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 September 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 November
12, 1999 was 100,045,166.
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<CAPTION>
EARTHSHELL CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1999
INDEX
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page
a) Balance Sheets
as of September 30, 1999 and December 31, 1998 (unaudited) ............. 1
b) Statements of Operations
for the three and nine months ended September 30, 1999 and 1998
(unaudited) and for the period from November 1, 1992 (inception)
through September 30, 1999 (unaudited) ................................. 2
c) Statements of Stockholders' Equity (Deficit)
for the period from November 1, 1992 (inception) to
September 30, 1999 (unaudited) ......................................... 3
d) Statements of Cash Flows
for the nine months ended September 30, 1999 and 1998 (unaudited)
and for the period from November 1, 1992 (inception)
through September 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
Item 3. Quantitative and Qualitative Disclosures About Market Risk .................. 14
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ........................................................... 15
Item 2. Use of Proceeds ............................................................. 15
Item 3. Defaults Upon Senior Securities ............................................. 15
Item 4. Submission of Matters to a Vote for Security Holders ........................ 15
Item 5. Other Information ........................................................... 16
Item 6 Exhibits and Reports on Form 8-K ............................................ 16
SIGNATURE ....................................................................................... 16
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<CAPTION>
EARTHSHELL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
BALANCE SHEETS
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
------------- -------------
1999 1998
------------- -------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ............................................. $ 47,786,663 $ 86,590,163
Restricted cash ....................................................... 3,500,000 3,500,000
Short-term investments ................................................ -- 6,530,928
Other assets .......................................................... 309,500 1,196,373
------------- -------------
Total current assets .............................................. 51,596,163 97,817,464
PROPERTY AND EQUIPMENT, NET ................................................. 47,643,840 37,820,917
INVESTMENT IN JOINT VENTURE ................................................. 517,194 --
------------- -------------
TOTAL ....................................................................... $ 99,757,197 $ 135,638,381
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses ................................. $ 6,326,124 $ 9,559,437
Trade payable to majority stockholder ................................. 570,593 1,181,300
Note payable to bank .................................................. -- 22,975
------------- -------------
Total current liabilities ......................................... 6,896,717 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 September 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 ...................... (133,695,226) (100,841,037)
------------- -------------
Total stockholders' equity ........................................ 92,860,480 124,874,669
------------- -------------
TOTAL ....................................................................... $ 99,757,197 $ 135,638,381
============= =============
See notes to financial statements.
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<TABLE>
<CAPTION>
EARTHSHELL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF OPERATIONS
(UNAUDITED)
FOR THE THREE MONTHS FOR THE NINE MONTHS NOVEMBER 1,1992
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, (INCEPTION)THROUGH
--------------------- --------------------- SEPTEMBER 30,1999
1999 1998 1999 1998 -----------------
---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
EXPENSES:
Related party research and development ..... $ 2,683,296 $ 2,492,976 $ 8,041,331 $ 6,297,348 $ 54,648,808
Other research and development ............. 6,151,749 2,164,243 13,480,202 6,468,139 29,254,967
Related party general and administrative
expenses ................................ 56,029 16,800 169,017 50,400 2,037,817
Other general and administrative expenses .. 2,608,145 4,184,697 10,306,308 6,217,692 35,113,168
Depreciation and amortization .............. 1,452,276 224,868 3,180,227 612,993 6,320,281
Related party patent expenses .............. 167,486 33,024 495,506 118,125 8,181,783
------------- ------------- ------------- ------------- -------------
Total expenses .......................... 13,118,981 9,116,608 35,672,591 19,764,697 135,556,824
Interest income ............................... (729,826) (1,704,025) (2,821,873) (3,597,424) (8,429,338)
Related party interest expense ................ -- -- -- 651,587 4,770,731
Other interest expense ........................ -- 692 -- 434,530 1,788,738
------------- ------------- ------------- ------------- -------------
Loss Before Income Taxes ...................... 12,389,155 7,413,275 32,850,718 17,253,390 133,686,955
Income Taxes .................................. 2,671 -- 3,471 800 8,271
------------- ------------- ------------- ------------- -------------
Net Loss ...................................... 12,391,826 7,413,275 32,854,189 17,254,190 133,695,226
Preferred Dividends ........................... -- -- -- 776,813 9,926,703
------------- ------------- ------------- ------------- -------------
Net Loss Available To Common Stockholders ..... $ 12,391,826 $ 7,413,275 $ 32,854,189 $ 18,031,003 $ 143,621,929
============= ============= ============= ============= =============
Basic And Diluted Loss Per Common Share ....... $ 0.12 $ 0.07 $ 0.33 $ 0.19 $ 1.66
Weighted Average Number Of Common Shares ...... 100,045,166 99,883,320 100,045,166 94,178,427 86,333,069
See notes to financial statements.
