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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: JUNE 30, 2003
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 each class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [ ] No [X]
As of July 31, 2003, the number of shares outstanding of the registrant's sole
class of common stock, par value $0.01 per share was 13,974,087.
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION....................................................................................1
ITEM 1. FINANCIAL STATEMENTS................................................................................1
Consolidated Balance Sheets..............................................................................1
Consolidated Statements of Operations....................................................................2
Consolidated Statements of Cash Flows....................................................................3
Notes to Consolidated Financial Statements...............................................................4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS...............10
Overview................................................................................................11
Results of Operations...................................................................................13
Three months ended June 30, 2003 compared with the three months ended June 30, 2002.....................13
Six months ended June 30, 2003 compared with the six months ended June 30, 2002.........................15
Liquidity and Capital Resources.........................................................................16
Cash Flows..............................................................................................17
Recent Financial Accounting Standards Board Statements..................................................17
Special Note Regarding Forward-Looking Statements.......................................................18
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..........................................19
ITEM 4. CONTROLS AND PROCEDURES.............................................................................19
PART II -- OTHER INFORMATION....................................................................................20
ITEM 1. LEGAL PROCEEDINGS...................................................................................20
ITEM 2. CHANGES IN SECURITIES...............................................................................21
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.....................................................................21
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................................................21
ITEM 5. OTHER INFORMATION...................................................................................22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K....................................................................22
SIGNATURES..................................................................................................23
CERTIFICATION PURSUANT TO SECTION 302 (A) OF THE SARBANES-OXLEY ACT OF 2002......................................24
CERTIFICATION PURSUANT TO SECTION 302(A) OF THE SARBANES-OXLEY ACT OF 2002.......................................25
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF
2002.............................................................................................................26
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF
2002.............................................................................................................27
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2003 2002
------------- ----------------
(Unaudited)
ASSETS
CURRENT ASSETS
Receivables $ 189,139 $ 372,011
Current portion of inventories 2,300,000 2,300,000
Prepaid expenses 289,397 586,662
------------- ----------------
LONG-TERM INVENTORIES, net of current portion 3,295,845 3,824,298
PROPERTY AND EQUIPMENT, net of accumulated depreciation 6,383,212 6,801,389
PROPERTY AND EQUIPMENT IDLE, net 701,287 1,382,570
OTHER ASSETS 360,395 546,846
------------- ----------------
Total assets $ 13,519,275 $ 15,813,776
============= ================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Bank overdraft $ 554,885 $ 468,008
Accounts payable 761,338 594,329
Commissions payable 899,535 970,315
Sales taxes payable 57,908 69,797
Accrued payroll and related liabilities 338,518 291,140
Other accrued expenses 816,615 1,848,070
Current portion of long-term debt 2,550,600 2,872,145
Related party payable 573,002 427,767
------------- ----------------
Total current liabilities 6,552,401 7,541,571
------------- ----------------
LONG-TERM LIABILITIES
Long-term debt, net of current portion (Note 5) 782,262 1,019,920
Other long-term liabilities 50,000 -
------------- ----------------
Total liabilities 7,384,663 8,561,491
------------- ----------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Series A convertible preferred stock - no par value; 4,175,000 shares
authorized; none issued and outstanding in 2003 and 2002 - -
Series B convertible preferred stock - no par value; 800,000 shares
authorized; none issued and outstanding in 2003 and 2002 - -
Undesignated preferred stock - no par value; 1,825,000 shares
authorized; none issued and outstanding in 2003 and 2002 - -
Common stock - $.01 par value; in 2003 and 2002, 50,000,000 shares
authorized, 13,974,087 and 10,640,895 shares issued and outstanding 139,741 106,409
Additional paid-in capital 2,891,224 2,299,696
Retained earnings 3,103,647 4,846,180
-------------- ---------------
Total stockholders' equity 6,134,612 7,252,285
------------- ----------------
Total liabilities and stockholders' equity $ 13,519,275 $ 15,813,776
============= ================
1
See accompanying notes to consolidated financial statements.
