<PAGE>
U.S. 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 the quarterly period ended July 31, 1999
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 small business issuer 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
(Issuer's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal
year, if changed since last report)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for
such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
YES X NO
-- --
As of July 31, 1999, the number of shares outstanding of issuer's Common
Stock, $0.0001 par value, was 83,932,698 shares.
<PAGE>
Aquasearch, Inc.
Form 10-QSB For The
Quarter Ended July 31, 1999
Contents
<TABLE>
<CAPTION>
Part I - Financial Information
Page
<S> <C>
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 18
Management's Discussion and Analysis of Financial Condition
and Results of Operations 26
Part II - Other Information
Item 1: Legal Proceedings 28
Item 2: Changes in Securities 28
Item 3. Defaults Upon Senior Securities 29
Item 4: Submission of Matters to a Vote of Security Holders 29
Item 5: Other Information 29
Item 6: Exhibits and Reports on Form 8-K 29
</TABLE>
2
<PAGE>
Aquasearch, Inc.
(A Development Stage Enterprise)
Balance Sheets
<TABLE>
<CAPTION>
October 31, July 31,
1998 1999
(Audited) (Unaudited)
-----------------------------------------
<S> <C> <C>
Assets
Current assets:
Cash $ 151,473 $ 75,124
Accounts receivable - 6,131
Prepaid expenses 48,703 22,297
Refundable deposits 3,081 3,053
-----------------------------------------
Total current assets 203,257 106,605
-----------------------------------------
Notes receivable from officer 50,000 50,000
Notes receivable 59,696 58,133
Plant and equipment:
Plant 2,519,044 3,694,922
Equipment 167,203 186,917
Less accumulated depreciation (201,292) (353,753)
-----------------------------------------
Net plant and equipment 2,484,955 3,528,086
-----------------------------------------
Total assets $ 2,797,908 $ 3,742,824
=========================================
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 1,084,829 $ 1,410,365
Notes payable 315,000 145,000
Notes payable to officer 265,000 1,405,000
-----------------------------------------
Total current liabilities 1,664,829 2,960,365
-----------------------------------------
Stockholders' Equity
Preferred stock (5,000,000 shares authorized) -- --
Common stock ($0.0001 par value, 100,000,000 shares
authorized, 68,564,013 and 83,932,698 shares
outstanding at October 31, 1998 and July 31, 1999,
respectively) 7,979 9,515
Additional paid-in capital 8,189,414 10,659,660
Deficit accumulated during the development stage (7,064,314) (9,886,716)
-----------------------------------------
Total stockholders' equity 1,133,079 782,459
-----------------------------------------
Total liabilities and stockholders' equity $ 2,797,908 $ 3,742,824
=========================================
</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 Three
From Inception Months Ended Months Ended
To July 31, July 31, July 31,
1999 1999 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 4,259,825 515,318 320,514
General and administrative expenses 5,174,530 366,945 218,562
-----------------------------------------------------------
Loss from operations (9,446,742) (882,263) (539,076)
Other Income (Expense)
Interest (243,883) (40,646) (79,322)
Other (225) 7,227 (2,291)
Investment in joint venture (147,096) -- --
-----------------------------------------------------------
Total other income (expense) (391,204) (33,419) (81,613)
-----------------------------------------------------------
Loss before income taxes and
extraordinary item (9,837,946) (915,682) (620,689)
Extraordinary item - loss on write down
of assets to liquidation basis (14,502) -- --
-----------------------------------------------------------
Loss before income taxes (9,852,448) (915,682) (620,689)
Federal and State income taxes -- -- --
-----------------------------------------------------------
Net loss (9,852,448) (915,682) (620,689)
Accumulated Deficit
Balance, beginning of period (34,268) (8,971,034) (5,809,159)
===========================================================
Balance, end of period $ (9,886,716) $ (9,886,716) $ (6,429,848)
===========================================================
Loss per share $ (0.38) $ (0.01) $ (0.01)
===========================================================
Weighted average shares outstanding 25,701,408 71,283,181 47,819,881
===========================================================
</TABLE>
4
<PAGE>
Aquasearch, Inc.
(A Development Stage Enterprise)
Statements of Loss and Accumulated Deficit
<TABLE>
<CAPTION>
For the Period For the Nine For the Nine
From Inception Months Ended Months Ended
To July 31, July 31, July 31,
1999 1999 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 4,259,825 1,206,523 866,204
General and administrative expenses 5,174,530 1,505,162 634,446
-----------------------------------------------------------
Loss from operations (9,446,742) (2,711,685) (1,500,650)
Other Income (Expense)
Interest (243,883) (117,546) (114,662)
Other (225) 6,829 (2,615)
Investment in joint venture (147,096) -- --
-----------------------------------------------------------
Total other income (expense) (391,204) (110,717) (117,277)
-----------------------------------------------------------
Loss before income taxes and
extraordinary item (9,837,946) (2,822,402) (1,617,927)
Extraordinary item - loss on write down
of assets to liquidation basis (14,502) -- --
-----------------------------------------------------------
Loss before income taxes (9,852,448) (2,822,402) (1,617,927)
Federal and State income taxes -- -- --
-----------------------------------------------------------
Net loss (9,852,448) (2,822,402) (1,617,927)
Accumulated Deficit
Balance, beginning of period (34,268) (7,064,314) (4,811,921)
-----------------------------------------------------------
Balance, end of period $ (9,886,716) $ (9,886,716) $ (6,429,848)
===========================================================
Loss per share $ (0.38) $ (0.04) $ (0.03)
===========================================================
Weighted average shares outstanding 25,701,408 71,283,181 47,819,881
===========================================================
</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,
1999 1999 1998
(Unaudited) (Unaudited) (Unaudited)
---------------------------------------------------------
<S> <C> <C> <C>
Cash Flows from Operating Activities
Net loss $ (9,852,448) $ (2,822,402) $ (1,617,927)
Adjustments to reconcile net loss to net
cash used in operating activities:
Amortization 3,527 -- --
Depreciation 359,460 152,461 68,490
Expenses paid with common stock 801,198 -- --
Loss on write down of assets to
liquidation basis 5,392 -- --
Changes in:
Other current assets (25,149) 26,434 (44,532)
Receivables (6,131) (6,131) 1,219
Accounts payable 1,326,652 325,536 90,453
---------------------------------------------------------
Cash used in operating activities (7,387,499) (2,324,102) (1,536,879)
Cash Flows from Investing Activities
Purchase of fixed assets (3,791,423) (1,195,592) (446,939)
---------------------------------------------------------
Cash used in investing activities (3,791,423) (1,195,592) (446,939)
Cash Flows from Financing Activities
Increase in notes receivable (108,133) 1,563 (79,180)
Issuance of common stock 10,054,244 2,471,782 2,992,018
Increase in notes payable 1,579,800 970,000 310,000
Offering costs (271,919) -- --
---------------------------------------------------------
Cash provided by financing activities 11,253,992 3,443,345 2,602,838
---------------------------------------------------------
Net increase (decrease) in cash 75,070 (76,349) 619,020
Cash, beginning of the period 54 151,473 47,006
---------------------------------------------------------
Cash, end of the period $ 75,124 $ 75,124 $ 666,026
=========================================================
</TABLE>
6
<PAGE>
Aquasearch, Inc.
(A Development Stage Enterprise)
Notes To Financial Statements
July 31, 1999
(Unaudited)
1. Common Stock and Common Stock Purchase Warrants
As of July 31, 1999, there were a total of 11,241,731 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 4,868,513 Warrants had an exercise price of
$0.50 per share. No Warrants were exercised during the three months ended
July 31, 1999. Aquasearch can redeem the $1.00 per share Warrants 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. At July 31, 1999, we
had reserved a sufficient number of shares of our Common Stock to issue when
the Warrants are exercised.
