UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 1999
|_| TRANSITION REPORT PURSUANT SECTION 13 OR 15 (d)
OF SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From ______to_________
Commission File Number 333-13287
EARTHSHELL CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 77-0322379
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
111 S. CALVERT ST. SUITE 1950, BALTIMORE, MARYLAND 21202
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (410) 949-1300
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 |_|
The number of shares outstanding of the registrant's common stock as of
August 10, 1999 was 100,045,166.
<PAGE>
<TABLE>
<CAPTION>
EARTHSHELL CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 1999
INDEX
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements .............................................. Page
a) Balance Sheets
as of June 30, 1999 and December 31, 1998 (unaudited) .......... 1
b) Statements of Operations
for the three and six months ended June 30, 1999 and 1998
(unaudited) and for the period from November 1, 1992 (inception)
through June 30, 1999 (unaudited) .............................. 2
c) Statements of Stockholders' Equity (Deficit)for the period
from November 1, 1992 (inception) to December 31, 1998 and
the six months ended June 30, 1999 (unaudited) ................. 3
d) Statements of Cash Flows
for the six months ended June 30, 1999 and 1998 (unaudited)
and for the period from November 1, 1992 (inception)
through June 30, 1999 (unaudited) .............................. 4
e) Notes to Financial Statements (unaudited) ...................... 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ............................... 7
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ................................................. 13
Item 2. Use of Proceeds ................................................... 13
Item 4. Submission of Matters to a Vote for Security Holders .............. 13
Item 5. Other Information ................................................. 14
Item 6. Exhibits and Reports on Form 8-K .................................. 14
SIGNATURE ................................................................... 15
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EARTHSHELL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
BALANCE SHEETS
(UNAUDITED)
JUNE 30, DECEMBER 31,
------------------------------
1999 1998
------------- -------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ....................... $ 61,528,453 $ 86,590,163
Restricted cash ................................. 3,500,000 3,500,000
Short-term investments .......................... -- 6,530,928
Other assets .................................... 398,185 1,196,373
------------- -------------
Total current assets ......................... 65,426,638 97,817,464
PROPERTY AND EQUIPMENT, NET .......................... 48,068,309 37,820,917
------------- -------------
TOTAL ................................................ $ 113,494,947 $ 135,638,381
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses .......... $ 7,253,142 $ 9,559,437
Trade payable to majority stockholder .......... 989,500 1,181,300
Note payable to bank ........................... -- 22,975
------------- -------------
Total current liabilities ................... 8,242,642 10,763,712
------------- -------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value,200,000,000 shares
authorized; 100,045,166 issued and outstanding
as of June 30, 1999 and
December 31,1998 ............................... 1,000,451 1,000,451
Additional paid-in common capital .............. 225,555,255 224,715,255
Deficit accumulated during the development stage (121,303,401) (100,841,037)
------------- -------------
Total stockholders' equity .................. 105,252,305 124,874,669
------------- -------------
TOTAL ................................................ $ 113,494,947 $ 135,638,381
============= =============
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EARTHSHELL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF OPERATIONS
(UNAUDITED)
FOR THE THREE MONTHS FOR THE SIX MONTHS NOVEMBER 1, 1992
ENDED JUNE 30, ENDED JUNE 30, (INCEPTION) THROUGH
------------------------------ ------------------------------ JUNE 30, 1999
1999 1998 1999 1998 -------------------
---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
EXPENSES:
Related party research and development .. $ 2,957,725 $ 2,044,706 $ 5,358,035 $ 3,804,372 $ 51,965,512
Other research and development .......... 4,026,548 3,653,482 7,328,453 4,303,897 23,103,218
Related party general and administrative
expenses ............................. 96,188 16,800 112,988 33,600 1,981,788
Other general and administrative expenses 4,696,307 1,629,551 7,698,163 2,133,197 32,505,023
Depreciation and amortization ........... 1,464,293 194,000 1,727,951 388,125 4,868,005
Related party patent expenses ........... 26,273 26,712 328,021 85,101 8,014,297
------------- ------------- ------------- ------------- -------------
Total expenses ....................... 13,267,334 7,565,251 22,553,611 10,748,292 122,437,843
Interest income ............................ (1,065,004) (1,893,383) (2,092,047) (1,943,493) (7,699,512)
Related party interest expense ............. -- -- -- 651,587 4,770,731
Other interest expense ..................... -- 565 -- 383,729 1,788,738
------------- ------------- ------------- ------------- -------------
Loss Before Income Taxes ................... 12,202,330 5,672,433 20,461,564 9,840,115 121,297,800
Income Taxes ............................... -- -- 800 800 5,600
------------- ------------- ------------- ------------- -------------
Net Loss ................................... 12,202,330 5,672,433 20,462,364 9,840,915 121,303,400
Preferred Dividends ........................ -- -- -- -- 9,926,703
------------- ------------- ------------- ------------- -------------
Net Loss Available To Common Stockholders .. $ 12,202,330 $ 5,672,433 20,462,364 9,840,915 131,230,103
============= ============= ============= ============= =============
Basic And Diluted Loss Per Common Share .... $ 0.12 $ 0.06 0.20 0.11 $ 1.53
Weighted Average Number Of Common Shares ... 100,045,166 98,831,320 100,045,166 91,325,981 85,814,568
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EARTHSHELL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(UNAUDITED)
