10-Q 1 d10q.txt FOR PERIOD ENDED SEPTEMBER 30, 2001 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------- FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2001 Commission file number 333-39202 EarthWatch Incorporated (Exact Name of Registrant as Specified in Its Charter) Delaware 31-1420852 (State or other jurisdiction of (I.R.S. Employer Identification Incorporation or organization) Number) EarthWatch Incorporated 1900 Pike Road Longmont, Colorado 80501 (Address of principal executive offices, including zip code) (303) 682-3800 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] The registrant had 272,059 shares of common stock outstanding as of September 30, 2001. ================================================================================ Table of Contents PART I. FINANCIAL INFORMATION Item 1. Financial Statements. Consolidated Balance Sheet. 1 Consolidated Statement of Operations. 2 Consolidated Statement of Cash Flows. 3 Consolidated Statement of Stockholders' Equity (Deficit). 4 Notes to Consolidated Financial Statements. 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. 8 Item 3. Quantitative and Qualitative Disclosures About Market Risk. 10 PART II. OTHER INFORMATION Item 2. Changes in Securities and Use of Proceeds. 11 Item 6. Exhibits and Reports on Form 8-K. 11 Signatures 12

================================================================================ Reference is made in this document to Digital Globe (R), Your Planet Online (R) and Seconds on Orbit(R), which are registered trademarks owned by the Company. EarthWatch Incorporated, dba DigitalGlobe (A Development Stage Company)

The accompanying notes are an integral part of these consolidated financial statements. 1 EarthWatch Incorporated, dba DigitalGlobe (A Development Stage Company) Consolidated Statement of Operations (unaudited)

The accompanying notes are an integral part of these consolidated financial statements. 2 EarthWatch Incorporated, dba DigitalGlobe (A Development Stage Company)

The accompanying notes are an integral part of these consolidated financial statements. 3 EarthWatch Incorporated, dba DigitalGlobe (A Development Stage Company) Consolidated Statement of Stockholders' Equity (Deficit) --------------------------------------------------------------------------------

The accompanying notes are an integral part of these consolidated financial statements. 4 EarthWatch Incorporated, dba DigitalGlobe (A Development Stage Company) Notes to Consolidated Financial Statements -------------------------------------------------------------------------------- 1. Basis of Presentation The consolidated financial statements have been prepared by EarthWatch Incorporated and its subsidiaries, dba DigitalGlobe, without an audit, except for the December 31, 2000 balance sheet, which has been derived from audited financial statements. The statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC") and reflect all adjustments, consisting of only normal recurring adjustments that are, in the opinion of management, necessary for a fair presentation of the consolidated financial statements. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto filed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2000. The results of operations for the three and nine months ended September 30, 2001 are not necessarily indicative of the results to be expected for the full year ending December 31, 2001. New Accounting Pronouncements Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," SFAS No. 142, "Goodwill and Other Intangible Assets," SFAS No. 143, "Accounting for Asset Retirement Obligations," and SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," were issued in 2001. The adoption of these standards is not expected to have a material impact on our consolidated financial position or results of operations. 