Edgar Filing: EARTHSHELL CORP

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended
June 30, 2006

|_| TRANSITION REPORT PURSUANT SECTION 13 OR 15 (d)
OF SECURITIES EXCHANGE ACT OF 1934

For the Transition Period From ______to_________

Commission File Number 0-23567

EARTHSHELL CORPORATION

(Exact name of registrant as specified in its charter)

DELAWARE 77-0322379
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

1301 YORK ROAD, SUITE 200
BALTIMORE, MD 21093
(Address of principal executive office) (Zip Code)

(410) 847-9420
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|

Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.

Large accelerated filer |_| Accelerated filer |_| Non-accelerated filer |X|

Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act).

The number of shares outstanding of the Registrant's Common Stock as of
July 28, 2006 is 20,095,190

EARTHSHELL CORPORATION

FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2006

INDEX TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES

PART I. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements Page

a) Condensed Consolidated Balance Sheets as of June 30,
2006 (unaudited) and December 31, 2005.................. 1

b) Condensed Consolidated Statements of Operations for
the three month and six month periods ended June 30, 2006
and June 30, 2005 (unaudited)............................ 2

c) Condensed Consolidated Statements of Cash Flows for
the six months ended June 30, 2006 and June 30, 2005
(unaudited) ............................................ 3

d) Notes to Condensed Consolidated Financial Statements
(unaudited) ............................................ 6

Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ................................ 11

Item 3. Quantitative and Qualitative Disclosures About Market Risk. 16

Item 4. Controls and Procedures .................................. 16

PART II. OTHER INFORMATION

Item 1. Legal Proceedings......................................... 17

Item 1A. Risk Factors.............................................. 17

Item 2. Unregistered Sales of Securities and Use of Proceeds...... 17

Item 3. Defaults Upon Senior Securities........................... 18

Item 4. Submission of Matters to a Vote of Security Holders....... 18

Item 5. Other Information......................................... 18

Item 6 Exhibits ................................................. 19

SIGNATURE.............................................................. 20

EARTHSHELL CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

JUNE 30 DECEMBER 31
2006 2005
------------- -------------
(UNAUDITED)

ASSETS
CURRENT ASSETS
Cash and cash equivalents ................ $ 404,374 $ 347,812
Prepaid expenses and other current assets 72,506 83,473
------------- -------------
Total current assets ................ 476,880 431,285

PROPERTY AND EQUIPMENT, NET .................... 12,039 11,991
EQUIPMENT HELD FOR SALE ........................ 1 1

------------- -------------
TOTALS ......................................... $ 488,920 $ 443,277
============= =============

LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Accounts payable and accrued expenses .... $ 4,417,564 $ 5,908,670
Current portion of settlements ........... 179,160 300,786
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 ..... 7,513,661 11,889,752

DEFERRED REVENUES, LESS CURRENT PORTION......... 737,500 787,500
NOTE PAYABLE, NET OF DISCOUNT OF $1,752,132 2,747,868 --
OTHER LONG-TERM LIABILITIES .................... 59,436 117,914
------------- -------------
Total liabilities ................... 11,058,465 12,795,166

STOCKHOLDERS' DEFICIT
Preferred Stock, $.01 par value, 10,000,000
shares authorized; 400,000 Series D
shares designated - 128,205 and 0 Series D
shares issued and outstanding as of June 30,
2006 and December 31, 2005, respectively...... 1,282 --

Common Stock, $.01 par value, 40,000,000
shares authorized: 19,845,190 and
18,981,167 shares issued and outstanding
as of June 30, 2006 and December 31 2005,
respectively.................................. 198,452 189,812
Common Stock to be issued....................... 106,500 --
Additional paid-in capital...................... 319,627,214 315,306,825
Accumulated deficit............................. (330,455,124) (327,786,868)
Accumulated other comprehensive loss ........... (47,869) (61,658)
------------- -------------
Total stockholders' deficit .............. (10,569,545) (12,351,889)
------------- -------------