CUMULATIVE
CONVERTIBLE ADDITIONAL
PREFERRED STOCK PAID-IN COMMON STOCK
SERIES A PREFERRED ------------
--------
SHARES AMOUNT CAPITAL SHARES AMOUNT
------------------------------ ------------- -----------------------------
<S> <C> <C> <C> <C> <C>
ISSUANCE OF COMMON STOCK
AT INCEPTION ........................ $ -- $ -- $ -- $ 82,530,000 $ 3,150
Sale of preferred stock, net ........ 6,988,850 $ 267 $ 24,472,734 -- --
Net loss ............................ -- -- -- -- --
------------- ------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 1993 .......... 6,988,850 267 24,472,734 82,530,000 3,150
Net loss ............................ -- -- -- -- --
------------- ------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 1994 .......... 6,988,850 267 24,472,734 82,530,000 3,150
Contribution to equity .............. -- -- -- -- --
Net loss ............................ -- -- -- -- --
------------- ------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 1995 .......... 6,988,850 267 24,472,734 82,530,000 3,150
Contribution to equity .............. -- -- -- -- --
Issuance of stock warrants .......... -- -- -- -- --
Net loss ............................ -- -- -- -- --
------------- ------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 1996 .......... 6,988,850 267 24,472,734 82,530,000 3,150
Compensation related to Stock options
and warrants ........................ -- -- -- -- --
Net loss ............................ -- -- -- -- --
------------- ------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 1997 .......... 6,988,850 267 24,472,734 82,530,000 3,150
262 to 1 stock split ................ -- 69,621 (69,621) -- 822,150
Conversion of preferred stock to
common stock ........................ (6,988,850) (69,888) (24,403,113) 6,988,850 69,888
Issuance of common stock ............ -- -- -- 10,526,316 105,263
Preferred stock dividends ........... -- -- -- -- --
Net loss ............................ -- -- -- -- --
------------- ------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 1998 .......... -- -- -- 100,045,166 1,000,451
Compensation related to stock options -- -- -- -- --
Net loss ............................ -- -- -- -- --
------------- ------------- ------------- ------------- -------------
BALANCE, JUNE 30, 1999 .............. -- $ -- $ -- 100,045,166 $ 1,000,451
============= ============= ============= ============= =============
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EARTHSHELL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(UNAUDITED)
(CONTINUED)
DEFICIT
ADDITIONAL ACCUMULATED
PAID-IN DURING
COMMON DEVELOPMENT
CAPITAL STAGE TOTAL
------- ----- -----
<S> <C> <C> <C>
ISSUANCE OF COMMON STOCK
AT INCEPTION ........................ $ 6,850 $ -- $ 10,000
Sale of preferred stock, net ........ -- -- 24,473,001
Net loss ............................ -- $ (7,782,551) (7,782,551)
------------- ------------- -------------
BALANCE, DECEMBER 31, 1993 .......... 6,850 (7,782,551) 16,700,450
Net loss ............................ -- (16,582,080) (16,582,080)
------------- ------------- -------------
BALANCE, DECEMBER 31, 1994 .......... 6,850 (24,364,631) 118,370
Contribution to equity .............. 1,117,723 -- 1,117,723
Net loss ............................ -- (13,914,194) (13,914,194)
------------- ------------- -------------
BALANCE, DECEMBER 31, 1995 .......... 1,124,573 (38,278,825) (12,678,101)
Contribution to equity .............. 650,000 -- 650,000
Issuance of stock warrants .......... 246,270 -- 246,270
Net loss ............................ -- (16,950,137) (16,950,137)
------------- ------------- -------------
BALANCE, DECEMBER 31, 1996 .......... 2,020,843 (55,228,962) (28,731,968)
Compensation related to Stock options
and warrants ........................ 3,156,659 -- 3,156,659
Net loss ............................ -- (18,992,023) (18,992,023)
------------- ------------- -------------
BALANCE, DECEMBER 31, 1997 .......... 5,177,502 (74,220,985) (44,567,332)
262 to 1 stock split ................ (822,150) -- --
Conversion of preferred stock to
common stock ........................ 24,403,113 -- --
Issuance of common stock ............ 205,883,493 -- 205,988,756
Preferred stock dividends ........... (9,926,703) -- (9,926,703)
Net loss ............................ -- (26,620,052) (26,620,052)
------------- ------------- -------------
BALANCE, DECEMBER 31, 1998 .......... 224,715,255 (100,841,037) 124,874,669
Compensation related to stock options 840,000 -- 840,000
Net loss ............................ -- (20,462,364) (20,462,364)
------------- ------------- -------------
BALANCE, JUNE 30, 1999 .............. $ 225,555,255 $(121,303,401) $ 105,252,305
============= ============= =============
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EARTHSHELL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF CASH FLOWS
(UNAUDITED)
NOVEMBER 1, 1992
FOR THE SIX MONTHS ENDED (INCEPTION)
JUNE 30, THROUGH
1999 1998 JUNE 30, 1999
------------------------------ ---------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ........................................................ $ (20,462,364) $ (9,840,915) $(121,303,400)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization ................................ 1,727,951 388,125 4,868,005
Issuance of stock options to directors, consultant and officer 840,000 -- 4,701,522
Amortization of debt issue costs ............................. -- -- 271,277
Loss on sale or disposal of property and equipment ........... 289,821 -- 3,792,297
Net loss on sale of investments .............................. -- -- 32,496
Accretion of discounts on investments ........................ -- -- (410,084)
Changes in operating assets and liabilities:
Other assets ................................................. 798,188 (427,913) (398,185)
Accounts payable and accrued expenses ........................ (2,329,270) 4,378,679 7,230,164
Payable to majority stockholder .............................. (191,800) (25,476,182) 27,872,713
Accrued interest on notes payable to majority stockholder .... -- (636,068) --
------------- ------------- -------------
Net cash used in operating activities .................... (19,327,474) (31,614,274) (73,343,195)
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of investments ......................................... -- (4,998,698) (43,449,182)
