================================================================================ 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: DECEMBER 31, 2002 Commission File No. 0-19566 EARTH SEARCH SCIENCES, INC. --------------------------- (Exact Name of Registrant as Specified in its Charter) UTAH 87-0437723 ---- ---------- (State or other Jurisdiction of (IRS Employer ID) Incorporation or Organization) 1729 MONTANA HIGHWAY 35, KALISPELL, MT 59901 -------------------------------------------- (Address of Principal Executive Offices, Including Zip Code) Registrant's telephone number, including area code: (406) 751-5200 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 and 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 requirement for the past 90 days. Yes X No The number of shares outstanding of each of the registrant's classes of common stock, as of February 14, 2003, covered by this report: 179,159,558 shares. The registrant has only one class of common stock. ================================================================================ EARTH SEARCH SCIENCES, INC. FORM 10-Q QUARTER ENDED DECEMBER 31, 2002 PART I ------ FINANCIAL INFORMATION --------------------- TABLE OF CONTENTS ----------------- ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS PAGE ---- Consolidated Balance Sheets as of December 31, 2002, (unaudited) and March 31, 2002. 3 Consolidated Statements of Loss for the Three and Nine Months Ended December 31, 2002 and 2001 (unaudited). 4 Consolidated Statements of Cash Flows for the Nine Months Ended December 31, 2002 and 2001 (unaudited). 5 Selected Notes to Consolidated Financial Statements. 6-9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 10-12 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 12 PART II ------- OTHER INFORMATION REQUIRED -------------------------- Item 1. Legal Proceedings 13 Item 2. Changes in Securities 13 Item 3. Defaults Upon Senior Securities 13 Item 4. Submission of Matters of a Vote of Security Holders 13 Item 5. Other information 13 Item 6. Exhibits and Reports on Form 8-K 13 2 EARTH SEARCH SCIENCES, INC. CONSOLIDATED BALANCE SHEETS - --------------------------------------------------------------------------------------- December 31, 2002 March 31, (unaudited) 2002 ------------ ------------ Assets Current assets: Cash $ 437,400 $ 66,681 Accounts receivable, net 1,017,259 1,205,175 Other current assets 51,521 134,155 ------------ ------------ Total current assets 1,506,180 1,406,011 Property and equipment, net 5,274,909 5,690,580 ------------ ------------ Total assets $ 6,781,089 $ 7,096,591 ============ ============ Liabilities and Shareholders' (Deficit) Current liabilities: Notes payable $ 89,007 $ 440,387 Capital lease obligation 3,415,198 3,277,415 Deferred officers' compensation -- 423,641 Accounts payable 8,943,725 8,620,402 Accrued expenses 174,580 212,773 Accrued interest 424,981 498,928 Investor deposit 377,215 190,000 ------------ ------------ Total current liabilities 13,424,706 13,663,546 ------------ ------------ Long-term liabilities: Notes payable less current portion 1,023,558 1,033,698 Shareholder loans 1,072,197 1,256,844 Deferred officers' compensation 2,487,965 2,215,094 ------------ ------------ Total liabilities 18,008,426 18,169,182 Minority interest 10,881 219,759 Commitments and contingencies -- -- Redeemable common stock, $.001 par value 17,981 17,981 Nonredeemable shareholders' (deficit): Series A preferred stock; 200,000 shares authorized, issued and outstanding at March 31, 2002; liquidation preference $1,000,000 -- 1,000,000 Common stock, $.001 par value; 200,000,000 shares authorized; 178,353,918 and 158,775,576 shares, respectively, issued and outstanding 178,354 158,776 Additional paid-in capital 35,595,396 32,697,066 Treasury stock (200,000) (200,000) Accumulated deficit (46,829,949) (44,966,173) ------------ ------------ (11,256,199) (11,310,331) ------------ ------------ Total liabilities and shareholders' (deficit) $ 6,781,089 $ 7,096,591 ============ ============ The accompanying notes are an integral part of these financial statements. 