TOTALS ......................................... $ 488,920 $ 443,277
============= =============

See Notes to Condensed Consolidated Financial Statements.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

For the For the
Three Months Six Months
Ended June 30, Ended June 30,
---------------------------- ----------------------------
2006 2005 2006 2005
------------ ------------ ------------ ------------

Revenues ............................................. $ 25,000 $ 58,333 $ 50,000 $ 133,333

Operating Expenses

Research and development expenses ............... 61,317 119,183 61,317 222,778
Related party general and administrative expenses
(reimbursements) ........................... 10,000 (4,218) 30,000 (3,640)
Other general and administrative expenses ....... 1,122,877 1,577,688 2,074,923 2,610,001
Depreciation and amortization ................... 1,218 838 2,321 1,675
------------ ------------ ------------ ------------
Total operating expenses .................... 1,195,412 1,693,491 2,168,561 2,830,814

Operating Loss ....................................... 1,170,412 1,635,158 2,118,561 2,697,481

Other (Income) Expenses
Interest income ................................. (3,861) (2,274) (7,221) (2,752)
Related party interest expense .................. 19,965 100,758 48,337 101,314
Other interest expense .......................... 340,392 144,364 839,274 165,825
Gain on sales of property and equipment ......... -- (16,600) (26,096) (23,705)
Gain on settlement of debt ...................... (49,575) -- (304,599) --
Loss Before Income Taxes ............................. 1,477,333 1,861,406 2,668,256 2,938,163

Income taxes ......................................... -- -- -- 800
------------ ------------ ------------ ------------
Net Loss ............................................. $ 1,477,333 $ 1,861,406 $ 2,668,256 $ 2,938,963
============ ============ ============ ============

Basic and Diluted Loss Per Common Share .............. $ 0.07 $ 0.10 $ 0.14 $ 0.16
Weighted Average Number of Common Shares Outstanding . 19,629,584 18,394,967 19,429,242 18,323,013

See Notes to Condensed Consolidated Financial Statements.

EARTHSHELL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

SIX MONTHS ENDED
JUNE 30,
----------------------------------
2006 2005
--------------- ---------------

CASH FLOWS FROM OPERATING ACTIVITIES
Net loss ................................................................. $ (2,668,256) $ (2,938,963)
Adjustments to reconcile net loss to net cash used in operating activities
Depreciation and amortization .......................................... 2,321 1,675
Amortization of debt discount .......................................... 519,327 100,196
(Gain) Loss on sale, disposal, or impairment of property and equipment . (26,096) (23,705)
(Gain) on settlements of debt .......................................... (304,599) --
Stock option and restricted stock compensation expense ................. 260,837 251,692
Other non-cash expense items ........................................... 39,367 (196,526)
Changes in operating assets and liabilities
Prepaid expenses and other current assets .............................. 10,966 30,172
Deferred revenues ...................................................... (50,000) (133,333)
Accounts payable and accrued expenses .................................. 8,849 1,076,893
Payables to a related party ............................................ -- (37,854)
Other long-term liabilities ............................................ 4,955 --
--------------- ---------------
Net cash used in operating activities ............................... (2,202,329) (1,869,753)
--------------- ---------------

CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment ....................................... (2,368) --
Proceeds from sales of property and equipment ............................ 26,096 23,705
--------------- ---------------
Net cash provided by investing activities ........................... 23,728 23,705
--------------- ---------------

CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of preferred stock ................................ 500,000 --
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 ................. 150,000 322,000
Repayment of notes payable to related party .............................. -- (322,000)
Principal payments on settlements ........................................ (185,059) (146,270)
Proceeds from issuance of note payable ................................... 1,975,803 2,500,000
Note payable issuance costs .............................................. (280,000) (402,500)
--------------- ---------------
Net cash provided by financing activities ........................... 2,221,378 1,976,230
--------------- ---------------

Effect of exchange rate changes on cash and cash equivalents ............. 13,785 (7,465)
--------------- ---------------

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ......................... 56,562 122,717

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ........................... 347,812 272,371
--------------- ---------------

CASH AND CASH EQUIVALENTS, END OF PERIOD ................................. $ 404,374 $ 395,088
=============== ===============

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for
Income taxes ......................................................... $ -- $ 800
Interest ............................................................. $ 105,924 $ 12,619

See Notes to Condensed Consolidated Financial Statements.