Purchase of restricted time deposit ............................. -- -- (3,500,000)
Proceeds from sales and redemptions of investments .............. 6,530,928 -- 43,826,770
Proceeds from sale of property and equipment .................... -- -- 297,670
Purchase of property and equipment .............................. (12,265,164) (13,217,266) (57,898,016)
------------- ------------- -------------
Net cash used in investing activities ..................... (5,734,236) (18,215,964) (60,722,758)
------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of notes payable to stockholders ......... -- 1,450,000 14,270,000
Proceeds from drawings on line of credit with bank .............. -- 2,150,000 14,000,000
Proceeds from issuance of common stock .......................... -- 221,052,636 221,062,636
Common stock issuance costs ..................................... -- (14,989,831) (15,178,641)
Preferred dividends paid ........................................ -- (9,725,201) (9,926,703)
Proceeds from issuance of preferred stock ....................... -- -- 25,675,000
Preferred stock issuance costs .................................. -- -- (1,201,999)
Repayment of line of credit with bank ........................... -- -- (14,000,000)
Repayment of note payable ....................................... -- (21,824,568) (39,105,887)
------------- ------------- -------------
Net cash provided by financing activities ................. -- 178,113,036 195,594,406
------------- ------------- -------------
(DECREASE) INCREASE IN CASH AND CASH
EQUIVALENTS ..................................................... (25,061,710) 128,282,798 $ 61,528,453
CASH AND CASH EQUIVALENTS, BEGINNING OF
PERIOD .......................................................... 86,590,163 8,437 --
------------- ------------- -------------
CASH AND CASH EQUIVALENTS, END OF
PERIOD .......................................................... $ 61,528,453 $ 128,291,235 $ 61,528,453
============= ============= =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid for:
Income taxes ............................................... $ 800 $ 800 $ 5,600
Interest ................................................... -- $ 1,721,509 $ 3,026,633
Warrants issued with debt ....................................... -- -- $ 306,168
Transfer of property from EKI ................................... -- -- $ 28,745
Conversion of preferred stock to common stock ................... -- $ 57,750 $ 69,888
</TABLE>
<PAGE>
EARTHSHELL CORPORATION
NOTES TO FINANCIAL STATEMENTS (Unaudited)
JUNE 30, 1999
- --------------------------------------------------------------------------------
PRESENTATION OF FINANCIAL INFORMATION
The foregoing interim financial information is unaudited and has been prepared
from the books and records of EarthShell Corporation (the "Company"). In the
opinion of management, the financial information reflects all adjustments
necessary for a fair presentation of the financial condition, results of
operations and cash flows in conformity with generally accepted accounting
principles. All such adjustments were of a normal recurring nature for interim
financial reporting.
The accompanying unaudited financial statements and these notes do not include
certain information and footnote disclosures required by generally accepted
accounting principles, which were included in the Company's financial statements
for the year ended December 31, 1998. The information included in this Form 10-Q
should be read in conjunction with Management's Discussion and Analysis and
financial statements and notes thereto for the year ended December 31, 1998
included in the Company's Annual Report on Form 10-K.
Basic and diluted loss per common share is calculated based on the weighted
average shares outstanding of 100,045,166 for the three months and six months
ended June 30, 1999, and 98,831,320 and 91,325,981 for the three and six months
ended June 30, 1998, respectively. Basic and diluted loss per common share are
the same because common stock equivalents are considered anti-dilutive.
RELATED PARTY TRANSACTIONS
During the three months ended June 30, 1999 and 1998, the Company paid or
accrued $2,957,725 and $2,044,706, respectively, and for the six months ended
June 30, 1999 and 1998, $5,358,035 and $3,804,372, respectively, for services
performed by E. Khashoggi Industries, LLC ("EKI"), the Company's majority
stockholder, under the Amended and Restated Technical Services and Sublease
Agreement effective October 1, 1997, between the Company and EKI. Additionally,
the Company paid EKI $16,800 and $33,600 in sublease payments during each of the
respective three month and six month periods ended June 30, 1999 and 1998.
Pursuant to resolutions adopted by the Board of Directors on February 4, 1999,
the Company reimbursed $79,388 to EKI for salaries and benefits paid by EKI for
administrative support personnel during the six months ended June 30, 1999.
Under the Amended and Restated Agreement for Allocation of Patent Costs
effective October 1, 1997, legal fees related to patents of $26,273 and $26,712
were paid to or on behalf of EKI for the three months ended June 30, 1999 and
1998, respectively, and $328,021 and $85,101 for the six months ended June 30,
1999 and 1998, respectively.
<PAGE>
EARTHSHELL CORPORATION
NOTES TO FINANCIAL STATEMENTS (Unaudited) - continued
JUNE 30, 1999
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PROPERTY AND EQUIPMENT
At June 30, 1999, property and equipment consisted of the following:
<S> <C>
Commercial Manufacturing Equipment: ..................... $ 43,545,803
Product Development Center:
Equipment .......................................... 3,941,668
Construction in progress ........................... 1,396,448
Leasehold improvements ............................. 521,253
------------
5,859,369
Office equipment and furniture .......................... 441,163
Office leasehold improvements ........................... 924,991
Less: accumulated depreciation .......................... (2,703,017)
------------
Property and equipment - net ............................ $ 48,068,309
============
</TABLE>
COMMITMENTS
The Company has committed to capital equipment and infrastructure expenditures
for the Sweetheart Cup Company Inc. manufacturing equipment installation of $3.5
million and $3.6 million, respectively for second generation manufacturing
equipment as of June 30, 1999.