2. Construction in Progress Construction in progress consists primarily of satellite construction and launch costs, ground station construction costs, and third-party developed software. Construction in progress consisted of the following: December 31, 2000 September 30, 2001 ----------------- ------------------ (unaudited) QuickBird 2 satellite $ 55,952,495 $ 132,542,313 Digital Globe software 26,570,191 28,795,398 Ground station equipment 7,193,788 8,428,133 ------------ ------------- $ 89,716,474 $ 169,765,844 ============ ============= 3. Debt to Related Parties On February 28, 2001, as required by the indentures governing our 12 1/2% Senior Notes due 2005 and our 13% Senior Discount Notes due 2007, we offered to purchase all of our outstanding notes at their accreted values per their respective indentures on the date of purchase, using the insurance proceeds relating to the loss of our QuickBird 1 satellite in November 2000. The offer expired on April 2, 2001, and we repurchased $127.4 million in principal amount at maturity of outstanding 13% notes and all outstanding 12 1/2% notes on April 3, 2001, resulting in an extraordinary loss on early extinguishment of debt of approximately $23.0 million. The extraordinary loss on early extinguishment of debt was the result of the write-off of unamortized debt discount and deferred financing costs associated with the redeemed notes. The combined repurchase price totaled $172.9 million. In connection with the offer, we entered into a Recapitalization Agreement and Consent dated as of April 2, 2001 (the "Recapitalization Agreement") with certain holders of our 13% notes. Pursuant to the Recapitalization Agreement, these noteholders agreed to refrain from tendering their notes in the offer, thus allowing us to have the use of the funds that would otherwise be used to repurchase their notes. Pursuant to the Recapitalization Agreement, we also: . granted registration rights to certain holders of notes and Series C preferred stock; 5 EarthWatch Incorporated, dba DigitalGlobe (A Development Stage Company) Notes to Consolidated Financial Statements -------------------------------------------------------------------------------- . obtained the consent of the holders of notes and amended the indenture governing the notes in certain respects; . amended our certificate of incorporation to, among other things, (a) require that we purchase, at each holder's option, that holder's shares of our Series A and B preferred stock, if an insurable event occurs under the QuickBird 2 insurance policy, (b) increase the number of authorized shares of our common stock and each series of our preferred stock, and (c) extend the time period by one year during which holders of our preferred stock may convert their shares into shares of our common stock; . issued 10,843,297 additional shares of our Series C preferred stock to the holders of the notes that signed the Recapitalization Agreement and their assignees; . purchased launch and in-orbit insurance for our QuickBird 2 satellite; and . pledged the QuickBird 2 insurance in favor of The Bank of New York, as collateral agent for (a) the holders of notes and for Ball Aerospace, and (b) the holders of our Series A preferred stock and Series B preferred stock. We have incurred transaction costs associated with the Recapitalization Agreement of approximately $1.2 million, of which $1.0 million was paid to Morgan Stanley. In April 2001, we obtained a $9.0 million borrowing facility with Ball Aerospace, one of our stockholders, which we are using to fund the completion of QuickBird 2. This vendor financing facility accrues interest at an annual rate of 11%, which will become payable seven months following the launch of QuickBird 2. Beginning in June 2002 and ending with April 2003, principal, in equal monthly amounts, and interest are payable in cash each month. In conjunction with this arrangement, we issued to Ball Aerospace 903,608 shares of Series C preferred stock in June 2001. Based on our current operating plan, we believe that existing capital resources will meet our anticipated cash needs through fiscal 2002. If our satellite system takes longer than expected to become operational, if technical or regulatory developments require that we modify the design of our satellite system, if we are unable to achieve our revenue targets, or if we incur other additional unforeseen costs, we may require additional capital. We do not have a revolving credit facility or other source of readily available capital. Therefore, any shortfall in funds available for our operations or to service our debt would cause us serious liquidity problems. In such case, we would need to seek additional financing which we may not be able to obtain on commercially reasonable terms or at all. Failure to obtain such additional financing may result in a material adverse effect on our business and would significantly increase risk of our ability to continue as a going concern. The book value of our debt, net of unamortized deferred financing costs and debt discounts, approximates its fair value at September 30, 2001.

