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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2003
Commission File Number 0-11997
Carrington Laboratories, Inc.
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(Exact name of Registrant as specified in its charter)
Texas 75-1435663
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(State of Incorporation) (IRS Employer ID No.)
2001 Walnut Hill Lane, Irving, Texas 75038
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(Address of principal executive offices)
Registrant's telephone number, including area code: (972) 518-1300
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of exchange on which registered
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None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock ($.01 par value)
(Title of class)
Preferred Share Purchase Rights
(Title of class)
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K (S229.405 of this chapter) is not contained
herein, and will not be contained, to the best of the Registrant's
knowledge, in definitive proxy or information statements incorporated
by reference in Part III of this Form 10-K or any amendment to this Form
10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes [ ] No [ X ]
The aggregate market value of the voting and non-voting common equity
held by non-affiliates of the Registrant (treating all executive officers
and directors of the Registrant and holders of 10% or more of shares
outstanding, for this purpose, as if they may be affiliates of the
Registrant) was $42,016,000, computed by reference to the price at which
common equity was sold on March 11, 2004.
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of the latest practicable date:
10,451,816 shares of Common Stock, par value $.01 per share, were
outstanding on March 11, 2004.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's proxy statement for its annual meeting of
shareholders to be held on May 20, 2004 are incorporated by reference into
Part III hereof, to the extent indicated herein.
PART I
ITEM 1. BUSINESS.
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General
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Incorporated in Texas in 1973, Carrington Laboratories, Inc. ("Carrington"
or the "Company") is a research-based biopharmaceutical, medical device, raw
materials and nutraceutical company engaged in the development,
manufacturing and marketing of naturally-derived complex carbohydrates and
other natural product therapeutics for the treatment of major illnesses,
the dressing and management of wounds and nutritional supplements. The
Company is comprised of two business segments. See Note Thirteen to the
consolidated financial statements in this Annual Report for financial
information about these business divisions. The Company sells prescription
and nonprescription human and veterinary products through its Medical
Services Division. Through Caraloe, Inc., its consumer products subsidiary,
the Company sells consumer and bulk raw material products and also provides
product development and manufacturing services to customers in the cosmetic,
nutraceutical and medical markets. The Company's research and product
portfolios are based primarily on complex carbohydrates isolated from the
Aloe vera L. plant.
In 2001, the Company incorporated a wholly-owned subsidiary named DelSite
Biotechnologies, Inc. ("DelSite"). DelSite operates independently from the
Company's research and development program and is responsible for the
research, development and marketing of the Company's proprietary GelSite[TM]
technology for controlled release and delivery of bioactive pharmaceutical
ingredients.
Medical Services Division
-------------------------
Carrington's Medical Services Division offers a comprehensive line of wound
management products. Carrington products are used in a wide range of acute
and chronic wounds, for skin conditions and incontinence care. The primary
marketing emphasis for Carrington's wound and skin care products is directed
toward hospitals, nursing homes, alternate care facilities, cancer centers,
home health care providers and managed care organizations. The wound and
skin care product lines are being promoted primarily to physicians and
specialty nurses, for example, enterostomal therapists.
In response to changing market conditions and to improve the Company's
competitive position, the Company decided during 2000 to redirect the
distribution of its Medical Services products from multiple distributors to
a single, sole-source distributor. As a result of this decision, the
Company entered into an exclusive Distributor and License Agreement
effective December 1, 2000 with Medline Industries, Inc. ("Medline"). The
agreement provides that Carrington will continue to manufacture its existing
line of products and sell them to Medline at specified prices. The prices,
which were generally firm for the first two years of the contract term, are
thereafter subject to adjustment not more than once each year to reflect
increases in manufacturing cost. The agreement requires Medline to pay the
Company a base royalty totaling $12,500,000 in quarterly installments that
began on December 1, 2000. In addition to the base royalty, if Medline
elects to market any of the Other Products under any of the Company's
trademarks, Medline must pay the Company a royalty of between one percent
and five percent of Medline's aggregate annual net sales of the Products and
the Other Products, depending on the amount of the net sales, except that
the royalty on certain high volume commodity products will be two percent.
The Company maintains control of certain national pricing agreements which
cover hospitals, alternate care facilities, home health care agencies and
cancer centers. These agreements allow Medline representatives to make
presentations in member facilities throughout the country. In order to
promote continued brand-name recognition, the Company engages in limited
marketing and advertising to bolster Medline's efforts in these areas.
The Company has several distribution and licensing agreements for the
sale of its products into international markets. The Company also sells
wound care products into international markets on a non-contract, purchase
order basis. Opportunities in the growing Internet market are also
addressed through the Company's websites, www.carringtonlabs.com. and
www.woundcare.com.
The Company also produces Acemannan Immunostimulant[TM], a Biologic fully
licensed by the United States Department of Agriculture ("USDA") as an
adjuvant therapy for certain cancers in dogs and cats. This product, in
addition to several wound and skin care products developed specifically for
the veterinary market, are marketed and distributed through an exclusive
distribution arrangement with Farnam Companies, Inc., a leading veterinary
marketing company.
Carrington is actively involved in developing and promoting the SaliCept[TM]
line of products, which includes an oral rinse, patches for oral wounds and
extraction sites, and other products. The SaliCept line[TM] is supported by
a dedicated sales representative and the Company is actively seeking a
strategic sales/distribution partner for this line.
Caraloe, Inc.
-------------
Caraloe, Inc., a subsidiary of the Company, markets or licenses consumer
products and bulk raw materials utilizing the Company's patented complex
carbohydrate technology into the consumer health and nutritional products
markets. Caraloe's premier product is Manapol[R] powder, a bulk raw
material rich in complex carbohydrates. Manapol[R] powder is marketed
to manufacturers of nutritional products who desire quality complex
carbohydrate ingredients for their finished products. Caraloe also markets
finished products containing Manapol[R] powder into domestic health and
nutritional products markets through health food stores, through internet
marketing services at www.aloevera.com, and to the international marketplace
on a non-contract, purchase order basis. In the fourth quarter of 2000,
Caraloe introduced a new raw material, Hydrapol[TM], for use by cosmetic
manufacturers.
In 1997, Caraloe signed a non-exclusive supply agreement with Mannatech,
Inc. to supply Manapol[R] powder. This agreement was renewed through
December 2004 and contains monthly minimum purchase requirements. During
2001, 2002, and 2003 sales of Manapol[R] powder to this customer represented
30%, 35%, and 35% respectively, of the Company's total revenues. Due to the
nature of the product and the Company's relationship with this customer, the
Company expects this supply agreement will be renewed at the end of December
2004. However, the Company is continually seeking to expand its customer
base in this area.
Caraloe, Inc. also provides product development and manufacturing services
to customers in the cosmetic, nutraceutical and medical markets. In June
2001 a development group was formed to concentrate efforts on providing
these services. The scope of services provided by this group includes taking
projects from formulation design through manufacturing, manufacturing and
filling according to customer-provided formulations and specifications,
filling customer-provided packaging components and assembling custom kits
for customers.
In December 2002 the Company entered into an agreement to acquire certain
assets of the Custom Division of Creative Beauty Innovations, Inc. ("CBI"),
including specialized manufacturing customer information, intellectual
property, equipment and selected inventories. CBI is a privately held
manufacturer of skin and cosmetic products with operations in Carrollton,
Texas.
Under the agreement, the Company paid CBI $1.6 million, including $0.6
million for related inventory. In addition, for the five-year period ending
in December 2007, the Company agreed to pay CBI an amount equal to 9.0909%
of Carrington's net sales of CBI products to CBI's transferring customers up
to $6.6 million per year, and 8.5% of Carrington's net sales of CBI products
to CBI's transferring customers over $6.6 million per year. The acquired
assets include equipment and other physical property previously used by
CBI's Custom Division to compound and package cosmetic formulations of
liquids, creams, gels and lotions into bottles, tubes or cosmetic jars.
Carrington uses these assets in a substantially similar manner. The Company
provides services to these customers through Caraloe's development and
manufacturing services group.
To finance the acquisition, the Company entered into an agreement with
Medline for accelerated payment of $2.0 million of the royalties due under
the Distributor and License Agreement. The royalty acceleration agreement
provides for each of the remaining quarterly royalty payments due to be paid
to the Company by Medline to be reduced by equal amounts, the sum of which
offsets the royalty advance. In addition, the Company will pay Medline
interest on the advance at the rate of 6.5% per year on the outstanding
balance of the advance.
DelSite Biotechnologies, Inc.
-----------------------------
In 2001 the Company incorporated a wholly-owned subsidiary named DelSite
Biotechnologies, Inc. DelSite operates independently from the Company's
research and development program, which supports the activities associated
with the Company's Medical Services and Caraloe, Inc. divisions, and was
formed to commercialize innovations discovered by scientists at Carrington.
Delsite is responsible for the research, development and marketing of the
Company's proprietary drug delivery technology based on GelSite[TM] polymer,
a new and unique complex carbohydrate, which was isolated in 1998 from Aloe
vera L. DelSite commenced operations in January 2002 and is currently
developing new technologies for controlled delivery of bioactive proteins
and peptides as therapeutics and vaccines.
DelSite's business plan is to partner with biotechnology and pharmaceutical
companies to provide novel delivery solutions for their drugs and vaccines.
Together with its collaborators and contractors, DelSite has the following
capabilities:
* Formulation development
* Feasibility studies
* Preclinical development
* Clinical supply production
* Product scale-up
* Technology transfer
In January 2002 DelSite formed a strategic collaboration with Southern
Research Institute, Inc. of Birmingham, Alabama, ("Southern Research")to
assist in the development of an injectable drug delivery system based on the
GelSite[TM] polymer. Southern Research is an independent, not-for-profit
center for scientific research affiliated with the University of Alabama at
Birmingham. Under the three-year collaborative agreement, DelSite retains
all product rights plus intellectual property rights to its existing
technology as well as any discoveries made by DelSite or Southern Research,
either jointly or individually, as a result of any project undertaken as
part of the agreement. Southern Research will receive fees and royalties
when undertaking certain specified projects on behalf of DelSite. In
addition, a second five-year collaborative agreement with Southern Research
was signed in April 2003. Under this agreement the two companies will
jointly develop an injectable long-term delivery system for proteins
and peptides. The companies will jointly own intellectual property that
originates from this relationship.
Research and Development
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General
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Carrington has developed proprietary processes for obtaining materials from
Aloe vera L. The Company intends to seek approval of the Food and Drug
Administration (the "FDA") and other regulatory agencies to sell products
containing materials obtained from Aloe vera L. in the United States and in
foreign countries. For a more comprehensive listing of the type, indication
and status of products currently under development by the Company, see
"Research and Development -- Summary" below. The regulatory approval
process, both domestically and internationally, can be protracted and
expensive, and there is no assurance that the Company will obtain approval
to sell its produc ts for any treatment or use (see "Governmental Regulation"
below).
The Company expended approximately $2,442,000, $3,580,000 and $3,660,000 on
research and development in fiscal 2001, 2002 and 2003, respectively.
Research activities associated with DelSite accounted for 51% of the 2002
and 75% of the 2003 research and development expenditures.
DelSite Research and Development
--------------------------------
The Company believes that DelSite's products' functionality and/or
pharmacological activity make them potential candidates for further
development as pharmaceutical or therapeutic agents. In 2004, DelSite
intends to focus its activities in drug delivery through developing proof of
concept data for potential pharmaceutical and vaccine partners. There is no
assurance, however, that DelSite will be successful in its efforts.
The Company sponsors a research and development laboratory at Texas A&M
University in association with the College of Veterinary Medicine to support
research activities of the Company and its DelSite subsidiary. Pursuant to
this arrangement, the Company has access to leading authorities in the life
sciences, as well as facilities and equipment to help further the Company's
research programs. DelSite also has a research relationship with the
University of Southern Mississippi and sponsors research in the University's
School of Polymer Science.
DelSite is developing a new platform technology based on its proprietary
GelSite[TM] polymer for controlled delivery of bioactive proteins and
peptides as therapeutics and vaccines. Basic proof of concept research is
continuing on this material, which includes both injectable delivery of
therapeutic proteins and peptides and delivery of protein antigens as
vaccines using its proprietary GelVac[TM] intranasal powder vaccine delivery
system. Selected studies have been completed through sponsored research at
Texas A&M and Southern Research Institute. Pilot scale production has been
accomplished and studies to refine the process are ongoing. The technology
has varied utility, but the primary focus of research is in the area of
injectable and intranasal drug delivery. Three patents covering this
invention have been issued to DelSite with two patents pending. The
composition and process patent was issued in 1999.
Specialized Research and Development
------------------------------------
The Company also has a separate, specialized research team to support
research and in-house development for Carrington products as well as to
provide services to customers in the medical, nutraceutical and cosmetic
markets. These services typically include research and development of
a formulation from the customer's initial concept and specifications.
Development efforts also include packaging design, label design and, where
required by regulations, production validation.
During 2003, the Specialized Research and Development group contributed
to the successful transfer and start-up of the technologies and
products acquired from CBI. These activities included proof of formulation
capabilities and technology transfer services to assist in production of
initial quantities of products in the manufacturing facility. Research and
Development provides the necessary technology support to successfully meet
requirements for new customers of new cosmetic and nutraceutical products.
In 2003, several wound care projects were also initiated in the general area
of wound infection control, which Carrington's marketing partners have
identified as a potentially significant addition to its wound care product
line.
Human Clinical Studies
----------------------
The Company's new product programs for its operating divisions do not
require clinical trials for clearance or approval prior to commercial
distribution. However, the Company intends to support its existing products
and new products with clinical studies that will support the product claims
and indications for use and thereby demonstrate the product's features and
benefits. The Company intends to initiate several such clinical studies
during 2004.
Research and Development Summary
--------------------------------
The following table outlines the status of the products and potential
indications of the Company's products developed, planned or under
development. There is no assurance of successful development, completion or
regulatory approval of any product not yet on the market.
PRODUCTS AND POTENTIAL INDICATIONS DEVELOPED,
PLANNED OR UNDER DEVELOPMENT
PRODUCT OR POTENTIAL
POTENTIAL INDICATION MARKET APPLICATIONS STATUS
-------------------- ------------------- ------
Topical
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Dressings Pressure and Vascular Ulcers Marketed
Dressings Diabetic Ulcers, Surgical Wounds Marketed
Cleansers Wounds Marketed
Anti-fungal Cutaneous Fungal Infection Marketed
Hydrocolloids Wounds Marketed
Alginates Wounds Marketed
Anti-infective Wounds Development
Sunscreens Skin Development
Oral
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Human
Pain Reduction Mucositis Marketed
Dental
Pain Reduction Aphthous Ulcers, Oral Wounds Marketed
Post Extraction Wounds Oral Surgery Marketed
Injectable
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Human
Neutropenia Neutropenia associated with Discovery
cancer
GelSite[TM] polymer (CR1013) Drug delivery Preclinical
Intranasal
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GelSite[TM] polymer (CR1013) Vaccine delivery Preclinical
Veterinary
Adjunct for cancer Fibrosarcoma Marketed
Nutraceuticals
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Immune Enhancing Product Manapol[R]/Maitake Gold 4047 Marketed
Immune Enhancing Product Manapol[R]/Calcium Enriched Clinical
Evaluation
Licensing Strategy
------------------
The Company expects that prescription pharmaceutical products containing
certain defined drug substances will require a substantial degree of
developmental effort and expense. Before governmental approval to market
any such product is obtained, the Company may license these products for
certain indications to other pharmaceutical companies in the United States
or foreign countries and require such licensees to undertake the steps
necessary to obtain marketing approval in a particular country or for
specific indications.
Similarly, the Company intends to license third parties to market products
containing defined chemical entities for certain human indications when it
lacks the expertise or financial resources to market such products
effectively. If the Company is unable to enter into such agreements, it may
undertake marketing the products itself for such indications. The Company's
ability to market these products for specific indications will depend
largely on its financial condition at the time and the results of related
clinical trials. There is no assurance that the Company will be able to
enter into any license agreements with third parties or that, if such
license agreements are concluded, they will contribute to the Company's
overall profits.
Raw Materials and Processing
----------------------------
The principal raw material used by the Company in its operations is the leaf
of the plant known as Aloe vera L. Through patented processes, the Company
obtains several bulk freeze-dried extracts from the central portion of
the Aloe vera L. leaf known as the gel. A basic bulk mannan, Acemannan
Hydrogel[TM], is used as an ingredient in certain of the Company's
proprietary wound and skin care products.
The Company owns a 405-acre farm in the Guanacaste province of northwest
Costa Rica which currently has approximately 82 acres planted with Aloe vera
L. The Company is currently performing a land reclamation project on the
farm to increase productive acreage. Currently, the Company's need for
leaves exceeds the supply of harvestable leaves from the Company's farm,
requiring the purchase of leaves from other sources in Costa Rica at prices
comparable to the cost of acquiring leaves from the Company's farm. The
Company has entered into several supply agreements with local suppliers near
the Company's factory to provide leaves. From time to time the Company also
imports leaves from other Latin American countries at prices comparable to
those in the local market. The Company anticipates that the suppliers it
currently uses will be able to meet all of its requirements for leaves in
2004.
The Company has a 23% ownership interest in Aloe and Herbs International,
Inc., ("Aloe & Herbs", a Panamanian corporation formed for the purpose of
establishing an Aloe vera L. farm in Costa Rica. The Company purchases
leaves from Rancho Aloe, S.A., ("Rancho Aloe") a wholly-owned subsidiary of
Aloe & Herbs, which has a 5,000-acre farm in close proximity to the
Company's farm, at a market price per kilogram of leaves supplied, with the
final price payable to Rancho Aloe based upon the yield of the final
product.
