<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-------------------
FORM 10-Q
(Mark One)
X Quarterly report under Section 13 or 15(d) of the Securities Exchange
- ---- Act of 1934. For the quarterly period ended September 30, 1999
____ Transition report under Section 13 or 15(d) of the Exchange Act.
For the transition period from ___________ to ___________
Commission File Number: 0-21975
ECO SOIL SYSTEMS, INC.
(Exact Name of Small Business Issuer as Specified in its Charter)
NEBRASKA 47-0709577
------------------------------- -------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
10740 THORNMINT ROAD
SAN DIEGO, CALIFORNIA 92127
(Address, Including Zip Code, of Principal Executive Offices)
(858) 675-1660
(Registrant's Telephone Number, Including Area Code)
Check whether the Registrant (1) has filed all reports required to be filed by
section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the Registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days.
YES X NO
----- -----
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: As of November 5, 1999, 17,920,755
shares of the Registrant's Common Stock, $.005 par value per share, were
outstanding.
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INDEX
ECO SOIL SYSTEMS, INC.
FORM 10-Q
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE
----
<S> <C>
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 1999 (unaudited)
and December 31, 1998 3
Condensed Consolidated Statements of Operations (unaudited) for the Three
Months and Nine Months Ended September 30, 1999 and 1998 4
Consolidated Statements of Cash Flows (unaudited) for the Nine
Months Ended September 30, 1999 and 1998 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 8
Item 3. Quantitative and Qualitative Disclosures About Market Risk 13
PART II. OTHER INFORMATION
Item 1. Legal Proceedings N/A
Item 2. Changes in Securities and Use of Proceeds 14
Item 3. Defaults Upon Senior Securities 14
Item 4. Submission of Matters to a Vote of Security Holders N/A
Item 5. Other Information 14
Item 6. Exhibits and Reports on Form 8-K 17
</TABLE>
2
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ECO SOIL SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
ASSETS
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------------- -----------------
(unaudited)
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 5,953 $ 3,410
Accounts receivable, net of allowance for doubtful accounts of $932 and $1,261
at September 30, 1999 and December 31, 1998, respectively 34,118 13,523
Finished goods inventory 21,640 10,475
Prepaid expenses and other current assets 9,236 6,288
------------------- -----------------
Total current assets 70,947 33,696
Equipment under construction 3,694 4,731
Property and equipment, net 15,397 11,652
Intangible assets, net 14,643 14,571
Other assets 2,829 2,355
------------------- -----------------
Total assets $107,510 $67,005
------------------- -----------------
------------------- -----------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 34,506 $ 8,037
Accrued expenses 5,783 7,061
Short-term obligations 23,047 -
Current portion of long-term obligations 107 178
------------------- -----------------
Total current liabilities 63,443 15,276
Long-term obligations, net of current portion 16,673 22,620
Deferred gain on sale/leaseback of building 538 566
Commitments
Shareholders' Equity:
Preferred stock
$.005 par value; 5,000,000 shares authorized; none issued and outstanding - -
Common stock 89 85
$.005 par value; 50,000,000 shares authorized; 17,887,739 and 17,064,576
issued and outstanding at September 30, 1999 and December 31, 1998,
respectively
Additional paid-in capital 54,261 51,485
Warrants 1,124 958
Notes receivable from shareholders - (15)
Accumulated deficit (28,618) (23,970)
------------------- -----------------
Total shareholders' equity 26,856 28,543
------------------- -----------------
Total liabilities and shareholders' equity $107,510 $67,005
------------------- -----------------
------------------- -----------------
</TABLE>
See accompanying notes.
Note: The Balance Sheet at December 31, 1998 is derived from the audited
financial statements at that date, but do not include all of the disclosures
required by generally accepted accounting principles.
3
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ECO SOIL SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
-----------------------------------------------------------------
1999 1998 1999 1998
---------------- -------------- -------------- ----------
(unaudited) (unaudited) (unaudited) (unaudited)
<S> <C> <C> <C> <C>
Revenues:
Turf Partners $ 35,346 $ 21,678 $ 81,169 $ 50,808
Agricultural Supply 8,497 8,311 20,599 14,474
--------------- ----------- ------------ -----------
Total revenues 43,843 29,989 101,768 65,282
Cost of revenues:
Turf Partners 27,393 15,071 62,089 35,727
Agricultural Supply 6,003 5,323 14,121 9,857
--------------- ----------- ------------ -----------
Total cost of revenues 33,396 20,394 76,210 45,584
Gross profit 10,447 9,595 25,558 19,698
Operating expenses:
Selling, general and administrative 9,606 6,465 26,055 15,942
Research and development 516 145 768 313
Amortization of intangibles 271 395 864 852
Legal settlement - - 198 -
--------------- ----------- ------------ -----------
Income (loss) from operations 54 2,590 (2,327) 2,591
Interest expense 1,123 439 2,629 779
Interest income 166 147 308 353
--------------- ----------- ------------ -----------
Net income (loss) $ (903) $ 2,298 $ (4,648) $ 2,165
--------------- ----------- ------------ -----------
--------------- ----------- ------------ -----------
Net income (loss) per share of common stock, basic $ (0.05) $ 0.14 $ (0.27) $ 0.13
--------------- ----------- ------------ -----------
Net income (loss) per share of common stock, diluted $ (0.05) $ 0.12 $ (0.27) $ 0.11
Shares used in calculating net income (loss) per share,
basic 17,647 16,598 17,392 16,214
--------------- ----------- ------------ -----------
Shares used in calculating net income (loss) per share,
diluted 17,647 19,488 17,392 19,546
--------------- ----------- ------------ -----------
--------------- ----------- ------------ -----------
</TABLE>
See accompanying notes.