6 EarthWatch Incorporated, dba DigitalGlobe (A Development Stage Company) Notes to Consolidated Financial Statements -------------------------------------------------------------------------------- 4. Related Party Transaction During the three-month period ended September 30, 2001, a division of ITT Industries, Inc., a stockholder of ours, performed research and development services for us totaling $500,000. 5. Commitments As of September 30, 2001, we have noncancelable operating lease and contract commitments totaling $17.6 million. 6. Subsequent Event On October 18, 2001, our QuickBird satellite was successfully launched and deployed from Vandenberg Air Force Base in California. The spacecraft is now undergoing an on-orbit calibration and commissioning period, which is expected to last approximately 90 days. 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. The following discussion should be read in conjunction with, and is qualified in its entirety by, the consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q. Some of the statements in this Quarterly Report on Form 10-Q constitute forward-looking statements. These statements involve known and unknown risks, uncertainties, and other factors that may cause our or our industry's results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by such forward-looking statements. These factors include, among others, those listed under "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this Quarterly Report on Form 10-Q and in the other documents we file with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the year ended December 31, 2000. In some cases, you can identify forward-looking statements by terminology, such as "may," "will," "should," "expects," "plans," "intends," "anticipates," "believes," "estimates," "predicts," "potential," or "continue" or the negative of these terms or comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, events, levels of activity, performance, or achievements. Our actual results and the timing of certain events could differ materially from those anticipated in the forward-looking statements. Results of Operations Three months ended September 30, 2000 compared to three months ended September 30, 2001 Revenue. Our revenue has been generated primarily from the processing and sale of geographic imagery purchased from third-party suppliers. These sources of revenue increased from $268,000 for the three-month period ended September 30, 2000 to $3.7 million for the three-month period ended September 30, 2001, due to increased quantities of images sold. Revenue from the sale of third-party imagery decreased for the remainder of fiscal 2000 due to diversion of resources in anticipation of the launch of QuickBird 1. A similar decrease is not expected in fiscal 2001. Cost of Goods Sold. Our cost of goods sold includes third party geographic imagery sold under contract. As a result of our increased revenue, our cost of goods sold consequently increased from $168,000 for the three-month period ended September 30, 2000 to $2.8 million for the three-month period ended September 30, 2001. Costs for both periods were primarily the direct costs associated with obtaining third-party geographic imagery for resale. Selling, General, and Administrative Expenses. Selling, general, and administrative expenses were $4.5 million for the three-month period ended September 30, 2000 and $3.9 million for the three-month period ended September 30, 2001. The decrease was due to lower marketing and legal expenditures during the period. We expect these costs to increase in the future as we increase staff levels and implement new procedures in preparation for full-scale operations and market entry of our products and services. Research and Development. Our research and development costs were $3.3 million for the three-month period ended September 30, 2000 and $3.7 million for the three-month period ended September 30, 2001. This increase was the result of the additional research and development services provided during the three-month period ended September 30, 2001 by a division of ITT Industries, one of our stockholders. Interest Expense. Interest expense decreased from $1.5 million for the three-month period ended September 30, 2000 to zero for the three-month period ended September 30, 2001. This decrease was the result of lower average debt balances outstanding during the three-month period ended September 30, 2001 resulting in the allocation of all interest incurred during the period to capitalized interest as part of the cost of our QuickBird 2 satellite. Interest Income. Interest income decreased from $1.1 million for the three-month period ended September 30, 2000 to $325,000 for the three-month period ended September 30, 2001, due to lower average investment balances outstanding and lower rates of return on investments during the three-month period ended September 30, 2001. 