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<CAPTION>
EARTHSHELL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(UNAUDITED)
CUMULATIVE
CONVERTIBLE
PREFERRED STOCK ADDITIONAL COMMON STOCK
SERIES A PAID-IN ------------
-------- 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, SEPTEMBER 30,1999 .......... $ -- $ -- $ -- 100,045,166 $ 1,000,451
=========== ============== ============== =========== =============
See notes to financial statements.
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<TABLE>
<CAPTION>
EARTHSHELL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(UNAUDITED)
(CONTINUED)
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
Compensation related to stock options 840,000 -- 840,000
Net loss ............................ -- (32,854,189) (32,854,189)
------------- ------------- -------------
BALANCE, SEPTEMBER 30,1999 .......... $ 225,555,255 $(133,695,226) $ 92,860,480
============= ============= =============
See notes to financial statements.
</TABLE>
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<CAPTION>
EARTHSHELL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE NINE MONTHS ENDED NOVEMBER 1, 1992
SEPTEMBER 30, (INCEPTION) THROUGH
1999 1998 SEPTEMBER 30, 1999
--------------------------- ------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss .................................................................. $ (32,854,189) $ (17,254,190) $(133,695,226)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization .......................................... 3,180,227 612,993 6,320,281
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 ..................... 1,835,519 265,840 5,337,995
Net loss on sale of investments ........................................ -- -- 32,496
Loss from investment in joint venture .................................. 37,555 -- 37,555
Accretion of discounts on investments .................................. -- -- (410,084)
Changes in operating assets and liabilities: .............................. --
Other assets ........................................................... 886,873 (243,174) (309,500)
Accounts payable and accrued expenses .................................. (3,233,313) 5,978,148 6,326,122
Payable to majority stockholder ........................................ (610,707) (25,476,182) 27,453,806
Accrued interest on notes payable to majority stockholder ............. -- (636,068) --
------------- ------------- -------------
Net cash used in operating activities .............................. (29,918,035) (36,752,633) (83,933,756)
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of investments ................................................... -- (4,999,091) (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
Investment in joint venture ............................................... (554,748) -- (554,748)
Purchase of property and equipment ........................................ (14,838,670) (26,846,832) (60,471,522)
------------- ------------- -------------
Net cash used in investing activities .............................. (8,862,490) (31,845,923) (63,851,012)
------------- ------------- -------------
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 ............................................... -- (15,180,580) (15,178,641)
Preferred dividends paid .................................................. -- (9,926,703) (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 notes payable ................................................ (22,975) (21,783,495) (39,128,862)
------------- ------------- -------------
Net cash (used) provided by financing activities ................... (22,975) 177,761,858 195,571,431
------------- ------------- -------------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS .......................... (38,803,500) 109,163,303 47,786,663
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ............................ 86,590,163 8,437 --
------------- ------------- -------------
CASH AND CASH EQUIVALENTS, END OF PERIOD .................................. $ 47,786,663 $ 109,171,740 $ 47,786,663
============= ============= =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for:
Income taxes ......................................................... $ 3,471 $ 800 $ 8,271
Interest ............................................................. -- $ 1,722,201 $ 3,026,633
Warrants issued with debt ................................................. -- -- $ 306,168
Transfer of property from EKI ............................................. -- -- $ 28,745
Conversion of preferred stock to common stock ............................. -- $ 69,888 $ 69,888
See notes to financial statements.
