Rhett R. Atkins, D.B.A. was
appointed President, Chief Executive Officer and a member of the Board of Directors in June 2002. From January 2001 to June 2002, Dr. Atkins was
President of Palmetto Ag Inc., a retail provider of seed and chemical crop inputs. From September 1991 to December 2000, Dr. Atkins worked for Micro
Flo Company, an agricultural chemical production company, in various executive positions related to sales, marketing and research and development. From
1981 to 1991, Dr. Atkins worked for BASF, a chemical company, in sales and marketing. Dr. Atkins received a B.S. degree from Clemson University, an
M.B.A. degree from Campbell University and a D.B.A. degree from Nova Southeastern University.
Bradley S. Powell served as our
Interim President from November 2001 to June 2002, and has served as Secretary since June 2000 and as Chief Financial Officer and Vice President of
Finance since July 1998. From March 1994 to July 1998, he served as Vice President and Corporate Controller of Omega Environmental, Inc., a provider of
products and services to owners of underground storage tanks. In 1983, Mr. Powell joined KPMG Peat Marwick, an international public accounting firm, as
a certified public accountant and, from 1990 to March 1994, served as a Senior Audit Manager. Mr. Powell received a B.S. degree from Central Washington
University.
Zhongmin Wei, Ph.D. has served
as our Chief Scientific Officer since November 2001, as Vice President of Research since May 1998, as Director of Research from April 1997 to May 1998
and as Senior Scientist from June 1996 to April 1997. From November 1995 to April 1996, Dr. Wei served as Principal Investigator at the Institute of
Molecular Agrobiology in Singapore, an agricultural biotechnology research organization. From July 1992 to June 1996, Dr. Wei served as a Research
Scientist and, from September 1989 to September 1992, as a Post-Doctoral Associate at the Cornell University School of Agricultural and Life Sciences.
Dr. Wei received a B.S. degree from Zhejiang University and M.S. and Ph.D. degrees from Nanjing Agricultural University, both in the People’s
Republic of China.
William T. Weyerhaeuser, Ph.D.
has served as Chairman of the Board of Directors since November 2001 and as one of our directors since May 1998. Dr. Weyerhaeuser was in private
practice as a clinical psychologist from 1975 to 1999. From May 1993 to June 1994, he served as President of Rock Island Company, a private investment
company, and from July 1994 to June 1998 as its Chairman of the Board and Chief Executive Officer. Dr. Weyerhaeuser currently serves as a director of
several privately held companies and foundations, and of two other public companies, Potlatch Corporation, a timber and paper products company, and
Columbia Banking System, Inc., a financial institution. Dr. Weyerhaeuser received a B.A. degree from Stanford University, an M.A. degree from Fuller
Theological Seminary and a Ph.D. degree from the Fuller Graduate School of Psychology.
Gilberto H. Gonzalez has served
as one of our directors since February 2003. Mr. Gonzalez currently serves as Chairman of Evergreen Business Group, LLC, a company involved in real
estate marketing, investing and development, and as Chairman of Select Capital Group, a financial services company. Beginning in 1970, Mr. Gonzalez has
worked in the agricultural chemical business in various executive capacities in sales and marketing. Most recently, Mr. Gonzalez served as Executive
Vice President of Micro Flo Company, an agricultural chemical production company, from 1991 to 1999, and Regional Sales Manager from 1985 to 1989. From
1970 to 1985, Mr. Gonzalez worked for Helena Chemical Company in a variety of managerial roles, most notably Division Manager of the Midwest and
Northcentral Divisions, and as Director of the Andean Block for Vertac International, an international division of Helena. Mr. Gonzalez received a B.S.
degree in Agricultural Business and Economics from Texas A&M University.
Roger M. Ivesdal has served as
one of our directors since September 20, 2005. Mr. Ivesdal has spent 33 years in various sales, marketing, and management roles in the agricultural
chemicals industry. Mr. Ivesdal started his career in 1970 as a sales representative for Helena Chemical Company in DesMoines, Iowa and became sales
manager for Helena Proprietary Products in 1974. In 1977, Mr. Ivesdal became a sales representative for Ostlund Chemical in Fargo, ND. In 1982, he
became sales manager and in 1988 he became General Manager of Ostlund. In 1998, Mr. Ivesdal was named Executive Vice President for the Western Region
for United Agri Products, an operating company of ConAgra, and was responsible for managing four
18
operating companies in the western
United States. In 2003, Mr. Ivesdal retired from UAP. Mr. Ivesdal received a BS degree in agronomy from North Dakota State University.
Jon E. M. Jacoby has served as
one of our directors since February 1999. Until his retirement in October 2003, Mr. Jacoby worked in various capacities since 1963, most recently as
Vice-Chairman and member of the Executive Committee, for Stephens Inc. and Stephens Group, Inc., collectively engaged in investment banking and other
business activities, and remains a director of Stephens Group, Inc. He is also a director of Delta & Pine Land Company, an agricultural products
company; Power-One, Inc., a power supplies manufacturer; Sangamo Biosciences, a biotechnology company; and Conn’s Inc., retail stores specializing
in electronics. Mr. Jacoby received a B.S. degree from the University of Notre Dame and an M.B.A. degree from Harvard Business School.
Albert A. James has served as
one of our directors since May 1995 and as our Secretary from May 1995 to June 2000. Mr. James is a private investor and currently serves as a general
partner in several real estate projects in the western United States. Mr. James has also served as a director of several privately held companies. From
1982 to November 1997, Mr. James served as Managing Partner of Bellevue Associates, a commercial real estate management company. He served as Secretary
and Treasurer of Anthony’s Restaurants, a regional chain of restaurants, from 1976 to June 1995, and, from 1981 to March 1994, Mr. James served as
Vice President of Alpine Industries, a window and laminated glass manufacturing company. In 1957, Mr. James founded a discount drug and cosmetic
business that merged with a chain of discount retail drug stores, which was ultimately sold to Payless Drug Stores Northwest in 1969. Mr. James
received a B.S. degree in Pharmacy from the University of Washington.
Agatha L. Maza has served as one
of our directors since May 1995. From February 1994 to October 1995, Ms. Maza served as Chief Executive Officer of the National Testing Laboratory in
Portland, a division of the American Red Cross involved in biological testing of blood. From July 1991 to January 1994, she served as Chief Executive
Officer of Medical Arts Laboratory and, from January 1988 to December 1990, as Chief Executive Officer of Eastside Medical Laboratory, both of which
are medical diagnostics services laboratories. From 2001 to 2005, Ms. Maza served as Chief Executive Officer, President of Roadable Aircraft
International, Inc., a start-up company involved in the research and development of new transportation technologies. Currently, Ms. Maza serves as
managing partner of several privately held companies. Ms. Maza received a B.S. degree from Seattle University and an M.B.A. degree from City University
and has completed the Executive Marketing Management Program at Stanford University.
Richard N. Pahre has served as
one of our directors since February 2003. Mr. Pahre is a certified public accountant and, effective December 31, 2002, retired as a partner of Moss
Adams LLP, a public accounting firm that provides services to a wide-range of public and private clients. From February 1977 to December 2002, Mr.
Pahre served as an audit partner of Moss Adams LLP. Mr. Pahre joined Moss Adams LLP in August 1975 and served as a Senior Audit Manager through January
1977. Mr. Pahre joined the public accounting firm of Price Waterhouse & Co. in June 1962, and from June 1967 to August 1975 served as a Senior
Audit Manager. Since 1993, Mr. Pahre has served on the Board of Directors and as Treasurer (non-executive) of Seattle Goodwill, a nonprofit
organization. In February 2005, Mr. Pahre was elected to the Board of Directors of CityBank, a commercial bank, headquartered in Lynnwood, Washington,
and a NASDAQ listed public company. Mr. Pahre received a B.A. degree in accounting from the University of Washington.
Item 1A. Risk
Factors.
Factors That May Affect Our Business, Future Operating
Results and Financial Condition
You should carefully consider the
risks described below, together with all of the other information included in this Annual Report on Form 10-K. The risks and uncertainties described
below are not the only ones facing our company. If any of the following risks actually occurs, our business, financial condition or operating results
could be harmed.
19
We have a history of losses since inception, we expect to
continue to incur losses and we may not achieve or sustain profitability.
We have incurred operating losses in
each quarter since inception and we expect to continue to incur further operating losses for the foreseeable future. From our inception in July 1994 to
December 31, 2005, we have accumulated a deficit of $116.8 million. For the years ended December 31, 2005, 2004, 2003, 2002 and 2001, we had net losses
of $10.9 million, $8.9 million, $11.2 million, $23.5 million and $23.7 million, respectively. To date, our revenues have been limited. For example,
there were no sales in the fourth quarter of 2001 and annual net sales decreased from $3.5 million in 2001 to $1.9 million in 2002, $1.8 million in
2003 and $1.0 million in 2004. Our annual net sales were $3.8 million in 2005. We expect our future revenues to come primarily from the sale of
Messenger STS, employ, MightyPlant, ProAct™, N-Hibit™ and other products and these sales are highly uncertain.
We expect to continue to devote
substantial resources to funding sales and marketing activities in the United States and foreign countries, maintaining and operating our manufacturing
facility and funding our research and development activities. As a result, we will need to generate significant revenues to achieve and maintain
profitability. We may never generate profits, and if we do become profitable, we may be unable to sustain or increase profitability on a quarterly or
annual basis.
We currently anticipate that our
operating expenses will significantly exceed net product sales and that net losses and working capital requirements will consume a material amount of
our cash resources. If net product sales do not significantly increase in the near term, we will have to further reduce our operating expenses. We
believe that the balance of our cash and cash equivalents at December 31, 2005 will be sufficient to meet our anticipated cash needs for net losses,
working capital and capital expenditures for more than the next 12 months, although there can be no assurance in that regard.
We may have to reduce or cease operations if we are unable
to meet our funding requirements.
We will require substantial additional
funding to continue our sales and marketing and research and development activities in the United States and foreign countries and to maintain and
operate our manufacturing facilities. If we are unable to generate sufficient cash flow from operations, or obtain funds through additional financing,
we may have to delay, curtail or eliminate some or all of our research and development, field-testing, marketing or manufacturing programs or cease all
operations. For example, we reduced our workforce by 34% in May 2003 and by 23% in May 2002, significantly curtailing certain research and development
activities and our European and Mexican operations. Our future capital requirements will depend on the success of our operations.
If our capital requirements vary from
our current plans, we may require additional financing sooner than we anticipate. Financing may be unavailable to us when needed or on acceptable
terms.
Our common stock listing was transferred from The
Nasdaq National Market to The Nasdaq Capital Market (formerly known as The Nasdaq SmallCap Market); we currently are not in compliance with The Nasdaq
Capital Market minimum bid requirement and failure to regain and maintain compliance with this and other continued listing standards could result in
delisting and adversely affect our market price and liquidity.
Our common stock listing was
transferred from The Nasdaq National Market to The Nasdaq Capital Market on October 10, 2005. We elected to seek a transfer to The Nasdaq Capital
Market because we had been unable to regain compliance with Nasdaq’s minimum $1.00 bid price requirement for continued listing. By transferring to
The Nasdaq Capital Market, we have been afforded an additional 180-calendar day grace period, or until March 31, 2006, in which to satisfy
Nasdaq’s $1.00 minimum bid price requirement. To regain compliance, the closing bid price of our common stock has to remain at $1.00 per share or
more for a minimum of ten consecutive trading days. If we do not regain compliance with the minimum bid price rule by March 31, 2006, which as of the
date of this report we have been unable to do, Nasdaq will provide us written notification that our common stock will be delisted. In such case, we
have the right to appeal Nasdaq’s delisting determination to a Listing Qualifications Panel. In order to regain compliance with the
minimum
20
bid price requirement, our Board of
Directors may approve a reverse stock split of our common stock, although there can be no assurance that a reverse stock split would allow us to meet
the minimum bid price requirement for the required period of time.
Trading on The Nasdaq Capital Market
may have a negative impact on the value of our common stock, because securities trading on The Nasdaq Capital Market typically are less liquid than
those traded on The Nasdaq National Market. Furthermore, we will not be eligible to relist our common stock on The Nasdaq National Market unless and
until our common stock maintains a minimum bid price of $5.00 per share for 90 consecutive trading days and we otherwise comply with the initial
listing requirements for The Nasdaq National Market.
If our common stock were to be delisted
from The Nasdaq Capital Market, we may seek quotation on a regional stock exchange, if available. Such listing could reduce the market liquidity for
our common stock. If our common stock is not eligible for quotation on another market or exchange, trading of our common stock could be conducted in
the over-the-counter market on an electronic bulletin board established for unlisted securities such as the Pink Sheets or the OTC Bulletin Board. As a
result, an investor would find it more difficult to dispose of, or obtain accurate quotations for the price of, our common stock.
If our common stock is delisted from
The Nasdaq Capital Market, and if we fail to obtain quotation on another market or exchange, and if the trading price remains below $5.00 per share,
then trading in our common stock might also become subject to the requirements of certain rules promulgated under the Securities Exchange Act of 1934,
which require additional disclosure by broker-dealers in connection with any trade involving a stock defined as a “penny stock” (generally,
any equity security not listed on a national securities exchange or quoted on Nasdaq that has a market price of less than $5.00 per share, subject to
certain exceptions). Many brokerage firms are reluctant to recommend low-priced stocks to their clients. Moreover, various regulations and policies
restrict the ability of shareholders to borrow against or “margin” low-priced stocks, and declines in the stock price below certain levels
may trigger unexpected margin calls. Additionally, because brokers’ commissions on low-priced stocks generally represent a higher percentage of
the stock price than commissions on higher priced stocks, the current price of the common stock can result in an individual shareholder paying
transaction costs that represent a higher percentage of total share value than would be the case if our share price were higher. This factor may also
limit the willingness of institutions to purchase our common stock. Finally, the additional burdens imposed upon broker-dealers by these requirements
could discourage broker-dealers from facilitating trades in our common stock, which could severely limit the market liquidity of the stock and the
ability of investors to trade our common stock.
We currently depend on products that are based on the same
new technology, and our development and commercialization of those products may not be successful.
For the immediately foreseeable future
we will be dependent on the successful development and commercialization of six products in our Harp-N-Tek product portfolio (Messenger, Messenger STS,
ProAct, N-Hibit, employ and MightyPlant) which are based on the same new technology. We have had only limited sales of Messenger since its introduction
in August 2000 and we began marketing employ in November 2003, Messenger STS in January 2004, MightyPlant in April 2004 and N-Hibit and ProAct in early
2005. These six products may not be commercially successful. Our products may not prove effective or economically viable for all crops or markets. In
addition, because our products have not been put to widespread commercial use over significant periods of time, no assurance can be given that adverse
consequences might not result from their use, such as soil or other environmental degradation, the development of negative effects on animals or plants
or reduced benefits in terms of crop yield or protection.
The markets for our products and other
harpin-based products we may develop are unproven. Our products have not gained, and may not gain, commercial acceptance or success. If we are unable
to successfully achieve broad market acceptance of our products, we may not be able to generate enough product revenues in the future to achieve
profitability. A variety of factors will determine the success of our market development and commercialization efforts and the rate and extent of
market acceptance of our products, including our ability to
21
implement and maintain an
appropriate pricing policy and general economic conditions in agricultural markets, including commodity prices, climatic conditions and the extent that
growers, regulatory authorities and the public accept new agricultural practices and products developed through biotechnology.
We have experienced limited grower usage of Messenger and
Messenger STS, and independent distributors hold significant inventories of Messenger STS.
Based on information received from
distributors, we estimate that distributors sold the following amounts of Messenger and/or Messenger STS to growers: 66,000 ounces in 2000, 596,000
ounces in 2001, 684,000 ounces in 2002, 734,000 ounces in 2003, 800,000 ounces in 2004 and 860,000 in 2005. We estimate that Messenger and Messenger
STS inventory held by distributors at December 31, 2005 was approximately 309,000 ounces. We sent distributors approximately 470,000 ounces of
additional Messenger STS for free in 2004 as part of an effort to lower the average cost of their year-end Messenger inventories by approximately 50%.
This free product significantly increased channel inventory and negatively affected our sales to distributors. We do not expect distributors that hold
significant inventories of Messenger or Messenger STS to place additional orders for our products until their current inventories are reduced, which
will adversely affect our sales and results of operations.
Inability to develop adequate sales and marketing
capabilities could prevent us from successfully commercializing our current products and other products we may develop.
We currently have limited sales and
marketing experience and capabilities. Our internal sales and marketing staff consist primarily of sales and marketing specialists who are trained to
educate growers and independent distributors on the uses and benefits of our products. We will need to further develop our sales and marketing
capabilities in order to enhance our commercialization efforts, which will involve substantial costs. These specialists require a high level of
technical expertise and knowledge regarding our products’ capabilities and other plant protection and yield enhancement products and techniques.
We cannot assure you that our specialists and other members of our sales and marketing team will successfully compete against the sales and marketing
operations of our current and future competitors that may have more established relationships with distributors, retailers and growers. Failure to
recruit, train and retain important sales and marketing personnel, such as our sales and marketing specialists, or the inability of new sales and
marketing personnel to effectively market and sell our current products and other products we may develop, could impair our ability to gain market
acceptance of our products and cause our sales to suffer.
We may be unable to establish or maintain successful
relationships with independent distributors and retailers, which could adversely affect our sales.
