================================================================================
UNITED STATES
SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------------------------
FORM 10-Q
(Mark One)
|X| Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the quarterly period ended September 30, 2006
or
|_| Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the transition period from ________ to ________
Commission File Number 0-31499
Eden Bioscience Corporation
(Exact name of registrant as specified in its charter)
Washington 91-1649604
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
11816 North Creek Parkway N.
Bothell, Washington 98011-8201
(Address of principal executive offices, including zip code)
(425) 806-7300
(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 past 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 non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
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). Yes |_| No |X|
State the number of shares outstanding of each of the registrant's classes of
common equity, as of the latest practicable date:
Class Outstanding as of October 31, 2006
Common Stock, $.0025 Par Value 8,149,554
================================================================================
Eden Bioscience Corporation
Index to Form 10-Q
Page
Part I. Financial Information
Item 1. Unaudited Financial Statements.................................... 2
Condensed Consolidated Balance Sheets as of September 30, 2006
and December 31, 2005........................................... 2
Condensed Consolidated Statements of Operations for the Three
Months and Nine Months Ended September 30, 2006 and 2005........ 3
Condensed Consolidated Statements of Cash Flows for the Nine
Months Ended September 30, 2006 and 2005........................ 4
Notes to Unaudited Condensed Consolidated Financial Statements.... 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................. 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk........ 23
Item 4. Controls and Procedures........................................... 24
Part II. Other Information
Item 1A. Risk Factors...................................................... 24
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds....... 25
Item 6. Exhibits.......................................................... 25
Signatures................................................................. 25
- 1 -
PART I -- FINANCIAL INFORMATION
Item 1. Unaudited Financial Statements
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
ASSETS
September 30, December 31,
2006 2005
------------- -------------
Current assets:
Cash and cash equivalents ............................................... $ 5,892,191 $ 6,825,652
Accounts receivable, net of sales allowances and allowance
for doubtful accounts ................................................ 136,018 212,213
Inventory, current ...................................................... 733,458 1,713,274
Prepaid expenses and other current assets ............................... 409,593 580,938
------------- -------------
Total current assets ............................................ 7,171,260 9,332,077
Inventory, non-current .................................................... 1,957,592 1,910,280
Property and equipment, net ............................................... 698,062 5,967,122
Other assets .............................................................. 287,880 287,704
------------- -------------
Total assets .................................................... $ 10,114,794 $ 17,497,183
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable ........................................................ $ 362,913 $ 229,667
Accrued liabilities ..................................................... 1,060,299 1,260,405
------------- -------------
Total current liabilities ....................................... 1,423,212 1,490,072
Other long-term liabilities ............................................... 450,531 250,428
------------- -------------
Total liabilities ............................................... 1,873,743 1,740,500
------------- -------------
Commitments and contingencies
Shareholders' equity:
Preferred stock, $.01 par value, 10,000,000 shares authorized; no shares
issued and outstanding at September 30, 2006 and December 31, 2005 .... -- --
Common stock, $.0025 par value, 33,333,333 shares authorized;
8,149,554 issued and outstanding shares at September 30, 2006
and 8,135,554 at December 31, 2005 .................................... 20,374 20,339
Additional paid-in capital .............................................. 132,840,471 132,586,598
Accumulated other comprehensive loss .................................... (35,467) (42,502)
Accumulated deficit ..................................................... (124,584,327) (116,807,752)
------------- -------------
Total shareholders' equity ...................................... 8,241,051 15,756,683
------------- -------------
Total liabilities and shareholders' equity ...................... $ 10,114,794 $ 17,497,183
============= =============
The accompanying notes are an integral part of these statements.
- 2 -
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
2006 2005 2006 2005
------------- -------------- ------------- -------------
Product sales, net of sales allowances . $ 258,284 $ 343,398 $ 3,666,711 $ 3,175,347
Operating expenses:
Cost of goods sold ..................... 185,920 611,030 2,040,972 1,785,389
Research and development ............... 324,200 847,965 1,013,675 2,777,538
Selling, general and administrative .... 898,995 1,230,368 3,837,348 4,197,858
Loss on impairment of equipment and
leasehold improvements ............ -- -- 4,880,516 --
Lease termination loss ................. -- 2,260,538 -- 2,260,538
Loss (gain) on sale of equipment ....... 2,874 (63,081) (41,748) (84,806)
------------ ------------ ------------ ------------
Total operating expenses ............... 1,411,989 4,886,820 11,730,763 10,936,517
------------ ------------ ------------ ------------
Loss from operations ................... (1,153,705) (4,543,422) (8,064,052) (7,761,170)
------------ ------------ ------------ ------------
Other income (expense):
Gain on sale of investment ............. -- -- 99,884 --
Interest income ........................ 70,921 83,781 187,593 223,507
Interest expense ....................... -- (72) -- (538)
------------ ------------ ------------ ------------
Total other income ..................... 70,921 83,709 287,477 222,969
------------ ------------ ------------ ------------
Loss before income taxes .......... (1,082,784) (4,459,713) (7,776,575) (7,538,201)
Income taxes ........................... -- -- -- --
------------ ------------ ------------ ------------
Net loss .......................... $ (1,082,784) $ (4,459,713) $ (7,776,575) $ (7,538,201)
============ ============ ============ ============
Basic and diluted net loss per share ... $ (0.13) $ (0.55) $ (0.95) $ (0.93)
============ ============ ============ ============
Weighted average shares outstanding used
to compute net loss per share ....... 8,149,554 8,131,957 8,146,829 8,129,905
============ ============ ============ ============
The accompanying notes are an integral part of these statements.
- 3 -
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended September 30,
-------------------------------
2006 2005
------------- -------------
Cash flows from operating activities:
Net loss .............................................................. $ (7,776,575) $ (7,538,201)
Adjustments to reconcile net loss to cash used in operating activities:
Depreciation and amortization ....................................... 350,744 1,737,971
Loss on impairment of equipment and leasehold improvements .......... 4,880,516 --
Stock compensation expense .......................................... 232,908 --
Gain on sale of fixed assets ........................................ (41,748) (84,806)
Gain on sale of investment .......................................... (99,884) --
Accretion expense ................................................... 23,457 20,821
Deferred rent payable ............................................... 76,646 33,704
Loss on property and equipment on lease termination ................. -- 3,480,883
Termination of lease obligations .................................... -- (2,724,124)
Forfeiture of security deposit on lease termination ................. -- 1,250,000
Changes in assets and liabilities:
Accounts receivable ................................................. 87,647 (75,562)
Inventory ........................................................... 869,822 80,242
Prepaid expenses and other assets ................................... (34,813) 360,537
Accounts payable .................................................... 133,246 38,717
Accrued liabilities ................................................. (113,544) 358,737
Accrued loss on facility subleases .................................. -- (336,915)
------------ ------------
Net cash from operating activities ................................ (1,411,578) (3,397,996)
------------ ------------
Cash flows from investing activities:
Purchase of equipment ................................................. (16,377) --
Proceeds from sale of investment ...................................... 100,000 --
Proceeds from sale of equipment ....................................... 301,791 204,228
------------ ------------
Net cash from investing activities ................................ 385,414 204,228
------------ ------------
Cash flows from financing activities:
Reduction in capital lease obligations ................................ -- (10,453)
Proceeds from issuance of common stock ................................ 21,000 5,600
------------ ------------
Net cash from financing activities ................................ 21,000 (4,853)
------------ ------------
Effect of foreign currency exchange rates on cash and cash equivalents .. 71,703 (29,978)
------------ ------------
Net decrease in cash and cash equivalents ............................... (933,461) (3,228,599)
Cash and cash equivalents at beginning of period ........................ 6,825,652 11,860,385
------------ ------------
Cash and cash equivalents at end of period .............................. $ 5,892,191 $ 8,631,786
============ ============
Supplemental disclosures:
Cash paid for interest ................................................ $ -- $ 538
The accompanying notes are an integral part of these statements.
- 4 -
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of Significant Accounting Policies
Organization and Business
Eden Bioscience Corporation ("Eden Bioscience" or the "Company") was
incorporated in the State of Washington on July 18, 1994. Eden Bioscience is a
plant health technology company focused on developing, manufacturing and
marketing innovative natural-based protein products for agriculture.
The Company is subject to a number of risks including, among others:
dependence on a limited number of products and the development and
commercialization of those products, which may not be successful; the need to
develop adequate sales and marketing capabilities to commercialize the Company's
products; reliance on independent distributors and retailers to sell the
Company's products; competition from other companies with greater financial,
technical and marketing resources; and other risks associated with
commercializing a new technology.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with U.S. generally accepted accounting
principles for interim financial information and pursuant to the instructions to
Form 10-Q. Accordingly, they do not include all of the information and notes
required by U.S. generally accepted accounting principles for complete financial
statements. 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 notes required by U.S. generally accepted accounting principles
for complete financial statements. These financial statements and notes should
be read in conjunction with the financial statements and notes as of and for the
year ended December 31, 2005 included in the Company's Annual Report on Form
10-K, which was filed with the Securities and Exchange Commission on March 15,
2006.
In the opinion of management, the unaudited condensed consolidated
financial statements include all adjustments, consisting only of normal
recurring adjustments, necessary to state fairly the financial information set
forth therein. Results of operations for the three months and nine months ended
September 30, 2006 are not necessarily indicative of the results expected for
the full fiscal year or for any future period.