3 EARTH SEARCH SCIENCES, INC. CONSOLIDATED STATEMENTS OF LOSS - --------------------------------------------------------------------------------------------------- For the Three Months For the Nine Months Ended December 31, Ended December 31, ------------------------------ ------------------------------ 2002 2001 2002 2001 ------------- ------------- ------------- ------------- Revenue $ 219,116 $ 1,603,999 $ 651,315 $ 4,103,747 Costs of revenue 157,816 1,443,225 480,695 4,182,563 ------------- ------------- ------------- ------------- Gross margin (deficit) 61,300 160,774 170,620 (78,816) Expenses General and administrative 514,090 681,909 1,683,773 2,454,380 Non-cash compensation 3,656 3,656 10,968 10,968 ------------- ------------- ------------- ------------- 517,746 685,565 1,694,741 2,465,348 Loss from operations (456,446) (524,791) (1,524,121) (2,544,164) Other income (expense) Interest income 417 392 484 4,567 Interest expense (172,110) (226,095) (549,017) (562,952) ------------- ------------- ------------- ------------- Loss before minority interest (628,139) (750,494) (2,072,654) (3,102,549) Minority interest in losses of consolidated subsidiaries 69,626 76,491 208,878 266,718 ------------- ------------- ------------- ------------- Net loss $ (558,513) $ (674,003) $ (1,863,776) $ (2,835,831) ============= ============= ============= ============= Shares applicable to basic and diluted loss per share 177,343,925 155,142,599 172,593,946 154,519,159 Basic and diluted loss per share $ -- $ -- $ (0.01) $ (0.02) The accompanying notes are an integral part of these financial statements. 4 EARTH SEARCH SCIENCES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS - ----------------------------------------------------------------------------------------- For the Nine Months Ended December 31, 2002 2001 -------------------------- Cash flows from operating activities: Net loss $(1,863,776) $(2,835,831) Adjustments to reconcile net loss to net cash used in operating activities: Non cash compensation expense 10,968 81,245 Issuance of common stock for services and interest expense 132,829 40,000 Loss attributed to minority interest (208,878) (266,718) Depreciation, amortization and depletion 457,227 371,101 Write off capitalized costs on oil and gas properties 29,758 476,521 Changes in assets and liabilities: Accounts receivable 187,916 (425,347) Other current assets 82,634 (75,175) Accounts payable and accrued expenses 285,130 1,009,722 Accrued interest 222,070 275,645 Deferred officers' compensation 290,108 541,849 ----------- ----------- Net cash used in operating activities (374,014) (806,988) ----------- ----------- Cash flow from investing activities: Capital expenditures (187,937) (955,241) ----------- ----------- Net cash used in investing activities (187,937) (955,241) ----------- ----------- Cash flows from financing activities: Proceeds from notes payable -- 8,943 Repayments on notes payable (11,520) (21,938) Issuance of common stock for cash 300,000 -- Proceeds from shareholder loans 40,353 1,534,000 Proceeds from sale of interests in mineral properties 116,622 -- Proceeds from investor deposit 187,215 -- Proceeds from sale of common stock of subsidiary 300,000 -- ----------- ----------- Net cash provided by financing activities 932,670 1,521,005 ----------- ----------- Net increase (decrease) in cash 370,719 (241,224) Cash at beginning of period 66,681 367,902 ----------- ----------- Cash at end of period $ 437,400 $ 126,678 =========== =========== Interest paid $ 117,189 $ 131,963 =========== =========== Non-cash investing and financing activities: Conversion of notes payable, shareholder loans and related accrued interest to common stock $ 733,233 $ -- =========== =========== Settlement of deferred officers' compensation with common stock $ 440,878 $ -- =========== =========== Capital asset acquired with common stock $ -- $ 250,000 =========== =========== The accompanying notes are an integral part of these financial statements 5 EARTH SEARCH SCIENCES, INC SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002 (unaudited) 1. FINANCIAL STATEMENTS The unaudited consolidated financial statements of Earth Search Sciences, Inc. (the Company) have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. The results of operations for interim periods are not necessarily indicative of the results to be expected for the entire fiscal year ending March 31, 2003. The accompanying unaudited consolidated financial statements and related notes should be read in conjunction with the audited consolidated financial statements and the Form 10-K of the Company for its fiscal year ended March 31, 2002. 