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.

On December 30, 2005 in connection with a Securities Purchase Agreement, 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 a security and pledge agreement
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. 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 certain funding) 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. Following the conversion of $558,063 into 186,021
shares of common stock, 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.

See Notes to Condensed Consolidated Financial Statements.

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.

On March 7, 2005, the Company entered into an agreement with Capital Group
Communications ("CGC") in which CGC would perform investor relations functions
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, 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.

During June, 2006, the Company issued a total of 160,000 shares of restricted
common stock to two individuals in connection with the termination of a license
agreement, mutual release, and settlement of claims between the parties.

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.

See Notes to Condensed Consolidated Financial Statements.

EARTHSHELL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
June 30, 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 condensed financial information has been prepared from the books
and records of EarthShell Corporation Certain information and footnote
disclosures, normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States of America,
have been condensed or omitted pursuant to such SEC rules and regulations.
Operating results for the period ended June 30, 2006 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2006.

The balance sheet at December 31, 2005 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by accounting principles generally accepted in the United
States of America for complete financial statements. The accompanying interim
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto included in the Company's Form 10-K for
the year ended December 31, 2005.

EarthShell Corporation's condensed 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, thefinancial 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 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 $7.0 million at June 30, 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. The condensed 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.

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. On January 6, 2006, the Company
received this funding. Additionally, on June 21, 2006, EarthShell Corporation
entered into a Securities Purchase Agreement (the "SPA") by and among the
Company and certain investors named therein pursuant to which the Company sold
an aggregate of 128,205 shares of Series D convertible preferred stock for a
total purchase price of $500,000. (See Item 2. Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Financial Resources. Also see Subsequent Events). 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.

PROPERTY AND EQUIPMENT AND EQUIPMENT HELD FOR SALE

The cost and accumulated depreciation of property and equipment and equipment
held for sale at June 30, 2006 and December 31, 2005 were as follows:

JUNE 30, DECEMBER 31,
2006 2005
------------ ------------

Total office furniture and equipment ............... 96,737 158,854
Less: Accumulated depreciation and amortization ... (84,698) (146,863)
------------ ------------
Property and equipment - net ....................... $ 12,039 $ 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 June 30,
2006 and December 31, 2005:

JUNE 30, DECEMBER 31,
2006 2005
------------ ------------

Accounts payable and other accrued expenses $ 3,505,779 $ 3,137,261
Legal accruals ............................ 235,610 1,920,575
Deferred officer compensation ............. 489,683 453,544
Accrued property taxes .................... 111,002 116,002
Accrued salaries, wages and benefits ...... 75,490 281,288
------------ ------------
Total accounts payable and accrued expenses $ 4,417,564 $ 5,908,670
============ ============

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") which
was subsequently amended on August 2, 2006 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.

STOCK OPTIONS

In 1995 the Company subsequently established the EarthShell Corporation 1995
Stock Incentive Plan (the "Plan"). The Plan as amended 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 Plan.
Options issued to date under the Plan generally vest over varying periods from 0
to 5 years and generally expire 5 to 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 Plan.

Effective January 1, 2006, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 123(R), "Share-Based Payment: An Amendment of SFAS 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. 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 six months ended June 30,
2006 was $0.3 million.