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, 1999 76,401,020 $ 8,762 $9,448,034 $ (8,971,034) $ 485,762
Conversion of convertible
notes to common stock
($0.16 per share) 7,531,678 753 1,211,626 -- 1,212,379
Loss for the three months
ended July 31, 1999 -- -- -- (915,682) (915,682)
-----------------------------------------------------------------------------------
Balance, July 31, 1999 83,932,698 $ 9,515 $10,659,660 $ (9,886,716) $ 782,459
===================================================================================
</TABLE>
In November 1996, we executed a Letter of Intent with C. Brewer and Company,
Limited ("C. Brewer"). Under the proposed agreement, we would acquire 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 return, C. Brewer would receive
between 2,570,000 and 2,850,000 shares of our Common Stock at a purchase
price of $0.35 per share. In addition, C. Brewer acquired a three-year
warrant to purchase up to 500,000 shares of our Common Stock at a purchase
price of $1.25 per share. The stockholders' equity at July 31, 1999 does not
reflect the issuance of the Common Stock or the warrant to C. Brewer. We have
not consummated the transaction with C. Brewer. We have decided that we do
not yet need 80 to 90 acres of land, because production at our current
facility has increased beyond expectation. We want to delay any transaction
with C. Brewer until we determine the best strategy and location for future
development.
7
<PAGE>
2. Management's Representations of Interim Financial Information
These financial statements reflect all adjustments that 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, 1998 (the "1998 Form 10-KSB"). You are
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. We undertake no obligation to publicly release the
results of any revision of these forward-looking statements. You are strongly
urged to read the information set forth under the caption "Factors That May
Affect Future Operating Results" in the 1998 Form 10-KSB for a more detailed
description of these significant risks and uncertainties.
OVERVIEW
We are a development stage company that develops and commercializes natural
products from microalgae using our proprietary photobioreactor technology
known as the Aquasearch Growth Module, or AGM.
Microalgae are a diverse group of over 30,000 species of microscopic plants
that have a wide range of physiological and biochemical characteristics.
Microalgae produce many different and unusual fats, sugars, proteins, amino
acids, vitamins, enzymes, pigments and other bioactive compounds that have
existing and potential commercial applications in such fields as animal and
human nutrition, food colorings, cosmetics, diagnostic products,
pharmaceuticals, research grade chemicals, pigments and dyes. Microalgae grow
ten times faster than the fastest growing land-based crops and represent a
largely unexploited and renewable natural resource with a biodiversity
comparable to that of land-based plants.
Although microalgae are believed to be a potential source for many valuable
commercial applications, less than 5,000 species of microalgae have ever been
isolated from nature, and fewer than 10 species of microalgae - less than
one-third of one percent of all such species - have ever been cultivated
commercially.
We believe that the development of a large biotechnology industry, based on
thousands of species of microalgae, has been impeded only by a lack of
technology. We anticipate that our commercial production technology will
allow us to create a market for new and valuable substances derived from
microalgae. Our Company, since its inception, has been dedicated to this
proposition.
Our key achievements in the past year include major advances in our platform
technology, the AGM, including:
- - created the new "Ultra-AGM," which has six-fold greater capacity than the
previous
8
<PAGE>
AGM model - an increase from 1,060 to 6,600 gallons;
- - tripled the capacity-per-unit-cost of the AGM;
- - tripled the productivity-per-unit-capacity of HAEMATOCOCCUS - our
astaxanthin-rich microalgae; and
- - doubled the astaxanthin content of HAEMATOCOCCUS - from 1.5% to 3.0%.
At the same time, we have:
- - tripled the size of our production facility;
- - tripled our patents - from three to nine;
- - tripled our total production capacity;
- - initiated sales of our products;
- - expanded our product pipeline to include nutraceuticals and
pharmaceuticals;
- - strengthened our management team in areas of strategic development and
marketing; and
- - augmented our research team in natural products chemistry and drug
development.
In the past year we focused primarily on technology and infrastructure. This
year we are focused on marketing, sales, and further expanding our product
pipeline.
HISTORY: KEY EVENTS
1984
AQUASEARCH FOUNDED. Scientists from Scripps Institution of
Oceanography in La Jolla, California founded Aquasearch, Inc. as a
California corporation.
1988
FEB: We incorporated Aquasearch Inc. in Colorado.
MAY: Aquasearch (Colorado) acquired all the assets of Aquasearch
(California) in a stock-for-stock exchange.
JUN: OPERATIONS BEGIN in Borrego Springs, California.
1988-1993
RESEARCH AND DEVELOPMENT. We developed our first prototype of the
AGM. Over the next few years we refined certain details of
engineering in the AGM. At the same time, we cultivated microalgal
species of markedly different varieties.
1993
MAR: AQUASEARCH-CYANOTECH JOINT VENTURE FORMED. We formed a joint
venture company with Cyanotech Corporation ("Cyanotech"), an
unaffiliated producer of microalgae. Our goal was to develop
commercial systems for producing astaxanthin-rich microalgae.
We contributed approximately $147,000 in capital and licensed
our AGM technology to the joint venture. Cyanotech
contributed approximately $15,000 in capital to the joint
venture and made available its facilities and personnel at
the Hawaii Ocean Science and Technology (HOST) Business Park
at Keahole Point, Kailua-Kona, Hawaii.
1994
JUN: CULTOR NEGOTIATION BEGINS. We began discussions with Cultor,
Ltd. ("Cultor"), a Finnish
9
<PAGE>
food conglomerate, regarding the purchase of astaxanthin-rich
microalgae.
JUL: FIRST ASTAXANTHIN PRODUCED. We constructed AGMs that
demonstrated the economics of the production process. We
also produced samples of astaxanthin-rich microalgae for
analysis and trial applications. Samples were sent to Cultor
for testing.
NOV: AQUASEARCH-CYANOTECH JOINT VENTURE TERMINATED. We decided to
discontinue the joint venture with Cyanotech. Under our
dissolution agreement, all intellectual property rights to
AGM technology reverted to Aquasearch.
DEC: CULTOR STARTS FEEDING TRIALS on farmed salmon using
astaxanthin-rich microalgae we produced.
1995
APR: CONSTRUCTION BEGINS on our own half-acre facility in Hawaii,
leased from the HOST Business Park. We designed the facility
for research and development, and for production of small
amounts of astaxanthin-rich microalgae for marketing.
JUN: CONSTRUCTION COMPLETED. Our first facility was comprised of
AGMs and an operating laboratory.
JUL: SVENSKA FODER CONTRACT. We entered into a three-year Supply
Agreement with Svenska Foder, then a subsidiary of Cultor.
Svenska Foder agreed to act as the exclusive distributor of
our natural astaxanthin product for animal feed applications
in Sweden, Norway and Finland. In December 1996, Cultor sold
Svenska Foder to KKR, a Danish animal feeds company, and
assumed all of Svenska Foder's rights and obligations under
the Supply Agreement.
FACILITY EXPANSION BEGINS. We leased additional space in the
HOST Business Park to expand our half-acre research and
development facility to one acre.
OCT: ONE-ACRE EXPANSION COMPLETED. We expanded the facility to
include finishing ponds (the second stage of our production
process), and additional laboratory space.
1996
MAY: CULTOR AGREEMENT. We entered into a three-year Distribution
and Development Agreement with Cultor (recently extended to
four years). We agreed to act as the exclusive worldwide
supplier to Cultor of natural astaxanthin derived from
microalgae for animal feed applications. Cultor agreed to act
as the exclusive worldwide distributor of our natural
astaxanthin product for animal feed applications. Under our
agreement, Cultor and Aquasearch may, at Cultor's option,
create a new joint venture company for the sole purpose of
producing and selling natural astaxanthin derived from
microalgae for animal feed applications.
SCIENTIFIC ADVISORY BOARD FORMED. We created an active
Scientific Advisory Board consisting of 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.
JUL: PROCESS PATENT IN THE U.S. We were awarded U.S. Patent
Number 5,541,056 for a
10
<PAGE>
"Method of Control of Microorganism Growth Process." This
patent claims certain processes that operate in our
proprietary, closed-system photobioreactor, the AGM. Our
U.S. filing was made under the Patent Cooperation Treaty. We
began to pursue international patents in certain
treaty-member nations.
OCT: CULTOR ACQUIRES AQUASEARCH STOCK. Cultor acquired 400,000
shares of our Common Stock at a purchase price of $0.50 per
share.