As of December 31, 2003, Rancho Aloe was providing an average of 78% of the
Company's monthly requirement of leaves. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources" for further information regarding the Company's
relationship with Aloe & Herbs.
Manufacturing
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Since 1995, the Company's manufacturing facility has been located in the
Company's headquarters in Irving, Texas. The Company believes that this
manufacturing facility has sufficient capacity to provide for the present
line of products and to accommodate new products and sales growth. Final
packaging of certain of the Company's wound care products is completed by
outside vendors. The Company's calcium alginates, films, hydrocolloids,
foam dressings, gel sheets, tablets, capsules, and freeze-dried products are
being provided by third parties.
All of the Company's proprietary bulk pharmaceutical products and freeze-
dried Aloe vera L. extracts are produced in its processing plant in Costa
Rica. This facility has the ability to supply the bulk aloe raw materials
requirements of the Company's current product lines and bulk material
contracts for the foreseeable future. Certain liquid nutraceutical products
which the Company provides to customers on a custom manufacturing basis are
also produced at the Costa Rica facility. In addition, production of the
Salicept[TM] Patch has been transferred to the plant in Costa Rica to better
meet anticipated market demands for the product for post-extraction wounds
and aphthous ulcers.
Competition
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Research and Development. The biopharmaceutical field is expected to
continue to undergo rapid and significant technological change. Potential
competitors in the United States are numerous and include pharmaceutical,
chemical and biotechnology companies. Many of these companies have
substantially greater capital resources, research and development staffs,
facilities and expertise (in areas including research and development,
manufacturing, testing, obtaining regulatory approvals and marketing) than
the Company. This competition can be expected to become more intense as
commercial applications for biotechnology and pharmaceutical products
increase. Some of these companies may be better able than the Company to
develop, refine, manufacture and market products which have application to
the same indications as the Company is exploring. The Company understands
that certain of these competitors are in the process of conducting human
clinical trials of, or have filed applications with government agencies for
approval to market certain products that will compete with the Company's
products, both in its present wound care market and in markets associated
with products the Company currently has under development.
Medical Services Division and Caraloe, Inc. The Company competes against
many companies that sell products which are competitive with the Company's
products, with many of its competitors using very aggressive marketing
efforts. Many of the Company's competitors are substantially larger than
the Company in terms of sales and distribution networks and have
substantially greater financial and other resources. The Company's ability
to compete against these companies will depend in part on the expansion of
the marketing network for its products. The Company believes that the
principal competitive factors in the marketing of its products are their
quality, and that they are naturally based and competitively priced.
Governmental Regulation
-----------------------
The production and marketing of the Company's products, and the Company's
research and development activities, are subject to regulation for safety,
efficacy and quality by numerous governmental authorities in the United
States and other countries. In the United States, drug devices for human
use are subject to rigorous FDA regulation. The Federal Food, Drug and
Cosmetic Act, as amended (the "FFDC Act"), the regulations promulgated
thereunder, and other federal and state statutes and regulations govern,
among other things, the testing, manufacture, safety, effectiveness,
labeling, storage, record keeping, approval, advertising and promotion of
the Company's products. For marketing outside the United States, the
Company is subject to foreign regulatory requirements governing human
clinical trials and marketing approval for drugs and devices. The
requirements governing the conduct of clinical trials, product licensing,
pricing and reimbursement may vary widely from country to country.
Food and Drug Administration. The contents, labeling and advertising of
many of the Company's products are regulated by the FDA. The Company is
required to obtain FDA approval before it can study or market any proposed
prescription drugs and may be required to obtain such approval for proposed
nonprescription products. This procedure involves extensive clinical
research, and separate FDA approvals are required at various stages of
product development. The approval process requires, among other things,
presentation of substantial evidence to the FDA, based on clinical studies,
as to the safety and efficacy of the proposed product.
After approval, manufacturers must continue to expend time, money and effort
in production and quality control to assure continual compliance with the
current Good Manufacturing Practices regulations. Also, under the new
program for harmonization between Europe and the U.S., the Company is
required to meet the requirements of the International Committee on
Harmonization and the ISO 13485 regulations, for OTC drugs and medical
devices, respectively. A company can, under certain circumstances after
application, have a new drug approved under a process known as
centralization rather than having to go through a country-by-country
approval in the European Union.
Certain of the Company's wound and skin care products are registered with
the FDA as medical devices pursuant to the regulations under Section 510(k)
of the FFDC Act (known as Premarket Notification). A medical device is a
product whose primary intended medical purpose, such as to cover a wound, is
accomplished without a chemical or pharmacological action. A medical device
which is substantially equivalent to a predicate product will be reviewed by
the FDA and if clearance to market is granted, then the device can be sold
in the United States without additional developmental studies. A medical
device which is not substantially equivalent is subject to an FDA approval
process similar to that required for a new drug, beginning with an
Investigational Device Exemption and culminating in a Premarket Approval.
The Company has sought and obtained all its device approvals under Section
510(k). The Company currently markets seven (7) products which require a
prescription as medical devices.
Other Regulatory Authorities. The Company's advertising and sales practices
are subject to regulation by the Federal Trade Commission (the "FTC"), the
FDA and state agencies. The Company's processing and manufacturing plants
are subject to federal, state and foreign laws and to regulation by the
Bureau of Alcohol, Tobacco and Firearms of the Department of the Treasury
and by the Environmental Protection Agency (the "EPA"), as well as the FDA
and USDA.
The Company believes that it is in substantial compliance with all
applicable laws and regulations relating to its operations, but there is no
assurance that such laws and regulations will not be changed. Any such
change may have a material adverse effect on the Company's operations.
The manufacturing, processing, formulating, packaging, labeling and
advertising of products of the Company's subsidiary, Caraloe, are also
subject to regulation by one or more federal agencies, including the FDA,
the FTC, the USDA and the EPA. These activities are also regulated by
various agencies of the states, localities and foreign countries to which
Caraloe's products are distributed and in which Caraloe's products are sold.
The FDA, in particular, regulates the formulation, manufacture and labeling
of vitamin and other nutritional supplements.
The Dietary Supplement Health and Education Act of 1994 ("DSHEA") revised
the provisions of the FFDC Act concerning the composition and labeling of
dietary supplements and, in the judgment of the Company, is favorable to the
dietary supplement industry. The legislation created a new statutory class,
entitled dietary supplement, which includes vitamins, minerals, herbs, amino
acids and other dietary substances for human use to supplement the diet.
DSHEA grandfathered, with certain limitations, dietary ingredients on the
market before October 15, 1994. A dietary supplement which contains a new
dietary ingredient, one not on the market before October 15, 1994, requires
evidence of a history of use or other evidence of safety establishing that
it will reasonably be expected to be safe. The majority of the products
marketed by Caraloe are classified as dietary supplements under DSHEA.
Both foods and dietary supplements are subject to the Nutrition Labeling and
Education Act of 1990 (the "NLEA"), which prohibits the use of any health
claim for foods, including dietary supplements, unless the health claim is
supported by significant scientific agreement and is either pre-approved by
the FDA or the subject of substantial government scientific publications and
a notification to the FDA. To date, the FDA has approved the use of only
limited health claims for dietary supplements. However, among other things,
DSHEA amended, for dietary supplements, the NLEA by providing that
statements of nutritional support may be used in labeling for dietary
supplements without FDA pre-approval if certain requirements, including
prominent disclosure on the label of the lack of FDA review of the relevant
statement, possession by the marketer of substantiating evidence for the
statement and post-use notification to the FDA, are met. Such statements
may describe how particular nutritional supplements affect the structure,
function or general well-being of the body (e.g., "promotes cardiovascular
health").
Advertising and label claims for dietary supplements and conventional foods
have been regulated by state and federal authorities under a number of
disparate regulatory schemes. There can be no assurance that a state will
not interpret claims presumptively valid under federal law as illegal under
that state's regulations, or that future FDA regulations or FTC decisions
will not restrict the permissible scope of such claims.
Governmental regulations in foreign countries where Caraloe plans to
commence or expand sales may prevent or delay entry into the market, or
prevent or delay the introduction of, or require the reformulation of,
certain of Caraloe's products. Compliance with such foreign governmental
regulations is generally the responsibility of Caraloe's distributors for
those countries. These distributors are independent contractors over which
Caraloe has limited control.
As a result of Caraloe's efforts to comply with applicable statutes and
regulations, Caraloe has from time to time reformulated, eliminated or
relabeled certain of its products and revised certain provisions of its
sales and marketing program. Caraloe cannot predict the nature of any
future laws, regulations, interpretations or applications, nor can it
determine what effect additional governmental regulations or administrative
orders, when and if promulgated, would have on its business in the future.
They could, however, require the reformulation of certain products to meet
new standards, the recall or discontinuance of certain products not capable
of reformulation, additional record keeping, expanded documentation of the
properties of certain products, expanded or different labeling, and/or
scientific substantiation. Any or all of such requirements could have a
material adverse effect on the Company's results of operations and financial
condition.
Compliance with the provisions of national, state and local environmental
laws and regulations has not had a material adverse effect upon the capital
expenditures, earnings, financial position, liquidity or competitive
position of the Company.
Patents and Proprietary Rights
------------------------------
As is industry practice, the Company has a policy of using patents,
trademarks and trade secrets to protect the results of its research and
development activities and, to the extent it may be necessary or advisable,
to exclude others from appropriating the Company's proprietary technology.
The Company's policy is to protect aggressively its proprietary technology
by seeking and enforcing patents in a worldwide program.
The Company has obtained patents or filed patent applications in the United
States and approximately 26 other countries in three series regarding the
compositions of acetylated mannan derivatives, the processes by which they
are produced and the methods of their use. The first series of patent
applications, relating to the compositions of acetylated mannan derivatives
and certain basic processes of their production, was filed in a chain of
United States patent applications and its counterparts in the other 26
countries. The first United States patent application in this first series,
covering the composition claims of acetylated mannan derivatives, matured
into United States Patent No. 4,735,935 (the "935 Patent"), which was issued
on April 5, 1988. United States Patent No. 4,917,890 (the "890 Patent") was
issued on April 17, 1990 from a divisional application to the 935 Patent.
This divisional application pertains to most of the remaining claims in the
original application not covered by the 935 Patent. The 890 Patent
generally relates to the basic processes of producing acetylated mannan
derivatives, to certain specific examples of such processes and to certain
formulations of acetylated mannan derivatives. Two other divisional
applications covering the remaining claims not covered by the 890 Patent
matured into patents, the first on September 25, 1990, as United States
Patent No. 4,959,214, and the second on October 30, 1990, as United States
Patent No. 4,966,892. Foreign patents that are counterparts to the
foregoing United States patents have been granted in some of the member
states of the European Economic Community and several other countries.
The second series of patent applications related to preferred processes for
the production of acetylated mannan derivatives. One of them matured into
United States Patent No. 4,851,224, which was issued on July 25, 1989. This
patent is the subject of a Patent Cooperation Treaty application and
national foreign applications in several countries. An additional United
States patent based on the second series was issued on September 18, 1990,
as United States Patent No. 4,957,907.
The third series of patent applications, relating to the uses of acetylated
mannan derivatives, was filed subsequent to the second series. Three of
them matured into United States Patent Nos. 5,106,616, issued on April 21,
1992; 5,118,673, issued on June 2, 1992, and 5,308,838, issued on May 3,
1994. The Company has filed a number of divisional applications to these
patents, each dealing with specific uses of acetylated mannan derivatives.
Patent Cooperation Treaty applications based on the parent United States
applications have been filed designating a number of foreign countries where
the applications are pending. In addition, the Company has also obtained a
patent in the United States relating to a wound cleanser, U.S. Patent
No. 5,284,833, issued on February 8, 1994.
The Company has obtained a patent in the United States relating to a
therapeutic device made from freeze-dried complex carbohydrate hydrogel
(U.S. Patent No. 5,409,703, issued on April 25, 1995). A Patent Cooperation
Treaty application based on the parent United States application has been
filed designating a number of foreign countries where the applications are
pending.
The Company has obtained patents in the United States (U.S. Patent No.
5,760,102, issued on June 2, 1998) and Taiwan (Taiwan Patent No. 89390,
issued on August 21, 1997) related to the uses of a denture adhesive and
also a patent in the United States relating to methods for the prevention
and treatment of infections in animals (U.S. Patent No. 5,703,060, issued on
December 30, 1997).
The Company obtained a patent in the United States (U.S. Patent
No.5,902,796, issued on May 11, 1999) related to the process for obtaining
bioactive material from Aloe vera L. The Company obtained an additional
patent in the United States (U.S. Patent No. 5,929,051, issued on July 27,
1999) related to the composition and process for a new complex carbohydrate
(pectin) isolated from Aloe vera L. Also obtained was a United States
patent (U.S. Patent No. 5,925,357, issued on July 20, 1999) related to the
process for a new Aloe vera L. product that maintains the complex
carbohydrates with the addition of other substances normally provided by
"Whole Leaf Aloe."
Additionally, the Company obtained a Japanese letters-patent (Patent No.
2888249, having a Patent Registration Date of February 19, 1999) for the use
of acemannan (a) in a vaccine product; (b) in enhancing natural kill cell
activity and in enhancing specific tumor cell lysis by white cells and/or
antibodies; (c) in correcting malabsorption and mucosal cell maturation
syndromes in man or animals; and (d) in reducing symptoms associated with
multiple sclerosis.
The Company also received the grant of European Patent Application under No.
0611304, having the date of publication and mention of the grant of the
patent of September 15, 1999. This European Letters Patent claims the use
of acetylated mannan for the regulation of blood cholesterol levels and for
the removal of plaque in blood vessels. A patent was also issued in South
Korea. Applications are pending in Canada and Japan.
In addition, the Company obtained an Australian Patent (Patent No. 718631,
having an Accepted Journal Date of April 20, 2000) on Uses of Denture
Adhesive Containing Aloe Extract. On June 20, 2000, Singapore granted the
Company a patent on Bioactive Factors of Aloe Vera Plants (P-No. 51748).
The Company received the grant of two U.S. patents (Patent No. 6,274,548
issued August 14, 2001, and Patent No. 6,313,103 issued November 6, 2001)
associated with the use of pectins for purification, stabilization and
delivery of certain growth factors. Other U.S. PCT applications on Aloe
Pectin are pending. A U.S. patent application on growth factor and protease
enzyme is also pending.
The Company obtained on September 25, 2002, a European Patent (Patent No.
0884994) which was validated in Great Britain, Germany (No. 69715827.6),
France, Italy and Portugal associated with the uses of denture adhesive
containing Aloe Vera L. extract.
In addition, the Company was issued on October 13, 2002, a Canadian Patent
(No. 2,122,604) associated with the process for preparation of Aloe
Products.
The Company also obtained on June 24, 2002, a Korean Patent (No. 343293) and
on June 5, 2002, European Patent (No. 0705113) which was validated in Great
Britain, France, Germany (No. 69430746.7-08), Italy and Austria associated
with dried Hydrogel from Hydrophilic Hygroscopic Polymer.
Further, on September 25, 2002, the Company obtained a European Patent (No.
884994) which was validated in France, Great Britain, Italy, Portugal and
Germany (No. 69715827.6) associated with Denture Adhesive.
The Company also obtained, on May 28, 2003, a European Patent (No. 966294),
which was validated in Great Britain, France, Italy, Sweden, and Germany
(No. 69815071.6) associated with the Bifurcated Method to Process Aloe Whole
Leaf.
Also, the Company was issued, on July 23, 2003 a European Patent (No.
965346), which was validated in France, Great Britain, Italy, and Germany
(No. 09133298.3), associated with Uses of Acetylated Mannan Derivatives in
Treating Chronic Respiratory Disease.
The Company has filed and intends to file patent applications with respect
to subsequent developments and improvements when it believes such protection
is in the best interest of the Company. The scope of protection which
ultimately may be afforded by the patents and patent applications of the
Company is difficult to quantify. There can be no assurance that (i) any
additional patents will be issued to the Company in any or all appropriate
jurisdictions, (ii) litigation will not be commenced seeking to challenge
the Company's patent protection or such challenges will not be successful,
(iii) processes or products of the Company do not or will not infringe upon
the patents of third parties or (iv) the scope of patents issued to the
Company will successfully prevent third parties from developing similar
and competitive products. It is not possible to predict how any patent
litigation will affect the Company's efforts to develop, manufacture or
market its products.
The Company also relies upon, and intends to continue to rely upon, trade
secrets, unpatented proprietary know-how and continuing technological
innovation to develop and maintain its competitive position. The Company
typically enters into confidentiality agreements with its scientific
consultants, and the Company's key employees have entered into agreements
with the Company requiring that they forbear from disclosing confidential
information of the Company and assign to the Company all rights in any
inventions made while in the Company's employ relating to the Company's
activities.
The technology applicable to the Company's products is developing rapidly.
A substantial number of patents have been issued to other biopharmaceutical
companies. In addition, competitors have filed applications for, or have
been issued, patents and may obtain additional patents and proprietary
rights relating to products or processes competitive with those of the
Company. To the Company's knowledge, acetylated mannan derivatives do not
infringe any valid, enforceable United States patents. A number of patents
have been issued to others with respect to various extracts of the Aloe vera
L. plant and their uses and formulations, particularly in respect to skin
care and cosmetic uses. While the Company is not aware of any existing
patents which conflict with its current and planned business activities,
there can be no assurance that holders of such other Aloe vera L.-based
patents will not claim that particular formulations and uses of acetylated
mannan derivatives in combination with other ingredients or compounds
infringe, in some respect, on these other patents. In addition, others may
have filed patent applications and may have been issued patents relating to
products and technologies potentially useful to the Company or necessary to
commercialize its products or achieve their business goals. There is no
assurance that the Company will be able to obtain licenses of such patents
on acceptable terms.