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EARTHSHELL CORPORATION
NOTES TO FINANCIAL STATEMENTS (Unaudited)
SEPTEMBER 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 of the Company 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 of
Financial Condition and Results of Operations 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 nine months
ended September 30, 1999, and 99,883,320 and 94,178,427 for the three and nine
months ended September 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 September 30, 1999 and 1998, the Company paid or
accrued $2,683,296 and $2,492,976, respectively, and for the nine months ended
September 30, 1999 and 1998, $8,041,331 and $6,297,348, 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 $50,400, respectively, in
sublease payments during each of the respective three month and nine month
periods ended September 30, 1999 and 1998.
Pursuant to resolutions adopted by the Board of Directors on February 4, 1999,
the Company reimbursed $39,229 and $118,617 to EKI for salaries and benefits
paid by EKI for administrative support personnel during the three months and
nine months ended September 30, 1999, respectively.
Under the Amended and Restated Agreement for Allocation of Patent Costs
effective October 1, 1997, legal fees related to patents of $167,486 and $33,024
were paid to or on behalf of EKI for the three months ended September 30, 1999
and 1998, respectively, and $495,506 and $118,125 for the nine months ended
September 30, 1999 and 1998, respectively.
<PAGE>
EARTHSHELL CORPORATION
NOTES TO FINANCIAL STATEMENTS (Unaudited) - continued
SEPTEMBER 30, 1999
- --------------------------------------------------------------------------------
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<CAPTION>
PROPERTY AND EQUIPMENT
At September 30, 1999, property and equipment consisted of the following:
<S> <C>
Commercial Manufacturing Equipment: ..................... $ 43,754,757
Product Development Center:
Equipment .......................................... 4,294,685
Construction in progress ........................... 2,016,318
Leasehold improvements ............................. 521,253
------------
6,832,256
Office equipment and furniture .......................... 442,365
Office leasehold improvements ........................... 769,754
Less: accumulated depreciation .......................... (4,155,292)
------------
Property and equipment - net ............................ $ 47,643,840
============
</TABLE>
COMMITMENTS
The Company has committed to capital equipment and infrastructure expenditures
of $6.1 million for the Sweetheart Cup Company Inc. manufacturing equipment
installation and $2.3 million for the next generation manufacturing equipment as
of September 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.
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 has contributed 63,000 Danish krone as nominal share capital and
500,000 Euros for start-up capital. The Company is required to pay for the
development of the initial prototypes of the next generation manufacturing
systems. After both joint venture partners agree that acceptable next 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.
BACKGROUND
The Company was organized in November 1992 as a Delaware corporation and
continues to be a development stage enterprise at September 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. 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").
The Company has experienced aggregate net losses of approximately $134 million
from its inception on November 1, 1992 through September 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.
DEVELOPMENT OF FIRST COMMERCIAL MANUFACTURING FACILITY
The development and installation of the Company's first commercial manufacturing
lines at Sweetheart Cup Company Inc's. ("Sweetheart") Owings Mills, Maryland
facility has been the Company's major focus since Sweetheart secured the Perseco
(the primary packaging purchasing agent for McDonald's Corporation) supply
agreement for EARTHSHELL containers for the Big Mac(R) sandwich in October 1997.
Following the Company's initial public offering in early 1998 and in cooperation
with Sweetheart, the Company contracted for the design and construction of
commercial scale EarthShell manufacturing lines to meet projected demand under
the Perseco/McDonald's supply contract. In late 1998, the Company began the
process of debugging and startup of the first of these manufacturing lines.
<PAGE>
The debugging and startup of the first line has taken longer than originally
anticipated. The production output from the first line is currently at lower
than acceptable commercial yields and at a low volume level relative to the
intended capacity requirements. The Company has not run the entire line, on a
fully integrated basis, at a commercially acceptable level of manufacturing
efficiency. One of the primary causes of the delay has been the failure of a
high-speed conveyor segment to meet its original performance specifications. A
new conveyor segment was designed, installed, and placed in operation in early
November 1999. The new conveyor section appears to be functioning as required.