NOV: C. BREWER AGREEMENT. We executed a Letter of Intent with C.
Brewer and Company, Limited ("C. Brewer"). Under the
proposed agreement we would acquire between 80 and 90 acres
of C. Brewer property in the Ka'u region of the Big Island of
Hawaii, valued at between $900,000 and $1,000,000. In
return, C. Brewer would acquire approximately 4% of our
outstanding Common Stock. In addition, C. Brewer acquired a
three-year warrant to purchase up to 500,000 shares of
Aquasearch Common Stock at $1.25 per share. To date, we have
not consummated the transaction with C. Brewer because
production at our current facility has increased beyond
expectation.
1997
APR: EARL FUSATO NAMED CHIEF FINANCIAL OFFICER, JOINS BOARD. Mr.
Fusato brought considerable experience to our management
team. At VeriFone, Inc., global leader in the transaction
automation industry, he served as VP Finance (1983-87),
Treasurer (1987-90) and Director of Internal Audit and
Manager of Transaction Automation (1990-92). He served as CFO
of RESCO Inc., a residential real estate brokerage company
(1992-94). He also served in various key positions at Ernst
and Young (1978-83) and KPMG Peat Marwick (1971-77).
JUN: APPARATUS PATENT IN EUROPE. We were awarded European Patent
Number 0494887 for a "Process and Apparatus for the
Production of Photosynthetic Microbes." This patent not only
claims certain processes, but also certain features of our
core technology, the Aquasearch Growth Module. The European
patent complements, but does not supplant claims made in the
U.S. Patent awarded in 1996. Our European filing was made
under the Patent Cooperation Treaty. We are pursuing
additional patents in certain treaty-member nations.
SEP: DR. EDWARD DAVID JOINS BOARD. Dr. David has a long history
of management experience in the fields of science and
technology. During his career he has served as President of
Exxon Research and Engineering, Science Advisor to the
President of the United States, Executive Director of the
Communications Systems Division at Bell Laboratories, and
Director of the White House Office of Science and Technology
Policy.
1998
APR: EXPANSION BEGINS TO TRIPLE OUR PRODUCTION FACILITY. We began
construction to expand our production facility in Kona,
Hawaii from one acre to three acres. At the same time, we
began upgrading every component of our production system
hardware.
JUN: WE QUESTION CYANOTECH REGARDING INTELLECTUAL PROPERTY. We
formally notified Cyanotech of our concern that their use of
photobioreactor technology may violate one of our patents
(U.S. patent No. 5,541,056) relating to processes for
controlling microalgae growth. We also expressed concern
regarding possible trade secret misappropriation.
11
<PAGE>
JUL: DAVID WATUMULL NAMED EXECUTIVE VP, CORPORATE FINANCE AND
STRATEGIC DEVELOPMENT. Mr. Watumull brought more strength to
our management team. He has been a respected biotechnology
industry analyst, investment banker and money manager for
more than 15 years, serving at both Paine Webber and First
Honolulu Securities.
WE TEST A NEW PHOTOBIOREACTOR - THE ULTRA-AGM. In previous
months we designed and engineered the Ultra-AGM. The
Ultra-AGM is more than six times larger than any standard
production growth module we have used. To our knowledge, the
Ultra-AGM is larger than any closed-system photobioreactor
ever operated. A six-month testing period begins.
CYANOTECH FILES LAWSUIT. Our former joint venture partner
filed a complaint in the United States District Court for the
District of Hawaii (Case No. CV98-00600ACK) against us. They
sought a declaratory judgment of:
- invalidity of our U.S. patent (No. 5,541,056)
for a method to grow microalgae;
- non-infringement (by Cyanotech) of our same
patent; and
- non-misappropriation of our trade secrets
regarding the Aquasearch Growth Module.
SEP: WE COUNTER-SUE CYANOTECH. We asserted the validity of our
U.S. patent. We also alleged that Cyanotech:
- infringed our U.S. patent;
- misappropriated trade secrets related to our AGM
technology;
- breached our joint venture dissolution
agreement; and
- engaged in unfair competition.
We requested a combination of damages, injunctive relief and
attorney's fees on each count.
APPARATUS PATENT IN HONG KONG. We were awarded patent number
HK1001232 for the "Process and Apparatus for the Production
of Photosynthetic Microbes." This patent was awarded under
the Patent Cooperation Treaty, based on the original filing
approved by the European Patent Office in 1997.
NOV: CHARTER MEMBERSHIP IN THE MARINE BIOPRODUCTS ENGINEERING
CENTER (MARBEC). MarBEC is a 10-year, $40 million
Engineering Research Center, funded by the U.S. National
Science Foundation. MarBEC is focused on developing new
enzymes, pigments and pharmaceuticals, primarily from
microalgae. It is based at the University of Hawaii and the
University of California, Berkeley. Aquasearch, Monsanto and
Eastman Chemical are among the charter industry members,
which have certain preferential rights to new products
developed by MarBEC. We are the only member of MarBEC that
has developed photobioreactor technology, which we believe is
likely to be required for the commercial exploitation of any
new product from microalgae.
DEC: ENZYMED AGREEMENT. We entered into a Compound Library
Agreement with EnzyMed, Inc. of Iowa, a privately-held
biotechnology company. Under the agreement, we will provide
extracts of microalgae that contain unexplored or unexploited
substances with biomedical value. EnzyMed agreed to generate
compounds from our microalgae extracts using their method of
"combinatorial biocatalysis." This method generally produces
several hundred compounds from a single extract. We expect
some of these compounds
12
<PAGE>
to be novel and proprietary. Both companies intend to
commercialize the resulting compound "libraries." Compound
libraries are typically screened for possible medical
applications by the pharmaceutical industry. The pharmaceutical
company typically pays an "access fee" for the right to screen
the library for a limited time and for limited applications.
Under our agreement, Aquasearch and EnzyMed will share revenues
from commercialization, including access fees, licensing fees,
milestone payments, royalties, and commercial sales.
1999
JAN: MARTIN GUERIN NAMED VP, SALES AND MARKETING. Mr. Guerin has
international experience with world-leading groups in food
and feed industries. He held top management positions for
marketing and business development with Finfeeds
International (1996-98) and EWOS (1994-96), both Cultor
companies. His previous experience includes management
positions with BP Nutrition (now Nutreco) and Champagnes
Cereales.
NEW EQUIPMENT INSTALLATION BEGINS. With construction nearly
complete on our expanded 3-acre facility, we began to install
new equipment for process control and for final processing of
raw products.
THE ULTRA-AGM GOES INTO OPERATION. After a successful 6-month
testing period, we installed and began to operate the new
Ultra-AGM. This new photobioreactor is much larger, more
efficient, and less costly than any previous AGM. It also
requires 75% less manpower to operate.
FEB: CONSTRUCTION COMPLETED ON 3-ACRE PHYSICAL PLANT. We completed
all new structures at our production facility. We tripled the
area for both AGMs and finishing ponds. We quadrupled the
area under roof to more than 8,000 square feet. We added a
multi-purpose building for product processing, packaging and
storage. The processing building can accommodate further
increases in production at our current site. We laid the
foundation for a 10,000 square-foot laboratory that will
accommodate expansion of our drug discovery program.
NEW PLANT BEGINS PRODUCTION AT FULL CAPACITY. While
installing our final processing equipment, we increased our
production of raw product to full capacity. We began to store
raw product. Final processing of the product will be done
once equipment installation is complete.
DAVID TARNAS JOINS BOARD. Mr. Tarnas brings political
experience to our Board of Directors. As a Hawaii State
Representative and Chairman of the House Committee on Ocean
Recreation and Marine Resources, he led many important policy
initiatives in Hawaii until 1998.
PROCESS PATENT IN EUROPE. We were awarded European Patent
Number 0772676 for a "Method of Control of Microorganism
Growth Process." This patent, originally granted in the U.S.,
was awarded in Europe under the Patent Cooperation Treaty. It
claims certain processes that operate in our proprietary,
closed-system photobioreactor, the AGM.
