ITEM 1. BUSINESS
Organization - ------------
Earth Search Sciences, Inc. (the Company) was incorporated in 1984 under the laws of the state of Utah.
Corporate Focus - ---------------
The Company's mission is to commercially exploit the science of remote sensing in a wide variety of industries around the globe. The science of remote sensing includes acquiring, processing and interpreting imagery of the earth captured from instruments deployed on aircraft or satellites. The advantages of airborne and satellite remote sensing over other methods of gathering visual information are that data can be collected better, faster and cheaper over larger areas including sites inaccessible from the ground. By collecting data at different times, changes can be detected that may be due to significant natural or man-made processes. Detection of such changes can assist in environmental/land use management. Remote sensing instruments measure reflected, visible and infrared sunlight from the earth's surface over a spectral range seven times broader than the human eye can see. This collected data can then be digitally analyzed using personal computers. The digitally analyzed imagery can provide information useful to a wide range of industries such as, but not limited to, natural resource development (including oil and mineral exploration, fisheries and forestry), land use development, environmental remediation and monitoring, agriculture (including vegetation stress analysis), disaster assessment, marine sciences and military sciences.
Development of Core Technology - ------------------------------
In 1991, the Company was invited to participate in the Visiting Investigator Program (VIP) sponsored by the National Aeronautics and Space Administration (NASA). In the VIP program, the Company sought to compare the benefits of using the NASA operated Airborne Visible and Infra-Red Imaging Spectrometer (AVIRIS), along with other less advanced instruments, in locating geologic areas of interest in a test area in Nevada. The results of that program were published in January 1993. As a result of its participation in the program, the Company recognized the need to refine existing remote sensing technology in order to improve the economics of commercial remote sensing applications. To achieve its goal, the Company undertook the development of a miniaturized hyperspectral remote sensing instrument, Probe 1, which designed to be used with cost effective and easily available aircraft. This instrument has become known for its accuracy, reliability, and cost effectiveness and with the addition of geo-rectification capabilities and automated original processing steps continues to be one of the most accurate and cost effective instruments in the airborne remote sensing industry.
Current Business Plan - ---------------------
The Company is evolving from a mineral exploration and research and development organization into a leading provider of remote sensing services. Data is provided for clients as well as for the Company's own mineral and hydrocarbon exploration purposes. It is also accumulated for future resale to a variety of users. On June 1, 1997, the Company took delivery of the first Probe 1 instrument. In August of 1999, the Company took delivery of its second Probe 1 instrument. Since June 1, 1997, the Company has collected and currently owns a substantial archive of Probe 1 hyperspectral imagery from Kazakhstan, Australia, British Columbia, Ontario, Quebec, Chile, Peru, Mexico, California, Nevada, Arizona, Idaho, Montana, Wyoming, Texas, Louisiana, Florida and Utah. At the present time, the value of this data archive has not been independently appraised and its value is not reflected in the Company's
financial statements, although recent announcements from Noranda Mining and Exploration Inc., a customer, indicate that their Probe 1 data from Chile and Peru has revealed new potential major mineral deposits.
The Company believes cost effective hyperspectral remote sensing and imagery processing has tremendous potential in various global applications and markets. The ASPRS/NASA TEN-YEAR INDUSTRY FORECAST (http://www.asprs.org/news.html) published in 2003 validates this position and indicates that the remote sensing market has been growing at a rate of 13% per year, with the hyperspectral portion of that market growing to12% of the total by 2006 and worth approximately $440 million. The Company is ensuring its maximum exposure to this market by continuing a business model that is establishing subsidiary companies to focus on hyperspectral remote sensing applications in key industries. Each subsidiary will focus on a specific sector of commercial remote sensing and have a management team with relevant skills and expertise. The Company will provide an exclusivity license for each one, the Company's hyperspectral technology intellectual property, processing support, marketing and management assistance. With the establishment and growth of the subsidiaries this strategy will gradually create a ready market for the Company, as well situate the Company to receive royalties from any resource development that occurs as a result of the use of the Company's instruments and technology. Another advantage is that any required capital will be raised by the subsidiary separate from the parent company. One of the subsidiary companies, Petro Probe, Inc, the oil & gas spin-off, is already producing a steady cash flow from operations.
To complement its Probe 1 technology, in fiscal 2000 the Company in acquired Space Technology Development Corporation (STDC) and its ownership of satellite based imagery technology. STDC had acquired ownership of a difficult to obtain commercial satellite license and the accompanying hyperspectral data stream from the proposed space based instrument, NEMO, a very desirable asset. The strategy the Company sought to develop was joint use of satellite and airborne remote sensing instruments to capture a strong market position. The economical large area imagery collection by the satellite instrument could complement and add value to the high-resolution imagery collection of specific target areas provided by the airborne instruments.
As attractive as the proposition was, the financial markets were not willing to invest in new satellite ventures at the time. Thus, the Company has been unable to complete funding of the NEMO project based on the risks of a launch and the unproven potential for revenues from a hyperspectral satellite.
In May 2002, the Company received notification from the Office of Naval Research (ONR) indicating that the performance period for the agreement with the Navy for the NEMO project had ended and that is was time to initiate close-out procedures, account for the distribution of Federal funds under the agreement and to account for and dispose of all real property and equipment acquired under the agreement. Further, the Navy requested an audited record of all distributions of Federal Funds made under this agreement, including those from the period when STDC was owned and operated prior to its acquisition by ESSI. Until the audit was completed and reviewed the ONR decided not to reimburse STDC (and hence ESSI) for certain invoices for subcontract and vendor costs on the NEMO program even though these costs were approved by the Naval Research Laboratory and the ONR for payment with government funds. As of March 31, 2002, the Company has $1,105,995 of receivables on its balance sheet from the ONR, of which $808,401 are outstanding as of the date of this filing. The Company believes that the ONR will make payment of the remaining receivables.
SFAS 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF, and APB Opinion 30, REPORTING THE RESULTS OF OPERATIONS - REPORTING THE EFFECTS OF DISPOSAL OF A SEGMENT OF A BUSINESS, AND EXTRAORDINARY, UNUSUAL AND INFREQUENTLY OCCURRING EVENTS AND TRANSACTIONS, is the applicable accounting guidance for potential impairment of long-lived assets. Based
on the guidance of SFAS 121 and since the Company was not able to receive any written confirmation from the ONR re: the matter, the Company had effectively no ability to value future oriented negotiated settlement on the NEMO program. Without such documentation of value, the Company provided in 2002 a loss from impairment of $13,010,364, the amount the Company was carrying in construction in progress for the NEMO program (see Notes 4 and 5 to the financial statements.) Although the situation with NEMO and the ONR financially damaged the Company, ESSI is moving forward in its plan to capture leadership in the airborne remote sensing industry. The Company recognizes the fragmented nature of the remote sensing industry and its composition by a majority of very small companies. The Company's long-term strategic plan is to create partnerships, strategic alliances, mergers or acquisitions as the most expeditious and cost-effective way to consolidate commercial hyperspectral remote sensing collections and services.
The Company's near-term plans are to continue pursuing:
(1) contracts that produce revenues from the application of remote sensing;
(2) the development of additional miniaturized remote sensing instruments;
(3) the integration of other advanced technology exploration instruments;
(4) the development of promising mineral, oil and gas properties in which the Company has an equity interest, identifying such properties by utilizing its existing imagery database or acquiring such data; and
(5) the marketing of ESSI archived raw data
The negative events of 2001, including the stock market decline and September 11, 2001, left the Company in a tenuous highly leveraged position. Recognizing that the economy and the general business climate was declining rapidly, the Company made every effort to reduce overhead as quickly as possible, even though that may have been detrimental to longer-term expansion plans in some cases. Although cash flow was conserved the Company entered 2002 in an undercapitalized state and sought assistance from a variety of sources including some who indicated they could bring in necessary new investment into the Company. None of the individual sources proved successful, however all of those sources highly recommended a reorganization of the company in order to encourage migration of capital into the company. The reorganization would also include bringing in experienced directors and outsiders to fill the roles of senior management. In early 2004, the Board of Directors acted on the recommendation of investor sources and its own research and began to implement these actions.
Subsidiary Companies - -------------------- Formation of Petro Probe, Inc. - ------------------------------
The Company formed Petro Probe, Inc. to identify and develop potential hydrocarbon properties by utilizing Probe 1 surface imagery integrated with other sub-surface exploration techniques. Petro Probe, Inc.'s strategy will entail capturing data over areas of interest that the Company may later take an equity interest in, as well as the sale of hyperspectral imagery and processing services to oil and gas properties owned by third party customers. A primary objective in evaluating a potential hydrocarbon resource project is to provide geologic mapping of outcrop lithology and surface structure. The Probe 1 instrument is an excellent tool to obtain this mapping. Probe 1 imagery can identify subtle features due to topographic offset, vegetation change and/or soil alteration that play a major role in forming hydrocarbon traps. Hyperspectral imagery can also aid in petroleum exploration by detecting surface indicators of potential petroleum reserves such as micro seepage.
Petro Probe, Inc.'s goal is to develop the competitive advantages of Probe 1 resource mapping capability, combining this with conventional hydrocarbon exploration tools and then applying newer value-added technology, such as 3D seismic to identify and acquire equity positions in oil and gas properties. 3D seismic is the technology of measuring underground explosions to map subsurface geologic structures.
From it's inception in 2000 through March 31, 2002, Petro Probe, Inc. has acquired working interests in seven oil and gas projects in the U.S. The first project acquired was the Louisiana West Scott Field Prospect, where an oil well has been drilled and logged based on data from Probe 1 as well as other exploration measurements.
Petro Probe, Inc.'s working interests in its seven (7) oil and gas projects offer them the right to participate in drilling additional wells on the project lease acreage. Petro Probe Inc. will determine whether or not to participate in additional drilling efforts on a case by case basis. Besides the West Scott field project, Petro Probe has interests in the well known fields of SpindleTop and Lost Soldier and has data and interests in the Green River Basin, Paradox Basin, and the Australian Basin.
