REGISTRATION NO. 333-131865
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 2, 2006
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
AMENDMENT NO. 1
TO
FORM S-1
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933, AS AMENDED
DELAWARE EARTHSHELL CORPORATION 77-0322379
------------------------------- ---------------------- -------------------
(State or Other Jurisdiction of (Name of Registrant in (I.R.S. Employer
Incorporation Our Charter) or Organization) Identification No.)
VINCENT J. TRUANT
1301 YORK ROAD, SUITE 200 1301 YORK ROAD, SUITE 200
BALTIMORE, MARYLAND 21093 BALTIMORE, MARYLAND 21093
(410) 847-9420 2650 (410) 847-9420
-------------------------------- ----------------- ----------------------------
(Address and telephone number (Primary Standard (Name, address and telephone
of Principal Executive Offices Industrial number of agent for service)
and Principal Place of Business) Classification
Code Number)
COPIES TO:
Clayton E. Parker, Esq. Ronald S. Haligman, Esq.
Kirkpatrick & Lockhart Kirkpatrick & Lockhart
Nicholson Graham LLP Nicholson Graham LLP
201 S. Biscayne Boulevard, 201 S. Biscayne Boulevard,
Suite 2000 Suite 2000
Miami, Florida 33131 Miami, Florida 33131
Telephone: (305)539-3300 Telephone: (305)539-3300
Telecopier: (305)358-7095 Telecopier: (305)358-7095
Approximate date of commencement of proposed sale to the public: As soon as
practicable after this Registration Statement becomes effective.
If any of the securities being registered on this Form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the 1933 Act check the
following box. |X|
If this Form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the 1933 Act, please check the following box and list the
1933 Act registration statement number of the earlier effective registration
statement for the same offering. |_|
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under
the 1933 Act, check the following box and list the 1933 Act registration
statement number of the earlier effective registration statement for the same
offering. |_|
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. |_|
CALCULATION OF REGISTRATION FEE
PROPOSED
MAXIMUM PROPOSED MAXIMUM AMOUNT OF
TITLE OF EACH CLASS OF SECURITIES AMOUNT TO BE OFFERING PRICE AGGREGATE REGISTRATION
TO BE REGISTERED REGISTERED PER SHARE(1) OFFERING PRICE(1) FEE(4)
--------------------------------------- ------------ -------------- ----------------- ------------
Common Stock, par value $0.01 per share 10,327,844 $1.76 $18,177,005 $1,945
shares(2)(3)
------------ -------------- ----------------- ------------
TOTAL 10,327,844 $1.76 18,177,005 $1,945
shares(2)(3)
============ ============== ================= ============
(1) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(c) under the Securities Act of 1933, as amended. For
the purposes of this table, we have used a recent closing price at January
17, 2006.
(2) These shares consist of: (i) 6,700,000 shares which are being registered
pursuant to the Purchase Agreement, dated December 30, 2005, with Cornell
Capital Partners, (ii) 143,550 shares which have been issued to Cornell
Capital Partners and 6,450 shares which have been issued to each of Sloan
Securities Corporation and Crown Capital Investment, Inc. on or about
March 23, 2005, in connection with a financing transaction, (iii)
1,295,000 shares underlying warrants, (iv) 1,909,727 shares being
registered pursuant to various settlement arrangements, (v) 266,667 shares
in connection with the EarthShell Asia Transaction.. The Registrant hereby
amends this Registration Statement on such date or dates as may be
necessary to delay its effective date until the Registrant shall file a
further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section
8(a) of the Securities Act of 1933, as amended, or until this Registration
Statement shall become effective on such date as the Commission, acting
pursuant to said Section 8(a), may determine.
(3) The Company initially intended to register 10,327,844 shares of common
stock in this registration statement. Since the Company's initial filing
of this registration statement in January 2006, some of the selling
stockholders have sold their shares prior to the filing of Amendment No. 1
to Form SB-2 and these shares are being removed from this registration
statement; therefore the Company is registering 9,687,034 shares of common
stock in this registration statement.
(4) Registration fee has previously been paid.
PROSPECTUS
SUBJECT TO COMPLETION, DATED AUGUST 2, 2006
EARTHSHELL CORPORATION
9,687,034 SHARES OF COMMON STOCK
This prospectus (this "Prospectus") relates to the registration of
9,687,034 shares of common stock of EarthShell Corporation ("EarthShell" or the
"Company") by certain persons who are stockholders of the Company. The selling
shareholders may not choose to sell all of the shares covered by this
registration statement, or, under certain market conditions, may not be entitled
to convert and sell all of the shares covered by their respective registration
or conversion agreements. Please refer to "Selling Stockholders" beginning on
page 16. EarthShell is not selling any shares of common stock in this offering
and therefore will not receive any proceeds from this offering. All costs
associated with this registration will be borne by the Company.
The shares of common stock associated with this offering are being
offered for sale by certain persons who are selling stockholders at prices
established on the Over-the-Counter Bulletin Board during the term of this
offering. On July 21, 2006, the last reported market sale price of our common
stock was $2.20 per share. Our common stock is quoted on the Over-the-Counter
Bulletin Board under the symbol "ERTH.OB". The price of our common stock will
fluctuate based on the demand for the shares of common stock.
The selling stockholders consist of: (a) Cornell Capital Partners, who
may sell up to 7,360,500 shares of common stock, consisting of: (i) 6,700,000
shares which may be issued from time to time upon the conversion of secured
convertible debentures (the "Cornell Capital Debentures") acquired by Cornell
Capital Partners pursuant to the Securities Purchase Agreement, dated December
30, 2005 (the "Purchase Agreement"), and (ii) 660,500 shares of common stock
which may be issued upon the exercise of warrants issued on May 26, 2005, August
26, 2005 and December 30, 2005; (b) Sloan Securities Corporation, who may sell
up to 6,450 shares of common stock which the Company issued on or about March
23, 2005, in connection with a financing transaction; (c) Highgate House Funds,
Ltd., who may sell up to 364,500 shares of common stock which may be issued upon
the exercise of a warrant issued on December 30, 2005; (d) SF Capital Partners
Ltd., who may sell up to 1,000,000 shares of common stock upon the conversion of
existing debt pursuant to a settlement arrangement; (e) 266,667 shares in
connection with the EarthShell Asia Transaction, (f) other selling shareholders
who may sell up to 418,917 shares of common stock previously issued by the
Company and (g) additional selling stockholders, who may sell up to 270,000
shares of common stock upon the exercise of warrants previously issued by the
Company.
Pursuant to the Purchase Agreement, the Company issued to Cornell
Capital Partners the Cornell Capital Debentures, which shall be convertible into
shares of the Company's common stock as set forth herein. The Company received
proceeds equal to $4,500,000 from the sale of the Cornell Capital Debentures on
January 6, 2006. The Cornell Capital Debentures are secured by (i) a Pledge and
Escrow Agreement, by and among the Company, Cornell Capital Partners, and David
Gonzalez, Esq., (ii) an Insider Pledge Agreement and Escrow Agreement (the
"IPEA"), by and among the Company, Cornell Capital Partners, David Gonzalez,
Esq. and Mr. Benton Wilcoxon and (iii) an Amended and Restated Security
Agreement, by and between the Company and Cornell Capital Partners. The Cornell
Capital Debentures are secured by substantially all of the Company's assets,
have a three (3) year term and accrue interest at twelve percent (12%) per
annum. Beginning 60 days after the Securities and Exchange Commission ("SEC")
declares the accompanying registration statement effective, Cornell Capital
Partners is entitled, at its option, to convert and sell up to $250,000 of the
principal amount of the Cornell Capital Debentures, plus accrued interest, into
shares of the Company's common stock, within any 30 day period at the lesser of
(i) a price equal to $3.00 or (ii) eighty-eight percent (88%) of the average of
the two (2) lowest volume weighted average prices of the common stock during the
ten (10) trading days immediately preceding the conversion date, as quoted by
Bloomberg, LP. The conversion limitation of $250,000 per month does not apply if
the market price is greater than $3.00 per share.
i
The holder of the Cornell Capital Debentures may not convert the
Cornell Capital Debentures or receive shares of the Company's common stock as
payment of interest thereunder to the extent such conversion or receipt of such
interest payment would result in the holder, together with any affiliate
thereof, beneficially owning (as determined in accordance with Section 13(d) of
the Securities Exchange Act of 1934, as amended, and the rules promulgated
thereunder) in excess of 4.9% of the then issued and outstanding shares of
common stock, including shares issuable upon conversion of, and payment of
interest on, the Cornell Capital Debentures held by such holder after
application of this 4.9% restriction. This 4.9% restriction may be waived by the
holder (but only as to itself and not to any other holder) upon not less than
sixty-five (65) days prior notice to the Company. The Company may redeem, with
three (3) business days advance written notice to Cornell Capital Partners, a
portion or all amounts outstanding under the Cornell Capital Debentures prior to
the maturity date provided that the closing bid price of the of the Company's
common stock, as reported by Bloomberg, LP, is less than $3.00 at the time of
the redemption notice. The Company shall pay an amount equal to the principal
amount being redeemed plus a redemption premium equal to ten percent (10%) of
the principal amount being redeemed, and accrued interest, to be delivered to
the Cornell Capital Partners on the third (3rd) business day after the
redemption notice, provided, however, this redemption premium does not apply
until the outstanding principal balance of the Cornell Capital Debentures has
been reduced by $2.5 million. The amount that Cornell may convert in any 30 day
period will be reduced by the amount that the Company redeems.
On July 12, 2006, the Company entered into a Letter Agreement with
Cornell Capital Partners, pursuant to which Cornell Capital Partners has agreed
to forbear from exercising certain rights and remedies under the Cornell Capital
Debentures and that certain Registration Rights Agreement, of even date with the
Cornell Capital Debentures in exchange for the issuance by the Company to
Cornell Capital Partners of 250,000 shares of the Company's common stock.
The Company has acknowledged in the Agreement that an event of default
under the Cornell Capital Debentures had occurred as of June 30, 2006 with the
Company failing to timely register with the U.S. Securities and Exchange
Commission the common stock underlying the Cornell Capital Debentures. The
Company also acknowledged that Cornell Capital Partners is entitled to
liquidated damages equal to one percent (1%) of the liquidated value of the
Cornell Capital Partners for each thirty (30) day period after May 31, 2006.
Pursuant to the Agreement, Cornell Capital Partners has agreed to waive the
default, including all liquidated damages that may have accrued through the date
of the Agreement and during the Forbearance Period (as defined below), in
exchange for the 250,000 shares of common stock and the Company obtaining the
effectiveness by September 30, 2006 of that certain Registration Statement
originally filed with the U.S. Securities and Exchange Commission on February
14, 2006, which includes the shares of common stock underlying the Cornell
Capital Debentures.
Furthermore, Cornell Capital Partners has agreed not to make any
conversions under the Cornell Capital Debentures until the earlier of September
30, 2006 or the expiration of the Forbearance Period, which such Forbearance
Period shall commence on the date of the execution of the Agreement and continue
for so long as the Company strictly complies with the terms of the Agreement and
there is no occurrence or existence of any event of default other than the
Default under the transaction documents or any other agreement that the Company
has entered into with Cornell Capital Partners. The 250,000 shares of commons
stock shall have piggy-back registration rights and Cornell Capital Partners
shall also have the right to demand the registration of the 250,000 shares of
common stock by providing to the Company with thirty (30) days prior written
notice of such request.
In connection with the Purchase Agreement, on December 30, 2005, the
Company issued to Cornell Capital Partners the December Warrant to purchase up
to 350,000 shares of common stock. This December Warrant has an exercise price
of $4.00 per share, which may be adjusted as low as $3 per share in the event
the Company issues or sells any shares of its common stock for a consideration
per share less than the exercise price for the December Warrant except for
certain exclusions. The December Warrant expires two (2) years from the date it
was issued. Furthermore, in connection with the Company's sale of Cornell
Capital Debentures, the Company issued to Mr. Benton Wilcoxon, in consideration
of his pledge of shares of common stock of Composite Technology Corporation
pursuant to the terms of the IPEA, a warrant to purchase up to 125,000 shares of
common stock. This warrant has an exercise price of $4.00 per share and expires
three (3) years from the date it was issued.
Brokers or dealers effecting transactions in these shares should
confirm that the shares are registered under the applicable state law or that an
exemption from registration is available.
These securities are speculative and involve a high degree of risk.
Please refer to "Risk Factors" beginning on page 8.
No underwriter or person has been engaged to facilitate the sale of
shares of common stock in this offering. This offering will terminate
twenty-four (24) months after the accompanying registration statement (the
"Registration Statement") is declared effective by the "SEC". None of the
proceeds from the sale of stock by the selling stockholders will be placed in
escrow, trust or any similar account.
ii
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED.
THE SELLING STOCKHOLDERS MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION
STATEMENT FILED WITH THE SEC IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO
BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
THE SEC AND STATE SECURITIES REGULATORS HAVE NOT APPROVED OR
DISAPPROVED OF THESE SECURITIES, OR DETERMINED IF THIS PROSPECTUS IS TRUTHFUL OR
COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
iii
TABLE OF CONTENTS
PROSPECTUS SUMMARY ....................................................... 1
THE OFFERING ............................................................. 3
SUMMARY FINANCIAL DATA ................................................... 6
SUPPLEMENTARY FINANCIAL INFORMATION ...................................... 7
RISK FACTORS ............................................................. 8
RISKS RELATED TO THIS OFFERING ........................................... 13
FORWARD-LOOKING STATEMENTS ............................................... 15
SELLING STOCKHOLDERS ..................................................... 16
USE OF PROCEEDS .......................................................... 23
DILUTION ................................................................. 24
PLAN OF DISTRIBUTION ..................................................... 25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS .................................................. 27
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING ......... 39
MATERIAL WEAKNESSES IDENTIFIED ........................................... 40
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE ................................................... 41
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ............... 42
DESCRIPTION OF BUSINESS .................................................. 43
MANAGEMENT ............................................................... 52
EMPLOYMENT AGREEMENTS AND ARRANGEMENTS ................................... 59
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE .................. 60
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION .............. 61
COMPENSATION COMMITTEE CHARTER ........................................... 63
COMPENSATION COMPONENTS .................................................. 64
COMPENSATION TO CHIEF EXECUTIVE OFFICER .................................. 66
DEDUCTIBILITY OF EXECUTIVE COMPENSATION .................................. 67
STOCK PERFORMANCE GRAPH .................................................. 68
PRINCIPAL STOCKHOLDERS ................................................... 69
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS ....... 70
MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND
OTHER STOCKHOLDER MATTERS .............................................. 71
DIVIDENDS ................................................................ 72
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ........................... 73
DESCRIPTION OF CAPITAL STOCK ............................................. 75
EXPERTS .................................................................. 80
VALIDITY OF SECURITIES ................................................... 80
INTERESTS OF NAMED EXPERT AND COUNSEL .................................... 80
HOW TO GET MORE INFORMATION .............................................. 80
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES ............................. I-i
PART II .................................................................. II-1
iv
PROSPECTUS SUMMARY
The following is only a summary of the information, financial statements
and the notes included in this Prospectus. You should read the entire Prospectus
carefully, including "Risk Factors" and our financial statements and the notes
to the financial statements before making any investment decision.
Our Company
EarthShell was organized in November 1992 to engage in the
commercialization of proprietary composite material technology, designed with
the environment in mind, for the manufacture of disposable packaging to be used
in the foodservice industry. Current and future products include hinged-lid
containers, plates, bowls, foodservice wraps, cups and cutlery (collectively,
"EarthShell Packaging(R)"). EarthShell composite material is primarily made from
abundantly available and low cost natural raw materials such as limestone and
starch from annually renewable crops, such as corn and potatoes. The Company has
determined that foodservice disposables made of this material should offer
certain environmental benefits, will have performance characteristics, such as
strength and rigidity, and it believes that it should be able to commercially
produce and sell these products at prices that are competitive with comparable
conventional paper and plastic foodservice disposables.
The Company's objective is to establish EarthShell Packaging(R) as the
preferred disposable packaging material for the foodservice industry throughout
the world based on comparable performance, environmental superiority and
competitive pricing. EarthShell's approach for achieving this objective has been
to: (i) license the EarthShell technology to strategically selected
manufacturing or operating partners to manufacture, market, distribute and sell
EarthShell Packaging(R); (ii) demonstrate customer acceptance and demand for
EarthShell Packaging(R) through key market leaders and environmental groups; and
(iii) demonstrate the manufacturability and improved economics with initial
strategic partners.
To date, the Company has licensed the technology to certain carefully
selected partners who are working to commercialize the technology. The Company
currently has three active licensees: one in the United States, one in Mexico
and one in Asia. In cooperation with its licensing partners, more than
50,000,000 units of EarthShell Packaging, including plates, bowls and sandwich
containers have been manufactured and sold to key customers within a variety of
market segments in order to demonstrate commercial product quality, customer
acceptance and demand. The Company has received support for its environmental
claims from a number of governmental and non-environmental organizations. In
addition, the Company has worked with a machinery manufacturer who has developed
turn-key manufacturing machinery for EarthShell plates and bowls. The Company's
primary focus is now on supporting its licensee in the United States, Renewable
Products Inc. ("RPI"), who has put in place a commercial production facility and
is commencing manufacturing and distribution operations. The Company expects to
acquire RPI in the near future, thereby bringing manufacturing capability in
house. In addition, the Company is supporting its Mexican licensee in acquiring
and putting into service manufacturing capacity to serve the Mexican market.
Finally, the Company has entered into various license agreements with EarthShell
Asia, an Asian licensee, to demonstrate and to exploit a new aspect of the
EarthShell technology.
Going Concern
The condensed consolidated financial statements have been prepared on a
going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. The Company has
incurred significant losses since inception, has minimal revenues and has a
working capital deficit of $7.5 million as of March 31, 2006. These factors,
along with others, may indicate that the Company will be unable to continue as a
going concern for a period of twelve (12) months or less. The Company will have
to raise additional funds to meet its current obligations and to cover operating
expenses through the year ending December 31, 2006. If the Company is not
successful in raising additional capital, it may not be able to continue as a
going concern for a period of 12 months or less. Management plans to address
this need by raising cash through either the issuance of debt or equity
securities.
Recent Developments
On or about June 1, 2006, the Company issued a total of 160,000 shares of
common stock to two individuals in connection with the termination of a license
agreement, mutual release, and settlement of claims between the parties. This
issuance was made in reliance upon the exemption from registration provided for
by Rule 506 of Regulation D and alternatively Section 4(2) of the Act. The
Company did not offer or sell any of the securities issued by any form of
general solicitation or general advertising and affixed a legend on the
certificates representing the Series D Preferred Stock and the Warrants, stating
that the securities have not been registered under the Act and referring to the
restrictions on transferability and sale of such securities.
On July 28, 2006, the Company entered into a Loan and Mutual Release
Agreement (the "Agreement") with E. Khashoggi Industries, LLC ("EKI"), the
Company's largest stockholder. Pursuant to the Agreement, EKI advanced $350,000
directly to the Company and an additional $150,000 to a law firm on behalf of
the Company to cover legal fees related to patent renewals. The Agreement also
contains mutual releases of any and all claims, known or unknown, which the
respective parties may have through the date of the Agreement under existing
license, debt conversion and service agreements. The Company executed and
delivered two Promissory Notes to EKI on July 28, 2006; one in the amount of
$350,000 and the other in the amount of $150,000. Interest accrues on the
principal balance of the $350,000 note at a variable per annum rate, as of any
date of determination, that is equal to the rate published in the "Money Rates"
section of The Wall Street Journal as being the "Prime Rate", compounded
monthly. The $150,000 note is non-interest bearing. All accrued but unpaid
interest and outstanding principal under the notes is due and payable on the
earliest to occur of the following: (i) the second anniversary of the date of
the note; (ii) five days following the date the Company has received $3.0
million or more in aggregate net cash proceeds from all financing transactions,
equity contributions, and transactions relating to the sale, licensing,
sublicensing or disposition of assets or the provision of services (including
advance royalty payments, proceeds from the sale of the Company's common stock
and fees for technological services rendered to third parties), occurring
subsequent to the date of the notes.
1
On June 21, 2006, the Company entered into a Securities Purchase Agreement
(the "SPA") by and among the Company and certain investors named therein (the
"Investors") pursuant to which the Company sold an aggregate of 128,205 shares
of Series D convertible preferred stock (the "Series D Preferred Stock") for a
total purchase price of $500,000. The Series D Preferred Stock, which was sold
to the Investors in a private offering, pays a cumulative 20% annual dividend,
which shall be paid on conversion or liquidation of the Company. The Series D
Preferred Stock is callable in certain circumstances by the Company. In the
event of any voluntary or involuntary liquidation, dissolution or winding up of
the Company, the holders of the Series D Preferred Stock will be entitled to
receive, prior and in preference to any distribution of the assets or surplus
funds of the Company to the holders of any shares of common stock by reason of
the ownership thereof, an amount equal to the Liquidation Value of $3.90 per
share and any accrued dividends. Each share of Series D Preferred Stock is
convertible into one share of the Company's common stock, par value $0.01 per
share, subject to adjustment. In order to (i) effect an amendment of the
Company's Certificate of Incorporation or By-Laws (except to increase the number
of directors), (ii) issue, or permit any Subsidiaries to issue, any additional
shares of capital stock or other equity interests at less than Fair Market
Value, or (iii) change the Company's business or business model, the affirmative
vote of the holders of at least seventy-five percent (75%) of the then
outstanding shares of Series D Preferred Stock must first be obtained.
In connection with the issuance and sale of the Series D Preferred Stock,
the Company granted the Investors immediately exercisable warrants to purchase
an aggregate of 555,555 shares of the Company's common stock at an exercise
price of $3.90 per share, subject to adjustment (the "Warrants"). The Investors
also have been granted certain registration rights with respect to the shares of
common stock underlying the Series D Preferred Stock and the Warrants as set
forth in Section 3 of the SPA.
On July 12, 2006, the Company entered into a Letter Agreement with Cornell
Capital Partners, pursuant to which Cornell Capital Partners has agreed to
forbear from exercising certain rights and remedies under the Cornell Capital
Debentures and that certain Registration Rights Agreement, of even date with the
Cornell Capital Debentures in exchange for the issuance by the Company to
Cornell Capital Partners of 250,000 shares of the Company's common stock.
The Company has acknowledged in the Agreement that an event of default
under the Cornell Capital Debentures had occurred as of June 30, 2006 with the
Company failing to timely register with the U.S. Securities and Exchange
Commission the common stock underlying the Cornell Capital Debentures. The
Company also acknowledged that Cornell Capital Partners is entitled to
liquidated damages equal to one percent (1%) of the liquidated value of the
Cornell Capital Partners for each thirty (30) day period after May 31, 2006.
Pursuant to the Agreement, Cornell Capital Partners has agreed to waive the
default, including all liquidated damages that may have accrued through the date
of the Agreement and during the Forbearance Period (as defined below), in
exchange for the 250,000 shares of common stock and the Company obtaining the
effectiveness by September 30, 2006 of that certain Registration Statement
originally filed with the U.S. Securities and Exchange Commission on February
14, 2006, which includes the shares of common stock underlying the Cornell
Capital Debentures.
Furthermore, Cornell Capital Partners has agreed not to make any
conversions under the Cornell Capital Debentures until the earlier of September
30, 2006 or the expiration of the Forbearance Period, which such Forbearance
Period shall commence on the date of the execution of the Agreement and continue
for so long as the Company strictly complies with the terms of the Agreement and
there is no occurrence or existence of any event of default other than the
Default under the Cornell Capital Debenture transaction documents or any other
agreement that the Company has entered into with Cornell Capital Partners. The
250,000 shares of commons stock shall have piggy-back registration rights and
Cornell Capital Partners shall also have the right to demand the registration of
the 250,000 shares of common stock by providing to the Company with thirty (30)
days prior written notice of such request.
About Us
Our principal executive offices are located at 1301 York Road, Suite 200,
Baltimore, Maryland 21093. Our telephone number is (410) 847-9420. The address
of our website is www.earthshell.com. Information on our website is not part of
this Prospectus.
2
THE OFFERING
(1) Cornell Capital Partners, who may sell up to 7,360,500 shares of
common stock, consisting of: (i) 6,700,000 shares which may be issued from time
to time upon the conversion of secured convertible debentures (the "Cornell
Capital Debentures") acquired by Cornell Capital Partners pursuant to the
Securities Purchase Agreement, dated December 30, 2005 (the "Purchase
Agreement"), and (ii) 660,500 shares of common stock which may be issued upon
the exercise of warrants 260,500 of which were issued on May 26, 2005, 50,000 of
which were issued on August 26, 2005 and 350,000 of which were issued December
30, 2005;
(2) Sloan Securities Corporation, who may sell up to 6,450 shares of
common stock which the Company issued on or about March 23, 2005, in connection
with a financing transaction;
(3) Highgate House Funds, Ltd., who may sell up to 364,500 shares of
common stock which may be issued upon the exercise of a warrant issued on
December 30, 2005;
(4) SF Capital Partners Ltd., who may sell up to 1,000,000 shares of
common stock upon the conversion of existing debt pursuant to a settlement
arrangement;
(5) 266,667 shares in connection with the EarthShell Asia Transaction,
(6) other selling shareholders who may sell up to 916,177 shares of common
stock previously issued by the Company and
(7) additional selling stockholders, who may sell up to 270,000 shares of
common stock upon the exercise of warrants previously issued by the Company.
Pursuant to the Purchase Agreement, the Company issued to Cornell Capital
Partners the Cornell Capital Debentures, which shall be convertible into shares
of the Company's common stock as set forth herein. The Company received proceeds
equal to $4,500,000 from the sale of the Cornell Capital Debentures on January
6, 2006. The Cornell Capital Debentures are secured by (i) a Pledge and Escrow
Agreement, by and among the Company, Cornell Capital Partners, and David
Gonzalez, Esq., (ii) an Insider Pledge Agreement and Escrow Agreement (the
"IPEA"), by and among the Company, Cornell Capital Partners, David Gonzalez,
Esq. and Mr. Benton Wilcoxon and (iii) an Amended and Restated Security
Agreement, by and between the Company and Cornell Capital Partners. The Cornell
Capital Debentures are secured by substantially all of the Company's assets,
have a three (3) year term and accrue interest at twelve percent (12%) per
annum. Beginning 60 days after the Securities and Exchange Commission ("SEC")
declares the accompanying registration statement effective, Cornell Capital
Partners is entitled, at its option, to convert and sell up to $250,000 of the
principal amount of the Cornell Capital Debentures, plus accrued interest, into
shares of the Company's common stock, within any 30 day period at the lesser of
(i) a price equal to $3.00 or (ii) eighty-eight percent (88%) of the average of
the two (2) lowest volume weighted average prices of the common stock during the
ten (10) trading days immediately preceding the conversion date, as quoted by
Bloomberg, LP. The conversion limitation of $250,000 per month does not apply if
the market price is greater than $3.00 per share.
The holder of the Cornell Capital Debentures may not convert the Cornell
Capital Debentures or receive shares of the Company's common stock as payment of
interest thereunder to the extent such conversion or receipt of such interest
payment would result in the holder, together with any affiliate thereof,
beneficially owning (as determined in accordance with Section 13(d) of the
Securities Exchange Act of 1934, as amended, and the rules promulgated
thereunder) in excess of 4.9% of the then issued and outstanding shares of
common stock, including shares issuable upon conversion of, and payment of
interest on, the Cornell Capital Debentures held by such holder after
application of this 4.9% restriction. This 4.9% restriction may be waived by the
holder (but only as to itself and not to any other holder) upon not less than
sixty-five (65) days prior notice to the Company.
The Company may redeem, with three (3) business days advance written
notice to Cornell Capital Partners, a portion or all amounts outstanding under
the Cornell Capital Debentures prior to the maturity date provided that the
closing bid price of the of the Company's common stock, as reported by
Bloomberg, LP, is less than $3.00 at the time of the redemption notice. The
Company shall pay an amount equal to the principal amount being redeemed plus a
redemption premium equal to ten percent (10%) of the principal amount being
redeemed, and accrued interest, to be delivered to the Cornell Capital Partners
on the third (3rd) business day after the redemption notice, provided, however,
this redemption premium does not apply until the outstanding principal balance
of the Cornell Capital Debentures has been reduced by $2.5 million. The amount
that Cornell may convert in any 30 day period will be reduced by the amount that
the Company redeems.
3
On July 12, 2006, the Company entered into a Letter Agreement with Cornell
Capital Partners, pursuant to which Cornell Capital Partners has agreed to
forbear from exercising certain rights and remedies under the Cornell Capital
Debentures and that certain Registration Rights Agreement, of even date with the
Cornell Capital Debentures in exchange for the issuance by the Company to
Cornell Capital Partners of 250,000 shares of the Company's common stock.
The Company has acknowledged in the Agreement that an event of default
under the Cornell Capital Debentures had occurred as of June 30, 2006 with the
Company failing to timely register with the U.S. Securities and Exchange
Commission the common stock underlying the Cornell Capital Debentures. The
Company also acknowledged that Cornell Capital Partners is entitled to
liquidated damages equal to one percent (1%) of the liquidated value of the
Cornell Capital Partners for each thirty (30) day period after May 31, 2006.
Pursuant to the Agreement, Cornell Capital Partners has agreed to waive the
default, including all liquidated damages that may have accrued through the date
of the Agreement and during the Forbearance Period (as defined below), in
exchange for the 250,000 shares of common stock and the Company obtaining the
effectiveness by September 30, 2006 of that certain Registration Statement
originally filed with the U.S. Securities and Exchange Commission on February
14, 2006, which includes the shares of common stock underlying the Cornell
Capital Debentures.
Furthermore, Cornell Capital Partners has agreed not to make any
conversions under the Cornell Capital Debentures until the earlier of September
30, 2006 or the expiration of the Forbearance Period, which such Forbearance
Period shall commence on the date of the execution of the Agreement and continue
for so long as the Company strictly complies with the terms of the Agreement and
there is no occurrence or existence of any event of default other than the
Default under the Cornell Capital Debenture transaction documents or any other
agreement that the Company has entered into with Cornell Capital Partners. The
250,000 shares of commons stock shall have piggy-back registration rights and
Cornell Capital Partners shall also have the right to demand the registration of
the 250,000 shares of common stock by providing to the Company with thirty (30)
days prior written notice of such request.
In connection with the Purchase Agreement, on December 30, 2005, the
Company issued to Cornell Capital Partners the December Warrant to purchase up
to 350,000 shares of common stock. This December Warrant has an exercise price
of $4.00 per share, which may be adjusted to as low as $3 per share in the event
the Company issues or sells any shares of its common stock for a consideration
per share less than the exercise price of the December Warrant except for
certain exclusions. The December Warrant and expires two (2) years from the date
it was issued. Furthermore, in connection with the Company's sale of Cornell
Capital Debentures, the Company issued to Mr. Benton Wilcoxon, in consideration
of his pledge of shares of common stock of Composite Technology Corporation
pursuant to the terms of the IPEA, a warrant to purchase up to 125,000 shares of
common stock. This warrant has an exercise price of $4.00 per share and expires
three (3) years from the date it was issued.
Common Stock Offered 9,687,034 shares by the selling
stockholders
Offering Price Market price
Common Stock Outstanding Before the 20,095,190 shares as of July 21, 2006
Offering(1)
Use of Proceeds We will not receive any proceeds of the
shares offered by the selling
stockholders. We did, however, receive
proceeds on January 6, 2006 equal to
$4,500,000 from the sale of the Cornell
Capital Debentures pursuant to the
Purchase Agreement with Cornell Capital
Partners. Any proceeds we receive from
the sale of common stock under the
warrants will be used for general
working capital purposes. See "Use of
Proceeds".
Risk Factors The securities offered hereby involve a
high degree of risk and immediate
substantial dilution. See "Risk Factors"
and "Dilution".
Over-the-Counter Bulletin Board Symbol ERTH.OB
4
(1) Excludes up to 6,700,000 which may be issued to Cornell Capital Partners
upon the conversion of the Cornell Capital Debentures pursuant to the
Purchase Agreement, up to 1,295,000 shares issuable upon the exercise of
warrants, and 1,000,000 shares being registered pursuant to a settlement
arrangement.
5
SUMMARY FINANCIAL DATA
The following selected financial data have been derived from the Company's
consolidated financial statements which have been audited by Farber Hass Hurley
& McEwen LLP as of and for the years ended December 31, 2005, 2004, 2003 and
2002 and by Deloitte & Touche LLP for the year ended December 31, 2001. The
following data should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" in this Prospectus
and in the Consolidated Financial Statements and Notes thereto included in this
Prospectus.
(Dollars in thousands, except per share data)
-------------------------------------------------------------------------
For the For the For the For the For the
Year Ended Year Ended Year Ended Year Ended Year Ended
December 31, December 31, December 31, December 31, December 31,
Statement of Operations ------------ ------------ ------------ ------------ ------------
Data 2005 2004 2003 2002 2001
------------------------- ------------ ------------ ------------ ------------ ------------
Revenues $ 183 $ 138 $ -- $ -- $ --
Research and
development expenses 201 1,170 9,547 26,890 47,148
General and
administrative
expenses 5,485 3,749 5,786 9,590 9,634
Depreciation and
amortization 3 42 380 3,099 5,874
Gain on sale of
property and equipment (23) (168) (452) (441) --
Interest expenses
(income), net 696 1,068 1,791 132 (356)
Related party patent
expenses -- -- -- -- --
Other expense (income) -- 1,532 1,464 321 --
Net loss 6,179 7,257 18,517 39,591 62,302
Average shares
outstanding 18,503 15,047 13,267 11,277 9,353
Per Common Share Basic
and diluted loss per
share $ 0.33 $ 0.48 $ 1.40 $ 3.51 $ 6.66
(Dollars in thousands, except per share data)
------------------------------------------------------------------------
For the For the For the For the For the
Year Ended Year Ended Year Ended Year Ended Year Ended
December 31, December 31, December 31, December 31, December 31,
-------------------- ------------ ------------ ------------ ------------ ------------
Balance Sheet Data 2005 2004 2003 2002 2001
-------------------- ------------ ------------ ------------ ------------ ------------
Cash and cash
equivalents $ 348 $ 272 $ 1,902 $ 111 $ 828
Total current assets 431 -- -- -- --
Total assets 443 483 2,287 18,024 19,886
Total current
liabilities 11,890 7,763 10,148 21,497 8,350
Total long-term
obligations 905 1,475 4,408 -- --
Deficit accumulated
during development
stage (327,787) (321,608) (314,351) (295,834) (256,243)
Stockholders' equity
(deficit) (12,352) (8,755) (12,269) (3,473) 11,536
Shares outstanding 18,981 18,235 14,129 12,055 9,860
6
SUPPLEMENTARY FINANCIAL INFORMATION
The following table presents EarthShell Corporation and Subsidiaries
condensed operating results for each of the ten (10) fiscal quarters through the
period ended March 31, 2006 The information for each of these quarters is
unaudited. In the opinion of management, all necessary adjustments, which
consist only of normal and recurring accruals, have been included to fairly
present the unaudited quarterly results. This data should be read together with
EarthShell Corporation and Subsidiaries consolidated financial statements and
the notes thereto, and Management's Discussions and Analysis of Financial
Condition and Results of Operations.
THREE (3) MONTHS ENDED (IN THOUSANDS)
---------------------------------------------------------------------------------------------------------
Mar 31, DEC 31, SEPT 30, JUN 30, MAR 31, DEC 31, SEP 30, JUN 30, MAR 31, DEC 31,
2006 2005 2005 2005 2005 2004 2004 2004 2004 2003
-------- -------- -------- -------- -------- -------- -------- -------- ------- -------
Revenues $ 25 $ 25 $ 25 $ 58 $ 75 $ 63 $ 50 $ 25 $ -- $ --
Net income
(loss) (1,191) (1,346) (1,894) (1,861) (1,078) (1,280) (1,646) (2,264) (2,067) (5,217)
Net income
(loss) per share:
Basic .06 .07 0.10 0.10 0.06 0.07 0.12 0.16 0.15 0.37
Diluted .06 .07 0.10 0.10 0.06 0.07 0.12 0.16 0.15 0.37
Shares used in
computing per share
amounts:
Basic 19,303 18,853 18,508 18,395 18,250 17,659 14,223 14,128 14,129 14,014
Diluted 19,303 18,853 18,508 18,395 18,250 17,659 14,223 14,128 14,129 14,014
7
RISK FACTORS
We are subject to various risks that may materially harm our business,
financial condition and results of operations. You should carefully consider the
risks and uncertainties described below and the other information in this filing
before deciding to purchase our common stock. If any of these risks or
uncertainties actually occurs, our business, financial condition or operating
results could be materially harmed. In that case, the trading price of our
common stock could decline and you could lose all or part of your investment.
Risks Related To Our Business
Our obligations under the Cornell Capital Debentures are secured by
substantially all of our assets which could cause our operations to cease if we
default
Our obligations under the $4.5 million of secured convertible debentures
(the "Cornell Capital Debentures"), issued to Cornell Capital Partners on
December 30, 2005 are secured by substantially all of our assets. As a result,
if we default under the terms of the Cornell Capital Debentures, Cornell Capital
Partners could foreclose its security interest and liquidate substantially all
of our assets. This would cause us to cease operations.
On July 12, 2006, the Company entered into a Letter Agreement with Cornell
Capital Partners, pursuant to which Cornell Capital Partners has agreed to
forbear from exercising certain rights and remedies under the Cornell Capital
Debentures and that certain Registration Rights Agreement, of even date with the
Cornell Capital Debentures in exchange for the issuance by the Company to
Cornell Capital Partners of 250,000 shares of the Company's common stock.
The Company has acknowledged in the Agreement that an event of default
under the Cornell Capital Debentures had occurred as of June 30, 2006 with the
Company failing to timely register with the U.S. Securities and Exchange
Commission the common stock underlying the Cornell Capital Debentures. The
Company also acknowledged that Cornell Capital Partners is entitled to
liquidated damages equal to one percent (1%) of the liquidated value of the
Cornell Capital Partners for each thirty (30) day period after May 31, 2006.
Pursuant to the Agreement, Cornell Capital Partners has agreed to waive the
default, including all liquidated damages that may have accrued through the date
of the Agreement and during the Forbearance Period (as defined below), in
exchange for the 250,000 shares of common stock and the Company obtaining the
effectiveness by September 30, 2006 of that certain Registration Statement
originally filed with the U.S. Securities and Exchange Commission on February
14, 2006, which includes the shares of common stock underlying the Cornell
Capital Debentures.
Furthermore, Cornell Capital Partners has agreed not to make any
conversions under the Cornell Capital Debentures until the earlier of September
30, 2006 or the expiration of the Forbearance Period, which such Forbearance
Period shall commence on the date of the execution of the Agreement and continue
for so long as the Company strictly complies with the terms of the Agreement and
there is no occurrence or existence of any event of default other than the
Default under the Cornell Capital Debenture transaction documents or any other
agreement that the Company has entered into with Cornell Capital Partners. The
250,000 shares of commons stock shall have piggy-back registration rights and
Cornell Capital Partners shall also have the right to demand the registration of
the 250,000 shares of common stock by providing to the Company with thirty (30)
days prior written notice of such request.
We have a limited operating history upon which you can evaluate our
business
Although the Company earned its first revenues in 2004 and is no longer
classified as a "developmental stage company", it has limited operating history,
therefore, it remains subject to the inherent challenges and risks of
establishing a new business enterprise. The Company may not be successful in
addressing such risks. The limited operating history of the Company makes the
prediction of future results of operations difficult or impossible. To date,
production volumes of EarthShell Packaging products have been low relative to
intended and necessary capacity of the manufacturing lines.
The initial plates, bowls, and sandwich containers that were sold
commercially were produced on lab equipment, pilot machinery, or first
generation commercial equipment. Although we have produced and sold 40-50
million pieces, the commercial equipment envisioned by the Company that will
allow for the manufacturing to be done profitably needed to be operated at
higher speeds and good part throughput rates than was experienced during the
early stages of production. Ultimately the Company discontinued production using
the pilot and first generation equipment to allow Detroit Tool and Engineering
Company ("DTE") to finish the machinery development to achieve the commercial
levels of quality and throughput.
8
As of December 31, 2005, the first modules of DTE equipment have been
purchased by ReNewable Products, Inc. ("RPI"), as EarthShell's U.S. licensee,
and are operational at commercial throughput rates. Production and distribution
has begun and commercial quality product is beginning to be re-introduced into
the market.
The success of future operations depends upon the ability of RPI and other
licensees to manufacture and sell EarthShell Packaging Products in sufficient
quantities so as to be commercially feasible and then to distribute and sell
those products at competitive prices. While commercial manufacturing operations
by RPI have commenced and RPI is selling EarthShell plates and bowls in the
market place at prices that appear to be competitive, full production capacity
utilization necessary to reach manufacturing profitability has not yet been
achieved, and the sales have not occurred over a sufficient period of time to
assure broad market acceptance. As a result of the foregoing factors, the
Company expects to incur losses for at least the next 12 months and, depending
on the success of the Company's products and services in the marketplace, for
potentially an even longer period.
We have a working capital deficit of $7.5 million as of March 31, 2006,
which means that our current assets at were not sufficient to satisfy our
current liabilities on that date
For the year ended December 31, 2005, the Company had reported operating
revenues of $0.2 million and an aggregate net loss of approximately $6.2
million. For the year ended December 31, 2004, the Company had reported
operating revenues of $0.1 million and an aggregate net loss of approximately
$7.3 million. For the three months ended March 31, 2006, the Company had
reported operating revenues of $0.025 million and an aggregate net loss of
approximately $1.2 million. Although the Company hopes to achieve break-even
cash flow by the end of 2006, the Company does not expect to operate profitably
during the current fiscal year. Although the Company is actively seeking equity
financing to restructure the debt on its balance sheets and to meet its
operating and capital needs, additional funding may not be available to the
Company, and, even if it is available, such financing may be (i) extremely
costly, (ii) dilutive to existing stockholders and/or (iii) restrictive to the
Company's ongoing operations. If the Company is unable to obtain such additional
capital, the Company may be required to reduce the scope of its anticipated
expansion, which could adversely affect the Company's business, financial
condition and results of operations or cease operations.
We are the subject of a "Going Concern" Opinion from our Independent
Auditors
The consolidated financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the satisfaction
of liabilities in the normal course of business. The Company has incurred
significant losses since inception, has minimal revenues and has a working
capital deficit of $7.5 million as of March 31, 2006. These factors, along with
others, raise substantial doubt as to whether the Company will be able to
continue as a going concern for a period of twelve months or less. The Company
will have to raise additional funds to meet its current obligations and to cover
operating expenses through the year ending December 31, 2006. If the Company is
not successful in raising additional capital, it may not be able to continue as
a going concern for a period of twelve months or less.
Management has identified the following material weaknesses in the
Company's internal controls over financial reporting:
o The Company has inadequate segregation of critical duties within
each of its accounting processes and a lack of sufficient monitoring
controls over these processes to mitigate this risk. The
responsibilities assigned to one employee include maintaining the
vendor master file, processing payables, creating and voiding
checks, reconciling bank accounts, making bank deposits and
processing payroll.
o There are weaknesses in the Company's information technology
controls which make the Company's financial data vulnerable to error
or fraud. Specifically, there is a lack of documentation regarding
the roles and responsibilities of the IT function, lack of security
management and monitoring and inadequate segregation of duties
involving IT functions.
o The departure of the Company's Controller in November 2004 resulted
in the accounting and reporting functions being centralized under
the Chief Financial Officer, with no additional personnel in the
Company having an adequate knowledge of accounting principles and
practices throughout most of 2005. In addition, the Company
relocated its headquarters and accounting systems from Santa
Barbara, CA to Baltimore, MD in late 2005. As a result, some
transactions were not recorded in a timely manner and adjustments to
the financial statements were recorded that were considered material
to the financial position at December 31, 2005 and results of
operations for the year then ended.
9
The Company has begun taking remediation steps to enhance its internal
control over financial reporting and reduce control deficiencies in general,
including the material weaknesses enumerated above. In the 4th Quarter 2005, the
Company employed a new Controller, CPA, with 15 years' experience in public and
private accounting. The new Controller is in the process of developing revised
accounting systems and procedures that will strengthen the Company's controls
over financial reporting. The Company has hired an additional accounting
employee as of March 30, 2006.
We need additional capital to finance our operating deficit and to fund
capital requirements
For the year ended December 31, 2005, the Company had reported operating
revenues of $0.2 million and an aggregate net loss of approximately $6.2
million. For the three months ended March 31, 2006, the Company had reported
operating revenues of $0.025 million and an aggregate net loss of approximately
$1.2 million. Although the Company hopes to achieve break-even cash flow by the
end of 2006, the Company does not expect to operate profitably during this
fiscal year. Although the Company is actively seeking equity financing to
restructure the debt on its balance sheets and to meet its operating and capital
needs, additional funding may not be available to the Company, and, even if it
is available, such financing may be (i) extremely costly, (ii) dilutive to
existing stockholders and/or (iii) restrictive to the Company's ongoing
operations. If the Company is unable to obtain such additional capital, the
Company may be required to reduce the scope of its anticipated expansion, which
could adversely affect the Company's business, financial condition and results
of operations or cease operations.
Our Common Stock is deemed to be a "Penny Stock," which may make it more
difficult for stockholders to sell their shares
The Company's common stock is no longer traded on the NASDAQ Small Cap
Market. SEC regulations generally define a "penny stock" to be any non-NASDAQ
equity security that has a market price of less than $5.00 per share, subject to
certain exceptions. Based upon the price of EarthShell common stock as currently
traded, EarthShell common stock is subject to Rule 15g-9 under the Securities
and Exchange Act of 1934 which imposes additional sales practice requirements on
broker-dealers which sell securities to persons other than established customers
and "accredited investors." For transactions covered by this rule, a
broker-dealer must make a special suitability determination for the purchaser
and have received a purchaser's written consent to the transaction prior to
sale. Consequently, this rule may have a negative effect on the ability of
stockholders to sell common shares of the Company in the secondary market.
We are dependent on our licensees, which could have a material adverse
effect on our business
The Company's current business model is to license the manufacturing and
distribution of EarthShell Packaging foodservice disposables to licensees.
Agreements with the licensees permit them to manufacture and sell other
foodservice disposable packaging products that are not based on EarthShell
Packaging. The licensees may also manufacture paper or polystyrene packaging
which could compete with EarthShell products, and they may not devote sufficient
resources or otherwise be able successfully to manufacture, distribute or market
EarthShell Packaging. Their failure to do so would be grounds for termination of
exclusivity provisions in their license agreement, but might also delay the
rollout of EarthShell Packaging into the marketplace, which could have an
adverse affect on our business.
We have not yet fully evaluated all of the EarthShell Packaging products
and it is possible that some of the products may not perform as well as
conventional packaging products
Although we believe that we can engineer EarthShell Packaging products to
meet many of the critical performance requirements for specific applications,
individual products may not perform as well as conventional foodservice
disposables; for example, some consumers may prefer clear cups and clear lids on
take-home containers which are not available with our foam technology. We are
still developing many of our EarthShell Packaging products and we have not yet
evaluated the performance of all of them. If we fail to develop EarthShell
Packaging products that perform comparably to conventional foodservice
disposables, this could cause consumers to prefer our competitors' products.
10
Established manufacturers in the foodservice disposables industry could
improve their ability to recycle their existing products or develop new
environmentally preferable disposable foodservice containers, which could render
our technology obsolete and could negatively impact our ability to compete
Competition among existing food and beverage container manufacturers in
the foodservice industry is intense. Virtually all of the key participants in
the industry have substantially greater financial and marketing resources at
their disposal than we do, and many have well-established supply, production and
distribution relationships and channels. Companies producing competitive
products utilizing competitive materials may reduce their prices or engage in
advertising or marketing campaigns designed to protect their respective market
shares and impede market acceptance of EarthShell Packaging products. In
addition, some of the Company's licensees and joint venture partners manufacture
paper, plastic or foil packaging that may compete with EarthShell Packaging
products. Several paper and plastic disposable packaging manufacturers and
converters and others have made efforts to increase the recycling of these
products. Increased recycling of paper and plastic products could lessen their
harmful environmental impact, one major basis upon which the Company intends to
compete. A number of companies have introduced or are attempting to develop
biodegradable starch-based materials, plastics, or other materials that may be
positioned as potential environmentally superior packaging alternatives. We
expect that many existing packaging manufacturers may actively seek competitive
alternatives to our products and processes. The development of competitive,
environmentally attractive, disposable foodservice packaging, whether or not
based on our products and technology, could render our technology obsolete and
could impair our ability to compete, which would have an adverse effect on our
business, financial condition and results of operations.
Our anticipated international revenues are subject to risks inherent in
international business activities
We expect sales of our products and services in foreign countries to
account for a material portion of our revenues. These sales are subject to risks
inherent in international business activities, including:
o any adverse change in the political or economic environments in
these countries;
o economic instability;
o any adverse change in tax, tariff and trade or other regulations;
o the absence or significant lack of legal protection for intellectual
property rights;
o exposure to exchange rate risk for revenues which are denominated in
currencies other than U.S. dollars; and
o difficulties in managing joint venture businesses spread over
various jurisdictions.
Our revenues could be substantially less than we expect if these risks
affect our ability to successfully sell our products in the international
market.
Our products may be perceived poorly by customers and/or environmental
groups, which could have an adverse affect on our business
Our success depends substantially on our ability to design and develop
foodservice disposables that are not as harmful to the environment as
conventional disposable foodservice containers made from paper, plastic and
polystyrene. EarthShell has used a life cycle inventory methodology in its
environmental assessment of EarthShell Packaging products and in the development
of associated environmental claims, and we have received support for the
EarthShell concept from a number of environmental groups. Although we believe
that EarthShell Packaging products offer several environmental advantages over
conventional packaging products, our products may also possess characteristics
that consumers or some environmental groups could perceive as negative for the
environment. In particular, EarthShell Packaging products may result in more
solid waste by weight and, in a dry environment, by volume, and manufacturing
them may release greater amounts of some pollutants and lesser amounts of other
pollutants than occurs with conventional packaging. Whether, on balance,
EarthShell Packaging products are better for the environment than conventional
packaging products is a somewhat subjective judgment. Environmental groups,
regulators, customers or consumers may not agree that present and future
EarthShell Packaging products have an environmental advantage over conventional
packaging.
11
Third parties may infringe the patents that we license, new products that
we develop may not be covered by our licensed patents and we could suffer an
adverse determination in a patent infringement proceeding, which could allow our
competitors to duplicate our products without having incurred the research and
development costs we have incurred and therefore allow them to produce and
market those products more profitably
Our ability to compete effectively with conventional packaging will
depend, in part, on our ability to protect our proprietary rights to the
licensed technology. Although EKI, the largest stockholder of the Company, and
EarthShell endeavor to protect the licensed technology through, among other
things, U.S. and foreign patents, the duration of these patents is limited and
the patents and patent applications licensed to us may not be sufficient to
protect our technology. The patents that EKI obtains and licenses to us may not
be validly held and others may try to circumvent or infringe those patents. We
also rely on trade secrets and proprietary know-how that we try to protect in
part by confidentiality agreements with our licensee manufacturers, proposed
joint venture partners, employees and consultants. These agreements have limited
terms and these agreements may be breached, we may not have adequate remedies
for any breach and our competitors may learn our trade secrets or independently
develop them. It is necessary for us to litigate from time to time to enforce
patents issued or licensed to us, to protect our trade secrets or know-how and
to determine the enforceability, scope and validity of the proprietary rights of
others.