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Six Months Ended For the Three Months Ended
June 30, June 30,
------------------------------- -----------------------------------
2003 2002 2003 2002
------------- ------------- ------------------ -------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
REVENUE $ 11,600,925 $ 13,860,819 $ 5,667,933 $ 6,755,115
COST OF SALES 3,628,427 3,967,740 1,762,165 1,955,816
------------- ------------- ------------------ -------------
GROSS PROFIT 7,972,498 9,893,079 3,905,768 4,799,299
COMMISSIONS 4,896,457 6,380,258 2,361,022 3,053,187
------------- ------------- ------------------ -------------
GROSS PROFIT AFTER COMMISSIONS 3,076,041 3,512,821 1,544,746 1,746,112
SHIPPING AND HANDLING EXPENSES 747,012 742,024 363,408 359,088
SELLING EXPENSES 2,182,396 1,941,493 1,072,359 990,060
RESEARCH AND DEVELOPMENT 105,724 82,143 46,165 46,263
GENERAL AND ADMINISTRATIVE 1,112,159 610,051 633,271 348,213
ASSET WRITE-DOWN 528,632 - 528,632 -
------------- ------------- ------------------ -------------
OPERATING INCOME (LOSS) (1,599,882) 137,110 (1,099,089) 2,488
OTHER INCOME 133,386 120,185 (33,083) 98,588
INTEREST EXPENSE (276,037) (95,735) (111,310) (48,589)
------------- ------------- ------------------ -------------
NET INCOME (LOSS) $ (1,742,533) $ 161,560 $ (1,243,482) $ 52,487
============== ============== ================== ==============
BASIC AND DILUTED INCOME (LOSS)
PER SHARE $ (0.13) $ 0.01 $ (0.09) $ 0.01
============== ============== ================== ==============
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING
USED TO CALCULATE BASIC AND
DILUTED LOSS PER SHARE 13,790,519 12,467,534 13,790,519 12,467,534
============== ============== ================== ==============
See accompanying notes to consolidated financial statements.
2
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended
June 30,
---------------------------------
2003 2002
-------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (1,742,533) $ 161,560
Adjustments to reconcile net loss to cash
provided by operating activities:
Depreciation and amortization 519,966 580,277
Impairment of fixed assets and intangibles 528,632 -
Loss on sale of fixed assets 90,498 3,381
Changes in assets and liabilities:
Receivables 182,872 50,577
Inventories 528,453 631,155
Prepaid expenses 297,265 201,901
Other assets 186,451 (28,473)
Accounts payable 167,009 (367,122)
Commissions payable (70,780) (93,327)
Sales tax payable (11,889) (12,569)
Accrued payroll and payroll related liabilities 47,378 (14,400)
Other accrued expenses (356,595) 102,560
-------------- -------------
Net cash provided by operating activities 366,727 1,215,520
-------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment (64,724) (162,417)
Proceeds from disposals of equipment 75,116 700
Additions to construction in progress (50,028) (167,066)
-------------- -------------
Net cash used for investing activities (39,636) (328,783)
-------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES
Bank overdraft 86,877 (567,373)
Net payments on long-term debt (559,203) (145,311)
Net proceeds from related party debt 145,235 (174,053)
-------------- -------------
Net cash used for financing activities (327,091) (886,737)
-------------- -------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS - -
CASH AND CASH EQUIVALENTS, beginning of year - -
-------------- -------------
CASH AND CASH EQUIVALENTS, end of period $ - $ -
================ ==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest $ 276,037 $ 79,075
================ ==============
NON-CASH FLOW TRANSACTIONS
Par value of accrued penalty shares issued: $ 33,332 $ -
Additional paid-in capital related to accrued
penalty shares issued $ 591,528 $ -
Decrease in other accrued expenses for accrued
penalty shares issued $ (624,860) $ -
================ ==============
See accompanying notes to consolidated financial statements.
3
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 ("Cell Tech" or "we" "us" "our") and The
New Algae Company, Inc. ("NAC"), collectively the "Company," are engaged in
producing and marketing food supplement products made with blue-green algae
harvested from Klamath Lake, Oregon. We use a multi-level distributor network
throughout the United States, the District of Columbia, Guam, Puerto Rico,
American Samoa, the Virgin Islands and Canada to distribute our products.