Because of the national need for new hydrocarbon discoveries, Petro Probe, Inc. is actively seeking petroleum based companies to either joint venture with, or merge with, and is in excellent position to move forward in this direction.
Formation of Geo Probe, Inc. - ----------------------------
The Company formed Geo Probe, Inc. to pursue geologically tailored hyperspectral imaging services to mineral exploration companies and develop new markets in geological applications. The same indicators that can be used to find mineral deposits can also be used to monitor the environmental impact of active and past-producing mines, mills, smelters, refineries and pipelines. Mineral deposits are part of larger geological systems that typically have mineralogical characteristics that are mappable using Probe 1 imagery. In vegetated areas, the subtle effects that bedrock geology has on plants can be measured to identify hidden minerals. The Company's mapping agreement with Noranda in 1998-2000 provided the ability to develop and prove new approaches to mineral exploration. The experience gained from this application still remains a rare and valuable intellectual property today, evidenced by the discovery of 145 mineral targets in Chile by Noranda . Therefore, Geo Probe's business focus will be to use the Company's remote sensing instruments to globally survey any areas that have promise for the location of minerals either for its own use, or for third party customers, and to sell hyperspectral collection and processing services in the geological hazards and environmental geology sectors.
As in the hydrocarbon industry sector there is a build-up of new demand for mineral exploration beginning to occur and Geo Probe, Inc. is actively seeking companies to either joint venture with or merge with in order to position itself well for the upturn in global mining activity. The company has recently signed a Memo of Understanding with a Canadian mineral exploration company to move forward in the creation of such a joint venture.
Formation of Eco Probe, Inc. - ----------------------------
The Company formed Eco Probe, Inc. to pursue hyperspectral remote sensing applications in the environmental industry. The Company has taken an industrial leadership role in working with U.S. government agencies such as the Environmental Protection Agency, the Bureau of Land Management and the Office of Surface Mining on setting up applications for commercial monitoring of industries, forest inventory and health issues, slope stability assessment and the spread of noxious weeds.
ESSI and Eco Probe, Inc. have performed important hyperspectral surveys and research in aquatic and vegetation-related projects. The environmental markets are vast, however, and the Company's current lack of resources dictates continued priorities to mineral and hydrocarbon exploration with its more mature background of data and experience.
Formation of Terranet, Inc. - ---------------------------
The Company formed Terranet, Inc. to act as a imagery product distribution conduit and perform as the Company's e-commerce content provider through a unique internet imagery distribution system. Imagery collected today and yesterday could be sold repeatedly to multiple end users. In addition to selling the Company's own imagery, Terranet, Inc. would pursue the resale of imagery obtained from third parties. Terranet completed the design and testing of the software and is anticipating development and expansion of the remote sensing market will provide opportunities for joint venture partners and or contract data suppliers. The unique design features are protected by copyright.
Fiscal 2004 Significant Projects - --------------------------------
In fiscal 2004, the Company completed airborne hyperspectral surveys primarily for local, state and federal governmental agencies. These projects produced the majority of the Company's 2004 airborne revenue. The Company's agreement with the ONR produced all the Satellite Development business segment revenue (see note 10 to the financial statements.)
To date, gigabyte quantities of imagery have been collected by the Company. Selected portions of these data tapes are being processed and the imagery is being examined for the presence of mineral properties. The Company is currently working to outsource the processing and interpretation of its archived data in order to quickly expand its commercial offering.
Proposals are being developed to partner with private industry, universities and state and federal agencies to develop, package and deliver competitive advanced technology products and services. These are being evaluated on a priority basis. The Company continues to respond to an ever increasing volume of requests for quotations. This demonstrates the growing demand for hyperspectral services and gives reason for the Company to have a brighter outlook for the near future.
Business Segment Information - ----------------------------
Included in the attached financial statements is business segment information and financial information about geographic areas for the Company.
Employees - ---------
As of March 31, 2004 the Company had 4 full-time employees.
Available Information - ---------------------
The Securities and Exchange Commission maintains an internet site at http://www.sec.gov that contains reports and financial information filed by the Company. The Company maintains an internet site at http://www.earthsearch.com that contains information about the Company's business, markets and technology.
Seasonal Nature of Business - ---------------------------
The Company experiences the highest demand for its collection services April through October in the Northern Hemisphere and October through April in the Southern Hemisphere.
Customers and Geographic Areas of Business - ------------------------------------------
In fiscal 2004, the Company operated its airborne hyperspectral sensors under contracts with third parties in several areas around the United States. In fiscal 2004 and 2003, the Company's sensors were operated in the United States and abroad. Contracts to operate the sensors in the United States as an ecological, mining, agricultural, hydrocarbon, and target identification contributed approximately $258,843, $384,212 and $460,000, to revenue in 2004, 2003, and 2002, respectively. STDC's contract with the Office of Naval Research to design, build, and operate a hyperspectral sensor mounted on a satellite contributed approximately $0, $6,459 and $4,235,000, to revenue in 2004, 2003 and 2002. In fiscal 2003, projects with four clients accounted for approximately 76% of total revenue. In fiscal 2002, projects with one client accounted for approximately 84% of total revenue
ITEM 2.
ITEM 2. PROPERTIES
The Company leases its corporate headquarters from two officers of the Company. Its headquarters consist of approximately 6,400 square feet of office space in Kalispell, Montana. All other office obligations have been cancelled.
In addition, the Company owns working interests in seven (7) oil and gas properties. (See Note 4 to the Notes to Consolidated Financial Statements).
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In November 2000, Applied Science and Image Technology, Inc. (ASIT) sued the Company in the Circuit Court of Baltimore County, Third Judicial Circuit of Maryland, alleging breach of contract and other related causes of action. ASIT alleges that the Company was required to deliver 500,000 shares of ESSI common stock to ASIT on demand pursuant to a written contract between ASIT and the Company in which ASIT agreed to perform certain services for the Company.
In May 2002, the Company filed counterclaims against ASIT for breach of contract and unjust enrichment on the grounds that, despite the Company having paid approximately $300,000 and transferring 500,000 of the Company common stock to ASIT, ASIT failed to provide the Company with the products and services it was contractually obligated to provide the Company. On June 12, 2002, ASIT moved to dismiss ESSI's counterclaims on the grounds that they were untimely. The action has not been resolved and neither party is presently pursuing this end.
In October of 2002, Terranet, Inc. a subsidiary company, received notice of a judgment issued by the Supreme Court of British Columbia in regards to monies owed resulting from a contract with plaintiff Cal Data Ltd., of Vancouver, B.C. The plaintiff alleged that seventy-five thousand dollars was overdue from invoices for services dating from January of 2002 to October, 2002. Terranet, Inc.is examining its position and has not accrued any liability associated with this demand in its financial statements.
In May of 2003, the Company received notice of a civil action commenced against it from Stern & Co. Communications LLC d/ba Stern & Co. registered in the United States District Court, Southern District of New York. The plaintiffs allege that the Company has not completely paid for services rendered and owes $92,048.22, nor forwarded stock options for 1,500,000 shares exercisable for three years at the price of $1.50 per share. The Company responded with a counter-claim alleging it never received the promised services. This matter has been resolved out of court.
In January of 2004, the Company received notice of a complaint over deferred expenses owed to Mr. Brian Soliday. The Company disagreed with the amount and is working toward a settlement and/or an agreed amount.
Except as described above, to the knowledge of our executive officers and directors, neither we nor our subsidiaries are party to any legal proceeding or litigation and none of our property is the subject of a pending legal proceeding and our executive officers and directors know of no other threatened or contemplated legal proceedings or litigation.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK EQUITY AND RELATED STOCKHOLDER MATTERS
(a) Principal Market or Markets. The Company's common stock trades in the over-the-counter market. The range of reported high and low bid quotations for the Company's common stock, as set forth below, reflect interdealer bid prices, without retail markups, markdowns, commissions, or adjustments as reported in the NASDAQ "pink sheets" and do not represent actual transactions.
Quarter Ended High Low ------------- ---- ---
June 30, 2002 .08 .08 September 30, 2002 .05 .05 December 31, 2002 .04 .03 March 31, 2003 .01 .01
June 30, 2003 .01 .01 September 30, 2003 .01 .01 December 31, 2003 .01 .01 March 31, 2004 .03 .025
(b) Approximate Number of Holders of Common Stock. The number of record owners of the Company's $.001 par value common stock at March 31, 2004 was approximately 1,204. This does not include shareholders that hold stock in their accounts at brokers/dealers.
(c) Dividends. Holders of the Company's common stock are entitled to receive such dividends as may be declared by the Company's Board of Directors. No dividends have been paid with respect to the Company's common stock and no dividends are anticipated to be paid in the foreseeable future.
(d) In the last three years, the Company has made the following sales of unregistered securities, all of which sales were exempt from the registration requirements of the Securities Act of 1933, as amended, pursuant to Section 4(2) or as otherwise indicated:
Securities authorized for issuance under Equity Compensation Plans - ------------------------------------------------------------------
The following table sets forth certain information on the Company's Equity Compensation Plans. See Note 13 to the Notes to Consolidated Financial Statements for additional information on equity compensation including material terms of options granted that have not been approved by security holders.
Securities authorized for private placement issuance under subsidiary companies - -------------------------------------------------------------------------------
The subsidiary companies of Terranet, Inc. Petro Probe, Inc. and Eco Probe, Inc have issued shares of common stock to private placement investors, all of which were accredited investors as that term is defined under Regulation D. The investors executed subscription agreements and acknowledged that the securities to be issued have not been registered under the 1933 Securities Act, that the investors understood the economic risk of an investment in the securities, and that the investors had the opportunity to ask questions of and receive answers from the Company's management concerning any and all matters related to acquisition of the securities. No underwriter was involved in the transaction, and no commissions or other remuneration were paid in connection with the offer and sale of the securities.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth certain selected financial data for each of the last five fiscal years with respect to the Company and is qualified in its entirety by reference to the Company's audited financial statements and notes thereto. STDC was acquired by the Company on December 21, 1999. The results of operations for 2003, 2002 and 2001 include the results of operation for STDC from December 22, 1999 to March 31, 2003.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial comparisons will be made between the fiscal years ended March 31, 2004 and 2003 and 2002.
