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The Struggle to Sell a 'Green' Wrapper

SIMON K. HODSON, chief executive of EarthShell, is not the first entrepreneur to come up with an environmentally friendly alternative to the paper and plastic foam used in food packaging. But because of the steadfast backing of EarthShell's chairman and largest shareholder, Essam Khashoggi, Mr. Hodson looks as if he has pulled off a rare achievement: staying solvent long enough to gain a realistic shot at breaking into this $12 billion market.

EarthShell's product — a mix of limestone, sand and starch from plants like corn and potatoes — grew from efforts to improve concrete. It decomposes in weeks when exposed to air and takes little landfill space.

"It's clear that this product is environmentally preferable," said Arthur B. Weissman, president and chief executive of Green Seal, a nonprofit group that tested a clamshell-like package made from the compound and designed for use by McDonald's.

Now EarthShell is trying to overcome the dismal reputation of green packaging as an ideal way to lose money. "Efforts to distinguish products by environmental packaging have been kind of a bust," said J. Winston Porter, president of the Waste Policy Center, an environmental management research center in Leesburg, Va. Consumers, he said, care far more about what is in a package than what it is made of.

Instead of expecting that to change, EarthShell, based here, has set out to prove it can replace many of today's materials at similar or even lower prices. The environmental benefits would be sold as a bonus.

Taken public in 1998 by Mr. Khashoggi, a publicity-shy younger brother of Adnan Khashoggi, a flamboyant Saudi investor and former arms broker, EarthShell has sunk $270 million and more than a decade of work into its effort. But it has dwindling cash reserves to see it through to commercialization and will rely heavily on investment decisions made over the next year or so by major packagers, manufacturers of packaging equipment and users of packaging, like McDonald's.

EarthShell has invested most of its resources in prototype production lines that have made millions of disposable plates, cups and other fast-food containers out of its compound, called Ali-ITE, after Mr. Khashoggi's son Ali.

With EarthShell's stock trading at 88 cents and investors fixated on its outside accountant's standard warning that the company is not profitable and may fail, EarthShell clearly has a long way to go to prove its strategy will succeed. The recent layoff of two-thirds of its workers, reducing its staff to about 50, was not greeted as progress, though EarthShell said many employees were simply being shifted to packagers that planned to make its products.

EarthShell says it took a crucial if little-noticed step in May, when Detroit Tool and Engineering of Lebanon, Mo., a subsidiary of DT Industries, agreed to build equipment to make EarthShell materials that it will deliver with performance guarantees to packaging manufacturers. Sweetheart Cup, a unit of SF Holdings and long a partner in EarthShell's research, then announced plans to buy equipment capable of generating $500 million of EarthShell brand products annually. The first customers are expected to be 1,000 McDonald's restaurants, Wal-Mart Stores and packaging distributors like Sodexho.

"It's beyond the pilot stage," said Leslie Aun, a spokeswoman for Sodexho, which began distributing EarthShell products to Hampshire College and the cafeteria at an Alaskan oil rig last fall and has expanded to several other campuses. "It's something we are integrating into our product line."

EarthShell says three other tool companies, which it did not name, have built sample production lines. And at least two other packagers, Green Earth of Malaysia and Huhtamaki of Finland, plan to begin mass production overseas late this year or early in 2003. (Green Earth has said that it will also take over a small production line that it helped EarthShell develop in Goleta, Calif., just west of here.)

But most of the ultimate jurors — the businesses and institutions that buy packaging in huge quantities — still know little or nothing about EarthShell. And those who know it well seem more interested than committed. McDonald's describes EarthShell as "still in the test process," even though EarthShell's filings with the Securities and Exchange Commission upon going public in 1998 said its materials were approved for use by McDonald's.

WALL STREET'S skepticism that EarthShell can make the final leap to commercial success has been apparent ever since it went public at $21 a share. The stock fell sharply the first day and in recent months has rarely crept above $1.

Although it flirted with becoming a manufacturer, EarthShell now aims only to license others to make and distribute its products.

