<PAGE>
- ------------------------------------------------------------------------------
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 March 31, 1999
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE 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 May
7, 1999 was 100,045,166.
- ------------------------------------------------------------------------------
<PAGE>
EARTHSHELL CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 1999
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
Page
<S> <C>
Item 1. Financial Statements
a) Balance Sheets as of March 31, 1999 and December 31, 1998
(unaudited)...............................................................1
b) Statements of Operations for the three months ended March 31,
1999 and 1998 (unaudited) and for the period from November 1, 1992
through March 31, 1999 (unaudited)........................................2
c) Statements of Stockholders' Equity (Deficit) for the years ended 1993
through 1998 and the three months ended March 31, 1999 (unaudited)........3
d) Statements of Cash Flows for the three months ended March 31, 1999
and 1998 (unaudited) and for the period from November 1, 1992
(inception) through March 31, 1999 (unaudited)............................4
e) Notes to Financial Statements (unaudited).................................5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations........................................................6
Item 3. Quantitative and Qualitative Disclosures About Market Risk..................11
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds...................................12
Item 5. Other Information...........................................................13
Item 6. Exhibits and Reports on Form 8-K............................................13
SIGNATURE............................................................................14
</TABLE>
<PAGE>
EARTHSHELL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
MARCH 31 DECEMBER 31
----------------------------------
1999 1998
------------- -------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ............................................... $ 69,142,942 $ 86,590,163
Restricted cash ......................................................... 3,500,000 3,500,000
Short-term investments .................................................. 6,530,928 6,530,928
Other assets ............................................................ 1,468,863 1,196,373
------------- -------------
Total current assets ................................................ 80,642,733 97,817,464
PROPERTY AND EQUIPMENT, NET ............................................... 45,396,209 37,820,917
------------- -------------
TOTAL ..................................................................... $ 126,038,942 $ 135,638,381
------------- -------------
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses .................................. $ 8,543,100 $ 9,559,437
Trade payable to majority stockholder .................................. 881,206 1,181,300
Notes payable to banks ................................................. - 22,975
------------- -------------
Total current liabilities ........................................... 9,424,306 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 March 31, 1999 and
December 31,1998 ....................................................... 1,000,451 1,000,451
Additional paid-in common capital ...................................... 224,715,255 224,715,255
Deficit accumulated during the development stage ....................... (109,101,070) (100,841,037)
------------- -------------
Total stockholders' equity .......................................... 116,614,636 124,874,669
------------- -------------
TOTAL ..................................................................... $ 126,038,942 $ 135,638,381
------------- -------------
------------- -------------
</TABLE>
<PAGE>
EARTHSHELL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
NOVEMBER 1, 1992
FOR THE THREE MONTHS (INCEPTION)
ENDED MARCH 31, THROUGH MARCH 31,
1999 1998 1999
------------- ------------- -------------
<S> <C> <C> <C>
EXPENSES:
Related party research and development .. $ 2,400,310 $ 1,759,666 $ 49,007,787
Other research and development .......... 3,301,905 650,415 19,076,670
Related party general and administrative
expenses ............................. 16,800 16,800 1,885,600
Other general and administrative expenses 3,001,856 403,427 27,808,716
Depreciation and amortization ........... 263,658 194,125 3,403,712
Related party patent expenses ........... 301,747 58,389 7,988,024
------------- ------------- -------------
Total expenses ....................... 9,286,276 3,082,822 109,170,509
Interest income ............................ (1,027,043) - (6,634,508)
Related party interest expense ............. - 651,586 4,770,731
Other interest expense ..................... - 433,274 1,788,738
------------- ------------- -------------
Loss Before Income Taxes ................... 8,259,233 4,167,682 109,095,470
Income Taxes ............................... 800 800 5,600
------------- ------------- -------------
Net Loss ................................... 8,260,033 4,168,482 109,101,070
Preferred Dividends ........................ - 533,500 9,926,703
------------- ------------- -------------
Net Loss Available To Common Stockholders .. $ 8,260,033 $ 4,701,982 $ 119,027,773
------------- ------------- -------------
------------- ------------- -------------