We intend to rely on independent
distributors and retailers of agri-chemicals to distribute and assist with the marketing and sale of our current products and any other products we may
develop. We have engaged several independent distributors and retailers for the distribution and sale of our products. Our future revenue growth will
depend in large part on our success in establishing and maintaining these sales and distribution channels. We are continuing to develop our
distribution network and we may be unable to establish or maintain these relationships in a timely or cost-effective manner. Moreover, we cannot assure
you that the distributors and retailers on which we rely will focus adequate resources on selling these products or will be successful in selling them.
Many of our potential distributors and retailers are in the business of distributing and sometimes manufacturing other, possibly competing, plant
protection and yield enhancement products and may perceive our products as a threat to various product lines currently being manufactured or
distributed by them. In addition, the distributors and retailers may earn higher margins by selling competing products or combinations of competing
products. If we are unable to establish or maintain successful relationships with independent distributors and retailers, we will need to further
develop our own distribution and sales and marketing capabilities, which would be expensive and time-consuming and the success of which would be
uncertain.
Five distributors accounted for an
aggregate of 59% of net product sales revenue in 2005, three distributors accounted for an aggregate of 46% of our net sales revenue in 2004 and three
distributors accounted for an
22
aggregate of 40% of our net sales
revenue in 2003. If any distributor that purchases a significant amount of our products were to discontinue purchasing our products at any time, our
sales would be adversely affected. In addition, the failure of any of these distributors, or of any other distributor to which we extend a significant
amount of credit, to pay its account, now or in the future, may harm our operating results.
If our ongoing or future field trials are unsuccessful, we
may be unable to achieve market acceptance or obtain regulatory approval of our current products or any other products we may
develop.
The successful completion of multiple
field trials in domestic and foreign locations on a wide variety of crops is critical to the success of our product development and marketing efforts.
If our ongoing or future field trials are unsuccessful or produce inconsistent results or adverse side effects, or if we are unable to collect reliable
data, regulatory approval of our current products or any other products we may develop could be delayed or withheld or we may be unable to achieve
market acceptance of these products. Although we have conducted successful field trials on a broad range of crops, we cannot be certain that additional
field trials conducted on a greater number of acres, or on crops for which we have not yet conducted field trials, will be successful. Moreover, the
results of our ongoing and future field trials are subject to a number of conditions beyond our control, including weather-related events such as
droughts and floods, severe heat and frost, hail, tornadoes and hurricanes. Generally, we pay third parties, such as consultants and universities, to
conduct our field trials for us. Incompatible crop treatment practices or misapplication of the product by third parties could interfere with the
success of our field trials.
We are largely in the development stage and are subject to
the risks of a new enterprise and the commercialization of a new technology.
We began our operations in 1994 and
began the marketing and sale of our first product, Messenger, in the third quarter of 2000. Our stage of development, our novel technology and the
uncertain nature of the market in which we compete make it difficult to assess our prospects or predict our future operating results. We are subject to
risks and uncertainties frequently encountered in the establishment of a new business enterprise, particularly in the rapidly changing market for plant
protection and yield enhancement products. These risks include our inability to develop a company capable of supporting commercial activities,
including manufacturing, quality control and assurance, regulatory approval and compliance, marketing, sales, distribution and customer service. Our
inability to adequately address these risks could cause us to be unprofitable or to cease operations.
International expansion will subject us to risks associated
with international operations, which could adversely affect both our domestic and international operations.
Our success depends in part on our
ability to expand internationally as we obtain regulatory approvals to market and sell our current products, and any other products we may develop, in
other countries. We received registration to sell Messenger in Spain in March of 2004. We have been conducting field trials in several international
locations and we have personnel in Europe to develop operations in that region. International expansion of our operations could impose substantial
burdens on our resources, divert management’s attention from domestic operations or otherwise adversely affect our business. Furthermore,
international operations are subject to several inherent risks, such as different regulatory requirements and reduced protection of intellectual
property rights, which could adversely affect our ability to compete in international markets and could have a negative effect on our operating
results.
The high level of competition in our market may result in
price reductions, reduced margins or the inability of our products to achieve market acceptance.
The market for plant protection and
yield enhancement products is intensely competitive, rapidly changing and undergoing consolidation. We may be unable to compete successfully against
our current or future competitors, which may result in price reductions, reduced margins or the inability to achieve market acceptance of our current
products or any other products we may develop. For example, from September to
23
December 2003 we offered growers a
“buy one, get one free” promotion and in January 2004 we introduced Messenger STS at a price that is approximately 50% of the 2003 price of
Messenger.
Many companies are engaged in
developing plant protection and yield enhancement products. Our competitors include major international agri-chemical companies, specialized
biotechnology companies and research and academic institutions. Many of these organizations have significantly more capital, research and development,
regulatory, manufacturing, distribution, sales, marketing, human and other resources than we do. As a result, they may be able to devote greater
resources to the development, manufacture, promotion or sale of their products, receive greater resources and support from independent distributors,
initiate or withstand substantial price competition or take advantage of acquisition or other opportunities more readily. Furthermore, these large
agri-chemical companies have a more diversified product offering than we do, which may give them an advantage in meeting customer needs by enabling
them to offer integrated solutions to plant protection and yield enhancement.
Age and actual storage conditions of our products may cause
them to degrade, which could adversely affect market acceptance of our products or our results of operations.
Our products are currently being stored
in large quantities under various conditions by us and by distributors. Most of this material was manufactured in 2002, 2004 and 2005. The results of
re-testing of Messenger manufactured in 2000 indicate that it is still stable with similar biological activity and performance as of the original
manufacture date. No assurance can be given, however, that actual storage conditions will not cause our products’ quality to degrade over a
shorter time period.
The inventory of Messenger STS held by us and by
distributors is aging and may not meet our quality standards, which could adversely affect market acceptance of our products and our results of
operations.
Our inventory at December 31, 2005
includes approximately 2.1 million ounces of Messenger STS that was manufactured in 2002 and 2004. In addition, we estimate that distributors own
approximately 239,000 ounces of Messenger and Messenger STS that was manufactured between 2002 and 2004. We conducted limited re-testing of Messenger
samples produced in 2000 and 2001. In 2003, we voluntarily recalled and replaced approximately 10,000 ounces of Messenger owned by distributors that
our limited re-testing indicated had degraded below our quality control standards.
Although results of our limited
re-testing in 2004 indicated that almost all of inventory manufactured in 2001 and 2002 continues to meet our quality standards, no assurance can be
given that this material will continue to meet our quality standards, nor can we predict if or when this material might fail to meet our quality
standards. If re-testing indicates that additional material has degraded below our quality standards, we may have to record additional inventory
write-downs and, although we are not required to, may choose to replace any such product owned by distributors or growers, which could adversely affect
the market acceptance of our products or our results of operations.
Inability to obtain regulatory approvals, or to comply with
ongoing and changing regulatory requirements, could delay or prevent sales of our current products or any other products we may
develop.
The field testing, manufacture, sale
and use of plant health products, including Messenger, Messenger STS, ProAct, N-Hibit, employ, MightyPlant and other products we may develop, are
extensively regulated by the EPA and/or state, local and foreign governmental authorities. These regulations substantially increase the cost and time
associated with bringing our current products and any other products we may develop to market. If we do not continue to receive the necessary
governmental approvals to test, manufacture and market these products, or if the regulatory authorities revoke our approvals or grant them subject to
restrictions on their use, we may be unable to sell these products and our business may fail.
We are required to obtain regulatory
approval from certain state and foreign regulatory authorities before we market our products in those jurisdictions. Some of these jurisdictions may
apply different criteria than the EPA in connection with their approval processes. Although we are authorized to sell Messenger STS in
24
49 states for use on virtually all
crops for crop production and disease management, and to sell Messenger STS in California for use on strawberries, citrus, grapes and fruiting
vegetables, such as tomatoes and peppers, for disease management, we have not received approval of Messenger, Messenger STS or N-Hibit for use on other
crops in California. ProAct has been approved for use in all states except California. In January 2006, ProAct was approved for use in Germany as a
plant strengthener. We have also received authorization to sell Messenger, or are exempt from formal authorization requirements, in at least 26 foreign
countries, including Spain, Germany, Greece, Turkey, Mexico, China and six Central American countries. Our registration in China is temporary and
limited to the sale of Messenger for use on tomatoes, peppers, tobacco, and rapeseed. Our registration in Spain was limited to the sale of Messenger
for use on tomatoes, peppers, cucumbers, melons, strawberries, lettuce, citrus and olives and was extended to all crops in early 2006. The EPA has
approved the use of Messenger STS and we are currently in the process of obtaining foreign registrations for this product, but there can be no
assurance that such registrations will be obtained on acceptable terms.
Neither employ nor MightyPlant are
pesticides and they are not regulated by the EPA. However, several states and foreign governments regulate both products. Many states regulate employ
as a plant amendment or soil conditioner and some of these states and foreign regulatory authorities require the submission and review of performance
data and other information prior to granting their approval. We are authorized to sell employ in 33 states and no foreign countries. MightyPlant is
classified by most states as a fertilizer and we are authorized to sell MightyPlant in 47 states and no foreign countries. However, there can be no
assurance that we will obtain approval to sell employ or MightyPlant in other states or foreign countries.
If we significantly modify our current
products’ designs as a result of our ongoing research and development projects, additional EPA and other regulatory approvals may be required.
Moreover, we cannot assure you that we will be able to obtain approval for marketing additional harpin-based products or product extensions that we may
develop. For example, while the EPA has in place a registration procedure for products such as Messenger that is streamlined in comparison to the
registration procedure for chemical pesticides, there can be no assurance that all of our products or product extensions will be eligible for the
streamlined procedure or that the EPA will not impose additional requirements that could make the procedure more time-consuming and costly for any
future products we may develop.
Even if we obtain all necessary
regulatory approvals to market and sell our current products and any other products we may develop, these products will be subject to continuing review
and extensive regulatory requirements. The EPA, as well as state and foreign governmental authorities, could withdraw a previously approved product
from the market upon discovery of new information, including an inability to comply with regulatory requirements or the occurrence of unanticipated
problems with the product, or for other reasons. In addition, federal, state and foreign regulations relating to crop production and protection
products developed through biotechnology are subject to public concerns and political circumstances and, as a result, regulations have changed and may
change substantially in the future. These changes may result in limitations on the manufacturing, marketing or use of our current products or any other
products we may develop and commercialize.
Our product development efforts, which are based on an
innovative technology that is commercially unproven, may not be successful.
Our harpin and harpin-related
technology is new and commercially unproven. It may take years and significant capital investment to develop viable enhancements of our current
products or any new products we may develop based on our harpin and harpin-related technology. Risks inherent in the development of products based on
innovative technologies include the possibility that:
• |
|
new products or product enhancements will be uneconomical to
market or will be difficult to produce on a large scale; |
• |
|
proprietary rights of third parties will prevent us from
marketing products; and |
• |
|
third parties will market superior or equivalent products or
will market their products first. |
25
Our operating results are likely to fluctuate, resulting in
an unpredictable level of sales and earnings and a decrease in our stock price.
Our operating results for a particular
quarter or year are likely to fluctuate, which could result in uncertainty surrounding our level of sales and losses or earnings and possibly result in
a decrease in our stock price. For example, there were no sales of Messenger in the fourth quarter of 2001 and annual net product sales decreased 70%
from 2001 to 2004. Numerous other factors will contribute to the unpredictability of our operating results. In particular, our sales are expected to be
highly seasonal. Sales of plant protection and yield enhancement products depend on planting and growing seasons, climatic conditions and economic and
other variables, which we expect to result in substantial fluctuations in our quarterly sales and earnings. For example, weather-related events such as
droughts and floods, severe heat and frost, hail, tornadoes and hurricanes could decrease demand for our products and any future products we may
develop, and have an adverse impact on our operating results from quarter to quarter. In addition, most of our expenses, such as employee compensation
and lease payments for facilities, are relatively fixed. Our expense levels are based, in part, on our expectations regarding future sales. As a
result, any shortfall in sales relative to our expectations could cause significant changes in our operating results from quarter to quarter. Other
factors may also contribute to the unpredictability of our operating results, including the amount of our products carried in inventory by independent
distributors and retailers, the amount of free product to be given to retailers, the size and timing of significant customer transactions, the delay or
deferral of customer use of our products and the fiscal or quarterly budget cycles of our customers. For example, customers may purchase large
quantities of our products under a promotion such as “buy one, get one free” in a particular quarter to store and use over long periods of
time, or time their purchases to coincide with the availability of capital, either of which may cause significant fluctuations in our operating results
for a particular quarter or year.
Inability to protect our patents and proprietary rights in
the United States and foreign countries could limit our ability to compete effectively since our competitors may take advantage of our patents or
proprietary rights.
Our success depends on our ability to
obtain and maintain patent and other proprietary-right protection for our technology and products in the United States and other countries. If we are
unable to obtain or maintain these protections, we may not be able to prevent third parties from using our proprietary rights. We also rely on trade
secrets, proprietary know-how and continuing technological innovation to remain competitive. We have taken measures to protect our trade secrets and
know-how, including the use of confidentiality agreements with our employees, consultants and advisors. It is possible that these agreements may be
breached and that any remedies for breach will not make us whole. We generally control and limit access to, and the distribution of, our product
documentation and other proprietary information. Despite our efforts to protect these proprietary rights, unauthorized parties may copy aspects of our
products or obtain and use information that we regard as proprietary. We also cannot guarantee that other parties will not independently develop our
know-how or otherwise obtain access to our technology.
The laws of some foreign countries do
not protect proprietary rights to the same extent as the laws of the United States, and many companies have encountered significant problems and
incurred significant costs in protecting their proprietary rights in these foreign countries.
Patent law is still evolving with
respect to the scope and enforceability of claims in the fields in which we operate. We are like many biotechnology companies in that our patent
protection is highly uncertain and involves complex legal and technical questions for which legal principles are not firmly established. Our patents
and those patents for which we have license rights may be challenged, narrowed, invalidated or circumvented. In addition, our issued patents may not
contain claims sufficiently broad to protect us against third parties with similar technologies or products, or provide us with any competitive
advantage. We are not certain that our pending patent applications will be issued. Moreover, our competitors could challenge or circumvent our patents
or pending patent applications.
The U.S. Patent and Trademark Office
and the courts have not established a consistent policy regarding the breadth of claims allowed in biotechnology patents. The allowance of broader
claims may increase the
26
incidence and cost of patent
interference proceedings and the risk of infringement litigation. On the other hand, the allowance of narrower claims may limit the value of our
proprietary rights.
Other companies may claim that we infringe their
intellectual property or proprietary rights, which could cause us to incur significant expenses or be prevented from selling our current products or
any other products we may develop in the future.
Our success depends on our ability to
operate without infringing the patents and proprietary rights of third parties. Product development is inherently uncertain in a rapidly evolving
technological environment in which there may be numerous patent applications pending, many of which are confidential when filed, with regard to similar
technologies. Future patents issued to third parties may contain claims that conflict with our patents. Although we believe that our current products
do not infringe the proprietary rights of any third parties, third parties could assert infringement claims against us in the future. Any litigation or
interference proceedings, regardless of their merit or outcome, would probably be costly and require significant time and attention of our key
management and technical personnel. Litigation or interference proceedings could also force us to:
• |
|
stop or delay selling, manufacturing or using products that
incorporate the challenged intellectual property; |
• |
|
enter into licensing or royalty agreements that may be
unavailable on acceptable terms. |
If we do not adequately distinguish our products from
genetically modified plants and products, public concerns over those products could negatively impact market acceptance of our
products.
Claims that the output of genetically
modified plants is unsafe for consumption or that these plants pose a danger to the environment have led to public concerns and negative attitudes
about genetically modified crops, particularly in Europe. We intend to distinguish our products and other topically applied harpin technologies from
genetically modified plants and products. Our products are topically applied and do not modify the plant’s DNA. If the public or our customers
perceive our products as products that genetically modify plants, market acceptance and registration of our products could be delayed, impaired or
limited in countries with strong political resistance to genetically modified plants.
We may be exposed to product liability claims, which could
adversely affect our operations.
We may be held liable or incur costs to
settle product liability claims if our current products or any products we may develop, or any products that use or incorporate any of our
technologies, cause injury or are found unsuitable during product testing, manufacturing, marketing, sale or use. These risks exist even with respect
to any products that have received, or may in the future receive, regulatory approval, registration or clearance for commercial use. We cannot
guarantee that we will be able to avoid product liability exposure.
We currently maintain product liability
insurance at levels we believe are sufficient and consistent with industry standards for companies at our stage of development. We cannot guarantee
that our product liability insurance is adequate, and, at any time, it is possible that such insurance coverage may not be available on commercially
reasonable terms or at all. A product liability claim could result in liability to us greater than our assets and insurance coverage. Moreover, even if
we have adequate insurance coverage, product liability claims or recalls could result in negative publicity or force us to devote significant time and
attention to matters other than those that arise in the normal course of business.
Rapid changes in technology could render our current
products or any other products we may develop unmarketable or obsolete.
We are engaged in an industry
characterized by extensive research efforts and rapid technological development. Our competitors, many of which have substantially greater
technological and financial resources than we do, may develop plant protection and yield enhancement technologies and products that are
more
27
effective than ours or that render
our technology and products obsolete or uncompetitive. To be successful, we will need to continually enhance our current products and any other
products we may develop and to design, develop and market new products that keep pace with new technological and industry
developments.
Inability to comply with regulations applicable to our
facilities and procedures could delay, limit or prevent our research and development or manufacturing activities.