We believe that we own or have the rights to use all of the technology
that we expect to incorporate into EarthShell Packaging products, but an adverse
determination in litigation or infringement proceedings to which we are or may
become a party could subject us to significant liabilities and costs to third
parties or require us to seek licenses from third parties. Although patent and
intellectual property disputes are often settled through licensing or similar
arrangements, costs associated with those arrangements could be substantial and
could include ongoing royalties. Furthermore, we may not obtain the necessary
licenses on satisfactory terms or at all. We could incur substantial costs
attempting to enforce our licensed patents against third party infringement, or
the unauthorized use of our trade secrets and proprietary know-how or in
defending ourselves against claims of infringement by others. Accordingly, if we
suffered an adverse determination in a judicial or administrative proceeding or
failed to obtain necessary licenses, it would prevent us from manufacturing or
licensing others to manufacture some of our products.
Failure of our licensees to produce EarthShell Packaging products
profitably on a commercial scale would adversely affect our ability to compete
with conventional disposable foodservice packagers
Production volumes of EarthShell Packaging products to date have been low
relative to the intended capacity of the various manufacturing lines, and, until
production volumes approach design capacity levels, actual costs and
profitability will not be certain. Since the actual cost of manufacturing
EarthShell Packaging products on a commercial scale has not been fully
demonstrated, they may not be manufactured at a competitive cost. As our
licensees and joint venture partners begin to commercially produce EarthShell
Packaging products, they may encounter unexpected difficulties that cause
production costs to exceed current estimates. The failure to manufacture
EarthShell Packaging products at commercially competitive costs would make it
difficult to compete with other foodservice disposable manufacturers.
Unavailability of raw materials used to manufacture our products,
increases in the price of the raw materials, or the necessity of finding
alternative raw materials to use in our products could delay the introduction
and market acceptance of our products
Although we believe that sufficient quantities of all raw materials used
in EarthShell Packaging products are generally available, if any raw materials
become unavailable, it could delay the commercial introduction and hinder market
acceptance of EarthShell Packaging products. In addition, our licensees and
joint venture partners may become significant consumers of certain key raw
materials such as starch, and if such consumption is substantial in relation to
the available resources, raw material prices may increase which in turn may
increase the cost of EarthShell Packaging products and impair our profitability.
In addition, we may need to seek alternative sources of raw materials or modify
our product formulations if the cost or availability of the raw materials that
we currently use become prohibitive.
If initial purchasers of the EarthShell Packaging products do not purchase
significant quantities, it could delay the introduction and market acceptance of
the products
It will be important for our licensees and joint venture partners to
identify and obtain contractual commitments from major customers for substantial
quantities of product. If initial purchasers of our products do not ultimately
purchase significant quantities or continue to purchase on a repeat basis, it
will delay our ability to realize meaningful royalty revenues from sales of
those products.
12
We do not own the technology necessary to manufacture EarthShell Packaging
EarthShell Packaging is based primarily on patented composite material
technology licensed on an exclusive worldwide basis from EKI, the largest
stockholder of the Company, and to a lesser extent, on a limited exclusive,
worldwide basis from the Biotec Group. The Company does not own the technology
necessary to manufacture EarthShell Packaging and is dependent upon a license
agreement with EKI (the "EKI Licensing Agreement") to use that technology. The
licensed technology is limited to the development, manufacture and sale of
specified foodservice disposables for use in the foodservice industry, and there
is no right to exploit opportunities to apply this technology or improve it
outside this field of use. If EKI were to file for or be declared bankrupt, the
Company would likely be able to retain its rights under the EKI License
Agreement with respect to U.S. patents; however, it is possible that steps could
be taken to terminate its rights under the EKI License Agreement with respect to
international patents. EKI is the largest stockholder of the Company, and
conflicts could arise with regard to performance under the License Agreement,
corporate opportunities or time devoted to the business of the Company by
officers and employees of EKI.
Our operations are subject to regulation by the U.S. Food and Drug
Administration
The manufacture, sale and use of EarthShell Packaging are subject to
regulation by the U.S. Food and Drug Administration (the "FDA"). The FDA's
regulations are concerned with substances used in food packaging materials, not
with specific finished food packaging products. Thus, food and beverage
containers are in compliance with FDA regulations if the components used in the
food and beverage containers: (i) are approved by the FDA as indirect food
additives for their intended uses and comply with the applicable FDA indirect
food additive regulations; or (ii) are generally recognized as safe for their
intended uses and are of suitable purity for those intended uses. The Company
believes that EarthShell Packaging plates, bowls and hinged-lid containers and
all other current and prototype EarthShell Packaging products of the Company are
in compliance with all requirements of the FDA and do not require additional FDA
approval. However, the FDA may not agree with these conclusions, which could
have a material adverse affect on our business operations.
RISKS RELATED TO THIS OFFERING
Future Sales By Our Stockholders May Adversely Affect Our Stock Price And Our
Ability To Raise Funds In New Stock Offerings
Sales of our common stock in the public market following this offering
could lower the market price of our common stock. Sales may also make it more
difficult for us to sell equity securities or equity-related securities in the
future at a time and price that our management deems acceptable or at all. Of
the 20,095,190 shares of common stock outstanding as of July 21, 2006,
11,686,330 shares are, or will be, freely tradable without restriction, unless
held by our "affiliates". The remaining shares of common stock, which will be
held by existing stockholders, including the officers and directors, are
"restricted securities" and may be resold in the public market only if
registered or pursuant to an exemption from registration. Some of these shares
may be resold under Rule 144.
Existing Shareholders will Experience Significant Dilution From Our Sale Of
Shares Pursuant To The Purchase Agreement with Cornell Capital Partners
The sale of shares pursuant to the Purchase Agreement with Cornell Capital
Partners will have a dilutive impact on our stockholders. For example, if the
offering occurred March 31, 2006 at an assumed conversion price of $1.7776 per
share (eighty-eight percent (88%) of the average of the two (2) lowest volume
weighted average prices during the ten (10) days immediately preceding a recent
trading date), the new stockholders would experience an immediate dilution in
the net tangible book value of $2.0279 per share. Dilution per share at prices
of $1.3332, $0.8888 and $0.4444 per share would be $1.5835, $1.1391 and $0.6947,
respectively. As a result, our net income per share could decrease in future
periods, and the market price of our common stock could decline. In addition,
the lower our stock price, the more shares of common stock we will have to
convert under the Purchase Agreement. If our stock price is lower, then our
existing stockholders would experience greater dilution.
Under The Purchase Agreement Cornell Capital Partners Will Pay Less Than The
Then-Prevailing Market Price Of Our Common Stock
Pursuant to the Purchase Agreement, Cornell Capital Partners will convert
the Cornell Capital Debentures into shares of EarthShell's common stock at a
discount equal to eighty-eight percent (88%) of the average of the two (2)
lowest volume weighted average prices during the ten (10) days immediately
preceding the date of conversion. The common stock to be issued will be at a
twelve percent (12%) discount to the two (2) lowest volume weighted average
prices during the ten (10) days immediately preceding the date of conversion.
Based on this discount, Cornell Capital Partners will have an incentive to
convert immediately to realize the gain on the twelve percent (12%) discount.
These discounted sales could cause the price of our common stock to decline,
based on increased selling of the Company's common stock.
13
The Selling Stockholders May Sell Their Shares Of Common Stock In The Market,
Which Sales May Cause Our Stock Price To Decline
The selling stockholders may sell in the public market up to 10,327,844
shares of common stock being registered in this offering. That means that up to
9,687,034 shares may be sold pursuant to this Registration Statement. Such sales
may cause our stock price to decline. The officers and Directors of the Company
and those stockholders who are significant shareholders as defined by the SEC
will continue to be subject to the provisions of various insider trading and
rule 144 regulations.
The Price You Pay In This Offering Will Fluctuate And May Be Higher Or Lower
Than The Prices Paid By Other Persons Participating In This Offering
The price in this offering will fluctuate based on the prevailing market
price of the common stock on the Over-the-Counter Bulletin Board. Accordingly,
the price you pay in this offering may be higher or lower than the prices paid
by other persons participating in this offering.
Our Common Stock Is Deemed To Be "Penny Stock", Which May Make It More Difficult
For Investors To Sell Their Shares Due To Suitability Requirements
Our common stock is deemed to be "penny stock" as that term is defined in
Rule 3a51-1 promulgated under the Securities Exchange Act of 1934, as amended
(the "Exchange Act"). Penny stocks are stock:
o With a price of less than $5.00 per share;
o That are not traded on a "recognized" national exchange;
o Whose prices are not quoted on the NASDAQ automated quotation system
(NASDAQ listed stock must still have a price of not less than $5.00
per share); or
o In issuers with net tangible assets less than $2.0 million (if the
issuer has been in continuous operation for at least three (3)
years) or $5.0 million (if in continuous operation for less than
three (3) years), or with average revenues of less than $6.0 million
for the last three (3) years.
Broker/dealers dealing in penny stocks are required to provide potential
investors with a document disclosing the risks of penny stocks. Moreover,
broker/dealers are required to determine whether an investment in a penny stock
is a suitable investment for a prospective investor. These requirements may
reduce the potential market for our common stock by reducing the number of
potential investors. This may make it more difficult for investors in our common
stock to sell shares to third parties or to otherwise dispose of them. This
could cause our stock price to decline.
14
FORWARD-LOOKING STATEMENTS
This Prospectus contains certain forward-looking statements regarding
management's plans and objectives for future operations including plans and
objectives relating to our planned marketing efforts and future economic
performance. The forward-looking statements and associated risks set forth in
this Prospectus include or relate to, among other things, (a) our projected
sales and profitability, (b) our growth strategies, (c) anticipated trends in
our industry, (d) our ability to obtain and retain sufficient capital for future
operations, and (e) our anticipated needs for working capital. These statements
may be found under "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and "Description of Business" as well as in this
Prospectus generally. Actual events or results may differ materially from those
discussed in forward-looking statements as a result of various factors,
including, without limitation, the risks outlined under "Risk Factors" and
matters described in this Prospectus generally. In light of these risks and
uncertainties, there can be no assurance that the forward-looking statements
contained in this Prospectus will in fact occur.
The forward-looking statements herein are based on current expectations
that involve a number of risks and uncertainties. Such forward-looking
statements are based on assumptions that there will be no material adverse
competitive or technological change in conditions in our business, that demand
for our products will significantly increase, that our Chief Executive Officer
and Chief Financial Officer will remain employed as such, that our forecasts
accurately anticipate market demand, and that there will be no material adverse
change in our operations or business or in governmental regulations affecting us
or our manufacturers and/or suppliers. The foregoing assumptions are based on
judgments with respect to, among other things, future economic, competitive and
market conditions, and future business decisions, all of which are difficult or
impossible to predict accurately and many of which are beyond our control.
Accordingly, although we believe that the assumptions underlying the
forward-looking statements are reasonable, any such assumption could prove to be
inaccurate and therefore there can be no assurance that the results contemplated
in forward-looking statements will be realized. In addition, as disclosed
elsewhere in the "Risk Factors" section of this Prospectus, there are a number
of other risks inherent in our business and operations which could cause our
operating results to vary markedly and adversely from prior results or the
results contemplated by the forward-looking statements. Growth in absolute and
relative amounts of cost of goods sold and selling, general and administrative
expenses or the occurrence of extraordinary events could cause actual results to
vary materially from the results contemplated by the forward-looking statements.
Management decisions, including budgeting, are subjective in many respects and
periodic revisions must be made to reflect actual conditions and business
developments, the impact of which may cause us to alter marketing, capital
investment and other expenditures, which may also materially adversely affect
our results of operations. In light of significant uncertainties inherent in the
forward-looking information included in this Prospectus, the inclusion of such
information should not be regarded as a representation by us or any other person
that our objectives or plans will be achieved.
Some of the information in this Prospectus contains forward-looking
statements that involve substantial risks and uncertainties. Any statement in
this Prospectus and in the documents incorporated by reference into this
Prospectus that is not a statement of an historical fact constitutes a
"forward-looking statement". Further, when we use the words "may", "expect",
"anticipate", "plan", "believe", "seek", "estimate", "internal" and similar
words, we intend to identify statements and expressions that may be forward-
looking statements. We believe it is important to communicate certain of our
expectations to our investors. Forward-looking statements are not guarantees of
future performance. They involve risks, uncertainties and assumptions that could
cause our future results to differ materially from those expressed in any
forward-looking statements. Many factors are beyond our ability to control or
predict. You are accordingly cautioned not to place undue reliance on such
forward-looking statements. Important factors that may cause our actual results
to differ from such forward-looking statements include, but are not limited to,
the risk factors discussed below. Before you invest in our common stock, you
should be aware that the occurrence of any of the events described under "Risk
Factors" below or elsewhere in this Prospectus could have a material adverse
effect on our business, financial condition and results of operation. In such a
case, the trading price of our common stock could decline and you could lose all
or part of your investment.
15
SELLING STOCKHOLDERS
The following table presents information regarding the selling
stockholders. The selling stockholders are the entities who have assisted in or
provided financing to EarthShell. A description of each selling stockholder's
relationship to EarthShell and how each selling stockholder acquired the shares
to be sold in this offering is detailed in the information immediately following
this table.
The selling shareholders may not choose to sell all of the shares covered
by this registration statement, or, under certain market conditions, may not be
entitled to convert and sell all of the shares covered by their respective
registration or conversion agreements.
Percentage of
Maximum Outstanding
Percentage of Number of Shares Which
Outstanding Shares To Be May be Percentage
Shares Shares Acquired Acquired of Shares
Beneficially Beneficially Pursuant to Pursuant to Shares to be Beneficially
Owned Before Owned Before the Purchase the Purchase Sold in the Owned After
Selling Stockholder Offering Offering(1) Agreement Agreement Offering Offering(1)
--------------------------- -------------- --------------- -------------- -------------- -------------- -------------
Shares Acquired In Financing Transactions With EarthShell
--------------------------- ----------------------------------------------------------------------------------------------
Cornell Capital
Partners, LP 1,037,000(2) 4.9% 6,700,000 33.34% 7,360,500(3) 1.24%
Highgate House Funds, Ltd. 364,500(4) 1.84% -- -- 364,500(4) 0%
Debt Restructuring And Settlement Transactions With EarthShell
---------------------------------------------------------------------------------------------------------------------------
Islandia, L.P. 100,000 * -- -- 100,000 0%
Midsummer Investment,
Ltd. (5) 25,000 * -- -- 25,000 0%
Omicron Master Trust(6) 93,000 * -- -- 93,000 0%
SF Capital Partners Ltd. 1,000,000 5.04% -- -- 1,000,000 0%
Straus - GEPT L.P. 36,250 * -- -- 26,250 0%
Straus Partners L.P. (8) 63,750 * -- -- 48,750 *
Vam Dam Machine Corp. 75,000 * -- -- 75,000 0%
Alcalde & Fay 50,917 * -- -- 50,917 0%
EarthShell Asia Transaction
---------------------------------------------------------------------------------------------------------------------------
Ying Wang 83,333 * -- -- 83,333 0%
Monty Waltz 38,333 * -- -- 33,333 *
Greg C. Hoffman 1,231,535(7) 6.21% -- -- 66,668 *
Steven L. Galvanoni Trust 746,799(8) 3.76% -- -- 83,333 *
Consultants And Others
---------------------------------------------------------------------------------------------------------------------------
Sloan Securities
Corporation 6,450 * -- -- 6,450 0%
Mr. Benton Wilcoxon 190,000(9) * -- -- 190,000(9) 0%
Mr. Douglas Metz 81,000(10) * -- -- 80,000 *
-------------- --------------- -------------- -------------- -------------- -------------
Total 5,222,867 6,700,000 9,687,034
============== ============== ==============
* Less than one percent (1%).
(1) Applicable percentage of ownership is based on 20,095,190 shares of common
stock outstanding as of July 21, 2006, together with securities
exercisable or convertible into shares of common stock within sixty (60)
days of July 21, 2006, for each stockholder. Beneficial ownership is
determined in accordance with the rules of the Securities and Exchange
Commission and generally includes voting or investment power with respect
to securities. Shares of common stock subject to securities exercisable or
convertible into shares of common stock that are currently exercisable or
exercisable within sixty (60) days of July 21, 2006 are deemed to be
beneficially owned by the person holding such securities for the purpose
of computing the percentage of ownership of such person, but are not
treated as outstanding for the purpose of computing the percentage
ownership of any other person. Note that affiliates are subject to Rule
144 and Insider Trading regulations - percentage computation is for form
purposes only.
16
(2) Represents 910,500 shares and 126,500 shares underlying convertible
debentures.
(3) Includes 6,700,000 shares that may be acquired by Cornell Capital Partners
pursuant to convertible debentures and 910,500 shares of common stock
underlying warrants. Under the purchase agreement, Cornell has the right
to convert up to $4.5 million, plus accrued interest, into shares of
EarthShell common stock over a period of time. Assuming the market price
for EarthShell common stock is at or above $3 per share at the time of
conversion, EarthShell will need to deliver approximately 1.65 million
shares. In the event that the market price for EarthShell common stock is
less than $3 per share at the time of the conversion, the conversion price
will be adjusted to 88% of the fair market value of EarthShell common
stock at the time of the conversion. Because of the potentially variable
nature of the future conversion price, pursuant to the Purchase Agreement,
EarthShell has agreed to register 6,700,000 shares underlying the full
$4.5 million of convertible debentures.
(4) Represents 364,500 shares of common stock underlying warrants.
(5) Midsummer Capital, LLC is the investment manager to Midsummer Investment
Ltd. By virtue of such relationship, Midsummer Capital, LLC may be deemed
to have dispositive power over the shares owned by Midsummer Investment
Ltd. Midsummer Capital, LLC disclaims beneficial ownership of such shares.
Mr. Michel Amsalem and Mr. Scott Kaufman have delegated authority from the
members of Midsummer Capital, LLC with respect to the shares of common
stock owned by Midsummer Investment Ltd. Messrs. Amsalem and Kaufman may
be deemed to share dispositive power over the shares of our common stock
owned by Midsummer Investment Ltd. Messrs. Amsalem and Kaufman disclaim
beneficial ownership of such shares of our common stock and neither person
has any legal right to maintain such delegated authority.
(6) Omicron Capital, L.P., a Delaware limited partnership ("Omicron Capital"),
serves as investment manager to Omicron Master Trust, a trust formed under
the laws of Bermuda ("Omicron"), Omicron Capital, Inc., a Delaware
corporation ("OCI"), serves as general partner of Omicron Capital, and
Winchester Global Trust Company Limited ("Winchester") serves as the
trustee of Omicron. By reason of such relationships, Omicron Capital and
OCI may be deemed to share dispositive power over the shares of our common
stock owned by Omicron, and Winchester may be deemed to share voting and
dispositive power over the shares of our common stock owned by Omicron.
Omicron Capital, OCI and Winchester disclaim beneficial ownership of such
shares of our common stock. Omicron Capital has delegated authority from
the board of directors of Winchester regarding the portfolio management
decisions with respect to the shares of common stock owned by Omicron and,
as of June 9, 2005, Mr. Olivier H. Morali and Mr. Bruce T. Bernstein,
officers of OCI, have delegated authority from the board of directors of
OCI regarding the portfolio management decisions of Omicron Capital with
respect to the shares of common stock owned by Omicron. By reason of such
delegated authority, Messrs. Morali and Bernstein may be deemed to share
dispositive power over the shares of our common stock owned by Omicron.
Messrs. Morali and Bernstein disclaim beneficial ownership of such shares
of our common stock and neither of such persons has any legal right to
maintain such delegated authority. No other person has sole or shared
voting or dispositive power with respect to the shares of our common stock
being offered by Omicron, as those terms are used for purposes under
Regulation 13D-G of the Securities Exchange Act of 1934, as amended.
Omicron and Winchester are not "affiliates" of one another, as that term
is used for purposes of the Securities Exchange Act of 1934, as amended,
or of any other person named in this Prospectus as a selling stockholder.
No person or "group" (as that term is used in Section 13(d) of the
Securities Exchange Act of 1934, as amended, or the SEC's Regulation
13D-G) controls Omicron and Winchester.
(7) Includes 66,668 shares of common stock to be registered in this offering
and 664,867 shares of common stock underlying warrants. Also includes
500,000 shares of common stock that a third party may assert disputed
competing claims to some or all such stock.
(8) Includes 636,466 shares of common stock underlying warrants and 83,333
shares that will be registered as part of this offering.
(9) Consists of 65,000 shares of common stock underlying warrants at $3.00 per
share and 125,000 shares of common stock underlying warrants at $4.00 per
share.
(10) Consists of 80,000 shares of common stock underlying warrants and 1,000
shares of free trading common stock.
The following information contains a description of each selling
shareholder's relationship to EarthShell and how each selling shareholder
acquired the shares to be sold in this offering is detailed below. None of the
selling stockholders have held a position or office, or had any other material
relationship, with the Company, except as follows:
Financing Transactions With EarthShell
Cornell Capital Partners, LP. Cornell Capital Partners is the investor
pursuant to the Purchase Agreement and a holder of the May Warrant, the August
Warrant and the December Warrant. All investment decisions of, and control of,
Cornell Capital Partners are held by its general partner, Yorkville Advisors,
LLC ("Yorkville"). Mark Angelo, the managing member of Yorkville, makes the
investment decisions on behalf of and controls Yorkville. Cornell Capital
Partners has acquired or will acquire all shares being registered in this
offering in financing transactions with EarthShell. Those transactions are
explained below:
Cornell Capital Partners Financings. On March 23, 2005, the Company
entered into a financing arrangement with Cornell Capital Partners whereby the
Company issued promissory notes to, and entered into a security agreement with,
Cornell Capital Partners. Pursuant to the financing, the Company issued
promissory notes (collectively, the "CCP Notes") to Cornell Capital Partners
with a total principal amount of $2.5 million. Upon consummation of the December
Debenture Purchase Agreement with Cornell Capital Partners on January 6, 2006,
described below, the CCP Notes and all accrued interest thereon have been paid
in full.
On March 23, 2005, the Company entered into a Standby Equity Distribution
Agreement (the "SEDA") with Cornell Capital Partners whereby the Company was
entitled to, at its sole discretion, periodically sell to Cornell Capital
Partners shares of its common stock for a total aggregate purchase price of up
to $10.0 million. On June 9, 2005, the Company filed a registration statement on
Form S-1 with the SEC to register shares of its common stock underlying the
SEDA. On September 27, 2005, the registration statement was withdrawn and, on
December 30, 2005, the parties terminated the SEDA.
17
On May 26, 2005, the Company issued a common stock purchase warrant to
Cornell Capital Partners to purchase 625,000 shares of common stock of the
Company. This May Warrant expires on May 26, 2006, has an exercise price which
was adjusted to $3.00 per share of common stock and has "piggy back" and demand
registration rights. In August 2005 Cornell Capital Partners agreed to
consolidate the CCP Notes and to defer the commencement of repayment
installments. In consideration of this modification to CCP Notes, the Company
issued a warrant to Cornell Capital Partners to purchase 50,000 shares of common
stock of the Company. This Warrant expires on May 26, 2006, has an exercise
price, which was adjusted to $3.00 per share of common stock as of December 30,
2005, and has "piggy back" and demand registration rights.
o Purchase Agreement. On December 30, 2005, the Company entered into a
Purchase Agreement with Cornell Capital Partners. Pursuant to the
Purchase Agreement, the Company issued to Cornell Capital Partners
the Cornell Capital Debentures. The Cornell Capital Debentures shall
be convertible into shares of the Company's common stock, and the
Company received proceeds from the sale of the Cornell Capital
Debentures equal to $4,500,000 on January 6, 2006. The selling
shareholders may not choose to sell all of the shares covered by
this registration statement, or, under certain market conditions,
may not be entitled to convert and sell all of the shares provided
covered by their respective registration or conversion agreements.
The Cornell Capital Debentures are secured by (i) a Pledge and Escrow
Agreement, by and among the Company, Cornell Capital Partners and David
Gonzalez, Esq., (ii) an Insider Pledge and Escrow Agreement (the "IPEA"), by and
among the Company, Cornell Capital Partners, David Gonzalez, Esq. and Mr. Benton
Wilcoxon and (iii) an Amended and Restated Security Agreement, by and between
the Company and Cornell Capital Partners. The Cornell Capital Debentures are
secured by substantially all of the Company's assets, have a three (3) year term
and accrue interest at twelve percent (12%) per annum. Beginning 60 days after
the Securities and Exchange Commission ("SEC") declares the accompanying
registration statement effective, Cornell Capital Partners is entitled, at its
option, to convert and sell up to $250,000 of the principal amount of the
Cornell Capital Debentures, plus accrued interest, into shares of the Company's
common stock, within any 30 day period at the lesser of (i) a price equal to
$3.00 or (ii) eighty-eight percent (88%) of the average of the two (2) lowest
volume weighted average prices of the common stock during the ten (10) trading
days immediately preceding the conversion date, as quoted by Bloomberg, LP. The
conversion limitation of $250,000 per month does not apply if the market price
is greater than $3.00 per share. The holder of the Cornell Capital Debentures
may not convert the Cornell Capital Debentures or receive shares of the
Company's common stock as payment of interest thereunder to the extent such
conversion or receipt of such interest payment would result in the holder,
together with any affiliate thereof, beneficially owning (as determined in
accordance with Section 13(d) of the Exchange Act, and the rules promulgated
thereunder) in excess of 4.9% of the then issued and outstanding shares of
common stock, including shares issuable upon conversion of, and payment of
interest on, the December Debenture held by such holder after application of
this 4.9% restriction. This 4.9% restriction may be waived by a holder (but only
as to itself and not to any other holder) upon not less than sixty-five (65)
days prior notice to the Company.
The Company may redeem, with three (3) business days advance written
notice to Cornell Capital Partners, a portion or all amounts outstanding under
the Cornell Capital Debentures prior to the maturity date provided that the
closing bid price of the Company's common stock, as reported by Bloomberg, LP,
is less than $3.00 at the time of the redemption notice. The Company shall pay
an amount equal to the principal amount being redeemed plus a redemption premium
equal to ten percent (10%) of the principal amount being redeemed, and accrued
interest, to be delivered to the Cornell Capital Partners on the third (3rd)
business day after the redemption notice, provided, however, this redemption
premium does not apply until the outstanding principal balance of the Cornell
Capital Debentures have been reduced by $2.5 million. The amount that Cornell
may convert in any 30 day period will be reduced by the amount that the Company
redeems.
Under the purchase agreement, Cornell has the right to convert up to $4.5
million, plus accrued interest, into shares of EarthShell common stock over a
period of time. Assuming the market price for EarthShell common stock is at or
above $3 per share at the time of conversion, EarthShell will need to deliver
approximately 1.65 million shares. In the event that the market price for
EarthShell common stock is less than $3 per share at the time of the conversion,
the conversion price will be adjusted to 88% of the fair market value of
EarthShell common stock at the time of the conversion. Because of the
potentially variable nature of the future conversion price, pursuant to the
Purchase Agreement, EarthShell has agreed to register a number of shares equal
to 4 times the number of shares that would be required to convert the full $4.5
million, plus accrued interest, at $3 per share.
18
On July 12, 2006, the Company entered into a Letter Agreement with Cornell
Capital Partners, pursuant to which Cornell Capital Partners has agreed to
forbear from exercising certain rights and remedies under the Cornell Capital
Debentures and that certain Registration Rights Agreement, of even date with the
Cornell Capital Debentures in exchange for the issuance by the Company to
Cornell Capital Partners of 250,000 shares of the Company's common stock.
The Company has acknowledged in the Agreement that an event of default
under the Cornell Capital Debentures had occurred as of June 30, 2006 with the
Company failing to timely register with the U.S. Securities and Exchange
Commission the common stock underlying the Cornell Capital Debentures. The
Company also acknowledged that Cornell Capital Partners is entitled to
liquidated damages equal to one percent (1%) of the liquidated value of the
Cornell Capital Partners for each thirty (30) day period after May 31, 2006.
Pursuant to the Agreement, Cornell Capital Partners has agreed to waive the
default, including all liquidated damages that may have accrued through the date
of the Agreement and during the Forbearance Period (as defined below), in
exchange for the 250,000 shares of common stock and the Company obtaining the
effectiveness by September 30, 2006 of that certain Registration Statement
originally filed with the U.S. Securities and Exchange Commission on February
14, 2006, which includes the shares of common stock underlying the Cornell
Capital Debentures.
Furthermore, Cornell Capital Partners has agreed not to make any
conversions under the Cornell Capital Debentures until the earlier of September
30, 2006 or the expiration of the Forbearance Period, which such Forbearance
Period shall commence on the date of the execution of the Agreement and continue
for so long as the Company strictly complies with the terms of the Agreement and
there is no occurrence or existence of any event of default other than the
Default under the transaction documents or any other agreement that the Company
has entered into with Cornell Capital Partners. The 250,000 shares of commons
stock shall have piggy-back registration rights and Cornell Capital Partners
shall also have the right to demand the registration of the 250,000 shares of
common stock by providing to the Company with thirty (30) days prior written
notice of such request.
o May Warrant. On May 26, 2005, the Company issued a common stock
purchase warrant to Cornell Capital Partners to purchase 260,500
shares of common stock of the Company. This May Warrant expires the
earlier of one (1) year or the date that 2,500,000 is repaid, has an
exercise price that was adjusted to $3.00 per share of common stock
as of December 30, 2005 and has "piggy back" and demand registration
rights. These shares are being registered in this offering.
o August Warrant. In August 2005, the Company issued a common stock
purchase warrant to Cornell Capital Partners to purchase 50,000
shares of common stock of the Company as consideration for
consolidating two (2) promissory notes (the "CCP Notes") and
extending the date upon which amortization and repayment of the CCP
Notes is to begin. This August Warrant expires two (2) years from
the date of issuance, has an exercise price of $3.00 per share of
common stock and has "piggy back" registration and demand rights.
These shares are being registered in this offering.
o December Warrant. On December 30, 2005, the Company issued to
Cornell Capital Partners a common stock purchase warrant to purchase
up to 350,000 shares of common stock of the Company. This December
Warrant has an exercise price of $4.00 per share, expires two (2)
years from the date it was issued and has "piggy back" and demand
registration rights. In the event that the Company issues common
stock or other security convertible into common stock at a price
less than $4.00 per share, the $4.00 exercise price is subject to
adjustment downward to a price not less than $3.00 per share in the
event the Company issues or sells any shares of its common stock for
a consideration per share less than the exercise price of the
December Warrant except for certain exclusions.
There are certain risks related to sales by Cornell Capital Partners,
including:
o The outstanding shares will be issued upon conversion of the Cornell
Capital Debentures based on a twelve percent (12%) discount to the
market price. As a result, the lower the stock price around the time
Cornell Capital Partners is issued shares, the greater chance that
Cornell Capital Partners will receive more shares. This could result
in substantial dilution to the interests of other holders of common
stock.
o To the extent Cornell Capital Partners sells its common stock, the
common stock price may decrease due to the additional shares in the
market. This could allow Cornell Capital Partners to sell greater
amounts of common stock, the sales of which would further depress
the stock price.
19
o The significant downward pressure on the price of the common stock
as Cornell Capital Partners sells material amounts of common stocks
could encourage short sales by third parties. This could place
further downward pressure on the price of the common stock.
Highgate House Funds, Ltd. All of the investment decisions for Highgate
House Funds are made by its portfolio manager, Mark Angelo. Control of Highgate
House Funds is held by its general partner, Yorkville Advisors, LLC. Mark
Angelo, the managing member of Yorkville Advisors, makes the investment
decisions on behalf of and controls Yorkville Advisors. Highgate House Funds has
acquired all of the shares being registered in this offering in financing
transactions with EarthShell.
Shares Acquired In Debt Restructuring And Settlement Transactions With
EarthShell
Islandia, L.P. Pursuant to an amended and restated debenture purchase
agreement dated September 29, 2004, in connection with the restructuring of its
debt and settlement of $400,000 in convertible debentures issued to Islandia,
L.P. in July, 2004, the Company issued 100,000 shares of its unregistered common
stock to Islandia, L.P. in settlement of the Company's default under the
debentures. These shares are being registered in this offering. All investment
decisions of, and control of, Islandia, L.P. are held by its parent, John Lang,
Inc. Richard O. Berner makes the investment decisions on behalf of and controls
John Lang, Inc.
Midsummer Investment, Ltd. Pursuant to an amended and restated debenture
purchase agreement, dated September 29, 2004, in connection with the
restructuring of the Company's debt and settlement of $600,000 in convertible
debentures issued to Midsummer Investment, Ltd. in July 2004, the Company issued
150,000 shares of its unregistered common stock to Midsummer Investment, Ltd. in
settlement of the Company's default under the debentures. In February 2006, the
Company issued to Midsummer an additional 25,000 shares of its unregistered
common stock in settlement of claims for damages pursuant to the amended and
restated debenture purchase agreement in which EarthShell agreed to timely file
a registration statement to register the 150,000 shares issued as part of the
agreement. These additional shares are being registered in this offering. Michel
A. Amsalem and Scott Kaufman make the investment decisions on behalf of and
control Midsummer Investment, Ltd.
Omicron Master Trust. Pursuant to an amended and restated debenture
purchase agreement, dated September 29, 2004, in connection with the
restructuring of the Company's debt and settlement of $750,000 in convertible
debentures issued to Omicron Master Trust in July, 2004, the Company issued
187,500 shares of its unregistered common stock to Omicron Master Trust in
settlement of the Company's default under the debentures. These shares are being
registered in this offering. Bruce Bernstein makes the investment decisions on
behalf of Omicron Master Trust.
SF Capital Partners Ltd. Pursuant to an Amended and Restated Debenture
Purchase Agreement, dated September 30, 2004, in connection with the
restructuring of the Company's debt and settlement of $4,500,000 in debentures
issued to SF Capital Partners Ltd. ("SF Capital Partners") in July, 2004, the
Company agreed to a settlement resulting in a $2,375,000 contingent settlement
obligation may be converted, at SF Capital Partners' option, into 791,667
shares, subject to a price protection clause, of the Company's unregistered
common stock at $3.00 per share. (See "Management Discussion and Analysis,
Liquidity and Capital Resources, SF Capital") SF Capital has the right to
convert the unpaid portion of the $2.375 million into shares of the Company's
common stock at a price equal to the lesser of $3.00 per share, or the price per
share that EarthShell shall subsequently receive upon the issuance of its common
stock (or other convertible security) during the three year period commencing
September 30, 2004. On January 11, 2006, SF Capital Partners delivered a
conversion notice to the Company on January 11, 2006 requesting conversion of
$558,063 of the Contingent Settlement into shares of the Company's common stock.
Following the conversion, the remaining balance of the Contingent Settlement was
approximately $1.8 million. Pursuant to the Amended and Restated debenture
Purchase Agreement, the company had the obligation to secure the registration of
the shares of common stock underlying the conversion feature. The Company has
not yet secured the registration of these shares and is subject to a liquidated
damages obligation of 1% per month of the outstanding portion of the contingent
settlement amount. As of June 30, 2006, the accumulated liquidated damages total
approximately $450,000. The Company has agreed to register on behalf of SF
Capital partners 1,000,000 shares of the Company's common stock to be available
for the conversion of the remaining balance owed to SF Capital subject to
conversion price adjustments pursuant to the price protection clause of the
amended and restated debenture purchase agreement, to pay liquidated damages
stemming from the Company's non-performance under the registration rights clause
of the settlement agreement and in settlement of any other claims. The shares
underlying this conversion right and settlement of claims are being registered
in this offering. Michael A. Roth and Brian J. Stark make the investment
decisions on behalf of SF Capital Partners.
20
On January 11, 2006, the Company issued 186,021 shares of the Company's
common stock to SF Capital Partners pursuant to a conversion right related to
the Contingent Settlement of $2.375 million reached under the September 30, 2004
Amended and Restated Debenture Purchase Agreement. Pursuant to the Contingent
Settlement, EarthShell must pay $2.375 million to SF Capital Partners from 33%
of any equity funding received by the Company (excluding the first $2.7 million
funded by MBS) or 50% of the royalties received by EarthShell in excess of
$250,000 per month (as determined on a cumulative basis commencing July 1,
2004). The Company has the right to convert the unpaid portion of the $2.375
million into shares of the Company's common stock at a price equal to the lesser
of $3.00 per share, or the price per share that EarthShell shall subsequently
receive upon the issuance of its common stock (or other convertible security)
during the three year period commencing September 30, 2004. SF Capital Partners
delivered a conversion notice to the Company on January 11, 2006 requesting
conversion of $558,063 of the Contingent Settlement into shares of the Company's
common stock. Following the conversion, the remaining balance of the Contingent
Settlement was approximately $1.8 million. The Company recorded that difference
between the conversion value and the fair value of the common stock at the time
of the conversion as a settlement gain in the amount of $213,924.
Straus - GEPT L.P. Pursuant to an amended and restated debenture purchase
agreement, dated September 30, 2004, in connection with the restructuring of the
Company's debt and settlement of $105,000 in debentures issued to Straus - GEPT
L.P. in July, 2004, the Company issued 26,250 shares of its unregistered common
stock to Straus - GEPT L.P. in settlement of the Company's default under the
debentures. These shares are being registered in this offering. Mickey Straus
makes the investment decisions on behalf of and controls Straus - GEPT L.P.
Straus Partners L.P. Pursuant to an amended and restated debenture
purchase agreement, dated September 30, 2004, in connection with the
restructuring of the Company's debt and settlement of $195,000 in debentures
issued to Straus Partners L.P. in July, 2004, the Company issued 48,750 shares
of its unregistered common stock to Straus Partners L.P. in settlement of the
Company's default under the debentures. These shares are being registered in
this offering. Mickey Straus makes the investment decisions on behalf of and
controls Straus Partners L.P.
Van Dam Machine Corp. In December 2005, in connection with the settlement
of litigation between the Company and Van Dam Machine Company ("Van Dam") the
Company agreed to issue 75,000 shares of its unregistered common stock. These
shares are being registered in this offering. John Sari makes the investment
decisions on behalf of Van Dam..
Alcalde & Fay. In November 2003 and December 2005, the Company agreed to
issue 2, 917 and 48,000 shares of its unregistered common stock, respectively,
in settlement of certain accounts payable to Alcalde & Fay, a consultant to the
Company. These shares are being registered in this offering. Kevin Fay makes the
investment decisions on behalf of Alcalde & Fay.
EarthShell Asia Transaction
In December 2005, in connection with a stock purchase agreement with
EarthShell Asia dated August 22 which was subsequently amended and restated, the
Company received approximately $800,000 and issued 266,667 shares of its
unregistered common stock. All of these shares are to be registered in this
offering. The shares were issued to and are held by various principals of
EarthShell Asia as follows:
Ying Wang. Mr. Ying Wang received 83,333 shares of the Company's
unregistered common stock.
Monty Waltz. Mr. Monty Waltz received 33,333 shares of the Company's
unregistered common stock.
Greg C. Hoffman. Mr. Greg C. Hoffman received 66,668 shares of the
Company's unregistered common stock.
Steven L. Galvanoni Trust. The Steven L. Galvanoni Trust received 83,333
shares of the Company's unregistered common stock. Mr. Steven Galvanoni makes
the investment decisions with respect to these shares.
Consultants And Other Shareholders
Sloan Securities Corporation. Sloan Securities Corporation is an
unaffiliated registered broker-dealer that has been retained by us in connection
with services provided pursuant to a financing transaction with Cornell Capital
Partners. James C. Ackerman, Sloan Securities Corporation's President, makes the
investment decisions on behalf of and controls Sloan Securities Corporation.
Sloan Securities Corporation received a fee of 6,450 shares of unregistered
common stock on or about March 23, 2005. These shares have "piggy back"
registration and demand rights and are being registered in this offering.
21
Mr. Benton Wilcoxon. In consideration for Mr. Benton Wilcoxon pledging his
personal shares in Composite Technology Corporation as a guaranty for a security
agreement entered into by the Company with Cornell Capital Partners in
connection with a financing transaction, the Company issued a warrant to Mr.
Wilcoxon to purchase 65,000 shares of common stock of the Company at an exercise
price of $3.00 per share. This warrant expires on March 23, 2008. In addition,
in connection with the Company's issuance and sale to Cornell Capital Partners
of the Cornell Capital Debentures, the Company issued to Mr. Wilcoxon, in
consideration of his pledge of shares of common stock of Composite Technology
Corporation pursuant to the terms of the IPEA, a warrant to purchase up to
125,000 shares of common stock. This warrant has an exercise price of $4.00 per
share and expires three (3) years from the date it was issued. The shares
underlying these warrants are being registered in this offering. The Company
also granted to Mr. Wilcoxon a right of refusal to enter into a license
agreement for certain of the Company's technology in certain Asian territories.
Mr. Douglas Metz. In consideration for consulting services rendered by Mr.
Douglas Metz in connection with the Company obtaining financing, the Company
issued a warrant to Mr. Metz to purchase 80,000 shares of common stock of the
Company at an exercise price of $3.00 per share. This warrant expires on March
23, 2008. The shares underlying this warrant are being registered in this
offering.
With respect to the sale of unregistered securities referenced above, all
transactions were exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933, as amended (the "1933 Act"), and Regulation D
promulgated under the 1933 Act. In each instance, the purchaser had access to
sufficient information regarding the Company so as to make an informed
investment decision. More specifically, we had a reasonable basis to believe
that each purchaser was an "accredited investor" as defined in Regulation D of
the 1933 Act and otherwise had the requisite sophistication to make an
investment in our securities.
22
USE OF PROCEEDS
This Prospectus relates to shares of our common stock that may be offered
and sold from time to time by certain selling stockholders. There will be no
proceeds to us from the sale of shares of common stock in this offering.
However, we did receive proceeds from the sale and issuance to Cornell Capital
Partners of the Cornell Capital Debentures pursuant to the Purchase Agreement
equal to $4,500,000 which the Company received on January 6, 2006, of which
approximately $2.6 million was used to payoff the existing $2.5 million
promissory note to Cornell and Highgate. This transaction is more completely
described under "Shares To Be Acquired In Financing Transactions With
EarthShell" in the "Selling Stockholder" section in this Prospectus. We received
$800,000 from the sale of common stock and $100,000 from the sale of warrants to
EarthShell Asia. We will also receive proceeds upon the exercise of warrants
held by our several selling stockholders in this offering.
23
DILUTION
The net tangible book value of EarthShell as of March 31, 2006 was
$(10,933,711) or $(0.5653) per share of common stock. Net tangible book value
per share is determined by dividing the tangible book value of the Company
(total tangible assets less total liabilities) by the number of outstanding
shares of our common stock. Since this offering is being made solely by the
selling stockholders and none of the proceeds will be paid to EarthShell, our
net tangible book value will be unaffected by this offering. Our net tangible
book value and our net tangible book value per share, however, will be impacted
by the common stock to be issued from time to time to Cornell Capital Partners
upon conversion of the Cornell Capital Debentures pursuant to the Purchase
Agreement. The amount of dilution will depend on the conversion price
(eighty-eight percent (88%) of the average of the two (2) lowest volume weighted
average prices of the common stock during the ten (10) trading days immediately
preceding the date of conversion) and number of shares to be issued pursuant to
the Purchase Agreement. The following example shows the dilution to new
investors at an assumed conversion price of $1.7776 per share (using an assumed
market price of $2.02 per share).
If we assume that EarthShell issued 6,700,000 shares of common stock to
Cornell Capital Partners (i.e., the number of shares registered in this offering
pursuant to the Purchase Agreement) upon conversion of the Cornell Capital
Debentures pursuant to the Purchase Agreement at an assumed conversion price of
$1.7776 per share (eighty-eight percent (88%) of the average of the two (2)
lowest volume weighted average market prices of the common stock during the ten
(10) trading days immediately preceding a recent trading date) less offering
expenses of $85,000, our net tangible book value as of March 31, 2006 would have
been ($6,518,711) or ($0.2503) per share. Such an offering would represent an
immediate increase in net tangible book value to existing stockholders of
$0.3150 per share and an immediate dilution to new stockholders of $2.0279 per
share. The following table illustrates the per share dilution:
Assumed conversion price per share $ 1.7776
Net tangible book value per share before this offering ($ 0.5653)
Increase attributable to new investors $ 0.3150
Net tangible book value per share after this offering ($ 0.2503)
--------------
Dilution per share to new stockholders $ 2.0279
==============
The conversion price of our common stock is based on the then-existing
market price. In order to give prospective investors an idea of the dilution per
share they may experience, we have prepared the following table showing the
dilution per share at various assumed conversion prices:
Number of Shares to be Dilution per Share to New
Assumed Conversion Price Issued Investors
--------------------------- ---------------------- -----------------------
$1.7776 6,700,000(1) $2.0279
$1.3332 6,700,000(1) $1.5835
$0.8888 6,700,000(1) $1.1391
$0.4444 6,700,000(1) $0.6947
(1) This represents the maximum number of shares of common stock that are
being registered pursuant to the Purchase Agreement.
24
PLAN OF DISTRIBUTION
The selling stockholders have advised us that the sale or distribution of
our common stock owned by the selling stockholders may be effected directly to
purchasers by the selling stockholders as principals or through one (1) or more
underwriters, brokers, dealers or agents from time to time in one or more
transactions (which may involve crosses or block transactions) (i) on the on the
Over-the-Counter Bulletin Board or in any other market on which the price of our
shares of common stock are quoted or (ii) in transactions otherwise than on the
Over-the-Counter Bulletin Board or in any other market on which the price of our
shares of common stock are quoted. Any of such transactions may be effected at
market prices prevailing at the time of sale, at prices related to such
prevailing market prices, at varying prices determined at the time of sale or at
negotiated or fixed prices, in each case as determined by the selling
stockholders or by agreement between the selling stockholders and underwriters,
brokers, dealers or agents, or purchasers. If the selling stockholders effect
such transactions by selling their shares of common stock to or through
underwriters, brokers, dealers or agents, such underwriters, brokers, dealers or
agents may receive compensation in the form of discounts, concessions or
commissions from the selling stockholders or commissions from purchasers of
common stock for whom they may act as agent (which discounts, concessions or
commissions as to particular underwriters, brokers, dealers or agents may be in
excess of those customary in the types of transactions involved).
On December 30, 2005, EarthShell entered into a Purchase Agreement with
Cornell Capital Partners pursuant to which the Company issued and sold to
Cornell Capital Partners the secured Cornell Capital Debentures. The Cornell
Capital Debentures shall be convertible into shares of the Company's common
stock, and the Company is registering 6,700,000 shares in connection with the
Purchase Agreement. The Company received proceeds equal to $4,500,000 from the
sale of the Cornell Capital Debentures on January 6, 2006, of which
approximately $2.6 million was used to payoff the existing $2.5 million
promissory note to Cornell and Highgate.
In connection with the Purchase Agreement, on December 30, 2005, the
Company issued to Cornell Capital Partners the December Warrant to purchase up
to 350,000 shares of common stock. This December Warrant has an exercise price
of $4.00 per share, which may be adjusted to as low as $3 per share in the event
the Company issues or sells any shares of its common stock for a consideration
per share less than the exercise price for the December Warrant and expires two
(2) years from the date it was issued. Furthermore, in connection with the
Company's sale of Cornell Capital Debentures, the Company issued to Mr. Benton
Wilcoxon, in consideration of his pledge of shares of common stock of Composite
Technology Corporation pursuant to the terms of the IPEA, a warrant to purchase
up to 125,000 shares of common stock. This warrant has an exercise price of
$4.00 per share and expires three (3) years from the date it was issued.
Cornell Capital Partners was formed in February 2000 as a Delaware limited
partnership. Cornell Capital Partners is a domestic hedge fund in the business
of investing in and financing public companies. Cornell Capital Partners does
not intend to make a market in our stock or to otherwise engage in stabilizing
or other transactions intended to help support the stock price. Prospective
investors should take these factors into consideration before purchasing our
common stock.
Under the securities laws of certain states, the shares of common stock
may be sold in such states only through registered or licensed brokers or
dealers. The selling stockholders are advised to ensure that any underwriters,
brokers, dealers or agents effecting transactions on behalf of the selling
stockholders are registered to sell securities in all fifty (50) states. In
addition, in certain states the shares of common stock may not be sold unless
the shares have been registered or qualified for sale in such state or an
exemption from registration or qualification is available and is complied with.
We will pay all the expenses incident to the registration, offering and
sale of the shares of common stock to the public hereunder other than
commissions, fees and discounts of underwriters, brokers, dealers and agents. If
any of these other expenses exists, EarthShell expects the selling stockholders
to pay these expenses. Pursuant to the Purchase Agreement, we have agreed to
indemnify Cornell Capital Partners and its controlling persons against certain
liabilities, including liabilities under the 1933 Act. We estimate that the
expenses of the offering to be borne by us will be approximately $85,000. For
services rendered in connection with the Purchase Agreement, the Company paid to
Yorkville Advisors, LLC ("Yorkville") $200,000. The Company also paid to
Yorkville $10,000 as a structuring and due diligence fee. Both amounts were paid
directly from the gross proceeds of the closing. The estimated offering expenses
consist of: an SEC registration fee of $1,945 printing expenses of $2,500,
accounting fees of $15,000, legal fees of $50,000 and miscellaneous expenses of
$15,555. We will not receive any proceeds from the sale of any of the shares of
common stock by the selling stockholders. However, we did receive proceeds from
the issuance and sale to Cornell Capital Partners of the Cornell Capital
Debentures pursuant to the Purchase Agreement equal to $4,500,000, which the
Company received on January 6, 2006. We will also receive proceeds upon the
exercise of warrants held by our several selling stockholders in this offering.
25
The selling stockholders are subject to applicable provisions of the
Exchange Act, and its regulations, including, Regulation M. Under Regulation M,
the selling stockholders or their agents may not bid for, purchase, or attempt
to induce any person to bid for or purchase, shares of our common stock while
such selling stockholders are distributing shares covered by this Prospectus.
Pursuant to the requirements of Item 512 of Regulation S-K and as stated in Part
II of this Registration Statement, the Company must file a post-effective
amendment to the accompanying Registration Statement once informed of a material
change from the information set forth with respect to the Plan of Distribution.
26
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management's discussion and analysis of results of operations and
financial condition are based on our financial statements. These statements have
been prepared in accordance with accounting principles generally accepted in the
United States of America. These principles require management to make certain
estimates, judgments and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, we evaluate our estimates based on
historical experience and various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions. The following discussion
should be read in conjunction with the Company's financial statements and notes
thereto, which are included elsewhere within this Registration Statement.
Overview
Organized in November 1992 as a Delaware corporation, EarthShell
Corporation (the "Company") is engaged in the commercialization of composite
material technology for the manufacture of foodservice disposable packaging
designed with the environment in mind. EarthShell Packaging is based on patented
composite material technology (collectively, the "EarthShell Technology"),
licensed on an exclusive, worldwide basis from E. Khashoggi Industries LLC and
its wholly owned subsidiaries.
The EarthShell Technology has been developed over many years in
consultation with leading material scientists and environmental experts to
reduce the environmental burdens of foodservice disposable packaging through the
careful selection of raw materials, processes, and suppliers. EarthShell
Packaging, including hinged-lid sandwich containers, plates, bowls, foodservice
wraps, and cups, is primarily made from commonly available natural raw materials
such as natural ground limestone and potato starch. EarthShell believes that
EarthShell Packaging has comparable or superior performance characteristics and
can be commercially produced and sold at prices that are competitive with
comparable paper and plastic foodservice disposables.
EarthShell was a development stage enterprise through the first quarter of
2004. With the recognition of the Company's first revenues resulting from the
receipt of $0.5 million in technology fees in connection with granting a license
to a strategic partner in the second quarter of 2004, the Company was no longer
a development stage enterprise.
Critical Accounting Assumptions
The preparation of financial statements and related disclosures in
conformity with accounting principles generally accepted in the United States
requires management to make judgments, assumptions and estimates that affect the
amounts reported in the Company's financial statements and the accompanying
notes. The amounts of assets and liabilities reported in the Company's balance
sheet and the amounts of revenues and expenses reported for each fiscal period
are affected by estimates and assumptions which are used for, but not limited
to, the accounting for asset impairments and transactions involving the
Company's equity securities. Actual results could differ from these estimates.