Basic And Diluted Loss Per Common Share .... $ 0.08 $ 0.06 $ 1.40
Weighted Average Number Of Common Shares ... 100,045,166 83,820,642 85,176,165
</TABLE>
<PAGE>
EARTHSHELL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(UNAUDITED)
<TABLE>
<CAPTION>
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
Net loss............................. - - - - -
--------- ----- ----------- ---------- ------
BALANCE, MARCH 31, 1999 - $ - $ - 100,045,166 $1,000,451
--------- ----- ----------- ---------- ------
--------- ----- ----------- ---------- ------
<CAPTION>
DEFICIT
ACCUMULATED
ADDITIONAL DURING
PAID-IN DEVELOPMENT
COMMON 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
Net loss............................. - (8,260,033) (8,260,033)
----------- ----------- -----------
BALANCE, MARCH 31, 1999 $224,715,255 $(109,101,070) $116,614,636
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
<PAGE>
EARTHSHELL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NOVEMBER 1,
1992
(INCEPTION)
FOR THE THREE MONTHS ENDED THROUGH
MARCH 31, MARCH 31,
1999 1998 1999
--------------------------- ---------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss...................................................................... $(8,260,033) $(4,168,482) $(109,101,070)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization............................................... 263,658 194,125 3,403,712
Issuance of stock options to director and consultant........................ - - 3,211,522
Issuance of stock options to officer........................................ - - 650,000
Amortization of debt issue costs............................................ - - 271,277
Loss on sale or disposal of property and equipment.......................... 267,562 - 3,770,038
Net loss on sale of investments............................................. - - 32,496
Accretion of discounts on investments....................................... - - (410,084)
Changes in operating assets and liabilities:
Other assets................................................................ (272,490) (374,840) (1,468,863)
Accounts payable and accrued expenses....................................... (1,039,312) (30,996) 8,520,123
Payable to majority stockholder............................................. (300,094) (622,090) 27,764,419
Accrued interest on notes payable to majority stockholder.............. - (636,068) -
----------- ---------- -----------
Net cash used in operating activities.................................. (9,340,709) (5,638,351) (63,356,430)
</TABLE>
<PAGE>
<TABLE>
<S> <C> <C> <C>
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of investments U.S. government securities............................ - - (43,449,182)
Purchase of restricted time deposit.......................................... - - (3,500,000)
Proceeds from sales and redemptions of investments............................ - - 37,295,842
Proceeds from sale of property and equipment.................................. - - 297,670
Purchase of property and equipment............................................ (8,106,512) (4,536,906) (53,739,364)
----------- ---------- -----------
Net cash used in investing activities.................................. (8,106,512) (4,536,906) (63,095,034)
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................................................... - (15,106,142) (15,178,641)
Preferred dividends paid...................................................... - - (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) (14,000,000)
Repayment of note payable..................................................... - (33,477,403) (39,105,887)
----------- ---------- -----------
Net cash provided by financing activities.............................. - 162,069,091 195,594,406
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.............................. (17,447,221) 151,893,834 $69,142,942
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD................................ 86,590,163 8,437 -
----------- ---------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD...................................... $69,142,942 $151,902,271 $69,142,942
----------- ---------- -----------
----------- ---------- -----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for:
Income taxes............................................................... $800 $800 $5,600
Interest................................................................... - $1,702,944 $3,026,633
Warrants issued with debt..................................................... - - $306,168
Transfer of property from EKI................................................. - - $28,745
Conversion of preferred stock to common stock................................. - $39,934 $69,888
</TABLE>
<PAGE>
EARTHSHELL CORPORATION
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 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 and 83,820,642 for the three months
ended March 31, 1999 and 1998, respectively. Basic and diluted are the same
because common stock equivalents are considered anti-dilutive.
RELATED PARTY TRANSACTIONS
For the three months ended March 31, 1999 and 1998, the Company paid or
accrued $2,400,310 and $1,759,666, respectively, for services performed by
EKI under the Amended and Restated Technical Services and Sublease Agreement
effective October 1, 1997, between the Company and EKI and $16,800 in
sublease payments to EKI for each of the respective periods.