4
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ECO SOIL SYSTEMS, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
----------------------------
1999 1998
------------- -----------
<S> <C> <C>
Operating activities:
Net income (loss) $(4,648) $ 2,165
Adjustments to reconcile net cash used in operating activities: - -
Depreciation and amortization 2,652 2,070
Amortization of debt issuance costs and discount on long-term obligations 339 -
Provision for losses on accounts receivable 416 63
Loss (gain) on sale of property and equipment 93 (12)
Compensation expense incurred upon issue of stock options/warrants 242 -
Changes in operating assets and liabilities, net of effect of acquired
businesses:
Accounts receivable (21,011) (6,483)
Inventories (11,783) (5,161)
Prepaid expenses and other assets (3,635) (5,180)
Accounts payable 26,469 224
Accrued liabilities (1,308) (74)
------------- -----------
Net cash used in operating activities (12,174) (12,388)
Investing activities:
Payments related to acquired businesses, net of cash acquired - (2,452)
Proceeds from the sale of property and equipment 117 -
Purchase of property and equipment (4,006) (1,311)
Sale of short-term investments - 3,000
Purchase of patents and licenses (275) (25)
------------- -----------
Net cash used in investing activities (4,164) (788)
Financing activities:
Advances (to) from shareholders 15 (1,068)
Debt issuance costs (125) (1,532)
Proceeds from subordinated debt - 15,000
Proceeds from long-term obligations 4,242 14,719
Repayments of long-term obligations (10,263) (17,204)
Proceeds on short-term obligations 53,898 -
Repayments on short-term obligations (30,943) -
Payments on capital lease obligations - (13)
Net proceeds from issuance of common stock 2,057 1,999
------------- -----------
Net cash provided by financing activities 18,881 11,901
------------- -----------
Net increase (decrease) in cash and cash equivalents 2,543 (1,275)
Cash and cash equivalents at beginning of period 3,410 3,125
------------- -----------
Cash and cash equivalents at end of period $5,953 $1,850
------------- -----------
------------- -----------
</TABLE>
See accompanying notes.
5
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ECO SOIL SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of Eco Soil Systems, Inc. (the "Company"),
all adjustments, consisting only of normal recurring adjustments, necessary for
the fair statement of the results for the three-month and nine-month periods
ended September 30, 1999 and 1998 have been made. The results of operations for
the three-month and nine-month periods ended September 30, 1999 are not
necessarily indicative of the results to be expected for the full fiscal year.
For further information, refer to the audited financial statements and notes
thereto included in the Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1998.
2. NET INCOME/(LOSS) PER SHARE
In accordance with Financial Accounting Standards Board Statement No.
128, "Earnings per share" ("SFAS 128"), basic earnings per share is calculated
by dividing net income by the weighted average number of common shares
outstanding for the period. Diluted earnings per share reflects the potential
dilution of securities that could share in the earnings of the Company such as
common stock which may be issuable upon exercise of outstanding common stock
options, warrants and preferred stock. These shares are excluded when their
effects are antidilutive.
3. SEGMENT INFORMATION
For purposes of analyzing and understanding the financial statements,
the Company's operations have been classified into the following business
segments:
TURF PARTNERS: This segment enters into contracts with golf courses or
turf maintenance service businesses, or distributors that sell to those end-user
markets to manage the health and productivity of their soil during the golf
season. The contracts require the Company to perform a comprehensive soil
analysis at the beginning of the season, develop a treatment regimen, install
the Company's proprietary BioJect system at the customer's site and provide the
microbials throughout the season. This segment also wholesales and distributes a
wide range of traditional chemical and turf maintenance products and golf course
supplies to the above-mentioned market.
AGRICULTURAL SUPPLY: This segment enters into contracts with
agricultural growers to manage the health and productivity of their soil during
the course of the growing season, which requires the Company to perform a
comprehensive soil analysis at the beginning of the season, develop a treatment
regimen, install the Company's proprietary BioJect system at the customer's site
and provide the microbials and other soil additive products for the customer to
use throughout the season. This segment also distributes a wide range of
irrigation and other agricultural supplies to growers. In 1998, the Company
actively commenced its soil maintenance service business and acquired several
distributors of irrigation and other agricultural supplies, and therefore
created this business segment. Prior to 1998, agricultural operations were
insignificant and were not considered to be a separate segment.