PRESENTATION OF INTERIM INFORMATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United States
of America for interim financial information and with the instructions to Form
10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of
the information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of our management,
the accompanying unaudited consolidated financial statements contain all
adjustments, consisting of normal recurring adjustments, considered necessary
for a fair statement of our financial information as of and for the periods
presented. The consolidated results of operations of any interim period are not
necessarily indicative of the consolidated results of operations we expect for
the fiscal year. For further information, refer to the consolidated financial
statements and accompanying footnotes included in our annual report on Form 10-K
and 10-K/A for the year ended December 31, 2002.
GOING CONCERN
During 2002, we were able to obtain new financing that allowed us to repay the
borrowings under the former line of credit. As of June 30, 2003, we are in
compliance with the loan covenants under the new loan agreement. Additionally,
management has introduced several new products and advertising campaigns in
order to increase revenues and reverse the trend of net losses in the first half
of 2003 and prior years. Although management believes that it has made progress
during the first half of 2003 on issues affecting our ability to continue as a
going concern, we have experienced recurring net losses and have negative
working capital at June 30, 2003. These conditions give rise to substantial
doubt about our ability to continue as a going concern.
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 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.
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.
4
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
NOTE 1 - SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
BASIS OF CONSOLIDATION
Our accompanying consolidated financial statements include our accounts and our
subsidiary, NAC. We have eliminated Intercompany transactions and balances on
consolidation.
USE OF ESTIMATES
The preparation of the financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect amounts reported in the
financial statements and accompanying notes. Actual results could differ
materially from those estimates.
REVENUE RECOGNITION
We recognize revenue from the sale of our products upon shipment, at which time
title passes. We estimate an allowance for sales returns based on historical
experience with product returns.
ACCOUNTING FOR STOCK OPTIONS
We have adopted the intrinsic value method of accounting for employee stock
options as permitted by Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-based Compensation" (SFAS No. 123) and as amended by SFAS
No. 148. It discloses the pro forma effect on loss and loss per share as if we
had applied the fair value based method. For equity instruments, including stock
options issued to non-employees, the fair value of the equity instruments or the
fair value of the consideration received, whichever is more readily
determinable, is used to determine the value of services or goods received and
the corresponding charge to operations.
We have not disclosed the effect on loss and loss per share as if we had applied
the fair value recognition provision of SFAS No. 123 to stock-based employee
compensation because it is not significantly different from the historical
results.
SALES INCENTIVES
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." 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. We pay commissions to our
distributors as compensation for sales and marketing activities as evidenced by
downline growth and sales volume and accordingly classify these expenses as a
cost, rather than as a reduction of revenue. There was no effect on the
consolidated financial position, results of operations or cash flows as a result
of implementation of this pronouncement.
GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). Under
SFAS 142, goodwill and intangible assets with indefinite lives are no longer
amortized but will be reviewed annually, or more frequently if impairment
indicators arise, for impairment. We will continue to amortize, over their
estimate useful lives of 10 years, other intangible assets with finite lives,
consisting of trademarks with a carrying value of $57,302 at January 1, 2002. As
of the date of the adoption of the new accounting standards, there was no
remaining goodwill to be amortized.
5
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
NOTE 1 - SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS
On January 1, 2002, we adopted Statement of Financial Accounting Standards No.
144, "Accounting for the Impairment or Disposal of Long-Lived Asset," ("SFAS No.
144"), which, for impaired assets or long-lived assets to be disposed of,
supercedes SFAS No. 121. The adoption of SFAS No. 144 did not affect the
financial position or results of operations.
We account 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. We report long-lived assets held for disposal at the lower
of their carrying value or fair value less costs to sell.
During the three months ended June 30, 2003, we identified certain assets for
sale by auction and recorded an additional impairment of $528,632 in order to
value the assets at their net realizable value.
RECLASSIFICATIONS
We have reclassified certain prior period amounts to conform to the current
period presentation.
NOTE 2 - INVENTORIES
Inventories consist of the following:
June 30, December 31,
2003 2002
----------------- ----------------
Work in progress $ 8,447,041 $ 9,520,527
Finished goods 551,908 588,586
Sales aids 18,687 15,185
----------------- ----------------
9,017,636 10,124,298
Less reserve for potentially
unsaleable inventories (3,421,791) (4,000,000)
----------------- ----------------
5,595,845 6,124,298
Less current portion (2,300,000) (2,300,000)
----------------- ----------------
$ 3,295,845 $ 3,824,298
----------------- ----------------
Certain of our inventory is marketable only to the agricultural market. Sales in
this market have been less than anticipated and management has recognized that
an impairment of inventory may exist. We have established reserves of $3,421,791
and $4,000,000 at June 30, 2003 and December 31, 2002, respectively.