Results of Operations - ---------------------
The Company recognized revenue of $516,490 in 2004 compared with $786,208 and $5,044,498 in 2003 and 2002, respectively. In 2004, costs of services provided was $25,551 compared with $328,104 and $5,342,983 in 2003 and 2002, respectively.
Provision for loss on impairment of fixed assets was $2,469,672 in 2004 compared with $2,168,997 and $13,010,364 in 2003 and 2002. This loss in 2002 is due recognition of an impairment of the NEMO asset previously carried in the construction in progress account. Exploration costs in 2004 were $0 compared with $0 in 2003 and 2002. General and administrative costs were $351,520 in 2004 compared with $3,138,442 and $3,053,024 in 2003 and 2002, respectively.
During 2001, the Board of Directors approved the issuance of 8,587,000 shares against options as a performance based stock bonus. The issuance of these shares resulted in non-cash compensation expense of $2,926,781. In 2000, the Company recognized non-cash compensation expense of $1,608,001 for the vesting of options. Of this amount, $1,593,600 relates to performance options issued to officers of the Company in 1997. At the time these options were granted, the officer's salaries was deferred and the Company's common stock price was approximately $0.48 These options allow the officers to purchase restricted shares in the Company at exercise prices ranging from $.50 per share to $2.50 per share, for up to 24 months after vesting. The vesting of these options is dependent on the Company's stock price reaching certain prices and maintaining that level for a specified number of days. In 2000, 3,000,000 of options met the performance criteria and resulted in the recording of $1,593,600 of compensation expense. In 2003 and 2002, no options met the performance criteria and thus no compensation expense was recorded.
Interest income in 2004 was $2,848 compared to $627 and $4,813 in 2003 and 2002, respectively. In 2004, the Company recognized interest expense of $686,092 compared to $730,719 and $760,730 in 2003 and 2002, respectively. The decrease in interest expense over the prior year is a result of the Company's conversion of convertible notes to equity in the fourth quarter of 2001.
In 2004, the Company recorded minority interest in losses of consolidated subsidiaries of $279,891 compared to $239,867 and $335,333 in 2003 and 2002. ESSI Probe 1 LC minority interest loss for a full year of operations was $115,671, $233,353 and 308,738 in 2004, 2003 and 2002, respectively.
The Company recognized a net loss of $3,860,529 in fiscal 2004 compared with a net loss of $5,354,184 and $16,797,081 in 2003 and 2002, respectively. The loss on a per share basis was $0.02, $0.03 and $0.11 in fiscal 2004, 2003, and 2002, respectively. Included in the loss in 2004, 2003 and 2002 is a loss of $1,396, $1,778,336 and $14,251,858 and $1,822,434 or $0.01, $0.09 and $0.01 per share, respectively, from the operations of STDC. The operations of STDC in 2002 reflect a $13,010,364 provision for loss on NEMO fixed asset.
Liquidity and Capital Resources - -------------------------------
The Company has financed its activities to date with a combination of cash flow from operations and the use of equity securities and promissory notes. During 2002, the Company signed a definitive
agreement with an investor for an equity line of up to $10,000,000 for one year with an extension option for a second year. The terms of the equity line are that the Company, after the effectiveness of a registration statement, at its option can sell its registered shares of common stock to the investor on a monthly basis. The maximum amount of funds that can be raised in any month is $1,500,000 limited by a calculation based on the average volume of the stock for the preceding month and the price of the stock. The stock will be sold at 88% of the average of the lowest five (5) trading days over the ten (10) days of trading immediately proceeding the sale date. Subsequent to March 31, 2002, the Company made its first drawdown on the equity line and raised $150,000 from the sale of its common stock.
Net cash used in operating activities was $575,331 in 2004, resulting primarily from payments for salaries and services and changes in current assets and liabilities. Net cash used in operating activities was $282,167 in 2003, resulting primarily from payments for salaries and services and changes in current assets and liabilities. Net cash used in operating activities was $492,063 in 2002, resulting primarily from payments for salaries and services and changes in current assets and liabilities. Of the $16,797,081 net loss in 2002, approximately $14,675,423 was non cash items.
Capital expenditures for March 31, 2004 were primarily for purchases of working interests in hydrocarbon properties.
Capital expenditures for March 31, 2003 were primarily for purchases of new computer equipment, purchases of working interests in mineral properties and payments on a subsidiary's satellite hyperspectral instrument.
At March 31, 2004 and 2003, the Company had cash of $11,753 and $347,682 and a working deficit of $15,440,818 and $13,700,198, respectively.
The Company does not intend to pay cash dividends to the holders of its common stock and intends to retain future earnings to finance the expansion and development of its business.
Under the original agreement with the ONR, STDC needed to raise private industry funds of approximately $125,000,000 in order to complete, launch and operate the hyperspectral imaging satellite and instrument. Subsequent to March 31, 2002, STDC received notification from the ONR that it would not be giving STDC an extension to its current agreement. The success of STDC and payment of approximately $8,216,424 of STDC accounts payable due subcontractors and vendors on the NEMO program, is dependent on the Company and ONR negotiating plans for going forward and additional funds being identified either commercially or under governmental programs to complete and launch the NEMO satellite and sensor.
The Company believes that funds generated from its operations, together with future borrowings and the equity line will be adequate to meet the Company's anticipated cash needs during the immediate term.
There can be no assurance that additional capital beyond the amounts currently forecasted by the Company will be required or that any such required additional capital will be available on reasonable terms, at such time or times as required by the Company. The Board of Directors has appointed a management committee to examine the option of re-organizing and re-structuring the company to ensure that a viable avenue is available for the attraction of capital. The management committee will also recommend priority new management appointments.
The total number of employees employed by the Company now numbers four people.
Significant Accounting Policies - -------------------------------
In October 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144 (SFAS 144), ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS. SFAS 144 supersedes SFAS 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF, and APB Opinion 30, REPORTING THE RESULTS OF OPERATIONS - REPORTING THE EFFECTS OF DISPOSAL OF A SEGMENT OF A BUSINESS, AND EXTRAORDINARY, UNUSUAL AND INFREQUENTLY OCCURRING EVENTS AND TRANSACTIONS, for segments of a business to be disposed of. SFAS 144 is effective for fiscal years beginning after December 15, 2001. The Company is currently evaluating the potential effect of the initial application of SFAS 144 on its consolidated financial statements.
The Company uses the successful efforts method to account for its oil and gas properties. Under this method, it capitalizes costs incurred for property acquisition, exploration, and drilling related to its oil and gas properties. Once the project is completed, and, if oil or gas is located, costs capitalized to date on the specific project are amortized under the unit-of-production method as revenue is recognized. Capitalized costs for unsuccessful projects will be expensed when that determination is made.
Unproved oil and gas properties that are individually significant are periodically assessed for impairment of value, and a loss is recognized at the time of impairment by providing an impairment allowance. Other unproved properties are amortized based on the Company's experience of successful drilling and average holding period. Capitalized costs of producing oil and gas properties, after considering estimated dismantlement and abandonment costs and estimated salvage values, are depreciated and depleted by the unit-of production method.
Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company evaluates long-lived assets to determine potential impairment by comparing the carrying amount to the undiscounted estimated future cash flows of the related assets. In fiscal 2002, based on such review, the Company established a provision for loss on the NEMO program of $13,010,364 (see Note 6 to attached financial statements.)
In fiscal 2002, the Company changed its method of accounting for the sales of stock by its subsidiaries to account for these sales as increases in additional paid-in capital instead of as an increase to minority interest in the accompanying consolidated financial statements. Management believes that because of the developing nature of operations of the subsidiaries with minority interest, the new method of accounting will provide more meaningful information concerning sales of stock by its subsidiaries and, correspondingly, the minority interest liability account. The Company recognized an increase in additional paid-in capital of $1,707,868, as a cumulative effect on prior years of this change in account principles.
Future Operations - -----------------
The Company will undergo a re-organization of its stock structure to ensure that it can establish and provide for the ability to continue its business model and business strategy. In order to achieve maximum results, the Board of Directors has approved the Company's re-organization include necessary Board and Senior Management changes
In addition, the Company will continue to operate in the mineral and hydrocarbon resource exploration areas where the Company will operate its remote sensing instruments for its own use and secure equity interests in promising properties identified from the remote sensing imagery. Further, previously collected imagery will be analyzed and processed to aid in the Company's decisions to take new or additional equity interests in prospective properties.
Management believes that a significant market opportunity exists for a company that can combine satellite and airborne hyperspectral remote sensing data and custom design the best and most efficient solutions to geological, environmental, defense, and surveillance problems. It is this belief that led the Company to acquire STDC. The Company believes that the opportunity still exists for a successful negotiation with a data supplier with access to satellite data.
Research & Development of next generation hyperspectral instrumentation is continuing. The Company is pursuing the approval of nano-technology patent pendings for hyperspectral remote sensing instrumentation and processing in order to secure its market position for the next decade of industry developments.
The Board of Directors will continue to seek outside directors to ensure that its commitment to corporate governance improvements is implemented.
Additional Risk Factors That Could Affect Liquidity, Operating Results And - -------------------------------------------------------------------------- Market Price Of Stock - ---------------------
Risks Related to Our Industry - -----------------------------
Competitive pressures may adversely affect our operating revenues. The Company has numerous competitors in the remote sensing services (airborne hyperspectral services) and natural resource development industries. Competition in the remote sensing industry comes from several primary sources, including HyMap, CASI and GER, whose hyperspectral instruments operate within the USA. Our principal competitors in the natural resource development industry include traditional exploration companies using a variety of other technologies. Some of our competitors in both remote sensing and natural resource development have substantially greater financial and other resources than the Company. Competitive pressures in either industry may materially adversely affect our operating revenues and in turn, our business and financial condition.