2. GOING CONCERN The Company is experiencing working capital deficiencies because of operating losses and capital expenditures. The Company and its subsidiaries have operated with funds received from the sale of its common stock, sale of common stock of subsidiaries, sale of interest in mineral properties, the issuance of notes and operating revenue. The ability of the Company to continue as a going concern is dependent upon continued debt or equity financings until or unless the Company is able to generate sufficient operating cash flows to sustain ongoing operations. The Company plans to increase the number of revenue producing services by executing its sales and marketing plan and thereby continue as a going concern. There can be no assurance that the Company can generate sufficient operating cash flows or raise the necessary funds to continue as a going concern. 3. NEW ACCOUNTING PRONOUNCEMENTS 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 initial application of SFAS 142 did not have a material effect on the Company's financial statements. The FASB issued SFAS No. 145, RESCISSION OF FASB STATEMENTS NO. 4, 44, AND 64, AMENDMENT OF FASB STATEMENT NO. 13, AND TECHNICAL CORRECTIONS, on April 30, 2002. Statement No. 145 rescinds Statement No.4, which required all gains and losses from extinguishments of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. Upon adoption of Statement No. 145, companies will be required to apply the criteria in APB Opinion No. 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 in determining the classification of gains and losses resulting from the extinguishments of debt. Statement No. 145 is effective for fiscal years beginning after May 15, 2002. The Company is currently evaluating the requirements and impact of this statement on its results of operations and financial position. 6 In June 2002, the FASB issued SFAS No. 146, ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES. This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, LIABILITY RECOGNITION FOR CERTAIN EMPLOYEE TERMINATION BENEFITS AND OTHER COSTS TO EXIT AN ACTIVITY (INCLUDING CERTAIN COSTS INCURRED IN A RESTRUCTURING). The Company will be required to adopt this statement for exit or disposal activities that are initiated after December 31, 2002. The Company is currently evaluating the potential effect of the initial application of SFAS 146 on its consolidated financial statements. 4. NAVAL EARTHMAP OBSERVER (NEMO) PROJECT The Company, through a wholly owned subsidiary, in cooperation with the Department of the Navy's Office of Naval Research (ONR) and several commercial partners, has worked on developing a remote-sensing instrument to be mounted on a satellite, Naval EarthMap Observer (NEMO). In May 2002, the Company received notification from the ONR indicating that the performance period for the agreement governing the NEMO project had ended and that it was time to initiate close-out procedures, which include accounting for the distributions of federal funds under the agreement and accounting for and disposing of all real property and equipment acquired under the agreement. Further, the ONR requested the Company to provide an audited record of all distributions of federal and non-federal funds under the agreement. Management anticipates that after the closeout procedures and the related audit of project distributions, the Company may have an opportunity to enter into a new agreement with the ONR relating to the NEMO project. Further, management has reason to believe that given the Company's significant contribution to the NEMO project to date, any future agreement with the ONR would most likely include appropriate compensation and reimbursement. The ONR is unwilling to formally discuss this possibility until after the completion of the closeout audit. Given the uncertainty surrounding the future of the NEMO project, the Company reevaluated the carrying value of the costs incurred in the development of the remote sensing instrument and satellite. Under the direction of current accounting pronouncements, the Company determined that the asset was impaired and recognized a loss on the long-lived asset of $13,010,364 as of March 31, 2002. As of December 31, 2002, accounts receivables include $814,495 due from the ONR as reimbursement for certain subcontract costs, which