The following critical accounting policies are significantly affected by
judgments, assumptions and estimates used in the preparation of the consolidated
financial statements.
Going Concern Basis. The consolidated financial statements have been
prepared on a going concern basis, which contemplates the realization of assets
and the satisfaction of liabilities in the normal course of business. The
Company has incurred significant losses since inception, has minimal revenues
and has a working capital deficit of approximately $7.5 million at March 31,
2006. These factors, along with others, raise substantial doubt as to whether
the Company will be able to continue as a going concern for the next 12 months.
The Company will have to raise additional funds to meet its current obligations
and to cover operating expenses through the year ending December 31, 2006. If
the Company is not successful in raising additional capital it may not be able
to continue as a going concern. Management plans to address this need by raising
cash through short-term borrowings and/or the issuance of debt or equity
securities. The consolidated financial statements do not include any adjustments
relating to the recoverability and classification of recorded asset amounts or
the amounts and classification of liabilities that might be necessary should the
Company be unable to continue as a going concern.
27
Revenue Recognition. The Company recognizes revenue when persuasive
evidence of an arrangement exists, the price is fixed or readily determinable
and collectibility is probable. The Company recognizes revenue in accordance
with Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements," (SAB 101), as amended by SAB 104. EarthShell's revenues consist of
technology fees that are recognized ratably over the life of the related
agreements and royalties based on product sales by licensees that are recognized
in the quarter that the licensee reports the sales.
Results of Operations
Three Months Ended March 31, 2006 Compared With The Three Months Ended
March 31, 2005.
The Company's net loss increased by approximately $0.1 million to
approximately $1.2 million from approximately $1.1 million for the three months
ended March 31, 2006 compared to the three months ended March 31, 2005,
respectively.
Revenues. The Company recorded revenues of approximately $0.03 million for
the three months ended March 31, 2006 as compared to $0.08 for the three months
ended March 31, 2005. These revenues reflect realization of technology fees
receivable under the sublicense agreements. The decrease is due to the
termination of the MBS Sublicense Agreement in June, 2005 and the consummate
elimination of the prepaid technology fee being amortized.
Research and Development Expenses. Total research and development expenses
are comprised of related party license fee and research and development expenses
and other research and development expenses. Total research and development
expenses for the development of EarthShell Packaging(R) decreased $0.07 million
to $0.03 million for the three months ended March 31, 2006 from approximately
$0.1 million for the three months ended March 31, 2005.
The related party license fee agreement was discontinued in 2005.
Therefore, the related party research and development expenses decreased to zero
for 2006.
Other research and development expenses are comprised of fees paid to the
USDA under a Cooperative Research and Development Agreement, personnel costs,
travel and direct overhead for development and demonstration production. Other
research and development expenses decreased $0.07 million to $0.03 million for
the three months ended March 31, 2006 from $0.1 million for the three months
ended March 31, 2005. The reduction is due to the Company focusing its efforts
on the licensing business model whereby licensees and future licensees will
install and run the equipment to produce EarthShell Packaging in their
facilities.
Other General and Administrative Expenses. Other general and
administrative expenses are comprised of personnel costs, travel and direct
overhead for marketing, finance and administration. Total general and
administrative expenses decreased by approximately $0.09 million to
approximately $0.94 million from approximately $1.03 million for the three
months ended March 31, 2006, compared to the three months ended March 31, 2005,
respectively. The largest reductions were in personnel costs, legal and
professional fees as the Company works to control expenses given the limited
cash availability.
Interest Expense. Interest expense is comprised of related party interest
expense and other interest expense.
o Related party interest expense increased by approximately $0.03
million to $0.03 for the three months ended March 31, 2006 from
approximately $0.001 million for the three months ended March 31,
2005. The related party interest expense is comprised of interest
accrued on the $1.0 million note payable to E. Khashoggi Industries,
LLC.
o Other interest expense increased by approximately $0.48 million to
approximately $0.5 million for the three months ended March 31, 2006
from approximately $0.02 million for the three months ended March
31, 2005.Other interest expense in the first three months of 2006
was primarily composed of amortization of the debt discount and
interest accrued on Cornell Capital Debentures.
Other Income. Other income increased by approximately $0.3 million to $0.3
million for the three months ended March 31, 2006 from $0.008 million for the
three months ended March 31, 2005. This other income was the result of a gain on
the sale of certain minor pieces of equipment which had previously been scrapped
and consigned to an equipment dealer and recognition of gains on settlement of
debt.
28
Year Ended December 31, 2005 Compared with the Year Ended December 31,
2004
The Company's net loss decreased $1.1 million to $6.2 million from $7.3
million for the year ended December 31, 2005 compared to the year ended December
31, 2004, respectively.
Revenues. The Company recorded revenues of $0.2 million for the year ended
December 31, 2005. These revenues reflect amortization of the technology fees
receivable under the sublicense agreements.
Research and Development Expenses. Total research and development expenses
are comprised of Related party license fee and research and development expenses
and Other research and development expenses. Total research and development
expenditures for the development of EarthShell Packaging decreased $1.0 million
to $0.2 million from $1.2 million for the year ended December 31, 2005 compared
to the year ended December 31, 2004, respectively.
o Related party license fee and research and development expenses
decreased $0.8 million to $0 from $.8 million for the year ended
December 31, 2005 compared to the year ended December 31, 2004,
respectively. Prior to 2005, related party license fee and research
and development expenses were comprised a $0.1 million minimum
monthly licensing fee for the use of the EarthShell technology and
for technical services, both of which were payable to EKI, a
principal stockholder of the Company, or Biotec, a wholly-owned
subsidiary of EKI. The minimum monthly licensing fee to Biotec was
terminated in 2004.
o Other research and development expenses are comprised of personnel
costs, travel and direct overhead for development and demonstration
production, as well as impairment charges on manufacturing property
and equipment constructed for demonstration production purposes.
Other research and development expenses decreased $0.2 million to
$0.2 million from $0.4 million for the year ended December 31, 2005
compared to the year ended December 31, 2004, respectively. The
reduction is due to the Company focusing its efforts on the
licensing business model whereby licensees and future licensees will
install and run the equipment to produce EarthShell Packaging in
their facilities.
Other General and Administrative Expenses. Other general and
administrative expenses are comprised of personnel costs, travel and direct
overhead for marketing, finance and administration. Total general and
administrative expenses increased $1.7 million to $5.5 million from $3.8 million
for the year ended December 31, 2005 compared to the year ended December 31,
2004, respectively. This was due to increases in legal fees of $0.2 million,
investor relations fees of $0.6 million, financing costs of $0.2 million,
property taxes of $0.5 million (property taxes had a negative balance in 2004
due to a settlement of back taxes of $0.5 million), and bad debt expense of $0.2
million.
Depreciation and Amortization Expense. Depreciation and amortization
expense decreased $0.039 million to $0.003 million from $0.04 million for the
year ended December 31, 2005 compared to the year ended December 31, 2004,
respectively. The decrease in depreciation expense is attributable to the
continued write-off of discontinued manufacturing and development assets.
Interest Expense. Interest expense is comprised of related party interest
expense and other interest expense.
o Related party interest expense decreased $0.3 million to $0.1
million from $0.4 million for the years ended December 31, 2005 and
2004, respectively. Related party interest expense includes interest
accrued on outstanding loans made to the Company by EKI under the
Loan Agreement (see "Business - Relationship with EKI"), accretion
of the discount related to the warrants issued to EKI in conjunction
with the March 2003 financing transactions, plus accrued interest
payable on amounts owed to EKI for monthly licensing fees that were
accrued rather than being paid in accordance with the terms of the
subordination agreements entered into in connection with the 2006
Debentures (see "Business - Relationship with EKI"). During the
third quarter of 2004, agreements were negotiated with EKI to
convert the EKI Simple Interest Loans, and accrued but unpaid
interest, into common stock of the Company and to restructure the
unpaid licensing fees under the Biotec License Agreement (see "Item
1 - Business Relationship with EKI").
o Other interest expense decreased $0.1 million to $0.6 million from
$0.7 million for the year ended December 31, 2005 compared to the
year ended December 31, 2004, respectively. Other interest expense
for 2005 is primarily comprised of accretion of the discount and
interest accrued on the CCP Notes. Other interest expense for 2004
was primarily comprised of accretion of discount on the 2006
Debentures.
29
Gain on Sale of Property and Equipment. Gain on the sale of property and
equipment decreased $0.18 million to $.02 million from $0.2 million for the year
ended December 31, 2005 compared to the year ended December 31, 2004,
respectively. The gains in both 2005 and 2004 were realized due to the sale of
non-essential machine shop equipment and excess office furniture and equipment
over their net book value, most of which was fully depreciated.
Premium due to Debenture Default. During the year ended December 31, 2004,
the Company accrued $1.7 million in premium due to a default under the 2006
Debentures. See the discussion below.
(Gain) Loss on Extinguishment of Debentures. There was no gain or loss on
extinguishment of debentures for the year ended December 31, 2005 compared to a
gain on extinguishment of debentures of $0.1 million for the year ended December
31, 2004. The $0.1 million gain for the year ended December 31, 2004 relates to
interest payable on the 2006 Debentures that was not paid by the Company upon
conversion of the Debentures.
Year Ended December 31, 2004 Compared with the Year Ended December 31,
2003
The Company's net loss decreased $11.2 million to $7.3 million from $18.5
million for the year ended December 31, 2004 compared to the year ended December
31, 2003, respectively.
Revenues. The Company recorded revenues of $0.1 million for the year ended
December 31, 2004. These revenues reflect amortization of the $3.0 million of
technology fees payable under the sublicense agreements that were entered into
with MBS and with ESH in the second and fourth quarters of 2004 over the ten
years of the agreements. Prior to this, the Company had no recognized revenue as
it was a development stage company.
Research and Development Expenses. Total research and development expenses
are comprised of related party license fee and research and development expenses
and other research and development expenses. Total research and development
expenditures for the development of EarthShell Packaging decreased $8.3 million
to $1.2 million from $9.5 million for the year ended December 31, 2004 compared
to the year ended December 31, 2003, respectively.
o Related party license fee and research and development expenses are
comprised of the $.1 million minimum monthly licensing fee for the
use of the EarthShell technology and for technical services, both of
which were payable to EKI, a stockholder of the Company, or Biotec,
a wholly-owned subsidiary of EKI. Related party license fee and
research and development expenses decreased $0.5 million to $0.8
million from $1.3 million for the year ended December 31, 2004
compared to the year ended December 31, 2003, respectively. The
decrease was primarily due to a decrease in the license fee as a
result of an agreement with Biotec to eliminate the $0.1 million per
month minimum licensing fee.
o Other research and development expenses are comprised of personnel
costs, travel and direct overhead for development and demonstration
production, as well as impairment charges on manufacturing property
and equipment constructed for demonstration production purposes.
Other research and development expenses decreased $7.8 million to
$0.4 million from $8.2 million for the year ended December 31, 2004
compared to the year ended December 31, 2003, respectively. The
reduction was due to the non-recurrence of the following 2003
activities: the winding down of on-going demonstration manufacturing
in Goleta, California in the first quarter of 2003, the start-up in
mid-May of a new manufacturing line for plates and bowls built and
financed by Detroit Tool and Engineering Company (DTE) at their
Lebanon, Missouri facility, expenses incurred to vacate the
Company's demonstration manufacturing facility in Goleta at the
expiration of the lease on May 31, 2003, costs incurred in
connection with testing of the Goettingen, Germany manufacturing
equipment during the third quarter, the write down of the Goettingen
manufacturing equipment to $1 as of December 31, 2003 due to the
uncertainty of the proceeds to be realized upon sale of the
equipment, and the losses of the Company's joint venture. In early
August 2003, the Company discontinued its day-to-day support of
manufacturing activities at DTE. In keeping with its business model,
in 2004 the Company primarily focused on the licensing of its foam
analog material and other technologies to new licensees, and these
licensees and future licensees will install and run equipment to
produce EarthShell Packaging in their own facilities.
30
Other General and Administrative Expenses. Other general and
administrative expenses are comprised of personnel costs, travel and direct
overhead for marketing, finance and administration. Total general and
administrative expenses decreased $2.0 million to $3.8 million from $5.8 million
for the year ended December 31, 2004 compared to the year ended December 31,
2003, respectively. This was primarily the result of efforts to significantly
reduce general and administrative expenses throughout 2003 and 2004, which
resulted in reductions in the following expenses: personnel costs by $0.7
million (due to a reduction in headcount from 14 employees at December 31, 2003
to 9 employees at December 31, 2004), professional fees and services by $0.8
million, facility and support costs by $0.3 million, business insurance costs by
$0.2 million, travel and entertainment expenses by $0.1 million and franchise
taxes by $0.1 million. In addition, the Company was able to reduce previously
provided expense accruals by approximately $0.6 million due to their favorable
resolution in the third quarter of 2004. Most of the credit to general and
administrative expenses related to the favorable resolution of property tax
disputes within the states of California and Maryland. The expense reductions
were partially offset by approximately $0.8 million of accounts payable
settlement gains in 2003. The settlement gains were the result of a program
began by the Company in the second quarter of 2003 to satisfy vendors for
outstanding aged invoices.
Depreciation and Amortization Expense. Depreciation and amortization
expense decreased $0.34 million to $0.04 million from $0.38 million for the year
ended December 31, 2004 compared to the year ended December 31, 2003,
respectively. The decrease in depreciation expense is primarily attributable to
taking the remainder of EarthShell's manufacturing and development assets out of
service as of the end of 2003.
Interest Expense. Interest expense is comprised of related party interest
expense and other interest expense.
o Related party interest expense was $0.4 million for both the year
ended December 31, 2004 and the year ended December 31, 2003.
Related party interest expense includes interest accrued on
outstanding loans made to the Company by EKI under the Simple
Interest Loan Agreement (see "Related Party Transactions"),
accretion of the discount related to the warrants issued to EKI in
conjunction with the March 2003 financing transactions, plus accrued
interest payable on amounts owed to EKI for monthly licensing fees
that were accrued rather than being paid in accordance with the
terms of the subordination agreements entered into in connection
with the 2006 Debentures (see "Business - Relationship with EKI").
During the third quarter of 2004, agreements were negotiated with
EKI to convert the EKI Simple Interest Loans, and accrued but unpaid
interest, into common stock of the Company and to restructure the
unpaid licensing fees under the Biotec License Agreement (see "Item
1 Business Relationship with EKI").
o Other interest expense decreased $0.7 million to $0.7 million from
$1.4 million for the year ended December 31, 2004 compared to the
year ended December 31, 2003, respectively. Other interest expense
for 2004 is primarily comprised of accretion of the discount and
interest accrued on the 2006 Debentures. Other interest expense for
2003 was primarily comprised of accretion of discount on the 2006
Debentures and a beneficial conversion charge in the amount of $0.4
million due to a change in the 2007 Debentures conversion price. In
addition, Other interest expense for 2003 also included accretion of
the discount on the 2007 Debentures and accrued interest payable on
the 2006 and 2007 Debentures.
Gain on Sale of Property and Equipment. Gain on the sale of property and
equipment decreased $0.3 million to $0.2 million from $0.5 million for the year
ended December 31, 2004 compared to the year ended December 31, 2003,
respectively. The gains in both 2004 and 2003 were realized due to the sale of
non-essential machine shop equipment and excess office furniture and equipment
over their net book value, most of which was fully depreciated. In addition,
2003 also included proceeds received from the sale of production line equipment
that was previously impaired and therefore had a net book value of zero.
Premium due to Debenture Default. At September 30, 2004, the Company was
in non-compliance with certain covenants of the 2006 Debentures. Two of the
debenture holders, including the debenture holder with the largest ownership
position, notified the Company in writing that the Company was in default and
requested that the Company repurchase the entire principal amount of the 2006
Debentures held at the price specified in the debenture, along with any accrued
and unpaid interest. The debenture contains a provision for repurchase of the
debenture at a premium if the repurchase is due to an event of default, and the
Company accrued the amount of the premium specified in the debenture of $1.7
million.
Other Income. Other income for the year ended December 31, 2004 was zero
compared to $0.4 million for the year ended December 31, 2003. The 2003 other
income represents the net gain realized in the third quarter of 2003 from
reducing the balance of the warrant obligation to its estimated fair value of
zero. The warrant obligation was initially recorded in connection with the March
2003 financing transactions.
31
(Gain) Loss on Extinguishment of Debentures. There was a gain on
extinguishment of debentures of $.1 million for the year ended December 31, 2004
compared to a loss on extinguishment of debentures of $1.7 million for the year
ended December 31, 2003. The $0.1 million gain for the year ended December 31,
2004 relates to interest payable on the 2006 Debentures that was not paid by the
Company upon conversion of the Debentures. In connection with the March 2003
financing transactions, the Company prepaid $5.2 million aggregate principal
amount of the 2007 Debentures, resulting in a prepayment penalty of
approximately $0.2 million. The Company also issued to the holders of the
prepaid 2007 Debentures 52,083 shares of common stock, valued at approximately
$0.2 million based upon the closing price of the Company's common stock of $4.56
per share on March 5, 2003. In addition, one of the holders of the 2007
Debentures exchanged $2.0 million aggregate principal amount of 2007 Debentures
for $2.0 million aggregate principal amount of 2006 Debentures. In connection
with the prepayment and exchange transactions, the Company incurred cash
transaction costs of approximately $0.3 million, excluding the prepayment
penalty. In addition, the Company incurred a charge of approximately $0.9
million for the prorated portion of the original discount attributed to the $7.2
million of the 2007 Debentures repaid and exchanged. Therefore, the Company
recognized a $1.7 million loss upon extinguishment of the 2007 debentures
through the prepayment and exchange.
Debenture Conversion Cost. Debenture Conversion Cost was $0.2 million for
the year ended December 31, 2003. The expense represents the prorated portion of
the original discount attributed to the 2007 Debentures whose conversion was
forced by the Company in the respective periods.
Liquidity and Capital Resources
Cash Flow. The Company's principal uses of cash for the three months ended
March 31, 2006 were to fund operations, repay notes and payment of accounts
payable and accrued expenses. Net cash used in operations was $1.6 million and
$0.8 million for the three months ended March 31, 2006 and 2005, respectively.
The use for 2006 was primarily from the loss incurred plus an additional $0.5
million decrease in accounts payable and accrued expenses. In the first three
months of 2005, the use of cash was comprised of the net loss offset by an
increase in deferred revenue of $0.2 million Net cash provided by investing
activities was $0.02 million and $0.007 million for the three months ended March
31, 2006 and 2005, respectively. Net cash provided by financing activities was
$1.8 million and $0.9 million for the three months ended March 31, 2006 and
2005, respectively. For 2006, the cash provided by financing activities was
comprised of $1.6 million from the issuance of notes (net of issue costs of $0.3
million) and $0.2 million from the proceeds of a note payable to a related
party. As of March 31, 2006, the Company had cash and related cash equivalents
totaling $0.6 million. The Company is actively seeking additional financing from
third parties. The Company anticipates, without raising additional funds from
third parties, it has resources sufficient to sustain operations through the
third quarter of 2006.
The Company's principal uses of cash for the year ended December 31, 2005
were to fund operations, repay notes, and pay accounts payable and accrued
expenses. Net cash used in operations was $3.4 million and $2.7 million for the
years ended December 31, 2005 and 2004, respectively. The uses for 2005 and 2004
were mainly from losses incurred offset by $2.1 million increase in accounts
payable and accrued expenses in 2005, changes in other operating assets and
liabilities and premium due to debenture default in 2004. Net cash provided by
investing activities was $0.02 million and $0.2 million for the years ended
December 31, 2005 and 2004, respectively. Net cash provided by financing
activities was $3.4 million and $0.9 million for the years ended December 31,
2005 and 2004, respectively. For 2005, the cash provided by financing activities
was comprised of $0.8 million from the issuance of common stock, $2.5 million
from the issuance of notes (net of issue costs of $0.4 million), $0.9 million
from the proceeds of notes payable to a related party (net of principal payments
on settlements of $0.3 million). As of December 31, 2005, the Company had cash
and related cash equivalents totaling $0.3 million.
Capital Requirements. The Company only made minor capital expenditures
during the three months ended March 31, 2006 and years ended December 31, 2005
and 2004 and does not anticipate significant capital expenditures in 2006.
Contractual Obligations. The following table summarizes the Company's
known obligations to make future payments pursuant to certain contracts as of
March 31, 2006, as well as an estimate of the timing in which these obligations
are expected to be satisfied:
Payments
due by
period (in
thousands) Less than 1-3
Contractual Obligations Total 1 year Years
-------------------------------------------- ---------- ---------- ----------
Note payable to related party (including
interest) $ 1,225 $ 75 $ 1,150
Convertible debenture 4,500 -- 4,500
Other long-term liability 323 234 89
---------- ---------- ----------
Totals $ 6,048 $ 309 $ 5,739
========== ========== ==========
32
Sources of Capital - Financing and Restructuring Transactions
To date, the Company's operations have been financed through a series of
debt and equity issuances and to a lesser extent through the receipt of a
limited amount of technology and licensing fees. Since January 1, 2003, the
Company has received: (i) an aggregate of $2.9 million through private
placements of its capital stock and warrants; (ii) an aggregate of $16.9 million
through the sale of debentures other debt securities; and $0.3 million in
licensing and technology fees. The discussion below summarizes these financings
and arrangements and the terms of various restructuring transactions the Company
has undertaken to continue to finance its operations.
The 2006 Debentures. On March 5, 2003, the Company issued to a group of
institutional investors 416,667 shares of common stock and $10.55 million in
aggregate principal amount of secured convertible debentures due in March 5,
2006 (the"2006 Debentures"), for which the Company received proceeds of
approximately $9.0 million, net of financing costs of approximately $1.5
million. In connection with the March 2003 financing transactions, the Company
issued 54,167 shares of common stock to the lead purchaser of these 2006
Debentures and two warrants to a placement agent, both of whom received the
instruments as compensation for their services rendered in connection with the
transaction. In 2003, $5.75 million principal amount of the 2006 Debentures was
converted into 958,334 shares of common stock. At December 31, 2003, the
outstanding principal balance of 2006 Debentures was $6.8 million. The remaining
shares under a December 2001 shelf registration statement were used to secure
shares potentially issuable upon conversion of the 2006 Debentures. Although the
Company was in compliance with all covenants of the 2006 Debentures at December
31, 2003, on March 8, 2004 the Company's common stock was delisted from the
NASDAQ SmallCap Market because the Company's market capitalization failed to
meet the minimum required standard for continued listing. In addition, the
Company did not make interest payments related to the 2006 Debentures as
required on January 31, 2004. These actions put the Company in non-compliance
with its covenants under the 2006 Debentures. During 2004, the Company sold $2.7
million of its common stock in a private equity transaction, received $1.5
million in prepaid technology fees related to the granting of new licenses, and
worked to negotiate settlements with each of the remaining holders of its 2006
Debentures to retire the 2006 Debentures, to resolve the defaults, and to
restructure its long-term debt.
2006 Debenture Settlements. As of September 30, 2004, the Company entered
into agreements with each of the holders of the 2006 Debentures to amend and
restate the secured debenture purchase agreements entered into in July 2004 by
and among EarthShell and the Holders (as amended and restated, the "Debenture
Purchase Agreements") and the transactions contemplated therein (collectively,
the "Debenture Transactions"). The 2006 Debentures were in default and their
outstanding principal balance totaled $6.5 million prior to their repurchase.
Collectively, the Debenture Purchase Agreements required (i) EKI to pay $1.0
million in cash (EarthShell was obligated to reimburse EKI for this cash payment
as discussed below), (ii) the Holders to convert the 2006 Debentures in
accordance with their terms, resulting in the issuance by EarthShell of
1,091,666 shares of its common stock, which shares were previously registered
for resale by the Company in connection with the issuance of the 2006
Debentures, (iii) EarthShell to issue to the Holders an aggregate of 512,500
additional shares of EarthShell common stock and (iv) EarthShell to pay $2.3
million (the "Contingent Settlement") to SF Capital Partners from 33% of any
equity funding received by the Company (excluding the first $2.7 million funded
by MBS) or 50% of the royalties received by EarthShell in excess of $250,000 per
month (as determined on a cumulative basis commencing July 1, 2004). EarthShell
has the right to convert the unpaid portion of the $2.3 million into shares of
the Company's common stock at a price equal to the lesser of $3.00 per share, or
the price per share that EarthShell shall subsequently receive upon the issuance
of its common stock (or other convertible security) during the three year period
commencing September 30, 2004. The 512,500 shares of common stock issued to the
Holders on October 6, 2004 have been included in a Form S-1 registration
statement filed with the Securities and Exchange Commission on February 14,
2006, which has not yet become effective. The consideration for the repurchase
of the 2006 Debentures has been paid or issued, and the 2006 Debentures have
been retired by EarthShell.
In connection with the settlement of the 2006 Debentures and the related
restructuring of the Company's debt, the Company provided registration rights
with respect to newly issued unregistered shares of its common stock. Such
registration rights required the Company to, among other things, file a
registration statement with the SEC in December 2004 registering the resale of
such shares of common stock. Under certain agreements, the Company not filing
such a registration statement (or the registration statement not being declared
effective) within a required timeframe provided the holders of the registrable
securities with a right to liquidated damages which, in the aggregate, may
amount to approximately $50,000 per month until a registration statement is
filed. If the Company fails to pay such liquidated damages, the Company must
also pay interest on such amount at a rate of 10% per year (or such lesser
amount as is permitted by law). Because this Registration Statement was not
filed as planned, in December 2004 the Company became obligated on the direct
financial obligation described above. In light of the Company's current
liquidity and financial position any such claim could have a negative effect on
the Company.
33
On January 11, 2006, the Company issued 186,021 shares of the Company's
common stock to SF Capital Partners pursuant to a conversion right related to
the Contingent Settlement of $2.375 million reached under the September 30, 2004
Amended and Restated Debenture Purchase Agreement. Pursuant to the Contingent
Settlement, EarthShell must pay $2.375 million to SF Capital Partners from 33%
of any equity funding received by the Company (excluding the first $2.7 million
funded by MBS) or 50% of the royalties received by EarthShell in excess of
$250,000 per month (as determined on a cumulative basis commencing July 1,
2004). The Company has the right to convert the unpaid portion of the $2.375
million into shares of the Company's common stock at a price equal to the lesser
of $3.00 per share, or the price per share that EarthShell shall subsequently
receive upon the issuance of its common stock (or other convertible security)
during the three year period commencing September 30, 2004. SF Capital Partners
delivered a conversion notice to the Company on January 11, 2006 requesting
conversion of $558,063 of the Contingent Settlement into shares of the Company's
common stock. Following the conversion, the remaining balance of the Contingent
Settlement was approximately $1.8 million. The Company recorded that difference
between the conversion value and the fair value of the common stock at the time
of the conversion as a settlement gain in the amount of $213,924.
Agreements with MBS. On May 13, 2004, the Company entered into a ten year
license agreement with MBS and granted to MBS a priority license to supply
certain retail and government market segments in the United States (the "MBS
Sublicense"). MBS has paid EarthShell $0.5 million in technology fees to date.
On June 8, 2005, the Company terminated the MBS Sublicense as set forth herein
below.
On August 5, 2004, EarthShell and MBS entered into a stock purchase
agreement (the "MBS SPA") pursuant to which MBS agreed to fund $5.0 million to
EarthShell in exchange for EarthShell's issuance of 1,666,666 shares of common
stock at $3.00 per share. On August 20, 2004, EarthShell received $0.5 million
from MBS, for which the Company issued to MBS 166,666 shares of its common
stock. On October 1, 2004, EarthShell received an additional $1.2 million of the
$5.0 million commitment, and the Company issued to MBS 400,000 shares of its
common stock. On October 11, 2004, MBS purchased an additional 333,333 shares
for $1.0 million, of which it had paid $0.5 million as of December 31, 2004 and
$0.5 million was still due. During 2005, the unamortized balance of MBS'
deferred technology fee of $0.3 million was applied to the stock receivable. The
shares of common stock issued to MBS were not registered for resale under the
1933 Act. The cash received from MBS was used, in part, to fund the repurchase
of the 2006 Debentures and to restructure the Company's long-term debt.
On June 8, 2005, the Company entered into a letter agreement with MBS
terminating its sublicense agreement (the "MBS Sublicense"), dated as of May 13,
2004. At the time the letter agreement was executed, MBS had not yet implemented
the sublicense granted to it under the MBS Sublicense. The parties separately
agreed that the effectiveness of the termination would be conditioned upon the
effectiveness of the agreements with RPI as described herein below. The Company
entered into additional sublicense agreements with MBS covering non-competing
technologies in other markets and territories than those covered by the MBS
Sublicense and the present RPI Sublicense. The effectiveness of such sublicense
agreements was expressly conditioned upon the satisfaction of certain conditions
before July 31, 2005, including the receipt by the Company of $2.6 million in
technology fees and other payments. These agreements expired under their own
terms.
RPI Agreements. On June 17, 2005, EarthShell entered into a sublicense
agreement with RPI (the "RPI Sublicense"), a newly formed subsidiary of Thompson
Street Capital Partners ("Thompson Street"), pursuant to which the Company
granted to RPI an exclusive license to produce plates, bowls, and certain other
EarthShell products incorporating the Company's technology and to sell these
products in the retail and governmental market segments in the United States.
The Company has been advised that RPI has received the full $12.0 million
funding commitment from Thompson Street in order to begin production of
EarthShell Packaging products. The RPI Sublicense requires RPI to pay to the
Company a royalty fee equal to 20% of RPI's net sales, not to exceed 50% of
RPI's gross margin
34
On June 17, 2005, the Company, RPI and RPI's sole stockholder, Renewable
Products, LLC ("RPI LLC"), entered into an agreement and plan of merger (the
"RPI Merger"), which contemplates the Company's eventual acquisition of RPI in
exchange for 8.0 million shares of the Company's Series C Convertible Preferred
stock (the "Series C Preferred") at such time as the following conditions, among
others, are achieved: (i) RPI's procurement, installation and start-up of 16
manufacturing modules for producing the Company's product, which equipment is to
be designed to produce an aggregate of approximately $16.0 million of EarthShell
products per year, (ii) RPI's establishment of plant facilities to support the
full commercial operations of such machines, (iii) RPI's receipt of funding to
support additional working capital needs of $1.0 million, (iv) RPI's receipt of
at least $12.0 million of capital to purchase the machines described above, and
(v) the 20% royalty described above having become payable and either accrued or
paid to the Company pursuant to the RPI Sublicense. At such time as the
conditions to the transactions contemplated by the RPI Merger are met, RPI has
the right, through March 31, 2006, to call for the merger to occur. The parties
have mutually agreed to extend RPI's call date to December 31, 2006. At the time
the merger is triggered, a valuation of RPI will be obtained and the Company
will acquire RPI pursuant to the terms of the RPI Merger in exchange for 8.0
million shares of Series C Preferred, as described above. The Series C Preferred
will be convertible on a share for share basis into 8.0 million shares of the
Company's common stock which will be subject to registration rights.
EA License. On August 22, 2005, the Company entered into a letter
agreement with EA to grant sub-licenses to use EarthShell Technology for various
applications in certain Asian territories (the "EA License"). Shortly after
executing the letter agreement, both the Company and EA entered into
negotiations to restructure the transaction and ultimately entered into an
amended and restated letter agreement dated December 9, 2005. Per the
transaction as restructured in accordance with the amended and restated letter
agreement, the Company may receive a total of up to $2.6 million from a
combination of (i) prepaid technology fees (up to $1.7 million), (ii) the sale
of up to 266,667 shares of its common stock (at $3 per share or a total of
$800,000) and (iii) the issuance of warrants to purchase one million thirty
three thousand three hundred thirty three (1,033,333) shares of the Company's
common stock at $3.90 per share (for $100,000). . Realization of the $1.7
million in technology fees from EarthShell Asia dependent on the Company
successfully demonstrating the commercial viability of its technology in each of
four new application families. For each of the four applications successfully
demonstrated, EarthShell Asia will pay to EarthShell a technology transfer fee
of $425,000 to activate the license.
The Company received $500,000 from EA in August 2005 as an initial partial
payment and reserved 166,667 shares of its common stock in connection with this
payment. The Company received an additional $300,000 in December 2005 and the
payment, of approximately $100,000 on February 10, 2006. The final payment of
$100,000 was offset by $39,000 in legal fees that the Company agreed to
reimburse to EarthShell Asia. . Upon receipt of the final payment, the
transaction became effective and the Company issued a total of 266,667 shares
and the warrants to purchase the 1,033,333 shares.
Financing Transactions and Arrangements with EKI. During 2002 and 2003,
EKI, an affiliated entity, made a series of Simple Interest Loans to the Company
totaling approximately $5.8 million. In addition, EKI purchased $1.0 million of
the Company's 2006 Debentures. On September 30, 2004, EKI entered into an
agreement with EarthShell to sell back to the Company the 2006 Debentures it had
purchased for $1.0 million in cash, the cash price originally paid by EKI. The
Company retired the 2006 Debentures shortly thereafter.
In October 2004, in connection with the settlement of the 2006 Debentures,
EKI converted all of its outstanding loans to EarthShell ($2,755,000) into
unregistered common stock at $3.00 per share and $532,644 of accumulated
interest at $4.00 per share for a total of 1,051,494 shares received by EKI. As
of December 31, 2004, the loans from EKI to EarthShell had all been retired.
In May 2005, an additional 44,387 shares were issued to EKI pursuant to a
ninety day price protection in the clause, which provided for an adjustment in
the effective conversion price of the interest portions of the EKI loans from
$4.00 per share to $3.00 per share. The Company also granted a ten year warrant
to EKI to purchase one million shares of the Company's common stock at $3.00 per
share in consideration of EKI's continued support of the Company since its
inception, including providing bridge loans at below market terms from time to
time. This warrant was cancelled and subsequently a new warrant with similar
terms was reissued in August 2005 to Essam Khashoggi, beneficial owner of EKI.
On October 11, 2005, the Company entered into the 2005 EKI Loan with EKI
pursuant to which the Company issued to EKI a promissory note in the principal
amount of $1.0 million. As of December 31, 2005, EKI had advanced $0.85 million
with the balance being funded by the second week of January 2006. Interest
accrues on the principal balance of the 2005 EKI Loan at a variable per annum
rate, as of any date of determination, that is equal to the rate published in
the "Money Rates" section of The Wall Street Journal as being the "Prime Rate",
compounded monthly. All accrued but unpaid interest and outstanding principal is
due and payable on the earliest to occur of the following: (i) the second
anniversary of the date of the 2005 EKI Loan; (ii) five days following the date
the Company has received $3.0 million or more in aggregate net cash proceeds
from all financing transactions, equity contributions, and transactions relating
to the sale, licensing, sublicensing or disposition of assets or the provision
of services (including advance royalty payments, proceeds from the sale of the
Company's common stock and fees for technological services rendered to third
parties), measured from the date of the 2005 EKI Loan and not taking into
account the proceeds advanced under the 2005 EKI Loan; or (iii) the occurrence
of an Event of Default (as defined in the 2005 EKI Loan).
On July 28, 2006, the Company entered into a Loan and Mutual Release
Agreement (the "Agreement") with E. Khashoggi Industries, LLC ("EKI"), the
Company's largest stockholder. Pursuant to the Agreement, EKI advanced $350,000
directly to the Company and an additional $150,000 to a law firm on behalf of
the Company to cover legal fees related to patent renewals. The Agreement also
contains mutual releases of any and all claims, known or unknown, which the
respective parties may have through the date of the Agreement under existing
license, debt conversion and service agreements. The Company executed and
delivered two Promissory Notes to EKI on July 28, 2006; one in the amount of
$350,000 and the other in the amount of $150,000. Interest accrues on the
principal balance of the $350,000 note at a variable per annum rate, as of any
date of determination, that is equal to the rate published in the "Money Rates"
section of The Wall Street Journal as being the "Prime Rate", compounded
monthly. The $150,000 note is non-interest bearing. All accrued but unpaid
interest and outstanding principal under the notes is due and payable on the
earliest to occur of the following: (i) the second anniversary of the date of
the note; (ii) five days following the date the Company has received $3.0
million or more in aggregate net cash proceeds from all financing transactions,
equity contributions, and transactions relating to the sale, licensing,
sublicensing or disposition of assets or the provision of services (including
advance royalty payments, proceeds from the sale of the Company's common stock
and fees for technological services rendered to third parties), occurring
subsequent to the date of the notes.
35
Also on October 11, 2005, the Company entered into a debt conversion and
mutual release agreement (the "Debt Conversion Agreement") with EKI. Pursuant to
the Debt Conversion Agreement, the Company and EKI agreed that a payable in an
amount equal to $837,145 (previously owed the Biotec Group, but which payable
was subsequently assigned to EKI) be converted into 279,048 shares of common
stock of the Company. The conversion price equals $3.00 per share. Pursuant to
the Debt Conversion Agreement, the Company and EKI released each other from any
and all claims in connection with the payable.
Cornell Capital Partners Financings. On March 23, 2005, the Company
entered into a financing arrangement with Cornell Capital Partners whereby the
Company issued promissory notes to, and entered into a security agreement with,
Cornell Capital Partners. Pursuant to the financing, the Company issued
promissory notes (collectively, the "CCP Notes") to Cornell Capital Partners
with a total principal amount of $2.5 million. Upon consummation of the December
Debenture Purchase Agreement with Cornell Capital Partners on January 6, 2006,
described below, the CCP Notes and all accrued interest thereon have been paid
in full.
On March 23, 2005, the Company entered into a Standby Equity Distribution
Agreement (the "SEDA") with Cornell Capital Partners whereby the Company was
entitled to, at its sole discretion, periodically sell to Cornell Capital
Partners shares of its common stock for a total aggregate purchase price of up
to $10.0 million. On June 9, 2005, the Company filed a registration statement on
Form S-1 with the SEC to register shares of its common stock underlying the
SEDA. On September 27, 2005, the registration statement was withdrawn and, on
December 30, 2005, the parties terminated the SEDA.
On May 26, 2005, the Company issued a common stock purchase warrants to
Cornell Capital Partners and Highgate House Funds to purchase 260,500 and
364,500 shares of common stock of the Company, respectively. This May Warrant
expires on May 26, 2006, has an exercise price which was adjusted to $3.00 per
share of common stock and has "piggy back" and demand registration rights. In
August 2005 Cornell Capital Partners agreed to consolidate the CCP Notes and to
defer the commencement of repayment installments. In consideration of this
modification to CCP Notes, the Company issued a warrant to Cornell Capital
Partners to purchase 50,000 shares of common stock of the Company. This Warrant
expires on May 26, 2006, has an exercise price, which was adjusted to $3.00 per
share of common stock as of December 30, 2005, and has "piggy back" and demand
registration rights.
Cornell Capital Debentures. On December 30, 2005, EarthShell entered into
a Securities Purchase Agreement with Cornell Capital Partners (the "Cornell
Capital Debenture Purchase Agreement") pursuant to which the Company issued and
sold to Cornell Capital Partners $4.5 million in principal amount of secured
convertible debentures (the "Cornell Capital Debentures") on the terms described
below. This agreement was consummated on January 6, 2006. The Cornell Capital
Debentures are convertible into shares of the Company's common stock on the
terms discussed below The Company received the aggregate proceeds of $4.5
million from the sale of the Cornell Capital Debentures on January 6, 2006, of
which approximately $2.6 million was used to payoff the CCP Notes.
The Cornell Capital Debentures are secured by (i) a Pledge and Escrow
Agreement, by and among the Company, Cornell Capital Partners, and David
Gonzalez, Esq., (ii) an Insider Pledge Agreement and Escrow Agreement (the
"IPEA"), by and among the Company, Cornell Capital Partners, David Gonzalez,
Esq. and Mr. Benton Wilcoxon and (iii) an Amended and Restated Security
Agreement, by and between the Company and Cornell Capital Partners. The Cornell
Capital Debentures are secured by substantially all of the Company's assets,
have a three year term and accrue interest at 12% per annum. The December
Debenture Purchase Agreement required the Company to register the shares of the
Company's common stock into which the Cornell Capital Debentures are convertible
under the Securities Act of 1933. On February 14, 2006, the Company filed a
registration statement on Form S-1 with the Securities and Exchange Commission
("SEC") in order to register 6,700,000 shares of common stock that may be
issuable to the holders of the Cornell Capital Debentures upon conversion.
Beginning 60 days after the SEC declares the registration statement effective,
Cornell Capital Partners is entitled, at its option, to convert and sell up to
$250,000 of the principal amount of the Cornell Capital Debentures, plus accrued
interest, into shares of the Company's common stock, within any 30 day period at
the lesser of (i) a price equal to $3.00 or (ii) 88% of the average of the two
lowest volume weighted average prices of the common stock during the ten trading
days immediately preceding the conversion date, as quoted by Bloomberg, LP.
The holder of the Cornell Capital Debentures may not convert the Cornell
Capital Debentures or receive shares of the Company's common stock as payment of
interest thereunder to the extent such conversion or receipt of such interest
payment would result in the holder, together with any affiliate thereof,
beneficially owning (as determined in accordance with Section 13(d) of the
Securities Exchange Act of 1934, as amended, and the rules promulgated
thereunder) in excess of 4.9% of the then issued and outstanding shares of
common stock, including shares issuable upon conversion of, and payment of
interest on, the Cornell Capital Debentures held by such holder after
application of this 4.9% restriction. This 4.9% restriction may be waived by the
holder (but only as to itself and not to any other holder) upon not less than 65
days prior notice to the Company.
36
The Company may redeem, with three business days advance written notice to
Cornell Capital Partners, a portion or all amounts outstanding under the Cornell
Capital Debentures prior to the maturity date provided that the closing bid
price of the of the Company's common stock, as reported by Bloomberg, LP, is
less than $3.00 at the time of the redemption notice. The Company shall pay an
amount equal to the principal amount being redeemed plus a redemption premium
equal to ten percent of the principal amount being redeemed, and accrued
interest, to be delivered to the Cornell Capital Partners on the third business
day after the redemption notice, provided, however, this redemption premium does
not apply until the outstanding principal balance of the Cornell Capital
Debentures has been reduced by $2.5 million. The amount that Cornell may convert
in any 30 day period will be reduced by the amount that the Company redeems.
On July 12, 2006, the Company entered into a Letter Agreement with Cornell
Capital Partners, pursuant to which Cornell Capital Partners has agreed to
forbear from exercising certain rights and remedies under the Cornell Capital
Debentures and that certain Registration Rights Agreement, of even date with the
Cornell Capital Debentures in exchange for the issuance by the Company to
Cornell Capital Partners of 250,000 shares of the Company's common stock.
The Company has acknowledged in the Agreement that an event of default
under the Cornell Capital Debentures had occurred as of June 30, 2006 with the
Company failing to timely register with the U.S. Securities and Exchange
Commission the common stock underlying the Cornell Capital Debentures. The
Company also acknowledged that Cornell Capital Partners is entitled to
liquidated damages equal to one percent (1%) of the liquidated value of the
Cornell Capital Partners for each thirty (30) day period after May 31, 2006.
Pursuant to the Agreement, Cornell Capital Partners has agreed to waive the
default, including all liquidated damages that may have accrued through the date
of the Agreement and during the Forbearance Period (as defined below), in
exchange for the 250,000 shares of common stock and the Company obtaining the
effectiveness by September 30, 2006 of that certain Registration Statement
originally filed with the U.S. Securities and Exchange Commission on February
14, 2006, which includes the shares of common stock underlying the Cornell
Capital Debentures.
Furthermore, Cornell Capital Partners has agreed not to make any
conversions under the Cornell Capital Debentures until the earlier of September
30, 2006 or the expiration of the Forbearance Period, which such Forbearance
Period shall commence on the date of the execution of the Agreement and continue
for so long as the Company strictly complies with the terms of the Agreement and
there is no occurrence or existence of any event of default other than the
Default under the Cornell Capital Debenture transaction documents or any other
agreement that the Company has entered into with Cornell Capital Partners. The
250,000 shares of commons stock shall have piggy-back registration rights and
Cornell Capital Partners shall also have the right to demand the registration of
the 250,000 shares of common stock by providing to the Company with thirty (30)
days prior written notice of such request.
In connection with the December Debenture Purchase Agreement, on December
30, 2005, the Company issued to Cornell Capital Partners the warrant to purchase
up to 350,000 shares of common stock (the "December Warrant"). This December
Warrant has an exercise price of $4.00 per share, which may be adjusted to as
low as $3 per share in the event the Company issues or sells any shares of its
common stock for a consideration per share less than the exercise price for the
December Warrants and expires two years from the date it was issued.
Furthermore, in connection with the Company's sale of Cornell Capital
Debentures, the Company issued to Mr. Benton Wilcoxon, in consideration of his
pledge of shares of common stock of Composite Technology Corporation pursuant to
the terms of the IPEA, a warrant to purchase up to 125,000 shares of common
stock. This warrant has an exercise price of $4.00 per share and expires three
years from the date it was issued.
The Company has valued the convertible note payable, related warrants and
the beneficial conversion option to convert the principal balance into shares,
using the "Relative Fair Value" approach. Accordingly, the Company recognized a
discount of $2.1 million on the $4.5 million principal value of the convertible
note payable and is amortizing the debt discount over the 36 month life of the
note.
Thompson Street Capital SPA. On June 21, 2006, EarthShell Corporation (the
"Company") entered into a Securities Purchase Agreement (the "SPA") by and among
the Company and certain investors named therein (the "Investors") pursuant to
which the Company sold an aggregate of 128,205 shares of Series D convertible
preferred stock (the "Series D Preferred Stock") for a total purchase price of
$500,000. The Series D Preferred Stock, which was sold to the Investors in a
private offering, pays a cumulative 20% annual dividend, which shall be paid on
conversion or liquidation of the Company. The Series D Preferred Stock is
callable in certain circumstances by the Company. In the event of any voluntary
or involuntary liquidation, dissolution or winding up of the Company, the
holders of the Series D Preferred Stock will be entitled to receive, prior and
in preference to any distribution of the assets or surplus funds of the Company
to the holders of any shares of common stock by reason of the ownership thereof,
an amount equal to the Liquidation Value of $3.90 per share and any accrued
dividends. Each share of Series D Preferred Stock is convertible into one share
of the Company's common stock, par value $0.01 per share, subject to adjustment.
In order to (i) effect an amendment of the Company's Certificate of
Incorporation or By-Laws (except to increase the number of directors), (ii)
issue, or permit any Subsidiaries to issue, any additional shares of capital
stock or other equity interests at less than Fair Market Value, or (iii) change
the Company's business or business model, the affirmative vote of the holders of
at least seventy-five percent (75%) of the then outstanding shares of Series D
Preferred Stock must first be obtained.
37
In connection with the issuance and sale of the Series D Preferred Stock,
the Company granted the Investors immediately exercisable warrants to purchase
an aggregate of 555,555 shares of the Company's common stock at an exercise
price of $3.90 per share, subject to adjustment (the "Warrants").
The Investors also have been granted certain registration rights with
respect to the shares of common stock underlying the Series D Preferred Stock
and the Warrants as set forth in Section 3 of the SPA.
In addition to (a) the $0.9 million received pursuant to the EA agreements
(b) the $1.0 million received pursuant to the 2005 EKI Loan (c) the $1.7 million
in net proceeds received from the $4.5 million note to Cornell Capital Partners'
Cornell Capital Debentures, and (d) the $0.5 million the Company received from
the sale of convertible preferred stock in June 2006, and (e) the $0.35 million
received pursuant to the 2006 EKI Loan, the Company believes it will have to
raise additional funds to meet its current obligations and to cover operating
expenses through the next 12 months. The Company expects to receive additional
technology fees in connection with the granting of additional new licenses
during 2006. If the Company is not successful in raising additional capital it
may not be able to continue as a going concern. Management will also continue in
its efforts to reduce expenses, but cannot assure that it will be able to reduce
expenses below current levels. If the Company is not successful in raising
additional capital it may not be able to continue as a going concern.
Off-Balance Sheet Arrangements. The Company does not have any off-balance
sheet arrangements as of March 31, 2006, and has not entered into any
transactions involving unconsolidated, limited purpose entities.
38
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
General
The Management of EarthShell is responsible for establishing and
maintaining adequate internal control over financial reporting and for the
assessment of the effectiveness of internal control over financial reporting. As
defined by the SEC, internal control over financial reporting is a process
designed by, or supervised by, the Company's principal executive and principal
financial officers, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements in accordance
with generally accepted accounting principles.
The Company's internal control over financial reporting is supported by
written policies and procedures, that (1) pertain to the maintenance of records
that, in reasonable detail, accurately and fairly reflect the transactions and
dispositions of the Company's assets; (2) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that
receipts and expenditures of the Company are being made only in accordance with
authorizations of the Company's management and directors; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of the Company's assets that could have a
material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
A material weakness is a significant deficiency (within the meaning of
PCAOB Auditing Standard No. 2), or a combination of significant deficiencies,
that results in there being more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected on a timely basis by employees in the normal course of their
assigned functions.
In making its assessment of internal control over financial reporting,
management used the framework set forth in the report entitled "Internal
Control--Integrated Framework" published by the Committee of Sponsoring
Organizations ("COSO") of the Treadway Commission to evaluate the effectiveness
of the Company's internal control over financial reporting. Because of the
material weaknesses described below, management believes that, as of December
31, 2004, the Company did not maintain effective internal control over financial
reporting based on those criteria.
The Company's independent auditors have issued an attestation report on
management's assessment of the Company's internal control over financial
reporting. Although the Company operated during 2004 with a significantly
reduced number of personnel compared to prior years, the Company's management
has implemented and documented internal control over financial reporting which
it believed would be considered sufficient, given the resources available to it.
However, during the fourth (4th) quarter of 2004, the Company's Controller
resigned, leaving the Company's Chief Financial Officer as the only accounting
professional employed by the Company. This resulted in the loss of segregation
of responsibilities that are typical to effective financial reporting control
methodology. The Company employed certain mitigating controls designed to offset
the inherent control weaknesses that resulted from a lack of segregation of
responsibilities.
We engaged an accounting firm in December 2004 to assist us in documenting
and testing our controls and procedures in compliance with the Sarbanes-Oxley
Act. This process was not completed until late in the first (1st) quarter 2005.
The testing and evaluation of our internal controls as of that time indicated
that our controls were considered effective.
Based on the timing of this work and the filing deadline for our Annual
Report on Form 10-K as an accelerated filer, our independent registered public
accounting firm was not able to perform its audit of management's assessment of
the effectiveness of its internal control over financial reporting as of
December 31, 2004, until subsequent to the filing of our Annual Report on Form
10-K. Their audit disclosed the material weaknesses. We reviewed the results of
their audit of our assessment and concurred with their conclusion. Accordingly,
we modified our assessment in Amendment No. 1 to the Company's Quarterly Report
on Form 10-Q for the quarter ended March 31, 2005 and in Amendment No. 1 to the
Company's Annual Report on Form 10-K.
39
The Company ceased to be an accelerated filer for the year ended December
31, 2005, due to our market capitalization being less than $75 million dollars,
the Company has not submitted a report on the Sarbanes Oxley 404 compliance work
for the year ended December 31, 2005.
