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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------------
FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NO. 0-21130
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ENERGY BIOSYSTEMS CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 04-3078857
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
ENERGY BIOSYSTEMS CORPORATION 77381
4200 Research Forest Drive (Zip code)
The Woodlands, Texas
(Address of principal executive offices)
(281) 419-7000
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Title of Class
Common Stock, par value $.01 per share
Preferred Stock Purchase Rights
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter 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 _____
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. /X/
The aggregate market value of the voting stock held by non-affiliates of
the registrant was approximately $55,487,200 as of March 20, 2000, based on
the closing sales price of the registrant's common stock on the Nasdaq
National Market on such date of $13.125 per share and assuming full
conversion of the registrant's Series B Convertible Preferred Stock. For
purposes of the preceding sentence only, all directors, executive officers
and beneficial owners of ten percent or more of the common stock are assumed
to be affiliates. As of March 20, 2000, 6,732,794 shares of common stock were
outstanding and 493,400 shares of Series B Convertible Preferred Stock
(convertible into 486,108 shares of common stock) were outstanding.
Certain sections of the registrant's definitive proxy statement relating
to the registrant's 2000 annual meeting of stockholders, which proxy
statement will be filed under the Securities Exchange Act of 1934 within 120
days of the end of the registrant's fiscal year ended December 31, 1999, are
incorporated by reference into Part III of this Form 10-K.
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WHEN USED IN THIS DOCUMENT, THE WORDS "ANTICIPATE," "BELIEVE," "EXPECT,"
"ESTIMATE," "PROJECT" AND SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY
FORWARD-LOOKING STATEMENTS. SUCH STATEMENTS ARE SUBJECT TO CERTAIN RISKS,
UNCERTAINTIES AND ASSUMPTIONS. SHOULD ONE OR MORE OF THESE RISKS OR
UNCERTAINTIES MATERIALIZE, OR SHOULD UNDERLYING ASSUMPTIONS PROVE INCORRECT,
ACTUAL RESULTS MAY VARY MATERIALLY FROM THOSE ANTICIPATED, BELIEVED,
EXPECTED, ESTIMATED OR PROJECTED. FOR ADDITIONAL DISCUSSION OF SUCH RISKS,
UNCERTAINTIES AND ASSUMPTIONS, SEE "ITEM 1. BUSINESS-RISK FACTORS" INCLUDED
ELSEWHERE IN THIS REPORT.
PART I.
ITEM 1. BUSINESS
OVERVIEW
Energy BioSystems Corporation ("EBC" or "the Company") is a
biotechnology company that is applying its proprietary, state-of-the-art
directed evolution techniques to accelerate development and commercialization
of biocatalyst-based processes for petroleum refining and petrochemicals
production. EBC's primary focus to date has been development of biocatalytic
desulfurization ("BDS"), a proprietary process involving the use of enzymes
in bacteria to remove sulfur from petroleum. In 1999, a strategic initiative
was implemented to develop a new proprietary gene shuffling method called
RACHITT (an acronym for Random Chirmaragenesis on Transient Templates) and to
apply this method to accelerate biocatalyst development for BDS. Gene
shuffling is a powerful method to create millions of new variant genes coding
for enzymes with altered properties. To complement this effort,
high-throughput-screening ("HTS") capabilities were developed at EBC's
laboratories to screen and select improved bacterial strains. The directed
evolution program of gene-shuffling and HTS has made a major impact on the
biocatalyst development program, and EBC believes that expansion of these
capabilities may create new business opportunities in other areas of
biotechnology, including industrial enzymes, crop enhancement and protection
and protein-based pharmaceuticals. It is the intent of EBC to further develop
these assets in gene-shuffling technology and aggressively pursue near-term
business opportunities in this area through technology licensing and other
business relationships.
EBC has also pursued use of its proprietary biocatalytic technology for
production of a broad family of industrial organosulfur chemicals with
potential uses in detergent, surfactant, polymer and adhesive markets. In
1999, the organosulfur product was prepared on a multi-kilogram scale in
pilot units at EBC's Woodlands facility, and prototype surfactant products
were prepared for testing. Joint development and testing agreements were
executed with major chemical companies for detailed evaluation of these
products in specific commercial applications, and it is the intent of EBC to
continue pursuit of strategic business alliances or licensing opportunities
for commercialization of this technology.
Research in biodesulfurization continued to target removal of sulfur
from diesel fuel, and EBC believes that the combination of BDS with
conventional hydrodesulfurization may offer refiners an option to achieve
ultra-low sulfur levels in diesel fuel with attractive economics, lower
energy consumption, and lower CO2 emissions than by the use of conventional
hydrodesulfurization alone. In 1997, EBC was awarded funding by the U.S.
Department of Energy ("DOE") for a $2.4 million dollar, three-year program
dedicated to the development of biocatalytic desulfurization catalysts for
gasoline. Work in this area has progressed well, and will continue through
2000.
EBC maintained several strategic alliances to support its BDS
activities, providing an opportunity for EBC to build on established
expertise and resources in critical areas. These alliances include an
agreement with Kellogg Brown & Root ("Kellogg") and collaborations with
TOTALFINA ("TOTALFINA"), Koch Refining Company ("Koch"), and Texaco Group
Inc. ("Texaco"). See "-Alliances." In March 1998, EBC entered into an
agreement with Petro Star Inc. ("Petro Star") regarding the design and
installation of a BDS unit at Petro Star's Valdez Alaska refinery for
desulfurization of a straight-run diesel stream. Research and development
efforts in 1998 and 1999
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were heavily focused on biocatalyst and process development for this
application. Although significant technical progress has been made, the
Company's BDS and organosulfur chemical processes require additional
research, development and testing in order to determine their commercial
viability. No assurances can be made that the Company will be able to achieve
the improvements necessary of its BDS technology to become commercially
viable or to reach agreements with respect to commercial application of the
technology within the time anticipated or at all. See "-Risk
Factors-Technological Uncertainty; Risks Associated with Commercialization of
BDS Technology."
EBC was incorporated in Delaware on December 20, 1989. EBC's executive
offices and laboratories are located at 4200 Research Forest Drive, The
Woodlands, Texas 77381 and the main telephone number is (281) 419-7000. The
company can also be reached by fax at 281-364-6112, or by e-mail at
[email protected]. The company website is www.energybiosystems.com.
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EBC'S TECHNOLOGY
EBC'S BDS TECHNOLOGY
In 1988, researchers at the Institute of Gas Technology ("IGT") achieved
a breakthrough in microbial desulfurization when they isolated two unique
strains of bacteria. These strains have the ability to desulfurize coal and
selectively remove sulfur from dibenzothiophene, the industry-recognized
model for heterocyclic sulfur molecules found in coal and petroleum. In 1991,
EBC obtained exclusive, worldwide, royalty-free rights to the IGT
desulfurization technology. A critical milestone was achieved in 1992 when
the relevant genes from the patented bacteria were cloned and sequenced.
These genes have now been extensively characterized and modified to increase
the expression of the desired properties. EBC was issued fundamental patents
on these genes, plus numerous other patents on the BDS process by the U.S.
and foreign patent offices.
EBC's BDS process employs enzymes specifically directed at a certain
class of sulfur molecules in petroleum to catalyze the desulfurization
reactions. Although this class of sulfur molecules includes the predominant
types of sulfur molecules found in diesel fuel, anticipated future
regulations governing the sulfur content of diesel fuel are expected to
require such low concentrations of sulfur that the Company's BDS process may
also need to address less predominant, more complex sulfur molecules found in
diesel fuel. EBC has identified and characterized these "desulfurization
resistant" molecules and developed a strategy for the optimization of the
biocatalyst to increase the ability of the biocatalyst to remove such
molecules. Stability of enzyme activity is also an important biocatalyst
characteristic. EBC's research and development team had observed a gradual
decay of biocatalyst activity in the reactor system as a result of natural
metabolic processes that continually make and destroy enzymes within the
cell. In 1997 and 1998, EBC researchers developed new strains with improved
stability and altered bioreactor conditions to enhance enzyme regeneration.
In 1999, the company expanded its efforts in proprietary directed evolution
to accelerate development of improved biocatalysts for BDS and for production
of an organosulfur chemical product. These directed evolution techniques also
have potentially broad application in development of industrial biocatalysts
for other processes.
In addition to efforts in biocatalyst development, EBC has allocated
significant resources to the development and scale-up of process technology.
EBC believes that scale-up of its BDS process can be accomplished with
conventional chemical and biochemical process engineering technology. In 1997
and 1998, EBC pursued several opportunities to improve process efficiency and
reduced cost significantly through more innovative use of available process
technology in reactor design and separations. In 1999, EBC continued to
pursue additional reductions in cost through process engineering efforts in
two areas: (i) bioreactor design and (ii) chemical co-product recovery.
BDS is a proprietary process based on naturally occurring bacteria that
can selectively attack and remove organically bound sulfur from petroleum.
Enzymes in the bacteria selectively cleave carbon-sulfur bonds in the
presence of oxygen to yield an oxygenated sulfur compound. In the IGT
biocatalyst and one EBC biocatalyst strain, the sulfur containing end-product
is sodium sulfate. Alternatively, by genetic manipulation of the bacteria, a
novel water-soluble organosulfur compound can be produced as a co-product of
biodesulfurization. This co-product can be recovered from the process water
using conventional technologies. The enzymes in the EBC biocatalysts can
effectively oxidize a range of sulfur compounds, including the
dibenzothiophene class in diesel fuels. For diesel fuels, EBC believes that
the BDS process can be used in several configurations: (i) as a "polishing
step" to further lower sulfur levels in previously hydrotreated diesel fuels;
(ii) as a stand-alone desulfurization process; or (iii) as a desulfurization
process before hydrotreating.
For comparison, the conventional technology for the removal of sulfur,
nitrogen and other impurities from oil is hydrotreating. When this process is
used primarily for the removal of sulfur, it is called hydrodesulfurization
("HDS"). In this process, petroleum fractions are subjected to high
temperatures and pressure in the presence of inorganic catalysts and
hydrogen. Organic sulfur molecules are converted to hydrogen sulfide, which
is further
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processed to yield elemental sulfur. Although HDS is effective for removal of
many sulfur compounds, it is relatively ineffective against
dibenzothiophenes, the more complex sulfur molecules found in diesel and
heavier fractions. HDS is also a costly process for refiners. A typical HDS
unit costs between $30 million and $80 million to construct, depending on the
product stream to be treated, the level of desulfurization required, the unit
size and the existing refinery infrastructure. The high pressure and
temperature required for HDS translate directly into high capital and
maintenance costs. Although some refinery units produce hydrogen, the large
amount of hydrogen required for HDS to treat fuels to lower sulfur levels may
require refiners to build new hydrogen production capacity at additional
significant capital expense.
The BDS process differs from the conventional HDS processes for diesel
in several important aspects. First, the BDS process is oxidative, not
reductive as in HDS, so hydrogen is not required. The combination of mild
operating conditions and the absence of a hydrogen demand for BDS results in
projected lower energy consumption and CO2 emissions for BDS compared with
HDS during refining. Second, the range of sulfur compounds treated by BDS
includes the dibenzothiophene class, a very difficult class of sulfur
compounds to treat by HDS. EBC believes that HDS and BDS may potentially be
used effectively in combination.
While EBC believes its BDS process will be economically attractive to
petroleum refiners, the BDS process will require significant capital
expenditures by refiners and producers. The refining and oil production
industries historically have been reluctant to accept new technologies. There
is a risk, therefore, that EBC will have difficulty in obtaining the refining
and oil production industries' acceptance of the BDS process. Also, the rate
of purchase of the Company's BDS process may be affected by economic
conditions in the refining and oil production industries. The refining and
oil production industries have been subject to periods of depressed
profitability and are affected substantially by fluctuations in the price of
crude oil and finished products. Nonetheless, if a refinery is to operate and
produce fuels, it must meet regulatory requirements regardless of the price
of oil. There can be no assurances made that the Company will be able to
achieve the improvements necessary of its BDS technology to become
commercially viable or to reach agreements with respect to commercial
application of the technology within the time anticipated or at all.
ORGANOSULFUR CO-PRODUCTS
The organosulfur co-product from BDS falls within the chemical class of
alkyl aryl sulfonates and these products are similar chemically to commercial
wetting agents, hydrotropes and other surfactants and detergents. Currently,
alkyl aryl sulfonate products are produced by alkylation and/or sulfonation
of benzene/toluene/xylene ("BTX") aromatics. The world-wide petroleum
industry currently produces approximately one million barrels per day of BTX
aromatics.. As chemical feedstocks, these materials typically command a
premium price over and above their value as high octane gasoline blending
components. With the BDS process, an alkyl aryl sulfonate product can be
produced without the costly aromatics recovery, purification and subsequent
sulfonation steps employed in conventional surfactant manufacturing routes.
This approach may also be beneficial to the refiner in treating high sulfur
distillates because BDS removes polycyclic aromatic sulfur heterocycles
("PASH's") from these distillates, thereby improving the value of the
distillate to the refiner. The aromatic sulfonate products may, in turn, find
application as chemical feedstocks that can be subsequently alkylated via
conventional technologies to produce high quality anionic surfactants or
other products. A series of prototype detergents have been prepared by EBC
from the alkyl aryl sulfonate products of BDS, and testing indicates that
many properties are competitive to conventional detergents.
. GENE SHUFFLING TECHNOLOGY AND EBC'S RACHITT TECHNOLOGY
Gene shuffling technologies are molecular biology techniques used to
combine desirable properties of a number of different genes into a single
hybrid gene. Such technologies are typically used as part of a directed
evolution strategy to improve the properties of particular enzymes or other
proteins.
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The applied evolution of proteins, specifically enzymes, has become a
basic tool for many disciplines in science. The simplest approach to altering
the structure of an enzyme involves changing codons with a DNA sequence by
site-directed muagenesis. This rational method of protein design can be
useful to probe pre-selected regions by specific substitutions. Additionally,
this method requires no selection or screening because the mutant protein can
be assayed directly. Nevertheless, site-directed mutagenesis as a method to
create new proteins with enhanced properties is severely limited because of a
general lack of understanding of amino acid interactions within most proteins
and their effect on function.
By contrast, the process of altering genetic functions through the
generation of mutants, and/or chimeric genetic recombinants, coupled with
selection and/or screening for a desired phenotype, is known as "directed
evolution." Genetic improvements are markedly more rapid and dramatic when
the generation of mutations in a population is combined with genetic
recombination. The ability to combine altered or similar DNA targets allows
one to consolidate favorable mutations that originally occurred on separate
copies of the target, as well as eliminate detrimental mutations from targets
that also possess advantageous mutations.
Random shuffling or "chimeragenesis" of divergent genes has proven to be
a useful tool in the directed evolution of enzyme characteristics. Protein
engineering employing directed evolution does, however, require a robust,
efficient and random method to generate chimeric gene libraries. The Company
has developed a novel, proprietary gene shuffling method, RACHITT,
specifically developed for accomplishing this goal by random reassortment and
relygation of divergent single-stranded gene fragments. This rational, yet
combinatorial method of directed evolution is capable of creating a multitude
of new variant genes coding for enzymes with improved properties.
EBC believes that its RACHITT technology has several advantages over
other gene shuffling techniques currently being employed. For example, it
avoids the use of often problematic polymerase chain reaction, or PCR, cycles
to generate full-length chimeric molecules. RACHITT also reduces the
generation of potentially problematic "blind spots" in the gene of interest
encountered in the "sexual PCR" and staggered extension process, or StEP,
methods. EBC's RACHITT method also facilitates combination of genes or
regions of genes from related family members or otherwise similar sequences
recombination. No evidence for divergent gene shuffling has yet been
demonstrated by the StEP technique. Furthermore, the RACHITT method can also
facilitate the incorporation of genetic diversity from uncharacterized
sources (e.g. DNA isolated or amplified from soils and aquatic environments)
thereby further exploring "natural" sequence space of a protein. RACHITT can
also create entirely new solutions using combinatorial libraries of synthetic
ologonucleotides.
The Company's RACHITT technology was applied to the BDS process through
RACHITTing of the Company's leading BDS genes (the dszC gene from IGTS8 and
A3H1). Further analysis of these isolates at a larger scale (in shake flasks)
demonstrated that some of these cultures had higher rates of desulfurization
while others had improved rates and extents of desulfurization. Once these
results had been reproduced and the dszC genes sequenced to confirm the
hybrid nature of the genes, the criteria for the demonstration had been
satisfied.