NOTE 3 -- EARNINGS PER SHARE COMPUTATION
The computations of the weighted-average common shares used in the computation
of basic and diluted net loss per share is based on 13,790,519 and 12,467,534
shares for the six months ended June 30, 2003 and 2002, respectively. Potential
dilutive securities were not included in the EPS calculation since their effect
would be antidilutive. Potential dilutive securities consisted of outstanding
stock options and convertible preferred stock and common stock purchase
warrants.
6
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
NOTE 4 - RECENT ACCOUNTING PRONOUNCEMENTS
In November 2002, the FASB issued FIN No. 45 "Guarantor's Accounting and
Disclosure Requirements for Guarantees, including Indirect Guarantees of
Indebtedness of Others -- an interpretation of FASB Statements No. 5, 57 and 107
and rescission of FIN 34." The following is a summary of our agreements that we
have determined are within the scope of FIN 45.
Under our bylaws, we have agreed to indemnify our officers and directors for
certain events or occurrences arising as a result of the officer or director's
serving in such capacity. The term of the indemnification period is for the
officer's or director's lifetime. We have a separate indemnification agreement
with each of our directors that requires us, subject to certain exceptions, to
indemnify him or her to the fullest extent authorized or permitted by our bylaws
and the Delaware Corporation Code. The maximum potential amount of future
payments we could be required to make under these indemnification agreements is
unlimited. However, we have a directors and officer liability insurance policy
that limits our exposure and enables us to recover a portion of any future
amounts paid. As a result of our insurance policy coverage, we believe the
estimated fair value of these indemnification agreements is minimal and has no
liabilities recorded for these agreements as of December 31, 2002 or June 30,
2003.
We enter into indemnification provisions under (i) our agreements with other
companies in our ordinary course of business, typically with business partners,
contractors, and customers, landlords and (ii) our agreements with investors.
Under these provisions, we generally indemnify and hold harmless the indemnified
party for losses suffered or incurred by the indemnified party as a result of
our activities or, in some cases, as a result of the indemnified party's
activities under the agreement. These indemnification provisions often include
indemnifications relating to representations made by us with regard to
intellectual property rights. These indemnification provisions generally survive
termination of the underlying agreement. In addition, in some cases, we have
agreed to reimburse employees for certain expenses. The maximum potential amount
of future payments we could be required to make under these indemnification
provisions is unlimited. We have not incurred material costs to defend lawsuits
or settle claims related to these indemnification agreements. As a result, we
believe the estimated fair value of these agreements is minimal. Accordingly, we
have no liabilities recorded for these agreements as of December 31, 2002 or
June 30, 2003.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest
Entities, an Interpretation of ARB 51." The primary objectives of FIN No. 46 are
to provide guidance on the identification of entities for which control is
achieved through means other than through voting rights ("variable interest
entities" or "VIEs") and how to determine when and which business enterprise
should consolidate the VIE. This new model for consolidation applies to an
entity for which either: (a) the equity investors (if any) do not have a
controlling financial interest; or (b) the equity investment at risk is
insufficient to finance that entity's activities without receiving additional
subordinated financial support from other parties. In addition, FIN No. 46
requires that both the primary beneficiary and all other enterprises with a
significant variable interest in a VIE make additional disclosures. We are
required to apply FIN No. 46 to all new variable interest entities created or
7
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
acquired after January 31, 2003. For variable interest entities created or
acquired prior to February 1, 2003, we are required to apply FIN No. 46
beginning on July 1, 2003. We do not anticipate that FIN No. 46 will materially
affect our consolidated financial statements.