MAR: PROCESS PATENT IN U.S. We received U.S. Patent Number
5,882,849 for a "Method of
13
<PAGE>
Control of HAEMATOCOCCUS Species Growth Process." This patent
applies to proprietary techniques we use to grow
HAEMATOCOCCUS, our principal source of astaxanthin. We are
pursuing international patents in certain member nations that
are signatories of the Patent Cooperation Treaty.
APR: APPARATUS PATENT IN NORWAY. We were awarded Norwegian Patent
Number 304556 for a "Process and Apparatus for the Production
of Photosynthetic Microbes." This patent not only claims
certain processes, but also certain features of our core
technology, the Aquasearch Growth Module. Originally granted
in Europe, this patent was awarded in Norway under the Patent
Cooperation Treaty.
PRODUCT FORMULATION BEGINS ON OUR FIRST NUTRACEUTICAL
PRODUCT. A large U.S. chemical company began collaborating
with us - under a confidentiality agreement - to formulate an
astaxanthin-rich nutraceutical product.
MAY: PROCESS PATENT IN AUSTRALIA. We were awarded Australian
Patent Number 698772 for a "Method of Control of
Microorganism Growth Process." This patent, originally
granted in the U.S., was awarded in Australia under the
Patent Cooperation Treaty.
APPARATUS PATENT IN SOUTH KOREA. We received South Korea
Patent Number 700834 for a "Process and Apparatus for the
Production of Photosynthetic Microbes." Originally granted in
Europe, this patent was awarded in South Korea under the
Patent Cooperation Treaty.
MICROALGAE FOR OUR SECOND NUTRACEUTICAL PRODUCT APPROVED. The
State of Hawaii Department of Agriculture approved our permit
application to import a new microalgae species. This species
is the basis for our second nutraceutical product, planned
for product launch in 2000.
JUN: PROCESSING EQUIPMENT INSTALLED. Our manufacturing process
became fully operational as final processing equipment came
on line.
RECORD ASTAXANTHIN LEVELS ACHIEVED. We achieved an
astaxanthin content of more than 3% in our final processed
product - sustained over the previous three months. This
content is at least double the amount claimed by any other
known producer of natural astaxanthin. Some of our production
runs approached 4% content, and we achieved 6% content at
smaller scales.
Jul: WE BEGIN SHIPPING NATURAL ASTAXANTHIN to an undisclosed
European company.
THE MARINE BIOTECHNOLOGY INDUSTRY
There are 30,000 species of microalgae. Many of these are known to contain
valuable substances, including pharmaceuticals, nutraceuticals, and certain
commodities. Fewer than one-tenth of one percent of these 30,000 species have
been produced commercially.
The total market for only three species of microalgae that are now produced
commercially (SPIRULINA, CHLORELLA and HAEMATOCOCCUS) is estimated to be in
the range of $200-300 million per year. We believe that the total market for
all products derived from microalgae could eventually range into the billions
of
14
<PAGE>
dollars, provided that: (1) the products are unique, valuable, and numerous;
and (2) production technology is reliable and cost-effective.
Scientific literature demonstrates that:
- microalgae contain unique substances;
- these unique substances are potentially valuable as pharmaceuticals
and nutraceuticals; and
- these unique substances are numerous among the microalgae.
Until recently, however, there was no technology to provide for the
cost-effective production of microalgae in commercial quantities. We believe
that our AGM provides a reliable and cost-effective production technology
that will contribute to the development of a multi-billion dollar marine
biotechnology industry. However, there can be no assurance that such an
industry will develop.
OUR KEY ACHIEVEMENTS
(1) RELIABLE AND COST EFFECTIVE PRODUCTION TECHNOLOGY
The Aquasearch Growth Module is a novel, reliable and cost-effective
production technology. We have proven the efficacy of the AGM through a
10-year process of engineering, development, and demonstration.
We continue to achieve targeted improvements in AGM technology and
performance, as this table shows:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
IMPROVEMENT PLANNED IN 1998 ACHIEVED IN 1999
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Increase AGM size 6X Greater than 6X
Decrease capital cost 2X 3X
(per gallon capacity)
Increase AGM production cycle 30 days 60 days
HAEMATOCOCCUS production rate Increase 3X Greater than 3X
Astaxanthin content of product 2.0% of dry weight Greater than 3.0% of dry weight
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
These improvements to the AGM have reduced costs and increased productivity.
We believe the AGM is the largest commercial photobioreactor in operation. To
our knowledge, our current HAEMATOCOCCUS production rate is higher than any
reported in the scientific literature.
(2) INTELLECTUAL PROPERTY
We now have issued patents relating to:
- the AGM apparatus (Europe, Australia, Norway, Hong Kong, South Korea)
- general processes for cultivating microalgae in photobioreactors
(U.S., Europe, Australia)
- specific processes for cultivating HAEMATOCOCCUS (U.S.)
15
<PAGE>
Five of these patents issued in the first 5 months of 1999 alone. Additional
patents are pending.
We continue to develop trade secrets. We believe that our trade secrets have
been critical to our recent improvements in production rates and product
quality.
(3) PRODUCTION CAPACITY
In the past year we expanded our physical plant by a factor of three. We now
have a completely new manufacturing plant. The plant includes new processing
equipment and an upgraded process-control system.
Our HAEMATOCOCCUS cultivation process is done in two steps. We use two types
of large-scale production systems: (1) Aquasearch Growth Modules, and (2)
"finishing" ponds. This table shows the key features of these two production
systems:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
FEATURE AQUASEARCH GROWTH MODULE FINISHING POND
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Function Produce HAEMATOCOCCUS biomass Convert biomass to astaxanthin
Technology Proprietary Public domain
Utilized capacity 20% 100%
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
We have achieved much greater improvements in AGM performance than
anticipated. As a result, we are now using only 20% of our AGM production
capacity. If the market demands, we could increase total production by 5X by
increasing our finishing pond capacity. Relative to AGMs, finishing ponds are
less costly to construct.
(4) SALES
In 1998 we projected sales to begin as soon as our expanded facility was
constructed, and our new processing equipment was installed.
We completed construction of the expanded facility in February 1999. New
processing equipment was installed in June 1999. Sales began immediately.
(5) PRODUCT PIPELINE
In 1998 our pipeline consisted of a single product: natural astaxanthin for
use in animal nutrition. We have now expanded our pipeline to include:
1) Nutraceuticals
- Natural astaxanthin
- A second microalgae-based product
2) Drug discovery
- Compound libraries
These products are all in active development. A large U.S. chemical company
is collaborating with us -
16
<PAGE>
under a confidentiality agreement - to formulate our natural astaxanthin
nutraceutical. However, we cannot guarantee that the collaboration will
extend beyond product formulation. The State of Hawaii Department of
Agriculture has just approved our import permit for a new species of
microalgae that is the basis of our second nutraceutical product. EnzyMed has
received our first microalgae extracts, and has begun work to produce our
first compound library.
(6) OUR TEAM
NEW MANAGEMENT. We believe our team is stronger than ever - at all levels.
Within the last year we added important experience and expertise at the
management level, including David Watumull, Martin Guerin and David Tarnas.
Together, these individuals bring us new experience and expertise in:
- international marketing and sales in food and feed industries;
- strategic development in biotechnology and pharmaceutical
industries;
- public/private sector collaboration; and
- fund raising.
NEW RESEARCH SCIENTISTS. Dr. Walter Nordhausen, Dr. Mai Lopez, and Dr. Mia
Unson have joined our research team in the past six months. Together, they
more than double our research effort, and bring us proven experience in:
- biopharmaceutical product development;
- marine biology and biochemistry;
- natural products chemistry; and
- research program management.
EMPLOYEES. We believe our employees are strongly motivated for success. In
1998 we introduced a pay-for-performance compensation plan that includes both
stock options and cash bonus programs. We structured the compensation plan to
reward both teamwork and individual excellence. Rewards are generated by
performance on quarterly targets. We believe that our employees are directly
responsible for Aquasearch's recent achievements.
(7) RECENT FINANCING ACTIVITY
From June 1997 to September 1998, the Company raised $3,305,000 through the
private placement of convertible notes. Between July and September 1998, all
of the outstanding convertible notes (together with accrued interest), were
converted into 20,075,648 shares of Common Stock. We also issued 3,305,000
Warrants under the terms of the Notes. The Warrants have an exercise price of
$0.50 per share and have a term of three years.
