DRUG DEVELOPMENT: Aquasearch intends to pursue drug
development agreements with several biotechnology and pharmaceutical
companies. The Company believes that the consummation of such agreements
will cover the significant portion of the Company's pharmaceutical
research and development costs. The Company believes that additional
personnel will need to be hired to perform such projects, but the Company
intends to keep its current personnel entirely focused on
astaxanthin-related science and technology. New personnel hired for drug
development work will be dedicated entirely to those projects and will
function as a separate team, which costs will
12
<PAGE>
be borne by strategic partners. The Company believes that additional
laboratory facilities may also be required for drug development activities.
The Company intends that costs for such dedicated facilities will be borne
by strategic partners.
- - EMPLOYEE INCENTIVES: At the outset of fiscal year 1998 Aquasearch
implemented an incentive compensation program to award significant cash
bonus incentives to all employees provided that the Company met certain
quarterly production targets. Targets were planned that management
believes would significantly advance the Company's research and production
efforts. Under the incentive program, cash bonuses represented as much as
a 25% increase in salary on a quarterly basis. The Company also awarded
stock options to employees as a further incentive to increase productivity.
Aquasearch believes that the implementation of it's incentive compensation
program at the outset of fiscal 1998 was a significant factor in the
Company's productivity gains in fiscal 1998.
The Company expects to continue producing relatively small amounts of
astaxanthin (less than six kilograms (dry weight) per month) until November
1998, when it expects to ship 25 kilograms (dry weight) to Cultor. The
Company is currently satisfying Cultor's requirements for product testing,
regulatory approvals and related developmental activities. The Company will
focus in the next twelve months on continuing to improve yields and
increasing the cost-effectiveness of its production.
The Company believes that strategic relationships and collaborations will
continue to be an important part of its business strategy. There can be no
assurances that the Company will be able to maintain existing corporate partner
relationships, enter into future relationships to develop additional
applications for natural astaxanthin or to develop new microalgae products or
that any such relationships will be successful.
Since inception, the Company's primary operating activities have consisted
of basic research and development and production process development; recruiting
personnel; purchasing operating assets; and raising capital. From inception
through July 31, 1998, the Company had an accumulated deficit of approximately
$6.4 million. The Company's losses to date have resulted primarily from costs
incurred in research and development and from general and administrative costs
associated with the Company's operations. The Company expects to continue to
incur operating losses for at least the next two years as it continues to
expand its production facilities and increases its research and development
efforts. The Company expects to have quarter-to-quarter and year-to-year
fluctuations in revenues, expenses and losses, some of which could be
significant.
The Company has a limited operating history and any assessment of the
Company's prospects must include the technology risks, market risks, expenses
and other difficulties frequently encountered by development stage companies,
and particularly companies attempting to enter competitive industries with
significant technology risks and barriers to entry. Although the Company has
attempted to address these risks by, among other things, hiring and retaining
highly qualified persons and forging strategic alliances
13
<PAGE>
with companies that complement the Company's technical strengths, there can be
no assurance that the Company will overcome these risks in a timely manner, if
at all.
The Company is in the process of transitioning to a full-scale commercial
producer of microalgae products. These changes in its business have placed and
will continue to place significant demands on the Company's management, working
capital and financial and management control systems.
RESULTS OF OPERATIONS - COMPARISON OF QUARTERS AND NINE MONTHS ENDED JULY 31,
1997 AND 1998
Revenues for the quarter ended July 31, 1998 were $ -0- compared with
revenues of $146 for the quarter ended July 31, 1997. The Company has
continued to supply Cultor with sufficient astaxanthin product to conduct
additional tests, trials and other analyses involved in product development
under the Cultor Distribution and Development Agreement. The Company has also
supplied test product to several other potential strategic partners that are
investigating uses of astaxanthin in the fields other than animal feeds and
animal nutrition.
The Company's staff, in conjunction with consultants and representatives
from Cultor, have designed certain improvements in hardware and procedures that
are intended to improve production. The Company is implementing and will
continue to implement these improvements as resources allow.
Consistent with the Company's efforts to implement improvements in its
production system, research and development costs increased by $167,800, or
approximately 109%, during the quarter ended July 31, 1998 compared with the
quarter ended July 31, 1997. These increases included additional compensation,
and cost of automation improvements.
General and administrative expenses decreased by $78,700, or approximately
26% during the quarter ended July 31, 1998 compared with the quarter ended July
31, 1997. The decrease in general and administrative expenses was primarily due
to decreases in legal, insurance and consulting expenses.
The Company incurred a net loss of $620,689 or $0.01 per share, for the
quarter ended July 31, 1998 compared with a net loss of $449,632, or $0.01 per
share, for the same period in 1997.