On July 2, 1999, the Company entered into a lease, effective October 1, 1999,
for 34,956 square feet of research and development space in Annapolis Junction,
Maryland. This lease expires on September 30, 2004. The monthly lease payment
with respect to this space is $18,876. EarthShell plans to relocate its
development center in California to this new facility in Maryland.
INVESTMENT IN JOINT VENTURE
On May 24, 1999, the Company entered into a joint venture agreement with
Huhtamaki Oyj to commercialize EARTHSHELL Products throughout Europe, Australia,
New Zealand, and, on a country by country basis, Asia. The agreement provides
for the formation of a Danish holding company for the purpose of establishing
operating companies to manufacture, market, sell and distribute EARTHSHELL
Products.
The Company is required to contribute 63,000 Danish krone as nominal share
capital and 500,000 Euros for start-up capital by December 31, 1999.
Additionally, the Company is required to pay for the development of the initial
prototypes of the second generation manufacturing systems. After both joint
venture partners agree that acceptable second generation manufacturing economics
can be achieved, the joint venture partners will share in the commercialization
costs on an equal basis.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Information contained in this Quarterly Report on Form 10-Q including
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" contain forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995, as amended. These statements may be
identified by the use of forward-looking terminology such as "may," "will,"
"expect," "anticipate," "estimate," or "continue," or the negative thereof or
other comparable terminology. Any one factor or combination of factors could
cause the Company's actual operating performance or financial results to differ
substantially from those anticipated by management that are described herein.
Factors influencing the Company's operating performance and financial results
include, but are not limited to, changes in the general economy, the
availability of financing, governmental regulations concerning, but not limited
to, environmental issues, and other risks and unforeseen circumstances affecting
the Company's business and should be read in conjunction with other factors
discussed in the Company's 1998 Annual Report on Form 10-K.
RESULTS OF OPERATIONS
The Company was organized in November 1992 as a Delaware corporation and
continues to be a development stage enterprise at June 30, 1999. E. Khashoggi
Industries LLC, the Company's principal stockholder, or its predecessors
("EKI"), has been involved since July 1985 in the development of various new
material technologies. The Company was formed to develop, license and
commercialize foodservice disposables made of EarthShell composite material
("EARTHSHELL Products"). The Company has an exclusive, worldwide, royalty-free
license from EKI to use certain technology for this purpose. The Company intends
to continue to license or joint venture with existing manufacturers of
foodservice disposables for the manufacture and distribution of EARTHSHELL
Products. The Company expects to derive revenues primarily from license
royalties and distributions from joint ventures that are licensed to manufacture
EARTHSHELL Products.
The Company has experienced aggregate net losses of approximately $121 million
from its inception on November 1, 1992 through June 30, 1999. The Company has
been unprofitable to date and expects to continue to incur operating losses
until its products are commercially introduced and achieve broad market
acceptance and market penetration. Successful future operations will depend upon
the ability of the Company, its licensees and joint venture partners to
commercialize various types of EARTHSHELL Products at a competitive cost. Prior
to the Company's initial public offering in March 1998, in which the Company
raised net proceeds of $206 million, the Company financed its operations from
inception primarily through the private placement of preferred stock and loans
from EKI and a commercial bank. Since inception, the Company has relied on EKI
to provide extensive management and technical support. The Company and EKI are
parties to an Amended and Restated Technical Services and Sublease Agreement
(the "Technical Services Agreement") which continues through December 31, 2002,
under the terms of which, the Company pays EKI for all direct project labor
hours incurred by EKI technical personnel and direct expenses incurred on
approved projects. In addition, under an Amended and Restated Agreement for the
Allocation of Patent Costs (the "Patent Agreement"), the Company reimburses EKI
for the costs and expenses of filing, prosecuting, acquiring and maintaining
certain patents and patent applications relating to the technology licensed to
the Company under an Amended and Restated License Agreement (the "License
Agreement").
DEVELOPMENT OF FIRST COMMERCIAL MANUFACTURING FACILITY
One of the Company's licensees, Sweetheart Cup Company Inc. ("Sweetheart"), has
secured a contract with Perseco (the primary packaging purchasing agent for
McDonald's Corporation), to supply McDonald's U.S. restaurants with Big Mac(R)
sandwich containers made from EARTHSHELL Products, representing the initial
commercial application of EARTHSHELL Products. To support this initial
commercial application of EARTHSHELL Products, the Company agreed to provide
EarthShell-owned manufacturing equipment to be used at Sweetheart with adequate
capacity to fulfill the Perseco/McDonald's order. The Company has been
successful in moving from a laboratory prototyping activity to the production of
Big Mac(R) containers on commercial equipment. Additionally, the Company has
been successful in the process of sequentially integrating each assembly line
operation and in producing commercially acceptable parts, although to date with
lower than anticipated yields and at a low volume level relative to purchase
order requirements. The Company has introduced commercially viable Big Mac(R)
containers in a limited market, the initial results of which have been
encouraging. The Company expects to achieve a full U.S. national rollout of the
Big Mac(R) container during the year 2000.