Additionally, from September 1998 through July 1999, the Company raised
$3,700,000 through the private placement of convertible notes. These
convertible notes bear interest at 10 percent per annum, have a term of one
year and are convertible into shares of Common Stock. Upon conversion of the
notes, each note holder will receive warrants to purchase 1,000 shares of
Common Stock at $0.50 per share for each $1,000 aggregate principal amount of
convertible notes purchased. In the nine months ended July 31, 1999, some of
these convertible note holders along with other outstanding convertible note
holders converted their notes into a total of 15,368,685 shares of the
Company's Common Stock and received an aggregate of 2,449,800 warrants.
17
<PAGE>
MANAGEMENT'S PLAN OF OPERATION FOR THE NEXT TWELVE MONTHS
Last year we focused on technology and infrastructure. We strengthened our
intellectual property, expanded our physical plant, and augmented production
capacity.
During the next twelve months we will focus on sales and product development,
specifically:
- initiating sales of our first nutraceutical product, natural
astaxanthin;
- formulating our second nutraceutical product;
- growing sales of AQUAXAN-TM-;
- marketing and selling compound libraries for drug discovery; and
- expanding our product pipeline.
(1) NUTRACEUTICAL ASTAXANTHIN
THE PRODUCT. Our first major nutraceutical product is a dietary supplement
rich in astaxanthin. Astaxanthin is a powerful, bioactive anti-oxidant
(approximately 100 times more potent than Vitamin E). Astaxanthin has
demonstrated efficacy in animal or human models of:
- ALZHEIMER'S AND PARKINSON'S DISEASE: major neurodegenerative
diseases
- MACULAR DEGENERATION: the leading cause of blindness in the U.S.
- CHOLESTEROL DISEASE: ameliorates the effects of LDL (the "bad"
cholesterol)
- STROKE: repairs damage caused by lack of oxygen
- CANCER: protects against several types of cancer
THE MARKET. We believe a strong market could develop for our nutraceutical
astaxanthin product among persons afflicted with these ailments because of:
- LARGE SIZE OF POTENTIAL MARKET: millions of Americans are
affected
- POOR PROGNOSIS: some of these diseases have ineffective or no
approved treatments
- PROMISING DATA: quality of data in relevant human and animal
models to date is promising.
Our analysis of reasonable dosage and customary pricing in the nutraceutical
industry suggests that nutraceutical astaxanthin may command retail prices in
the range of $50,000 per kilogram, depending on various factors. If this
estimate proves to be accurate, then we would estimate the potential U.S.
market to exceed $500 million per year. This estimate is based on just one of
the six diseases described above, and is derived from the number of persons
affected by the condition, as estimated by physicians who provide treatment
for the disease, and the conventional price of an appropriate daily dosage.
Certain consumers may be highly motivated to use nutraceutical astaxanthin
because:
- treatment alternatives do not exist for some ailments; and
- sufferers have used nutraceuticals with less demonstrated
efficacy than astaxanthin.
PRODUCTION CAPACITY. Our current production capacity would satisfy
approximately 1% of the estimated U.S. market. We estimate this would
generate retail sales of more than $5 million per year. We can expand most
cost-effectively by adding only finishing ponds on adjacent property. We do
have space available for expansion. We estimate this would allow a 5-fold
expansion at a cost of approximately $1.8 million.
18
<PAGE>
PRODUCT FORMULATION. We are collaborating in product formulation with a
large U.S. chemical company that has significant experience in nutraceutical
products. Our collaboration is being carried out under a confidentiality
agreement. However, we cannot guarantee that the collaboration will extend
beyond product formulation.
MARKETING STRATEGY. We intend to sell this product directly to consumers.
Several wholesale purchasers of nutraceutical products have also contacted us
regarding our product. We may or may not enter into supply agreements with
one or more wholesalers.
REGULATORY ISSUES. The U.S. Food and Drug Administration (FDA) has primary
regulatory responsibility in nutraceutical markets. Many regulations apply.
The DSHEA Act of 1994 governs certain conditions of sale of all nutraceutical
products or dietary supplements in the U.S. The FDA details certain
procedures that comprise "Good Manufacturing Practice" (GMP) with which we
will have to comply. The State of Hawaii Department of Health imposes certain
regulations on the preparation of substances for human consumption. We are
taking action to comply with all relevant regulations and recommended
procedures. We plan to achieve compliance in 1999.
COMPETITION. AstaCarotene AB of Sweden produces and sells an astaxanthin-rich
nutraceutical product in Europe that, like ours, is based on HAEMATOCOCCUS
microalgae. AstaCarotene must produce their product in a controlled climate,
rather than in Sweden's natural climate. We believe their cost of production
is significantly higher than ours.
Cyanotech recently announced its intention to launch a HAEMATOCOCCUS-based
nutraceutical. Cyanotech advertises its natural astaxanthin product to
contain 1.5% astaxanthin. Our product contains 3%. To produce the same amount
of astaxanthin, therefore, Aquasearch requires only half the HAEMATOCOCCUS
production capacity. We therefore believe our cost of production may be less
than Cyanotech's. We also believe that customers may perceive our 3% product
as superior to a 1.5% product, which could confer a competitive advantage
over Cyanotech's product.
Igene Biotechnology, Inc. produces astaxanthin from yeast. The chemical form
of astaxanthin in HAEMATOCOCCUS is the one that prevails in nature, and is
different from that in yeast. We believe the nutraceutical market will view
the prevailing natural form of astaxanthin - from HAEMATOCOCCUS - as superior
as its astaxanthin content is also 10 times more than that of yeast.
Itano of Japan produces an astaxanthin extract from Antarctic krill, a marine
microcrustacean. The product is distributed in the U.S. in very small amounts
and at very high prices (GREATER THAN $650,000 per kilogram). Krill fishing
in Antarctica is very expensive and highly regulated. Krill fishing vessels
must travel for more than two weeks, at a cost of approximately $50,000 per
day to complete the voyage between Japan and the Southern Ocean. Suitably
equipped vessels cost approximately $30 million and typically have a lifetime
of only 20 years. The krill fishery is regulated by the Committee for
Conservation of Antarctic Living Resources, an international body comprised
of scientists from Antarctic Treaty member nations. The krill fishery reached
its peak in the mid-1980s and has since declined.
BASF and Hoffman La-Roche both produce synthetic astaxanthin from
petrochemicals. Their compound is chemically different than natural
astaxanthin. The effect of the difference has not been studied. However, the
natural form of a closely related antioxidant, Vitamin E, was found by its
manufacturer (Eastman Chemical) to be four times more potent than the
synthetic form. We believe the nutraceutical market shows less interest in
synthetic products than in natural products, and will pay a premium for a
natural product.
19
<PAGE>
TIMING OF PRODUCT RELEASE. We plan to release our nutraceutical astaxanthin
product in the first quarter of 2000.
(2) OUR SECOND NUTRACEUTICAL PRODUCT
THE PRODUCT. Our second nutraceutical product is a dietary supplement rich in
a certain carotenoid pro-vitamin. The pro-vitamin is known to perform certain
vital functions in human physiology. Like astaxanthin, it is a potent
anti-oxidant. Like astaxanthin, which has very similar molecular properties,
it is present in trace quantities in certain common foods. Also like
astaxanthin, it is overproduced in certain microalgae.
THE MARKET. We believe the market for this product is similar to that for
nutraceutical astaxanthin. Animal and human models have demonstrated the
efficacy of this product in its effect on certain common illnesses. We
believe the potential market for this product could exceed $100 million per
year.
PRODUCTION CAPACITY. In mid-1999 we received approval from the State of
Hawaii Department of Agriculture to import the microalgae that is the basis
of our second nutraceutical product. We plan to begin cultivation at AGM
(commercial) scale in late 1999. We intend to devote approximately six months
to optimizing production in AGMs. Based on our knowledge and observations of
this microalgae, we believe we have enough production capacity to sustain
product introduction. After approximately one year of production, we project
that initial sales would support the cost of expanding our physical plant.
