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FORM 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended: December 31, 2001
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission File No. 0-21015
CELL TECH INTERNATIONAL INCORPORATED
(Exact Name of Registrant as Specified in its Charter)
Delaware 22-3345046
(State or other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
565 Century Court
KLAMATH FALLS, OREGON 97601
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, including Area Code: (541) 882-5406
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, Par Value $0.01 per Share
(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 |_| No |X|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of 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. |_|
State the aggregate market value of the voting stock held by non-affiliates of
the registrant. The aggregate market value shall be computed by reference to the
price at which the stock was sold, or the average bid and asked prices of such
stock, as of a specified date within 60 days prior to the date of filing. The
aggregate market value of the 800,000 shares of registrant's voting stock held
by non-affiliates of the registrant was $240,000 as of May 14, 2002, based on
the closing price of the registrant's common stock on the National Quotation
Bureau's Pink Sheets or $0.30 per share.
The number of shares outstanding of the registrant's sole class of common stock,
par value $0.01 per share, as of May 14, 2002, the latest practicable date, was
10,640,895.
DOCUMENTS INCORPORATED BY REFERENCE
None.
CELL TECH INTERNATIONAL INCORPORATED
FORM 10-K ANNUAL REPORT
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
TABLE OF CONTENTS
CELL TECH INTERNATIONAL INCORPORATED ............................................................... I
PART I ............................................................................................. 2
ITEM 1. BUSINESS 2
ITEM 2. PROPERTIES 20
ITEM 3. LEGAL PROCEEDINGS 20
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 22
PART II ............................................................................................ 23
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 23
ITEM 6. SELECTED FINANCIAL DATA 25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION 27
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 39
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 40
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 40
PART III ........................................................................................... 41
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 41
ITEM 11. EXECUTIVE COMPENSATION 43
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 49
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 50
PART IV ............................................................................................ 51
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K 51
SIGNATURES ......................................................................................... 57
i
Special Note Regarding Forward-Looking Statements
Some of our statements under "Business," "Properties," "Legal
Proceedings," "Management's Discussion and Analysis of Financial Condition and
Results of Operations," "Quantitative and Qualitative Disclosures about Market
Risk," the Notes to Consolidated Financial Statements and elsewhere in this
report constitute "forward-looking statements" within the meaning of Section 27A
of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934. These statements are subject to certain events, risks and uncertainties
that may be outside our control. Some of these forward-looking statements
include statements of:
o management's plans, objectives and budgets for its future operations
and future economic performance;
o capital budget and future capital requirements;
o meeting future capital needs;
o realization of any deferred tax assets;
o the level of future expenditures;
o impact of foreign currency translations;
o impact of recent accounting pronouncements;
o the outcome of regulatory and litigation matters; and
o the assumptions described in this report underlying such
forward-looking statements.
Actual results and developments may materially differ from those expressed
in or implied by such statements due to a number of factors, including:
o those described in the context of such forward-looking statements;
o future product development and manufacturing costs;
o changes in our incentive plans;
o timely development and acceptance of new products;
o the markets of our domestic and international operations;
o the impact of competitive products and pricing;
o the political, social and economic climate in which we conduct
operations; and
o the risk factors described in other documents and reports filed with
the Securities and Exchange Commission.
In some cases, forward-looking statements are identified by terminology
such as "may," "will," "should," "could," "would," "expects," "plans,"
"intends," "anticipates," "believes," "estimates," "approximates," "predicts,"
"potential" or "continue" or the negative of such terms and other comparable
terminology.
Although we believe that the expectations reflected in these
forward-looking statements are reasonable, it cannot guarantee future results,
levels of activity, performance or achievements. Moreover, neither we nor anyone
else assumes responsibility for the accuracy and completeness of such statements
and is under no duty to update any of the forward-looking statements after the
date of this report.
1
PART I
ITEM 1. BUSINESS.
Overview
We are a network marketing company and we develop and distribute a wide
range of products made with Aphanizomenon flos-aquae (trade name Super Blue
Green(R) Algae) ("SBGA") and other nutrients and ingredients through a network
of independent distributors ("Distributors"). We currently offer twenty
different products intended to appeal to health-conscious consumers. Our
products are divided into five product lines including Daily Health Maintenance,
Digestive Health, Defensive Health, Powdered Drinks and Snacks, and Animal and
Plant Food.
We harvest SBGA and manufacture most of our products at our modern
production facilities in Klamath Falls, Oregon. We market our products through
independent Distributors located in all fifty states, the District of Columbia,
Guam, Puerto Rico, American Samoa, the Virgin Islands and Canada. We encourage
our Distributors to recruit interested people as new Distributors for our
products. These recruits are placed beneath the recruiting Distributor in the
"network" and are referred to as the distributor's "downline" or "network."
Distributors earn commissions on sales by their organizations as well as retail
profits on the sales they generate directly. We assist Distributors in
establishing their own businesses and provide support programs such as audio and
videotapes for training, empowerment teams, seminars and an annual convention
called the August Celebration.
We are currently considering establishing additional channels of
distribution, such as marketing to TV viewers through infomercials. On May 18,
2001, we began airing a limited number of infomercials, on a test basis, as an
additional marketing and distribution method and discontinued them on July 1,
2001, until we can obtain additional financing. This additional distribution
method could appear to create conflicts with our Distributors that could result
in the loss of many of our Distributors, which in turn would mean a decline in
our sales volume and would be detrimental to our business and result in losses
from our operations; however, our tests results, and the responses that we have
received from Distributors, indicate that there are no conflicts with our
present distribution methods. Although we anticipate the sales from the
additional channels of distribution, we cannot predict if these sales will
offset any losses from our existing distribution methods.
History and Organization
Unless otherwise specifically stated, references to "we" and "us" in this
Form 10-K (the "Report") refer: (a) for periods prior to the Reorganization, to
the historical operations of HumaScan and (b) for periods following the
Reorganization, to the operations of Cell Tech International Incorporated,
including its wholly owned subsidiaries NEC and NAC.
We were formed under the name "HumaScan Inc." in 1994 to manufacture and
market in the United States and Canada a device called the BreastAlert(TM)
Differential Temperature Sensor, a non-invasive, easy to use, adjunctive test
for use as part of a breast disease monitoring program (the "BreastAlert
Device"). We commenced shipments of the BreastAlert Device in December
2
1997. In November 1998, we announced that we were in the process of evaluating
various strategic alternatives, as we did not have adequate resources for the
completion of clinical trials and marketing of the BreastAlert Device. Before
the end of 1998, as a result of the lack of adequate financing, we terminated
all employees and suspended all operations, focusing substantially all of our
efforts on obtaining new financing and/or restructuring the business. The Board
of Directors then entered into consulting agreements with three former key
employees to negotiate settlement agreements with Scantek Medical, Inc.
("Scantek") to terminate the license agreement and negotiate settlements with
other creditors, and explore the possibilities for restructuring and/or
reorganizing the business.
In March 1999, we concluded a settlement agreement with Scantek that
terminated the license for the technology used in the BreastAlert Device.
Certain assets related to the licensed business were transferred to Scantek and
additional shares of common stock were issued to Scantek and an affiliated
company as consideration for release of all obligations concerning the license
agreement and equipment supply agreements. We also received a cash payment from
Scantek, which was applied to some of our other outstanding obligations.
On July 16, 1999, we entered into an Agreement and Plan of Reorganization
(the "Reorganization Agreement") with Daryl J. Kollman and Marta C. Kollman (the
"Kollmans"). The Reorganization Agreement provided for the exchange ("Exchange")
of all the outstanding shares of The New Earth Company, Inc. ("NEC") and The New
Algae Company, Inc. ("NAC") for shares of our common stock and preferred stock
that together represented, on August 6, 1999, approximately 92% of our
outstanding common stock (including the common stock issuable upon conversion of
the preferred stock). The reorganization was completed on August 6, 1999. On
August 10, 1999, we changed our name to Cell Tech International Incorporated.
Cell Tech, Inc. and NEC were formed in 1982 and 1988, respectively, to
develop and distribute products made from a unique natural strain of blue green
algae growing in massive quantities in Upper Klamath Lake in southern Oregon -
the algae we now call SBGA. In 1990, NAC was formed and acquired the assets of
Cell Tech, Inc. and began doing business under the trade name Cell Tech. Through
1999, NAC housed the sales organization, and provided the research and
development and administrative functions of our business, while NEC handled the
harvesting and manufacturing of our products. Beginning in 2000, NAC took over
these functions and NEC became inactive.
Executive Offices
Our principal executive offices are located at 565 Century Court, Klamath
Falls, Oregon 97601; our telephone number at that address is (541) 882-5406; and
our internet address is www.celltech.com.
Industry Overview
According to Nutrition Business Journal, the global nutrition industry was
a $140 billion industry in 2000, of which $50 billion related to the United
States. The Nutrition Business Journal believes the nutrition industry, which
includes vitamins, minerals, herbs and botanicals, sports performance, organic
food, personal care and functional foods may be stabilizing; however, the
Nutrition Business Journal currently predicts the industry will continue to grow
between 4% to 6% annually through 2004. The Nutrition Business Journal also
indicates that the
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total domestic retail sales of nutritional supplements - including vitamins,
herbs/botanicals, sports nutrition minerals and meal supplements - during 2000
were approximately $16.7 billion. According to Packaged Facts, the nutrition
industry (which includes supplements) has grown at a 15% compounded annual rate
for the last four years and is expected to grow at a 13% compounded annual rate
from 1998 to 2003. According to Packaged Facts, this growth stems from the
passage of the Dietary Supplement and Health Education Act of 1994, a growing
body of scientific research showing the benefits of vitamins, the introduction
of new types of nutritional supplements, increased consumer interest in
nutritional and alternative medicine and changing attitudes within the medical
community. We believe, however, based on informal discussions with industry
professionals and our own experience that this rate of growth will decline in
2002.
The primary distribution channels in the nutritional supplements industry
consist of mass-market retailers (including mass merchandisers, drug stores,
supermarkets, discount and convenience stores), health and natural food stores,
direct sales and mail order organizations, practitioners and the Internet.
Retail is the largest of these channels, accounting for 84% of sales during
2000, according to Nutrition Business Journal. The retail channel includes food
stores, drugstores, mass merchandisers and health/natural food stores. Direct
selling accounted for 16% of sales during 2000.
The Nutrition Business Journal also reports that the potential for natural
and healthier products to penetrate mainstream product categories looks
promising--and is still largely untapped. Dietary supplements sales of $16.7
billion are less than 10% of over-the-counter medicine and prescription drug
sales. Natural and organic food sales of $11.8 billion represent barely 2% of
the U.S. food industry (only 1.5% when food service is included). Functional
foods sales at $17.2 billion, even when broadly defined as manufactured foods
with any ingredient added specifically for health purposes, still account for
only 3.5% of the U.S. food industry. Natural personal care products, even more
loosely and broadly defined than natural food, had sales of $3.6 billion in 2000
and are just 10% of total health & beauty care spending. The $50 billion
nutrition industry accounted for just 7% of the $680 billion food, medicine,
health and personal care products market in the United States in 2000.
The international nutritional supplement market is more fragmented than
the domestic market. As a result, industry data is not readily available.
However, many of the demographic and other trends and events present in the
domestic market are also present in the international market.
Growth Strategy
Public awareness of the positive effects of nutritional supplements on
health has been heightened in the last several years by widely publicized
reports and medical research findings indicating a correlation between the
consumption of nutrients and the reduced incidence of certain diseases. The
United States government and universities generally have increased sponsorship
of research relating to nutritional supplements. For example, Congress has
established an Office of Alternative Medicine and an Office of Dietary
Supplements within the National Institutes of Health to foster research into
alternative medical treatment modalities and the role of dietary supplements in
maintaining health and preventing disease, respectively. However, according to a
published report by Grant Ferrier, the editor and publisher of the
4
Nutrition Business Journal in the March 2002 issue of Functional Foods and
Nutriceuticals, nutritional supplement sales have been and may continue to be
affected by questions about the efficiency and safety of such supplements.
We believe that the aging of the United States population, together with a
corresponding increased focus on preventative health care measures, will
continue to result in increased demand for certain nutritional supplement
products despite negative publicity of the type described in the Ferrier
article. According to the United States Bureau of the Census, the 35-and-older
age group of consumers, which represents a large majority of the regular users
of vitamin and mineral supplements, is projected to grow significantly faster
than the general United States population through 2010.
Our growth strategy is to capitalize on the increased interest in
nutritional supplements described above by increasing product sales through
existing distribution channels in the U.S. and Canada and expanding into new
markets. In particular, we believe that we may realize our growth by achieving
the following:
o We will introduce new products complementary to our current product
lines. Our product development strategy is to expand our existing
product lines to complement our current products. We will rely on
our own on-going research and development and results of university
research on the indications on human health of SBGA consumption. We
have introduced two new products, BG Bar and NaturaLight, and are
actively working on introducing additional products.
o We intend to introduce alternative distribution channels through
infomercials. Our ability to establish distribution through
infomercials will be dependent upon our ability to increase our
working capital in order to pay for the costs associated with
infomercials. Our product distribution strategy is to provide
complementary marketing methods for our Distributors. On May 18,
2001 we began airing a limited number of infomercials, on a test
basis, as an additional marketing and distribution method and
discontinued them on July 1, 2001.
o We have introduced a revised compensation plan and other promotion
and recognition programs to provide additional incentives to our
Distributors. Our ability to increase sales is significantly
dependent on our ability to attract, motivate and retain
Distributors. We utilize an innovative marketing program that we
believe is competitive with programs offered by many other network
marketing companies. This program provides financial incentives,
including several forms of commission (bonus), optional Distributor
training and support, no sign-up costs, inventory requirements, and
low monthly purchase requirements. We intend to reach potential new
Distributors through increased advertising, teleconferencing and
regional sales and training meetings. Successful management of
Distributors supports the marketing of products as well as the
recruitment of new Distributors.
o We intend to tackle international markets by entering into marketing
distribution agreements for Europe and Asia. We believe that growth
potential exists in international markets and will seek to enter
into international distribution agreements.
o We intend to engage government relations personnel to assist our
international expansion. We will engage government relations
personnel throughout the world who will take a systematic, proactive
approach to working with government and licensing
5
agencies in new markets to ensure that our products and distribution
model are in compliance with all local laws and regulations. We will
utilize outside market consultants and work with private
organizations throughout the world to prepare for introducing our
products in diverse markets.
o We intend to seek to enter into agreements and joint ventures with
strategic partners. We believe that opportunities exist with various
strategic partners that may improve our ability to market and
distribute our products, enter into new markets and provide our
Distributors with new products that complement our existing product
lines.
Product Overview
Our product line consists primarily of consumable products that are
targeted to those consumers with an interest in natural alternatives for health
and nutrition. In developing our product line, we have emphasized quality,
purity, potency, and safety. We offer a line of approximately twenty products
that can be divided into five categories, including Daily Health Maintenance,
Digestive Health, Defensive Health, Powdered Drinks and Snacks, and Animal and
Plant Food, as further described below the chart.
The following chart lists our products and the categories targeted by
each, as of April 30, 2002:
- --------------------------------------------------------------------------------------------------------------------
Daily Health Digestive Defensive Powered Drinks Animal and
Maintenance Health Health and Snacks Plant Food
- --------------------------------------------------------------------------------------------------------------------
Super Blue Green(R) Alpha Sun(R) X X
- --------------------------------------------------------------------------------------------------------------------
Super Blue Green(R) Omega Sun(R) X X
- --------------------------------------------------------------------------------------------------------------------
Acidolphilus X
- --------------------------------------------------------------------------------------------------------------------
Bifudus X
- --------------------------------------------------------------------------------------------------------------------
Spectrabiotic(R) X
- --------------------------------------------------------------------------------------------------------------------
Internal Cleansing System X
- --------------------------------------------------------------------------------------------------------------------
Super Blue Green(R) Enzyme X
- --------------------------------------------------------------------------------------------------------------------
SBG Anytime X X X
- --------------------------------------------------------------------------------------------------------------------
Super Q10 X X X
- --------------------------------------------------------------------------------------------------------------------
Super Sprouts & Algae X X
- --------------------------------------------------------------------------------------------------------------------
Alpha Gold Promoting Physical Well-being X X
- --------------------------------------------------------------------------------------------------------------------
Omega Gold Enhancing Mental Well-being X X
- --------------------------------------------------------------------------------------------------------------------
Super Sun Smoothies X
- --------------------------------------------------------------------------------------------------------------------
Mazama Mix X
- --------------------------------------------------------------------------------------------------------------------
Cell Tech Essentials X X X
- --------------------------------------------------------------------------------------------------------------------
Super Blue Green(R) Animal Food X
- --------------------------------------------------------------------------------------------------------------------
NaturaLight X
- --------------------------------------------------------------------------------------------------------------------
BG Bar X X X X
- --------------------------------------------------------------------------------------------------------------------
PLANeT Food(R) X
- --------------------------------------------------------------------------------------------------------------------
Animal Algae X
- --------------------------------------------------------------------------------------------------------------------
6
Daily Health Maintenance
o Super Blue Green(R) Alpha Sun(R) Energy for the Entire Body. Alpha
Sun(R) is whole, complete algae. Because its cell walls contain a
high percentage of floridan starch, it provides natural sugars
critical to the health and vitality of tissues and cells. Alpha
Sun(R) also contains high concentrations of easily assimilated vital
minerals. It is available in capsules and tablets.
o Super Blue Green(R) Omega Sun(R) Energy for the Mind. Omega Sun(R)
is the heart of the algae with the cell wall carefully removed
through a special separation process. This super-concentrated food
contains a higher overall amino acid content than Alpha Sun(R). It
is a source of raw materials for building the neuro-peptides
associated with brain activity. It is available in capsules and
tablets.
o Cell Tech Essentials. Cell Tech Essentials, named for our most
essential products, is a repackaging of them. It attains a new level
of convenience and effectiveness and, at $40.00 per bag, a new level
of value. Each bag contains 30 packets and each packet contains the
following capsules: one Alpha Sun(R), one Omega Sun(R), one
Acidophilus, one Bifidus, and two Enzymes.
o NaturaLight. NaturaLight is a herbal supplement designed to work
with the metabolism to help users reach their weight loss goals.
Formulated with enzymes, botanicals, and other complementary
ingredients, this product works with user's metabolisms to help them
reach their weight loss goals. We believe that this herbal
supplement can be used exclusively, or used in concert with any
other weight loss program. We believe that, combined with proper
diet and exercise, NaturaLight can help reduce cravings, increase
energy, and improve mental clarity and attitude. The goal of this
new product is to help the body reduce fat and lose weight while
maintaining lean muscle mass. It is available in capsules.
o BG Bar. BG Bar is a food bar made with quality organic ingredients,
fortified with sprouted grains, greens, and Super Blue Green
Algae(R). It has an almond butter texture with minced almonds on
top. We believe that consumers will find it attractive and a useful
source of nutrition. Each bar weighs 56 grams.
Digestive Health
o Acidophilus. Acidophilus (Lactobacillus acidophilus) is the first of
our probiotic products and operates in the small intestine. Without
proper cleansing, the small intestine can fill with wastes and
harmful by-products that impair natural digestive functions. Our
Acidophilus helps process food quickly and eliminate waste. It is a
single-strain beneficial bacteria called DDS-1a Acidophilus, which
helps keep harmful bacteria out by colonizing the walls of the small
intestine and by secreting substances that prevent the growth of
unfriendly bacteria. Each capsule is carefully micro blended with 85
milligrams of Super Blue Green(R) Omega Sun(R) Algae.
o Bifidus. Bifidus (Bifidobacterium bifidum) is the second of our
probiotic products. While Acidophilus serves the small intestine,
Bifidus is for the large intestine. The large intestine absorbs the
water from food and passes the remaining waste out of the body. A
good intestinal flora in the large intestine can help prevent gas,
bloating and diarrhea. Our Bifidus helps repopulate the large
intestine with friendly bacteria, restoring the healthful
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environment it needs to do its job well. Each capsule is micro
blended with 85 milligrams of Super Blue Green(R) Omega Sun(R)
Algae.
o Spectrabiotic(R). Spectrabiotic(R) is designed to complement
Acidophilus and Bifidus in providing a complete system for building
and maintaining healthy intestinal flora. In the Spectrabiotic(R)
formula, eight key "good bacteria" are micro blended with 85
milligrams of Super Blue Green(R) Omega Sun(R) Algae, providing the
entire digestive tract with probiotic support, especially when
combined with a regular program of Acidophilus and Bifidus.
Spectrabiotic(R) also contains Jerusalem artichoke, acerola, and
rose hips.
o Internal Cleansing System. The New Seasons Cleansing System is a
two-product program that is designed to assist the body's natural
elimination systems. The Herbal Formula supports the processes that
remove toxins from the tissues of the body; then the Fiber Formula
helps the body eliminate those toxins.
o Super Blue Green(R) Enzymes. Our Super Blue Green(R) Enzymes
contains a full range of food enzymes to help break down all types
of foods, including fats, carbohydrates, protein and fiber. Super
Blue Green(R) Enzymes is micro blended with 25 milligrams of Alpha
Sun(R), adding specific vitamins and minerals many enzymes need for
optimum functioning.
o Super Sprouts & Algae. Super Sprouts & Algae is a unique product
combining the nutritional benefits of three "superfoods" from three
natural environments -- land, lake and sea: a super concentration of
custom-grown wheat sprouts; Super Blue Green(R) Alpha Sun(R) Algae;
and Super Red Beta Algae (Dunaleilla salina), a strain of marine
algae. These three superfoods together supply the body with
antioxidant nutrition to neutralize the effects of highly unstable,
reactive molecules known as free radicals. Two tablets of Super
Sprouts & Algae provide over 100% of the RDA for vitamin A. Each
tablet contains 540 milligrams of wheat sprouts, 60 milligrams of
Super Blue Green(R) Alpha Sun(R) Algae and 25 milligrams of Super
Red Beta Algae.
o Super Q10. Super Q10 contains Super Blue Green(R) Alpha Sun and a
special enzyme enhancer called coenzyme Q10. This nutrient has been
shown to be beneficial for functioning of the heart, muscles, and
the nervous and immune systems. It is especially important in
helping the mitochondria, or powerhouses of cells, to generate
energy. Super Q10 is a synergistic combination of pure premium
coenzyme Q10 with 85 milligrams of Super Blue Green(R) Alpha Sun(R)
Algae and is a way to assist cells in converting nutrients into
energy.
Defensive Health
o Alpha Gold. Promoting Physical Well-being. Alpha Gold contains a
carefully chosen group of ingredients, each with documented health
benefits, that works synergistically with Super Blue Green(R) Algae
to facilitate overall good health. Alpha Gold contains bee pollen to
increase stamina, vitality and athletic performance; noni to help
stimulate the immune system; turmeric to help protect against
environmental contaminants; and gluten-free sprouted wheat grass
juice, which contributes a variety of assimilative enzymes. This
product is available in capsules or powder.
o Omega Gold. Enhancing Mental Well-being. In addition to the
ingredients found in Alpha Gold, Omega Gold also contains ginkgo
biloba, which increases circulation to the brain and has effects
upon memory, clarity and mental alertness. Siberian ginseng is added
to stimulate both mental and physical performance. This product is
available in capsules or powder.