The Company has given the trade name Carrasyn[R] to certain of its products
containing acetylated mannans. The Company has filed a selected series of
domestic and foreign trademark applications for the marks Manapol[R] powder,
Carrisyn[R], Carrasyn[R] and CarraGauze[R]. Further, the Company has
registered the trademark AVMP[TM] Powder and the trade name Carrington[R] in
the United States. In 1999, the Company obtained four additional registered
trademarks in Brazil.
In June 2000 the Company obtained registration in the United States of its
mark AloeCeuticals[R] for its skin care and nutritional supplement products.
In September 2002 the Company obtained registration in the United States of
its mark CaraKlenz[R] for its proprietary wound cleanser product with that
name.
In addition, applications for the registration of the marks ISG[TM],
GelVac[TM], GelSite[TM], OraPatch[TM], and SaliCept[TM] are pending in the
United States. Applications for the registration of the mark GelVac[TM] are
also pending in Japan, South Korea, and Europe.
In November 2003, the Company obtained registration in the United States of
its mark "Delsite and design[TM]" for its Research and Development of Dry
Stabilization and Delivery Systems for Customers in the field of
Pharmaceuticals and Diagnostic Reagents.
Employees
---------
As of February 27, 2004, the Company employed 262 persons, of whom 44 were
engaged in the operation and maintenance of its Irving, Texas processing
plant, 139 were employed at the Company's facility in Costa Rica and the
remainder were executive, research, quality assurance, manufacturing,
administrative, sales, and clerical personnel. Of the total number of
employees, 121 were located in Texas, 139 in Costa Rica, one in Puerto Rico
and one in Europe. The Company considers relations with its employees to be
good. The employees are not represented by a labor union.
ITEM 2. PROPERTIES.
----------
The Company believes that all its farming property, manufacturing and
laboratory facilities, as described below, and material farm, manufacturing
and laboratory equipment are in satisfactory condition and are adequate for
the purposes for which they are used, except that the farm is not adequate
to supply all of the Company's needs for Aloe vera L. leaves. (See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" for more information regarding the Company's arrangements to
purchase Aloe vera L. leaves.)
Walnut Hill Facility. The Company's corporate headquarters and principal
U.S. manufacturing facility occupy all of the 35,000 square foot office and
manufacturing building (the "Walnut Hill Facility"), which is situated on an
approximately 6.6 acre tract of land located in the Las Colinas area
of Irving, Texas. The Company owns the land and the building. The
manufacturing operations occupy approximately 19,000 square feet of the
facility, and administrative offices occupy approximately 16,000 square
feet.
Laboratory and Warehouse Facility. The Company has leased a 51,200 square
foot building in close proximity to the Walnut Hill facility for a ten-year
term to house its Research and Development, Quality Assurance and Quality
Control Departments. Laboratories and offices for DelSite are also located
in this facility. In addition, the Company utilizes a portion of the
building as warehouse space. The Company relocated those functions to this
facility in the third quarter of 2001.
Warehouse and Distribution Facility. In February 2003, the Company leased a
58,130 square foot building for a term of five years for additional
warehouse space. In addition, the Company relocated its distribution
operations to this new facility.
Costa Rica Facility. The Company owns approximately 405 acres of land in
the Guanacaste province of northwest Costa Rica. This land is being used
for the farming of Aloe vera L. plants and for a processing plant to produce
bulk pharmaceutical and injectable mannans and freeze-dried extracts from
Aloe vera L. used in the Company's operations. The processing plant became
operational in 1993.
ITEM 3. LEGAL PROCEEDINGS.
-----------------
On April 3, 2001, Arthur Singer, a former employee of the Company (the
"Plaintiff"), filed a lawsuit entitled Arthur Singer vs. Carrington
Laboratories, Inc. and Carlton Turner, CV-01-2084 in the United States
District Court for the Eastern District of New York, Long Island Division,
alleging multiple causes of action against the company and its chief
executive officer (the "Defendants") and seeking damages in excess of $4.0
million, plus legal fees and expenses. The Plaintiff, who was formerly
employed by the Company as a sales representative, alleged in substance that
the Company failed to pay the full amount of commissions owed to him; that
the Defendants breached an alleged contract of employment with him; that the
Company deprived him of the opportunity to exercise some vested stock
options, prevented some of his unvested stock options from vesting and
caused all of his options to expire earlier than they otherwise would have;
and that the Defendants misrepresented that the Company intended to retain
him as an employee, fraudulently induced him to remain in its employ and
breached alleged covenants of fair dealing.
On May 31, 2001, the Defendants filed a motion seeking to have the complaint
dismissed or to have the case transferred to Texas. On August 28, 2001, the
Defendants' motion to transfer was granted, and the case was transferred to
the United States District Court for the Northern District of Texas, Dallas
Division, as Case No. 01-CV-1776.
The Defendants and Plaintiff then both filed motions for summary judgment.
On October 3, 2003, the court denied the Plaintiffs motion for summary
judgment and granted Defendants motion for summary judgment for all
complaints except three, the alleged damages for which total approximately
$56,000.
On January 5, 2004, a jury trial was held to settle the remaining claims,
with the jury finding for the Plaintiff on one claim, awarding $28,162, plus
interest, for unpaid commissions, and finding for the Defendants on a second
claim. The judge dismissed the third claim at the end of testimony, citing
lack of sufficient evidence to support the Plaintiff's claim. The court
awarded no legal fees or expenses to the Plaintiff. Total judgment was for
approximately $35,000, which has been accrued as of the period ended
December 31, 2003. The Company has received notice of Plaintiff's intention
to appeal the courts ruling on legal fees.
On June 22, 2001, a lawsuit styled Swiss-American Products, Inc. v. G. Scott
Vogel and Carrington Laboratories Inc., Cause No. 01-5163-A, was filed in
the 193rd Judicial District Court of Dallas County, Texas. On June 25,
2001, the Company was served with this lawsuit, an Ex Parte Temporary
Restraining Order, and an Order Appointing Independent Third Party Expert
Pursuant to Temporary Restraining Order. The suit alleges, among other
things, that Mr. Vogel (the Company's former Vice President, Operations)
improperly obtained proprietary information of Swiss-American Products, Inc.
("Plaintiff") from a former employer that manufactured products under
contract for Plaintiff, and used that information on behalf of the Company,
in breach of certain common law duties and a confidentiality agreement
between his former employer and Plaintiff. The suit further alleges that
Mr. Vogel and the Company ("Defendants") conspired to unlawfully disclose,
convert and misappropriate Plaintiff's trade secrets.
The suit seeks permanent injunctive relief, including a permanent injunction
prohibiting Defendants from disclosing or using to Plaintiff's disadvantage
any confidential proprietary information belonging to Plaintiff which Mr.
Vogel allegedly obtained from his former employer, or from developing or
marketing products based on Plaintiff's formulas or other information
allegedly taken from Mr. Vogel's former employer. The suit also seeks to
recover damages in an unspecified amount from Defendants.
Following a hearing on July 30, 2001, the trial court entered an order
setting the case for trial on July 30, 2002 and granted a temporary
injunction that prohibits Defendants from (i) disclosing or using any of
Plaintiff's confidential, proprietary or trade secret information; (ii)
developing or marketing a wound cleanser product that is the same or
substantially the same as reflected in a formula that is at issue in the
lawsuit (although this prohibition expressly does not apply to products
actively manufactured and sold by the Company before January 1, 2001 using
the exact same formula then in effect); and (iii) destroying, concealing,
altering, removing or disposing of any documents, files, computer data or
other things relating to Plaintiff or Mr. Vogel's former employer, or
containing or referring to trade secrets or confidential or proprietary
information of Plaintiff or Mr. Vogel's former employer.
A trial was held on October 7, 2003. Three days into the proceeding a
mistrial was declared due to juror misconduct. The trial judge ordered the
two parties to mediate the suit and in the event mediation efforts are not
successful, the court has set a new trial date of June 1, 2004.
The Company believes that Plaintiff's claims are without merit and intends
to vigorously defend against those claims.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
---------------------------------------------------
The Company did not submit any matter to a vote of security holders during
the fourth quarter of the fiscal year covered by this Annual Report.
PART II
-------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
---------------------------------------------------------------------
The Common Stock of the Company is traded on the NASDAQ National Market
under the symbol "CARN." The following table sets forth the high and low
sales prices per share of the Common Stock for each of the periods
indicated.
Fiscal 2002 High Low
----------- ---- ----
First Quarter $3.25 $1.07
Second Quarter 1.98 1.20
Third Quarter 1.33 0.95
Fourth Quarter 1.11 0.71
Fiscal 2003 High Low
----------- ---- ----
First Quarter $1.08 $0.91
Second Quarter 2.80 0.95
Third Quarter 6.20 2.18
Fourth Quarter 4.68 3.35
At March 11, 2004, there were 908 holders of record (including brokerage
firms) of Common Stock.
The Company has not paid any cash dividends on the Common Stock and
presently intends to retain all earnings for use in its operations. Any
decision by the Board of Directors of the Company to pay cash dividends in
the future will depend upon, among other factors, the Company's earnings,
financial condition and capital requirements.
In March 2001, the Board of Directors authorized the repurchase of up to
1,000,000 shares, or approximately 9.9%, of the Company's outstanding Common
Stock, dependent on market conditions. Under the authorization, purchases
of Common Stock may be made on the open market or through privately
negotiated transactions at such times and prices as are determined jointly
by the Chairman of the Board and the President of the Company. The Board
authorized the repurchase program based on its belief that the Company's
stock is undervalued in light of the Company's future prospects and that it
would be in the best interest of the Company and its shareholders to
repurchase some of its outstanding shares. As of March 11, 2004, the Company
had repurchased 2,400 of its outstanding Common Stock under the program.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA.
------------------------------------
The selected consolidated financial data below should be read in conjunction
with the consolidated financial statements of the Company and notes thereto
and "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations." The selected consolidated financial information for
the five years ended December 31, 2003, is derived from the consolidated
financial statements of the Company, of which the Statements for the years
ended December 31, 1999 through 2002, have been audited by Ernst & Young
LLP, independent public accountants and for the year ended December 31, 2003
have been audited by Grant Thornton LLP, independent public accountants.
Years ended December 31,
(Dollars and numbers of shares in -----------------------------------------
thousands except per share amounts) 1999 2000 2001 2002 2003
------------------------------------------------------------------------------
OPERATIONS STATEMENT INFORMATION:
Revenues:
Net product sales $28,128 $22,833 $15,115 $15,571 $26,636
Royalty income - 270 2,479 2,470 2,467
------ ------ ------ ------ ------
Total revenues 28,128 23,103 17,594 18,041 29,103
Cost of sales 13,640 12,782 9,803 11,739 18,806
------ ------ ------ ------ ------
Gross margin 14,488 10,321 7,791 6,302 10,297
Expenses:
Selling, general and
administrative 10,346 10,162 5,016 6,040 8,017
Research and development 2,434 2,979 2,442 1,701 899
Research and development, DelSite - - - 1,879 2,761
Research and development,
Aliminase[TM] clinical trial
expenses 2,866 623 - - -
Charges related to Oregon
Freeze Dry, Inc. 1,042 223 - - -
Interest expense (income), net (105) (80) (32) 19 249
Other expense (income), net (62) (110) (13) 41 (123)
------ ------ ------ ------ ------
Income (loss) before income taxes (2,033) (3,476) 378 (3,378) (1,506)
Provision for income taxes - - - - -
------ ------ ------ ------ ------
Net income (loss) $(2,033) $(3,476) $ 378 $(3,378) $(1,506)
====== ====== ====== ====== ======
Net income (loss) per common share
- basic and diluted(1) $ (0.22) $ (0.36) $ 0.04 $ (0.34) $ (0.15)
====== ====== ====== ====== ======
Weighted average shares used in
per share computations 9,376 9,545 9,743 9,889 10,120
BALANCE SHEET INFORMATION (as of December 31):
Working capital $ 7,911 $ 6,275 $ 6,315 $ 3,989 $ 3,019
Total assets 23,493 20,702 21,217 22,159 22,784
Total shareholders' equity 19,504 16,440 16,929 13,689 12,619
(1) For a description of the calculation of basic and diluted net income
(loss) per share, see Note Twelve to the consolidated financial
statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS.
---------------------
Company Overview
----------------
The Company is a research-based biopharmaceutical, medical device, raw
materials and nutraceutical company engaged in the development,
manufacturing and marketing of naturally-derived complex carbohydrates and
other natural product therapeutics for the treatment of major illnesses, the
dressing and management of wounds and nutritional supplements. The Company
is comprised of two business segments. The Company generates revenues
through the sales of prescription and non-prescription human and veterinary
medical products through its Medical Services Division. It also generates
revenues through the sales of consumer and bulk raw material nutritional
products and sales of specialized product development and manufacturing
services to customers in the cosmetic, nutraceutical and medical markets
through its Caraloe, Inc. subsidiary. Additional revenues to the Company
arise through licensing arrangements for distribution of products and, from
time to time, through research grants.
Products sold through the Medical Services Division include hydrogels, wound
cleansers, hydrocolloids, advanced wound covering products, incontinence-
care products and two lines of condition-specific products. Many products
sold through this division contain the Company's proprietary, medical-grade
raw material, Acemannan Hydrogel[TM]. The Company regularly engages in
development projects to create line extensions and other new products
for this category. Products sold through Caraloe, Inc. include Manapol[R]
and other proprietary and non-proprietary raw materials sold to
nutraceutical and cosmetic customers; nutritional products sold under the
AloeCeuticals[TM] brand; skin care products sold under the Snow and Sun[TM]
brand and private-labeled products manufactured to customer specifications,
including powders, creams, liquids, gels, lotions, drinks, tablets and
capsules for various customers.
Prior to 1996, the Company generated most of its revenues from product sales
in its Medical Services Division. In 1996, the Company launched its line of
raw materials, including Manapol[R] powder, through Caraloe, Inc. In 2001,
the Company created its specialty manufacturing group to provide services to
cosmetic, nutraceutical and medical markets. In December 2002, the Company
acquired the assets of the custom division of CBI, which substantially
increased revenues for Caraloe, Inc. In 2003 approximately 29% of the
Company's revenues were generated through product sales and royalties in its
Medical Services Division and 71% through sales of products and services in
its Caraloe, Inc. subsidiary.
Revenues
-------- Year-over- Year-over-
Year Year
2002 2003 Growth Growth
($) (%)
-----------------------------------------------------------------------
Net product sales $15,571 $26,636 $11,065 71.1
Royalty income 2,470 2,467 (3) (0.1)
------ ------ ------ ----
Total revenues $18,041 $29,103 $11,062 61.3
The Company utilizes the cash flow generated from its manufacturing and
sales operations to fund additional capital projects in support of
manufacturing operations and to fund the research activities of its DelSite
subsidiary.
Cash Flow
--------- Year-over- Year-over-
Year Year
2002 2003 Growth Growth
($) (%)
-----------------------------------------------------------------------
Net cash used in
operating activities $(1,365) $(1,288) $ 77 5.6
Net cash used in
investing activities (1,379) (1,472) (93) (6.7)
Net cash provided by
financing activities 2,926 1,044 (1,882) (64.3)
The decrease in net cash used in operating activities was primarily related
to the decrease in the net loss, which was partially offset by an increase
in inventory and accounts receivable. The increase in net cash used in
investing activities resulted from an increased investment in facilities and
equipment to support the Company's operations. Cash provided by financing
activities in 2003 was adversely affected by increased principal payments on
debt and capital lease obligations.
The Company's operating expenses generally fall into three broad categories;
sales and distribution expenses in support of product sales; product
support and DelSite research and development expenses; and general and
administrative expenses. In recent years, the Company has seen moderate but
steady increases in its sales and distribution expenses and has shifted a
greater percentage of its overall research and development expenses to its
DelSite subsidiary. General and administrative expenses represent corporate
infrastructure costs, such as accounting, human resources and information
systems, and executive management expenses. In addition to its operating
expenses, the Company also incurs interest expense arising from the debt
portion of its capital structure. In 2003, the Company experienced a
substantial increase in interest expense, due to increased borrowings
in 2003. The proceeds of these borrowings were used in the Company's
operations.
Expenses
-------- Year-over- Year-over-
Year Year
2002 2003 Growth Growth
($) (%)
-----------------------------------------------------------------------
Selling, general and
administrative $ 6,040 $ 8,017 $ 1,977 32.7
Research and development 1,701 899 (802) (47.1)
Research and development,
DelSite 1,879 2,761 882 46.9
Other expenses (income) 19 (123) (142) (747.4)
Interest expense (income), net 41 249 208 507.3
The Company utilizes the cash flow generated from its manufacturing and
sales operations to fund additional capital projects in support of
manufacturing operations and to fund the research activities of its wholly-
owned subsidiary, DelSite. DelSite, which was incorporated in 2001,
operates separately from the Company's product-support research and
development program and is responsible for the research, development and
marketing of the Company's proprietary GelSite[TM] technology for controlled
release and delivery of bioactive pharmaceutical ingredients. DelSite,
together with its collaborators and contractors, has the capability to
provide formulation development, feasibility study, preclinical development,
clinical supply production, production scale-up and technology transfer
services. DelSite's business plan is to develop its data in support of it
technologies and then partner with biotechnology and pharmaceutical
companies to provide novel delivery solutions for their drugs and vaccines.