LIQUIDITY AND CAPITAL RESOURCES
Cash increased by $659,900 in the quarter ended July 31, 1998 from the
prior period, resulting in a cash balance of $666,000 at July 31, 1998.
Purchases of fixed assets of $446,900 were made during the quarter, primarily
for cost of expansion and purchase of equipment, bringing the Company's net
plant and equipment assets to $1,185,500 and total assets to $2,034,800.
The Company currently estimates that it will require between $2.0 million
and $2.5 million in operating capital over the next twelve months after planned
capital expenditures. In addition, the Company will require approximately $1.0
million in funding during the remainder of fiscal 1998. The Company may require
up to an additional $5.0 million over the next twelve months to fund
construction of an additional production facility if Cultor and Aquasearch enter
into either a joint venture or other relationship to produce astaxanthin on a
large-scale (assuming that Cultor does not provide any portion of the financing
for this project). The Company believes that its existing capital resources,
funds to be raised through public and/or private offerings of equity and/or debt
securities and bank financing will be sufficient for continued operations
through the next twelve months. Aquasearch is presently pursuing
14
<PAGE>
additional sources of capital in order to maintain and expand its operations.
These capital sources include product sales, license agreements and equity or
debt financing. There can be no assurance that the Company will be
successful in raising the additional capital necessary to sustain or expand
its operations, or that such capital will be available on terms that would
not result in substantial dilution to existing investors. The Company's
inability to raise sufficient capital could cause it to significantly curtail
operations, which would have a material adverse effect on the Company's
business, financial condition, results of operations and relationships with
its corporate partners. See "Risk Factors--Substantial Near-Term Capital
Needs; Uncertainty of Additional Funding; Dilution" and "--Substantial
Long-Term Capital Needs; Uncertainty of Additional Funding; Dilution" in the
1997 Form 10-KSB.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On July 13, 1998, Cyanotech Corporation ("Cyanotech") filed a complaint
(the "Complaint") in the United States District Court for the District of Hawaii
(Case No. CV98-00600ACK) against the Company. In the Complaint, Cyanotech seeks
declaratory judgment of noninfringement of the Company's U.S. Letters Patent No.
5,541,056 (the "5,541,056 Patent"); invalidity of the 5,541,056 Patent; and
non-misappropriation of the Company's trade secrets relating to closed culture
production of astaxanthin. Cyanotech filed the complaint after the Company
expressed to Cyanotech its concern that Cyanotech's use of closed system
technology may violate the 5,541,056 patent and constitute misappropriation of
trade secrets. The Company does not believe that Cyanotech's claims are
meritorious. However, the Company may be required to dedicate significant
management time and incur significant legal fees and expenses to pursue this
action, which could have a material adverse effect on the Company's business,
financial condition, results of operations and relationships with corporate
partners. In addition, in the event that Cyanotech were to prevail in this
action, a declaration of invalidity of the 5,541,056 Patent could have a
material adverse effect on the Company's business, financial condition, results
of operations and relationships with corporate partners.
On September 11, 1998, the Company filed a counter complaint to
Cyanotech's complaint, alleging patent infringement; misappropriation of
trade secrets; unfair competition; and breach of contract relative to its
1994 Dissolution Agreement with Cyanotech.
ITEM 2. CHANGES IN SECURITIES
During the quarter ended July 31, 1998, the Company issued $1,625,000
aggregate principal amount of one-year Convertible Notes bearing interest at
10% per annum. The holders of the Convertible Notes have an option to
convert their Convertible Notes into the Company's Common Stock. The
Noteholders also received Warrants to purchase shares of the Company's
Common Stock. As of July 31, 1998, the holders of these and previously
issued Convertible Notes (amounting to $2,805,000 aggregate principal amount)
exercised their option to convert their Convertible Notes into shares of
Common Stock. The Company will issue 16,870,520 shares of Common Stock upon
conversion of the outstanding principal and interest in the Convertible
Notes. Company will also issue 2,918,713 Warrants under the provisions of
the Convertible Notes. The Warrants have an exercise price of $0.50 per
share and a term of three years. The financial
15
<PAGE>
statements as of July 31, 1998. reflect the conversion of all of the outstanding
Convertible Notes into shares of Common Stock. These transactions were exempt
from registration under the Securities Act of 1933 pursuant to Section 4(2). No
underwriters were involved in these transactions.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES -- None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS -- None
ITEM 5. OTHER INFORMATION -- None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS -- None
(b) REPORTS ON FORM 8-K -- None
16
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Quarterly Report on Form 10-QSB to be signed on
its behalf by the undersigned thereunto duly authorized.
AQUASEARCH, INC.
Dated: September 14, 1998 By: /s/ Mark E. Huntley
--------------------------------------
Mark E. Huntley, Ph.D.
President and Chief Executive Officer
17
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