MATERIAL WEAKNESSES IDENTIFIED
The Company's assessment of its internal control over financial reporting
identified the following material weaknesses for the years ended December 31,
2004 and 2005:
o The Company has inadequate segregation of critical duties within
each of its accounting processes and a lack of sufficient monitoring
controls over these processes to mitigate this risk. The
responsibilities assigned to one employee include maintaining the
vendor master file, processing payables, creating and voiding
checks, reconciling bank accounts, making bank deposits and
processing payroll.
o The departure of the Company's Controller in November 2004 resulted
in the accounting and reporting functions being centralized under
the Chief Financial Officer, with no additional personnel in the
Company having an adequate knowledge of accounting principles and
practices. As a result, certain transactions had not been recorded
in a timely manner and several adjustments to the financial
statements that were considered material to the financial position
at December 31, 2004 and results of operations for the year then
ended were recorded.
o There are weaknesses in the Company's information technology ("IT")
controls which makes the Company's financial data vulnerable to
error or fraud. Specifically, there is a lack of documentation
regarding the roles and responsibilities of the IT function, lack of
security management and monitoring and inadequate segregation of
duties involving IT functions.
Additionally, at the conclusion of our independent auditor's examination
of the Company's internal control over financial reporting, our independent
auditor noted several other areas of operations which could be improved. Our
auditors did not believe these items constituted material weaknesses.
Remediation Steps To Address The Material Weaknesses
In consultation with its independent auditors, as of September 30, 2005,
the Company has begun taking the following remediation steps, among others, to
enhance its internal control over financial reporting and reduce control
deficiencies in general, including the material weaknesses enumerated above:
o Management has interviewed multiple qualified candidates to perform
the Controller responsibilities, and as of October 31, 2005 hired a
new controller, a CPA, with 15 years' experience in public and
private accounting. The new Controller is in the process of
developing revised accounting systems and procedures that will
strengthen the Company's controls over financial reporting. The
Company hired an additional accounting employee on March 30, 2006.
o Management employs an outside firm, to monitor and maintain the
Company's information systems. This group was been directed to
develop and implement Company-wide information management control
procedures in response to the control weaknesses noted by the
Company's auditors and in consultation with the Company's internal
auditors. A first draft was completed in July 2005. In connection
with the recent move of its corporate offices to Maryland, a new
group was retained to perform a similar function. It is expected
that a final information technology controls policy and procedures
document will be finalized and implemented 2006.
To date, the Company has expended approximately $60,000 towards
remediation of these material weaknesses.
40
CHANGES IN AND DISAGREEMENTS
WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
41
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's treasury function controls all decisions and commitments
regarding cash management and financing arrangements. Treasury operations are
conducted within a framework that has been authorized by the Board of Directors.
The Company is exposed to interest rate risk on its obligations under the
2005 EKI Loan. Currently, the principal amount of the 2005 EKI Loan totals $1.0
million. The loan bears interest on the principal balance of $1.0 million at a
variable rate per annum, as of any date of determination, that is equal to the
rate published in the "Money Rates" section of The Wall Street Journal as being
the "Prime Rate", compounded monthly. In addition, there remain a few
settlements of accounts payable obligations that will be paid out over terms
from 18 months to 36 months, the long term portion of which may be exposed to
interest rate risk.
Generally, an increase in market interest rates will increase the
Company's interest expense on this debt and any decreases in rates will
generally have the opposite effect.
42
DESCRIPTION OF BUSINESS
The Company
EarthShell was organized in November 1992 to engage in the
commercialization of proprietary composite material technology, designed with
the environment in mind, for the manufacture of disposable packaging to be used
in the foodservice industry. Current and future products include hinged-lid
containers, plates, bowls, foodservice wraps, cups and cutlery (collectively,
"EarthShell Packaging"). EarthShell composite material is primarily made from
abundantly available and low cost natural raw materials such as limestone and
starch from annually renewable crops, such as corn and potatoes. The Company has
determined that foodservice disposables made of this material should offer
certain environmental benefits, will have performance characteristics, such as
strength and rigidity, and it believes that it should be able to commercially
produce and sell these products at prices that are competitive with comparable
conventional paper and plastic foodservice disposables.
The Company's objective is to establish EarthShell Packaging as the
preferred disposable packaging material for the foodservice industry throughout
the world based on comparable performance, environmental superiority and
competitive pricing. EarthShell's approach for achieving this objective has been
to: (i) license the EarthShell technology to strategically selected
manufacturing or operating partners to manufacture, market, distribute and sell
EarthShell Packaging; (ii) demonstrate customer acceptance and demand for
EarthShell Packaging through key market leaders and environmental groups; and
(iii) demonstrate the manufacturability and improved economics with initial
strategic partners.
To date, the Company has licensed the technology to certain carefully
selected partners who are working to commercialize the technology. The Company
currently has three active licensees: one in the United States, one in Mexico
and one in Asia. In cooperation with its licensing partners, more than
50,000,000 units of EarthShell Packaging, including plates, bowls and sandwich
containers have been manufactured and sold to key customers within a variety of
market segments in order to demonstrate commercial product quality, customer
acceptance and demand. The Company has received support for its environmental
claims from a number of governmental and non-environmental organizations. In
addition, the Company has worked with a machinery manufacturer who has developed
turn-key manufacturing machinery for EarthShell plates and bowls. The Company's
primary focus is now on supporting its licensee in the United States, Renewable
Products Inc. ("RPI"), who has put in place a commercial production facility and
is commencing manufacturing and distribution operations. In June of 2005, the
Company entered into an Agreement and Plan of Merger with RPI pursuant to which
the Company and RPI are expected to merge at such time as RPI completes its
investment in manufacturing capacity, is successfully manufacturing EarthShell
plates and bowls and is profitably selling these products into the marketplace.
Upon consummation of this merger, EarthShell will be directly engaged in
manufacturing and distributing EarthShell product in addition to its licensing
activities (See "Strategic Manufacturing and Distribution Relationships - RPI").
In addition to its efforts with RPI, the Company is supporting its Mexican
licensee in acquiring and putting into service manufacturing capacity to serve
the Mexican market. It is also working with EarthShell Asia, an Asian licensee,
to demonstrate and to exploit a new aspect of the EarthShell technology.
Industry Overview
Based on industry studies, the Company believes that the annual spending
on foodservice disposable packaging is approximately $13 billion in the United
States and over $30 billion globally. According to industry studies of the
market, approximately 54% of the total foodservice disposable packaging is
purchased by quick-service restaurants and 46% by other institutions such as
hospitals, stadiums, airlines, schools, restaurants (other than quick-service
restaurants), and retail stores. The Company believes that of the foodservice
disposables purchased in the United States by quick-service restaurants and
other institutions, approximately 45% are made of coated or plastic laminated
paper and 55% are made of non-paper materials such as plastic, polystyrene or
foil. A breakdown of the various components of the global market for foodservice
disposables is as follows:
43
Global Market Size
------------------
$ %
-------- --------
($ in millions)
Commercial Products
Plates, Bowls $ 5,700 19
Hinged-Lid Containers 1,800 6
Commercial Prototypes
Wraps 2,000 7
Hot Cups 3,300 11
Concept Prototypes
Cold Cups 5,700 19
Containers, Trays 4,200 13
Straws, Cup Lids 3,300 11
Pizza Boxes 2,000 7
Cutlery 2,000 7
-------- --------
Total $ 30,000 100
======== ========
In addition to the United States, the Company believes the market
opportunity for EarthShell Packaging is particularly strong in Europe and parts
of Asia due to heightened environmental concerns and government regulations. In
Europe, environmental legislation, such as the so-called "Green Dot" laws have
created an opportunity for environmentally preferable products. Meanwhile, new
regulations in many Asian countries have mandated a reduction in polystyrene
production stimulating an increased demand for foodservice packaging
manufactured from acceptable alternative materials. Furthermore, improvements in
the Asian and European composting and recycling infrastructure are expected to
facilitate the use of environmentally preferable products.
Products
EarthShell Packaging is based on a patented composite material technology
licensed on an exclusive worldwide basis from E. Khashoggi Industries, LLC
("EKI"), the largest stockholder of the Company. The Company's licensed field of
use of the technology is for the development, manufacture and sale of disposable
packaging for use in the foodservice industry and for certain specific food
packaging applications.
Traditional foodservice disposables, wraps, and paperboard are currently
manufactured from a variety of materials, including paper and plastic. The
Company believes that none of these materials fully addresses three of the
principal challenges facing the foodservice industry; namely performance, price,
and environmental impact. The Company believes that EarthShell Packaging
addresses the combination of these challenges better than traditional
alternatives and therefore will be able to achieve a significant share of the
foodservice disposable packaging market.
EarthShell Packaging can be categorized into four types: (i) laminated
foamed products, (ii) pellet technology products, (iii) paperboard substitutes
and (iv) flexible wraps. To date, the EarthShell technology has been used to
produce limited commercial quantities of laminated foam plates, bowls, and
hinged-lid containers intended for use by all segments of the foodservice
disposable packaging market, including quick-service restaurants, food and
facilities management companies, the United States government,
universities/colleges, and retail operations. These products were developed
using detailed environmental assessments and carefully selected raw materials
and processes to minimize the harmful impact on the environment without
sacrificing competitive price or performance.
Environment
EarthShell's foodservice disposable products were developed over many
years based on environmental models to reduce the environmental concerns of
foodservice disposable packaging through the careful selection of raw materials,
manufacturing processes and suppliers. For example, EarthShell Packaging reduces
risk to wildlife compared to polystyrene foam packaging because it biodegrades
when exposed to moisture in nature and can be composted in a commercial facility
(where available) or even in consumers' backyards. EarthShell Packaging and the
designs approach for its manufacture and disposal has received support from many
governmental and non-governmental organizations.
44
Performance
The Company believes that it has demonstrated that its laminated foam
products, including plates, bowls, and hinged lid containers, meet the critical
performance requirements of the marketplace, including strength, graphic
capabilities, insulation, shipping, handling and packaging. Additionally, the
Company believes that its other product families, which are currently under
development, may be manufactured using the same basic raw materials as the foam
laminate disposables and should be readily accepted by the market when
available.
Cost
Since EarthShell Packaging is uniquely engineered from readily available,
low-cost natural raw materials such as limestone and starch, the Company
believes EarthShell products can be manufactured cost-effectively at commercial
production levels.
Business Strategy
The Company's objective is to establish EarthShell Packaging as the
preferred foodservice disposable packaging in the foodservice industry. The
Company's strategies to achieve this objective are to:
o Develop products which deliver comparable or greater performance,
are competitively priced and offer environmental advantages as
compared to traditional packaging alternatives;
o Support the ramp-up of EarthShell plate and bowl manufacturing and
sales by Renewable Products, Inc. ("RPI") and build initial brand
awareness and share of market;
o Accelerate market penetration/sales by current licensees with
shallow draw foam analog, e.g. dinnerware line extensions and other
related items;
o Establish and grow international business opportunities, as well as
development of pellet technology;
o Promote and support additional products with the greatest potential
for near term success: a.) deep draw foam analog products, hot cups
and lids, and b.) injection molded products.
The Company's strategy includes licensing the EarthShell technology to, or
joint venturing with, strategically selected manufacturing or operating partners
for the manufacture, marketing, distribution and sale of EarthShell Packaging.
The Company has entered into new license agreements with RPI in the U.S. market
and EarthShell Hidalgo ("ESH") for the Mexican market. In addition, the Company
has entered into an agreement with a new licensee, EarthShell Asia, granting
certain licenses to use a new embodiment of the EarthShell Technology for
various applications in certain Asian territories (the "EA License"). Under the
license agreements, the Company may receive a total of up to $1.7 million from
technology fees, plus an ongoing royalty. Prior to receiving the prepaid
technology fees, the Company must successfully demonstrate the commercial
viability of this new technology for certain applications.
The Company is seeking additional qualified licensees and will provide
each of its licensees with technical and ongoing support to facilitate the
application of the EarthShell Technology, further refine the manufacturing
processes and reduce production costs. The Company will monitor product quality
at licensee operations.
Over the past several years, the Company has garnered support and achieved
commercial validation for EarthShell Packaging from key environmental groups and
foodservice purchasers. The Company has also devoted resources to the
optimization of product design and the development of cost-effective
manufacturing processes.
Throughout the course of developing the manufacturing processes for
EarthShell Products, the Company worked with an equipment manufacturer, Detroit
Tool and Engineering ("DTE"), which has developed turn-key manufacturing lines
for EarthShell plates and bowls. One of the Company's more recent licensees,
Renewable Products, Inc. (RPI), has acquired 16 manufacturing modules and is in
the process of obtaining orders and ramping up its manufacturing and
distribution operations. The Company's primary focus is now on supporting its
licensees. EarthShell believes it has a high quality and cost-effective product
and a profitable business model necessary to take advantage of a significant
market opportunity. With the introduction of commercial production capacity by
its licensees and commercial sales of its products in 2006, EarthShell expects
its products to continue to gain acceptance in the marketplace and believes it
is well positioned to support capacity expansion and market penetration by its
licensees, leading to growth of the Company's royalty revenue.
45
Licensing Business Model
The licensing business model enables the Company to concentrate on the
continuing development of quality food service packaging products with reduced
impact on the environment. This approach contemplates that manufacturing,
marketing, sale and distribution of EarthShell Packaging will be the
responsibility of the Company's manufacturing licensees. EarthShell believes
that its licensing business model will enable it to generate a sustainable
royalty revenue stream. Beyond the revenue opportunities, the Company believes
the licensing business model has positive implications for the Company's cost
structure. As the Company has moved from product and process development to the
product commercialization phase, it has been able to significantly reduce
monthly operating costs and reposition itself to take advantage of the operating
leverage provided by the licensing model.
EarthShell Packaging will be exclusively manufactured by licensed
manufacturing partners. Given the low cost of the raw materials required, these
strategic manufacturing partners should have a financial incentive to produce
EarthShell Packaging rather than comparable traditional paperboard/polystyrene
products even after making the required royalty payments to EarthShell. With the
first turnkey commercial manufacturing equipment successfully in service by its
first licensee, the Company expects that other licensees will then move quickly
to invest to build additional new manufacturing capacity.
While the Company believes it will be successful in developing cost
competitive products with its partners, delays in developing such products could
adversely impact the introduction and market acceptance of EarthShell Packaging
and could have an adverse effect on the Company's business, financial condition
and results of operations.
Strategic Manufacturing and Distribution Relationships
The Company believes that it has demonstrated that the performance of
EarthShell plates, bowls and hinged-lid containers is commercially competitive
and that there is a customer base that is willing to buy them. The Company
intends to promote the use of EarthShell Packaging in the U.S. and international
markets through agreements with additional licensed partners. The following is a
summary of the Company's current sublicensing relationships.
ReNewable Products, Inc. (RPI) The Company entered into the RPI Sublicense
coupled with the RPI Merger Agreement on June 17, 2005. Under these agreements,
EarthShell has granted to RPI the exclusive rights in the U.S. to produce
EarthShell plates, bowls, and other shallow-draw products for certain
distribution channels, including the retail and government market segments. In
return, RPI agreed to invest in excess of $12.0 million and purchase and install
the initial eight commercial modules that had been built by DTE and to order an
additional eight modules. The merger agreement gives RPI the right, ultimately,
to merge with EarthShell at such time as it has invested substantial capital in
building new EarthShell manufacturing capacity and the equipment is operational.
RPI currently has eight manufacturing modules in service and an additional eight
modules have been installed and will be place in service as demand requires. RPI
has commenced manufacturing and distribution operations and is actively selling
EarthShell plates and bowls. The RPI Sublicense requires RPI to pay to the
Company a royalty fee equal to 20% of RPI's net sales, not to exceed 50% of
RPI's gross margin. It is anticipated that EarthShell and RPI will merge
pursuant to the merger agreement entered into in June 2005. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources."
EarthShell Hidalgo S.A. de C.V. (ESH) In November 2004, the Company
entered into a ten year license agreement with ESH as the Company's exclusive
licensee for the country of Mexico. To date, ESH has paid to the Company a $1.0
million technology fee that will be credited against future royalty obligations.
Under the terms of the ESH License, in order to retain its priority in its
market segments, ESH must acquire manufacturing capacity to supply its market
segments and meet other minimum performance criteria.
46
EarthShell Asia, Limited (EA). On August 22, 2005, the Company entered
into a letter agreement with EA to grant sub-licenses to use EarthShell
Technology for various applications in certain Asian territories (the "EA
License"). Shortly after executing the letter agreement, both the Company and EA
entered into negotiations to restructure the transaction and ultimately entered
into an amended and restated letter agreement dated December 9, 2005. Per the
transaction as restructured in accordance with the amended and restated letter
agreement, the Company may receive a total of up to $2.6 million from a
combination of (i) prepaid technology fees (up to $1.7 million), (ii) the sale
of up to 266,667 shares of its common stock (at $3 per share or a total of
$800,000) and (iii) the issuance of warrants to purchase one million thirty
three thousand three hundred thirty three (1,033,333) shares of the Company's
common stock at $3.90 per share (for $100,000). . Realization of the $1.7
million in technology fees from EarthShell Asia dependent on the Company
successfully demonstrating the commercial viability of its technology in each of
four new application families. For each of the four applications successfully
demonstrated, EarthShell Asia will pay to EarthShell a technology transfer fee
of $425,000 to activate the license.
The Company received $500,000 from EA in August 2005 as an initial partial
payment and reserved 166,667 shares of its common stock in connection with this
payment. The Company received an additional $300,000 in December 2005 and the
payment, of approximately $100,000 on February 10, 2006. The final payment of
$100,000 was offset by $39,000 in legal fees that the Company agreed to
reimburse to EarthShell Asia. . Upon receipt of the final payment, the
transaction became effective and the Company issued a total of 266,667 shares
and the warrants to purchase the 1,033,333 shares.
Manufacturing
The current EarthShell manufacturing process for laminated foamed products
consists of blending the component ingredients of a proprietary composite
material in a mixer, depositing the mixture into heated cavity molds, heating
the molded mixture for approximately one minute, removing the product, trimming
excess material, and applying functional coatings. EarthShell Packaging uses
readily available natural raw materials, such as limestone, potato or corn
starch, as well as natural fiber and functional coatings. The Company believes
that these raw materials are currently available from multiple existing
suppliers in quantities sufficient to satisfy projected demand.
In prior years, the Company has devoted resources to develop manufacturing
machinery and to demonstrate the commercial viability of its manufacturing
processes to enable its operating partners to compete effectively with
conventional disposable foodservice packaging and to transfer the operational
and financial responsibility of its production lines to its operating partners.
In cooperation with former manufacturing partners, the Company financed and
built initial commercial production capacity. Previously, the Company has
produced limited amounts of EarthShell Packaging bowls, plates and hinged-lid
containers at production volumes that are low relative to the intended and
necessary capacities of the manufacturing lines that are required to achieve
efficiencies and cost effectiveness. Having demonstrated the manufacturability
of EarthShell foam products, the Company has now concluded its commercial
demonstration production activities and is relying on its equipment
manufacturing partners to demonstrate and guarantee the long-term
manufacturability of EarthShell Packaging.
Detroit Tool & Engineering (DTE). DTE was one of the initial equipment
manufacturers to work with EarthShell in developing its first generation
commercial manufacturing equipment. In 2002, EarthShell granted a license to DTE
to become an approved EarthShell equipment supplier. In early 2005, the Company
extended the license through 2007 with exclusivity to manufacture equipment for
production of shallow draw products. Building on previous experience with
EarthShell manufacturing, DTE designed and built a modular and integrated,
turn-key manufacturing line for the production of EarthShell plates and bowls,
comprising four plate and four bowl manufacturing modules and has demonstrated
to EarthShell's satisfaction that this equipment is fully capable of continuous
commercial service. This equipment was planned for delivery, installation and
start-up in early 2004 with one of EarthShell's licensees. However, due to a
change in EarthShell licensees, as well as a reorganization of DTE that was
completed in late 2004, the placement of this equipment was delayed. In 2005,
these first eight commercial modules were sold to RPI and were moved from DTE's
fabrication floor and installed in an adjacent manufacturing facility leased to
RPI that is in close proximity to the fabrication facility. The Company granted
a license agreement to RPI as described above. Subsequently, RPI ordered an
additional 8 modules which have been installed in RPI's facility and are ready
for operation.
Patents, Proprietary Rights And Trademarks
The technology that the Company licenses from EKI is the subject of
numerous issued and pending patents in the United States and internationally.
The Company believes the patents and pending patent applications provide broad
protection covering foam laminate EarthShell Packaging, material composition and
the manufacturing processes. Currently, EKI has over 130 U.S. and international
patents and has pending patent applications relating to the compositions,
products and manufacturing processes used to produce EarthShell Packaging food
and beverage containers. Patents currently issued do not begin to expire until
2012 and provide some protection until 2020. Pending patents, if granted, would
extend protection through 2022. Sixteen of the issued U.S. patents and five of
the pending U.S. patents relate specifically to molded food and beverage
containers manufactured from the new composite material, the formulation of the
new composite material used in virtually all of the EarthShell Packaging are
currently under development. The Company and EKI will continue to seek domestic
and international patent protection for further developments in the technology
and will vigorously enforce rights against any person infringing on the
technology.
47
The Company owns the EarthShell Packaging trademark and certain other
associated trademarks, and has been licensed by EKI to use the trademark ALI-ITE
for the composite material.
Relationship With EKI
The Company has an exclusive, worldwide, royalty-free license in
perpetuity to use and license EKI technology to manufacture and sell disposable,
single-use containers for packaging or serving food or beverages intended for
consumption within a short period of time (less than twenty-four hours). Mr.
Essam Khashoggi, Chairman of EKI, served as our Company's Chairman of the Board
of Directors since its organization in November 1992 through July 2005 when he
retired and resigned from the Board of Directors. Mr. Khashoggi, personally and
through affiliated entities, currently beneficially owns 7,933,603 shares of the
Company's common stock, which represents approximately 31.79% of the shares
outstanding as of December 31, 2005. On July 29, 2002, the Company entered into
an amendment to its previously Amended and Restated License Agreement with EKI
expanding the field of use for the EarthShell Technology to include noodle bowls
used for packaging instant noodles, a worldwide market that the Company
estimates to be approximately $1 billion. Because the noodle bowl development
was made at nominal cost to EarthShell and is an incremental field of use,
EarthShell will pay to EKI 50% of any royalty or other consideration it receives
in connection with the sale of products within this particular field of use.
Summary of EKI Agreements. During 2002 and January 2003, EKI made a series
of working capital loans (the "EKI Simple Interest Loans") to the Company
totaling approximately $5.8 million. The Simple Interest Loans were interest
bearing at a rate of seven percent or ten percent per annum, and were payable on
demand. In connection with the issuance and sale in March 2003 of the Company's
secured convertible debentures due in 2006 (the "2006 Debentures") to a group of
institutional investors, EKI agreed to subordinate the repayment of these loans
to the payment in full of the Company's obligations under the 2006 Debentures.
In addition, EKI and the Biotec Group agreed to subordinate certain payments
discussed below to which they were otherwise entitled under the EKI License
Agreement and the Biotec License Agreement to the satisfaction in full of the
Company's obligations under the 2006 Debentures. They further agreed not to
assert any claims against the Company for breaches of the EKI License Agreement
or the Biotec License Agreement until such time as the Company's obligations
under the 2006 Debentures were satisfied in full. EKI and the Biotec Group also
agreed to allow the Company to pledge its interest in the EKI License Agreement
to secure its obligations under the 2006 Debentures, and certain additional
concessions were made by EKI and the Biotec Group to permit the Company greater
flexibility in selling its rights under the EKI License Agreement and the Biotec
License Agreement to third parties in an insolvency context. These rights
terminated upon the satisfaction in full of the obligations under the 2006
Debentures in October of 2004. In consideration for its willingness to
subordinate the payments and advances that were owed to it, the Company issued
to EKI in March 2003 a warrant to acquire 83,333 shares of the Company's common
stock at a price of $6.00 per share with a ten year term.
As part of the 2006 Debenture Settlements that EKI helped negotiate and
settle, EKI purchased the debentures for $1.0 million. On September 30, 2004,
EKI entered into an agreement with EarthShell to sell back to the Company the
2006 Debentures it had purchased for $1.0 million in cash, the cash price
originally paid by EKI. The Company retired the 2006 Debentures shortly
thereafter.
In October 2004, in connection with the settlement of the 2006 Debentures,
EKI converted all of its then outstanding loans to EarthShell ($2,755,000) into
unregistered common stock at $3.00 per share and $0.53 million of accumulated
interest at $4.00 per share for a total of 1,051,494 shares received by EKI.
These shares are not subject to registration rights. As of December 31, 2004,
the loans from EKI to EarthShell had all been retired.
In May of 2005, an additional 44,387 shares were issued to EKI pursuant to
a 90 day price protection provision, which provided for an adjustment in the
effective conversion price of the interest portions of the Simple Interest Loans
from $4.00 per share to $3.00 per share.
In August 2005, the Company also granted a ten year warrant to Essam
Khashoggi, the Company's beneficial largest shareholder to purchase one million
shares of the Company's common stock at $3.00 per share in consideration of his
continued support of the Company since its inception, including providing bridge
loans either directly or through EKI at below market terms from time to time.
48
On October 11, 2005, the Company entered into a loan arrangement (the
"2005 EKI Loan") with EKI pursuant to which the Company issued to EKI a
promissory note in the principal amount of $1.0 million. As of December 31,
2005, EKI had advanced $0.85 million with the balance being funded by the second
week of January 2006. Interest accrues on the principal balance of the 2005 EKI
Loan at a variable per annum rate, as of any date of determination, that is
equal to the rate published in the "Money Rates" section of The Wall Street
Journal as being the "Prime Rate", compounded monthly. All accrued but unpaid
interest and outstanding principal is due and payable on the earliest to occur
of the following: (i) the second anniversary of the date of the EKI Loan; (ii)
five days following the date the Company has received $3.0 million or more in
aggregate net cash proceeds from all financing transactions, equity
contributions, and transactions relating to the sale, licensing, sublicensing or
disposition of assets or the provision of services (including advance royalty
payments, proceeds from the sale of the Company's common stock and fees for
technological services rendered to third parties), measured from the date of the
EKI Loan and not taking into account the proceeds advanced under the EKI Loan;
or (iii) the occurrence of an Event of Default (as defined in the 2005 EKI
Loan).
On July 28, 2006, the Company entered into a Loan and Mutual Release
Agreement (the "Agreement") with E. Khashoggi Industries, LLC ("EKI"), the
Company's largest stockholder. Pursuant to the Agreement, EKI advanced $350,000
directly to the Company and an additional $150,000 to a law firm on behalf of
the Company to cover legal fees related to patent renewals. The Agreement also
contains mutual releases of any and all claims, known or unknown, which the
respective parties may have through the date of the Agreement under existing
license, debt conversion and service agreements. The Company executed and
delivered two Promissory Notes to EKI on July 28, 2006; one in the amount of
$350,000 and the other in the amount of $150,000. Interest accrues on the
principal balance of the $350,000 note at a variable per annum rate, as of any
date of determination, that is equal to the rate published in the "Money Rates"
section of The Wall Street Journal as being the "Prime Rate", compounded
monthly. The $150,000 note is non-interest bearing. All accrued but unpaid
interest and outstanding principal under the notes is due and payable on the
earliest to occur of the following: (i) the second anniversary of the date of
the note; (ii) five days following the date the Company has received $3.0
million or more in aggregate net cash proceeds from all financing transactions,
equity contributions, and transactions relating to the sale, licensing,
sublicensing or disposition of assets or the provision of services (including
advance royalty payments, proceeds from the sale of the Company's common stock
and fees for technological services rendered to third parties), occurring
subsequent to the date of the notes.
In September of 2004, as part of an overall restructuring of its debt,
EarthShell entered into an agreement with Biotec to convert $1.475 million of
the $2.475 million of accrued license fees owing to Biotec as of September 1,
2004, plus accrued interest into 491,778 shares of EarthShell common stock and
to eliminate, the $100,000 per month minimum license fee. In December of 2004,
EarthShell paid to Biotec $125,000, leaving a balance of $875,000 as of December
31, 2004. During 2005, the balance was further reduced to $837,145 and assigned
to EKI. Also on October 11, 2005, the Company entered into the Debt Conversion
Agreement with EKI, pursuant to which the Company and EKI agreed that a payable
in an amount equal to $837,146 (previously owed to the Biotec Group but
subsequently assigned to EKI) be converted into 279,048 shares of common stock
of the Company. The conversion price equaled $3.00 per share. Pursuant to the
Debt Conversion Agreement, the Company and EKI released each other from any and
all claims in connection with the payable.
Under the terms of the EKI License Agreement and an amended and restated
Patent Agreement for the Allocation of Patent Costs by and between the Company
and EKI, EarthShell has the obligation to pay the patent prosecution and
maintenance costs for those patents which i) "directly relate to" its field of
use, and which ii) "primarily benefit" EarthShell. Any patents granted in
connection with the EarthShell Technology are the property of EKI, and EKI may
obtain a benefit therefrom, including the utilization and/or licensing of the
patents and related technology in a manner or for uses unrelated to the license
granted to the Company in the foodservice disposables field of use. Effective
January 1, 2001, EarthShell assumed direct responsibility to manage and maintain
the patent portfolio underlying the EKI License Agreement with EKI and continues
to pay directly all relevant costs.
See Notes to Consolidated Financial Statements - Related Party
Transactions for a further discussion of the relationship with EKI and other
related party matters.
Biotec License Agreement. On July 29, 2002 the Company entered into a
license and information transfer agreement (the "Biotech License Agreement")
with bio-tec Biologische Naturverpackungen GmbH & Co. KG and bio-tec Biologische
Naturverpackungen Forschungs und Entwicklungs GmbH (the "Biotec Group") to
utilize the Biotec Group technology for foodservice disposable packaging
applications. EKI had previously granted to the Company priority rights to
license certain product applications on an exclusive basis from the Biotec Group
in consideration for the Company's payment of a $100,000 minimum monthly payment
to Biotec. In addition, in consideration for the monthly payment, the Biotec
Group agreed to render technical services to the Company at the Biotec Group's
cost plus five percent . The licensing fee and services arrangements were
continued in the Biotec License Agreement. Under the terms of the Biotec License
Agreement, the Biotec Group was entitled to receive 25% percent of any royalties
or other consideration that the Company receives in connection with the sale of
products utilizing the Biotec Group technology, after applying a credit for all
minimum monthly payments received. In connection with the issuance of the 2006
Debentures, the Biotec Group agreed to subordinate the licensee fee payments due
from EarthShell until the debentures were retired. During this period, the
license fees due to the Biotec Group were accrued.
In September of 2004, as part of an overall restructuring of its debt,
EarthShell and Biotec entered into an agreement to convert $1.475 million of the
$2.475 million of accrued license fees as of September 1, 2004, plus accrued
interest into 491,778 shares of EarthShell common stock and to eliminate, for
two years, the $100,000 per month minimum license fee. In December of 2004, the
amended Biotec License Agreement was further amended and EarthShell paid to
Biotech $125,000, leaving a balance owing of approximately $875,000, which was
subsequently reduced to approximately $837,000. On August 31, 2005, in
connection with the sale of Biotec by EKI, Biotec License Agreement was again
amended and restated (the "Amended and Restated Biotec License") and the minimum
monthly payment to retain exclusivity was completely eliminated and the balance
of approximately $837,000 owing to EarthShell was assigned by the Biotec Group
to EKI. Under the Amended and Restated Biotec License, the Company has a fully
paid up license to use the Biotec technology in the EarthShell fields of use,
with certain limited exclusions, exclusively through June 2008. The Company can
maintain its exclusivity provided it has been successful in commercializing the
Biotec technology and is making certain minimum royalty payments under the
license by June 2008. As of October 11, 2005, the Company has paid to the Biotec
Group $125,000 in cash, has converted approximately $1.475 million into 491,778
shares of unregistered stock, and has assigned the balance owing to the Biotec
Group of $837,000 to EKI. The $837,000 balance was ultimately converted by EKI
in October 2005 into shares of EarthShell common stock at $3.00 per share (see
"Relationship with EKI" above).
49
Competition
Competition among food and beverage container manufacturers in the
foodservice industry is intense. Virtually all of these competitors have greater
financial and marketing resources at their disposal than does the Company, and
many have established supply, production and distribution relationships and
channels. Companies producing competitive products may reduce their prices or
engage in advertising or marketing campaigns designed to protect their
respective market shares and impede market acceptance of EarthShell Packaging.
Several paper and plastic disposable packaging manufacturers and
converters and others have made efforts to increase the recycling of these
products. Increased recycling of paper and plastic products could lessen their
harmful environmental impact, one major basis upon which the Company intends to
compete. A number of companies have introduced or are attempting to develop
biodegradable starch-based materials, plastics, or other materials that may be
positioned as potential environmentally superior packaging alternatives. It is
expected that many existing packaging manufacturers may actively seek to develop
competitive alternatives to the Company's products and processes. While the
Company believes the patents it licenses from EKI uniquely position the Company
to incorporate a proportion of low cost, inorganic fillers with its material,
which, relative to other starch-based or specialty polymers, will result in
lower material costs, the development of competitive, environmentally
attractive, disposable foodservice packaging could render the Company's
technology obsolete and could have an adverse effect on the business, financial
condition and results of operations of the Company.
Government Regulation
The manufacture, sale and use of EarthShell Packaging are subject to
regulation by the U.S. Food and Drug Administration (the "FDA"). The FDA's
regulations are concerned with substances used in food packaging materials, not
with specific finished food packaging products. Thus, food and beverage
containers are in compliance with FDA regulations if the components used in the
food and beverage containers: (i) are approved by the FDA as indirect food
additives for their intended uses and comply with the applicable FDA indirect
food additive regulations; or (ii) are generally recognized as safe for their
intended uses and are of suitable purity for those intended uses.
The Company believes that EarthShell Packaging plates, bowls and
hinged-lid containers and all other current and prototype EarthShell Packaging
products of the Company are in compliance with all requirements of the FDA and
do not require additional FDA approval. The Company cannot be certain, however,
that the FDA will agree with these conclusions.
Available Information
The Company's internet website is www.earthshell.com. The Company makes
available free of charge on its website its annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, reports filed
pursuant to Section 16 of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), and amendments to those reports as soon as reasonably
practicable after such materials are electronically filed or furnished to the
SEC. Materials the Company files with the SEC may be read and copied at the
SEC's Public Reference Room at 100 F Street, NE, Washington, DC 20549. This
information may also be obtained by calling the Securities and Exchange
Commission at 1-800-SEC-0330. The Securities and Exchange Commission also
maintains an internet website that contains reports, proxy and information
statements, and other information regarding issuers that file electronically
with the SEC at www.sec.gov. The Company will provide a copy of any of the
foregoing documents to shareholders upon request.
Management And Employees
Currently, the Company has seven employees. The Company's employees are
not represented by a labor union, and the Company believes it has a good
relationship with its employees.
The Company established a qualified 401(k) plan for all of its employees
in 1998. The 401(k) plan allows employees to contribute, on a tax-deferred
basis, up to fifteen percent of their annual base compensation subject to
certain regulatory and plan limitations. The Company uses a discretionary
matching formula that matches one half of the employee's 401(k) deferral up to a
maximum of six percent of annual base compensation. The 401(k) employer match
was $24,842 in 2005, $24,311 in 2004, and $44,047 in 2003.
50
Description Of Property
In November 2005, the Company closed its California operations and
relocated its corporate headquarters to its current location at 1301 York Road,
Suite 200, Lutherville, Maryland 21393. The Company leases 3,353 square feet of
this office space on a month to month basis. The Company's monthly lease payment
with respect to this space is approximately $5,500. The Company believes it will
be able to lease comparable space at a comparable price when this lease expires.
Legal Proceedings
The Company has been engaged in litigation with two (2) equipment
suppliers seeking to collect a total of approximately $600,000 for manufacturing
equipment in connection with the Company's former Goettingen, Germany
manufacturing line that is no longer in service. The entire amount claimed in
the litigation has already been accrued as part of the Company's accounts
payable. During the first half of 2006, the Company reached settlements with
both of these equipment suppliers and the litigation matters are being
dismissed.
The Company has been engaged in settlement discussions with Baltimore
County, Maryland (the "County") related to personal property taxes that are owed
to the County. The County holds a judgment against the Company in the amount of
$963,648 for personal property taxes for the years 1999 through 2005. However,
the amount of the taxes owed was calculated in error by the County. As a result,
the County has offered to reduce to judgment to $92,287 plus accrued interest
pending the Company entering into a satisfactory payment plan with the County.
On June 23, 2006, the Company entered into a payment plan with the County to
satisfy the judgment. As part of the settlement, the County will reduce its
recorded judgment to $92,287.
51
MANAGEMENT
Executive Officers
The following table sets forth the names, ages and positions of each of
the Company's executive officers. Subject to rights under any employment
agreements, officers of the Company serve at the pleasure of the Board of
Directors (the "Board").
Officer
Name Age Position Since
------------------------- --- --------------------------------------- -------
Vincent J. Truant 58 Chief Executive Officer, President and 1998
Chairman of the Board
D. Scott Houston 51 Chief Financial Officer, Secretary and 1993
Director
Paul Susie 39 Principal Accounting Officer 2005
The following is a biographical summary of the experience of each of the
executive officers:
Vincent J. Truant has served as the Company's Chief Executive Officer
since August 26, 2005, as President since 2002 and as a Director since 2005. In
February 2005, Mr. Truant was also elected Chairman of the Board of EarthShell.
From May 15, 2002 to August 26, 2005, Mr. Truant served as the Company's
President and Chief Operating Officer. From March 2001 to May 2002, Mr. Truant
served as Senior Vice President and Chief Marketing Officer of the Company. From
October 1999 to March 2001, and from March 1999 to October 1999, respectively,
he served as Senior Vice President and as Vice President of Marketing,
Environmental Affairs and Public Relations, and from April 1998 to March 1999 as
Vice President of Marketing and Sales. During a prior fifteen (15) year tenure
at Sweetheart Cup Company ("Sweetheart"), Mr. Truant served as Vice President
and General Manager for the National Accounts Group and the McDonald's
Corporation Strategic Business Units. Before joining Sweetheart, Mr. Truant was
engaged in both domestic and international marketing assignments for Philip
Morris Inc. and its subsidiary, Miller Brewing Company, as well as Eli Lilly &
Company.
D. Scott Houston has served as the Company's Chief Financial Officer since
October 1999, as the Company's Secretary since December 1999 and as a Director
since 2005. From January to October 1999, Mr. Houston served as Senior Vice
President of Corporate Planning and Assistant Secretary. From July 1993 until
January 1999, Mr. Houston served as Chief Financial Officer. From August 1986
until joining the Company, he held various positions with EKI and its
affiliates, including Chief Financial Officer and Vice President of CTC from
1986 to 1990. From 1984 to 1986, Mr. Houston operated Houston & Associates, a
consulting firm. From July 1980 until September 1983, Mr. Houston held various
positions with the Management Information Consulting Division of Arthur Andersen
& Co., an international accounting and consulting firm.
Paul B. Susie has served as the Company's Controller since October 2005.
From March 1998 until joining the Company, Mr. Susie held positions as
controller for Baltimore Marine Industries, Inc. and more recently American Pool
Enterprises, Inc. (a division of First Service Corporation). From 1994 to 1998,
Mr. Susie held various audit, tax and consulting positions with Stegman &
Company, a regional accounting and consulting firm. From 1991 to 1994, Mr. Susie
served in the audit division of PriceWaterhouseCoopers, an international
accounting and consulting firm.
Directors
The Board of the Company is currently comprised of five (5) members. All
Directors are elected each year at the annual meeting of stockholders. The
following table sets forth the name and age of each director, the year the
Director was first elected and his position with the Company:
Director
Name Age Position Since
------------------------ --- --------------------------------------- --------
Vincent J. Truant 58 Director, Chief Executive Officer and 2005
President
D. Scott Houston 51 Director, Chief Financial Officer and 2005
Secretary
Hamlin M. Jennings 58 Director 2003
Walker Rast 70 Director 2003
Michael C. Gordon 70 Director 2005
52
The following is a biographical summary of the experience of each of the
Company's Directors. For biographical summaries of the experience of Messrs.
Truant and Houston, kindly refer to the summaries of Executive Officers'
experience provided above:
Hamlin M. Jennings has served as a Director of the Company since January
1, 2003. Since 1987, Dr. Jennings has been a Professor in the Civil and
Environmental Engineering Department and the Materials Sciences and Engineering
Department at Northwestern University. In 2002, he assumed the Chairmanship of
the Civil and Environmental Engineering Department. Prior to his appointment at
Northwestern, Dr. Jennings worked at the National Institute of Standards and
Technology, Imperial College London, and the University of Cape Town. He is a
fellow of the Institute of Materials in the United Kingdom and Fellow of the
American Ceramic Society. Dr. Jennings received a Ph.D. in materials science
from Brown University in 1975, and a Bachelor of Science in Physics from Tufts
University in 1969. Additionally, Dr. Jennings is owner and President of
Evanston Materials Consulting Corporation, founded in 1997, which specializes in
cement-based materials and coatings. Dr. Jennings holds twelve (12) patents, is
the associate editor of two (2) journals and has published over 120 scientific
papers.
Walker Rast has served as a Director of the Company since September 2003,
when he was appointed to fill the vacancy created by the resignation of Mr. Bert
Moyer from the Board in August 2003. Mr. Rast is currently a business consultant
and a member of the Educational Foundation Board of the University of South
Carolina and a member of the Advisory Board of the College of Engineering and
Information Technology. From 1987 to 1994, Mr. Rast was a member of the
Executive Board of Directors of Royal Packaging Industries Van Leer, a worldwide
packaging company based in the Netherlands. From 1979 to 1987, Mr. Rast was
President of Keyes Fibre Company (now know as The Chinet Company), first (1st)
an operating group of Arcata Corporation and then of Royal Packaging Industries
Van Leer. Mr. Rast held various executive positions with Arcata Corporation for
over ten years, and was previously with U.S. Gypsum Corporation for over ten
(10) years.
Michael C. Gordon was appointed to the Board of Directors in June 2005.
Mr. Gordon is currently the Director of SEC Services for Gumbiner Savett Inc.,
Certified Public Accountants and Business Advisors. From 1990 through 2001, Mr.
Gordon was an audit partner with BDO Seidman, where he was in charge of the
audit department of the Los Angeles office. From 1977 to 1990, he was an audit
partner with Laventhol and Horwath where he was also in charge of the audit
department of the Los Angeles office. Prior to 1977, he was an audit partner
with Arthur Young & Company. Mr. Gordon has over forty years of public
accounting, SEC, and financial reporting experience. The Board of Directors has
determined that Mr. Gordon qualifies as an "audit committee financial expert" as
that term is defined in Item 401(h)(2) of Regulation S-K in the Securities
Exchange Act of 1934. Mr. Gordon is serving as Chairman of the Audit Committee.
Committees Of The Board Of Directors
At the annual meeting of the Board in July 2005, the Company reorganized
the Committees of the Board, Currently, the Board maintains three (3) standing
committees: the Audit Committee, the Compensation Committee, the Corporate
Governance and Nominating Committee. The Board has written charters for each of
its committees.
Director nominees are recommended to the full Board by the Corporate
Governance and Nominating Committee with input from Management. The committees
are presently comprised of the following Directors:
Corporate Governance &
Audit Committee Compensation Committee Nominating Committee
--------------------------- -------------------------- -----------------------
Mr. Gordon (Chair) Dr. Jennings (Chair) Mr. Rast (Chair)
Mr. Rast Mr. Gordon Dr. Jennings
Dr. Jennings Mr. Rast Mr. Gordon
Executive Committee
The Executive Committee was dissolved at the July 2005 annual meeting of
the Board in connection with the reorganization of Board and the Board
committees. Prior to being dissolved, the Executive Committee held frequent
meetings in 2005, and at times took action by unanimous written consent in lieu
of meetings. The primary function of the Executive Committee was to perform all
of the duties otherwise vested in the Board when the Board is not in session,
except for the following matters which have not been delegated to the Executive
Committee: (a) declaring cash or stock dividends or distributions to
stockholders of the Company; (b) taking action on matters otherwise specifically
delegated to other committees of the Board of Directors; (c) amending or
repealing the Certificate of Incorporation or Bylaws of the Company, or adopting
new ones; (d) approving a plan of merger, acquisition or divestiture or sale,
lease or exchange of substantially all of the business, properties or assets of
the Company; (e) authorizing or approving the issuance or sale of shares of
stock of the Company; (f) authorizing the Company to perform or make a contract
or commitment that requires a financial commitment by the Company exceeding the
applicable amount budgeted under the operating budget or capital budget approved
by the Board, if such contract or commitment, together with any other such
contract or commitment, involves a payment by the Company of more than $1
million in the aggregate; and (g) electing or removing officers, directors or
members of any committee of the Board. The Executive Committee functioned
according to a written charter.
53
Compensation Committee
The Compensation Committee held two (2) meetings in 2005. At the annual
meeting of the Board in July 2005, the Stock Options Committee was dissolved and
the functions of that committee were assumed by the Compensation Committee.
Prior to August 2005, the functions of the Compensation Committee
included:
(a) reviewing and recommending to the Board of Directors the annual base
salary, bonus and other benefits for each of the senior executive officers of
the Company; (b) reviewing and commenting on new executive compensation programs
that the Company proposes to adopt; (c) periodically reviewing the results of
the Company's executive compensation and perquisite programs to ensure that they
are properly coordinated to yield payments and benefits that are reasonably
related to executive performance; (d) helping to ensure that a significant
portion of executive compensation is reasonably related to the long-term
interests of the stockholders; (e) participating in the preparation of certain
portions of the Company's annual proxy statement; (f) hiring a compensation
expert to provide independent advice on compensation levels, if necessary; and
(g) helping to ensure that the Company undertakes appropriate planning for
management succession and advancement.
On August 11, 2005, a new charter was adopted for the Compensation
Committee. As outlined in the new charter, the functions of the Compensation
Committee include: (a) oversee the Company's overall compensation structure,
policies and programs, and assess whether the Company's compensation structure
establishes appropriate incentives for management and employees; (b) review and
approve corporate goals and objectives relevant to the compensation of the Chief
Executive Officer (the "CEO"), evaluate the CEO's performance in light of those
goals and objectives, and either as a committee or together with the other
independent directors (as directed by the Board), determine and approve the
CEO's compensation level based on this evaluation; (c) administer and make
recommendations to the Board with respect to non-CEO compensation and the
Company's incentive-compensation and equity-based compensation plans; (d) review
and recommend to the Board the annual base salary, bonus, and other benefits for
the executive officers of the Company with the goal of ensuring that a
significant portion of executive compensation is reasonably related to the
long-term interests of the stockholders; (e) approve stock option and other
stock incentive awards for executive officers; (f) review and approve the design
of other benefit plans pertaining to executive officers; (g) review and
recommend employment agreements and severance arrangements for executive
officers, including change-in-control provisions, plans or agreements; (h)
approve, amend or modify the terms of any compensation or benefit plan that does
not require shareholder approval; (i) review periodically succession plans
relating to positions held by executive officers, and make recommendations to
the Board regarding the selection of individuals to fill these positions; (j)
annually evaluate the performance of the Committee and the adequacy of the
committee's charter; and (k) produce a Committee report on executive
compensation as required by the Securities and Exchange Commission (the "SEC")
to be included in the company's annual proxy statement filed with the SEC.
Audit Committee
The Audit Committee held four (4) meetings in 2005. Previous to August 11,
2005 the functions of the Audit Committee included:
(a) engaging an accounting firm to act as the Company's independent
external auditor (the "Auditor"); (b) determining the Auditor's compensation,
the proposed terms of its engagement, its independence from the Company and its
performance during each year of its engagement; (c) reviewing the Company's
annual financial statements and significant disputes, if any, between management
of the Company and the Auditor that arise in connection with the preparation of
those financial statements; (d) reviewing the results of each external audit;
(e) reviewing the procedures employed by the Company in preparing published
quarterly financial statements and related management commentaries; (f)
reviewing any major changes proposed to be made in auditing and accounting
principles and practices in connection with the Company's financial statements;
(g) reviewing the adequacy of the Company's internal financial controls; and (h)
if the Company appoints a Director of Internal Audit, meeting periodically with
that person to evaluate compliance with the foregoing duties.
54
On August 11, 2005, a new charter was adopted for the Audit Committee. As
outlined in the new charter, the functions of the Compensation Committee
include: a) oversee the Company's accounting and financial reporting processes
and the audits of the Company's financial statements; b) oversee the Company's
compliance with legal and regulatory requirements; c) oversee the outside
auditor's qualifications and independence; d) oversee the performance of the
company's internal audit function and outside auditor; e) oversee the Company's
system of disclosure controls and system of internal controls; and f) prepare
the report required by the rules of the SEC to be included in the Company's
annual proxy statement.
The Company's Audit Committee is to be comprised of at least three (3)
independent Directors. Mr. Gordon serves as Chairman of the Audit Committee. The
Board has determined that Mr. Gordon is an "audit committee financial expert" as
that term is defined in Item 401(h)(2) of Regulation S-K in the Securities
Exchange Act of 1934, as amended. The Committee is currently comprised of
Messrs. Gordon, Jennings and Rast, each of whom are independent Directors within
the meaning of the National Association of Securities Dealers' listing
standards.
Stock Option Committee
The Stock Option Committee was dissolved in connection with the
reorganization of the Board and the committees of the Board at the annual
meeting of the Board in July 2005. The functions of the Stock Option Committee
are now carried out by the Compensation Committee, as outlined above. Previous
to being dissolved, the Stock Option Committee held two (2) meetings in 2004 and
one (1) meeting in 2005. The Stock Option Committee was responsible for
administering the Company's 1994 Stock Option Plan and 1995 Stock Incentive Plan
(collectively, the "Plans") including, without limitation, the following:
(a) adopting, amending and rescinding rules relating to the Plans; (b)
determining who may participate in the Plans and what awards may be granted to
such participants; (c) granting awards to participants and determining the terms
and conditions thereof, including the number of shares of common stock issuable
pursuant to the awards; (d) determining the terms and conditions of options
automatically granted to directors pursuant to the Plans; (e) determining
whether and the extent to which adjustments are required pursuant to the
anti-dilution provisions of the Plans; and (f) interpreting and construing the
Plans and the terms and conditions of any awards granted thereunder.
Conflicts Committee / Corporate Governance & Nominating Committee
At the annual meeting of the Board in July 2005, the Conflicts Committee
was dissolved and a new Corporate Governance and Nominating Committee was
organized. The Conflicts Committee held two (2) meetings in 2005. The functions
of the Conflicts Committee included reviewing potential related party or
conflict of interest transactions to: (a) determine whether each such
transaction is on at least as favorable terms to the Company as might be
available from other third parties, (b) determine whether such transactions are
reasonably likely to further the Company's business activities and interests,
(c) determine whether the process by which the decision to enter into such
transactions was approved or ratified and is fair, (d) help ensure that all such
transactions are disclosed in the Company's filings with the SEC as necessary
and (e) if necessary, retain an independent expert to determine the advisability
of the Company's entering into such transactions, and to determine fair terms
for such transactions.
A charter for the Corporate Governance and Nominating Committee was
adopted on August 11, 2005. The functions of the Corporate Governance and
Nominating Committee include: a) identifying qualified individuals to become
Board members; b) determining the composition of the Board and its committees;
c) considering questions of possible conflicts of interest; d) developing and
implementing the Company's corporate governance guidelines; and e) monitoring a
process to assess Board effectiveness.
Board And Committee Attendance
The Board of Directors held twelve (12) meetings in 2005. All Directors
attended at least seventy-five percent (75%) of the Board meetings and the
meetings of the Committees on which they served.
Independent Auditors
The Audit Committee pre-approved the engagement of Farber, Hass, Hurley &
McEwen, LLP (formerly Farber & Hass, LLP) to provide both audit and tax services
for the fiscal year ended December 31, 2005, including the quarterly reviews for
the three quarters of 2005. Farber, Hass, Hurley & McEwen. LLP provided no other
audit services, audit-related services, tax services or permitted non-audit
services for and during the fiscal year ending 2005. The Audit Committee adopted
a pre-approval policy relating to audit services for all audit-related services,
tax services and non-audit services to be performed by its auditors from 2004
onward.