Liquidity and Capital Resources
-------------------------------
The following table summarizes the Company's contractual obligations at
December 31, 2003 (amounts in thousands):
Payments Due by Period
---------------------------------------
Less than One to Four to More than
One Three Five Five
Total Year Years Years Years
----------------------------------------------------------------------------
Contractual Obligations
Notes Payable
Line of Credit with $ 1,587 $ 1,587 $ - $ - $ -
Comerica Bank (4% at
December 31, 2003)
Comerica Bank note payable 917 200 400 317 -
(4% at December 31,2003)
Medline note payable (6.5% 1,316 734 582 - -
at December 31, 2003)
Bancredito note payable 463 52 114 130 167
(U.S. prime plus 2% at
December 31, 2003)
Other 17 3 8 6 -
Capital leases 345 115 181 32 17
Operating leases 5,500 860 1,693 1,442 1,505
------ ------ ------ ------ ------
Total contractual
obligations $10,145 $ 3,461 $ 2,978 $ 1,927 $ 1,689
====== ====== ====== ====== ======
The Company has historically depended on operating cash flows, bank
financing and equity financing to fund its operations, capital projects and
research and development projects, with the majority of funds generated from
operating cash flows. The Company also has available to it various leasing
arrangements for financing equipment purchases, and is seeking potential
grant awards for funding DelSite projects, other potential collaborative or
sponsorship funding for DelSite projects and potential licensing revenues
for product lines or DelSite projects.
At December 31, 2003 and 2002, the Company held cash and cash equivalents of
$1,920,000 and $3,636,000, respectively, a decrease of $1,716,000. The
decrease in cash was primarily due to increases in accounts receivable
balances arising from the increase in sales, additional inventory needed
to support the increased level of operations and operating results.
Significant cash outflows during 2003 included a $1,393,000 investment
in property plant and equipment. Customers with significant accounts
receivable balances at the end of 2003 included Mannatech, Inc. ($1,540,000)
and Medline Industries ($935,000), and of these amounts, $2,346,000 has been
collected as of February 29, 2004.
In July 2003, the Company received a loan of $1,000,000 from Comerica under
a variable rate installment note with interest and principal to be repaid in
monthly installments over five years. The interest rate on the loan is the
U.S. Prime Rate plus 0.5%. The loan is collateralized by the Company's
accounts receivable and inventory and by a first lien on the Company's
production facility in Irving, Texas. The proceeds of the loan are being
used in the Company's operations. As of December 31, 2003, there was
$917,000 outstanding on the loan.
In March 2003 the Company received a loan of $500,000 from Bancredito, a
Costa Rica bank, with interest and principal to be repaid in monthly
installments over eight years. The interest rate on the loan is the U.S.
Prime Rate plus 2.0%. The loan is secured by a mortgage on an unused, 164-
acre parcel of land owned by the Company in Costa Rica plus a lien on
specified oral patch production equipment. The proceeds of the loan were
used in the Company's operations. As of December 31, 2003, there was
$463,000 outstanding on the loan.
The Company had no additional material capital commitments as of that date
other than its leases and agreements with suppliers.
In December 2002, the Company entered into an agreement with Medline for
accelerated payment of $2.0 million of the royalties due under the
Distributor and License Agreement. The royalty acceleration agreement
provides for each of the remaining quarterly royalty payments due to be paid
to the Company by Medline to be reduced by equal amounts, the sum of which
offsets the royalty advance. The Company has accounted for this transaction
in its financial statements as a loan, which bears interest at 6.5%. As of
December 31, 2003, there was $1,316,000 outstanding on the advance.
In July 1998 the Company provided a $187,000 cash advance to Rancho Aloe,
which is evidenced by a note receivable, due in installments, with payments
being made monthly based upon farm production. The Company also advanced
$300,000 to Aloe & Herbs in November 1998 for the acquisition of an
irrigation system to improve production on the farm and allow harvesting of
leaves year-round. In the fourth quarter of 1998, the Company fully
reserved all amounts owed to it by Aloe & Herbs, in the total amount of
$487,000, due to the start-up nature of the business. In 2003, the Company
received payments totaling $149,500 from Aloe & Herbs against the amount
due.
The Company has a line of credit with Comerica Bank-Texas ("Comerica") that
provides for borrowings of up to $3 million based on the level of qualified
accounts receivable and inventory. The line of credit is collateralized by
accounts receivable and inventory. Borrowings under the line of credit bear
interest at the bank's prime rate (4.0% at December 31, 2003) plus 0.5%.
The credit facility with Comerica includes covenants that require the
Company to maintain certain financial ratios. The Company was not in
compliance with two of the covenant ratios as of December 31, 2003.
Comerica has waived the events of non-compliance for the period ended
December 31, 2003. The Company and Comerica may amend the covenants in the
future. As of December 31, 2003, there was $1,587,000 outstanding on the
credit line with $713,000 credit available for operations, net of
outstanding letters of credit of $700,000.
In December 2002, the Company acquired the assets of the custom division of
Cosmetic Beauty Innovations (CBI) for $1.0 million plus a royalty on the
Company's sales to custom division customers for five years and $583,000 for
useable inventories. The CBI custom division provided product development
and manufacturing services to customers in the cosmetic and skin care
markets. Included in the purchase were intellectual property, certain
inventories and specified pieces of equipment. The Company provides
services to these customers through the Caraloe, Inc. development and
manufacturing services group. The Company began producing products for the
transferring CBI customers in February 2003 at its Irving, Texas facility.
The Company anticipates capital expenditures in 2004 of approximately $1.2
million. The expenditures will primarily be comprised of production and
laboratory equipment and facility modifications.
Presently, the Company's debt/equity ratio is 0.8 to 1. Based on its
current estimates, management believes that the Company has the capacity to
incur additional debt, and, in 2004, the Company intends to seek additional
financing to be used as working capital. The Company anticipates that such
borrowings, together with the expected cash flows from operations and
licensing agreements and expected revenues from government grant programs,
will provide the funds necessary to finance its current operations,
including expected levels of research and development. However, the Company
does not expect that its current cash resources will be sufficient to
finance future major clinical studies and costs of filing new drug
applications necessary to develop its products to their full commercial
potential. Additional funds, therefore, may need to be raised through
equity offerings, borrowings, licensing arrangements or other means.
Management believes that each of the enumerated financing avenues is
presently available to the Company. However, there is no assurance that the
Company will be able to obtain such funds on satisfactory terms when they
are needed.
In March 2001, the Board of Directors authorized the Company to repurchase
up to one million shares of its outstanding Common Stock. See "Market for
Registrant's Common Equity and Related Stockholder Matters" above. The
Company believes it has the financial resources necessary to repurchase
shares from time to time pursuant to the Board's repurchase authorization.
The Company is subject to regulation by numerous governmental authorities in
the United States and other countries. Certain of the Company's proposed
products will require governmental approval prior to commercial use. The
approval process applicable to pharmaceutical products and therapeutic
agents usually takes several years and typically requires substantial
expenditures. The Company and any licensees may encounter significant
delays or excessive costs in their respective efforts to secure necessary
approvals. Future United States or foreign legislative or administrative
acts could also prevent or delay regulatory approval of the Company's or any
licensee's products. Failure to obtain requisite governmental approvals or
failure to obtain approvals of the scope requested could delay or preclude
the Company or any licensees from marketing their products, or could limit
the commercial use of the products, and thereby have a material adverse
effect on the Company's liquidity and financial condition.
Results of Operations
---------------------
Fiscal 2003 Compared to Fiscal 2002
-----------------------------------
Total revenues were $29,103,000 in 2003, compared with $18,041,000 in 2002.
Total sales in the Company's Medical Services Division were $8,453,000 in
2003 as compared to $8,394,000 in 2002, and total sales in the Company's
Caraloe, Inc. subsidiary were $20,650,000 in 2003 as compared to $9,647,000
in 2002.
Total sales of the Company's wound and skin care products in 2003 were
$5,985,000 as compared with $5,855,000 in 2002. The increase in wound care
revenue was primarily due to an increase in orders from Medline, the
Company's exclusive domestic distributor. The Company's products are facing
increasing competitive pressure from low-end, commodity-type products which
is eroding its market share. Educational efforts are underway to support
the distributor's sales efforts in product differentiation, performance
and net cost of therapy to the customer. The Company has also initiated
selective advertisements to support its brand.
Partially offsetting the increase in domestic wound care sales was a
decrease in sales to international customers. The Company sells its wound
care products to international distributors, primarily in Europe and Central
and South America. Total international wound care sales in 2003 were
$448,000 as compared to $534,000 in 2002, with the decrease primarily due to
decreased South America sales.
Sales of the Company's oral technology products increased from $56,000 in
2002 to $78,000 in 2003 due primarily to the increased product demand
internationally.
The Company recorded royalty revenue in 2003 of $2,467,000 relating to the
exclusive Licensing and Distribution Agreement with Medline, as compared to
$2,470,000 in 2002.
Of the total Caraloe, Inc. sales in 2003, $11,456,000 was related to
the sale of bulk Manapol[R] powder as compared to $6,493,000 in 2002.
Caraloe currently sells bulk Manapol[R] powder to a major customer under
a one-year, non-exclusive supply and licensing agreement. The current
agreement expires in December 2004. Sales to this customer increased from
$6,366,000 in 2002 to $10,357,000 in 2003.
Caraloe also sells its AloeCeuticals[R] line of immune-enhancing dietary
supplements containing Manapol[R], which are available in liquid, capsule
and tablet forms. These products are sold directly to health and nutrition
stores and broker/distributors. They are also sold through the Company's
Internet sites. Sales of these products in 2002 and 2003 totaled $532,000
and $519,000, respectively.
Caraloe continued to develop its contract manufacturing business during
2003. Caraloe manufactures a variety of products that can be filled using
the Company's current equipment including gels, creams, lotions and drinks.
Total contract manufacturing sales in 2003 were $8,675,000 compared with
$2,622,000 in 2002. Of the $6,053,000 increase, $4,111,000 was attributable
to products the Company produced for former customers of CBI that were
acquired in December 2002. Additionally, $1,278,000 was attributable to
products the Company produced for Medline under a supply agreement entered
into in December 2000, whereby the Company manufactures Medline's own
branded skin care products on a contract basis.
Cost of goods sold increased from $11,739,000 in 2002 to $18,806,000 in
2003, or 60.2%. As a percentage of sales, cost of sales decreased from
65.1% to 64.6%. The slight decrease in the cost of goods sold percentage
was attributable to a decrease in unfavorable manufacturing variances.
The Company experienced significant unfavorable variances associated with
its manufacturing processes in its Irving, Texas facility. These variances
are expected to improve as volumes increase and efficiencies improve. The
Company experienced significant favorable variances associated with its
manufacturing processes in its Costa Rica facility due to increased
production of the Manapol[R] powder through much of the year.
Selling, general and administrative expenses increased to $8,017,000 from
$6,040,000, or 32.7%. The Company recorded additional distribution related
expenses in 2003 of $1,094,000, which was primarily related to the
increased shipping volume and increased facility costs associated with the
growing business volume. The Company recorded additional selling expenses
in 2003 of $403,000, primarily related to support of the business acquired
from CBI. The Company also recorded additional administrative expenses in
2003 of $480,000 primarily in the areas of salary, professional fees and
information systems expenses to support the increased level of operations
and to improve the infrastructure of the Company.
Specialized research and development expenses in support of the Company's
ongoing operations decreased to $899,000 in 2003 from $1,701,000 in 2002, or
52.8%. This decrease resulted from the Company's efforts to refocus the
activities of this group toward services in support of manufacturing,
including formulation design, formulation modifications and re-engineering,
technology transfer to the manufacturing suite and stability studies.
DelSite operates independently from the Company's specialized research and
development program and is responsible for the research, development and
marketing of the Company's proprietary Gelsite[TM] technology for controlled
release and delivery of bioactive pharmaceutical ingredients. DelSite began
operations in January 2002 and its expenses in support of this mission
totaled $2,761,000 in 2003. Combined research and development expenses
totaled $3,660,000 in 2003, an increase of 2.2% over 2002.
Net interest expense of $249,000 was recorded in 2003 versus net interest
expense of $41,000 in 2002, with the variance primarily due to increased
Company borrowings in 2003.
There was no benefit for income taxes in 2003 due to fact that the Company
has provided a valuation allowance against all deferred tax asset balances
at December 31, 2003 and 2002 due to uncertainty regarding realization of
the asset.
The Company's net loss for 2003 was $1,506,000, versus a net loss of
$3,378,000 for 2002. The 2003 net loss was primarily due to unfavorable
plant operating variances at the Irving, Texas manufacturing facility, as
well as additional operating expenses incurred in support of additional
sales volume and in improving the infrastructure of the company. Results in
2002 were affected by reduced gross margins resulting from mix of products
sold and from unfavorable plant operating variances in both Irving, Texas
and Costa Rica manufacturing facilities. The loss per share in 2003 was
$0.15, compared to loss per share of $0.34 in 2002.
Fiscal 2002 Compared to Fiscal 2001
-----------------------------------
Total revenues were $18,041,000 in 2002, compared with $17,594,000 in 2001.
Total sales in the Company's Medical Services Division were $8,394,000 in
2002 as compared to $10,400,000 in 2001 and total sales in the Company's
Caraloe, Inc. subsidiary were $9,647,000 in 2002 as compared to $7,194,000
in 2001.
Total sales of the Company's wound and skin care products in 2002 were
$5,855,000 as compared with $7,921,000 in 2001. The decrease in wound care
revenue was primarily due to a $2.2 million decrease in orders from Medline,
the Company's exclusive domestic distributor. A portion of the decrease can
be attributed to initial stocking orders made by Medline in early 2001, as
the distribution agreement was implemented. Additionally, the Company's
products are facing increasing competitive pressure from low-end, commodity-
type products which is eroding its market share. Educational efforts are
underway to support the distributor's sales efforts in product
differentiation, performance and net cost of therapy to the customer. The
Company has also initiated selective advertisements to support its brand.
Partially offsetting the decrease in domestic wound care sales was an
increase in sales to international customers. The Company sells its wound
care products to international distributors, primarily in Europe and Central
and South America. Total international wound care sales in 2002 were
$534,000 as compared to $386,000 in 2001, with the increase primarily due to
increased sales in Latin America.
Sales of the Company's oral technology products decreased from $129,000 in
2001 to $56,000 in 2002 due primarily to the loading of inventory by a
significant international customer in 2001.
The Company recorded royalty revenue in 2002 of $2,470,000 relating to the
exclusive Licensing and Distribution agreement with Medline as compared to
$2,479,000 in 2001.
Of the total Caraloe, Inc. sales in 2002, $6,493,000 was related to the sale
of bulk Manapol[R] powder. Caraloe currently sells bulk Manapol[R] powder
to a major customer under a non-exclusive supply and licensing agreement.
Sales to this customer increased from $5,192,000 in 2001 to $6,366,000 in
2002.
Caraloe also sells its AloeCeuticals[R] line of immune-enhancing dietary
supplements containing Manapol[R], which are available in liquid, capsule
and tablet forms. These products are sold directly to health and nutrition
stores and broker/distributors. They are also sold through the Company's
Internet sites. Sales of these products in 2001 and 2002 totaled $538,000
and $532,000, respectively.
Caraloe continued to develop its contract manufacturing business during
2002. Caraloe manufactures a variety of products that can be filled using
the Company's current equipment including gels, creams, lotions and drinks.
Total contract manufacturing sales in 2002 were $2,622,000 compared with
$1,144,000 in 2001. Of the $1,478,000 increase, $845,000 was attributable
to products the Company produced for Medline under a supply agreement
entered into in December 2000, whereby the Company manufactures Medline's
own branded skin care products on a contract basis.
Cost of goods sold increased from $9,803,000 in 2001 to $11,739,000 in 2002,
or 19.7%. As a percentage of sales, cost of sales increased from 55.7% to
65.1%. The increase in the cost of goods sold percentage was largely
attributable to a significant shift in sales mix toward lower margin
contract manufactured products. The Company experienced significant
unfavorable variances associated with its manufacturing processes in its
Irving, Texas facility due to lower manufacturing volumes associated with
the decrease in its wound care sales. The Company also experienced
significant unfavorable variances associated with its manufacturing
processes in its Costa Rica facility due to lower manufacturing volumes for
Manapol[R] powder through much of the year. Increased sales of Manapol[R]
powder in the fourth quarter of 2002 prompted the Company to increase its
production of Manapol[R] at the end of the year, thereby eliminating the
unfavorable variances through the first quarter of 2003.
Selling, general and administrative expenses increased to $6,040,000 from
$5,016,000, or 20.4%. The 2001 balance included a one-time favorable
adjustment of $211,000 to reduce the Company's franchise tax liability.
The Company recorded additional distribution expenses in 2002 of $285,000,
which was primarily due to increased shipping volume and increased facility
costs associated with the distribution facility leased in October 2001.
The Company recorded additional selling expense in 2002 of $201,000,
primarily in the areas of salaries, travel, literature and advertising, in
support of efforts to grow total sales. The Company also recorded
additional administrative expenses in 2002 of $327,000, primarily in the
areas of information systems, training, professional fees and travel as part
of an effort to improve the infrastructure of the Company and position it
for future growth.
Research and development expenses in support of the Company's ongoing
operations decreased to $1,701,000 in 2002 from $2,442,000 in 2001, or
30.3%. This decrease resulted from the Company's efforts to refocus the
activities of this group toward services in support of manufacturing,
including formulation design, formulation modifications and re-engineering,
technology transfer to the manufacturing suite and stability studies.