6
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<TABLE>
<CAPTION>
Revenues Segment Profits Segment Assets
--------------------------- -------------------------- -------------------------
For the three months ended September 30, As of September 30,
--------------------------------------------------------- -------------------------
1999 1998 1999 1998 1999 1998
----------- ----------- ----------- ----------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Turf Partners $35,346 $21,678 $ 1,425 $ 2,498 $ 71,766 $46,104
Agricultural Supply 8,497 8,311 375 1,422 29,105 22,216
Corporate and Other - - (2,703) (1,622) 6,639 8,803
----------- ----------- ----------- ----------- ----------- ----------
Total $43,843 $29,989 $ (903) $ 2,298 $107,510 $77,123
</TABLE>
4. LEGAL SETTLEMENT
In November 1998, the Company executed a term sheet with the Palladin
Group, L.P. ("Palladin") concerning negotiations for a possible investment by
Palladin in certain new classes of securities of the Company which, at the time,
the Company was considering issuing to a certain fund managed by Palladin. The
Company subsequently terminated the negotiations in December 1998. An affiliate
of Palladin, Halifax Fund, L.P. ("Halifax"), filed a lawsuit on or about March
19, 1999 in San Diego Superior Court alleging that the termination violated
duties owed by the Company to Halifax under the term sheet. The lawsuit sought
compensatory damages of approximately $2.6 million and punitive damages of
approximately $12.0 million. In July 1999, the Company executed Settlement and
Release Agreements with Halifax Fund, L.P., Palladin Group, L.P., Granite
Financial Group, Inc., and Midori Capital Corporation. These agreements mutually
release and discharge all claims arising from this litigation. The Company paid
termination charges and attorney's fees of $198,000 related to this settlement.
7
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Certain statements contained in this Management's Discussion
and Analysis that are not related to historical results are forward
looking statements. Actual results may differ materially from those
projected or implied in the forward statements. Further, certain forward
looking statements are based upon assumptions of future events, which may
not prove to be accurate. These forward looking statements involve
risks and uncertainties including but not limited to those referred to
below. See "Item 5. Other Information. Factors That Could Affect Future
Performance."
This information should be read in conjunction with the financial
statements and notes thereto included in Item 1 of this report for the quarter
ended September 30, 1999. Additionally, the financial statements and notes
thereto and Management's Discussion and Analysis in the Company's Annual Report
on Form 10-K for the year ended December 31, 1998 will provide additional
information.
In addition to other endeavors, the Company develops, markets and sells
proprietary biological products as well as distributes traditional chemical
products of third party manufacturers to two principal segments: The turf and
golf management market ("Turf Partners") and the agricultural and crop market
("Ag Supply").
THIRD QUARTER ENDED SEPTEMBER 30, 1999 COMPARED TO THIRD QUARTER ENDED
SEPTEMBER 30, 1998
RESULTS OF OPERATIONS
REVENUES
For the third quarter of 1999, revenues were $43.8 million, an increase
of 46% versus $30.0 million for the third quarter 1998. The increase in revenues
reflects an increase in both Turf Partners and Ag Supply distributed revenues.
For the third quarter of 1999, Turf Partners revenues were $35.3
million, an increase of 63% versus $21.7 million for the third quarter 1998. The
increase in Turf Partners sales occurred in all three operating regions of the
U.S. Proprietary sales for Turf Partners decreased by $1.0 million to $2.3
million from $3.3 million in the third quarter of 1998. The decrease in
proprietary sales was due to a decrease in BioJect usage as a result of the
following: (i) a reorganization in the fall of 1998 that impaired sales
momentum, (ii) integration of our sales force assumed from the Scotts Company,
(iii) new FreshPack programs challenged our sales force, while providing the
customer with a cheaper alternative to the BioJect, (iv) the delay of approval
on certain biocontrol products from the EPA, (v) customers believed their
improved turf, resulting from several seasons of BioJect programs, could manage
without a 1999 program and (vi) drought conditions in the Midwest and Northeast.
Distributed revenue increased to $33 million in the third quarter 1999 from
$18.3 million in the third quarter of 1998. The increase in distributed revenue
is due to the expansion of the Company's turf business. During the second
quarter of 1999, Turf Partners completed the integration of the sales force
assumed from the Scott's Company in December 1998 and completed the stocking of
several new warehouses and the realignment of its distribution networks which
extended market penetration to new geographic areas.
For the third quarter of 1999, Ag Supply revenues were $8.5 million, an
increase of 2%, versus $8.3 million for the third quarter of 1998. Proprietary
sales for Ag Supply were $616,000, a decrease of 51% from $1.2 million for the
third quarter of 1998. The decrease in proprietary sales was due to a decrease
of acreage under production in the Mexican agriculture market caused by growers'
decisions not to replant. Mexican weather conditions, political conditions and
the world tomato market downturn contributed to the growers' decision not to
replant. Distributed sales for the Ag Supply division increased to $7.9 million
in the third quarter of 1999 from $7.1 million in the third quarter of 1998. The
overall increase in distributed sales was
8
<PAGE>
due to the opening of new warehouses, which extended market penetration to
new geographic areas, offset by the above-mentioned conditions in Mexico
affecting proprietary sales.
GROSS PROFIT
For the third quarter of 1999, the Company's gross profit was $10.4
million, an increase of 9% versus $9.6 million for the third quarter of 1998.