On April 17, 2006, the Company amended its Restated Articles of
Incorporation to reduce the Company's number of authorized shares of common
stock from 100,000,000 to 33,333,333 and to effect a 1-for-3 reverse stock split
of the Company's outstanding common stock. The reverse stock split was effective
with respect to shareholders of record at 5:00p.m., Pacific daylight time, on
April 18, 2006 and the Company's common stock began trading as adjusted for the
reverse stock split on April 19, 2006. As a result of the reverse stock split,
each three shares of common stock were exchanged for one share of common stock
and the total number of shares outstanding were reduced from approximately 24.4
million shares to approximately 8.1 million shares. The Company has
retroactively adjusted all the share information to reflect the reverse stock
split in the accompanying condensed consolidated financial statements and
footnotes.
In the first quarter of 2006, the Company sold a minority stock investment
for $100,000 that resulted in a gain of $99,884.
Liquidity
The Company's operating expenditures have been significant since its
inception. The Company currently anticipates that its operating expenses will
significantly exceed net product sales and that net losses and working capital
requirements will consume a material amount of its cash resources. Net product
sales in the first nine months of 2006 have not increased enough to meet our
operating plans. The Company has taken steps to reduce its operating expenses
and the Board of Directors and management are reviewing strategic alternatives
for the future, including further reduction of operating expenses and/or the
sale of all or a portion of our business.. There can be no assurance, however,
that any actions the Compnay may take will improve operating results or
liquidity enough to support operations or that it will be able to sell its
business on acceptable terms, if at all. Management of the Company believes that
the balance of its cash and cash equivalents at September 30, 2006 will be
- 5 -
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
sufficient to meet its anticipated cash needs for net losses, working capital
and capital expenditures for more than the next 12 months, although there can be
no assurance in that regard. After the next 12 months, if operations do not
improve significantly, the Company will have to further reduce operating
expenses or secure additional financing. The Company may be unable to obtain
adequate or favorable financing at that time or at all and may cease operations.
The sale of additional equity securities could result in dilution of the
Company's shareholders.
Estimates Used in Financial Statement Preparation
The preparation of financial statements in conformity with generally
accepted accounting principles in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. Examples include fair value and depreciable lives
of property and equipment; expense accruals; provisions for sales allowances,
warranty claims and inventory valuation and classification; cash flow
projections used in evaluating whether asset impairment loss is recorded; fair
value of stock compensation arrangements and bad debts. Such estimates and
assumptions are based on historical experience, where applicable, management's
plans and other assumptions. Estimates and assumptions are reviewed periodically
and the effects of revisions are reflected in the consolidated financial
statements prospectively when they are determined to be necessary. Actual
results could differ from these estimates.
Accounts Receivable
Accounts receivable balances are reported net of customer-specific related
sales allowances of $12,000 at September 30, 2006 and $20,000 at December 31,
2005. In determining the adequacy of the allowance for doubtful accounts, the
Company considers a number of factors, including the aging of the accounts
receivable portfolio, customer payment trends, the financial condition of its
customers, historical bad debts and current economic trends. Based upon an
analysis of outstanding net accounts receivable, a $10,000 allowance for
doubtful accounts was recorded at September 30, 2006 and no allowance for
doubtful accounts was recorded at December 31, 2005.
Inventory
Effective January 1, 2006, the Company adopted Statement of Financial
Accounting Standards No. 151, Inventory Costs, which clarifies the accounting
for abnormal amounts of idle facility expense, freight, handling costs, and
wasted material (spoilage). Under this Statement, such items will be recognized
as current-period charges. In addition, the Statement requires that allocation
of fixed production overheads to the costs of conversion be based on normal
capacity of the production facilities. The adoption of this Statement did not
have a significant effect on the Company's financial statements.
Property and Equipment
As of September 30, 2006, equipment and leasehold improvements are stated
at estimated fair value. Prior to June 30, 2006, equipment and leasehold
improvements were stated at historical cost. Improvements and replacements are
capitalized. Maintenance and repairs are expensed when incurred. The provision
for depreciation and amortization is determined using straight-line and
units-of-production methods, which allocate costs less salvage value over their
estimated useful lives of two to twenty years. Leasehold improvements are
amortized over the shorter of their estimated useful lives or lease term, which
range between two to ten years.
Long-lived assets are reviewed for impairment whenever events or
circumstances indicate that the carrying value may not be recoverable. In
reviewing for impairment, the Company compares the carrying value of such assets
to the undiscounted cash flows expected from the use of the assets and their
eventual disposition. When necessary, an impairment loss is recognized equal to
the difference between the assets' fair value and their carrying value. Based
upon an analysis of estimated net cash flows to be realized from the Company's
investments in equipment and leasehold improvements in connection with the
preparation of the Company's financial statements for the quarter ended June 30,
2006, a $4.9 million impairment loss on equipment and leasehold improvements was
recognized at June 30, 2006 based on the estimate of fair value of equipment and
leasehold improvements.
In December 2005, the Company completed an efficiency analysis of its
manufacturing processes, including an assessment of all manufacturing equipment
and its usefulness in future manufacturing operations. The lower of carrying
value or estimated fair value less estimated costs to sell of equipment to be
sold totaled $105,000 at September 30, 2006 and $318,000 at December 31, 2005
and is included in other current assets on the balance sheet.
- 6 -
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Revenues
The Company recognizes revenue from product sales, net of sales
allowances, when product is delivered to its distributors and all significant
obligations of the Company have been satisfied, unless acceptance provisions or
other contingencies or arrangements exist, including whether collection is
reasonably assured. If acceptance provisions or contingencies exist, revenue is
deferred and recognized later if such provisions or contingencies are satisfied.
As part of the analysis of whether all significant obligations of the Company
have been satisfied or situations where acceptance provisions or other
contingencies or arrangements exist, the Company considers the following
elements, among others: sales terms and arrangements, historical experience and
current incentive programs. Distributors do not have price protection or
product-return rights. The Company provides an allowance for warranty claims
based on historical experience and expectations. Shipping and handling costs
related to product sales that are paid by the Company are included in cost of
goods sold.
Sales allowances represent allowances granted to independent distributors
for sales and marketing support and are estimated based on the terms of the
distribution arrangements or other arrangements. Sales allowances are estimated
and accrued when the related product sales are recognized or when services are
provided and are paid in accordance with the terms of the then-current
distributor program arrangements or other arrangements. Distributor program
arrangements expire annually, generally on December 31.
Gross product sales and sales allowances are as follows:
Three Months Ended September 30, Nine Months Ended September 30,
--------------------------------- ----------------------------------
2006 2005 2006 2005
-------------- -------------- -------------- --------------
Gross product sales ..................... $ 222,699 $ 371,418 $ 4,005,353 $ 3,758,215
Sales allowances ........................ -- (28,020) (507,932) (759,456)
Elimination of previously recorded sales
allowance liabilities ................ 35,585 -- 169,290 176,588
-------------- -------------- -------------- --------------
Product sales, net of sales allowances $ 258,284 $ 343,398 $ 3,666,711 $ 3,175,347
============== ============== ============== ==============
Net product sales by geographical region were:
Three Months Ended September 30, Nine Months Ended September 30,
--------------------------------- ----------------------------------
2006 2005 2006 2005
-------------- -------------- -------------- --------------
United States ........................... $ 159,460 $ 185,009 $ 3,309,468 $ 2,477,537
Spain ................................... -- 153,278 140,224 602,369
Other regions ........................... 98,824 5,111 217,019 95,441
-------------- -------------- -------------- --------------
Product sales, net of sales allowances $ 258,284 $ 343,398 $ 3,666,711 $ 3,175,347
============== ============== ============== ==============
Incentives
The Company periodically offers sales incentives, often in the form of
free product, to distributors and other customers. Costs associated with such
incentives are recognized as costs of sales in the later of the period in which
(a) the associated revenue is recognized by the Company or (b) the sales
incentive is offered to the customer.
Accounting for Stock Compensation
The Company maintains a stock equity incentive plan under which it may
grant non-qualified stock options, incentive stock options or restricted stock
to employees, non-employee directors and consultants. Prior to the January 1,
2006 adoption of the Financial Accounting Standards Board ("FASB") Statement No.
123(R), "Share-Based Payment" ("SFAS 123R"), the Company accounted for
stock-based compensation using the intrinsic value method prescribed in
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees," and related interpretations. Accordingly, because the stock
option grant price equaled the market price on the date of grant, no
compensation expense was recognized by the Company for stock-based compensation.
As permitted by SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123"), stock-based compensation was included as a pro forma disclosure in the
notes to the consolidated financial statements.
Effective January 1, 2006, the Company adopted the fair value recognition
provisions of SFAS 123R, using the modified-prospective transition method. Under
- 7 -
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
this transition method, stock-based compensation expense was recognized in the
consolidated financial statements for granted stock options. Compensation
expense recognized included the estimated expense for stock options granted
subsequent to January 1, 2006, based on the grant date fair value estimated in
accordance with the provisions of SFAS 123R, and the estimated expense for the
portion vesting in the period for options granted prior to, but not vested as of
January 1, 2006, based on the grant date fair value estimated in accordance with
the original provisions of SFAS 123. Results for prior periods have not been
restated, as provided for under the modified-prospective method. Total
stock-based compensation expense recognized in the consolidated statement of
operations for the three and nine months ended September 30, 2006 was $29,000
and $233,000, respectively.
The following table shows the impact of adoption of SFAS 123R on net loss
and loss per share for the three and nine months ended September 30, 2006:
Three Months Ended September 30, 2006 Nine Months Ended September 30, 2006
------------------------------------- ------------------------------------
As Reported If Reported As Reported If Reported
Following Following Following Following
SFAS 123R APB 25 SFAS 123R APB 25
-------------- -------------- -------------- --------------
Net loss ......................... $ (1,082,784) $ (1,053,835) $ (7,776,575) $ (7,543,667)
============== ============== ============== ==============
Loss per share:
Basic and diluted - as reported $ (0.13) $ (0.13) $ (0.95) $ (0.93)
============== ============== ============== ==============
The following table shows the effect on net loss and loss per share had
compensation cost been recognized based upon the estimated fair value on the
grant date of stock options in accordance with SFAS 123, as amended by SFAS No.