the Company believes were approved by the ONR for payment with federal funds. The ONR has questioned $649,839 of this balance and refuses reimbursement until the conclusion of the NEMO project closeout audit. Management is confident that the Company has accounted for the disbursements of federal funds properly, but it is possible that the amount in question may not ultimately be reimbursed by the ONR. Included in accounts payable as of December 31, 2002 and March 31, 2002 is $7,691,257 and $7,682,394, respectively, of accounts payable to NEMO subcontractors and vendors. These liabilities are payables of the subsidiary and are not guaranteed by Earth Search Sciences, Inc. 5. MINERAL PROPERTIES In the third quarter of fiscal 2003, the Company incurred additional expenditures on existing working interests in oil and gas properties of $107,090. Also in the third quarter of fiscal 2003, the Company wrote-off $5,815 of previously capitalized costs due to an unsuccessful drilling on one site within an oil and gas project. For the three quarters of fiscal 2003, the Company incurred additional expenditures on existing working interests in oil and gas properties of $135,301 and has wrote-off 7 $29,758 of previously capitalized costs due to unsuccessful drilling efforts. Also in the first quarter of 2003, the Company sold portions of two (2) properties to an outside investor for $116,622. Based on the agreements for the Company's oil and gas working interests, the Company will proportionately share in future revenues as well as future exploration, drilling and operating costs. For new drillings on existing properties, the Company will have the right but not the obligation to participate in new drilling efforts. On a case-by-case basis the Company will determine whether or not to participate in these new drilling efforts. 6. OPERATING SEGMENT AND GEOGRAPHIC INFORMATION Business Segment Information Year to Date as of December 31, 2002 Airborne Adjustments Hyperspectral Satellite Oil and Gas Other and Services Development Properties Industries Eliminations Combined ----------- ----------- ----------- ----------- ----------- ----------- Revenue $ 384,212 $ 6,459 $ 260,644 $ -- $ -- $ 651,315 =========== =========== =========== =========== =========== =========== Operating (loss) income $(1,157,546) $ (313,875) $ 34,289 $ (86,989) $ -- $(1,524,121) =========== =========== =========== =========== =========== =========== Interest income $ 17 $ 467 $ -- $ -- $ -- $ 484 Interest expense (239,081) (309,936) -- -- -- (549,017) (Loss) income from continuing operations before income taxes and minority interests (1,396,610) (623,344) 34,289 (86,989) -- (2,072,654) Identifiable assets at 12/31/2002 $ 4,278,313 $ 1,155,803 $ 1,236,125 $ 110,848 $ -- $ 6,781,089 =========== =========== =========== =========== =========== =========== Total assets at 12/31/2002 -- -- -- -- -- $ 6,781,089 =========== Depreciation, amortization and depletion for the period ended 12/31/2002 $ 413,151 $ 3,447 $ 38,983 1,646 $ -- $ 457,227 =========== =========== =========== =========== =========== =========== Capital expenditures for the period ended 12/31/2002 $ 52,636 $ -- $ 135,301 $ -- $ -- $ 187,937 =========== =========== =========== =========== =========== =========== Business Segment Information Year to Date as of December 31, 2001 Airborne Adjustments Hyperspectral Satellite Oil and Gas Other and Services Development Properties Industries Eliminations Combined ----------- ----------- ----------- ----------- ----------- ----------- Revenue $ 378,904 $ 3,420,525 $ 304,318 $ -- $ -- $ 4,103,747 =========== =========== =========== =========== =========== =========== Operating loss $ (366,917) $(1,343,783) $ (479,175) $ (354,289) $ -- $(2,544,164) =========== =========== =========== =========== =========== =========== Interest income $ 2,104 $ 2,463 $ -- $ -- $ -- $ 4,567 Interest expense (190,418) (372,534) -- -- -- (562,952) Loss from continuing operations before income taxes and minority interests (555,231) (1,713,854) (479,175) (354,289) -- (3,102,549) Identifiable assets at 12/31/2001 $ 4,726,525 $14,086,106 $ 1,402,834 $ 111,577 $ -- $20,327,042 =========== =========== =========== =========== =========== =========== Total assets at 12/31/2001 -- -- -- -- -- $20,327,042 =========== Depreciation, amortization and depletion for the period ended 