DelSite operates independently from the Company's research and development
program and is responsible for the research, development and marketing of
the Company's proprietary Gelsite[TM] technology for controlled release and
delivery of bioactive pharmaceutical ingredients. DelSite began operations
in January 2002 and its expenses in support of this mission totaled
$1,879,000 in 2002. Combined research and development expenses totaled
$3,580,000 in 2002, an increase of 46.6% over 2001.
Net interest expense of $41,000 was recorded in 2002 versus net interest
income of $32,000 in 2001, with the variance primarily due to lower interest
rates earned on investments in 2002 and increased Company borrowings.
There was no provision for income taxes in 2002 due to the Company's
utilization of net operating loss carryforwards. The Company has provided a
valuation allowance against all deferred tax asset balances at December 31,
2002 and 2001 due to uncertainty regarding realization of the asset.
The Company's net loss for 2002 was $3,378,000, versus a net income of
$378,000 for 2001. The 2002 net loss was due to reduced gross margins
resulting from the mix of products sold and from plant operating variances,
as well as additional operating expenses incurred in defense of litigation
and in support of positioning business for future growth. Results in 2001
benefited from higher unit volume sales of wound care products, lower
production costs and a one time gain of $211,000 from adjustments to
franchise tax liabilities booked in prior periods. The loss per share in
2002 was $0.34, compared to earnings per share of $0.04 in 2001.
Impact of Inflation
-------------------
The Company does not believe that inflation has had a material impact on its
results of operations.
Critical Accounting Policies
----------------------------
Management has identified the following accounting policies as critical. The
Company's accounting policies are more fully described in Note Two of the
Financial Statements. The preparation of consolidated financial statements
requires the Company to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. On an ongoing basis, the
Company evaluates its estimates, including those related to bad debts and
inventories. The Company bases its estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments
about the carrying values of assets and liabilities that are not readily
apparent from other sources. Actual results may differ from these estimates
under different assumptions or conditions.
The Company records estimated reductions to revenue for incentive offerings
including promotions and other volume-based incentives as well as estimates
for returns based upon recent history. If market conditions were to decline
or inventory was in danger of expiring or becoming obsolete, the Company may
take actions to increase customer incentive offerings possibly resulting in
an incremental reduction of revenue at the time the incentive is offered.
Additionally, if demand for the Company's product were to drop, the
Company's distributors may request return of product for credit causing a
need to re-evaluate and possibly increase the reserve for product returns.
The Company maintains allowances for doubtful accounts for estimated losses
resulting from the inability of its customers to make required payments. If
the financial condition of the Company's customers were to deteriorate,
resulting in an impairment of their ability to make payments, additional
allowances may be required. The Company writes down its inventory for
estimated obsolescence or unmarketable inventory equal to the difference
between the cost of inventory and the estimated market value based upon
assumptions about future demand and market conditions. If actual market
conditions are less favorable than those projected by management, additional
inventory write-downs may be required.
Forward Looking Statements
--------------------------
All statements other than statements of historical fact contained in this
report, including but not limited to statements in this Management's
Discussion and Analysis of Financial Condition and Results of Operations
(and similar statements contained in the Notes to Consolidated Financial
Statements) concerning the Company's financial position, liquidity, capital
resources and results of operations, its prospects for the future and other
matters, are forward-looking statements. Forward-looking statements in this
report generally include or are accompanied by words such as "anticipate",
"believe", "estimate", "expect", "intend", "will", "would", "should" or
words of similar import. Such forward-looking statements include, but are
not limited to, statements regarding the ability of local suppliers of Aloe
vera L. leaves in Costa Rica to supply the Company's need for leaves; the
condition, capacity and adequacy of the Company's manufacturing and
laboratory facilities and equipment; the adequacy of the protection that the
Company's patents provide to the conduct of its business operations; the
adequacy of the Company's protection of its trade secrets and unpatented
proprietary know-how; the Company's belief that the claims of the Plaintiffs
identified under Item 3 of Part I of this report are without merit; the
adequacy of the Company's cash resources and cash flow from operations to
finance its current operations; and the Company's intention, plan or ability
to repurchase shares of its outstanding Common Stock, to initiate, continue
or complete clinical and other research programs, to obtain financing when
it is needed, to fund its operations from revenue and other available cash
resources, to enter into licensing agreements, to develop and market new
products and increase sales of existing products, to obtain government
approval to market new products, to file additional patent applications, to
rely on trade secrets, unpatented proprietary know-how and technological
innovation, to reach satisfactory resolutions of its disputes with third
parties, to acquire sufficient quantities of Aloe vera L. leaves from local
suppliers at significant savings, to collect the amounts owed to it by its
distributors, customers and other third parties, and to use its tax loss
carryforwards before they expire, as well as various other matters.
Although the Company believes that the expectations reflected in its
forward-looking statements are reasonable, no assurance can be given that
such expectations will prove correct. Factors that could cause the
Company's results to differ materially from the results discussed in such
forward-looking statements include but are not limited to the possibilities
that the Company may be unable to obtain the funds needed to carry out large
scale clinical trials and other research and development projects, that the
results of the Company's clinical trials may not be sufficiently positive to
warrant continued development and marketing of the products tested, that new
products may not receive required approvals by the appropriate government
agencies or may not meet with adequate customer acceptance, that the Company
may not be able to obtain financing when needed, that the Company may not be
able to obtain appropriate licensing agreements for products that it wishes
to market or products that it needs assistance in developing, that the
Company's efforts to improve its sales and reduce its costs may not be
sufficient to enable it to fund its operating costs from revenues and
available cash resources, that one or more of the customers that the Company
expects to purchase significant quantities of products from the Company or
Caraloe may fail to do so, that competitive pressures may require the
Company to lower the prices of or increase the discounts on its products,
that the Company's sales of products it is contractually obligated to
purchase from suppliers may not be sufficient to enable and justify its
fulfillment of those contractual purchase obligations, that other parties
who owe the Company substantial amounts of money may be unable to pay what
they owe the Company, that the Company's patents may not provide the Company
with adequate protection, that the Company's manufacturing facilities may be
inadequate to meet demand, that the Company's distributors may be unable to
market the Company's products successfully, that the Company may not be
able to resolve its disputes with third parties in a satisfactory manner,
that the Company may be unable to reach a satisfactory agreement with
important suppliers, that the Company may not be able to use its tax loss
carryforwards before they expire, that the Company may not have sufficient
financial resources necessary to repurchase shares of its outstanding Common
Stock, and that the Company may be unable to produce or obtain, or may have
to pay excessive prices for, the raw materials or products it needs.
All forward-looking statements in this report are expressly qualified in
their entirety by the cautionary statements in the two immediately preceding
paragraphs.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
----------------------------------------------------------
Foreign Currency
----------------
The Company's manufacturing operation in Costa Rica accounted for 29.6%
of cost of sales for the year ended December 31, 2003. The Company's
functional currency in Costa Rica is the U.S. Dollar. As a result, the
Company's financial results could be significantly affected by factors such
as changes in foreign currency exchange rates or economic conditions in
Costa Rica. When the U.S. Dollar strengthens against the Costa Rica ColEn,
the cost of sales decreases. During 2003, the exchange rate from U.S.
Dollar to Costa Rica ColEn increased by 22.9% to 418 at December 31, 2003.
The effect of an additional 10% strengthening in the value of the U.S.
Dollar relative to the Costa Rica ColEn in 2003 would have resulted in an
increase of $81,588 in gross profit. The Company's sensitivity analysis of
the effects of changes in foreign currency rates does not factor in a
potential change in sales levels or local currency prices.
Sales of products to foreign markets comprised 4.0% of sales for 2003.
These sales are generally denominated in U.S. Dollars. The Company does not
believe that changes in foreign currency exchange rates or weak economic
conditions in foreign markets in which the Company distributes its products
would have a significant effect on operating results. If sales to foreign
markets increase in future periods, the effects could become significant.
For quantitative and qualitative disclosures about market risk related to
the supply of Aloe vera L. leaves, see "Business - Raw Materials and
Processing."
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
-------------------------------------------
The response to Item 8 is submitted as a separate section of this Form 10-K.
See Item 15.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
---------------------------------------------------------------
FINANCIAL DISCLOSURE.
--------------------
On August 18, 2003, the Audit Committee of the Board of Directors resolved
to change the Company's independent accountants. Accordingly, on that date
the Company dismissed Ernst & Young LLP and appointed Grant Thornton LLP to
serve as its independent public accountants for the fiscal year ending
December 31, 2003. This change followed the Audit Committee's decision to
seek proposals from other independent auditors to audit the Company's
consolidated financial statements for the fiscal year ended December 31,
2003. During 2001, 2002 and the period from January 1, 2003 through August
18, 2003, there were no disagreements with Ernst & Young LLP on any matter
of accounting principle or practice, financial statement disclosure or
auditing scope or procedures or any reportable events. Having completed its
standard client acceptance procedure with respect to its engagement by the
Company, Grant Thornton LLP accepted its appointment as of August 18, 2003.
ITEM 9A. CONTROLS AND PROCEDURES.
-----------------------
Management of the Company with the participation of its Chief Executive
Officer and Chief Financial Officer, evaluated the effectiveness of the
Company's disclosure controls and procedures. Based on their evaluation, as
of the end of the period covered by this Form 10-K, the Company's Chief
Executive Officer and Chief Financial Officer have concluded that the
Company's disclosure controls and procedures (as defined in Rules 13a-15(e)
and 15d-15(e) under the Securities Exchange Act of 1934, as amended) are
effective.
There have been no significant changes in internal control over financial
reporting, for the period covered by this report, that have materially
affected or are reasonably likely to materially affect, the Company's
internal control reporting.
PART III
--------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
--------------------------------------------------
The information required by Item 10 of Form 10-K is hereby incorporated by
reference from the information appearing under the captions "Election of
Directors," "Executive Officers" and "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Company's definitive Proxy Statement relating
to its 2004 annual meeting of shareholders, which will be filed pursuant to
Regulation 14A within 120 days after the Company's fiscal year ended
December 31, 2003.
ITEM 11. EXECUTIVE COMPENSATION.
----------------------
The information required by Item 11 of Form 10-K is hereby incorporated by
reference from the information appearing under the caption "Executive
Compensation" in the Company's definitive Proxy Statement relating to its
2004 annual meeting of shareholders, which will be filed pursuant to
Regulation 14A within 120 days after the Company's fiscal year ended
December 31, 2003.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
--------------------------------------------------------------
The information required by Item 12 of Form 10-K is hereby incorporated by
reference from the information appearing under the captions "Security
Ownership of Management" and "Principal Shareholders" in the Company's
definitive Proxy Statement relating to its 2004 annual meeting of
shareholders, which will be filed pursuant to Regulation 14A within 120 days
after the Company's fiscal year ended December 31, 2003.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
----------------------------------------------
The information, if any, required by Item 13 of Form 10-K is hereby
incorporated by reference from the information appearing under the caption
"Certain Transactions", if any, in the Company's definitive Proxy Statement
relating to its 2004 annual meeting of shareholders, which will be filed
pursuant to Regulation 14A within 120 days after the Company's fiscal year
ended December 31, 2003.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
--------------------------------------
The information required by Item 14 of Form 10-K is hereby incorporated by
reference from the information appearing under the captions "Principal
Accountant Fees and Services" in the Company's definitive Proxy Statement
relating to its 2004 annual meeting of shareholders, which will be filed
pursuant to Regulation 14A within 120 days after the Company's fiscal year
ended December 31, 2003.
PART IV
-------
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
---------------------------------------------------------------
(a)(1) Financial Statements.
Reference is made to the index on page F-1 for a list of all
financial statements filed as a part of this Annual Report.
(2) Financial Statement Schedules.
Reference is made to the index on page F-1 for a list of one
financial statement schedule filed as a part of this Annual
Report.
(3) Exhibits.
Reference is made to the Index to Exhibits on pages E-1 through
E-8 for a list of all exhibits to this report.
(b) Reports on Form 8-K.
The Company filed a Form 8-K and Form 8-A/A Report on December 18,
2003 to report Amendment No. 1 to the Original Rights Agreement
amending the Original Rights Agreement in certain respects.
CARRINGTON LABORATORIES, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
Consolidated Financial Statements of the Company:
Consolidated Balance Sheets --
December 31, 2002 and 2003 F-2
Consolidated Statements of Operations -- years ended
December 31, 2001, 2002 and 2003 F-3
Consolidated Statements of Shareholders' Equity --
years ended December 31, 2001, 2002 and 2003 F-4
Consolidated Statements of Cash Flows -- years ended
December 31, 2001, 2002 and 2003 F-5
Notes to Consolidated Financial Statements F-6
Financial Statement Schedule
Valuation and Qualifying Accounts F-18
Report of Grant Thornton LLP F-19
Report of Ernst & Young LLP F-20
Consolidated Balance Sheets
(Amounts in thousands, except share and per share amounts)
December 31,
2002 2003
-------- --------
Assets:
Current Assets:
Cash and cash equivalents $ 3,636 $ 1,920
Accounts receivable, net of allowance
for doubtful accounts of $110 and $181
December 31, 2002 and 2003, respectively 2,370 3,098
Inventories, net 4,333 5,960
Prepaid expenses 603 253
-------- --------
Total current assets $ 10,942 $ 11,231
Property, plant and equipment, net 10,065 10,538
Customer relationships, net 893 777
Other assets, net 259 238
-------- --------
Total assets $ 22,159 $ 22,784
======== ========
Liabilities and Shareholder's Equity:
Current Liabilities:
Line of credit $ 1,587 $ 1,587
Accounts payable 1,458 2,037
Accrued liabilities 1,256 1,604
Current portion of long-term debt and
capital lease obligations 730 1,104
Deferred revenue 1,922 1,880
-------- --------
Total current liabilities: 6,953 8,212
Long-term debt and capital lease obligations 1,517 1,953
SHAREHOLDERS' EQUITY:
Common stock, $.01 par value, 30,000,000 shares
authorized, 9,967,938 and 10,384,669 shares
issued at December 31, 2002 and 2003,
respectively 100 104
Capital in excess of par value 52,568 53,000
Accumulated Deficit (38,976) (40,482)
Treasury stock at cost, 2,400 shares
at December 31, 2002 and 2003 (3) (3)
-------- --------
Total shareholders' equity 13,689 12,619
-------- --------
Total liabilities and shareholders' equity $ 22,159 $ 22,784
======== ========
The accompanying notes are an integral part of these balance sheets.
Consolidated Statements of Operations
(Amounts in thousands, except per share amounts)
Years Ended December 31,
----------------------------
2001 2002 2003
------ ------ ------
Revenues:
Net product sales $15,115 $15,571 $26,636
Royalty income 2,479 2,470 2,467
------ ------ ------
Total revenues 17,594 18,041 29,103
Cost of sales 9,803 11,739 18,806
------ ------ ------
Gross margin 7,791 6,302 10,297
Expenses:
Selling, general and administrative 5,016 6,040 8,017
Research and development 2,442 1,701 899
Research and development, DelSite - 1,879 2,761
Other expense (income) (13) 19 (123)
Interest expense (income), net (32) 41 249
------ ------ ------
Net income (loss) before income taxes 378 (3,378) (1,506)
Provision for income taxes - - -
------ ------ ------
Net income (loss) $ 378 $(3,378) $(1,506)
====== ====== ======
Basic and diluted earnings (loss)
per share $ 0.04 $ (0.34) $ (0.15)
====== ====== ======
Basic and diluted average shares
outstanding 9,743 9,889 10,120
====== ====== ======
The accompanying notes are an integral part of these statements.
Consolidated Statements of Shareholders' Equity
For the Years Ended December 31, 2001, 2002 and 2003
(Amounts in thousands)
Common Stock Capital in Treasury Stock
-------------- Excess of Accumulated --------------
Shares Amount Par Value Deficit Shares Amount Total
------ ----- ------ ------- ------ ----- ------
January 1, 2001 9,659 $ 97 $52,319 $(35,976) - $ - $16,440
Issuance of common
stock for employee
stock purchase plan 150 1 110 - - - 111
Net income - - - 378 - - 378
------ ----- ------ ------- ------ ----- ------
December 31, 2001 9,809 98 52,429 (35,598) - - 16,929
Issuance of common
stock for employee
stock purchase plan 149 2 126 - - - 128
Issuance of common
stock for stock
option plan 10 - 13 - - - 13
Treasury stock
purchase - - - - 2 (3) (3)
Net loss - - - (3,378) - - (3,378)
------ ----- ------ ------- ------ ----- ------
December 31, 2002 9,968 100 52,568 (38,976) 2 (3) 13,689
Issuance of common
stock for employee
stock purchase plan 246 2 197 - - - 199
Issuance of common
stock for stock
option plan 171 2 235 - - - 237
Net loss - - - (1,506) - - (1,506)
------ ----- ------ ------- ------ ----- ------
December 31, 2003 10,385 $ 104 $53,000 $(40,482) 2 $ (3) $12,619
====== ===== ====== ======= ===== ===== ======
The accompanying notes are an integral part of these statements.