Although the Company has operated a number of the presses in the first line, to
date the Company has not yet run the line with mold tooling in all of the
presses at the same time. Now that the new conveyor system is in place, the
Company expects to have the first line fully tooled and operational during
December 1999. The complete validation of the performance of the line with the
new conveyor is expected to be complete in December 1999. Once the first line is
operating satisfactorily, the Company will proceed to enable the second system
mixer and to startup the remaining lines. Building on the first line experience,
the startup process for these lines is expected to proceed more quickly.
To assure that it will have adequate capacity to meet the anticipated
Perseco/McDonald's rollout schedule, the Company has made contingent plans for
installing additional forming and coating capacity and has obtained commitments
from vendors to supply the required equipment. Implementation of the additional
forming and coating capacity will depend upon the degree to which the first
manufacturing line has achieved targeted manufacturing efficiencies by year-end.
Concurrent with the work to debug and optimize the performance of the first
line, a portion of each week is reserved for regular production to support the
Perseco/McDonald's validation process and to build inventory. Currently, the
line is available for production three days a week in two shifts working 24
hours a day. Initially, this production was staffed by a combination of Company
engineering professionals and Sweetheart manufacturing personnel. Beginning in
late September 1999, Sweetheart's manufacturing personnel assumed responsibility
for the regular production shifts.
Because the Owings Mills facility is the Company's first commercial
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. The
Company believes the estimated capitalized cost of the Sweetheart lines will be
approximately $58.3 million upon completion. The Company expects to have
expensed approximately $10.2 million of process development, design and
engineering costs and approximately $10.9 million in start-up and debugging
expense associated with preparing the Sweetheart facility for full-scale
production. If the addition of forming and coating capacity is not required, the
total project cost was estimated to be approximately $72 million at September
30, 1999. The total project cost for this facility with the additional forming
and coating capacity is estimated to be approximately $79 million.
<PAGE>
KEY CUSTOMER AND PRODUCT VALIDATION
To support the contract with Perseco to supply McDonald's U.S. restaurants with
EARTHSHELL containers for the Big Mac(R) sandwich, the Company agreed to provide
EarthShell-owned manufacturing equipment to be used at Sweetheart with adequate
capacity to fulfill the Perseco/McDonald's supply contract. The manufacturing
facility has been built and the first of these lines is currently being operated
on a limited basis to produce and supply EARTHSHELL containers for the Big
Mac(R) sandwich to Perseco/McDonald's to validate that they meet the performance
specifications agreed to in the supply contract.
The validation process began in June 1999, and is being conducted by Perseco
using a protocol that is typical for all new product introductions into the
McDonald's system. It includes kitchen testing and a number of other tests as
well as evaluating various aspects of product performance and consumer reaction
in actual restaurants. Following initial kitchen and core testing, in July 1999,
EARTHSHELL containers for the Big Mac(R) sandwich were shipped to four
McDonald's stores in the Las Vegas area for testing. In addition, containers
were supplied to two stores in the Baltimore area and two stores in the Chicago
area. Product performance in Las Vegas was monitored during July and August 1999
and feedback was provided to the Company to fine-tune the product. The results
from this testing were encouraging, and in September 1999, Perseco notified the
Company that it was expanding the Las Vegas test from four stores to
approximately 30 stores.
In mid-October 1999, as use of the product was being expanded within the Las
Vegas area, a higher than expected level of breakage was noted. With concurrence
of Perseco, the Company removed the product from all of the Las Vegas area
stores until the problem could be thoroughly assessed and rectified. Analysis
indicated that the breakage problem resulted primarily from the failure of an
automatic bagging machine to consistently seal the product in airtight shipping
bags. As a consequence, certain sleeves of product fell below the specified
moisture content during warehousing and shipping to the stores and became more
susceptible to damage during shipping and handling. The defective bagger has
been repaired and overall quality control procedures have been improved. The
Company and Sweetheart are running extensive internal verification tests before
notifying Perseco that Sweetheart is ready to resume product shipments.