148 "Accounting for Stock-Based Compensation - Transition and Disclosure":
Three Months Ended Nine Months Ended
September 30, September 30,
2005 2005
------------------ -----------------
Net loss, as reported .................. $ (4,459,713) $ (7,538,201)
Deduct: stock-based compensation expense
under fair value based method ....... (161,650) (489,611)
-------------- --------------
Pro forma net loss ..................... $ (4,621,363) $ (8,027,812)
============== ==============
Loss per share:
Basic and diluted - as reported ..... $ (0.55) $ (0.93)
============== ==============
Basic and diluted - pro forma ....... $ (0.57) $ (0.99)
============== ==============
Disclosures for the three and nine months ended September 30, 2006 are not
presented because the amounts are recognized in the consolidated financial
statements.
The fair value for stock awards was estimated at the date of grant using
the Black-Scholes-Merton ("BSM") option valuation model with the following
weighted average assumptions for the nine months ended September 30, 2006 and
2005:
September 30,
-------------
2006 2005
------ ------
Expected term (in years) ..................... 6.25 5.0
Expected stock price volatility .............. 95% 98%
Risk-free interest rate ...................... 4.29% 3.85%
Expected dividend yield ...................... -- --
Estimated fair value per option granted ...... $ 0.57 $ 0.66
For the nine months ended September 30, 2006, the expected life of each
award granted was calculated using the "simplified method" in accordance with
Staff Accounting Bulletin No. 107. Prior to January 1, 2006, the expected term
of the options represents the estimated period of time until exercise and is
based on historical experience of similar awards, giving consideration to the
contractual terms, vesting schedules and expectations of future employee
behavior. Expected stock price volatility is based on historical volatility of
the Company's stock. The risk-free interest rate is based on the implied yield
- 8 -
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
available on U.S. Treasury zero-coupon issues with an equivalent remaining term.
The Company has not paid dividends in the past and does not plan to pay any
dividends in the near future.
The BSM option valuation model was developed for use in estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions, particularly for the expected term and expected stock
price volatility. The Company's employee stock options have characteristics
significantly different from those of traded options, and changes in the
subjective input assumptions can materially affect the fair value estimate.
Because Company stock options do not trade on a secondary exchange, employees do
not derive a benefit from holding stock options unless there is an increase,
above the grant price, in the market price of the Company's stock.
Net Loss Per Share
Basic net loss per share is the net loss divided by the average number of
shares outstanding during the period. Diluted net loss per share is the net loss
divided by the sum of the average number of shares outstanding during the period
plus the additional shares that would have been issued had all dilutive options
been exercised, less shares that would be repurchased with the proceeds from
such exercise using the treasury stock method. The effect of including
outstanding options is antidilutive for all periods presented. Therefore,
options have been excluded from the calculation of diluted net loss per share.
Shares issuable pursuant to stock options that have not been included in the
above calculations because they are antidilutive totaled 824,459 and 834,750 as
of September 30, 2006 and 2005, respectively.
Reclassifications
Certain reclassifications have been made to the prior period condensed
consolidated financial statements to conform to classifications used in the
current period.
2. Stock Compensation
During 2000, the shareholders and Board of Directors approved the 2000
Stock Incentive Plan (the "2000 Plan"). Upon completion of the Company's initial
public offering, the 2000 Plan replaced the 1995 Combined Incentive and
Nonqualified Stock Option Plan (the "1995 Plan" and, together with the 2000
Plan, the "Stock Option Plans") for the purpose of all future stock incentive
awards. All reserved but ungranted shares under the 1995 Plan and any shares
subject to outstanding options under the 1995 Plan that expire or are otherwise
cancelled without being exercised will be added to the shares available under
the 2000 Plan.
The Board of Directors has the authority to determine all matters relating
to options to be granted under the Stock Option Plans, including designation as
incentive or nonqualified stock options, the selection of individuals to be
granted options, the number of shares subject to each grant, the exercise price,
the term and vesting period, if any. Generally, options vest over periods
ranging from three to five years and expire ten years from date of grant. The
Board of Directors reserved an initial total of 500,000 shares of common stock
under the 2000 Plan, plus an automatic annual increase equal to the lesser of
(a) 500,000 shares; (b) 5% of the outstanding shares of common stock on a fully
diluted basis as of the end of the immediately preceding year; and (c) a lesser
amount as may be determined by the Board of Directors. No additional shares were
added to the 2000 Plan on January 1, 2006, 2005 or 2004.
At September 30, 2006, the Company had reserved 179,773 shares of common
stock for issuance under the 1995 Plan, all of which had been granted, and
1,082,951 shares for issuance under the 2000 Plan, including 582,951 shares
transferred from the 1995 Plan. Options totaling 644,686 under the 2000 Plan had
been granted at September 30, 2006, leaving 438,265 options available for future
grant. Additionally, in the first quarter of 2006, the Board of Directors
approved cash and equity incentive arrangements for certain employees in 2006.
If certain net revenue goals are achieved for 2006, these employees would be
granted fully vested stock options to purchase between 41,669 and 104,169 shares
of the Company's common stock, depending on actual annual net revenues achieved.
The exercise price of any options issued under this plan would be equal to the
market price of the Company's common stock at the date of grant. At September
30, 2006, management has determined it is not probable that the annual net
revenue targets will be achieved and no compensation expense has been recorded
under this incentive plan during 2006.
- 9 -
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The fair value of each stock option granted is estimated on the date of
grant using the BSM option valuation model. The assumptions used to calculate
the fair value of options granted are evaluated and revised, as necessary, to
reflect market conditions and the Company's experience. Options granted are
valued using the single option valuation approach, and the resulting expense is
recognized over the entire requisite service period. Compensation expense is
recognized only for those options expected to vest, with forfeitures estimated
at the date of grant and at each balance sheet date based on the Company's
historical experience and future expectations. Prior to the adoption of SFAS
123R, the effect of forfeitures on the pro forma expense amounts was recognized
as the forfeitures occurred.
The following table summarizes stock option activity:
Weighted Weighted Average Aggregate
Number of Average Exercise Remaining Intrinsic
Options Price Per Option Contractual Life Value
-------------- ---------------- ---------------- --------------
Balance at December 31, 2005 ..................... 882,538 $ 8.02
Granted ........................................ 9,999 2.16
Exercised ...................................... (14,000) 1.50
Cancelled ...................................... (54,078) 11.20
--------------
Balance at September 30, 2006 .................... 824,459 7.97 5.9 $ 0
==============
Exercisable at September 30, 2006 ................ 670,523 $ 9.04 5.5 $ 0
The aggregate intrinsic value in the table above is based on the Company's
closing stock price of $0.62 as of September 30, 2006, which would have been
received by the optionees had all in-the-money options been exercised on that
date. As of September 30, 2006, total unrecognized stock-based compensation
expense related to nonvested stock options was approximately $128,000 and the
Company expects to recognize $23,000 in the remainder of 2006, $77,000 in 2007,
$24,000 in 2008 and $4,000 in 2009.
The following table summarizes stock option information at September 30,
2006:
Options Outstanding Options Exercisable
------------------------------------------------ -------------------------------
Weighted-Average Weighted- Weighted-
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life (in years) Price Outstanding Price
--------------------------------- -------------- ---------------- -------------- -------------- --------------
$ 1.62-3.00 ..................... 169,465 7.4 $ 2.26 57,167 $ 2.70
4.20-5.55 ..................... 488,527 6.3 4.81 451,252 4.78
6.00-18.00 ..................... 92,000 2.8 11.37 90,867 11.42
21.00-42.00 ..................... 74,467 3.9 37.44 71,237 38.07
-------------- --------------
824,459 5.9 7.97 670,523 9.04
============== ==============
3. Licensing Agreement
In May 1995, the Company entered into an exclusive worldwide licensing
agreement with Cornell Research Foundation ("CRF")for certain patents, patent
applications and biological material relating to harpin proteins and related
technology. The license agreement terminates on the expiration date of the
last-to-expire licensed patent covered by the agreement, which is currently
February 2018. As consideration for the license, the Company issued 400,000
shares of common stock to CRF, has funded certain research and development
activities at Cornell University and has agreed to pay a 2% royalty on net sales
of current Harp-N-Tech products that incorporate the licensed technology,
subject to a $200,000 minimum annual royalty payment.
Effective July 1, 2006, the licensing agreement was amended to establish a
development fund at CRF to advance harpin technology and reduced the Company's
minimum obligation required to maintain the rights under the licensing agreement
to contributions to the development fund of $100,000 in each of 2006, 2007 and
2008 license years, which begin on May 1 and end on April 30. The amendment also
requires the Company to pay CFR $100,000 by May 30, 2008, which is recorded in
other long-term liabilities on the balance sheet.
- 10 -
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
4. Inventory
Inventory, at average cost, consists of the following:
September 30, December 31,
2006 2005
----------- -----------
Raw materials .......................... $ 501,728 $ 503,259
Bulk manufactured goods ................ 426,600 561,318
Finished goods ......................... 1,762,722 2,558,977
----------- -----------
Total inventory ...................... 2,691,050 3,623,554
Less non-current portion of inventory .. (1,957,592) (1,910,280)
----------- -----------
Current portion of inventory ......... $ 733,458 $ 1,713,274
=========== ===========
The non-current portion of inventory consists of raw materials, bulk
manufactured goods and finished goods that the Company does not expect to
utilize in the next twelve months.