55
During the fiscal year ended December 31, 2005, the following audit,
audit-related, tax and other fees were incurred by the Company:
Audit Fees. For the year ended December 31, 2005, Farber Hass Hurley &
McEwen, LLP charged the Company an aggregate of approximately $94,200 for
professional services rendered for the 2005 audit of the Company's financial
statements and the review of the financial statements included in the Company's
Quarterly Reports on Form 10-Q for the three quarters of 2005.
Audit-Related Fees. During the year ended December 31, 2005, the Company
incurred no fees for services related to Farber Hass Hurley & McEwen, LLP
(formerly Farber & Hass, LLP.) review of the Company's financial statements
included in various SEC documents that are not included in "Audit Fees" and
during the year-ended December 31, 2005.
Tax Fees. During the year ended December 31, 2005, the Company incurred
fees of $8,750 for Farber Hass Hurley & McEwen, LLP (formerly Farber & Hass,
LLP) preparation of its tax returns.
All Other Fees. None.
Audit Committee Report
The Audit Committee reviews the Company's financial reporting process on
behalf of the Board. Management has the primary responsibility for the financial
statements and the reporting process including the internal control system. The
Company's independent auditors are responsible for expressing an opinion on the
conformity of our audited financial statements to generally accepted accounting
principles.
In this context, the Audit Committee has reviewed and discussed the
audited financial statements with management and the independent auditors, and
has also discussed with the independent auditors the matters required to be
discussed by Statement on Auditing Standards No. 61 (Communication with Audit
Committees). The Audit Committee also received from the independent auditors the
written disclosures required by Independence Standards Board Standard No. 1
(Independence Discussions with Audit Committees), and discussed with them their
independence from the Company and its management. The Audit Committee has
further considered whether, and determined that, the independent auditors'
provision of non-audit services to the Company is compatible with the firm's
independence.
In reliance on the reviews and discussions referred to above, the Audit
Committee recommended to the Board that the audited financial statements be
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2005 for filing with the SEC.
Compensation Of Directors
The Board pays to each non-employee Director an annual retainer fee of
$20,000, payable quarterly, plus a fee of $1,000 for each regular meeting
attended in person. Committee chairpersons receive an additional $1,000 per
quarter except for the chairman of the audit committee, who receives an
additional $3,000 per quarter. All of the directors, except for Messrs. Truant
and Houston, are considered to be non-employee Directors of the Company.
The 1995 Stock Incentive Plan provides that each non-employee Director
automatically be granted options to purchase 25,000 shares of the Company's
common stock, effective at the conclusion of each annual meeting. All such stock
options have an exercise price equal to the "fair market value" of the
underlying shares, which is defined in the 1995 Stock Incentive Plan as the
closing trading price on the day before such annual meeting.
In April 2004, based on the financial condition of the Company, the Board
unanimously agreed to defer the payment of the Director fees discussed above
until such time as the financial condition of the Company improves. Certain of
the deferred Directors' fees have been paid subsequent to April 2004. As of
March 31, 2006, the Company had outstanding accrued and unpaid Directors' fees
of approximately $48,156. In June 2005, the Board granted to each of the
Company's non-employee Directors who have served during the past year 10,000
restricted shares of the Company's common stock.
56
In June, 2005, Mr. Gordon was appointed to the Board to fill the vacancy
created by the resignation of Dr. Roland. Mr. Gordon received an initial grant
of 10,000 restricted shares of the Company's common stock.
Code Of Ethics
The Company has adopted a Code of Ethics that applies to all Directors,
officers and employees, including the Chief Executive Officer, Chief Financial
Officer and Principal Accounting Officer of the Company. The Company has posted
its Code of Ethics on its website at www.earthshell.com. The Company intends to
satisfy the disclosure requirement under Item 5.05 of Form 8-K regarding an
amendment to, or a waiver from, a provision of its Code of Ethics that applies
to the Company's Principal Executive Officer, Principal Financial Officer,
Principal Accounting Officer or Controller, or persons performing similar
functions and that relates to an element enumerated in Item 406(b) of Regulation
S-K by posting such information on its website.
Executive Compensation
The following table sets forth certain information with respect to the
compensation of the Named Executive Officers. The "Named Executive Officers"
include, (i) the Company's Chief Executive Officer, (ii) the Company's executive
officers as of December 31, 2005; and (iii) two (2) additional individuals who
were not executive officers as of the year ended December 31, 2005. The Company
did not grant any restricted stock awards or stock appreciation rights or make
any long-term incentive plan payouts during the periods set forth below.
Summary Compensation Table
Long-Term
Compensation
Annual Compensation Awards
--------------------------------------- ------------
Securities
Fiscal year Other Annual Underlying
Name and Ended Salary Bonus Compensation Options
Principal Position December 31 ($) ($) ($)(1) (#)
------------------------------------ ----------- ----------- ----------- ------------ ------------
Vincent J. Truant 2005 $ 366,667(2) $ -- $ 1,747 350,000
Chairman of the Board, Chief
Executive Officer and Former
President 2004 350,000 -- 2,625 50,000
2003 350,000 -- 3,063 20,833 (7)
D. Scott Houston (3) 2005 220,533 (4) 106,667 (3) 13,229 (4) 375,000
Chief Financial Officer and 2004 184,978 142,222 (5) 10,790 (4) 50,000
Secretary 2003 327,200 -- 9,654 (4) 20,833 (7)
Paul B. Susie (5) 2005 24,724 (5) -- 544 40,000
Principal Accounting Officer
Simon K. Hodson 2005 395,444 (6) -- 5,833 500,000
Former Vice Chairman of the Board 2004 500,000 (6) -- 2,750 400,000
and Former Chief Executive Officer 2003 500,000 -- 2,250 41,667 (6)
------------------------
(1) Reflects payments under the Company's 401(k) plan. The Company provides
various perquisites to its executives which, in accordance with SEC
regulations, are not itemized because their value is less than ten percent
(10% ) of an executive's salary.
(2) Reflects a mid-year salary adjustment effective September 1, 2005 as a
result of Mr. Truant's becoming Chief Executive Officer of the Company on
that date.
(3) The bonus amounts in 2004 and 2005 were not paid in cash and have been
accrued as deferred compensation.
(4) Includes $7,200 in car allowance made to Mr. Houston in 2003, 2004 and
2005.
(5) Mr. Susie joined the Company on October 31, 2005.
(6) Includes $141,667 deferred salary for 2004 and $133,333 in 2005. Mr.
Hodson resigned on October 31, 2005.
(7) This option grant is only exercisable upon the successful completion of a
sale of the Company.
Stock Option Grants In 2005
The following table sets forth information with respect to options to
purchase shares of the Company's common stock granted in 2005 to the Named
Executive Officers:
57
Potential Realizable Value
at Assumed Rates of Stock
Appreciation for Option Term
Individual Grants (1)
-------------------------------------------------- ----------------------------
Number of % of Total
Shares Options
Underlying Granted to Exercise
Options Employees in Price (Per Expiration
Name and Principal Position Granted 2005 Share) Date 5% 10%
------------------------------- ---------- ------------ ------------ ---------- ------------- -------------
Vincent J. Truant 350,000 28% $2.10 9/1/2015 $ 771,750 $ 808,500
Chairman of the Board, Chief
Executive Officer and
Former President
D. Scott Houston. 300,000 24% $1.85 5/11/2015 $ 236,250 $ 247,500
Chief Financial Officer 75,000 6% $2.15 10/12/2014 169,313 177,375
and Secretary
Paul B. Susie 40,000 3% $2.15 11/29/2015 $ 90,300 $ 94,600
Principal Accounting Officer
Simon K. Hodson 500,000 39% $1.85 10/31/2010 $ 393,750 $ 412,500
Former Vice Chairman of the
Board and Former Chief
Executive Officer
--------------
(1) The 5% and 10% assumed rates of appreciation are mandated by the rules of
the Securities and Exchange Commission and do not represent the Company's
estimate or projection of the future Common Stock price. In each case, the
Company would use the market price of the Common Stock on the date of
grant to compute the potential realizable values.
Aggregated Option Exercises In 2005 And 2005 Year End Option Values
The following table sets forth for the Named Executive Officers
information with respect to options exercised, unexercised options and year-end
option values, in each case with respect to options to purchase shares of the
Company's common stock.
Number of Securities
Underlying Unexercised Value of Unexercised
Options at Fiscal Year End In-the-Money Options at
2005 Fiscal Year End 2005 (1)
-------------------------- --------------------------
Shares
Acquired on Value
Name and Principal Position Exercise Realized Unexercisable Exercisable Unexercisable Exercisable
------------------------------ ------------ ---------- ------------- ----------- ------------- -----------
Vincent J. Truant -- -- 450,000 32,917 $ 100,000 $ --
Chairman of the Board, Chief
Executive Officer and
Former President
D. Scott Houston -- -- 97,500 398,958 100,000 600,000
Chief Financial Officer
and Secretary
Paul B. Susie
Principal Accounting Officer -- -- 30,000 10,000 -- --
Simon K. Hodson -- -- -- 500,000 -- 1,000,000
Former Vice Chairman of the
Board and Former Chief
Executive Officer
----------------
(1) The market price of the Company's common stock at December 30, 2005 was
$2.00.
58
EMPLOYMENT AGREEMENTS AND ARRANGEMENTS
Vincent J. Truant entered into an employment agreement with the Company on
August 26, 2005. Pursuant to the agreement, Mr. Truant receives and annual
salary of $400,000. Additionally, Mr. Truant was granted options to acquire
350,000 shares of the Company's stock at an exercise price equal to the market
share price of the Company's common stock at the close of trading on August 26,
2005, ($2.10 per share). Mr. Truant may also be entitled to receive (i) an
annual bonus in an amount up to one year's base salary, provided certain
criteria is met and (ii) additional stock options or restricted stock under such
terms and conditions as are defined in the future by the Compensation Committee
of the Board of Directors at their sole discretion.
D. Scott Houston entered into a written employment agreement with the
Company on October 19, 1993. Mr. Houston receives an annual salary of $320,000,
subject to annual review and increase at the discretion of the Board of
Directors. He may also be entitled to receive (i) an annual bonus, the amount of
which is determined by the Compensation Committee, and (ii) options or other
rights to acquire the Common Stock, under terms and conditions determined by the
Stock Option Committee. Mr. Houston may be terminated at any time, with or
without cause, upon thirty (30) days notice. Mr. Houston also receives a car
allowance of $600 per month. In order to conserve cash until the Company was
able to establish its royalty revenue stream, in April 2004, Mr. Houston
voluntarily agreed to go part time and to reduce his base salary 75%, which
resulted in an adjustment to his cash compensation to $80,000 per year. Mr.
Houston continued to work much more than was originally contemplated and in
October 2004, the cash portion of Mr. Houston's salary was adjusted to a rate of
$213,333 per year. The Company also agreed to payout Mr. Houston's accrued
vacation pay in the amount of $61,540, which was paid out over several pay
periods in 2005. As of September 1, 2005, Mr. Houston resumed his full time
status with the Company, at his original salary of $320,000 per year. However,
he receives only 2/3 of his salary in cash and has agreed to receive the balance
in the future as deferred compensation. In 2005, based on his continued
contributions at significantly reduced compensation during the Company's
difficult financial period, the Board approved the grant to Mr. Houston of a
deferred compensation award relating to that period, to be paid at such future
time as the Company is in a position to do so. Although this deferred
compensation award was initially booked as deferred salary, the Board has
clarified that this amount be classified as a special deferred bonus. Total
accrued deferred compensation due to Mr. Houston as of the year ended December
31, 2005 was $248,889.
59
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act requires the Company's officers and
Directors and persons who beneficially own more than ten percent (10%) of the
Company's Common Stock to file reports of ownership and changes in ownership on
Forms 3, 4 and 5 with the SEC. Officers, directors and greater than ten percent
(10%) beneficial owners are required by the SEC to furnish the Company with
copies of all Forms 3, 4 and 5 that they file. Based solely upon the Company's
review of the copies of such forms it has received, and certain other
information available to it, to the best of the Company's knowledge:
EKI, a ten percent (10%) beneficial owner, did not timely file one report
reporting three conversions of debt. The conversions of debt were reported on
November 15, 2004.
Mr. Khashoggi did not timely file one (1) report reporting the gift of
shares of common stock to each of his three (3) children and one (1) report
reporting the conversion of debt by EKI, an affiliate of Mr. Khashoggi,
described above. The gift was reported on May 20, 2005 and the conversions of
debt by EKI were reported on February 24, 2006.
Mrs. Khashoggi did not timely file one (1) report reporting her husband's
gift of shares of common stock reported above and one (1) report reporting the
conversion of debt by EKI, an affiliate of Ms. Khashoggi, described above. The
gift was reported on May 20, 2005 and the conversions of debt by EKI were
reported on February 24, 2006.
60
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
All decisions relating to executive compensation during 2005 were made by
the Company's Compensation Committee. None of the members of the Committee were
officers of the Company in 2005.
In July 2002, the Company extended a loan in the amount of $55,000 to Mr.
Vincent Truant, President and Chief Operating Officer. The loan, which bore
interest at 7% per annum, was due upon demand by the Company. In May 2005, the
Compensation Committee of the Board of Directors approved a bonus to Mr. Truant
equal to the total principal amount and accrued interest, and the note was
cancelled.
Mr. Essam Khashoggi and E. Khashoggi Industries represent a greater than
10% ownership in the Company. The following transactions occurred during 2005.
During 2002 and 2003, EKI made various simple interest working capital
loans to the Company (the "Simple Interest Loans"). As part of the settlement of
the 2006 Debentures in October of 2004, EKI agreed to convert all of the
outstanding Simple Interest Loans to EarthShell ($2,755,000) into unregistered
common stock at $3.00 per share and $532,644 of accumulated interest into
unregistered common stock at $4.00 per share, for a total of 1,051,494 shares
received by EKI. In May 2005, an additional 44,387 shares were issued to EKI
pursuant to a ninety (90) day price protection clause, which provided for an
adjustment in the effective conversion price of the interest portions of the
Simple Interest Loans from $4.00 per share to $3.00 per share.
In 2005, the Company also granted a ten (10) year warrant to Essam
Khashoggi to purchase one million (1,000,000) shares of the Company's common
stock at $3.00 per share in consideration of his continued support of the
Company since its inception, including providing bridge loans at below market
terms from time to time.
On October 11, 2005, the Company entered into the EKI Loan with EKI
pursuant to which the Company issued to EKI a promissory note to EKI in the
principal amount of $1,000,000. As of the second week of January 2006, EKI has
advanced the full $1,000,000 to the Company. Interest accrues on the principal
balance of the EKI Loan at a variable per annum rate, as of any date of
determination, that is equal to the rate published in the "Money Rates" section
of The Wall Street Journal as being the "Prime Rate", compounded monthly. All
accrued but unpaid interest and outstanding principal is due and payable on the
earliest to occur of the following: (i) the second (2nd) anniversary of the date
of the EKI Loan; (ii) five (5) days following the date the Company has received
$3 million or more in aggregate net cash proceeds from all financing
transactions, equity contributions, and transactions relating to the sale,
licensing, sublicensing or disposition of assets or the provision of
services(including advance royalty payments, proceeds from the sale of the
Company's common stock and fees for technological services rendered to third
parties), measured from the date of the EKI Loan and not taking into account the
proceeds advanced under the EKI Loan; or (iii) the occurrence of an Event of
Default (as defined in the EKI Loan).
On October 11, 2005, the Company entered into the Debt Conversion
Agreement with EKI, pursuant to which the Company and EKI agreed that a
receivable in an amount equal to $837,145.69 (previously owed to bio-Tec
Biologische Naturverpackunger GmbH & Co.KG), but which receivable was
subsequently assigned to EKI) be converted into 279,048 shares of common stock
of the Company. The conversion price equals $3.00 per share. Pursuant to the
Debt Conversion Agreement, the Company and EKI released each other from any and
all claims in connection with the receivable.
Biotec License Agreement. On July 29, 2002 the Company entered into a
license and information transfer agreement (the "Biotech License Agreement")
with bio-tec Biologische Naturverpackungen GmbH & Co. KG and bio-tec Biologische
Naturverpackungen Forschungs und Entwicklungs GmbH (the "Biotec Group") to
utilize the Biotec Group technology for foodservice disposable packaging
applications. EKI had previously granted to the Company priority rights to
license certain product applications on an exclusive basis from the Biotec Group
in consideration for the Company's payment of a $100,000 minimum monthly payment
to Biotec. In September of 2004, as part of an overall restructuring of its
debt, EarthShell and Biotec entered into an agreement to convert $1.475 million
of the $2.475 million of accrued license fees as of September 1, 2004, plus
accrued interest into 491,778 shares of EarthShell common stock and to
eliminate, for two (2) years, the $100,000 per month minimum license fee. In
December of 2004, the amended Biotec License Agreement was further amended and
EarthShell paid to Biotech $125,000, leaving a balance owing of approximately
$875,000, which was subsequently reduced to approximately $837,000. On August
31, 2005, in connection with the sale of Biotec by EKI, Biotec License Agreement
was again amended and restated (the "Amended and Restated Biotec License") and
the minimum monthly payment to retain exclusivity was completely eliminated and
the balance of approximately $837,000 owing to EarthShell was assigned by the
Biotec Group to EKI. Under the Amended and Restated Biotec License, the Company
has a fully paid up license to use the Biotec technology in the EarthShell
fields of use, with certain limited exclusions, exclusively through June 2008.
61
The Company can maintain its exclusivity provided it has been successful
in commercializing the Biotec technology and is making certain minimum royalty
payments under the license by June 2008. The Company has paid to the Biotec
Group $125,000 in cash, has converted approximately $1.475 million into 491,778
shares of unregistered stock, and in 2005 had assigned the balance owing to the
Biotec Group of $837,000 to EKI. The $837,000 balance was ultimately converted
by EKI in October 2005 into shares of EarthShell common stock at $3 per share,
as described above.
In August 2005, the Company granted a warrant to Mr. Essam Khashoggi to
purchase 1 million shares of the Company's common stock at $3 per share in
consideration of Mr. Khashoggi's continued support of the Company since its
inception, including providing bridge loans at below market terms from time to
time. The warrant expires in May of 2015.
62
COMPENSATION COMMITTEE CHARTER
Below describes the function of the Compensation Committee, the objectives
of the Company's executive compensation program, the various components of
compensation, and explains the basis upon which 2005 compensation determinations
were made by the Compensation Committee with respect to the executive officers
of the Company, including the Named Executive Officers.
Compensation Committee Charter
The Compensation Committee is charged with the following responsibilities:
o reviewing and recommending to the Board of Directors the annual base
salary, bonus and other benefits for the senior executive officers
of the Company;
o reviewing and commenting on new executive compensation programs that
the Company proposes to adopt;
o periodically reviewing the results of the Company's executive
compensation and perquisite programs to ensure that they are
properly coordinated to yield payments and benefits that are
reasonably related to executive performance;
o helping to ensure that a significant portion of executive
compensation is reasonably related to the long-term interests of the
stockholders;
o participating in the preparation of certain portions of the
Company's annual proxy statement;
o if necessary, hiring a compensation expert to provide independent
advice on compensation levels; and
o helping to ensure that the Company undertakes appropriate planning
for management succession and advancement.
63
COMPENSATION COMPONENTS
The Company's executive compensation program consists of a mixture of base
salary, cash bonuses and stock options. In determining the mix and total amount
of compensation for each executive officer, the Compensation Committee
subjectively considers each executive's overall value to the Company including
past and expected contributions by the executive to the Company's goals. In
addition, the Compensation Committee strives to balance short-term and long-term
incentive compensation to achieve desired results.
Shortly following the Company's initial public offering in March 1998,
anticipating that it would be hiring several new executives as part of its next
stage of development, the Company commissioned SCA Consulting LLC ("SCA"), a Los
Angeles based executive compensation consulting firm, to update its executive
compensation strategy and total pay structure. As part of its assignment, SCA
developed a study of the compensation practices of newly public, development
stage companies. The Compensation Committee references this study as it
administers each of the three components of its executive compensation program
to ensure that its compensation practices are competitive and that the overall
compensation package appropriately attracts, motivates, rewards, and retains key
employees with outstanding abilities.
Base Salary. The Company has historically determined base salary for its
executives based on qualifications, job requirements and competitive market
salaries that such qualifications and job requirements command. As the Company
grows, it will continue to rely on peer group competitive compensation practices
to remain consistent and competitive in its compensation practices.
Salaries for executives are reviewed by the Compensation Committee on an
annual basis and may be adjusted based upon their assessment of the individual's
contribution to and financial growth of the Company as well as competitive pay
levels.
The Company paid base compensation to Mr. Vincent Truant, Chairman of the
Board and Chief Executive Officer, at an annual rate of $350,000 which was then
adjusted to $400,000 upon his being named Chief Executive Officer effective
September 1, 2005. Also effective September 1, 2005, the salary for Mr. D. Scott
Houston, Chief Financial Officer and Secretary resumed his full time status with
the Company and his salary was adjusted to the former rate of $320,00 per year,
of which, Mr. Houston receives $213,333 in cash payments and $106,667 in
deferred compensation, as described above.
Bonus. Bonuses may be granted for a fiscal year after the financial
results for that fiscal year become available. The Compensation Committee meets
to consider annual bonuses for each executive based on individual performance as
well as overall financial results of the Company for the year. There is no plan
requiring that bonuses be paid. However, pursuant to their employment
agreements, certain executive officers may be entitled to receive an annual
bonus, the actual amount of which is determined in the sole discretion of the
Compensation Committee.
The Compensation Committee also may consider bonus compensation in light
of the accomplishment of specific milestones developed by management in support
of the annual strategic plan.
In determining whether to grant management bonuses for 2005, the
Compensation Committee considered both individual performance as well as the
Company's overall performance. Although the Compensation Committee noted several
significant individual and Company achievements during the year, in light of the
delays the Company has experienced in commercializing the Company's technology
as well as the financial condition of the Company, the Compensation Committee
granted only one bonus, which was in the form of deferred compensation in the
amount of $106,667 to Mr. Houston, who had voluntarily gone to reduced salary on
a part time basis, but continued to put in a nearly full time effort. The bonus
for Mr. Houston has been accrued and will be paid at some future date in cash or
in stock as the Company is able.
64
Stock Options. The Stock Option Committee believes that significant equity
interests in the Company in the form of stock options held by the Company's
management serve to align the interests of the executive management team with
those of stockholders. The Stock Option Committee may grant stock options and
restricted stock to executives and other key employees of the Company pursuant
to the 1995 Stock Incentive Plan, or may recommend that the Board of Directors
do so, as appropriate. In 2005, the Stock Option Committee or its successor
committee, the Compensation Committee, granted the Named Executive Officers
stock options issued under the 1995 Stock Incentive Plan at the then-current
market as follows:
Stock
Name Options
----------------------------------------------- -------
Vincent Truant 350,000
D. Scott Houston 375,000
Paul B. Susie 40,000
Simon K. Hodson 500,000
The stock options granted are reflected in the Stock Options Grant table.
The Stock Option Committee will continue to consider various methods to
provide additional incentives to management and employees of the Company,
including granting additional stock options and/or restricted stock or
recommending that the Board of Directors do so, as appropriate. In determining
the grants of stock options and restricted stock, the Stock Option Committee
will take into account, among other things, the respective scope of
responsibility and the anticipated performance requirements and contributions to
the Company of each proposed award recipient as well as the amounts of prior
grants.
65
COMPENSATION TO CHIEF EXECUTIVE OFFICER
The Compensation Committee meets annually to evaluate the Chief Executive
Officer's performance and to review the Chief Executive Officer's compensation.
In reviewing Mr. Vincent J. Truant's compensation, the Compensation
Committee considers his principal responsibilities, which include providing
overall vision and strategic direction for EarthShell, attracting and retaining
highly qualified employees and developing and maintaining key customer and
capital relationships.
Mr. Truant received a base annual salary of $400,000 which was effective
on September 1, 2005. This amount was based on the Compensation Committee's
assessment that Mr. Truant is uniquely qualified to lead the Company through its
transition stage and into commercialization. Based in part on the foregoing, the
Compensation Committee concluded that the $400,000 base salary compensation was
appropriate for 2005.
The former CEO, Mr. Simon K. Hodson, resigned effective August 31, 2005
and his last day of employment was October 31, 2005. He received a salary at the
annual rate of $500,000 for 2005, of which $300,000 was cash compensation and
$200,000 was deferred compensation, accruing interest at the rate of 8% per
annum. During 2005, Mr. Hodson received total cash compensation of $395,444,
which was comprised of cash salary through October 31, 2005 of $250,000, and the
payment of accumulated deferred compensation of $141,667 related to 2004 and
$25,000 related to 2005. The balance of accumulated deferred compensation due to
Mr. Hodson as of December 31, 2005 was $179,361.
66
DEDUCTIBILITY OF EXECUTIVE COMPENSATION
Section 162(m) of the Internal Revenue Code of 1986, as amended (the
"Code"), limits the deductibility of compensation over $1 million to certain
executive officers unless, in general, the compensation is paid pursuant to a
plan which is performance related, non-discretionary and has been approved by
the Company's stockholders. The Company did not pay any compensation in 2005
that would be subject to Code Section 162(m). The Compensation Committee intends
to establish policies regarding qualification of compensation under Section
162(m) of the Code to the extent it considers such policies appropriate.
67
STOCK PERFORMANCE GRAPH
The graph below compares the cumulative total return on the Company's
common stock for the last six (6) fiscal years to the total cumulative return on
the S&P 500 Index and the Dow Jones Containers & Packaging Industry Group Index
(USA). The comparison assumes $100 was invested in the Company's common stock
and the indexes on December 31, 1999 and assumes reinvestment of dividends
before consideration of income taxes.
The stock performance depicted in the graph below is not necessarily
indicative of future performance. The Stock Performance Graph shall not be
deemed to be "soliciting material" or to be "filed" with the SEC or subject to
Regulations 14A or 14C or to the liabilities of Section 18 of the Exchange Act,
except to the extent that the Company specifically requests that such
information be treated as soliciting material or specifically incorporates it by
reference into a filing under the 1933 Act or Exchange Act.
[Comparison of Cumulative Total Shareholder Return Since December 31, 2000]
Indexed Total Return
12/31/2000 12/31/2001 12/31/2002 12/31/2003 12/31/2004 12/31/2005
---------- ---------- ---------- ---------- ---------- ----------
EarthShell Index 100.0 156.1 45.3 11.7 16.3 13.0
S&P 500 Index 100.0 87.0 66.6 84.2 91.8 94.5
Dow Jones CTR 100.0 124.1 132.2 155.8 183.8 175.7
68
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information with respect to the
beneficial ownership of each class of the Company's voting securities as of July
21, 2006, by (i) each person or company known by the Company to be the
beneficial owner of more than five percent (5%) of the Company's outstanding
shares, (ii) each Director of the Company,(iii) the Chief Executive Officer of
the Company and each of the other named executive officers and (iv) all
Directors and named executive officers of the Company as a group.
Percentage
Number of of Shares
Shares of of Common
Common Stock
Name and Address(1) Stock Outstanding(1)(2)
------------------------------------------------- ---------- ----------------
Mr. Hamlin Jennings (3) 50,034 *
Mr. Walker Rast (4) 48,603 *
Mr. Michael C. Gordon (5) 35,000 *
Mr. Vincent J. Truant (6) 37,083 *
Mr. D. Scott Houston (7) 419,120 *
Mr. Paul Susie (8) 10,000 *
Directors and Named Executive Officers as a Group
(5 Persons) (9) 579,840 2.27%
Mr. Essam Khashoggi (10) 7,943,603 31.16%
E. Khashoggi Industries, LLC(11) 5,999,939 23.54%
------------------------------------
* Indicates ownership of less than one percent (1%).
(1) The address of all individuals, entities and stockholder groups listed in
the table is c/o EarthShell Corporation, 1301 York Road, Suite 200,
Lutherville, MD 21093.
(2) Applicable percentage of ownership is based on 20,095,190 shares of common
stock outstanding as of July 21, 2006 together with securities exercisable
or convertible into shares of common stock within 21 days of July 21,
2006, for each stockholder. Beneficial ownership is determined in
accordance with the rules of the Securities and Exchange Commission and
generally includes voting or investment power with respect to securities.
Shares of common stock subject to securities exercisable or convertible
into shares of common stock that are currently exercisable or exercisable
within 60 days of July 21, 2006 are deemed to be beneficially owned by the
person holding such securities for the purpose of computing the percentage
of ownership of such person, but are not treated as outstanding for the
purpose of computing the percentage ownership of any other person. Note
that affiliates are subject to Rule 144 and insider trading regulations -
percentage computation is for form purposes only.
(3) Includes options to purchase 30,034 shares of common stock issued under
the 1995 Stock Incentive Plan, which are fully vested and exercisable.
(4) Includes options to purchase 28,603 shares of common stock issued under
the 1995 Stock Incentive Plan, which are fully vested and exercisable
(5) Includes options to purchase 25,000 shares of common stock issued under
the 1995 Stock Incentive Plan, all of which are fully vested and
exercisable and 10,000 shares of common stock, received as a restricted
stock bonus for his service as a director in June 2005. The restrictions
lapsed after one year.
(6) Includes options to purchase 32,917 shares of common stock issued under
the 1995 Stock Incentive Plan, which are fully vested and exercisable.
(7) Includes options to purchase 417,037 shares of common stock issued under
the 1995 Stock Incentive Plan, which are fully vested and exercisable.
(8) Includes options to purchase 10,000 shares of common stock issued under
the 1995 Stock Incentive Plan, which are fully vested and exercisable.
(9) Includes options to purchase 533,591 shares of common stock issued under
the 1995 Stock Incentive Plan, which are fully vested and exercisable.
(10) Includes 5,916,606 shares held by E. Khashoggi Industries, LLC ("EKI"),
and 715,436 shares held by EKINVESCO, the controlling owner of each being
Mr. Khashoggi. Includes 218,228 shares held by other entities, including
CTC, in which Mr. Khashoggi also has a controlling ownership interest.
Also includes fully exercisable options to purchase 1,000,000 shares of
common stock issued by the Company to Mr. Khashoggi and warrants held by
EKI to purchase 83,333 shares of common stock of the Company. Mr.
Khashoggi has sole voting and dispositive power with respect to all shares
referred to in this note, and is therefore deemed to be the beneficial
owner of such shares.
(11) Includes warrants to purchase 83,833 shares of common stock of the
Company.
69
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
The following table provides information with respect to compensation
plans (including individual compensation arrangements) under which equity
securities of the Company are authorized for issuance to employees or
non-employees (such as directors, consultants, advisors, vendors, customers,
suppliers or lenders), as of March 31, 2006.
Equity Compensation Plan Information
Number Of
Securities
Remaining
Available For
Future
Number Of Issuance Under
Securities To Equity
Be Issued Upon Weighted-Average Compensation
Exercise Of Exercise Price Plans
Outstanding Of Outstanding (Excluding
Options, Options, Securities
Warrants And Warrants And Reflected In
Rights Rights Column (a))
-------------- ---------------- -------------
(a) (b) (c)
------------------------------- -------------- ---------------- -------------
Equity compensation plans
approved by security holders 1,145,720 $ 7.70 --
Equity compensation plans not
approved by security holders(1) 465,000 $ 2.10 --
TOTAL 1,610,720 $ 6.09 --
(1) These options are intended to be included within the 1995 Plan, and were
granted, subsequent to the 2005 Annual Stockholders Meeting, subject to
approval by the Shareholders of a proposed amendment to the 1995 Plan to
increase the number of shares authorized under the 1995 Plan.
70
MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S
COMMON EQUITY AND OTHER STOCKHOLDER MATTERS
The Company's common stock is currently listed on the Bulletin Board
published by the National Quotation Bureau, Inc., and prior to March 8, 2004
traded on the NASDAQ SmallCap Market. The Company's common stock trades under
the symbol "ERTH.OB." For the periods indicated, the following table presents
the range of high and low closing sale prices for the Company's common stock.
High Low
------- ------
YEAR ENDED DECEMBER 31, 2006: ($) ($)
------- ------
First (1st) Quarter 2.10 1.65
Second (2nd) Quarter 2.20 1.61
High Low
------- ------
YEAR ENDED DECEMBER 31, 2005: ($) ($)
------- ------
First (1st) Quarter 2.45 1.48
Second (2nd) Quarter 3.20 1.65
Third (3rd) Quarter 2.95 1.77
Fourth (4th) Quarter 2.50 1.74
High Low
------- ------
YEAR ENDED DECEMBER 31, 2004: ($) ($)
------- ------
First (1st) Quarter 2.52 1.49
Second (2nd) Quarter 2.03 0.45
Third (3rd) Quarter 3.75 1.75
Fourth (4th) Quarter 2.97 1.95
High Low
------- ------
YEAR ENDED DECEMBER 31, 2003: ($) ($)
------- ------
First (1st) Quarter 7.80 4.20
Second (2nd) Quarter 7.08 4.32
Third (3rd) Quarter 5.64 3.72
Fourth (4th) Quarter 4.56 1.33
The Company's common stock sales prices have been restated, where
applicable, to reflect the one-for-twelve reverse split of the Company's common
stock effective as of October 31, 2003. Quotations since the Company's stock
began trading on the Over-the-Counter Bulletin Board may reflect inter-dealer
prices, without retail mark-up, mark-down or commission and may not necessarily
represent actual transactions.
The number of stockholders of record of the Company's common stock at July
21, 2006 was 1,198.
71
DIVIDENDS
The Company does not intend to declare or pay cash dividends on its common
stock in the foreseeable future nor has it paid dividends in the past three (3)
years.
72
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
As of July 21, 2005 when the Compensation Committee was reorganized, all
decision relating to executive compensation have been made by the Company's
Compensation Committee, which is comprised of Hamlin Jennings, chairman, Walker
Rast, and Michael Gordon. All members of the current Compensation Committee are
independent directors. All decisions relating to executive compensation during
2004 through July 21, 2005 were made by the Company's former Compensation
Committee, which was comprised of Mr. Khashoggi, Mrs. Khashoggi and, until
February 2, 2005 when he resigned, Dr. Roland or the Board, as appropriate. None
of the members of the Compensation Committee were officers of the Company in
2004. Mr. Khashoggi is the controlling stockholder of EKI, the Company's largest
stockholder with whom the Company has certain relationships and related
transactions described below. Mr. Khashoggi is the beneficial owner of 33.29% of
the common stock of the Company.
The Company has an exclusive, worldwide, royalty-free license in
perpetuity to use and license the EKI technology to manufacture and sell
disposable, single-use containers for packaging or serving food or beverages
intended for consumption within a short period of time (less than twenty-four
(24) hours).
On July 29, 2002, the Company EKI for the amended and restated license
agreement with EKI for the license described above (the "EKI License Agreement")
expanding the field of use for the EarthShell technology to include noodle bowls
used for packaging instant noodles, a worldwide market that the Company
estimates to be approximately $1 billion. Because the noodle bowl development
was made at no cost to EarthShell and is an incremental field of use, EarthShell
agreed to pay to EKI fifty percent (50%) of any royalty or other consideration
it receives in connection with the sale of products within this particular field
of use.
In addition, on July 29, 2002 the Company entered into a license and
information transfer agreement (the "Biotech License Agreement") with bio-tec
Biologische Naturverpackungen GmbH & Co. KG and bio-tec Biologische
Naturverpackungen Forschungs und Entwicklungs GmbH (the "Biotec Group") to
utilize the Biotec Group technology for foodservice disposable packaging
applications. EKI had previously granted to the Company priority rights to
license certain product applications on an exclusive basis from the Biotec Group
in consideration for the Company's payment of a $100,000 minimum monthly payment
to Biotec. In addition, in consideration for the monthly payment, the Biotec
Group agreed to render technical services to the Company at the Biotec Group's
cost plus five percent (5%). The licensing fee and services arrangements were
continued in the Biotec License Agreement. Under the terms of the Biotec License
Agreement, the Biotec Group was entitled to receive twenty-five percent (25%) of
any royalties or other consideration that the Company receives in connection
with the sale of products utilizing the Biotec Group technology, after applying
a credit for all minimum monthly payments received. In connection with the
issuance of the 2006 Debentures, the Biotec Group agreed to subordinate the
licensee fee payments due from EarthShell until the debentures were retired.
During this period, the license fees due to the Biotec Group were accrued.
In September of 2004, as part of an overall restructuring of its debt,
EarthShell and Biotec entered into an agreement to convert $1.475 million of the
$2.475 million of accrued license fees as of September 1, 2004, plus accrued
interest into 491,778 shares of EarthShell common stock and to eliminate, for
two (2) years, the $100,000 per month minimum license fee. In December of 2004,
the amended Biotec License Agreement was further amended and EarthShell paid to
Biotech $125,000, leaving a balance owing of approximately $875,000, which was
subsequently reduced to approximately $837,000. On August 31, 2005, in
connection with the sale of Biotec by EKI, Biotec License Agreement was again
amended and restated (the "Amended and Restated Biotec License") and the minimum
monthly payment to retain exclusivity was completely eliminated and the balance
of approximately $837,000 owing to EarthShell was assigned by the Biotec Group
to EKI. Under the Amended and Restated Biotec License, the Company has a fully
paid up license to use the Biotec technology in the EarthShell fields of use,
with certain limited exclusions, exclusively through June 2008. The Company can
maintain its exclusivity provided it has been successful in commercializing the
Biotec technology and is making certain minimum royalty payments under the
license by June 2008. As of the date of this Prospectus, the Company has paid to
the Biotec Group $125,000 in cash, has converted approximately $1.475 million
into 491,778 shares of unregistered stock, and had assigned the balance owing to
the Biotec Group of $837,145.69 to EKI. On October 11, 2005, the Company entered
into the Debt Conversion Agreement with EKI, pursuant to which the Company and
EKI agreed that a receivable in an amount equal to $837,145.69 (previously owed
to bio-Tec Biologische Naturverpackunger GmbH & Co.KG), but which receivable was
subsequently assigned to EKI) be converted into 279,048 shares of common stock
of the Company. The conversion price equals $3.00 per share. Pursuant to the
Debt Conversion Agreement, the Company and EKI released each other from any and
all claims in connection with the receivable.
73
During 2002 and 2003, EKI made various simple interest working capital
loans to the Company (the "Simple Interest Loans"). These Simple Interest Loans
were interest bearing at a rate of seven percent (7%) or ten percent (10%) per
annum, and were payable on demand. As of December 31, 2003, the outstanding
principal balance of the Simple Interest Loans was $2,755,000. In connection
with the sale of the 2006 Debentures, EKI subordinated the payments and advances
that were owed to it, and as consideration, the Company issued to EKI a warrant
in March 2003, expiring ten (10) years thereafter, to acquire 83,333 shares of
the Company's common stock at $6.00 per share. As part of the settlement of the
2006 Debentures in October of 2004, EKI agreed to convert all of the outstanding
Simple Interest Loans to EarthShell ($2,755,000) into unregistered common stock
at $3.00 per share and $532,644 of accumulated interest into unregistered common
stock at $4.00 per share, for a total of 1,051,494 shares received by EKI. As of
December 31, 2004, the Simple Interest Loans were paid in full. In May 2005, an
additional 44,387 shares were issued to EKI pursuant to a ninety (90) day price
protection clause, which provided for an adjustment in the effective conversion
price of the interest portions of the Simple Interest Loans from $4.00 per share
to $3.00 per share. The 1,051,494 shares of common stock issued to EKI as a
result of the EKI Conversion Agreement will not be registered for resale under
the 1933 Act.
On September 30, 2004, EKI entered into an agreement with EarthShell to
sell back to the Company the 2006 Debentures it had purchased for $1 million in
cash, the cash price paid by EKI for the purchased 2006 Debentures (the "EKI
DPA"). In connection therewith, immediately after the acquisition, EKI sold the
2006 Debentures to the Company and, as discussed above, the Company retired the
2006 Debentures shortly thereafter.
In August 2005, the Company also granted a ten (10) year warrant to Essam
Khashoggi to purchase one million (1,000,000) shares of the Company's common
stock at $3.00 per share in consideration of his continued support of the
Company since its inception, including providing bridge loans at below market
terms from time to time.
On October 11, 2005, the Company entered into the EKI Loan with EKI
pursuant to which the Company issued to EKI a promissory note to EKI in the
principal amount of $1,000,000. As of the second week of January 2006, EKI has
advanced the full $1,000,000 to the Company. Interest accrues on the principal
balance of the EKI Loan at a variable per annum rate, as of any date of
determination, that is equal to the rate published in the "Money Rates" section
of The Wall Street Journal as being the "Prime Rate", compounded monthly. All
accrued but unpaid interest and outstanding principal is due and payable on the
earliest to occur of the following: (i) the second (2nd) anniversary of the date
of the EKI Loan; (ii) five (5) days following the date the Company has received
$3 million or more in aggregate net cash proceeds from all financing
transactions, equity contributions, and transactions relating to the sale,
licensing, sublicensing or disposition of assets or the provision of services
(including advance royalty payments, proceeds from the sale of the Company's
common stock and fees for technological services rendered to third parties),
measured from the date of the EKI Loan and not taking into account the proceeds
advanced under the EKI Loan; or (iii) the occurrence of an Event of Default (as
defined in the EKI Loan).
On July 28, 2006, the Company entered into a Loan and Mutual Release
Agreement (the "Agreement") with E. Khashoggi Industries, LLC ("EKI"), the
Company's largest stockholder. Pursuant to the Agreement, EKI advanced $350,000
directly to the Company and an additional $150,000 to a law firm on behalf of
the Company to cover legal fees related to patent renewals. The Agreement also
contains mutual releases of any and all claims, known or unknown, which the
respective parties may have through the date of the Agreement under existing
license, debt conversion and service agreements. The Company executed and
delivered two Promissory Notes to EKI on July 28, 2006; one in the amount of
$350,000 and the other in the amount of $150,000. Interest accrues on the
principal balance of the $350,000 note at a variable per annum rate, as of any
date of determination, that is equal to the rate published in the "Money Rates"
section of The Wall Street Journal as being the "Prime Rate", compounded
monthly. The $150,000 note is non-interest bearing. All accrued but unpaid
interest and outstanding principal under the notes is due and payable on the
earliest to occur of the following: (i) the second anniversary of the date of
the note; (ii) five days following the date the Company has received $3.0
million or more in aggregate net cash proceeds from all financing transactions,
equity contributions, and transactions relating to the sale, licensing,
sublicensing or disposition of assets or the provision of services (including
advance royalty payments, proceeds from the sale of the Company's common stock
and fees for technological services rendered to third parties), occurring
subsequent to the date of the notes.
Under the terms of the EKI License Agreement and an amended and restated
Agreement for the Allocation of Patent Costs by and between the Company and EKI,
EarthShell has the obligation to pay the patent prosecution and maintenance
costs for those patents which i) "directly relate to" it's field of use, and
which ii) "primarily benefit" EarthShell.
Any patents granted in connection with the EarthShell Technology are the
property of EKI, and EKI may utilize and/or license the patents and related
technology in a manner or for uses unrelated to the license granted to the
Company in the foodservice disposables field of use. Effective January 1, 2001,
rather than reimbursing EKI for patent costs, EarthShell assumed direct
responsibility to manage and maintain the patent portfolio underlying the EKI
License Agreement with EKI and continues to pay directly all relevant costs.
In July 2002, the Company extended a loan in the amount of $55,000 to Mr.
Vincent Truant, Chief Executive Officer. The loan, which bore interest at seven
percent (7%) per annum, was due upon demand by the Company. In May 2005, the
Compensation Committee of the Board approved a bonus to Mr. Truant equal to the
total principal amount and accrued interest, and the note was cancelled.
74
DESCRIPTION OF CAPITAL STOCK
Common Stock
EarthShell is authorized to issue 40,000,000 shares of Common Stock $0.01
par value, of which 20,095,190 were issued and outstanding at July 21, 2006. The
securities being offered hereby are common stock, with one vote per share on all
matters to be voted on by shareholders, without any right to accumulate their
votes. Shareholders have no preemptive rights and have no liability for further
calls or assessments on their shares. The shares of common stock are not subject
to repurchase by the Company or conversion into any other security. All
outstanding shares of common stock are, and those issued pursuant to the
Purchase Agreement and the warrants will be fully paid and non assessable.
Shareholders are entitled to receive such dividends as may be declared by
the Board of the EarthShell out of funds legally available therefore and, upon
the liquidation, dissolution or winding up of the Company, are entitled to share
ratably in all net assets available for distribution to such holders after
satisfaction of all of our obligations, including stock preferences. It is not
anticipated that we will pay any dividends in the foreseeable future since we
intend to follow the policy of retaining its earnings to finance the growth of
its business. Future dividend policies will depend upon the Company's earnings,
financial needs and other pertinent factors.
Preferred Stock
The Board has the authority, without further action by stockholders, to
issue up to 10,000,000 shares of preferred stock ("Preferred Stock") in one (1)
or more series and to fix the powers, designations, rights, preferences,
privileges, qualifications and restrictions thereof, including dividend rights,
conversion rights, voting rights, rights and terms of redemption, liquidation
preferences and sinking fund terms, any or all of which may be greater than the
rights of the common stock. The Board, without stockholder approval, can issue
Preferred Stock with voting, conversion, and other rights which could adversely
affect the voting power and other rights of the holders of common stock. The
issuance of Preferred Stock in certain circumstances may have the effect of
delaying, deferring or preventing a change of control of the Company without
further action by the stockholders, may discourage bids for the Company's common
stock at a premium over the market price of the common stock, and may adversely
affect the market price of the common stock.
Series A Preferred Stock
In 1993, the Company issued Series A Preferred Stock in connection with
the funding of the early development stage of the Company. In 1998, the entire
Series A Preferred Stock was converted to common stock in connection with the
Company's Initial Public Offering. As of June 5, 2006, there were no shares of
Series A Preferred Stock issued and outstanding.
Series B Convertible Preferred Stock
As of June 5, 2006, there were 100 shares of Series B Convertible
Preferred Stock, par value $0.01 per share, designated. The one hundred (100)
shares of Series B Convertible Preferred Stock have been pledged to secure the
CCP Notes issued to Cornell Capital Partners and have been placed in escrow to
be issued to Cornell Capital Partners in the event of default. The shares will
be released to the Company from escrow upon (i) repayment of $1,350,000 of
principal under the promissory notes; (ii) in the event the shares pledged
pursuant to that certain Amended and Restated Pledge and Escrow Agreement by and
among Mr. Benton Wilcoxon, Cornell Capital Partners and David Gonzalez, Esq. is
equal to or exceeds 3 times the amount of principal then outstanding under the
promissory notes; (iii) a registration statement has been declared effective by
the SEC relating to the shares to be issued pursuant to the Standby Equity
Distribution Agreement; and (iv) the 100 shares of Series B Convertible
Preferred Stock have been redeemed pursuant the Certificate of Designation.
Pursuant to the Certificate of Designation, the Series B Convertible Preferred
Stock is senior to the Company's common stock with respect to the distribution
of the assets of the Company upon liquidation and junior to all other series of
Preferred Stock. The holders of the Series B Convertible Preferred Stock are not
entitled to dividends or distributions. Each share of Series B Convertible
Preferred Stock is convertible, at the option of the holder, at any time upon an
event of default under the promissory notes, into 33,333 shares of fully paid
and non-assessable common stock of the Company. As of July 21, 2006, no events
of default exist. The Series B Convertible Preferred Stock has no voting rights,
except as required under the Delaware General Corporation Law. After full
repayment of the notes, the Company has the absolute right to redeem (unless
otherwise prevented by law) any outstanding shares of Series B Convertible
Preferred Stock at an amount equal to $0.01 per share.
75
Series C Convertible Preferred Stock
In May 2005, the Company authorized the creation of 10,000,000 shares of
blank preferred stock with a par value of $0.01 per share. In June 2005, the
Company designated 8,000,000 shares of preferred stock as the Series C
Convertible Preferred Stock (the "Series C Preferred Stock"), which rank, with
respect to rights on liquidation, senior to the Company's common stock and
junior to or on parity with any other series of preferred stock designated by
the Company. In an event of liquidation, the holders of the Series C Preferred
Stock are entitled to receive in cash, an amount equal to $0.000125 per share
and thereafter, to share ratably with the holders of the common stock in the
assets remaining for distribution. Holders of the Series C Preferred Stock are
entitled to receive dividends, as calculated under the Certificate of
Designation, when such dividends are declared by the Company.
Series D Convertible Preferred Stock
In June 2006, the Company designated 400,000 shares of preferred stock as
the Series D Convertible Preferred Stock (the "Series D Preferred Stock"), which
rank, with respect to rights on liquidation, senior to the Company's common
stock and senior to any other series of preferred stock designated by the
Company. In an event of liquidation, the holders of the Series D Preferred Stock
are entitled to receive in cash, an amount equal to $3.90 per share, plus all
accrued and unpaid dividends thereon. Holders of the Series D Preferred Stock
are entitled to receive dividends, as calculated under the Certificate of
Designation, when such dividends are declared by the Company. Dividends on each
share of Seried D Preferred Stock accrue on a daily basis at a rate of 20% per
annum of the sum of the liquidation value of the stock plus all dividends which
have accumulated and are unpaid from the date of the issuance of the Seried D
Preferred Stock until either the date the Series D Preferred Stock has been
liquidated, converted into shares of common stock, or acquired.
As of June 19, 2006, there were 400,000 shares of Series D Convertible
Preferred Stock , par value $0.01 per share, designated. As of July 21, 2006,
there were 128,205 shares of Series D Preferred Stock Issued and outstanding.
Convertible Debentures
o Purchase Agreement. On December 30, 2005, the Company entered into a
Purchase Agreement with Cornell Capital Partners. Pursuant to the
Purchase Agreement, the Company issued to Cornell Capital Partners
the Cornell Capital Debentures. The Cornell Capital Debentures shall
be convertible into shares of the Company's common stock, and the
Company received proceeds from the sale of the Cornell Capital
Debentures equal to $4,500,000 on January 6, 2006. The selling
shareholders may not choose to sell all of the shares covered by
this registration statement, or, under certain market conditions,
may not be entitled to convert and sell all of the shares provided
covered by their respective registration or conversion agreements.
The Cornell Capital Debentures are secured by (i) a Pledge and Escrow
Agreement, by and among the Company, Cornell Capital Partners and David
Gonzalez, Esq., (ii) an Insider Pledge and Escrow Agreement (the "IPEA"), by and
among the Company, Cornell Capital Partners, David Gonzalez, Esq. and Mr. Benton
Wilcoxon and (iii) an Amended and Restated Security Agreement, by and between
the Company and Cornell Capital Partners. The Cornell Capital Debentures are
secured by substantially all of the Company's assets, have a three (3) year term
and accrue interest at twelve percent (12%) per annum. Beginning 60 days after
the Securities and Exchange Commission ("SEC") declares the accompanying
registration statement effective, Cornell Capital Partners is entitled, at its
option, to convert and sell up to $250,000 of the principal amount of the
Cornell Capital Debentures, plus accrued interest, into shares of the Company's
common stock, within any 30 day period at the lesser of (i) a price equal to
$3.00 or (ii) eighty-eight percent (88%) of the average of the two (2) lowest
volume weighted average prices of the common stock during the ten (10) trading
days immediately preceding the conversion date, as quoted by Bloomberg, LP. The
conversion limitation of $250,000 per month does not apply if the market price
is greater than $3.00 per share. The holder of the Cornell Capital Debentures
may not convert the Cornell Capital Debentures or receive shares of the
Company's common stock as payment of interest thereunder to the extent such
conversion or receipt of such interest payment would result in the holder,
together with any affiliate thereof, beneficially owning (as determined in
accordance with Section 13(d) of the Exchange Act, and the rules promulgated
thereunder) in excess of 4.9% of the then issued and outstanding shares of
common stock, including shares issuable upon conversion of, and payment of
interest on, the December Debenture held by such holder after application of
this 4.9% restriction. This 4.9% restriction may be waived by a holder (but only
as to itself and not to any other holder) upon not less than sixty-five (65)
days prior notice to the Company.