HIGH-THROUGHPUT-SCREENING
To complement its RACHITT gene shuffling technology, EBC developed HTS
capabilities at its laboratories to screen and select improved bacterial
strains. HTS is an automated, robotic method to evaluate thousands of
candidates per day. Automated colony pickers and liquid handling systems are
at the heart of the process, along with miniaturized desulfurization assays.
Implementing the HTS system increased the weekly throughput of candidates
from 5-10 per week to over 2000 per week.
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MARKET OVERVIEW
REFINING INDUSTRY
One of the principal markets for EBC's BDS technology is the worldwide
refining industry, which processes more than 66 million barrels of crude oil
per day or approximately 24 billion barrels per year. The primary business
driver for this technology are recent "clean-fuels" regulations that target
sulfur in fossil fuels due to its harmful effects on the environment. The
combustion of sulfur results in the emission of sulfur oxides ("SOx"), which
are believed to be a cause of "acid rain" and smog. Sulfur also inactivates
catalysts contained in automobile catalytic converters and diesel tail-pipe
converters over time, resulting in a significant increase in the emission of
unburned hydrocarbons and nitrogen oxides ("NOx") from gasoline and diesel
engines and particulate matter ("PM") from diesel engines. In 1999, the US
Environmental Protection Agency ("EPA") issued a new Tier-2 Rule under the
U.S. Federal Clean Air Act (the "Amendments") that requires a reduction in
gasoline sulfur from the national average of roughly 300 ppm to a 30 ppm
sulfur average and 80 ppm sulfur cap by 2006 for major refiners. For diesel
fuel, a similar Tier-2 ruling on allowable sulfur in on-highway diesel fuel
sulfur is expected in mid-2000. The ruling is expected to include a 90%
decrease in sulfur levels for on-road diesel fuel from the currently
permitted level of 500 ppm to 50 ppm sulfur or lower by 2006. Reductions in
fuel sulfur are also increasingly being mandated elsewhere in the developed
and developing world. The European Union has established regulations
requiring the reduction in the sulfur content of diesel fuel to 350 ppm in
the year 2000 and to 50 ppm or lower by the year 2005. Similarly, the EU
regulations require gasoline sulfur levels to be 150 ppm currently, reduced
to 30-50 ppm by 2005. Lastly, several international auto makers are calling
for further, dramatic sulfur reductions in gasoline and diesel fuels,
essentially "sulfur-free" fuels of 5-10 ppm sulfur, in their World Wide Fuel
Charter.
Estimated costs of deep desulfurization to the refining industry vary by
the source, but consensus exists that ultra-deep desulfurization of fuels by
conventional hydrotreating will be a high-cost process due to the severity of
conditions required using conventional metal catalysts. As an example,
estimated capital costs for U.S. refineries to comply with the 2006 gasoline
regulations range up to $7 billion, and compliance with diesel regulations is
estimated at $5 to $9 billion. (Reference Octane Week Jan. 24, 2000). EBC
believes that integration of BDS into the refinery to produce ultra-low
sulfur diesel products in conjunction with existing hydrotreating units may
offer a cost-effective alternative.
CRUDE OIL DESULFURIZATION
Large reserves of high-sulfur crude oil exist in Venezuela, Canada, the
United States, Mexico, the former Soviet Union, and the Middle East.
Venezuela has proven reserves in excess of one trillion barrels of crude oil
with a sulfur content greater than two percent. Canada has in excess of 50
billion barrels of proven reserves of crude oil with a two percent or greater
sulfur content, and the United States has approximately 125 billion barrels
of proven reserves of crude oil with a two percent or greater sulfur content.
The price of crude oil is affected by its sulfur content, and lower-sulfur
crude oils command a premium in the market compared to higher-sulfur crude.
To date, conventional desulfurization technologies have not proven
economically viable for the desulfurization of crude oil. Cost-effective
desulfurization technology could play a key role in making many of these
high-sulfur crude oil reserves more economically exploitable.
Crude oil biodesulfurization is a challenging problem due to the broad
range of sulfur compounds present in crude oils and the diversity of crude
oils. In 1994, EBC was awarded $2 million of federal funding under the
Advanced Technology Program administered by the National Institute of
Standards and Technology. The program evaluated several aspects of crude oil
biodesulfurization, identified favorable characteristics of crude oils, and
laid the groundwork for further biocatalyst development in this area. Current
research to broaden the range of sulfur compounds that are oxidized by the
biocatalyst has direct bearing on long-term future developments of a crude
oil BDS process.
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NOVEL ORGANOSULFUR FEEDSTOCK CHEMICALS
In 1998, EBC discovered that its proprietary biodesulfurization
technology could also be used to produce a class of novel organosulfur
compounds with surface-active properties. Further chemical derivation of
these compounds via commercially practiced methods of manufacturing produces
excellent anionic surfactants and detergents. In this case, the
biodesulfurization process is targeted at bio-treatment of highly aromatic
high-sulfur diesel boiling point-range streams ("cracked stocks") within the
heart of the refinery and includes processes for recovery of a chemical
product. The BDS process removes significant levels of polynuclear aromatic
sulfur compounds from these cracked stocks, thus increasing their value and
reducing downstream refining costs. This new application of EBC's proprietary
biocatalyst technology has received interest from large refiners and
surfactant manufacturers. One of the markets EBC has been targeting, the
linear alkyl benzene sulfonate ("LAS") market, is currently a four billion
pound per year market with a 4% average annual growth rate. EBC's new product
could displace or alternatively, reduce the use of benzene and possibly
eliminate the need for a sulfonation step in the manufacture of a LAS
substitute. It is the intent of EBC to pursue development of strategic
business alliances or licensing opportunities for commercialization of this
technology. No assurance can be given that EBC will be successful in
partnering with existing surfactant manufacturers to develop this technology,
or will otherwise be able to successfully develop and commercialize this new
discovery.
DIRECTED EVOLUTION/TWO-PHASE BIOCATALYSIS
EBC believes that many applications exist for its RACHITT technology in
gene-shuffling and bioprocessing. Applications of gene-shuffling to produce
improved bacterial strains span a broad range from pharmaceutical and
agricultural applications to commodity chemicals and enzymes. Through its
work in BDS over the last decade, the company has developed specialized
knowledge of RHODOCOCCUS and related bacterial genera that may be useful for
two-phase (oil-water) biotransformations of other oil-soluble (hydrophobic)
substrates in commodity or fine chemicals production. Examples of the latter
could be in steroid or antibiotic manufacture. Oxygenase biochemistry and
bioprocessing of multi-phase systems are also core competencies.
BUSINESS STRATEGY
EBC's goal is to become the leading provider of biocatalytic solutions
for the energy and chemical industries. The strategy is to focus its internal
resources on the research and development of its proprietary gene-shuffling
and biocatalytic technologies while entering into strategic alliances to
assist in product and process development. Long-term, EBC believes that its
proprietary technologies in gene-shuffling and biocatalysis will have very
broad potential applications in biorefining as well as the production of fine
chemicals and pharmaceuticals.
RESEARCH AND DEVELOPMENT PROGRESS
To commercialize BDS and the organosulfur chemical processes, additional
improvements in the biocatalyst are required. In 1999, research and
development efforts were focused on acceleration of biocatalyst development
for diesel desulfurization and production of the organosulfur chemical
products by development of a new proprietary gene-shuffling method and
high-throughput-screening ("HTS") of new bacterial strains. EBC believes that
expansions of these capabilities may create new business opportunities in
other areas of commercial biocatalysis and biotransformations. It is the
intent of EBC to further develop these assets in gene-shuffling technology
and HTS for BDS biocatalyst development and other applications.
EBC had research and development expenses for the years ended December
31, 1997, 1998, and 1999 were $9.1, $7.7 and $4.8 million, respectively. See
"Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations."
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BIOCATALYST DEVELOPMENT
The central element of EBC's BDS technology is the "biocatalyst," a
microorganism originally isolated from the soil that has been genetically
engineered to maximize its effectiveness in removing the sulfur molecules in
petroleum. The effectiveness of the biocatalyst, as with any other catalyst,
depends upon the optimization of three important attributes: (i) the rate of
reaction; (ii) the specificity of the catalyst for the target molecules (the
extent of reaction); and (iii) the stability of the catalyst under operating
conditions. In 1999, a program was implemented to rapidly screen mutant
strains for improved performance, and a proprietary directed evolution
platform with gene shuffling was conceived, designed and implemented to
increase the diversity of strains that are tested. EBC believes that this
strategy will greatly accelerate the development of the BDS commercial
biocatalysts.
Gene shuffling is a powerful method to create millions of new gene
variants coding for enzymes with improved properties and characteristics. The
DNA shuffling platform is designed to maximize the value of genetic
diversity. To harness this diversity, EBC developed proprietary methods of
"gene recruitment" from a variety of microbial environments. Since the
majority of micro-organisms present in natural environments are not able to
be cultured, the company's ability to access the vast wealth of genetic
diversity endows EBC with a powerful tool that can be used in the development
and commercialization of BDS. Unique DNA sequences isolated from soils, for
example, can be manipulated and recombined with the EBC gene shuffling
technology to generate an almost limitless supply of unique genes. EBC has
validated this technology by successfully isolating a large number of diverse
desulfurization gene clusters from a variety of environmental samples.
EBC also made considerable advances in the development of HTS
capabilities. Fast, sensitive assays developed in conjunction with
bio-robotics and automated methods now enable EBC to screen literally
millions of candidates. A "modular" screening approach to assay development
allows several gene shuffled libraries to be assayed simultaneously thereby
significantly accelerating the biocatalyst development process. EBC continued
to expand its capabilities in analysis and identification of sulfur compounds
in fuels as well. New organo-sulfur characterization techniques were
developed to measure multiple sulfur compound classes simultaneously. The
method encompassing selective oxidation, sulfur species isolation and
subsequent GC-SCD/MS analysis has been described as ESSA (Extended Sulfur
Speciation Analysis). This technique was used extensively to monitor the
efficacy of new BDS biocatalysts towards the sulfur species present in
different petroleum streams. Please see "Item 1 -Business -EBC's Technology
- -Gene Shuffling Technology and EBC's RACHITT Technology" and " -
High-Throughput-Screening" for a discussion of our recent progress in RACHITT
and HTS technologies.
Significant technical progress was also made in the DOE sponsored
gasoline desulfurization program. For the first time, EBC established a
definitive role for the DSZ desulfurization genes in gasoline BDS. In
addition, EBC's efforts led to the isolation of a number of novel bacterial
strains capable of utilizing gasoline as a sulfur source. These isolates are
ideal for further evaluation as candidates for a valuable source of gasoline
desulfurization genes. While most of the work in 1999 was focused on
biocatalyst development, key advancements were made in supporting areas such
as assay/screen development. EBC also developed methods to incorporate
gasoline into growth media, thereby facilitating the screening of large
numbers of isolates, and methods to accurately monitor biodesulfurization of
gasoline.
PROCESS AND PRODUCT DEVELOPMENT
EBC has historically allocated significant resources to the development
of its process technology, leading to preliminary designs for BDS units that
encompass on-site fermentors, bioreactors, separations equipment and
co-product recovery units. In 1997 and 1998, EBC substantially improved the
efficiency of the BDS reactor and separations systems and reduced the overall
capital and operating costs. In 1999, EBC continued to pursue additional
improvements in efficiency and cost reduction through process engineering
efforts, albeit at lower
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staffing levels, and shifted from laboratory-based research to process
modeling, costing and optimization using commercial engineering software
packages. Laboratory efforts in process development were re-focused in two
narrow areas: (i) bioreactor design; and (ii) chemical co-product recovery
from process water.
In parallel, the organosulfur chemical product was produced in kilogram
quantities from Petro Star diesel for testing by several chemical companies
under joint development and secrecy agreements. The chemical co-product was
recovered by ion-exchange, but the projected costs of ion-exchange on a
commercial scale lead EBC to examine a variety of alternatives. Ultimately, a
novel liquid extraction process was developed and tested in bench-scale pilot
units. Development of a cost-effective product recovery operation was a key
step forward in process development.
In the product development area, a series of prototype detergents was
prepared at EBC by reaction of the organosulfur product with olefins. These
detergents were prepared as part of a joint development agreement with a
large chemical company, and were tested extensively in their laboratories.
Detergents prepared from EBC's BDS organosulfur co-product display favorable
basic physical properties and performance in applications. For example, the
EBC products displayed high effectiveness at significantly lower dose levels
than linear alkylbenzene sulfonates in detergent formulations.
PRODUCTION OF THE BIOCATALYST
Large-scale growth and production, or fermentation, of biocatalysts is
essential to the commercialization of the BDS technology. EBC's efforts in
developing alternative microbial hosts have been directed toward selection of
hosts that can be produced more rapidly and at lower cost. EBC believes that
this fermentation will not be substantially different from the many
antibiotic and enzyme fermentations routinely commercialized by other
biotechnology companies. EBC currently conducts small- and intermediate-scale
(300 liter) fermentations at its laboratory facilities. These facilities are
sufficient to supply laboratory and preliminary pilot plant needs for the
biocatalyst. See "--Risk Factors--Technological Uncertainty; Risks Associated
with Commercialization of BDS Technology" and "--Risk Factors--Manufacture of
Biocatalyst."
SCIENTIFIC ADVISORY BOARD
EBC has retained a group of distinguished research scientists and
engineers to provide advice on matters relating to its research, development
and business activities. The Scientific Advisory Board, composed of five
members, meets with EBC's scientists and management and is regularly
available for consultation. Scientific advisors are compensated for expenses
and all advisors have been granted options to acquire Common Stock. The
members of the Scientific Advisory Board are as follows:
CHARLES L. COONEY, PH.D., PROFESSOR OF CHEMICAL AND BIOCHEMICAL
ENGINEERING, MASSACHUSETTS INSTITUTE OF TECHNOLOGY. Dr. Cooney is widely
recognized as an expert in the field of bioreactor design and engineering. He
is the author or co-author of more than 200 scientific publications and
patents and has received many academic awards and honors, including being
named Founding Fellow, American Institute for Medical and Biological
Engineering, in 1992. In addition to his serving as Professor of Chemical and
Biochemical Engineering, Dr. Cooney also is Executive Officer in the
Department of Chemical Engineering and Co-Director of the Program on the
Pharmaceutical Industry at Massachusetts Institute of Technology. Dr. Cooney
received his B.S. in Chemical Engineering from the University of Pennsylvania
and his M.S. and Ph.D. in Biochemical Engineering from Massachusetts
Institute of Technology.
NORMAN HACKERMAN, PH.D., PRESIDENT EMERITUS AND DISTINGUISHED PROFESSOR
EMERITUS OF CHEMISTRY, RICE UNIVERSITY, AND FORMER PRESIDENT AND PROFESSOR
EMERITUS OF CHEMISTRY, THE UNIVERSITY OF TEXAS AT AUSTIN. Dr. Hackerman is a
member of the National Academy of Sciences and of the American Philosophical
Society, a Fellow
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of the American Academy of Arts and Sciences, and Chairman of the Scientific
Board of the Robert A. Welch Foundation. Dr. Hackerman has been the recipient
of many awards, including the American Institute of Chemists Gold Medal and
the Mirabeau B. Lamar Award of the Association of Texas Colleges and
Universities. He received his A.B. and Ph.D. from Johns Hopkins University.
HERBERT L. HEYNEKER, PH.D., FOUNDER AND CHIEF TECHNICAL OFFICER, EOS
BIOTECHNOLOGY, INC. Dr. Heyneker is an authority in microbial expression of
human proteins, including insulin, growth hormone and tPA; protein
engineering; and expression systems for industrial microorganisms. Dr.
Heyneker serves as a director of Genpharm International, Inc. and Introgene,
B.V., and as chairman of the Scientific Advisory Board of Pharming, B.V. He
also serves as a scientific advisor for Genencor International, Inc., Genomyx
Corp., ProtoGene Laboratories, Inc., and MaxyGen, Inc. He earned his Ph.D.
from the University of Leiden, The Netherlands, and completed his
post-doctoral fellowship at the University of California-San Francisco
Medical School.
CHARLES F. KULPA, JR., PH.D., PROFESSOR OF BIOLOGICAL SCIENCES,
UNIVERSITY OF NOTRE DAME. Dr. Kulpa is a recognized expert in the fields of
microbiology, bioremediation and biochemistry. His laboratory research work
is concentrated in the areas of environmental and applied microbiology. Dr.
Kulpa has authored or co-authored numerous papers detailing his research in
microbiological and biochemistry processes. Active in many scientific
organizations, Dr. Kulpa has served as President of the Indiana Branch of the
American Society for Microbiology and currently is a director of the Southern
Great Lakes Region, Society of Industrial Microbiology. He received his B.S.,
M.S. and Ph.D. in Microbiology from the University of Michigan.