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Powdered Drinks and Snacks
o Super Sun Smoothies. Super Sun Smoothies are all-vegetable powder
shake mixes. We make Super Sun Smoothies with premium ingredients
that are dairy free and contain no preservatives, yeast artificial
flavorings or colorings. They also provide the "superfood" benefits
of 500 milligrams of Super Blue Green(R) Alpha Sun(R) and 500
milligrams of Omega Sun(R) Algae blended into every scoop.
o Mazama Mix. Mazama Mix is a nutrient-rich green drink derived from
all-natural whole food sources. It contains minerals and trace
minerals that we believe are essential for the proper functioning of
the body. This product is designed to help enhance overall health,
vitality and energy levels.
Animal and Plant Food
o Super Blue Green(R) Animal Food. Super Blue Green(R) Animal Food is
a blend of coarse-grade Alpha Sun(R) and Omega Sun(R) Algae,
providing the fundamental building blocks for strengthening the
immune system of animals. The broad spectrum of organic minerals,
vitamins, amino acids, enzymes and the supply of beta carotene and
chlorophyll found in Super Blue Green(R) Algae is readily absorbed
by animals. Super Blue Green(R) Animal Food is sprinkled over the
pets' food.
o PLANeT FOOD(R). PLANeT FOOD(R) is designed to add trace minerals and
other components to soils. It is a mixture of volcanic rock dust
from Colorado and algae from Klamath Lake and is sold for use on
potted plants, lawns, gardens, and trees and for composting.
The Food and Drug Administration has not evaluated these statements. These
products are not intended to diagnose, treat, cure, or prevent any disease.
Distributors and Our Network Marketing System
Our products are distributed through a network marketing system of
Distributors. Distributors are independent contractors who purchase products
directly from us for resale to retail consumers. Distributors may elect to work
on a full-time or a part-time basis. We believe that our network marketing
system is well suited to marketing our nutritional supplements and other
products because sales of such products are strengthened by ongoing personal
contact between retail consumers and Distributors, most of whom use our
products. Currently, we have Distributors in all fifty states, the District of
Columbia, Guam, Puerto Rico, American Samoa, Virgin Islands and Canada.
Each Distributor has the opportunity to sponsor additional Distributors,
which can enhance the original Distributor's income, as described below. Each
new Distributor that is sponsored, as well as his or her own "downline" groups,
becomes a member of the Distributor's network or "downline."
Commission System
We currently offer two categories of membership. The first category is
called a "Distributor" and the other is called a "Preferred Customer."
Distributors are interested in receiving commissions for their own purchases as
well as for purchases made by members enrolled in their "downline." A Preferred
Customer ("PC") is a customer who is interested in consuming our products, but
is not interested in the business opportunity we offer to our
9
Distributors. Many PCs eventually become Distributors. Both categories of
membership purchase our products at wholesale prices.
Distributors are compensated through a Distributor commission system that
encourages both retail selling and sales organization management. Distributors
may derive income from several sources. First, Distributors may receive revenues
by purchasing our products at wholesale prices and selling them to customers at
retail prices. Second, Distributors earn the right to receive bonuses
(commissions) based upon purchases by members of their "downline" or sales
marketing organization. Each new Distributor that a Distributor sponsors becomes
a member of his selling organization or "downline." The Distributors that a
Distributor directly sponsors are referred to as his "first generation" or
"first level."
In January 2001, we revised our commission system to better suit our
long-term growth objectives of attracting new Distributors and appropriately
rewarding the Distributors that work to increase their business with us. Our
goal was to redistribute our commission expense to those Distributors who
demonstrate to us that they are actively contributing to our growth. While we
believe that we have designed a commission system that is suited to achieve
these goals, our overall commission expense increased as a result of the revised
plan. Therefore, we have revised our commission system to continue to meet our
growth objectives while reducing our overall commission expense. The changes to
our system, which will take effect in June 2002, are as follows:
o The Personal Volume percentage paid to Members will be reduced to 5%
from 10%. This change will not affect titles above Member. Once a
Member reaches the title of Representative, the commission on
Personal Volume will be 15% and 5% on any volume of Members in the
Representative's network.
o Generation 4, 5, and 6 payout percentages will be reduced to 3%, 2%,
and 1% from 4%, 3%, and 2%, respectively. The titles of Amethyst,
Ruby and Sapphire will not be affected by this change.
The first level is "Member" and the highest level is "Executive."
Distributors may attain "Member" status by purchasing any product from Cell
Tech. There are two intermediary levels between Member and Executive:
Representative and Leader. A Distributor achieves higher levels in the bonus
structure primarily through increased purchases by Distributors sponsored
directly by them (their first level) and in their personal group. The
requirements for a Distributor to reach the first "Executive" level are monthly
personal purchases of at least $100 and monthly group volume of $500. For each
"Executive" level attained thereafter, the Distributor must maintain monthly
personal purchases of at least $100 and monthly group volume of at least $500.
The program is such that each month a Distributor must qualify at that level to
be paid at that level. The advantage to this is that the Distributors must
remain active in purchasing and sponsoring to retain their bonuses, but if they
do not qualify in a certain month, their income is only reduced that one month.
The Distributor commission system includes three kinds of bonuses, as
described below:
Standard Bonus. The standard bonus is available to any Distributor who has
an "active" status with us. Distributors may attain the title of "Assistant
Leader" by purchasing a minimum
10
of $50 of products in a month. The percentages used to determine the bonus and
the number of levels in the organization the Distributor receives bonuses upon
is based on the individual's title with us. The standard bonus grants rebates to
the Distributor as he consumes and sells our products to others.
Executive Generation Bonus. A second form of bonus is available to those
who have Executives in their downline. Based on the number of "Executives" they
have at each level, and assuming certain minimum personal purchases each month,
Distributors receive a percentage of such Executives' standard bonus as an
additional bonus.
Blue-Green Diamond Bonus. Finally, those Executives attaining the highest
levels in our structure are eligible to receive an additional bonus called the
"Blue-Green Diamond Bonus" which is a percentage of the gross commissionable
sales volume for the year.
We believe that the opportunity of Distributors to earn bonuses
contributes significantly to our ability to retain our productive Distributors.
The Distributor commission system encourages promotion to higher commission
levels by enabling Distributors to earn commissions on a deeper sales base
(i.e., more levels of their organization). We believe that this will encourage
sponsoring growth (depth) in an organization and not just acquiring customers
personally.
To become a Distributor, a person must simply sign an agreement to comply
with our policies and procedures. No investment is necessary to become a
Distributor. We consider, as of March 31, 2002, approximately 46,000 of our
Distributors to be "active," that is, an individual Distributor who has ordered
at least $50 of our products during the preceding six-month period.
Training
We support opportunity meetings in various key cities and participate in
motivational and training events in various market areas, designed to inform
prospective and existing Distributors about our product line and selling
techniques. Distributors give presentations relating to their experiences with
our products and the methods by which they have developed their own organization
of Distributors. Motivation is offered to participants in the form of
recognition, promotions, excursions and tours, which are intended to foster an
atmosphere of excitement throughout the Distributor organization. Prospective
Distributors are educated about the structure, dynamics and benefits of our
network marketing system.
We continually develop marketing strategies and programs to motivate
Distributors. These programs are designed to increase Distributors' monthly
product sales and the recruiting of new Distributors.
Distributor Support
As part of our program to maintain constant communication with our
Distributor network, we offer the following support programs to our
Distributors:
o Associations/Teams/Advisory Board. Several associations and teams
support Distributors' efforts, including the Leadership Alliance, an
association of those
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Distributors having reached the top levels of our Marketing Plan,
which was formed in order to allow interaction among the Network's
"top level" group for discussion of business issues, development of
solutions and methods to improve the sales success and growth of
downlines and the Network as a whole. In addition, the Field
Advisory Board is an advisory team representing the entire field
organization and brings issues, recommendations, and other ideas to
us for discussion. The Field Advisory Board participates in
bi-monthly teleconferences with our marketing and operations
executives.
o August Celebration. For the past thirteen years, we have sponsored
and held the August Celebration, which is our annual convention.
o Ordering Support. We offer a variety of methods to order product and
support materials, including toll-free telephone operator access,
"Order Express" (a toll-free automated telephone system that
Distributors can call 24 hours a day to place orders or to access
their records), and our website at http://www.celltech.com.
o Information Support. Distributors may learn more about our products,
our history, distributor organization building, management
techniques and related matters through our website. In addition, we
produce color catalogues and brochures for our Distributors and
produce a monthly publication called "Networker's Edge" focused on
business building. We also maintain our ATG Technologies Voice Mail
System, which includes options for broadcasting messages to our
Distributors via temporary, permanent and super groups. A direct
access telephone line allows Distributors to access our most recent
announcements sent through the ATG Technologies System to our
Network. Finally, a 24-hour toll-free "Fax-on-Demand" system
provides Distributors with news bulletins, product literature and
articles of interest via facsimile.
Research and Development
We spent approximately $190,884 on research and development in 2001,
$456,098 in 2000 and $1,453,371 in 1999. We continually seek to identify,
develop and introduce innovative, effective and safe products. Twelve products
have been introduced since 1997. Management believes that our ability to
introduce new products increases our Distributors' product visibility and
competitiveness in the marketplace. We also continuously evaluate "existing"
products for viability and it is our policy to discontinue products that are not
selling satisfactorily.
New product ideas are derived from a number of sources, including trade
publications, scientific and health journals, management, independent
consultants, and our sponsored university research projects. We maintain our own
quality assurance/quality control staff, consisting of two full time employees
as of March 31, 2002 and December 31, 2001, but rely upon independent research,
consultants and others for ingredient research, development and formulation
services. When we identify a new product concept or when an existing product
must be reformulated for introduction into a new or existing market, the new
product concept or reformulation is generally submitted to our suppliers for
technological development and implementation. In addition, prior to introducing
products into our markets, our scientific consultants, legal counsel and other
representatives investigate product formulation matters as they relate to
regulatory compliance and other issues.
In 2001, we began formulating and testing two new products, NaturaLight
and the BG Bar, designed to compliment our existing product line and began
selling them to our Distributors in February 2002 and March 2002, respectively.
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NaturaLight. NaturaLight is an herbal supplement designed to work with the
metabolism to help users reach their weight loss goals. We formulate it with
enzymes, botanicals, and other complementary ingredients and we believe that it
works with a user's metabolism to assist them achieve their weight loss goals.
We believe that a consumer can use this herbal supplement exclusively, or used
in combination with any other weight loss program. Combined with proper diet and
exercise, NaturaLight can help reduce cravings, increase energy, and improve
mental clarity and attitude. The goal of this new product is to help the body
reduce fat and lose weight while maintaining lean muscle mass and is available
in capsules.
BG Bar. BG Bar is a food bar made with quality organic ingredients,
fortified with sprouted grains, greens, and Super Blue Green Algae(R). It has an
almond butter texture with minced almonds on top. We believe that consumers will
find it attractive and a useful source of nutrition. Each bar weighs 56 grams.
We are currently considering some additional products including new
antioxidant, weight management, and energy products. In addition to the
introduction of single products, we are also focusing on promoting groups of
products to be taken in conjunction with each other to address the specific
needs an individual may have (such as weight loss, stress or daily wellness).
Product Warranties and Returns
Our product warranties and policy regarding returns of products are
similar to those of other companies in our industry. Any consumer, who is not
satisfied with any of our products, may return it to the Distributor from whom
they purchased it from within 90 days of their purchase. The Distributor is
required to refund the purchase price to the consumer. The Distributor may then
return the unused portion of the product to us for an exchange of equal value.
If a Distributor requests a refund in lieu of an exchange, we will issue a check
or credit the appropriate amount to the Distributor's credit card.
We warrant all of our products against defect.
Raw Materials and Suppliers
Our primary raw material is Aphanizomenon flos-aquae, which we harvest
from Upper Klamath Lake using what we believe is modern technology. Upper
Klamath Lake produces approximately 200 million pounds of SBGA each year. When
we need to harvest, we typically harvest algae once or twice a year, timing our
harvests to coincide with the greatest density of algae.
In 2001, for the first time ever, we began harvesting on Upper Klamath
Lake by the use of an on-lake harvester. As a result of this additional method
of harvesting, we can gather Aphanizomenon flos-aquae directly from the Lake as
well as from the "A" and "C" canals.
This diversification in our harvesting techniques has made harvesting
possible in a drought year when the availability of water in the canals was
nonexistent or questionable, because of the nationally reported water crisis in
the Klamath Basin. As a result of this crisis, the water supply to the
irrigation canals was entirely cut off in the summer of 2001. Subsequent to our
harvest in 2001, the water flow to the canals has been temporarily restored,
however it is impossible to predict the quantity or availability of water to the
canals. We believe that
13
harvesting directly from Upper Klamath Lake with the use of the harvesters is
both cost-effective and provides us with excellent yields, utilizing the new
harvester that we conceived, designed and built. We have applied for a design
patent on our harvester as we believe that the technology utilized with this new
harvest system is effective, special and unique.
Processing of SBGA is a complex process including the following:
o Pre-Screening. We filter fresh algae out of the water with fine mesh
screens.
o Primary Separation. Primary separators remove everything suspended
in the lake water, which concentrates the algae by removing
virtually all extracellular water.
o Freezing. We quickly freeze the algae, converting it into slabs at a
temperature of -30(degree)Fahrenheit.
o Nutri-Lock Freeze-Drying System. We gently remove all cellular water
in a low temperature vacuum environment, converting the algae into a
dry, stable medium that retains vital nutrients.
o Powdering and Bottling. We sift and grind the algae to a fine
powder, which can be encapsulated or tabletized and sealed to retain
freshness and viability.
In years when there has been no harvest, we rely on our freeze-dried and
frozen inventory of SBGA. As of December 31, 2001, we had 994,369 pounds of
frozen algae inventory for use in capsules and tablets and 1,637,534 pounds of
frozen algae for use with vendor products. We had not harvested algae since 1998
due to excess inventory in relation to sales; however, in July 2001, we
commenced harvesting SBGA and in 2002 we plan to acquire additional harvesters
to increase our harvesting capacity for 2002. We believe that our present rate
of inventory consumption only partially reflects the demand that we anticipate
as we implement our growth strategy. Although the availability of new algae that
we may harvest from Upper Klamath Lake may change from year to year, we believe
that our existing inventory is adequate for several years.
We believe that Upper Klamath Lake will provide sufficient SBGA for our
foreseeable needs. However, from time to time a toxic species of algae called
Microcystis aeruginosa blooms in Upper Klamath Lake and contaminates a portion
of our harvest of SBGA with microcystin, a toxin. We have worked with state and
federal agencies to establish prudent safety precautions, and test each batch of
algae we harvest for microcystin levels before releasing it for production. In
July 2001, we began our harvest by utilizing a vessel we designed and built,
that will gather the algae directly from the water on Upper Klamath Lake. We
believe that utilizing this method for 2001 will help us to minimize the amount
of Microcystis aeruginosa in the harvested material, thus increasing the total
amount of algae that we can release for production. Our experts have informed us
that the nutritional quality of our algae does not change significantly as a
result of our harvesting and storage methods.
In addition to the encapsulating and bottling performed in-house, we also
purchase vitamins, nutritional supplements and other products and ingredients
from parties that manufacture such products to our specifications and standards.
During 2001, 2000 and 1999, one vendor supplied approximately 55%, 27% and 23%,
respectively, of the products that we purchased. This vendor was our source of
enzymes and probiotics. We place significant emphasis on quality control. All
nutritional supplements, raw materials and finished products are
14
subject to sample testing, weight testing and purity testing by independent
laboratories. We have written agreements with most of our suppliers and we
intend to implement written agreements with our remaining suppliers in the near
future. In the event of loss of any of our sources of supply, we believe that
suitable replacement sources of similar products and product ingredients exist
and are available to us.
Trademarks and Service Marks
Most products are packaged under our "private label." At December 31,
2001, we have six trademarks registered with the United States Patent and
Trademark Office and one trademark application pending, and three trademarks
registered and one application pending with the Canadian Intellectual Property
Office of Trade Marks. In addition, we have registered trademarks in eleven
foreign countries (and one application pending in a twelfth) for the mark
"Planet Food." While we believe customer identification with our name and brand
is important, we feel that our primary competitive edge arises from our
Distributor network and our strategic location which allows us to process algae
immediately after its harvest, and not from any proprietary technology.
We do not have a registered trademark for the name "Cell Tech." As of the
date of this Annual Report on Form 10-K, no other person has claimed
infringement based on our use of the name "Cell Tech," but there can be no
assurance that such a claim would not be made in the future. A British company
in a different business than ours has a United States trademark registration for
the name "Cell Tech" and it has not objected to our use of the name.
Competition
The nutritional supplements industry is large and intensely competitive.
We compete with other companies that manufacture and market retail nutritional
products to health-conscious consumers, including General Nutrition Companies,
Inc., Solgar Vitamin and Herb Company, Inc., Twinlab Corporation and Weider
Nutrition International, Inc. Many of our competitors in this market have longer
operating histories and greater name recognition and financial resources than
us.
In addition, nutritional supplements can be purchased in a wide variety of
distribution channels. While we believe that many consumers appreciate the
convenience of ordering products from home through a sales person, the buying
habits of many consumers accustomed to purchasing products through traditional
retail channels are difficult to change. We offered our products, on a limited
test basis, via infomercials in May 2001 and suspended them in July 2001 due to
a lack of financial resources. We intend to resume airing infomercials when we
have adequate financial resources. Our product offerings in each product
category are also relatively small compared to the wide variety of products
offered by many other nutritional product companies.
We compete with other companies for the supply of Upper Klamath Lake
algae. However, we are the largest harvester and the only one with access to the
"A" Canal, which along with the Link River, is the only outlet for Upper Klamath
Lake. We also have access to Upper Klamath Lake that is in close proximity to
our freezer facility.
15
We also compete in the nutritional supplements market and for new
Distributors with other retail, multi-level marketing and direct selling
companies in the nutritional supplements industry by emphasizing the proprietary
nature, value, and the quality of our products and the convenience of our
distribution system. We also compete with other direct selling organizations,
many of which have longer operating histories and greater name recognition and
financial resources than us. They include Amway Corporation, Nu Skin
Enterprises, Inc., Body Wise International, Inc., Herbalife International, Inc.,
Mannatech Incorporated, Rexall Showcase International, and Forever Living
Products, Inc. We compete for new Distributors on the basis of our compensation
plan and our proprietary and quality products. We believe that many more direct
selling organizations will enter the market place as this channel of
distribution expands over the next several years. We also compete for the
commitment of our Distributors. Given that the pool of individuals interested in
direct selling tends to be limited in each market, the potential pool of
Distributors for our products is reduced to the extent other network marketing
companies successfully recruit these individuals into their businesses.
Government Regulation
General
We are subject to laws, governmental regulations, administrative
determinations, and court decisions on the federal, state, and local levels.
These regulations pertain to a variety of issues related to us. First, they
pertain to the formulation, manufacturing, packaging, labeling, distribution,
importation, sale and storage of our products and taxation of our Distributors,
which in some instances may impose an obligation on us to collect the taxes and
maintain appropriate records. Second, the regulations pertain to product claims
and advertising, both by us and by our Distributors, for whom we are
responsible. Finally, certain regulations pertain to our network marketing
system.
Product Regulation
Several governmental agencies regulate certain aspects of our products,
including formulation, manufacturing, packaging, storing, labeling, advertising,
distribution, and sales. These agencies include the FDA, the Federal Trade
Commission ("FTC"), the Consumer Products Safety Commission, the Department of
Agriculture, the Environmental Protection Agency, and the Postal Service. In
addition, various state and local agencies can regulate us in areas where our
products are manufactured, distributed, and sold.
The FDA regulates the formulation, manufacture, packaging, storage,
labeling, promotion, distribution, and sale of foods, dietary supplements, and
over-the-counter drugs, including those we distribute. With respect to the
preparation, packaging and storage of our supplements, FDA regulations require
that our suppliers and we meet relevant good manufacturing practice regulations.
The Dietary Supplement Health and Education Act of 1994 ("DSHEA") revised
certain provisions of the Federal Food, Drug and Cosmetic Act ("FFDCA")
concerning the composition and labeling of dietary supplements. We believe that
DSHEA is generally favorable to the dietary supplement industry. The legislation
creates a new statutory class of "dietary supplements," which includes vitamins,
minerals, herbs, and amino acids. DSHEA applies with certain limitations to
dietary ingredients that were on the market before October 15, 1994. With
respect to dietary supplements that contain dietary ingredients not on the
market before October
16
15, 1994, DSHEA requires further evidence. This evidence must show that the
supplement contains only those ingredients that have been in the food supply or
other evidence of use or safety. Manufacturers of dietary supplements must make
a "statement of nutritional support," which is a statement describing certain
types of product performance characteristics. In making such a statement, we
must have substantiation that the statement is truthful and not misleading and
must make a disclaimer within the statement. Finally, we must notify the FDA of
the statement no later than 30 days after it is first made.
In January 2000, the FDA published a final rule that defines the types of
statements that can be made concerning the effect of a dietary supplement on the
structure or function of the body pursuant to the DSHEA. Under the DSHEA,
dietary supplement labeling may bear "structure/function" claims, which are
claims that the products affect the structure or function of the body, without
prior FDA review. They may not, without prior FDA review, bear a claim that they
can prevent, treat, cure, mitigate or diagnose disease (a disease claim). The
new final rule describes how the FDA will distinguish disease claims from
structure/function claims. In February 2001, the FDA issued a notice requesting
comments on the types of information that should be included in a guidance on
applying the regulations on statements made for dietary supplements concerning
the effect of a dietary supplement on the structure or function of the body. No
guidance document has been issued to date, and the Company has continued its
ongoing efforts to ensure that its dietary supplement product labeling complies
with the requirements of the "Structure/Function" final rule, which became
effective in February of 2000.
FFDCA classifies the majority of our products as "dietary supplements."
The FDA issued regulations governing the labeling and marketing of dietary
supplement products in September 1997. These regulations covered several issues.
First, they covered the identification of dietary supplements, as well as their
nutrition and ingredient labeling. Second, they covered the terminology to be
used for nutrient content claims, health content claims, and statements of
nutritional support. Third, they covered the labeling requirements for dietary
supplements that claim to be "high potency" and "antioxidant." Fourth, they
covered notification procedures for statements on dietary supplements. Finally,
the regulations covered the pre-market notification procedures for new dietary
ingredients in dietary supplements. The notification procedures became effective
in October 1997. The labeling requirements became effective in March 1999 and we
revised our product labels to reflect the new requirements. We must continue to
secure substantiation of our product performance claims and to notify the FDA of
certain types of performance claims made for our products. Our substantiation
program involves compiling and reviewing scientific literature, including our
own university research that is pertinent to the ingredients contained in our
products.
Dietary supplements are subject to the Nutrition, Labeling and Education
Act ("NLEA"), as well as the associated regulations. These regulate health
claims, ingredient labeling, and nutrient content claims, which characterize the
level of a nutrient in the product. NLEA prohibits the use of any health claim
for dietary supplements unless the claim is supported by significant scientific
agreement and is pre-approved by the FDA.