In June 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This statement
established standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify the following financial instruments as
liabilities (or assets in some circumstances) in its financial statements:
instruments issued in the form of shares that are manditorily redeemable through
the transfer of the issuer's assets at a specified date or upon an event that is
likely to occur; an instrument (other than an outstanding share) that embodies
an obligation to repurchase the issuer's equity shares and that requires or may
require the issuer to settle the obligation through the transfer of assets; an
instrument that embodies an unconditional obligation; or an instrument (other
than an outstanding share) that embodies a conditional obligation that the
issuer must or may settle by issuing a variable number of equity shares. SFAS
No. 150 is effective for financial instruments entered into or modified after
May 31, 2003 and is otherwise effective at the beginning of the first interim
period beginning after June 15, 2003. We are currently assessing the impact of
this statement on our consolidated financial statements.
NOTE 5 - LONG-TERM DEBT
In September 2002, La Jolla Loans, Inc. ("La Jolla Loans") purchased and took an
assignment of our financing facility with Coast Business Credit. At the same
time, we entered into a Forbearance and Extension Agreement with La Jolla Loans.
Under the terms of the forbearance agreement, La Jolla Loans will not declare a
default until June 30, 2003, when the entire principal is due. La Jolla Loans
extended the forbearance period to June 30, 2004 by payment of a $75,000 renewal
fee. Interest of $24,208 at an effective rate of 14% is payable monthly along
with additional monthly impound payments of approximately $65,000. La Jolla
Loans will defer the difference between the minimum interest payment of $45,000
under the agreement with Coast Business Credit and the $24,500 minimum interest
payments under the forbearance agreement for the forbearance period. If we fully
perform under the terms and conditions of the forbearance agreement and no
default occurs during the forbearance period, La Jolla Loans will release us
from any obligation to pay that portion of the minimum monthly interest payments
in excess of $24,208. The outstanding principal balance at June 30, 2003 was
$2,075,000.
NOTE 6 - CONTINGENCIES
MICROCYSTIS
As a result of certain conditions, Microcystis, a toxic algae, occasionally
blooms in Klamath Lake at the same time aphanizomenon flos-aquae algae is
harvested. We regularly test the algae we harvest for possible contamination.
Algae that does not meet our standards is not used in products for human or
animal consumption.
In 1997, the Oregon Department of Agriculture issued an administrative rule that
created a standard of 1 microgram per gram (1 ppm) of Microcystis in products
for human consumption that contain aphanizomenon flos-aquae algae. The Oregon
Department of Agriculture has raised no questions about our products under this
rule.
In some years, the presence of Microcystis may reduce the quantity of
aphanizomenon flos-aquae algae that we can harvest.
LITIGATION
In October of 2001, Teachers for Truth in Advertising filed an action in the
Superior Court of Tulare County, California alleging that we, erroneously sued
as Cell Tech Products, Inc., engaged in unfair business practices and misleading
advertising. In January 2003, the Superior Court of Tulare County issued a
tentative decision stating that Teachers for Truth in Advertising was entitled
to an injunction prohibiting us from making deceptive representations in its
advertising or literature disseminated in California and ordering us to refund
the purchase price paid by California customers for our algae products from the
date four years prior to the filing of the action through the trial date in
November of 2002. In response to the tentative decision, our counsel filed a
Request for Statement of Decision on January 23, 2003. On February 20, 2003, the
Superior Court issued its Final Decision, which essentially affirms the
tentative decision. Plaintiff has submitted a proposed judgment to the court
consistent with the Tentative and Final Decisions. The parties mediated this
matter on May 9, 2003 before a retired Orange County, California Superior Court
judge and agreed to submit a proposed confidential settlement to the Superior
Court within 60 days, which they have done. The Superior Court has scheduled a
hearing on the matter in late August. We do not believe that the proposed refund
to California customers will be in an amount that would have a material adverse
impact on our business and financial position.
8
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
NOTE 6 - CONTINGENCIES (CONTINUED)
On February 19, 2002, Daryl Kollman filed two separate Notices of Claim of Lien
upon Chattels against us, NAC and Marta Carpenter and others, in Klamath County,
Oregon. Mr. Kollman alleges, among other things, that we owe him approximately
$705,693 in past due rent. Mr. Kollman also claims that we owe Klamath Cold
Storage, Inc. ("KCS"), a company owned by Mr. Kollman and Marta Carpenter,
approximately $717,900 in past due rent. Mr. Kollman asserts that we are not
entitled to remove our property from property owned by him, Marta Carpenter and
KCS and seeks to subject our to foreclosure proceedings. We intend to vigorously
defend against these liens. We cannot predict the amount of loss, if any, that
could result from these liens, but do not believe that an unfavorable outcome
would have a material adverse impact upon our financial condition, cash flow, or
results of operations.