8 Net Loss. We had net losses of $8.2 million for the three-month period ended September 30, 2000 and $6.4 million for the three-month period ended September 30, 2001. This decrease in net loss was primarily the result of lower interest expense and higher gross profit for the period. Nine months ended September 30, 2000 compared to nine months ended September 30, 2001 Revenue. Our revenue increased from $2.7 million for the nine-month period ended September 30, 2000 to $8.8 million for the nine-month period ended September 30, 2001, due to increased quantities of images sold. Revenue from the sale of third-party imagery decreased for the remainder of fiscal 2000 due to diversion of resources in anticipation of the launch of QuickBird 1. A similar decrease is not expected in fiscal 2001. Cost of Goods Sold. As a result of our increased revenue, our cost of goods sold consequently increased from $1.7 million for the nine-month period ended September 30, 2000 to $6.7 million for the nine-month period ended September 30, 2001. Costs for both periods were primarily the direct costs associated with obtaining third-party geographic imagery for resale. Selling, General, and Administrative Expenses. Selling, general, and administrative expenses were $11.0 million for the nine-month period ended September 30, 2000 and $9.9 million for the nine-month period ended September 30, 2001. The decrease was due to lower marketing and legal expenditures during the period. We expect these costs to increase in the future as we increase staff levels and implement new procedures in preparation for full-scale operations and market entry of our products and services. Research and Development. Our research and development costs were $9.3 million for the nine-month period ended September 30, 2000 and $8.0 million for the nine-month period ended September 30, 2001. These expenses decreased due to staff reductions and reduced operating activities following the loss of QuickBird 1, partially offset by the additional research and development services provided during the third quarter of 2001 by a division of ITT Industries, one of our stockholders. We expect these costs to increase following the launch of QuickBird 2. Interest Expense. Interest expense decreased from $4.9 million for the nine-month period ended September 30, 2000 to $4.7 million for the nine-month period ended September 30, 2001. This decrease was the result of lower average debt balances outstanding during the period since our early extinguishment of notes in April 2001, resulting in the allocation of all interest incurred during the subsequent period to capitalized interest as part of the cost of our QuickBird 2 satellite. Interest Income. Interest income decreased from $3.6 million for the nine-month period ended September 30, 2000 to $2.8 million for the nine-month period ended September 30, 2001, due to lower average investment balances outstanding and lower rates of return on investments during the nine-month period ended September 30, 2001. Net Loss. We had net losses of $20.7 million for the nine-month period ended September 30, 2000 and $40.8 million for the nine-month period ended September 30, 2001. This increase in net loss was primarily the result of the extraordinary loss on early extinguishment of debt incurred in April 2001, as discussed in Note 3 to our consolidated financial statements. Liquidity and Capital Resources On February 28, 2001, as required by the indentures governing our 12 1/2% Senior Notes due 2005 and our 13% Senior Discount Notes due 2007, we offered to purchase all of our outstanding notes at their accreted values per their respective indentures on the date of purchase, using the insurance proceeds relating to the loss of our QuickBird 1 satellite in November 2000. The offer expired on April 2, 2001, and we repurchased $127.4 million in principal amount at maturity of outstanding 13% notes and all outstanding 12 1/2% notes on April 3, 2001, resulting in an extraordinary loss on early extinguishment of debt of approximately $23.0 million. The combined repurchase price totaled $172.9 million. 9 In connection with the offer, we entered into a Recapitalization Agreement and Consent dated as of April 2, 2001 (the "Recapitalization Agreement") with certain holders of our 13% notes. Pursuant to the Recapitalization Agreement, these noteholders agreed to refrain from tendering their notes in the offer, thus allowing us to have the use of the funds that would otherwise be used to repurchase their notes. Pursuant to the Recapitalization Agreement, we also: . granted registration rights to certain holders of notes and Series C preferred stock; . obtained the consent of the holders of notes and amended the indenture governing the notes in certain respects; . amended our certificate of incorporation to, among other things, (a) require that we purchase, at each holder's option, that holder's shares of our Series A and B preferred stock, if an insurable event occurs under the QuickBird 2 insurance policy, (b) increase the number of authorized shares of our common stock and each series of our preferred stock, and (c) extend the time period by one year during which holders of our preferred stock may convert their shares into shares of our common stock; . issued 10,843,297 additional shares of our Series C preferred stock to the holders of the notes that signed the Recapitalization Agreement and their assignees; . purchased launch and in-orbit insurance