The increase in gross profit was due to the increase in both Turf Partners and
Ag Supply distributed revenues. For the third quarter of 1999, the Company's
gross margin was 24% versus 32% during the third quarter of 1998. The decrease
in gross margin was due to the mix of proprietary and distributed sales during
the quarter. Proprietary sales, which carry higher gross margins than
distributed sales, decreased while distributed sales increased during the third
quarter of 1999.
For the third quarter of 1999, the gross profit on Turf Partners sales
was $8.0 million, an increase of 20% versus $6.6 million during the third
quarter of 1998. The increase in gross profit on Turf Partners sales is directly
related to the increase in distributed revenue. For the third quarter of 1999,
the gross margin on Turf Partners products was 22% versus 30% during the third
quarter of 1998. The decrease in gross margin on Turf Partners sales was due to
a decrease in proprietary sales, heavy seed discounting in the West and lower
than expected fungicide sales in the East.
For the third quarter of 1999, the gross profit on Ag Supply sales was
$2.5 million, compared to $3.0 million during the third quarter of 1998. The
gross margin on Ag Supply products was 29% versus 36% during the third quarter
of 1998. The decrease in gross margin on Ag Supply sales was due to a decrease
in proprietary sales, which carry higher margins than distributed sales.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
For the third quarter of 1999, selling, general and administrative
("SG&A") expense was $9.6 million, an increase of 48% versus $6.5 million during
the third quarter of 1998. The increase in SG&A expense was primarily due to
additional overhead costs associated with openings of additional warehouses,
integration of the Scotts' sales force and expenses related to marketing the
Company's proprietary technology as well as advancing strategic relationships to
benefit the Company's future. SG&A expense as a percentage of sales remained
consistent at 22% for the third quarter of 1999 and 1998.
RESEARCH AND DEVELOPMENT EXPENSE
For the third quarter of 1999, research and development ("R&D") expense
was $516,000, an increase of 256% versus $145,000 during the third quarter of
1998. The increase in R&D expense was due to ongoing analysis and testing of
proprietary technology spent by the Company and a $168,000 reclass from SG&A for
the first six months of 1999, related to prior period misclassification.
AMORTIZATION EXPENSE
For the third quarter of 1999, amortization expense was $271,000,
a decrease of 31% versus $395,000 for the third quarter of 1998. The
decrease in amortization expense is due to goodwill write-off related to
the Company's previous acquisitions of Turf Products, Inc. and Turfmakers,
Inc. in December 1998.
INTEREST EXPENSE
For the third quarter of 1999, interest expense was $1.1 million, an
increase of 156% versus $439,000 for the third quarter of 1998. The increase in
interest expense reflects an increase in the amount of debt outstanding and
write-off of debt issuance cost related to a credit facility which was retired
in July 1999.
9
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NET INCOME
For the third quarter of 1999, net loss was $903,000 or $.05 per
share versus net income of $2.3 million, or $.14 per share during the third
quarter of 1998.
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 1998
REVENUES
For the first nine months of 1999, revenues were $101.8 million, an
increase of 56% versus $65.3 million for the first nine months of 1998. The
increase in revenues reflects an increase in both Turf Partners and Ag Supply
revenues.
For the first nine months of 1999, Turf Partners revenues were $81.1
million, an increase of 60% versus $50.8 million for the first nine months of
1998. The increase in Turf Partners revenues occurred in all three operating
regions of the U.S. Proprietary sales for Turf Partners decreased to $4.6
million during the first nine months of 1999 from $6.9 million during the first
nine months of 1998. The decrease in proprietary sales was due to a decrease in
BioJect usage as a result of the following: (i) a reorganization in the fall of
1998 that impaired sales momentum, (ii) integration of our sales force assumed
from the Scotts Company, (iii) new FreshPack programs challenged our sales
force, while providing the customer with a cheaper alternative to the BioJect,
(iv) the delay of approval on certain biocontrol products from the EPA, (v)
customers believed their improved turf, resulting from several seasons of
BioJect programs, could manage without a 1999 program and (vi) drought
conditions in the Midwest and Northeast. Distributed sales increased to $76.5
million in the first nine months of 1999 from $43.9 million in the first nine
months of 1998. The increase in distributed revenue is due to the expansion of
the Company's turf business. During the second quarter of 1999, Turf Partners
completed the integration of the sales force assumed from the Scotts Company in
December 1998 and completed the stocking of several new warehouses and
realignment of its distribution networks which extended market penetration to
new geographic areas.
For the first nine months of 1999, Ag Supply revenues were $20.6
million, an increase of 42%, versus $14.4 million for the first nine months of
1998. Ag Supply revenues were affected favorably by the acquisitions of
Agricultural Supply, Inc. in April 1998 and Yuma Sprinkler & Pipe Supply and
RiegoMex S.A. de C.V. in June 1998. Proprietary sales in Mexico and the U.S.
increased to $1.5 million during the first nine months of 1999 compared to $1.3
million in the first nine months of 1998. Distributed sales for the Ag Supply
division increased to $19.1 million in the first nine months of 1999 from $13.1
million in the first nine months of 1998. The increase in proprietary and
distributed revenues was due to the 1998 acquisitions mentioned above and
opening of new warehouses which extended market penetration to new geographic
areas.