Information with respect to stock options is as follows for the six months ended
June 30, 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 June
30, 2006 ................... 1,610,720 $ 6.09 7.35 $ 324,000
========= =========== =========== ===========

Options exercisable as of
June 30, 2006 .............. 1,033,220 $ 6.51 6.40 $ 192,000
========= =========== =========== ===========

For 2005, prior to adoption of SFAS 123(R) the company did not record
compensation expense related to the options granted. If the Company had applied
the fair value based method to recognize compensation cost for the options
granted, the net loss and net loss per share would have been changed to the
following pro forma amounts for the six months ended June 30, 2005:

2005
----------
Net Loss as reported ....................................... $2,938,863
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
Relates to warrants issued to executive
Officers ................................................ $2,326,408
----------

Pro forma net loss ......................................... $5,265,371

Basic diluted loss per common share
As reported ............................................. $ 0.16
Pro forma ............................................... $ 0.29

In May of 2005, the Company granted to its chairman of the Board of Directors
(and majority beneficial stockholder) a warrant to purchase one million shares
of the Company's common stock at $3 per share in consideration of the
stockholder's continued support of the Company since its inception and providing
bridge loans from time to time. The warrant expires in May of 2015.

STOCK TRANSACTIONS

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 7, 2005, the Company entered into an agreement with Capital Group
Communications ("CGC") in which CGC would perform investor relations functions
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.

SUBSEQUENT EVENTS

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 pursuant to a Registration Rights Agreement. The Company has
acknowledged that an event of default under the Cornell Capital Debentures
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 issuance of 250,000 shares of common stock
and the Company obtaining the effectiveness by September 30, 2006 of the
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 commences on the date of the execution of the Agreement and
continues for so long as (i) the Company strictly complies with the terms of the
agreement and (ii) 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. 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 and also has certain "piggy-back" registration
rights.

On July 28, 2006, the Company entered into a Loan and Mutual Release Agreement
(the "LMRA") pursuant to which E. Khashoggi Industries, LLC ("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 (together,
the "2006 EKI Loans". The Company executed two separate 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 2006 EKI
Loans is due and payable on the earliest to occur of the following: (i) the
second anniversary of the date of the 2006 EKI Loans; (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 2006 EKI Loans and not taking
into account the proceeds advanced under the 2005 EKI Loan or the 2006 EKI
Loans; or (iii) the occurrence of an Event of Default (as defined in the 2006
EKI Loan).

The Company has been engaged in litigation with two (2) equipment suppliers
related to the purchase of manufacturing equipment for 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 July 2006, the Company reached
settlements with both of these equipment suppliers and the litigation matters
are being dismissed. The Company will record a gain on the settlement of this
litigation amounting to approximately $1.0 million in the third fiscal quarter.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

FORWARD LOOKING STATEMENTS

Information contained in this Quarterly Report on Form 10-Q, including but not
limited to "Management's Discussion and Analysis of Financial Condition and
Results of Operations," contains forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995, as amended. These
statements may be identified by the use of forward-looking terminology such as
"may," "expect," "anticipate," "believe," "estimate," or "continue," or the
negative thereof or other comparable terminology. Any one factor or combination
of factors could cause the Company's actual operating performance or financial
results to differ substantially from those anticipated by management that are
described herein. Investors should carefully review the risk factors set forth
in other Company reports or documents filed with the Securities and Exchange
Commission, including Forms 10-Q, 10-K, and 8-K. Factors influencing the
Company's operating performance and financial results include, but are not
limited to, the performance of licensees, changes in the general economy, the
availability of financing, governmental regulations concerning, but not limited
to, environmental issues, and other risks and unforeseen circumstances affecting
the Company's business. This Quarterly Report on Form 10-Q should be read in
conjunction with the Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 2005.

OVERVIEW OF OPERATIONS

CRITICAL ACCOUNTING POLICIES

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 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 $7.0 million at June 30, 2006. These
factors, along with others, may indicate that the Company will be unable 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
condensed 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.

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.

THREE MONTHS ENDED JUNE 30, 2006 COMPARED WITH THE THREE MONTHS ENDED JUNE 30,
2005.

The Company's net loss decreased by approximately $0.4 million to approximately
$1.4 million from approximately $1.8 million for the three months ended June 30,
2006 compared to the three months ended June 30, 2005, respectively.

REVENUES. The Company recorded revenues of approximately $0.03 million for the
three months ended June 30, 2006 as compared to $0.06 for the three months ended
June 30, 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 related elimination of the
prepaid technology fee being amortized.