The Company may need to expend significant capital to keep pace with technological developments in our industry. The remote sensing industry, as well as the computing industry's processing of the raw data, is constantly undergoing development and change and it is likely that new technology, whether embodied in new equipment or techniques, will be introduced in the future. In order to keep pace with any new developments, the Company is planning to expend significant capital to develop or acquire the next level of developments in new remote sensing equipment and to train our employees in the new techniques. The Company is pursuing financing to develop additional remote sensing instruments; however, we may not be able to raise sufficient funds, and if the Company does so, there is no guaranty that the new instruments will out perform instruments used by our competitors. In addition, the Company's ability to raise needed capital may be influenced by general economic conditions and the strength of capital markets. To ensure its ability to continue operations the Company will undergo a re-organization to include a stock re-structuring.
The Company may incur significant expenses to comply with new or more stringent governmental regulation. The sale of our imagery is regulated by the Department of Commerce. Although the Company (through its acquisition of STDC) has acquired a Department of Commerce (DOC) Remote Sensing License that permits the Company to market globally hyperspectral and panchromatic imagery, there is no guarantee that the government will not; impose restrictions on sales if the quality of our imagery increases with new technology that, for example, allows increased resolution. Because our license was the first issued DOC Remote Sensing License, the Company cannot anticipate how the DOC specifically will treat our license or how the airborne remote sensing industry will be regulated in the future.
Risks Related to Our Business - -----------------------------
The loss of our key customers could have a material adverse effect on us. In prior years, mining company exploration contributed a significant amount of revenue to the Company. In 2002, the depressed condition of mineral prices has severely curtailed mining company budgets and thus their use of the Company's hyperspectral technology for exploration. In 2002, revenue recorded on cost reimbursements for the NEMO project accounted for approximately 84% of revenue. The Company is now pursuing contracts that represent a smaller and wider variety of customers. This will reduce the Company's exposure to the higher risk level associated in dealing with single large clients. The Company may not realize our anticipated return on capital commitments made to expand our capabilities. The Company purchased an aircraft, additional satellite and airborne hyperspectral instruments, as well as oil and gas property rights. The aircraft and airborne hyperspectral instruments were purchased to increase our capacity to conduct airborne surveys. If the Company does not experience continued demand for our remote sensing services, the Company may incur significant expense without generating corresponding revenues. The oil and gas property rights were acquired in order to exploit suspected natural resources located within certain properties. If these properties do not contain sufficient natural resources to warrant exploitation, the Company may incur significant expenses without generating corresponding revenues.
In addition, from time to time, the Company expects to make significant capital expenditures to implement new processes and to increase both efficiency and capacity. Some of these projects may require additional training for our employees and not all projects may be implemented as anticipated. If any of these projects do not achieve the anticipated increase in efficiency or capacity, our returns on these capital expenditures may not be as expected.
Our ability to grow is dependent upon, and may be limited by, among other things, our capital structure, the price of our stock and our existing financing arrangements. If additional funding sources are needed, the Company may not be able to obtain the additional capital necessary to pursue our internal growth and acquisition strategy or, if the Company can obtain additional financing, the additional financing may not be on financial terms that are satisfactory to us.
The Company's continued involvement on the NEMO Project and successful negotiations with the ONR may not materialize.
The Company's database of spectral information may not be marketable or may not garner a price, which makes processing or analyzing the data economically reasonable. The Company has a substantial archive of Probe 1 hyperspectral imagery that was not gathered under contract with a client. The Company continues to gather hyperspectral imagery without having sold the rights to that data. The collection process requires variable as well as fixed expenditures that must be recouped though marketing the collected data. Although we do not carry the value of our existing Phase 1 hyperspectral archives as an asset on our balance sheet, the future success of the Company depends to some extent upon our ability to market this archived data.
Cancellations, reductions or delays in customer orders may adversely affect our results of operations. Our overall operating results are affected by many factors, including the timing of survey contracts from large clients, the timing of capital expenditures to increase our capacity for gathering data in anticipation of future sales of products and services, and the weather which can affect whether or not a customers target of interest can be collected at a certain stage of vegetal growth. Although a large portion of our expenses are relatively fixed; a significant portion of our operational expenses vary with the number of airborne surveys. Because several of our operating divisions and subsidiaries are new businesses and have not obtained long-term commitments from our clients, we must anticipate the future demand for our services based upon our discussions with clients. Cancellations, reductions or delays in
orders by a client or group of clients could have a material adverse effect on our business, financial condition and results of operations.
The unavailability of skilled personnel may have an adverse effect on our operations. From time to time, the Company or some of our operating divisions and subsidiaries may experience difficulties in attracting and retaining skilled personnel to process and interpret the substantial volume of imagery data that is already collected or is expected to be collected in the future. The Company's ability to operate successfully could be jeopardized if we are unable to attract and retain a sufficient number of skilled personnel to conduct our business.
Outlook - -------
This Report on Form 10-K, including the foregoing discussion in "Management's Discussion and Analysis of Financial Condition and Results of Operations," and other reports hereafter filed by the Company with the Securities and Exchange Commission may contain "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The Act provides a "safe harbor" for forward-looking statements to encourage companies to provide prospective information about themselves so long as they identify these statements as forward-looking and provide meaningful cautionary statements identifying important factors that could cause actual results to differ from the projected results. All statements other than statements of historical fact the Company makes in this Report on Form 10-K and such other reports filed with the Securities and Exchange Commission are forward-looking. In particular, statements regarding industry prospects, future OEM sales by the Company, the adequacy of existing manufacturing resources, the Company's continued expansion in foreign markets and the Company's future results of operations or financial position are forward-looking statements. Words such as "anticipates", "expects", "intends", "plans", "believes", "seeks", "estimates" and similar expressions identify forward-looking statements. But the absence of these words does not mean the statement is not forward-looking. The Company cannot guarantee any of the forward-looking statements, which are subject to risks, uncertainties and assumptions that are difficult to predict. Actual results may differ materially from those the Company forecasts in forward-looking statements due to a variety of factors, including those set forth above under the heading "Additional Risk Factors that could Affect Operating Results and Market Price of Stock" and elsewhere in this Report. The Company does not intend to update any forward-looking statements due to new information, future events or otherwise.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data required by this Item are included on pages to of this Report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
On June 10, 2003, the Board of Directors of the Company dismissed the Company's accountants, Grant Thornton, LLP. Grant Thornton LLP served as the Company's auditor beginning with the fiscal year ended March 31, 2001. The Board of Directors has appointed Malone & Bailey, PLLC as the Company's auditor for the year ended March 31, 2003. Malone & Bailey's office is located at 5444 Westheimer, Suite 2080 Houston, TX 77056.
The report of Grant Thornton LLP on the financial statements for year ended 2003 contained no adverse opinion or disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope or accounting principle except for the inclusion in the report of an explanatory paragraph regarding the Company's ability to continue as a going concern.
During the fiscal year ended March 31, 2003, and through June 10, 2003, there have been no reportable events (as defined in Regulation S-K Item 304(a)(1)(v)).
The Company has requested that Grant Thornton, LLP furnish it with a letter addressed to the SEC stating whether or not it agrees with the above statements. A copy of such letter, dated June 10, 2003, was filed as Exhibit 16.1 the Company's Form 8-K filed June 10, 2003.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information with respect to the executive officers of the Company for fiscal 2001 to the present.
NAME AGE POSITION ---- --- --------
Larry F. Vance 69 Chairman and Chief Executive Officer David Grant 53 Director Tami J Story 41 Director Secretary/Treasurer/Director
Larry F. Vance served as Chief Executive Officer of the Company from 1985 until April 8, 1995. Since April 8, 1995, Mr. Vance has served as Chairman of the Company. Mr. Vance is also a director of the Company and has been a full-time employee of the Company since 1985. Mr. Vance's training is in business and marketing. He served in a management capacity for the 3M companies, IBM, and Computer Usage Corporation prior to founding the Company.
David Grant has served as a senior consultant contractor with the Company since January 2004. Mr. Grant has an extensive and varied background spanning more than twenty years that includes business development, operations and technical marketing support, project management in both domestic and international venue. Included is time spent in high tech industry as well a underground utilities design and installation. Mr. Grant holds a Bachelors Degree in Biological Sciences from the University of Wyoming.
Tami J. Story served in an administrative support capacity for the Company from 1991 until April 1993. Since April 1993, Ms. Story has served as Secretary and Treasurer of the Company. Ms. Story also serves as a director of the Company. Ms. Story holds a degree with a major in Nursing and a minor in Business Administration.
Information with respect to directors of the Company will be included under "Election of Directors" in the Company's definitive proxy statement for its 2003 annual meeting of shareholders, to be filed not later than 120 days after the end of the fiscal year covered by this Report, and is incorporated herein by reference. Information with respect to executive officers of the Company is included under Item 4(a) of Part I of this Report.
Based solely on a review of copies of reports received by the Company from persons required to file reports of ownership and changes on ownership pursuant to Section 16(a) of the Securities Exchange
Act of 1934, the Company believes that all of its executive officers and directors complied with applicable filing requirements for the fiscal year ended March 31, 2003.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Table below summarizes information on Executives and Directors compensation
Employment Contracts - --------------------
In October 28, 2000, the Company entered into an employment agreement with Mr. Larry Vance. Pursuant to the agreement, the Company will pay Mr. Vance an annual salary of $160,000. In the event of termination of Mr. Vance without cause or due to a change in control, the Company will pay Mr. Vance two years of annual salary. Mr. Vance's options and vesting criteria are described above and in Note 11 to the attached consolidated financial statements.