Under the Amended and Restated Agreement for Allocation of Patent Costs
effective October 1, 1997, legal fees related to patents of $301,747 and
$58,389 were paid to or on behalf of EKI for the three months ended March 31,
1999 and 1998, respectively.
PROPERTY AND EQUIPMENT
At March 31, 1999, property and equipment consisted of the following:
<TABLE>
<CAPTION>
<S> <C>
Commercial Manufacturing Equipment: Construction in progress....... $ 40,405,846
Product Development Center:
Equipment ....................................................... 3,925,665
Construction in progress ........................................ 441,444
Leasehold improvements .......................................... 521,253
------------
4,888,362
Office equipment & furniture ...................................... 439,357
Office leasehold improvements ..................................... 905,582
Less: accumulated depreciation .................................... (1,242,938)
------------
</TABLE>
<PAGE>
<TABLE>
<S> <C>
Property and equipment - net ...................................... $ 45,396,209
============
</TABLE>
EARTHSHELL CORPORATION
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) - continued
MARCH 31, 1999
- -------------------------------------------------------------------------------
COMMITMENTS
The Company has committed to capital equipment and infrastructure
expenditures primarily for the Sweetheart Cup Company Inc. installation of
$5.3 million as of March 31, 1999.
1995 STOCK INCENTIVE PLAN
During the three months ended March 31, 1999, the Board of Directors approved
amendments, subject to shareholder approval, to the Company's 1995 Stock
Incentive Plan to:
- - grant to each director who is elected after January 1, 1999 a director's
option having a value at the time of grant equal to $120,000. This option
will vest immediately on grant, and in the case of grants made at the 1999
annual meeting, will have an exercise price of $21 per share, and in the
case of grants made in subsequent years, will have an exercise price equal
to the average price for the three consecutive trading days immediately
preceding the grant;
- - to increase the aggregate number of options that may be granted under the
1995 Stock Incentive Plan from 4,585,000 to 10,000,000;
- - to increase the aggregate number of options that may be granted to an
individual in a calendar year from 393,000 to 500,000.
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 that has not produced any
revenues from operations through the quarter ended March 31, 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 including the new composite material. The
Company was formed to develop, license and commercialize foodservice
disposables made of EarthShell composite material ("EarthShell Products").
The Company has
<PAGE>
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 $109
million from its inception on November 1, 1992 through March 31, 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. 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 Imperial Bank. Since inception, the Company has relied on
EKI to provide extensive management and technical support. The Company and
EKI entered into an Amended and Restated Technical Services and Sublease
Agreement (the "Technical Services Agreement") which continues through
December 31, 2002. Under the terms of the Technical Services Agreement, 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 US restaurants with a
minimum of 1.8 billion Big Mac-Registered Trademark- sandwich containers made
from EARTHSHEll Products over a three-year period, representing the initial
commercial application of EarthShell Products. To support this initial
commercial application of EarthShell Products, EarthShell agreed with
Sweetheart to provide manufacturing equipment to Sweetheart with adequate
capacity to fulfill the Perseco/McDonald's order.
The development and installation of 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-Registered Trademark-
sandwich containers in October 1997. Because the Owings Mills facility is the
first commercial effort at implementation of the EarthShell technology, the
Company believes that the cost incurred on manufacturing lines in this
facility will be significantly higher than the cost of manufacturing lines in
subsequent facilities.
At December 31, 1998, the Company estimated the capitalized cost of the first
three lines at approximately $38.5 million upon completion, and, in addition,
the Company expected to expense approximately $8.2 million of process
development, design and engineering costs related to these lines. The Company
also anticipated incurring approximately $3.5 million of capitalized costs
associated with future lines at Owings Mills. In addition, the Company
expected to incur $3.5 million in start-up and debugging expense associated
with preparing these lines for full-scale production. The total project cost
for this three-line facility was therefore estimated to be approximately $54
million at December 31, 1998.
The Company currently believes the estimated capitalized cost of the initial
three lines will be approximately $40.4 million upon completion. In addition,
the Company expects to expense approximately $9.1 million of process
development, design and engineering costs related to these lines. The Company
has also incurred approximately $3.5 million for capitalized costs associated
with future lines at Owings Mills. In addition, the Company expects 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 three-line facility is therefore estimated to be approximately $59
million. This $5 million increase in projected costs over previously
<PAGE>
reported estimates is a result of continued debugging efforts and ongoing
minor modification to installed equipment.