12/31/2001 $ 331,944 $ -- $ 37,865 $ 1,292 $ -- $ 371,101 =========== =========== =========== =========== =========== =========== Capital expenditures for the period ended 12/31/2001 $ 41,164 $ 606,914 $ 557,163 $ -- $ -- $ 1,205,241 =========== =========== =========== =========== =========== =========== 8 6. OPERATING SEGMENT AND GEOGRAPHIC INFORMATION (CONTINUED) Business Segment Information for Third Quarter Fiscal 2003 Airborne Adjustments Hyperspectral Satellite Oil and Gas Other and Services Development Properties Industries Eliminations Combined ----------- ----------- ----------- ----------- ----------- ----------- Revenue $ 119,816 $ 6,459 $ 92,841 $ -- $ -- $ 219,116 =========== =========== =========== =========== =========== =========== Operating (loss) income $ (446,880) $ (32,457) $ 26,541 $ (3,650) $ -- $ (456,446) =========== =========== =========== =========== =========== =========== Interest income $ 1 $ 416 $ -- $ -- $ -- $ 417 Interest expense (71,344) (100,766) -- -- -- (172,110) (Loss) income from continuing operations before income taxes and minority interests (518,223) (132,807) 26,541 (3,650) -- (628,139) Identifiable assets at 12/31/2002 $ 4,278,313 $ 1,155,803 $ 1,236,125 $ 110,848 $ -- $ 6,781,089 =========== =========== =========== =========== =========== =========== Total assets at 12/31/2002 -- -- -- -- -- $ 6,781,089 =========== Depreciation, amortization and depletion for the period ended 12/31/2002 $ 136,317 $ -- $ 12,794 $ 784 $ -- $ 149,895 =========== =========== =========== =========== =========== =========== Capital expenditures for the period ended 12/31/2002 $ -- $ -- $ 107,090 $ -- $ -- $ 107,090 =========== =========== =========== =========== =========== =========== Business Segment Information for Third Quarter Fiscal 2002 Airborne Adjustments Hyperspectral Satellite Oil and Gas Other and Services Development Properties Industries Eliminations Combined ----------- ----------- ----------- ----------- ----------- ----------- Revenue $ 211,748 $ 1,305,112 $ 87,139 $ -- $ -- $ 1,603,999 =========== =========== =========== =========== =========== =========== Operating income (loss) $ 78,397 $ (462,471) $ (30,792) $ (109,925) $ -- $ (524,791) =========== =========== =========== =========== =========== =========== Interest income $ 49 $ 343 $ -- $ -- $ -- $ 392 Interest expense (118,388) (107,707) -- -- -- (226,095) Loss from continuing operations before income taxes and minority interests (39,942) (569,835) (30,792) (109,925) -- (750,494) Identifiable assets at 12/31/2001 $ 4,726,525 $14,086,106 $ 1,402,834 $ 111,577 $ -- $20,327,042 =========== =========== =========== =========== =========== =========== Total assets at 12/31/2001 -- -- -- -- -- $20,327,042 =========== Depreciation, amortization and depletion for the period ended 12/31/2001 $ 137,694 $ -- $ 12,540 $ 430 $ -- $ 150,664 =========== =========== =========== =========== =========== =========== Capital expenditures for the period ended 12/31/2001 $ 4,567 $ 138,438 $ -- $ -- $ -- $ 143,005 =========== =========== =========== =========== =========== =========== 7. NET LOSS PER SHARE Basic loss per share is based on the weighted average number of shares outstanding during each quarter and income available to common shareholders. Loss per share assuming dilution is based on the assumption that outstanding stock options were exercised. The weighted average shares for computing basic loss per share were 177,343,925 and 155,142,599 for the three months ended December 31, 2002 and 2001, respectively, and 172,593,946 and 154,519,159 for the nine months ended December 31, 2002 and 2001, respectively. At December 31, 2002 and 2001, 19,325,000 and 17,575,500 stock options were exercisable, respectively. Because of the net loss for the nine months ended December 31, 2002 and 2001, potentially dilutive common stock issuances were not included in the calculation of diluted loss per share as their inclusion would be anti-dilutive. 9 8. CONVERTIBLE PREFERRED STOCK In the third quarter of 2003, in accordance with the terms of the Subscription Agreement dated January 30, 1998, all 200,000 shares issued and outstanding of Series A Convertible Preferred Stock was converted on a one to five basis for 1,000,000 shares of the Company's common stock. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS - --------------------- Based on the results on the past operations, the capital markets and the markets for satellite remote sensing, the Company has determined that it shall focus its business on Airborne Hyperspectral Services on a going forward basis. In the Airborne Hyperspectral Services business segment in the third quarter of 2002, the Company projects were mining, environmental and governmental agency related contracts. Hyperspectral revenues were $119,816 in the third quarter compared to $241,996 in the second quarter and $22,400 in the first quarter of fiscal 2003. The Company's revenues from Airborne Hyperspectral Services are seasonal in nature because the angle of the sun makes collections difficult in certain parts of North America during the Company's third and fourth fiscal quarters. Included in the financial statements of the Company is Space Technology Development Corporation (STDC), which was acquired on December 21, 1999. STDC was developing a remote sensing satellite in cooperation with the U.S. Navy and several corporate partners under the congressionally sanctioned Joint Dual Use Applications Program (JDUAP). This joint development provided for a long-term cooperative relationship with the U.S. Navy and substantial federal funding for what would have been a commercially owned and operated hyperspectral remote sensing satellite called the Naval EarthMap Observer (NEMO). In May 2002, the Company received notification from the ONR indicating that the performance period for the agreement governing the NEMO project had ended and that it was time to initiate close-out procedures, which include accounting for the distributions of federal funds under the agreement and accounting for and disposing of all real property and equipment acquired under the agreement. Further, the ONR requested the Company to provide an audited record of all distributions of federal and non-federal funds under the agreement. The Company is waiting for the results of the audit now underway by the Defense Contract Audit Agency. In the Oil and Gas Properties business segment in the third quarter of 2002, the Company continued with its strategic plan of investing in existing projects that explore and develop oil and gas properties. The Company did not invest in any new projects during the third quarter of 2003 however it did examine new technology available for exploration and production. The Company recognized revenue of $219,116 in the third quarter of 2003 compared with $1,603,999 in the third quarter of 2002. Included in the third quarter of 2003 is $92,841 in revenue from Oil and Gas Properties. Revenue for the nine months ended December 31, 2002 and 2001, was $651,315 and $4,103,747, respectively. Included in revenue for the nine months ended December 31, 2002 and 2001 is $6,459 and $3,420,525 from STDC. Revenue from airborne hyperspectral services was $384,212 and $378,904 for the nine months ended December 31, 2002 and 2001, respectively. Revenue from oil and gas properties was $260,644 and $304,318 for the nine months ended December 31, 2002 and 2001, respectively. The Company recognized costs of revenue of $157,816 in the three months ended December 31, 2002 compared with $1,443,225 for the three months ended December 31, 2001. Included in the three 10 months ended December 31, 2002 and 2001 is STDC cost of revenue of $29,997 and $1,305,112, respectively. Cost of revenue for the nine months ended December 31, 2002 and 2001, was $480,695 and $4,182,563, respectively. Included in cost of revenue for the nine months ended December 31, 2002 and 2001 is $49,474 and $3,420,525, respectively from STDC. Cost of revenue from airborne hyperspectral services was $407,866 and $236,844 for the nine months ended December 31, 2002 and 2001, respectively. Cost of revenue from oil and gas properties was $23,355 and $525,194 for the nine months ended December 31, 2002 and 2001, respectively. General and administrative expenses for the three months ended December 31, 2002 were $514,090 compared with $681,909 for the three months ended December 31, 2001. General and administrative expenses for the nine months ended December 31, 2002 were $1,683,773 compared with $2,454,380 for the six months ended December 31, 2001. Interest income for the three and nine months ended December 31, 2002 was $417 and $484, respectively, compared to $392 and $4,567 for the same