The development and installation of the Company's equipment lines at
Sweetheart's Owings Mills, Maryland facility has been the Company's major focus
since Sweetheart secured the Perseco supply agreement for Big Mac(R) sandwich
containers in October 1997. Because the Owings Mills facility is the Company's
first commercial effort at implementation of the EarthShell technology, the
Company believes that the cost incurred on the manufacturing lines in this
facility will be significantly higher than the cost of manufacturing lines in
subsequent facilities.
At March 31, 1999, the Company estimated the capitalized cost of the
manufacturing lines at approximately $43.9 million upon completion, and the
Company expected to expense approximately $9.1 million of process development,
design and engineering costs related to these lines. In addition, the Company
expected to incur approximately $6.4 million in start-up and debugging expense
associated with preparing these lines for full-scale production. The total
project cost for this facility was therefore estimated to be approximately $59
million.
The Company has recently determined that it will be necessary to replace
portions of the material handling and conveying systems and enable the second
mixer for the initial manufacturing lines. The Company believes it is likely to
require additional forming and coating equipment so that sufficient
manufacturing capacity is in place to assure a timely introduction of the Big
Mac(R) container for all U.S. restaurants. With the changes and additions the
Company believes the estimated capitalized cost of these lines would be
approximately $59.6 million upon completion. The Company expects to expense
approximately $11.1 million of process development, design and engineering
costs. The Company expects to incur approximately $8.7 million in start-up and
debugging expense associated with preparing the Sweetheart facility for
full-scale production. The total project cost for this facility is therefore
estimated to be approximately $79 million. Prior to making a final determination
to add additional forming and coating equipment, the Company will test new
conveying and molding systems which may reduce or eliminate the need for
additional forming and coating equipment. If the Company were successful in this
testing, the total project cost would be reduced to $69.5 million.
The Company recently signed a non-binding letter of intent with Sweetheart to
expand and further develop the manufacturing facility in Owings Mills, Maryland
beyond the scope of the initial Big Mac(R) commitment. This would require
investment in additional capacity of which 50% will be shared with Sweetheart.
This capacity will first be applied to incremental McDonald's business, on a
priority basis, and then to other customers. The Company believes the
incremental manufacturing capacity may cost at least 50% less than the original
equipment installed at Sweetheart, and that the incremental equipment can be
financed. The Company also believes that there will be a significant reduction
in the level of first time, non-recurring expenses as compared to its initial
manufacturing lines. There can be no assurances that this non-binding letter of
intent will result in definitive agreements with Sweetheart.
OTHER CUSTOMERS AND LICENSEES
In May 1999, the Company signed definitive agreements with Huhtamaki Oyj, a
leading international food and food packaging firm, establishing a new joint
venture company, Polarcup EarthShell, to commercialize EARTHSHELL Products
throughout Europe, Australia, New Zealand, and, on a country by country basis,
Asia. The Company believes that the opportunity for rapid market acceptance of
its products in Europe is exceptional due to their unique environmental profile
and the more developed regulations regarding disposal of foodservice disposable
products in Europe. In November 1998, the Company signed a non-binding letter of
intent with Prairie Packaging, Inc. ("Prairie)" to establish a joint venture to
produce an array of products. The proposed arrangement with Prairie encompasses
the production of plates, hinged-lid containers and cups, initially to be sold
to Sysco Corporation, the leading foodservice distributor in North America.
Based on the definitive joint venture agreements with Huhtamaki, the non-binding
letter of intent with Sweetheart and progress made on definitive agreements with
Prairie, engineering design work has been initiated to establish economic
manufacturing processes for the Company's second generation plants. Under the
terms of the definitive agreements, Huhtamaki Oyj is actively participating in
this effort. To date, discussions leading to a definitive agreement with Prairie
are still in progress, and no assurance can be given that the non-binding letter
of intent will result in a definitive agreement with Prairie.
SECOND GENERATION PLANT ECONOMICS
The Company has concluded that its next series of plant investments will not be
committed until the Company is satisfied that its second generation products may
be produced so that both EarthShell and its partners receive acceptable returns
validated by commercial scale pilot line experiences. EarthShell's partners and
prospective partners, under terms of existing and contemplated joint venture
agreements, will concur with the decision to invest in next facilities based on
probable economic returns. Due to the extensive technical effort being made at
the Company's first facility at Sweetheart, the Company has previously stated
that it will be delayed in fully demonstrating the economic viability of its
second generation products.
Work on second generation manufacturing systems is in progress. The Company's
manufacturing process comprises four core and discreet operations; mixing,
forming, coating and printing. These operations are installed into a line and a
continuous process is constructed through the use of material handling and
conveyance systems. The Company believes it has identified commercial processes
for mixing, forming and printing that will meet its second generation
manufacturing goals. Additionally, the Company is working with conventional film
thermoforming equipment in a coating process with biodegradable film. Initial
trials with this process have been encouraging. Prototype equipment has been
built and demonstration projects which tested the performance of products made
using this process on a small scale were well received by the U.S. Department of
the Interior and other users. The Company believes it is well positioned to
source competitively priced biodegradable films for the middle and higher
selling price markets, but such films are currently more expensive than the
coatings applied to the Big Mac(R) clamshell.
The Company expects that work on second generation manufacturing systems will
lead to the use of existing and conventional equipment to manufacture EARTHSHELL
Products. The Company believes it may take up to 12 months to prove second
generation manufacturing economics across a broader product range, depending on
product type, with some products potentially proven earlier. The Company
believes it will benefit from its experience at Sweetheart and from the broad
manufacturing experience of its partners.