Our research and development and
manufacturing facilities and procedures are subject to continual review and periodic inspection. To comply with the regulations applicable to these
facilities and procedures, we must spend funds, time and effort in the areas of production, safety and quality control and assurance to help ensure
full technical compliance. If the EPA or another regulator determines that we are not in compliance, regulatory approval of our current products or any
other products we may develop could be revoked, delayed or withheld or we may be required to limit or cease our research and development or
manufacturing activities or pay a monetary fine. If we were required to limit or cease our research and development activities, our ability to develop
new products would be impaired. In addition, if we were required to limit or cease our manufacturing activities, our ability to produce our current
products in commercial quantities would be impaired or prohibited, which could have an adverse effect on our sales.
Inability to produce high quality products could impair our
business.
To be successful, we will have to
manufacture our current products in large quantities at acceptable costs while also preserving high product quality. If we cannot maintain high product
quality on a large scale, we may be unable to achieve market acceptance of our products and our sales would likely suffer. Moreover, we do not have
back-up manufacturing systems and, as a result, the failure of any component required in the manufacturing process could delay or impair our ability to
manufacture our products in the quantities that we may require.
We intend to continue to make changes
to our manufacturing processes and facilities in order to improve the efficiency and quality of our manufacturing activities. We cannot guarantee that
we will be successful in this regard or that the changes we make will improve our manufacturing activities. We may encounter difficulties in the
production of our current products or any future products we may develop, including problems involving manufacturing processes or yields, packaging,
distribution, storage, quality control and assurance, shortages of qualified personnel or compliance with regulatory requirements. Even if we are
successful in developing our manufacturing capability and processes, there can be no assurance that we will satisfy the requirements of our
distributors or customers.
If third-party manufacturers fail to perform adequately, we
could be unable to meet demand and our revenues could be adversely affected.
When our manufacturing plant is
operating, we may depend on independent manufacturers for large-scale fermentation services and to perform certain other portions of our production
process. We intend to engage additional third-party manufacturers as necessary to perform these processes. Any failure or delay in the ability of our
current or any future manufacturers to provide us with material they produce could adversely affect our ability to produce our current products in the
quantities necessary to satisfy the requirements of our distributors or customers, or could increase our costs associated with obtaining such
materials. In addition, the time and resources that our current or future third-party manufacturers devote to our business are not within our control.
We cannot ensure that our current or future third-party manufacturers will perform their obligations to meet our quality standards, that we will derive
cost savings or other benefits from our relationships with them or that we will be able to maintain a satisfactory relationship with them on terms
acceptable to us. Moreover, these manufacturers may support products that compete directly or indirectly with ours, or offer similar or greater support
to our competitors. If any of these events were to occur, our business and operations could be adversely affected.
28
Inability to address strain on our resources caused by
growth could result in ineffective management of
our business.
If we experience growth and add
manufacturing, marketing, sales, field development or other personnel, both domestically and internationally, during the commercialization of our
current products, we expect that our operating expenses and capital requirements will increase. Our ability to manage growth effectively requires us to
continue to expend funds to improve our operational, financial and management controls, reporting systems and procedures. In addition, we must
effectively expand, train and manage our employee base. We will be unable to effectively manage our business if we are unable to timely and
successfully alleviate the strain on our resources caused by growth in our business, which could adversely affect our operating
results.
Inability to retain our key employees or other skilled
managerial or technical personnel could impair our ability to maintain or expand our business.
We are highly dependent on the efforts
and abilities of our current key managerial and technical personnel, particularly Dr. Rhett R. Atkins, our President and Chief Executive Officer, and
Dr. Zhongmin Wei, our Chief Scientific Officer and Vice President of Research. Our success will depend in part on retaining the services of Drs. Atkins
and Wei and our other existing key management and technical personnel and on attracting and retaining new, highly qualified personnel.
Inability to retain our existing key
management or technical personnel or to attract additional qualified personnel could, among other things, delay our sales, marketing, manufacturing and
research and development efforts. Moreover, in our field, competition for qualified management and technical personnel is intense and many of the
companies with which we compete for experienced personnel have greater financial and other resources than we do. As a result, we may be unable to
recruit, train and retain sufficient qualified personnel.
Item 1B. Unresolved Staff
Comments.
None.
Item 2.
Properties.
As of December 31, 2005, our principal
facilities in and around Bothell, Washington, which house our manufacturing, research, administration and warehouse functions, total approximately
41,900 square feet and are leased under the following arrangements:
• |
|
24,000 square feet of warehouse space is leased through January
2006; and |
• |
|
17,900 square feet of manufacturing, research and administration
space is leased through December 2009. |
We also lease office space in
Annapolis, Maryland and Mulhouse, France on a short-term basis. We do not own any real estate.
Item 3. Legal
Proceedings.
The Company is subject to various
claims and legal actions that arise in the ordinary course of business and believes that the ultimate liability, if any, with respect to these claims
and legal actions will not have a material effect on its consolidated financial statements.
Item 4. Submission of Matters to a
Vote of Security Holders.
None.
29
PART II
Item
5. |
|
Market for Registrant’s Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity Securities. |
Our common stock has been quoted on The
Nasdaq Capital Market under the symbol “EDEN” since October 10, 2005. From our initial public offering on September 27, 2000 through October
9, 2005, our stock was quoted on The Nasdaq National Market under the symbol “EDEN”. Prior to that time, there was no public market for our
common stock.
The following table sets forth, for the
periods indicated, the high and low trading prices for our common stock as quoted on The Nasdaq National Market and The Nasdaq Capital
Market.
|
|
|
|
High
|
|
Low
|
First Quarter
2004 |
|
|
|
|
1.95 |
|
|
|
1.30 |
|
Second Quarter
2004 |
|
|
|
|
1.66 |
|
|
|
0.65 |
|
Third Quarter
2004 |
|
|
|
|
0.90 |
|
|
|
0.37 |
|
Fourth Quarter
2004 |
|
|
|
|
1.25 |
|
|
|
0.43 |
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter
2005 |
|
|
|
|
1.38 |
|
|
|
0.60 |
|
Second Quarter
2005 |
|
|
|
|
0.93 |
|
|
|
0.46 |
|
Third Quarter
2005 |
|
|
|
|
1.20 |
|
|
|
0.65 |
|
Fourth Quarter
2005 |
|
|
|
|
0.81 |
|
|
|
0.51 |
|
We have never paid
any cash dividends on our common stock. We currently intend to retain any future earnings to fund the development and growth of our business.
Therefore, we do not currently anticipate paying any cash dividends in the foreseeable future.
As of March 14, 2006, there were
approximately 208 holders of record of our common stock.
On September 26, 2000, the SEC declared
effective our Registration Statement on Form S-1, as amended (Registration No. 333-41028), as filed with the SEC in connection with our initial public
offering. Our net proceeds, after accounting for $7.0 million in underwriting discounts and commissions and approximately $1.6 million in other
expenses of the offering, were $91.5 million. At December 31, 2005, we had used approximately $18.6 million of the net offering proceeds to expand and
enhance our manufacturing and research and development and administration facilities, and approximately $66.1 million for working capital and general
corporate purposes. The remaining portion of the net offering proceeds has been invested in cash equivalent instruments. Our use of the proceeds from
the offering does not represent a material change in the use of proceeds described in the prospectus included as part of the Registration
Statement.
30
Item 6. Selected Financial Data.
The following selected financial data
and other operating information are derived from our consolidated financial statements. When you read this selected financial data, it is important
that you also read the historical consolidated financial statements and related notes included in this report, as well as Item 7 of this report
entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Historical results are not necessarily
indicative of future results.
|
|
|
|
Year Ended December 31,
|
|
|
|
|
|
2005
|
|
2004
|
|
2003
|
|
2002
|
|
2001
|
|
|
|
|
(in thousands, except per share
data)
|
|
Statements
of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product sales,
net of sales allowances |
|
|
|
$ |
3,764 |
|
|
$ |
1,040 |
|
|
$ |
1,772 |
|
|
$ |
1,907 |
|
|
$ |
3,496 |
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of goods
sold |
|
|
|
|
2,480 |
|
|
|
2,023 |
|
|
|
2,190 |
|
|
|
2,629 |
|
|
|
4,879 |
|
Research and
development |
|
|
|
|
3,221 |
|
|
|
3,505 |
|
|
|
4,781 |
|
|
|
10,281 |
|
|
|
12,529 |
|
Selling,
general and administrative |
|
|
|
|
5,391 |
|
|
|
4,418 |
|
|
|
5,755 |
|
|
|
8,820 |
|
|
|
12,557 |
|
Lease
termination loss |
|
|
|
|
2,261 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Loss on
property and equipment |
|
|
|
|
1,564 |
|
|
|
— |
|
|
|
106 |
|
|
|
120 |
|
|
|
59 |
|
Loss on
facility subleases |
|
|
|
|
— |
|
|
|
202 |
|
|
|
366 |
|
|
|
4,242 |
|
|
|
— |
|
Total
operating expenses |
|
|
|
|
14,917 |
|
|
|
10,148 |
|
|
|
13,198 |
|
|
|
26,092 |
|
|
|
30,024 |
|
Loss from
operations |
|
|
|
|
(11,153 |
) |
|
|
(9,108 |
) |
|
|
(11,426 |
) |
|
|
(24,185 |
) |
|
|
(26,528 |
) |
Other income
(expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income |
|
|
|
|
296 |
|
|
|
224 |
|
|
|
290 |
|
|
|
717 |
|
|
|
2,896 |
|
Interest
expense |
|
|
|
|
(1 |
) |
|
|
(2 |
) |
|
|
(9 |
) |
|
|
(38 |
) |
|
|
(83 |
) |
Total other
income (expense) |
|
|
|
|
295 |
|
|
|
222 |
|
|
|
281 |
|
|
|
679 |
|
|
|
2,813 |
|
Cumulative
effect of adoption of SFAS No. 143 |
|
|
|
|
— |
|
|
|
— |
|
|
|
(64 |
) |
|
|
— |
|
|
|
— |
|
Net
loss |
|
|
|
$ |
(10,858 |
) |
|
$ |
(8,886 |
) |
|
$ |
(11,209 |
) |
|
$ |
(23,506 |
) |
|
$ |
(23,715 |
) |
Basic and
diluted net loss per share (1) |
|
|
|
$ |
(0.45 |
) |
|
$ |
(0.36 |
) |
|
$ |
(0.46 |
) |
|
$ |
(0.97 |
) |
|
$ |
(0.99 |
) |
Weighted
average shares outstanding used
in computation of basic and diluted net
loss per share (1) |
|
|
|
|
24,393 |
|
|
|
24,370 |
|
|
|
24,341 |
|
|
|
24,241 |
|
|
|
23,968 |
|
|
|
|
|
December 31,
|
|
|
|
|
|
2005
|
|
2004
|
|
2003
|
|
2002
|
|
2001
|
|
|
|
|
(in thousands)
|
|
Balance
Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash
equivalents |
|
|
|
$ |
6,826 |
|
|
$ |
11,860 |
|
|
$ |
19,823 |
|
|
$ |
30,730 |
|
|
$ |
48,327 |
|
Working
capital |
|
|
|
|
7,842 |
|
|
|
13,970 |
|
|
|
20,582 |
|
|
|
29,558 |
|
|
|
46,290 |
|
Total
assets |
|
|
|
|
17,497 |
|
|
|
31,336 |
|
|
|
40,703 |
|
|
|
53,993 |
|
|
|
75,539 |
|
Capital lease
obligations, net of current portion |
|
|
|
|
— |
|
|
|
1 |
|
|
|
12 |
|
|
|
30 |
|
|
|
130 |
|
Accumulated
deficit |
|
|
|
|
(116,808 |
) |
|
|
(105,950 |
) |
|
|
(97,064 |
) |
|
|
(85,855 |
) |
|
|
(62,349 |
) |
Total
shareholders’ equity |
|
|
|
|
15,757 |
|
|
|
26,609 |
|
|
|
35,435 |
|
|
|
46,594 |
|
|
|
69,994 |
|
(1) |
|
See Note 1 of Notes to Consolidated Financial Statements for
information concerning the calculation of basic and diluted net loss per share. |
31
Item 7. Management’s Discussion
and Analysis of Financial Condition and Results of Operations.
The following discussion of our
financial condition and results of operations contains forward-looking statements that involve risks and uncertainties, such as statements of our
plans, objectives, expectations and intentions. We use words such as “anticipate,” “believe,” “expect,”
“future” and “intend” and similar expressions to identify forward-looking statements. However, these words are not the exclusive
means of identifying such statements. In addition, any statements that refer to expectations, projections or other characterizations of future events
or circumstances are forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements
for many reasons, including the factors described below and in Item 1A of this report. You should not place undue reliance on these forward-looking
statements, which apply only as of the date of this Form 10-K. You should read the following discussion and analysis in conjunction with our financial
statements and related footnotes included in Item 8 of this report.
Overview
We are a plant health technology
company that markets a line of products based on Eden Bioscience’s proprietary harpin protein technology and manufacturing processes. These
products are marketed under the umbrella brand of Harp-N-Tek™ and are used in agricultural and horticultural production as well as the Home &
Garden market. We believe that Harp-N-Tek products enhance plant health and improve overall plant production and output quality. Harpins are naturally
occurring proteins produced by disease-causing bacteria that attack plants. Harpin proteins are not a part of the destructive disease complex but
instead serve the beneficial purpose of alerting plants to the fact that they are under attack. They activate signaling receptors present in most
plants designed to specifically detect the presence of harpin proteins. This warning signal is transmitted throughout the plant and turns on the
plant’s intrinsic ability to protect itself by deploying both growth and defense responses. Eden Bioscience’s Harp-N-Tek products provide
these harmless yet potent signal-inducing harpin proteins and protein extracts, which trigger beneficial responses designed to protect plants, to help
plants grow through stress, to improve plants’ uptake of nutrients, and to enhance the overall level of plant health.
We have incurred significant operating
losses since inception. At December 31, 2005, we had an accumulated deficit of $116.8 million. We incurred net losses of $10.9 million in 2005, $8.9
million in 2004, and $11.2 million in 2003. We expect to incur significant additional net losses as we proceed with the commercialization of our
current products and the development of new products and technologies.
Results of Operations
We generated our first product sales in
August 2000. Product sales revenue to date has resulted primarily from sales of Messenger, our initial product, and Messenger STS, an improved
formulation of Messenger introduced in January 2004, as well as N-Hibit™, ProAct™, MightyPlant™ and other related products (hereafter
referred to collectively as “Harp-N-Tech products”) primarily to distributors in the United States and Spain. Revenues from product sales are
recognized when (a) the product is delivered to independent distributors, (b) we have satisfied all of our significant obligations and (c) any
acceptance provisions or other contingencies or arrangements have been satisfied, including whether collection is reasonably assured. If acceptance
provisions or contingencies exist, revenue is recognized after such provisions or contingencies have been satisfied. As part of the analysis of whether
all of our significant obligations have been satisfied or situations where acceptance provisions or other contingencies or arrangements exist, we
consider the following elements, among others: sales terms and arrangements, historical experience and current incentive programs.
32
Our distributor arrangements
provide no price protection or product-return rights. Product sales revenues are reported net of applicable sales allowances, as
follows:
|
|
|
|
Year Ended December 31,
|
|
|
|
|
|
2005
|
|
2004
|
|
2003
|
Gross product
sales |
|
|
|
$ |
4,217,177 |
|
|
$ |
1,074,368 |
|
|
$ |
1,739,917 |
|
Sales
allowances |
|
|
|
|
(544,933 |
) |
|
|
(129,863 |
) |
|
|
(94,121 |
) |
Elimination of
previously recorded sales allowances |
|
|
|
|
91,371 |
|
|
|
95,237 |
|
|
|
126,301 |
|
Product sales,
net of sales allowances |
|
|
|
$ |
3,763,615 |
|
|
$ |
1,039,742 |
|
|
$ |
1,772,097 |
|
Gross product sales revenues were $4.2
million in 2005, an increase of $3.1 (293%) from $1.1 million in 2004, which decreased $666,000 (38%) from $1.7 million in 2003. The increase in 2005
is a result primarily of sales of our new Harp-N-Tech products — N-Hibit, ProAct and MightyPlant and Messenger sales in Spain, and to a lesser
extent sales growth in the home and garden market. Sales to consumers in the home and garden market in the United States totaled $391,000 (9% of gross
product sales) in 2005, $200,000 (19% of gross product sales) in 2004 and $60,000 (3% of gross product sales) in 2003. Sales of new products produced
over 50% of total gross revenue in 2005. Sales in 2005 were made to 53 distributors, five of which accounted for an aggregate of 59% of net product
sales. Sales in 2004 were made to 27 distributors, three of which accounted for an aggregate of 46% of net product sales. Sales in 2003 were made to 30
distributors, three of which accounted for an aggregate of 40% of net product sales. In addition, we sell directly to consumers in the home and garden
market over the Internet. Sales during 2004 and 2003 were significantly lower than expected and were impacted by high levels of Messenger STS inventory
in the channel and the continuing challenges of commercializing a new technology and products.
Gross sales to foreign customers
totaled $1.1 million (26% of gross product sales) in 2005, $535,000 (50% of gross product sales) in 2004 and $108,000 (6% of net product sales) in
2003. Foreign sales in 2005 and 2004 were made primarily to distributors in Spain. Foreign sales in 2003 were made primarily to distributors in China,
Europe, Mexico, Central and South America and Oman. In February 2004, we received approval to sell Messenger in Spain. We initiated marketing
activities in March 2004, but the approval was not received in time to meet initial sales activity. In order to ensure that an adequate supply of
Messenger was quickly disbursed in the new distribution channel and to limit the amount of working capital required by our new distributors at this
early stage of introduction, we granted flexible and/or extended payment terms to distributors in this new market. Because of this combination of
factors, revenues from product deliveries to certain distributors were deferred and are recognized as payment is received. We recognized net revenue of
$794,000 in 2005 and $416,000 in 2004 from product deliveries when payment was received. Gross revenues of $221,000 and cost of goods sold of $64,000
were deferred at December 31, 2005 and will be recognized when payment is received.