JAMES R. SWARTZ, PH.D., PROFESSOR OF CHEMICAL ENGINEERING, STANFORD
UNIVERSITY. James Swartz is a member of the National Academy of Engineering
and an expert in fermentation process development and scale-up, expression
and folding of proteins, and cell-free protein synthesis. He has authored
numerous papers and presentations and he is an inventor on 8 issued and 5
pending U.S. patents. He is a founding fellow of the American Institute of
Medical and Biological Engineers and received the James Van Lanen
Distinguished Service Award from the ACS Division of Biochemical Technology.
He has also served on a National Research Council Committee to evaluate the
status and needs of bioprocess engineering in the U.S. Prior to his position
at Stanford University, he held several technical and management positions at
Genentech. He received his B.S. in Chemical Engineering from South Dakota
School of Mines and Technology, and his M.S. and D.Sc. in chemical and
biochemical engineering, respectively from the Massachusetts Institute of
Technology.
ALLIANCES
EBC has entered into alliances with potential customers and suppliers in
support of its BDS development and commercialization activities. These
alliances give EBC an opportunity to build on established expertise and
resources in areas critical to its success. In the case of alliances with
potential customers, EBC believes that these relationships may enhance its
ability to sell BDS units. Entering into alliances with recognized industry
suppliers is expected to facilitate commercialization of the BDS technology.
However, there can be no assurance that EBC will be successful in maintaining
its existing collaborative relationships or in establishing new relationships.
ALLIANCES WITH POTENTIAL CUSTOMERS
TOTALFINA. In July 1994, EBC entered into an agreement with TOTALFINA
(Formerly Total Raffinage Distribution S.A.) to collaborate on the
application of EBC's BDS process to diesel and other middle distillate fuel
streams. EBC and TOTALFINA will each bear their own costs and expenses
incurred under the collaboration. In addition, as part of its obligations
under the agreement, TOTALFINA has provided EBC with the use of analytical
equipment valued at approximately $200,000. The agreement with TOTALFINA
provides that upon commercialization, the site license fees will be waived on
TOTALFINA's first commercial BDS unit. In addition, TOTALFINA will be
entitled to receive a 10 percent discount on future site license and service
fees until it has
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recovered two and one-half times its research costs and expenses for BDS
projects under the agreement. EBC expects that its alliance with TOTALFINA
will facilitate commercialization of the BDS technology for diesel fuel and
EBC's entrance into the European market.
EBC's alliance agreement with TOTALFINA contemplates an evaluation of
pilot plant operations, commencing after EBC's completion of the development
of a prototype biocatalyst. To date, the prototype biocatalyst has not been
completed. When the BDS processes reach commercial levels for activity and
extent, it is expected that TOTALFINA will build and operate, at TOTALFINA's
expense, a pilot BDS unit at TOTALFINA's European Center for Research and
Technology. TOTALFINA has indicated that it intends to employ its initial BDS
units for the "ultra deep" (below 50 ppm) desulfurization of diesel, a range
of desulfurization far below current regulatory standards in which BDS is
expected to possess greater cost advantages as compared to HDS. Fuels
provided by TOTALFINA have been used extensively in research and development
activities and pilot testing work for many years. These fuel samples continue
to be utilized in EBC's biocatalyst development and process development work.
KOCH REFINING COMPANY. In December 1993, EBC entered into an alliance
with Koch for the development of a biotechnology-based desulfurization system
for refinery oil streams. The alliance is expected to accelerate the
development of BDS for certain gasoline streams and customize that
development for Koch's applications. Under the terms of the alliance, EBC is
primarily responsible for improving the performance of the biocatalyst used
in the BDS process and developing a commercial BDS system. Koch primarily is
responsible for selecting and providing the target gasoline stream as well as
testing desulfurized product quality. Koch also will provide engineering
support as needed in the development of a BDS unit for Koch's operations.
Until commercialization, EBC and Koch will each bear their own costs and
expenses incurred in connection with the collaboration. Upon
commercialization, Koch will be repaid for direct costs and expenses incurred
in assisting BDS development. Repayment will be in the form of a 10 percent
rebate on desulfurization processing fees charged to Koch until Koch has been
repaid its share of BDS development costs. EBC expects that the development
alliance with Koch will facilitate commercialization of EBC's BDS technology
for target gasoline streams. Gasoline samples supplied by Koch have been used
extensively in gasoline BDS research, and results of the current DOE-funded
program in biocatalyst development for gasoline BDS will directly impact the
development of commercial gasoline BDS processes.
TEXACO GROUP, INC. In July 1993, EBC signed an agreement with Texaco
Group, Inc. ("Texaco") for the development of a BDS process for crude oil.
Under the terms of the alliance, EBC primarily is responsible for improving
the performance of the biocatalyst used in the BDS process. Texaco primarily
is responsible for field operations, analytical chemistry work, and selecting
and providing the target crude oil stream as well as testing desulfurized
product quality. Process engineering is conducted jointly by the parties. EBC
and Texaco each bear their own costs and expenses incurred in connection with
the collaboration. In the event EBC sub-licenses Texaco's intellectual
property and proprietary information, licensed by Texaco to EBC, EBC has
agreed to pay Texaco an amount equal to 10 percent of the desulfurization
processing fee charged to Texaco until such time as EBC has paid Texaco an
aggregate amount equal to two and one-half times the aggregate amount of
Texaco's direct costs and expenses incurred in connection with the
collaboration. EBC expects that the development alliance with Texaco will
facilitate commercialization of the Company's BDS technology for crude oil
applications. Current research with diesel fuels to broaden the range of
sulfur compounds treated by BDS is directly applicable in the long-term to
development of a crude oil BDS process.
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PROSPECTIVE ADDITIONAL CUSTOMER ALLIANCES.
EBC is also pursuing additional alliances with potential customers,
particularly for its organosulfur compounds with companies in the area of
industrial chemicals and directed evolution. No assurance can be made that
such alliances will be made in a timely manner or at all.
ALLIANCES WITH SUPPLIERS
KELLOGG, BROWN AND ROOT. In August 1994, EBC signed an agreement with
Kellogg to collaborate on the development and commercialization of BDS
technology. Under the terms of the collaboration, Kellogg will serve as an
engineering consultant to EBC during completion of the BDS development
process and will be the exclusive provider of the basic engineering design
services required for commercial BDS units. In return for these services,
Kellogg will receive a portion of the site license fee generated by the sale
of BDS units. The collaboration had a minimum term of at least five years or
the completion of 20 BDS units, whichever is longer, and applies to all
biorefining technologies EBC develops. During the first phase of the
collaboration, Kellogg provided 500 engineering work hours of service at no
cost to EBC. Kellogg also agreed to provide an additional 1,500 work hours of
service at Kellogg offices at reduced rates. EBC expects that the development
alliance with Kellogg will substantially enhance its refinery engineering
capabilities and market access.
CUSTOMER AGREEMENT
In March 1998, EBC entered into a site license agreement with Petro Star
regarding the design and installation of a BDS unit at Petro Star's Valdez,
Alaska refinery. The agreement involves several stages of work, the first of
which, involving the completion of scoping economics, is completed. In
addition, the agreement provides EBC with certain rights to conduct
development work and demonstrations of its BDS technology at Petro Star's
refinery. The agreement calls for the payment of staged license fees and
royalties to EBC, including a $200,000 initial site license fee which was
received upon execution of the agreement and $300,000 additional site license
fees payable at various stages during the term of the agreement. As is
customary in such arrangements in the petroleum refining industry, the
agreement provides certain approval and termination rights to Petro Star at
the completion of each stage prior to commercialization. In connection with
the execution of the agreement, EBC issued a four-year warrant entitling
Petro Star to purchase 28,571 shares of EBC Common Stock at an exercise price
of $21.77 per share. The successful implementation of a commercial BDS unit
will be dependent upon the Company's ability to achieve additional
improvements in the productivity of the biocatalyst (e.g., reaction rates,
specificity and stability) and process technology (e.g., bioreactor and
separations technology). The Petro Star fuel is currently used extensively in
the biocatalyst development and screening programs to increase the range of
sulfur compounds treated by the bioprocess, and was used to manufacture
kilogram quantities of the organosulfur chemical product. See "--Risk
Factors--Technological Uncertainty; Risks Associated with Commercialization
of BDS Technology."
COMPETITION
The primary competition for BDS technology is expected to come from
licensors of HDS technology and the manufacturers of catalysts used in those
units. In most initial diesel fuel applications, BDS will be sold as a
complementary process where expanded capacity is desired or a greater degree
of desulfurization becomes necessary in connection with an existing HDS unit.
Subsequently, BDS may be developed as a stand-alone diesel fuel
desulfurization process, competing directly with HDS. In the case of
gasoline, where HDS units are not typically used, EBC expects BDS to operate
as a stand-alone desulfurization system. EBC intends to compete on the basis
of cost effectiveness, ease of integration, effectiveness in removing complex
sulfur molecules that are resistant to conventional desulfurization
technologies, production of valuable chemical co-products and the ability to
process petroleum streams that are difficult for HDS to process.
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HDS process technologies and catalysts are supplied by a small number of
companies that maintain their market positions through a combination of
recognized expertise, intellectual property rights and established
relationships with refiners. Increasing environmental regulation has caused
these catalyst suppliers to make significant investments in research and
development during the past several years to develop more efficient HDS
technologies. EBC believes that these efforts have been directed at
refinement of the conventional HDS technology rather than development of
entirely new processes. Many of these companies supplying HDS technology have
substantially greater financial, technical and human resources than EBC.
BDS may face competition from other biotechnology processes. The most
significant competitive effort of which EBC is aware is based in Japan at the
Petroleum Energy Center ("PEC"), a consortium of Japanese petroleum companies
conducting research funded by the Japanese Ministry of International Trade
and Industry. EBC is also aware that one or more major oil companies have
attempted to develop microbial or biocatalytic desulfurization technologies,
although EBC believes that none of these companies has successfully developed
any of these technologies to date.
EBC believes it has developed a unique and significantly different
evolution technology in its RACHITT technology. Companies such as Maxygen,
Inc., Diversa Corporation and Evotech have alternative evolution
technologies. A number of companies are performing high-throughput-screening
of molecules. Any products that EBC develops will compete in highly
competitive markets. Many of the Company's competitors have significantly
greater experience than EBC in their respective fields. In addition, many of
the Company's potential competitors have substantially greater financial,
technical and marketing resources. There can be no assurance that EBC's
competitors will not succeed in developing products or technologies that will
render EBC's products or technologies obsolete or noncompetitive.
PATENTS AND PROPRIETARY TECHNOLOGY
EBC's ability to compete will depend in part on maintaining the
proprietary nature of its technology. EBC has established an active program
for the protection of its intellectual property. This program includes, among
other things: procedures, notebooks and forms for documenting, evidencing and
disclosing all Company inventions to management; a Patent Review Committee
which meets regularly to discuss all intellectual property issues; a system
for continuously monitoring patents issued to, and patent applications filed
by, relevant third parties; a program of seminars for employees on
intellectual property topics; personnel policies and agreements requiring
disclosure by employees of all inventions and protection of confidential
information; and agreements with all technical and scientific employees
providing for the assignment of inventions made by such employees to EBC.
EBC has an active program in place to maintain and build its
intellectual property position. Seven U.S. patents on BDS technology have
been issued to IGT and licensed exclusively to EBC, subject to the U.S.
government's rights to certain of such patents. Additionally, one U.S. patent
has been issued to the Korean Institute of Science & Technology and licensed
on a nonexclusive basis to EBC. A U.S. patent claiming the use of BDS in
combination with HDS for BDS technology was issued to EBC in 1993. The
two-stage process for deep desulfurization covered by this patent involves
the use of BDS in conjunction with conventional HDS technology, taking
advantage of the significant synergies between the two technologies. EBC was
issued three patents during the year ended December 31, 1994 and three
patents during the year ended December 31, 1995. The most significant of the
three patents issued in 1994 is the "Recombinant DNA Encoding a
Desulfurization Biocatalyst" patent, which is a fundamental recombinant DNA
patent on the genetic sequences for enzymes that desulfurize petroleum. The
remaining two patents issued in 1994 include "A Process for the
Desulfurization and the Desalting of Fossil Fuels" and "Microemulsion Process
for Direct Biocatalytic Desulfurization of Organosulfur Molecules." The
patents issued in 1995 include "Multistage Process for Deep Desulfurization
of Fossil Fuels," "Method for Separating a Sulfur Compound from Carbonaceous
Materials" and "Continuous Process for Biocatalytic Desulfurization of
Sulfur-Bearing Heterocyclic Molecules." In 1996, an additional five U.S.
patents were issued to EBC, including
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continuations in part on the HDS/BDS patent first issued in 1993 and the
desalting patent first issued in 1994 as well as two entirely new patents
related to oil/water separations technology and a novel process for the
reduction of oil viscosity. The technologies to which these patents relate
are expected to yield long-term improvement in the economics of
biodesulfurization for EBC. In 1997, an additional U.S. patent was issued to
EBC relating to a method for removing and separating metals from fossil
fuels. In 1998, six additional patents were issued to EBC, including one for
demetallization, and oil/water/biocatalyst three phase separation process,
and a patent covering a RHODOCOCCUS flavin reductase. In 1999, five U.S.
patents were issued to EBC including expression of the desulfurization genes
in alternate hosts, and a key patent in preparation of several detergents
from the organosulfur co-products of diesel BDS.
A provisional patent application for EBC's RACHITT technology was filed
at the US Patent and Trademark Office (the "PTO") on October 19,1999, and an
updated regular application was filed at the PTO on February 29, 2000.
EBC has filed patent applications in the U.S. and worldwide under the
Patent Cooperation Treaty as well as in targeted countries not involved in
the treaty such as Venezuela. In total, EBC has rights to 32 U.S. patents
(including cell recombinant DNA and fundamental process patents) and 35
foreign patents. In addition, EBC has 13 applications pending in the U.S.
patent office, and more than 70 foreign patent applications pending to cover
BDS process technology and the molecular cloning of the biocatalyst gene.
Patents issued to or licensed by EBC begin to expire in the year 2010. See
"-Risk Factors-Patents and Proprietary Technologies."
EMPLOYEES AND CONSULTANTS
EBC believes that its success will be based, among other things, on
achieving and retaining scientific and technological superiority and on
identifying and retaining capable management in order to conduct a fully
integrated program of biorefining technology development. EBC has assembled a
highly qualified team of scientists as well as executives with extensive
experience in the petroleum industry. EBC's product development program
combines basic scientific disciplines, such as molecular biology, microbial
genetics, biochemistry and biochemical engineering, with applied disciplines
such as fermentation, process development, refining, petroleum product
separations and recovery, and byproduct disposition expertise.
As of December 31, 1999, EBC employed 34 people, 14 of whom hold Ph.D.
degrees and 5 of whom hold other advanced degrees. EBC's employees with
doctoral degrees represent collective expertise in molecular biology,
microbiology, biochemistry, chemistry and chemical and process engineering.
EBC believes that its relationship with its employees is good.
GOVERNMENT REGULATION
Certain of EBC's current and planned operations are, or may be, subject
to regulation under various federal and state laws pertaining to protection
of the environment and employee health and safety. In the course of its
current research and development activities, EBC generates small quantities
of solid and hazardous wastes that are subject to regulation under the
Resource Conservation and Recovery Act ("RCRA") and various other federal and
state regulations. The research and development activities of EBC are also
subject to the Occupational Safety and Health Act ("OSHA") and similar state
laws and regulations. Upon commercialization of EBC's BDS technology, EBC's
operations will be subject to the full scope of environmental and employee
health and safety regulations including not only RCRA and OSHA, but also the
Clean Air Act, the Federal Water Pollution Control Act, the Toxic Substances
Control Act ("TSCA") and other applicable state and federal environmental
laws and regulations. Although current information is not definitive enough
to accurately predict compliance requirements with such laws and regulations,
EBC believes that compliance will not materially affect its operations.
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Under TSCA, the EPA regulates the use of chemicals for commercial
purposes, and the EPA has asserted that it has jurisdiction under TSCA to
regulate genetically engineered microorganisms. Prior to commercialization of
EBC's biocatalyst product, EBC will most likely be subject to the
Premanufacture Notice Requirements under TSCA in marketing its BDS
technology. Under the Premanufacture Notice Requirements, if the EPA finds
that EBC's biocatalyst product poses an unreasonable risk to the environment,
it may establish controls on its manufacture, distribution or disposal.