State Regulation
As a result of certain conditions, a toxic strain of algae called
Microcystis aeruginosa occasionally blooms in Klamath Lake and contaminates a
portion of our harvest of blue-green
17
algae with microcystin, a toxin. In 1994, we began to test the algae harvested
at this facility for possible contamination. The existence of Microcystis
aeruginosa has been regularly measured at various levels. In the absence of
established regulatory criteria for determining an acceptable level of
microcystin (the actual toxin), we sponsored an assessment of risk and set our
own standards for determining whether a particular batch of algae is acceptable
for human consumption. Algae that does not meet our standards and cannot be used
in alternative non-human consumable products is isolated and not used in
production.
On October 23, 1997, the Oregon Department of Agriculture issued an
Administrative Rule on the sale of blue-green algae, which stated, "the agency
has decided to adopt the 1 microgram per gram (1 ppm) level of microcystin in
blue-green algae." This ruling may have an impact on our ability to process and
distribute the raw algae harvested and finished goods produced. Such ruling may
also decrease the amount of salable inventory and may, therefore, have an
adverse impact on our ability to realize the carrying value of our inventories.
We have recognized that an impairment of our inventory may exist and therefore
have recorded our best estimate of the effect by establishing a reserve for
$900,000 at December 31, 2001, for the possible effects of inventories, which
may become unsaleable under this Rule. The Oregon Department of Agriculture has
taken no regulatory actions against our products under this Rule to date.
Foreign Markets
In 1999 Health Canada issued a warning about the safety of blue green
algae products due to concerns about microcystin. While we believe our products
are safe and comply with Canadian rules, the adverse publicity from the Health
Canada warning adversely affected our sales in Canada. Such warning may occur in
the future and could have an adverse affect on our business.
In Canada, both national and provincial law regulates our network
marketing system. Under Canada's Federal Competition Act, we must make sure that
any representations relating to Distributor compensation made to prospective
distributors constitute fair, reasonable and timely disclosure and that it meets
other legal requirements of the Federal Competition Act. Our revised
compensation plan is being reviewed and we will submit it to the appropriate
Canadian authorities. All Canadian provinces and territories, other than Ontario
have legislation requiring that we register or become licensed as a direct
seller within that province. Licensing is designed to maintain the standards of
the direct selling industry and to protect the consumer. Some provinces require
that both our Distributors and we be licensed. We are in the process of
obtaining all of the required provincial or territorial direct sellers'
licenses.
In April 2002, our insurance broker informed us that our insurance carrier
had issued a 30-day notice of cancellation with respect to various surety bonds
including a bond with Revenue Canada that we are required to have relating to
the gross sales tax on our products and our status as a non-resident. We are
attempting to find another carrier to issue a policy to us. In the event that we
are unable to successfully obtain a new surety bond for the sale of our products
in Canada, we will be required to post sufficient collateral directly with
Revenue Canada in order to be able to continue to sell our products in Canada.
18
Regulation of Advertising
We are unable to make any claim that any of our nutritional supplements
will diagnose, cure, mitigate, treat, or prevent disease. DSHEA, however,
permits substantiated, truthful, and non-misleading statements of nutritional
support to be made in labeling, such as statements describing general well-being
resulting from consumption of a dietary ingredient or the role of a nutrient or
dietary ingredient in affecting or maintaining a structure or a function of the
body. The FDA recently issued a proposed rule concerning these issues.
The FTC similarly requires that any claims be substantiated. The FTC
exercises jurisdiction over the marketing practices and advertising of all our
products. In years past, the FTC has instituted enforcement actions against
several dietary supplement companies for false and misleading marketing
practices. This has resulted in consent decrees and monetary payments by the
companies involved. We have not been the subject of FTC enforcement action with
respect to our advertising. However, there is no assurance that the FTC will not
subject us to inquiry in the future.
Through our manuals, seminars and other training materials and programs,
we attempt to educate our Distributors as to the scope of permissible and
impermissible activities in each market. We also investigate allegations of
Distributor misconduct. However, our Distributors generally are independent
contractors, and we are unable to monitor directly all of their activities. As a
consequence, we cannot be sure that our Distributors comply with applicable
regulations. Misconduct by Distributors in the past has had, and could again
have, a material adverse effect on us in a particular market or in general.
We are unable to predict the nature of any future laws, regulations,
interpretations or applications, nor can we predict what effect additional
governmental regulations or administrative orders, when and if promulgated,
would have on our business in the future. They could, however, require: (1) the
reformulation of some products not able to be reformulated; (2) imposition of
additional record keeping requirements; (3) expanded documentation of the
properties of some products; (4) expanded or different labeling; and (5)
additional scientific substantiation regarding product ingredients, safety or
usefulness.
Network Marketing System Regulation
Our Distributor commission system constitutes a network marketing system.
A number of federal and state statutes and regulations apply to this system,
including those administered by the FTC. The legal requirements that apply to
network marketing organizations ensure that product sales are ultimately made to
consumers. Further, they ensure that advancement within the organizations be
based on the sales of products, rather than from the recruitment of additional
Distributors, investment in the organization, or non-retail sale criteria. Where
required by law, we must obtain regulatory approval of our network marketing
system. If such approval is not required, the favorable opinion of local counsel
will suffice. Finally, in addition to these regulations, the FTC regulates trade
practices related to network marketing systems.
19
Employees
At March 31, 2002, we employed approximately 87 persons, of which 9 were
part-time. These numbers do not include our Distributors, who are generally
independent contractors rather than our employees. None of our employees are
represented by a labor union and we have never experienced any business
interruption as a result of any labor disputes. We believe that our relationship
with our employees is good.
Industry Segments and Export Sales
We have no assets outside of the United States. Our business consists of
one industry segment and is grouped into two geographic areas: United States and
Canada. The following table (dollars in thousands), summarizes the product sales
revenues from customers in each of the two geographic regions:
(Dollars in Thousands) 2001 2000 1999
---- ---- ----
United States $28,310 94.3% $36,796 94.4% $51,385 94.7%
Canada $ 1,702 5.7% $ 2,181 5.6% $ 3,103 5.7%
------- ----- ------- ----- ------- -----
Total $30,012 100.0% $38,977 100.0% $54,488 100.0%
======= ===== ======= ===== ======= =====
We believe that our profit margin on export sales is not significantly
different from that realized on sales in the United States. All foreign product
sales transactions are consummated in U.S. dollars.
ITEM 2. PROPERTIES.
Currently, our headquarters and all of our operating facilities are
located in Klamath Falls, Oregon. We lease approximately 250,000 square feet of
office, processing, freezer and storage space directly from our principal
shareholders or their affiliates. Most of these leases are year-to-year,
although we do rent some space on a month-to-month basis and one lease will
expire in 2005. We believe that the space leased from our shareholders and their
affiliate is rented to us at below or at fair market rates. We also lease an
additional 21 acres from an independent third party, on which we have built our
algae processing and storage facility. Our lease with the independent third
party will terminate in 2020, at which time we have the option to renew for an
additional 25 years. At the termination of such lease, ownership of the facility
will revert to the lessor.
We believe that the above-described properties will provide sufficient
space to meet our currently planned future needs and that comparable space is
readily available to meet any unforeseen circumstances.
ITEM 3. LEGAL PROCEEDINGS.
In 1996, we entered into a five-year contract with Oregon Freeze Dry,
Inc., one of our vendors to deliver 600,000 wet pounds of algae per month for
processing for a five-year period. The minimum monthly volume level increased in
September 1996 to 1,000,000 wet pounds of algae. On or about February 6, 1998,
the vendor filed a complaint against us. The complaint alleges that we
wrongfully terminated a contract requiring us to provide to the vendor not less
than a contractually agreed amount of raw product for processing every month, or
pay a penalty based on the shortfall until there was a validly terminated
contract. In its amended complaint, the
20
vendor is seeking $780,930 in damages as of February 1998, plus additional
damages that allegedly are continuing to accrue, plus prejudgment interest and
prevailing party attorney fees as provided by the contract. We counter-claimed
for breach of contract, alleging liquidated damages due, overcharges, and
failure to deliver product, consequential damage for failure to utilize quality
control methods required by the contract, prejudgment interest and attorney
fees. During the year ended December 31, 2001, the parties negotiated a
settlement agreement in which the parties have agreed to dismiss the lawsuit and
counter-claim and to enter into a new agreement for the processing of algae for
a five-year period. The parties have also agreed that we will pay $1,656,000
(included in accounts payable at December 31, 2001) to the vendor, of which we
will pay $1 million in cash and $656,000 in the form of a promissory note
payable to the vendor with interest at 10.5% per annum. As of December 31, 2001,
we have not signed the processing and settlement agreements. The parties expect
to execute the agreements upon our receipt of financing. Subsequent to December
31, 2001, the parties have reached an interim arrangement whereby we will pay
$0.15 per pound processed by the vendor until the parties finalize a formal
agreement.
On May 13, 1998, Steven Oberski, Jane Bean (Oberski's spouse) and Laurel
Boyajian, filed a claim against our Company in Superior Court in the
Commonwealth of Massachusetts alleging, among other things, that we breached the
terms of our Distributor agreement with them by transferring the income benefits
associated with them to another Distributor and they are seeking monetary
damages of approximately $750,000. Although we have repeatedly offered to settle
this matter, Oberski, et. al. has insisted in proceeding forward with the case.
The case came to trial by jury on September 10, 2001 and on September 15, 2001,
although the court found that we did not engage in unfair or deceptive
practices, the jury issued a verdict in favor of Steven Oberski and Jane Bean in
the amount of $1,500 and a verdict in favor of Laurel Boyajian in the amount of
$1,300 and we have paid the $2,800 judgment.
In May 1999, John Adams filed an action in the Circuit Court of Klamath
County alleging, among other things, we breached our Distributor agreement by
refusing to reinstate him as a Distributor and that we made health claims and he
is seeking an unspecified amount of monetary damages. On June 22, 2001, we
received a written settlement offer from his legal counsel stating that Mr.
Adams is willing to settle the case by dropping all health related claims and a
payment of $5,000 for his damages and $7,000 for his legal fees and costs. We
have declined his offer. On December 27, 2001, the parties agreed to a
Stipulated Judgment for Dismissal and the Court dismissed the case.
On January 16, 2001, we filed an action against Glenn Foods in the Circuit
Court of Klamath County alleging, among other things, that Glenn Foods breached
an agreement with us for the manufacture of our SBG Square Meal Bars and BG
Bites by failing to produce our products according to our specifications,
refusing to turn over our formula, and failing to refund our money. We are
seeking monetary damages of approximately $226,345 for all causes specified in
our complaint. The matter is presently in the discovery phase and no trial date
has been scheduled.
In October 2001, Teachers for Truth in Advertising filed an action in the
Superior Court for the County of Tulare, State of California, alleging among
other things, that our advertising is untrue or misleading, that our business
practices are unlawful and fraudulent and unfair and that
21
our website contains misleading information about our products and the benefits
that a consumer may derive from their use. The plaintiff is seeking injunctive
relief, corrective advertising, and restitution to California consumers who
purchased our products. The matter is presently in the discovery phase and no
trial date has been scheduled. We do not believe that the plaintiff's complaint
is meritorious and we believe that we will prevail in this matter.
On January 28, 2002, we terminated our lease between NAC and Klamath Cold
Storage, Inc. ("KCS"), a corporation owned by our principal shareholders, Daryl
Kollman and Marta Kollman. On February 19, 2002, Daryl Kollman, on behalf of
himself and as an officer of KCS, filed two separate Notice of Claim of Lien
upon Chattels (the "Possessory Liens") against us and our wholly owned
subsidiary, NAC and/or NEC, in the County of Klamath, State of Oregon, claiming
a lien upon us and our wholly owned subsidiaries by alleging among other things,
that we owe him and Marta Kollman approximately $508,246 in past due rent and
that we owe KCS approximately $576,232 in past due rent for our use of certain
real property owned by him and Marta Kollman, our President and Chief Executive
Officer, and KCS. Through the Possessory Liens, Daryl Kollman is claiming that
we are not entitled to remove any of our property from the premises and that the
properties will be subject to foreclosure proceedings. We do not believe that
Daryl Kollman will prevail in this matter and we have retained legal counsel to
represent us.
On March 27, 2002, the Nature Conservancy, a nonprofit corporation (the
"Conservancy"), filed an action against us in the Circuit Court of the State of
Oregon, for the County of Klamath, alleging among other things, that our wholly
owned subsidiary The New Earth Company ("NAC") has failed to pay the annual
payment due on a promissory note (the "Note") executed and delivered to the
Conservancy and that NAC's failure to make the payment constitutes a default
under certain provisions of the Note and a trust deed (the "Trust Deed") to
secure payment under the Note. The Conservancy is seeking $375,000 in principal
due under the Note plus interest from the date of default in addition to certain
leasehold rights that the Trust Deed grants to it. The Conservancy is also
seeking injunctive relief to recover rent payments from any sublessees. We have
retained legal counsel to represent us in this matter. We have previously
recorded the net present value of the Note, which has a balance of $313,790 and
is included in the current portion of long-term debt, in our consolidated
balance sheet at December 31, 2001.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
22
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Price Range of Common Stock
On August 14, 1996, HumaScan completed its initial public offering and our
common stock began trading on the NASDAQ Small Cap Market under the symbol
"HMSC." Prior to the IPO there was no established public trading market for our
common stock. On March 4, 1999, our common stock was delisted from the NASDAQ
Small Cap Market and commenced trading on the OTC Bulletin Board. On August 10,
1999, as part of the Reorganization, we executed a 1 for 10.8520933 reverse
stock split and changed our name to Cell Tech International Incorporated,
trading symbol "EFLI." On July 24, 2000, trading in our common stock on the OTC
Bulletin Board was suspended due to the fact that our 1934 Act filings were past
due and our common stock was subsequently quoted on the National Quotation
Bureau's Pink Sheets. The following table lists the bid prices at the end of
each period obtained from the National Quotation Bureau's Pink Sheet service and
is adjusted for subsequent stock dividends and stock splits. Prices do not
include retail mark-ups, mark-downs or commissions and may not represent actual
transactions. Trading in our common stock is limited and sporadic and such
quotations should not of themselves be deemed to constitute an established
public trading market.
High Bid Price for Low Bid Price for
Period ($) Period ($)
-------------------------------------
2001
First Quarter ........................ .30 .13
Second Quarter ....................... .65 .14
Third Quarter ........................ .68 .20
Fourth Quarter ....................... .52 .14
-------------------------------------
2000
First Quarter ........................ 2.25 1.03
Second Quarter ....................... 1.40 .25
Third Quarter ........................ .56 .37
Fourth Quarter ....................... 1.25 .15
At April 30, 2002, 10,640,895 shares of our common stock were issued and
outstanding and were held by approximately 126 stockholders of record.
Dividends
In 1999, before the Reorganization, we distributed certain real estate
valued at $1,050,000 to the Kollmans, and paid previously declared dividends of
$7.6 million to the Kollmans. We do not plan to pay dividends on our common
stock in the foreseeable future. The payment of dividends in the future will
depend on the evaluation by our Board of Directors of such factors as it deems
relevant at the time and restrictions imposed by the terms of our debt
obligations, if any. We are currently restricted from paying dividends pursuant
to a Loan and Security Agreement with Coast Business Credit, a division of
Southern Pacific Bank. Currently,
23
the Board of Directors believes that all of our earnings, if any, should be
retained for the development of our business.
Recent Sales of Unregistered Securities
On October 19, 1999, we sold 1,157,895 shares of our common stock and
warrants to purchase 1,157,895 shares of our common stock (collectively, the
"Purchased Securities") in a private placement to Zubair Kazi ("Kazi") for
$1,515,625, net of fundraising costs of $134,375. In connection with this
transaction, we also issued warrants to purchase 150,000 and 100,000 shares of
our common stock to Pacific Basin Capital and Richard Wade, respectively. Each
warrant has a 5-year term and an exercise price of $1.425 per share. We also
issued 50,000 shares of our common stock, at fair market value that amounted to
$134,375, to Pacific Basin Capital for its services. The transaction above
involved an investment by one person who is an accredited investor, as that term
is used in Regulation D, and did not involve a general solicitation. The above
transaction was effected pursuant to Section 4(2) of the Securities Act of 1933.
We are obligated to issue to Kazi additional Purchased Securities, as penalties
and interest, for any delay in filing our next registration statement beyond 120
days after October 19, 1999. As of April 30, 2002, we have not filed our next
registration statement and Kazi is entitled to an additional 1,606,117 Purchased
Securities as of December 31, 2001. As of April 30, 2002, we have not yet issued
to Kazi any of these additional Purchased Securities but have accrued the
liability to their issuance in our financial statements. We described in detail,
in our Annual Report on Form 10K for the fiscal years ended December 31, 1998,
1999 and 2000, which we incorporated herein by reference, the reset provisions
relating to the Purchased Securities.
24
ITEM 6. SELECTED FINANCIAL DATA.
The selected financial data as of and for the five years ended December
31, 2001 have been derived from our audited consolidated financial statements
and related notes. The selected financial and operating data should be read in
conjunction with Management's Discussion and Analysis of Results of Operations
and Financial Condition and the consolidated financial statements and related
notes.
Years ended December 31,
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
($ in thousands, except per share data)
RESULTS OF OPERATIONS
Revenue $ 30,012 $ 38,977 $ 54,488 $ 74,071 $ 124,788
Gross Profit 20,488 27,488 39,739 54,581 102,591
Gross Profit after Commissions 6,146 9,855 15,306 21,026 42,314
Operating Income (Loss) from Operations (5,000) (2,436) (4,439) 1,670 15,837
Net Income (Loss) before Taxes (5,015) (2,784) (4,141) 2,296 17,253
Net Income (Loss) (5,015) (2,784) (4,141) 2,296 17,253
Net Income (Loss) per common share
Basic (0.47) (0.26) (0.45) 0.26 1.99
Diluted (0.47) (0.26) (0.45) 0.26 1.99
Weighted Average Shares Outstanding
Basic 10,640,895 10,640,895 9,280,431 8,683,000 8,683,000
Diluted 10,640,895 10,640,895 9,280,431 8,683,000 8,683,000
Cash dividend per common share 0.00 0.00 0.82(1) 0.00 0.00
SELECTED BALANCE SHEET DATA
Cash & Cash Equivalents -- -- -- 1,502 --
Current Assets 2,788 3,881 5,505 19,961 20,032
Total Assets 19,975 27,250 41,099 46,224 47,925
Current Liabilities 9,225 11,223 8,577 12,526 21,653
Total Liabilities 9,225 11,485 14,266 9,376 14,007
Shareholders' Equity 10,750 15,765 18,549 31,723 32,217
(1) In 1999, before the Reorganization, we paid a previously declared dividend
of $7.6 million to the Kollmans. See "Dividends."
25
Our Quarterly Data:
The following table sets forth our unaudited consolidated quarterly
statement of income data for the periods indicated. In our opinion, this
information has been prepared on the same basis as our audited Consolidated
Financial Statements set forth in this report and includes all necessary
adjustments, consisting only of normal recurring adjustments that are considered
necessary to present fairly this information in accordance with generally
accepted accounting principles. You should read this information in conjunction
with the Consolidated Financial Statements and related Notes in Item 14 of this
report, beginning on page F-1. Our consolidated operating results for any one
quarter are not necessarily indicative of results for any future period.
2001 First Second Third Fourth
---- ----- ------ ----- ------
($ in thousands, except per share data)
RESULTS OF OPERATIONS
Revenue $ 8,062 $ 7,603 $ 7,279 $ 7,068
Operating Loss (935) (707) (438) (2,920)
Net Loss (1,048) (748) (423) (2,794)
Net Loss per common share
Basic and Diluted (0.10) (0.07) (0.03) (0.27)
Weighted Average Shares Outstanding
Basic and Diluted 10,640,895 10,640,895 10,640,895 10,640,895
2000 First Second Third Fourth
---- ----- ------ ----- ------
($ in thousands, except per share data)
RESULTS OF OPERATIONS
Revenue $ 11,136 $ 9,971 $ 9,166 $ 8.704
Operating Loss (287) (832) (487) (830)
Net Loss (314) (802) (630) (1,038)
Net Loss per common share
Basic and Diluted (0.03) (0.08) (0.06) (0.09)
Weighted Average Shares Outstanding
Basic and Diluted 10,640,895 10,640,895 10,640,895 10,640,895
26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION.
From time to time, we or our representatives have made or may make
forward-looking statements, orally or in writing, including in this Report. Such
forward-looking statements may be included in, without limitation, press
releases, oral statements made with the approval of one of our authorized
executive officers and filings with the Securities and Exchange Commission. The
words or phrases "anticipates," "believes," "expects," "intends," "will
continue," "estimates," "plans," "projects," or similar expressions are intended
to identify "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995.
Our forward-looking statements are subject to certain risks, trends, and
uncertainties that could cause actual results to vary materially from
anticipated results, including, without limitation, market acceptance of our
marketing and merchandising concepts, changes in political and general market
conditions, demand for and market acceptance of new and existing products,
availability and development of new products, increased competition, our failure
to attain satisfactory outside financing and adverse weather conditions at Upper
Klamath Lake. These factors are discussed in further detail below under "Risks
and Uncertainties." Should any one or more of these risks or uncertainties
materialize, or should any underlying assumptions prove incorrect, actual
results may vary materially from those discussed herein as expected, believed,
estimated, intended or anticipated. We undertake no obligation to revise or
publicly release the results of any revisions to these forward-looking
statements.
Critical Accounting Policies
We have identified the policies below as critical to our business
operations and the understanding of our results of operations. The impact and
any associated risks related to these policies on our business operations is
discussed throughout management's Discussion and Analysis of Financial Condition
and Results of Operations where such policies affect our reported and expected
financial results. For a detailed discussion on the application of these and
other accounting policies, see Note 1 in the Notes to the Consolidated Financial
Statements in Item 14 of this Annual Report on Form 10-K, beginning on page 62.
Note that our preparation of this Annual Report on Form 10-K requires us to make
estimates and assumptions that affect the reported amount of assets and
liabilities, disclosure of contingent assets and liabilities at the date of our
financial statements, and the reported amounts of revenue and expenses during
the reporting period. There can be no assurance that actual results will not
differ from those estimates.
Impairments of Long-Lived Assets
We record impairment losses on long-lived assets used in operations when
events and circumstances indicate that the assets might be impaired and the
undiscounted cash flows estimated to be generated by those assets are less than
the carrying amount of those items. Our cash flow estimates are based on
historical results adjusted to reflect our best estimate of future market and
operating conditions. The net carrying value of assets not recoverable is
reduced to fair value. Our estimates of fair value represent our best estimate
based on industry trends and reference to market rates and transactions.
27
Inventory
We value our inventory at the lower of the actual cost to purchase and/or
manufacture the inventory or the current estimated market value of the
inventory. We regularly review inventory quantities on hand and record a
provision for excess and obsolete inventory based primarily on our estimated
forecast of product demand and production requirements for the future.
Additionally, our estimates of future product demand may prove to be
inaccurate, in which case we may have understated or overstated the provision
required for excess and obsolete inventory. In the future, if our inventory is
determined to be overvalued, we would be required to recognize such costs in our
cost of goods sold at the time of such determination. Likewise, if our inventory
is determined to be undervalued, we may have over-reported our costs of goods
sold in previous periods and would be required to recognize such additional
operating income at the time of sale.