76
The Company may redeem, with three (3) business days advance written
notice to Cornell Capital Partners, a portion or all amounts outstanding under
the Cornell Capital Debentures prior to the maturity date provided that the
closing bid price of the Company's common stock, as reported by Bloomberg, LP,
is less than $3.00 at the time of the redemption notice. The Company shall pay
an amount equal to the principal amount being redeemed plus a redemption premium
equal to ten percent (10%) of the principal amount being redeemed, and accrued
interest, to be delivered to the Cornell Capital Partners on the third (3rd)
business day after the redemption notice, provided, however, this redemption
premium does not apply until the outstanding principal balance of the Cornell
Capital Debentures have been reduced by $2.5 million. The amount that Cornell
may convert in any 30 day period will be reduced by the amount that the Company
redeems.
Under the purchase agreement, Cornell has the right to convert up to $4.5
million, plus accrued interest, into shares of EarthShell common stock over a
period of time. Assuming the market price for EarthShell common stock is at or
above $3 per share at the time of conversion, EarthShell will need to deliver
approximately 1.65 million shares. In the event that the market price for
EarthShell common stock is less than $3 per share at the time of the conversion,
the conversion price will be adjusted to 88% of the fair market value of
EarthShell common stock at the time of the conversion. Because of the
potentially variable nature of the future conversion price, pursuant to the
Purchase Agreement, EarthShell has agreed to register a number of shares equal
to 4 times the number of shares that would be required to convert the full $4.5
million, plus accrued interest, at $3 per share
On July 12, 2006, the Company entered into a Letter Agreement with Cornell
Capital Partners, pursuant to which Cornell Capital Partners has agreed to
forbear from exercising certain rights and remedies under the Cornell Capital
Debentures and that certain Registration Rights Agreement, of even date with the
Cornell Capital Debentures in exchange for the issuance by the Company to
Cornell Capital Partners of 250,000 shares of the Company's common stock.
The Company has acknowledged in the Agreement that an event of default
under the Cornell Capital Debentures had occurred as of June 30, 2006 with the
Company failing to timely register with the U.S. Securities and Exchange
Commission the common stock underlying the Cornell Capital Debentures. The
Company also acknowledged that Cornell Capital Partners is entitled to
liquidated damages equal to one percent (1%) of the liquidated value of the
Cornell Capital Partners for each thirty (30) day period after May 31, 2006.
Pursuant to the Agreement, Cornell Capital Partners has agreed to waive the
default, including all liquidated damages that may have accrued through the date
of the Agreement and during the Forbearance Period (as defined below), in
exchange for the 250,000 shares of common stock and the Company obtaining the
effectiveness by September 30, 2006 of that certain Registration Statement
originally filed with the U.S. Securities and Exchange Commission on February
14, 2006, which includes the shares of common stock underlying the Cornell
Capital Debentures.
Furthermore, Cornell Capital Partners has agreed not to make any
conversions under the Cornell Capital Debentures until the earlier of September
30, 2006 or the expiration of the Forbearance Period, which such Forbearance
Period shall commence on the date of the execution of the Agreement and continue
for so long as the Company strictly complies with the terms of the Agreement and
there is no occurrence or existence of any event of default other than the
Default under the transaction documents or any other agreement that the Company
has entered into with Cornell Capital Partners. The 250,000 shares of commons
stock shall have piggy-back registration rights and Cornell Capital Partners
shall also have the right to demand the registration of the 250,000 shares of
common stock by providing to the Company with thirty (30) days prior written
notice of such request.
Warrants
In connection with the issuance of the convertible debentures on August
12, 2002, the Company issued to the debenture holders, Cranshire Capital, L.P.,
Cleveland Overseas Ltd., and Beacon Equities, Inc, warrants to purchase 208,333
shares of the Company's common stock at $14.40 per share. The exercise price and
number of common shares issuable upon exercise of the warrants are subject to
adjustment under certain circumstances, such as the occurrence of stock
dividends and splits, distributions of property or securities other than common
stock, equity issuances for less than the warrant exercise price and a change in
control of the Company. In March 2003, in connection with the issuance of the
2006 Debentures, the exercise price of the warrants was reduced to $6.00 per
share, but the number of shares of common stock issuable upon exercise remained
fixed at 357,143. At the same time, the warrant agreement was amended such that
any subsequent reduction in the exercise price of the warrants will not result
in any increase in the number of shares of common stock issuable under the
warrants. The warrants expire on August 12, 2007.
In connection with the issuance of the convertible debentures in March
2003, the Company issued to the placement agent warrants to purchase $1.055
million in aggregate principal amount of the 2006 Debentures at $1,200 per
$1,000 of principal amount, 28,810 shares of the Company's common stock at
$10.08 per share, and 41,667 shares of the Company's common stock at $7.20 per
share. When the 2006 Debentures were retired in 2004, the warrant to purchase
$1,055 million in the aggregate principal amount of the 2006 Debentures
converted to a warrant to purchase 175,833 shares of common stock.
77
Therefore, the total number of warrants held by Roth Capital Partners, LLC is
246,310. The exercise price and number of common shares issuable upon exercise
of the warrants are subject to adjustment under certain circumstances, such as
the occurrence of stock dividends and splits, distributions of property or
securities other than common stock and a change in control of the Company. The
warrants expire in March 2006.
On March 5, 2003, the Company issued to EKI a warrant to purchase 83,333
shares at $6.00 per share in connection with the subordination of loans of
$2.755 million made to the Company and the elimination of the conversion
feature. The warrant expires on March 5, 2013.
In August 2005, the Company also granted a ten (10) year warrant to Essam
Khashoggi to purchase one million (1,000,000) shares of the Company's common
stock at $3.00 per share in consideration of his continued support of the
Company since its inception, including providing bridge loans at below market
terms from time to time.
In March 2005, in consideration for Mr. Benton Wilcoxon pledging his
personal shares in Composite Technology Corporation as a guaranty for the
security agreement entered into by the Company with Cornell Capital Partners,
the Company issued a warrant to Mr. Wilcoxon to purchase 65,000 shares of common
stock of the Company at an exercise price of $3.00 per share. The warrant
expires on March 23, 2008. There is a business relationship between Composite
Technology Corporation and EKI.
In consideration for consulting services rendered by Mr. Douglas Metz in
connection with the Company obtaining financing, the Company issued a warrant to
Mr. Metz to purchase 80,000 shares of common stock of the Company at an exercise
price of $3.00 per share. The warrant expires on March 23, 2008.
On May 26, 2005, the Company issued a common stock purchase warrant to
Cornell Capital Partners to purchase 625,000 shares of common stock of the
Company. This May Warrant expires on May 26, 2005, has an adjusted exercise
price of $3.00 per share as of December 30, 2005 for common stock and has "piggy
back" and demand registration rights. These shares are being registered in this
offering.
In August 2005, the Company issued a common stock purchase warrant to
Cornell Capital Partners to purchase 50,000 shares of common stock of the
Company as consideration for consolidating two (2) promissory notes (the "CCP
Notes") and extending the date upon which amortization and repayment of the CCP
Notes is to begin. This August Warrant expires on May 26, 2006, has an adjusted
exercise price of $3.00 per share of common stock and has "piggy back"
registration and demand rights. These shares are being registered in this
offering.
On December 30, 2005, the Company issued to Mr. Wilcoxon in consideration
of his pledge of shares of common stock of Composite Technology Corporation
pursuant to the terms of the IPEA a warrant to purchase up to 125,000 shares of
common stock. This warrant has an exercise price of $4.00 per share and expires
three (3) years from the date it was issued. The shares underlying these
warrants are being registered in this offering.
On December 30, 2005, the Company issued to Cornell Capital Partners a
common stock purchase warrant to purchase up to 350,000 shares of common stock
of the Company. This December Warrant has an exercise price of $4.00 per share,
expires two (2) years from the date it was issued and has "piggy back" and
demand registration rights. These shares are being registered in this offering.
Options
In 1995, the Company established the EarthShell Corporation 1995 Stock
Incentive Plan (the "1995 Plan"). The 1995 Plan provides that the Company may
grant an aggregate number of options for up to 1,250,000 shares of common stock
to employees, directors and other eligible persons as defined by the 1995 Plan.
Options issued to date under the 1995 Plan generally vest over varying periods
from zero (0) to five (5) years and generally expire five (5) to ten (10) years
from the date of grant.
The Company currently has 1,610,720 options outstanding to purchase common
stock of EarthShell Corporation. The exercise prices range from $0.75-$252.00
per share. Options to purchase 375,000 shares of commons stock which were
granted in December of 2005 are subject to shareholder approval by the
stockholders of an increase in the number of shares of common stock reserved to
issue under the 1995 Stock Incentive Plan at the next annual meeting of the
stockholders.
78
Transfer Agent
The transfer agent for EarthShell common stock is U.S. Stock Transfer
Corporation. Its address is 1745 Gardena Avenue, Suite 200, Glendale, California
91204 and its telephone number is (800) 835-8778.
Reports To Shareholders
We intend to furnish our stockholders with annual reports which will
describe the nature and scope of our business and operations for the prior year
and will contain a copy of the Company's audited financial statements for its
most recent fiscal year.
Limitation Of Liability: Indemnification
The Company's Amended and Restated Certificate of Incorporation limits the
liability of directors to the maximum extent permitted by Delaware law. Delaware
law provides that Directors of a company will not be personally liable for
monetary damages for breach of their fiduciary duties as directors, except for
liability for (i) any breach of their duty of loyalty to the company or its
stockholders, (ii) acts or omissions not in good faith or involving intentional
misconduct or a knowing violation of law, (iii) unlawful payment of dividends or
unlawful stock repurchases or redemptions as provided in Section 174 of the
Delaware General Corporation Law, or (iv) any transaction from which the
director derived an improper personal benefit.
The Company's Bylaws provide that the Company shall indemnify its
officers, Directors, employees and other agents to the maximum extent permitted
by Delaware law. The Company's Bylaws also permit it to secure insurance on
behalf of any officer, director, employee or other agent for any liability
arising out of his or her actions in such capacity, regardless of whether the
Bylaws would permit indemnification.
The Company believes that the provisions in its Certificate of
Incorporation and its Bylaws are necessary to attract and retain qualified
persons as officers and Directors.
Insofar as indemnification for liabilities arising under the 1933 Act may
be permitted to Directors, officers and controlling persons of EarthShell
pursuant to the foregoing, or otherwise, the Company has been advised that in
the opinion of the SEC such indemnification is against public policy as
expressed in the 1933 Act and is, therefore, unenforceable.
Anti-Takeover Effects Of Provisions Of The Articles Of Incorporation
The Company is subject to Section 203 of the Delaware General Corporation
Law ("Section 203"), which restricts certain transactions and business
combinations between a corporation and an "Interested Stockholder" owning
fifteen percent (15%) or more of the corporation's outstanding voting stock, for
a period of three (3) years from the date the stockholder becomes an Interested
Stockholder. Subject to certain exceptions, unless the transaction is approved
by the board of directors and the holders of at least 66 2/3% of the outstanding
voting stock of the corporation (excluding shares held by the Interested
Stockholder), Section 203 prohibits significant business transactions such as a
merger with, disposition of assets to, or receipt of disproportionate financial
benefits by the Interested Stockholder, or any other transaction that would
increase the Interested Stockholder's proportionate ownership of any class or
series of the corporation's stock. The statutory ban does not apply if, upon
consummation of the transaction in which any person becomes an Interested
Stockholder, the Interested Stockholder owns at least eighty-five percent (85%)
of the outstanding voting stock of the corporation (excluding shares held by
persons who are both Directors and officers or by certain employee stock plans).
The Company's Amended and Restated Certificate of Incorporation and Bylaws
include a number of provisions which may have the effect of discouraging persons
from pursuing non-negotiated takeover attempts. These provisions include
limitations on stockholder action initiated by Interested Stockholders, a
prohibition on the call of special meetings of stockholders by persons other
than the Board, and a requirement of advance notice for the submission of
stockholder proposals or Director nominees.
79
EXPERTS
The audited financial statements included in this prospectus and elsewhere
in the registration statement for the fiscal years ended December 31, 2005,
December 31, 2004 and December 31, 2003 have been audited by Farber Hass Hurley
& McEwen, LLP (formerly Farber & Hass, LLP). The reports of Farber Hass Hurley &
McEwen, LLP are included in this prospectus in reliance upon the authority of
this firm as experts in accounting and auditing. The report of Farber Hass
Hurley & McEwen LLP contained elsewhere in this prospectus contain an
explanatory paragraph regarding its ability to continue as a going concern.
VALIDITY OF SECURITIES
The validity of the shares offered herein will be opined on for us by
Kirkpatrick & Lockhart Nicholson Graham LLP, which has acted as our outside
legal counsel in relation to certain, restricted tasks.
INTERESTS OF NAMED EXPERT AND COUNSEL
Legal Matters
The validity of the shares of common stock offered hereby as to their
being fully paid, legally issued and non-assessable will be passed upon for us
by Kirkpatrick & Lockhart Nicholson Graham LLP, Miami, Florida. Kirkpatrick &
Lockhart Nicholson Graham LLP does not have any interests in EarthShell and has
never been employed by EarthShell on a contingent basis.
The audited consolidated financial statements of the Company for the years
ended December 31, 2005, December 31, 2004 and December 31, 2003 have been
audited by Farber Hass Hurley & McEwen, LLP. Farber Hass Hurley & McEwen, LLP
does not have any interests in EarthShell and have never been employed by
EarthShell on a contingent basis.
HOW TO GET MORE INFORMATION
We have filed with the SEC a Registration Statement on Form S-1 under the
1933 Act with respect to the securities offered by this Prospectus. This
prospectus, which forms a part of the Registration Statement, does not contain
all the information set forth in the Registration Statement, as permitted by the
rules and regulations of the SEC. For further information with respect to us and
the securities offered by this Prospectus, reference is made to the Registration
Statement. Statements contained in this Prospectus as to the contents of any
contract or other document that we have filed as an exhibit to the registration
statement are qualified in their entirety by reference to the to the exhibits
for a complete statement of their terms and conditions. The Registration
Statement and other information may be read and copied at the SEC's Public
Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may
obtain information on the operation of the Public Reference Room by calling the
SEC at 1-800-SEC-0330. The SEC maintains a web site at http://www.sec.gov that
contains reports, proxy and information statements, and other information
regarding issuers that file electronically with the SEC.
80
EARTHSHELL CORPORATION
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES*
PAGE
EARTHSHELL CORPORATION FINANCIAL STATEMENTS FOR MARCH 31, 2006
Condensed Consolidated Balance Sheets as of March 31, 2006 (unaudited)
and December 31, 2005 F-1
Condensed Consolidated Statements of Operations for the three month
periods ended March 31, 2006 and March 31, 2005 (unaudited) F-2
Condensed Consolidated Statements of Cash Flows for the three months
ended March 31, 2006 and March 31, 2005 (unaudited) F-3
Notes to Condensed Consolidated Financial Statements (unaudited) F-5
EARTHSHELL CORPORATION FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2005, 2004 AND 2003
Reports of Independent Registered Public Accounting Firm F-11
Consolidated Balance Sheets as of December 31, 2005 and 2004 F-12
Consolidated Statements of Operations for the years ended December 31,
2005, 2004 and 2003 F-13
Consolidated Statements of Stockholders' Equity (Deficit) for the years
ended December 31, 2005, 2004 and 2003 F-14
Consolidated Statements of Cash Flows for the years ended December 31,
2005, 2004 and 2003 F-15
Notes to Consolidated Financial Statements F-18
* Consolidated Financial Statement Schedules have been omitted because they
are not required, not applicable, or the information required to be set
forth therein is included in the Company's Consolidated Financial
Statements or the Notes therein.
F-i
EARTHSHELL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31 DECEMBER 31
2006 2005
------------- -------------
(UNAUDITED)
ASSETS
CURRENT ASSETS
Cash and cash equivalents ................. $ 623,727 $ 347,812
Prepaid expenses and other current assets . 54,529 83,473
------------- -------------
Total current assets .................... 678,256 431,285
PROPERTY AND EQUIPMENT, NET ................. 12,504 11,991
EQUIPMENT HELD FOR SALE ..................... 1 1
------------- -------------
TOTALS .................................. $ 690,761 $ 443,277
============= =============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Accounts payable and accrued expenses ..... $ 5,049,163 $ 5,908,670
Current portion of settlements ............ 234,423 300,786
Current portion of deferred revenues ...... 100,000 100,000
Contingent settlement ..................... 1,816,937 2,375,000
Note payable, net of discount of $168,901 . -- 2,355,296
Payable to a related party ................ 1,000,000 850,000
------------- -------------
Total current liabilities ............... 8,200,523 11,889,752
DEFERRED REVENUES, LESS CURRENT PORTION ..... 762,500 787,500
Note payable, net of discount of $1,927,345 2,572,655 --
OTHER LONG-TERM LIABILITIES ................. 88,794 117,914
------------- -------------
Total liabilities ....................... 11,624,472 12,795,166
STOCKHOLDERS' DEFICIT
Preferred Stock, $.01 par value, 10,000,000
shares authorized; 9,170,000 Series A
shares designated: no shares issued and
outstanding as March 31, 2006 and
December 31 2005 .......................... -- --
Common Stock, $.01 par value, 40,000,000
shares authorized: 19,340,188
and 18,981,167 shares issued and
outstanding as of March 31, 2006 and
December 31 2005, respectively ............ 193,402 189,812
Additional paid-in common capital ........... 317,907,809 315,306,825
Accumulated deficit ......................... (328,977,790) (327,786,868)
Accumulated other comprehensive loss ........ (57,132) (61,658)
------------- -------------
Total stockholders' deficit ............... (10,933,711) (12,351,889)
------------- -------------
TOTALS .................................... $ 690,761 $ 443,277
============= =============
See Notes to Condensed Consolidated Financial Statements.
F-1
EARTHSHELL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
FOR THE
THREE MONTHS ENDED
MARCH 31,
----------------------------
2006 2005
------------ ------------
Revenues ........................................... $ 25,000 $ 75,000
Operating Expenses
Other research and development expenses ......... 30,643 103,595
Related party general and administrative expenses 20,000 578
Other general and administrative expenses ....... 921,402 1,032,313
Depreciation and amortization ................... 1,103 837
------------ ------------
Total operating expenses ...................... 973,148 1,137,323
Operating Loss ..................................... 948,148 1,062,323
Other (Income) Expense
Interest income ................................. (3,360) (478)
Related party interest expense .................. 28,372 556
Other interest expense .......................... 498,882 21,461
Gain on sales of property and equipment ......... (26,096) (7,105)
Gain on settlement of debt ...................... (255,024) --
------------ ------------
Loss Before Income Taxes ........................... 1,190,922 1,076,757
Income taxes ....................................... -- 800
------------ ------------
Net Loss ........................................... $ 1,190,922 $ 1,077,557
============ ============
Basic and Diluted Loss Per Common Share ............ $ 0.06 $ 0.06
Weighted Average Number of Common Shares ........... 19,302,932 18,250,260
See Notes to Condensed Consolidated Financial Statements.
F-2
EARTHSHELL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
----------------------------
2006 2005
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss ................................................................. $ (1,190,922) $ (1,077,557)
Adjustments to reconcile net loss to net cash used in operating activities
Depreciation and amortization .......................................... 1,103 838
Amortization of debt discount .......................................... 344,114 5,922
(Gain) Loss on sale, disposal, or impairment of property and equipment . (26,096) (7,105)
(Gain) on settlements of debt .......................................... (255,024) --
Other non-cash expense items ........................................... 39,367 (89,354)
Changes in operating assets and liabilities
Prepaid expenses and other current assets .............................. 28,944 58,382
Deferred revenues ...................................................... (25,000) 175,000
Accounts payable and accrued expenses .................................. (480,528) 90,869
Other long-term liabilities ............................................ 2,828 485
------------ ------------
Net cash used in operating activities ................................ (1,561,214) (842,520)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment ....................................... (1,615) --
Proceeds from sales of property and equipment ............................ 26,096 7,105
------------ ------------
Net cash provided by investing activities .............................. 24,481 7,105
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock ................................... -- 25,000
Proceeds from issuance of warrants (net of costs of $39,366) ............. 60,634
Proceeds from issuance of notes payable to related party ................. 150,000 251,000
Repayment of notes payable to related party .............................. -- (250,000)
Principal payments on settlements ........................................ (98,311) (93,412)
Proceeds from issuance of note payable ................................... 1,975,803 1,150,000
Note payable issuance costs .............................................. (280,000) (187,000)
------------ ------------
Net cash provided by financing activities .............................. 1,808,126 895,588
------------ ------------
Effect of exchange rate changes on cash and cash equivalents ........... 4,522 (4,686)
------------ ------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ............................ 275,915 55,487
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD .............................. 347,812 272,371
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD .................................... $ 623,727 $ 327,858
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for
Income taxes ........................................................... $ -- $ 800
Interest ............................................................... $ 105,924 $ 3,657
F-3
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
In March of 2005, in consideration for a loan guarantee, the Company issued a
warrant to Benton Wilcoxon to purchase 65,000 shares of common stock of the
Company at an exercise price of $ 3.00 per share. The warrant expires on March
23, 2008. Using the Black-Scholes pricing model, the warrant was valued at
$34,980. Also in March of 2005, in consideration for consulting services
rendered in connection with the company obtaining financing, the Company issued
a warrant to Douglas Metz for 80,000 shares of common stock of the Company at an
exercise price of $3.00 per share. The warrant expires on March 23, 2008. Using
the Black-Scholes pricing model, the warrant was valued at $43,048.
In May 2005, the Company issued a warrant to Cornell Capital Partners (CCP) to
purchase 625,000 shares of common stock of the Company. The warrant expires on
the later of : (a) May 26,2006 or (b) the date sixty days after the date the
$2,500,000 in promissory notes issued to Cornell Capital are fully repaid. The
warrant has an exercise price of $4.00 per share of common stock. Using the
Black-Scholes pricing model, the warrant was valued at $47,345.
In August 2005, the Company issued a warrant to CCP to purchase 50,000 shares of
common stock of the Company in consideration for consolidating the two CCP
promissory notes and extending the date upon which amortization and repayment of
the notes is to begin. The warrant expires on the later of: (a) August 26, 2007
or (b) the date sixty days after the date the $2,500,000 in promissory notes
issued to Cornell Capital are fully repaid. The warrant has an exercise price of
$4.00 per share of common stock. Using the Black-Scholes pricing model, the
warrant was valued at $3,788.
On October 11, 2005, the Company entered into a debt conversion and mutual
release agreement (the "Debt Conversion Agreement") with EKI. Pursuant to the
Debt Conversion Agreement, the Company and EKI agreed that the remaining payable
of $837,145 (previously owed to Bio-Tec Biologische Naturverpackunger GmbH &
Co.KG, but which payable was subsequently assigned to EKI) be converted into
279,048 shares of common stock of the Company. The conversion price equaled
$3.00 per share. Pursuant to the Debt Conversion Agreement, the Company and EKI
released each other from any and all claims in connection with the receivable.
In connection with a Securities Purchase Agreement dated December 30, 2005, the
Company issued to Cornell Capital Partners a warrant to purchase up to 350,000
shares of common stock (the "Cornell Capital Warrant"). This Cornell Capital
Warrant has an exercise price of $4.00 per share, which may be adjusted under
certain conditions to as low as $3.00 per share and expires two years from the
date it was issued. Furthermore, in connection with the Company's sale of
Cornell Capital Debentures, in January 2006 the Company issued to Mr. Benton
Wilcoxon, in consideration of his pledge of shares of common stock of Composite
Technology Corporation pursuant to the terms of the IPEA, a warrant to purchase
up to 125,000 shares of common stock. This warrant has an exercise price of
$4.00 per share and expires three years from the date it was issued. Using the
Black-Scholes pricing model, the warrants were valued at $241,155.
On January 11, 2006, the Company issued 186,021 shares of the Company's common
stock to SF Capital Partners pursuant to a conversion right related to the
Contingent Settlement of $2.375 million reached under the September 30, 2004
Amended and Restated Debenture Purchase Agreement. Under the terms of the
agreement, SF Capital has the right to convert any or all of the Contingent
Settlement amount into the Company's common stock at $3.00 per share. SF Capital
Partners delivered a conversion notice to the Company requesting conversion of
$558,063 of the Contingent Settlement into shares of the Company's common stock.
Following the conversion, the remaining balance of the Contingent Settlement was
approximately $1.8 million. The Company recorded that difference between the
conversion value and the fair value of the common stock at the time of the
conversion as a settlement gain in the amount of $213,924.
On February 9, 2006, the Company issued 123,000 shares of stock in settlement of
certain outstanding payables and settlement of litigation with Van Dam Machine
Corporation. A gain on the settlements amounting to $41,100 was recorded in the
quarter ended March 31, 2006.
On February 10, 2006, in connection with the issuance of a license and stock
purchase agreement, the Company issued a warrant to EarthShell Asia to purchase
1,033,033 shares of the Company's common stock at $3.90 per share, which, under
certain circumstances, may be adjusted to an exercise price of not less than
$3.00 per share. The warrant expires December 27, 2010. The Company received the
remaining $100,000 (less fees of $39,366) due under the license and stock
purchase agreement and subsequently issued the warrant.
F-4
On March 6, 2006, the Company issued a total of 50,000 shares of common stock to
current and past Directors pursuant to restricted stock grants given to the
directors in June 2005 as a bonus in recognition for their willingness to defer
their cash compensation since 2004. An accrual to compensation expense was
recorded in 2005.
See Notes to Condensed Consolidated Financial Statements.
F-5
EARTHSHELL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 2006
OVERVIEW OF OPERATIONS
Organized in November 1992 as a Delaware corporation, EarthShell Corporation
(the "Company") is engaged in the commercialization of composite material
technology for the manufacture of foodservice disposable packaging designed with
the environment in mind. EarthShell Packaging is based on patented composite
material technology (collectively, the "EarthShell Technology"), licensed on an
exclusive, worldwide basis from E. Khashoggi Industries, LLC and its wholly
owned subsidiaries.
The EarthShell Technology has been developed over many years in consultation
with leading material scientists and environmental experts to reduce the
environmental burdens of foodservice disposable packaging through the careful
selection of raw materials, processes, and suppliers. EarthShell Packaging,
including hinged-lid sandwich containers, plates, bowls, foodservice wraps, and
cups, is primarily made from commonly available natural raw materials such as
natural ground limestone and vegetable starches such as corn and
potato.EarthShell believes that EarthShell Packaging has comparable or superior
performance characteristics and can be commercially produced and sold at prices
that are competitive with comparable paper and plastic foodservice disposables.
EarthShell was a development stage enterprise through the first quarter of
2004.With the recognition of the Company's first revenues in the second quarter
of 2004, the Company was no longer a development stage enterprise.
BASIS OF PRESENTATION OF FINANCIAL INFORMATION
The foregoing financial information has been prepared from the books and records
of EarthShell Corporation. EarthShell Corporation's consolidated financial
statements include the accounts of its wholly-owned subsidiary, PolarCup
EarthShell GmbH. All significant intercompany balances and transactions have
been eliminated in consolidation. In the opinion of management, the financial
information reflects all adjustments, consisting of normal recurring adjustments
which are, in the opinion of management, necessary for a fair presentation of
the financial condition, results of operations and cash flows of the Company in
conformity with accounting principles generally accepted in the United States.
The accompanying consolidated financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the satisfaction
of liabilities in the normal course of business. The Company has incurred
significant losses since inception, has minimal revenues and has a working
capital deficit of $7.5 million at March 31, 2006. These factors, along with
others, indicate substantial doubt that the Company will be able to continue as
a going concern for the next 12 months.
F-6
EARTHSHELL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 2006
On December 30, 2005 the Company entered into a financing transaction with
Cornell Capital Partners to borrow $4.5 million, of which, the Company received
$1.7 million in net proceeds after repayment of prior loans of $2.5 million and
payment of fees in the amount of $0.3 million (See Item 2. Management's
Discussion and Analysis of Financial Condition and Results of Operation -
Liquidity and Financial Resources). On January 6, 2006, the Company received
this funding. The Company will have to raise additional funds to meet its
current obligations and to cover operating expenses through the year ending
December 31, 2006. If the Company is not successful in raising additional
capital it may not be able to continue as a going concern. Management plans to
address this need by raising cash through the sale of licenses, the generation
of royalty revenues, short term borrowings, and the issuance of debt or equity
securities. However, the Company cannot assure that additional financing will be
available to it, or, if available, that the terms will be satisfactory, or that
it will be able to sell additional licenses and receive any royalty payments in
2006. Management will also continue in its efforts to reduce expenses, but
cannot assure that it will be able to reduce expenses below current levels. The
consolidated financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the amounts and
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern. The Company's continuation as a going
concern is dependent upon its ability to generate sufficient cash flow to meet
its obligations on a timely basis, to obtain additional financing or refinancing
as may be required, and ultimately to attain successful operations.
PROPERTY AND EQUIPMENT AND EQUIPMENT HELD FOR SALE
The cost and accumulated depreciation of property and equipment and equipment
held for sale at March 31, 2006 and December 31, 2005 were as follows:
MARCH 31, DECEMBER 31,
2006 2005
------------ ------------
Total office furniture and equipment ........... 160,469 158,854
Less: Accumulated depreciation and amortization (147,965) (146,863)
------------ ------------
Property and equipment - net ................... $ 12,504 $ 11,991
============ ============
Equipment held for sale ........................ $ 1 $ 1
============ ============
ACCOUNTS PAYABLE AND ACCRUED EXPENSES
The following is a summary of accounts payable and accrued expenses at March 31,
2006 and December 31, 2005:
2006 2005
------------ ------------
Accounts payable and other accrued expenses ...... $ 4,180,039 $ 3,137,261
Legal accruals ................................... 208,442 1,920,575
Deferred officer compensation .................... 456,923 453,544
Accrued property taxes ........................... 116,002 116,002
Accrued salaries, wages and benefits ............. 87,757 281,288
------------ ------------
Total accounts payable and accrued expenses ...... $ 5,049,163 $ 5,908,670
============ ============
F-7
EARTHSHELL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 2006
NOTES PAYABLE
Cornell Capital Debentures. On December 30, 2005, EarthShell entered into a
Securities Purchase Agreement with Cornell Capital Partners (the "Cornell
Capital Debenture Purchase Agreement") pursuant to which the Company issued to
Cornell Capital Partners $4.5 million in principal amount of secured convertible
debentures (the "Cornell Capital Debentures") on the terms described below. This
agreement was consummated on January 6, 2006. The Cornell Capital Debentures are
convertible into shares of the Company's common stock on the terms discussed
below. The Company received the net proceeds of $1.7 million from the issuance
of the Cornell Capital Debentures on January 6, 2006, after repayment of prior
loans to Cornell Capital Partners of $2.5 million and payment of fees in the
amount of $0.3 million.
The Cornell Capital Debentures are secured by (i) a Pledge and Escrow Agreement,
by and among the Company, Cornell Capital Partners, and David Gonzalez, Esq.,
(ii) an Insider Pledge Agreement and Escrow Agreement (the "IPEA"), by and among
the Company, Cornell Capital Partners, David Gonzalez, Esq. and Mr. Benton
Wilcoxon and (iii) an Amended and Restated Security Agreement, by and between
the Company and Cornell Capital Partners. The Cornell Capital Debentures are
secured by substantially all of the Company's assets, have a three year term and
accrue interest at 12% per annum. The Cornell Capital Debenture Purchase
Agreement required the Company to register the shares of the Company's common
stock into which the Cornell Capital Debentures are convertible under the
Securities Act of 1933. On February 14, 2006, the Company filed a registration
statement on Form S-1 with the Securities and Exchange Commission ("SEC") in
order to register 6,700,000 shares of common stock that may be issuable to the
holders of the Cornell Capital Debentures upon conversion. Beginning 60 days
after the SEC declares the registration statement effective, Cornell Capital
Partners is entitled, at its option, to convert and sell up to $250,000 of the
principal amount of the Cornell Capital Debentures, plus accrued interest, into
shares of the Company's common stock, within any 30 day period at the lesser of
(i) a price equal to $3.00 or (ii) 88% of the average of the two lowest volume
weighted average prices of the common stock during the ten trading days
immediately preceding the conversion date, as quoted by Bloomberg, LP.
In connection with the Cornell Capital Debenture Purchase Agreement, on December
30, 2005, the Company issued to Cornell Capital Partners a warrant to purchase
up to 350,000 shares of common stock (the "Cornell Capital Warrant"). This
Cornell Capital Warrant has an exercise price of $4.00 per share, which may be
adjusted under certain conditions to as low as $3.00 per share and expires two
years from the date it was issued. Furthermore, in connection with the Company's
issuance of the Cornell Capital Debentures, the Company issued to Mr. Benton
Wilcoxon, in consideration of his pledge of shares of common stock of Composite
Technology Corporation pursuant to the terms of the IPEA, a warrant to purchase
up to 125,000 shares of common stock. This warrant has an exercise price of
$4.00 per share and expires three years from the date it was issued. Using the
Black-Scholes pricing model, the warrants were valued at $241,155.
The Company has valued the convertible note payable, related warrants and the
beneficial conversion feature to convert the principal balance into shares,
using the "Relative Fair Value" approach. Accordingly, the Company recognized a
discount of $2.1 million (which includes $0.3 million of issue costs) on the
$4.5 million principal value of the convertible note payable and is amortizing
the debt discount over the 36 month life of the note.
F-8
EARTHSHELL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 2006
STOCK OPTIONS
Effective January 1, 2006, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 123(R), "Share-Based Payment: A Revision of SFAS
Statement No. 123" using the modified prospective method. Under this method,
compensation cost is recognized on or after the effective date for the portion
of outstanding awards, for which the requisite service has not yet been
rendered, based on the grant date fair value of those awards. Prior to January
1, 2006, the Company accounted for employee stock options using the intrinsic
value method in accordance with Accounting Principles Board ("APB") Opinion No.
25 ("APB No. 25"), "Accounting for Stock Issued to Employees," and adopted the
disclosure only alternative of SFAS No. 123. For stock-based awards issued on or
after January 1, 2006, the Company recognizes the compensation cost on a
straight-line basis over the requisite service period for the entire award.
Measurement and attribution of compensation cost for awards existing on December
31, 2005 that are unvested as of the effective date of SFAS No. 123(R) are based
on the same estimate of the grant-date or modification-date fair value and the
same attribution method used previously under SFAS No. 123. There were no stock
option grants during three month period ended March 31, 2005. One option grant
in the amount of 10,271 shares expired under its terms. The outstanding balance
of all stock options of March 31, 2005 was 1,610,720.
STOCK OPTIONS
In 1994 the Company established the EarthShell Corporation 1994 Stock Option
Plan (the "1994 Plan"). In 1995 the Company subsequently established the
EarthShell Corporation 1995 Stock Incentive Plan (the "1995 Plan") which
effectively superseded the 1994 Plan for options issued on or after the date of
the 1995 Plan's adoption. The 1994 and 1995 Plans as amended (the "Plans")
provide that the Company may grant an aggregate number of options for up to
1,250,000 shares of common stock to employees, directors and other eligible
persons as defined by the Plans. Options issued to date under the Plans
generally vest over varying periods from 0 to 5 years and generally expire 10
years from the date of grant. Some of the options granted are subject to
approval by the shareholders of an increase in the number of shares reserved for
issuance under the Plans.
Effective January 1, 2006, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 123(R), "Share-Based Payment: An Amendment of FASB
Statements No. 123 and 95" using the modified prospective method. Under this
method, compensation cost is recognized on or after the effective date for the
portion of outstanding awards, for which the requisite service has not yet been
rendered, based on the grant date fair value of those awards. Prior to January
1, 2006, the Company accounted for employee stock options using the intrinsic
value method in accordance with Accounting Principles Board ("APB") Opinion No.
25 ("APB No. 25"), "Accounting for Stock Issued to Employees," and adopted the
disclosure only alternative of SFAS No. 123. For stock-based awards issued on or
after January 1, 2006, the Company recognizes the compensation cost on a
straight-line basis over the requisite service period for the entire award.
Measurement and attribution of compensation cost for awards existing on December
31, 2005 that are unvested as of the effective date of SFAS No. 123(R) are based
on the same estimate of the grant-date or modification-date fair value and the
same attribution method used previously under SFAS No. 123. As of January 1,
2006, the Company had 379,167 shares for which the requisite service period has
not yet been met. The compensation expense recorded for the portion of these
whose requisite service period had been rendered for the three months ended
March 31, 2006 was $0.1 million.
Information with respect to stock options is as follows for the three months
ended March 31, 2006:
Weighted-Average
Remaining Aggregate
Weighted-Average Contractual Term Intrinsic
Shares Exercise Price (in years) Value
--------- ---------------- ---------------- ---------
Outstanding as of January
1, 2006 1,629,425 $ 6.68 -- --
Granted -- -- -- --
Exercised -- -- -- --
Forfeited / Cancelled 18,705 $ 57.45 -- --
--------- ---------------- ---------------- ---------
Outstanding as of
March 31, 2006 1,610,720 $ 6.0 7.3 $ 36,000
========= ================ ================ =========
Options exercisable as of
March 31, 2006 1,033,220 $ 6.5 6.4 $ 192,000
========= ================ ================ =========
In accordance SFAS 123(R), the required pro forma disclosure for the three month
period ended March 31, 2005 is shown below:
Net Loss as reported .............................................. $1,077,557
Deduct:
Stock-based employee compensation
expense included in reported net loss,
net of tax ..................................................... --
Add:
Total stock-based employee compensation
determined under fair value based method
for all awards, net of tax ..................................... $ 5,275
----------
Pro forma net loss ................................................ $1,082,832
==========
Basic diluted loss per common share
As reported .................................................... $ 0.06
Pro forma ...................................................... $ 0.06
STOCK TRANSACTIONS
On January 11, 2006, the Company issued 186,021 shares of the Company's common
stock to SF Capital Partners pursuant to a conversion right related to the
Contingent Settlement of $2.375 million reached under the September 30, 2004
Amended and Restated Debenture Purchase Agreement. Pursuant to the Contingent
Settlement, EarthShell must pay $2.375 million to SF Capital Partners from 33%
of any equity funding received by the Company (excluding the first $2.7 million
funded by MBS) or 50% of the royalties received by EarthShell in excess of
$250,000 per month (as determined on a cumulative basis commencing July 1,
2004). The Company has the right to convert the unpaid portion of the $2.375
million into shares of the Company's common stock at a price equal to the lesser
of $3.00 per share, or the price per share that EarthShell shall subsequently
receive upon the issuance of its common stock (or other convertible security)
during the three year period commencing September 30, 2004. SF Capital Partners
delivered a conversion notice to the Company on January 11, 2006 requesting
conversion of $558,063 of the Contingent Settlement into shares of the Company's
common stock. Following the conversion, the remaining balance of the Contingent
Settlement was approximately $1.8 million. The Company recorded that difference
between the conversion value and the fair value of the common stock at the time
of the conversion as a settlement gain in the amount of $213,924.
F-9
EARTHSHELL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 2006
On February 9, 2006, the Company issued 123,000 shares of stock in settlement of
certain outstanding payables and settlement of litigation with Van Dam Machine
Corporation. As a result, the Company recorded settlement gains of $41,100
during the quarter ended March 31, 2006.
On February 10, 2006, in connection with the issuance of a license and stock
purchase agreement, the Company issued a warrant to EarthShell Asia to purchase
1,033,033 shares of the Company's common stock at $3.90 per share, which, under
certain circumstances, may be adjusted to an exercise price of not less than
$3.00 per share. The warrant expires on December 27, 2010. The Company received
the remaining $100,000 (less legal fees of $39,366) due under the license and
stock purchase agreement and subsequently issued the warrant.
On March 6, 2006, the Company issued a total of 50,000 shares of common stock to
current and past Directors pursuant to restricted stock grants given to the
directors in June 2005 as a bonus in recognition for their willingness to defer
their cash compensation since 2004. This transaction was accounted for in June
2005.
F-10
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of EarthShell Corporation:
We have audited the accompanying consolidated balance sheets of EarthShell
Corporation (the "Company") as of December 31, 2005 and 2004, and the related
consolidated statements of operations, stockholders' (deficit) equity, and cash
flows for the years ended December 31, 2005, 2004 and 2003. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with 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. The Company is not required to,
nor were we engaged to perform, an audit of its control over financial reporting
as a basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Company's internal control over financial reporting.
Accordingly we express no such opinion. 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, based on our audits, such consolidated financial statements
present fairly, in all material respects, the financial position of the Company
as of December 31, 2005 and 2004, and the results of its operations and its cash
flows for the years ended December 31, 2005, 2004 and 2003, in conformity with
accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in the notes to
the consolidated financial statements, the Company has incurred significant
losses, has minimal revenues and has a working capital deficit of $11,458,467
and a stockholders' deficit of $12,351,889 as of December 31, 2005. These
matters raise substantial doubt about the Company's ability to continue as a
going concern. Management's plans concerning these matters are also described in
the notes to the consolidated financial statements. The consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
/s/ Farber Hass Hurley & McEwen, LLP
Camarillo, California
March 10, 2006
F-11
EARTHSHELL CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31,
------------------------------
2005 2004
------------- -------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents ............................ $ 347,812 $ 272,371
Prepaid expenses and other current assets ............ 83,473 201,467
------------- -------------
Total current assets ............................... 431,285 473,838
PROPERTY AND EQUIPMENT, NET ............................. 11,991 9,037
EQUIPMENT HELD FOR SALE ................................. 1 1
------------- -------------
TOTAL ASSETS ............................................ $ 443,277 $ 482,876
============= =============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Accounts payable and accrued expenses ................ $ 5,908,670 $ 3,899,526
Current portion of settlements ....................... 300,786 313,743
Current portion of deferred revenues ................. 100,000 300,000
Payable to related party, current .................... 850,000 875,000
Debenture settlement ................................. 2,375,000 2,375,000
Note Payable, net of discount of $168,901 ............ 2,355,296 --
------------- -------------
Total current liabilities .......................... 11,889,752 7,763,269
DEFERRED REVENUES, LESS CURRENT PORTION ................. 787,500 1,062,500
OTHER LONG-TERM LIABILITIES ............................. 117,914 412,192
------------- -------------
Total liabilities .................................... 12,795,166 9,237,961
------------- -------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' DEFICIT
Preferred Stock, $.01 par value, 10,000,000 shares
authorized; 9,170,000 Series A shares designated;
no shares issued and outstanding as of
December 31, 2005 and 2004 ....................... -- --
Common stock, $.01 par value, 40,000,000 shares
authorized; 18,981,167 and 18,234,615 shares
issued and outstanding as of December 31, 2005
and 2004, respectively ........................... 189,812 182,346
Additional paid-in common capital .................. 315,306,825 313,196,905
Accumulated deficit ................................ (327,786,868) (321,607,782)
Less note receivable for stock ..................... -- (500,000)
Accumulated other comprehensive loss ............... (61,658) (26,554)
------------- -------------
Total stockholders' deficit ...................... (12,351,889) (8,755,085)
------------- -------------
TOTAL LIABILITES AND STOCKHOLDERS' DEFICIT ....... $ 443,277 $ 482,876
============= =============
See Notes to Consolidated Financial Statements.
F-12
EARTHSHELL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31,
--------------------------------------------
2005 2004 2003
------------ ------------ ------------
Revenues ...................................................... $ 183,333 $ 137,500 $ --
Operating Expenses
Related party license fee and research and development expenses -- 800,000 1,312,374
Other research and development expenses ....................... 200,817 370,163 8,234,416
General and administrative expenses ........................... 5,485,358 3,753,902 5,790,473
Related party general and administrative (reimbursements) ..... -- (4,875) (4,074)
Depreciation and amortization ................................. 2,939 42,236 379,949
Gain on sales of property and equipment ....................... (23,477) (168,458) (451,940)
------------ ------------ ------------
Total operating expenses ...................................... 5,665,637 4,792,968 15,261,198
Operating Loss ................................................ 5,482,304 4,655,468 15,261,198
Other (Income) Expenses
Interest income ............................................... (5,022) (4,606) (95,176)
Related party interest expense ................................ 101,314 410,965 445,628
Other interest expense ........................................ 599,690 661,721 1,440,118
Premium due to debenture default .............................. -- 1,672,426 --
Other income .................................................. -- -- (399,701)
(Gain) Loss on extinguishment of debentures ................... -- (139,673) 1,697,380
Debenture conversion costs .................................... -- -- 166,494
------------ ------------ ------------
Loss Before Income Taxes ...................................... 6,178,286 7,256,301 18,515,941
Income Taxes .................................................. 800 800 800
------------ ------------ ------------
Net Loss ...................................................... $ 6,179,086 $ 7,257,101 $ 18,516,741
============ ============ ============
Basic and Diluted Loss Per Common Share ....................... $ 0.33 $ 0.48 $ 1.40
Weighted Average Number of Common Shares Outstanding .......... 18,503,207 15,046,726 13,266,668
See Notes to Consolidated Financial Statements.
F-13
EARTHSHELL CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY
Common Stock
----------------------------
Additional
Paid-In
Common Accumulated
Shares Amount Capital Deficit
------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 2002 12,054,637 120,546 292,257,340 (295,833,940)
Issuance of common stock 137,264 1,373 811,267 --
Common stock and common
stock warrants issued
in connection with
issuance of convertible
debentures 624,747 6,248 2,921,594 --
Conversion of convertible
debentures to common
stock 1,312,318 13,123 7,536,877 --
Debenture conversion costs -- -- (1,493,332) --
Net loss -- -- -- (18,516,741)
Foreign currency
translation adjustment -- -- -- --
Comprehensive loss -- -- -- --
------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 2003 14,128,966 141,290 302,033,746 (314,350,681)
Issuance of common stock 2,443,272 24,432 7,181,970 --
Conversion of convertible
debentures to common
stock 1,662,377 16,624 4,970,508 --
Debenture conversion costs -- -- (989,319) --
Net loss -- -- -- (7,257,101)
Foreign currency
translation adjustment -- -- -- --
Comprehensive loss -- -- -- --
------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 2004 18,234,615 $ 182,346 $ 313,196,905 $(321,607,782)
============= ============= ============= =============
Issuance of common stock 266,667 2,667 797,333 --
Conversion of related
party note to common
stock 323,435 3,234 934,670 --
Common stock and common
stock warrants issued
in connection with
issuance of convertible
debentures 156,450 1,565 377,917 --
Net loss -- -- -- (6,179,086)
Foreign currency
translation adjustment -- -- -- --
Comprehensive loss -- -- -- --
------------- ------------- ------------- -------------
BALANCE, DECEMBER 31, 2005 18,981,167 $ 189,812 $ 315,306,825 $(327,786,868)
============= ============= ============= =============
Accumulated
Stock Other
Purchase Comprehensive
Receivable Loss Totals
------------- ------------- -------------
BALANCE, DECEMBER 31, 2002 -- (16,632) (3,472,686)
Issuance of common stock -- -- 812,640
Common stock and common
stock warrants issued
in connection with
issuance of convertible
debentures -- -- 2,927,842
Conversion of convertible
debentures to common
stock -- -- 7,550,000
Debenture conversion costs -- -- (1,493,332)
Net loss -- -- (18,516,741)
Foreign currency
translation adjustment -- (76,498) (76,498)
Comprehensive loss -- -- (18,593,239)
------------- ------------- -------------
BALANCE, DECEMBER 31, 2003 -- (93,130) (12,268,775)
Issuance of common stock (500,000) -- 6,706,402
Conversion of convertible
debentures to common
stock -- -- 4,987,132
Debenture conversion costs -- -- (989,319)
Net loss -- -- (7,257,101)
Foreign currency
translation adjustment -- 66,576 66,576
Comprehensive loss -- -- (7,190,525)
------------- ------------- -------------
BALANCE, DECEMBER 31, 2004 $ (500,000) $ (26,554) $ (8,755,085)
============= ============= =============
Issuance of common stock 500,000 -- 1,300,000
Conversion of related
party note to common
stock -- -- 937,904
Common stock and common
stock warrants issued
in connection with
issuance of convertible
debentures -- -- 379,482
Net loss -- -- (6,179,086)
Foreign currency
translation adjustment -- (35,104) (35,104)
Comprehensive loss -- -- (6,214,190)
------------- ------------- -------------
BALANCE, DECEMBER 31, 2005 -- $ (61,658) $ (12,351,889)
============= ============= =============
See Notes to Consolidated Financial Statements.
F-14
EARTHSHELL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
-----------------------------------------------
2005 2004 2003
------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss ................................................ $ (6,179,086) $ (7,257,101) $ (18,516,741)
Adjustments to reconcile net loss to net cash used in
operating activities
Bad debt expense ...................................... 183,333 -- --
Depreciation and amortization ......................... 2,939 42,236 379,949
Amortization and accretion of debenture issue costs ... 633,490 592,316 955,574
Compensation related to restricted stock issuance to
directors ........................................... 150,934 -- --
Interest paid in common stock ......................... 100,758 -- --
Premium due to debenture default ...................... -- 1,672,426 --
Debenture issuance and conversion costs ............... -- -- 166,494
Gain on change in fair value of warrant obligation .... -- -- (399,701)
(Gain) Loss on extinguishment of debentures ........... -- (139,673) 1,697,380
Beneficial conversion value due to change in debentures
conversion price .................................... -- -- 360,000
(Gain) Loss on sale, disposal or impairment of
property and equipment .............................. (23,476) (168,458) 3,548,059
Equity in the losses of joint venture ................. -- -- 392,116
Accrued purchase commitment ........................... -- -- (1,855,000)
Other non-cash expense items .......................... (223,962) 180,171 50,198
Changes in operating assets and liabilities
Prepaid expenses and other current assets ............. 117,994 120,549 264,153
Accounts payable and accrued expenses ................. 2,054,721 (553,710) (2,339,720)
Payable to related party .............................. (34,070) 1,043,869 1,214,683
Deferred revenues ..................................... (183,333) 1,362,500 --
Accrued purchase commitment ........................... -- -- (1,645,000)
Other long-term liabilities ........................... 28,914 378,859 33,333
------------- ------------- -------------
Net cash used in operating activities ............... (3,370,844) (2,726,016) (15,694,223)
============= ============= =============
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from release of restricted time deposit upon
settlement of purchase commitment ..................... -- -- 3,500,000
Proceeds from sales of property and equipment ........... 30,280 187,708 487,691
Investment in joint venture ............................. -- -- (26,104)
Purchases of property and equipment ..................... (12,697) (8,729) (1,320)
------------- ------------- -------------
Net cash provided by investing activities .......... 17,583 178,979 3,960,267
============= ============= =============
F-15
Year Ended December 31,
-----------------------------------------------
2005 2004 2003
------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock ..................... 800,000 2,086,755 --
Proceeds from issuance of common stock and convertible
debentures, net of issuance costs and discounts
amounting to approximately $3.4 million ................. -- -- 8,711,844
Proceeds from issuance of note payable ..................... 2,500,000 -- --
Proceeds from payment on stock purchase receivable ......... 25,000 -- --
Proceeds from release of restricted time deposit
upon conversion of convertible debentures into
common stock ............................................. -- -- 1,800,000
Proceeds from release of restricted time deposit
upon exchange of convertible debentures .................. -- -- 2,000,000
Proceeds from release of restricted time deposit for
repayment of convertible debentures ...................... -- -- 5,200,000
Repayment of convertible debentures ........................ -- (1,110,294) (5,200,000)
Principal payments on settlements .......................... (336,149) (66,387) --
Proceeds from issuance of notes payable to related party ... 850,000 -- 1,010,000
Note payable issuance costs ................................ (402,500) -- --
------------- ------------- -------------
Net cash provided by financing activities ................ 3,436,351 910,074 13,521,844
Effect of exchange rate changes on cash and cash equivalents (7,649) 7,695 2,736
------------- ------------- -------------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS .............. 75,441 (1,629,268) 1,790,624
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ................ 272,371 1,901,639 111,015
------------- ------------- -------------
CASH AND CASH EQUIVALENTS, END OF PERIOD ...................... $ 347,812 $ 272,371 $ 1,901,639
============= ============= =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for
Income taxes ............................................. $ 800 $ 800 $ 800
Interest ................................................. 410,772 111,353 21,058
Common stock warrants issued in connection with
convertible debentures ................................... 129,161 -- 745,562
Conversion of convertible debentures into common stock ..... 837,145 6,800,000 7,550,000
Interest paid in common stock .............................. 100,758 532,644 95,339
Commission paid in common stock ............................ -- -- 29,500
Common stock issued to service providers in connection
with the March 2003 financing ............................ -- -- 484,500
F-16
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
In March of 2005, in consideration for a loan guarantee, the Company issued
warrants to Benton Wilcoxon to purchase 65,000 shares of common stock of the
Company at an exercise price of $ 3.00 per share. The warrants expire on March
23, 2008. Using the Black-Scholes pricing model, the warrants are valued at $34,
980. Also in March of 2005, in consideration for consulting services rendered in
connection with the company obtaining financing, the Company issued a warrant to
Douglas Metz for 80,000 shares of common stock of the Company at an exercise
price of $3.00 per share. The warrant expires on March 23, 2008. Using the
Black-Scholes pricing model, the warrant was valued at $43,048.