On October 28, 2000, the Company entered into an employment agreement with Ms. Tami Story. Pursuant to the agreement, the Company will pay Ms. Story an annual salary of $80,000. In the event of termination of Ms. Story without cause or due to a change in control, the Company will pay Ms. Story two years of annual salary. Ms. Story 's options and vesting criteria are described above and in Note 11 to the attached consolidated financial statements.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding ownership of the Company's Common Stock as of June 15, 2003 by each person known by the Company to own beneficially more than five percent of the Common Stock and by all directors and officers and as a group:
Name and address of Amount and nature of beneficial owner beneficial ownership(1) Percent of class ----------------------------- ----------------------- ---------------- Larry Vance 14,765,003(2)(3)(4) 7.57% P.O. Box 763 Lakeside, MT 59922
Tami Story 2,365,169(5) 1.21% P.O. Box 763 Lakeside, MT 59901 Dr. Jan Arnett 9,150,830(4) 4.69%
42-07 30th Avenue Astoria, MT 11103 All directors and officers 18,130,172 9.29%
- -------------------------------- (1) All shares are held directly with sole voting and investment power unless otherwise indicated. (2) Includes 1,775,000 shares held by Universal Search Technology, a private company owned by Mr. Vance. (3) Includes 4,500,000 options, which are exercisable on March 31, 2002. (4) Excludes 17,663,842 shares held by Accuprobe. General Petroleum, Inc. (GPI), a company previously wholly-owned by Mr. Vance, and Accuprobe, a company previously wholly-owned by Dr. Arnett, have entered into an agreement whereby Dr. Arnett has exchanged his 100% ownership of Accuprobe for a percentage of the shares of GPI. Currently, all requirements of the transaction have not been met, but even if the transaction is completed, Mr. Vance will own 25% of the outstanding capital stock of GPI and Dr. Arnett will own 33% of the outstanding stock of GPI and neither Mr. Vance nor Dr. Arnett will likely have control over the disposition or voting power of the Earth Search shares owned by Accuprobe. (5) Includes 750,000 options, which are exercisable on March 31, 2002.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
During fiscal 2002, General Petroleum, Inc. (GPI) a company previously wholly-owned by an officer and director of the Company entered into an agreement with Accuprobe, lessor to the Company of a hyperspectral instrument (see Note 5 to the consolidated financial statements). The agreement requires the former sole shareholder of Accuprobe to transfer 100% of his equity in Accuprobe to GPI in exchange for equity in GPI. Presently, not all of the requirements of the agreement have been met. Also during fiscal 2002, GPI exchanged a portion of its equity for the 50% interest in the ESSI 1 LC owned by an outside party. It is the intention of ESSI and GPI to finalize an agreement in fiscal 2004 to allow ESSI to purchase and own 100% of both hyperspectral instruments.
In fiscal 2001, the Company entered into a lease for its office in Kalispell, Montana. The lease is with two officers of the Company and is for a term of 5 years with minimum monthly payments of $6,400.
PART IV -------
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
Page in (a)(1) Financial Statements filed as part of this Report this Report
Report of Independent Accountants - Consolidated Balance Sheet at March 31, 2004 and 2003 Consolidated Statement of Loss for the Years Ended March 31, 2004, 2003 and 2002 Consolidated Statement of Redeemable Common Stock And Nonredeemable Shareholders' Equity (Deficit) for the Years Ended March 31, 2004, 2003 and 2002 Consolidated Statement of Cash Flows for the Years Ended March 31, 2004, 2003 and 2002 Notes to Consolidated Financial Statements -
(a)(2) Financial Statement Schedules None
(a)(3) Exhibits
2.1 Agreement and Plan of Merger by and among Earth Search Sciences, Inc., ESS Acquisition Corp., Space Technology Development Corporation and the shareholders of Space Technology Development Corporation, dated December 21, 1999 (Incorporated by reference to Exhibit 2.1 to the Registrant's Form 10-K for fiscal year ended March 31, 2000).
3.1 Articles of Incorporation, as amended (Incorporated by reference to Exhibit 3.1 to the Registrant's Forms 10-K for the fiscal years ended March 31, 1995 and March 31, 1996).
3.2 Bylaws (Incorporated by reference to Exhibit 3.2 to the Registrants' Form 10-K for the fiscal year ended March 31, 1995).
4.1 See exhibits 3.1 and 3.2.
10.1 Memorandum of Understanding between the Registrant and Applied Signal and Imaging Technology, Inc. dated May 27, 1996 (Incorporated by reference to Exhibit 10.1 to the Registrant's Form 10-K for fiscal year ended March 31, 1996).
10.2 Contract of Sale and Leaseback dated June 10, 1997 between Registrant and Accuprobe, Inc. (Incorporated by reference to Exhibit 10.2 to the Registrant's Form 10-K for fiscal year ended March 31, 2000).
10.3 Operating Agreement of ESSI Probe1 LC, dated June 3, 1997 (Incorporated by reference to Exhibit 10.3 to the Registrant's Form 10-K for fiscal year ended March 31, 2000).
10.4 Hyperspectral Technology License Agreement between Earth Search Sciences, Inc. and Noranda Mining and Exploration, Inc. made as of December 16, 1997 (Incorporated by reference to the Registrant's for 8-K filed on February 6, 1998).
10.5 Agreement between the Office of Naval Research and Space Technology Development Corporation Agreement for NAVY EARTHMAP OBSERVER (NEMO) dated December 10, 1997 (Incorporated by reference to Exhibit 10.5 to the Registrant's Form 10-K for fiscal year ended March 31, 2000).
10.6 Sales Contract between Science Applications International Corp. and Space Technology Development Corp. Dated: 30 March 1998, Contract No.: STDC-98-NEMO-0003 (Incorporated by reference to Exhibit 10.6 to the Registrant's Form 10-K for fiscal year ended March 31, 2000).
10.7 Sales Contract between Science Applications International Corp. and Space Technology Development Corp. Dated: 30 March 1998, Contract No.: STDC-98-NEMO-004 (Incorporated by reference to Exhibit 10.7 to the Registrant's Form 10-K for fiscal year ended March 31, 2000).
10.8 Sales Contract between Space Systems/Loral (SS/L) and Space Technology Development Corporation (STDC). Dated 21 January 1999, Contract Number: STDC-98-NEMO-0001 (Incorporated by reference to Exhibit 10.8 to the Registrant's Form 10-K for fiscal year ended March 31, 2000).
10.9 Sales Contract between Litton Systems, Inc., Amecom Division (Litton Amecom) and Space Technology Development Corp. (STDC). Date 29 October 1998, Contract Number: STDC-98-NEMO-0009 (Incorporated by reference to Exhibit 10.9 to the Registrant's Form 10-K for fiscal year ended March 31, 2000).
10.10 Common Stock Purchase Agreement between Alpha Venture Capital, Inc. and Earth Search Sciences, Inc. (ESSI). Dated May 23, 2001. (Incorporated by reference to Exhibit 10.10 to the Registrant's Form 10-K for fiscal year ended March 31, 2001).
10.11 Registration Rights Agreement between Alpha Venture Capital, Inc. and Earth Search Sciences, Inc. (ESSI). Dated May 23, 2001. (Incorporated by reference to Exhibit 10.11 to the Registrant's Form 10-K for fiscal year ended March 31, 2001).
10.12 Common Stock Purchase Warrant A between Alpha Venture Capital, Inc. and Earth Search Sciences, Inc. (ESSI). Dated May 23, 2001. (Incorporated by reference to Exhibit 10.12 to the Registrant's Form 10-K for fiscal year ended March 31, 2001).
10.13 Common Stock Purchase Warrant B between Alpha Venture Capital, Inc. and Earth Search Sciences, Inc. (ESSI). Dated May 23, 2001. (Incorporated by reference to Exhibit 10.13 to the Registrant's Form 10-K for fiscal year ended March 31, 2001).
10.14 Larry F. Vance employment agreement (Incorporated by reference to Exhibit 10.1 to the Registrant's Form 10-Q for fiscal quarter ended December 31, 2000).
10.15 John W. Peel employment agreement (Incorporated by reference to Exhibit 10.2 to the Registrant's Form 10-Q for fiscal quarter ended December 31, 2000).
10.16 Rory J. Stevens employment agreement (Incorporated by reference to Exhibit 10.3 to the Registrant's Form 10-Q for fiscal quarter ended December 31, 2000).
10.17 Tami J. Story employment agreement (Incorporated by reference to Exhibit 10.4 to the Registrant's Form 10-Q for fiscal quarter ended December 31, 2000).
10.18 John J. Sciuto employment agreement (Incorporated by reference to Exhibit 10.18 to the Registrant's Form 10-K for fiscal year ended March 31, 2001).
16.1 Consent of Independent accountants re Registration Statement on Form No. S-1 (No. 333-66100).
16.2 Statement under oath of Principal Executive Officer and Principal Financial Officer regarding facts and circumstances relating to exchange act filings.
16.3 Letter re change in certifying accountant (Incorporated by reference to Exhibit 16.3 to the Registrant's form 8-K filed on May 25, 2001).
16.4 Letter re change in certifying accountant (Incorporated by reference to Exhibit 16.3 to the Registrant's form 8-K filed on June 10, 2003).
21.1.1 List of Subsidiaries (Incorporated by reference to Exhibit 21.1.1 to the Registrant's Form 10-K for fiscal year ended March 31, 2000)
(b) The Registrant filed the Following Reports on Form 8-K during the quarter ended March 31, 2004:
Date of Report Item Reported -------------- ------------- December 3, 2003 5
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
EARTH SEARCH SCIENCES, INC.