5. Property and Equipment
Property and equipment consists of the following:
September 30, December 31,
2006 2005
------------ ------------
Equipment ..................................... $ 698,062 $ 6,858,009
Leasehold improvements ........................ -- 3,557,590
------------ ------------
Total property and equipment ................ 698,062 10,415,599
Less accumulated depreciation and amortization -- (4,448,477)
------------ ------------
Net property and equipment .................. $ 698,062 $ 5,967,122
============ ============
The Company periodically reviews the carrying values of our property and
equipment to determine whether such assets have been impaired. An impairment
loss must be recorded pursuant to SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, when the undiscounted net cash flows expected to
be realized from the use of such assets are less than their carrying value. The
determination of expected undiscounted net cash flows requires us to make many
estimates, projections and assumptions, including the lives of the assets,
future sales and expense levels, additional capital investments or expenditures
necessary to maintain the assets, industry market trends and general and
industry economic conditions. Property and equipment consists primarily of
assets used to manufacture and sell our products and assets used in our research
and administration. For the purpose of assessing asset impairment, the Company
has grouped all of these assets together in one asset group because
administration and research activities support manufacturing and sales
activities and do not have a separate identifiable cash flow.
The Company continues to incur losses from operations and actual sales and
growth rates for the first half of 2006 were significantly lower than expected.
In reviewing for impairment in connection with the preparation of the Company's
financial statements for the quarter ended June 30, 2006, the Company compared
the carrying value of such assets to updated undiscounted cash flows expected
from the use of the asset group. As a result of continuing operating losses and
lower sales and growth rates in the first half of 2006 compared to forecasts,
the carrying value of the group of assets exceeded undiscounted cash flows
expected from the use of this asset group. Consequently, the Company concluded
on July 31, 2006 that a charge for impairment to its equipment and leasehold
improvements is required and a $4.9 million impairment loss was recognized at
June 30, 2006. The Company estimated the fair value of equipment using an
orderly liquidation method and no fair value was attributed to leasehold
improvements. The impairment charge will not result in future cash expenditures.
The Company recorded depreciation and amortization of zero and $552,342
for the three months ended September 30, 2006 and 2005, respectively, and
$350,744 and $2,135,990 for the nine months ended September 30, 2006 and 2005,
respectively. No depreciation was recorded in the three months ended September
30, 2006 for equipment depreciated under the units-of-production method due to
no production during this period or for equipment depreciated under the
straight-line method as estimated fair value approximates salvage value.
- 11 -
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
6. Accrued Liabilities
Accrued liabilities consist of the following:
September 30, December 31,
2006 2005
------------- -------------
Sales allowances ................................. 350,613 119,177
Compensation and benefits ........................ $ 335,538 $ 270,545
Research and development field trial expenses .... 84,258 243,463
Facility costs ................................... 76,846 290,499
Current portion of obligation to CRF ............. 14,792 160,684
Warranty ......................................... 74,871 74,871
Promotions ....................................... 35,252 33,177
Other ............................................ 88,129 67,989
------------- -------------
Total accrued liabilities ...................... $ 1,060,299 $ 1,260,405
============= =============
7. Warranty Liability
The Company provides a limited warranty to customers that at the time of
the first sale of its products they conform to the chemical description on the
label and under normal conditions are reasonably fit for the purposes referred
to in the directions for use, subject to certain inherent risks. The warranty
accrual percentage, which has ranged between zero and five percent, and warranty
liability are reviewed periodically and adjusted as necessary, based on
historical experience, the results of product quality testing and future
expectations. There were no changes to the Company's warranty liability during
the nine months ended September 30, 2006.
8. Commitments
Leases
The Company has entered into a non-cancelable facility lease agreement
through the year 2009. The Company also leases office space at three additional
locations on a short-term basis. The Company recorded rent expense of $86,182
and $245,400 for the three months ended September 30, 2006 and 2005,
respectively, and $391,536 and $785,689 for the nine months ended September 30,
2006 and 2005, respectively. Future minimum rental payments under the operating
lease as of September 30, 2006 are as follows:
Three months ended December 31, 2006 ....................... $ 53,253
Year-ended December 31, 2007 ............................... 220,472
Year-ended December 31, 2008 ............................... 229,424
Year-ended December 31, 2009 ............................... 238,366
--------
Total minimum lease payments ............................... $741,515
========
The Company has an asset retirement obligation at the expiration of this
facility lease. The Company has not restricted any assets for purposes of
settling this asset retirement obligation. Following is a reconciliation of the
asset retirement obligation liability, which is included in other long-term
liabilities:
Balance at December 31, 2005 ...................................... $238,272
Accretion expense for nine months ended September, 30, 2006 ..... 23,457
--------
Balance at September 30, 2006 ..................................... $261,729
========
Loss on Lease Termination
In January 2001, the Company entered into a ten-year lease agreement, with
two five-year extension options to be exercised at the Company's discretion, for
63,200 square feet of office space located near its manufacturing facility in
Bothell, Washington. Rent payments increase by approximately eight percent every
30 months over the term of the lease. In the first half of 2001, the Company
converted approximately 22,600 square feet of this building into laboratory
facilities and made other improvements at a cost of approximately $9.1 million.
- 12 -
EDEN BIOSCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
On September 9, 2005, the Company entered into an Amendment of Lease and
Termination Agreement with the landlord to terminate the ten-year lease. The
termination was effective as of August 31, 2005. In connection with the
termination, the existing sublease was transferred to the landlord. The lease
termination resulted in a loss totaling $2,260,538. The lease termination loss
is comprised of a termination fee totaling $1,500,000, consisting of $250,000
cash and the forfeiture of a $1,250,000 security deposit, a loss on leasehold
improvements and equipment at the leased facility totaling $3,480,883, and other
costs, offset by the write-off of liabilities recorded for accrued losses on
facility subleases and rent expense in excess of rent payments totaling
$2,724,124.
Employment and Change-in-Control Agreements
We have severance agreements with four employees that require us to make
severance payments equal to six months annual base salary if we terminate their
employment without cause, as defined in the agreements. One agreement expires
May 15, 2007, two other agreements expire on July 31, 2007 and one does not
expire. If we were required to make all of these payments, severance payments
would total approximately $325,000.
We also have change-in-control agreements with the Chief Science Officer
and the Chief Financial Officer. The agreements provide that, upon a change in
control, as defined in the agreements, we or the acquiring company would
continue to employ them, for a period of two years following a change in
control. During that time, the agreements each provide that the position,
authority, duties and responsibilities of the executives would be substantially
the same as they were during the 90-day period prior to the change in control,
and that their annual base salaries would be at least equal to their annual base
salaries established by our Board of Directors prior to the change in control.
If, during this two-year period, the employment of the executives is terminated
by us or the acquiring company, as applicable, other than for cause, as defined
in the agreements, or by the executives for good reason, as defined in the
agreements, the terminated executive would be entitled to receive (i) his annual
base salary, and pro rata annual bonus, through the date of termination, and any
deferred compensation; and (ii) a severance payment equal to twice the sum of
his annual base salary and the average of his past three annual bonuses. If we
were required to make all of these payments, severance payments would total
approximately $728,000 as of the date of this report. In addition, the
terminated employee's unvested stock options would accelerate and become fully
vested and exercisable.
9. Major Customers
Net product sales to the following distributors accounted for more than
ten percent of net revenues for the periods indicated:
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- ------------------------------
2006 2005 2006 2005
-------------- -------------- -------------- --------------
Customer A $ 30,000 $ ** $ 708,000 $ 455,000
Customer B -- ** 459,000 **
Customer C ** ** 399,000 **
Customer D 59,000 88,000 ** 421,000
Customer E 30,000 -- ** --
Customer F -- 80,000 ** **
Customer G -- 74,000 -- 337,000
** Less than ten percent.
10. Income Taxes
The Company files a Federal and certain foreign and state tax returns and
did not record an income tax benefit for any of the periods presented because it
has experienced operating losses since inception. The Company's total U.S. tax
net operating loss carryforwards were approximately $112.1 million at December
31, 2005 and expire between 2009 and 2025. The Company's total foreign tax net
operating loss carryforwards were approximately $10.4 million at December 31,
2005 and expire between 2006 and 2015. The Company's total general business
credit carryforwards were approximately $1.4 million at December 31, 2005 and
expire between 2013 and 2025.
- 13 -
Pursuant to Section 382 of the Internal Revenue Code, annual use of the
Company's net operating loss and credit carryforwards may be limited in the
event of a cumulative change in ownership of more than 50%. These Section 382
limitations and other limitations under state and foreign tax laws could result
in a portion of the Company's net operating losses never being utilized. The
difference between the statutory tax rate of 35% and the tax benefit of zero
recorded by the Company is due to the Company's full valuation allowance against
net deferred tax assets.
11. Recent Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board ("FASB") issued
Financial Interpretation No. 48, "Accounting for Uncertainty in Income Taxes-an
interpretation of FASB Statement No. 109" ("FIN 48"), which is a change in
accounting for income taxes. FIN 48 specifies how tax benefits for uncertain tax
positions are to be recognized, measured, and derecognized in financial
statements; requires certain disclosures of uncertain tax matters; specifies how
reserves for uncertain tax positions should be classified in the balance sheet;
and provides transition and interim-period guidance, among other provisions. FIN
48 is effective for fiscal years beginning after December 15, 2006 and, as a
result, is effective for us beginning January 1, 2007. The Company does not
expect the impact of FIN 48 to be significant to the consolidated financial
statements.
In September 2006, the SEC issued Staff Accounting Bulletin No. 108 (SAB
108). SAB 108 addresses how the effects of prior year uncorrected misstatements
should be considered when quantifying misstatements in current year financial
statements. SAB 108 requires companies to quantify misstatements using a balance
sheet and income statement approach and to evaluate whether either approach
results in quantifying an error that is material in light of relevant
quantitative and qualitative factors. SAB 108 is applicable for the Company
beginning in fiscal year 2007. The Company does not expect the impact of SAB No.