The Company believes a substantial portion of the incremental capitalized
cost of the Sweetheart installation is non-recurring. These non-recurring
costs include portions of plant engineering and design costs, oversizing of
system components to allow for margins of safety, installation of
instrumentation and monitoring equipment to provide input for future value
engineering, and premiums paid on component equipment for first time, single
item purchases. The Company also believes manufacturing process design and
development expenses will be reduced in future sites.
The Company has experienced persistent, but typical problems debugging its
first manufacturing lines. The manufacturing process includes various units
of operation, such as mixing, forming, trimming, sanding, coating, printing
and stacking, all of which are integrated and computer controlled along an
assembly line. The Company has now been successful in the process of
sequentially integrating each unit of operation along the assembly line and
in producing commercially acceptable parts, although at a relatively low
volume level. The Company believes it will be successful in the debugging
process going forward as it ramps its production lines up to produce at
higher levels. The Company previously reported that it believed the three
lines constructed could produce the quantities necessary to fulfill the
Perseco/McDonald's order. The three lines installed have been designed to
produce sufficient quantities to fulfill the commitment to Perseco, but,
there can be no assurance that the currently installed three line
configuration can fully support future order quantities under the purchase
commitment between Perseco and Sweetheart. By the end of the second quarter
of 1999, the Company will be in a position to make a determination as to
whether additional equipment will be required to meet this commitment.
The Company recently announced that McDonald's and Perseco had been notified
that initial commercial shipment quantities were ready to be released. This
event represented achievement of a significant first commercialization
milestone for the Company. The Company believes that the venture with
Sweetheart will generate positive cash flow.
OTHER CUSTOMERS AND LICENSEES
In addition to its agreement with Sweetheart, the Company is engaged in
discussions with additional companies for additional licensing or joint
venture agreements to further commercialize its technology. In October 1998,
the Company announced that it had signed a non-binding letter of intent to
establish a joint venture to commercialize EarthShell Products throughout
Europe, Australia, New Zealand, and Asia (except Japan) as determined on a
country by country basis, with Huhtamaki Oyj ("Huhtamaki"), a leading
international food and food packaging firm headquartered in Finland which
commands leading market shares in Europe, Australia, and significant
positions in several Asian markets. The Company also announced in November
1998 that it had signed a non-binding letter of intent with Prairie
Packaging, Inc. ("Prairie)" to produce an array of products. The proposed
arrangement encompasses the production of plates, hinged-lid containers and
cups, initially to be sold to Sysco Corporation, the leading foodservice
distributor in North America. Discussions leading to definitive agreements
are still in process as of March 31, 1999, but no assurances can be given
that these non-binding letters of intent will result in definitive agreements
with either Huhtamaki or 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
expected returns based upon commercial scale pilot line experiences. Due to
the extensive technical effort being made at the Company's first facility at
Sweetheart and due to the Company's need to complete the development of
specific manufacturing processes which can be commercially implemented, the
Company expects that it will be delayed in demonstrating the economic
<PAGE>
viability of its second generation products. To date, the Company has
initiated pilot line development on a limited number of products.
As part of definitive partnership agreements currently being negotiated, the
Company intends to enter into joint development of next generation
manufacturing systems with its partners. Once definitive agreements have been
signed, these partners will participate in this development process relative
to their respective product lines and a more specific timeline for completion
will be developed. The Company believes it has sufficient cash resources to
complete its first facility at Sweetheart, implement its second generation
manufacturing process in commercial scale pilots and, based on anticipated
equipment financing, initiate construction of its next two facilities.
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 1999, TO THE THREE MONTHS
ENDED MARCH 31, 1998
TOTAL RESEARCH AND DEVELOPMENT EXPENSES Total research and development
expenditures for the development of EarthShell Products increased $3.3
million to $5.7 million from $2.4 million for the three months ended March
31, 1999 compared with the three months ended March 31, 1998. Approximately
$1.7 million of the increase was related to the cost of start-up and
debugging of the Sweetheart manufacturing lines in the 1999 period, $0.8
million was due to Company staffing increases related to supporting the
Sweetheart operations, and $0.6 million was due to reimbursement to EKI for
its support for the Sweetheart operation.