By /s/ Larry F. Vance --------------------------- Larry F. Vance Chairman Date: July 12, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title - --------- -----
/s/ Larry F Vance Chairman and Director - ------------------------- Larry F. Vance Date: July 12, 2004
/s/ Tami Story Corporate Secretary and Treasurer and Director - ------------------------- Tami J. Story Date: July 12, 2003
EARTH SEARCH SCIENCES, INC. CONSOLIDATED BALANCE SHEET March 31, 2004
ASSETS - ------ Current Assets Cash $ 11,754 Accounts receivable, net 109,243 Other current assets 75,918 ------------ Total Current Assets 196,915 ------------ Oil and gas properties, using successful efforts accounting Proved properties 255,422 Unproved properties 330,671 ------------ 586,093 Less accumulated depletion (175,217) ------------ Net oil and gas properties 410,876 ------------ Other property and equipment, net 625,782 ------------ TOTAL ASSETS $ 1,233,573 ============
LIABILITIES - ----------- Current Liabilities Current portion of notes payable $ 1,208,622 Capital lease obligation 3,623,897 Deferred officers' compensation 240,000 Accounts payable 9,378,440 Accrued expenses 254,181 Due to related parties 555,378 Investor deposit 377,215 ------------ Total Current Liabilities 15,637,733
Long Term Liabilities Deferred officers' compensation 2,743,326 Notes payable less current portion 337,714 Shareholder loans 1,205,193 ------------ Total liabilities 19,923,966
Commitments and contingencies --
STOCKHOLDERS' DEFICIT - --------------------- Series A preferred stock; 200,000 shares authorized, issued and outstanding; liquidation preference $1,000,000 -- Common stock, $.001 par value; 200,000,000 shares authorized; 194,305,708 shares issued and outstanding 194,306 Additional paid in capital 35,496,187 Treasury stock (200,000) Accumulated deficit (54,180,886) ------------ (18,690,393) ------------ TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT $ 1,233,573 ============
See accompanying summary of accounting policies and notes to financial statements.
EARTH SEARCH SCIENCES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED MARCH 31, 2004 AND 2003
2004 2003 ------------ ------------ Revenue $ 516,490 $ 786,208 Cost of revenue (670,008) 888,758 ------------ ------------ Gross margin (153,518) (102,550) ------------ ------------ Expenses Asset impairment 2,469,072 2,168,997 General & administrative 537,365 2,592,412 Loss on debt renegotiations 297,221 -- ------------ ------------ Total Expenses 3,303,658 4,761,409 ------------ ------------ Loss from operations (3,457,176) (4,863,959) Other income (expenses) Interest income 2,848 627 Interest expense (686,092) (730,719) ------------ ------------ Loss before minority interest (4,140,420) (5,594,051) Minority interest in losses of consolidated subsidiaries 279,891 239,867 ------------ ------------ Net loss $ (3,860,529) $ (5,354,184) ============ ============
Basic and diluted loss per share $ (.02) $ (.03) Weighted average common shares outstanding 194,305,708 175,327,436
See accompanying summary of accounting policies and notes to financial statements.
EARTH SEARCH SCIENCES, INC. CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' DEFICIT YEARS ENDED MARCH 31, 2004 AND 2003
See accompanying summary of accounting policies and notes to financial statements.
EARTH SEARCH SCIENCES, INC. CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' DEFICIT YEARS ENDED MARCH 31, 2004 AND 2003
See accompanying summary of accounting policies and notes to financial statements.
EARTH SEARCH SCIENCES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED MARCH 31, 2004 AND 2003
2004 2003 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES Net loss $ (3,860,529) $ (5,354,184) Adjustments to reconcile net loss to cash used by operating activities: Employee options vesting expense 3,879 14,624 Common stock issued for services and interest expense 46,222 171,820 Loss attributed to minority interest (279,891) (239,867) Depreciation, amortization and depletion 369,324 594,646 Write off capitalized costs on oil and gas properties -- 616,784 Asset impairment 2,469,072 1,552,211 Bad debt expense -- 814,895 Changes in assets and liabilities: Accounts receivable 59,941 221,096 Other current assets (39,797) 98,038 Accounts payable and accrued expenses 92,705 241,684 Accrued interest 164,906 299,455 Deferred officers compensation 398,837 386,631 ------------ ------------ NET CASH USED IN OPERATING ACTIVITIES (575,331) (582,167) ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures (336,474) (180,550) Proceeds from sale of interests in mineral properties -- 112,785 Deposit on sale of fixed assets -- 187,215 ------------ ------------ NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (336,474) 119,450 ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from sale of common stock -- 440,985 Proceeds from sale of common stock of subsidiaries -- 300,000 Proceeds from shareholder loans, net 562,500 23,363 Proceeds from liquidation of escrow 90,000 Repayments on notes payable (76,624) (20,630) ------------ ------------ NET CASH PROVIDED BY FINANCING ACTIVITIES 575,876 743,718 ------------ ------------ NET INCREASE (DECREASE) IN CASH (335,929) 281,001 CASH AT BEGINNING OF PERIOD 347,682 66,681 ------------ ------------ CASH AT END OF PERIOD $ 11,753 $ 347,682 ============ ============
See accompanying summary of accounting policies and notes to financial statements.
EARTH SEARCH SCIENCES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED MARCH 31, 2004 AND 2003
SUPPLEMENTAL CASH FLOW INFORMATION Year ended March 31, ---------------------------------- 2004 2003 ------------ ------------ Supplemental Cash flow information: Interest paid $ 199,827 $ 157,688
Non-cash financing and investing activities: Notes payable and interest converted into common stock -- 733,233 Interest accrued on construction in progress -- 543,877 Issuance of shares for deferred compensation -- 440,878
See accompanying summary of accounting policies and notes to financial statements.
EARTH SEARCH SCIENCES, INC. NOTES TO FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Earth Search Sciences, Inc. ("ESSI") collects high value hyperspectral imagery of the earth's surface utilizing their proprietary hyperspectral imaging sensors, principally in North America. This imagery is either sold to end users via contracts to collect the information or collected for ESSI's own exploration purposes. ESSI also performs a range of imagery processing services. Information collected by the sensor has applications in natural resources development, environmental monitoring and remediation, wildlife habitat monitoring, hydrocarbon exploration and development, agricultural assessment and planning, including weed species identification, land use planning, forestry monitoring and planning, homeland security and target identification for defense surveillance.
ESSI has four wholly-owned subsidiaries: Skywatch Exploration, Inc., Polyspectrum Imaging, Inc., Geoprobe, Inc., and STDC, Inc. ("STDC"). In addition, there are five partially-owned consolidated subsidiaries: Earth Search Resources, Inc., Eco Probe, Inc., ESSI Probe 1 LC, Petro Probe, Inc. and Terranet, Inc. The 50% owned subsidiary ESSI Probe 1 LC was formed as a joint venture to own and operate hyperspectral instruments.
All subsidiaries excepting Petro Probe became inactive during fiscal 2003.
The majority-owned Petro Probe, Inc. was formed to identify and develop hydrocarbon properties by utilizing ESSI's hyperspectral instruments, hydrocarbon geologists, and imagery processors. At March 31, 2004, Petro Probe, Inc. holds interests in seven oil and gas projects.
In fiscal 2004 and 2003, ESSI operated its airborne hyperspectral sensors under contracts with third parties in several areas around the United States. Contracts to operate the sensors in the United States as an ecological, agricultural, hydrocarbon, and target identification contributed approximately $258,000 and $384,000 to revenue in fiscal 2004 and 2003 respectively.
PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of ESSI and its subsidiaries. All significant intercompany transactions have been eliminated.
OIL AND GAS PROPERTIES ESSI uses the successful efforts method to account for its oil and gas properties. Costs incurred for property acquisition, exploration, and drilling related to its oil and gas properties are capitalized. Once the project is completed, and, if oil or gas is located, costs capitalized to date on the specific project are amortized under the unit-of-production method as revenue is recognized. Capitalized costs for unsuccessful projects are expensed when that determination is made.
Based on the agreements for the working interests in oil and gas properties, ESSI will proportionately share in future revenues as well as future operating and drilling costs. Unproved oil and gas properties that are individually significant are periodically assessed for impairment of value, and a loss is recognized at the time of impairment by providing an impairment allowance. In fiscal 2004 and 2003, $439,000 and $617,000 of prior year
costs were impaired because profitable production had not yet been obtained in 5 of 7 properties.
Capitalized costs of producing oil and gas properties, after considering estimated dismantlement and abandonment costs and estimated salvage values, are depreciated and depleted by the unit-of-production method.
REVENUE RECOGNITION ESSI recognizes revenue and costs as services are rendered under contract for airborne hyperspectral services and imaging processing services.
DEPRECIATION AND AMORTIZATION ESSI recognizes depreciation on its property and equipment using the straight-line method over estimated useful lives ranging from five years for computers and software, vehicles and equipment to ten years for the two hyperspectral sensors.
IMPAIRMENT OF LONG-LIVED ASSETS Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. ESSI evaluates long-lived assets to determine potential impairment by comparing the carrying amount to the undiscounted estimated future cash flows of the related assets. In fiscal 2004 and 2003, ESSI incurred asset impairments of $137,000 and $543,877, $439,000 and $617,000 on unsuccessful oil and gas properties in fiscal 2004 and 2003, $1,958,000 on the Probe, LC abandoned construction in progress in fiscal 2004, $900,000 on the Polyspectrum abandoned construction in progress in fiscal 2003, and $108,334 on Terranet computer equipment in fiscal 2003.
INCOME TAXES Deferred income taxes are recognized for the tax consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts based on enacted tax laws and statutory tax rates applicable to the period in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.
MINORITY INTEREST Losses from subsidiaries with minority interest are allocated to the minority interest liability account based on the percentage of minority interest ownership. Once losses applicable to the minority interest in the subsidiary exceed the minority interest in the equity capital of the subsidiary, then no additional losses will be allocated to the minority interest liability account.
NET LOSS PER COMMON SHARE Net loss per common share has been computed based on the weighted average number of ESSI's common shares outstanding. Common stock equivalents have not been considered in the diluted net loss per share calculation because their effect on net loss per share is anti-dilutive.