Although we make every effort to ensure the accuracy of our forecasts of
future product demand, any significant unanticipated changes in demand or
technological developments could have a significant impact on the value of our
inventory and our reported operating results. We have experienced, and may
continue to experience, significant fluctuations in sales and operating results
from quarter to quarter.
Contingencies
We determine whether to disclose and accrue for loss contingencies based
on an assessment of whether the risk of loss is remote, reasonably possible or
probable and where reasonable estimates can be made of the amount of potential
loss, of the materiality of the loss contingency, in accordance with Statement
of Financial Accounting Standards No. 5 ("SFAS 5"), "Accounting for
Contingencies." Our assessment is developed in consultation with outside
advisors and is based on an analysis of possible outcomes under various
strategies. Loss contingency assumptions involve judgments that are inherently
subjective and frequently involve matters that are in litigation, which by its
nature is unpredictable. We believe that our loss contingency assumptions are
sound, but because of the subjectivity involved and the unpredictable nature of
the subject matter at issue, our assumptions may prove to be incorrect, which
could materially impact our consolidated financial statements in future periods.
General
We are a network marketing company and we develop and distribute a wide
range of products made with Aphanizomenon flos-aquae (trade name Super Blue
Green(R) Algae) ("SBGA") and other nutrients and ingredients through a network
of independent distributors ("Distributors"). We currently offer twenty
different products intended to appeal to health-conscious consumers. Our
products are divided into five product lines including Daily Health Maintenance,
Digestive Health, Defensive Health, Powdered Drinks and Snacks, and Animal and
Plant Food.
Results of Operations
Our results of operations for the periods described below are not
necessarily indicative of results of operations for future periods, which depend
upon numerous factors including our
28
ability to attract and retain new Distributors, enter new markets and to
introduce additional and new products into our markets.
Fiscal 2001 Compared to Fiscal 2000
Net sales for the year ended December 31, 2001 were $30,012,076, a
decrease of 23.0% from net sales of $38,976,663 for the year ended December 31,
2000. The decrease in sales is directly related to a decrease in orders for the
same period with a decrease in the average order size to $116 from $124 over the
same period. The average number of distributors in 2001 decreased to an average
of 52,948 in 2001, which was 13% lower than the average of 60,899 distributors
in 2000. Sales of our food supplement products are made through a multi-level
marketing network of distributors, so sales are positively linked with the
number of distributors.
Gross profit represents net sales less the cost of goods sold, which
includes the cost of harvesting blue-green algae from Klamath Lake, the cost of
other materials, direct labor expenses, an allocation of overhead costs,
amortization, and depreciation. Gross profit decreased to 68% from 71% of net
sales between the years ended December 31, 2001 and 2000, respectively. The
decrease in the gross profit margin is due to spreading out the fixed cost
component of cost of goods sold over a decreased revenue base.
Gross profit after commissions represents gross profit less commission
expense. Commission expense for 2001 and 2000 was 48% and 45% of net sales,
respectively. We are a multi-level marketing organization. Distributors make up
our sales force. Distributors buy algae products for their own consumption plus
they actively recruit other distributors into our network. Distributors are paid
commissions based upon their personal sales volumes and the sales of
distributors beneath them in their network. During the year ended December 31,
2001, we implemented a new commission structure in an attempt to attract and
retain new Distributors.
Operating expenses include shipping and handling expenses, selling
expenses, research and development expenses and general and administrative
expenses. In total, operating expenses decreased $1,146,316 or 9.3% to
$11,145,701 for the twelve months ended December 31, 2001 from $12,292,017 for
the twelve months ended December 31, 2000. The components of operating expenses
are discussed below.
o Shipping and handling expenses includes purchasing, receiving, and
materials management. Shipping and handling expenses decreased
$233,210 or 11%, to $1,864,159 in 2001 from $2,097,369 in 2000. The
decrease was due to a decrease in freight expenses in 2001 due to
the overall decrease in sales. Shipping and handling expenses as a
percent of net sales increased to 6% for the year ended December 31,
2001 from 5% for the year ended December 31, 2000.
o Selling expenses includes order operator and distributor services
expenses, marketing and promotion expenses, and the expenses of the
Office of the President and CEO. Selling expenses decreased
$1,278,212 or 24% between 2001 and 2000 to $4,059,982 from
$5,338,194. This decrease was primarily due to a decrease in
salaries and compensation, consulting expenses and utility costs of
$1,102,406. Selling expenses were 14% of sales for the years ended
December 31, 2001 and December 31, 2000, respectively.
o Research and development expenses decreased 58% to $190,884 in 2001
from $456,098 in 2000, which constituted 0.6% and 1% of net sales,
respectively.
29
o General and administrative expenses decreased by $1,823,231 or 43%
between 2001 and 2000 to $2,440,736 from $4,263,967. For the year
ended December 31, 2001, general and administrative expenses
averaged 8% of sales while they were 11% of sales for the year ended
December 31, 2000. The decrease between 2001 and 2000 is
attributable to additional costs incurred in 2000 relating to the
early repayment of the outstanding balance of the loan from the
former owner of Cell Tech, a decrease in legal and consulting fees
incurred during 2001, and a decrease in costs associated with the
consolidation of office space and leased facilities that occurred in
2000.
o Asset write-downs increased by $2,453,559 or 1,799% from $136,381 to
$2,589,940. The increase is due to management's decision not to
utilize the Harvest Site for the foreseeable future and represents
the costs of the unnecessary assets and license rights that relate
to the Harvest Site.
Other income increased to $606,962 for the year ended December 31, 2001
from $421,045 for the year ended December 31, 2000 principally due to an
increase in sundry income collected from Distributors offset by recording the
fair value cost of penalty shares and warrants to be issued to an investor in
the amount of $117,000. Interest expense decreased slightly to $622,235 in 2001
from $768,492 in 2000. This decrease was due to various fees paid to the current
lender, partially offset by a decrease in interest expense resulting from a
decrease in the outstanding debt in 2001 versus 2000.
Net loss for 2001 increased 80% to $5 million from $2.8 million reported
in the prior year or $0.47 per share for 2001 compared to $0.26 per share for
2000. The increase was primarily due to: (1) decreases in retail sales and (2)
the write-down of approximately $2.6 million in assets, which contributed $0.24
per share of the total $0.47 per share loss.
Fiscal 2000 Compared to Fiscal 1999
Net sales for the year ended December 31, 2000 were $38,976,663, a
decrease of 28% from net sales of $54,487,939 for the year ended December 31,
1999. The decrease in sales is directly related to a 29% decrease in orders for
the same period. Average order size increased to $127 from $124 over the same
period. The average number of distributors in 2000 decreased to an average of
60,899 in 2000, which was 22% lower than the average of 73,372 distributors in
1999. Sales of our food supplement products are made through a multi-level
marketing network of distributors, so sales are positively linked with the
number of distributors.
Gross profit represents net sales less the cost of goods sold, which
includes the cost of harvesting blue-green algae from Klamath Lake, the cost of
other materials, direct labor expenses, an allocation of overhead costs,
amortization, and depreciation. Gross profit decreased to 71% from 73% of net
sales between the years ended December 31, 2000 and 1999, respectively. The
decrease in the gross profit margin is due to the fixed cost component of cost
of goods sold being spread over a decreased revenue base.
Selling profit represents gross profit less commission expense. Commission
expense for 2000 and 1999 was 45% of net sales, respectively. We are a
multi-level marketing organization. Distributors make up our sales force.
Distributors buy algae products for their own consumption plus they actively
recruit other distributors into our network. Distributors are paid commissions
30
based upon their personal sales volumes and the sales of distributors beneath
them in their network.
Operating expenses include shipping and handling expenses, selling
expenses, research and development expenses and general and administrative
expenses. In total, operating expenses decreased $7,453,770 or 38% to
$12,292,009 for the twelve months ended December 31, 2000 from $19,745,779 for
the twelve months ended December 31, 1999. The components of operating expenses
are discussed below.
o Shipping and handling expenses includes purchasing, receiving, and
materials management. Shipping and handling expenses decreased
$1,801,992 or 46%, to $2,097,369 in 2000 from $3,899,361 in 1999.
The decrease was due to a $1,471,840 decrease in freight expenses in
2000 due to the overall decrease in sales. Shipping and handling
expenses as a percent of net sales decreased to 5% for the year
ended December 31, 2000 from 7% for the year ended December 31,
1999.
o Selling expenses includes order operator and distributor services
expenses, marketing and promotion expenses, and the expenses of the
Office of the President and CEO. Selling expenses decreased
$2,636,065 between 2000 and 1999 to $5,338,194 from $7,974,259. This
decrease was primarily due to a decrease in salaries and
compensation of $1,589,380. Selling expenses were 14% of sales for
the year ended December 31, 2000 and 15% of sales for the year ended
December 31, 1999.
o Research and development expenses decreased 69% to $456,098 in 2000
from $1,453,371 in 1999, which constituted 1% and 3% of net sales,
respectively.
o General and administrative expenses decreased by $2,018,440 between
2000 and 1999. For the year ended December 31, 2000, general and
administrative expenses averaged 11% of sales while they were 12% of
sales for the year ended December 31, 1999. The decrease between
2000 and 1999 is attributable to additional costs incurred in 1999
relating to the early repayment of the outstanding balance of the
loan from the former owner of Cell Tech, a decrease in legal and
consulting fees incurred during 2000, and a decrease in costs
associated with the consolidation of office space and leased
facilities that occurred in 1999.
Other income decreased to $421,015 for the year ended December 31, 2000
from $1,012,660 for the year ended December 31, 1999 principally due to a
decrease in sundry income collected from Distributors offset by recording the
fair value cost of penalty shares and warrants to be issued to an investor in
the amount of $250,000. Interest expense increased slightly to $768,492 in 2000
from $714,025 in 1999. This increase was due to various fees paid to the current
lender, partially offset by a decrease in interest expense due to a decrease in
outstanding debt in 2000 versus 1999.
Net loss for 2000 decreased 33% to $2.8 million from $4.1 million reported
in the prior year or $0.26 per share for 2000 compared to $0.45 per share for
1999. The decrease was primarily due to: (1) decreases in retail sales and (2)
decrease in marketing, distribution and administration expenses.
Prior to 1999, NEC and NAC were S corporations and their shareholders -
not NEC and NAC- were responsible for the payment of income taxes. During 1999,
NEC and NAC changed
31
their tax status to that of a C corporation. Subsequent to the change in the tax
status, we did not incur any income tax liabilities for the remainder of its
fiscal years ended December 31, 1999 or 2000.
Liquidity and Capital Resources
We have historically met our working capital and capital expenditure
requirements, including funding for expansion of operations, through net cash
provided by operating activities.
Cash Flows
Net cash flows provided by operating activities for the year ended
December 31, 2001 amounted to $1,372,836 compared to cash flows used by
operations of $564,012 for the year ended December 31, 2000. The increase in
cash flows provided by operations is primarily due to a smaller decrease in
current liabilities than in previous years.
Cash flows used for investing activities for the year ended December 31,
2001 was $206,662, net of $47,000 of proceeds from sales of equipment. This is
an increase of $65,263 from net cash used for investing activities of $141,399
for the year ended December 31, 2000, due to an increase in equipment purchases
related to the construction of the on-lake harvester during the fiscal year
ended December 31, 2001.
Net cash flows used for financing activities was $1,166,174 for the year
ended December 31, 2001 versus net cash provided by financing activities of
$705,411 during 2000. This change is principally due to a decrease in the bank
overdraft balance at December 31, 2001 of $547,446 and additional principal
repayments on the long-term debt of $963,357, offset by an increase in related
party debt of $344,620.
We do not plan to pay dividends on our common stock in the foreseeable
future. The payment of dividends in the future will depend on the evaluation by
our Board of Directors of such factors as it deems relevant at the time and
restrictions imposed by the terms of our debt obligations, if any. We are
currently restricted from paying dividends pursuant to a Loan and Security
Agreement with Coast Business Credit, a division of Southern Pacific Bank.
Currently, the Board of Directors believes that all of our earnings, if any,
should be retained for the development of our business.
Working capital deficit at December 31, 2001 amounted to $6,437,186, a
decrease of $904.778 from a working capital deficit of $7,341,964 as of December
31, 2000. At December 31, 2001, we had a bank overdraft of $763,105 versus a
bank overdraft of $1,310,551 as of December 31, 2000.
Line of Credit
In June 1999, we entered into a $15 million Line of Credit Agreement with
a financial institution. The agreement has four parts: Receivable Loans,
Advances and Inventory Loans, Term Loans, and Equipment Acquisition Loans. The
Receivable Loans and the Advances and Inventory Loans bear interest at a rate
equal to the prime rate plus 2.5% per annum, effectively 7.5% at December 31,
2001, and expire June 30, 2002. The balance outstanding under the Receivable
Loans and the Advances and Inventory Loans at December 31, 2001 and 2000 was
32
$633,852 and $1,105,012, respectively. The Term Loans and Equipment Acquisition
Loans bear interest at a rate equal to the prime rate plus 2.75%, effectively
7.75% at December 31, 2001, and are repayable in 60 monthly installments by July
1, 2004. The total balance outstanding under the Term Loans and Equipment
Acquisition Loans at December 31, 2001 and 2000 was $1,213,344 and $1,691,541,
respectively. We incur a minimum monthly interest charge for an amount equal to
all interest that would have been accrued had the daily aggregate outstanding
balance of all Loans been equal to 40% of the Maximum Dollar Debt.
We are working on a new credit facility (the "New Credit Facility") and
are in discussions with various parties to obtain the New Credit Facility. While
our current lender has indicated a desire to have the above mentioned Loans paid
in full by June 30, 2002, it has informed us that it would extend the term of
the Line of Credit if we meet certain conditions and pay off a portion of the
Line of Credit by June 30, 2002.
The majority shareholders and substantially all of our assets guarantee
the Line of Credit Agreement. Certain restrictive covenants exist and we are not
in compliance with such covenants.
In order to pay-off the outstanding balance the lender began withholding
funds in August 1999 from the daily collections and applied such withholdings to
the outstanding balance. Our ability to borrow under the Line of Credit
Agreement was also restricted as a result of the lender reducing the
availability under the Line of Credit Agreement by the cumulative of the daily
withholdings. As of April 30, 2002, we had no availability to draw on the line
of credit.
We have classified all outstanding debt to the lender as a current
liability.
Going Concern
We have experienced recurring net losses and have negative working capital
at December 31, 2001 and April 30, 2002. In addition, we are not in compliance
with certain restrictive covenants of our $15 million Line of Credit Agreement
with a financial institution as described and summarized in Note 7 to our
consolidated financial statements. Accordingly, we have classified the entire
amount outstanding under the Line of Credit Agreement of $1,847,196 at December
31, 2001 as a current liability. In order to pay-off the outstanding balance the
lender began withholding funds from our daily collections and applied such
withholdings to the outstanding balance. Our ability to borrow under the Line of
Credit Agreement was also restricted as a result of the lender reducing the
availability under the Line of Credit Agreement by the cumulative amount of the
daily withholdings. As a result, we are experiencing difficulty in generating
sufficient cash flows to meet our obligations. These conditions give rise to
substantial doubt about our ability to continue as a going concern.
Our financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the satisfaction of liabilities
in the normal course of business. Our financial statements do not include any
adjustments relating to the recoverability and classification of recorded asset
amounts or the amounts and classification of liabilities that might be necessary
should we be unable to continue as a going concern. Our continuation as a going
concern is dependent upon our ability to generate sufficient cash flows to meet
our obligations on a timely basis.
33
We are continuing our efforts to raise both debt and equity financing.
However, there can be no assurance that we will be able to service additional
financing or that if such financing is available, whether the terms or
conditions would be acceptable to us.
Quantitative and Qualitative Disclosures about Market Risk
We have not entered into any transactions using derivative financial
instruments or derivative commodity instruments. We believe our exposure to
market risk associated with other financial instruments is not material.
Risks and Uncertainties
Variability of Results
Our annual sales peaked at approximately $200 million in 1996. Subsequent
to 1996, sales have decreased annually. There can be no assurance that we will
return to generating profits on either a quarterly or annual basis. We have
experienced a continual downward trend in sales although the rate of decline is
less than in previous years. Many factors accounted for the past decrease in
sales, including low productivity of independent distributors, loss of services
of certain existing distributors, and competition. Our inability to adjust our
operating expenses to fully compensate for the decrease in sales contributes to
our small profit margins.
Consequently, we have experienced a significant decrease in working
capital since the end of 1998. We are facing difficulties generating sufficient
cash flow to timely meet our financial obligations, including complying with the
terms of the financing agreement for our Line of Credit.
Effects of Clinical Studies, Scientific Review, and Publicity
We believe that the increasing interest generally in vitamins, nutritional
supplements and similar products is driven by national media attention to recent
scientific research that highlights potential health benefits of consuming
certain vitamins and nutritional supplements. While we have concluded from
extensive independent research that SBGA, the principal ingredient in our
products, has significant nutritional value, consumer demands for nutritional
supplements are generally dependent on publicized scientific findings. Consumer
perception of the values of vitamins and nutritional supplements would be
greatly altered should future studies report that nutritional and alternative
medicine is in any way either harmful or not beneficial to health.
Moreover, any future publicity relating to illnesses or other adverse
effects resulting from consumers' use of certain nutritional products, which
existing and potential customers might associate with our products, could have
an adverse effect on our business. Media focus on the repercussions from
consumers' misuse or abuse of our products or other similar products, or from
consumers' failure to consume as we or other companies suggest could be equally
harmful to our operations. We cannot guarantee there will not be any future
unfavorable publicity or scientific findings about the effects of consumption of
vitamins and nutritional supplements. The previously referenced Grant Ferrier
article states that nutritional supplement sales have been and may continue to
be affected by questions about the efficiency and safety of such supplements.
34
Consumer Demand for New & Individual Products
Our ability to introduce safe, new and innovative products contributed to
the growth of our business in the nutritional supplement market. We have
expended and will expend a significant amount of resources on the research and
development of such products. The success of these products is, however,
conditioned upon different factors, including consumers' acceptance of
innovative products and our compliance with governmental regulatory laws. We
cannot be certain that sales of new products that we introduce into the markets
will achieve success in the future, as there is no assurance that consumers will
continue to accept such products or that we can obtain regulatory approvals for
them.
Supply of Raw Materials; Conditions Affecting Harvest
We harvest our own SBGA in Upper Klamath Lake, the only place in the world
where SBGA grows in massive quantities sufficient for harvesting. Although we
may not depend on third-party suppliers for sources, our reserve of SBGA is
determined by the growth of Aphanizomenon flos-aquae in the lake. Aphanizomenon
flos-aquae has flourished in Upper Klamath Lake because of Upper Klamath Lake's
protected environment, abundance of minerals, natural nitrogen, clean water and
regular sunshine. In 1996 the Klamath basin, which encompasses the Upper Klamath
Lake, experienced a drought. We do not believe that the 1996 drought had any
effect on our harvest. A severe shortage of water at the lake and a lack of
funds precluded our harvest of SBGA for the 2000 season; however, despite a
water shortage in 2001, which precludes a harvest from the "A" canal, we have
commenced harvesting directly from Upper Klamath Lake in July 2001 through the
use of a uniquely designed harvester. In 2002, we plan to acquire additional
harvest capacity to increase our ability to harvest directly from Upper Klamath
Lake. We cannot assure the absence of future adverse weather conditions
disturbing the growth of Aphanizomenon flos-aquae.
Furthermore, a toxic strain of algae called Microcystis aeruginosa
occasionally blooms in Upper Klamath Lake and contaminates some of our harvest
of SBGA with microcystin, a toxin. In 1997, the Oregon Department of Agriculture
adopted an administrative rule establishing a maximum level of 1 microgram per
gram (1 ppm) of microcystin that may be present in blue-green algae to be sold
for human consumption. We have not been able to determine the potential impact
of the rule on our operations. Any future toxic algae blooms would diminish our
supply of SBGA, and the administrative rule may also have the effect of reducing
our inventory of usable SBGA for the manufacture of some of our products.
However, due to the fact that we have an ample supply of algae inventory for use
in capsules and tablets (10.2 months are frozen and 4.4 months are freeze-dried
powder) and for use with vendor products (160 months are frozen and 78 months
are freeze-dried powder) we do not anticipate a shortage of supply resulting
from the microcystin problem. This availability of inventory usage is based on
our current consumption levels and our experts have informed us that the
nutritional quality of our algae does not change significantly as a result of
our harvesting and storage methods.
We constructed a modern SBGA processing system that is continually
improved and updated. Potential unexpected system failures may, however,
interrupt production and reduce sales revenue. System failures may result from
events beyond our control, including natural disasters such as fires and
unexpected weather changes, intentional acts of break-ins and sabotage, and
similar misconduct.
35
Competition--Products, Pricing, and Marketing; Intellectual Property Protection
The market for nutritional supplements and personal care products is
highly competitive at all stages of distribution. Most of our competitors in the
business of development, manufacture, and marketing of vitamins and other
nutritional supplements, including large pharmaceutical companies, have greater
product offerings, longer operating histories in the markets and superior
financial capabilities than us. We face intense competition with numerous
companies in traditional retail channels, such as drug store chains, independent
drug stores, supermarkets, and health and natural food stores. Although the
practice of ordering products from home is becoming increasingly popular,
consumers are more accustomed to purchasing products through these traditional
sales channels.
Although we now have trademark protection for a number of our product
labels in the United States and in some foreign countries, and are currently
pursuing registration of other trademarks, we do not have trademark registration
for the name "Cell Tech." Moreover, we do not have patent protection for our
products. Any unlawful or lawful use of our trade names or the ingredient Super
Blue Green(R) Algae to manufacture similar products by competitors could have a
material adverse effect on our business.
Retention and Productivity of Distributors
We rely almost exclusively on a network marketing system of independent
Distributors to sell our products. The success of our operations depends on our
ability to attract new Distributors and maintain business relationships with
existing Distributors. We compete with other network marketing companies for
Distributors and can experience high turnover among our Distributors. Because
some of these companies may have a longer history of operations and superior
resources, their ability to appeal to a large base of Distributors is greater.
There can be no assurance that existing Distributors will not terminate their
services to us or that the number of Distributors for our products will remain
steady or increase.
Moreover, our revenue is dependent on the ability of the Distributors to
attract and retain customers. A decrease in the productivity of existing
Distributors would adversely affect our financial conditions. We cannot assure
you that the Distributors will maintain or increase their productivity. We also
cannot accurately predict the future productivity of the Distributors since
their operations depend on their ability to sponsor, train, and motivate new
Distributors.
Regulation of Distributors and Network Marketing System
Since the Distributors in the network marketing system are not our
employees, they are not subject to the same degree of supervision and management
as our employees. While the services of the Distributors to our business are
governed by certain contractual rules of conduct, it is difficult to monitor or
control the conduct of the sales associates of Distributors marketing our
products. Violations of our policies and rules by sales associates in dealing
with customers could reflect negatively on our products and operations, and harm
our business reputation.
Furthermore, extensive federal, state, and local laws that regulate direct
selling activities govern our network marketing system. We believe that our
marketing practices have been and are consistent with such laws, but we cannot
provide assurance that any future changes to laws and regulations of any
particular jurisdiction will not affect our operations. We could also
36
be held civilly or criminally accountable on the basis of vicarious liability as
a result of the actions of independent Distributors.