PRODUCT FORMULATION. The pro-vitamin in this product has chemical properties
that are similar to astaxanthin, and therefore we believe the product
formulation would also be very similar. We have not yet conducted any studies
on product formulation.
MARKETING STRATEGY. We intend to market this product directly to consumers,
building on the experience we will have developed with nutraceutical
astaxanthin. We may also sell limited amounts to wholesalers.
REGULATORY ISSUES. We expect this product to be subject to the same
regulatory issues that govern nutraceutical astaxanthin.
COMPETITION. We know of no competition for this product, nor for the
pro-vitamin it contains.
TIMING OF PRODUCT RELEASE. We plan to release this product within the next
12 to 18 months.
(3) AQUAXAN-TM- - NATURAL ASTAXANTHIN FOR ANIMAL FEED
THE PRODUCT. We have spent several years developing astaxanthin rich
AQUAXAN-TM- in conjunction with Cultor. Astaxanthin is proven to be a vital
dietary component in salmon, trout, red sea bream, and several other species
of cultivated seafood products. In salmon, the primary market, astaxanthin is
important as the main source of their pink flesh color. Recent studies have
also demonstrated the importance of astaxanthin in enhancing the growth rate,
vision, and fertility of salmon. Astaxanthin is routinely used as a feed
additive in poultry feeds, for the purpose of improving the coloration of
eggs and reducing the incidence of infections. Astaxanthin in the diet of
swine has been shown to increase fertility. Several feeding studies with our
astaxanthin-rich microalgae in fish diets have produced the desired results.
THE MARKET. The market for astaxanthin in aquaculture has grown at about 10%
per year over the past 15 years. The markets for astaxanthin in feeds for
poultry, swine, and other domestic animals are not yet well developed, and
are much smaller. The 1998 global market for astaxanthin was estimated at
20
<PAGE>
approximately $185 million. The sales price for astaxanthin has remained at
about $2,500 per kilogram for the past decade. Consumers in certain niche
markets are willing to pay a premium price. Global annual consumption of
astaxanthin is in excess of 65,000 kilograms. Almost all astaxanthin is
consumed in five countries which are, in order of importance, Norway, Chile,
Scotland, Canada and Japan.
PRODUCTION CAPACITY. Our current production capacity amounts to less than
1.0% of the global market. We plan to increase production capacity only in
response to demand. We have the option to increase capacity in two phases.
The first phase would involve constructing more finishing ponds, which would
result in an expansion of our current production capacity by a factor of
five. We estimate this first phase would cost less than $1.8 million, and
could generate annual sales approaching $2.0 million. The second phase would
probably require a new site, because adjacent space is limited at our current
site. The modular nature of the AGM-based production system lends itself well
to expansion at any foreseeable scale. We believe that the experience gained
in our recent plant expansion will make it easier for us to expand our
capacity at our existing site or at adjacent or other sites.
PRODUCT FORMULATION. Any feed ingredient, including astaxanthin-rich
microalgae, requires careful formulation and testing prior to market. Our
primary goal has been to create a product that is at least equal, if not
superior to, competitive feed ingredients. We have focused on creating a
product with longer shelf life that is safer and easier to handle, and
produces a better result in the diet. We believe we have achieved these and
other goals to a great degree, some on our own, and some in collaboration
with Cultor. We also believe that further improvement is possible. If
significant changes are made in product formulation, then new regulatory
approvals may have to be obtained. Therefore, we have been very careful to
develop our product to a high standard before placing it on the market.
MARKETING STRATEGY. We believe that astaxanthin-rich microalgae could occupy
a significant niche within the global astaxanthin market. We intend to be a
leader in this niche for the following reasons:
1) A SUPERIOR PRODUCT. We believe a product that is safer, easier
to handle, has a longer shelf life, and provides equal or greater
efficacy per unit cost will eventually establish its place in
this market.
2) CONSUMER AWARENESS. Farmed salmon now account for almost 40% of
global salmon production. Consumers are generally not aware that
the farmed salmon they eat contain a synthetic,
petrochemical-based coloring. Recent studies by the U.S. FDA have
shown that farmed salmon are easily distinguished from wild
salmon because they do not contain the natural form of
astaxanthin. All other factors being equal, we believe that
informed consumers will generally prefer a natural astaxanthin
product over a synthetic one.
The former lead manager of sales and marketing of astaxanthin at Cultor,
Martin Guerin, is now our VP, Sales and Marketing. We recently re-negotiated
our Distribution and Development Agreement with Cultor.
REGULATORY ISSUES. All feed ingredients are regulated in the countries where
they are sold. Regulations differ among astaxanthin-consuming nations.
Product specifications may differ, the stringency of regulations may differ,
and the time required for the application process may differ. In Europe, for
example, we expect regulatory approval could take up to three years, whereas
in Chile we expect such approval should take substantially less time.
COMPETITION. AQUAXAN-TM- competes directly with only one product produced
from HAEMATOCOCCUS microalgae, NATUROSE-TM-, manufactured and sold by
Cyanotech. NATUROSE-TM- is advertised to contain
21
<PAGE>
1.5% astaxanthin. AQUAXAN-TM- contains 3% astaxanthin. Cyanotech recently
announced a possible joint venture to produce NATUROSE-TM- with Norsk-Hydro,
the world's dominant salmon farming company. The Cyanotech/Norsk-Hydro joint
venture appears to be contingent on the results of "production optimization"
that has yet to take place. We believe such a joint venture, if it occurs,
could substantially contribute to developing the market for AQUAXAN-TM-.
TIMING OF PRODUCT RELEASE. We began our first sales of astaxanthin-rich
microalgae for use in animal feeds in June 1999.
(4) DRUG DISCOVERY LIBRARIES
THE DRUG DISCOVERY PROCESS. A large number of modern medicines were
originally discovered in plants. The drug discovery process generally starts
by identifying a plant that has "bioactive" properties. The compound
responsible for bioactivity is identified through a sequence of chemical
extraction, testing, and purification. The pure compound is tested, first in
animal models and then in human clinical trials. If the entire process is
completed, the result is a new drug.
In conjunction with EnzyMed, we have developed a drug discovery process
adapted to microalgae. Our role in this process is to (1) identify and
cultivate bioactive microalgae species, and (2) chemically extract, test, and
purify the bioactive fractions. Our tests rely on cell cultures, human tissue
cultures and genomic screens, conducted in collaboration with certain
university research laboratories. Bioactive compounds or fractions are then
subjected to Combinatorial Biocatalysis, a process which creates derivative
compounds from each pure bioactive compound using EnzyMed's proprietary
enzymatic methods. The resulting Microalgae Compound Libraries are then ready
to market.
THE PRODUCT. Compound libraries are a major source of drug discovery in
today's pharmaceutical industry. The "library" consists of pure compounds,
commonly in sets of 96, packaged in special containers designed for
"High-Throughput Screening." The screening process identifies new drug
candidates by testing for bioactivity, often targeted at certain diseases.
Tests might be based on the ability to kill certain types of cells (e.g.
bacteria, cancer), or they might be based on genetic pathways involved in
specific diseases. Any positive result from a screening test could eventually
lead to a new medicine.
We believe the Aquasearch/EnzyMed Microalgae Compound Library is unique
because it has these features:
1) Unexplored resource
- Few microalgae have been screened by the pharmaceutical
industry
2) Quantity
- Species: 30,000
- Bioactive compounds: thousands
- Average derivatives of each bioactive compound: hundreds via
Combinatorial Biocatalysis
3) Possible Patentability
- Bioactive compounds in microalgae may be new to science
- Bioactive derivatives from Combinatorial Biocatalysis may be
new to science
THE MARKET. Consumers of compound libraries are biopharmaceutical companies.
These companies are
22
<PAGE>
strongly motivated to find new sources of drugs. According to a 1997 study by
Andersen Consulting, the pharmaceutical industry must increase its rate of
discovery of new drugs by a factor of 10 in five years in order to maintain
its historic growth rate.