In September 2003, with the cooperation
of its distributors, the Company instituted a “buy one, get one free” promotion at the grower level that ran through the end of 2003. Near
the end of 2003, the Company announced a reduction of approximately 50% in the price of Messenger and introduced Messenger STS, an improved formulation
in January 2004 at this lower price point. We also announced to distributors that we planned to send them Messenger STS at no charge in order to reduce
the average cost of their existing inventories of Messenger. In 2004, we delivered approximately 470,000 ounces of free Messenger STS to distributors.
This free product substantially increased channel inventory and negatively affected our sales to distributors in 2004. We do not expect distributors
that hold significant inventories of Messenger STS to place additional orders until their current inventories are reduced.
Due to the growing seasons of our
targeted crops and our current portfolio of Harp-N-Tek products, we expect grower usage of Harp-N-Tek products to be highly seasonal. Based on the
recommended application timing in our targeted crops and information received from our distributors, we expect the second quarter to be the most
significant period of use. Our product sales to distributors are also expected to be seasonal.
33
However, actual timing of orders
received from distributors will depend on many factors, including the amount of Harp-N-Tek products in distributors’ inventories.
Sales Allowances
Sales allowances represent allowances
granted to independent distributors for sales and marketing support and are based on the terms of the distribution agreements or other arrangements.
Sales allowances are estimated and accrued when the related product sales are recognized or when services are provided and are paid in accordance with
the terms of the then-current distributor program agreements or other arrangements. Distributor program agreements expire annually, generally on
December 31.
Sales allowances related to 2005 sales
totaled $545,000, an increase of $415,000 (319%) from $130,000 in 2004, which increased $36,000 (38%) from $94,000 in 2003. Sales allowances as a
percentage of gross product sales revenue were 13% in 2005, 12% in 2004 and 5% in 2003. The increase in sales allowances as a percentage of gross
product sales revenue in 2004 compared to 2003 is primarily the result of payments to distributors in Spain for marketing support programs. Sales
allowances also included the reduction by $91,000 in 2005, $95,000 in 2004 and $126,000 in 2003 of sales allowance liabilities recognized in prior
years that were not be paid because actual amounts earned by distributors were less than amounts previously estimated.
Cost of Goods Sold
Cost of goods sold includes the cost of
products sold to distributors, idle capacity charges, royalty expense, shipping and handling and other costs necessary to deliver product to
distributors, inventory cost reductions and write-offs and the cost of products used for promotional purposes. Cost of goods sold was $2.5 million in
2005, an increase of $0.5 million (25%) from $2.0 million in 2004, which decreased $0.2 million (9%) from $2.2 million in 2003. An increase in cost of
products sold related to higher sales volumes in 2005 was offset by a reduction in idle capacity charges resulting from additional manufacturing
activities in 2005 compared to 2004. Cost of goods sold includes manufacturing overhead costs incurred while our manufacturing plant was not in
production of approximately $0.9 million in 2005, $1.3 million in 2004 and $1.7 million in 2003. We expect to continue incurring idle capacity charges
in the future.
Included in cost of goods sold are
inventory cost reductions and write-offs totaling $10,000 in 2004 and $47,000 in 2003. These amounts relate to lower of cost or market adjustments for
inventory that failed to meet our quality control standards. In 2004, we also disposed of Messenger labels and boxes totaling $117,000 that were not
usable due to the introduction of Messenger STS and we recorded a $153,000 net reduction to cost of goods sold to adjust our warranty liability based
on our current expectations of future warranty claims.
The cost of products used for
promotional purposes was $84,000 in 2005, $53,000 in 2004 and $141,000 in 2003. The increase in 2005 over 2004 was primarily due the promotional
product used in the introduction of N-Hibit and ProAct. The majority of the 2003 expense related to the accrual of costs associated with approximately
470,000 ounces that was delivered to distributors at no cost in 2004 as part of the price reduction program.
Research and Development Expenses
Research and development expenses
consist primarily of personnel, field trial, laboratory, regulatory, patent and facility expenses. Research and development expenses totaled $3.2
million in 2005, a decrease of $0.3 million (9%) from $3.5 million in 2004, which decreased $1.3 million (27%) from $4.8 million in 2003. The decrease
from 2004 to 2005 was primarily a result of lower facility and field trial costs, which was offset by an increase in depreciation and amortization. The
decrease from 2003 to 2004 was primarily due to lower spending on personnel costs, field trials, facility costs and travel. The increase in
depreciation and amortization expense resulted from reducing the estimated useful life of leasehold improvements and certain equipment at our research
facility. Prior to terminating this facility lease in September 2005, we
34
were pursuing additional tenants to
sublease lab and office space and we had expected to complete the sublease by December 2005.We expect research and development expenses to decrease in
2006 due to the termination of this lease.
Selling, General and Administrative
Expenses
Selling, general and administrative
expenses consist of personnel and related expenses for sales and marketing, executive and administrative personnel; advertising, marketing and
professional fees; and other corporate expenses. Selling, general and administrative expenses totaled $5.4 million in 2005, an increase of $1.0 million
(23%) from $4.4 million in 2004, which decreased $1.4 million (24%) from $5.8 million in 2003. The increase in 2005 over 2004 resulted primarily from
additional spending on advertising and marketing costs for the home and garden market and for the introduction of our new products. The decrease in
2004 from 2003 resulted primarily from reductions in personnel, advertising and marketing expenses and facility costs. Included in selling, general and
administrative expenses in 2003 were severance costs of $160,000 in connection with workforce reductions.
Lease Termination Loss
On September 9, 2005, we entered into
an Amendment of Lease and Termination Agreement with the landlord to terminate the lease of 63,200 square feet of research and office space in Bothell,
Washington. The lease originally expired January 11, 2011. Average annual rent and operating costs under the lease were approximately $1.9 million. The
termination was effective as of August 31, 2005.
Approximately 34,300 square feet of the
space subject to the lease was subleased. The sublease had an initial term that expired in December 2007. Average annual rent and operating costs under
the sublease were approximately $1.1 million. In connection with the Amendment of Lease and Termination Agreement, the existing sublease was
transferred to the landlord.
The lease termination resulted in a
loss totaling approximately $2.3 million. The lease termination loss is comprised of a termination fee totaling $1.5 million, consisting of $250,000
cash and the forfeiture of a $1.25 million security deposit (previously included in long-term other assets on the balance sheet at December 31, 2004);
other costs, and an asset impairment loss on leasehold improvements and equipment at the leased facility totaling approximately $3.5 million, offset by
the write-off of liabilities recorded for accrued losses on facility subleases and rent expense in excess of rent payments totaling approximately $2.7
million.
Loss on Property and Equipment
In December 2005, we completed an
efficiency analysis of our manufacturing processes, including an assessment of all manufacturing equipment and its usefulness in future manufacturing
operations. As a result of this analysis, we recorded a loss of $1.6 million on equipment that will not be used in future manufacturing operations and
will be sold or disposed. The lower of carrying value or estimated fair value less estimated costs to sell of the equipment to be sold totals $318,000
and is included in other current assets on the balance sheet. We expect to sell these assets in 2006.
Loss on Facility Subleases
In April 2003, the Company subleased
approximately 7,300 square feet of office space to another company under a five year sublease agreement. Due to declines in the real estate market, the
rent we paid on the subleased space exceeded the initial rent to be collected under the sublease and we recorded a loss of $213,000. Due to the
subtenants financial difficulties, the subtenant later reduced the rental payment and an additional loss of $153,000 was recorded in 2003. The
subtenant vacated the space in October 2004 and we recorded an additional loss of $202,000 in 2004 based upon an estimate of the time needed to
re-sublease the space and expected future rents to be collected.
35
Interest Income
Interest income consists of earnings on
our cash and cash equivalents. Interest income totaled $295,000 in 2005, an increase of $71,000 (32%) from $224,000 in 2004, which decreased $66,000
(23%) from $290,000 in 2003. The increase in 2005 over 2004 was due higher interest rates in 2005 offset by lower average cash balances available for
investment. The decrease in 2004 compared to 2003 was due to significantly lower average cash balances available for investment offset by higher
interest rates in 2004.
Interest Expense
Interest expense consists of interest
we pay on capital leases used to finance certain equipment acquisitions. Interest expense totaled approximately $1,000 in 2005, a decrease of $2,000
from $3,000 in 2004, which decreased $6,000 from $9,000 in 2003. These decreases were due to lower average principal balances as we paid down the
capital lease obligations.
Income Taxes
We have generated a net loss from
operations for each period since we began doing business. As of December 31, 2005, we had accumulated approximately $112.1 million of net operating
loss carryforwards for federal income tax purposes, which expire between 2009 and 2025, and approximately $10.4 million in foreign tax net operating
loss carryforwards, which expire between 2006 and 2010. We have provided a valuation allowance against our net deferred tax assets because of the
significant uncertainty surrounding our ability to realize them. The annual use of these net operating loss carryforwards may be limited in the event
of a cumulative change in ownership of more than 50%.
Liquidity and Capital Resources
Our operating expenditures have been
significant since our inception. We currently anticipate that our operating expenses will significantly exceed net product sales and that net losses
and working capital requirements will consume a material amount of our cash resources. If net product sales do not significantly increase in the near
term, we will have to further reduce our operating expenses. Our future capital requirements will depend on the success of our operations. We believe
that the balance of our cash and cash equivalents at December 31, 2005 will be sufficient to meet our anticipated cash needs for net losses, working
capital and capital expenditures for more than the next 12 months, although there can be no assurance in that regard. After the next 12 months, if net
product sales do not significantly increase, we will have to further reduce operating expenses or secure additional financing. We may be unable to
obtain adequate or favorable financing at that time or at all and may be forced to cease operations. In this regard, our common stock listing was
transferred from The Nasdaq National Market to The Nasdaq Capital Market on October 10, 2005. We elected to seek a transfer to The Nasdaq Capital
Market because we had been unable to regain compliance with Nasdaq’s minimum $1.00 bid price requirement for continued listing. By transferring to
The Nasdaq Capital Market, we have been afforded an additional 180-calendar day grace period, or until March 31, 2006, in which to satisfy
Nasdaq’s $1.00 minimum bid price requirement. To regain compliance, the closing bid price of our common stock has to remain at $1.00 per share or
more for a minimum of ten consecutive trading days. If we do not regain compliance with the minimum bid price rule by March 31, 2006, which as of the
date of this report we have been unable to do, our common stock will be delisted. Trading on the Nasdaq Capital Market may have a negative impact on
the value of our common stock, because securities trading on the Nasdaq Capital Market typically are less liquid than those traded on The Nasdaq
National Market. As a result, it may be more difficult for us to raise capital. Moreover, if our common stock is delisted from The Nasdaq Capital
Market, it could become even more difficult for us to raise capital and would further reduce the market liquidity for our common stock. To avoid
delisting, our Board of Directors may approve a reverse stock split of our common stock, although there can be no assurance that a reverse stock split
would allow us to meet the minimum bid price requirement for the required period of time. The sale of additional equity securities could result in
dilution to our shareholders.
36
At December 31, 2005, our cash and cash
equivalents totaled $6.8 million, a decrease of $5.1 million from the balance of $11.9 million at December 31, 2004. Prior to October 2000, we financed
our operations primarily through the private sale of our equity securities, resulting in net proceeds of $36.5 million through September 30, 2000. In
October 2000, we received approximately $91.5 million in net proceeds from the initial public offering of 6,670,000 shares of our common stock. To a
lesser extent, we have financed our equipment acquisitions through lease financings.
Net cash used in operations totaled
$5.2 million in 2005, a decrease of $2.8 million (35%) from $8.0 million in 2004, which decreased $2.8 million (26%) from $10.8 million in 2003. Net
cash used in operations of $5.2 million in 2005 resulted primarily from net loss of $10.9 million, which includes depreciation and amortization, loss
on termination of lease and loss on property and equipment totaling $5.5 million, and fluctuations in various asset and liability balances totaling
$0.1 million.Net cash used in operations of $8.0 million in 2004 resulted primarily from net loss of $8.9 million, which includes depreciation and
amortization and loss on subleases totaling $2.2 million, and fluctuations in various asset and liability balances totaling $1.4 million. Net cash used
in operations of $10.8 million in 2003 resulted primarily from net loss of $11.2 million, which includes depreciation and amortization, loss on
property and equipment and loss on subleases totaling $2.6 million, and fluctuations in various asset and liability balances totaling $2.5 million. We
expect that cash used in operations will continue to be significant.
Net cash provided by investing
activities totaled $208,000 in 2005 and $10,000 in 2004 and resulted primarily from proceeds from the sale of equipment. Net cash used in investing
activities totaled $50,000 in 2003 as a result of purchases of equipment exceeding proceeds form the sale of equipment.
Net cash used in financing activities
totaled $2,000 in 2005, a reduction of $3,000 from $5,000 in 2004, which decreased $34,000 from net cash provided by financing activities of $39,000 in
2003. The primary use of funds during these years was to pay down principal on our outstanding capital leases, offset by proceeds from the issuance of
our common stock in connection with our stock option and employee stock purchase plans.
We conduct our operations in three
primary functional currencies: the U.S. dollar, the euro and, until December 31, 2004, the Mexican peso. Historically, neither fluctuations in foreign
exchange rates nor changes in foreign economic conditions have had a significant impact on our financial condition or results of operations. We
currently do not hedge our foreign currency exposures and are, therefore, subject to the risk of exchange rates. We may invoice our international
customers in U.S. dollars or euros, as the case may be. We are exposed to foreign exchange rate fluctuations as the financial results of foreign
subsidiaries are translated into U.S. dollars in consolidation. Foreign exchange rate fluctuations did not have a material impact on our financial
results in 2005, 2004 or 2003. As of December 31, 2004, we changed the functional currency of our Mexican subsidiary from the Mexican peso to the U. S.
dollar due to lower activity in Mexico and the majority of transactions being denominated in U.S. dollars.
The following are our contractual
obligations as of December 31, 2005 associated with our capital and operating lease obligations:
|
|
|
|
Payments Due by Period
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
Total
|
|
Less Than
1 Year
|
|
1–3
Years
|
|
3–5
Years
|
|
More Than
5 Years
|
Capital
lease obligations, including interest |
|
|
|
$ |
1 |
|
|
$ |
1 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
Operating
lease obligations |
|
|
|
|
943 |
|
|
|
255 |
|
|
|
450 |
|
|
|
238 |
|
|
|
— |
|
Cornell
minimum royalty obligation |
|
|
|
|
2,433 |
|
|
|
200 |
|
|
|
400 |
|
|
|
400 |
|
|
|
1,433 |
|
Total |
|
|
|
$ |
3,377 |
|
|
$ |
456 |
|
|
$ |
850 |
|
|
$ |
638 |
|
|
$ |
1,433 |
|
37
Critical Accounting Policies, Estimates and
Judgments
Our critical accounting policies are
more fully described in Note 1 to our consolidated financial statements included in this Annual Report on Form 10-K. Certain of our accounting policies
require the application of significant judgment by management in selecting the appropriate assumptions for calculating financial estimates. By their
nature, these judgments are subject to an inherent degree of uncertainty. These judgments are based on historical experience, terms of existing
contracts, commonly accepted industry practices, information provided by our customers and other assumptions that we believe are reasonable under the
circumstances. Our estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the consolidated financial
statements in the period in which they are determined to be necessary. Actual results may differ from these estimates under different assumptions or
conditions. Our critical accounting policies and estimates include:
Revenue Recognition
We sell the majority of our products to
independent, third-party distributors. Our arrangements with those distributors provide no price protection or product-return rights. We recognize
revenue from product sales, net of sales allowances, when product is delivered to our distributors and all of our significant obligations have been
satisfied, unless acceptance provisions or other contingencies or arrangements exist, including whether collection is reasonably assured. If acceptance
provisions or contingencies exist, revenue is recognized after such provisions or contingencies have been satisfied. As part of the analysis of whether
all of our significant obligations have been satisfied or situations where acceptance provisions or other contingencies or arrangements exist, we
consider the following elements, among others: sales terms and arrangements, including customer payment terms, historical experience and current
incentive programs.
Sales allowances represent allowances
granted to independent distributors for sales and marketing support and are based on the terms of the distribution agreements or other arrangements.
Sales allowances are estimated and accrued when the related product sales are recognized or when services are provided and are paid in accordance with
the terms of the then-current distributor program agreements or other arrangements.
We also record, at the time revenue is
recognized, a liability for warranty claims based on a percentage of sales. The warranty accrual percentage, which has ranged between zero and five
percent, and warranty liability are reviewed periodically and adjusted as necessary, based on historical experience, the results of product quality
testing and future expectations. Changes in our estimate of the warranty liability are recorded in cost of goods sold.
Accounts Receivable and Allowance for Doubtful
Accounts
Accounts receivable balances are
reported net of customer-specific related sales allowances. In determining the adequacy of the allowance for doubtful accounts, we consider a number of
factors, including the age of outstanding invoices, customer payment trends, the financial condition of our customers, historical bad debts and current
economic trends. Based upon our analysis of outstanding net accounts receivable at December 31, 2005, no allowance for doubtful accounts was recorded.
Changes in the factors above or other factors could result in a significant charge.