GROSS PROFIT
For the first nine months of 1999, the Company's gross profit was $25.6
million, an increase of 30% versus $19.7 million for the first nine months of
1998. The increase in gross profit was due to the increase in both Turf Partners
and Ag Supply revenues. For the first nine months of 1999, the Company's gross
margin was 25% versus 30% for the first nine months of 1998. The decrease in
gross margin was due to the mix of proprietary and distributed sales during the
first nine months of 1999. Proprietary sales, which carry higher gross margins
than distributed sales, decreased while distributed sales increased during the
first nine months of 1999.
For the first nine months of 1999, the gross profit on Turf Partners
revenues was $19.1 million, an increase of 27% versus $15.1 million during the
first nine months of 1998. The increase in the gross profit on Turf Partners
sales is directly related to the increase in distributed revenue. For the first
nine months of
10
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1999, the gross margin on Turf Partners products was 24% versus 30% during
first nine months of 1998. The decrease in gross margin on Turf Partners
sales was due to a decrease in proprietary sales, heavy seed discounting in
the West and lower than expected fungicide sales in the East.
For the first nine months of 1999, the gross profit on Ag Supply sales
was $6.5 million, an increase of 40%, compared to $4.6 million during the first
nine months of 1998. The increase in the gross profit on Ag Supply sales is
directly related to the increase in revenue, as previously discussed. The gross
margin on Ag Supply products was 31% versus 32% during the first nine months of
1998. The decrease in gross margin was due to the mix of proprietary and
distributed sales during the nine months. Proprietary sales, which carry higher
gross margins than distributed sales, did not increase in the same magnitude
that distributed sales did during the first nine months of 1999.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
For the first nine months of 1999, SG&A expense was $26.0 million, an
increase of 63% versus $15.9 million during the first nine months of 1998. The
increase in SG&A expense was primarily due to additional overhead costs
associated with the opening of additional warehouses, integration of the Scotts'
sales force and expenses of the Company spent on marketing the Company's
proprietary technology as well as advancing strategic relationships to benefit
the Company's future. SG&A expense as a percentage of sales was 26% compared to
24% for the first nine months of 1998.
RESEARCH AND DEVELOPMENT
For the first nine months of 1999, R&D expense was $768,000, an
increase of 145% versus $313,000 during the first nine months of 1998. The
increase in R&D expense was due to ongoing analysis and testing of proprietary
technology spent by the parent.
AMORTIZATION EXPENSE
For the first nine months of 1999, amortization expense was
$864,000, an increase of 1% versus $852,000 during the first nine months of
1998. The increase in amortization expense is due to an increase in the
Company's goodwill directly related to the previously discussed acquisitions,
offset by a decrease in amortization expense related to goodwill write-off
associated with the previous acquisitions of Turf Products, Inc. and
Turfmakers, Inc. in December 1998.
INTEREST EXPENSE
For the first nine months of 1999, interest expense was $2.6 million,
an increase of 237% versus $779,000 during the first nine months of 1998. The
increase in interest expense reflects an increase in the amount of debt
outstanding, amortization of debt issuance cost and the write-off of debt
issuance cost related to the Company's credit facility with Imperial Bank
retired in July 1999.
NET INCOME
For the nine months ended September 30, 1999, net loss was $4.6 million
or $.27 per share versus net income of $2.1 million or $.13 per share for the
nine months ended September 30, 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations from revenues from sales of its
products, issuance of its Common Stock, borrowing from its principal
shareholders and other lenders and bank financing. The
11
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Company's operating and investing activities used cash of $16.3 million
during the first nine months of 1999 and $13.2 million during the first nine
months of 1998.
On June 30, 1999, the Company's wholly owned subsidiary Turf Partners,
Inc. entered into a credit agreement with Coast Business Credit (the "Coast
Working Capital Facility"). The Coast Working Capital Facility is a $25 million,
three-year credit facility based upon Turf Partners' eligible inventory and
receivables and has an interest rate of prime rate plus 1.00%. On July 2, 1999
the Company drew down on the facility and paid all amounts due under and
terminated a line of credit with Imperial Bank. The Company had approximately
$10 million outstanding under a December 14, 1998 Credit Agreement with Imperial
Bank prior to the payoff. As of September 30, 1999, the Company had an
outstanding balance of $17.5 million under the Coast Working Capital Facility.
On June 30, 1999, the Company's wholly owned subsidiary Agricultural
Supply, Inc. entered into a credit agreement with First National Bank (the "FNB
Working Capital Facility"). The FNB Working Capital Facility is a $10 million,
three-year credit facility based upon Agricultural Supply's eligible inventory
and receivables and has an interest rate of prime plus .25%. As of September 30,
1999, the Company had an outstanding balance of $4.5 million under this
facility.