108 to be significant to the consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements
("SFAS No. 157"). SFAS No. 157 defines fair value, establishes a framework for
measuring fair value and expands disclosures about fair value measurements. SFAS
No. 157 is effective for the Company beginning with fiscal year 2008. The
Company is in the process of assessing the effect SFAS No. 157 may have on the
consolidated financial statements.
- 14 -
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
This discussion and analysis should be read in conjunction with our
unaudited condensed consolidated financial statements and accompanying notes
thereto included in this report and with our 2005 audited financial statements
and notes thereto included in our Annual Report on Form 10-K, which was filed
with the Securities and Exchange Commission on March 15, 2006.
This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995 that
involve risks and uncertainties, such as statements of our ability to sell
unused manufacturing equipment at estimated fair values less costs to sell; our
expectations regarding our sales in the last quarter of the year and the next
twelve months; our belief that our cash balance at September 30, 2006 will be
sufficient to meet anticipated cash needs for more than the next 12 months; and
our ability to further reduce operating expenses. We use words such as
"anticipate," "believe," "expect," "future" and "intend," the negative of these
terms and similar expressions to identify forward-looking statements. However,
these words are not the exclusive means of identifying such statements. In
addition, any statements that refer to expectations, projections or other
characterizations of future events or circumstances are forward-looking
statements. Our actual results could differ materially from those anticipated in
these forward-looking statements for many reasons, including the following
factors:
o Our inability to generate sufficient cash flow from operations, or
obtain funds through additional financing, which may force us to
delay, curtail or eliminate some or all of our research and
development, field-testing, marketing or manufacturing programs or
cease all operations;
o Our inability to sustain compliance with the continued listing
requirements of The Nasdaq Capital Market, including the $1 minimum
bid price requirement, which could result in delisting and adversely
affect the market price and liquidity of our common stock;
o Our inability to successfully achieve broad market acceptance of our
products sufficient to generate enough product revenues in the
future to achieve profitability;
o Our inability to develop adequate sales and marketing capabilities,
which could prevent us from successfully commercializing our current
products and other products we may develop;
o Our inability to establish or maintain successful relationships with
independent distributors and retailers, which could adversely affect
our sales;
o The results of our ongoing or future field trials, which if
unsuccessful could impair our ability to achieve market acceptance
or obtain regulatory approval of our current products or any other
products we may develop;
o Our inability to adequately address the risks of a new enterprise
and the commercialization of a new technology, including
manufacturing, quality control and assurance, regulatory approval
and compliance, marketing, sales, distribution and customer service;
o Our inability to successfully expand internationally as we obtain
regulatory approvals to market and sell our products in other
countries, expansion involves a number of risks, including different
regulatory requirements, reduced protection of intellectual property
rights and the diversion of management attention from domestic
operations;
o Our inability to compete successfully against our current or future
competitors, which may result in price reductions, reduced margins
or the inability to achieve market acceptance of our current
products or any other products we may develop;
o Our inability to obtain regulatory approvals, or to comply with
ongoing and changing regulatory requirements, which could delay or
prevent sales of our current products or any other products we may
develop;
- 15 -
o Our inability to protect our patents and proprietary rights in the
United States and foreign countries, which could limit our ability
to compete effectively since our competitors may take advantage of
our patents or proprietary rights;
o Our inability to operate without infringing the intellectual
property or proprietary rights of others, which could cause us to
incur significant expenses or be prevented from selling our current
products or any other products we may develop in the future;
o Our inability to adequately distinguish our products from
genetically modified plants and products, which could negatively
impact market acceptance of our products;
o Exposure to product liability claims, which could adversely affect
our operations;
o Rapid changes in technology, which could render our current products
or any other products we may develop unmarketable or obsolete;
o Our inability to comply with regulations applicable to our
facilities and procedures, which could delay, limit or prevent our
research and development or manufacturing activities;
o Our inability to maintain high product quality on a large scale,
which could negatively impact market acceptance of our products;
o The failure of any component required in the manufacturing process
of our products, which, because we do not have back-up manufacturing
systems, could delay or impair our ability to manufacture our
products in the quantities that we may require;
o The failure of third-party manufacturers on whom we rely for certain
aspects of our manufacturing process to perform adequately; and
o Our inability to retain our key employees or other skilled
managerial or technical personnel, which could impair our ability to
maintain or expand our business.
More information about factors that potentially could affect our financial
results and our business is included under Item 1A "Risk Factors" in our most
recent Annual Report on Form 10-K filed with the Securities and Exchange
Commission. You should not place undue reliance on our forward-looking
statements, which apply only as of the date of this report. The cautionary
statements made in this report apply to all forward-looking statements wherever
they appear in this report. Except as may be required by law, we undertake no
obligation to publicly release any revisions to these forward-looking statements
that may be made to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events.
Overview
We are a plant health technology company that markets a line of products
based on Eden Bioscience's proprietary harpin protein technology and
manufacturing processes. These products are marketed under the umbrella brand of
Harp-N-TekTM and are used in agricultural and horticultural production as well
as the Home & Garden market. We believe that Harp-N-Tek products enhance plant
health and improve overall plant production and output quality. Harpins are
naturally occurring proteins produced by disease-causing bacteria that attack
plants. Harpin proteins are not a part of the destructive disease complex but
instead serve the beneficial purpose of alerting plants to the fact that they
are under attack. They activate signaling receptors present in most plants
designed to specifically detect the presence of harpin proteins. This warning
signal is transmitted throughout the plant and turns on the plant's intrinsic
ability to protect itself by deploying both growth and defense responses. Eden
Bioscience's Harp-N-Tek products provide these harmless yet potent
signal-inducing harpin proteins and protein extracts, which trigger beneficial
responses designed to protect plants, to help plants grow through stress, to
improve plants' uptake of nutrients, and to enhance the overall level of plant
health.
We have incurred significant operating losses since inception. At
September 30, 2006, we had an accumulated deficit of $124.6 million. We incurred
net losses of $7.8 million and $7.5 million for the nine months ended September
30, 2006 and 2005, respectively, and annual losses of $10.9 million in 2005,
$8.9 million in 2004 and $11.2 million in 2003. We expect to incur significant
- 16 -
additional net losses as we proceed with the commercialization of our current
products and the development of new products and technologies. As a result of
continuing operating losses and lower sales and growth rates in the first half
of 2006 compared to forecasts, the carrying value of our assets exceeded
undiscounted cash flows expected from the use of these assets and a $4.9 million
loss on impairment of equipment and leasehold improvements was recognized at
June 30, 2006.
Our net product sales in the first nine months of 2006 have not increased
enough to meet our operating plans. We have taken steps to reduce our operating
expenses and our Board of Directors and management are reviewing strategic
alternatives for the future, including further reduction of our operating
expenses and/or sale of all or a portion of our business. There can be no
assurance, however, that any actions we take will improve our operating results
or liquidity enough to support our operations or that we will be able to sell
our business on acceptable terms, if at all.
Results of Operations
Three Months and Nine Months Ended September 30, 2006 and 2005
Revenues
We generated our first product sales revenue in August 2000. Product sales
revenue to date has resulted primarily from sales of Messenger, our initial
product, and Messenger STS, an improved formulation of Messenger introduced in
January 2004, as well as N-Hibit(TM), ProAct(TM), MightyPlant(TM) and other
related products (hereafter referred to collectively as "Harp-N-Tek(TM)
products") primarily to distributors in the United States and Spain. Revenues
from product sales are recognized when (a) the product is delivered to
independent distributors, (b) we have satisfied all of our significant
obligations and (c) any acceptance provisions or other contingencies or
arrangements have been satisfied, including whether collection is reasonably
assured. As part of the analysis of whether all of our significant obligations
have been satisfied or situations where acceptance provisions or other
contingencies or arrangements exist, we consider the following elements, among
others: sales terms and arrangements, historical experience and current
incentive programs. Our distributor arrangements provide no price protection or
product-return rights. Product sales revenue is reported net of applicable sales
allowances, as follows:
Three Months Ended September 30, Nine Months Ended September 30,
---------------------------------- -----------------------------------
2006 2005 2006 2005
--------------- --------------- --------------- ---------------
Gross product sales .................... $ 222,699 $ 371,418 $ 4,005,353 $ 3,758,215
Sales allowances ....................... -- (28,020) (507,932) (759,456)
Elimination of previously recorded sales
allowance liabilities ................ 35,585 -- 169,290 176,588
--------------- --------------- --------------- ---------------
Product sales, net of sales allowances $ 258,284 $ 343,398 $ 3,666,711 $ 3,175,347
=============== =============== =============== ===============
Gross product sales revenue for the third quarter of 2006 was $223,000, a
decrease of $148,000 (40%) from $371,000 in the same quarter of 2005. This
decrease was primarily due to no sales in Spain and lower sales in the United
States agriculture and home and garden markets offset by an increase in sales to
other regions. We believe the lack of sales in Spain is the result of high
levels of product in the distribution channel. Gross product sales for the first
nine months of 2006 totaled $4,005,000, an increase of $247,000 (7%) from
$3,758,000 for the same period of 2005. This is a result of increased sales of
ProAct in the United States, offset by sales declines in Spain. Sales in the
first nine months of 2006 were made primarily to 38 distributors, three of which
accounted for an aggregate of 43% of net product sales revenue. Sales in the
first nine months of 2005 were made primarily to 51 distributors, three of which
accounted for an aggregate of 38% of net product sales revenue. Based on
information received from distributors, we estimate that distributors hold
higher levels of our products than we expected as of September 30, 2006. We do
not expect distributors that hold significant inventories of our products to
place additional orders for our products until their current inventories are
reduced, which will adversely affect our future sales and results of operations.