The company traces its roots to Salt Lake City, where Mr. Hodson's family had a concrete business. Mr. Hodson, who was looking for investors to support research into novel forms of concrete like fast-draining cement for airport runways, made his initial pitch to Mr. Khashoggi in 1983. Mr. Khashoggi had become a frequent visitor to Utah as chairman of Triad American, a real estate development firm based in Salt Lake City and founded by his older brother. Mr. Khashoggi agreed 18 months later to become Mr. Hodson's financial angel.

The two make an unlikely pair. Mr. Hodson, 47, is a tall, curly-haired native of Utah who never strayed far from materials science. Mr. Khashoggi, 63, is shorter, rounder and, as the son of the chief physician to Saudi Arabia's rulers, born to a life of diverse investments and global connections. He came to the United States as a teenager and graduated from San Jose State in California as an industrial design major. He got his start in commerce using family connections to win commissions to furnish palaces.

Mr. Khashoggi insisted on shifting the focus to packaging after a researcher hired by Mr. Hodson showed him a cup fashioned from a raw version of Ali-ITE. It was heavy and far too brittle, but it was safely disposable, held heat better than paper and used cheaper materials than either plastic or paper.

Aware that McDonald's was looking for alternatives to plastic foam, in 1992 Mr. Khashoggi and Mr. Hodson formed EarthShell — then called EarthCrete — and made the wooing of McDonald's a priority. "We were intrigued from Day 1," said Robert L. Langert, then an environmental affairs specialist at McDonald's.

McDonald's interest has run so deep that at various times it has invested in preferred stock and offered short-term loans. That came after what McDonald's called "normal due diligence" about criticism that it might attract for any link with the Khashoggis's Triad American, which went bankrupt in 1987 and was liquidated in 1994.

McDonald's also knew that Adnan Khashoggi had been involved in scandals. He secretly mediated arms sales to Iran in 1985, in what became known as the Iran-contra scandal. In 1990 he was tried, and acquitted, on charges that he had helped Ferdinand and Imelda Marcos conceal ownership of four buildings in New York.

"Obviously we were aware of the family name," said Walt Riker, a McDonald's spokesman. "We were investing in a concept, not an individual."

If seeking out an influential partner came naturally to Essam Khashoggi, it created hurdles for EarthShell. The package McDonald's wanted most, for its Quarter Pounder with Cheese, presented a complex design problem. After McDonald's dismissed EarthShell's first effort — a two-piece container — it had to figure out how to make a hinged, single-piece clamshell.

McDonald's also pressed EarthShell to pay for independent studies to support its environmental claims. In 1996, McDonald's invited a dozen environmental groups to a meeting in Washington to assess the studies.

Such assessments can never be conclusive. Even today, some environmentalists fret that use of EarthShell might encourage littering and reduce demand for products made from recycled paper. But McDonald's concluded that the 1996 meeting provided a green light as long as EarthShell made further improvements, like cutting the package's weight, Mr. Langert said.

By then, EarthShell had signed licensing agreements with a number of leading packagers, including Sweetheart, Genpak and Dopaco. Mobil and International Paper also began experimenting with the material. But EarthShell was also discovering that no company was likely to go further until EarthShell had proved that the product could be mass-produced. "The packaging industry does very little research on its own," Mr. Hodson said. "These are guys who have to be able to touch it, see it and smell it."

It did not help that the packaging industry was in flux. Sweetheart was sold three times in the 1990's. After each sale, work with EarthShell was delayed while the new owners assessed their investment plans, said Vincent J. Truant, a former Sweetheart executive who joined EarthShell last year and recently became president and chief operating officer.

Essam Khashoggi said he was more optimistic than ever about EarthShell, but failure in food packaging would not mark the end of Ali-ITE. Mr. Khashoggi jokes that one of his sons caught a trout last year using Ali-ITE as bait.

He and Mr. Hodson, though, see real potential in the paper industry. Research with DuPont and others suggests that Ali-ITE can be made into sheets on existing paper-making equipment using less pulp, chemicals and energy than does standard paper.

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