Commercialization of EBC's technology outside the U.S. will require
compliance with the regulations of foreign countries. In anticipation of
early commercialization in Europe, EBC has begun efforts to prepare for
compliance with European Union regulations for genetically modified organisms
("GMOs"). Directive 90/219 of the European Commission provides a framework
for contained use of GMOs. Each of the member countries has enacted specific
regulations consistent with this directive.
RISK FACTORS
TECHNOLOGICAL UNCERTAINTY; RISKS ASSOCIATED WITH COMMERCIALIZATION OF BDS
TECHNOLOGY
Since its inception, EBC has engaged primarily in research and
development related to its BDS process. EBC's BDS process will require
substantial additional research, development and testing in order to
determine its commercial viability. EBC has not proven its BDS technology
other than to a limited extent in laboratory, bench-scale and pilot plant
trials. EBC's ability to make its BDS technology commercially viable will
depend in large part on its success in: (i) achieving improvement of its
biocatalyst; including the manipulation of the genes responsible for
desulfurization activity to increase the reaction rate and specificity
(extent) of the biocatalyst; (ii) improving the rate at which sulfur
molecules transfer from petroleum to the biocatalyst; (iii) more fully
developing the catalyst regeneration process; (iv) developing a bioreactor
for use with the BDS process capable of operating at commercial levels of
throughput and desulfurization; (v) identifying economically viable processes
for commercial-scale sulfur co-product recovery and (vi) marketing its BDS
systems effectively. The accomplishment of some or all of these objectives
may take longer than anticipated or may never occur. EBC will require
additional capital to continue the development and commercialization of its
BDS technology, and there can be no assurance that such capital will be
available or that EBC will be able to successfully commercialize the BDS
technology.
HISTORY OF OPERATING LOSSES AND UNCERTAINTY OF FUTURE PROFITABILITY
EBC has incurred net losses since its inception and expects its losses
to increase in the foreseeable future as it continues its expenditures for
the continued development and commercialization of its biorefining
technology. EBC's only derived revenues to date from the use or sale of its
biorefining technology has been the initial payment of the Petro Star license
of $200,000 in 1998. At December 31, 1999, EBC had an accumulated deficit of
approximately $75 million. The time required for EBC to become profitable is
uncertain, and there can be no assurance that EBC will achieve profitability
on a sustained basis, if at all.
NEED FOR ADDITIONAL FUNDS
EBC's operations to date have consumed substantial amounts of cash. The
negative cash flow from operations is expected to continue over the
foreseeable future. EBC believes that it can conserve its existing capital
resources at December 31, 1999 to fund its operations through mid-2001.
Accordingly, EBC may seek additional financing through various alternatives
that include an equity financing, government funding and alliances with
chemical companies and corporate partners to continue development and
commercialization of its biorefining technology. Adequate funds for these
purposes, whether obtained through financial markets or collaborative or
other arrangements with corporate partners or from other resources, may not
be available when needed or on terms acceptable to EBC. EBC's inability to
raise funds when needed may require EBC to delay, scale back or eliminate
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some or all of its research and product development programs. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations."
MANUFACTURE OF BIOCATALYST
EBC currently intends to manufacture, at its own facility, only a
quantity of biocatalyst sufficient for its in-house research and pilot plant
needs. EBC expects that the biocatalyst to be employed in the commercial BDS
process initially will be manufactured by a third party, including
manufacturing at each BDS unit site to generate startup quantities. EBC has
had discussions regarding non-exclusive biocatalyst supply arrangements with
several parties that it believes are capable of satisfying the Company's
supply requirements. If EBC is unable to enter into agreements for the supply
of commercial quantities of biocatalyst, EBC may be forced to establish its
own fermentation facilities. This alternative could delay the
commercialization of the BDS process and would require significant capital
expenditures.
MARKET ACCEPTANCE
The BDS process will require significant capital expenditures by
refiners and producers. The refining and oil production industries
historically have been reluctant to accept new technologies. There is a risk,
therefore, that EBC will have difficulty in obtaining the refining and oil
production industries' acceptance of the BDS process. Also, the rate of
purchase of the Company's BDS process may be affected by economic conditions
in the refining and oil production industries. The refining and oil
production industries have been subject to periods of depressed profitability
and are substantially affected by fluctuations in the price of crude oil and
finished products. Oil production and drilling activity are also largely
dependent on the level and volatility of oil prices.
RELIANCE ON ENVIRONMENTAL REGULATION
Demand for the BDS units and services being developed by EBC is based,
in large part, on legislation and regulations in the United States, Europe
and Asia that specify stringent environmental quality standards and that
impose penalties for noncompliance. The amendments to the federal Clean Air
Act required the EPA to develop maximum sulfur content standards for highway
diesel fuel and gasoline. In response, the EPA promulgated new regulations
regarding the maximum sulfur content of gasoline in 1999 and a new ruling on
maximum sulfur content in highway diesel fuel is expected in 2000. New,
strict regulations regarding the maximum sulfur content of diesel fuel have
been adopted by the European Union. EBC expects that Asian countries will
also adopt and enforce additional standards requiring a reduction in the
sulfur content of petroleum products. Any reduction of severity in current
regulations, lax enforcement of current regulations, delay in implementation
and enforcement of planned regulations, or reduction of severity in planned
or anticipated regulations worldwide may delay or decrease the worldwide
demand for the Company's BDS process.
PATENTS AND PROPRIETARY TECHNOLOGIES
The Company's success is heavily dependent upon its proprietary BDS and
other technologies. In total, EBC has rights to 32 U.S. and 35 foreign
patents. In addition, EBC has 13 patent applications pending in the U.S.
patent office and more than 70 foreign patent applications pending to cover
BDS process technology and the molecular cloning of the biocatalyst genes.
There can be no assurance concerning the scope, validity or value of such
patents, patent applications or related intellectual property rights.
Furthermore, there can be no assurance that the steps taken by EBC to protect
its proprietary technologies will be adequate to prevent misappropriation of
these technologies by third parties, particularly where third parties may
independently develop similar technologies, duplicate any of the Company's
technologies or design around any proprietary technologies owned by EBC. Any
such misappropriation could have a material adverse effect on EBC. Although
EBC does not believe any of its proprietary technologies infringe the patent
or other proprietary rights of third parties, there can be no assurance that
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infringement claims will not be asserted against EBC in the future or that
any such claims will not require EBC to enter into license arrangements or
result in litigation. In the event that EBC may be required to obtain
licenses to patents or other proprietary rights of third parties, there can
be no assurance that any required licenses would be made available to EBC on
terms acceptable to EBC, or at all. If EBC does not obtain such licenses, it
could encounter delays in commercializing its BDS technology while it
attempts to design around such patents or could find that the
commercialization of its BDS technology could be foreclosed. In addition, to
the extent that EBC seeks to protect its proprietary technologies overseas,
there can be no assurance that steps taken by EBC to protect its proprietary
technologies will be adequate under the laws of certain foreign countries,
which may not protect the Company's proprietary rights to the same extent as
do the laws of the United States.
EBC relies on secrecy to protect its proprietary technologies in
addition to patent protection, especially where patent protection is not
believed to be appropriate or obtainable. EBC has entered into
confidentiality agreements with its employees, licensors and certain of its
collaborators and consultants. There can be no assurance that such
obligations of confidentiality will be honored, that other parties will not
otherwise gain access to the Company's trade secrets or that EBC can
effectively protect its rights to its unpatented trade secrets. See " -
Patents and Proprietary Technology."
DEPENDENCE ON COLLABORATORS
EBC has been dependent on collaborative relationships for development of
certain key components of the BDS process, and the Company's
commercialization strategy contemplates continued dependence on collaborative
relationships. EBC has signed an agreement with Kellogg to provide the basic
engineering designs necessary for BDS implementation at customer sites. EBC
also has entered into an alliance with TOTALFINA relating to the application
of the BDS process to diesel fuel, an alliance with Koch to develop the BDS
process for certain gasoline products, and an alliance with Texaco to develop
a process for desulfurizing high-sulfur crude oil. Each alliance partner is
currently providing technical assistance during the development of the BDS
process. Collaborative arrangements involve risks that the participating
partners may disagree on business decisions and strategies, which may result
in delays, additional costs or litigation. The inability of EBC to
successfully maintain existing collaborative relationships or enter into new
collaborative relationships could have a material adverse effect on EBC. See
"- Alliances."
LIMITED MARKETING EXPERIENCE
EBC has only limited experience marketing its BDS technology, and has
assembled only a small sales and marketing staff. There can be no assurance
that EBC will be able to successfully implement its sales and marketing plan.
DEPENDENCE ON KEY PERSONNEL
EBC is dependent on the efforts of its executive officers, scientists
and other key employees, the loss of any one of whom could have a materially
adverse effect on the Company's business. Shortages of qualified scientists
within certain disciplines may occur and competition for the services of
qualified scientists may intensify. EBC may not be successful in recruiting
or retaining such personnel in the future.
GOVERNMENT REGULATION
Certain of the Company's current and planned operations are, or may be,
subject to regulation under various federal and state laws pertaining to
protection of the environment and employee health and safety. In the course
of its current research and development activities, EBC generates small
quantities of solid and hazardous wastes that are subject to regulation under
the RCRA and various other federal and state regulations. The research and
18
<PAGE>
development activities of EBC are also subject to the OSHA and similar state
laws and regulations. Upon commercialization of the Company's technology,
EBC's operations will be subject to the full scope of environmental and
employee health and safety regulations including not only RCRA and OSHA, but
also the Clean Air Act, the Federal Water Pollution Control Act, the TSCA and
other applicable state and federal environmental laws and regulations. In
addition, commercialization of the BDS technology outside the United States
will require compliance with the regulations of foreign countries. Failure to
comply with applicable regulations could have an adverse effect on EBC. See
"-Government Regulation."
COMPETITION
EBC expects to encounter competition from suppliers of existing
desulfurization technology in the marketing of the Company's BDS units. These
companies have well-established relationships in the refining industry and
have substantially greater financial, technical and human resources than EBC.
In addition, new desulfurization technologies could be developed that are
competitive with or superior to BDS technology. See "-Competition."
DILUTIVE EFFECT OF DIVIDENDS ON PREFERRED STOCK; DEFICIENCY IN FIXED CHARGES
AND PREFERRED STOCK DIVIDEND COVERAGE
EBC may pay dividends on its Preferred Stock in cash or a combination of
Common Stock and cash in its discretion. Dividends will be payable on the
Preferred Stock only when, as and if declared by the Company's Board of
Directors as permitted under Delaware Law. EBC has incurred net losses since
inception and expects its losses to increase in the foreseeable future.
Dividends on the Preferred Stock may be paid only out of capital surplus
(within the meaning of the Delaware General Corporation Law) or net profits
of EBC for the fiscal year in which the dividend is declared and the
preceding fiscal year. Unpaid dividends do not earn interest.
NASDAQ LISTING REQUIREMENTS
Although the Company's Common Stock meets the current listing
requirements of, and are presently included in, the Nasdaq Stock Market, EBC
will have to maintain certain minimum financial requirements for continued
inclusion on Nasdaq. If EBC is unable to satisfy Nasdaq's maintenance
requirements, the Company's Common Stock may be delisted from Nasdaq. In such
event, trading if any, in the Common Stock would thereafter be conducted in
the over-the-counter markets and so-called "pink sheets" of the NASD's "Over
the Counter Bulletin Board." Consequently, the liquidity of the Company's
Common Stock could be impaired, not only in the number of shares which could
be bought and sold, but also through delays in the timing of the
transactions, reductions in security analysts' and the news media's coverage
of EBC, and lower prices for the Company's Common Stock than might otherwise
be attained.
ITEM 2. PROPERTIES
FACILITIES
The Company's corporate offices and laboratories are situated in a
25,000 square-foot leased building located at 4200 Research Forest Drive in
The Woodlands, Texas, a suburb of Houston, Texas. Pursuant to the lease,
monthly payments of $33,678 are required for base rent. The lease for this
facility expires in 2003. Approximately 20,500 square feet of this space is
devoted to research and development. The facility includes two laboratories
designed for molecular biology/microbiology/microbial physiology, a process
engineering laboratory, a biochemistry laboratory, a media preparation
laboratory, and an analytical laboratory which provides all the routine
sulfur and hydrocarbon analyses for the operation, a fermentation laboratory,
microbiology laboratory and accelerated development program laboratories.
19
<PAGE>
ITEM 3. LEGAL PROCEEDINGS.
There are no material pending legal proceedings required to be reported
in response to this item.
20
<PAGE>
PART II.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
The Company's common stock (symbol: ENBC) is traded on the Nasdaq National
Market. The following table sets forth the range of high and low sales prices
for each calendar quarter in the two years ended December 31, 1999 as reported
on the Nasdaq National Market:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1999 HIGH LOW
---------- -------
<S> <C> <C>
First Quarter............................................................ $4.63 $ 0.38
Second Quarter........................................................... 6.50 1.25
Third Quarter............................................................ 4.75 1.81
Fourth Quarter........................................................... 4.63 2.00
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 HIGH LOW
---------- -------
<S> <C> <C>
First Quarter............................................................ $25.81 $ 14.00
Second Quarter........................................................... 18.81 10.50
Third Quarter............................................................ 14.88 3.28
Fourth Quarter........................................................... 9.41 1.69
</TABLE>
As of March 20, 2000, 6,732,794 shares of common stock were outstanding and
EBC had approximately 157 shareholders of record.
DIVIDENDS
EBC has never paid cash dividends on its common stock. EBC currently
intends to retain any earnings to finance the growth and development of its
business and does not anticipate paying cash dividends on its common stock in
the foreseeable future. For a discussion of dividends paid or payable on the
Series B Redeemable Convertible Preferred Stock, see "Item 1. Business - Risk
Factors - Dilutive Effect of Dividends on Preferred Stock; Deficiency in Fixed
Charges and Preferred Stock Dividend Coverage."
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below with respect to the Company's
statements of operations for each of the five years in the period ended December
31, 1999 and with respect to the Company's balance sheets as of December 31,
1995, 1996, 1997, 1998 and 1999 are derived from the audited financial
statements of EBC. The financial data should be read in conjunction with the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Company's Financial Statements and Notes thereto included
elsewhere in this report.
21
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1995 1996 1997 1998 1999
---- ---- ---- ---- ----
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Revenues:
Sponsored research revenues...... $ 1,567 $ 1,778 $ 1,652 $ 689 $ 1,415
Interest and investment income... 1,401 807 650 360 214
---------- ---------- ---------- ---------- ----------
Total revenues............... 2,968 2,585 2,302 1,049 1,629
Costs and Expenses:
Research and development......... 7,338 9,210 9,087 7,706 4,848
General and administrative....... 2,877 2,608 2,754 2,188 1,906
---------- ---------- ---------- ---------- ----------
Total costs and expenses..... 10,215 $ 11,818 $ 11,841 $9,894 $ 6,754
---------- ---------- ---------- ---------- ----------
Loss on disposal of fixed assets....... -- -- -- -- 140
---------- ---------- ---------- ---------- ----------
Net loss............................... $ (7,247) $ (9,233) $ (9,539) $(8,845) $ (5,265)
========== ========== ========== ========== ==========
Net loss per common share - basic and
diluted.......................... $ (6.65) $ (7.29) $ (7.64) $ (5.20) $ (1.78)
========== ========== ========== ========== ==========
Shares used in computing net loss
per common share - basic and
diluted.......................... 1,461,085 1,606,861 1,681,351 1,875,414 4,635,930
========== ========== ========== ========== ==========
</TABLE>
Net loss per common share has been computed by dividing the net loss, which
has been increased for periodic accretion and dividends on the Series A
Preferred Stock issued in October 1994 and the Series B Preferred Stock issued
in February and March 1997, by the weighted average number of shares of common
stock outstanding during the period.
<TABLE>
<CAPTION>
DECEMBER 31,
------------
1995 1996 1997 1998 1999
---------------------------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................ $ 6,172 $ 3,106 $ 9,661 $ 2,795 $ 2,510
Working capital.......................... 15,084 8,770 10,102 2,488 5,591
Total assets............................. 23,809 13,711 14,965 6,127 8,064
Accumulated deficit...................... (31,321) (42,713) (55,204) (67,200) (75,079)
Total stockholders' equity............... 21,577 12,715 13,698 5,306 7,557
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
EBC has devoted substantially all of its efforts to research and
development. There have been no revenues from operations other than sponsored
research revenues and one site license fee in 1998 and there is no assurance of
future revenues. EBC has a cumulative loss since inception of approximately $75
million and believes that it can
22
<PAGE>
conserve its existing financial resources to fund operations through
mid-2001. As of March 20, 2000, EBC had approximately $5 million in cash and
approximately $800,000 in liabilities.