periods in the prior year due to significantly lower average cash balances in 2002 compared to 2001. Interest expense for the three and nine months ended December 31, 2002 was $172,110 and $549,017, respectively, compared to $226,095 and $562,952 for the same periods in 2001. LIQUIDITY AND CAPITAL RESOURCES - ------------------------------- Net cash increased for the three months ended December 31, 2002 due to collections from accounts receivable less capital expenditures and operating losses. Capital expenditures in the third quarter of 2003 were primarily expenditures for the Company's oil and gas properties. Capital expenditures in the first three quarters of 2003 were primarily expenditures for the Company's oil and gas properties, computer related assets and Company's aircraft. Net cash used in operating activities was $374,014 for the nine months ended December 31, 2002, resulting primarily from a net loss of $1,863,776 net of certain non-cash expenses. Net cash used in operating activities was $806,988 for the nine months ended December 31, 2001, resulting primarily from a net loss of $2,835,831 net of certain non-cash expenses. Included in accounts payable and accrued expenses at December 31, 2002 and March 31, 2002 is $7,712,774 and $7,722,688, respectively, of STDC liabilities. These liabilities are not guaranteed by Earth Search Sciences, Inc. The Company is experiencing working capital deficiencies because of operating losses and capital expenditures. The Company has operated with funds received from the sale of its common stock and the issuance of notes. The ability of the Company to continue as a going concern is dependent upon continued debt or equity financings until or unless the Company is able to generate operating revenues to sustain ongoing operations. The Company plans to increase the number of revenue producing services through the use of additional hyperspectral instruments and thereby continue as a going concern. FUTURE OPERATIONS - ----------------- It has been the Company's experience that hyperspectral imagery is increasingly becoming an accepted tool by governments and businesses, although industry expectations for satellite remote sensing business have not materialized to date. The Company believes its goal to become the preeminent provider of hyperspectral images to the governments, businesses, and universities worldwide is still viable. The Company intends to focus attention in the environmental market and fossil energy sector as well as to pursue sales of hyperspectral services, including surveying and 11 processing, by aggressively responding to requests for proposals. In addition, the Company intends to develop new marketing strategies for offering remote sensing surveys. A draft of a contract to commence the installation of a Remote Sensing Center of Excellence and hyperspectral services was received from the Government of Fiji. The Company requested time to research the specific requests outlined and to offer a counter proposal. It is intended to pursue this opportunity and attend to a meeting with government officials in the next quarter. The Company believes that the market for hyperspectral remote sensing services will experience significant growth over the next several years. The current ASPRS/NASA TEN-YEAR INDUSTRY FORECAST (http://www.asprs.org/news.html) indicates that the remote sensing market has been growing at a rate of 13% per year and the hyperspectral portion of that market will be 12% by 2006 and worth approximately $440 million. The results of 9/11 on this market are only beginning to be recognized and the Company is closely following developments. The company had engaged the services of the strategic consulting firm of D'Angelo Cohen, LLC to review its operating procedures and strategic plan. The principals, Matthew Cohen and William D'Angelo presented their suggestions for improvements to the management of the Company. These are being reviewed and considered for implementation. The Company also engaged the services of Stern & Co., a pre-imminent public relations firm in New York. Stern have laid out strategies for public relations that management is reviewing. In the prior nine months, the Company has focused on reducing overhead as a result of the termination of the agreement with the ONR and in order to become more competitive. The Company believes