RESEARCH AND DEVELOPMENT EXPENSES. 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. Research and development expenses decreased $0.06
million to $0.06 million for the three months ended June 30, 2006 from $0.12
million for the three months ended June 30, 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 $0.5 million to approximately $1.1 million from
approximately $1.6 million for the three months ended June 30, 2006, compared to
the three months ended June 30, 2006, 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 decreased by approximately $0.08 million to
$0.02 for the three months ended June 30, 2006 from approximately $0.1
million for the three months ended June 30, 2005. The decrease is due to
interest expense being recorded on the EKI stock issuance and debt
conversion during the first quarter of 2005. The related party interest
expense in 2006 is comprised of interest accrued on the $1.0 million note
payable to E. Khashoggi Industries, LLC.

o Other interest expense increased by approximately $0.2 million to
approximately $0.3 million for the three months ended June 30, 2006 from
approximately $0.1 million for the three months ended June 30, 2005.Other
interest expense for the second quarter of 2006 was primarily composed of
amortization of the debt discount and interest accrued on debentures
issued to Cornell Capital Partners (the "Cornell Capital Debentures").

OTHER INCOME. Other income increased by approximately $0.03 million to $0.05
million for the three months ended June 30, 2006 from $0.02 million for the
three months ended June 30, 2005. This other income was the result of
recognition of gains on settlement of debt in 2006.

SIX MONTHS ENDED JUNE 30, 2006 COMPARED WITH THE SIX MONTHS ENDED JUNE 30, 2005.

The Company's net loss decreased by approximately $0.3 million to approximately
$2.6 million from approximately $2.9 million for the six months ended June 30,
2006 compared to the six months ended June 30, 2005, respectively.

REVENUES. The Company recorded revenues of approximately $0.05 million for the
six months ended June 30, 2006 as compared to $0.1 for the six months ended June
30, 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 related elimination of the prepaid
technology fee being amortized.

RESEARCH AND DEVELOPMENT EXPENSES. 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. Research and development expenses decreased $0.16
million to $0.06 million for the six months ended June 30, 2006 from $0.22
million for the six months ended June 30, 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 $0.6 million to approximately $2.0 million from
approximately $2.6 million for the six months ended June 30, 2006, compared to
the six months ended June 30, 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 decreased by approximately $0.05 million to
$0.05 million for the six months ended June 30, 2006 from approximately
$0.1 million for the six months ended June 30, 2005. The decrease is due
to interest expense being recorded on the EKI stock issuance and debt
conversion during the first quarter of 2005. The related party interest
expense for 2006 is comprised of interest accrued on the $1.0 million note
payable to E. Khashoggi Industries, LLC.

o Other interest expense increased by approximately $0.6 million to
approximately $0.8 million for the six months ended June 30, 2006 from
approximately $0.2 million for the six months ended June 30, 2005. Other
interest expense in the first six 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 $0.33
million for the six months ended June 30, 2006 from $0.03 million for the six
months ended June 30, 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 in 2005 and 2006 and recognition of gains on
settlement of debt in 2006.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flow. The Company's principal uses of cash for the six months ended June
30, 2006 were to fund operations, repay notes and payment of accounts payable
and accrued expenses. Net cash used in operations was $2.2 million and $1.9
million for the six months ended June 30, 2006 and 2005, respectively. The use
of cash for 2006 was primarily from the loss incurred. In the first six months
of 2005, the use of cash was comprised of the net loss offset by a change in
accounts payable and accrued expenses of $1.0 million. Net cash provided by
investing activities was $0.02 million and $0.02 million for the six months
ended June 30, 2006 and 2005, respectively which was primarily the proceeds from
the sale of property and equipment. Net cash provided by financing activities
was $2.2 million and $2.0 million for the six months ended June 30, 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), $0.5 million from the issuance of preferred stock and $0.2 million
from the proceeds of a note payable to a related party. As of June 30, 2006, the
Company had cash and related cash equivalents totaling $0.4 million.