Effective March 30, 1999, EBC implemented a restructuring which included an
employee headcount reduction of approximately 38 percent leaving approximately
34 employees. EBC retained certain key technical and administrative personnel.
RESULTS OF OPERATIONS
EBC had total revenues for the years ended December 31, 1997, 1998 and 1999
of, $2,302,225, $1,048,791 and $1,628,635, respectively. Sponsored research
revenues decreased by $962,894 from 1997 to 1998 primarily as a result of the
decreased revenues recognized from the National Institute of Standards and
Technology grant and The Carbide/Graphite Group, Inc. agreement offset in part
by increased revenues from the DOE grant and the site license fee from Petro
Star. Interest and investment income decreased by $290,540 in 1998 as a result
of a decrease in cash and cash equivalents and related investments in marketable
securities. Sponsored research revenues increased by $726,295 from 1998 to 1999
resulting from an increased funding from the DOE grant. Interest and investment
income decreased by $146,451 in 1999 as a result of a decrease in cash and cash
equivalents and related investments in marketable securities in the first half
of the year and recognition of a loss on the disposal of furniture and
equipment.
EBC had research and development expenses for the years ended December 31,
1997, 1998 and 1999 of $9,087,149, $7,706,490 and $4,847,641, respectively. The
decrease of $1,380,659 from 1997 to 1998 is a result of a reduction in research
and development personnel at the end of the first quarter of 1998 and the
cessation of the pilot plant operating expenses at the end of the second quarter
of 1998, offset in part by a charge to research and development in the first
quarter of 1998 for warrants issued to Petro Star in the amount of $404,500. The
decrease from 1998 to 1999 of $2,858,849 is primarily a result of a reduction in
workforce at the end of the first quarter of 1999 and a decrease in the use of
consultants and outside services.
EBC had general and administrative expenses for the years ended December
31, 1997, 1998 and 1999 of $2,754,137, $2,187,668 and $1,905,815, respectively.
The decrease of $566,469 from 1997 to 1998 reflects the reduction of the general
and administrative personnel at the end of the first quarter of 1998. The
decrease of $281,853 from 1998 to 1999 resulted from a decrease in insurance
costs, cost of consultants, recruiting expenses and professional fees.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception in December 1989, EBC has devoted substantially all of
its resources to research and development. To date, all of the Company's
revenues have resulted from interest and investment income and sponsored
research payments from collaborative agreements. EBC has incurred cumulative
losses since inception and, assuming EBC obtains additional financing, expects
to incur continued losses for at least the next several years, due primarily to
continued research and development activities and acceleration of the
development of its biocatalyst, fermentation and bioreactor programs;
organosulfur compounds; and directed evolution technology. EBC expects that
losses will fluctuate from quarter to quarter and that such fluctuations may be
substantial. As of December 31, 1999, the Company's accumulated deficit was
approximately $75 million.
The Company completed a private placement of its common stock during June
1999. The Company offered and sold 2,600,223 and 1,614,597 shares at $1.80 and
$2.00 per share, respectively. Those shares sold at $2.00 per share included one
warrant to purchase one share of the Company's common stock for every five
shares purchased in the private placement. Those shares sold at $1.80 per share
included no such warrants. Net proceeds from the offering were approximately
$7.5 million. In connection with the closing, warrants to purchase 646,623
shares of
23
<PAGE>
the Company's common stock were issued at an exercise price of $2.40.
Such number of warrants includes both those warrants issued to investors, as
described above, and warrants issued to the placement agent, SAMCO Capital
Markets, Inc. ("SAMCO"), in partial payment of its fee. The warrants have been
recorded at an estimated fair value of $1,147,358, which was computed using the
Black-Scholes option pricing model and the following assumptions: risk free
interest rate of 6.01 percent; expected dividend yield of zero; expected life of
three years (and with respect to the warrants issued to the placement agent five
years); and an expected volatility at an average weight of 125 percent.
For the year ended December 31, 1999, EBC used $3,917,293 of funds in
operating activities. At December 31, 1999, EBC had cash, cash equivalents and
short term investments totaling $5,955,473 and working capital of $5,591,337.
EBC expects to incur substantial additional research and development
expenses, including expenses associated with biocatalyst, fermentation and
bioreactor development; organosulfur compounds; and directed evolution
technology. EBC is subject to cost sharing arrangements under various
collaborative agreements, as discussed below. EBC also expects its general and
administrative expenses to decrease slightly as it reduces its marketing, sales
and other personnel to conserve its resources for the development of the
Company's proprietary BDS technology.
Recently, EBC has discovered that its proprietary biocatalytic technology
may also provide an economic basis for production of a broad family of
industrial organosulfur chemicals with potential uses in detergent, surfactant,
polymer and adhesive markets. In 1999, the organosulfur product was prepared on
a multi-kilogram scale in pilot units at EBC's Woodlands facility, and prototype
surfactant products were prepared for testing. Joint development and testing
agreements were executed with major chemical companies for detailed evaluation
of these products in specific commercial applications, and EBC is pursuing a
strategic business alliances for commercialization of this technology.
In 1999, a program was implemented to rapidly screen mutant strains for
improved performance, and a proprietary directed evolution platform with gene
shuffling was conceived, designed and implemented to increase the diversity
of strains that are tested. EBC believes that this strategy will greatly
accelerate the development of the BDS commercial biocatalyst. EBC also
believes that many applications exist for its technology in gene-shuffling
and bioprocessing.
In March 1998, EBC entered into a site license agreement with Petro Star
Inc. ("Petro Star") regarding the design and installation of a BDS unit at
Petro Star's Valdez, Alaska refinery. The agreement involves several stages
of work, the first of which, involving the completion of scoping economics,
is completed. In addition, the agreement provides EBC with certain rights to
conduct development work and demonstrations of its BDS technology at Petro
Star's refinery. The agreement calls for the payment of staged license fees
and royalties to EBC, including a $200,000 initial site license fee upon
execution of the agreement. As is customary in such arrangements in the
petroleum refining industry, the agreement provides certain approval and
termination rights to Petro Star at the completion of each stage prior to
commercialization. In connection with the execution of the agreement, EBC
issued a four-year warrant entitling Petro Star to purchase 28,571 shares of
EBC Common Stock at an exercise price of $21.77 per share. The warrant was
recorded as research and development expense at an
24
<PAGE>
estimated fair value of $404,500, which was computed using the Black-Scholes
option pricing model. The successful implementation of a commercial BDS unit
will be dependent upon EBC's ability to achieve additional improvements in
the productivity of the biocatalyst (e.g., reaction rates, specificity and
stability) and process technology (e.g., bioreactor and separations
technology).
EBC signed an agreement with Kellogg in August 1994, to collaborate on the
development and commercialization of the Company's proprietary biocatalytic
desulfurization technology for reducing sulfur levels in petroleum streams.
Under the terms of the collaboration, Kellogg will serve as an engineering
partner to EBC during completion of the BDS development process and will be the
exclusive provider of the basic engineering design services required for the
commercial BDS units. In return for these services, Kellogg will receive a
portion of the site license fee generated by the sale of BDS units. The
collaboration has a minimum term of at least five years or the completion of 20
BDS units, whichever is longer, and has applications to all biorefining
technologies EBC develops. During the first phase of the collaboration, Kellogg
provided 500 engineering work hours of service at no cost to EBC. Kellogg has
agreed to provide an additional 1,500 work hours of service at Kellogg offices
at reduced rates.
In July 1994, EBC entered into an Agreement with TOTALFINA to collaborate
on the application of the Company's biodesulfurization process to diesel fuel
streams. When the BDS processes reach commercial levels for activity and extent,
it is anticipated that TOTALFINA will build and operate at TOTALFINA's expense a
pilot BDS unit at TOTALFINA's European Centre for Research and Technology. Upon
successful economic trials of the pilot unit, TOTALFINA plans to build the first
commercial BDS unit at one of its refineries.
In December 1993, EBC entered into a research collaboration agreement with
Koch, to facilitate the development of BDS technology in refinery petroleum
streams. Under the terms of the alliance, EBC will be primarily responsible for
improving the performance of the biocatalyst used in the desulfurization
process. Koch will be primarily responsible for selecting and improving the
target refinery stream as well as testing desulfurized product quality. Koch
will also provide engineering support as needed in the development of a BDS unit
for Koch's operation. EBC and Koch will each bear their own costs and expenses
incurred in connection with the collaboration. EBC expects that the development
alliance with Koch will facilitate commercialization of the Company's BDS
technology.
In July 1993, EBC entered into a research collaboration agreement with
Texaco to facilitate the development of the Company's BDS technology in crude
oil. Under the terms of the alliance, EBC will be primarily responsible for
improving the performance of the biocatalyst used in the desulfurization
process. Texaco will be primarily responsible for field operations and
analytical chemistry work with respect to the application of the Company's BDS
technology to crude oil. EBC and Texaco will each bear their own costs and
expenses incurred in connection with the collaboration. EBC expects that the
development alliance with Texaco will facilitate commercialization of the
Company's BDS technology.
On March 27, 1998 EBC elected to terminate its agreement with
Baker-Petrolite as of March 27, 1999. EBC believes this will provide the
greatest future benefits, including competitive bidding by potential service
alliance partners, while maintaining a cost as low or lower than that provided
by continuing the agreement.
EBC has experienced negative cash flow from operations since its inception
and has funded its activities to date primarily from equity financings and
sponsored research revenues. EBC will continue to require substantial funds to
continue its research and development activities and to market, sell and
commercialize its technology. EBC will need to raise substantial additional
capital to fund its future operations. The Company's capital requirements will
depend on many factors, including the problems, delays, expenses and
complications frequently encountered by companies developing and commercializing
new technologies; the progress of the Company's research and development
activities; timing of environmental regulations; the rate of technological
advances; determinations as to
25
<PAGE>
the commercial potential of the Company's technology under development; the
status of competitive technology; the establishment of biocatalyst
manufacturing capacity or third-party manufacturing arrangements; the
establishment of collaborative relationships; the success of the Company's
sales and marketing programs; the cost of filing, prosecuting and defending
and enforcing patents and intellectual property rights; and other changes in
economic, regulatory or competitive conditions in the Company's planned
business. Estimates about adequacy of funding for the Company's activities
are based upon certain assumptions, including assumptions that the research
and development programs relating to the Company's technology can be
conducted at projected costs and that progress towards the commercialization
of its technology will be timely and successful. There can be no assurance
that changes in the Company's research and development plans, acquisitions or
other events will not result in accelerated or unexpected expenditures.
To satisfy its capital requirements, EBC may seek additional financing
through an equity financing, government funding and through alliances with
chemical companies and corporate partners. There can be no assurance that any
such funding will be available to EBC on favorable terms or at all. If adequate
funds are not available when needed, EBC may be required to delay, scale back or
eliminate some or all of its research and product development programs. If EBC
is successful in obtaining additional financing, the terms of such financing may
have the effect of diluting or adversely affecting the holdings or the rights of
the holders of the Company's common stock.
YEAR 2000 ISSUES
Year 2000 issues result from the inability of certain computer programs or
computerized equipment to accurately calculate, store or use a date subsequent
to December 31, 1999. The erroneous date can be interpreted in a number of
different ways; typically the year 2000 is represented as the year 1900. This
could result in a system failure or miscalculation causing disruptions of
operations, including, among other things, a temporary inability to process
transactions, send invoices or engage in similar normal business.
The Company has not experienced any significant failures related to Year
2000 issues. The amounts charged to expense during 1999, as well as the amounts
anticipated to be charged to expense related to the Year 2000 computer
compliance modifications, have been negligible and are not expected to be
material to the Company's financial position, results of operations or cash
flows.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
None
ITEM 8. FINANCIAL STATEMENTS.
The financial statements required by this Item are incorporated under Item
14 in Part IV of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this Item as to the directors and executive
officers of EBC is hereby incorporated by reference from the information
appearing under the captions "Election of Directors" and "Executive Officers" in
the Company's definitive proxy statement which involves the election of
directors and is to be filed with the
26
<PAGE>
Securities and Exchange Commission ("Commission") pursuant to the Securities
Exchange Act of 1934 within 120 days of the end of the Company's fiscal year
on December 31, 1999.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item as to the management of EBC is hereby
incorporated by reference from the information appearing under the captions
"Executive Compensation" and "Election of Directors - Director Compensation" in
the Company's definitive proxy statement which involves the election of
directors and is to be filed with the Commission pursuant to the Securities
Exchange Act of 1934 within 120 days of the end of the Company's fiscal year on
December 31, 1999. Notwithstanding the foregoing, in accordance with the
instructions to Item 402 of Regulation S-K, the information contained in the
Company's proxy statement under the sub-heading "Report of the Compensation
Committee of the Board of Directors" and "Performance Graph" shall not be deemed
to be filed as part of or incorporated by reference into this Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item as to the ownership by management and
others of securities of EBC is hereby incorporated by reference from the
information appearing under the caption "Security Ownership of Certain
Beneficial Owners and Management" to the Company's definitive proxy statement
which involves the election of directors and is to be filed with the Commission
pursuant to the Securities Exchange Act of 1934 within 120 days of the end of
the Company's fiscal year on December 31, 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item as to certain business relationships
and transactions with management and other related parties of EBC is hereby
incorporated by reference to such information appearing under the captions
"Certain Transactions" and "Compensation Committee Interlocks and Insider
Participation" in the Company's definitive proxy statement which involves the
election of directors and is to be filed with the Commission pursuant to the
Securities Exchange Act of 1934 within 120 days of the end of the Company's
fiscal year on December 31, 1999.
27
<PAGE>
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Documents Filed as a Part of this Report
1. FINANCIAL STATEMENTS:
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants............................................. F-1
Balance Sheets as of December 31, 1998 and 1999...................................... F-2
Statements of Operations for the Years Ended December 31, 1997, 1998 and 1999........ F-3
Statements of Stockholders' Equity for the Period from December 31, 1996 to
December 31, 1999................................................................. F-4
Statements of Cash Flows for the Years Ended December 31, 1997, 1998 and 1999........ F-5
Notes to Financial Statements........................................................ F-6
</TABLE>
All other schedules are omitted because they are not applicable, not
required, or because the required information is included in the financial
statements or notes thereto.
2. EXHIBITS:
Exhibits to the Form 10-K have been included only with the copies of the Form
10-K filed with the Commission and the Nasdaq Stock Market. Upon request to EBC
and payment of a reasonable fee, copies of the individual exhibits will be
furnished.
<TABLE>
EXHIBIT NO. DESCRIPTION
----------- -----------
<S> <C>
3.1(a) Amended and Restated Certificate of Incorporation of
Registrant (incorporated by reference to Exhibit 2 filed
with Post-Effective Amendment No. 1 to the Registrant's
Registration Statement on Form 8-A as filed with the
Commission on March 15, 1993).
3.1(b) Certificate of the Powers, Designations, Preferences and
Rights of the Series A Convertible Preferred Stock
(incorporated by reference to Exhibit 10.2 to EBC's
Quarterly Report on Form 10-Q for the quarter ended
September 30, 1994).
3.1(c) Certificate of Designation of Series One Junior
Participating Preferred Stock of EBC
(incorporated by reference to Exhibit 3.1(c) to EBC's
Annual Report on Form 10-K for the year ended December 31,
1994).
3.1(d) Certificate of the Powers, Designation, Preferences and
Rights of the Series B Convertible Preferred Stock
(incorporated by reference to Exhibit 3.1(d) to EBC's
Annual Report on Form 10-K for the year ended December 31,
1997).
3.2 Bylaws of Registrant (incorporated by reference to Exhibit
3 filed with Post-Effective Amendment No. 1 to the
Registrant's Registration Statement on Form 8-A as filed
with the Commission on March 15, 1993).
4.1 Form of Stock Purchase Agreement, dated as of October 27,
1994, by and between EBC and the Purchasers of the Series
A Convertible Preferred Stock (incorporated by reference
to Exhibit 10.1 to EBC's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1994).
4.2 Form of Stock Purchase Agreement, dated as of February 21,
1997, by and between EBC and the Purchasers of the Series
B Convertible Preferred Stock (incorporated by reference
to Exhibit 4.2 to EBC's Annual Report on Form
28
<PAGE>
10-K for the year ended December 31, 1997).
4.3 Form of Stock Exchange Agreement, dated as of February 21,
1997, by and between EBC and the Exchanging Holders of
Series A Convertible Preferred Stock (incorporated by
reference to Exhibit 4.3 to EBC's Annual Report on Form
10-K for the year ended December 31, 1997).
4.4 Stockholder Rights Agreement, dated as of March 8, 1995,
between EBC and Society National Bank (incorporated by
reference to Exhibit 4.1 to EBC's Current Report on Form
8-K dated March 8, 1995).