Inventory Valuation and Classification
Our inventory is valued at the lower of
cost or market on an average cost basis. We regularly review inventory balances to determine whether a write-down is necessary. We consider various
factors in making this determination, including recent sales history and predicted trends, industry market conditions, general economic conditions, the
age of our inventory and recent quality control data. Changes in the factors above or other factors could result in significant additional inventory
cost reductions and write-offs.
We also review our inventory to
determine inventory classification. Inventory expected to be utilized in the next twelve-month period is classified as current and inventory expected
to be utilized beyond that period
38
is classified as non-current. In
determining the classification of inventory, the Company considers a number of factors, including historical sales experience and trends, existing
distributor inventory, expansion into new markets, introduction of new products and estimates of future sales growth. Changes in the factors above or
other factors could result in significant changes in classification of inventory.
Valuation of Property and Equipment
We periodically review the carrying
values of our property and equipment to determine whether such assets have been impaired. An impairment loss must be recorded pursuant to SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets, when the undiscounted net cash flows expected to be realized from the use of
such assets are less than their carrying value. The determination of undiscounted net cash flows expected requires us to make many estimates,
projections and assumptions, including the lives of the assets, future sales and expense levels, additional capital investments or expenditures
necessary to maintain the assets, industry market trends and general and industry economic conditions. Our property and equipment consists primarily of
assets used to manufacture and sell our products and assets used in our research and administration. For the purpose of assessing asset impairment, we
have grouped all of these assets together in one asset group because our administration and research support our manufacturing and sales activities and
do not have a separate identifiable cash flow.
In December 2005, the Company completed
an efficiency analysis of its manufacturing processes, including an assessment of all manufacturing equipment and its usefulness in future
manufacturing operations. As a result of this analysis, the Company recorded a loss of $1.7 million on equipment that will not be used in future
manufacturing operations and will be sold or disposed. The lower of carrying value or estimated fair value less estimated costs to sell of equipment to
be sold totals $318,000 and is included in other current assets on the balance sheet.
Based upon our most recently completed
analysis of net cash flows expected to be realized from our remaining investments in property and equipment, including consideration of the reduction
of rent and operating costs, write-off of leasehold improvements and equipment associated with the lease termination and write-down of equipment held
for sale and to be disposed, no additional impairment loss was recorded. The critical estimates in the analysis are our ability to significantly
increase sales over the next four years while controlling operating expenses at about current levels and ability to sell certain equipment for our
estimated fair value in 2006. If net product sales do not significantly increase in the near term or if expenses significantly increase over the
current level, a significant impairment loss may need to be recorded.
Recent Accounting Pronouncements
In December 2004, the FASB issued
Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123R), which addresses the accounting for
transactions in which an entity exchanges its equity instruments for goods and services, with a primary focus on transactions in which an entity
obtains employee services in share-based payment transactions. SFAS 123R is a revision to Statement 123 and supersedes Accounting Principles Board
(APB) Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. SFAS 123R will require measurement of
the cost of employee services received in exchange for stock compensation based on the grant-date fair value of the employee stock options. Incremental
compensation costs arising from subsequent modifications of awards after the grant date must be recognized. The Company will adopt SFAS 123R on January
1, 2006 under the modified prospective method of application. Under that method, the Company will recognize compensation costs for new grants of
share-based awards, awards modified after the effective date, and the remaining portions of the fair value of the unvested awards at the adoption date.
The Company estimates that the adoption of SFAS 123R will result in the recognition of compensation costs for share based awards of approximately
$310,000 in 2006.
39
In December 2004, the FASB issued
Statement of Financial Accounting Standards No. 151, Inventory Costs (SFAS 151), which clarifies the accounting for abnormal amounts of idle
facility expense, freight, handling costs, and wasted material (spoilage). Under this Statement, such items will be recognized as current-period
charges. In addition, SFAS 151 requires that allocation of fixed production overheads to the costs of conversion be based on normal capacity of the
production facilities. SFAS 151 will be effective for the Company for inventory costs incurred on or after January 1, 2006. The adoption of SFAS 151
will not have a significant effect on the Company’s financial statements.
Item 7A. Quantitative and
Qualitative Disclosures About Market Risk.
We do not currently hold any derivative
instruments and we do not engage in hedging activities. Also, we do not have any outstanding variable interest rate debt and currently do not enter
into any material transactions denominated in foreign currency. Because of the relatively short-term average maturity of our investment funds, such
investments are sensitive to interest rate movements. Therefore, our future interest income may be adversely impacted by changes in interest rates. We
believe that the market risk arising from cash equivalents is not material.
40
Item 8. Financial Statements and
Supplementary Data.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM
The Board of Directors and Shareholders
Eden Bioscience
Corporation:
We have audited the accompanying
consolidated balance sheets of Eden Bioscience Corporation and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements
of operations, shareholders’ equity and comprehensive loss, and cash flows for each of the years in the three-year period ended December 31, 2005.
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance
with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated
financial statements referred to above present fairly, in all material respects, the financial position of Eden Bioscience Corporation and subsidiaries
as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended
December 31, 2005, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 12 to the
consolidated financial statements, the Company changed its method of accounting for asset retirement obligations effective January 1,
2003.
/s/ KPMG LLP
Seattle, Washington
February 27, 2006
41
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
|
|
|
|
December 31,
|
|
|
|
|
|
2005
|
|
2004
|
ASSETS
|
Current
assets:
|
|
|
|
|
|
|
|
|
|
|
Cash and cash
equivalents |
|
|
|
$ |
6,825,652 |
|
|
$ |
11,860,385 |
|
Accounts
receivable, net of sales allowances |
|
|
|
|
212,213 |
|
|
|
39,946 |
|
Inventory,
current |
|
|
|
|
1,713,274 |
|
|
|
3,487,586 |
|
Prepaid
expenses and other current assets |
|
|
|
|
580,938 |
|
|
|
498,670 |
|
Total current
assets |
|
|
|
|
9,332,077 |
|
|
|
15,886,587 |
|
Inventory,
non-current |
|
|
|
|
1,910,280 |
|
|
|
— |
|
Property and
equipment, net |
|
|
|
|
5,967,122 |
|
|
|
13,887,573 |
|
Other
assets |
|
|
|
|
287,704 |
|
|
|
1,561,902 |
|
Total
assets |
|
|
|
$ |
17,497,183 |
|
|
$ |
31,336,062 |
|
| |
LIABILITIES AND SHAREHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
|
|
Accounts
payable |
|
|
|
$ |
228,906 |
|
|
$ |
190,648 |
|
Accrued
liabilities |
|
|
|
|
1,260,405 |
|
|
|
1,206,411 |
|
Current
portion of accrued loss on facility subleases |
|
|
|
|
— |
|
|
|
507,748 |
|
Current
portion of capital lease obligations |
|
|
|
|
761 |
|
|
|
11,572 |
|
Total current
liabilities |
|
|
|
|
1,490,072 |
|
|
|
1,916,379 |
|
Accrued loss on
facility subleases, net of current portion |
|
|
|
|
— |
|
|
|
2,037,613 |
|
Capital lease
obligations, net of current portion |
|
|
|
|
— |
|
|
|
761 |
|
Other long-term
liabilities |
|
|
|
|
250,428 |
|
|
|
771,934 |
|
Total
liabilities |
|
|
|
|
1,740,500 |
|
|
|
4,726,687 |
|
| |
Commitments and
contingencies
|
|
|
|
|
|
|
|
|
|
|
| |
Shareholders’ equity:
|
|
|
|
|
|
|
|
|
|
|
Preferred
stock, $.01 par value, 10,000,000 shares authorized; no shares
issued and outstanding at December 31, 2005 and 2004 |
|
|
|
|
— |
|
|
|
— |
|
Common stock,
$.0025 par value, 100,000,000 shares authorized; issued
and outstanding shares — 24,406,870 shares at December 31, 2005;
24,381,870 shares
at December 31, 2004 |
|
|
|
|
61,017 |
|
|
|
60,955 |
|
Additional
paid-in capital |
|
|
|
|
132,545,920 |
|
|
|
132,535,982 |
|
Accumulated
other comprehensive loss |
|
|
|
|
(42,502 |
) |
|
|
(37,675 |
) |
Accumulated
deficit |
|
|
|
|
(116,807,752 |
) |
|
|
(105,949,887 |
) |
Total
shareholders’ equity |
|
|
|
|
15,756,683 |
|
|
|
26,609,375 |
|
Total
liabilities and shareholders’ equity |
|
|
|
$ |
17,497,183 |
|
|
$ |
31,336,062 |
|
The accompanying notes are an integral part of these
consolidated financial statements.
42
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
|
|
|
|
Year Ended December 31,
|
|
|
|
|
|
2005
|
|
2004
|
|
2003
|
Product sales,
net of sales allowances |
|
|
|
$ |
3,763,615 |
|
|
$ |
1,039,742 |
|
|
$ |
1,772,097 |
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of goods
sold |
|
|
|
|
2,479,965 |
|
|
|
2,023,338 |
|
|
|
2,190,034 |
|
Research and
development |
|
|
|
|
3,221,038 |
|
|
|
3,504,699 |
|
|
|
4,781,047 |
|
Selling,
general and administrative |
|
|
|
|
5,391,094 |
|
|
|
4,417,704 |
|
|
|
5,755,346 |
|
Lease
termination loss |
|
|
|
|
2,260,538 |
|
|
|
— |
|
|
|
— |
|
Loss on
property and equipment |
|
|
|
|
1,563,597 |
|
|
|
— |
|
|
|
105,890 |
|
Loss on
facility subleases |
|
|
|
|
— |
|
|
|
202,007 |
|
|
|
366,019 |
|
Total
operating expenses |
|
|
|
|
14,916,232 |
|
|
|
10,147,748 |
|
|
|
13,198,336 |
|
Loss from
operations |
|
|
|
|
(11,152,617 |
) |
|
|
(9,108,006 |
) |
|
|
(11,426,239 |
) |
Other income
(expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income |
|
|
|
|
295,365 |
|
|
|
224,405 |
|
|
|
290,206 |
|
Interest
expense |
|
|
|
|
(613 |
) |
|
|
(2,651 |
) |
|
|
(9,048 |
) |
Total other
income |
|
|
|
|
294,752 |
|
|
|
221,754 |
|
|
|
281,158 |
|
Loss before
income taxes and cumulative effect of adoption of SFAS No. 143 |
|
|
|
|
(10,857,865 |
) |
|
|
(8,886,252 |
) |
|
|
(11,145,081 |
) |
Income
taxes |
|
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Loss before
cumulative effect of adoption of
SFAS No. 143 |
|
|
|
|
(10,857,865 |
) |
|
|
(8,886,252 |
) |
|
|
(11,145,081 |
) |
Cumulative
effect of adoption of SFAS No. 143 |
|
|
|
|
— |
|
|
|
— |
|
|
|
(63,508 |
) |
Net
loss |
|
|
|
$ |
(10,857,865 |
) |
|
$ |
(8,886,252 |
) |
|
$ |
(11,208,589 |
) |
Basic and
diluted net loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before
cumulative effect of adoption of
SFAS No. 143 |
|
|
|
$ |
(0.45 |
) |
|
$ |
(0.36 |
) |
|
$ |
(0.46 |
) |
Cumulative
effect of adoption of SFAS No. 143 |
|
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Net
loss |
|
|
|
$ |
(0.45 |
) |
|
$ |
(0.36 |
) |
|
$ |
(0.46 |
) |
Weighted
average shares outstanding used to compute
net loss per share — basic and diluted |
|
|
|
|
24,393,075 |
|
|
|
24,370,467 |
|
|
|
24,340,980 |
|
The accompanying notes are an integral part of these
consolidated financial statements.
43
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE
LOSS
|
|
|
|
Outstanding
Shares
Common
Stock
|
|
Common
Stock
|
|
Additional
Paid-In
Capital
|
|
Accumulated
Other
Comprehensive
Loss
|
|
Accumulated
Deficit
|
|
Total
Shareholders’
Equity
|
Balance at
December 31, 2002 |
|
|
|
|
24,307,495 |
|
|
$ |
60,769 |
|
|
$ |
132,466,906 |
|
|
$ |
(78,842 |
) |
|
$ |
(85,855,046 |
) |
|
$ |
46,593,787 |
|
Comprehensive loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss |
|
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(11,208,589 |
) |
|
|
(11,208,589 |
) |
Cumulative
translation adjustment |
|
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(6,539 |
) |
|
|
— |
|
|
|
(6,539 |
) |
Comprehensive loss |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(11,215,128 |
) |
Sale of
common stock |
|
|
|
|
22,295 |
|
|
|
56 |
|
|
|
29,137 |
|
|
|
— |
|
|
|
— |
|
|
|
29,193 |
|
Exercise of
stock options |
|
|
|
|
32,200 |
|
|
|
80 |
|
|
|
27,319 |
|
|
|
— |
|
|
|
— |
|
|
|
27,399 |
|
Balance at
December 31, 2003 |
|
|
|
|
24,361,990 |
|
|
|
60,905 |
|
|
|
132,523,362 |
|
|
|
(85,381 |
) |
|
|
(97,063,635 |
) |
|
|
35,435,251 |
|
Comprehensive loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss |
|
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(8,886,252 |
) |
|
|
(8,886,252 |
) |
Cumulative
translation adjustment |
|
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
47,706 |
|
|
|
— |
|
|
|
47,706 |
|
Comprehensive loss |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(8,838,546 |
) |
Sale of
common stock |
|
|
|
|
19,880 |
|
|
|
50 |
|
|
|
12,620 |
|
|
|
— |
|
|
|
— |
|
|
|
12,670 |
|
Balance at
December 31, 2004 |
|
|
|
|
24,381,870 |
|
|
|
60,955 |
|
|
|
132,535,982 |
|
|
|
(37,675 |
) |
|
|
(105,949,887 |
) |
|
|
26,609,375 |
|
Comprehensive loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss |
|
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(10,857,865 |
) |
|
|
(10,857,865 |
) |
Cumulative
translation adjustment |
|
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(4,827 |
) |
|
|
— |
|
|
|
(4,827 |
) |
Comprehensive loss |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(10,862,692 |
) |
Sale of
common stock |
|
|
|
|
25,000 |
|
|
|
62 |
|
|
|
9,938 |
|
|
|
— |
|
|
|
— |
|
|
|
10,000 |
|
Balance at
December 31, 2005 |
|
|
|
|
24,406,870 |
|
|
$ |
61,017 |
|
|
$ |
132,545,920 |
|
|
$ |
(42,502 |
) |
|
$ |
(116,807,752 |
) |
|
$ |
15,756,683 |
|
The accompanying notes are an integral part of these
consolidated financial statements.
44
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
|
|
|
|
Year Ended December 31,
|
|
|
|
|
|
2005
|
|
2004
|
|
2003
|
Cash flows
from operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss |
|
|
|
$ |
(10,857,865 |
) |
|
$ |
(8,886,252 |
) |
|
$ |
(11,208,589 |
) |
Adjustments to
reconcile net loss to cash used in operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization |
|
|
|
|
1,952,027 |
|
|
|
1,976,015 |
|
|
|
2,149,267 |
|
Loss on
property and equipment on lease termination |
|
|
|
|
3,480,883 |
|
|
|
— |
|
|
|
— |
|
Termination of
lease obligations |
|
|
|
|
(2,724,124 |
) |
|
|
— |
|
|
|
— |
|
Forfeiture of
security deposit on lease termination |
|
|
|
|
1,250,000 |
|
|
|
— |
|
|
|
— |
|
Loss on
property and equipment |
|
|
|
|
1,563,597 |
|
|
|
— |
|
|
|
105,890 |
|
Loss on
facility subleases |
|
|
|
|
— |
|
|
|
202,007 |
|
|
|
366,019 |
|
Deferred rent
payable |
|
|
|
|
33,704 |
|
|
|
50,556 |
|
|
|
120,321 |
|
Accretion
expense |
|
|
|
|
28,187 |
|
|
|
25,015 |
|
|
|
21,156 |
|
Cumulative
effect of adoption of SFAS No. 143 |
|
|
|
|
— |
|
|
|
— |
|
|
|
63,508 |
|
Changes in
assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts
receivable |
|
|
|
|
(179,777 |
) |
|
|
127,431 |
|
|
|
56,118 |
|
Inventory |
|
|
|
|
295,307 |
|
|
|
(999,103 |
) |
|
|
172,101 |
|
Prepaid
expenses and other assets |
|
|
|
|
259,329 |
|
|
|
307,568 |
|
|
|
64,900 |
|
Accounts
payable |
|
|
|
|
38,336 |
|
|
|
87,605 |
|
|
|
(260,069 |
) |
Accrued
liabilities |
|
|
|
|
8,753 |
|
|
|
(379,489 |
) |
|
|
(2,085,753 |
) |
Accrued loss
on facility subleases |
|
|
|
|
(336,915 |
) |
|
|
(524,361 |
) |
|
|
(404,437 |
) |
Net cash used
in operating activities |
|
|
|
|
(5,188,558 |
) |
|
|
(8,013,008 |
) |
|
|
(10,839,568 |
) |
Cash flows
from investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases of
property and equipment |
|
|
|
|
(19,147 |
) |
|
|
(2,586 |
) |
|
|
(261,934 |
) |
Proceeds from
disposal of fixed assets |
|
|
|
|
226,908 |
|
|
|
13,040 |
|
|
|
212,030 |
|
Net cash
provided by (used in) investing activities |
|
|
|
|
207,761 |
|
|
|
10,454 |
|
|
|
(49,904 |
) |
Cash flows
from financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reduction in
capital lease obligations |
|
|
|
|
(11,572 |
) |
|
|
(17,257 |
) |
|
|
(95,428 |
) |
Proceeds from
issuance of stock |
|
|
|
|
10,000 |
|
|
|
12,670 |
|
|
|
56,592 |
|
Net cash used
in financing activities |
|
|
|
|
(1,572 |
) |
|
|
(4,587 |
) |
|
|
(38,836 |
) |
Effect of
foreign currency exchange rates on cash
and cash equivalents |
|
|
|
|
(52,364 |
) |
|
|
44,187 |
|
|
|
21,819 |
|
Net decrease
in cash and cash equivalents |
|
|
|
|
(5,034,733 |
) |
|
|
(7,962,954 |
) |
|
|
(10,906,489 |
) |
Cash and cash
equivalents at beginning of period |
|
|
|
|
11,860,385 |
|
|
|
19,823,339 |
|
|
|
30,729,828 |
|
Cash and cash
equivalents at end of period |
|
|
|
$ |
6,825,652 |
|
|
$ |
11,860,385 |
|
|
$ |
19,823,339 |
|
Supplemental
disclosures:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid for
interest |
|
|
|
$ |
613 |
|
|
$ |
2,651 |
|
|
$ |
9,048 |
|
The accompanying notes are an integral part of these
consolidated financial statements.