Capital Requirements. The Company only made minor capital expenditures during
the six months ended June 30, 2006 and does not anticipate additional
significant capital expenditures in 2006.

Financing and Restructuring Transactions.

SF Capital Settlement. 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
certain funding) 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. Following the
conversion of $558,063 into 186,021 shares of common stock, 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.

EarthShell Asia License. The Company is party to an amended licensing agreement
with EarthShell Asia ("EA") pursuant to which the Company has received a total
of $0.5 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 for $0.5
million and (iii) the issuance of a warrant to purchase 1,033,333 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
realization of further licensing fees under the agreement is dependent on the
Company successfully demonstrating the commercial viability of its technology in
certain new applications.

Financing Transactions and Arrangements with EKI. On October 11, 2005, the
Company borrowed $1.0 million from EKI under a promissory note (the "2005 EKI
Loan"). 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).

Subsequent to June 30, 2006, on July 28, 2006, the Company entered into a Loan
and Mutual Release Agreement (the "LMRA") pursuant to which E. Khashoggi
Industries, LLC ("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 (together, the "2006 EKI Loans". The Company executed
two separate 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 2006 EKI Loans is due and payable
on the earliest to occur of the following: (i) the second anniversary of the
date of the 2006 EKI Loans; (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 2006 EKI Loans and not taking into account the
proceeds advanced under the 2005 EKI Loan or the 2006 EKI Loans; or (iii) the
occurrence of an Event of Default (as defined in the 2006 EKI Loan).

Cornell Capital Debentures. On January 6, 2006, 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 repay prior loans to Cornell Capital Partners of $2.5
million.

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. On February
14, 2006, the Company filed a registration statement on Form S-1 with the
Securities and Exchange Commission ("SEC") which was subsequently amended on
August 2, 2006 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 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 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 Cornell Capital Debenture Purchase Agreement, the Company
issued to Cornell Capital Partners a two year warrant to purchase up to 350,000
shares of common stock (the "Cornell Capital Warrant"). The 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.

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.

Series D Preferred Stock. On June 21, 2006, the Company entered into a
Securities Purchase Agreement by and among the Company and certain investors
named therein pursuant to which the Company sold an aggregate of 128,205 shares
of Series D convertible preferred stock (the "Series D Preferred Stock") in a
private placement for a total purchase price of $500,000. The Series D Preferred
Stock carries a cumulative 20% annual dividend, which is payable on conversion
or liquidation of the Company. The Series D Preferred Stock is callable in
certain circumstances by the Company and is entitled to a preferential
liquidation value of $3.90 per share plus any accrued and unpaid 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. Holders of
Series D Preferred Stock also have approval rights with respect to certain
corporate matters.

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 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.

Financial Outlook. 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. 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. 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 June 30, 2006, and has not entered into any transactions
involving unconsolidated, limited purpose entities.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is exposed to interest rate risk on its obligations under the 2005
EKI Loan and the 2006 EKI Loans. Currently, the principal amount of the 2005 EKI
Loan and the 2006 EKI Loans total $1.5 million, of which, $1.35 million is
interest bearing. The loans bear interest on the principal balance of $1.35
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 decreases in rates will have the opposite
effect.

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures. The Company's Chief
Executive Officer and Chief Financial Officer have evaluated the effectiveness
of the Company's disclosure controls and procedures (as such term is defined in
Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the
period covered by this Report (the "Evaluation Date"). Based on such evaluation,
such officers have concluded that, as of the Evaluation Date, the Company's
disclosure controls and procedures were not effective in ensuring that (i)
information required to be disclosed by the Company in the reports that it files
or submits under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the SEC's rules and forms and
(ii) information required to be disclosed by the Company in the reports that it
files or submits under the Exchange Act is accumulated and communicated to the
Company's management, including its principal executive and principal financial
officers, or persons performing similar functions, as appropriate to allow
timely decisions regarding required disclosure. The deficiencies in disclosure
controls and procedures were related to the deficiencies in our internal control
over financial reporting and are being remedied as noted below.