10.1 License and Technology Assistance Agreement, dated January
15, 1991, between EBC and Institute of Gas Technology
("IGT") (incorporated by reference to the similarly
numbered exhibit to EBC's Registration Statement on Form
S-1 (No. 33-56718)).
10.2 First Amendment to License and Technology Assistance
Agreement, dated June 25, 1992, between EBC and IGT
(incorporated by reference to the similarly numbered
exhibit to EBC's Registration Statement on Form S-1 (No.
33-56718)).
10.3 Agreement, dated August 27, 1992, among EBC, IGT, the
University of North Dakota ("UND") and Dr. Kevin Young
(incorporated by reference to the similarly numbered
exhibit to EBC's Registration Statement on Form S-1
(No. 33-56718)).
10.4 Collaboration Agreement, dated March 5, 1992, between EBC
and Petrolite Corporation (incorporated by reference to
the similarly numbered exhibit to EBC's Registration
Statement on Form S-1 (No. 33-56718)).
10.5 Lease Agreement, dated January 24, 1994, between The
Woodlands Corporation and EBC (incorporated by reference
to Exhibit 10.6 to EBC's Annual Report on Form 10-K for
the fiscal year ended December 31, 1993).
10.6 Registration Agreement, dated January 30, 1992, among EBC,
The Travelers Indemnity Company and Gryphon Ventures II,
Limited Partnership (incorporated by reference to the
similarly numbered exhibit to EBC's Registration Statement
on Form S-1 (No. 33-56718)).
10.7 Registration Agreement, dated April 29, 1991, between EBC
and Gryphon Ventures II, Limited Partnership (incorporated
by reference to the similarly numbered exhibit to EBC's
Registration Statement on Form S-1 (No. 33-56718)).
10.8 ** Energy BioSystems Corporation 1992 Stock Compensation
Plan (incorporated by reference to Exhibit 10.10 to EBC's
Registration Statement on Form S-1 (No.
33-56718)).
10.9 ** Employment Agreement, dated January 31, 1996, between EBC
and Daniel J. Monticello (incorporated by reference to
Exhibit 10.10 to EBC's Annual Report on Form 10-K for the
year ended December 31, 1997).
10.10 ** Employment Agreement, dated July 18, 1995, between EBC and
Paul G. Brown, III (incorporated by reference to the
similarly numbered exhibit to EBC's Registration Statement
on Form S-1 (No. 33-96096)).
10.11 ** Simplified Employee Pension Plan Retirement Plan
Adoption Agreement (incorporated by reference to Exhibit
10.15 to EBC's Registration Statement on Form S-1 (No.
33-56718)).
10.12 ** Energy BioSystems Corporation Non-Employee Director Option
Plan (incorporated by reference to the similarly numbered
exhibit to EBC's Registration Statement on Form S-1 (No.
33-96096)).
10.13 First Amendment to Collaboration Agreement, dated July 1,
1992, between EBC and Petrolite Corporation (incorporated
by reference to the Exhibit 10.16 to EBC's Registration
Statement on Form S-1 (No. 33-56718)).
10.14 Research Collaboration Agreement, dated July 8, 1993,
between EBC and Texaco, Inc. (incorporated by reference to
Exhibit 99.1 to EBC's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1993).
10.15 Extension and Assignment of Research Collaboration
Agreement, dated June 23, 1995,
29
<PAGE>
between EBC and Texaco Inc. (incorporated by reference
to the similarly numbered exhibits to EBC's Registration
Statement on Form S-1 (No. 3-96096)).
10.16 Second Amendment to Collaboration Agreement, dated October
18, 1993, between EBC and Petrolite Corporation
(incorporated by reference to Exhibit 99.1 to EBC's
Quarterly Report on Form 10-Q for the quarter ended
September 30, 1993).
10.17 Lease Agreement, dated May 24, 1993, between EBC and The
Woodlands Corporation
(incorporated by reference to Exhibit 99.2 to EBC's
Quarterly Report on Form 10-Q for the quarter ended
September 30, 1993).
10.18 Second Amendment to License and Technology Assistance
Agreement, dated September 23, 1993, between EBC and IGT
(incorporated by reference to Exhibit 10.21 to EBC's
Annual Report on Form 10-K for the fiscal year ended
December 31, 1993).
10.19 Letter Agreement dated February 10, 1994, between The M.
W. Kellogg Company and EBC (incorporated by reference to
Exhibit 10.22 to EBC's Annual Report on Form 10-K for the
fiscal year ended December 31, 1993).
10.20 Letter Agreement for Accelerated Development Program dated
December 8, 1993, between EBC and Koch Refining Company
(incorporated by reference to Exhibit 10.23 to EBC's
Annual Report on Form 10-K for the fiscal year ended
December 31, 1993).
10.21 Collaboration Agreement dated July 7, 1994, between EBC
and Total Raffinage Distribution S.A. (incorporated by
reference to Exhibit 99.1 to EBC's Quarterly Report on
Form 10-Q for the second quarter ended June 30, 1994).
10.22 Extension and Assignment of Research Collaboration
Agreement, dated July 3, 1996, between EBC and Texaco
Group, Inc. (incorporated by reference to Exhibit 10.1 to
EBC's Quarterly Report on Form 10-Q for the quarter ended
June 30, 1996).
10.23 Third Amendment and Addendum to Collaboration Agreement,
dated August 24, 1995, between EBC and Petrolite
Corporation (incorporated by reference to Exhibit 10.36 to
EBC's Annual Report on Form 10-K for the year ended
December 31, 1996).
10.24 Fourth Amendment and Addendum to Collaboration Agreement,
dated October 25, 1996, between EBC and Petrolite
Corporation, as modified by Letter Agreement dated
December 30, 1996 (incorporated by reference to Exhibit
10.37 to EBC's Annual Report on Form 10-K for the year
ended December 31, 1996).
10.25** Employment Agreement, dated December 4, 1998, between EBC
and Peter P. Policastro.
10.26 Extension, Modification and Ratification of Lease , dated
March 23, 1998, between EBC and Woodlands Office
Equities-'95 Limited.
*11.1 Computation of earnings per share.
*23.1 Consent of Arthur Andersen LLP.
*27.1 Financial Data Schedule.
</TABLE>
- ---------------------
* Filed herewith
** Management contract or compensatory plan.
(b) Reports on Form 8-K
None.
30
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934, EBC HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF
BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
ENERGY BIOSYSTEMS CORPORATION
By: /s/ Peter P. Policastro
-------------------------------------
Peter P. Policastro
CHIEF EXECUTIVE OFFICER AND PRESIDENT
DATED the 29th day of March, 2000.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934,
THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF EBC AND
IN THE CAPACITIES AND ON THE DATES INDICATED:
<TABLE>
<CAPTION>
NAME TITLE DATE
---- ----- ----
<S> <C> <C>
/s/ Peter P. Policastro Chief Executive Officer and President March 29, 2000
- ----------------------------------------------
Peter P. Policastro
/s/ Paul G. Brown III Chief Financial Officer and Vice March 29, 2000
- ---------------------------------------------- President-Finance and
Paul G. Brown, III Administration (Principal
financial and accounting officer)
/s/ William E. Nasser Chairman of the Board March 28, 2000
- ----------------------------------------------
William E. Nasser
/s/ Daniel J. Monticello Vice President-Science and March 29, 2000
- ---------------------------------------------- Technology, and Director
Daniel J. Monticello, Ph.D.
/s/ R. James Comeaux Director March 28, 2000
- ----------------------------------------------
R. James Comeaux
/s/ Edward B. Lurier Director March 28, 2000
- ----------------------------------------------
Edward B. Lurier
/s/ Thomas E. Messmore Director March 28, 2000
- ----------------------------------------------
Thomas E. Messmore
/s/ Ramon Lopez Director March 28, 2000
- ----------------------------------------------
Ramon Lopez
/s/ John S. Patton Director March 28, 2000
- ----------------------------------------------
John S. Patton
/s/ William D. Young
- ----------------------------------------------
William D. Young Director March 28, 2000
</TABLE>
31
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Energy BioSystems Corporation:
We have audited the accompanying balance sheets of Energy BioSystems
Corporation ("the Company") (a Delaware corporation), as of December 31, 1998
and 1999, and the related statements of operations, stockholders' equity and
cash flows for each of the three years in the period ended December 31, 1999.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Energy BioSystems
Corporation as of December 31, 1998 and 1999, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1999 in conformity with accounting principles generally accepted in the United
States.
ARTHUR ANDERSEN LLP
Houston, Texas
March 2, 2000
F-1
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1998 1999
------------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents......................................... $2,795,429 $2,510,274
Short term investments............................................ -- 3,445,199
Prepaid expenses and other current assets......................... 512,487 143,014
============= =============
Total current assets......................................... 3,307,916 6,098,487
============= =============
Furniture, equipment and leasehold improvements, net................. 1,675,992 926,684
Intangible and other assets, net..................................... 1,142,837 1,038,927
------------- -------------
Total assets................................................. $6,126,745 $8,064,098
------------- -------------
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities......................... $513,673 $327,150
Deferred revenue.................................................. 180,000 180,000
Note payable...................................................... 126,613 --
============= =============
Total current liabilities.................................... 820,286 507,150
------------- -------------
Commitments and Contingencies
Stockholders' equity:
Series B convertible preferred stock $0.01 par value (liquidation value
$35,105,000, 760,000 shares authorized,
696,400 and 519,400 shares issued and outstanding,
respectively)................................................ 33,955,166 28,100,250
Common stock, $0.01 par value (30,000,000 shares
authorized, 2,179,142 and 6,572,135 shares
issued and outstanding, respectively)........................ 21,791 65,721
Additional paid-in capital........................................ 38,529,097 54,470,252
Accumulated deficit............................................... (67,199,595) (75,079,275)
============= =============
Total stockholders' equity................................... 5,306,459 7,556,948
------------- -------------
Total liabilities and stockholders' equity................... $6,126,745 $8,064,098
============= =============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-2
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1997 1998 1999
------------ ------------ ------------
<S> <C> <C> <C>
Revenues:
Sponsored research revenues...................... $ 1,651,776 $ 688,882 $ 1,415,177
Interest and investment income................... 650,449 359,909 213,458
============ ============ ============
Total revenues.............................. 2,302,225 1,048,791 1,628,635
============ ============ ============
Cost and expenses:
Research and development......................... 9,087,149 7,706,490 4,847,641
General and administrative....................... 2,754,137 2,187,668 1,905,815
============ ============ ============
Total costs and expenses.................... 11,841,286 9,894,158 6,753,456
------------ ------------ ------------
Loss on disposal of fixed assets.................... -- -- 139,641
------------ ------------ ------------
Net loss............................................ $(9,539,061) $(8,845,367) $(5,264,462)
============ ============ ============
Net loss per common share - basic and diluted..... $(7.64) $(5.20) $ (1.78)
============ ============ ============
Shares used in computing net loss per common
share - basic and diluted......................... 1,681,351 1,875,414 4,635,930
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK ADDITIONAL
--------------- ------------ PAID-IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT TOTAL
------ ------ ------ ------ ------- ------- -----
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1996 480,000 $ 23,295,585 1,642,447 $ 16,424 $32,116,766 $(42,713,302) $ 12,715,473
Exercise of stock options in
1997 -- -- 38,663 387 350,576 -- 350,963
Issuance of Series B Preferred
Stock 224,100 10,171,120 -- -- -- -- 10,171,120
Exchange of Series A Preferred
Stock for Series B Preferred
Stock (478,000) (22,853,138) -- -- -- -- (22,853,138)
Issuance of Series B Preferred
Stock for Series A Preferred
Stock 478,000 22,853,138 -- -- -- -- 22,853,138
Issuance of Common Stock in
exchange for Series A
Preferred Stock (2,000) (99,526) 1,797 18 99,508 -- --
Dividends on Series A Preferred
Stock paid in Common Stock -- (691,575) 14,074 141 691,387 -- (47)
Accretion and dividends on
Series A Preferred Stock -- 360,604 -- -- (67,904) (292,700) --
Dividends on Series B Preferred
Stock paid in Common Stock -- (2,132,629) 53,223 532 2,131,872 -- (225)
Accretion and dividends on
Series B Preferred Stock -- 2,949,801 -- -- (290,599) (2,659,202) --
Net loss -- -- -- -- -- (9,539,061) (9,539,061)
--------- ------------ ------------ --------- ----------- ------------ ------------
BALANCE AT DECEMBER 31, 1997 702,100 33,853,380 1,750,204 17,502 35,031,606 (55,204,265) 13,698,223
Exercise of stock options in -- -- 4,286 43 42,557 -- 42,600
1998
Warrants issued -- -- -- -- 404,500 -- 404,500
Dividends on Series B Preferred
Stock paid in Common Stock -- (3,144,825) 417,203 4,172 3,140,601 -- (52)
Accretion and dividends on
Series B Preferred Stock -- 3,531,611 -- -- (381,648) (3,149,963) --
Conversion of Series B Preferred
Stock to Common Stock (5,700) (285,000) 5,615 56 284,944 -- --
Fractional shares paid in cash
at one-for-seven reverse split -- -- (54) (1) (195) -- (196)
Stock issued to consultant .. -- -- 1,888 19 6,732 -- 6,751
Net loss -- -- -- -- -- (8,845,367) (8,845,367)
--------- ------------ ------------ --------- ----------- ------------ ------------
BALANCE AT DECEMBER 31, 1998 696,400 33,955,166 2,179,142 21,791 38,529,097 (67,199,595) 5,306,459
Accretion and dividends on
Series B Preferred Stock . -- 2,995,084 -- -- (379,866) (2,615,218) --
Conversion of Series B Preferred
Stock to Common Stock (177,000) (8,850,000) 174,379 1,744 8,848,256 -- --
Stock issued to consultant .. -- -- 1,549 16 5,984 -- 6,000
Issuance of Common Stock and
warrants -- -- 4,214,820 42,148 7,461,415 -- 7,503,563
Exercise of Common Stock
warrants -- -- 2,245 22 5,366 -- 5,388
Net loss -- -- -- -- -- (5,264,462) (5,264,462)
--------- ------------ ------------ --------- ----------- ------------ ------------
BALANCE AT DECEMBER 31, 1999 519,400 $ 28,100,250 6,572,135 $ 65,721 $54,470,252 $(75,079,275) $ 7,556,948
========= ============ ============ ========= =========== ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1997 1998 1999
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (9,539,061) $ (8,845,367) $ (5,264,462)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 1,255,622 1,243,100 1,015,754
Issuance of stock for services -- 6,751 6,000
Research and development expense recorded for
warrant issuance -- 404,500 --
Net loss on disposal of fixed assets -- 33,855 139,641
Changes in assets and liabilities: --
Decrease (increase) in prepaid expenses and
other current assets (27,373) 501,385 369,472
Decrease in notes receivable 6,683 -- --
Increase (decrease) in accounts payable and
accrued liabilities 327,091 (351,001) (186,523)
Decrease in deferred revenue (13,500) -- --
----------- ------------ ------------
Net cash used in operating activities (7,990,538) (7,006,777) (3,920,118)
----------- ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (682,017) (208,691) (152,157)
Patent expenditures (231,736) (290,496) (164,282)
Sale of fixed assets -- -- 14,263
Sale (purchase) of investments held to maturity 5,198,305 693,279 (3,445,199)
----------- ------------ ------------
Net cash provided by (used in ) investing activities 4,284,552 194,092 (3,747,375)
----------- ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on note payable (252,443) (91,993) (126,613)
Payments on capital lease obligations (8,076) (3,556) --
Proceeds from Series B Preferred Stock, net 10,171,120 -- --
Proceeds from exercise of stock options and warrants 350,691 42,353 5,388
Issuance of common stock and warrants -- -- 7,503,563
----------- ------------ ------------
Net cash provided by (used in) financing activities 10,261,292 (53,196) 7,382,338
----------- ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 6,555,306 (6,865,881) (285,155)
----------- ------------ ------------
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 3,106,004 9,661,310 2,795,429
----------- ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 9,661,310 $ 2,795,429 $ 2,510,274
=========== ============ ============
SUPPLEMENTAL INFORMATION OF NONCASH FINANCING
ACTIVITIES:
Outstanding note payable for prepaid insurance $ 218,606 $ 126,613 $ --
=========== ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
ENERGY BIOSYSTEMS CORPORATION
1. DESCRIPTION OF THE COMPANY
Energy BioSystems Corporation ("EBC") was incorporated in the State of
Delaware on December 20, 1989, and commenced operations in January 1990. EBC is
a biotechnology company that is applying state-of-the-art directed evolution
techniques to accelerate development and commercialization of biocatalyst-based
processes for petroleum refining and petrochemicals production. EBC's primary
focus to date has been development of biocatalytic desulfurization ("BDS"), a
proprietary process involving the use of enzymes in bacteria to remove sulfur
from petroleum. Removal of sulfur is one of the most costly issues facing the
petroleum industry and is severely limited in viable economic and environmental
options. Sulfur removal is desirable because of (i) environmental regulations
mandating decreased sulfur in refined products, (ii) an increasing level of
sulfur in crude oil processed by refiners and (iii) high construction,
operating, and maintenance costs associated with the existence of sulfur in
petroleum.