45
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
1. |
|
Organization and Summary of Significant Accounting
PoliciesOrganization and Business |
Eden Bioscience Corporation (“Eden
Bioscience” or the “Company”) was incorporated in the State of Washington on July 18, 1994. Eden Bioscience is a plant health technology
company focused on developing, manufacturing and marketing innovative natural protein-based products for agriculture.
The Company is subject to a number of
risks including, among others: dependence on a limited number of products and the development and commercialization of those products, which may not be
successful; the need to develop adequate sales and marketing capabilities to commercialize the Company’s products; reliance on independent
distributors and retailers to sell the Company’s products; competition from other companies with greater financial, technical and marketing
resources; and other risks associated with commercializing a new technology.
Liquidity
The Company’s operating
expenditures have been significant since its inception. The Company currently anticipates that its operating expenses will significantly exceed net
product sales and that net losses and working capital requirements will consume a material amount of its cash resources. If net product sales do not
significantly increase in the near term, the Company will have to further reduce its operating expenses. The Company’s future capital requirements
will depend on the success of its operations. Management of the Company believes that the balance of its cash and cash equivalents at December 31, 2005
will be sufficient to meet its anticipated cash needs for net losses, working capital and capital expenditures for more than the next 12 months,
although there can be no assurance in that regard. After the next 12 months, if net product sales do not significantly increase, the Company will have
to further reduce operating expenses or secure additional financing. The Company may be unable to obtain adequate or favorable financing at that time
or at all and may cease operations. The sale of additional equity securities could result in dilution to the Company’s
shareholders.
Principles of Consolidation
The consolidated financial statements
include the accounts of Eden Bioscience and its wholly-owned subsidiaries. Intercompany transactions and balances have been
eliminated.
Segments
The Company has one operating segment
— the development and commercialization of natural protein-based products for agriculture.
Estimates Used in Financial Statement
Preparation
The preparation of financial statements
in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period. Examples include depreciable lives of property and equipment; fair value of
assets held for sale; expense accruals; and provisions for sales allowances, warranty claims, inventory valuation and classification, cash flow
projections used in evaluating whether asset impairment loss is recorded, losses on facility subleases and bad debts. Such estimates and assumptions
are based on historical experience, where applicable, management’s plans and other assumptions. Estimates and assumptions are reviewed
periodically and the effects of revisions are reflected in the consolidated financial statements prospectively when they are determined to be
necessary. Actual results could differ from these estimates.
46
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
Cash and Cash Equivalents
The Company considers all highly liquid
investments with a maturity of three months or less when purchased to be cash equivalents. Cash equivalents are stated at cost, which approximates
market.
Accounts Receivable
Accounts receivable balances are
reported net of customer-specific related sales allowances of $20,000 and $11,000 at December 31, 2005 and 2004, respectively. In determining the
adequacy of the allowance for doubtful accounts, the Company considers a number of factors, including the aging of the accounts receivable portfolio,
customer payment trends, the financial condition of its customers, historical bad debts and current economic trends. Based upon an analysis of
outstanding net accounts receivable, no allowance for doubtful accounts was recorded at December 31, 2005 or 2004 and there were no write-offs in 2005
or 2004.
Inventory
Inventory is valued at the lower of
average cost or market. Costs include material, labor and overhead. The Company estimates inventory cost reductions based on the results of quality
control testing and the amount and age of product in the Company’s inventory. Cost reductions and write-offs were zero in 2005, $10,000 in 2004
and $47,000 in 2003.
Financial Instruments and Concentrations of Credit
Risk
Financial instruments that potentially
subject the Company to concentrations of credit risk consist of cash and cash equivalents, accounts receivable, accounts payable and accrued
liabilities. Financial instruments, including those listed above, that are short-term and/or that have little or no market risk are estimated to have a
fair value equal to book value. Deposits with banks may exceed the amount of insurance provided on such deposits; however, these deposits typically may
be redeemed upon demand and, therefore, bear minimal risk. The Company’s credit risk is managed by investing its excess cash in high-quality money
market instruments and securities of the U. S. government.
Property and Equipment
Equipment and leasehold improvements
are stated at historical cost. Improvements and replacements are capitalized. Maintenance and repairs are expensed when incurred. The provision for
depreciation and amortization is determined using straight-line and accelerated methods, which allocate costs over their estimated useful lives of two
to twenty years. On January 1, 2001, the Company adopted the units-of-production method of depreciation for manufacturing equipment placed into service
after that date. Equipment leased under capital leases is depreciated over the shorter of its estimated useful life or lease term, which ranged between
three to five years. Leasehold improvements are amortized over the shorter of their estimated useful lives or lease terms, which range between two to
four years. Substantially all of the Company’s assets are in the United States.
In December 2005, the Company completed
an efficiency analysis of its manufacturing processes, including an assessment of all manufacturing equipment and its usefulness in future
manufacturing operations. As a result of this analysis, the Company recorded a loss of $1.7 million on equipment that will not be used in future
manufacturing operations and will be sold or disposed. The lower of carrying value or estimated fair value less estimated costs to sell of equipment to
be sold totals $318,000 and is included in other current assets on the balance sheet.
Long-lived assets are reviewed for
impairment whenever events or circumstances indicate that the carrying value may not be recoverable. In reviewing for impairment, the Company compares
the carrying value of such assets to the undiscounted cash flows expected from the use of the assets and their eventual disposition. When necessary, an
impairment loss is recognized equal to the difference between the assets’ fair value and their
47
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
carrying value. Based upon an
analysis of estimated net cash flows to be realized from the Company’s investments in property and equipment at December 31, 2005, no additional
impairment loss was recorded.
In October 2004, the Company began
marketing lab and office space it occupied and estimated it would sublease substantially all of this space by the end of 2005. Based on the sublease
market at that time, the Company believed that a portion of the leasehold improvements and certain equipment related to the lab space would not be
recovered from the receipt of future sublease payments. Therefore, the estimated useful life of a portion of leasehold improvements and certain
equipment related to this lab space was reduced from January 2011, the end of the lease term, to December 31, 2005. In the fourth quarter of 2004,
additional amortization and depreciation of $355,000 was included in research and development expense in the consolidated statements of operations and
additional amortization and depreciation of $710,000 was recorded in 2005. The lease was terminated in September 2005, see note 8.
Other Assets
Other assets consist principally of
restricted investments held as deposits in connection with the Company’s operating leases.
Exit and Disposal Activities
Costs associated with one-time
termination benefits are estimated at the time the liability is incurred and are recognized over the future service period, if applicable, or
immediately, if there is no future service period. The cumulative effect of subsequent changes in the timing or amount of estimated cash flows over the
future service period is recognized as an adjustment to the liability in the period of the change.
Revenues
The Company recognizes revenue from
product sales, net of sales allowances, when product is shipped to its distributors and all significant obligations of the Company have been satisfied,
unless acceptance provisions or other contingencies or arrangements exist. If acceptance provisions or contingencies exist, revenue is deferred and
recognized later if such provisions or contingencies are satisfied. As part of the analysis of whether all significant obligations of the Company have
been satisfied or situations where acceptance provisions or other contingencies or arrangements exist, the Company considers the following elements,
among others: sales terms and arrangements, historical experience and current incentive programs. Distributors do not have price protection or
product-return rights. The Company provides an allowance for warranty claims based on historical experience and expectations. Shipping and handling
costs related to product sales that are paid by the Company are included in cost of goods sold.
Sales allowances represent allowances
granted to independent distributors for sales and marketing support and are estimated based on the terms of the distribution arrangements or other
arrangements. Sales allowances are estimated and accrued when the related product sales are recognized or when services are provided and are paid in
accordance with the terms of the then-current distributor program arrangements or other arrangements. Distributor program arrangements expire annually,
generally on December 31.
Gross product sales and sales
allowances are as follows:
|
|
|
|
Year Ended December 31,
|
|
|
|
|
|
2005
|
|
2004
|
|
2003
|
Gross product
sales |
|
|
|
$ |
4,217,177 |
|
|
$ |
1,074,368 |
|
|
$ |
1,739,917 |
|
Sales
allowances |
|
|
|
|
(544,933 |
) |
|
|
(129,863 |
) |
|
|
(94,121 |
) |
Elimination of
previously recorded sales
allowance liabilities |
|
|
|
|
91,371 |
|
|
|
95,237 |
|
|
|
126,301 |
|
Product sales,
net of sales allowances |
|
|
|
$ |
3,763,615 |
|
|
$ |
1,039,742 |
|
|
$ |
1,772,097 |
|
48
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
Gross product sales by geographical
region were:
|
|
|
|
Year Ended December 31,
|
|
|
|
|
|
2005
|
|
2004
|
|
2003
|
United
States |
|
|
|
$ |
3,134,058 |
|
|
$ |
539,479 |
|
|
$ |
1,631,496 |
|
Spain |
|
|
|
|
888,178 |
|
|
|
528,826 |
|
|
|
— |
|
Other
regions |
|
|
|
|
194,941 |
|
|
|
6,063 |
|
|
|
108,421 |
|
Product
sales |
|
|
|
$ |
4,217,177 |
|
|
$ |
1,074,368 |
|
|
$ |
1,739,917 |
|
Incentives
The Company sometimes offers sales
incentives, often in the form of free product, to distributors and other customers. Costs associated with such incentives are recognized as costs of
sales in the later of the period in which (a) the associated revenue is recognized by the Company or (b) the sales incentive is offered to the
customer.
In September 2003, with the cooperation
of its distributors, the Company instituted a “buy one, get one free” promotion at the grower level that ran through the end of 2003. Near
the end of 2003, the Company announced a reduction of approximately 50% in the price of Messenger and introduced Messenger STS, an improved formulation
in January 2004 at this lower price point. At the same time, the Company announced to distributors that it planned to send them additional products at
no charge in order to reduce the average cost of their existing inventories of Messenger. In 2004, the Company delivered approximately 470,000 ounces
of Messenger products at no charge to distributors. The total cost of these promotions was approximately $191,000, which the Company recorded as a cost
of sales in 2003. No such program was offered in 2005.
Cost of Goods Sold
Cost of goods sold includes all direct
and indirect costs incurred in the manufacturing process; shipping and handling and other costs necessary to deliver product to distributors; inventory
cost reductions; product used for promotional purposes; and idle capacity charges during periods of non-production.
Advertising Costs
Advertising costs are expensed as
incurred. The Company incurred advertising expenses of $768,926 in 2005, $296,849 in 2004 and $398,555 in 2003.
Research and Development Expenses
Research and development costs are
expensed as incurred.
Stock Compensation
The Company has elected to apply the
disclosure-only provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation,
as amended by SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure, an Amendment of SFAS No. 123. Accordingly,
the Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations. The following table illustrates the effect on net income and earnings per
share as if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based compensation.
49
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
|
|
|
|
Year Ended December 31,
|
|
|
|
|
|
2005
|
|
2004
|
|
2003
|
Net loss, as
reported |
|
|
|
$ |
(10,857,865 |
) |
|
$ |
(8,886,252 |
) |
|
$ |
(11,208,589 |
) |
Deduct total
stock-based employee compensation expense under fair value based method |
|
|
|
|
(646,672 |
) |
|
|
(779,031 |
) |
|
|
(1,516,909 |
) |
Pro forma net
loss |
|
|
|
$ |
(11,504,537 |
) |
|
$ |
(9,665,283 |
) |
|
$ |
(12,725,498 |
) |
Loss per
share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and
diluted — as reported |
|
|
|
$ |
(0.45 |
) |
|
$ |
(0.36 |
) |
|
$ |
(0.46 |
) |
Basic and
diluted — pro forma |
|
|
|
$ |
(0.47 |
) |
|
$ |
(0.40 |
) |
|
$ |
(0.52 |
) |
The per-share weighted average grant
date fair value of options granted was $0.46 in 2005, $0.81 in 2004 and $1.26 in 2003. The fair value of stock options granted was determined using the
Black-Scholes model. The following weighted average assumptions were used to perform the calculations:
|
|
|
|
December 31,
|
|
|
|
|
|
2005
|
|
2004
|
|
2003
|
Expected
dividend yield |
|
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Risk-free
interest rate |
|
|
|
|
4.35 |
% |
|
|
3.34 |
% |
|
|
2.94 |
% |
Expected life
(years) |
|
|
|
|
5.0 |
|
|
|
5.0 |
|
|
|
5.0 |
|
Volatility |
|
|
|
|
96 |
% |
|
|
98 |
% |
|
|
102 |
% |
Income Taxes
The Company accounts for income taxes
under the provisions of SFAS No. 109, Accounting for Income Taxes. SFAS No. 109 requires recognition of deferred tax assets and liabilities for
the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax
assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities and operating
loss and tax credit carryforwards using enacted tax rates in effect for the year in which the differences and carryforwards are expected to
reverse.
Foreign Currency Translation
The Company conducts its operations in
three primary functional currencies: the U.S. dollar, the euro and, until December 31, 2004, the Mexican peso. Balance sheet accounts of the
Company’s foreign operations are translated from foreign currencies into U.S. dollars at period-end exchange rates while income and expenses are
translated at average exchange rates during the period. Cumulative translation gains or losses related to net assets located outside the U.S. are shown
as a component of shareholders’ equity. Gains and losses resulting from foreign currency transactions, which are denominated in a currency other
than the entity’s functional currency, are included in the consolidated statements of operations. There were no significant gains or losses on
foreign currency transactions in 2005, 2004 or 2003. As of December 31, 2004, the Company changed the functional currency of its Mexican subsidiary
from the Mexican peso to the U. S. dollar due to lower activity in Mexico and the majority of transactions being denominated in U.S. dollars. The
impact of this change was not material.
Recent Accounting Pronouncements
In December 2004, the FASB issued
Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, which addresses the accounting for transactions in
which an entity exchanges its equity instruments for goods and services, with a primary focus on transactions in which an entity obtains employee
services in share-based payment transactions. This Statement is a revision to Statement 123 and supersedes Accounting Principles Board (APB) Opinion
No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. This Statement will require measurement of the cost
of employee
50
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
services received in exchange for
stock compensation based on the grant-date fair value of the employee stock options. Incremental compensation costs arising from subsequent
modifications of awards after the grant date must be recognized. The Company will adopt the Statement on January 1, 2006 under the modified prospective
method of application. Under that method, the Company will recognize compensation costs for new grants of share-based awards, awards modified after the
effective date, and the remaining portions of the fair value of the unvested awards at the adoption date. The Company estimates that the adoption of
Statement 123R will result in the recognition of compensation costs for share based awards of approximately $310,000 in 2006.
In December 2004, the FASB issued
Statement of Financial Accounting Standards No. 151, Inventory Costs, which clarifies the accounting for abnormal amounts of idle facility
expense, freight, handling costs, and wasted material (spoilage). Under this Statement, such items will be recognized as current-period charges. In
addition, the Statement requires that allocation of fixed production overheads to the costs of conversion be based on normal capacity of the production
facilities. This Statement will be effective for the Company for inventory costs incurred on or after January 1, 2006. The adoption of this Statement
will not have a significant effect on the Company’s financial statements.
Net Loss per Share
Basic net loss per share is the net
loss divided by the average number of shares outstanding during the period. Diluted net loss per share is the net loss divided by the sum of the
average number of shares outstanding during the period plus the additional shares that would have been issued had all dilutive warrants and options
been exercised, less shares that would be repurchased with the proceeds from such exercise using the treasury stock method. The effect of including
outstanding options and warrants is antidilutive for all periods presented. Therefore, options and warrants have been excluded from the calculation of
diluted net loss per share. Shares issuable pursuant to stock options and warrants that have not been included in the above calculations because they
are antidilutive totaled 2,647,751 in 2005, 2,820,578 in 2004 and 2,748,941 in 2003.
Reclassifications
Certain reclassifications have been
made to the prior years’ financial statements to conform to classifications used in the current year.
2. Shareholders’
Equity
During 2000, the shareholders and Board
of Directors approved the 2000 Stock Incentive Plan (the “2000 Plan”). Upon completion of the Company’s initial public offering, the
2000 Plan replaced the 1995 Combined Incentive and Nonqualified Stock Option Plan (the “1995 Plan” and, together with the 2000 Plan, the
“Stock Option Plans”) for the purpose of all future stock incentive awards. All reserved but ungranted shares under the 1995 Plan and any
shares subject to outstanding options under the 1995 Plan that expire or are otherwise cancelled without being exercised will be added to the shares
available under the 2000 Plan.