that its reduction of expense, the increased performance from the current backlog of surveys, and the execution of its sales and marketing plan, future financial results should improve with profitability being managements near term target. The Company is currently searching for potential replacements to the recently departed Chief Executive Officer and President. The Company is looking for qualified candidates with a proven record of directing the operations of an emerging technology company. Until replacement(s) are found, the Chairman has assumed the duties of CEO and President. The Company has added a new director to serve on the Board. Mr. Kenneth Danchuk is familiar with the Company's operations, having served as a consulting contractor to ESSI. He is also an active member of the National Investor Relations Institute (NIRI) and advisor to ESSI on corporate governance issues. With a strong background in business and economic development, Mr. Danchuk will be valuable for assisting the Board in review of mergers & acquisitions and new management appointments. The Company intends to continue to expedite the ONR's requested audit of STDC. Upon completion of the audit, management anticipates that ONR will meet with the Company to discuss options for going forward and attempt to negotiate either cash reimbursement or tasking and data stream rights from the NEMO hyperspectral instrument if it is successfully launched for the significant investment made in the NEMO program. The Company holds security interests in important space segment hardware for the NEMO program as well as a valuable commercial satellite remote sensing license. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - ---------------------------------------------------------- Not applicable 12 PART II OTHER INFORMATION REQUIRED -------------------------- Item 1. Legal proceedings None Item 2. Changes in securities Recent Sales of Unregistered Securities (1) Amount of Price per Total Cash Date Securities Sold Share($) Proceeds($) -------- --------------- --------- ----------- 5/20/02 200,000 0.08 (2) 5/30/02 3,074,273 0.12 (3) 6/7/02 8,332,329 0.09 (4) 6/19/02 377,220 0.05 (3) 6/30/02 300,000 0.09 (5) 6/30/02 500,000 0.12 (3) 9/30/02 547,960 0.04 (3) 11/12/02 1,098,350 0.06 (3) 11/13/02 500,000 0.05 (6) 12/11/02 500,000 0.04 (6) (1) Shares sold were common stock, par value $0.001 (2) Consideration received for the shares was consulting services (3) Consideration received for the shares was employee and consultant services (4) Shares exchanged pursuant to debt conversion (5) Shares issued for debt consideration (6) Shares exchanged pursuant to preferred stock agreement Amount of Price per Total Cash Date Securities Sold Share($) Proceeds($) -------- --------------- --------- ----------- 4/16/02 2,142,860 0.07 150,000 6/17/02 2,005,350 0.075 150,000 (1) Sales of securities made pursuant to Registration Statement effective September 14, 2001 file number 333-66100. Securities were sold at a 12% discount of the average market price on 5 trading days. All proceeds were used for working capital purposes. Item 3. Defaults upon senior securities None Item 4. Submission of matters to a vote of security holders None Item 5. Other information Exhibits attached Statement Under Oath of Principal Executive Officer and Principal Financial Officer Regarding Facts and Circumstances Relating to Exchange Act Filings 13 SIGNATURE 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. EARTH SEARCH SCIENCES, INC. Date: February 14, 2003 /s/ Larry F. Vance ------------------------------ Chief Executive Officer 14 CERTIFICATION I, Larry F. Vance, Chairman of the Board and Chief Executive Officer of Earth Search Sciences, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Earth Search Sciences, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: February 14, 2003 /s/ Larry F. Vance ------------------------------------- Larry F. Vance Chairman of the Board and Chief Executive Officer (Principal Executive Officer) CERTIFICATION I, Tami J Story, Acting Chief Financial Officer of Earth Search Sciences, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Earth Search Sciences, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: February 14, 2003 /s/ Tami J. Story ----------------------------------- Tami J. Story Acting Chief Financial Officer (Principal Financial Officer)