Net product sales revenue from sales to foreign customers totaled $99,000
and $158,000 in the three months ended September 30, 2006 and 2005,
respectively, and $357,000 and $698,000 in the nine months ended September 30,
2006 and 2005, respectively. This decrease is due to lower sales in Spain.
Net sales of Messenger to consumers in the home and garden market in the
United States totaled $33,000 and $40,000 in the three months ended September
30, 2006 and 2005, respectively, and $377,000 and $375,000 in the nine months
ended September 30, 2006 and 2005, respectively. Based on our experience and
seasonality, we expect fourth quarter sales of our home and garden products to
be comparable to third quarter sales.
- 17 -
Due to the growing seasons of our targeted crops and our current portfolio
of Harp-N-Tek products, we expect grower usage of Harp-N-Tek products to be
highly seasonal. Based on the recommended application timing in our targeted
crops and information received from our distributors, we expect the second
quarter to be the most significant period of use. Our product sales to
distributors are also expected to be seasonal. However, actual timing of orders
received from distributors will depend on many factors, including the amount of
Harp-N-Tek products in distributors' inventories.
Sales Allowances
Sales allowances represent allowances granted to independent distributors
for sales and marketing support and are estimated based on the terms of the
distribution arrangements. Sales allowances are estimated and accrued when the
related product sales revenue is recognized or when services are provided and
are paid in accordance with the terms of the then-current distributor program
arrangements. Distributor program arrangements expire annually, generally on
December 31.
Sales allowances during the three months ended September 30, 2006 were
zero compared to $28,000 (8% of gross product sales) in the comparable period of
2005. Sales allowances during the nine months ended September 30, 2006 totaled
$508,000 (13% of gross product sales) compared to $759,000 (20% of gross product
sales) in the comparable period of 2005. The decrease was primarily due to a
reduction in the estimated amounts to be paid to distributors based on the
changes in programs and distributors' participation in current programs. Net
revenue for the three months ended September 30, 2006 included $36,000 and net
revenue for the nine months ended September 30, 2006 and 2005 included $169,000
and $177,000, respectively, of sales allowance recognized in prior quarters that
will not paid because actual amounts earned by distributors were less than
amounts previously estimated.
Cost of Goods Sold
Cost of goods sold consists primarily of the cost of products sold to
distributors, idle capacity costs and the cost of products used for promotional
purposes. Cost of goods sold was $186,000 in the third quarter of 2006, compared
to $611,000 in the third quarter of 2005. This decrease is primarily due to no
depreciation being recorded in the quarter just completed as a result of the
loss on impairment of equipment and leasehold improvements recognized in the
second quarter of 2006 and a reduction in rent. Cost of goods sold was $2.0
million for the first nine months of 2006, compared to $1.8 million in the first
nine months of 2005. The increase in cost of goods sold was due to higher sales
volumes in 2006 and an increase in idle capacity costs resulting from no
manufacturing activities in the first nine months of 2006 compared to 107 days
of production in the same period of 2005.
Research and Development Expenses
Research and development expenses consist primarily of personnel, field
trial, laboratory, regulatory, patent and facility expenses. Research and
development expenses decreased $524,000 (62%) from $848,000 in the third quarter
of 2005 to $324,000 in the same quarter of this year. For the first nine months
of 2006, research and development costs were $1,014,000, a decrease of
$1,764,000 (63%) from $2,778,000 in the same period last year. This decrease was
primarily due to terminating a facility lease in September 2005 that
significantly reduced rent and depreciation and amortization expense related to
leasehold improvements and certain equipment at the facility. Stock compensation
expense included in research and development totaled $5,000 in the third quarter
of 2006 and $19,000 in the first nine months of 2006.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist of payroll and
related expenses for sales and marketing, executive and administrative
personnel; advertising, marketing and professional fees; and other corporate
expenses. Selling, general and administrative expenses decreased $331,000 (27%)
from $1,230,000 in the third quarter of 2005 to $899,000 in the same quarter of
2006. For the first nine months of 2006, selling, general and administrative
costs were $3,837,000 a decrease of $363,000 (9%) from $4,200,000 in the same
period last year. These decreases resulted primarily from less spending on
advertising and marketing costs for the United States market and the Spanish
market offset by recording stock compensation expense of $23,000 in the third
quarter of 2006 and $214,000 in the first nine months of 2006.
- 18 -
Effective January 1, 2006, the Company adopted the fair value recognition
provisions of SFAS 123R, using the modified-prospective transition method. Under
this transition method, stock-based compensation expense was recognized in the
consolidated financial statements for granted stock options. Compensation
expense recognized included the estimated expense for stock options granted
subsequent to January 1, 2006, based on the grant date fair value estimated in
accordance with the provisions of SFAS 123R, and the estimated expense for the
portion vesting in the period for options granted prior to, but not vested as of
January 1, 2006, based on the grant date fair value estimated in accordance with
the original provisions of SFAS 123. As of September 30, 2006, total
unrecognized stock-based compensation expense related to nonvested stock options
was approximately $128,000 and expected to recognize $23,000 in the remainder of
2006, $77,000 in 2007, $24,000 in 2008 and $4,000 in 2009. Total stock-based
compensation expense recognized in the consolidated statement of operations for
the quarter and nine months ended September 30, 2006 was $29,000 and $233,000,
respectively. Prior to the January 1, 2006 adoption of SFAS 123R, the Company
accounted for stock-based compensation using the intrinsic value method
prescribed in APB 25, and related interpretations. Accordingly, because the
stock option exercise price equaled the market price on the date of grant, no
compensation expense was recognized by the Company for stock-based compensation.
Results for prior periods have not been restated, as provided for under the
modified-prospective method.
We estimate the fair value of stock options granted using the
Black-Scholes-Merton option-pricing formula and a single option award approach.
This fair value is then amortized on a straight-line basis over the requisite
service periods of the awards, which is generally the vesting period. Options
generally become exercisable over a three or four-year period and, if not
exercised, expire ten years after the grant date. The majority of our employees
participate in our stock option program. This option-pricing model requires the
input of highly subjective assumptions, including the option's expected term and
the price volatility of the Company's stock. For the three and nine months ended
September 30, 2006, the expected term of each award granted was calculated using
the "simplified method" in accordance with Staff Accounting Bulletin No. 107.
Prior to January 1, 2006, the expected term of the options represents the
estimated period of time until exercise and is based on historical experience of
similar awards, giving consideration to the contractual terms, vesting schedules
and expectations of future employee behavior. Expected stock price volatility is
based on historical volatility of the Company's stock.
Loss on impairment of equipment and leasehold improvements
We periodically review the carrying values of our property and equipment
to determine whether such assets have been impaired. An impairment loss must be
recorded pursuant to SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, when the undiscounted net cash flows expected to be realized
from the use of such assets are less than their carrying value. The
determination of expected undiscounted net cash flows requires us to make many
estimates, projections and assumptions, including the lives of the assets,
future sales and expense levels, additional capital investments or expenditures
necessary to maintain the assets, industry market trends and general and
industry economic conditions. Our property and equipment consists primarily of
assets used to manufacture and sell our products and assets used in our research
and administration. For the purpose of assessing asset impairment, we have
grouped all of these assets together in one asset group because our
administration and research support our manufacturing and sales activities and
do not have a separate identifiable cash flow.
In the first half of 2006, we continued to incur losses from operations
and actual sales and growth rates for the first half of 2006 were significantly
lower than expected. In reviewing our assets for impairment in connection with
the preparation of the Company's financial statements for the quarter ended June
30, 2006, we compared the carrying value of such assets to updated undiscounted
cash flows expected from the use of this asset group. As a result of continuing
operating losses and lower sales and growth rates in the first half of 2006
compared to forecasts, the carrying value of the group of assets exceeded
undiscounted cash flows expected from the use of this asset group. Consequently,
the Company concluded on July 31, 2006 that a charge for impairment to its
equipment and leasehold improvements is required and a $4.9 million impairment
loss was recognized at June 30, 2006. We estimated the fair value of equipment
using an orderly liquidation method and no fair value was attributed to
leasehold improvements. Our estimates of fair value may change as we obtain
additional information about the fair value of our equipment and finalize our
valuation. The impairment charge will not result in future cash expenditures.
Lease Termination Loss
On September 9, 2005, we entered into an Amendment of Lease and
Termination Agreement with the landlord to terminate the lease of 63,200 square
feet of research and office space in Bothell, Washington. The lease originally
- 19 -
expired January 11, 2011. Average annual rent and operating costs under the
lease were approximately $1.9 million. The termination was effective as of
August 31, 2005.
Approximately 34,300 square feet of the space subject to the lease was
subleased. The sublease had an initial term that expired in December 2007.
Average annual rent and operating costs under the sublease were approximately
$1.1 million. In connection with the Amendment of Lease and Termination
Agreement, the existing sublease was transferred to the landlord.
The lease termination resulted in a loss totaling approximately $2.3
million. The lease termination loss is comprised of a termination fee totaling
$1.5 million, consisting of $250,000 cash and the forfeiture of a $1.25 million
security deposit; other costs, and an asset impairment loss on leasehold
improvements and equipment at the leased facility totaling approximately $3.5
million, offset by the write-off of liabilities recorded for accrued losses on
facility subleases and rent expense in excess of rent payments totaling
approximately $2.7 million.
Gain on sale of investment
In the first quarter of 2006, we sold a minority stock investment for
$100,000 that resulted in a gain of $99,884.
Interest Income
Interest income consists of earnings on our cash and cash equivalents.