Departure of Distributors
Certain Distributors have severed their ties with us and are now competing
against us. This will adversely affect us in that these Distributors will no
longer be generating revenues for us and furthermore, the departing Distributors
can be expected to divert business to our competitors.
Alternative Channels of Distribution
On May 18, 2001, we commenced, on a limited test basis, sales through
infomercials and discontinued them on July 1, 2001 due to our limited financial
resources. This alternative distribution strategy is designed to provide a
complementary marketing method for our Distributors. While we believe the
infomercials will complement the sales efforts of our Distributors, there can be
no assurance that it will have its intended effect with our Distributors and
could create conflicts with our Distributors that could result in the loss of
many of our Distributors, which in turn would mean a decline in our sales volume
and would be detrimental to our business and result in losses from our
operations. However, our tests results, and the responses that we have received
from Distributors, indicate that there are no conflicts with our present
distribution methods. Moreover, such a program requires an investment in
producing the infomercial videos. We have discontinued airing such infomercials
until we have sufficient funds to continue broadcasting.
Management of Operations
Limitations on our ability to attract additional key management personnel
as we grow could be materially adverse to our business and financial conditions.
Our location in Klamath Falls, Oregon is a limiting factor on our ability to
attract key management personnel when we need it, particularly in the areas of
marketing and information systems.
For similar reasons, we may face difficulty in recruiting a permanent
Chief Financial Officer. Our limited ability to attract such personnel could be
materially adverse to our business and financial conditions.
In addition, since we will need additional managers who have key strategic
skills, we could be confronted with new personnel challenges as our business
expands. The future success of our business and financial conditions will depend
significantly on our ability to add key management personnel in a timely and
cost effective manner.
Cancellation of Surety Bonds
In April 2002, our insurance broker informed us that our insurance carrier
had issued a 30-day notice of cancellation with respect to some of our surety
bonds due to the going concern opinion that our auditors had issued for our
fiscal year ended December 31, 2000. We are attempting to find another carrier
to provide us with comparable surety bonds. In the event that we are unable to
successfully obtain new surety bonds, we will be required to post sufficient
collateral directly with the various entities that require the bonds in order to
be able to continue to perform under our obligations under the various
agreements. The bonds relate to our non-
37
resident status for sales tax in Canada, tax payments with the Nevada Department
of Taxation, various bonds for the use and harvesting from the Canals and a
highway use tax with the Oregon Department of Transportation.
Lien on Kollman's Stock
Our common stock owned by majority shareholders Daryl J. Kollman and Marta
C. Kollman, is the subject of a tax lien filed by the Internal Revenue Service
for income taxes due from them arising from taxable income attributed from NEC
and NAC prior to the Reorganization. The lien is subordinated in favor of the
lender for the Receivable Loans, Advances and Inventory Loans, Term Loans, and
Equipment Acquisition Loans.
Dispute Between Principal Shareholders
Daryl and Marta Kollman, shareholders who together own approximately 82%
of our outstanding shares of common stock, have filed divorce proceedings. Daryl
Kollman and Marta Kollman jointly, and their affiliate Klamath Cold Storage Co.,
are lessors of substantially all of our facilities, including office space,
processing and freezer storage space. Although one lease is in effect until
2005, we lease the rest of these facilities on a month-to-month or year-to-year
basis. The disposition of these properties pursuant to the divorce could have an
adverse or disruptive effect on our operations. Daryl Kollman is no longer
actively involved in management and has been unwilling to execute personal
guarantees on our behalf, as he has done in the past. On May 14, 2001, Marta
Kollman petitioned the Circuit Court for the State of Oregon with a motion
seeking, among other court orders, to enjoin Daryl Kollman from interfering with
any future loan applications of Marta Kollman or us and a self executing
judgment provision whereby the court would sign a loan application on behalf of
Daryl Kollman. The court held that Daryl Kollman is to cease and desist from any
such endeavors of interfering with our loan applications during the pendency of
the dissolution proceedings and is prohibited from writing letters or
communicating orally with any lending institutions unless requested to do so by
the institution. The court also held that Daryl Kollman, if presented with loan
documents to sign and if he objects to those documents in form or content, he
must first raise it with the court.
On January 29, 2002, the Court issued its written Order after the matter
was heard before the court at trial on December 10, 11, and 12, 2001. The Court
ruled that Marta Kollman and Daryl Kollman were each entitled to an equal
division of their respective stock ownership in our Company, thus resulting in
no change in our current ownership. The Court also ruled Daryl Kollman and Marta
Kollman's joint ownership in certain real property assets leased by us from them
will be divided equally in each property and that they must sell the properties
and improvements to pay the indebtedness to the Internal Revenue Service. Any
remaining proceeds after the payment of Federal and State taxes applicable to
the sale will be shared equally.
We do not believe the Court Order issued on January 29, 2002, will have a
material impact on our business since we believe that we can maintain our
favorable leases in the event of the sale of the properties or provide for an
adequate transition to other properties for the orderly continuation of our
business.
38
Impact of Government Regulation
The formulation, manufacture, labeling, and advertising of our products
are subject to extensive federal, state, and local governmental regulation. We
have, from time to time, received formal and informal inquiries from
governmental regulators about our business and compliance with existing laws. We
have on occasions altered our product formulas and revised our labeling and
promotion practices to comply with such laws. To enforce statutes and
regulations, governmental agencies may initiate investigations, issue warning
letters and cease and desist orders, impose corrective measures, seek injunctive
relief or product seizure, impose civil penalties, or pursue criminal
prosecution. Therefore, any future repeal, amendment, or narrow interpretations
of current statutes or regulations that render our current practices
noncompliant could substantially hinder our ability to maintain or increase our
stream of distribution, or to introduce new products into the markets. We cannot
predict the nature of any of such future laws, regulations, or interpretations,
or what kind of impact they might have on our business. Future laws and
regulations requiring the reformulation, discontinuance, or relabeling of any of
our products to comply with new standards could interrupt our product
distribution and potentially harm our business. Even if future governmental
actions or investigations in our business do not halt the manufacture of any of
our products, they could create negative publicity, thereby harming our
business.
Uncertainties in the International Markets
Our operations growth strategy involves expanding product sales into the
international markets in Europe and Asia. We believe that there is a potential
for growth internationally, but our ability to enter these markets effectively
may be limited by various factors, which include varying domestic regulations,
responsiveness of government authorities, cultural differences and political
uncertainties. We cannot provide assurance that consumers in any of our
potential new international markets will be receptive to our nutritional
supplement and personal care products. We also cannot assure you that we will be
able to reformulate our products or adjust our labeling and promotion practices
to comply with foreign laws and regulations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We have not entered into any transactions using derivative financial
instruments or derivative commodity instruments and believe that our exposure to
market risk associated with other financial instruments is not material.
Our primary market risks include fluctuations in interest rates. Our
management believes that fluctuation in interest rates in the near term would
not materially affect our consolidated operating results, financial position or
cash flows as we have limited risks related to interest rate fluctuations.
The Kollmans have sole voting and investment power with respect to their
shares. The Internal Revenue Service has a security interest in all of their
shares pursuant to a Notice of Determination dated June 18, 1999, under the
terms of which the shares are held in trust and will be released upon the
Kollmans' payment of their federal income tax liabilities for various specified
years. The Kollmans will sell their shares as needed and allowed by federal and
state securities laws to make quarterly payments to the Internal Revenue
Service. The Kollmans retain all voting rights incident to their shares while
the shares are held in trust. The Internal Revenue
39
Service may seize the Kollmans' shares from trust if the Kollmans fail to timely
cure a default upon their commitments to the Internal Revenue Service under the
Notice of Determination. The Internal Revenue Service would thereafter proceed
to sell or judicially foreclose some or all of the shares for payment of the
Kollmans' tax liabilities as allowed by applicable law.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Our Consolidated Financial Statements together with the Report thereon of
BDO Seidman, LLP, independent auditors, and the Supplementary Data required by
this Item 8, are included elsewhere in Item 14.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
40
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Directors and Executive Officers
Our directors and executive officers are as follows:
Name Age Position
- ---- --- --------
Marta Carpenter Kollman (1) 56 Chief Executive Officer, President and Director
Justin Straus (2) 31 Chief Operating Officer and Director
Victor M. Bond 50 Vice President, Marketing and Strategy
Donald P. Hateley (2) 44 Chairman of the Board
Christopher J. Blaxland (1)(2) 60 Director
Donald M. Anderson (1) 53 Director
- ----------
(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.
Marta Carpenter Kollman has served as our Chief Executive Officer,
President and as a director since August 1999. She co-founded NEC in 1988 and
NAC in 1990 and has served as their President and as a director of both
companies since that time. Prior to joining us, Ms. Kollman also researched,
harvested and marketed algae to consumers. Ms. Kollman has been a member of the
Board of Directors of the Dan O'Brien Foundation since 1995 and has served as
its Secretary since 1997.
Justin Straus has served as one of our directors since August 1999 and has
served as our Chief Operating Officer from August 2000 to the present. From
January 1998 to August 2000, he served as our Vice President and Director of
Sales and from October 1999 to August 2000, he served as our Vice President,
Customer Fulfillment and fulfilled the function of Chief Operating Officer until
his appointment to that position. He joined NAC in 1984 as a harvest site
employee where he participated in the design, construction and preparation of
the NAC harvest site. After holding a variety of positions in NAC, he served as
the Vice President/Director of Sales from December 1994 to January 1998.
Victor M. Bond has served as our Vice President, Marketing and Strategy
since January 2001. From October 1999 to December 2000, he was a consultant to
us that performed the functions of the Office of Vice President, Marketing and
Strategy. From 1991 to 1999, he was President of ChangeNet, which developed and
implemented change management services and communications programs for
corporations and his clients included Xerox, Otis Elevator, and Dura
Pharmaceuticals. Prior to ChangeNet, he worked with and held executive positions
with International Business Machines Corporation including Director of Marketing
and Director of Strategy.
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Donald P. Hateley has served as our Chairman of the Board since August
1999. From 1994 to the present, he has been the Managing Director of InterCap
Partners, a boutique investment banking firm located in Los Angeles, California
that specializes in corporate finance, mergers and acquisitions and financial
advisory matters. From 1996 to the present, he has been an attorney with Hateley
& Hampton, a Los Angeles-based law firm that specializes in corporate, tax, real
estate and securities law. Mr. Hateley is also a California licensed certified
public accountant and real estate broker.
Dr. Christopher J. Blaxland has served as one of our directors since
September 1998. He was Chief Executive Officer and a director of HumaScan from
September 1 to December 22, 1998; from December 22, 1998 to August 6, 1999 he
was Chief Executive Officer and director in a consultant capacity of HumaScan
until the Reorganization. From May 1999 until December 2001, Dr. Blaxland served
as the Chief Operating Officer of PTC Therapeutics, Inc., a development stage
biopharmaceutical company, and has worked as a business consultant. From
September 1993 through December 1997, he was the President of Cell Pathways,
Inc., a development stage biopharmaceutical company.
Dr. Donald M. Anderson has served as one of our directors since August
1999. He has served as a consultant to NAC on scientific matters since 1993, and
became a director of NAC in July 1999. He is a Senior Scientist at the Woods
Hole Oceanographic Institution in Massachusetts, has served in that capacity
since 1991 and has been on the scientific staff since 1978, after receiving his
Ph.D. from the Massachusetts Institute of Technology. Dr. Anderson is a
recognized expert on toxic and harmful algal blooms and has been the director of
the U.S. National Office on Marine Biotoxins and Harmful Algal Blooms since
1993.
Board of Directors Meetings and Committees
During 2001, 2000 and 1999, our Board of Directors held 4, 8 and 5
meetings, respectively. We maintain a standing Audit Committee and Compensation
Committee, but do not maintain a standing nominating committee. Donald Hateley,
Chris Blaxland and Justin Straus serve on the Audit Committee. Marta Carpenter
Kollman, Chris Blaxland and Donald Anderson serve on the Compensation Committee.
There are no family relationships among our directors or executive officers,
except that Ms. Kollman is the mother of Mr. Straus.
Section 16(a) Beneficial Ownership Reporting Compliance
To our knowledge, based solely on a review of Section 16(a) forms
furnished to us, we believe that our directors, executive officers and ten
percent beneficial owners complied with all Section 16(a) reporting requirements
during 2001 except for Daryl Kollman.
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ITEM 11. EXECUTIVE COMPENSATION.
The following table sets forth, for the year ended December 31, 2001,
compensation paid by us to (a) each person serving as our Chief Executive
Officer during 2001 and (b) each of our other most highly compensated executive
officers (the "named executive officers") during 2001 who served as an executive
officer on December 31, 2001.
SUMMARY COMPENSATION TABLE
Securities
Other Annual Underlying
Name and Principal Location Year Salary ($) Bonus ($) Compensation ($) Options (#)
- --------------------------- ---- ---------- --------- ---------------- -----------
Marta Carpenter Kollman 2001 290,000 0 3,000(1) 0
President and Chief Executive Officer 2000 290,000 0 3,000(1) 0
(Beginning August 1999) 1999 350,000 0 3,000(1) 0
Victor M. Bond 2001 180,000 0 0 0
Vice President, Marketing & Strategy 2000 180,000 0 0 0
(Beginning January 2001) 1999 45,000 0 0 0
Justin Straus 2001 110,000 0 0 0
Chief Operating Officer, Secretary & Treasurer 2000 110,000 0 0 0
1999 110,000 0 0 0
- ------------
(1) Estimated dollar value of 1995 Chevy truck sometimes driven by the
named executive officer.
The following table summarizes the number of shares and the terms of stock
options we granted to the named executive officers in our 2001 fiscal year.
OPTIONS/SAR GRANTS DURING YEAR ENDED
DECEMBER 31, 2001
Individual Grants
Potential Realizable
Number of % of Total Value at Assumed
Securities Options/SARs Annual Rates of Stock
Underlying Granted to Exercise or Price Appreciation for
Options/SARs Employees in Base Price Option Term
Name Year Granted (#) Fiscal Year ($/Share) Expiration Date 5%($) 10%($)
------------ ------------ ----------- --------------- ----- ------
Marta Carpenter Kollman 2001 0 0 N/A N/A N/A N/A
Victor M. Bond 2001 0 0 N/A N/A N/A N/A
Justin Straus 2001 0 0 N/A N/A N/A N/A
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The following table sets forth information concerning the number and value
of unexercised options held by each of the named executive officers as of
December 31, 2001. None of the named executive officers exercised options in
2001.
AGGREGATE YEAR-END OPTION VALUES
(DECEMBER 31, 2001)
Number of securities underlying Value of unexercised in-the-money
unexercised options at fiscal year-end (#) options at fiscal year-end ($)(1)
------------------------------------------ ---------------------------------
Name Year Exercisable Unexercisable Exercisable Unexercisable
---- ---- ----------- ------------- ----------- -------------
Marta Carpenter Kollman 2001 0 0 0 0
Victor M. Bond 2001 0 0 0 0
Justin Straus 2001 0 0 0 0
- ----------
(1) Represents the difference between the aggregate market value at
December 31, 2001 and 2000, as applicable, of our common stock
(based on a last sale price of $0.30 and $0.20 on each such date,
respectively) and the options' aggregate exercise price.
Board Committees; Compensation Committee Interlocks and Insider Participation
Our Audit Committee conducted one meeting during 1999 and no meetings in
2001 and 2000, respectively. The committee reviews the scope of the independent
annual audit, the independent public accountants' letter to the Board of
Directors concerning the effectiveness of our internal financial and accounting
controls and the Board of Directors' response to that letter, if deemed
necessary.
Our Compensation Committee oversees our executive compensation program and
makes recommendations to our full Board of Directors regarding changes in
compensation. It also administers our stock option plans. The committee held one
meeting during each of 2001, 2000 and 1999, respectively.
Marta Carpenter Kollman, our Chief Executive Officer, President and a
director, Chris Blaxland, a director and Dr. Donald M. Anderson, a director,
served on the Compensation Committee in 2001 and 2000.
Introduction to Report of Compensation Committee
The Compensation Committee of the Board of Directors (the "Committee") is
composed of Messrs. Blaxland and Anderson and Ms. Kollman. The Committee is
responsible for the establishment and oversight of the Company's executive
compensation programs. The following report of the Committee discusses generally
the Company's executive compensation objectives and policies and their
relationship to the Company's performance in 2001.
Executive Compensation Philosophy and Objectives
Our executive compensation program is designed to attract, retain and
motivate highly effective executives and to reward sustained corporate and
individual performance with an appropriate base annual salary and incentive
compensation. We seek to increase management ownership of our common stock and
to link executive compensation with stockholder value, achievement of business
objectives and corporate profitability.
44
Our compensation philosophy is to compensate our executive officers at
market-competitive levels for achieving planned performance. Market comparisons
include general industry norms, nutritional supplements manufacturers companies,
and a selected group of direct selling companies that are approximately the same
size as us. More emphasis is placed on general industry than the nutritional
supplement industry norms.
Compensation Program Components
Consistent with our executive compensation objectives, our compensation
for our senior management, including the Chief Executive Officer, consists of
three components: an annual base salary, annual cash incentive awards and
long-term incentive awards. During the year ended December 31, 2001, our
compensation of our senior executives consisted of annual base salary. No cash
incentive awards were paid in 2001.
Annual Base Salary. Base salaries for executive officers are determined
with reference to a salary range for each position. Salary ranges are determined
by evaluating a particular employee's position and comparing it with what were
believed to be representative prevailing norms for similar positions in
similarly sized companies. Within this salary range, an executive's initial
salary level is determined largely through Committee judgment, based on the
experience of our members. Salaries were set at a level to attract, retain and
motivate superior executives.
Long-Term Incentive Awards. Long-term incentive compensation will be
provided by the grant of options to purchase shares of our Common Stock under
the 2000 Plan, if amended, or a successor or additional stock option plan to be
approved by our Board of Directors. In considering the awards, the Committee
takes into account such factors as prevailing norms for the ratio of options
outstanding to total shares outstanding, the effect on maximizing long-term
stockholder value, and vesting and expiration dates of each executive's
outstanding options.
The Compensation Committee
Marta C. Kollman
Chris J.M. Blaxland
Donald M. Anderson
Compensation of Directors
Members of our Board of Directors who are our officers are not separately
compensated for serving on the Board of Directors. We pay directors who are not
our employees an annual retainer of $40,000 ($30,000 if the director does not
attend at least 3/4 of the Board meetings held), an additional $10,000 to the
Chairman of the Board, $5,000 for each Board committee on which the director
serves, a meeting fee of $1,500 ($500 if attendance is by telephone), and
reimbursement of reasonable expenses. In addition, in February 2000, we adopted
the 2000 Stock Incentive Plan that provides that each non-employee director will
receive on the date of each annual meeting of our stockholders options to
purchase 10,000 shares of our common stock under terms more fully described
below.
Upon the Board's adoption of our 2000 Stock Incentive Plan, again in 2002
for our fiscal year ended December 31, 2001, and under its terms, we granted to
each of Donald Hateley, Christopher Blaxland and Donald Anderson a 10-year
option to purchase 15,000 shares of our
45
common stock, in each of 2000 and 2001, at an exercise price as provided by our
Board of Directors which is equal to the fair market value of our common stock
on the date on which the options are granted. These options are fully
exercisable as of the date of their grant.
Stock Options
2000 Stock Incentive Plan. The Board of Directors adopted our 2000 Stock
Incentive Plan in February 2000 for the purpose of securing for us and our
shareholders the benefits arising from the ownership of restricted shares of our
common stock, stock appreciation rights, and stock options by directors who are
not employees (Donald Hateley, Christopher Blaxland and Donald Anderson are our
current non-employee directors), officers, other key employees and consultants
to us and our subsidiaries who are expected to contribute to our future growth
and success. We have not granted restricted shares or stock appreciation rights
under the plan. As stated above, we have granted options under the plan for an
aggregate of 90,000 shares to our eligible non-employee directors. We may not
grant awards under the plan after February 2010. The plan is subject to
shareholders approval.
The plan provides for the issuance of up to 700,000 shares of our common
stock. Under the plan, we may grant awards to key employees and will annually
grant an option to purchase 10,000 shares of our common stock to our eligible
non-employee directors, as described below. The Board of Directors administers
the plan, which, subject to the terms of the plan, determines the key employees
who will receive awards and the terms of the awards granted.
Under the plan, provided that a sufficient number of shares remain
available for grant, non-employee directors serving on the Board of Directors
immediately following each annual meeting of shareholders (including those
elected at the meeting), are automatically granted a 10-year option to purchase
10,000 shares of our common stock at an exercise price equal to the fair market
of the common stock on the annual meeting date. These options become exercisable
with respect to 1/3 of the shares underlying the option on the date of grant,
2/3 of such shares one year later and all of such shares two years later, in
each case assuming the recipient's continuous service as a director during that
time.
1996 Stock Incentive Plan. HumaScan adopted a 1996 Stock Incentive Plan in
June 1996. The provisions of the 1996 plan were substantially similar to the
provisions of our 2000 Stock Incentive Plan except that the 1996 plan provides
for the issuance of up to 64,504 shares of our common stock. We will make no
further awards under the 1996 plan, but options to purchase 25,802 shares remain
outstanding and exercisable under the plan at a weighted average exercise price
of between $3.05 and $142.49 per share.
Other Options. We have issued options outside of our stock option plans to
certain officers, directors, employees and consultants. We granted options to
purchase (a) 13,131 shares in February 1996 with a five-year term and an
exercise price of $57.84 per share, (b) 1,382 shares in March 1998 with a
ten-year term and an exercise price of $98.69 per share, and (c) 4,607 shares to
a consultant with a 5 year term and an exercise price of $14.98. We granted
4,216 shares in prior years that have been exercised. All of these options,
except for the options exercised, remain outstanding and are fully exercisable.
In September 1996, we also granted options to purchase an aggregate of 691
shares with a 10-year term and an exercise price of $65.11 to five former
non-employee directors. These options are outstanding and exercisable.
46
Performance Measurement Comparison*
The rules and regulations of the SEC require the presentation of a line
graph since the Common Stock has been registered under Section 12 of the
Exchange Act comparing the yearly percentage change in our cumulative
stockholder return to (i) the cumulative total return of a broad market equity
index and (ii) the cumulative return of either a published industry index or a
self-constructed group of peer issuers that we believe is relevant to a
comparative understanding of its performance.
We have used the NASDAQ Market (U.S.) and a peer group. The
publicly-traded companies in our peer group are Mannatech, Inc., Market America,
Inc., Usana Health Sciences, Inc., Nature's Sunshine Products, Inc., Reliv
International, Inc. and Nu Skin Enterprises Inc.
----------
* The material in this graph is not "solicitation material", is not
deemed filed with the SEC, and is not incorporated by reference in
any of our filings under the Securities Act or the Exchange Act,
whether made before or after the date hereof and irrespective of any
general incorporation language in any filing. Research Data Group,
Inc. has provided the information in the graph.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
AMONG CELL TECH INTERNATIONAL INCORPORATED,
THE NASDAQ STOCK MARKET (U.S.) INDEX AND A PEER GROUP
[LINE CHART]
* $100 Invested on 12/31/96 in stock or index-including reinvestment of
dividends. Fiscal year ending December 31.