The Company expects to achieve production capacity to meet U.S. demand for the
EARTHSHELL containers for the Big Mac(R) sandwich during the year 2000.
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 demanding 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 "next generation" EarthShell products. The proposed
arrangement with Prairie encompasses the production of plates, bowls, hinged-lid
containers and cups, initially to be sold to Sysco Corporation, the leading
foodservice distributor in North America. 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.
<PAGE>
In August 1999, the Company 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 EARTHSHELL container for the Big
Mac(R) sandwich commitment. This proposal would require investment in additional
capacity of which Sweetheart would pay 50%. This capacity will first be applied
to incremental McDonald's business, on a priority basis, and then to other
customers. The Company also believes that there will be a significant reduction
in the capital cost of this new capacity as well as 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.
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, planning is underway to establish manufacturing capacity based on the
Company's next generation manufacturing processes. Under the terms of the
definitive agreements, Huhtamaki Oyj is actively participating in this effort.
SECOND GENERATION MANUFACTURING DEVELOPMENT
Due to the extensive technical effort and costs required to initially
commercialize the EarthShell technology, the Company does not expect to
demonstrate the full economic potential of EarthShell products at the Company's
first commercial manufacturing facility at Sweetheart. With the benefit of its
experience at Sweetheart and the broad manufacturing experience of its partners,
the Company is developing a next generation manufacturing approach that
utilizes, as much as possible, commercially available conventional industrial
processing equipment. In addition, the Company is developing a next generation
commercial product set that will include bowls, plates, other hinged-lid
containers, and cups.
The Company's manufacturing process is comprised of four core operations;
mixing, forming, coating and printing. These operations must be integrated in a
continuous process through the use of material handling and conveyance systems.
The Company has identified conventional, commercially available process
equipment for mixing, forming and printing that it believes can meet its next
generation manufacturing goals and is working with suppliers of this equipment
to validate suitability. Additionally, the Company is working with conventional
film thermoforming equipment to develop a process to apply biodegradable film as
a coating for EarthShell products. Pilot equipment has been built and used to
manufacture and coat products such as plates, bowls and trays on a small scale.
These products have been used in demonstration projects with the U.S. Department
of the Interior and other users to validate the performance of products as well
as customer acceptance. Initial trials with conventional commercial scale
machinery have also been encouraging. The Company believes it is well positioned
to source competitively priced biodegradable films for the middle and higher
selling price markets for plates and bowls, but more development is required to
arrive at films which satisfy the Company's economic and technical requirements.
Under the terms of existing and contemplated joint venture agreements,
EarthShell and its partners will invest jointly in the commercial facilities
based on projected economic returns. The Company does not intend to commit to
its next series of commercial plant investments until it has demonstrated, using
commercial scale equipment in integrated pilot lines, that its next generation
products can be manufactured at a cost that will produce returns acceptable to
both EarthShell and its partners.
<PAGE>
The Company believes it will take up to nine months to prove next generation
manufacturing economics for plates and bowls during 2000. The Company has not
yet developed a commercial manufacturing process for hot and cold cups, which
represent a significant portion of the Company's targeted market, and therefore,
development of next generation manufacturing systems for cups are expected to
take longer. 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. 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 NINE MONTHS ENDED SEPTEMBER 30, 1999, TO THE
THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 1998
TOTAL RESEARCH AND DEVELOPMENT EXPENSES Total research and development
expenditures for the development of EARTHSHELL Products increased $8.7 million
from $12.8 million for the nine months ended September 30, 1998 to $21.5 million
for the nine months ended September 30, 1999. The increase was primarily related
to the cost of start-up, debugging and supporting the Sweetheart manufacturing
lines. This included a $3.9 million increase in reimbursement to Sweetheart for
costs incurred during the startup and debugging phase of the project, an
increase of $2.3 million related to additional staffing costs to support the
Sweetheart project and next generation product development, an increase of $1.7
million related to reimbursement to EKI for its support of the Sweetheart
operation, for EKI work performed on several demonstration projects and for EKI
efforts in support of next generation manufacturing systems, an increase of $1.0
million for expensed equipment and supplies related to supporting the Sweetheart
project, and an increase of $0.5 million for EarthShell-led next generation
manufacturing activity. These costs were offset by a net reduction of $1.2
million in construction management and design services at Sweetheart as various
vendors completed their work at Sweetheart.