On July 31, 1999, the Company obtained a $2.5 million, two-year term
loan from Coast Business Credit (the "Coast Term Loan"). The Coast Term Loan
bears interest at Coast's prime rate plus 2.25%, payable monthly. One third
of the principal must be repaid in level monthly payments during the first
year of the term, with the remainder due in level monthly payments during the
second year of the term. The Coast Term Loan is secured by substantially all
of the assets of the parent Company, and has been guaranteed by Turf
Partners. The Company had an outstanding balance of $2.4 million as of
September 30, 1999, with $1.0 million due within the next twelve months.
The Coast Term Loan and the Note Agreements contain certain
financial covenants pertaining to debt service ratios, as defined. As of
September 30, 1999, we were not in compliance with certain of these
covenants. Both Coast Business Credit and the Note holders have waived their
rights with respect to such noncompliance based on our agreement to enter
into amendments on or before December 10, 1999. See ""Item 3. Defaults Upon
Senior Securites."
The Company intends to fund its future operations and growth through a
combination of product revenues, borrowings available under the line of credit,
and public or private debt or equity financing. However, there can be no
assurance that such financing alternatives will be available under favorable
terms, if at all. The Company believes that it has sufficient resources to
finance its operations and future growth for at least the next twelve months.
YEAR 2000
Many currently installed computer systems are coded to accept only two
digit entries in the date code field. These date code fields need to be modified
or upgraded to accept four digit entries to distinguish 21st century dates from
20th century dates. Many organizations are expending significant resources to
modify or upgrade their computer systems for such "Year 2000" compliance. We
presently believe that, with modifications to existing software and conversions
to new software, the Year 2000 problem can be mitigated. However, if such
modifications and conversions are not made, or are not timely completed, the
Year 2000 problem could have a material impact on our operations.
The Year 2000 issue affects our internal systems, including information
technology ("IT") and non-IT systems. We are in the process of upgrading our
existing computer software and IT systems and recognize the need to ensure our
operations will not be adversely impacted by Year 2000 software failures. We
rely upon microprocessor-based personal computers and commercially available
applications software. In addition, in the ordinary course of our product
development efforts, we have designed our current proprietary
12
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equipment, consisting of hardware and software, including the BioJect system
itself, to be Year 2000 ready. We are also reviewing our utility systems
(heat, light, telephones, etc.) and other non-IT systems for the impact of
Year 2000. Additionally, should we undertake future acquisitions, the Year
2000 risks that affect us can be expected to similarly affect such potential
acquisition candidates. We intend to review the systems of all potential
acquisitions for Year 2000 compliance. However, the failure to correct a
material Year 2000 problem either within the Company, within a vendor or
supplier or within a potential acquisition candidate could result in an
interruption in, or a failure of, certain normal business activities or
operations. Such interruptions or failures could materially adversely affect
our business, operating results and financial condition.
We depend on smooth and timely interactions with our vendors, customers
and other third parties. Any unexpected costs or disruption in the operations or
activities of such vendors, customers or other third parties as a result of Year
2000 compliance issues within such entities could materially adversely affect
our business, operating results or financial condition. The Company intends to
take continuous steps to identify Year 2000 problems related to its vendors and
to formulate a system of working with key third-parties, including financial
institutions and utility-providers, to understand their ability to continue
providing services and products through the change to Year 2000.
The cost of our Year 2000 compliance assessment and upgrade is being
funded from current operations. The cost to us of our Year 2000 identifications,
assessment, remediation and testing efforts, as well as costs we currently
expect to be incurred with respect to Year 2000 issues of third parties, is
expected to be approximately $40,000. We will continue to consider the
likelihood of a material business interruption due to the Year 2000 issue and,
if necessary, implement appropriate contingency plans. A contingency plan has
not been developed for dealing with the most reasonably likely worst case
scenario, and such scenario has not yet been clearly identified. Since we have
adopted a plan to address these Year 2000 issues, we have not developed a
comprehensive contingency plan should Year 2000 issues fail to be addressed
successfully or in their entirety. However, if we identify significant risks or
are unable to meet our anticipated timeline, we will develop contingency plans
as deemed necessary at that time.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's foreign sales are principally to Mexico. All foreign
transactions are denominated in U.S. dollars, therefore, the Company's exposure
to foreign currency fluctuations is minimal.
The Company is exposed to changes in interest rates from its senior
subordinated notes, which are due in full in 2003. A hypothetical 100 basis
point adverse move (decrease) in interest rates along the entire interest rate
yield curve would adversely affect the net fair value of the Notes by
approximately $600,000 as of September 30, 1999.