Consolidated Statements of Cash Flows
(Amounts in thousands)
Years Ended December 31,
---------------------------
2001 2002 2003
------ ------ ------
Operating activities:
Net income (loss) $ 378 $(3,378) $(1,506)
Adjustments to reconcile net income (loss)
to net cash provided by (used in)
operating activities:
Provision for bad debts 55 38 150
Provision for inventory obsolescence 91 135 200
Depreciation and amortization 1,050 1,087 1,309
Loss on disposal of assets - 21 8
Changes in operating assets and liabilities:
Accounts receivable 504 (786) (878)
Inventories (706) 870 (1,827)
Prepaid expenses (6) (414) 350
Other assets (117) (49) 21
Accounts payable and accrued liabilities (849) 731 927
Deferred revenue 875 380 (42)
------ ------ ------
Net cash provided by (used in) operating
activities 1,275 (1,365) (1,288)
Investing activities:
Cash paid in purchase of business, net of
cash acquired - (1,001) (79)
Purchases of property, plant and equipment (1,132) (378) (1,393)
------ ------ ------
Net cash used in investing activities (1,132) (1,379) (1,472)
Financing activities:
Borrowings on line of credit - 824 -
Proceeds from debt issuances - 2,000 1,500
Principal payments on debt and capital
lease obligations - (36) (892)
Issuances of common stock 111 141 436
Treasury stock purchased - (3) -
------ ------ ------
Net cash provided by financing activities 111 2,926 1,044
------ ------ ------
Net increase (decrease) in cash and cash
equivalents 254 182 (1,716)
Cash and cash equivalents at beginning of year 3,200 3,454 3,636
------ ------ ------
Cash and cash equivalents at end of year $ 3,454 $ 3,636 $ 1,920
====== ====== ======
Supplemental Disclosure of Cash Flow
Information
Cash paid during the year for interest $ 58 $ 61 $ 259
The accompanying notes are an integral part of these statements.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE ONE. BUSINESS
Carrington Laboratories, Inc. (the "Company") is a research-based
biopharmaceutical, medical device, raw materials and nutraceutical company
engaged in the development, manufacturing and marketing of naturally-derived
complex carbohydrates and other natural product therapeutics for the
treatment of major illnesses, the dressing and management of wounds and
nutritional supplements.
The Company's Medical Services Division offers a comprehensive line of wound
management products to hospitals, alternative care facilities, cancer
centers and the home health care market. The Company and Medline
Industries, Inc. ("Medline") entered into a Distributor and License
Agreement dated November 3, 2000, under which the Company granted to Medline
the exclusive right, subject to certain limited exceptions, to distribute
all of the Company's wound and skin care products (the "Products") in the
United States, Canada, Puerto Rico and the U.S. Virgin Islands for a term
of five years that began December 1, 2000. The agreement provides that
Carrington will continue to manufacture its existing line of Products and
sell them to Medline at specified prices. The prices, which were generally
firm for the first two years of the contract term, are thereafter subject
to adjustment not more than once each year to reflect increases in
manufacturing cost.
The agreement also grants Medline a nonexclusive license to use certain of
the Company's trademarks in connection with the marketing of the Products.
In addition, it permits Medline, if it so elects, to use those trademarks in
connection with the marketing of various Medline products and other products
not manufactured by the Company (collectively, "Other Products").
The agreement requires Medline to pay the Company a base royalty totaling
$12,500,000 in quarterly installments that began on December 1, 2000. In
addition to the base royalty, if Medline elects to market any of the Other
Products under any of the Company's trademarks, Medline must pay the Company
a royalty of between one percent and five percent of Medline's aggregate
annual net sales of the Products and the Other Products, depending on the
amount of the net sales, except that the royalty on certain high volume
commodity products will be two percent.
Caraloe, Inc., a subsidiary, markets or licenses consumer products and bulk
raw material products. Principal sales of Caraloe, Inc., are bulk raw
material products which are sold to United States manufacturers who include
the high quality extracts from Aloe vera L. in their finished products.
Caraloe also provides product development and manufacturing services to
customers in the cosmetic, nutraceutical and medical markets.
The Company formed a subsidiary, DelSite Biotechnologies, Inc., in October
2001 as a vehicle to further the development and commercialization of its
new proprietary complex carbohydrate (Gelsite[TM] polymer) that the Company
is developing for use as a drug and vaccine delivery system.
In December 2002 the Company entered into an agreement to acquire certain
assets of the Custom Division of Creative Beauty Innovations, Inc. ("CBI"),
including specialized manufacturing customer information, intellectual
property and equipment. CBI is a privately held manufacturer of skin and
cosmetic products with operations in Carrollton, Texas.
Under the agreement, the Company paid CBI $1.6 million, including $0.6
million for inventory of CBI. In addition, for the five-year period ending
in December 2007 the Company agreed to pay CBI an amount equal to 9.0909% of
Carrington's net sales up to $6.6 million per year and 8.5% of Carrington's
net sales over $6.6 million per year of CBI products to CBI's transferring
customers. The acquired assets include equipment and other physical
property previously used by CBI's Custom Division to compound and package
cosmetic formulations of liquids, creams, gels and lotions into bottles,
tubes or cosmetic jars. Carrington uses these assets in a substantially
similar manner. The Company provides services to these customers through
the Caraloe, Inc. development and manufacturing services group. The Company
recorded $100,000 for the purchase of equipment and $901,000 for the
purchase of customer relationship intangibles in connection with the
acquisition.
The Company's products are produced at its plants in Irving, Texas and Costa
Rica. A portion of the Aloe vera L. leaves used for manufacturing the
Company's products are grown on a Company-owned farm in Costa Rica. The
remaining leaves are purchased from other producers in Costa Rica.
NOTE TWO. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION. The consolidated financial statements include
the accounts of Carrington Laboratories, Inc., and its subsidiaries, all of
which are wholly-owned. All intercompany accounts and transactions have
been eliminated in consolidation.
CASH EQUIVALENTS. The Company's policy is that all highly liquid
investments purchased with a maturity of three months or less at date of
acquisition are considered to be cash equivalents unless otherwise
restricted.
INVENTORY. Inventories are recorded at the lower of cost (first-in, first-
out) or market. The Company records a reserve for inventory obsolescence
based on an analysis of slow moving and expired products.
PROPERTY, PLANT AND EQUIPMENT. Property, plant and equipment are recorded
at cost less accumulated depreciation. Land improvements, buildings and
improvements, furniture and fixtures and machinery and equipment are
depreciated on the straight-line method over their estimated useful lives.
Leasehold improvements and equipment under capital leases are amortized over
the terms of the respective leases or the estimated lives of the assets,
whichever is less.
LONG-LIVED ASSETS. The Company reviews long-lived assets, including finite-
lived intangible assets for impairment whenever events or changes in
circumstances indicate that the carrying amount may not be recoverable. If
the sum of the expected future undiscounted cash flows is less than the
carrying amount of the asset, a loss is recognized for the difference
between the fair value and carrying value of the asset. There have been no
impairment charges recorded in the years presented.
CUSTOMER RELATIONSHIPS. In connection with the CBI acquisition described in
Note One, the Company recorded a finite-lived intangible asset of $901,000
for customer relationships acquired. The Company is amortizing this
intangible asset over five years, which is based on the estimated life of
the customer relationships. Future amounts paid to the sellers based on a
percentage of sales of CBI products as described in Note One will be
recorded as an expense in the same period the corresponding sales are
recorded. The Company recorded expenses of $383,000 in 2003 for royalties
due under the agreement. The Company recorded amortization expense of
$195,000 in 2003.
DEFERRED REVENUE. Deferred revenue is primarily related to the licensing
and royalty agreement with Medline Industries and represents amounts
received in excess of amounts amortized to royalty income.
TRANSLATION OF FOREIGN CURRENCIES. The functional currency for
international operations (Costa Rica) is the U.S. Dollar. Accordingly, such
foreign entities translate monetary assets and liabilities at year-end
exchange rates, while non-monetary items are translated at historical rates.
Revenue and expense accounts are translated at the average rates in effect
during the year, except for depreciation and amortization, which are
translated at historical rates. Translation adjustments and transaction
gains or losses are recognized in the consolidated statement of operations.
REVENUE RECOGNITION. The Company recognizes revenue for product sales at
the time of shipment when title to the goods transfers and collectibility is
reasonably assured. Royalty income is recognized over the period of the
licensing and royalty agreement.
FEDERAL INCOME TAXES. The Company uses the liability method of accounting
for income taxes. Under this method, deferred income taxes are recorded to
reflect the tax consequences of differences between the tax basis of assets
and liabilities and the financial reporting basis. Valuation allowances are
provided against net deferred tax assets when it is more likely than not,
based on available evidence, that assets may not be realized.
RESEARCH AND DEVELOPMENT. Research and development costs are expensed
as incurred. Certain laboratory and test equipment determined to have
alternative future uses in other research and development activities has
been capitalized and is depreciated as research and development expense over
the life of the equipment.
FREIGHT COSTS. Shipping costs incurred by the Company are included in the
consolidated statement of operations in selling, general and administrative
expenses for the years ended December 31, 2001, 2002 and 2003.
STOCK-BASED COMPENSATION. The Company accounts for employee stock options
in accordance with Accounting Principles Board Opinion No. 25 (APB 25),
Accounting for Stock Issued to Employees and Financial Accounting Standards
Board Interpretation No. 44, Accounting for Certain Transactions involving
Stock Compensation, an interpretation of APB Opinion No. 25. Under APB 25,
the Company recognizes no compensation expense related to employee or
director stock options when options are granted with exercise prices at the
quoted market price of the stock on the date of grant.
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123 (FAS1 123), Accounting for Stock-
Based Compensation and Statement of Financial Accounting Standards No. 148
(FAS 148), Accounting for Stock-Based Compensation - Transition and
Disclosure - An Amendment of FASB Statement No. 123. Under the provisions
of FAS 123, pro forma compensation expense related to options issued to
employees is disclosed based on the fair value of options on the grant date.
The following table (in thousands) illustrates the effect on net income
(loss) if the Company had applied the fair value recognition provision of
FAS 123 to stock based compensation:
---------------------------------------------------------------------------
2001 2002 2003
---------------------------------------------------------------------------
Net income (loss) (in thousands):
As reported $ 378 $(3,378) $(1,506)
Less: Stock-based compensation
expense determined under fair
value-based method (461) (331) (583)
------ ------ ------
Pro forma net loss $ (83) $(3,709) $(2,089)
====== ====== ======
Net income (loss)
per share:
As reported $ 0.04 $ (0.34) $ (0.15)
Pro forma $ (0.01) $ (0.38) $ (0.21)
---------------------------------------------------------------------------
Because options vest over a period of several years and additional awards
are generally made each year, the pro forma information presented above is
not necessarily indicative of the effects on reported or pro forma net
earnings or losses for future years.
NET INCOME (LOSS) PER SHARE. Basic net income (loss) per share is based on
the weighted average number of shares of common stock outstanding during the
year. Diluted net income (loss) per share includes the effects of options,
warrants and convertible securities unless the effect is antidilutive.
USE OF ESTIMATES. 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 at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. These estimates include accounts receivable bad debt and
inventory obsolescence reserves. Actual results could differ from those
estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS. The Company's financial instruments
include cash and cash equivalents, accounts receivable, accounts payable,
accrued liabilities and debt. The carrying value of financial instruments
approximates fair value at December 31, 2003 and 2002.
RECLASSIFICATIONS. Certain prior year amounts have been reclassified to
conform to the current year presentation.
NEW PRONOUNCEMENTS. The FASB has issued Interpretation No. 46,
"Consolidation of Variable Interest Entities". FIN 46 addresses the
consolidation by business enterprises of variable interest entities whose
equity holders have not provided sufficient equity to allow the entity to
finance its own activities or whose equity holders lack the essential
characteristics of a controlling financial interest. FIN 46 requires a
variable interest entity to be consolidated by a company if that company is
subject to a majority of the risk of loss from the entity's activities or
entitled to receive a majority of the entity's residual returns, or both.
The provisions of FIN 46 are effective March 31, 2004 for entities formed
before February 2003. The Company anticipates no material effect from the
adoption of FIN 46.
NOTE THREE. INVENTORIES
The following summarizes the components of inventory at December 31, 2002
and 2003, in thousands:
2002 2003
---------------------------------------------------------------------------
Raw materials and supplies $1,776 $3,009
Work-in-process 624 638
Finished goods 2,565 3,048
Less obsolescence reserve (632) (735)
---------------------------------------------------------------------------
Total $4,333 $5,960
---------------------------------------------------------------------------
NOTE FOUR. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consisted of the following at December 31,
2002 and 2003, in thousands:
Estimated
2002 2003 Useful Lives
---------------------------------------------------------------------------
Land and improvements $ 1,391 $ 1,391
Buildings and improvements 8,984 9,286 7 to 25 years
Furniture and fixtures 593 620 4 to 8 years
Machinery and equipment 8,094 8,831 3 to 10 years
Leasehold improvements 782 846 1 to 3 years
Equipment under capital leases 197 379 4 years
---------------------------------------------------------------------------
Total 20,041 21,353
Less accumulated depreciation
and amortization 9,976 10,815
---------------------------------------------------------------------------
Property, plant and
equipment, net $10,065 $10,538
---------------------------------------------------------------------------
The net book value of property, plant and equipment in Costa Rica at
December 31, 2002 and 2003 was $3,716,000 and $3,593,000, respectively.
NOTE FIVE. ACCRUED LIABILITIES
The following summarizes significant components of accrued liabilities at
December 31, 2002 and 2003, in thousands:
2002 2003
---------------------------------------------------------------------------
Accrued payroll $ 343 $ 550
Accrued insurance 81 227
Accrued taxes 278 181
Accrued professional fees 247 197
Other 307 449
---------------------------------------------------------------------------
Total $1,256 $1,604
---------------------------------------------------------------------------
NOTE SIX. LINE OF CREDIT
The Company has a line of credit with Comerica Bank that provides for
borrowings of up to $3 million based on the level of qualified accounts
receivable and inventory. The line of credit is collateralized by accounts
receivable and inventory. Borrowings under the line of credit bear interest
at the bank's prime rate (4.0% at December 31, 2003) plus 0.5%. The credit
facility with Comerica includes covenants that require the Company to
maintain certain financial ratios. The Company was not in compliance with
two of the covenant ratios as of December 31, 2003. Comerica has waived the
events of noncompliance for the period ended December 31, 2003. If the
financial covenants are violated in future periods, Comerica may choose not
to waive the violation and require the debt to be due and payable. However,
given the Company's good relationship with Comerica and the ability of the
Company to obtain waivers currently, and in the past, management believes
waivers can be obtained in the future. The Company and Comerica may also
amend the covenants in the future. As of December 31, 2003 there was
$1,587,000 outstanding on the credit line with $713,000 of credit available
for operations, net of outstanding letter of credits of $700,000.
NOTE SEVEN. LONG-TERM DEBT
Medline advanced the Company $2,000,000 on December 16, 2002. The amount
bears interest at 6.5% and is being repaid by reducing each quarterly
royalty payment due from Medline through September 2005 by approximately
$200,000. As of December 31, 2003, there was $1,316,000 outstanding on the
advance.
In March 2003, the Company received a loan of $500,000 from Bancredito, a
Costa Rica bank, with interest and principal to be repaid in monthly
installments over eight years. The interest rate on the loan is the U.S.
Prime Rate plus 2.0%. The loan is secured by a mortgage on an unused, 164-
acre parcel of land owned by the Company in Costa Rica plus a lien on
specified oral patch production equipment. The proceeds of the loan were
used in the Company's operations. As of December 31, 2003, there was
$463,000 outstanding on the loan.
In July 2003, the Company received a loan of $1,000,000 from Comerica Bank-
Texas ("Comerica") under a variable rate installment note with interest and
principal to be repaid in monthly installments over five years. The
interest rate on the loan is the U.S. Prime Rate plus 0.5%. The loan is
collateralized by the Company's accounts receivable and inventory and by a
lien on the Company's production facility in Irving, TX. The proceeds of
the loan are being used in the Company's operations. As of December 31,
2003 there was $917,000 outstanding on the loan.
The following summarizes annual maturities at December 31, 2003, in
thousands:
2004 $ 989
2005 840
2006 263
2007 267
2008 186
Thereafter 167
-----
Total $2,712
---------------------------------------------------------------------------
NOTE EIGHT. COMMON STOCK
SHARE PURCHASE RIGHTS PLAN The Company has a share purchase rights plan
which provides, among other rights, for the purchase of common stock by
existing common stockholders at significantly discounted amounts in the
event a person or group acquires or announces the intent to acquire 15% or
more of the Company's common stock. The rights expire in 2011 and may be
redeemed at any time at the option of the Board of Directors for $.001 per
right.
EMPLOYEE STOCK PURCHASE PLAN. The Company has an Employee Stock Purchase
Plan under which employees may purchase common stock at a price equal to the
lesser of 85% of the market price of the Company's common stock on the last
business day preceding the enrollment date (defined as January 1, April 1,
July 1 or October 1 of any plan year) or 85% of the market price on the last
business day of each month. A maximum of 1,000,000 shares of common stock
was reserved for purchase under this Plan. As of December 31, 2003, a total
of 871,000 shares had been purchased by employees at prices ranging from
$0.77 to $29.54 per share.
STOCK OPTIONS. The Company has an incentive stock option plan which was
approved by the shareholders in 1995 under which incentive stock options and
nonqualified stock options may be granted to employees, consultants and non-
employee directors. Options are granted at a price no less than the market
value of the shares on the date of the grant, except for incentive options
to employees who own more than 10% of the total voting power of the
Company's common stock, which must be granted at a price no less than 110%
of the market value. Employee options are normally granted for terms of 10
years. Options granted prior to December 1998 normally vested at the rate
of 25% per year beginning on the first anniversary of the grant date.
Options granted from December 1998 through March 2001 normally vested at the
rate of 33-1/3% per year beginning on the first anniversary of the grant
date, but certain options granted in December 1998, 1999 and 2001 were 25%,
50% or 100% vested on the grant date, with the remainder of each option
vesting in equal installments on the first, second and third anniversaries
of the grant date. Options granted subsequent to March 2001 normally vest
at the rate of 50% per year beginning on the first anniversary of the grant
date. Options to non-employee directors have terms of ten years and are 100%
vested on the grant date. The Company has reserved 2,250,000 shares of
common stock for issuance under this plan. As of December 31, 2003, options
to purchase 332,000 shares were available for future grants under the plan.