47
Cumulative Total Return
12/96 12/97 12/98 12/99 12/00 12/01
----- ----- ----- ----- ----- -----
Cell Tech International Incorporated 100 151.11 1.12 24.44 26.94 3.72
NASDAQ Stock Market (U.S.) 100 122.48 172.68 320.89 193.01 153.15
Peer Group 100 98.36 80.50 42.51 24.04 43.62
48
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth certain information regarding ownership of
our capital stock as of March 31, 2002, by (i) each person known to us to
beneficially own more than 5% of the shares of our outstanding common stock,
(ii) each of our directors, (iii) each of the named executive officers, and (iv)
all of our directors and executive officers as a group.
Number of
Shares Percent of
Beneficially Shares
Name and Address of Beneficial Owner Owned (1) Outstanding
- ------------------------------------ --------- -----------
Marta Carpenter Kollman 4,341,498(2) 40.8
565 Century Court
Klamath Falls, Oregon 97601
Daryl J. Kollman 4,341,498(3) 40.8
5248 Timber Branch Way
San Diego, CA 92130
Victor M. Bond 0 *
565 Century Court
Klamath Falls, Oregon 97601
Donald P. Hateley 330,000(4) 2.8
1800 Century Park East
Los Angeles, California 90067
Dr. Christopher J. Blaxland 32,764(5) *
509 County Line Road
Radnor, Pennsylvania 19087
Donald M. Anderson 32,949(6) *
Biology Department
Mail Stop 32, Redfield 332
Woods Hole, Massachusetts 02543-1049
Justin Straus 0 *
565 Century Court
Klamath Falls, Oregon 97601
Zubair Kazi 5,528,023(7) 39.9
3671 Sunswept Drive
Studio City, California 91604
All executive officers and directors as a group (6 persons) 9,018,524(8) 84.4
- ----------
* Less than 1% of the outstanding shares.
(1) A person is considered to "beneficially own" any shares (a) over which
such person exercises sole or shared voting or investment power, or (b) of
which such person has the right to acquire ownership at any time within 60
days (e.g., through exercise of stock options). Voting and investment
power relating to the shares referenced in the table above is exercised
solely by the beneficial owner, except as indicated otherwise.
49
(2) Excludes 4,341,498 shares held by Ms. Kollman's spouse. Ms. Kollman has
sole voting and investment power with respect to her shares. The Internal
Revenue Service has a security interest in all of Ms. Kollman's shares
pursuant to a Notice of Determination dated June 18, 1999 under the terms
of which the shares are held in trust and will be released upon the
Kollmans' payment of their federal income tax liabilities for various
specified years. Ms. Kollman will sell her shares as needed and allowed by
federal and state securities laws to make quarterly payments to the
Internal Revenue Service. Ms. Kollman retains all voting rights incident
to her shares while the shares are held in trust. The Internal Revenue
Service may seize Ms. Kollman's shares from trust if the Kollmans fail to
timely cure a default upon their commitments to the Internal Revenue
Service under the Notice of Determination. The Internal Revenue Service
would thereafter proceed to sell or judicially foreclose some or all of
the shares for payment of the Kollmans' tax liabilities as allowed by
applicable law.
(3) Excludes 4,341,498 shares held by Mr. Kollman's spouse. Mr. Kollman has
sole voting and investment power with respect to his shares. The Internal
Revenue Service has a security interest in all of Mr. Kollman's shares
pursuant to a Notice of Determination dated June 18, 1999 under the terms
of which the shares are held in trust and will be released upon the
Kollmans' payment of their federal income tax liabilities for various
specified years. Mr. Kollman will sell his shares as needed and allowed by
federal and state securities laws to make quarterly payments to the
Internal Revenue Service. Mr. Kollman retains all voting rights incident
to his shares while the shares are held in trust. The Internal Revenue
Service may seize Mr. Kollman's shares from trust if the Kollmans fail to
timely cure a default upon their commitments to the Internal Revenue
Service under the Notice of Determination. The Internal Revenue Service
would thereafter proceed to sell or judicially foreclose some or all of
the shares for payment of the Kollmans' tax liabilities as allowed by
applicable law.
(4) Represents warrants to purchase 300,000 shares of common stock held by
Hateley & Hampton, a Professional Law Corporation of which Donald P.
Hateley is a President, co-founder and a shareholder and 30,000 shares Mr.
Hateley has the right to acquire pursuant to options exercisable within 60
days.
(5) Represents 32,764 shares Dr. Blaxland has the right to acquire pursuant to
options exercisable within 60 days.
(6) Includes 30,000 shares Mr. Anderson has the right to acquire pursuant to
options exercisable within 60 days.
(7) Includes 1,157,895 shares already issued to Kazi and an additional
1,606,117 issuable to Kazi under various covenants to his existing shares
and 1,157,895 issuable to Kazi upon the exercise of his warrants and
1,606,117 issuable to Kazi under various covenants upon the exercise of
his warrants.
(8) Includes 330,000 shares issuable upon the exercise of warrants and 32,764
shares issuable upon the exercise of options within 60 days. See footnotes
4 through 6 above.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
We lease approximately 250,000 square feet of office, processing, freezer
and storage space directly from the Kollmans, our principal shareholders, or
their affiliate, Klamath Cold Storage ("KCS"). Most of these leases are
year-to-year, although we do rent some space on a month-to-month basis and one
lease will expires in 2005. We believe that the space we lease from the Kollmans
and KCS and the rent we pay to them is at below or at fair market values. Rental
payments to the Kollmans or KCS in 2001 were $1,127,855. We currently owe the
Kollmans or KCS $1,086,099 in accrued rental payments and we show it on our
balance sheet as a related party payable.
In 2001, we also received $196,218 in management fees and other income
from the Kollmans or KCS.
50
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
(a) Exhibits required by Item 601 of Regulation S-K
(a)(1) and (2) Financial Statements. The Financial Statements and Schedules are
listed in the Index to Financial Statements on page F-1 of this Form 10-K.
(a)(3) Exhibits:
(Exhibit Number Description
- --------------- -----------
(2) Plan of Acquisition, Reorganization, Arrangement, Liquidation
or Succession
(2.1) Agreement and Plan of Reorganization,
dated July 16, 1999, among the Company,
Daryl J. Kollman and Marta C. Kollman
(filed as Exhibit 2.1 without schedules
and exhibits to the Current Report on Form
8-K on August 2, 1999 and incorporated by
reference)
(3) Articles of Incorporation and Bylaws
(3.1) Certificate of Incorporation, as amended
(filed as Exhibit 3.1 to the Registration
Statement for Small Business on Form SB-2
on June 21, 1996 and incorporated by
reference)
(3.2) Certificate of Amendment of Certificate of
Incorporation (filed as Exhibit 3.1(a) to
the Current Report on Form 8-K on November
19, 1999 and incorporated by reference)
(3.3) Certificate of Designations, Preferences
and Rights of Series B Convertible
Preferred Stock (filed as Exhibit 3.1 to
the Current Report on Form 8-K on August
2, 1999 and incorporated by reference)
(3.4) Amended and Restated Bylaws (filed as
Exhibit 3.2 to the Registration Form for
Small Business on Form SB-2 on June 21,
1996 and incorporated by reference)
(4) Instruments Defining the Rights of Security Holders
(4.1) Loan and Security Agreement, dated June
21, 1999, by and among The New Earth
Company, The New Algae Company and Coast
Business Credit (filed as Exhibit 4.1 to
the Current Report on Form 8-K on November
19, 1999 and incorporated by reference)
51
(4.2) Continuing Guaranty, dated August 6,
1999 (filed as Exhibit 4.2 to the Current
Report on Form 8-K on November 19, 1999
and incorporated by reference)
(4.3) Form of Common Stock Certificate (filed as
Exhibit 4.1 to the Amendment to
Registration Statement for Small Business
on Form SB-2/A on July 26, 1996 and
incorporated by reference)
(4.4) Form of Series A Preferred Stock
Certificate (filed as Exhibit 4.2 to the
Amendment to Registration Statement for
Small Business on Form SB-2/A on July 26,
1996 and incorporated by reference)
(4.5) Form of Warrant to Purchase Shares of
Common Stock to be issued to Andromeda
Enterprises, Inc. or its designees,
Hateley & Hampton or its designees and
Wharton Capital Partners, Ltd. (filed as
Exhibit 4.1 to the Current Report on Form
8-K on August 2, 1999 and incorporated by
reference)
(4.6) Nonqualified Stock Option Agreement
between the Company and Physicians World
Communications Group (filed as Exhibit 4.9
to the Quarterly Report on Form 10-Q for
the quarterly period ended September 30,
1998 and incorporated by reference)
(4.7) Warrant to Purchase Shares of Common Stock
issued to Scantek Medical, Inc. as of May
15, 1998 (filed as Exhibit 4.7 to the
Quarterly Report on Form 10-Q for the
quarterly period ended September 30, 1998
and incorporated by reference)
(4.8) Warrant to Purchase Shares of Common Stock
issued to Zigmed, Inc. as of May 15, 1998
(filed as Exhibit 4.8 to the Quarterly
Report on Form 10-Q for the quarterly
period ended September 30, 1998 and
incorporated by reference)
(4.9) Representative's Warrant Agreement between
the Company and Keane Securities Co.,
including Form of Warrant Certificate
(filed as Exhibit 4.3 to the Amendment to
Registration Statement for Small Business
on Form SB-2/A on July 26, 1996 and
incorporated by reference)
52
(4.10) Form of Warrant Certificate for March
Bridge Warrants (filed as Exhibit 4.4 to
the Registration Statement for Small
Business on Form SB-2 on June 21, 1996 and
incorporated by reference)
(4.11) Nonqualified Stock Option Agreements with
Certain Officers (Donald Brounstein, James
Whidden, Whidden & Associates, Inc., Amy
Lewis, and Everett Lautin) (filed as
Exhibit 4.5 to the Registration Statement
for Small Business on Form SB-2 on June
21, 1996 and incorporated by reference)
(4.12) Form of Private Warrants issued in
connection with May Private Placement
(filed as Exhibit 4.6 to the Registration
Statement for Small Business on Form SB-2
on June 21, 1996 and incorporated by
reference)
(10) Material Contracts
(10.1) General Release, dated January 25, 2000
between the Company and Donald Brounstein
(filed as Exhibit 10.1 to the Annual
Report on Form 10-K for the year ended
December 31, 2000 and incorporated by
reference)
(10.2) Settlement Agreement, dated May 15, 1998,
between the Company and Scantek Medical,
Inc. (filed as Exhibit 10.16 to the
Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 1998 and
incorporated by reference)
(10.3) Settlement Agreement, dated May 15, 1998,
between the Company and Zigmed, Inc.
(filed as Exhibit 10.17 to the Quarterly
Report on Form 10-Q for the quarterly
period ended June 30, 1998 and
incorporated by reference)
(10.4) Employment Agreement between the Company
and Dr. Chris J. M. Blaxland, dated as of
September 1, 1998 (filed as Exhibit 10.18
to the Quarterly Report on Form 10-Q for
the quarterly period ended September 30,
1998 and incorporated by reference)
(10.5) Employment Agreement between the Company
and Donald Brounstein, dated January 1,
1996 (filed as Exhibit 10.8 to the
Registration Statement for Small Business
on Form SB-2 on June 21, 1996 and
incorporated by reference)
(10.6) Employment Agreement between the Company
and James J. Whidden (filed as Exhibit
10.9 to the Registration
53
Statement for Small Business on Form SB-2
on June 21, 1996 and incorporated by
reference)
(10.7) Employment Agreement between the Company
and Kenneth S. Hollander, dated June 3,
1996 (filed as Exhibit 10.10 to the
Registration Statement for Small Business
on Form SB-2 on June 21, 1996 and
incorporated by reference)
(10.8) Consulting Agreement, dated March 1, 1996,
between the Company and Don Anderson
(filed as Exhibit 10.8 to the Annual
Report on Form 10-K for the year ended
December 31, 2000 and incorporated by
reference)
(10.9) Exclusive Supply and Distribution
Agreement between the Company and
Physician Sales & Services, Inc., as
amended (filed as Exhibit 10.1 to the
Amendment to Registration Statement for
Small Business on Form SB-2/A on July 26,
1996 and incorporated by reference)
(10.10) License Agreement, dated October 20, 1995,
between the Company and Scantek Medical,
Inc., as amended (filed as Exhibit 10.2 to
the Registration Statement for Small
Business on Form SB-2 on June 21, 1996 and
incorporated by reference)
(10.11) Construction Contract between the Company
and Zigmed, Inc. (filed as Exhibit 10.3 to
the Registration Statement for Small
Business on Form SB-2 on June 21, 1996 and
incorporated by reference)
(10.12) Lease, dated June 11, 1996, between the
Company and the Moen Organization, Inc.
(filed as Exhibit 10.14 to the
Registration Statement for Small Business
on Form SB-2 on June 21, 1996 and
incorporated by reference)
(10.13) Lease Termination Agreement, dated
February 2, 1999, between the Company and
the Moen Organization, Inc. (filed as
Exhibit 10.13 to the Annual Report on Form
10-K for the year ended December 31, 2000
and incorporated by reference)
(10.14) Intentionally omitted
(10.15) Commercial Lease Agreement, dated July 1,
1995, between and among The New Earth
Company, Daryl Kollman and Marta Kollman
(filed as Exhibit 10.15 to the Annual
Report
54
on Form 10-K for the year ended December
31, 2000 and incorporated by reference)
(10.16) Commercial Lease Agreement, dated August
15, 1995, between and among The New Algae
Company, Daryl Kollman and Marta Kollman
(filed as Exhibit 10.16 to the Annual
Report on Form 10-K for the year ended
December 31, 2000 and incorporated by
reference)
(10.17) Ground Lease Agreement, dated December 9,
1995, between and among The New Earth
Company, Emil Nobel and Mary Ann Nobel
(filed as Exhibit 10.17 to the Annual
Report on Form 10-K for the year ended
December 31, 2000 and incorporated by
reference)
(10.18) Commercial Lease Agreement, dated May 1,
1996, between and among The New Algae
Company, Daryl Kollman and Marta Kollman
(filed as Exhibit 10.18 to the Annual
Report on Form 10-K for the year ended
December 31, 2000 and incorporated by
reference)
(10.19) Commercial Lease Agreement, dated
September 1, 1996, between Klamath Cold
Storage, Inc. and The New Earth Company,
including Sublease between The New Earth
Company and The New Algae Company (filed
as Exhibit 10.19 to the Annual Report on
Form 10-K for the year ended December 31,
2000 and incorporated by reference)
(10.20) Voting and Stockholders' Rights Agreement,
dated May 15, 1996 (filed as Exhibit 10.4
to the Registration Statement for Small
Business on Form SB-2 on June 21, 1996 and
by this reference incorporated herein)
(10.21) Agreement to Issue Warrants, dated March
19, 1996, between the Company and Udi
Toledano (filed as Exhibit 10.5 to the
Registration Statement for Small Business
on Form SB-2 on June 21, 1996 and by this
reference incorporated herein)
(10.22) Agreement to Issue Warrants, dated March
19, 1996, between the Company and Herbert
V. Turk (filed as Exhibit 10.6 to the
Registration Statement for Small Business
on Form SB-2 on June 21, 1996 and by this
reference incorporated herein)
(10.23) Non-Negotiable Warrant Certificate between
the Company and Physician Sales & Service,
Inc. (filed as Exhibit 10.7 to
55
the Registration Statement for Small
Business on Form SB-2 on June 21, 1996 and
by this reference incorporated herein)
(10.24) HumaScan, Inc. Non-Employee Director Stock
Option Plan (filed as Exhibit 10.12 to the
Registration Statement for Small Business
on Form SB-2 on June 21, 1996 and by this
reference incorporated herein)
(10.25) Form of Indemnification Agreement between
the Company and its Executive Officers and
Directors (filed as Exhibit 10.15 to the
Annual Report for Small Business on Form
10KSB40 for the fiscal year ended December
31, 1997 and by this reference
incorporated herein)
(10.26) The Company's 2000 Stock Incentive Plan
(filed as Exhibit 10.26 to the Annual
Report on Form 10-K for the year ended
December 31, 2000 and incorporated by
reference)
(16) Letter from KPMG, dated November 2, 1999, agreeing with the
statements contained in the Company's Form 8-K, dated November
2, 1999 (filed as Exhibit 16 to the Current Report on Form 8-K
on November 22, 1999 and by this reference incorporated
herein)
(21) List of the Company's Subsidiaries (filed as Exhibit 21 to the
Annual Report on Form 10-K for the year ended December 31,
2000 and incorporated by reference)
(99) Additional Exhibits
(99.1) Internal Revenue Service Notice of
Determination, dated July 18, 1999 (filed
as Exhibit 99.2 to the Current Report on
Form 8-K on November 19, 1999 and by this
reference incorporated herein)
(99.2) Pledge and Escrow Agreement between and
among Daryl Kollman and Marta Kollman, the
Internal Revenue Service and West Coast
Trust Co., Inc. (filed as Exhibit 99.3 to
the Current Report on Form 8-K on November
19, 1999 and by this reference
incorporated herein)
(b) Reports on Form 8-K. None.
56
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 duly authorized, in the City of Klamath
Falls, State of Oregon on May 23, 2002.
CELL TECH INTERNATIONAL INCORPORATED.
By: /s/ Marta C. Kollman
---------------------------------
Marta C. Kollman, Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, the
following persons on behalf of the registrant and in the capacities indicated
have signed this report below:
Signature Title Date
--------- ----- ----
By: /c/ Marta C. Kollman President and Chief Executive May 23, 2002
----------------------- Officer and Director
Marta C. Kollman (principal executive officer,
principal financial officer and
principal accounting officer)
By: /s/ Donald P. Hateley Chairman of the Board May 23, 2002
------------------------
Donald P. Hateley
By: /s/ Justin Straus Vice President of Customer May 23, 2002
------------------------ Fulfillment and Director
Justin Straus
By: /s/ Chris J.M. Blaxland Director May 23, 2002
------------------------
Chris J.M. Blaxland
By: /s/ Donald M. Anderson Director May 23, 2002
------------------------
Donald M. Anderson
57
CELL TECH INTERNATIONAL
INCORPORATED AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Certified Public Accountants F-3
Consolidated Financial Statements
Consolidated Balance Sheets F-4
Consolidated Statements of Operations F-5
Consolidated Statements of Shareholders' Equity F-6
Consolidated Statements of Cash Flows F-7
Notes to Consolidated Financial Statements F-8
F-2
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Shareholders of
Cell Tech International Incorporated and Subsidiaries
Klamath Falls, Oregon
We have audited the accompanying consolidated balance sheets of Cell Tech
International Incorporated and Subsidiaries as of December 31, 2001 and 2000,
and the related consolidated statements of operations, shareholders' equity and
cash flows for each of the three years in the period ended December 31, 2001.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits 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 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 financial position of Cell Tech
International Incorporated and Subsidiaries as of December 31, 2001 and 2000,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company experienced recurring losses, has a negative
working capital at December 31, 2001, is in default of certain restrictive
covenants on its bank loan agreement and is experiencing difficulty in
generating sufficient cash flows to meet its obligations. These matters raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plan in regard to these matters is also described in Note 2. The
accompanying financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the amounts and
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern.
Los Angeles, California
March 27, 2002
F-3
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
---------------------------
2001 2000
----------- -----------
Assets (Note 7)
Current assets
Receivables (Note 3) $ 327,083 $ 535,145
Inventories, current portion (Note 4) 2,000,000 2,500,000
Prepaid expenses 460,860 845,855
----------- -----------
Total current assets 2,787,943 3,881,000
----------- -----------
Inventories, net of current portion (Note 4) 7,304,778 8,675,999
Property and equipment, net (Note 5) 7,318,683 13,218,097
Property and equipment held for sale (Note 5) 2,271,305 342,889
Other assets (Note 6) 292,092 1,131,661
----------- -----------
Total assets $19,974,801 $27,249,646
=========== ===========
Liabilities and Shareholders' Equity
Current liabilities
Bank overdraft $ 763,105 $ 1,310,551
Accounts payable 2,527,078 2,897,684
Commissions payable 1,219,136 1,869,135
Sales taxes payable 82,343 112,988
Accrued payroll and related liabilities 252,944 255,132
Other accrued expenses 1,133,438 1,173,321
Current portion of long-term debt (Note 7) 2,160,986 2,862,683
Related party payable (Note 12) 1,086,099 741,470
----------- -----------
Total current liabilities 9,225,129 11,222,964
----------- -----------
Long-term liabilities
Long-term debt, net of current portion (Note 7) -- 261,660
----------- -----------
Total liabilities 9,225,129 11,484,624
----------- -----------
Commitments and contingencies (Notes 9 and 10)
Shareholders' equity
Series A convertible preferred stock - no par value;
4,175,000 shares authorized; none issued and
outstanding -- --
Series B convertible preferred stock - no par value;
800,000 shares authorized; none issued and
outstanding -- --
Undesignated preferred stock - no par value; 1,825,000
shares authorized; none issued and outstanding -- --
Common stock - $.01 par value; 50,000,000 shares
authorized, 10,640,895 shares issued and outstanding
in 2001 and 2000 (Notes 9 and 10) 106,409 106,409
Additional paid-in capital 2,299,696 2,299,696
Retained earnings 8,343,567 13,358,917
----------- -----------
Total shareholders' equity 10,749,672 15,765,022
----------- -----------
Total liabilities and shareholders' equity $19,974,801 $27,249,646
=========== ===========
See accompanying notes to consolidated financial statements.
F-4
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 31,
------------------------------------------------
2001 2000 1999
------------ ------------ ------------
Sales $ 30,012,076 $ 38,976,663 $ 54,487,939
Cost of sales 9,524,517 11,488,802 14,748,570
------------ ------------ ------------
Gross profit 20,487,559 27,487,861 39,739,369
Commissions 14,341,935 17,632,344 24,433,049
------------ ------------ ------------
Gross profit after commissions 6,145,624 9,855,517 15,306,320
Operating Expenses:
Selling expenses 4,059,982 5,338,194 7,974,259
General and administrative 2,440,736 4,263,967 6,418,788
Shipping and handling expenses 1,864,159 2,097,369 3,899,361
Research and development 190,884 456,098 1,453,371
Asset write-down (Notes 5 and 6) 2,589,940 136,389 --
------------ ------------ ------------
Operating loss (5,000,077) (2,436,492) (4,439,459)
Other income (Note 13) 606,962 421,045 1,012,660
Interest expense (622,235) (768,492) (714,025)
------------ ------------ ------------
Loss before taxes (5,015,350) (2,783,939) (4,140,824)
Income tax benefit (Note 8) -- -- --
------------ ------------ ------------
Net loss $ (5,015,350) $ (2,783,939) $ (4,140,824)
============ ============ ============
Basic and diluted loss per share $ (0.47) $ (0.26) $ (0.45)
============ ============ ============
Weighted average number of common
shares outstanding used to calculate
basic and diluted loss per share 10,640,895 10,640,895 9,280,431
============ ============ ============
See accompanying notes to consolidated financial statements.