On March 27, 2002, the Nature Conservancy filed an action against us in the
Circuit Court for the State of Oregon for Klamath County, alleging, among other
things, that our wholly owned subsidiary, The New Earth Company, was in default
on a promissory note and a trust deed. The Nature Conservancy was seeking
$375,000, the principal amount due under the promissory note, plus interest and
certain leasehold rights. We have previously recorded the net present value of
the promissory note, which has a balance of $313,790 and has been included in
the current portion of long-term debt in the December 31, 2002 consolidated
balance sheet. The parties signed a settlement agreement and the court action
dismissed in January 2003. The net effect of this was to increase net income
during the first quarter of 2003 by $161,956.
On June 6, 2002, Daryl Kollman filed a lawsuit in the name of KCS in the Circuit
Court for the State of Oregon for Klamath County to evict us from property owned
by KCS. In this lawsuit, Mr. Kollman also alleges that we have not paid
approximately $1,050,000 in rent. We have voluntarily vacated all of the KCS
property we do not need to support our current operations. We contend that we
have paid all rents owing and intend to vigorously defend this lawsuit. We
cannot predict the amount of loss, if any, that could result from this lawsuit
but an unfavorable outcome could have a material adverse effect on our financial
condition.
On October 7, 2002, Daryl Kollman, one of our principal shareholders, filed a
lawsuit against us and certain of our officers, directors and counsel in the
Circuit Court for the State of Oregon for Klamath County. The complaint makes a
number of individual and derivative claims. Mr. Kollman makes two claims against
us. First, Mr. Kollman alleges that we breached an agreement to register our
stock for public sale and seeks damages of an amount he must prove at trial, but
not less than $9,282,000. Second, Mr. Kollman claims that we conspired with
Marta C. Carpenter (formerly known as Marta C. Kollman), a principal stockholder
and our President, Chief Executive Officer and one of our directors; Donald P.
Hateley, our Chairman of the Board of Directors; and others to prevent the
registration of Mr. Kollman's stock and to cause other financial injury to him.
As a result, Mr. Kollman seeks $32,931,976 against the defendants. Mr. Kollman
also seeks millions of dollars in damages on his own behalf and on behalf of us
against Marta Carpenter, Mr. Hateley and others based on a variety of legal
theories, many of which either have been or are being litigated in other cases.
We intend to vigorously defend the direct claims asserted in this lawsuit, and
are currently evaluating the claims that Mr. Kollman has asserted on our behalf.
We cannot predict the amount of loss, if any, which could result from this
lawsuit and an unfavorable outcome could have a material adverse impact upon our
financial condition, cash flow, or results of operations.
LIEN ON COMPANY STOCK
Our stock owned by Daryl Kollman and Marta C. Carpenter is subject to a tax lien
filed by the Internal Revenue Service. A trust holds the stock and the IRS will
release it upon satisfaction of federal income taxes owed by Mr. Kollman and Ms.
Carpenter. Mr. Kollman and Ms. Carpenter retain voting power over the stock held
in trust. Mr. Kollman and Ms. Carpenter have agreed to sell their shares as
needed, and as allowed by federal securities laws, to make quarterly payments to
the Internal Revenue Service. Should Mr. Kollman or Ms. Carpenter fail to make
such payments in a timely manner, the Internal Revenue Service may seize the
shares from the trust. The Internal Revenue Service would thereafter sell or
judicially foreclose on some or all of the shares to satisfy Mr. Kollman and Ms.
Carpenter's tax liabilities. The IRS has subordinated its lien in favor of our
lender for receivable loans, advances and inventory loans, term loans, and
equipment acquisition loans.
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NOTE 6 - CONTINGENCIES (CONTINUED)
COVENANTS RELATED TO THE PRIVATE PLACEMENT TO ZUBAIR KAZI
In connection with the sale of common shares to a private investor, Zubair Kazi,
in 1999, we agreed to issue common stock and warrants to purchase common stock
to Mr. Kazi if the consolidated stockholders' equity was less than $20,000,000
at December 31, 1999. As a result, penalty shares have accrued and we issued
3,333,192 shares of common stock to Mr. Kazi during the second quarter of 2003
and we converted the associated accrued liability of $624,860 to equity.