The Company believes it will be able to achieve acceptable economic returns for
products such as plates, bowls, trays and hinged-lid containers. The Company has
not yet identified a commercial manufacturing process for hot and cold cups,
which represent a significant portion of the Company's targeted market.
Therefore, development of second generation manufacturing systems for cups are
expected to take longer than 12 months. Based on its current product costing
models, the Company believes its products will be able to compete in the middle
and higher selling price markets, which the Company estimates to represent about
half of the worldwide market place for its products. Additional value
engineering and a lower total cost of coating will be required to be competitive
in lower priced markets.
COMPARISON OF THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 1999,
TO THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 1998
TOTAL RESEARCH AND DEVELOPMENT EXPENSES Total research and development
expenditures for the development of EARTHSHELL Products increased $4.6 million
to $12.7 million from $8.1 million for the six months ended June 30, 1999
compared with the six months ended June 30, 1998, and increased $1.3 million to
$7.0 million from $5.7 million for the three months ended June 30, 1999 compared
with the three months ended June 30, 1998.
The increase in both periods was primarily related to the cost of start-up and
debugging of the Sweetheart manufacturing lines. This included a $2.3 million
and $1.4 million increase in reimbursement to Sweetheart for costs incurred
during the startup and debugging phase of the project for the six months and
three months ended June 30, 1999, respectively. An increase of $1.7 million and
$0.9 million for the six months and three months ended June 30, 1999,
respectively, was related to additional staffing costs to support the Sweetheart
project. An increase of $1.6 million and $0.9 million for the six months and
three months ended June 30, 1999, respectively, was a result of increased
reimbursement to EKI for its support of the Sweetheart operation, for work
performed on several demonstration projects and for acceleration of efforts in
support of second generation manufacturing systems. An increase of $0.9 million
and $0.5 million resulted from additional expensed equipment and supplies
related to the Sweetheart project during the six months and three months ended
June 30, 1999, respectively. These costs were offset by a reduction of $3.0 and
$2.7 million for the six months and three months ended June 30, 1999,
respectively, for services provided by the construction management and design
firm at Sweetheart as its part of the project is completed.
TOTAL GENERAL AND ADMINISTRATIVE EXPENSES When comparing the six months ended
June 30, 1999 to the six months ended June 30, 1998, total general and
administrative expenses increased $5.6 million to $7.8 million from $2.5
million. This is primarily due to increased compensation and benefits for a
higher number of employees in the 1999 period of $2.4 million and $0.9 million
in compensation to directors, related primarily to the grant of compensatory
stock options. Approximately $1.1 million was due to the increased costs of
being a public company, such as costs of preparing and issuing an annual report,
developing and implementing an investor relations program and for legal services
related to structuring joint ventures.
When comparing the three months ended June 30, 1999 to the three months ended
June 30, 1998, total general and administrative expenses increased $3.2 million
to $4.8 million from $1.6 million. Approximately $1.3 million was a result of
compensation and benefits for a higher number of employees in the 1999 period
and $0.9 million in compensation to directors, related primarily to the grant of
compensatory stock options. An increase of approximately $0.5 million was due to
increased costs of being a public company, such as costs of preparing and
issuing an annual report, developing and implementing an investor relations
program and for legal services related to structuring joint ventures.
Approximately $0.3 million was a result of marketing and public relations
expenses in preparation of the national rollout of the Big Mac(R) container.
DEPRECIATION AND AMORTIZATION EXPENSE Depreciation and amortization expense
increased $1.3 million to $1.7 million from $0.4 million for the six months
ended June 30, 1999 compared with the six months ended June 30, 1998, and
increased $1.3 million to $1.5 million from $0.2 million for the three months
ended June 30, 1999 compared with the three months ended June 30, 1998. The
increase in depreciation is primarily due to the purchase of commercial
manufacturing equipment for the Company's Sweetheart facility.
RELATED PARTY PATENT EXPENSES Legal fees reimbursed to EKI under the Amended and
Restated Agreement for Allocation of Patent Costs with EKI increased $242,920 to
$328,021 from $85,101 for the six months ended June 30, 1999 compared with the
six months ended June 30, 1998. This increase was primarily a result of
increased domestic and international patent research activity.
INTEREST INCOME Interest income increased $0.2 million to $2.1 million from $1.9
million for the six months ended June 30, 1999 compared with the six months
ended June 30, 1998. This increase is primarily due to proceeds of the initial
public offering being invested during the six-month period in 1999 versus three
months in 1998.
Interest income decreased $0.8 million to $1.1 million from $1.9 million for the
three months ended June 30, 1999 compared with the three months ended June 30,
1998 due to a reduction of cash and investments from June 30,1998 to June 30,
1999 of $68 million. These funds were expended primarily for construction and
equipment costs related to the Sweetheart facility, continued research and
development and general and administrative activities.
INTEREST EXPENSE Interest expense decreased from $1.0 million to zero for the
six months ended June 30, 1999 compared with the six months ended June 30, 1998.
Following the initial public offering, the interest-bearing debt was repaid.