Compound libraries are typically marketed as a package that includes the
following terms and conditions:
1) Library Access Fee
- access time: limited to 3-12 months
- application: limited to certain diseases or disease areas
- multiple customers allowed
2) Licensing Fee
- $3 million to $15 million per compound
- activated by decision to begin trials
3) Milestone Payments
- $500,000 to $25 million per event
- activated by the results of pre-clinical and clinical trials
4) Royalties
- activated by FDA approval and full commercialization
PRODUCTION CAPACITY. We are producing our first compound library in
collaboration with EnzyMed. We have provided EnzyMed with a purified extract
of a known bioactive compound, and they are now producing derivatives using
Combinatorial Biocatalysis.
We have demonstrated capability in identification, microalgae cultivation,
extraction, purification, and testing of bioactivity. Our research team
includes professional scientists with expertise in all these areas. However,
we have only limited facilities and equipment for chemistry (extraction,
purification) and biochemistry (testing). In these areas, we now rely on
collaborations with several universities and members of our Scientific
Advisory Board. We plan to expand capacity with a 6,000 sq. ft. laboratory
dedicated to drug discovery and appropriate equipment, at an estimated cost
of $2.0 million. Our ability to finance this expansion depends on funds we
would have to raise through revenues, debt or equity.
EnzyMed has demonstrated capability in Combinatorial Biocatalysis. Its
contract customers for this type of "lead optimization" currently include
leading pharmaceutical and biopharmaceutical companies.
MARKETING STRATEGY. Both Aquasearch and EnzyMed have considerable marketing
know-how in the drug discovery market. A number of major pharmaceutical and
biotech companies have already expressed an interest in our first compound
library. Senior officers of both companies are responsible for marketing the
compound libraries.
TIMING OF PRODUCT RELEASE. We plan to release our first library for access
within six months.
(5) EXPANDING OUR PRODUCT PIPELINE
PRODUCT AREAS. We have established two areas to expand our product pipeline:
- Nutraceuticals
- Pharmaceutical drug development
23
<PAGE>
BASIC STRATEGY: NUTRACEUTICALS. We plan to expand our nutraceutical product
pipeline using a common process. A fundamental principle of this process is
that we rely on strategic collaborations and alliances whenever special
Aquasearch expertise and technology is not required. We have already
identified many potential nutraceutical products among the microalgae, mostly
through the published scientific literature.
We are focused on markets for high-value products that, like those for
natural astaxanthin and our second nutraceutical product, have potential
sales of more than $100 million, and few or no known competitors. At our
recently completed facility, we can directly measure economic feasibility
from data gathered during a six-month production run in our commercial-scale
Ultra-AGM.
We are well aware that nutraceutical products, because they are not highly
regulated, have caused concern among some consumers. Our goal is to
self-regulate at a higher standard than required by law. We are implementing
a variety of testing procedures designed to maximize product safety and
product efficacy.
Our marketing approach may determine many aspects of product development. We
would prefer to sell products directly to the consumer. However, if a
strategic partner can contribute significantly to product development or
marketing, then we will consider an alliance that could accelerate or
maximize the process.
BASIC STRATEGY: PHARMACEUTICAL DRUG DEVELOPMENT. Our process for expanding
the pipeline in drug development is firmly founded on strategic
collaborations and alliances. We have leveraged our ability to identify,
extract, test, and purify novel bioactive substances from microalgae through
partnerships with major universities. Additionally, we have enhanced our
ability to produce Microalgae Compound Libraries through our collaboration
with EnzyMed.
We are focused in the next year on developing strategic license agreements
with biopharmaceutical companies. We expect many biopharmaceutical companies
will be interested to access our Compound Libraries for drug discovery. We
believe our management team has well-developed networks and relationships in
the biotechnology industry that bring credibility to our marketing approach.
PRODUCT DEVELOPMENT: MARBEC. The Marine Bioproducts Engineering is a
10-year, $40 million Engineering Research Center ("ERC"), funded in 1998 by
the U.S. National Science Foundation. There are fewer than two dozen ERCs in
the U.S. In 1998, more than 160 universities competed for only 5 ERCs
awarded by the National Science Foundation.
MarBEC combines the expertise of world-leading marine science and ocean
engineering programs at the School of Ocean and Earth Sciences and Technology
at University of Hawaii with the nationally-famous chemical engineering
program at the Department of Chemical Engineering at University of
California, Berkeley.
CORE RESEARCH: Discovery and development of new products from microalgae
COST: Industrial Partnership, $20,000 annually
BENEFITS TO AQUASEARCH:
- New research results prior to public disclosure
- Preferential rights to intellectual property
- Privilege to sponsor focused research, resulting in exclusive
intellectual property rights
- Preferred access to specialized and unique facilities and
equipment
- Preferred access to microalgae culture collections
24
<PAGE>
- Membership on Industrial Advisory Board (current members:
Aquasearch, Monsanto, Eastman Chemical, Cyanotech)
- Opportunity to influence specific research
- Preferential access to student interns
In the first ten years of the ERC program, two dozen centers generated more
than 1,000 patents. Industry members in other ERCs have cited the principal
benefits as (1) strategic relationships arising out of the academic/industry
network, (2) access to specialized equipment and facilities, and (3) better
educated ERC graduates.
PRODUCT DEVELOPMENT: OTHER UNIVERSITIES. We are currently negotiating
research agreements with medical schools at four universities. If
consummated, these agreements will strongly leverage our own product
development efforts. Our goals are as follows:
CORE RESEARCH: Pre-clinical screening for drug candidates
- Purification of extracts from approximately 1,200 species of
microalgae in 3 years
- Tissue culture screening
- Genomic screening: allows extracts to be tested for effects on
specific diseases
- Genetic control of microalgae biochemistry
- Targets: skin cancer, breast cancer, antivirals, antifungals
COST: Approximately $500,000 per year. Projects range from 1 to 3
years. One project requires no funds.
BENEFITS TO AQUASEARCH:
- Ownership of intellectual property
- Increases value of drug candidates to $3 to $15 million per
compound
We recognize that pre-clinical screening is costly. However, we believe it is
a very cost-effective investment. The industry-standard license fee for one
compound alone would more than double our anticipated investment.
If we are able to enter into agreements with all four universities, we expect
to generate and screen approximately 10,000 extracts over 3 years at a cost
of $1.5 million. If our pre-clinical trials yield only one bioactive
compound, the minimum license fee we expect would be $3 million.
We have three options for screening and pre-clinical trials. We can do them
ourselves, with a corporate partner, or with a university partner. The cost
of facilities, equipment and expertise dictates that we work with a partner.
The advantage of the university partners we have chosen is significant,
because the universities perform contract research and we retain ownership of
the compounds.
TIMING OF PRODUCT RELEASE. Our pipeline expansion is a process designed to
yield many more products at minimal cost. Our goal is two products per year.
The result could be less, or it could be far greater.
GENERAL ASPECTS OF PLANNED OPERATIONS
We expect to steadily increase revenues from sales of our natural astaxanthin
for animal feed. However, we do not expect this product alone to be
profitable, because we intend to reserve significant production capacity for
nutraceutical astaxanthin.
25
<PAGE>
We intend to launch our nutraceutical astaxanthin product in early 2000. We
anticipate that we will become profitable within one year of the launch if we
hit our targets - with no increase in production capacity. However, there can
be no assurance that this will occur.
Strategic relationships and collaborations will continue to be an important
part of our business strategy. We now have such relationships with EnzyMed,
MarBEC and Cultor. We expect collaborations will expand to include other
corporations and other universities. However, we cannot be certain to
maintain existing partner relationships, nor can we guarantee to develop
other successful relationships.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Since inception, our 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, 1999, we had an accumulated deficit of approximately $9.9
million. Our losses to date have resulted primarily from costs incurred in
research and development and from general and administrative costs associated
with operations. We expect to continue to incur operating losses for at least
the next year as we increase the expansion of our product pipeline. We expect
to have quarter-to-quarter and year-to-year fluctuations in revenues,
expenses and losses, some of which could be significant.