(b) Changes in Internal Control Over Financial Reporting. The Company has begun
taking remediation steps to enhance its internal control over financial
reporting and reduce control deficiencies. In the 4th Quarter 2005, the Company
employed 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. Additionally, the Company has hired an accounting
employee to assist the Controller in March 2006. There were no changes to the
Company's internal controls over Financial Reporting for the Quarter Ended June
30, 2006.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Company has been engaged in litigation with two (2) equipment suppliers
related to the purchase of manufacturing equipment for 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 July 2006, the Company reached settlements
with both of these equipment suppliers and the litigation matters are being
dismissed. The Company will record a gain on the settlement of this litigation
amounting to approximately $1.0 million in the third fiscal quarter.

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.

ITEM 1A. RISK FACTORS

There has been no material change to the risk factors required to be disclosed
by the Company in its Form 10-K for the year ended December 31, 2005.

ITEM 2. UNREGISTERED SALES OF SECURITIES AND USE OF PROCEEDS

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.

Pursuant to a letter agreement dated February 27, 2006, the EarthShell and
Capital Group Communications ("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.

On June 21, 2006, the Company sold an aggregate of 128,205 shares of Series D
Preferred Stock for a total purchase price of $500,000. In connection with the
issuance and sale of the Series D Preferred Stock, the Company issued
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 Company 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 issued 250,000 shares of common stock to Cornell
Capital Partners in connection with the letter agreement discussed in Item 3
below.

The foregoing transactions were consummated without registration under the
Securities Act of 1933, as amended (the "1933 Act"), in reliance upon the
exemption from registration pursuant to Section 4 (2) of the 1933 Act and Rule
506 of Regulation D promulgated thereunder. All of the purchasers are believed
by the Company to be "accredited investors" within the meaning of the 1933 Act

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

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 pursuant to a Registration Rights Agreement. The Company has
acknowledged that an event of default under the Cornell Capital Debentures
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 issuance of 250,000 shares of common stock
and the Company obtaining the effectiveness by September 30, 2006 of the
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 commences on the date of the execution of the Agreement and
continues for so long as (i) the Company strictly complies with the terms of the
agreement and (ii) 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. Cornell Capital
Partners has 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 and also has certain "piggy-back" registration rights.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

ITEM 5. OTHER INFORMATION

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 of the agreements, the Company's
registration statement not being declared effective within the required
timeframe provides the holders of the registerable securities with a right to
liquidated damages which, in the aggregate, may amount to approximately $47,000
per month until the 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 has not been declared effective, in December 2004
the Company began accruing the liquidated damages described above. In light of
the Company's current liquidity and financial position any such claim could have
a negative effect on the Company.

During the first six months of 2006, the Company issued certain equity
securities for cash and in settlement transactions as disclosed in Item 2 of
Part II hereof.

ITEM 6. EXHIBITS

The following documents are filed as a part of this report:

Exhibit
Number Description
------- -----------

4.1 Certificate of Designation of Series D convertible preferred
stock (incorporated by reference fro Exhibit 4.1 t the Form 8-K
filed by the Registrant on June 26, 2006).

10.1 Loan and Mutual Release Agreement (the "Agreement"), dated as
of July 28, 2006, by and between HarthShell Corporation
Khashoggi Industries, LLC.

10.2 Securities Purchase Agreement, dated June 21, 2006, by and
among the Company and certain investors named therein.

31.1 Certification of the CEO pursuant to Rules 13a-14 and 15d-14
under the Exchange Act, as Adopted Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.

31.2 Certification of the CFO pursuant to Rules 13a-14 and 15d-14
under the Exchange Act, as Adopted Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.

32.1 Certifications pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized August___, 2006.

August 14, 2006 EARTHSHELL CORPORATION

By: /s/ D. Scott Houston
---------------------------
Name: D. Scott Houston,
Title: Chief Financial Officer

(Mr. Houston is the Chief Financial Officer and has been duly authorized
to sign on behalf of the registrant.)