The following summarizes stock option activity for each of the three years
in the period ended December 31, 2003 (shares in thousands):
Weighted
Average
Exercise
Shares Price Per Share Price
---------------------------------------------------------------------------
Balance, January 1, 2001 1,243 $ 1.31 to $28.75 $3.78
Granted 345 $ 1.05 to $ 1.37 $1.17
Lapsed or canceled (215) $ 1.25 to $27.00 $3.94
---------------------------------------------------------------------------
Balance, December 31, 2001 1,373 $ 1.05 to $28.75 $3.11
Granted 375 $ 1.05 to $ 1.50 $1.28
Lapsed or canceled (227) $ 1.05 to $12.75 $3.62
Exercised (10) $ 1.31 to $ 2.06 $1.38
---------------------------------------------------------------------------
Balance, December 31, 2002 1,511 $ 1.05 to $28.75 $2.58
Granted 358 $ 1.58 to $ 4.26 $2.94
Lapsed or canceled (73) $ 1.05 to $10.25 $1.68
Exercised (171) $ 1.05 to $ 4.81 $1.41
---------------------------------------------------------------------------
Balance, December 31, 2003 1,625 $ 1.05 to $28.75 $2.82
======
Options exercisable at
December 31, 2001 902 $ 1.31 to $28.75 $3.78
Options exercisable at
December 31, 2002 1,092 $ 1.05 to $28.75 $3.12
Options exercisable at
December 31, 2003 1,326 $ 1.05 to $28.75 $2.81
The following table summarizes information about stock options outstanding
at December 31, 2003:
Options Outstanding Options Exercisable
------------------------------ -------------------
Weighted
Average Weighted Weighted
Shares Remaining Average Shares Average
Range of (In Contractual Exercise (In Exercise
Exercise Prices thousands) Life Price thousands) Price
---------------------------------------------------------------------
$27.00 to $28.75 8 2.2 years $28.64 8 $28.64
$10.25 to $12.75 4 .5 years $11.77 4 $11.77
$ 6.00 to $ 8.25 94 2.9 years $ 6.74 94 $ 6.74
$ 4.26 to $ 4.81 406 8.7 years $ 4.58 244 $ 4.79
$ 2.03 to $ 3.00 312 5.0 years $ 2.35 312 $ 2.35
$ 1.05 to $ 1.80 801 8.9 years $ 1.37 664 $ 1.39
----- -----
1,625 7.3 years $ 2.82 1,326 $ 2.81
===== =====
The fair value of each option granted was estimated on the date of the grant
using the Black-Scholes option pricing model with the following weighted-
average assumptions used for grants to employees in 2001, 2002, and 2003,
respectively: risk-free interest rates of 5.09%, 3.00% and 4.27%; expected
dividend yields of 0%; expected volatility of 89.7%, 105.2% and 89.7% and
expected lives of 10 years for 2001 and 5 years for 2002 and 2003. The
weighted average fair values of options granted were $0.84, $1.00 and $2.20
in 2001, 2002, and 2003, respectively.
STOCK WARRANTS. From time to time, the Company has granted warrants to
purchase common stock to the Company's research consultants and other
persons rendering services to the Company. The exercise price of such
warrants was normally the market price or in excess of the market price of
the common stock at date of issuance. At December 31, 2002 and 2003 there
were 50,000 warrants exercisable at $3.50 per share. Warrants outstanding
at December 31, 2003 had a weighted average remaining contractual life of
0.6 years.
COMMON STOCK RESERVED. At December 31, 2003, the Company had reserved a
total of 2,136,000 common shares for future issuance relating to the
employee stock purchase plan, stock option plan and stock warrants disclosed
above.
NOTE NINE. COMMITMENTS AND CONTINGENCIES
The Company conducts a significant portion of its operations from two
office/warehouse/distribution facilities under operating leases. In
addition, the Company leases certain office equipment under operating leases
and certain manufacturing and transportation equipment under capital leases.
Future minimum lease payments under noncancelable operating leases and the
present value of future minimum capital lease payments as of December 31,
2003 were as follows, in thousands:
Capital Operating
Leases Leases
---------------------------------------------------------------------
2004 $ 136 $ 860
2005 136 862
2006 70 831
2007 21 775
2008 18 667
Thereafter 19 1,505
---------------------------------------------------------------------
Total minimum lease payments 400 $5,500
=====
Amounts representing interest (55)
-----
Present value of capital lease obligations 345
Less current portion of capital lease obligations (115)
-----
Obligations under capital lease agreements,
excluding the current portion $ 230
=====
Total rental expense under operating leases was $666,000, $667,000, and
$774,000 for the years ended December 31, 2001, 2002 and 2003, respectively.
From time to time in the normal course of business, the Company is party
to various matters involving claims or possible litigation. Management
believes the ultimate resolution of these matters will not have a material
adverse effect on the Company's financial position or results of operations.
The Company has outstanding a letter of credit in the amount of $600,000
which is used as security on the lease for the Company's laboratory and
warehouse facility. The Company has outstanding a letter of credit in the
amount of $100,000 which is used as security on a capital lease for
equipment.
NOTE TEN. INCOME TAXES
The tax effects of temporary differences that gave rise to deferred tax
assets and deferred tax liabilities at December 31, 2002 and 2003 were as
follows, in thousands:
2002 2003
---------------------------------------------------------------------
Net operating loss carryforward $14,282 $14,849
Research and development
and other credits 254 131
Property, plant and equipment 333 302
Inventory 399 324
Other, net 92 103
Bad debt reserve 448 218
Deferred income 653 639
ACI Stock Valuation 204 204
Accrued liability 93 36
Less - Valuation allowance (16,758) (16,806)
------ ------
$ 0 $ 0
====== ======
The Company has provided a valuation allowance against the entire net
deferred tax asset at December 31, 2002 and 2003 due to the uncertainty as
to the realization of the asset.
The provision (benefit) for income taxes for the three years in the period
ended December 31, 2003 was offset by changes in the valuation reserve.
At December 31, 2003, the Company had net operating loss carryforwards of
approximately $43.6 million for federal income tax purposes, which begin to
expire in 2004, and research and development tax credit carryforwards of
approximately $386,000, which begin to expire in 2004, all of which are
available to offset federal income taxes due in future periods. Net
operating loss carryforwards of $2.2 million expired during the year ended
December 31, 2003, $1.5 million will expire in the year ending December 31,
2004 and $5.3 million will expire in the year ending December 31, 2005. All
other net operating loss carryforwards will expire between the year 2009
and the year 2023. The Company has approximately $28,000 in alternative
minimum tax credits which do not expire.
NOTE ELEVEN. CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially expose the Company to concentrations
of credit risk consist primarily of trade accounts receivable. The
Company's customers are not concentrated in any specific geographic region
but are concentrated in the health care industry. Significant sales were
made to three customers. Owens & Minor, a customer in the Medical Services
segment, accounted for 10% of the Company's net sales in 2001. Sales to
Mannatech, Inc., a customer in the Caraloe, Inc., segment, accounted for
30%, 35%, and 36% of the Company's net sales in 2001, 2002 and 2003,
respectively. Accounts receivable from Mannatech represented 53% and 47% of
gross accounts receivable at December 31, 2002 and 2003. Sales to Medline
Industries, Inc., a customer in the Medical Services segment, accounted for
35%, 34% and 26% of the Company's sales during 2001, 2002 and 2003,
respectively. Accounts receivable from Medline represented 25% and 29% of
the Company's gross accounts receivable at December 31, 2002 and 2003. The
Company performs ongoing credit evaluations of its customers' financial
condition and establishes an allowance for doubtful accounts based on
factors surrounding the credit risk of specific customers and historical
trends and other information.
Accounts are considered past due after contractual terms (net 30 days) and
are written-off after extensive collection efforts and nine months time.
The following table summarizes the allowance for doubtful accounts activity
for the period ended December 31, 2003.
Balance at Beginning Charges to Balance at End
of Period Expenses Deductions of Period
---------------------------------------------------------------------------
A/R Reserve $110 $150 $79 $181
NOTE TWELVE. NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share was computed by dividing net income (loss)
by the weighted average number of common shares outstanding. In calculating
the diluted net income (loss) per share for each of the three years in the
period ended December 31, 2003, no effect was given to options or warrants,
because the effect of including these securities would have been
antidilutive. In 2001 all options and warrants had exercise prices which
exceed the average market price of the common stock during the year.
NOTE THIRTEEN. REPORTABLE SEGMENTS
The Company operates in two reportable segments: human and veterinary
products sold through its Medical Services Division and Caraloe, Inc., a
consumer products subsidiary, which sells bulk raw materials, consumer
beverages and nutritional and skin care products. Caraloe also provides
product development and manufacturing services to Customers in the cosmetic,
nutraceutical and medical markets.
The Company evaluates performance and allocates resources based on profit or
loss from operations before income taxes. The accounting policies of the
reportable segments are the same as those described in the Summary of
Significant Accounting Policies (Note Two).
Corporate income (loss) before income taxes set forth in the following table
includes research and development expenses which were related to the
development of pharmaceutical products not associated with the reporting
segments. Assets which are used in more than one segment are reported in
the segment where the predominant use occurs. The Company's production
facility in Costa Rica, which provides bulk ingredients for all segments,
and total cash for the Company are included in the Corporate Assets figure.
Reportable Segments (in thousands)
Medical Caraloe,
Services Inc. Corporate Total
---------------------------------------------------------------------------
2001
---------------------------------------------------------------------------
Sales to unaffiliated
customers $ 10,400 $ 7,194 $ - $17,594
Income (loss) before
income taxes 1,333 1,121 (2,076) 378
Identifiable assets 12,481 1,420 7,316 21,217
Capital expenditures - - 1,132 1,132
Depreciation and
amortization 586 - 464 1,050
---------------------------------------------------------------------------
2002
---------------------------------------------------------------------------
Sales to unaffiliated
customers $ 8,394 $ 9,647 $ - $18,041
Income (loss) before
income taxes 955 (2,413) (1,920) (3,378)
Identifiable assets 15,006 1,960 5,193 22,159
Capital expenditures - - 378 378
Depreciation and
amortization 634 - 453 1,087
---------------------------------------------------------------------------
2003
---------------------------------------------------------------------------
Sales to unaffiliated
customers $ 8,453 $20,650 $ - $29,103
Income (loss) before
income taxes 863 641 (3,010) (1,506)
Identifiable assets 6,364 8,017 8,403 22,784
Capital expenditures - - 1,393 1,393
Depreciation and
amortization 366 548 395 1,309
NOTE FOURTEEN. RELATED PARTY TRANSACTIONS
At December 31, 2003, the Company had a 23% interest in a company which was
formed in 1998 to acquire and develop a 5,000-acre tract of land in Costa
Rica to be used for the production of Aloe vera L. leaves, the Company's
primary raw material. The Company's initial investment was written off in
1998 and no additional investments have been made or are expected to be
made. The Company has no influence on the business or operating decisions
of this company. Additionally, $149,500 was collected in 2003 from this
company against fully reserved note receivable balances. The Company is
accounting for its investment on the cost basis. The Company purchases Aloe
vera L. leaves from this company at prices the Company believes are
competitive with other sources. Such purchases totaled $450,000, $468,000
and $1,229,000 in 2001, 2002 and 2003, respectively.
NOTE FIFTEEN. SUBSEQUENT EVENT
On January 5, 2004, a jury trial was held to settle the remaining claims in
the legal action entitled Arthur Singer vs Carrington Laboratories, Inc. and
Carlton Turner with the jury finding for the Plaintiff on one claim,
awarding $28,162, plus interest for unpaid commissions and finding for the
Defendants on a second claim. The judge dismissed the third claim at the
end of testimony, citing lack of sufficient evidence to support plaintiffs
claim. No legal fees or expenses were awarded to the Plaintiff. Total
judgment was for approximately $35,000, which has been accrued as of the
period ended December 31, 2003.
NOTE SIXTEEN. UNAUDITED SELECTED QUARTERLY FINANCIAL DATA
The unaudited selected quarterly financial data below reflect the fiscal
years ended December 31, 2002 and 2003, respectively.
(Amounts in thousands, except shares and per share amounts)
---------------------------------------------------------------------------
2002 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
---------------------------------------------------------------------------
Revenue $3,736 $4,346 $5,093 $4,866
Gross margin 1,145 1,472 2,042 1,643
Net loss (1,042) (858) (541) (937)
Basic and diluted loss
per share $(0.11) $(0.09) $(0.05) $(0.09)
---------------------------------------------------------------------------
2003 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
---------------------------------------------------------------------------
Revenue $6,904 $7,962 $7,532 $6,705
Gross margin 2,567 3,079 2,497 2,154
Net income (loss) (298) 339 (466) (1,081)
Basic and diluted income
(loss) per share $(0.03) $ 0.03 $(0.05) $(0.10)
NOTE SEVENTEEN. OTHER
Commodities or components used in the Company's production processes which
can be only be obtained from a single supplier could potentially expose the
Company to risk of production interruption should the supplier be unable to
deliver the necessary materials in a timely manner. The Company utilizes
alcohol as a key part of its production process in Costa Rica. The Company
engages the services of an alcohol refinery company, located adjacent to its
facility, to repurify the alcohol used in its production utilizing a
distillation process. The purified alcohol is then returned to the
Company's inventory for further use. The Company is unaware of any other
providers of this service in Costa Rica. Senior managers from the Company's
Costa Rica operations meet regularly with owners and managers of the
refinery company to discuss operational issues.
Financial Statement Schedule
Valuation and Qualifying Accounts
(In thousands)
Description Additions
----------------
Balance Charged Charged
at to to Balance
Beginning Cost and Other at End
of Period Expenses Accounts Deductions of Period
---------------------------------------------------------------------------
2001
---------------------------------------------------------------------------
Bad debt reserve $ 98 $ 55 $ - $ 53 $ 100
Inventory reserve 441 91 - 16 516
Rebates 272 - - 272 -
Reserve Aloe & Herbs
non-current notes and
investments included
in other assets 433 - - 37 396
---------------------------------------------------------------------------
2002
---------------------------------------------------------------------------
Bad debt reserve $ 100 $ 38 $ - $ 28 $ 110
Inventory reserve 516 135 - 19 632
Reserve for Aloe & Herbs
non-current notes and
investments included
in other assets 396 - - 19 377
---------------------------------------------------------------------------
2003
---------------------------------------------------------------------------
Bad debt reserve $ 110 $ 150 $ - $ 79 $ 181
Inventory reserve 632 200 - 97 735
Reserve for Aloe & Herbs
non-current notes and
investments included
in other assets 377 - - 150 227
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Shareholders and Board of Directors
Carrington Laboratories, Inc.
We have audited the accompanying consolidated balance sheet of Carrington
Laboratories, Inc. and subsidiaries as of December 31, 2003 and the related
consolidated statements of operations, shareholders' equity and cash flows
for the year ended December 31, 2003. Our audit also included the financial
statement schedule listed in the Index at Item 15(a) for the same period.
These financial statements and schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. 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 audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial
position of Carrington Laboratories, Inc. and subsidiaries as of December
31, 2003, and the consolidated results of their operations and their cash
flows for the year ended December 31, 2003 in conformity with accounting
principles generally accepted in the United States of America. Also, in our
opinion, the related financial statement schedule, when considered in
relation to the basic financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.
/s/ Grant Thornton LLP
Dallas, Texas
February 20, 2004
REPORT OF INDEPENDENT AUDITORS
Shareholders and Board of Directors
Carrington Laboratories, Inc.
We have audited the accompanying consolidated balance sheet of Carrington
Laboratories, Inc. and subsidiaries as of December 31, 2002 and the related
consolidated statements of operations, shareholders' equity and cash flows
for each of the two years in the period ended December 31, 2002. Our audits
also included the financial statement schedule listed in the Index at Item
15(a) for the same periods. These financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements and schedule based on our
audits.
We conducted our audits in accordance with auditing standards generally
accepted in the 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 consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial
position of Carrington Laboratories, Inc. and subsidiaries as of December
31, 2002, and the consolidated results of their operations and their cash
flows for each of the two years in the period ended December 31, 2002 in
conformity with accounting principles generally accepted in the United
States. Also, in our opinion, the related financial statement schedule,
when considered in relation to the basic financial statements taken as a
whole, presents fairly in all material respects the information set forth
therein.
/s/ Ernst & Young LLP
Dallas, Texas
February 28, 2003, except for Note Seven
as to which the date is March 10, 2003.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto dully authorized.
Carrington Laboratories, Inc.
Date: March 18, 2004 By: /s/ Carlton E. Turner
----------------------------------
Carlton E. Turner, Ph.D., D.Sc.
President, Chief Executive
Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
/s/ Carlton E. Turner President, Chief Executive March 18, 2004
------------------------- Officer and Director
Carlton E. Turner, Ph.D. (principal executive officer)
D.Sc.
/s/ Robert W. Schnitzius Vice President and Chief March 18, 2004
------------------------- Financial Officer
Robert W. Schnitzius (principal financial and
accounting officer)
/s/ Ronald R. Blanck Director March 18, 2004
-------------------------
Ronald R. Blanck, D.O.