Total research and development expenditures for the development of EARTHSHELL
Products increased $4.2 million from $4.6 million for the three months ended
September 30, 1998 to $8.8 million for the three months ended September 30,
1999. The increase was primarily related to the cost of start-up, debugging and
supporting the Sweetheart manufacturing lines. This included a $1.6 million
increase in reimbursement to Sweetheart for costs incurred during the start-up
and debugging phase of the project, an increase of $0.8 million related to
additional staffing costs to support the Sweetheart project and next generation
product development, and an increase of $0.5 million for expensed equipment and
supplies related to supporting the Sweetheart project.
TOTAL GENERAL AND ADMINISTRATIVE EXPENSES Total general and administrative
expenses increased $4.2 million from $6.3 million for the nine months ended
September 30, 1998 to $10.5 million for the nine months ended September 30,
1999. This is primarily due to increased compensation and benefit costs for a
higher number of employees in the 1999 period of $1.6 million and $1.0 million
in compensation to directors, related primarily to the grant of compensatory
stock options. Approximately $1.6 million of the increase was due to the costs
of being a public company, such as costs of preparing and issuing an annual
report, developing and implementing an investor relations program and legal
costs primarily related to structuring joint ventures. An increase of
approximately $0.7 million was a result of marketing and public relations
expenses in preparation of the national rollout of the EARTHSHELL container for
the Big Mac(R) sandwich. Rent and utility costs also increased $0.2 million in
the nine months ended September 30, 1999 compared to the nine months ended
September 30, 1998 due to the Baltimore, Maryland office being in operation for
the entire period in 1999. Professional services performed by The Boston
Consulting Group decreased $1.0 million in the nine months ended September 30,
1999 due to the completion of the project in the 1998 period.
<PAGE>
Total general and administrative expenses decreased $1.5 million from $4.2
million for the three months ended September 30, 1998 to $2.7 million for the
three months ended September 30, 1999. This is primarily due to decreased
compensation expense incurred in the three months ended September 30, 1999 of
$1.1 million and reduced professional service costs of $1.0 related to a 1998
consulting project by The Boston Consulting Group. These decreases in expenses
were offset by increased marketing and public relations expenses of $0.1 million
and increased costs of being a public company, including legal costs, of $0.3
million during the three months ended September 30, 1999 compared to the three
months ended September 30, 1998.
DEPRECIATION AND AMORTIZATION EXPENSE Depreciation and amortization expense
increased $2.6 million from $0.6 million for the nine months ended September 30,
1998 to $3.2 million for the nine months ended September 30, 1999, and increased
$1.3 million from $0.2 million for the three months ended September 30, 1998 to
$1.5 million for the three months ended September 30, 1999. 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 $377,381
from $118,125 for the nine months ended September 30, 1998 to $495,506 for the
nine months ended September 30, 1999, and increased $134,462 from $33,024 for
the three months ended September 30, 1998 to $167,486 for the three months ended
September 30, 1999. These increases were primarily a result of increased
domestic and international patent activity.
INTEREST INCOME Interest income decreased $0.8 million from $3.6 million for the
nine months ended September 30, 1998 to $2.8 million for the nine months ended
September 30, 1999, and decreased $1.0 million from $1.7 million for the three
months ended September 30, 1998 to $0.7 million for the three months ended
September 30, 1999. These decreases are primarily due to a declining balance of
funds available to be invested in interest bearing securities. 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 $1.1 million to zero for the
nine months ended September 30, 1999 compared with the nine months ended
September 30, 1998. Following the initial public offering, the interest-bearing
debt was repaid.