STOCK OPTIONS AND WARRANTS ESSI accounts for non-cash stock-based compensation issued to non-employees in accordance with the provisions of SFAS No. 123 and EITF No. 96-18, Accounting for Equity Investments That Are Issued to Non-Employees for Acquiring, or in Conjunction with Selling Goods or Services. Common stock issued to non-employees and consultants is based upon the value of the services received or the quoted market price, whichever value is more readily
determinable. ESSI accounts for stock options and warrants issued to employees under the intrinsic value method. Under this method, ESSI recognizes no compensation expense for stock options or warrants granted when the number of underlying shares is known and the exercise price of the option or warrant is greater than or equal to the fair market value of the stock on the date of grant. The following table illustrates the effect on net loss and net loss per share if ESSI had applied the fair value provisions of FASB Statement No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, to stock-based employee compensation.
2004 2003 ------------ ------------ Net loss as reported $ (3,095,627) $ (5,354,184) Less: stock based compensation determined under fair value- based method 0 0 ------------ ------------ Pro forma net loss $ (3,095,627) $ (5,534,184) ============ ============ Basic and diluted net loss per common share: As reported $ (.02) $ (.03) Pro forma (.02) (.03)
The weighted average fair value of the stock options granted during 2003 and 2003 was $.25. Variables used in the Black-Scholes option-pricing model include (1) 4.0% interest rate in 2003, (2) expected option life is the actual remaining life of the options as of each year end, (3) expected volatility is 0% in 2003, and (4) zero expected dividends.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and 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. Actual results could differ from those estimates.
RECENTLY-ISSUED ACCOUNTING STANDARDS ESSI does not expect the adoption of recently issued accounting pronouncements to have a significant impact on their financial position, results of operations or cash flow.
NOTE 2 - GOING CONCERN
ESSI is experiencing severe working capital deficiencies because it has incurred substantial operating losses. ESSI has operated with funds received from the sale of its common stock and the issuance of notes. ESSI's ability to continue as a going concern is dependent upon continued debt or equity financings until or unless ESSI is able to generate operating revenues to sustain ongoing operations. There can be no assurance that ESSI can raise the necessary funds to continue as a going concern.
NOTE 3 - PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
March 31, --------------------------------- 2004 2003 ------------ ------------ Mineral properties (A) $ 586,093 $ 692,090 ATM imagery database -- 134,000 Computers and software -- 186,788 Vehicles and equipment 1,144,536 1,144,536 Hyperspectral instruments (B) -- 4,058,000 Construction in progress (C) -- - ------------ ------------ 1,730,629 6,215,414 Accumulated depreciation, amortization and depletion (693,972) (2,676,835) ------------ ------------ $ 1,036,657 $ 3,538,579 ============ ============
(A) In fiscal 2003, ESSI paid $150,000 for drilling on two existing properties and sold a portion of its interests to others on those two properties for $112,785.
In fiscal 2001, one of the oil and gas properties with capitalized costs of about $250,000 began production. ESSI recognized $257,000 and $348,000 in revenue from that property in fiscal 2004 and 2003 respectively. Depletion was $30,208 and $51,760 in fiscal 2004 and 2003 respectively.
In fiscal 2004 and 2003, ESSI wrote-off $ 439,732 and $616,786 respectively, of previously capitalized costs on properties that were determined to be uneconomical wells.
(B) This category is three hyperspectral instruments which originally cost $3,958,235. All instruments were fully impaired in fiscal 2003.
The related debt as of March 31, 2004 is $3,623,896 and includes $873,896 of accrued interest. No lease payments have been made since June 2000, and the entire balance due is shown as a current liability.
(C) Fiscal 2001 construction costs related to the development of a remote sensing instrument and satellite. In fiscal 2002, ESSI's agreement with the ONR for the satellite was terminated and ESSI impaired $13,010,364 in such development costs. The $900,000 balance representing development costs of the second generation hyperspectral instrument was impaired in fiscal 2003.
NOTE 4 - OIL AND GAS INTERESTS
Supplemental information (unaudited) Successful Capitalized costs relating to oil and gas Efforts producing activities at March 31, 2004 ------------ Unproved oil and gas properties $ 330,671 Proved oil and gas properties 255,422 Less accumulated depletion (175,217) ------------ Net capitalized costs $ 410,876 ============ Costs incurred in oil and gas producing activities for the years ended March 31, 2004 and 2003 2004 2003 ------------ ------------ Property acquisition costs Proved $ 5,803 -- Unproved 330,671 439,472
Results of operations for oil and gas producing activities for the years ended March 31, 2004 and 2003 Oil and gas sales $ 265,050 $ 395,536 Development Costs (7,403) (23,355) Depletion (30,208) (51,760) Impairment (439,472) (646,545) ------------ ------------ Results of operations for oil and gas producing activities (excluding corporate overhead and financing costs) $ (212,033) $ (326,124) ============ ============
The following estimates of proved and proved developed reserve quantities and related standardized measure of discounted net cash flow are estimates only, and do not purport to reflect realizable values or fair market values of ESSI's reserves. ESSI emphasizes that reserve estimates are inherently imprecise and that estimates of new discoveries are more imprecise than those producing oil and gas properties. Accordingly, these estimates are expected to change as future information becomes available. All of ESSI's reserves are located in the United States.
Proved reserves are estimated reserves of crude oil (including condensate and natural gas liquids) and natural gas that geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. Proved developed reserves are those expected to be recovered through existing wells, equipment and operating methods.
The standardized measure of discounted future net cash flows is computed by applying year end prices of oil and gas (with consideration of price changes only to the extent provided by contractual arrangements) to the estimated future production of proved oil and gas reserves, less estimated future expenditures (based on year-end costs) to be incurred in developing and producing the proved reserves, less estimated future income tax expenses (based on year-end statutory tax rates, with consideration of future tax rates already legislated) to be incurred on pretax net cash flows less tax basis of the properties and available credits, and assuming
continuation of existing economic conditions. The estimated future net cash flows are then discounted using a rate of 10 percent a year to reflect the estimated timing of the future cash flows.
NOTE 5 - NAVAL EARTHMAP OBSERVER (NEMO) PROJECT
In May 2002, ESSI received notification from the ONR indicating that the performance period for the agreement governing the NEMO project had ended. The related unpaid receivable of $814,895 as of March 31, 2003 has been fully reserved and no payments have been received since that date.
Included in accounts payable as of March 31, 2004 is $8,216,424 in unpaid accounts payable to NEMO subcontractors and vendors.
NOTE 6 - NOTES PAYABLE
Notes payable consists of the following: 2004 2003 ------------ ------------ Installment note payable with a balloon due June 15, 2004, secured by airplane, the hyperspectral sensor, and the producing oil and gas property, with interest at 15%, due in monthly installments of $18,011 $ 1,080,870 $ 1,058,859
Installment note payable secured by producing oil and gas property, with interest at 15%, due in monthly installments of $6,929 420,866 --
Unsecured convertible promissory notes, delinquent, with interest at 12.5% 41,568 41,568
Other 3,033 3,033
Less: current portion (1,208,622) (108,417) ------------ ------------ $ 337,715 $ 995,043 ============ ============
In fiscal 2003, $733,233 of notes outstanding plus accrued interest were converted into common stock at the agreed upon conversion rates.
NOTE 7 - SHAREHOLDER LOANS
ESSI has financed its operations in part by funds received from advances by shareholders. These advances are in the form of unsecured promissory notes and bear interest at rates ranging from 8% to 10%. As of March 31, 2004 and 2003, interest accrued on such advances aggregated $555,378 and $448,965 respectively, and has been included in accrued interest.
NOTE 8 - DEFERRED OFFICERS' COMPENSATION
Deferred compensation consists of the cumulative unpaid compensation due to corporate officers (Chairman, Chief Executive Officer, Chief Financial Officer and Secretary). ESSI recorded net deferred officer compensation, accrued payroll taxes and accrued interest of $400,116 and $(54,247) during fiscal 2004 and 2003, and included these amounts in general and administrative expenses. ESSI is accruing interest on the deferred compensation balances at a rate of 8.5%, compounded quarterly. ESSI is making full salary payments to the Chairman and CEO and Secretary/Treasurer as cash flow allows.
NOTE 9 - BUSINESS SEGMENT INFORMATION
ESSI's major activities are broken down into an Airborne Hyperspectral Services business segment, a Satellite Development business segment, an Oil and Gas property business segment and an Other Industries business segment. The Airborne Hyperspectral Services segment and Satellite Development segment will utilize remote sensing instruments to earn revenue from the sale of hyperspectral imagery. The current Satellite Development business segment revenue is from a cost reimbursement contract with the U.S. Navy for the construction of the NEMO project, which has been disbanded. Transactions between the business segments are loans, interest, and management fees based on an allocation of incurred costs for general and administrative expenses. As the consolidated group is operating at a net loss position, no income tax expense or benefit is provided.
NOTE 10 - INCOME TAXES
The Company recorded no provision for income taxes in fiscal 2004 and 2003 due to the operating losses incurred from inception to date.
The tax effect of temporary differences between financial reporting and the tax bases of assets and liabilities relate to the following:
March 31, ------------------------------ 2004 2003 ------------ ------------ Net operating loss carryforwards $ 15,364,448 $ 13,445,538 Other net deferred tax assets 1,158,986 1,158,986 ------------ ------------ Gross deferred tax assets 16,523,434 14,604,524 Deferred tax assets valuation allowance (16,523,434) (14,604,524) ------------ ------------ $ -- $ -- ============ ============
The deferred tax asset has been fully reserved because ESSI cannot anticipate future taxable income to realize the potential benefits of the gross deferred tax asset.
The Company has net tax operating loss carryforwards at March 31, 2004 of approximately $47,000,000. Such carry forwards may be used to offset taxable income, if any, in future years through their expiration in 2003 through 2022. The annual amount of tax loss carryforward, which can be utilized, may be limited due to the substantial changes in the Company's ownership as defined by section 382 of the Internal Revenue Code, which may occur in the future. Such limitations could result in the expiration of a part or all of the loss carryforwards before their utilization.