In May 2005, the Company issued a warrant to Cornell Capital Partners (CCP) to
purchase 625, 000 shares of common stock of the Company. The warrant expires on
the later of : (a) May 26,2006 or (b) the date sixty days after the date the
$2,500,000 in promissory notes issued to Cornell Capital are fully repaid. The
warrant has an exercise price of $4.00 per share of common stock. Using the
Black-Scholes pricing model, the warrant was valued at $47,345.
In August 2005, the Company issued a warrant to CCP to purchase 50,000 shares of
common stock of the Company in consideration for consolidating the two CCP
promissory notes and extending the date upon which amortization and repayment of
the notes is to begin. The warrant expires on the later of: (a) May 26, 2006 or
(b) the date sixty days after the date the $2,500,000 in promissory notes issued
to Cornell Capital are fully repaid. The warrant has an exercise price of $4.00
per share of common stock. Using the Black-Scholes pricing model, the warrant
was valued at $3,788.
On October 11, 2005, the Company entered into a debt conversion and mutual
release agreement (the "Debt Conversion Agreement") with EKI. Pursuant to the
Debt Conversion Agreement, the Company and EKI agreed that the remaining payable
of $837,145 (previously owed to Bio-Tec Biologische Naturverpackunger GmbH &
Co.KG, but which payable was subsequently assigned to EKI) be converted into
279,048 shares of common stock of the Company. The conversion price equals $3.00
per share. Pursuant to the Debt Conversion Agreement, the Company and EKI
released each other from any and all claims in connection with the receivable.
In connection with a Securities Purchase Agreement, on December 30, 2005, the
Company issued to Cornell Capital Partners a warrant to purchase up to 350,000
shares of common stock (the "December Warrant). This December Warrant has an
exercise price of $4.00 per share, which may be adjusted under certain
conditions to as low as $3.00 per share and expires two years from the date it
was issued. Furthermore, in connection with the Company's sale of Cornell
Capital Debentures, the Company issued to Mr. Benton Wilcoxon, in consideration
of his pledge of shares of common stock of Composite Technology Corporation
pursuant to the terms of the IPEA, a warrant to purchase up to 125,000 shares of
common stock. This warrant has an exercise price of $4.00 per share and expires
three years from the date it was issued.
In 2003, warrants for the purchase of $1.055 million in aggregate principal
amount of convertible debentures and 70,477 shares of common stock were issued
in connection with the issuance of convertible debentures. The estimated fair
value of the warrants of $442,040, based upon the Black-Scholes method of
valuation, was recorded as an original issue discount thereby reducing the
carrying value of the convertible debentures and as an increase in additional
paid-in common capital.
In 2003, warrants for the purchase of 83,333 shares of common stock were issued
to EKI, in connection with the issuance of convertible debentures, in
consideration for its willingness to subordinate amounts owed to it. The
estimated fair value of the warrants of $303,522, based upon the Black-Scholes
method of valuation, was recorded as an original issue discount thereby reducing
the carrying value of the notes payable to EKI and as an increase in additional
paid-in common capital.
In 2003, 137,264 shares of common stock were issued to satisfy accounts payable
and accrued interest payable of $812,640.
See Notes to Consolidated Financial Statements.
F-17
EARTHSHELL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Overview of Operations
Organized in November 1992 as a Delaware corporation, EarthShell Corporation
(the "Company") is engaged in the commercialization of composite material
technology for the manufacture of foodservice disposable packaging designed with
the environment in mind. EarthShell Packaging is based on patented composite
material technology (collectively, the "EarthShell Technology"), licensed on an
exclusive, worldwide basis from E. Khashoggi Industries, LLC and its wholly
owned subsidiaries.
The EarthShell Technology has been developed over many years in consultation
with leading material scientists and environmental experts to reduce the
environmental burdens of foodservice disposable packaging through the careful
selection of raw materials, processes, and suppliers. EarthShell Packaging,
including hinged-lid sandwich containers, plates, bowls, foodservice wraps, and
cups, is primarily made from commonly available natural raw materials such as
natural ground limestone and potato starch. EarthShell believes that EarthShell
Packaging has comparable or superior performance characteristics and can be
commercially produced and sold at prices that are competitive with comparable
paper and plastic foodservice disposables.
EarthShell was a development stage enterprise through the first quarter of 2004.
With the recognition of the Company's first revenues in the second quarter of
2004, the Company was no longer a development stage enterprise.
Basis Of Presentation Of Financial Information
The foregoing financial information has been prepared from the books and records
of EarthShell Corporation. EarthShell Corporation's consolidated financial
statements include the accounts of its wholly-owned subsidiary, PolarCup
EarthShell GmbH. All significant intercompany balances and transactions have
been eliminated in consolidation. In the opinion of management, the financial
information reflects all adjustments necessary for a fair presentation of the
financial condition, results of operations and cash flows of the Company in
conformity with accounting principles generally accepted in the United States.
The accompanying consolidated financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the satisfaction
of liabilities in the normal course of business. The Company has incurred
significant losses since inception, has minimal revenues and has a working
capital deficit of $11,458,467 at December 31, 2005. These factors, along with
others, indicate substantial doubt that the Company will be able to continue as
a going concern for a reasonable period of time.
Subsequent to December 31, 2005 the Company entered into a financing transaction
to borrow $4.5 million, of which, the Company netted $1.6 million (See
Subsequent Events). On January 6, 2006, the Company received this funding. The
Company will have to raise additional funds to meet its current obligations and
to cover operating expenses through the year ending December 31, 2006. If the
Company is not successful in raising additional capital it may not be able to
continue as a going concern. Management plans to address this need by raising
cash through either the sale of licenses, the generation of royalty revenues or
the issuance of debt or equity securities. In addition, the Company expects cash
to be generated in 2006 through royalty payments from licensees. However, the
Company cannot assure that additional financing will be available to it, or, if
available, that the terms will be satisfactory, or that it will receive any
royalty payments in 2006. Management will also continue in its efforts to reduce
expenses, but can not assure that it will be able to reduce expenses below
current levels. The consolidated financial statements do not include any
adjustments relating to the recoverability and classification of recorded asset
amounts or the amounts and classification of liabilities that might be necessary
should the Company be unable to continue as a going concern.
The consolidated financial statements do not include any adjustments relating to
the recoverability and classification of recorded asset amounts or the amounts
and classification of liabilities that might be necessary should the Company be
unable to continue as a going concern. The Company's continuation as a going
concern is dependent upon its ability to generate sufficient cash flow to meet
its obligations on a timely basis, to obtain additional financing or refinancing
as may be required, and ultimately to attain successful operations.
F-18
EARTHSHELL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In January 2004, the Company announced that it was not in compliance with a
NASDAQ SmallCap Market minimum requirement. On March 8, 2004 the Company's
common stock was de-listed by the NASDAQ SmallCap Market and trading was moved
to the over-the-counter (OTC) [Pink Sheets Electronic Quotation Service]. Since
June 21, 2004, the Company's common stock has been listed through the OTC
Bulletin Board. The Company's common stock trades under the symbol "ERTH.OB."
Operations and Financing
The Company was engaged in initial concept development from 1993 to 1998. During
this period, the Company focused on enhancing the material science technology
licensed from EKI, initial development of the Company's foam packaging products
(primarily, its hinged-lid sandwich containers, which are referred to as
"hinged-lid containers"), and the development of relationships with key
licensees and end-users.
Since 1998, the Company has been primarily engaged in commercial validation of
EarthShell Packaging for plates, bowls, hinged-lid containers, and sandwich
wraps, and other market development activities. During this stage, the Company
has worked to demonstrate the commercial viability of its business model by
optimizing product design, garnering support from key members of the
environmental community, expanding validation of the environmental profile
through third party evaluations, developing commercially viable manufacturing
processes, establishing and refining licensing arrangements with the Company's
licensees, and validating product performance and price acceptance through
commercial contracts with influential purchasers in key segments of the
foodservice market. In cooperation with its operating partners, the Company
financed and built initial commercial demonstration production capacity and has
sold limited quantities of plates, bowls, and hinged-lid containers. In 2003,
the Company concluded commercial demonstration production activity and is
relying on its equipment and manufacturing partners to demonstrate and to
guarantee the long-term manufacturability of EarthShell Packaging.
As demonstration of the business fundamentals to licensees is accomplished, the
Company expects that its operating partners will build production capacity. The
Company intends to expand the use of EarthShell Packaging in the U.S. and in
international markets through agreements with additional licensees. By
leveraging the infrastructure of its licensees, the Company believes the
go-to-market strategy will accelerate the market penetration of EarthShell
Packaging.
Currently, the Company's strategic relationships include Detroit Tool and
Equipment ("DTE") and Renewable Products, Inc. ("RPI") in the U.S, as well as
EarthShell Hidalgo ("ESH") in Mexico and EarthShell Asia. During 2005, the
Company received technology fees from ESH. During prior years, proceeds from
initial sales of plates, bowls and hinged-lid containers were not significant
and were recorded as an offset to the costs of its demonstration manufacturing
operations.
During 2004, as a result of its stock price dropping below $3 per share for an
extended period of time, the Company was de-listed from NASDAQ. Consequently, it
became in default on its 2006 Debentures. In the 4th quarter of 2004, the
Company sold $2.7 million of unregistered stock, negotiated a settlement with
each of its debenture holders, and retired all of the outstanding debentures.
On October 11, 2005, the Company entered into the 2005 EKI Loan with EKI
pursuant to which the Company issued to EKI a promissory note to EKI in the
principal amount of $1,000,000. As of the second week of January 2006, EKI has
advanced the full $1,000,000 to the Company. Interest accrues on the principal
balance of the 2005 EKI Loan at a variable per annum rate, as of any date of
determination, that is equal to the rate published in the "Money Rates" section
of The Wall Street Journal as being the "Prime Rate", compounded monthly. During
2002 and 2003, the Company's largest shareholder, EKI, made various simple
interest working capital loans to the Company. These loans bear interest at a
rate of 7% or 10% per annum, and are payable on demand. As of December 31, 2003,
the outstanding principal balance of these loans was $2,755,000. In connection
with the March 2003 convertible debenture financing the remaining outstanding
balance of these loans was subordinated to the 2006 Debentures, with strict
covenants governing their repayment. In October 2004, these related party loans,
including accrued interest were converted to unregistered shares of EarthShell
common stock. (See Related Party Transactions).
F-19
EARTHSHELL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Recent Accounting Pronouncements
The FASB recently issued the following statements:
In December 2004, the FASB issued SFAS No. 123R, "Share Based Payment". This
Statement is a revision of FASB Statement No. 123, Accounting for Stock-Based
Compensation. This Statement supersedes APB Opinion No. 25, Accounting for Stock
Issued to Employees, and its related implementation guidance. This Statement
establishes standards for the accounting for transactions in which an entity
exchanges its equity instruments for goods or services. It also addresses
transactions in which an entity incurs liabilities in exchange for goods or
services that are based on the fair value of the entity's equity instruments or
that may be settled by the issuance of those equity instruments. This Statement
focuses primarily on accounting for transactions in which an entity obtains
employee services in share-based payment transactions. This Statement does not
change the accounting guidance for share-based payment transactions with parties
other than employees provided in Statement 123 as originally issued and EITF
Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to Other
Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services." This Statement does not address the accounting for employee share
ownership plans, which are subject to AICPA Statement of Position 93-6,
Employers' Accounting for Employee Stock Ownership Plans. This statement will
require the Company to recognize the fair value of employee services received in
exchange for awards of equity instruments in current earnings. The Company will
adopt this pronouncement January 1, 2006 as required.
F-20
EARTHSHELL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections--a replacement of APB Opinion No. 20 and FASB Statement No. 3" (SFAS
154). This Statement replaces APB Opinion No. 20, "Accounting Changes," and FASB
Statement No. 3, "Reporting Accounting Changes in Interim Financial Statements,"
and changes the requirements for the accounting for and reporting of a change in
accounting principle by requiring retrospective application to prior periods'
financial statements of changes in accounting principle, unless it is
impractical to determine either the period-specific effects or the cumulative
effect of the change. It also applies to changes required by an accounting
pronouncement in the unusual instance that the pronouncement does not include
specific transition provisions. In addition, the Statement also requires that a
change in depreciation or amortization for long-lived assets be accounted for as
a change in accounting estimate effected by a change in accounting principle.
When a pronouncement includes specific transition provisions, those provisions
should be followed. SFAS 154 is effective for accounting changes and corrections
of errors made in fiscal years beginning after December 15, 2005. Consequently,
the Company will adopt provisions of SFAS 154 for the fiscal year beginning
January 1, 2006. Management currently believes the adoption of the provisions of
SFAS 154 will not have a material impact on its financial position or results of
operations.
Other Comprehensive Income
The Company has reflected the provisions of SFAS No. 130, "Reporting
Comprehensive Income", in the accompanying consolidated financial statements for
all periods presented. The accumulated comprehensive loss and other
comprehensive loss as reflected in the accompanying consolidated financial
statements, respectively, consists of foreign currency translation adjustments,
which historically have been insignificant to the Company's operations.
Foreign Currency Translation
Assets and liabilities of the Company's foreign subsidiary, PolarCup EarthShell
GmbH, are translated into United States dollars at the exchange rate in effect
at the close of the period, and revenues and expenses are translated at the
weighted average exchange rate during the period. The aggregate effect of
translating the financial statements of PolarCup EarthShell GmbH is included as
a separate component of stockholders' equity. Foreign exchange gains/losses have
been insignificant.
Reverse Stock Split
Effective as of October 31, 2003, the Company's Board of Directors ("Board")
approved an amendment to the Company's Certificate of Incorporation to effect a
reverse split of the Company's common stock. This action by the Board followed
approval by 88% of the stockholders of a proposal at the 2003 Annual Meeting of
the Company that authorized the Board to take such action. The decision by the
Board was prompted by the need to maintain compliance with certain covenants of
the Company's 2006 Debentures that require the Company to retain its listing on
a national market.
After careful analysis, the Board approved the final ratio for the split at
one-for-twelve (1:12), whereby each twelve shares of the Company's issued and
outstanding common stock was automatically converted into one share of new
common stock. The percentage of the Company's stock owned by each shareholder
remained the same. No fractional shares were issued, and instead, the Company's
transfer agent aggregated and sold any fractional shares on the open market and
distributed the pro rata share of the cash proceeds to the holders of fractional
share interests.
The reverse split has been retroactively reflected in these financial
statements.
In conjunction with the reverse split, the authorized shares of common stock
were reduced from 200 million to 25 million as of October 31, 2003. The
authorized shares of common stock were increased in conjunction with the annual
meeting of the shareholders held on June 26, 2004, from 25 million to 40
million.
F-21
EARTHSHELL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Disclosure About Fair Value of Financial Instruments
The Company has financial instruments, none of which are held for trading
purposes. The Company estimates that the fair value of all financial instruments
at December 31, 2005 and 2004, as defined in FASB 107, does not differ
materially from the aggregate carrying values of its financial instruments
recorded in the accompanying balance sheet. The estimated fair value amounts
have been determined by the Company using available market information and
appropriate valuation methodologies. However, the fair value of payables to
related parties and notes payable to related party cannot be determined due to
their related party nature. In addition, it is impractical for the Company to
estimate the fair value of the convertible debentures because a market for such
debentures does not readily exist. Considerable judgment is required in
interpreting market data to develop the estimates of fair value, and
accordingly, the estimates are not necessarily indicative of the amounts that
the Company could realize in a current market exchange.
Concentration of Risk - Financial Instruments
Financial instruments which potentially subject the Company to concentrations of
credit risk consist principally of Cash and Cash Equivalents. The Company places
its excess cash in reputable federally insured financial institutions and in
high quality money market fund deposits. Money market fund deposits ($433,514 on
deposit with one bank at December 31, 2005) are subject to market fluctuations
and there is no guarantee as to their ultimate value.
Reclassifications
Certain items in the 2003 and 2004 financial statements have been reclassified
to conform to the 2005 presentation.
Cash and Cash Equivalents
Cash and cash equivalents include cash, funds invested in money market funds and
cash invested temporarily in various instruments with maturities of three months
or less at the time of purchase. The money market fund deposits have an
investment objective to provide high current income to the extent consistent
with the preservation of capital and the maintenance of liquidity and,
therefore, are subject to minimal risk.
Prepaid Expenses and Other Current Assets
The following is a summary of prepaid expenses and other current assets at
December 31:
2005 2004
-------- --------
Prepaid expenses and other current assets ..... $ 83,473 $ 83,583
Receivable on sale of equipment .............. -- 78,009
Related party receivable ...................... -- 12,875
Retainer for financing ........................ -- 27,000
-------- --------
Total Prepaid Expenses and Other Current Assets $ 83,473 $201,467
======== ========
Evaluation of Long-Lived Assets
The Company evaluates the recoverability of long-lived assets whenever events or
changes in circumstances indicate that the carrying value of an asset may not be
recoverable. If there is an indication that the carrying value of a long-lived
asset may not be recoverable and the estimated future cash flows (undiscounted
and without interest charges) from the use of the asset are less than the
carrying value, a write-down is recorded to reduce the related asset to its
estimated fair value.
Property and Equipment and Equipment Held for Sale
Property and equipment are carried at cost. Depreciation and amortization is
provided for using the straight-line method for financial reporting purposes
based upon the estimated useful lives of the assets, which range from three to
seven years. As described further below, the Company wrote down property and
equipment related to commercialization of the EarthShell Packaging products
technology by $4.0 million in 2003. The impairment charges were expensed to
"Other research and development" in the accompanying Statements of Operations.
F-22
EARTHSHELL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The cost and accumulated depreciation of property and equipment and equipment
held for sale at December 31, 2005 were as follows:
2005 2004
--------- ---------
Property and Equipment
Office furniture and equipment .................. $ 158,854 $ 245,274
Less: accumulated depreciation and amortization (146,863) (236,237)
--------- ---------
Property and equipment--net ....................... $ 11,991 $ 9,037
========= =========
Equipment held for sale ........................... $ 1 $ 1
========= =========
The Company has fully depreciated equipment (original cost of $893,657) and a
commercial production line which are being held for sale. The commercial
production line in Goettingen, Germany was financed and constructed by the
Company for the Company's joint venture (see Investment in Joint Venture) with
Huhtamaki. During 2001, $1.2 million of the Goettingen line was written off to
reflect equipment that had no further application in the product development
cycle. During the third quarter of 2002 the Company concluded, after obtaining
quotations from various machinery suppliers for an identical line, that $1.7
million of the cost of the line would not be recoverable and therefore the
carrying value of the line was written down by this amount, of which $1.6
million was recorded in the third quarter of 2002 and the remaining $0.1 million
was recorded in the fourth quarter of 2002. At December 31, 2003, the Company
was negotiating to sell the line to a party who would become a licensee with
rights to produce foodservice disposables. However, because the Company was
unable to determine with certainty the proceeds that would be realized upon sale
of the equipment, the Company wrote the line down to $1 as of December 31, 2003
and reclassified it to the long-term asset account "Equipment held for sale."
The $4.0 million impairment charge for 2003 was expensed to "Other research and
development" in the accompanying Statements of Operations. If the equipment is
sold, the Company will record a gain equal to the proceeds received for the
equipment.
The Company sold non-essential machine shop equipment and excess office
furniture and equipment in 2004 and 2005, realizing gains on the sale.
Investment in Joint Venture
On May 24, 1999, the Company entered into a joint venture agreement with
Huhtamaki to commercialize EarthShell Packaging throughout Europe, Australia,
New Zealand, and, on a country by country basis, Asia. The Company and Huhtamaki
formed PolarCup EarthShell ApS ("PolarCup"), a Danish holding company, for the
purpose of establishing operating companies to manufacture, market, sell and
distribute EarthShell Packaging.
The Company contributed approximately 10,000 Euros as nominal share capital and
500,000 Euros for start-up capital. The Company paid for the development of the
initial commercial production line to be located at the Huhtamaki facility at
Goettingen, Germany (see Property and Equipment). In January 2004, the Company
announced the conclusion of its joint venture structure with Huhtamaki. During
2003 and 2002 the Company recorded its equity in the losses of the joint venture
of $392,117 and $20,263 respectively, including the write off of its remaining
investment as of December 31, 2003.
F-23
EARTHSHELL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Related Party Transactions
In connection with the formation of the Company, the Company entered into a
License Agreement (the "License Agreement") with EKI, a stockholder of the
Company. Pursuant to the license agreement, as amended, the Company has an
exclusive, worldwide, royalty-free license to use and license the EKI technology
to manufacture and sell disposable, single-use containers for packaging or
serving food or beverages intended for consumption within a short period of time
(less than 24 hours) and to use certain trademarks owned by EKI in connection
with the products covered under the License Agreement. The license continues to
be in effect during the life of the patents licensed under the License Agreement
covering the technologies. Patents currently issued do not begin to expire until
2012 and provide some protection through 2020. Pending patents, if granted,
would extend protection through 2022. On July 29, 2002, the License Agreement
was amended to expand the field of use for the EarthShell technology to include
noodle bowls used for packaging instant noodles. The Company will pay to EKI 50%
of any royalty or other consideration it receives in connection with the sale of
products within this particular field of use. In addition, on July 29, 2002 the
Company entered into a License & Information Transfer Agreement with Biotec, a
wholly owned subsidiary of EKI, to utilize the Biotec technology for foodservice
applications, including the food wraps used in foodservice applications (the
"Biotec Agreement"). Effective January 1, 2001, EKI had previously granted to
the Company priority rights to license certain product applications on an
exclusive basis from Biotec in consideration for the Company's payment of a
$100,000 monthly licensing fee to Biotec. In addition, in consideration of the
monthly payment, Biotec agreed to render technical services to the Company at
Biotec's cost plus 5%. The licensing fee and services arrangements were
continued in the Biotec Agreement. Under the terms of the Biotec Agreement,
Biotec is entitled to receive 25% of any royalties or other consideration that
the Company receives in connection with the sale of products utilizing the
Biotec technology. As part of the convertible debenture financing completed in
March 2003 (see Convertible Debentures), payment of amounts due to EKI under the
License Agreement or the Biotec Agreement were subordinated to the 2006
Debentures with strict covenants governing their repayment. However, any amounts
deferred pursuant to this subordination requirement shall accrue interest at the
rate of 10% per annum until paid. For the years ended December 31, 2005, 2004,
and 2003, the Company paid or accrued to EKI $0, $800,000, and $1,312,374 ,
respectively, under the License Agreement and Biotec Agreement, consisting of
the $100,000 per month licensing fee, materials and services provided by EKI,
which vary based on the Company's given requirements, and interest payable on
outstanding balances.
In September of 2004, as part of an overall restructuring of its debt,
EarthShell entered into an agreement with Biotec to convert $1.475 million of
the $2.475 million of accrued license fees owing to Biotec as of September 1,
2004, plus accrued interest into 491,778 shares of EarthShell common stock and
to eliminate, the $100,000 per month minimum license fee. In December of 2004,
EarthShell paid to Biotec $125,000, leaving a balance of $875,000 as of December
31, 2004. During 2005, the balance was further reduced to $837,145 and assigned
to EKI. On October 11, 2005, the Company entered into a debt conversion and
mutual release agreement (the "Debt Conversion Agreement") with EKI. Pursuant to
the Debt Conversion Agreement, the Company and EKI agreed that the remaining
receivable of $837,145 (previously owed to Bio-Tec Biologische Naturverpackunger
GmbH & Co.KG, but which receivable was subsequently assigned to EKI) be
converted into 279,048 shares of common stock of the Company. The conversion
price equals $3.00 per share. Pursuant to the Debt Conversion Agreement, the
Company and EKI released each other from any and all claims in connection with
the receivable.
In connection with the settlement of the March 2006 Debentures in October of
2004, EKI converted all of its outstanding loans to EarthShell ($2,755,000) into
unregistered common stock at $3.00 per share and converted $532,644 of
accumulated interest into unregistered common stock at $4.00 per share for a
total of 1,051,494 shares received by EKI.
In September 2004, the Company hired an executive assistant who supports both
EKI and Company executives. The Company paid the salary and benefits of the
executive assistant and charged EKI for the portion of her time that was spent
supporting EKI executives. The Company invoiced EKI $32,608 and $12,875 for the
years ended December 31, 2005 and 2004, respectively, for such support services.
This arrangement terminated in October 2005.
F-24
EARTHSHELL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In May 2004, the Company sold non-essential machine shop equipment and excess
office furniture and equipment with a net book value of approximately $19,122 to
EKI for $78,409.
On September 22, 2004, Simon K. Hodson, the then Chief Executive Officer of the
Company, loaned $50,000 to the Company on a short-term basis at an annual
interest rate of 7%, and on September 29, 2004 Mr. Hodson loaned the Company an
additional $86,000. During the fourth quarter of 2004, the Company repaid both
short-term loans.
Accounts Payable and Accrued Expenses
The following is a summary of accounts payable and accrued expenses at December
31:
2005 2004
------------- -------------
Accounts payable and other accrued expenses $ 3,137,261 $ 1,333,101
Legal accruals ............................ 1,283,842 1,497,103
Deferred officer compensation ............. 453,544 298,194
Accrued property taxes .................... 116,002 112,159
Accrued salaries, wages and benefits ...... 281,288 258,691
Accrued legal fees ........................ 636,733 400,278
------------- -------------
Total accounts payable and accrued Expenses $ 5,908,670 $ 3,899,526
Convertible Debentures
On August 12, 2002, the Company issued $10.0 million in aggregate principal
amount of the 2007 Debentures to institutional investors. These debentures bore
interest at a rate of 1.5% per annum, payable quarterly in arrears on each
January 31, April 30, July 31 and October 31. The holders of these debentures
had the right to convert the debentures into the Company's common stock at an
initial conversion price of $15.60 per share, which was reduced to $8.40 per
share in November 2002 and then to $6.00 per share in March 2003 as a result of
anti-dilution adjustments. Based on the conversion price relative to the fair
market value of the common stock at the date of issue, the debentures were
deemed to have no beneficial conversion feature. In March 2003, the conversion
price of the 2007 Debentures was adjusted downward, resulting in a beneficial
conversion charge of $360,000 that is included in other interest expense in the
Statements of Operations. During the third quarter of 2002, the Company forced
conversion of $1.0 million principal amount of the debentures for 168,696 shares
of common stock, resulting in the release to the Company of $1.0 million of
restricted cash. During 2003, the Company forced conversion of an additional
$1.3 million principal amount of the debentures and debenture holders
voluntarily converted $0.5 million principal amount of the debentures, for a
total of 353,985 shares of common stock, resulting in the release to the Company
of $1.8 million of restricted cash.
In connection with the issuance of the 2007 Debentures, the Company issued to
the debenture holders warrants to purchase 208,333 shares of the Company's
common stock at $14.40 per share. A value of $1,521,046 was ascribed to the
warrants and recorded as an original issue discount based on the Black-Scholes
method of valuation. During 2002, non-cash interest expense of $144,500 and
debenture conversion costs of $320,970 were recognized in the Statements of
Operations to reflect amortization of the original issue discount associated
with the warrants and to reflect the 15% discount to the market price of the
Company's common stock resulting from the forced conversions of the 2007
Debentures. During 2003, non-cash interest expense of $74,927 was recognized in
the Statements of Operations to reflect amortization of the original issue
discount associated with the warrants. In addition, $59,747 of the original
issue discount associated with the debentures voluntarily converted was charged
to additional paid in common capital.
F-25
EARTHSHELL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In March 2003, as part of a new convertible debenture financing, the Company
prepaid $5.2 million principal amount of the 2007 Debentures, resulting in a
prepayment penalty of $208,000. The Company also issued to the holders of the
2007 Debentures 52,083 shares of common stock, valued at $237,500 based upon the
closing price of the Company's common stock on the NASDAQ SmallCap Market of
$4.56 per share on March 5, 2003. In addition, one of the holders of the 2007
Debentures exchanged $2.0 million aggregate principal amount of 2007 Debentures
for $2.0 million aggregate principal amount of 2006 Debentures and 78,989 shares
of common stock valued at approximately $360,000 based upon the closing price of
the Company's common stock of $4.56 per share on March 5, 2003. In connection
with the prepayment and exchange transactions, the Company incurred cash
transaction costs of approximately $296,000, excluding the prepayment penalty.
The Company recognized a $1.7 million loss upon extinguishment of the 2007
Debentures through the prepayment and exchange. The exchange of $2.0 million of
the 2007 Debentures for 2006 Debentures resulted in the release to the Company
of $2.0 million of restricted cash. There were no outstanding 2007 Debentures as
of December 31, 2003.
On March 5, 2003, the Company issued to a group of institutional investors
416,667 shares of common stock and $10.55 million in aggregate principal amount
of secured convertible debentures due in March 2006 (the "2006 Debentures"), for
which the Company received proceeds of approximately $9.0 million, net of
financing costs of approximately $1.5 million. The 2006 Debentures bore interest
at a rate of 2.0% per annum, payable quarterly in arrears on each January 31,
April 30, July 31 and October 31.
In accordance with Accounting Principles Board Opinion No. 14, "Accounting for
Convertible Debt and Debt Issued with Stock Purchase Warrants," the Company
allocated the net proceeds of $9.0 million to the 2006 Debentures and the common
stock based upon their relative fair values. A discount on the 2006 Debentures
of $3.4 million and a discount on the common stock of $604,000 resulted from the
fair value allocation. Based on the conversion price of the 2006 Debentures
relative to the fair market value for a share of the Company's common stock at
the date of issue, the 2006 Debentures were deemed to have no beneficial
conversion feature.
In addition to the $1.5 million of financing costs, the Company also incurred
approximately $646,000 of non-cash costs attributable to 54,167 shares of common
stock issued to the lead purchaser of the 2006 Debentures and two warrants
issued to a placement agent, both of whom received the instruments as
compensation for their services rendered in connection with the transaction. The
fair value of the 54,167 shares of common stock issued to the lead purchaser was
determined to be $247,000, based on the closing price of $4.56 per share of the
Company's common stock on the NASDAQ SmallCap Market on March 5, 2003. The fair
value of approximately $42,000 of the first of the two warrants issued to the
placement agent, which would expire in March 2006 and was immediately
exercisable by the placement agent to purchase 28,810 shares of the Company's
common stock for $10.08 per share, was estimated using the Black Scholes
option-pricing model and is reflected in the accompanying financial statements
as an increase in additional paid-in capital and as a component of the $4.0
million aggregate discount on the 2006 Debentures and common stock issued in the
March 2003 transaction. The second of the two warrants issued to the placement
agent, which would expire in March 2006, was immediately exercisable by the
placement agent to purchase $1.055 million in aggregate principal amount of the
2006 Debentures and 41,667 shares of the Company's common stock. At September
30, 2003, the Company evaluated the current value of this warrant, considering
the Company's current cash flow projections, continued operating losses, the
prospects of raising additional equity capital, the significant excess of the
conversion price to the current stock price and the volatility in the Company's
stock price. Based upon these factors, the Company determined that the warrant
had no value as of September 31, 2003 and December 31, 2003 and therefore
reduced the balance of the warrant obligation to zero as of September 30, 2003,
resulting in a $0.5 million gain that is reflected in "Other (income) expense"
in the Statements of Operations.
In 2003, $5.75 million principal amount of the 2006 Debentures was converted
into 958,334 shares of common stock resulting in the approximately $4.4 million
carrying amount of the 2006 Debentures being transferred to common stock.
F-26
EARTHSHELL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 2003, the Company was in compliance with all covenants of the
2006 Debentures. However, on March 8, 2004, the Company's common stock was
delisted from the NASDAQ SmallCap Market because the Company's market
capitalization failed to meet the minimum required standard. In addition, the
Company did not make interest payments related to the 2006 Debentures as
required on January 31, 2004. These actions put the Company in non-compliance
with its covenants under the 2006 Debentures. The Company negotiated with the
various debenture holders to resolve the defaults. From July through October
2004, the Company reached settlements with each of the remaining debenture
holders to retire the entire $6.8 million outstanding at the end of 2003. Taken
together, the debenture holders converted their debenture holdings into
1,149,877 shares of registered stock, received a total of $1.11 million in cash
payments, and received an additional 512,500 shares of unregistered common
stock. One of the debenture holders also received a settlement payable of $2.375
million, which may be converted to common stock at the option of the holder at
$3 per share. This holder also has the right to elect to be paid from up to 1/3
of the proceeds of future equity capital transactions or from up to 1/3 of
future revenues until he has received a total of $2.375 million, less any
portion that has already been converted. As of December 31, 2004, 100% of the
outstanding debentures had been retired, the security interest held by the 2006
Debenture Holders had been released, and any and all defaults under these
debentures had been waived. Because the $2.375 million settlement payable is
payable only from future proceeds, it is classified on the balance sheet under
Current Liabilities as a Debenture Settlement.
In connection with the March 2003 financing transactions, EKI agreed to
subordinate the repayment of its outstanding loans totaling $2.755 million to
the Company's payment obligations under the 2006 Debentures. In addition, EKI
and The Biotec Group agreed to subordinate certain payments to which they were
otherwise entitled under the Biotec License Agreement (other than their
respective percentages of any royalties received by the Company) to the
satisfaction of the Company's payment obligations under the 2006 Debentures. In
consideration for its willingness to subordinate the payments and advances that
are owed to it, in March 2003 the Company issued to EKI a warrant, expiring in
ten years, to acquire 83,333 shares of the Company's common stock for $6.00 per
share. The fair value of the warrant was estimated to be approximately $0.3
million using the Black-Scholes option pricing model and was recorded as a
discount on the outstanding loans.
On October 11, 2005, the Company entered into the 2005 EKI Loan with EKI
pursuant to which the Company issued to EKI a promissory note to EKI in the
principal amount of $1.0 million. As of December 31, 2005, EKI had advanced
$0.85 million with the balance being funded by the second week of January 2006.
Interest accrues on the principal balance of the EKI Loan at a variable per
annum rate, as of any date of determination, that is equal to the rate published
in the "Money Rates" section of The Wall Street Journal as being the "Prime
Rate", compounded monthly. All accrued but unpaid interest and outstanding
principal is due and payable on the earliest to occur of the following: (i) the
second anniversary of the date of the 2005 EKI Loan; (ii) five days following
the date the Company has received $3.0 million or more in aggregate net cash
proceeds from all financing transactions, equity contributions, and transactions
relating to the sale, licensing, sublicensing or disposition of assets or the
provision of services (including advance royalty payments, proceeds from the
sale of the Company's common stock and fees for technological services rendered
to third parties), measured from the date of the EKI Loan and not taking into
account the proceeds advanced under the 2005 EKI Loan; or (iii) the occurrence
of an Event of Default (as defined in the 2005 EKI Loan).
Notes Payable
In March 2005, the Company entered into a promissory note and Security Agreement
with Cornell Capital Partners. Pursuant to the Security Agreement, the Company
issued promissory notes to Cornell Capital Partners in the original principal
amount of $2.5 million. The $2.5 million was disbursed as follows: $1.15 million
was disbursed on March 28, 2005 and on May 23, 2005 the remaining $1.35 million
was issued in a second closing. After origination costs, the Company realized
approximately $2.1 million of net proceeds. The promissory notes are secured by
the assets of the Company and shares of stock of another entity pledged by an
affiliate of that entity. In addition, the Company pledged to the lender 100
shares of Series B convertible preferred stock which are convertible in the
event of default into approximately $3.3 million shares of the Company's common
stock. The promissory notes have a one-year term and accrue interest at 12% per
year.
F-27
EARTHSHELL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In connection with the financing with Cornell Capital Partners, the Company
issued a warrant to Cornell Capital Partners to purchase 625,000 shares of
common stock of the Company. The warrant expires on the later of: (a) May 26,
2006 or (b) the date sixty days after the date the $2.5 million in promissory
notes issued to Cornell Capital Partners are fully repaid. The warrant has an
exercise price of $4.00 per share of common stock. The first installment payment
on the promissory notes was due on July 25, 2005. In August 2005 Cornell Capital
Partners agreed to consolidate the two notes and to defer the commencement of
repayment installments until October 1, 2005. In consideration of this
modification to the promissory notes, the Company issued a warrant to Cornell
Capital Partners to purchase 50,000 shares of common stock of the Company. The
warrant expires on the later of: (a) May 26, 2005 or (b) the date sixty days
after the date the $2.5 million in promissory notes issued to Cornell Capital
are fully repaid. The warrant has an exercise price of $4.00 per share of common
stock.
Also in March 2005, the Company entered into a Standby Equity Distribution
Agreement with Cornell Capital Partners. Pursuant to the Standby Equity
Distribution Agreement, the Company may, at its discretion, periodically sell to
Cornell Capital Partners shares of common stock for a total aggregate purchase
price of up to $10.0 million. For each share of common stock purchased under the
Standby Equity Distribution Agreement, Cornell Capital Partners will pay the
Company 98% of the lowest volume weighted average price of the Company's common
stock as quoted by Bloomberg, LP on the Over-the-Counter Bulletin Board or other
principal market on which the Company's common stock is traded for the 5 days
immediately following the notice date. The price paid by Cornell Capital
Partners for the Company's stock shall be determined as of the date of each
individual request for an advance under the Standby Equity Distribution
Agreement. Cornell Capital Partners will also retain 5% of each advance under
the Standby Equity Distribution Agreement. Cornell Capital Partners' obligation
to purchase shares of the Company's common stock under the Standby Equity
Distribution Agreement is subject to certain conditions, including the Company's
registration statement for shares of common stock sold under the Standby Equity
Distribution Agreement being declared effective by the Securities and Exchange
Commission and is limited to $0.5 million per weekly advance. On June 9, 2005
the Company filed a registration statement on Form S-1 with the Securities and
Exchange Commission to register the shares of EarthShell common stock underlying
this transaction. On September 27, 2005, the registration statement was
withdrawn. The Company expects to filed a revised S-1 on February 14, 2006.
The notes above were fully repaid and refinanced through the Cornell Capital
Debentures. See "Subsequent Events" below.
Other Long Term Liabilities
The Company has negotiated settlements with a number of its trade payable
vendors comprised of payment plans of up to 36 months. These settlements have
been reclassified on the balance sheet from trade payables to Current Portion of
Settlements for payments due within the current reporting year and Other Long
Term Liabilities for payments due after December 31, 2006. Payments on such
settlements due in 2007 and 2008 total $0.18million and $0, respectively.
F-28
EARTHSHELL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Commitments
During 2005,the company relocated its headquarters to its current location where
it leases 3,353 square feet of office space in Lutherville, Maryland, on a
month-to-month basis. The Company's monthly lease payment with respect to this
space is $5,780. Rental expenses for the years ended December 31, 2005, 2004 and
2003 amounted to $98,885, $165,382, and $558,195 respectively. During 1998, EKI
entered into certain agreements with an equipment manufacturer providing for the
purchase by EKI of certain technology applicable to starch-based disposable
packaging. EKI licenses such technology to the Company on a royalty-free basis
pursuant to the License Agreement. In connection with the purchase, and pursuant
to the terms of a letter agreement with EKI, the Company agreed to pay the
seller of the technology $3.5 million on or about December 31, 2003, which
obligation was secured by a letter of credit. In the fourth quarter of 2002, the
Company established a liability for the $3.5 million commitment as of December
31, 2002 ("Accrued Purchase Commitment") and recorded a corresponding expense to
"Other research and development" in the Statements of Operations. In the fourth
quarter of 2003, the Company negotiated a reduction of the obligation to $1.6
million. Upon payment of the reduced obligation amount in the fourth quarter of
2003, the seller simultaneously released the letter of credit. Therefore, as of
December 31, 2003, the Accrued Purchase Commitment was considered fulfilled and
the excess $1.8 million recorded in 2002 was recorded as an offset to "Other
research and development" in the 2003 Statements of Operations.
Contingencies
The Company is engaged in litigation with two equipment suppliers seeking to
collect a total of approximately $600,000 for manufacturing equipment in
connection with the Company's former Goettingen, Germany manufacturing line that
is no longer in service. The entire amount claimed in the litigation has already
been accrued as part of the Company's accounts payable. The Company believes
that it has good defenses and counterclaims inasmuch as the equipment did not
reach the performance requirements specified in the purchase contracts, and
expects to settle the respective matters soon.
The Company is periodically involved in litigation and administrative
proceedings primarily arising in the normal course of its business. In the
opinion of management, the Company's gross liability, if any, and without any
consideration given to the availability of indemnification or insurance
coverage, under any pending or existing litigation or administrative
proceedings, other than those separately addressed above, would not have a
material adverse impact upon the Company's financial statements.
Retirement Benefits
The Company established a qualified 401(k) plan for all of its employees in
1998. The 401(k) plan allows employees to contribute, on a tax-deferred basis,
up to 15% of their annual base compensation subject to certain regulatory and
plan limitations. The Company uses a discretionary matching formula that matches
one half of the employee's 401(k) deferral up to a maximum of six percent of
annual base compensation. The 401(k) employer match was $24,842 in 2005, $24,311
in 2004, and $44,057 in 2003.
F-29
EARTHSHELL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock Options
In 1994 the Company established the EarthShell Corporation 1994 Stock Option
Plan (the "1994 Plan"). In 1995 the Company subsequently established the
EarthShell Corporation 1995 Stock Incentive Plan (the "1995 Plan") which
effectively superseded the 1994 Plan for options issued on or after the date of
the 1995 Plan's adoption. The 1994 and 1995 Plans as amended (the "Plans")
provide that the Company may grant an aggregate number of options for up to
1,250,000 shares of common stock to employees, directors and other eligible
persons as defined by the Plans. Options issued to date under the Plans
generally vest over varying periods from 0 to 5 years and generally expire 10
years from the date of grant. Some of the options granted are subject to
approval by the shareholders of an increase in the number of shares reserved for
issuance under the Plans.
Stock option activity for 2005, 2004 and 2003 is as follows:
2005 2004 2003
---------------------------- ---------------------------- ----------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------------ ------------ ------------ ------------ ------------ ------------
Outstanding at beginning of year 1,043,245 $ 12.58 384,912 $ 38.24 320,924 $ 50.49
Granted ........................ 1,341,520 2.00 762,498 0.78 121,699 4.87
Cancelled ...................... -- -- (92,499) 15.00 (43,748) 34.02
Expired ........................ (755,340) 6.52 (11,666) 68.95 (13,963) 42.14
------------ ------------ ------------ ------------ ------------ ------------
Outstanding at end of year ..... 1,629,425 $ 6.68 1,043,245 $ 12.58 384,912 $ 38.24
============ ============ ============ ============ ============ ============
Options exercisable at year-end 1,051,925 $ 7.41 141,162 $ 61.35 155,228 $ 61.70
============ ============ ============ ============ ============ ============
F-30
EARTHSHELL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes information about stock options outstanding at
December 31, 2005:
Options Outstanding Options Exercisable
------------------------------------------------------ -----------------------------------
Weighted-
Number Average Weighted- Number Weighted-
Outstanding At Remaining Average Exercisable At Average
Exercise Price 12/31/05 Contractual Life Exercise Price 12/31/05 Exercise Price
---------------- ---------------- ---------------- ---------------- ---------------- ----------------
$0.75 100,000 8.49 $ 0.75 -- $ --
1.85 800,000 6.53 1.85 800,000 1.85
2.10 350,000 9.67 2.10 -- --
2.15 115,000 9.18 2.15 85,000 2.15
2.55 4,166 3.58 2.55 4,166 2.55
2.85 75,000 4.56 2.85 75,000 2.85
4.80 41,666 7.72 4.80 -- --
5.64 4,471 2.42 5.64 4,471 5.64
15.00 8,334 0.19 15.00 8,334 15.00
36.00 55,834 6.53 36.00 -- --
44.04 16,666 5.36 44.04 16,666 44.04
60.00 41,667 3.79 60.00 41,667 60.00
91.56 10,371 0.08 91.56 10,371 91.56
252.00 6,250 2.38 252.00 6,250 252.00
---------------- ---------------- ---------------- ---------------- ----------------
1,629,425 7.26 $ 6.68 1,051,925 $ 7.41
================ ================ ================ ================ ================
The Company accounts for the Plans in accordance with the provisions of
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees," and complies with the disclosure provisions of Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation." Under APB Opinion No. 25, compensation expense is based on the
difference, if any, on the date of grant, between the fair value of the
Company's common stock and the exercise price of the option. For disclosure
purposes, to measure stock-based compensation in accordance with SFAS No. 123,
"Accounting for Stock-Based Compensation", the fair value of each option grant
is estimated on the date of grant using the Black-Scholes option-pricing model.
The fair value of each option grant will be amortized as pro forma compensation
expense over the vesting period of the options. The following table sets forth
the assumptions used and the pro forma net loss and loss per share resulting
from applying SFAS No. 123:
Year Ended Year Ended Year Ended
December 31, 2005 December 31, 2004 December 31, 2003
----------------- ----------------- -----------------
Net Loss as reported ........................................ $ 6,179,086 $ 7,257,101 $ 18,516,741
Deduct: Stock-based employee compensation expense
included in reported net loss, net of tax ................... -- -- --
Add: Total stock-based employee compensation determined under
fair value based method for all awards, net of tax ....... 745,441 472,267 776,018
----------------- ----------------- -----------------
Pro forma net loss .......................................... $ 6,924,527 $ 7,729,368 $ 19,292,759
Net loss per common share
As reported .............................................. $ 0.33 $ 0.48 $ 1.40
Pro forma ................................................ 0.37 0.51 1.45
Average risk-free interest rate ............................. 3.38% 4.05% 4.53%
Average expected life in years .............................. 7.17 9.5 9.5
Volatility .................................................. 71% 80% 102%
Average fair value of options granted during the year ....... $ 1.37 $ 0.64 $ 3.99
F-31
EARTHSHELL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock Warrants
In connection with the issuance of the convertible debentures on August 12, 2002
(see Convertible Debentures), the Company issued to the debenture holders
warrants to purchase 208,333 shares of the Company's common stock at $14.40 per
share. A value of $1,521,046 was ascribed to the warrants and recorded as an
original issue discount based on the Black-Scholes method of valuation. The
exercise price and number of common shares issuable upon exercise of the
warrants are subject to adjustment under certain circumstances, such as the
occurrence of stock dividends and splits, distributions of property or
securities other than common stock, equity issuances for less than the warrant
exercise price and a change in control of the Company. In March 2003, in
connection with the issuance of the 2006 Debentures, the exercise price of the
warrants was reduced to $3.90 per share, but the number of shares of common
stock issuable upon exercise remained fixed at 357,143. At the same time, the
warrant agreement was amended such that any subsequent reduction in the exercise
price of the warrants will not result in any increase in the number of shares of
common stock issuable under the warrants. The warrants expire on August 12,
2007.
In connection with the issuance of the convertible debentures in March 2003 (see
Convertible Debentures), the Company issued to the placement agent warrants to
purchase $1.055 million in aggregate principal amount of the 2006 Debentures at
$1,200 per $1,000 of principal amount, 28,810 shares of the Company's common
stock at $10.08 per share, and 41,667 shares of the Company's common stock at
$7.20 per share. When the 2006 Debentures were retired in 2004, the warrant to
purchase $1,055 million in the aggregate principal amount of the 2006 Debentures
converted to a warrant to purchase 175,833 shares of common stock at $7.20 per
share. Therefore, the total number of warrants now held by Roth Capital
Partners, LLC is 246,310. The exercise price and number of common shares
issuable upon exercise of the warrants are subject to adjustment under certain
circumstances, such as the occurrence of stock dividends and splits,
distributions of property or securities other than common stock and a change in
control of the Company. The warrants expire in March 2006.
In connection with a Securities Purchase Agreement, on December 30, 2005, the
Company issued to Cornell Capital Partners a warrant to purchase up to 350,000
shares of common stock (the "December Warrant). This December Warrant has an
exercise price of $4.00 per share, which may be adjusted under certain
conditions to as low as $3.00 per share and expires two years from the date it
was issued. Furthermore, in connection with the Company's sale of Cornell
Capital Debentures, the Company issued to Mr. Benton Wilcoxon, in consideration
of his pledge of shares of common stock of Composite Technology Corporation
pursuant to the terms of the IPEA, a warrant to purchase up to 125,000 shares of
common stock. This warrant has an exercise price of $4.00 per share and expires
three years from the date it was issued. The related debt proceeds were received
in January 2006, accordingly, the fair value of the warrants will be recorded as
a debt discount in the fiscal quarter ended March 31, 2006.
Revenue Recognition Policy
The Company recognizes revenue when persuasive evidence of an arrangement
exists, the price is fixed or readily determinable and collectibility is
probable. The Company recognizes revenue in accordance with Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements," (SAB 101), as
amended by SAB 104. EarthShell's revenues consist of technology fees that are
recognized ratably over the life of the related agreements and royalties based
on product sales by licensees that are recognized in the quarter that the
licensee reports the sales.
F-32
EARTHSHELL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Income Taxes
Deferred income tax assets and liabilities are computed annually for differences
between the financial statement and income tax bases of assets and liabilities.
Such deferred income tax asset and liability computations are based on enacted
tax laws and rates applicable to periods in which the differences are expected
to reverse. Valuation allowances are established, when necessary, to reduce
deferred income tax assets to the amounts expected to be realized. Income tax
expense is the tax payable or refundable for the period plus or minus the change
during the period in deferred income tax assets and liabilities.
Deferred income taxes result from temporary differences in the recognition of
revenues and expenses for financial and tax reporting purposes. At December 31,
2005 and 2004, deferred income tax assets, which are fully reserved, were
comprised primarily of the following:
2005 2004
------------- -------------
Federal:
Depreciation .................. $ 1,273,296 $ 1,375,770
Deferred compensation ......... 154,205 101,386
Deferred contributions ........ 361,117 361,117
Accrued management fees ....... -- 272,000
Accrued vacation .............. 44,320 87,955
Other reserves ................ 62,333 22,258
Net operating loss carryforward 104,184,369 99,808,790
------------- -------------
Subtotal .................. $ 106,079,640 $ 102,029,276
============= =============
Valuation Allowance ........... (106,079,640) (102,029,276
------------- -------------
Balance ....................... $ -- $ --
The valuation allowance (decreased) increased by $4,050,364, ($1,843,850) and
$8,810,963 during the years ended December 31, 2005, 2004, and 2003,
respectively, as a result of changes in the components of the deferred income
tax items.