The Board of Directors has the
authority to determine all matters relating to options to be granted under the Stock Option Plans, including designation as incentive or nonqualified
stock options, the selection of individuals to be granted options, the number of shares subject to each grant, the exercise price, the term and vesting
period, if any. Generally, options vest over periods ranging from three to five years and expire ten years from date of grant. The Board of Directors
reserved an initial total of 1,500,000 shares of common stock under the 2000 Plan, plus an automatic annual increase equal to the lesser of (a)
1,500,000 shares; (b) 5% of the outstanding shares of common stock on a fully diluted basis as of the end of the immediately preceding year; and (c) a
lesser amount as may be determined by the Board of Directors. No additional shares were added to the 2000 Plan on January 1, 2006, 2005 or
2004.
51
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 2005, the Company had
reserved 598,001 shares of common stock for issuance under the 1995 Plan, all of which had been granted, and 3,232,171 shares for issuance under the
2000 Plan, including 1,732,171 shares transferred from the 1995 Plan. Options totaling 2,049,750 under the 2000 Plan had been granted at December 31,
2005, leaving 1,182,421 options available for future grant. The following table summarizes stock option activity:
|
|
|
|
Number of
Shares
|
|
Weighted
Average Exercise
Price Per
Share
|
Balance at
December 31, 2002 |
|
|
|
|
1,868,452 |
|
|
|
5.47 |
|
Options
granted |
|
|
|
|
1,281,000 |
|
|
|
1.65 |
|
Options
forfeited |
|
|
|
|
(568,311 |
) |
|
|
7.98 |
|
Options
exercised |
|
|
|
|
(32,200 |
) |
|
|
0.85 |
|
Balance at
December 31, 2003 |
|
|
|
|
2,548,941 |
|
|
|
3.05 |
|
Options
granted |
|
|
|
|
347,000 |
|
|
|
1.08 |
|
Options
forfeited |
|
|
|
|
(275,363 |
) |
|
|
1.88 |
|
Balance at
December 31, 2004 |
|
|
|
|
2,620,578 |
|
|
|
2.91 |
|
Options
granted |
|
|
|
|
210,000 |
|
|
|
0.62 |
|
Options
forfeited |
|
|
|
|
(182,827 |
) |
|
|
3.62 |
|
Balance at
December 31, 2005 |
|
|
|
|
2,647,751 |
|
|
|
2.68 |
|
The following table
summarizes stock option information at December 31, 2005:
|
|
|
|
Options Outstanding
|
|
Options Exercisable
|
|
Range of Exercise Prices
|
|
|
|
Number
Outstanding
|
|
Weighted-Average
Remaining
Contractual
Life (in
years)
|
|
Weighted-
Average
Exercise Price
|
|
Number
Outstanding
|
|
Weighted-
Average
Exercise Price
|
$0.40 –
1.00 |
|
|
|
|
579,001 |
|
|
|
7.19 |
|
|
$ |
0.73 |
|
|
|
230,168 |
|
|
$ |
0.83 |
|
1.40 –
1.85 |
|
|
|
|
1,529,250 |
|
|
|
6.97 |
|
|
|
1.60 |
|
|
|
1,155,431 |
|
|
|
1.60 |
|
2.00 –
6.00 |
|
|
|
|
276,000 |
|
|
|
3.27 |
|
|
|
3.79 |
|
|
|
272,600 |
|
|
|
3.81 |
|
7.00 –
14.00 |
|
|
|
|
263,500 |
|
|
|
5.00 |
|
|
|
11.99 |
|
|
|
231,710 |
|
|
|
12.49 |
|
|
|
|
|
|
2,647,751 |
|
|
|
6.43 |
|
|
|
2.68 |
|
|
|
1,889,909 |
|
|
|
3.16 |
|
Stock options
exercisable were 1,573,506 and 1,169,173 at December 31, 2004 and 2003, respectively. The weighted-average exercise prices of options exercisable were
$3.60 and $4.08 at December 31, 2004 and 2003, respectively.
On June 17, 2002, the Company offered
to exchange certain outstanding options to purchase shares of its common stock granted to its current U.S. employees and officers (other than its Chief
Financial Officer and then-Interim President) under the Stock Option Plans for new options to be granted under the 2000 Plan on a date that was at
least six months and one day after the date that the Company cancelled the tendered options. The offer expired on July 17, 2002, at which time the
Company cancelled options to purchase 788,900 shares of its common stock with a weighted average exercise price of $9.05 that were tendered for
exchange or cancellation without replacement. On January 21, 2003, the Company granted new options to purchase 558,700 shares of its common stock,
subject to new option agreements executed by the Company and its employees who participated in the offer. Each new option has an exercise price of
$1.64 per share (the fair market value of the Company’s common stock on the new grant date) and vests over four years at a rate of 25% on each
anniversary of the vesting start date of the tendered option that it replaced.
52
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
Common Stock Warrants
In August 2000, the Company issued
warrants to purchase 133,333 shares of its common stock at $15.00 per share to Stephens Group, Inc. (“Stephens”) and warrants to purchase
66,667 shares of its common stock at $15.00 per share to WBW Trust Number One (“WBW”), in connection with credit facilities it established
with these entities. The Company also paid loan commitment fees of $200,000 to Stephens and $100,000 to WBW. Under the terms of the credit facilities,
the Company had the ability to borrow up to $10 million from Stephens and $5 million from WBW. The Company did not borrow any amounts pursuant to the
credit facilities and, with the completion of the initial public offering, no longer has the ability to borrow any amounts under the credit facilities.
One of the Company’s directors, William T. Weyerhaeuser, is trustee of WBW. At the time, Stephens beneficially owned approximately 10% of the
Company’s common stock (approximately 17% at December 31, 2005) and Jon E. M. Jacoby, a director of the Company, is also a director and was an
executive vice president of Stephens. The warrants expired in August 2005.
Employee Stock Purchase Plan
The 2000 Employee Stock Purchase Plan
(the “2000 Stock Purchase Plan”) was implemented in October 2000 at the completion of the Company’s initial public offering. The 2000
Stock Purchase Plan allowed employees to purchase common stock through payroll deductions of up to 15% of their annual compensation. No employee could
purchase common stock worth more than $25,000 in any calendar year, valued as of the first day of each offering period. In addition, no more than an
aggregate of 125,000 shares could be purchased in any six-month purchase period and no employee could purchase more than 1,000 shares in any six-month
purchase period.
The 2000 Stock Purchase Plan utilized
twenty-four-month offering periods, each of which consists of four six-month purchase periods, with purchases made on the last day of each such period.
Offering periods began on each May 1 and November 1. The price of the common stock purchased under the 2000 Stock Purchase Plan was the lesser of 85%
of the fair market value on the first day of an offering period and 85% of the fair market value on the last day of a purchase period.
The 2000 Stock Purchase Plan authorized
the issuance of a total of 500,000 shares of common stock, plus an automatic annual increase equal to the lesser of (a) 250,000 shares; (b) 1% of the
outstanding shares of common stock as of the end of the immediately preceding fiscal year on a fully diluted basis; and (c) a lesser amount determined
by the Board of Directors. No additional shares were added to the 2000 Stock Purchase Plan on January 1, 2006, 2005 or 2004. A total of 25,000 shares
were purchased under the plan in 2005, for total proceeds of $10,000; 19,880 shares of stock were purchased under the plan in 2004, for total proceeds
of $12,670; and 22,295 shares were purchased in 2003, for total proceeds of $29,193. The 2000 Stock Purchase Plan was terminated by the Board of
Directors in November 2005.
3. Licensing
Agreement
In May 1995, the Company entered into
an exclusive worldwide licensing agreement with Cornell Research Foundation for certain patents, patent applications and biological material relating
to harpin proteins and related technology. The license agreement terminates on the expiration date of the last-to-expire licensed patent covered by the
agreement, which is currently February 2018. As consideration for the license, the Company issued 400,000 shares of common stock to Cornell Research
Foundation, has funded certain research and development activities at Cornell University and has agreed to pay a 2% royalty on net sales of current
Harp-N-Tech products that incorporate the licensed technology, subject to a $200,000 minimum annual royalty payment.
53
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
4. Inventory
Inventory, at average cost, consists of
the following:
|
|
|
|
December 31,
|
|
|
|
|
|
2005
|
|
2004
|
Raw
materials |
|
|
|
$ |
503,259 |
|
|
$ |
579,385 |
|
Bulk manufactured
goods |
|
|
|
|
561,318 |
|
|
|
1,906,681 |
|
Finished
goods |
|
|
|
|
2,558,977 |
|
|
|
1,001,520 |
|
Total
inventory |
|
|
|
|
3,623,554 |
|
|
|
3,487,586 |
|
Less non-current
portion of inventory |
|
|
|
|
(1,910,280 |
) |
|
|
— |
|
Current
portion of inventory |
|
|
|
$ |
1,713,274 |
|
|
$ |
3,487,586 |
|
The non-current portion of inventory at
December 31, 2005 consists primarily of raw materials, bulk manufactured goods and finished goods that the Company does not expect to utilize in the
next twelve months. Prior to September 30, 2005, the Company expected all inventories to be utilized in the twelve month period subsequent to the
balance sheet date.
5. Property and
Equipment
Property and equipment, at cost,
consists of the following:
|
|
|
|
December 31,
|
|
|
|
|
|
2005
|
|
2004
|
Equipment |
|
|
|
$ |
6,838,591 |
|
|
$ |
12,460,206 |
|
Equipment under
capital leases |
|
|
|
|
19,418 |
|
|
|
66,646 |
|
Leasehold
improvements |
|
|
|
|
3,557,590 |
|
|
|
10,817,391 |
|
Total property
and equipment |
|
|
|
|
10,415,599 |
|
|
|
23,344,243 |
|
Less accumulated
depreciation and amortization |
|
|
|
|
(4,448,477 |
) |
|
|
(9,456,670 |
) |
Net property
and equipment |
|
|
|
$ |
5,967,122 |
|
|
$ |
13,887,573 |
|
The Company recorded depreciation and
amortization expense of $1,952,027 in 2005, $1,976,015 in 2004, and $2,149,267 in 2003.
6. Accrued
Liabilities
Accrued liabilities consist of the
following:
|
|
|
|
December 31,
|
|
|
|
|
|
2005
|
|
2004
|
Facility
costs |
|
|
|
$ |
290,499 |
|
|
$ |
232,097 |
|
Compensation and
benefits |
|
|
|
|
270,545 |
|
|
|
307,313 |
|
Research and
development field trial expenses |
|
|
|
|
243,463 |
|
|
|
256,873 |
|
Royalty |
|
|
|
|
160,684 |
|
|
|
118,434 |
|
Sales
allowances |
|
|
|
|
119,177 |
|
|
|
84,769 |
|
Warranty |
|
|
|
|
74,871 |
|
|
|
75,000 |
|
Promotions |
|
|
|
|
33,177 |
|
|
|
95,415 |
|
Other |
|
|
|
|
67,989 |
|
|
|
36,510 |
|
Total accrued
liabilities |
|
|
|
$ |
1,260,405 |
|
|
$ |
1,206,411 |
|
54
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
7. Warranty
Liability
The Company provides a limited warranty
to customers that products, at the time of the first sale, conform to the chemical description on the label and under normal conditions are reasonably
fit for the purposes referred to in the directions for use, subject to certain inherent risks. The Company records, at the time revenues are
recognized, a liability for warranty claims based on a percentage of sales. The warranty accrual percentage, which has ranged between zero and five
percent, and warranty liability are reviewed periodically and adjusted as necessary, based on historical experience, the results of product quality
testing and future expectations. The following table summarizes changes to the Company’s warranty liability:
|
|
|
|
Year Ended December 31,
|
|
|
|
|
|
2005
|
|
2004
|
|
2003
|
Beginning
balance |
|
|
|
$ |
75,000 |
|
|
$ |
228,021 |
|
|
$ |
331,059 |
|
Payments and
other settlements |
|
|
|
|
(129 |
) |
|
|
— |
|
|
|
(41,071 |
) |
Accruals, net
of changes in estimate of liability |
|
|
|
|
— |
|
|
|
(153,021 |
) |
|
|
(61,967 |
) |
Ending
balance |
|
|
|
$ |
74,871 |
|
|
$ |
75,000 |
|
|
$ |
228,021 |
|
8. Commitments and Contingencies
Leases
The Company has entered into
non-cancelable lease agreements involving equipment and facilities through the year 2009. Future minimum rental payments under capital lease
obligations and operating leases as of December 31, 2005 are as follows:
|
|
|
|
Capital
|
|
Operating
|
2006 |
|
|
|
$ |
769 |
|
|
$ |
254,664 |
|
2007 |
|
|
|
|
— |
|
|
|
220,472 |
|
2008 |
|
|
|
|
— |
|
|
|
229,424 |
|
2009 |
|
|
|
|
— |
|
|
|
238,366 |
|
Total minimum
lease payments |
|
|
|
|
769 |
|
|
$ |
942,926 |
|
Less amount
representing interest |
|
|
|
|
(8 |
) |
|
|
|
|
Capital lease
obligation, current |
|
|
|
$ |
761 |
|
|
|
|
|
Rental expense was as
follows:
|
|
|
|
Year Ended December 31,
|
|
|
|
|
|
2005
|
|
2004
|
|
2003
|
Minimum
rentals |
|
|
|
$ |
1,452,481 |
|
|
$ |
1,921,310 |
|
|
$ |
1,912,104 |
|
Payment of
accrued loss on facility subleases |
|
|
|
|
(350,080 |
) |
|
|
(525,120 |
) |
|
|
(376,144 |
) |
Less sublease
rental income |
|
|
|
|
(269,416 |
) |
|
|
(448,820 |
) |
|
|
(358,117 |
) |
Net rental
expense |
|
|
|
$ |
832,985 |
|
|
$ |
947,370 |
|
|
$ |
1,177,843 |
|
In February 2006, the Company entered
into a First Amendment to Lease and Extension Agreement with the landlord of the manufacturing facility to extend the lease term to December 31, 2009
and reduce rent payments.
Loss on Lease Termination
In January 2001, the Company entered
into a ten-year lease agreement, with two five-year extension options to be exercised at the Company’s discretion, for 63,200 square feet of
office space located near its manufacturing facility in Bothell, Washington. Rent payments increase by approximately eight percent every 30 months over
the term of the lease. Total rent is expensed on a straight-line basis over the lease term. A liability for rent expense in excess of rent payments is
included in other long-term liabilities and totaled approximately $550,000 at December 31, 2004 and zero at December 31, 2005. In the first half of
2001, the
55
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
Company converted approximately
22,600 square feet of this building into laboratory facilities and made other improvements at a cost of approximately $9.1 million.
On September 9, 2005,
the Company entered into an Amendment of Lease and Termination Agreement with the landlord to terminate the ten-year lease. The termination was
effective as of August 31, 2005. In connection with the termination, the existing sublease was transferred to the landlord. The lease termination
resulted in a loss totaling $2,260,538. The lease termination loss is comprised of a termination fee totaling $1,500,000, consisting of $250,000 cash
and the forfeiture of a $1,250,000 security deposit (previously included in long-term other assets on the balance sheet), a loss on leasehold
improvements and equipment at the leased facility totaling $3,480,883, and other costs, offset by the write-off of liabilities recorded for accrued
losses on facility subleases and rent expense in excess of rent payments totaling $2,724,124.
Loss on Facility Subleases
In order to offset
its future facility costs, the Company, in December 2002, entered into an agreement to sublease to another company 34,302 square feet of laboratory and
office space. The sublease agreement had an initial non-cancelable term of five years, with one three-year extension option to be exercised at the
subtenant’s discretion and two five-year extension options to be exercised at the subtenant’s discretion, provided that the Company exercises
its options to extend the lease beyond the initial ten-year term. The rent to be collected under the sublease exceeded the rent the Company paid for
the subleased space. However, the excess did not cover the unamortized cost of leasehold improvements and equipment in the subleased space. As a
result, a $4.2 million loss on the sublease was recorded in December 2002. The loss included a write-off of net leasehold improvements and equipment
directly related to the subleased space totaling $1.0 million; an accrued loss of $4.0 million for the subtenant’s estimated portion of
depreciation and amortization of shared assets, offset by excess rents of approximately $1.1 million; and sublease transaction costs of approximately
$300,000.
In April 2003, the
Company subleased to another company approximately 7,300 square feet of office space. The sublease agreement had a term of five years. Due to declines
in the real estate market, the rent the Company paid on the subleased space exceeded the rent to be collected under the sublease. As a result, the
Company recorded a loss on the sublease in 2003 of approximately $366,000. This subtenant was not in compliance with the sublease agreement at
September 30, 2004 and the agreement was terminated in October 2004. As a result, the Company recorded an additional loss of approximately $202,000 in
2004 based upon an estimate of the time needed to re-sublease the space and expected future rents to be collected.
Legal Proceedings
The Company is
subject to various claims and legal actions that arise in the ordinary course of business and believes that the ultimate liability, if any, with
respect to these claims and legal actions will not have a material effect on its consolidated financial statements.