NOTE 11 - OFFICER AND DIRECTOR STOCK OPTIONS
In August 1997, the Board of Directors granted performance based options to ESSI's Chairman, President and Chief Executive Officer to each purchase 5,000,000 shares of ESSI's stock at exercise prices ranging from $0.50 per share to $2.50 per share and to ESSI's Secretary to purchase 1,000,000 shares of ESSI's stock at an exercise price of $0.50 per share. All of these performance based stock options are exercisable for a period of 24 months from the date of vesting. The options will be deemed vested for each individual if that individual is employed by ESSI on the first date on which the closing market price of ESSI's common stock equals or exceeds the price per share performance targets for 30 consecutive days. The specific vesting criteria for these options are described below:
When and if the closing market price of common stock equals or exceeds each of the following prices $0.50, $1.00, $1.50, $2.00 and $2.50 per share for 30 consecutive days, each of the three individuals shall become fully vested with an option to purchase 1,000,000 shares of common stock for each milestone at a price equal to the milestone price of $0.50, $1.00, $1.50, $2.00 and $2.50 per share, exercisable for a period of 24 months from the date of vesting.
During fiscal 2000, the Board of Directors issued options to a new employee to purchase 650,000 shares of ESSI's common stock with an exercise price below fair value. In fiscal 2003, 2002 and 2001, ESSI recognized $14,624 in
each year of non-cash compensation expense related to these options.
During fiscal 2001, the Board of Directors approved performance based bonuses in the form of options to ESSI's officers. The specific vesting criteria for these options are described below:
10% of options shall be considered vested and bonused as paid in full shares for past services to ESSI; 15% of all options shall become vested and paid in full when ESSI is successful in obtaining a commitment from a strategic partner, financial institution, reputable investment banker or other source in raising capital sufficient to fund the NEMO program (shut down in 2002 - see Note 6); 20% vested and paid in full when successful in raising gross capital of at least $6,000,000; 20% vested and paid in full when successful in raising gross capital of at least $30,000,000; 20% vested and paid in full when successful in raising gross capital of at least $100,000,000; and 15% vested and paid in full in the event the NEMO program is successfully funded.
During fiscal 2001, the Board of Directors approved the issuance of 8,587,000 shares against options as a stock bonus. ESSI reduced options outstanding by 8,587,000 and recorded non-cash compensation expense of $2,926,781.
ESSI has adopted the disclosure requirements of Statement of Financial Accounting Standard No. 123 ("FAS 123"), Accounting for Stock-Based Compensation. This statement allows companies to choose whether to account for stock-based compensation under the intrinsic method as prescribed by Accounting Principles Board Opinion No. 25 ("APB 25") or to use a fair value method described in FAS 123. ESSI continues to follow the provisions of APB 25. No compensation cost has been recognized on ESSI's stock option grants except as described previously, as the options include an exercise price equal to or exceeding the fair value on the date of grant.
Prior to fiscal 2002, ESSI granted two individuals a combined total of 1,687,500 stock options, which vest after certain pre-established performance criteria have been met. As of March 31, 2004, the Board had not determined the criteria. Therefore, these options are considered to be non-vested.
In fiscal 2003, 700,000 were granted. In fiscal 2002, no stock options were granted. ESSI has determined that the pro forma effects of applying FAS 123 in 2002 is immaterial. The fair value was determined using the Black-Scholes option pricing model using the following weighted-average assumptions:
Fiscal Fiscal Fiscal 2003 2002 2001 ---- ---- ---- Risk-free interest rate 4.0% N/A 5.6% Expected dividend yield -- N/A -- Expected lives 2.3 N/A 2.5 Expected volatility 0% N/A 131%
The following table summarizes the employee stock option transactions described above. Shares under Weighted-average option exercise price ----------- ---------- Balance, March 31,2000 34,350,000 $ 0.83 Options granted 4,750,000 0.49 Options cancelled (4,500,000) 0.46 Options exercised (8,787,000) 0.27 ----------- ---------- Balance, March 31,2001 25,813,000 1.01 Options granted -- -- Options cancelled (1,875,000) 0.50 Options exercised -- -- ----------- ---------- Balance, March 31,2002 23,938,000 1.05 Options granted 700,000 0.25 Options cancelled (1,500,000) 0.30 Options exercised -- -- ----------- ---------- Balance, March 31, 2003 23,138,000 1.07 Options granted -- -- Options cancelled (1,162,500) 0.57 Options exercised -- -- ----------- ---------- Balance, March 31, 2004 21,975,500 1.07 =========== ==========
The weighted average per share fair value of options granted during fiscal years 2003 was $0.25.
NOTE 12 - SHAREHOLDERS' EQUITY
PREFERRED STOCK During fiscal 1998, ESSI issued 200,000 shares of its Series A preferred stock; 100,000 of these shares were issued as a result of the conversion of a note payable. Each share of ESSI's Series A preferred stock is convertible into five shares of ESSI's common stock. The preferred stock has liquidation preference in the amount of $5.00 per share or $1,000,000. The preferred stock is redeemable by ESSI and has no voting rights. In addition, the recipient of the preferred stock was granted warrants as discussed below to purchase an additional 1,000,000 shares of ESSI's common stock. In fiscal 2003, the preferred stock was converted to common stock and the warrants were exercised.
TREASURY STOCK In fiscal 1999, ESSI received into treasury 1,000,000 shares of redeemable common stock previously issued to a vendor as payment for a hyperspectral instrument contract that was subsequently cancelled. ESSI subsequently reissued 500,000 of these shares to a third party during fiscal 1999.
PRIVATE PLACEMENT OF PETRO PROBE, INC. COMMON STOCK In fiscal 2001 and 2000, Petro Probe, Inc. issued 22,332 and 10,166 shares, respectively, of its common stock at approximately $3.00 per share. This transaction increased minority interest by $67,000 and $30,500, respectively (see note 3). In fiscal 2002, 250,000 shares of Petro Probe stock were allocated against investor deposit. This transaction increased minority interest by $13,864 and additional paid-in capital by $736,136.
PRIVATE PLACEMENT OF ECO PROBE, INC. COMMON STOCK In fiscal 2001, Eco Probe, Inc., issued 151,667 shares of its common stock at approximately $3.00 per share. This transaction increased minority interest by $445,004 (see note 3).
In fiscal 2000, warrants to purchase 100,000 shares of either Petro Probe or Terranet at $3.00 per share for two years and 100,000 shares of either Petro Probe or Terranet at $5.00 per share for five years were issued to a consultant. In fiscal 2002, 100,000 of these warrants expired.
EQUITY LINE In fiscal 2002, ESSI signed an agreement with an investor for an equity line of up to $10,000,000 for one year with an extension option for another year. Under this equity line, ESSI sold 15,148,210 shares to the investor for $440,985 in fiscal 2003. No additional sales are anticipated.
NOTE 13 - WARRANTS
STOCK WARRANTS In conjunction with the equity line, ESSI issued warrants in fiscal 2002 to the investor to purchase 1,500,000 shares of ESSI's common stock for 5 years at a price equal to the lesser of 95% of an average stock price after the definitive documents were signed or 95% of the market price at the date of effectiveness of the registration statement. ESSI determined the estimated fair value of these warrants to be immaterial, and, as such, did not record the deferred financing cost asset. Additional warrants up to 1,500,000 will be issued pro rata as the equity line is used. The price of these additional warrants will be based on the market price immediately following sale to the investor. There has been no additional activity for fiscal 2004.
NOTE 14 - COMMITMENT AND CONTINGENCIES
OPERATING RENT Future minimum rental payments and sublease rental income to be received under non-cancelable leases with initial terms in excess of one year are as follows at March 31, 2004: 2005 $ 76,800 2006 25,600 ---------- $ 102,400 ==========
Rental expense for office space included in operations for fiscal 2004 and 2003 is $76,800. In fiscal 2001, the Company entered into a lease for its office in Kalispell, Montana. The lease is with two officers of ESSI and is for a term of 5 years with minimum monthly payments of $6,400.
LITIGATION In November 2000, a lawsuit was filed against ESSI by a vendor. The vendor alleges that ESSI has not paid them 500,000 shares of ESSI's stock, which it is owed pursuant to a written contract between the vendor and ESSI in which the vendor agreed to perform certain services for the Company in return for cash and ESSI's common stock. The relief sought by the vendor in the lawsuit includes significant compensatory and punitive damages; however, ESSI believes that it will be able to settle the lawsuit for less than the relief sought. ESSI has recorded a contingency loss accrual of $185,000. It is management's opinion that the loss accrual is their best estimate of the potential liability and associated legal costs of the dispute. ESSI filed counterclaims in May 2002 and there has been no activity since that date.
INDEPENDENT AUDITORS REPORT
To the Board of Directors Earth Search Sciences, Inc. Houston, Texas
We have audited the accompanying balance sheets of Earth Search Sciences, Inc. as of March 31, 2004, and the related statements of expenses, stockholders' deficit, and cash flows for each of the years ended March 31, 2004 and 2003. These financial statements are the responsibility of ESSI's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audit in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Earth Search Sciences, Inc., as of March 31, 2004, and the results of its operations and its cash flows for the years ended March 31, 2004 and 2003, in conformity with accounting principles generally accepted in the United States.
The accompanying financial statements have been prepared assuming that ESSI will continue as a going concern. As shown in the financial statements, ESSI's gross revenues dropped from $786,000 to $516,490 from fiscal 2003 to fiscal 2004, ESSI incurred a net loss of $3,095,627 during fiscal 2004, and as of March 31, 2004, ESSI's current liabilities exceeded its current assets by $15,411,835. These factors, among others, as discussed in note 2 to the financial statements, raise substantial doubt about ESSI's ability to continue as a going concern. Management's plans in regard to these matters are also described in note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
MALONE & BAILEY, PLLC Houston, Texas www.malone-bailey.com
July 12, 2004