F-5
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Common Stock Additional
----------------------- Paid-In Retained Shareholders'
Shares Amount Capital Earnings Equity
---------- -------- ---------- ------------ -------------
Balances, January 1, 1999 8,683,000 $ 86,830 $ 192,213 $ 31,444,019 $ 31,723,062
Reorganization, recapitalization and
reverse stock split (Note 1) 750,000 7,500 69,562 -- 77,062
Issuance of common stock and warrants
for cash (Note 9) 1,157,895 11,579 1,504,046 -- 1,515,625
Common stock issued for services (Note 9) 50,000 500 133,875 -- 134,375
Warrants issued for services (Note 9) -- -- 400,000 -- 400,000
Distributions to shareholders -- -- -- (11,160,339) (11,160,339)
Net loss -- -- -- (4,140,824) (4,140,824)
---------- -------- ---------- ------------ ------------
Balances, December 31, 1999 10,640,895 106,409 2,299,696 16,142,856 18,548,961
Net loss -- -- -- (2,783,939) (2,783,939)
---------- -------- ---------- ------------ ------------
Balances, December 31, 2000 10,640,895 106,409 2,299,696 13,358,917 15,765,022
Net loss -- -- -- (5,015,350) (5,015,350)
---------- -------- ---------- ------------ ------------
Balances, December 31, 2001 10,640,895 $106,409 $2,299,696 $ 8,343,567 $ 10,749,672
========== ======== ========== ============ ============
See accompanying notes to consolidated financial statements.
F-6
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31,
----------------------------------------------
2001 2000 1999
----------- ----------- ------------
Cash flows from operating activities
Net loss $(5,015,350) $(2,783,939) $ (4,140,824)
Adjustments to reconcile net loss to cash
provided by (used for) operating activities:
Depreciation and amortization 2,607,668 3,347,670 2,621,377
(Gain) loss on sale of fixed assets (15,175) 60,693 530,095
Impairment of fixed assets and intangibles 2,589,940 136,381 --
Warrants issued for services -- -- 400,000
Changes in assets and liabilities:
Receivables 208,062 (45,494) (77,285)
Inventories 1,871,221 2,355,388 3,036,854
Prepaid expenses 290,165 (112,205) 207,302
Other assets (70,374) (36,159) 25,365
Accounts payable (370,606) (1,305,316) 2,190,930
Commissions payable (649,999) (2,527,240) 226,571
Sales tax payable (30,645) (61,527) (103,176)
Accrued payroll and payroll related liabilities (39,883) (125,135) 28,217
Other accrued expenses (2,188) 532,871 (434,538)
----------- ----------- ------------
Net cash provided by (used for) operating activities 1,372,836 (564,012) 4,510,888
----------- ----------- ------------
Cash flows from investing activities
Purchase of property and equipment (253,662) (145,493) (605,236)
Proceeds from sale of equipment 47,000 4,094 71,325
----------- ----------- ------------
Net cash used for investing activities (206,662) (141,399) (533,911)
----------- ----------- ------------
Cash flows from financing activities
Bank overdraft (547,446) 1,062,967 247,584
Payments on long-term debt (963,357) (1,099,026) (22,451,347)
Proceeds from issuance of long-term debt -- -- 25,185,015
Net proceeds from related party debt 344,629 741,470 --
Proceeds from issuance of common stock -- -- 1,650,000
Distributions to shareholders -- -- (10,110,339)
----------- ----------- ------------
Net cash provided by (used for) financing activities (1,166,174) 705,411 (5,479,087)
----------- ----------- ------------
Net increase (decrease) in cash and cash
equivalents -- -- (1,502,110)
Cash and cash equivalents, beginning of year -- -- 1,502,110
----------- ----------- ------------
Cash and cash equivalents, end of year $ -- $ -- $ --
=========== =========== ============
Supplemental disclosure of cash flow information
Cash paid during the year for:
Interest $ 602,570 $ 779,424 $ 503,230
=========== =========== ============
Supplemental disclosure of non-cash transactions
Stock issued for fundraising activities $ -- $ -- $ 134,375
Distributions of fixed assets to shareholders -- -- 1,050,000
=========== =========== ============
See accompanying notes to consolidated financial statements.
F-7
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Business
Cell Tech International Incorporated, The New Algae Company (NAC), and The New
Earth Company (NEC), collectively the "Company", are engaged in the production
and marketing of food supplement products made with blue-green algae harvested
from Klamath Lake, Oregon. The Company uses a multi-level distributor network
throughout the United States and Canada to distribute its products. The Company
commenced operations as NAC in 1982 and subsequently formed NEC to further its
operations. In 1990 NAC purchased the assets of Cell Tech, Inc. and then began
doing business under the trade name "Cell Tech".
Effective August 6, 1999, pursuant to an Agreement and Plan of Reorganization,
HumaScan, Inc., a Delaware public shell corporation ("Holding Company"),
acquired all of the issued and outstanding shares of NAC and NEC ("Operating
Companies"). In consideration of the shares of Operating Companies, the Holding
Company issued to Daryl J. Kollman and Marta C. Kollman (together the
"Kollmans") an aggregate of 13,000,000 shares of common stock of the Holding
Company and an aggregate of 748,507 shares of Series B Preferred Stock
("Preferred Stock") of the Holding Company. Each share of preferred stock has
converted automatically into 108.520933 shares of the Holding Company common
stock (an aggregate of 81,228,723 shares). As of August 6, 1999, the Holding
Company had 8,139,070 shares of common stock outstanding immediately prior to
the reorganization and issuance to the Kollmans, and had reserved 2,569,107
shares of common stock for issuance upon the exercise of outstanding options and
warrants or pursuant to the Holding Company's 1996 Stock Incentive Plan. On
August 10, 1999, the Holding Company undertook a 1:10.8520933 reverse stock
split and amended its certificate of incorporation to increase its authorized
shares of common stock from 25,000,000 to 50,000,000 to provide a sufficient
number of shares of the Holding Company common stock to permit the conversion of
all of the preferred stock. All share data, including warrants and options for
the purchase of common stock has been restated to reflect the reverse stock
split.
For accounting purposes, the acquisition has been treated as a recapitalization
of the Operating Companies with the Operating Companies as the acquirer
("reverse acquisition"). The accompanying financial statements include the
accounts of the Operating Companies for all periods presented, and the accounts
of the Holding Company from August 6, 1999, the effective date of the merger.
On August 19, 1999, the Holding Company changed its name to "Cell Tech
International Incorporated." With effect from January 1, 2000, NAC and NEC were
combined into one company.
Basis of Consolidation
The accompanying consolidated financial statements of the Company include the
accounts of the Holding Company and its subsidiaries NAC and NEC. Intercompany
transactions and balances have been eliminated on consolidation.
F-8
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Management Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period. Actual
results could differ materially from those estimates.
Cash and Cash Equivalents
The Company considers all liquid investments with an original maturity of three
months or less to be cash equivalents.
Inventories
Work in progress, finished goods and sales aids inventories are stated at the
lower of cost or market. The Company uses a weighted average method to determine
cost for work in progress and finished goods based upon normal harvesting
volumes (see Note 4). Cost of work in progress and finished goods includes
direct labor and an allocation of overhead costs. Sales aids consist of video
tapes, audio tapes, brochures and other promotional items sold by the Company to
its distributors. Inventory which is not anticipated to be sold within the
subsequent year is classified as a non-current asset.
Property and Equipment
Property and equipment are stated at cost and are depreciated using the
straight-line method over the estimated useful lives of 40 years for buildings
and 3 to 10 years for machinery and equipment as well as furniture and fixtures.
Additions, renewals and improvements are capitalized. Expenditures for
maintenance, repairs and minor renewals and improvements are charged to expense.
Upon sale or retirement of property and equipment, the cost and related
accumulated depreciation are removed from the accounts, and the resulting gain
or loss is recorded in operations.
Intangible Assets
Intangible assets included in other assets consist principally of canal license
rights and trademarks. The canal licensing rights permit the Company to harvest
algae on specified canals in the Klamath Irrigation District (see Note 6). Such
intangibles are amortized using the straight-line method over 10 to 12 years.
Financial Instruments
The Company estimates the fair value of its monetary assets and liabilities
based upon the existing interest rates related to such assets and liabilities
compared to the current market rates of interest for instruments of a similar
nature and degree of risk. The fair value of debt is estimated using discounted
cash flow analyses, based on the Company's incremental borrowing rates for
similar types of borrowing arrangements. The fair value of the Company's debt at
December 31, 2001 and 2000 approximates carrying value.
F-9
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Revenue Recognition
The Company recognizes revenue from the sale of its products upon shipment. The
Company estimates an allowance for sales returns based on historical experience
with product returns.
Shipping and Handling Fees and Costs
The Company bills customers for shipping and handling costs. The amounts billed
are included in sales and totaled $1,443,692, $1,711,031 and $2,798,040, in
2001, 2000 and 1999 respectively. The related costs for shipping and handling
goods shipped by the Company to customers are included in a separate caption,
shipping and handling expenses, in the statements of operations.
Income Taxes
The Company accounts for income taxes by recognizing deferred tax assets and
liabilities for the expected future tax consequences of events that have been
recognized in the Company's financial statements or tax returns. Under this
method, deferred tax assets and liabilities are determined based on the
difference between the financial statements carrying amounts and tax basis of
assets and liabilities using enacted tax rates in effect in the years in which
the differences are expected to reverse.
Impairment of Long-Lived Assets
The Company accounts for the impairment of long-lived assets to be held and
used, when indications of impairment are present, by evaluating the carrying
value in relation to the operating performance and future undiscounted cash
flows of the underlying business. Long-lived assets held for disposal are
reported at the lower of their carrying value or fair value less costs to sell
(see Notes 5 and 6).
Stock Option Plan
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation", encourages, but does not require, companies to record
compensation cost for stock-based employee compensation plans at fair value. The
Company has chosen to continue to account for stock-based compensation using the
intrinsic value method prescribed in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issues to Employees" (APB No. 25), and related
Interpretations. Accordingly, for employee options, the Company records expense
in an amount equal to the quoted market price on the grant date over the option
price. The Company provides pro forma disclosures of net earning and earnings
per share, as if the fair value based method of accounting had been applied.
Stock based compensation paid to non-employees is recorded at fair value using
the Black Scholes options pricing model (see Note 9).
Segment Reporting
The Company operates in one segment, which is the production and sale of food
supplement products made from blue green algae.
F-10
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Earnings Per Share
Basic earnings per share includes no dilution and is computed by dividing income
available to common shareholders by the weighted average number of common shares
outstanding for the period. Diluted earnings per share reflects the potential
dilution of securities that could share in the earnings of the Company, such as
stock options, warrants or convertible preferred stock. The Company's potential
common shares, consisting of the stock options and warrants, have not been
included in the calculation of diluted earnings per share for any period as
their effect is antidilutive.
Research and Development
Research and development costs are expensed as incurred.
Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board finalized FASB Statements
No. 141, Business Combinations (SFAS 141), and No. 142, Goodwill and Other
Intangible Assets (SFAS 142). SFAS 141 requires the use of the purchase method
of accounting and prohibits the use of the pooling-of-interests method of
accounting for business combinations initiated after June 30, 2001. SFAS 141
also requires that the Company recognize acquired intangible assets apart from
goodwill if the acquired intangible assets meet certain criteria. SFAS 141
applies to all business combinations initiated after June 30, 2001 and for
purchase business combinations completed on or after July 1, 2001. It also
requires, upon adoption of SFAS 142, that the Company reclassify the carrying
amounts of intangible assets and goodwill based on the criteria in SFAS 141.
SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that the Company identify reporting units for the
purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in
fiscal years beginning after December 15, 2001 to all goodwill and other
intangible assets recognized at that date, regardless of when those assets were
initially recognized. SFAS 142 requires the Company to complete a transitional
goodwill impairment test six months from the date of adoption. The Company is
also required to reassess the useful lives of other intangible assets within the
first interim quarter after adoption of SFAS 142. The Company does not believe
that implementation of the new pronouncements will have a material effect on the
financial position of the company.
In July 2001, the FASB issued Statement of Financial Accounting Standards No.
143 ("SFAS No. 143"), "Accounting for Asset Retirement Obligations". SFAS No.
143 establishes standards associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. This statement is effective
for financial statements issued for fiscal years beginning after June 15, 2002.
The Company has not yet assessed the impact of this standard on its financial
statements, but does not expect the impact to be material.
F-11
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Recent Accounting Pronouncements (Continued)
In August 2001, the FASB issued Statement of Financial Accounting Standards No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which is
effective for fiscal years beginning after December 15, 2001. SFAS No. 144,
which addresses financial accounting and reporting for the impairment of
long-lived assets and for long-lived assets to be disposed of, supercedes SFAS
No. 121. While the Company is currently evaluating the impact the adoption of
SFAS No. 144 will have on its financial position and results of operations, it
does not expect such impact to be material.
In November 2001, the Emerging Issues Task Force ("EITF") issued EITF Issue No.
01-09, "Accounting for Consideration Given by a Vendor to a Customer or a
Reseller of the Vendor's Products," which addresses the accounting for
consideration given by a vendor to a customer or a reseller of the vendor's
products. In April 2001, the EITF reached a consensus on EITF Issue No. 00-25,
"Vendor Income Statement Characterization of Consideration Paid to a Reseller of
the Vendor's Products," which provides guidance on the income statement
classification of consideration from a vendor to a reseller in connection with
the reseller's purchase of the vendor's products or to promote sales of the
vendor's products. This new guidance provides that consideration from a vendor
to a reseller is generally presumed to be a reduction of the selling prices of
the vendor's products, and, therefore, should be characterized as a reduction of
revenue when recognized in the vendor's income statement. We provide
distributors with discounts on product purchases and classify these discounts as
a reduction of revenue. We are currently assessing whether the implementation of
this guidance will result in any income statement reclassifications. EITF Issue
No. 00-25 and EITF Issue No. 01-09 are both effective for us on January 1, 2002.
Reclassification
Certain prior year amounts have been reclassified to conform to the 2001
financial statement presentation. These reclassifications have no effect on
previously reported net income.
NOTE 2 -- GOING CONCERN
The Company has experienced recurring net losses and has negative working
capital at December 31, 2001. In addition, the Company is not in compliance with
certain restrictive covenants of its $15 million Line of Credit Agreement with a
financial institution as described and summarized in Note 7. Accordingly, the
entire amount outstanding under the Line of Credit Agreement of $1,847,196 as at
December 31, 2001 has been classified as a current liability. In order to
pay-off the outstanding balance the lender began withholding funds from the
daily collections of the Company and applied such withholdings to the
outstanding balance. The ability of the Company to borrow under the Line of
Credit Agreement was also restricted as a result of the lender reducing the
availability under the Line of Credit Agreement by the cumulative amount of the
daily withholdings. As a result, the Company is experiencing difficulty in
generating sufficient cash flows to meet its obligations. These conditions give
rise to substantial doubt about the Company's ability to continue as a going
concern.
F-12
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 -- GOING CONCERN (Continued)
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. The financial statements do not
include any adjustments relating to the recoverability and classification of
recorded asset amounts or the amounts and classification of liabilities that
might be necessary should the Company be unable to continue as a going concern.
The Company's continuation as a going concern is dependent upon its ability to
generate sufficient cash flows to meet its obligations on a timely basis.
The Company is continuing its efforts to raise both debt and equity financing.
However, there can be no assurance that the Company will be able to service
additional financing, or that if such financing is available, whether the terms
or conditions would be acceptable to the Company.
NOTE 3 -- RECEIVABLES
As revenues are generally paid with credit cards and thereby collected prior to
shipment, the Company does not record trade accounts receivable. Receivables
consist of the following:
December 31,
------------------------------
2001 2000
------------ ------------
Credit card deposits in transit $ 239,618 $ 437,832
Miscellaneous receivables 87,465 97,313
------------ ------------
$ 327,083 $ 535,145
============ ============
NOTE 4 -- INVENTORIES
Inventories consist of the following: December 31,
------------------------------
2001 2000
------------ ------------
Work in progress $ 9,524,882 $ 11,172,105
Finished goods 654,759 884,208
Sales aids 25,137 19,686
------------ ------------
10,204,778 12,075,999
Less reserve for potentially unsaleable inventories (Note 12) (900,000) (900,000)
------------ ------------
9,304,778 11,175,999
Less current portion (2,000,000) (2,500,000)
------------ ------------
$ 7,304,778 $ 8,675,999
============ ============
During 2001, 2000 and 1999, the Company curtailed the volume of algae harvested.
Accordingly, the Company experienced excess processing capacity which was not
fully utilized. As a result, the Company incurred costs aggregating $4.1
million, $4.5 million and $3.7 million, representing negative volume variances
in 2001, 2000 and 1999, respectively. Such costs are included in cost of sales
for 2001, 2000 and 1999.
Inventories that are in excess of the following year's estimated sales have been
classified as long-term inventories.
F-13
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 -- PROPERTY AND EQUIPMENT
Property and equipment consist of the following: December 31,
------------------------------
2001 2000
------------ ------------
Land and improvements $ 17,817 $ 17,817
Buildings and improvements 6,403,785 6,479,846
Furniture and fixtures 752,921 754,235
Machinery and equipment 8,228,088 17,328,457
------------ ------------
15,402,611 24,580,355
Less accumulated depreciation (8,083,928) (11,362,258)
------------ ------------
$ 7,318,683 $ 13,218,097
============ ============
Depreciation expense aggregated $2,386,418, $2,459,190 and $2,719,335, for 2001,
2000 and 1999, respectively.
The Company has determined that it will cease utilizing the harvest site on the
canals of the Klamath Irrigation District (KID) for an indefinite period of
time. As a result, the Company will utilize the building on the adjacent leased
property and certain of the equipment in other production areas and will
continue to record depreciation expense for these assets. Some of the equipment
located on the canal site cannot be relocated or used for other purposes and
will be written-off. Certain other equipment will be held for sale.
Property and equipment held for sale consists of machinery and equipment with a
cost of $7,338,735 and $724,375, and accumulated depreciation and valuation
reserve of $5,067,430 and $381,486 at December 31, 2001 and 2000, respectively.
No depreciation has been recorded on these assets since the date they were
identified as being held for sale. The financial statements for the years ended
December 31, 2001 and 2000 include adjustments due to the impairment of fixed
assets of $2,589,940 and $136,381, respectively. There was no adjustment due to
the impairment of long-lived assets in 1999.
NOTE 6 -- OTHER ASSETS
Other assets consist of the following: December 31,
--------------------------
2001 2000
---------- -----------
Canal licensing rights, net of accumulated amortization of $ -- $ 981,872
$1,617,317 and 1,396,066
Trademarks, net of accumulated amortization of $33,623 and $28,985 57,302 56,441
Deposits 75,466 118,740
Restricted cash 159,324 35,973
Other -- 33,465
---------- -----------
292,092 1,226,491
Less current portion of lease rights included in prepaid expenses -- (94,830)
---------- -----------
$ 292,092 $ 1,131,661
========== ===========
Amortization expense aggregated $221,250, $888,480 and $573,214 for 2001, 2000
and 1999, respectively. The Company determined that it does not expect to
utilize the canal harvest site and as a result has written-off the unamortized
value of canal licensing rights totaling $783,523 at December 31, 2001. The
total written-off is included in assets written-down in the consolidated
statement of operations in 2001.
F-14
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 -- LONG-TERM DEBT
Long-term debt consists of the following:
December 31,
----------------------------
2001 2000
----------- -----------
Receivable loans, advances and inventory loans, secured by substantially all of
the assets of the Company, interest at the prime rate plus 2.5% per annum
(7.5% at December 31, 2001), expiring June 30, 2002 $ 633,852 $ 1,105,012
Term loans and equipment acquisition loans, secured by substantially all of the
assets of the Company, interest at prime rate plus 2.75% (7.75% at December
31, 2001) and repayable in 60 monthly installments by July 1, 2004 1,213,344 1,691,541
Note payable to a nonprofit organization, secured by rights of property and
leasehold improvements, with annual payments of $75,000 including interest at
6.25%, maturing July 19, 2005 (see Note 10) 313,790 313,790
Note payable to a university with monthly installments of $3,500 per month, paid
in full in April 2001 -- 14,000
----------- -----------
2,160,986 3,124,343
Less current portion (2,160,986) (2,862,683)
----------- -----------
$ -- $ 261,660
=========== ===========
In June 1999, the Company entered into a $15 million Line of Credit Agreement
with a financial institution. The agreement has four parts: Receivable Loans,
Advances and Inventory Loans, Term Loans, and Equipment Acquisition Loans. The
Receivable Loans and the Advances and Inventory Loans bear interest at a rate
equal to the prime rate plus 2.5% per annum, effectively 7.5% at December 31,
2001, and expire June 30, 2002. The Term Loans and Equipment Acquisition Loans
bear interest at a rate equal to the prime rate plus 2.75%, effectively 7.75% at
December 31, 2001, and are repayable in 60 monthly installments by July 1, 2004.
The Company incurs a minimum monthly interest charge for an amount equal to all
interest that would have been accrued had the daily aggregate outstanding
balance of all Loans been equal to 40% of the Maximum Dollar Debt.
The Line of Credit Agreement is guaranteed by the majority shareholders and
substantially all of the assets of the Company. Certain restrictive covenants
exist and the Company is not in compliance with such covenants.
In order to pay-off the outstanding balance the lender began withholding funds
in August 1999 from the daily collections and applied such withholdings to the
outstanding balance. The ability of the Company to borrow under the Line of
Credit Agreement was also restricted as a result of the lender reducing the
availability under the Line of Credit Agreement by the cumulative of the daily
withholdings. As of March 13, 2002, the Company had no availability to draw on
the line of credit.
The Company has classified all outstanding debt to the lender as a current
liability.
F-15
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8 -- INCOME TAX
The Company incurred certain loan fees amounting to $864,505, upon closing of
the agreement. The Line of Credit incurs annual loan fees, a renewal fee and an
early termination fee.
The Company is subject to Federal income taxes subsequent to June 20, 1999. As
the Company has experienced operating losses for the years 2001, 2000 and 1999,
no income tax is provided.
On June 20, 1999, NAC and NEC elected to change their tax status from an
S-Corporation to a C-Corporation. There is no significant difference between the
Company's net loss and net loss per share as reported in the 1999 consolidated
statement of operations compared with the net loss and net loss per share that
would have been reported if NAC and NEC were taxed as a C-Corporation effective
as of January 1, 1999.
At December 31, 2001, the Company had state and federal net operating loss
carryforwards available to offset future taxable income of approximately $10.5
million that expire at various dates through 2021.
The primary components of temporary differences which compose the Company's net
deferred tax assets and liabilities as of December 31, 2001 and 2000 are as
follows:
December 31,
------------------------------
2001 2000
----------- -----------
Deferred tax assets (liability):
Inventory adjustments $ 645,000 $ 644,832
Accrued expenses 308,000 308,436
Litigation reserve 633,000 632,940
Other 38,000 38,047
----------- -----------
Current deferred tax assets 1,624,000 1,624,255
----------- -----------
Net operating losses and credits 3,790,000 2,982,305
Depreciation (1,500,000) (1,645,074)
Write down of equipment 1,036,000 --
----------- -----------
Non-current deferred tax assets 3,326,000 1,337,231
----------- -----------
Net deferred tax assets 4,950,000 2,961,486
Less: valuation allowance (4,950,000) (2,961,486)
----------- -----------
$ -- $ --
=========== ===========
The Company annually evaluates the realization of the net deferred tax asset,
taking into consideration prior earnings history, projected operating results
and the reversal of temporary tax differences. At December 31, 2001 and 2000,
the Company recorded a valuation allowance as a result of the uncertainty
relating to the realizability of the net deferred asset.