Interest income decreased $36,000 from $224,000 in the first nine months of 2005
to $188,000 in the same period of this year. The change was due to higher
interest rates in 2006 offset by significantly lower average cash balances
available for investment in the nine months ended September 30, 2006 compared to
the same period in 2005.
Income Taxes
We have generated a net loss from operations for each period since we
began doing business. As of December 31, 2005, we had accumulated approximately
$112.1 million of net operating loss carryforwards for federal income tax
purposes, which expire between 2009 and 2025, and approximately $10.4 million in
foreign tax net operating loss carryforwards, which expire between 2006 and
2015. We have provided a valuation allowance against our net deferred tax assets
because of the significant uncertainty surrounding our ability to realize them.
The annual use of these net operating loss carryforwards may be limited in the
event of a cumulative change in ownership of more than 50%.
Liquidity and Capital Resources
Our operating expenditures have been significant since our inception. We
currently anticipate that our operating expenses will significantly exceed net
product sales and that net losses and working capital requirements will consume
a material amount of our cash resources. Net product sales have not increased
enough to meet our operating plans and we have taken steps to reduce our
operating expenses, primarily in the European and home and garden markets, and
we are currently examining strategic alternatives for the future including plans
to further reduce operating expenses and/or to sell all or a portion of our
business. We believe that the balance of our cash and cash equivalents at
September 30, 2006 will be sufficient to meet our anticipated cash needs for net
losses, working capital and capital expenditures for more than the next 12
months, although there can be no assurance in that regard. After the next 12
months, if operations do not improve significantly, we will have to further
reduce operating expenses or secure additional financing. We may be unable to
obtain adequate or favorable financing at that time or at all and may be forced
to cease operations. The sale of additional equity securities could result in
dilution of our shareholders.
At September 30, 2006, our cash and cash equivalents totaled $5.9 million,
a decrease of $0.9 million from the balance of $6.8 million at December 31,
2005. Prior to October 2000, we financed our operations primarily through the
private sale of our equity securities, resulting in net proceeds of
approximately $36.5 million through September 30, 2000. In October 2000, we
received approximately $91.5 million in net proceeds from the initial public
offering of 2,223,333 shares of our common stock. To a lesser extent, we have
financed our equipment purchases through lease financings.
Net cash used in operations decreased $2.0 million (59%) from $3.4 million
in the first nine months of 2005 to $1.4 million in the same period of 2006. Net
cash used in operations in the first nine months of 2006 resulted primarily from
a net loss of $7.8 million, which includes loss on impairment of equipment and
leasehold improvements of $4.9 million, depreciation and amortization expense of
$351,000 and stock compensation expense of $233,000, and fluctuations in various
asset and liability balances totaling $942,000. We expect that net cash used in
operations will continue to be significant.
- 20 -
We conduct our operations in two primary functional currencies: the U.S.
dollar and the euro. Historically, neither fluctuations in foreign exchange
rates nor changes in foreign economic conditions have had a significant impact
on our financial condition or results of operations. We currently do not hedge
our foreign currency exposures and are, therefore, subject to the risk of
exchange rate fluctuations. We may invoice our international customers in U.S.
dollars and euros, as the case may be. We are exposed to foreign exchange rate
fluctuations as the financial results of foreign subsidiaries are translated
into U.S. dollars in consolidation. Foreign exchange rate fluctuations did not
have a material impact on our financial statements in the nine months ended
September 30, 2006 or 2005.
The following are our contractual obligations as of September 30, 2006:
Payments Due by Period (in thousands)
----------------------------------------------------
Remainder Years 2007 Years 2009
Total of 2006 and 2008 And 2010
---------- ---------- ---------- ----------
Operating lease obligations, including
operating expenses paid to landlord 1,373 73 606 694
CRF minimum obligation ............... 100 -- 100 --
---------- ---------- ---------- ----------
Total .............................. $ 1,473 $ 73 $ 706 $ 694
========== ========== ========== ==========
In addition to the CRF minimum obligation, if we decide to maintain the
rights under the licensing agreement, we agreed to contribute $50,000 by January
15, 2007, $50,000 by May 30, 2007 and $50,000 by November 30, 2007 to a
development fund established at CRF to advance harpin technology and pay a
$200,000 minimum annual royalty payment starting in the license year that begins
May 1, 2008. The license agreement terminates on the expiration date of the
last-to-expire licensed patent covered by the agreement, which is currently
February 2018.
Employment and Change-in-Control Agreements
We have severance agreements with four employees that require us to make
severance payments equal to six months annual base salary if we terminate their
employment without cause, as defined in the agreements. One agreement expires
May 15, 2007, two other agreements expire on July 31, 2007 and one does not
expire. If we were required to make all of these payments, severance payments
would total approximately $325,000.
We also have change-in-control agreements with the Chief Science Officer
and the Chief Financial Officer. The agreements provide that, upon a change in
control, as defined in the agreements, we or the acquiring company would
continue to employ them, for a period of two years following a change in
control. During that time, the agreements each provide that the position,
authority, duties and responsibilities of the executives would be substantially
the same as they were during the 90-day period prior to the change in control,
and that their annual base salaries would be at least equal to their annual base
salaries established by our Board of Directors prior to the change in control.
If, during this two-year period, the employment of the executives is terminated
by us or the acquiring company, as applicable, other than for cause, as defined
in the agreements, or by the executives for good reason, as defined in the
agreements, the terminated executive would be entitled to receive (i) his annual
base salary, and pro rata annual bonus, through the date of termination, and any
deferred compensation; and (ii) a severance payment equal to twice the sum of
his annual base salary and the average of his past three annual bonuses. If we
were required to make all of these payments, severance payments would total
approximately $728,000 as of the date of this report. In addition, the
terminated employee's unvested stock options would accelerate and become fully
vested and exercisable.
Critical Accounting Policies, Estimates and Judgments
Our critical accounting policies are more fully described in Note 1 to our
consolidated financial statements included in our most recent Annual Report on
Form 10-K, which was filed with the Securities and Exchange Commission on March
15, 2006. Certain of our accounting policies require the application of
significant judgment by management in selecting the appropriate assumptions for
calculating financial estimates. By their nature, these judgments are subject to
an inherent degree of uncertainty. These judgments are based on historical
experience, terms of existing contracts, commonly accepted industry practices,
- 21 -
information provided by our customers and other assumptions that we believe are
reasonable under the circumstances. Our estimates and assumptions are reviewed
periodically and the effects of revisions are reflected in the consolidated
financial statements in the period in which they are determined to be necessary.
Actual results may differ from these estimates under different assumptions or
conditions. Our critical accounting policies and estimates include:
Revenue Recognition
We sell the majority of our products to independent, third-party
distributors. Our arrangements with those distributors provide no price
protection or product-return rights. We recognize revenue from product sales,
net of sales allowances, when product is delivered to our distributors and all
of our significant obligations have been satisfied, unless acceptance provisions
or other contingencies or arrangements exist, including whether collection is
reasonably assured. If acceptance provisions or contingencies exist, revenue is
recognized after such provisions or contingencies have been satisfied. As part
of the analysis of whether all of our significant obligations have been
satisfied or situations where acceptance provisions or other contingencies or
arrangements exist, we consider the following elements, among others: sales
terms and arrangements, including customer payment terms, historical experience
and current incentive programs.
Sales allowances represent allowances granted to independent distributors
for sales and marketing support and are based on the terms of the distribution
agreements or other arrangements. Sales allowances are estimated and accrued
when the related product sales are recognized or when services are provided and
are paid in accordance with the terms of the then-current distributor program
agreements or other arrangements.
We also record, at the time revenue is recognized, a liability for
warranty claims based on a percentage of sales. The warranty accrual percentage,
which has ranged between zero and five percent, and warranty liability are
reviewed periodically and adjusted as necessary, based on historical experience,
the results of product quality testing and future expectations. Changes in our
estimate of the warranty liability are recorded in cost of goods sold.
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable balances are reported net of customer-specific related
sales allowances. In determining the adequacy of the allowance for doubtful
accounts, we consider a number of factors, including the age of outstanding
invoices, customer payment trends, the financial condition of our customers,
historical bad debts and current economic trends. Based upon our analysis of
outstanding net accounts receivable at September 30, 2006, a $10,000 allowance
for doubtful accounts was recorded. Changes in the factors above or other
factors could result in a significant charge.
Inventory Valuation and Classification
Our inventory is valued at the lower of cost or market on an average cost
basis. We regularly review inventory balances to determine whether a write-down
is necessary. We consider various factors in making this determination,
including recent sales history and predicted trends, industry market conditions,
general economic conditions, introduction of new products that may obsolete
existing products, the age of our inventory and recent quality control data.
Changes in the factors above or other factors could result in significant
additional inventory cost reductions and write-offs.
We also review our inventory to determine inventory classification.
Inventory expected to be utilized in the next twelve-month period is classified
as current and inventory expected to be utilized beyond that period is
classified as non-current. In determining the classification of inventory, the
Company considers a number of factors, including historical sales experience and
trends, existing distributor inventory, expansion into new markets, introduction
of new products and estimates of future sales growth. Changes in the factors
above or other factors could result in significant changes in classification of
inventory.
Valuation of Property and Equipment
We periodically review the carrying values of our property and equipment
to determine whether such assets have been impaired. An impairment loss must be
recorded pursuant to SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, when the undiscounted net cash flows expected to be realized
from the use of such assets are less than their carrying value. The
determination of expected undiscounted net cash flows requires us to make many
estimates, projections and assumptions, including the lives of the assets,
future sales and expense levels, additional capital investments or expenditures
necessary to maintain the assets, industry market trends and general and
industry economic conditions. Our property and equipment consists primarily of
assets used to manufacture and sell our products and assets used in our research
and administration. For the purpose of assessing asset impairment, we have
grouped all of these assets together in one asset group because our
administration and research support our manufacturing and sales activities and
do not have a separate identifiable cash flow.