/s/ R. Dale Bowerman Director March 18, 2004
-------------------------
R. Dale Bowerman
/s/ George DeMott Director March 18, 2004
-------------------------
George DeMott
/s/ Thomas J. Marquez Director March 18, 2004
-------------------------
Thomas J. Marquez
/s/ Edwin Meese, III Director March 18, 2004
-------------------------
Edwin Meese, III
/s/ Selvi Vescovi Director March 18, 2004
-------------------------
Selvi Vescovi
INDEX TO EXHIBITS
-----------------
Sequentially
Exhibit Numbered
Number Exhibit Page
------ --------------------------------------------------- ----
3.1 Restated Articles of Incorporation of Carrington
Laboratories, Inc. (incorporated by reference to
Exhibit 3.1 to Carrington's 1999 Annual Report on
Form 10-K).
3.2 Statement of Change of Registered Office and
Registered Agent of Carrington Laboratories, Inc.
(incorporated by reference to Exhibit 3.2 to
Carrington's 1999 Annual Report on Form 10-K).
3.3 Statement of Resolution Establishing Series D
Preferred Stock of Carrington Laboratories, Inc.
(incorporated by reference to Exhibit 3.3 to
Carrington's 1999 Annual Report on Form 10-K).
3.4 Bylaws of Carrington Laboratories, Inc., as
amended through March 3, 1998 (incorporated
herein by reference to Exhibit 3.8 to
Carrington's 1997 Annual Report on Form 10-K).
4.1 Form of certificate for Common Stock of
Carrington Laboratories, Inc. (incorporated
herein by reference to Exhibit 4.5 to
Carrington's Registration Statement on Form S-3
(No. 33-57360) filed with the Securities and
Exchange Commission on January 25, 1993).
4.2 Rights Agreement dated as of September 19, 1991
between Carrington Laboratories, Inc. and
Ameritrust Company National Association
(incorporated by reference to Exhibit 4.2 to
Carrington's 1999 Annual Report on Form 10-K).
4.3 Amendment No. 1 to Rights Agreement dated October
21, 1998 (incorporated herein by reference to
Exhibit 4 to the Company's Form 8-A/A Post-
Effective Amendment No. 1).
10.1 + Retirement and Consulting Agreement dated August
14, 1997 between Carrington Laboratories, Inc.
and David Shand (incorporated herein by reference
to Exhibit 4.1 to Carrington's quarterly report
on Form 10-Q for the quarter ended September 30,
1997).
10.2 + First Amendment to Retirement and Consulting
Agreement dated September 30, 1997 between
Carrington Laboratories, Inc. and David G. Shand
(incorporated herein by reference to Exhibit 4.2
to Carrington's quarterly report on Form 10-Q for
the quarter ended September 30, 1997).
10.3 Contract Research Agreement dated as of August 8,
1991 between Carrington Laboratories, Inc. and
Texas Agriculture Experimental Station, as agent
for the Texas A&M University System (incorporated
herein by reference to Exhibit 10.55 to
Carrington's 1991 Annual Report on Form 10-K).
10.4 + Employee Stock Purchase Plan of Carrington
Laboratories, Inc., as amended through June 15,
1995 (incorporated by reference to Exhibit 10.9
to Carrington's 1999 Annual Report on Form 10-K).
10.5 Common Stock Purchase Warrant dated September 14,
1993 issued by Carrington Laboratories, Inc. to
E. Don Lovelace (incorporated by reference to
Exhibit 10.10 to Carrington's 1999 Annual Report
on Form 10-K).
10.6 Common Stock Purchase Warrant dated September 14,
1993, issued by Carrington Laboratories, Inc., to
Jerry L. Lovelace (incorporated by reference to
Exhibit 10.11 to Carrington's 1999 Annual Report
on Form 10-K).
10.7 Lease Agreement dated June 15, 1994 between DFW
Nine, a California limited partnership, and
Carrington Laboratories, Inc. (incorporated by
reference to Exhibit 10.12 to Carrington's 1999
Annual Report on Form 10-K).
10.8 Lease Amendment dated August 23, 1994 amending
Lease Agreement listed as Exhibit 10.12
(incorporated by reference to Exhibit 10.13 to
Carrington's 1999 Annual Report on Form 10-K).
10.9 Production Contract dated February 13, 1995
between Carrington Laboratories, Inc. and Oregon
Freeze Dry, Inc. (incorporated by reference to
Exhibit 10.14 to Carrington's 1999 Annual Report
on Form 10-K).
10.10 Modification Number One dated February 19, 1996
to the Production Contract dated February 13,
1995 between Carrington Laboratories, Inc. and
Oregon Freeze Dry, Inc. (incorporated by
reference to Exhibit 10.15 to Carrington's 1999
Annual Report on Form 10-K).
10.11 Modification Number Two dated November 11, 1996
to the Production Contract dated February 13,
1995 between Carrington Laboratories, Inc. and
Oregon Freeze Dry, Inc. (incorporated by
reference to Exhibit 10.16 to Carrington's 1999
Annual Report on Form 10-K).
10.12 Modification Number Three to the Production
Contract dated February 13, 1995 between
Carrington Laboratories, Inc. and Oregon Freeze
Dry, Inc. (incorporated herein by reference to
Exhibit 10.89 to Carrington's 1998 Annual Report
on Form 10-K).
10.13 + 1995 Management Compensation Plan (incorporated
herein by reference to Exhibit 4.1 to Form S-8
Registration Statement No. 33-64403 filed with the
Commission on November 17, 1995).
10.14 Trademark License Agreement dated August 14, 1997
between Caraloe, Inc. and Mannatech, Inc.
(incorporated herein by reference to Exhibit 10.2
to Carrington's quarterly report on Form 10-Q for
the quarter ended September 30, 1997).
10.15 Supply Agreement dated August 14, 1997 between
Caraloe, Inc. and Mannatech, Inc.(incorporated
herein by reference to Exhibit 10.3 to
Carrington's quarterly report on Form 10-Q for the
quarter ended September 30, 1997).
10.16 Letter of Agreement dated January 12, 2000
extending Trademark License Agreement and Supply
Agreement between Caraloe, Inc. and Mannatech,
Inc. (incorporated by reference to Exhibit 10.21
to Carrington's 1999 Annual Report on Form 10-K).
10.17 Trademark License and Product Supply Agreement
dated July 22, 1997 between Caraloe, Inc., and Nu
Skin International, Inc. (incorporated herein by
reference to Exhibit 10.1 to Carrington's
quarterly report on Form 10-Q for the quarter
ended September 30, 1997).
10.18 Non-exclusive Sales and Distribution Agreement
dated August 22, 1995 between Innovative
Technologies Limited and Carrington Laboratories,
Inc. (incorporated herein by reference to Exhibit
10.6 to Carrington's Third Quarter 1995 Report on
Form 10-Q).
10.19 Supplemental Agreement dated October 16, 1995 to
Non-exclusive Sales and Distribution Agreement
between Innovative Technologies Limited and
Carrington Laboratories, Inc.(incorporated herein
by reference to Exhibit 10.7 to Carrington's Third
Quarter 1995 Report on Form 10-Q).
10.20 Product Development and Exclusive Distribution
Agreement dated November 10, 1995 between
Innovative Technologies Limited and Carrington
Laboratories, Inc.(incorporated herein by
reference to Exhibit 10.8 to Carrington's Third
Quarter 1995 Report on Form 10-Q).
10.21 Form of Stock Purchase Agreement dated April 5,
1995 between Carrington Laboratories, Inc. and
persons named in Annex I thereto (incorporated
herein by reference to Exhibit 2.1 to Carrington's
Registration Statement 33-60833 on Form S-3).
10.22 Form of Registration Rights Agreement dated June
20, 1995 between Carrington Laboratories, Inc. and
persons named in Annex I thereto (incorporated
herein by reference to Exhibit 2.2 to Carrington's
Registration Statement 33-60833 on Form S-3).
10.23 Supply and Distribution Agreement dated March 22,
1996 between Farnam Companies, Inc. and Carrington
Laboratories, Inc. (incorporated herein by
reference to Exhibit 10.76 to Carrington's 1995
Annual Report on Form 10-K).
10.24 + Carrington Laboratories, Inc. 1995 Stock Option
Plan, As Amended and Restated Effective January
15, 1998 (incorporated herein by reference to
Exhibit 10.3 to Carrington's Quarterly Report on
Form 10-Q for the quarter ended March 31, 1998).
10.25 + Form of Nonqualified Stock Option Agreement with
Outside Director, relating to the Registrant's
1995 Stock Option Plan, as amended (incorporated
herein by reference to Exhibit 10.3 to
Carrington's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1998).
10.26 + Form of Incentive Stock Option Agreement for
Employees (incorporated herein by reference to
Exhibit 4.4 to Carrington's Second Quarter 1996
Report on Form 10-Q).
10.27 Sales Distribution Agreement dated December 20,
1996 between Recordati, S.P.A. and Carrington
Laboratories, Inc. and Carrington Laboratories
Belgium N.V.(incorporated by reference to Exhibit
10.55 to Carrington's 1996 Annual Report on Form
10-K).
10.28 Sales Distribution Agreement dated December 4,
1996 between Darrow Laboratorios S/A and
Carrington Laboratories, Inc. (incorporated by
reference to Exhibit 10.59 to Carrington's 1996
Annual Report on Form 10-K).
10.29 Supply Agreement dated February 13, 1997 between
Aloe Commodities International, Inc. and Caraloe,
Inc. (incorporated by reference to Exhibit 10.63
to Carrington's 1996 Annual Report on Form 10-K).
10.30 Sales Distribution Agreement dated November 1, 1995
between Laboratories PiSA S.A. DE C.V. and
Carrington Laboratories, Inc. (incorporated by
reference to Exhibit 10.70 to Carrington's 1996
Annual Report on Form 10-K).
10.31 Sales Distribution Agreement dated January 1, 1998
between Carrington Laboratories, Inc. and
Carrington Laboratories Belgium N.V. and Henry
Schein U.K. Holdings, Ltd., (incorporated herein by
reference to Exhibit 10.1 to Carrington's Quarterly
Report on Form 10-Q for the quarter ended March 31,
1998).
10.32 Sales Distribution Agreement dated January 5, 1998
between Carrington Laboratories, Inc. and
Carrington Laboratories Belgium N.V. and Saude 2000
(incorporated herein by reference to Exhibit 10.2
to Carrington's Quarterly Report on Form 10-Q for
the quarter ended March 31, 1998).
10.33 Sales Distribution Agreement dated March 27, 1998
between Carrington Laboratories, Inc. and
Carrington Laboratories Belgium N.V. and Hemopharm
GmbH (incorporated herein by reference to Exhibit
10.4 to Carrington's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1998).
10.34 Promissory Note of Aloe Commodities International,
Inc.,dated June 17, 1998, payable to the order of
the Registrant in the principal amount of $200,000
(incorporated herein by reference to Exhibit 10.4
to Carrington's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1998).
10.35 Letter agreements dated September 30, 1998 and
November 4, 1998 between Aloe Commodities
International, Inc. and the Registrant amending due
date of Promissory Note dated June 17, 1998 from
Aloe Commodities International, Inc. to the
Registrant (incorporated herein by reference to
Exhibit 10.2 to Carrington's Quarterly Report on
Form 10-Q for the quarter ended September 30,
1998).
10.36 Letter Agreement dated February 4, 1999 between
Aloe Commodities International, Inc. and the
Registrant amending due date of Promissory Note
dated June 17, 1998 from Aloe Commodities
International, Inc. to the Registrant (incorporated
herein by reference to Exhibit 10.98 to
Carrington's 1998 Annual Report on Form 10-K).
10.37 Promissory Note dated July 1, 1998 of Rancho Aloe,
(C.R.) S.A. payable to the order of the Registrant
in the principal amount of $186,655.00
(incorporated herein by reference to Exhibit 10.1
to Carrington's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1998).
10.38 Wound and Skin Care Purchase Agreement dated August
27, 1998 between American Association for Homes &
Services for the Aging and Carrington Laboratories,
Inc. (incorporated herein by reference to Exhibit
10.2 to Carrington's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1998).
10.39 Purchase Agreement dated October 1, 1998 between
Vencor, Inc. and Carrington Laboratories, Inc.
(incorporated herein by reference to Exhibit 10.3
to Carrington's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1998).
10.40 Promissory Note of Aloe & Herbs International, Inc.
dated November 23, 1998 payable to the order of the
Registrant in the principal amount of $300,000
(incorporated herein by reference to Exhibit 10.92
to Carrington's 1998 Annual Report on Form 10-K).
10.41 Clinical Services Agreement dated January 25, 1999
between Carrington Laboratories, Inc. and PPD
Pharmaco, Inc. (incorporated herein by reference to
Exhibit 10.96 to Carrington's 1998 Annual Report on
Form 10-K).
10.42 Common Stock Purchase Warrant dated November 23,
1998, issued by Aloe and Herbs International, Inc.
to Carrington Laboratories, Inc. (incorporated
herein by reference to Exhibit 10.99 to
Carrington's 1998 Annual Report on Form 10-K).
10.43 Letter dated February 25, 1999 from Aloe
Commodities, Inc. to Carrington Laboratories, Inc.
(incorporated herein by reference to Exhibit 10.1
to Carrington's Quarterly Report on Form 10-Q for
the quarter ended March 31, 1999).
10.44 Exclusive Sales Representative Agreement dated
April 13, 1999, between Caraloe, Inc. and Classic
Distributing Company (incorporated herein by
reference to Exhibit 10.1 to Carrington's Quarterly
Report on Form 10-Q for the quarter ended June 30,
1999).
10.45 Terms Sheet for Lease of Rancho Aloe Farm Land to
Sabila Industrial dated April 20, 1999
(incorporated herein by reference to Exhibit 10.1
to Carrington's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1999).
10.46 Terms Sheet for Maintenance of Sabila Industrial
Plants on Leased Land dated April 20, 1999
(incorporated herein by reference to Exhibit 10.1
to Carrington's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1999).
10.47 Exclusive Sales and Trademark Agreement dated June
11, 1999, between Caraloe, Inc. and Nutra Vine
(incorporated herein by reference to Exhibit 10.1
to Carrington's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1999).
10.48 Lease Agreement dated September 23, 1999 between
Rancho Aloe and Sabila Industrial, S.A.
(incorporated herein by reference to Exhibit 10.1
to Carrington's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1999).
10.49 Letter Agreement dated September 29, 1999 between
Aloe Commodities International, Inc. and Carrington
Laboratories, Inc. (incorporated herein by
reference to Exhibit 10.1 to Carrington's Quarterly
Report on Form 10-Q for the quarter ended September
30, 1999).
10.50 Sales Distribution Agreement dated October 26,
1999. between Carrington Laboratories, Inc. and E-
Wha International, Inc. (incorporated by reference
to Exhibit 10.78 to Carrington's 1999 Annual Report
on Form 10-K).
10.51 Supplier Agreement dated August 6, 1999 between
Novation, LLC and Carrington Laboratories, Inc. MS
91022 (incorporated by reference to Exhibit 10.80
to Carrington's 1999 Annual Report on Form 10-K).
10.52 Supplier Agreement dated August 6, 1999 between
Novation, LLC and Carrington Laboratories, Inc. MS
91032 (incorporated by reference to Exhibit 10.81
to Carrington's 1999 Annual Report on Form 10-K).
10.53 Distributor and License Agreement dated November 3,
2000 between Carrington Laboratories, Inc. and
Medline Industries, Inc. (Exhibits A, B and C to
this agreement have been excluded pursuant to a
request for confidential treatment submitted by the
registrant to the Securities and Exchange
Commission)(incorporated by reference to Exhibit
10.82 to Carrington's 1999 Annual Report on Form
10-K).
10.54 Supply Agreement dated November 3, 2000 between
Carrington Laboratories, Inc. and Medline
Industries, Inc. (Exhibit A to this agreement has
been excluded pursuant to a request for
confidential treatment submitted by the registrant
to the Securities and Exchange Commission,
(incorporated by reference to Exhibit 10.83 to
Carrington's 1999 Annual Report on Form 10-K).
10.55 Lease Agreement dated January 22, 2001 between
Plazamerica, Inc and Carrington Laboratories, Inc.
10.56 + Employee Stock Purchase Plan of Carrington
Laboratories, Inc., as amended through May 17, 2001
(incorporated by reference to Exhibit 10.1 to
Carrington's Quarterly Report on Form 10-Q for the
quarter ended June 30, 2001).
10.57 + 1995 Stock Option Plan of Carrington Laboratories,
Inc., As Amended and Restated Effective January 15,
1998 and further amended through May 17, 2001
(incorporated by reference to Exhibit 10.2 to
Carrington's Quarterly Report on Form 10-Q for the
quarter ended June 30, 2001).
10.58 + Employee Stock Purchase Plan of Carrington
Laboratories, Inc., as amended through November 15,
2001 (incorporated by reference to Exhibit 10.87,
filed on Carrington's Form 8-K on March 20, 2002).
10.59 Lease Agreement dated February 28, 2003 between
Maintenance Warehouse/America Corp and Carrington
Laboratories, Inc. (incorporated by reference to
Exhibit 10.59, filed on Carrington's Form 10-K on
March 31, 2003).
21.1 * Subsidiaries of Carrington
23.1 * Consent of Grant Thornton, LLP
23.2 * Consent of Ernst & Young, LLP
31.1 * Certification of Chief Executive Officer Required
by Rule 13a-14(a)(17 CFR 240.13a-14(a).
31.2 * Certification of Chief Financial Officer Required
by Rule 13a-14(a)(17 CFR 240.13a-14(a).
32.1 * Certification of Chief Executive Officer Pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 * Certification of Chief Financial Officer Pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
* Filed herewith.
+ Management contract or compensatory plan.