TOTAL GENERAL AND ADMINISTRATIVE EXPENSES When comparing the three months
ended March 31, 1999 to the three months ended March 31, 1998, total general
and administrative expenses increased $2.6 million to $3.0 million from $0.4
million. Approximately $1.1 million of the increase was due to compensation
and benefits related to the new staff hired in the second half of 1998 and
early 1999. The majority of the remaining increase was due to operating a
publicly traded-company in the 1999 period and includes activity for an
investor relations program, creation of an annual report, stock transfer
activity and general expenses associated with an additional office site in
Maryland.
DEPRECIATION AND AMORTIZATION EXPENSE Depreciation and amortization expense
increased $70,000 to $264,000 from $194,000 for the three months ended March
31, 1999 compared with the three months ended March 31, 1998. The increase in
depreciation expense was primarily the result of the purchase of pilot
manufacturing equipment installed in the Company's product development center.
As the commercial manufacturing equipment is being installed at Sweetheart,
it is anticipated that depreciation and amortization will increase
significantly when the equipment is placed in service.
RELATED PARTY PATENT EXPENSES Legal fees reimbursed to EKI under the Amended
and Restated Agreement for Allocation of Patent Costs with EKI increased
$244,000 to $302,000 from $58,000 for the three months ended March 31, 1999
compared with the three months ended March 31, 1998. The increase was
primarily a result of increased patent research activity and filing more new
patent applications than in the previous period.
INTEREST INCOME Interest income was $1.0 million and zero for the three
months ended March 31, 1999 and 1998, respectively, and reflects investment
earnings on the net proceeds of the Company's initial public offering
completed at the end of March 1998.
INTEREST EXPENSE Interest expense decreased from $1.1 million to zero for the
three months ended March 31, 1999 compared with the three months ended March
31, 1998. Following the initial public offering, the interest-bearing debt
was repaid.
LIQUIDITY AND CAPITAL RESOURCES AT MARCH 31, 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 $133.1 million of the net proceeds through March 31, 1999. A portion of
the proceeds was used to repay indebtedness to the majority stockholder of
$36.6 million, bank debt of
<PAGE>
$14.0 million and to pay accrued dividends on the Company's Series A
preferred stock of $9.9 million. The remaining proceeds are anticipated to be
used (i) to facilitate the development of manufacturing capacity for the
Company's products by engineering, developing and constructing manufacturing
lines for licensees or joint ventures; (ii) to expand the EarthShell product
development center; (iii) to launch an initial public relations and
advertising campaign; and (iv) for general corporate purposes, including the
employment of additional personnel, the continued design and development of
EarthShell Products and anticipated operating losses. As of March 31, 1999
the Company had cash and short-term investments totaling approximately $79.2
million.
Net cash used in operations was $9.3 million for the three months ended March
31, 1999 and $5.6 million for the three months ended March 31, 1998. Net cash
used in investing activities was $8.1 million and $4.5 million for the three
months ended March 31, 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 believes that it is not dependent on third party financing to
meet its operating and working capital needs through the next twelve months,
exclusive of new commercial plant manufacturing investments beyond the
current project with Sweetheart.
The Company intends to use third party financing in the development of its
next commercial manufacturing plants. The Company intends to prove its
manufacturing economics using pilot lines before soliciting such third party
financing and prior to making its next plant investments. The Company
believes, contingent on securing third party financing, that it has
sufficient capital resources to meet its operating and working capital needs
and to initiate construction of its next two facilities.
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 as needed
after demonstrating the commercial viability of its manufacturing process,
the Company may be required to reduce the scope of its anticipated
manufacturing ramp-up and product introductions, which could have an adverse
effect on the Company's business, financial condition, results of operations
and cash flows.
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 minimal amounts to date to become Year 2000 compliant since major
<PAGE>
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 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 EarthShell
Products. Such failures could have a material adverse effect on the Company.