We do have a limited operating history. Your assessment of our prospects
should 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. We have attempted to
address these risks by, among other things, hiring and retaining highly
qualified persons and forging strategic alliances with companies and
universities that complement and leverage our technical strengths. However,
our best efforts cannot guarantee that we will overcome these risks in a
timely manner, if at all.
We are in the process of transition to a full-scale commercial producer of
microalgae products. These changes in our business have placed and will
continue to place significant demands on our management, working capital and
financial and management control systems.
RESULTS OF OPERATIONS
REVENUES. Since inception, our main activities have been basic research and
development and manufacture process development; recruiting personnel;
purchasing operating assets; and raising capital. We had no revenues for the
quarter ended July 31, 1998. During the quarter ended July 31, 1999, we
started to ship our natural astaxanthin product. This revenue amounting to
$8,400 is classified as other income. Most of the product we produced in 1997
and 1998 was used for product development and testing. The product we have
produced in 1999 is in inventory, and most of this awaits final formulation
before it can be sold.
RESEARCH AND DEVELOPMENT COSTS. Research and development costs include
salaries, consulting fees, development materials, equipment depreciation and
costs associated with operating our three-acre research and
development/production facility. Research and development costs increased by
approximately $195,000, or 60%, during the quarter ended July 31, 1999
compared to the quarter ended July 31, 1998. Most of these funds were
expended to develop the very large Ultra-AGM, to expand production capacity,
to implement improved computerized process control, and to reduce capital
costs of the AGM technology. From inception through July 31, 1999, our total
research and development costs
26
<PAGE>
were approximately $4.2 million. We expect to incur significant additional
research and development expenses in the future.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
consist principally of salaries and fees for professional services. General
and administrative costs increased approximately $148,000, or 67%, for the
quarter ended July 31, 1999 compared with the quarter ended July 31, 1998.
The increase in general and administrative expenses reflects additional costs
associated with personnel additions, legal fees incurred in connection with
developing and protecting the Company's intellectual property position and
raising capital, as well as other expenses. From inception through July 31,
1999, our total general and administrative expenses were approximately $5.2
million. We anticipate that general and administrative expenses will increase
over time as we expand production capacity, develop more new products,
increase our intellectual property protection, and raise additional capital.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations until now through public and private sales of
equity securities. In the past nine months, we raised approximately $3.7
million from the private placement of convertible notes. In the fiscal years
ended October 31, 1998 and 1997, we raised approximately $3.4 million and
$1.3 million (net), respectively, from the sale of shares of Common Stock
and/or the issuance of Convertible Notes in private placement transactions.
From inception through July 31, 1999, we had raised total net proceeds of
approximately $11.6 million through public and private sales of equity and
debt securities.
During the quarter ended July 31, 1999, operating activities consumed
approximately $883,000 compared with $695,000 in the quarter ended July 31,
1998. From inception through July 31, 1999, operating activities have
consumed approximately $7.3 million.
Capital expenditures for the quarters ended July 31, 1999 and 1998 were
$60,500 and $446,900, respectively. From inception through July 31, 1999,
total capital expenditures have been approximately $3.8 million.
As of July 31, 1999, our liquidity was approximately $75,000 in cash and cash
equivalents.
We estimate a need for approximately $3.0 million in operating capital over
the next twelve months. We need an additional $0.5 million to consummate
strategic research agreements with three university medical schools.
Projected product sales will begin to pay some operating costs. We now
believe that product sales could lead to profitability within twelve months
after the start of astaxanthin nutraceutical product sales, and that some
future expansion could be financed out of profits. In the near term, we
believe that 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.
We are now pursuing more sources of capital to maintain operations and, more
importantly, to expand our product pipeline. These capital sources include
government contracts and grants, product sales, license agreements and equity
or debt financing. We cannot guarantee success in raising the additional
capital necessary to sustain or expand operations, nor are we certain that
such capital will be available on terms that prevent substantial dilution to
existing investors. If we cannot raise sufficient capital, then we might be
forced to significantly curtail operations. Any reduction in operating
activity could have a material adverse effect on our business, financial
condition, results of operations, and relationships with corporate partners.
See "Factors That May Affect Future Operating Results--Substantial Near-Term
Capital Needs; Uncertainty of Additional Funding; Dilution" and
"--Substantial Long-Term Capital Needs; Uncertainty of Additional Funding;
Dilution" in the 1998 Form 10-KSB.
27
<PAGE>
Part II - Other Information
Item 1. Legal Proceedings
On July 13, 1998, Cyanotech filed a complaint (the "Complaint") in the United
States District Court for the District of Hawaii (Case No. CV98-00600ACK)
against our company. In the Complaint, Cyanotech seeks declaratory judgment
of noninfringement of our U.S. Letters Patent No. 5,541,056 (the "5,541,056
Patent"); invalidity of the 5,541,056 Patent; and non-misappropriation of our
trade secrets relating to closed culture production of astaxanthin. Cyanotech
filed the Complaint after we expressed to Cyanotech our concern that
Cyanotech infringed the 5,541,056 Patent and misappropriated Aquasearch trade
secrets. We do not believe that Cyanotech's Complaint is meritorious.
However, we 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 our 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 finding of
noninfringement or declaration of invalidity of the 5,541,056 Patent could
have a material adverse effect on our business, financial condition, results
of operations and relationships with corporate partners.
On September 11, 1998, we filed an answer denying all of Cyanotech's
allegations and a counter claim, alleging infringement of the 5,541,056
Patent; misappropriation of trade secrets; unfair competition; and breach of
contract relative to our 1994 Dissolution Agreement with Cyanotech.
On December 14, 1998, Cyanotech filed a motion for partial summary judgment
of noninfringement and invalidity of the 5,541,056 Patent. We do not believe
that this motion is meritorious.
On March 1, 1999, we filed a motion for partial summary judgment against
Cyanotech for breach of contract and misappropriation of trade secrets. On
March 26, 1999, we filed a cross-motion for summary judgment of patent
infringement. All motions for summary judgment are currently scheduled to be
heard in November 1999.
Item 2. Changes In Securities
During the quarter ended July 31, 1999, we issued $830,000 aggregate
principal amount of one-year convertible notes bearing interest at 10% per
annum, of which $635,000 was issued to an officer of the company. The holders
of the convertible notes have an option to convert their convertible notes
into our Common Stock. The convertible notes provide that upon conversion,
the holders would receive warrants to purchase shares of our Common Stock.
The warrants have an exercise price of $0.50 per share and a term of three
years. During the quarter ended July 31, 1999, some of the holders of these
convertibles notes and other outstanding convertible note holders (amounting
to $1,190,000 aggregate principal amount) exercised their option to convert
their convertible notes into shares of Common Stock. Upon conversion of the
outstanding principal of, and interest on, the convertible notes, we issued
7,531,678 shares of Common Stock and also issued 1,190,000 warrants in
connection thereof. 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
28
<PAGE>
Item 5. Other Information -- None
Item 6. Exhibits And Reports on Form 8-K
(a) Exhibits -- None
(b) Reports on Form 8-K -- None
SIGNATURE
In accordance with the requirements of the Exchange Act, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AQUASEARCH, INC.
Dated: September 14, 1999 By: /s/ Mark E. Huntley
------------------------------
Mark E. Huntley, Ph.D.
President and Chief Executive Officer
29
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> OCT-31-1998
<PERIOD-START> MAY-01-1999
<PERIOD-END> JUL-31-1999
<CASH> 75,124
<SECURITIES> 0
<RECEIVABLES> 6,131
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 106,605
<PP&E> 3,881,839
<DEPRECIATION> 353,753
<TOTAL-ASSETS> 3,742,824
<CURRENT-LIABILITIES> 2,960,365
<BONDS> 0
0
0
<COMMON> 9,515
<OTHER-SE> 10,659,660
<TOTAL-LIABILITY-AND-EQUITY> 3,742,824
<SALES> 0
<TOTAL-REVENUES> 0
<CGS> 0
<TOTAL-COSTS> 882,263
<OTHER-EXPENSES> (33,419)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (915,682)
<INCOME-TAX> 0
<INCOME-CONTINUING> (915,682)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (951,682)
<EPS-BASIC> (0.01)
<EPS-DILUTED> (0.01)
</TABLE>