Recently, EBC has discovered that its proprietary biocatalytic technology
may also provide an economic basis for production of a broad family of
industrial organosulfur chemicals with potential uses in detergent, surfactant,
polymer and adhesive markets. In 1999, the organosulfur product was prepared on
a multi-kilogram scale in pilot units at EBC's Woodlands facility, and prototype
surfactant products were prepared for testing. Joint development and testing
agreements were executed with major chemical companies for detailed evaluation
of these products in specific commercial applications, and EBC is a pursuing
strategic business alliances for commercialization of this technology.
In 1999, a program was implemented to rapidly screen mutant strains for
improved performance, and a proprietary directed evolution platform with gene
shuffling was conceived, designed and implemented to increase the diversity of
strains that are tested. EBC believes that this strategy will greatly accelerate
the development of the BDS commercial biocatalyst. EBC also believes that many
applications exist for its technology in gene-shuffling and bioprocessing.
EBC has devoted substantially all of its efforts to research and
development. There have been no revenues from operations other than sponsored
research revenues and one site license fee in 1998 and there is no assurance of
future revenues. During 1999, EBC used $3,917,293 in cash for operating
activities. As of December 31, 1999, EBC had $5,955,473 in cash, cash
equivalents and short term investments and $507,150 in liabilities. EBC has a
cumulative loss since inception of approximately $75 million and expects that it
can conserve its existing financial resources to fund operations through
mid-2001. EBC may seek additional financing through various alternatives that
include: an equity financing, government funding and alliances with chemical
companies and corporate partners. Adequate funds for these purposes, whether
obtained through financial markets or collaborative or other arrangements with
corporate partners or from other resources, may not be available when needed or
on terms acceptable to EBC. EBC's inability to raise funds when needed may
require EBC to delay, scale back or eliminate some or all of its research and
product development programs.
EBC's BDS process will require substantial additional research, development
and testing in order to determine its commercial viability. EBC has proven its
BDS technology only to a limited extent in laboratory, bench-scale and pilot
plant trials, which is not yet sufficient for full commercialization. If EBC
successfully field tests its BDS technology, the commercialization of the BDS
technology will require significant additional time and expenditures. The
commercialization of the technology will depend on, among other things, EBC's
success in achieving improvement of its biocatalyst and success in developing
fermentation processes, as well as EBC's ability to manufacture or contract for
the manufacture of sufficient biocatalyst for use in commercial BDS units; to
apply process engineering to design bioreactor systems capable of accomplishing
the BDS process on a commercial scale; and to market its BDS systems
effectively. The accomplishment of some or all of these objectives may be
delayed or may never occur. EBC will require additional capital to continue the
development and commercialization of its
F-6
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
BDS technology, and there can be no assurance that such capital will be
available or that EBC will be able to successfully commercialize its BDS
technology.
2. ACCOUNTING POLICIES
CASH, CASH EQUIVALENTS AND SHORT TERM INVESTMENTS
EBC considers short term investments with original maturities of 90 days
or less to be cash equivalents. Debt and equity securities that EBC has the
intent and ability to hold to maturity are classified as "held to maturity"
and reported at amortized cost which approximates fair value. Debt and equity
securities that are held for current resale are classified as "trading
securities" and reported at fair value with unrealized gains and losses
included in earnings. Debt and equity securities not classified as either
"held to maturity" or "trading securities" are classified as "securities
available for sale" and reported at fair value, with unrealized gains and
losses excluded from earnings and reported as a separate component of
stockholders' equity. At December 31, 1999, short term investments consist
entirely of held-to-maturity securities.
At December 31, 1998 and 1999, EBC held cash and cash equivalents in excess
of the federally insured amounts.
FURNITURE, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Furniture and equipment consists of office furniture and equipment,
computers and laboratory equipment and are carried at cost which approximates
fair value. Depreciation is calculated on the straight-line method using a
five-year estimated useful life. Leasehold improvements are amortized on the
straight-line method over the term of the lease or the useful life of the
assets, whichever is shorter.
Maintenance and repairs that do not improve or extend the life of assets
and expenditures for research and development equipment for which there is no
future alternative use are expensed as incurred. Expenditures which improve or
extend the life of assets are capitalized.
INTANGIBLE AND OTHER ASSETS
Intangible and other assets mainly consist of patent costs, which are
primarily legal fees. These costs are being amortized over 15 years. Accumulated
amortization at December 31, 1998 and 1999, amounted to $417,104 and $684,997,
respectively.
REVENUE RECOGNITION
Sponsored research revenue is recognized based on the percentage of
total research payments to be received in relation to the total research and
development costs to be incurred under the specific research agreements. In
December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin 101, "Revenue Recognition in Financial Statements" ("SAB
101") which provides guidance related to revenue recognition based on
interpretations and practices followed by the SEC. SAB 101 is effective for
fiscal years beginning after December 15, 1999 and requires companies to
report any changes in revenue recognition as a cumulative change in
accounting principle at the time of implementation. EBC is currently in the
process of evaluating what impact, if any, SAB 101 will have on its financial
position or its results of operations.
RESEARCH AND DEVELOPMENT
F-7
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
All research and development costs, both generated internally and from
research and development contracts, are expensed as incurred. EBC allocates
certain indirect costs to research and development expenses which consist
primarily of overhead related to the administration of research and
development activities.
NET LOSS PER COMMON SHARE
Net loss per common share has been computed by dividing the net loss, which
has been increased for periodic accretion and accrued dividends on the Series A
Convertible Preferred Stock and Series B Convertible Preferred Stock issued in
October 1994 and February 1997, respectively, by the weighted average number of
shares of Common Stock outstanding during the periods. In all applicable years,
common stock equivalents were antidilutive and, accordingly, were not included
in the computation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenue and
expenses and the disclosure of contingent assets and liabilities during the
reporting period. Actual results could differ from those estimates.
3. FURNITURE, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
A summary of furniture, equipment and leasehold improvements is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
1998 1999
---- ----
<S> <C> <C>
Office furniture and equipment...................................... $407,976 $344,537
Laboratory equipment................................................ 3,938,885 3,846,187
Computer equipment.................................................. 638,071 640,887
Leasehold improvements.............................................. 1,734,011 1,734,011
Equipment under capital lease....................................... 55,203 -
Automobiles......................................................... 23,670 23,670
------ ------
6,797,816 6,589,292
Less--Accumulated depreciation and amortization..................... (5,121,824) (5,662,608)
----------- -----------
$1,675,992 $926,684
========== ========
</TABLE>
4. STOCKHOLDERS' EQUITY
In December 1998, EBC declared a one-for-seven reverse stock split which
was effective December 18, 1998. All references to earnings per share, number of
shares and share amounts prior to December 18, 1998 have been retroactively
restated to reflect the reverse stock split.
SERIES B CONVERTIBLE PREFERRED STOCK
In February and March 1997, EBC sold an aggregate of 224,100 shares of
Series B Convertible Preferred Stock at $50.00 per share in a private placement.
The net proceeds from the offering were approximately $10.2 million. The
placement agent for the Series B Preferred Stock received warrants to purchase
an aggregate of 20,319 shares of Series B Preferred Stock at an exercise price
of $50.00 per share of Series B Preferred Stock in addition to customary
commissions. The warrants have been recorded at an estimated fair value of
$466,000, which was
F-8
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
computed using the Black-Scholes option pricing model and the following
assumptions: risk free interest rate of 6.51 percent; expected dividend yield
of zero; expected life of three years, and an expected volatility of 68
percent.
Dividends on the Series B Preferred Stock are cumulative from February 27,
1997 and payable semi-annually commencing May 1, 1997, at an annual rate equal
to (i) $4.00 per share of Series B Preferred Stock to the extent the dividend is
paid in cash and (ii) $4.50 per share of Series B Preferred Stock to the extent
the dividend is paid in common stock. Dividends on shares of Series B Preferred
Stock are payable in cash or common stock of EBC, or a combination thereof, at
EBC's option. The Company deferred payment of the May 1999 and November 1999
dividends.
Shares of Series B Preferred Stock are convertible into shares of common
stock at a conversion price equal to $50.75 per share, subject to certain
adjustments. The Series B Preferred Stock may be redeemed by EBC under
certain circumstances after February 26, 1999 and is required to be redeemed,
subject to certain limitations, on February 26, 2002 at a redemption price of
$50.00 per share, plus accrued and unpaid dividends, may be paid in shares of
common stock or cash or in a combination of common stock and cash, at the
Company's option. It is the Company's intent, however, to redeem the Series B
Preferred Stock for common stock. Accordingly, the Series B Preferred Stock
is included in stockholders' equity. In April and July 1998, 4,000 shares and
1,700 shares of the Series B Preferred Stock were converted to 3,941 shares
and 1,674 shares of common stock, respectively. In May 1999, 177,000 shares
of Series B Preferred Stock were converted to 174,379 shares of common stock.
Concurrently with the private placement, EBC conducted an exchange offering
and consent solicitation with respect to its outstanding Series A Preferred
Stock, pursuant to which EBC offered to exchange one share of Series B Preferred
Stock for each of its 480,000 outstanding shares of Series A Preferred Stock and
requested the holders of its Series A Preferred Stock consent to the ranking of
the Series B Preferred Stock on a parity with the Series A Preferred Stock with
respect to the payment of dividends and liquidation preference. EBC did not
receive any cash proceeds from the exchange offering. Of the 480,000 shares of
Series A Preferred Stock outstanding, 478,000 shares were exchanged for the same
number of shares of Series B Preferred Stock. In September 1997 the remaining
2,000 shares of Series A Preferred Stock were exchanged for 1,797 shares of
common stock.
The carrying amount of the Series B Preferred Stock is increased for
accrued and unpaid dividends plus periodic accretion, using the effective
interest method, such that the carrying amount will equal the redemption amount
on the Series B Preferred Stock on February 26, 2002. No dividends were paid on
the Series B Preferred Stock in 1999.
COMMON STOCK
In March 1995, EBC adopted a Stockholder Rights Plan (the "Rights Plan") in
which Preferred Stock Purchase Rights (the "Rights") were distributed for each
share of common stock held as of the close of business on March 27, 1995 and are
distributed to each share of common stock issued thereafter until the earlier of
(i) the Distribution Date (as defined in the Rights Plan), (ii) the date Rights
are redeemed or (iii) March 8, 2005. The Rights Plan is designed to deter
coercive takeover tactics and to prevent an acquirer from gaining control of EBC
without offering a fair price to all of EBC's stockholders. The Rights will
expire on March 8, 2005.
Each Right entitles stockholders to buy one-hundredth of a share of a new
series of Junior Preferred Stock of EBC at an exercise price of $50.00 per
one-hundredth of a share. The Rights are exercisable only if a person acquires
beneficial ownership of 20% or more of EBC's outstanding common stock. The
Rights Plan grandfathers certain stockholders who beneficially owned more than
20% of the outstanding shares of EBC's common stock on the effective date of the
Rights Plan from triggering the exercisability of the Rights.
During March 1998, EBC issued a warrant in connection with a license
agreement (see Note 7). The warrant entitles the purchaser to purchase 28,571
shares of common stock at an exercise price of $21.77 per share over a four year
term.
F-9
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The Company completed a private placement of its common stock during
June 1999. The Company sold 2,600,223 and 1,614,597 shares at $1.80 and $2.00
per share, respectively. Those shares sold at $2.00 per share included one
warrant to purchase one share of the Company's common stock for every five
shares purchased in the private placement. Those shares sold at $1.80 per
share included no such warrants. Net proceeds from the offering were
approximately $7.5 million. In connection with the closing, warrants to
purchase 646,623 shares of the Company's common stock were issued at an
exercise price of $2.40. Such number of warrants includes both those warrants
issued to investors, as described above, and warrants issued to the placement
agent, SAMCO Capital Markets, Inc. ("SAMCO"), in partial payment of its fee.
The warrants have been recorded at an estimated fair value of $1,147,358,
which was computed using the Black-Scholes option pricing model and the
following assumptions: risk free interest rate of 6.01 percent; expected
dividend yield of zero; expected life of three years (and with respect to the
warrants issued to the placement agent five years); and an expected
volatility at an average weight of 125 percent.
In 1998 and 1999, the Company paid consultants 1,888 and 1,329 shares of
common stock, respectively, at a fair market value on the date of issuance
between $2.63 and $4.81 per share in 1998 and between $3.00 and $4.38 per
share in 1999.
5. STOCK OPTIONS
In January 1997, EBC's Board of Directors adopted the 1997 Stock Option
Plan (the "1997 Plan"). Under the 1997 Plan, EBC may issue options for and sell
up to 14,285 shares of Common Stock to employees and consultants of EBC. The
options granted under this plan may not have an exercise price per share less
than the fair market value on the date of grant and are limited to a term not to
exceed ten years. In May 1999, the 1997 Plan was amended to increase to
1,200,000 the number of shares available for grant.
EBC maintains a Stock Compensation Plan (the "1992 Plan") which is composed
of non-qualified stock options, incentive stock options, year-end stock bonuses
and restricted and non-restricted stock grants. Under the 1992 Plan, 290,147
shares of common stock are reserved for issuance upon the exercise of stock
options. Under a 1994 Non-Employee Director Option Plan, composed of
non-qualified stock options, 25,000 shares of common stock are reserved for
issuance upon the exercise of stock options. In May 1999, the Non-Employee
Director Option Plan was amended to increase to 200,000 the number of shares
available for grant.
At December 31, 1999, employees had outstanding options to purchase
572,638 shares of common stock pursuant to the 1992 and 1997 Plans.
Additionally, as of December 31, 1999 consultants and directors had
outstanding options to purchase 150,128 shares of common stock that were not
issued under the 1992 or 1997 Plans. Options generally vest over a three-year
period and upon the earlier of the completion of the specified performance
milestones, or over a four year period, or nine years and ten months from the
date of grant. The options expire ten years from the date of grant. The
following table summarizes information about fixed-price stock options
outstanding at December 31, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------- -------------------
WEIGHTED
AVERAGE
REMAINING WEIGHTED WEIGHTED
RANGE OF OUTSTANDING CONTRACTUAL LIFE AVERAGE EXERCISABLE AVERAGE
EXERCISE PRICES SHARES (IN YEARS) EXERCISE PRICE SHARES EXERCISE PRICE
- --------------- ------ ---------- -------------- ------ --------------
<S> <C> <C> <C> <C> <C>
$ 2.06 - $ 5.25 479,644 9.0 $2.28 63,232 $3.38
$ 9.63 - $34.38 56,212 7.5 $24.28 37,088 $23.34
$40.25 - $84.00 32,541 5.0 $56.95 20,657 $59.24
</TABLE>
F-10
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
EBC accounts for its stock options under APB Opinion No. 25 under which no
compensation cost has been recognized. EBC records deferred compensation for the
difference between the exercise price and the fair market value on the
measurement date. During 1997, 1998 and 1999, EBC issued all options at fair
market value. Had compensation cost for these options been determined consistent
with SFAS. 123, EBC's net loss and loss per share would have been increased to
the following pro forma amounts:
<TABLE>
<CAPTION>
1997 1998 1999
---- ---- ----
<S> <C> <C> <C> <C>
Net Loss: As Reported $(9,539,061) $(8,845,367) $(5,264,462)
----------- ------------ ------------
Pro Forma (10,180,316) (10,183,481) (8,562,311)
----------- ------------ ------------
Net Loss Per Common
Share: As Reported $(7.64) $(5.20) $(1.78)
----------- ------------ ------------
Pro Forma (8.02) (5.43) (1.85)
----------- ------------ ------------
</TABLE>
Because the SFAS 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the resulting pro forma compensation cost may
not be representative of that expected in future years. A summary of the status
of EBC's stock options at December 31, 1997, 1998 and 1999, and changes during
the years then ended is presented in the table and narrative below:
<TABLE>
<CAPTION>
1992 AND 1997 PLANS OPTIONS NOT ISSUED UNDER PLAN
------------------- -----------------------------
NUMBER WEIGHTED AVG. NUMBER WEIGHTED AVG.