- 22 -
In December 2005, the Company completed an efficiency analysis of its
manufacturing processes, including an assessment of all manufacturing equipment
and its usefulness in future manufacturing operations. As a result of this
analysis, the Company identified equipment that will not be used in future
manufacturing operations and will be sold or disposed. The lower of carrying
value or estimated fair value less estimated costs to sell of equipment to be
sold totals $105,000 at September 30, 2006 and is included in other current
assets on the balance sheet. We expect to complete the sale or disposal of this
equipment by the end of 2006.
Based upon our analysis of net cash flows expected to be realized from our
remaining investments in property and equipment in connection with the
preparation of the Company's financial statements for the quarter ended June 30,
2006, a $4.9 million impairment loss was recorded at June 30, 2006. The critical
estimates in the analysis are our forecast sales and expenses over the next
seven years, our ability to sell certain equipment for our estimated fair value
in 2006 and our estimated fair value of equipment held for use.
Stock-Based Compensation
We account for stock-based compensation in accordance with the fair value
recognition provisions of SFAS 123R. We use the Black-Scholes-Merton
option-pricing model which requires the input of highly subjective assumptions.
These assumptions include estimating the length of time employees will retain
their vested stock options before exercising them ("expected term"), the
estimated volatility of the Company's common stock price over the expected term
and the number of options that will ultimately not complete their vesting
requirements ("forfeitures"). Changes in the subjective assumptions can
materially affect the estimate of fair value of stock-based compensation and
consequently, the related amount recognized on the consolidated statements of
operations.
Recent Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board ("FASB") issued
Financial Interpretation No. 48, "Accounting for Uncertainty in Income Taxes-an
interpretation of FASB Statement No. 109" ("FIN 48"), which is a change in
accounting for income taxes. FIN 48 specifies how tax benefits for uncertain tax
positions are to be recognized, measured, and derecognized in financial
statements; requires certain disclosures of uncertain tax matters; specifies how
reserves for uncertain tax positions should be classified in the balance sheet;
and provides transition and interim-period guidance, among other provisions. FIN
48 is effective for fiscal years beginning after December 15, 2006 and, as a
result, is effective for us beginning January 1, 2007. The Company does not
expect the impact of FIN 48 to be significant to the consolidated financial
statements.
In September 2006, the SEC issued Staff Accounting Bulletin No. 108 (SAB
108). SAB 108 addresses how the effects of prior year uncorrected misstatements
should be considered when quantifying misstatements in current year financial
statements. SAB 108 requires companies to quantify misstatements using a balance
sheet and income statement approach and to evaluate whether either approach
results in quantifying an error that is material in light of relevant
quantitative and qualitative factors. SAB 108 is applicable for the Company
beginning in fiscal year 2007. The Company does not expect the impact of SAB No.
108 to be significant to the consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements
("SFAS No. 157"). SFAS No. 157 defines fair value, establishes a framework for
measuring fair value and expands disclosures about fair value measurements. SFAS
No. 157 is effective for the Company beginning with fiscal year 2008. The
Company is in the process of assessing the effect SFAS No. 157 may have on the
consolidated financial statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We do not currently hold any derivative instruments, and we do not engage
in hedging activities. Also, we do not have any outstanding variable-rate debt
and currently do not enter into any material transactions denominated in foreign
currency. Because of the relatively short-term average maturity of our
investment funds, such investments are sensitive to interest rate movements and
we do not expect interest rate fluctuations to significantly affect our results
of operations. Our direct exposure to interest rate and foreign exchange rate
fluctuation is currently not material to our results of operations. We believe
that the market risk arising from the financial instruments we hold is not
material.
- 23 -
Item 4. Controls and Procedures
Under the supervision and with the participation of management, including
our President and Chief Executive Officer and our Chief Financial Officer, we
have carried out an evaluation of the effectiveness of our disclosure controls
and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act
of 1934) as of the end of the fiscal quarter covered by this report. Based on
that evaluation, our President and Chief Executive Officer and our Chief
Financial Officer concluded that our disclosure controls and procedures are
effective as of the end of such quarter. There have been no changes in our
internal control over financial reporting during the quarter covered by this
report that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.
PART II -- OTHER INFORMATION
Item 1A. Risk Factors
Except as described below, there have not been any material changes during
the quarter ended September 30, 2006 to the risk factors set forth in Part I,
Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2005,
as updated in our Quarterly Reports on Form 10-Q for the quarters ended March
31, 2006 and June 30, 2006.
We currently are not in compliance with The Nasdaq Capital Market $1.00 minimum
bid price requirement and failure to regain and maintain compliance with this
and other continued listing standards could result in delisting and adversely
affect the market price and liquidity of our common stock.
On October 26, 2006, we received a letter from the Nasdaq Stock Market
notifying us that the closing price per share of our common stock was above
Nasdaq's $1.00 minimum bid price requirement (the "Bid Price Requirement") for
10 consecutive trading days and that, as a result, we had regained compliance
with The Nasdaq Capital Market's continued listing criteria. Since that time,
however, the closing bid price of our common stock has fallen below $1.00 per
share and we have not been in compliance with the Bid Price Requirement since of
October 26, 2006. If the deficiency continues for a period of 30 consecutive
business days from October 26, 2006, Nasdaq will provide us written notification
that we have 180 calendar days to regain compliance with the Bid Price
Requirement. To regain compliance, the closing bid price of our common stock has
to remain at $1.00 per share or more for a minimum of ten consecutive trading
days. If we do not regain compliance within this requisite period, we may be
provided an additional 180 days to achieve compliance, if at such time we
satisfy all of the initial listing standards for listing on the Nasdaq Capital
Market, with the exception of the Bid Price Requirement. If we do not meet the
initial listing standards or are not able to achieve compliance with the Bid
Price Requirement after the subsequent 180 calendar day period, Nasdaq will
provide us written notification that our common stock will be delisted. In such
case, we have the right to appeal Nasdaq's delisting determination to a Listing
Qualifications Panel.
If our common stock were to be delisted from The Nasdaq Capital Market, we
may seek quotation on a regional stock exchange, if available. Such listing
could reduce the market liquidity for our common stock. If our common stock is
not eligible for quotation on another market or exchange, trading of our common
stock could be conducted in the over-the-counter market on an electronic
bulletin board established for unlisted securities such as the Pink Sheets or
the OTC Bulletin Board. As a result, an investor would find it more difficult to
dispose of, or obtain accurate quotations for the price of, our common stock.
If our common stock is delisted from The Nasdaq Capital Market, and if we
fail to obtain quotation on another market or exchange, then trading in our
common stock might also become subject to the requirements of certain rules
promulgated under the Securities Exchange Act of 1934, which require additional
disclosure by broker-dealers in connection with any trade involving a stock
defined as a "penny stock" (generally, any equity security not listed on a
national securities exchange or quoted on Nasdaq that has a market price of less
than $5.00 per share, subject to certain exceptions). Many brokerage firms are
reluctant to recommend low-priced stocks to their clients. Moreover, various
regulations and policies restrict the ability of shareholders to borrow against
or "margin" low-priced stocks, and declines in the stock price below certain
levels may trigger unexpected margin calls. Additionally, because brokers'
commissions on low-priced stocks generally represent a higher percentage of the
stock price than commissions on higher priced stocks, the current price of the
- 24 -
common stock can result in an individual shareholder paying transaction costs
that represent a higher percentage of total share value than would be the case
if our share price were higher. This factor may also limit the willingness of
institutions to purchase our common stock. Finally, the additional burdens
imposed upon broker-dealers by these requirements could discourage
broker-dealers from facilitating trades in our common stock. As a result, the
ability of our shareholders to resell their shares of common stock, and the
price at which they could sell their shares, could be adversely affected. The
delisting of our stock from the Nasdaq Capital Market would also make it more
difficult for us to raise additional capital. Further, if we are delisted we
could also incur additional costs under state blue sky laws in connection with
any sales of our securities.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On September 26, 2000, the SEC declared effective our Registration
Statement on Form S-1, as amended (Registration No. 333-41028), as filed with
the SEC in connection with our initial public offering. Proceeds to Eden
Bioscience, after accounting for $7.0 million in underwriting discounts and
commissions and approximately $1.6 million in other expenses of the offering,
were approximately $91.5 million.
To date, of the net offering proceeds, we have used approximately $18.6
million to expand and enhance our manufacturing, research and development and
administration facilities, and approximately $67.0 million for working capital
and general corporate purposes. The remaining portion of the net offering
proceeds has been invested in cash equivalent investments. Our use of the
proceeds from the offering does not represent a material change in the use of
proceeds described in the prospectus included as part of the Registration
Statement.
Item 6. Exhibits
Exhibits 31.1 and 31.2 are being filed as part of this quarterly report on
Form 10-Q. Exhibits 32.1 and 32.2 are being furnished with this quarterly report
on Form 10-Q.
Exhibit
Number Description
------- -----------
31.1 Rule 13a-14(a) Certification (Chief Executive Officer).
31.2 Rule 13a-14(a) Certification (Chief Financial Officer).
32.1 Section 1350 Certification (Chief Executive Officer).
32.2 Section 1350 Certification (Chief Financial Officer).
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
EDEN BIOSCIENCE CORPORATION
Date: November 1, 2006
By: /s/ Rhett R. Atkins
--------------------------------------------
Rhett R. Atkins
President and Chief Executive Officer
By: /s/ Bradley S. Powell
--------------------------------------------
Bradley S. Powell
Vice President of Finance, Chief Financial
Officer and Secretary
(principal financial and accounting officer)
- 25 -