LIQUIDITY AND CAPITAL RESOURCES AT JUNE 30, 1999
In connection with the Company's initial public offering on March 27, 1998, the
Company issued 10,526,316 shares of its common stock, $.01 par value, for which
it received net proceeds of approximately $206 million. The Company has used
$148.3 million of the net proceeds through June 30, 1999. A portion of the
proceeds was used to repay indebtedness to the majority stockholder of $36.6
million, bank debt of $14.0 million and to pay accrued dividends on the
Company's Series A preferred stock of $9.9 million. The remaining proceeds are
being used to: (i) to purchase manufacturing equipment and construct the
Company's first manufacturing facility; (ii) to build commercial scale prototype
manufacturing lines which validate favorable economic returns over a broader
array of products; (iii) to establish the EarthShell product development center;
(iv) to launch an initial public relations and advertising campaign; and (v) for
general corporate purposes, including the employment of personnel, the design
and development of EARTHSHELL Products and anticipated operating losses. As of
June 30, 1999 the Company had cash totaling approximately $65.0 million.
Net cash used in operations was $19.3 million and $31.6 million for the six
months ended June 30, 1999 and 1998, respectively. Net cash used in investing
activities was $5.7 million and $18.2 million for the six months ended June 30,
1999 and 1998, respectively. In addition to the repayment of indebtedness, the
Company used the initial public offering proceeds to pay outstanding payables
and purchase equipment to facilitate the development of manufacturing capacity
for EARTHSHELL Products.
The Company intends to seek third party financing during the next twelve months
to meet its operating and working capital needs, to prove second generation
manufacturing economics and initiate design and development of its next
manufacturing facilities. The Company believes that efforts to obtain additional
financing will be successful based on initial discussions with several financial
institutions. The Company has no commitments for any additional financing, and
there can be no assurance that any such commitments can be obtained on favorable
terms, if at all. If the Company is unable to obtain additional financing, the
Company will be unable to fund its operations.
The Company has incurred significant costs at its first manufacturing site at
Sweetheart, and has continued to incur significant costs associated with the
internal development of its second generation manufacturing systems. The Company
has created a core in-house competence in manufacturing engineering and design,
and EKI, its related party, has expanded its workforce to increase EarthShell
support capabilities in basic material science and applied materials
engineering. These activities, during the Company's early stages of
commercialization, have been instrumental in providing solutions to first time
manufacturing issues at Sweetheart and the re-design and location of suitable
equipment vendors for second generation manufacturing systems. Having reached
this stage in its development, the Company believes it is now in a position to
better leverage relationships with vendors and joint venture partners going
forward. Relationships now established or under development provide the Company
with a basis to reduce cash used for these activities in future periods.
YEAR 2000 COMPLIANCE
The Company is currently reviewing its business operations to minimize the risk
of potential disruption from the Year 2000 issue. This problem is a result of
computer programs having been written using two digits, rather than four, to
define the applicable year. Any information systems that have time-sensitive
software may recognize a date using "00" as the year 1900 rather than the year
2000, which could result in miscalculations and system failures. The problem
also extends to many non-information technology systems; that is, operating and
control systems that rely on embedded chips systems. For the purposes of this
discussion, "Year 2000 compatible " means that the computer hardware, software
or device in question will function in 2000 without modification or adjustment
or will function in 2000 with a one-time manual adjustment. However, there can
be no assurance that any such Year 2000 compatible hardware, software or device
will function properly when interacting with any Year 2000 non-compatible
hardware, software or device.
The Company does not rely on any internally developed software to run its
systems. The Company has received documentation from its major vendors asserting
that equipment and software in use for its Sweetheart operations, accounting,
payroll and phone systems is Year 2000 compliant. Additionally, the Company
contractually requires that manufacturing equipment suppliers deliver equipment
that is Year 2000 compliant.
Based on documented vendor assertions and Company contractual requirements, the
Company believes that the cost of completing any internal modifications
necessary to become Year 2000 compliant will not be material. The Company has
spent less than $100,000 to date to become Year 2000 compliant since major
purchases for hardware, software and devices were deemed to be Year 2000
compliant by the Company's vendors. The Company has not formally tested each
vendor's assertion and plans to do this testing for its major systems,
consisting primarily of the manufacturing control system at Sweetheart, before
the end of 1999. There can be no assurances that each vendor's claim to be Year
2000 compliant will ultimately be true and the Company is unable to estimate the
cost to become Year 2000 compliant, if a vendor's assertion proves to be
incorrect.
The failure to correct a material Year 2000 problem could result in an
interruption in or failure of certain normal business activities or operations
of the Company including the ability to produce and introduce EARTHSHELL
Products to the in market. Such failures could have a material adverse effect on
the Company including unanticipated effects on cash flow. The Company believes
that both its major information technology systems and non-information
technology systems are Year 2000 compliant.
The Company believes that the areas that present the greatest risk to the
Company are (i) disruption of the Company's business due to Year 2000
non-compatibility of one of its critical business systems (primarily the
manufacturing control system at Sweetheart) and (ii) disruption of the business
of certain of its significant customers and vendors due to their non-compliance.
Whether disruption of a customer's or vendor's business due to non-compliance
will have a material adverse effect on the Company will depend on several
factors including the nature and duration of the disruption, the significance of
the customer or vendor and, in the case of vendors, the availability of
alternate sources for the vendor's products.
The Company does not currently have a contingency plan, but is considering the
development of such a plan to address Year 2000 non-compliance issues.