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PART II
OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
RECENT SALES OF UNREGISTERED SECURITIES
On September 2, 1999, the Company issued 91,548 shares of the Company's
common stock to Agrium Inc. pursuant to a Purchase Agreement dated as of July
29, 1999 ("Agrium Asset Purchase Agreement"). Pursuant to the Agrium Asset
Purchase Agreement, the Company issued to Agrium Inc. 91,548 shares of the
Company's common stock valued at $7.10 per share and $350,000 in cash in
exchange for certain assets of Agrium. These assets consist of research
equipment, and the rights and technology to certain product lines. The issuance
of the Company's common stock in connection with the Agrium Asset Purchase
Agreement was effected pursuant to the exemption from registration provided by
Section 4(2) of the Securities Act of 1933, as amended (the "Securities Act"),
taking into account the representations of Agrium that it is an accredited
investor, that Agrium acquired the common stock of the Company for its own
account and not with a view to any distribution thereof to the public and that
the transaction was completed without any general solicitation or advertising.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
The Coast Term Loan and the Note Agreements contain certain
financial covenants pertaining to debt service ratios, as defined. As of
September 30, 1999, we were not in compliance with certain of these
covenants. Both Coast Business Credit and the Note holders have waived their
rights with respect to such noncompliance based on our agreement to enter
into amendments on or before December 10, 1999. The Company and Coast have
agreed that the subsequent amendments to the Coast Term Loan will provide for
adjustments in the financial ratios for future periods. The Company and the
Note holders have agreed that the subsequent amendment to the Note Agreement
will provide for adjustments in the financial ratios for future periods, will
eliminate prepayment penalties on the Notes, will provide for amendments of
warrants currently held by the Note holders to extend the terms thereof and
for the issuance of additional warrants, and, as consideration for the
elimination of the prepayment penalty, will require the Company to issue to
the Note holders a number of shares of Common Stock equal to $1,275,000
divided by the lesser of (i) $4.00 and (ii) the average of the closisng
prices for the Common Stock for the ten consecutive trading days immediately
prior to the subsequent amendment.
ITEM 5. OTHER INFORMATION
FACTORS THAT COULD AFFECT FUTURE PERFORMANCE
This report contains certain forward looking statements about the
business and financial condition of the Company, including various statements
contained in "Management's Discussion and Analysis of Financial Condition and
Results of Operations." The actual results of the Company could differ
materially from any forward looking statements contained herein. The following
information sets forth certain factors that could cause the actual results to
differ materially from those contained in the forward looking statements. For a
more detailed discussion of the factors that could cause actual results to
differ, see "Item 1: Business -- Factors That Could Affect Future Performance"
in the Company's Form 10-K for the fiscal year ended December 31, 1998.
At September 30, 1999, the Company had an accumulated deficit of $28.6
million. The Company has evolved from an organizational activities and research
and development focus to a Company emphasizing product introductions and sales
and marketing. The Company's recent losses have resulted due to the seasonal
nature of the business as well as expenditures on marketing, research and
manufacturing of the Company's proprietary technology.
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<PAGE>
Sales of the Company's proprietary products recently have declined in
both turf and agricultural markets. These products remain in the early stages of
market introduction and are subject to the risks inherent in the
commercialization of new product concepts, particularly with respect to
agricultural applications. There can be no assurance that the Company's efforts
to increase sales of proprietary products to turf and agricultural crop and
ornamental markets will prove successful, that marketing partnerships will be
established and will become successful, or that the Company's intended customers
will purchase the Company's systems and products instead of competing products.
In addition, there can be no assurance that the Company will be able to obtain
significant customer satisfaction or market share with its proprietary products.
Failure to reverse the decline in sales of proprietary products would have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company has received a term loan and its subsidiaries have received
lines of credit from financial institutions, and the Company has received debt
financing from institutional investors through the issuance of senior
subordinated notes. The loan documents to which the Company and its subsidiaries
are parties, including the senior subordinated notes, contain restrictions on
the Company's activities and financial covenants with which the Company and its
subsidiaries must comply. Among other things, the financial covenants require
the Company and its subsidiaries to satisfy net worth requirements, debt service
coverage ratios and other financial tests. In the past, the Company has obtained
waivers and an amendment of the senior subordinated notes to remain in
compliance with the financial covenants and avoid default. For the quarter ended
September 30, 1999, the Company's failure to comply with these covenants
resulted in a default under the senior subordinated notes, which was
subsequently waived by the note holders. There can be no assurance that the
Company and its subsidiaries will satisfy all of the applicable financial
covenants in future quarters. To the extent the Company or any of its
subsidiaries does not satisfy these requirements, the Company would be in
default and its obligations could be declared immediately due and payable. To
avoid a default, the Company may be required to obtain waivers from third
parties, which might not be granted. A default on indebtedness from one lender
could result in the acceleration of indebtedness from other lenders. In
addition, the Company also can give no assurance that its cash flow and capital
resources will be sufficient to repay its indebtedness or that it will be
successful in obtaining alternate financing. In the event the Company or any of
its subsidiaries is unable to repay its debts, the Company may be forced to
delay the expansion of its business, sell some of its assets, obtain additional
equity capital or refinance or restructure its debt, any of which could have a
material adverse effect on the business, prospects and financial condition of
the Company.
Distribution and sales of the Company's products have historically
occurred through direct sales efforts and independent dealers and distributors.
The Company has initiated a strategy of attempting to establish a nationwide
distribution system for its products through the acquisition of various
independent dealers and distributors. Any failure to identify acquisition
candidates properly, any large expenditures on acquisitions that prove to be
unprofitable, or any inability to sell the Company's proprietary products
through the acquired distribution system could have a material adverse effect on
the Company's business, financial position and results of operations.
The Company's success will be dependent in large measure upon its
ability to obtain and enforce patent protection for its products, maintain
confidentiality of its trade secrets and know-how and operate without infringing
upon the proprietary rights of third parties. Despite precautions taken by the
Company, it may be possible for a third party to copy or otherwise obtain or use
the Company's products or technology without authorization, or to develop
similar products or technology independently.