For federal income tax purposes, the Company has net operating loss
carryforwards of $306,424,613 as of December 31, 2005 that expire through 2024.
For state income tax purposes, the Company has California net operating loss
carryforwards of $183,854,768 as of December 31, 2005 that expire through 2009,
and Maryland net operating loss carryforwards of $122,569,845 that follow the
federal treatment and expire through 2024. Additionally, the ultimate
utilization of net operating losses may be limited by change of control
provision under section 382 of the Internal Revenue Code.
Income tax expense for 2005, 2004, and 2003 consists of the minimum state
franchise tax.
F-33
EARTHSHELL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Loss Per Common Share
Basic loss per common share is computed by dividing net loss available to common
stockholders by the weighted-average number of common shares outstanding during
the period, including Common stock to be issued. Diluted loss per common share
is computed by dividing net loss available to common stockholders by the
weighted-average number of common shares outstanding including Common stock to
be issued) plus an assumed increase in common shares outstanding for potentially
dilutive securities, which consist of options and warrants to acquire common
stock and convertible debentures. Potentially dilutive shares are excluded from
the computation in loss periods, as their effect would be anti-dilutive. The
dilutive effect of options and warrants to acquire common stock is measured
using the treasury stock method. The dilutive effect of convertible debentures
is measured using the if-converted method. Basic and diluted loss per common
share is the same for all periods presented because the impact of potentially
dilutive securities is anti-dilutive.
The dilutive effect of potentially dilutive securities was approximately 2.1
million shares, 3.0 million shares, and 900,000 shares for the years ended at
December 31, 2005, 2004 and 2003, respectively.
Subsequent Events
On December 30, 2005, EarthShell entered into a Securities Purchase Agreement
with Cornell Capital Partners (the "December Debenture Purchase Agreement")
pursuant to which the Company issued and sold to Cornell Capital Partners $4.5
million in principal amount of secured convertible debentures (the "Cornell
Capital Debentures") on the terms described below. This agreement was
consummated on January 6, 2006. The Cornell Capital Debentures are convertible
into shares of the Company's common stock on the terms discussed below The
Company received the aggregate proceeds of $4.5 million from the sale of the
Cornell Capital Debentures on January 6, 2006, of which approximately $2.6
million was used to payoff the CCP Notes.
The Cornell Capital Debentures are secured by (i) a Pledge and Escrow Agreement,
by and among the Company, Cornell Capital Partners, and David Gonzalez, Esq.,
(ii) an Insider Pledge Agreement and Escrow Agreement (the "IPEA"), by and among
the Company, Cornell Capital Partners, David Gonzalez, Esq. and Mr. Benton
Wilcoxon and (iii) an Amended and Restated Security Agreement, by and between
the Company and Cornell Capital Partners. The Cornell Capital Debentures are
secured by substantially all of the Company's assets, have a three year term and
accrue interest at 12% per annum. The December Debenture Purchase Agreement
required the Company to register the shares of the Company's common stock into
which the Cornell Capital Debentures are convertible under the Securities Act of
1933. On February 14, 2006, the Company filed a registration statement on Form
S-1 with the Securities and Exchange Commission ("SEC") in order to register
6,700,000 shares of common stock that may be issuable to the holders of the
Cornell Capital Debentures upon conversion. Beginning 60 days after the SEC
declares the registration statement effective, Cornell Capital Partners is
entitled, at its option, to convert and sell up to $250,000 of the principal
amount of the Cornell Capital Debentures, plus accrued interest, into shares of
the Company's common stock, within any 30 day period at the lesser of (i) a
price equal to $3.00 or (ii) 88% of the average of the two lowest volume
weighted average prices of the common stock during the ten trading days
immediately preceding the conversion date, as quoted by Bloomberg, LP.
The holder of the Cornell Capital Debentures may not convert the Cornell Capital
Debentures or receive shares of the Company's common stock as payment of
interest thereunder to the extent such conversion or receipt of such interest
payment would result in the holder, together with any affiliate thereof,
beneficially owning (as determined in accordance with Section 13(d) of the
Securities Exchange Act of 1934, as amended, and the rules promulgated
thereunder) in excess of 4.9% of the then issued and outstanding shares of
common stock, including shares issuable upon conversion of, and payment of
interest on, the Cornell Capital Debentures held by such holder after
application of this 4.9% restriction. This 4.9% restriction may be waived by the
holder (but only as to itself and not to any other holder) upon not less than 65
days prior notice to the Company.
F-34
EARTHSHELL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company may redeem, with three business days advance written notice to
Cornell Capital Partners, a portion or all amounts outstanding under the Cornell
Capital Debentures prior to the maturity date provided that the closing bid
price of the of the Company's common stock, as reported by Bloomberg, LP, is
less than $3.00 at the time of the redemption notice. The Company shall pay an
amount equal to the principal amount being redeemed plus a redemption premium
equal to ten percent of the principal amount being redeemed, and accrued
interest, to be delivered to the Cornell Capital Partners on the third business
day after the redemption notice, provided, however, this redemption premium does
not apply until the outstanding principal balance of the Cornell Capital
Debentures has been reduced by $2.5 million. The amount that Cornell may convert
in any 30 day period will be reduced by the amount that the Company redeems.
In connection with the settlement of the 2006 Debentures and the related
restructuring of the Company's debt, the Company provided registration rights
with respect to newly issued unregistered shares of its common stock. Such
registration rights required the Company to, among other things, file a
registration statement with the SEC in December 2004 registering the resale of
such shares of common stock. Under certain agreements, the Company not filing
such a registration statement (or the registration statement not being declared
effective) within a required timeframe provided the holders of the registrable
securities with a right to liquidated damages which, in the aggregate, may
amount to approximately $50,000 per month until a registration statement is
filed. If the Company fails to pay such liquidated damages, the Company must
also pay interest on such amount at a rate of 10% per year (or such lesser
amount as is permitted by law). Because this Registration Statement was not
filed as planned, in December 2004 the Company became obligated on the direct
financial obligation described above. In light of the Company's current
liquidity and financial position any such claim could have a negative effect on
the Company.
In February 2006, the Company issued to Midsummer an additional 25,000 shares of
its common stock in settlement of certain claims relating to the settlement.
In January 2006, SF Capital Partners converted a portion of the settlement
balance into shares of the Company's common stock. In addition, the Company has
agreed to register on behalf of SF Capital partners 1,000,000 shares of the
Company's common stock to be available for the conversion of the remaining
balance owed to SF Capital and to pay damages stemming the Company's
non-performance under the registration rights clause of the settlement
agreement.
F-35
EARTHSHELL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
First Second Third Fourth Total Year
------------ ------------ ------------ ------------ ------------
2005
Revenues $ 75,000 $ 58,333 $ 25,000 $ 25,000 $ 183,333
Related party research and development -- -- -- -- --
Other research and development 103,595 119,183 110,628 (132,589) 200,817
Related party general & administrative 578 (4,218) (2,227) 5,867 --
Other general and administrative 1,048,384 1,804,774 1,810,481 1,497,963 6,161,602
Net loss common shareholders $ 1,077,557 $ 1,861,406 $ 1,893,882 $ 1,346,241 $ 6,179,086
Basic and diluted loss per common share $ .06 $ .10 $ .10 $ .07 $ .33
Weighted average common shares outstanding 18,250,260 18,394,967 18,507,916 18,853,010 18,503,207
2004
Revenues $ -- $ 25,000 $ 50,000 $ 62,500 $ 137,500
Related party research and development 300,000 300,000 200,000 -- 800,000
Other research and development 222,538 42,913 64,121 40,591 370,163
Other general and administrative 1,173,855 1,071,116 99,162 1,409,769 3,753,902
Net loss common shareholders $ 2,066,857 $ 2,264,383 $ 1,645,931 $ 1,279,930 $ 7,257,101
Basic and diluted loss per common share $ 0.15 $ 0.16 $ 0.12 $ 0.07 $ 0.48
Weighted average common shares outstanding 14,128,966 14,128,966 14,223,402 17,659,043 15,046,726
F-36
We have not authorized any dealer, salesperson or other person to provide any
information or make any representations about EarthShell Corporation except the
information or representations contained in this prospectus. You should not rely
on any additional information or representations if made.
----------------------------------------------
This prospectus does not constitute an offer to sell, or a solicitation of an
offer to buy any securities:
o except the common stock offered by this
prospectus;
o in any jurisdiction in which the offer or
solicitation is not authorized;
PROSPECTUS
o in any jurisdiction where the dealer or other
salesperson is not qualified to make the offer
or solicitation;
o to any person to whom it is unlawful to make the
offer or solicitation; or
o to any person who is not a United States 10,327,844 Shares of Common Stock
resident or who is outside the jurisdiction of
the United States.
The delivery of this prospectus or any accompanying EARTHSHELL CORPORATION
sale does not imply that:
o there have been no changes in the affairs of
EarthShell Corporation after the date of
this prospectus; or
______________, 2006
o the information contained in this prospectus
is correct after the date of this prospectus.
Until _________, 2006, all dealers effecting transactions in the registered
securities, whether or not participating in this distribution, may be required
to deliver a prospectus. This is in addition to the obligation of dealers to
deliver a prospectus when acting as underwriters.
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS
The Company's Amended and Restated Certificate of Incorporation limits the
liability of Directors to the maximum extent permitted by Delaware law. Delaware
law provides that Directors of a company will not be personally liable for
monetary damages for breach of their fiduciary duties as Directors, except for
liability for (i) any breach of their duty of loyalty to the Company or its
stockholders, (ii) acts or omissions not in good faith or involving intentional
misconduct or a knowing violation of law, (iii) unlawful payment of dividends or
unlawful stock repurchases or redemptions as provided in Section 174 of the
Delaware General Corporation Law, or (iv) any transaction from which the
director derived an improper personal benefit.
The Company's Bylaws provide that the Company shall indemnify its
officers, Directors, employees and other agents to the maximum extent permitted
by Delaware law. The Company's Bylaws also permit it to secure insurance on
behalf of any officer, Director, employee or other agent for any liability
arising out of his or her actions in such capacity, regardless of whether the
Bylaws would permit indemnification.
The Company believes that the provisions in its Amended and Restated
Certificate of Incorporation and its Bylaws are necessary to attract and retain
qualified persons as officers and Directors.
Insofar as indemnification for liabilities arising under the 1933 Act may
be permitted to Directors, officers and controlling persons of EarthShell
pursuant to the foregoing, or otherwise, the Company has been advised that in
the opinion of the SEC such indemnification is against public policy as
expressed in the 1933 Act and is, therefore, unenforceable.
ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth estimated expenses expected to be incurred
in connection with the issuance and distribution of the securities being
registered. EarthShell will pay all expenses in connection with this offering.
Securities and Exchange Commission Registration Fee $ 1,945.00
Printing and Engraving Expenses $ 2,500.00
Accounting Fees and Expenses $ 15,000.00
Legal Fees and Expenses $ 50,000.00
Miscellaneous $ 15,555.00
-----------
TOTAL $ 85,000.00
===========
ITEM 26. SALES OF UNREGISTERED SECURITIES
During the past three (3) years the registrant has issued the following
securities without registration under the 1933 Act:
(1) In connection with the issuance of the convertible debentures in March
2003, the Company issued to the placement agent warrants to purchase $1.055
million in aggregate principal amount of the 2006 Debentures at $1,200 per
$1,000 of principal amount, 28,810 shares of the Company's common stock at
$10.08 per share, and 41,667 shares of the Company's common stock at $7.20 per
share. When the 2006 Debentures were retired in 2004, the warrant to purchase
$1,055 million in the aggregate principal amount of the 2006 Debentures
converted to a warrant to purchase 175,833 shares of common stock. Therefore,
the total number of warrants held by Roth Capital Partners, LLC is 246,310. The
exercise price and number of common shares issuable upon exercise of the
warrants are subject to adjustment under certain circumstances, such as the
occurrence of stock dividends and splits, distributions of property or
securities other than common stock and a change in control of the Company. The
warrants expire in March 2006.
II-1
(2) On March 5, 2003, the Company issued to EKI a warrant to purchase
83,333 shares at $6.00 per share in connection with the subordination of loans
of $2.755 million made to the Company and the elimination of the conversion
feature. The warrants expire on March 5, 2013.
(3) Pursuant to an agreement entered into in September 2004, as part of an
overall restructuring of its debt, EarthShell issued an aggregate of 491,778
shares of its common stock in October 2004 to Biotec in exchange for the
cancellation of $1.475 million of accrued license fees EarthShell owed to the
Biotec Group, which transaction computed to a $3.00 per share conversion price.
(4) Pursuant to an agreement entered into in September 2004, in connection
with the restructuring of its debt and settlement of the 2006 Debentures, in
October 2004, EarthShell issued an aggregate of 1,051,494 shares of its common
stock to EKI of the 2006 Debentures in exchange for the cancellation of $3.288
million of principal and interest due under then outstanding loans.
(5) Pursuant to various agreements dated September 29 and September 30,
2004 in connection with the restructuring of its debt and settlement of the 2006
Debentures, EarthShell issued an aggregate of 512,500 additional shares of its
common stock to the holders of the 2006 Debentures in settlement of the
Company's default under the 2006 Debentures.
(6) In October 2004, as part of an overall restructuring of its debt,
EarthShell issued an aggregate of 900,000 shares of its common stock to MBS at
$3.00 per share for an aggregate offering price of $2.7 million.
(7) On March 23, 2005, the Company entered into a Standby Equity
Distribution Agreement (the "SEDA") with Cornell Capital Partners, LP. In
connection with the SEDA, Cornell Capital Partners received a one-time
commitment fee in the form of 143,550 shares of common stock on March 23, 2005.
On December 30, 2005, the parties terminated the SEDA; however Cornell Capital
Partners retained the commitment shares.
(8) For its services in connection with the SEDA, Sloan Securities
Corporation received 6,450 shares of common stock of the Company on March 23,
2005.
(9) On March 31, 2005, the Company issued 6,450 shares of common stock to
Crown Investment Banking, Inc. in consideration for the services rendered by
Crown Investment Banking, Inc. in connection with the Company obtaining
financing.
(10) In consideration for Mr. Benton Wilcoxon pledging his personal shares
in Composite Technology Corporation as a guaranty for the security agreement
entered into by the Company with Cornell Capital Partners, the Company issued a
warrant to Mr. Wilcoxon to purchase 65,000 shares of common stock of the Company
at an exercise price of $3.00 per share. The warrant expires on March 23, 2008.
(11) In consideration for consulting services rendered by Mr. Douglas Metz
in connection with the Company obtaining financing, the Company issued a warrant
to Mr. Metz to purchase 80,000 shares of common stock of the Company at an
exercise price of $3.00 per share. The warrant expires on March 23, 2008.
(12) In August 2005, the Company granted a ten (10) year warrant to Essam
Khashoggi, the Company's largest shareholder, to purchase one million shares of
the Company's common stock at $3.00 per share in consideration of Mr.
Khashoggi's continued support of the Company since its inception, including
providing bridge loans at below market terms from time to time.
(13) In May of 2005, the Company issued 44,387 shares of unregistered
common stock to EKI pursuant to a provision of the EKI conversion agreement
which provided for the issuance of these additional shares if the Company did
not sell equity to a third party within ninety (90) days of the initial
conversion at a price of at least $4.00 per share.
(14) On May 26, 2005, one hundred (100) shares of our Series B Convertible
Preferred Stock, par value $0.01 per share, were pledged to secure the CCP Notes
issued to Cornell Capital Partners and were been placed in escrow to be issued
to Cornell Capital Partners in the event of default. The shares were released
from escrow to the Company upon (i) repayment of $1,350,000 of principal under
the promissory notes; (ii) in the event the shares pledged pursuant to that
certain Amended and Restated Pledge and Escrow Agreement by and among Mr. Benton
Wilcoxon, Cornell Capital Partners and David Gonzalez, Esq. is equal to or
exceeds 3 times the amount of principal then outstanding under the promissory
notes; (iii) a registration statement has been declared effective by the SEC
relating to the shares to be issued pursuant to the Standby Equity Distribution
Agreement; and (iv) the 100 shares of Series B Convertible Preferred Stock have
been redeemed pursuant the Certificate of Designation. Pursuant to the
Certificate of Designation, the Series B Convertible Preferred Stock is senior
to the Company's common stock with respect to the distribution of the assets of
the Company upon liquidation and junior to all other series of preferred stock.
The holders of the Series B Convertible Preferred Stock are not entitled to
dividends or distributions. Each share of Series B Convertible Preferred Stock
is convertible, at the option of the holder, at any time upon an event of
default under the promissory notes, into 33,333 shares of fully paid and
non-assessable common stock of the Company. The Series B Convertible Preferred
Stock has no voting rights, except as required under Delaware law. After full
repayment of the notes, the Company has the absolute right to redeem (unless
otherwise prevented by law) any outstanding shares of Series B Convertible
Preferred Stock at an amount equal to $0.01 per share.
II-2
(15) On May 26, 2005, the Company issued common stock purchase warrants to
Cornell Capital Partners and Hishgate House Funds, Ltd. to purchase 260,500 and
364,500 shares of common stock of the Company, respectively. This May Warrant
expires on May 26, 2006, has an exercise price of $4.00 per share of common
stock and has "piggy back" and demand registration rights. These shares are
being registered in this offering.
(16) In August 2005, the Company issued a common stock purchase warrant to
Cornell Capital Partners to purchase 50,000 shares of common stock of the
Company as consideration for consolidating two (2) promissory notes (the "CCP
Notes") and extending the date upon which amortization and repayment of the CCP
Notes is to begin. This August Warrant expires on May 26, 2006, has an exercise
price of $4.00 per share of common stock and has "piggy back" registration and
demand rights. These shares are being registered in this offering.
(17) On August 22, 2005, the Company entered into a letter agreement with
EA to grant sub-licenses to use EarthShell Technology for various applications
in certain Asian territories (the "EA License"). Shortly after executing a
letter agreement, both the Company and EA entered into negotiations to
restructure the transaction and ultimately entered into an amended and restated
letter agreement dated December 9, 2005. By its terms, the amended and restated
letter agreement was not to become effective until all conditions to the
transactions described therein were satisfied. Per the transaction as
restructured in accordance with the amended and restated letter agreement, the
Company may receive a total of up to $2.6 million from a combination of (i)
prepaid technology fees (up to $1.7 million), (ii) the sale of up to 266,667
shares of its common stock and (iii) the issuance of warrants to purchase one
million thirty three thousand three hundred thirty three (1,033,333) shares of
the Company's common stock at $3.90 per share (which, if the Company does not
file with the Securities and Exchange Commission a registration statement for
the resale of such shares by January 31, 2006, may be adjusted to an exercise
price of not less than $3 per share). Subsequent to the execution of the amended
and restated letter agreement, EA agreed to change the deadline for filing the
resale registration statement to February 15, 2006. Realization of the full
potential of the transaction is dependent on the Company successfully
demonstrating the commercial viability of its technology in certain new
applications.
The Company received $500,000 from EA in August 2005 as an initial partial
payment and issued 166,667 shares of its common stock in connection with this
payment. The Company received an additional $300,000 in December 2005 and the
final payment, of approximately $61,000 on February 10, 2006. The remainder was
retained by EA as compensation for various costs and fees. Upon receipt of the
final payment, the Company issued a total of 266,667 shares and the warrants to
purchase the 1,033,333 shares.
(18) On October 11, 2005, the Company entered into a debt conversion and
mutual release agreement (the "Debt Conversion Agreement") with EK1. Pursuant to
the Debt Conversion Agreement, the Company and EK1 agreed that a receivable in
an amount equal to $837,145.69 (previously owed to bio-Tec Biologische
Naturverpackunger GmBH & Co.KG, but which receivable was subsequently assigned
to EKI) be converted into 279,048 shares of common stock of the company. The
conversion price equals $3.00 per share. Pursuant to the Debt Conversion
Agreement, the Company and EKI released each other from any and all claims in
connection with the receivable.
(19) On December 30, 2005, EarthShell entered into the Purchase Agreement
with Cornell Capital Partners, pursuant to which the Company issued and sold to
Cornell Capital Partners the Cornell Capital Debentures. The Cornell Capital
Debentures shall be convertible into shares of the Company's common stock and
the Company received proceeds equal to $4,500,000 from the sale of the Cornell
Capital Debentures on January 6, 2006. The Cornell Capital Debentures are
secured by (i) a Insider Pledge and Escrow Agreement by and among the Company,
Cornell Capital Partners, and David Gonzalez, Esq., (ii) an Insider Pledge and
Escrow Agreement (the "IPEA"), by and among the Company, Cornell Capital
Partners, David Gonzalez, Esq. and Mr. Benton Wilcoxon and (iii) an amended and
restated security agreement, by and between the Company and Cornell Capital
Partners. The Cornell Capital Debentures are secured by substantially all of the
Company's assets, have a three (3) year term and accrue interest at twelve
percent (12%) per annum. Cornell Capital Partners is entitled, at its option, to
convert and sell all or any part of the principal amount of the Cornell Capital
Debentures, plus accrued interest, into shares of the Company's common stock, at
the lesser of (i) a price equal to $3.00 or (ii) eighty-eight percent (88%) of
the average of the two (2) lowest volume weighted average prices of the common
stock during the ten (10) trading days immediately preceding the conversion
date, as quoted by Bloomberg, LP. The holder of the Cornell Capital Debentures
may not convert the Cornell Capital Debentures or receive shares of the
Company's common stock as payment of interest hereunder to the extent such
conversion or receipt of such interest payment would result in the holder,
together with any affiliate thereof, beneficially owning (as determined in
accordance with Section 13(d) of the Exchange Act and the rules promulgated
thereunder) in excess of 4.9% of the then issued and outstanding shares of
common stock, including shares issuable upon conversion of, and payment of
interest on, the Cornell Capital Debentures held by such holder after
application of this 4.9% restriction. This 4.9% restriction may be waived by the
holder (but only as to itself and not to any other holder) upon not less than
sixty-five (65) days prior notice to the Company.
II-3
The Company may redeem, with three (3) business days advance written
notice to Cornell Capital Partners, a portion or all amounts outstanding under
the Cornell Capital Debentures prior to the maturity date provided that the
closing bid price of the Company's common stock, as reported by Bloomberg, LP,
is less than $3.00 at the time of the redemption notice. The Company shall pay
an amount equal to the principal amount being redeemed plus a redemption premium
equal to ten percent (10%) of the principal amount being redeemed, and accrued
interest, to be delivered to the Cornell Capital Partners on the third (3rd)
business day after the redemption notice, provided, however, this redemption
premium does not apply until the outstanding principal balance of the Cornell
Capital Debentures has been reduced by $2.5 million.
(20) On December 30, 2005, the Company issued to Cornell Capital Partners
a common stock purchase warrant to purchase up to 350,000 shares of common stock
of the Company. This December Warrant has an exercise price of $4.00 per share,
expires two (2) years from the date it was issued and has "piggy back" and
demand registration rights. These shares are being registered in this offering.
(21) On December 30, 2005, the Company issued to Mr. Wilcoxon, in
consideration of his pledge of shares of common stock of Composite Technology
Corporation pursuant to the terms of the IPEA, a warrant to purchase up to
125,000 shares of common stock. This warrant has an exercise price of $4.00 per
share and expires three (3) years from the date it was issued. The shares
underlying these warrants are being registered in this offering.
(22) In December, 2005 the Company entered into various settlement
agreements to settle litigation or to retire obligations for services received.
The Company issued 48,000 shares of its unregistered common stock to Alcalde and
Fay, 75,000 shares to the Van Dam Machine Corp. and 25,000 shares to Midsummer
Capital. These shares of common stock are being registered in this offering.
(23) On January 11, 2006, the Company issued 186,021 shares of the
Company's common stock to SF Capital Partners pursuant to a conversion right
related to the Contingent Settlement of $2.375 million reached under the
September 30, 2004 Amended and Restated Debenture Purchase Agreement. Pursuant
to the Contingent Settlement, EarthShell must pay $2.375 million to SF Capital
Partners from 33% of any equity funding received by the Company (excluding the
first $2.7 million funded by MBS) or 50% of the royalties received by EarthShell
in excess of $250,000 per month (as determined on a cumulative basis commencing
July 1, 2004). The Company has the right to convert the unpaid portion of the
$2.375 million into shares of the Company's common stock at a price equal to the
lesser of $3.00 per share, or the price per share that EarthShell shall
subsequently receive upon the issuance of its common stock (or other convertible
security) during the three year period commencing September 30, 2004. SF Capital
Partners delivered a conversion notice to the Company on January 11, 2006
requesting conversion of $558,063 of the Contingent Settlement into shares of
the Company's common stock. Following the conversion, the remaining balance of
the Contingent Settlement was approximately $1.8 million. The Company recorded
that difference between the conversion value and the fair value of the common
stock at the time of the conversion as a settlement gain in the amount of
$213,924.
(24) On March 6, 2006, the Company issued a total of 50,000 shares of
common stock to current and past Directors pursuant to restricted stock grants
given to the directors in June 2005 as a bonus in recognition for their
willingness to defer their cash compensation since 2004.
(25) On March 7, 2005, the Company entered into an agreement with Capital
Group Communications ("CGC") in which CGC would perform investor relations
function on behalf of the Company in return for up to 600,000 shares of the
Company's common stock. During the past year, the Company has accrued for this
expense. Pursuant to a letter agreement dated February 27, 2006, the EarthShell
and CGC reached an agreement in which CGC agreed to accept a total of 320,000
unregistered shares of EarthShell's Common Stock under this agreement as payment
in full for its services. EarthShell agreed to include 300,000 of such shares in
the next registration statement it files with the Securities and Exchange
Commission. The 320,000 shares were issued to CGC on May 2, 2006.
II-4
(26) On or about June 1, 2006, the Company issued a total of 160,000
shares of common stock to two individuals in connection with the termination of
a license agreement, mutual release, and settlement of claims between the
parties. This issuance was made in reliance upon the exemption from registration
provided for by Rule 506 of Regulation D and alternatively Section 4(2) of the
Act. The Company did not offer or sell any of the securities issued by any form
of general solicitation or general advertising and affixed a legend on the
certificates representing the Series D Preferred Stock and the Warrants, stating
that the securities have not been registered under the Act and referring to the
restrictions on transferability and sale of such securities.
(27) On June 21, 2006, EarthShell Corporation (the "Company") entered into
a Securities Purchase Agreement (the "SPA") by and among the Company and certain
investors named therein (the "Investors") pursuant to which the Company sold an
aggregate of 128,205 shares of Series D convertible preferred stock (the "Series
D Preferred Stock") for a total purchase price of $500,000. The Series D
Preferred Stock, which was sold to the Investors in a private offering, pays a
cumulative 20% annual dividend, which shall be paid on conversion or liquidation
of the Company. The Series D Preferred Stock is callable in certain
circumstances by the Company. In the event of any voluntary or involuntary
liquidation, dissolution or winding up of the Company, the holders of the Series
D Preferred Stock will be entitled to receive, prior and in preference to any
distribution of the assets or surplus funds of the Company to the holders of any
shares of common stock by reason of the ownership thereof, an amount equal to
the Liquidation Value of $3.90 per share and any accrued dividends. Each share
of Series D Preferred Stock is convertible into one share of the Company's
common stock, par value $0.01 per share, subject to adjustment. In order to (i)
effect an amendment of the Company's Certificate of Incorporation or By-Laws
(except to increase the number of directors), (ii) issue, or permit any
Subsidiaries to issue, any additional shares of capital stock or other equity
interests at less than Fair Market Value, or (iii) change the Company's business
or business model, the affirmative vote of the holders of at least seventy-five
percent (75%) of the then outstanding shares of Series D Preferred Stock must
first be obtained. In connection with the issuance and sale of the Series D
Preferred Stock, the Company granted the Investors immediately exercisable
warrants to purchase an aggregate of 555,555 shares of the Company's common
stock at an exercise price of $3.90 per share, subject to adjustment (the
"Warrants"). The Investors also have been granted certain registration rights
with respect to the shares of common stock underlying the Series D Preferred
Stock and the Warrants as set forth in Section 3 of the SPA.
(28) On July 12, 2006, the Company entered into a Letter Agreement with
Cornell Capital Partners, pursuant to which Cornell Capital Partners has agreed
to forbear from exercising certain rights and remedies under the Cornell Capital
Debentures and that certain Registration Rights Agreement, of even date with the
Cornell Capital Debentures in exchange for the issuance by the Company to
Cornell Capital Partners of 250,000 shares of the Company's common stock. The
Company has acknowledged in the Agreement that an event of default under the
Cornell Capital Debentures had occurred as of June 30, 2006 with the Company
failing to timely register with the U.S. Securities and Exchange Commission the
common stock underlying the Cornell Capital Debentures. The Company also
acknowledged that Cornell Capital Partners is entitled to liquidated damages
equal to one percent (1%) of the liquidated value of the Cornell Capital
Partners for each thirty (30) day period after May 31, 2006. Pursuant to the
Agreement, Cornell Capital Partners has agreed to waive the default, including
all liquidated damages that may have accrued through the date of the Agreement
and during the Forbearance Period (as defined below), in exchange for the
250,000 shares of common stock and the Company obtaining the effectiveness by
September 30, 2006 of that certain Registration Statement originally filed with
the U.S. Securities and Exchange Commission on February 14, 2006, which includes
the shares of common stock underlying the Cornell Capital Debentures.
Furthermore, Cornell Capital Partners has agreed not to make any conversions
under the Cornell Capital Debentures until the earlier of September 30, 2006 or
the expiration of the Forbearance Period, which such Forbearance Period shall
commence on the date of the execution of the Agreement and continue for so long
as the Company strictly complies with the terms of the Agreement and there is no
occurrence or existence of any event of default other than the Default under the
transaction documents or any other agreement that the Company has entered into
with Cornell Capital Partners. The 250,000 shares of commons stock shall have
piggy-back registration rights and Cornell Capital Partners shall also have the
right to demand the registration of the 250,000 shares of common stock by
providing to the Company with thirty (30) days prior written notice of such
request.
EarthShell claimed an exemption from registration under the 1933 Act for
the sales and issuance of its common stock in the transactions described in
paragraphs (1) through (22) above by virtue of Section 4(2) of the 1933 Act in
that such sales and issuances did not involve a public offering. EarthShell
believed that the recipients of common stock in each of these transactions
intended to acquire the securities for investment only and not with a view to or
for sale in connection with any distribution thereof, and appropriate legends
were affixed to the share certificates and instruments issued in such
transactions. These sales and issuances were made without general solicitation
or advertising and each purchaser was a sophisticated investor. All recipients
had adequate access, through their relationships with the Company, to
information about the Company. There were no underwriters involved in any of
these sales and issuances.
II-5
ITEM 27. EXHIBITS
EXHIBIT NO. DESCRIPTION LOCATION
----------- ----------- --------
3.1 Amended and Restated Certificate of Incorporated by reference to Exhibit 3.1(1) to
Incorporation of the Company the Company's Registration Statement on Form
S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
3.2 Amended and Restated Bylaws Incorporated by reference to Exhibit 3.2(1) to
the Company's Registration Statement on Form
S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
3.3 Certificate of Designation, Preferences Incorporated by reference to Exhibit 3.3(1) to
Relative, Participating, Optional and Other the Company's Registration Statement on Form
Special Rights of the Company's Series A S-1 and Amendments thereto, File No. 333-1327,
Cumulative Senior Convertible Preferred Stock as filed with the SEC on June 9, 2005
3.4 Certificate of Designation of the Company's Incorporated by reference to Exhibit 99.3 to
Series B Convertible Preferred Stock the Company's Current Report on Form 8-K, as
filed with the SEC on May 27, 2005
4.1 Specimen certificate of Common Stock Incorporated by reference to Exhibit 4.1(1) to
the Company's Registration Statement on Form
S-1 and Amendments thereto, File No. 333-1327
as filed with the SEC on June 9, 2005.
4.2 Form of Warrant to purchase Common Stock dated Incorporated by reference to Exhibit 4.3 to
August 12, 2002 the Company's Current Report on Form 8-K, as
filed with the SEC on August 12, 2002
4.3 Form of Note under Loan Agreement, dated as of Incorporated by reference to Exhibit 10.2 to
September 9, 2002, by and between the Company the Company's Current Report, as filed with the
and E. Khashoggi Industries, LLC SEC on September 26, 2002
4.4 Form of Secured Convertible Debenture due March Incorporated by reference to Exhibit 4.2 to
5, 2006 the Company's Current Report on Form 8-K, as
filed with the SEC on March 5, 2003
4.5 Intellectual Property Security Agreement, dated Incorporated by reference to Exhibit 4.3 to
as of March 5, 2003, by and among the Company, the Company's Current Report on Form 8-K, as
E. Khashoggi Industries, LLC and the investors filed with the SEC on March 5, 2003
listed therein
4.6 Waiver and Amendment to Debentures and Warrants Incorporated by reference to Exhibit 4.4 to
dated as of March 5, 2003 among the Company and the Company's Current Report on Form 8-K, as
the purchasers identified on the signature pages filed with the SEC on March 5, 2003
thereto
4.7 Exchange Agreement, dated as of March 5, 2003, Incorporated by reference to Exhibit 4.6 to
by and between the Company and the Institutional the Company's Current Report on Form 8-K, as
Investor signatory thereto filed with the SEC on March 5, 2003
5.1 Opinion of Counsel To be provided by Amendment
10.1 Amended and Restated License Agreement, dated Incorporated by reference to Exhibit 10.1(1) to
February 28, 1995, by and between the Company the Company's Registration Statement on Form
and E. Khashoggi Industries, LLC S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.2 Registration Rights Agreement, dated as of Incorporated by reference to Exhibit 10.2(1) to
February 28, 1995, by and between the Company the Company's Registration Statement on Form
and E. Khashoggi Industries, LLC, as amended S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
II-6
EXHIBIT NO. DESCRIPTION LOCATION
----------- ----------- --------
10.3 1994 Stock Option Plan Incorporated by reference to Exhibit 10.3(1) to
the Company's Registration Statement on Form
S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.4 1995 Stock Incentive Plan Incorporated by reference to Exhibit 10.4(1) to
the Company's Registration Statement on Form
S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.5 Form of Stock Option Agreement under the Incorporated by reference to Exhibit 10.5(1) to
EarthShell Container Corporation 1994 Stock the Company's Registration Statement on Form
Option Plan S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.6 Form of Stock Option Agreement under the Incorporated by reference to Exhibit 10.6(1) to
EarthShell Container Corporation 1995 Stock the Company's Registration Statement on Form
Incentive Plan S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.7 Warrant to Purchase Stock, issued July 2, 1996, Incorporated by reference to Exhibit 10.7(1) to
by the Company to Imperial Bank the Company's Registration Statement on Form
S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.8 Amended and Restated Technical Services and Incorporated by reference to Exhibit 10.8(1) to
Sublease Agreement, dated October 1, 1997, by the Company's Registration Statement on Form
and between the Company and E. Khashoggi S-1 and Amendments thereto, File No. 333-1327,
Industries, LLC as filed with the SEC on June 9, 2005
10.9 Amended and Restated Agreement for Allocation of Incorporated by reference to Exhibit 10.9(1) to
Patent Costs, dated October 1, 1997, by and the Company's Registration Statement on Form
between the Company and E. Khashoggi Industries, S-1 and Amendments thereto, File No. 333-1327,
LLC as filed with the SEC on June 9, 2005
10.10 Warrant to Purchase Stock, issued October 6, Incorporated by reference to Exhibit 10.10(1) to
1997, by the Company to Imperial Bank the Company's Registration Statement on Form
S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.11 Warrant to Purchase Stock, issued December 31, Incorporated by reference to Exhibit 10.11(1) to
1997, by the Company to Imperial Bank the Company's Registration Statement on Form
S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.12 Letter Agreement re Haas/BIOPAC Technology, Incorporated by reference to Exhibit 10.12(1) to
dated February 17, 1998, by and between the the Company's Registration Statement on Form
Company and E. Khashoggi Industries, LLC S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.13 Second Amendment to 1995 Stock Incentive Plan of Incorporated by reference to Exhibit 10.13(1) to
the Company the Company's Registration Statement on Form
S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.14 Amendment No. 2 to Registration Rights Incorporated by reference to Exhibit 10.14(1) to
Agreement, dated as of September 16, 1993, by the Company's Registration Statement on Form
and between the Company and the purchasers of S-1 and Amendments thereto, File No. 333-1327,
series A convertible preferred stock. as filed with the SEC on June 9, 2005
10.15 Amendment No. 2 to Registration Rights Incorporated by reference to Exhibit 10.15(1) to
Agreement, dated February 28, 1995, by and the Company's Registration Statement on Form
between the Company and EKI S-1 and Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
II-7
EXHIBIT NO. DESCRIPTION LOCATION
----------- ----------- --------
10.16 First Amendment to the Amended and Restated Incorporated by reference to Exhibit 10.8 to
License Agreement, dated June 2, 1998, by and the Company's Quarterly Report on Form 10-Q,
between the Company and E. Khashoggi Industries, for the quarter ended September 30, 1998, as
LLC filed with the SEC on November 12, 1998
10.17 First Amendment to 1995 Stock Incentive Plan of Incorporated by reference to Exhibit 10.51 to
the Company the Company's Annual Report on Form 10-K, for
the fiscal year ended December 31, 1998, as
filed with the SEC on March 31, 1999
10.18 Third Amendment to 1995 Stock Incentive Plan of Incorporated by reference to Exhibit to
the Company the Company's Definitive Proxy Statement on
Schedule 14A, file No. 000-23567, as filed with
the SEC on April 22, 1999
10.19 Fourth Amendment to 1995 Stock Incentive Plan of Incorporated by reference to the Company's
the Company Definitive Proxy Statement on Schedule 14A,
file No. 000-23567, as filed with the SEC on
April 22, 1999
10.20 Lease Agreement, dated August 23, 2000, by and Incorporated by reference to Exhibit 10.39 to
between the Company and Heaver Properties, LLC the Company's Annual Report on Form 10-K, for
the fiscal year ended December 31, 2000, as
filed with the SEC on April 2, 2001
10.21 Settlement Agreement, dated August 3, 2001, by Incorporated by reference to Exhibit 10.48 to
and between the Company and Novamont the Company's Quarterly Report on Form 10-Q,
for the quarter ended June 30, 2001, as filed
with the SEC on August 14, 2001
10.22 Amendment to Common Stock Purchase Agreement Incorporated by reference to Exhibit 10.49 to
dated March 28, 2001 the Company's Quarterly Report on Form 10-Q,
for the quarter ended June 30, 2001, as filed
with the SEC on August 14, 2001
10.23 Securities Purchase Agreement, dated as of Incorporated by reference to Exhibit 4.1 to
August 12, 2002, by and between the Company and the Company's Current Report on Form 8-K, as
the Investors listed therein filed with the SEC on August 12, 2002
10.24 Loan Agreement, dated as of September 9, 2002, Incorporated by reference to Exhibit 10.1 to
by and between the Company and E. Khashoggi the Company's Current Report on Form 8-K dated
Industries, LLC September 17, 2002
10.25 Second Amendment to the Amended and Restated Incorporated by reference to Exhibit 10.54 to
License Agreement, dated 29 July, 2002, by and the Company's Quarterly Report on Form 10-Q,
between the Company and E. Khashoggi Industries, for the quarter ended September 30, 2002, as
LLC filed with the SEC on November 15, 2002
10.26 License and Information Transfer Agreement, Incorporated by reference to Exhibit 10.55 to
dated 29 July, 2002, by and between the Biotec the Company's Quarterly Report on Form 10-Q,
Group and the Company for the quarter ended September 30, 2002, as
filed with the SEC on November 15, 2002
10.27 Loan and Securities Purchase Agreement, dated as Incorporated by reference to Exhibit 4.1 to
of March 5, 2003, by and between the Company and the Company's Current Report on Form 8-K, as
the Investors listed therein filed with the SEC on March 7, 2003
10.28 Sublicense Agreement, dated February 20, 2004, Incorporated by reference to Exhibit 10.30 to
by and between the Company and Hood Packaging the Company's Annual Report on Form 10-K, for
Corporation the fiscal year ended December 31, 2003, as
filed with the SEC on April 14, 2004
II-8
EXHIBIT NO. DESCRIPTION LOCATION
----------- ----------- --------
10.29 Operating and Sublicense Agreement, dated Incorporated by reference to Exhibit 10.31 to
October 3, 2002, by and between the Company and the Company's Annual Report on Form 10-K, for
Sweetheart Cup Company, Inc. the fiscal year ended December 31, 2003, as
filed with the SEC on April 14, 2004
10.30 First Amendment to Operating and Sublicense Incorporated by reference to Exhibit 10.32 to
Agreement, dated July 2003, by and between the the Company's Annual Report on Form 10-K, for
Company and Sweetheart Cup Company, Inc. the fiscal year ended December 31, 2003, as
filed with the SEC on April 14, 2004
10.31 Lease Agreement, dated July 2003, by and between Incorporated by reference to Exhibit 10.33 to
the Company and Sweetheart Cup Company, Inc. the Company's Annual Report on Form 10-K, for
the fiscal year ended December 31, 2003, as
filed with the SEC on April 14, 2004
10.32 First Amendment to Lease Agreement, dated Incorporated by reference to Exhibit 10.34 to
December 16, 2003, by and between the Company the Company's Annual Report on Form 10-K, for
and Sweetheart Cup Company, Inc. the fiscal year ended December 31, 2003, as
filed with the SEC on April 14, 2004
10.33 Sublicense Agreement, dated November 11, 2004, Incorporated by reference to Exhibit 10.37 to
by and between the Company and EarthShell the Company's Annual Report on Form 10-K, for
Hidalgo S.A. de C.V. the fiscal year ended December 31, 2004, as
filed with the SEC on April 14, 2005
10.34 Standby Equity Distribution Agreement, dated as Incorporated by reference to Exhibit 99.1 to
of March 23, 2005, by and between the Company the Company's Current Report on Form 8-K, as
and Cornell Capital Partners, LP filed with the SEC on March 29, 2005
10.35 Registration Rights Agreement, dated as of March Incorporated by reference to Exhibit 99.2 to
23, 2005, by and between the Company and Cornell the Company's Current Report on Form 8-K, as
Capital Partners, LP filed with the SEC on March 29, 2005
10.36 Placement Agent Agreement, dated as of March 23, Incorporated by reference to Exhibit 99.3 to
2005, by and among the Company, Cornell Capital the Company's Current Report on Form 8-K, as
Partners, LP and Sloan Securities Corporation filed with the SEC on March 29, 2005
10.37 Security Agreement, dated as of March 23, 2005, Incorporated by reference to Exhibit 99.4 to
by and between the Company and Cornell Capital the Company's Current Report on Form 8-K, as
Partners, LP filed with the SEC on March 29, 2005
10.38 Promissory Note, dated as of March 23, 2005, Incorporated by reference to Exhibit 99.5 to
issued by the Company to Cornell Capital the Company's Current Report on Form 8-K, as
Partners, LP filed with the SEC on March 29, 2005
10.39 Promissory Note, dated as of May 26, 2005, Incorporated by reference to Exhibit 99.1 to
issued by the Company to Cornell Capital the Company's Current Report on Form 8-K, as
Partners, LP filed with the SEC on May 27, 2005
10.40 Pledge and Escrow Agreement, dated as of May 26, Incorporated by reference to Exhibit 99.2 to
2005, by and among the Company, Cornell Capital the Company's Current Report on Form 8-K, as
Partners, LP and David Gonzalez, Esq. filed with the SEC on May 27, 2005
10.41 Meridian Business Solutions, Ltd. Sublicense Incorporated by reference to Exhibit 10.1 to
Agreement, dated May 13, 2004, by and between the Company's Quarterly Report on Form 10-Q,
the Company and Meridian Business Solutions, Ltd. for the quarter ended September 30, 2004, as
filed with the SEC on November 9, 2004
II-9
EXHIBIT NO. DESCRIPTION LOCATION
----------- ----------- --------
10.42 Amended and Restated Debenture Purchase Incorporated by reference to Exhibit 10.2 to
Agreement, dated September 30, 2004, by and the Company's Quarterly Report on Form 10-Q,
among the Company, E. Khashoggi Industries, Inc. for the quarter ended September 30, 2004, as
and SF Capital Partners, Ltd. filed with the SEC on November 9, 2004
10.43 Amended and Restated Debenture Purchase Incorporated by reference to Exhibit 10.3 to
Agreement, dated September 29, 2004, by and the Company's Quarterly Report on Form 10-Q,
among the Company, E. Khashoggi Industries, LLC for the quarter ended September 30, 2004, as
and Omicron Master Trust filed with the SEC on November 9, 2004
10.44 Amended and Restated Debenture Purchase Incorporated by reference to Exhibit 10.44(20) to
Agreement, dated September 29, 2004, by and the Company's Registration Statement on Form S-1
among the Company, E. Khashoggi Industries, and Amendments thereto, File No. 333-1327,
LLC on and Islandia, Ltd. as filed with the SEC on June 9, 2005
10.45 Amended and Restated Debenture Purchase Incorporated by reference to Exhibit 10.45(20) to
Agreement, dated September 29, 2004, by and the Company's Registration Statement on Form S-1 and,
among the Company, E. Khashoggi Industries, LLC Amendments thereto, File No. 333-1327,
and Midsummer Investment as filed with the SEC on June 9, 2005
10.46 Conversion Agreement, dated July 20, 2004, by Incorporated by reference to Exhibit 10.46(20) to
and among the Company, E. Khashoggi Industries, the Company's Registration Statement on Form S-1 and,
LLC and RHP Master Fund, Ltd. Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.47 Amended and Restated Debenture Purchase Incorporated by reference to Exhibit 10.47(20) to
Agreement, dated September 29, 2004, by and the Company's Registration Statement on Form S-1 and,
among the Company, E. Khashoggi Industries, LLC Amendments thereto, File No. 333-1327,
and Straus-GEPT L.P. as filed with the SEC on June 9, 2005
10.48 Amended and Restated Debenture Purchase Incorporated by reference to Exhibit 10.48(20) to
Agreement, dated September 29, 2004, by and the Company's Registration Statement on Form S-1 and,
among the Company, E. Khashoggi Industries, Ltd. Amendments thereto, File No. 333-1327,
and Straus Partners, L.P. as filed with the SEC on June 9, 2005
10.49 Amended and Restated Debenture Purchase Incorporated by reference to Exhibit 10.49(20) to
Agreement, dated September 30, 2004, by and the Company's Registration Statement on Form S-1 and,
among the Company and E. Khashoggi Industries, Amendments thereto, File No. 333-1327,
LLC as filed with the SEC on June 9, 2005
10.50 Agreement To Convert Debt To Equity, dated Incorporated by reference to Exhibit 10.50 to
July 16, 2004, by and between the Company and E. the Company's Registration Statement on Form S-1 and,
Khashoggi Industries, LLC Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.51 Agreement dated September 1, 2004 for conversion Incorporated by reference to Exhibit 10.51(20) to
of Biotec indebtedness the Company's Registration Statement on Form S-1 and,
Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.52 Stock Purchase Agreement, dated August 5, 2004, Incorporated by reference to Exhibit 10.52(20) to
by and between the Company and Meridian Business the Company's Registration Statement on Form S-1 and,
Solutions, Ltd. Amendments thereto, File No. 333-1327,
as filed with the SEC on June 9, 2005
10.53 Warrant, dated issued by the Company to Incorporated by reference to Exhibit 99.4 to
Cornell Capital Partners, LP the Company's Current Report on Form 8-K dated
May 27, 2005
10.54 Letter Agreement, dated July 12, 2006, by and between Incorporated by reference to Exhibit 10.1 to the Company's
the Company and Cornell Capital Partners, LP Current Report on Form 8-K dated July 17, 2006
II-10
EXHIBIT NO. DESCRIPTION LOCATION
----------- ----------- --------
14.1 Code of Ethics Incorporated by reference to Exhibit 14.4 to
the Company's Annual Report on Form 10-K, for
the fiscal year ended December 31, 2003, as
filed with the SEC on April 4, 2004
23.1 Consent of Kirkpatrick & Lockhart Nicholson Provided herewith (included in Exhibit 5.1)
Graham LLP
23.2 Consent of Farber Hass Hurley & McEwen, Provided herewith
LLP (Formerly Farber & Hass, LLP
ITEM 28. UNDERTAKINGS
The undersigned registrant hereby undertakes:
(1) To file, during any period in which it offers or sells securities, a
post-effective amendment to this registration statement to:
(i) Include any prospectus required by Sections 10(a)(3) of the 1933
Act (the "1933 Act");
(ii) Reflect in the prospectus any facts or events arising after the
effective date of the Registration Statement (or the most recent post-effective
amendment thereof) which, individually or in the aggregate, represent a
fundamental change in the information set forth in the Registration Statement.
Notwithstanding the foregoing, any increase or decrease in volume of securities
offered (if the total dollar value of securities offered would not exceed that
which was registered) and any deviation from the low or high end of the
estimated maximum offering range may be reflected in the form of prospectus
filed with the SEC pursuant to Rule 424(b) if, in the aggregate, the changes in
volume and price represent no more than twenty percent (205) change in the
maximum aggregate offering price set forth in the "Calculation of Registration
Fee" table in the effective Registration Statement;
(iii) Include any additional or changed material information on the
plan of distribution;
(2) That, for the purpose of determining any liability under the 1933 Act,
each such post-effective amendment shall be deemed to be a new registration
statement relating to the securities offered therein, and the offering of such
securities at that time shall be deemed to be the bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment any
of the securities that remain unsold at the end of the offering.
Insofar as indemnification for liabilities arising under the Act may be
permitted to directors, officers and controlling persons of the small business
issuer pursuant to the foregoing provisions, or otherwise, the small business
issuer has been advised that in the opinion of the SEC such indemnification is
against public policy as expressed in the 1933 Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the small business issuer of expenses
incurred or paid by a director, officer or controlling person of the small
business issuer in the successful defense of any action, suit or proceeding) is
asserted by such director, officer or controlling person in connection with the
securities being registered, the small business issuer will, unless in the
opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the 1933 Act and
will be governed by the final adjudication of such issue.
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SIGNATURES
In accordance with the requirements of the Securities Act of 1933, as amended,
the registrant certifies that it has reasonable grounds to believe that it meets
all of the requirements for filing on Form S-1 and authorized this Registration
Statement to be signed on our behalf by the undersigned, on August 2, 2006.
EARTHSHELL CORPORATION
Date: August 2, 2006 By: /s/ Vincent J. Truant
------------------------------
Name: Vincent J. Truant
Title: Chief Executive Officer and
Principal Executive Officer
Date: August 2, 2006 By: /s/ D. Scott Houston
------------------------------
Name: D. Scott Houston
Title: Chief Financial Officer and
Secretary
Date: August 2, 2006 By: /s/ Paul Susie
------------------------------
Name: Paul Susie
Title: Controller and Principal
Accounting Officer
In accordance with the Securities Exchange Act of 1934, as amended, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
/s/ Vincent J. Truant Date: August 2, 2006
------------------------------------------
Vincent J. Truant
Chief Executive Officer,
Principal Executive Officer and Secretary
/s/ D. Scott Houston Date: August 2, 2006
------------------------------------------
D. Scott Houston
Chief Financial Officer and Secretary
/s/ Hamlin Jennings Date: August 2, 2006
------------------------------------------
Hamlin Jennings
Director
/s/ Walker Rast Date: August 2, 2006
------------------------------------------
Walker Rast
Director
/s/ Michael Gordon Date: August 2, 2006
------------------------------------------
Michael Gordon
Director
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