OF OPTIONS EXERCISE PRICE OF OPTIONS EXERCISE PRICE
---------- -------------- ---------- --------------
<S> <C> <C> <C> <C>
Balance at December 31, 1996 ... 233,948 $33.18 45,450 $21.14
Granted ..................... 46,194 63.83 -- --
Exercised ................... (28,829) 11.13 (9,833) 3.01
Forfeited ................... (20,284) 36.47 -- --
-------- --------
Balance at December 31, 1997 ... 231,029 35.84 35,617 26.11
-------- --------
Granted ..................... 49,956 18.52 -- --
Exercised ................... (4,286) 9.94 -- --
Forfeited ................... (110,118) 35.99 -- --
-------- --------
Balance at December 31, 1998 ... 166,581 31.21 35,617 26.11
-------- --------
Granted ..................... 453,200 2.11 -- --
Exercised ................... -- -- -- --
Forfeited ................... (51,384) 36.05 -- --
-------- --------
Balance at December 31, 1999 ... 568,397 7.80 35,617 26.11
======== ========
Exercisable at December 31, 1997 100,283 $34.79 35,617 $26.11
Exercisable at December 31, 1998 97,158 $27.86 35,617 $26.11
Exercisable at December 31, 1999 120,977 $19.04 35,617 $26.11
</TABLE>
The weighted average fair value of the options issued under the 1992 and
1997 Plans for the years ended December 31, 1997, 1998 and 1999 was $27.65,
$9.09 and $1.92, respectively.
During the years ended December 31, 1997, 1998 and 1999, EBC granted 4,000,
17,714 and 83,100 options respectively, under the Non-Employee Director Option
Plan. These options are fully vested upon issuance. The weighted average
exercise price per share on these grants was $32.41, $13.15 and $2.29,
respectively. As of December 31, 1997, 1998 and 1999, EBC had 13,714, 67,045 and
150,128 options exercisable, respectively, under this plan with weighted average
exercise price of $43.54, $26.26 and $12.99, respectively. The weighted average
fair market value of the options issued under this plan during the years ended
December 31, 1997, 1998 and 1999 was $32.41, $7.13 and $1.89, respectively.
F-11
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The fair market value of each option grant is estimated on the date of
grant using the Black-Scholes option pricing model with the following
weighted-average assumptions used for grants in 1997, 1998 and 1999,
respectively: risk-free interest rates of 6.5, 5.8 and 6.4 percent for all the
Plans; expected dividend yields of zero for all the Plans; expected lives of
nine years and ten months for all options; and expected volatility of 69.6, 71.4
and 100.8 percent for all the Plans.
6. FEDERAL INCOME TAXES
EBC has had losses since inception and, therefore, has not been subject
to federal income taxes. As of December 31, 1999, EBC had accumulated net
operating loss ("NOL") and research and development tax credit carryforwards
for income tax purposes of approximately $62,949,723 and $1,707,190,
respectively. These carryforwards begin to expire in 2005. The Tax Reform Act
of 1986 provided for an annual limitation on the use of NOL and tax credit
carryforwards following certain ownership changes that limit EBC's ability to
utilize these carryforwards. In April 1991 and October 1994, EBC underwent a
"more than 50 percent change in ownership" as defined by Internal Revenue
Code Section 382. Additionally, because U.S. tax laws limit the time during
which NOL and tax credit carryforwards may be applied against future taxable
income and tax liabilities, EBC may not be able to take full advantage of its
NOL and tax credits for federal income tax purposes.
Significant components of EBC's net deferred tax asset at December 31, 1998
and 1999 are as follows:
<TABLE>
<CAPTION>
1998 1999
------------- -------------
<S> <C> <C>
DEFERRED TAX ASSETS RELATING TO:
Federal net operating loss carryforwards......................... $ 19,747,000 $ 21,402,906
Research and development credit carryovers....................... 1,800,821 1,707,190
Capital and Texas business loss carryforwards.................... 830,791 950,282
Book/tax differences on depreciable, amortizable and other
assets and accrued liabilities........................... 65,024 175,573
Deferred revenue and unrealized gains 61,200 61,200
Deferred tax valuation allowance................................. (22,504,836) (24,297,151)
Net deferred tax asset........................................... $ -- $ --
============= =============
</TABLE>
Beginning January 1, 1993, EBC adopted SFAS 109 which requires recognition
of deferred tax liabilities and assets for the expected future tax consequences
of events that have been recognized in the financial statements or tax returns.
Since EBC has had a net operating loss carry forward since inception and there
is no assurance of future taxable income, a valuation allowance has been
established to fully offset the deferred tax assets.
7. LICENSE AND RESEARCH AGREEMENTS
To finance its research and development budgets, EBC intends to seek
additional collaborative research and development agreements with corporate
partners.
In March 1998, EBC entered into a site license agreement with Petro Star
Inc. ("Petro Star") regarding the design and installation of a BDS unit at Petro
Star's Valdez, Alaska refinery. The agreement involves several stages of work,
the first of which, involving the completion of scoping economics, is completed.
In addition, the agreement provides EBC with certain rights to conduct
development work and demonstrations of its BDS technology at Petro Star's
refinery. The agreement calls for the payment of staged license fees and
royalties to EBC, including a $200,000 initial site license fee upon execution
of the agreement. As is customary in such arrangements in the petroleum refining
industry, the agreement provides certain approval and termination rights to
F-12
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Petro Star at the completion of each stage prior to commercialization. In
connection with the execution of the agreement, EBC issued a four-year warrant
entitling Petro Star to purchase 28,571 shares of EBC Common Stock at an
exercise price of $21.77 per share. The warrant was recorded as research and
development expense at an estimated fair value of $404,500, which was computed
using the Black-Scholes option pricing model. The successful implementation of a
commercial BDS unit will be dependent upon EBC's ability to achieve additional
improvements in the productivity of the biocatalyst (e.g., reaction rates,
specificity and stability) and process technology (e.g., bioreactor and
separations technology).
In August 1997, EBC was awarded funding by the U.S. Department of Energy
("DOE") for a $2.4 million, three-year program dedicated to the development of a
BDS application for gasoline. Through December 31, 1999, EBC had recognized
$1,992,981 in sponsored research revenue from the grant.
EBC signed an agreement with Kellogg, Brown and Root ("Kellogg") in August
1994, to collaborate on the development and commercialization of EBC's
biocatalytic desulfurization ("BDS") technology. Under the collaboration,
Kellogg will serve as an engineering partner to EBC during completion of the BDS
development process and will be the exclusive provider of the basic engineering
design services required for the commercial units. In return for these services,
Kellogg will receive a portion of the site license fee generated by the sale of
BDS units. The collaboration has a minimum term of at least five years or the
completion of 20 BDS units, whichever is longer, and has applications to all
biorefining technologies EBC develops. During the first phase of the
collaboration, Kellogg provided up to 500 engineering work hours of service at
no cost to EBC. Kellogg has also agreed to provide an additional 1,500 work
hours per year of service at Kellogg offices at reduced rates.
In July 1994, EBC entered into an agreement with TOTALFINA ("Total") to
collaborate on the application of EBC's biodesulfurization process to diesel
fuel streams. Following the evaluation of results from EBC's domestic pilot
operation, it is anticipated that Total will build and operate at Total's
expense a pilot BDS unit at Total's European Centre for Research and Technology.
Upon successful economic trials of the pilot unit, Total plans to build the
first commercial BDS unit at one of its refineries. EBC and Total will each bear
their own costs and expenses incurred under the collaboration. In addition, as
part of its obligations under the agreement, Total will provide EBC with the use
of analytical equipment valued at approximately $200,000. The Total agreement
provides that upon commercialization, the site licenses will be waived on
Total's first commercial BDS unit. In addition, Total will be entitled to
receive a ten percent (10%) discount on future site licenses and service fees
until it has recovered two and one-half times its research cost and expenses for
BDS projects under the agreement.
In December 1993, EBC entered into an alliance with Koch Refining Company
("Koch") to facilitate the development of BDS technology in crude oil. Under the
terms of the alliance, EBC will be primarily responsible for improving the
performance of the biocatalyst used in the desulfurization process. Koch will be
primarily responsible for selecting and improving the target oil stream as well
as testing desulfurized product quality. Koch will also provide engineering
support as needed in the development of a BDS unit for Koch's operation. EBC and
Koch will each bear their own costs and expenses incurred in connection with the
collaboration. Repayment will be in the form of a ten percent (10%) rebate on
desulfurization processing fees charged to Koch until Koch has been repaid their
contribution of BDS development costs.
In July 1993, EBC entered into an agreement with the Texaco Group, Inc.
("Texaco") to facilitate the development of EBC's BDS technology in crude oil.
Under the terms of the alliance, EBC will be primarily responsible for improving
the performance of the biocatalyst used in the desulfurization process. Texaco
will be
F-13
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
primarily responsible for field operations and analytical chemistry work
with respect to the application of EBC's BDS technology to crude oil. EBC and
Texaco will each bear their own costs and expenses incurred in connection with
the collaboration. In the event EBC sub-licenses Texaco's intellectual and
proprietary information, licensed by agreement to EBC by Texaco, EBC shall pay
Texaco an amount equal to ten percent (10%) of the desulfurization processing
fee charged to Texaco until such time as EBC has paid Texaco an aggregate amount
equal to two and one-half times the aggregate amount of Texaco's direct costs
and expenses incurred in connection with the collaboration.
EBC has also entered into other contracts with various institutions for
research and development. The amounts paid under these agreements totaled
$85,000, $25,000 and zero for the years ended December 31, 1997, 1998 and 1999,
respectively. EBC has no commitments to pay these institutions after December
31, 1998.
In March 1992, EBC entered into a collaborative agreement with Petrolite
Corporation ("Petrolite") to commercialize EBC's BDS technology. On March 27,
1998 EBC elected to terminate the agreement as of March 27,1999.
In December 1994, EBC was awarded a $2 million federal grant under the
Advanced Technology Programs administered by the National Institute of Standards
and Technology ("NIST"). The three-year program funded by this grant is
dedicated to the development of a biotechnology-based method of removing sulfur
from crude oil. Through January 31, 1998, EBC has recognized $1,977,366 in
sponsored research revenue relating to this grant.
8. COMMITMENTS AND CONTINGENCIES
EBC maintains a Simplified Employee Pension Plan (the "Plan") for all
employees. Under the terms of the Plan, employees are eligible to participate
after completion of six months of service. EBC contributes an amount equal to 8%
of the employees' annual compensation to the Plan. Employees are vested
immediately and there is at present no employee contribution. Total expenses
under the Plan were approximately $316,000, $284,000 and $195,000 for the years
ended December 31, 1997, 1998 and 1999, respectively.
EBC maintains an operating lease agreement for its headquarters, which
expires in 2003.
F-14
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Future minimum payments under the non-cancelable operating lease consist of
the following at December 31, 1999:
<TABLE>
<CAPTION>
FISCAL YEAR OPERATING
----------- ---------
<S> <C>
2000 .............................. 404,141
2001 .............................. 409,617
2002 .............................. 436,998
2003 .............................. 364,165
----------
Total minimum lease payments $1,614,921
==========
</TABLE>
EBC incurred rent expense of $395,070, $399,724 and $382,829 during 1997,
1998 and 1999, respectively.
9. RELATED-PARTY TRANSACTIONS
EBC paid consulting fees to certain stockholders and directors totaling $
13,700, $35,000 and $6,000 during the years ended December 31, 1997, 1998 and
1999, respectively.
F-15
<PAGE>
ENERGY BIOSYSTEMS CORPORATION EXHIBIT 11.1
BASIC AND DILUTED EARNINGS PER SHARE COMPUTATION
YEAR ENDED DECEMBER 31, 1997
WEIGHTED AVERAGE SHARES OUTSTANDING:
<TABLE>
<CAPTION>
TOTAL # DAYS
SHARES OUTSTANDING
- ---------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
11,497,135 x 15 = 172,457,025
11,502,135 x 1 = 11,502,135
11,502,235 x 7 = 80,515,645
11,502,395 x 18 = 207,043,110
11,505,395 x 8 = 92,043,160
11,506,053 x 13 = 149,578,689
11,507,163 x 6 = 69,042,978
11,605,377 x 52 = 603,479,604
11,712,758 x 63 = 737,903,754
11,763,593 x 20 = 235,271,860
11,764,343 x 36 = 423,516,348
11,765,343 x 8 = 94,122,744
11,777,924 x 24 = 282,670,176
11,778,204 x 1 = 11,778,204
11,780,704 x 15 = 176,710,560
11,896,470 x 1 = 11,896,470
11,896,670 x 4 = 47,586,680
11,899,670 x 9 = 107,097,030
11,935,951 x 6 = 71,615,706
12,201,434 x 4 = 48,805,736
12,218,434 x 11 = 134,402,774
12,251,434 x 43 = 526,811,662
------------- -----------------
365 = 4,295,852,050
4,295,852,050 / 365 = 11,769,458
============
LOSS PER
SHARE:
Net Loss plus dividend accrual
plus accretion of offering costs ($12,849,466) = ($7.64)
- --------------------------------- ------------------- ============
Weighted Avg. Shares 1,681,351
</TABLE>
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
BASIC AND DILUTED EARNINGS PER SHARE COMPUTATION
YEAR ENDED DECEMBER 31, 1998
WEIGHTED AVERAGE SHARES
OUTSTANDING:
<TABLE>
<CAPTION>
TOTAL # DAYS
SHARES OUTSTANDING
- ------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
12,251,434 x 119 = 1,457,920,646
12,281,591 x 1 = 12,281,591
12,970,109 x 40 = 518,804,360
12,995,109 x 50 = 649,755,450
13,006,833 x 6 = 78,040,998
13,011,833 x 88 = 1,145,041,304
15,241,169 x 48 = 731,576,112
------------- ---------------
352 4,593,420,461
1:7 Reverse split 656,202,923
2,177,254 x 3 = 6,531,762
2,179,142 x 10 = 21,791,420
------------- ------------
365 684,526,105 / 365 = 1,875,414
============= ============ =========
LOSS PER SHARE:
Net loss plus dividend accrual
plus accretion of offering costs $ (9,761,067) = $ (5.20)
-------------------------------- -------------- ========
Weighted Avg. Shares 1,875,414
</TABLE>
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
BASIC AND DILUTED EARNINGS PER SHARE COMPUTATION
YEAR ENDED DECEMBER 31, 1999
Weighted Average Shares Outstanding:
<TABLE>
<CAPTION>
TOTAL # DAYS
SHARES OUTSTANDING
<S> <C> <C> <C> <C> <C> <C> <C>
2,179,124 x 19 = 41,403,356
2,179,713 x 30 = 65,391,390
2,180,358 x 20 = 43,607,160
2,180,691 x 54 = 117,757,314
2,182,661 x 3 = 6,547,983
2,315,663 x 13 = 30,103,619
2,328,667 x 7 = 16,300,669
2,355,070 x 15 = 35,326,050
6,150,401 x 11 = 67,654,411
6,569,890 x 178 = 1,169,440,420
6,572,135 x 15 = 98,582,025
------------- ----------------
365 1,692,114,397
============= ================
1,692,114,397 /365 = 4,635,930
=========
Loss Per Share:
Net Loss plus dividend accrual
plus accretion of offering costs $ (8,259,546) = $ (1.78)
- --------------------------------- -------------- =========
Weighted Avg. Shares 4,635,930
</TABLE>
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of
our report included in this Form 10-K, into the Company's previously filed
Registration Statements on Form S-8 dated September 9, 1993 and September 13,
1993 and Form S-3 dated February 13, 1995.
/s/ Arthur Andersen LLP
Houston, Texas
March 30, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS INCLUDED IN THE REGISTRANT'S ANNUAL REPORT ON FORM 10-K FOR
THE YEAR ENDED DECEMBER 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 2,510,274
<SECURITIES> 3,445,199
<RECEIVABLES> 11,668
<ALLOWANCES> 0
<INVENTORY> 11,937
<CURRENT-ASSETS> 6,238,508
<PP&E> 6,589,292
<DEPRECIATION> 5,662,608
<TOTAL-ASSETS> 8,064,098
<CURRENT-LIABILITIES> 507,150
<BONDS> 0
0
28,100,250
<COMMON> 65,721
<OTHER-SE> 54,470,252
<TOTAL-LIABILITY-AND-EQUITY> 8,064,098
<SALES> 0
<TOTAL-REVENUES> 1,628,635
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 6,753,456
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (5,264,462)
<INCOME-TAX> 0
<INCOME-CONTINUING> (5,264,462)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (5,264,462)
<EPS-BASIC> (1.78)
<EPS-DILUTED> (1.78)
</TABLE>