9. Major Customers
Net product sales to
the following distributors accounted for more than ten percent of net revenues for the periods indicated:
|
|
|
|
Year Ended December 31,
|
|
|
|
|
|
2005
|
|
2004
|
|
2003
|
Customer
A |
|
|
|
$ |
517,000 |
|
|
$ |
— |
|
|
$ |
182,000 |
|
Customer
B |
|
|
|
|
509,000 |
|
|
|
159,000 |
|
|
|
363,000 |
|
Customer
C |
|
|
|
|
449,000 |
|
|
|
— |
|
|
|
— |
|
Customer
D |
|
|
|
|
384,000 |
|
|
|
175,000 |
|
|
|
— |
|
Customer
E |
|
|
|
|
375,000 |
|
|
|
— |
|
|
|
— |
|
Customer
F |
|
|
|
|
** |
|
|
|
146,000 |
|
|
|
— |
|
Customer
G |
|
|
|
|
** |
|
|
|
** |
|
|
|
168,000 |
|
{footnote}
%** Less than ten percent.
56
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
10. Restructuring Charges and Other
Costs
The Company recorded and paid
restructuring costs for severance and other costs associated with a workforce reduction in 2003 totaling $160,082. These costs are recorded in the
consolidated statements of operations as components of research and development expense or selling, general and administrative expense, depending upon
the classification of the affected employees. Of the 18 employees included in the workforce reductions, nine worked in research and development and the
remainder worked in a variety of other areas, principally administration and sales and marketing.
11. Defined Contribution
Plan
The Eden Bioscience Corporation 401(k)
Plan and Trust (the “Plan”) was established in 1997 and revised in 2001. The current Plan covers all employees of the Company who are at
least 21 years old. The Plan includes a provision for deferral of up to 100% of participant compensation, subject to IRS limitations, and a
discretionary employer match at an amount to be determined by the Company’s Board of Directors. To date, the Company has made no contributions to
the Plan.
12. Asset Retirement
Obligation
As of January 1, 2003, the Company
adopted SFAS No. 143, “Accounting for Asset Retirement Obligations,” by recording an asset and liability in the amount of $129,093 related to
asset retirement obligations the Company has at the expiration or earlier termination of its manufacturing facility lease. In 2006, the Company
extended the lease for three additional years through December 31, 2009. The Company has not restricted any assets for purposes of settling this asset
retirement obligation. As of January 1, 2003, the Company also recorded a $63,508 charge for the cumulative effect of adopting SFAS No. 143, which
consists of cumulative accretion of $34,821 and depreciation of $28,687 related to periods prior to January 1, 2003. Following is a reconciliation of
the beginning and ending aggregate carrying value of the asset retirement obligation liability, which is included in other long-term
liabilities:
Initial
measurement of obligation |
|
|
|
$ |
129,093 |
|
Accretion
expense for periods prior to January 1, 2003 |
|
|
|
|
34,821 |
|
Accretion
expense in 2003 |
|
|
|
|
21,156 |
|
Accretion
expense in 2004 |
|
|
|
|
25,015 |
|
Accretion
expense in 2005 |
|
|
|
|
28,187 |
|
Balance at
December 31, 2005 |
|
|
|
$ |
238,272 |
|
13. Income Taxes
The Company files a Federal and certain
foreign and state tax returns and did not record an income tax benefit for any of the periods presented because it has experienced operating losses
since inception. The Company’s total U.S. tax net operating loss carryforwards were approximately $112.1 million at December 31, 2005 and expire
between 2009 and 2025. The Company’s total foreign tax net operating loss carryforwards were approximately $10.4 million at December 31, 2005 and
expire between 2006 and 2015. The Company’s
57
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
total general business credit
carryforwards were approximately $1.4 million at December 31, 2005 and expire between 2013 and 2025. The significant components of the deferred tax
asset were as follows:
|
|
|
|
2005
|
|
2004
|
Net operating
loss carryforwards |
|
|
|
$ |
42,693,000 |
|
|
$ |
38,843,000 |
|
Depreciation and
amortization |
|
|
|
|
(1,806,000 |
) |
|
|
(2,467,000 |
) |
General business
credit carryforwards |
|
|
|
|
1,423,000 |
|
|
|
1,345,000 |
|
Accrued loss on
facility subleases |
|
|
|
|
— |
|
|
|
963,000 |
|
Other |
|
|
|
|
368,000 |
|
|
|
317,000 |
|
Deferred tax
asset |
|
|
|
|
42,678,000 |
|
|
|
39,001,000 |
|
Deferred tax
asset valuation allowance |
|
|
|
|
(42,678,000 |
) |
|
|
(39,001,000 |
) |
Net deferred
tax asset |
|
|
|
$ |
— |
|
|
$ |
— |
|
The valuation allowance on deferred tax
assets increased by $3.7 million during 2005 and $3.3 million during 2004. Pursuant to Section 382 of the Internal Revenue Code, annual use of the
Company’s net operating loss and credit carryforwards may be limited in the event of a cumulative change in ownership of more than 50%. These
Section 382 limitations and other limitations under state and foreign tax laws could result in a portion of the Company’s net operating losses
never being utilized. The difference between the statutory tax rate of 35% and the tax benefit of zero recorded by the Company is due to the
Company’s full valuation allowance against net deferred tax assets.
14. Quarterly Financial Data
(Unaudited)
The following table summarizes selected
unaudited quarterly financial data for each quarter of the years ended December 31, 2005 and 2004.
|
|
|
|
Three Months Ended
|
|
|
|
|
|
March 31
|
|
June 30
|
|
September 30
|
|
December 31
|
Fiscal year
2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
revenues |
|
|
|
$ |
1,154,486 |
|
|
$ |
1,677,463 |
|
|
$ |
343,398 |
|
|
$ |
588,268 |
|
Loss from
operations |
|
|
|
|
(1,754,852 |
) |
|
|
(1,462,896 |
) |
|
|
(4,543,422 |
) |
|
|
(3,391,447 |
) |
Net
loss |
|
|
|
|
(1,686,828 |
) |
|
|
(1,391,660 |
) |
|
|
(4,459,713 |
) |
|
|
(3,319,664 |
) |
Basic and
diluted net loss per share |
|
|
|
|
(0.07 |
) |
|
|
(0.06 |
) |
|
|
(0.18 |
) |
|
|
(0.14 |
) |
Common stock
trading range:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
High |
|
|
|
$ |
1.38 |
|
|
$ |
0.93 |
|
|
$ |
1.20 |
|
|
$ |
0.81 |
|
Low |
|
|
|
|
0.60 |
|
|
|
0.46 |
|
|
|
0.65 |
|
|
|
0.51 |
|
Fiscal year
2004:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
revenues |
|
|
|
$ |
213,401 |
|
|
$ |
289,937 |
|
|
$ |
368,383 |
|
|
$ |
168,021 |
|
Loss from
operations |
|
|
|
|
(2,397,603 |
) |
|
|
(2,041,706 |
) |
|
|
(1,996,600 |
) |
|
|
(2,672,097 |
) |
Net
loss |
|
|
|
|
(2,346,399 |
) |
|
|
(1,995,581 |
) |
|
|
(1,937,799 |
) |
|
|
(2,606,473 |
) |
Basic and
diluted net loss per share |
|
|
|
|
(0.10 |
) |
|
|
(0.08 |
) |
|
|
(0.08 |
) |
|
|
(0.11 |
) |
Common stock
trading range:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
High |
|
|
|
$ |
1.95 |
|
|
$ |
1.66 |
|
|
$ |
0.90 |
|
|
$ |
1.25 |
|
Low |
|
|
|
|
1.30 |
|
|
|
0.65 |
|
|
|
0.37 |
|
|
|
0.43 |
|
In December 2005, the
Company recorded a loss of $1.7 million on equipment that will not be used in future manufacturing operations and will be sold or disposed; see Note 1
Property and Equipment.
58
Item 9. Changes in and
Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and
Procedures.
Under the supervision and with the
participation of management, including our President and Chief Executive Officer and our Chief Financial Officer, we have carried out an evaluation of
the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of
the fiscal year covered by this report. Based on that evaluation, our President and Chief Executive Officer and our Chief Financial Officer concluded
that our disclosure controls and procedures are effective as of the end of such year. There have been no changes in our internal control over financial
reporting during the fourth quarter of 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over
financial reporting.
Item 9B. Other
Information.
None.
PART III
Item 10. Directors and Executive
Officers of the Registrant.
The information required by this item
is incorporated by reference from the sections captioned “Board of Directors and Corporate Governance” and “Section 16(a) Beneficial
Ownership Reporting Compliance” contained in our proxy statement for the 2006 annual meeting of shareholders, to be filed with the Commission
pursuant to Regulation 14A not later than 120 days after December 31, 2005.
Item 11. Executive Compensation.
The information required by this item
is incorporated by reference from the sections captioned “Executive Compensation,” “Board of Directors and Corporate Governance —
Board of Director Compensation” and “Board of Directors and Corporate Governance — Compensation Committee Interlocks and Insider
Participation” contained in our proxy statement for the 2006 annual meeting of shareholders, to be filed with the Commission pursuant to
Regulation 14A not later than 120 days after December 31, 2005.
Item
12. |
|
Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters. |
The information required by this item
is incorporated by reference from the section captioned “Security Ownership of Certain Beneficial Owners and Management and Related Shareholder
Matters — Equity Compensation Plan Information” contained in our proxy statement for the 2006 annual meeting of shareholders, to be filed
with the Commission pursuant to Regulation 14A not later than 120 days after December 31, 2005.
Item 13. Certain Relationships and Related
Transactions.
None.
Item 14. Principal Accountant Fees and
Services.
The information required by this item
is incorporated by reference from the section captioned “Independent Registered Public Accounting Firm” contained in our proxy statement for
the 2006 annual meeting of shareholders, to be filed with the Commission pursuant to Regulation 14A not later than 120 days after December 31,
2005.
59
PART IV
Item 15. Exhibits and Financial
Statement Schedules.
The following documents are being filed
as part of this annual report on Form 10-K.
(a) |
|
Financial Statements. |
|
|
|
|
Page
|
Report of
Independent Registered Public Accounting Firm |
|
|
|
|
41 |
|
Consolidated
Balance Sheets |
|
|
|
|
42 |
|
Consolidated
Statements of Operations |
|
|
|
|
43 |
|
Consolidated
Statements of Shareholders’ Equity and Comprehensive Loss |
|
|
|
|
44 |
|
Consolidated
Statements of Cash Flows |
|
|
|
|
45 |
|
Notes to
Consolidated Financial Statements |
|
|
|
|
46 |
|
Exhibits 31.1 and 31.2 are being filed
as part of this annual report on Form 10-K. Exhibits 32.1 and 32.2 are being furnished with this annual report on Form 10-K.
Exhibit
Number
|
|
|
|
Description
|
| 3.1 |
|
|
|
Restated Articles of Incorporation of the Registrant (incorporated by reference to Exhibit 3.1 to Eden Bioscience’s Quarterly Report on
Form 10-Q for the quarterly period ended September 30, 2000 (Commission File No. 0-31499)). |
| 3.2 |
|
|
|
Third
Amended and Restated Bylaws of the Registrant (incorporated by reference to Exhibit 3.2 to Eden Bioscience’s Registration Statement on Form S-1,
as amended (Commission File No. 333-41028), initially filed with the SEC on July 7, 2000). |
| 9.1 |
|
|
|
Form
of Voting Trust Agreement between Stephens-EBC, LLC and James Sommers, as Trustee (incorporated by reference to Exhibit 9.1 to Eden Bioscience’s
Registration Statement on Form S-1, as amended (Commission File No. 333-41028), initially filed with the SEC on July 7, 2000). |
| 10.1 |
† |
|
|
Exclusive License Agreement, dated May 1, 1995, between Cornell Research Foundation, Inc. and the Registrant, as amended as of June 2, 2000
(incorporated by reference to Exhibit 10.1 to Eden Bioscience’s Quarterly Report on Form 10-Q (Commission File No. 0-31499), filed with the SEC on
July 26, 2005). |
| 10.2 |
|
|
|
Lease,
dated November 4, 1996, between Koll Real Estate Group for Koll North Creek Business Park and the Registrant (incorporated by reference to Exhibit 10.2
to Eden Bioscience’s Registration Statement on Form S-1, as amended (Commission File No. 333-41028), initially filed with the SEC on July 7,
2000). |
| 10.3 |
|
|
|
First
Amendment to Lease and Extension Agreement, dated February 16, 2006, with S/I North Creek I, LLC (the “Amendment”), which amends the Lease,
dated November 4, 1996, between Koll Real Estate Group for Koll North Creek Business Park and Eden Bioscience (incorporated by reference to Exhibit
99.1 to Eden Bioscience’s Current Report on Form 8-K (Commission File No. 0-31499), filed with the SEC on February 24, 2006). |
| 10.4 |
** |
|
|
1995
Combined Incentive and Nonqualified Stock Option Plan (incorporated by reference to Exhibit 10.3 to Eden Bioscience’s Registration Statement on
Form S-1, as amended (Commission File No. 333-41028), initially filed with the SEC on July 7, 2000). |
60
Exhibit
Number
|
|
|
|
Description
|
| 10.5 |
** |
|
|
2000
Stock Incentive Plan (incorporated by reference to Exhibit 10.4 to Eden Bioscience’s Registration Statement on Form S-1, as amended (Commission
File No. 333-41028), initially filed with the SEC on July 7, 2000). |
| 10.6 |
** |
|
|
Form
of Option Letter Agreement for Directors and Officers (incorporated by reference to Exhibit 10.1 to Eden Bioscience’s Quarterly Report on Form
10-Q (Commission File No. 0-31499), filed with the SEC on October 28, 2005). |
| 10.7 |
|
|
|
Form
of Indemnification Agreement (incorporated by reference to Exhibit 10.6 to Eden Bioscience’s Registration Statement on Form S-1, as amended
(Commission File No. 333-41028), initially filed with the SEC on July 7, 2000). |
| 10.8 |
** |
|
|
Change
of Control Agreement, dated August 16, 2000, between the Registrant and Bradley S. Powell (incorporated by reference to Exhibit 10.10 to Eden
Bioscience’s Registration Statement on Form S-1, as amended (Commission File No. 333-41028), initially filed with the SEC on July 7,
2000). |
| 10.9 |
** |
|
|
Change
of Control Agreement, dated August 16, 2000, between the Registrant and Zhongmin Wei (incorporated by reference to Exhibit 10.11 to Eden
Bioscience’s Registration Statement on Form S-1, as amended (Commission File No. 333-41028), initially filed with the SEC on July 7,
2000). |
| 10.10 |
** |
|
|
Letter
agreement, dated January 28, 2002, between the Registrant and Bradley S. Powell (incorporated by reference to Exhibit 10.15 to Eden Bioscience’s
Annual Report on Form 10-K (Commission File No. 0-31499), filed with the SEC on March 29, 2002). |
| 21.1 |
|
|
|
Subsidiaries of the Registrant (incorporated by reference to Exhibit 21.1 to Eden Bioscience’s Annual Report on Form 10-K (Commission
File No. 0-31499), filed with the SEC on March 29, 2002). |
| 23.1 |
* |
|
|
Consent of Independent Registered Public Accounting Firm. |
| 31.1 |
* |
|
|
Rule
13a-14(a) Certification (Chief Executive Officer). |
| 31.2 |
* |
|
|
Rule
13a-14(a) Certification (Chief Financial Officer). |
| 32.1 |
* |
|
|
Section 1350 Certification (Chief Executive Officer). |
| 32.2 |
* |
|
|
Section 1350 Certification (Chief Financial Officer). |
** |
|
Management contract or compensatory plan.
|
† |
|
The Exclusive License Agreement was originally filed as Exhibit
10.1 to Eden Bioscience’s Registration Statement on Form S-1, as amended, initially filed on July 7, 2000. Portions of the License Agreement filed
with the Form S-1 were redacted pursuant to a confidential treatment request granted by the SEC and effective through July 7, 2005. The License
Agreement was filed in unredacted form with Eden Bioscience’s Form 10-Q filed with the SEC on July 26, 2005). In accordance with Rule 202 of
Regulation S-T, portions of the exhibit have been filed in paper format pursuant to a continuing hardship exemption.
|
61
SIGNATURES
Pursuant to the requirements of Section
13 or 15(d) 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 in the City of Bothell, State of Washington, on March 14, 2006.
EDEN BIOSCIENCE
CORPORATION
By: |
|
/s/ Rhett R. Atkins
Rhett R. Atkins,
President, Chief Executive Officer and Director |
By: |
|
/s/ Bradley S. Powell
Bradley S. Powell,
Vice President of Finance, Chief Financial Officer and Secretary |
Pursuant to the requirements of the
Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities indicated
below on March 14, 2006.
Signature
|
|
|
|
Title
|
/s/ Rhett R.
Atkins
Rhett R. Atkins |
|
|
|
President,
Chief Executive Officer and Director
(Principal Executive Officer) |
|
/s/ Bradley
S. Powell
Bradley S. Powell |
|
|
|
Vice President
of Finance,
Chief Financial Officer and Secretary
(Principal Financial and Accounting Officer) |
|
/s/ William
T. Weyerhaeuser
William T. Weyerhaeuser |
|
|
|
Chairman of the
Board of Directors |
|
/s/ Gilberto
H. Gonzalez
Gilberto H. Gonzalez |
|
|
|
Director |
|
/s/ Jon E. M.
Jacoby
Jon E. M. Jacoby |
|
|
|
Director |
|
/s/ Roger
Ivesdal
Roger Ivesdal |
|
|
|
Director |
|
/s/ Albert A.
James
Albert A. James |
|
|
|
Director |
|
/s/ Agatha L.
Maza
Agatha L. Maza |
|
|
|
Director |
|
/s/ Richard
N. Pahre
Richard N. Pahre |
|
|
|
Director |
|
62