F-16
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 -- STOCK OPTIONS AND WARRANTS
Warrants
On August 6, 1999, the Company issued warrants to purchase shares of its common
stock to the following parties for their services as follows:
Number of Exercise
Warrants Price Term
--------- -------- ----
Andromeda 100,000 $1.3337 5 year
Hateley & Hampton 300,000 $0.0749 5 year
Wharton Capital 267,000 $0.0749 5 year
The Company recognized $400,000 of expense in 1999 for the warrants granted to
Andromeda and Hateley & Hampton for services calculated using the Black Scholes
pricing model to determine fair value. The assumptions used in the Black Scholes
pricing model were a discount rate of 5.16%, a volatility of 1%, a dividend
yield of 1% and a term of l year.
On October 19, 1999, the Company sold 1,157,895 shares of its common stock with
warrants to purchase 1,157,895 shares of its common stock in a private placement
to Mr. Zubair Kazi (see Note 12) for $1,515,625, net of fundraising costs of
$134,375. In connection with this transaction, the Company also issued warrants
to purchase 150,000 and 100,000 shares of its common stock to Pacific Basin and
Richard Wade, respectively. Each warrant has a 5-year term and an exercise price
of $1.425 per share. The Company also issued 50,000 shares of its common stock,
at fair market value which amounted to $134,375, to Pacific Basin Capital for
their services. Warrant activity during the years ended December 31, 2001, 2000
and 1999 is summarized as follows:
Shares Price
--------- --------------
Outstanding at January 1, 1999 193,429 $ 7.27 - 84.65
Granted 2,074,895 0.075 - 1.425
--------- --------------
Outstanding at December 31, 1999 2,268,324 0.075 - 84.65
Granted -- --
--------- --------------
Outstanding at December 31, 2000 2,268,324 0.075 - 84.65
Granted -- --
Expired (128,926) --
--------- --------------
Outstanding at December 31, 2001 2,139,398 $0.075 - 84.65
========= ==============
The above options have a weighted average remaining contractual life of 2.56
years.
F-17
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 -- STOCK OPTIONS AND WARRANTS (CONTINUED)
1996 Stock Incentive Plan
In June 1996, the Company adopted the 1996 Stock Incentive Plan (the 1996 Plan)
pursuant to which the Company's Board of Directors may grant stock options to
officers, key employees, and consultants. The 1996 Plan authorizes grants of
options to purchase up to 64,504 shares of authorized but unissued common stock.
Stock options are granted with an exercise price equal to the stock's fair
market value at the date of grant. The stock option activity is as follows:
Shares Price
------- --------------
Outstanding, December 31, 1998 41,785 $4.77 - 142.49
Granted 16,126 3.05
Expired (32,109) 4.77 - 142.49
Exercised -- --
------- --------------
Outstanding, December 31, 1999 25,802 3.05 - 142.49
Granted -- --
Expired -- --
Exercised -- --
------- --------------
Outstanding, December 31, 2000 25,802 3.05 - 142.49
Granted -- --
Expired -- --
Exercised -- --
------- --------------
Outstanding, December 31, 2001 25,802 $3.05 - 142.49
======= ==============
The above options have a weighted average remaining contractual life of 3.51
years.
In addition to the options provided for in the 1996 Plan, in early 1996, 13,131
options were issued to certain officers, employees and consultants at an
exercise price of $57.84 per share, each with a five-year term. All the
outstanding options related to these grants expired in 2001. The Company granted
691 options to certain former directors on September 25, 1996 to replace certain
options, which terminated upon resignation of such directors in connection with
the Company's initial public offering. These 691 options have an exercise price
of $65.11 per share and a ten-year term. During 1998, 1,382 stock options were
issued to a director, at an exercise price of $98.65 per share and a ten-year
term. During 1998, 4,607 stock options were issued to a consultant at an
exercise price of $14.98 and a five-year term. Outstanding options at December
31, 2001 have a weighted average remaining contractual life of 2.55 years.
The 2000 Stock Incentive Plan
On February 14, 2000, the Board of Directors approved a new stock incentive plan
(the 2000 Plan). The 2000 Plan is for the benefit of employees, consultants and
non-employee directors of the Company and its subsidiaries. The maximum number
of shares with respect to which stock options or stock appreciation rights may
be grated or awarded as restricted stock under the 2000 Plan is 700,000 shares
in aggregate of common stock of the Company.
F-18
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9-- STOCK OPTIONS AND WARRANTS (CONTINUED)
The 2000 Plan provides for options to purchase 15,000 shares of common stock of
the Company to be automatically granted to each Non-Employee Director who was
serving as a member of the Board of Directors on the date the 2000 Plan was
adopted (Initial Non-Employee Director Options). The 2000 Plan also provides for
10,000 shares of common stock of the Company to be automatically granted to each
Non-Employee Director, who is serving on or elected to the Board of Directors at
each annual meeting of the stockholders of the Company after the date the 2000
Plan is adopted (Regular Non-Employee Director Options). The options issued are
Non-Qualified Options.
During December 2001, 45,000 options were granted to Non-Employee Directors
under the 2000 Plan. These options have an exercise price of not less than 100%
of the fair market value of the stock at the date of the grant.
Pro Forma Disclosure
The pro forma net loss and net loss per share as if compensation cost was
computed based on the fair value at the grant date computed under SFAS No. 123
for employee stock options are as follows:
December 31,
---------------------------------------------------
2001 2000 1999
------------- ------------- -------------
Net loss:
As reported $ (5,015,350) $ (2,783,939) $ (4,140,824
Pro forma (5,015,350) (2,783,939) (4,140,824
Net loss per share:
As reported $ (0.47) $ (0.26) $ (0.45
Pro forma (0.47) (0.26) (0.45
============= ============= =============
The fair value of stock options granted was determined using the Black Scholes
option-pricing model with the following weighted-average assumptions: no
expected dividend yield, risk-free interest rate of 5.1%, volatility of 0%, and
an expected life of 5 years.
NOTE 10 -- COMMITMENTS AND CONTINGENCIES
Microcystis
As a result of certain conditions, a toxic strain of algae called Microcystis
occasionally blooms in Klamath Lake and contaminates a portion of the Company's
harvest of blue-green algae. In 1994, the Company began to test the algae
harvested at its facility for possible contamination. The existence of
Microcystis has been regularly measured at various levels. In the absence of
established regulatory criteria for determining an acceptable level of
Microcystin (the actual toxin), the Company sponsored an assessment of risk and
set its own standards for determining whether a particular batch of algae is
acceptable for human consumption. Algae, which does not meet the Company's
standards and cannot be used in alternative non-human consumable products is
isolated and not used in production.
F-19
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 -- COMMITMENTS AND CONTINGENCIES (CONTINUED)
On October 23, 1997, the Oregon Department of Agriculture issued an
Administrative Rule on the sale of blue-green algae, which stated that "the
agency has decided to adopt the 1 microgram per gram (1 ppm) level of
Microcystin in blue-green algae." This ruling may have an impact on the
Company's ability to process and distribute the raw algae harvested and finished
goods produced. Such ruling may also decrease the amount of salable inventory on
hand and may therefore have an adverse impact on the Company's ability to
realize the carrying value of its inventories. Management has recognized that an
impairment of its inventory may exist and therefore has recorded its best
estimate of the effect by establishing a reserve in the amount of $900,000 at
December 31, 2001 and 2000 for the possible effects of inventories which may
become unsaleable under this Rule. The Oregon Department of Agriculture has
raised no questions about the Company's products under this Rule to date.
Litigation
In 1996, the Company entered into an agreement with one of its vendors to
deliver 600,000 wet pounds of algae per month for processing for a five-year
period. The minimum monthly volume level increased in September 1996 to
1,000,000 wet pounds of algae. On or about February 6, 1998, the vendor filed a
complaint against the Company. The complaint alleges that the Company wrongfully
terminated a contract requiring the Company to provide to the vendor not less
than a contractually agreed amount of raw product for processing every month, or
pay a penalty based on the shortfall until the contract was validly terminated.
In its amended complaint, the vendor is seeking $780,930 in damages as of
February 1998, plus additional damages that allegedly are continuing to accrue,
plus prejudgment interest and prevailing party attorney fees as provided by the
contract. The Company counter-claimed for breach of contract, alleging
liquidated damages due, overcharges, and failure to deliver product,
consequential damage for failure to utilize quality control methods required by
the contract, prejudgment interest and attorney fees. Subsequent to December 31,
2000, a settlement agreement was negotiated in which the parties have agreed to
dismiss the lawsuit and counter-claim and to enter into a new agreement for the
processing of algae for a five-year period. The parties have also agreed that
the Company will pay $1,656,000 (included in accounts payable at December 31,
2001) to the vendor; $1 million of which will be paid in cash and $656,000 will
be in the form of a promissory note payable to the vendor with interest at 10.5%
per annum. As of December 31, 2001, the Company has not signed the processing
and settlement agreements. The agreements are expected to be executed upon the
Company's receipt of financing. Subsequent to December 31, 2001, the parties
have reached an interim arrangement whereby the Company will pay $0.15 per pound
processed by the vendor until a formal agreement is finalized.
On January 16, 2001, the Company filed an action against Glenn Foods in the
Circuit Court of Klamath County alleging, among other things, that Glenn Foods
breached an agreement with the Company for the manufacture of SBG Square Meal
Bars and BG Bites by failing to produce products according to Company
specifications, refusing to turn over the formula, and failing to refund the
money. The Company is seeking monetary damages of approximately $226,345 for all
causes specified in the complaint. The matter is presently in the discovery
phase and no trial date has been scheduled.
F-20
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 -- COMMITMENTS AND CONTINGENCIES (CONTINUED)
In October 2001, Teachers for Truth in Advertising filed an action in the
Superior Court for the County of Tulare, State of California, alleging among
other things, that the Company's advertising is untrue or misleading, that the
Company's business practices are unlawful and fraudulent and unfair and that the
website contains misleading information about the products and the benefits that
a consumer may derive from their use. The plaintiff is seeking injunctive
relief, corrective advertising, and restitution to California consumers who
purchased the products. The matter is presently in the discovery phase and no
trial date has been scheduled. The Company does not believe that the plaintiff's
complaint is meritorious and believes that the Company will prevail in this
matter.
On January 28, 2002, the Company terminated our lease between NAC and Klamath
Cold Storage, Inc. ("KCS"), a corporation owed by the principal shareholders,
Daryl Kollman and Marta Kollman. On February 19, 2002, Daryl Kollman, on behalf
of himself and as an officer of KCS, filed two separate Notice of Claim of Lien
upon Chattels (the "Possessory Liens") against the Company and its wholly owned
subsidiary, NAC and/or NEC, in the County of Klamath, State of Oregon, claiming
a lien upon them by alleging among other things, that the Company owes him and
Marta Kollman approximately $508,246 in past due rent and that the Company owes
KCS approximately $576,232 in past due rent for the use of certain real property
owned by him and Marta Kollman, the Company's President and Chief Executive
Officer, and KCS. Through the Possessory Liens, Daryl Kollman is claiming that
the Company is not entitled to remove any of our property from the premises and
that the properties will be subject to foreclosure proceedings. The Company does
not believe that Daryl Kollman will prevail in this matter and has retained
legal counsel to represent the Company.
The Company is also involved in various legal matters arising in the normal
course of business. In the opinion of management, the Company's liability, if
any, arising from legal proceedings related to these matters is not expected to
have a material effect on the consolidated financial statements of the Company.
On March 27, 2002, the Nature Conservancy, a nonprofit corporation (the
"Plaintiff"), filed an action against us in the Circuit Court of the State of
Oregon, for the County of Klamath, alleging among other things, that our wholly
owned subsidiary The New Earth Company ("NEC") has failed to pay the annual
payment due on a non-interest bearing promissory note (the "Note") executed and
delivered to Plaintiff and that NEC's failure to make the payment constitutes a
default under certain provisions of the Note and a trust deed (the "Trust Deed")
to secure payment under the Note. The Plaintiff is seeking $375,000 in principal
due under the Note plus interest from the date of default in addition to certain
leasehold rights that the Trust Deed grants to it. The Plaintiff is also seeking
injunctive relief to recover rent payments from any sublessees. We have retained
legal counsel to represent us in this matter. The Company has previously
recorded the net present value of the Note, which has a balance of $313,790 has
been included in current portion of long-term debt in the consolidated balance
sheet at December 31, 2001.
Lien on Company Stock
The Company stock owned by majority shareholders Daryl J. Kollman and Marta C.
Kollman, is the subject of a tax lien filed by the Internal Revenue Service for
income taxes due from them arising from taxable income attributed from the
Company. The lien is subordinated in favor of the lender for the Receivable
Loans, Advances and Inventory Loans, Term Loans, and Equipment Acquisition Loans
(Note 7).
F-21
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 -- COMMITMENTS AND CONTINGENCIES (CONTINUED)
Dispute Between Principal Shareholders
Daryl and Marta Kollman, shareholders who together own approximately 82% of our
outstanding shares of common stock, have filed divorce proceedings. Daryl
Kollman and Marta Kollman jointly, and their affiliate Klamath Cold Storage Co.,
are lessors of substantially all of our facilities, including office space,
processing and freezer storage space. Although one lease is in effect until
2005, we lease the rest of these facilities on a month-to-month or year-to-year
basis. The disposition of these properties pursuant to the divorce could have an
adverse or disruptive effect on our operations, if the party who receives a
particular property elects to significantly increase rents or terminate any such
lease arrangement at the end of the then current lease term. In addition,
compliance with discovery requests may also have a disruptive effect on our
business and operations, and it may be necessary for our Chief Executive
Officer, Marta Kollman, to spend a portion of her time devoted to handling
matters related to the divorce. Moreover, Daryl Kollman is no longer actively
involved in management and has been unwilling to execute personal guarantees on
our behalf, as he has done in the past. On May 14, 2001, Marta Kollman
petitioned the Circuit Court for the State of Oregon with a motion seeking,
among other court orders, to enjoin Daryl Kollman from interfering with any
future loan applications of Marta Kollman or us and a self executing judgment
provision whereby the court would sign a loan application on behalf of Daryl
Kollman. The court subsequently held that Daryl Kollman is to cease and desist
from any such endeavors of interfering with our loan applications during the
pendency of the dissolution proceedings and is prohibited from writing letters
or communicating orally with any lending institutions unless requested to do so
by the institution. The court also held that Daryl Kollman, if presented with
loan documents to sign and if he objects to those documents in form or content,
he must first raise it with the court.
On January 29, 2002, the Court issued its written Order after the matter was
heard before the court at trial on December 10, 11, and 12, 2001. The Court
ruled that Marta Kollman and Daryl Kollman were each entitled to an equal
division of their respective stock ownership in our Company, thus resulting in
no change in our current ownership. The Court also ruled Daryl Kollman and Marta
Kollman's joint ownership in certain real property assets leased by us from them
will be divided equally in each property and that they must sell the properties
and improvements to pay the indebtedness to the Internal Revenue Service. Any
remaining proceeds after the payment of Federal and State taxes applicable to
the sale will be shared equally.
The Company does not believe the Court Order issued on January 29, 2002, will
have a material impact on our business since we believe that we can maintain our
favorable leases in the event of the sale of the properties or provide for an
adequate transition to other properties for the orderly continuation of our
business.
F-22
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 -- COMMITMENTS AND CONTINGENCIES (CONTINUED)
Covenants Related to the Private Placement to Mr. Zubair Kazi
In connection with the sale of 1,157,895 common shares to a private investor in
1999, the Company made certain promises to the investor. In the event that the
consolidated shareholders' equity of the Company is less than $20,000,000 at
December 31, 1999 and the first reset date (see below), the Company shall
immediately issue to Mr. Zubair Kazi additional common stock and warrants. The
amount shall equal 1,157,895 multiplied by the percentage by which the
shareholders' equity is less than $20,000,000. The Company did not maintain a
shareholders' equity of $20,000,000 at December 31, 1999 and as a result,
681,798 shares and 681,798 warrants were due to Mr. Kazi as of December 31,
2000. As of December 31, 2001, there were 1,606,117 shares and 1,606,117
warrants due to Mr. Kazi. The accrued liability related to the issuance of these
shares and warrants is $325,239 and has been accounted for in the financial
statements.
The shares sold were to be registered within 120 days of the sale. Additional
penalties will accrue until such time that the shares are registered.
Also, if within one year after October 19, 1999 the Company sells its common
stock at a price less than $1.425 per share in an event other than in a
registered underwriting, the Company shall immediately issue to Mr. Zubair Kazi
such additional shares of common stock and warrants so that Mr. Zubair Kazi
maintains his percentage shareholdings as if he had purchased shares of common
stock at the reduced purchase price. The Company did not sell any common stock
during the one year period ended October 19, 2000 or for the year ended December
31, 2000.
The Company is obligated, upon the effective date of its' next registration
statement (First reset date), to issue additional purchased securities in
accordance with the following reset rights:
- - If the ratio of $1.425 per share divided by the average closing bid price
for the last twenty trading days prior to the first reset date (the first
reset ratio) is greater than the ratio of $1.425 divided by the average
closing bid price for the last twenty days prior to the execution of the
Term Sheet, or September 13, 1999 (the Initial Ratio), on the first reset
date, then the Company shall issue to the investor additional purchased
securities so that the initial ratio and the first reset ratio are equal
and pursuant to the following formula:
o Amount of Additional Purchased Securities = ((First Reset
Ratio)/(Initial Ratio)-1) times 1,157,895.
- - In addition, if the investor holds any Purchased Warrants for the period
covered by the last three reset dates, the exercise price of these
Purchased Warrants shall be reduced by the following formula:
o Exercise Price of Purchased Warrants = ((Initial Ratio)/(First Reset
Ratio)) times $1.425.
- - The investor is entitled to five additional reset dates which will occur
as follows:
o The next three reset dates will occur each three months after the
first reset date.
o The next two subsequent reset dates will occur each six-month period
thereafter.
Since the Company has not filed its first registration statement, the first
reset date has not yet occurred.
F-23
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 -- COMMITMENTS AND CONTINGENCIES (CONTINUED)
Leases
The Company has noncancelable operating leases (Note12), primarily for
facilities space, vehicles and phone systems, which expire over the next five
years and thereafter. Future minimum lease payments under operating leases are
summarized as follows:
Years ending December 31, Amount
- ------------------------- --------
2002 $ 98,922
2003 99,352
2004 99,795
2005 57,951
Thereafter 219,114
--------
$575,134
========
Rent expense for 2001, 2000 and 1999 aggregated $1,178,496, $1,366,149 and
$1,447,101, respectively.
NOTE 11 -- EMPLOYEE BENEFIT PLAN
Effective June 1, 1994, the Company established a 401(k) Employee Savings Plan
which allows eligible employees to contribute up to 15% of their compensation
annually. The plan allows for Company matching at the discretion of management.
Each employee receives a pro rata allocation of the discretionary matching based
on the employee's compensation in relation to the compensation of all
participants entitled to profit sharing contributions. The Company matching
aggregated $52,614, $60,134 and $99,315 in 2001, 2000 and 1999, respectively.
NOTE 12 -- RELATED PARTY TRANSACTIONS
The lease agreements described and summarized in Note 12 include certain
building and equipment leases in which the lessors are shareholders of the
Company. Rental payments to the shareholders for 2001, 2000 and 1999 aggregated
$1,127,855, $1,149,528 and $1,197,152, respectively.
The amount payable to a related party at December 31, 2001 and 2000 is due to
the President of the Company and relates to unpaid rent on properties owned by
the President.
The Company purchases promotional publications from an entity with common
ownership. Payments for promotional publications to the shareholders for 2001,
2000 and 1999 aggregated $0, $0 and $15,360, respectively.
The Company also received management fees and other income of $196,218 and
$209,142 from its shareholders during 2001 and 2000, respectively, which is
included in other income in the consolidated statement of operations.
The Company paid consulting fees to a director of $32,500, $32,500 and $38,852
during 2001, 2000 and 1999, respectively.
The Company paid a law firm, which is owned by a director, legal fees of $0, $0
and $632,502 during 2001, 2000 and 1999, respectively.
F-24
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 -- OTHER INCOME
Other income insists of the following:
Years ended December 31,
-------------------------------------------
2001 2000 1999
--------- ----------- -----------
August celebration sales $ 16,058 $ 27,750 $ 38,457
Genealogy fee income 102,924 163,648 234,739
Interest income 37,981 57,507 87,852
Miscellaneous income (expense) 313,846 286,916 683,767
Management fee income from a related party 196,217 195,917 66,660
Stock penalties (75,239) (250,000) --
Gain (loss) on disposal of assets 15,175 (60,693) (98,815)
--------- ----------- -----------
$ 606,962 $ 421,045 $ 1,012,660
========= =========== ===========
NOTE 14 -- CONCENTRATION OF CUSTOMERS AND SUPPLIERS
No customers accounted for more than 10% of sales during the years ended
December 31, 2001, 2000 and 1999. One vendor supplied approximately 55%, 27% and
23% of the products that the Company purchased for the years then ended.
NOTE 15 -- QUARTERLY RESULTS (UNAUDITED)
Quarterly results for the years ended December 31, 2001 and 2000 are reflected
below:
First Second Third Fourth(a)
- -----------------------------------------------------------------------------------------------------------
2001
Revenue $ 8,062,064 $ 7,603,248 $ 7,278,704 $ 7,068,060
Operating loss $ (935,474) $ (706,956) $ (437,693) $(2,919,954)
Net loss $ (1,048,261) $ (748,594) $ (423,908) $(2,794,587)
Net loss per share - basic and diluted $ (.10) $ (.07) $ (.03) $ (.27)
2000
Revenue $ 11,135,803 $ 9,970,884 $ 9,166,080 $ 8,703,896
Operating loss $ (286,993) $ (832,112) $ (486,540) $ (830,847)
Net loss $ (313,586) $ (802,013) $ (629,912) $(1,038,428)
Net loss per share - basic and diluted $ (.03) $ (.08) $ (.06) $ (.09)
(a) Includes fourth quarter adjustments.
During the fourth quarter of 2001, the Company recorded adjustments that
increased its net loss by approximately $2.9M, which includes a charge to
Write-down expense for the impairment of certain Property, Plant & Equipment of
$2.6 million.
F-25
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 -- SUBSEQUENT EVENTS
Cancellation of Surety Bonds
In April 2002, the Company was informed that their insurance carrier had issued
a 30-day notice of cancellation with respect to some of the surety bonds due to
the going concern opinion that was issued for fiscal year ended December 31,
2000. The Company is attempting to find another carrier to provide comparable
surety bonds. In the event that the Company is unable to successfully obtain new
surety bonds, it will be required to post sufficient collateral directly with
the various entities that require the bonds in order to be able to continue to
perform their obligations under the various agreements. The bonds relate to the
non-resident status for sales tax in Canada, tax payments with the Nevada
Department of Taxation, various bonds for the use and harvesting from the Canals
and a highway use tax with the Oregon Department of Transportation.
F-26