The Company plans to acquire the rights to additional microbial
products. The Company does not engage in its own research and development with
respect to microbial products. Although the Company is actively seeking to
obtain licenses for additional microbial products, there can be no assurance
that the Company will be successful in obtaining any such licenses on terms
acceptable to the Company, if at all.
15
<PAGE>
The Company may be exposed to liability resulting from the commercial
use of its products. Such liability might result from claims made directly by
customers or others manufacturing such products on behalf of the Company. The
Company currently carries a product liability insurance policy with an aggregate
limit of $45 million. There can be no assurance, however, that such product
liability insurance will adequately protect the Company against any product
liability claim. A product liability or other claim with respect to uninsured
liabilities or in excess of insured liabilities could have a material adverse
effect on the business and prospects of the Company.
Some states have laws imposing liability on certain parties for the
release of fertilizers and other agents into the environment in certain manners
or concentrations. Such liability could include, among other things,
responsibility for cleaning up the damage resulting from such a release. In
addition, the federal Comprehensive Environmental Response, Compensation and
Liability Act (CERCLA), commonly known as the "Superfund" law, and other
applicable laws impose liability on certain parties for the release into the
environment of hazardous substances, which might include fertilizers and water
treatment chemicals. The Company is also subject to certain other environmental
laws, including the Environmental Protection Act, the Toxic Substance Control
Act, the Resource Conservation and Recovery Act, the Clean Air Act and the Clean
Water Act and may be subject to other present and potential future federal,
state or local regulations. The Company does not currently maintain insurance
for any environmental claims which might result from the release of its products
into the environment in a manner or in concentrations not permitted by law.
Thus, a claim for environmental liability could have a material adverse effect
on the Company.
The Company competes for market share with a number of companies that
manufacture and market chemical compounds. In addition, a number of companies
are developing biological and organic products for turf maintenance. Many of
these competitors have substantially greater capital resources, research and
development staffs and facilities than the Company, and many of these
competitors have extensive experience in turf maintenance. The fields of
biotechnology and related technologies in which the Company is engaged have
undergone rapid and significant technological changes. The Company expects that
the technologies associated with its research and development will continue to
develop rapidly. There can be no assurance that the Company will be able to
establish itself in such fields or, if established, that it will be able to
maintain a competitive position. Further, there can be no assurance that the
development by others of new or improved processes or products will not make the
Company's products and processes less competitive or obsolete.
The Company is dependent upon the active participation of William B.
Adams, its Chairman of the Board and Chief Executive Officer, and Douglas M.
Gloff, its President and Chief Operating Officer. The loss of the services of
either of these individuals could have a material adverse effect upon the
Company's future operations. The Company's success depends in large part on its
ability to attract and retain qualified scientific, financial and management
personnel. The Company faces competition for such persons from other companies,
academic institutions, government entities and other organizations. There can be
no assurance that the Company will be successful in recruiting or retaining
personnel of the requisite caliber or in adequate numbers to enable it to
conduct its business as proposed.
RECENT DEVELOPMENTS
In August 1999 the Company signed a letter of intent to acquire
Agri-Valley Irrigation, Inc. (Agri-Valley) of Fresno, California. The Company
currently is negotiating the terms of a definitive agreement, and plans for a
closing of the acquisition in early January 2000. Agri-Valley is a full-service
irrigation company and services customers throughout most of California.
The Company has formed an alliance with the J.R. Simplot Company
regarding fertilizer marketing and field trials of Eco Soil's BioJect system.
Under the agreement, Turf Partners, an Eco Soil subsidiary, has received
preferred marketing rights to the Simplot Company's BEST fertilizer products for
distribution east of the Rocky Mountains. Additionally, the companies intend to
commence trials using Eco Soil's BioJect
16
<PAGE>
system on commercial potato production and waste water reclamation. The
Simplot Company is a privately held agribusiness corporation based in Boise,
Idaho. Annual sales are $2.8 billion derived principally from food
processing, fertilizer manufacturing and cattle feeding.
In November 1999, the Company signed a letter of intent with Cebeco
Seeds Group to jointly evaluate the use of Eco Soil's products in the European
market. The letter of intent covers different plant categories including turf,
horticultural and ornamental uses and also provides testing of the biological
programs. Cebeco Seeds Group is part of Cebeco Group UA, based in the
Netherlands, a $4-billion corporation involved in the use and distribution of
agronomical products. When combined with its member cooperatives, the Cebeco
Group's revenues exceed $7 billion, utilizing a 40,000-greenhouse grower network
engaged in the development of seed, seedlings, bulbs, food and animal feed.
17
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
27.1 Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed with the SEC during the period ended
September 30, 1999.
18
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Eco Soil Systems, Inc.
Date November 15, 1999 By: /s/ William B. Adams
--------------------
William B. Adams
Chairman and Chief Executive
Officer
Date November 15, 1999 By: /s/ Mark D. Buckner
--------------------
Mark D. Buckner
Chief Financial Officer,
Corporate Secretary,
and Senior Vice President
19
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