for our QuickBird 2 satellite; and . pledged the QuickBird 2 insurance in favor of The Bank of New York, as collateral agent for (a) the holders of notes and for Ball Aerospace, and (b) the holders of our Series A preferred stock and Series B preferred stock. We have incurred transaction costs associated with the Recapitalization Agreement of approximately $1.2 million, of which $1.0 million was paid to Morgan Stanley. In April 2001, we obtained a $9.0 million borrowing facility with Ball Aerospace, one of our stockholders, which we are using to fund the completion of QuickBird 2. This vendor financing facility accrues interest at an annual rate of 11%, which will become payable seven months following the launch of QuickBird 2. Beginning in June 2002 and ending with April 2003, principal, in equal monthly amounts, and interest are payable in cash each month. In conjunction with this arrangement, we issued to Ball Aerospace 903,608 shares of Series C preferred stock in June 2001. As of September 30, 2001, we had drawn the full $9.0 million under this facility. Net cash used by operating activities increased from $21.2 million for the nine-month period ended September 30, 2000 to $79.8 million for the nine- month period ended September 30, 2001. This increase was primarily the result of the payment of accrued interest and the extraordinary loss incurred in conjunction with the redemption of notes in 2001. Based on our current operating plan, we believe that existing capital resources will meet our anticipated cash needs through fiscal 2002. If our satellite system takes longer than expected to become operational, if technical or regulatory developments require that we modify the design of our satellite system, if we are unable to achieve our revenue targets, or if we incur other additional unforeseen costs, we may require additional capital. We do not have a revolving credit facility or other source of readily available capital. Therefore, any shortfall in funds available for our operations or to service our debt would cause us serious liquidity problems. In such case, we would need to seek additional financing which we may not be able to obtain on commercially reasonable terms or at all. Failure to obtain such additional financing may result in a material adverse effect on our business and would significantly increase risk of our ability to continue as a going concern. Item 3. Quantitative and Qualitative Disclosures About Market Risk. We invest our cash and cash equivalents and restricted investments in short-term, U.S. dollar interest-bearing, investment grade securities with maturities less than 90 days. As of September 30, 2001, the interest rates on these investments have not fluctuated more than one percentage point since they were purchased. We do not currently hold any derivative instruments and do not engage in hedging activities. Also, we are not obligated for any variable interest rate debt or lines of credit, and currently do not generally enter into any transactions denominated in a foreign currency. Therefore, our exposure to interest rate and foreign exchange fluctuations is minimal. 10 PART II. OTHER INFORMATION Item 2. Changes in Securities and Use of Proceeds. During the three months ended September 30, 2001, we granted stock options to purchase 412,060 shares of our common stock with a price of $0.25 per share to our employees, consultants, directors, and other service providers under our 1999 Equity Incentive Plan. During the period covered by this report, we also issued and sold an aggregate of 11,971 shares of our common stock for $0.25 per share to employees, consultants, directors, and other service providers under direct issuances and exercises of stock options under our 1999 Equity Incentive Plan and 1995 Stock Option/Stock Issuance Plan. These securities were not registered under the Securities Act of 1933, as amended (the "Securities Act"), in reliance upon the exemption provided by Section 4(2) of the Securities Act and/or Rule 701 promulgated thereunder for transactions by an issuer not involving a public offering. Appropriate legends are affixed to the stock certificates issued in the transactions listed above. Similar legends were imposed in connection with any subsequent sales of any such securities. Each of the purchasers that are our employees or directors had access to information through their relationship with us. Each purchaser was given the opportunity to ask questions of and request information from EarthWatch. Each investor represented and acknowledged to EarthWatch in writing that it had this opportunity. Some of the purchasers asked questions and requested information. EarthWatch complied with all requests that it deemed reasonable. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits None. (b) Reports on Form 8-K None. 11 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. EARTHWATCH INCORPORATED (Registrant) Date: November 13, 2001 By: /s/ Henry E. Dubois --------------------- -------------------------------------------- Henry E. Dubois Chief Financial Officer, Chief Operating Officer, Executive Vice President (Principal Financial and Accounting Officer) 12

EARTHWATCH INC 10-Q