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 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 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
CHANGES IN SECURITIES
Effective March 27, 1998, the number of authorized common shares increased
from 1,000,000 to 200,000,000 and the number of authorized preferred shares
increased from 100,000 to 10,000,000. On that day, the Company issued an
additional 10,526,316 shares of its common stock in a public offering in
which the Company received $205,873,995, net of issuance costs. In addition,
the Company declared a 262-for-one stock split of its common stock.
Furthermore, in connection with the Company's public offering of common
stock, selling stockholders sold 2,673,684 shares of common stock. After
giving effect to the split, 3,993,404 shares of Series A Preferred Stock were
converted to common stock to allow for the sale of stock by preferred
stockholders. The Company did not receive any proceeds from the sale of
common stock by the selling stockholders.
In the Company's Prospectus dated March 23, 1998, the Company disclosed its
intent to redeem all Series A convertible preferred stock shortly following
the initial public offering. By notice dated May 13, 1998, the Company called
for redemption, effective July 14, 1998, of the remaining 2,995,446 shares of
Series A preferred stock. As of March 31, 1999, all outstanding shares of
Series A Preferred Stock had been converted to common stock.
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 offering terminated on April 23, 1998 upon the
underwriters' election not to exercise their overallotment option. The IPO
Shares were issued in a registered offering pursuant to a Registration
Statement on Form S-1 (Commission File No. 333-13287; effective March 23,
1998) through a syndicate of underwriters, the representatives of which were
Salomon Smith Barney Inc. and Credit Suisse First Boston Corporation. 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.
The Company incurred expenses in connection with its initial public offering
as follows:
<TABLE>
<CAPTION>
<S> <C>
Underwriting discounts and commissions.......... $13,815,790
Other expenses.................................. 1,362,851
-----------
Total expenses.................................. $15,178,641
-----------
-----------
</TABLE>
None of the above expenses was paid either directly or indirectly to
directors, officers, general partners of the Company or its associates, or to
persons owning more than 10% of any class of equity security of the Company
or to affiliates of the Company.
Through March 31, 1999, the Company applied $133,079,546 of the
$205,873,995 in net offering proceeds as follows:
<TABLE>
<CAPTION>
<S> <C>
Repayment of indebtedness owed to principal stockholder...... $36,630,548
Repayment of indebtedness owed to bank....................... 14,000,000
Purchases of manufacturing equipment......................... 23,548,225
Construction and engineering costs for manufacturing plants.. 22,160,654
Demonstration and prototype facility......................... 3,683,006
Payment of cash dividend to preferred stockholders........... 9,926,703
Payment of legal fees........................................ 1,669,658
</TABLE>
<PAGE>
<TABLE>
<S> <C>
Other operating expenses..................................... 21,460,752
------------
Total proceeds applied.............................. $133,079,546
------------
------------
</TABLE>
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." Based partially on this, the Company has been
refining 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 or exceeding the original expected return
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 joint ventures and to fund operations.
ITEM 5. OTHER INFORMATION
The Company recently announced that William F. McLaughlin, President and
Chief Operating Officer had resigned for personal reasons. Mr. Simon Hodson
will assume the responsibilities of 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
March 31, 1999.
Items 1, 3 and 4 are not applicable and have 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: May 14, 1999 By:
------------- -----------------------
William F. Spengler
CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER
AND DULY AUTHORIZED OFFICER)
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE
SHEET AND STATEMENT OF OPERATIONS FOUND ON PAGES 1 AND 2 OF THE COMPANYS 10-Q
FOR THE QUARTER TO DATE AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 72,642,942
<SECURITIES> 6,530,928
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 80,642,733
<PP&E> 46,639,147
<DEPRECIATION> 1,242,938
<TOTAL-ASSETS> 126,038,942
<CURRENT-LIABILITIES> 9,424,306
<BONDS> 0
0
0
<COMMON> 1,000,451
<OTHER-SE> 115,614,185
<TOTAL-LIABILITY-AND-EQUITY> 126,038,942
<SALES> 0
<TOTAL-REVENUES> 0
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 9,286,276
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (8,259,233)
<INCOME-TAX> 800
<INCOME-CONTINUING> (8,260,033)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (8,260,033)
<EPS-PRIMARY> (.08)
<EPS-DILUTED> (.08)
</TABLE>