Readers are cautioned that the preceding discussion contains forward-looking
statements and should be read in conjunction with the "Forward-Looking Statement
Notice" appearing at the beginning of "Management's Discussion and Analysis of
Financial Condition and Results of Operations." Expectations about future Year
2000-related costs and the progress of the Company's Year 2000 efforts are
subject to various uncertainties that could cause the actual results to differ
materially from the Company's expectations, including: (i) the success of the
Company in identifying hardware, software and devices that are not Year 2000
compatible; (ii) the nature and amount of remediation required to make them
compatible; (iii) the availability, rate and amount or related labor and
consulting costs and (iv) the success of the Company's significant vendors and
customers in addressing their Year 2000 issues.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable
<PAGE>
Part II. Other Information
ITEM 1. LEGAL PROCEEDINGS
On August 2, 1999, a third party filed a complaint in the United States District
Court Northern District of Illinois alleging infringement of three patents
related to the Company's technology. Although the lawsuit is still in the
preliminary stage, the Company believes it has strong meritorious defenses and
plans to vigorously defend the lawsuit.
ITEM 2. USE OF PROCEEDS
In connection with the Company's initial public offering, the Company issued
10,526,316 shares of its common stock, $.01 par value (the "IPO Shares"), on
March 27, 1998. The IPO Shares were offered and sold by the underwriters at an
initial public offering price of $21.00 per share, resulting in aggregate
offering proceeds of $221,052,636. In addition, selling stockholders sold
2,673,684 shares of common stock. Net offering proceeds were $205,873,995.
Through March 31, 1999, the Company applied $133,079,546 of the net offering
proceeds. The Company applied an additional $15,210,420 in the three months
ended June 30, 1999 for a total of $148,289,966. The increase was comprised of
$4,078,683 in additional purchases of manufacturing equipment, $2,767,218 in
additional construction and primarily for the Sweetheart facility, $511,087 for
demonstration and prototype equipment and $7,853,432 in ongoing operating
expenses.
The cost of designing, installing and debugging the Company's first
manufacturing lines at Sweetheart will exceed the Company's initial estimates as
discussed in "Management's Discussion and Analysis of Financial Conditions and
Results of Operations." As a result, the Company intends to prove its second
generation manufacturing systems in advance of a next tier plant investment.
Based partly on this, the Company has refined its business strategy and intends
to utilize joint ventures in which the joint venture partner generally will
share equally the cost of turnkey equipment lines and will assume equally risks
associated with failures of the equipment lines to meet targeted throughput
efficiencies. The Company believes using joint ventures in which both venturers
generally assume equal responsibility and risk, as well as share equally any
upside opportunities, will enable the Company to share the product introduction
and capital risk with its partners while maintaining a favorable return on
investment to the Company. As a result of this business model change and other
changed circumstances, the actual use of initial public offering proceeds will
vary from the anticipated use of proceeds described in the Company's Prospectus.
For example, the Company plans now to use some of the $7.4 million initial
public offering proceeds that were shown in the Company's Prospectus as
anticipated to be used for patent enforcement and protection in the development
of its second generation manufacturing systems and to fund operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders of the Company was held on May 14, 1999,
where the following actions were taken:
1) The Board of Directors was elected until the next Annual Meeting of
Stockholders and until their successors are elected as follows:
Name For Withheld
- ---- --- --------
Essam Khashoggi 87,858,128 43,295
Simon K. Hodson 87,857,827 43,596
Lynn Scarlett 87,860,328 41,095
John Daoud 87,856,328 45,095
Ellis B. Jones 87,860,403 41,020
Layla Khashoggi 87,853,028 48,395
William A. Marquard 87,856,453 44,970
Jerold H. Rubenstein 87,855,103 46,320
Howard J. Marsh 87,852,608 48,815
2) A proposal to amend the Company's 1995 Stock Incentive Plan was approved with
74,166,772 shares voted in favor, 265,881 shares voted against, 46,599 shares
voted abstained and 13,422,171 broker non-votes.
3) The selection of Deloitte & Touche LLP, as auditors of the Company for the
year 1999, was ratified with 87,834,467 shares voted for, 47,355 shares voted
against and 19,601 shares voted abstained.
ITEM 5. OTHER INFORMATION
As previously reported, William McLaughlin resigned as President and Chief
Operating Officer, effective May 12, 1999, for personal reasons. Mr. Simon
Hodson assumed the responsibilities of the President, in addition to his role as
Vice Chairman and Chief Executive Officer.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) Exhibits
27.1 Financial Data Schedule
(B) Reports on Form 8-K
No reports on Form 8-K were filed by EarthShell during the quarter ended
June 30, 1999.
Item 3 is not applicable and has been omitted.
<PAGE>
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
EarthShell Corporation
Date: August 13, 1999 By: /s/ William F. Spengler
-----------------------------
William F. Spengler
Chief Financial Officer
(Principal Financial and Accounting
Officer and Duly Authorized Officer)
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Form
10-Q, for the quarterly period ending June 30,1999 and is qualified in its
entirety by reference to such Form 10-Q.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
<CASH> 65,028,453
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 65,426,638
<PP&E> 50,771,326
<DEPRECIATION> 2,703,017
<TOTAL-ASSETS> 113,494,947
<CURRENT-LIABILITIES> 8,242,642
<BONDS> 0
0
0
<COMMON> 1,000,451
<OTHER-SE> 104,251,854
<TOTAL-LIABILITY-AND-EQUITY> 113,494,947
<SALES> 0
<TOTAL-REVENUES> 0
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 22,553,611
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (20,461,564)
<INCOME-TAX> 800
<INCOME-CONTINUING> (20,462,364)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (20,462,364)
<EPS-BASIC> .20
<EPS-DILUTED> .20
</TABLE>