LIQUIDITY AND CAPITAL RESOURCES AT SEPTEMBER 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
$162.8 million of the net proceeds through September 30, 1999. As of September
30, 1999 the Company had cash totaling approximately $51.3 million. Net cash
used in operations was $29.9 million and $36.8 million for the nine months ended
September 30, 1999 and 1998, respectively. Net cash used in investing activities
was $8.9 million and $31.8 million for the nine months ended September 30, 1999
and 1998, respectively. Other uses of the initial public offering proceeds
include the repayment of indebtedness, payment of outstanding payables, and the
purchase of equipment to facilitate the development of manufacturing capacity
for EARTHSHELL Products.
<PAGE>
The Company has incurred greater than anticipated costs on its first commercial
manufacturing facility at Sweetheart and has incurred costs associated with the
development of its next generation manufacturing systems. During the course of
the development of the Sweetheart manufacturing lines, the Company created a
core in-house competence in manufacturing engineering and design. At the same
time EarthShell's related party, EKI, expanded its workforce to increase its
capabilities in basic material science and applied materials engineering to
support the EarthShell commercialization effort. These activities have been
instrumental in providing solutions to first time manufacturing issues at
Sweetheart as well as assisting in the process re-design and location of
suitable equipment vendors for next 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.
In view of the fact that the commercialization effort is not yet complete, the
Company is moving aggressively to reduce its fundamental operating expense base
by eliminating those functions and related expenses not directly necessary to
complete the commercialization at Sweetheart or next generation manufacturing
development. Similarly the Company is reducing its reliance on EKI and other
outside consultants. Most of the planned cost reduction initiatives will be
completed by year-end, resulting in a reduced cash burn rate entering 2000. With
the planned reductions in scope of activities and related operating expenses,
the Company believes it will have enough cash to complete the initial
commercialization of the manufacturing lines at Sweetheart and demonstrate the
first of the next generation pilot lines.
The Company intends to seek third party financing during the next 12 months to
ensure that it will meet its operating and working capital needs and to initiate
design and development of its next manufacturing facilities at the appropriate
time. 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.
YEAR 2000 COMPLIANCE
The Company is 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 chip systems. For the purposes of this
discussion, "Year 2000 ready " 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 ready. Additionally, the Company
contractually requires that manufacturing equipment suppliers deliver equipment
that is Year 2000 ready.
<PAGE>
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 ready will not be material. The Company has spent
less than $100,000 to date to become Year 2000 ready since major purchases for
hardware, software and devices were deemed to be Year 2000 ready 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 ready will ultimately be
true and the Company is unable to estimate the cost to become Year 2000 ready,
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 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 ready.
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
ready; (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, Novamont S.p.A., an Italian company specializing in the
manufacture of a biodegradable plastic resin and products, filed a complaint in
the United States District Court for the Northern District of Illinois alleging
infringement of three patents. The Company has analyzed all three patents and
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.
At December 31, 1998, the company had applied $114.6 million of the $205.9
million in net offering proceeds. For the nine months ended September 30, 1999,
the Company applied an additional $48.2 million of the net offering proceeds. Of
this amount, $14.3 million was used for the purchase of manufacturing equipment,
$10.2 million was used for construction and engineering costs related to the
manufacturing plant, $2.1 million was used for the demonstration and prototype
facility, and $21.6 million for other 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 next
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 next generation manufacturing systems and to fund operations.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
<PAGE>
ITEM 5. OTHER INFORMATION
As previously reported, D. Scott Houston, Senior Vice President of Corporate
Planning, resumed the position of Chief Financial Officer effective October 8,
1999. Mr. Houston replaces William Spengler who resigned to pursue other
interests.
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
September 30, 1999.
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: November 15, 1999 By:____________________
D. Scott Houston
Chief Financial Officer
(Principal Financial and Accounting
Officer and Duly Authorized Officer)
<TABLE> <S> <C>
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<LEGEND>
This schedule contains summary financial information extracted from Form
10-Q, for the quarterly period ending September 30, 1999 and is qualified
in its entirety by reference to such Form 10-Q.
</LEGEND>
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