Warrants to purchase an additional 3,333,192 shares of common stock were also
due to Mr. Kazi on March 31, 2003. During the second quarter of 2003, an
additional liability was recognized under the agreement in the amount of $22,974
related to the issuance of these shares and warrants, based on the fair value of
the securities and has been accounted for in the financial statements.
Additionally, we were to register the shares originally sold to Mr. Kazi for
resale within 120 days of the sale. We have accrued and will continue to accrue
additional penalties until the shares are registered. The additional expense for
the three months ended June 30, 2003 was $22,974 and 222,092 shares and 222,092
warrants are issuable to Mr. Kazi. We are also obligated to issue additional
securities to Mr. Kazi upon the effective date of our next registration
statement.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This Quarterly Report on Form 10-Q contains "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. The Act
provides a safe harbor for forward-looking statements to encourage companies to
provide prospective information about themselves so long as they identify these
statements as forward-looking and provide meaningful cautionary statements
identifying important factors that could cause actual results to differ from the
projected results. All statements, other than statements of historical fact,
that we make in this Quarterly Report on Form 10-Q are forward-looking. The
words "anticipates," "believes," "expects," "intends," "will continue,"
"estimates," "plans," "projects," the negative of these terms and similar
expressions are intended to identify forward-looking statements. However, the
absence of these words does not mean the statement is not forward-looking.
Our forward-looking statements are subject to certain risks, trends, and
uncertainties that are difficult to predict and could cause actual results to
vary materially from anticipated results. In particular, statements regarding
market acceptance of our marketing and merchandising concepts, changes in market
conditions, demand for and market acceptance of new and existing products,
availability and development of raw materials and new products, increased
competition, failure to attain satisfactory outside financing and adverse
weather conditions at Upper Klamath Lake are forward-looking.
The following factors, among others, could cause actual results to differ from
those indicated in the forward-looking statements:
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 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;
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CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
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, including our
Annual Report on Form 10-K and Form 10-K/A
for the year ended December 31, 2002.
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 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.
During 2002, we were able to obtain new financing that allowed us to repay the
borrowings under the former line of credit. As of June 30, 2003, we are in
compliance with the loan covenants under the new loan agreement. Additionally,
management has introduced several new products and advertising campaigns in
order to increase revenues and reverse the trend of net losses in the first half
of 2003 and prior years. Although management believes that it has made progress
during the first half of 2003 on issues affecting our ability to continue as a
going concern, we have experienced recurring net losses and have negative
working capital at June 30, 2003. These conditions give rise to substantial
doubt about our ability to continue as a going concern.
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.
Although we believe the expectations reflected in the forward-looking statements
are reasonable, we cannot guarantee future results, performance or achievement.
We undertake no obligation to revise or publicly release the results of any
revisions to these forward-looking statements. If we do update or correct one or
more forward-looking statements, investors and others should not conclude that
we will make additional updates or corrections to other forward-looking
statements.
We intend the following discussion to assist in the understanding of our
financial position and our results of operations for the three and six months
ended June 30, 2003 compared to the same period in 2002. You should refer to the
Consolidated Financial Statements and related Notes in conjunction with this
discussion. Unless stated otherwise, all financial information presented below,
throughout this report and in the Consolidated Financial Statements and related
Notes includes Cell Tech and NAC on a consolidated basis.
OVERVIEW
We develop and distribute products made with Aphanizomenon flos-aquae (trade
name Super Blue Green(R) Algae, "SBGA") through a network of independent
distributors. We currently offer 27 different products intended to appeal to
health-conscious consumers. We divide our products into five product lines:
Daily Health Maintenance, Digestive Health, Defensive Health, Powdered Drinks
and Snacks, Animal and Plant Food and Personal Care.
We harvest SBGA and manufacture some of our products at our production
facilities in Klamath Falls, Oregon. We are a multi-level marketing
organization. Independent distributors make up our sales force. We market our
products through our distributors in all fifty states, the District of Columbia,
Guam, Puerto Rico, American Samoa, the Virgin Islands and Canada. We encourage
our distributors to recruit new distributors into our network. We place
recruited distributors beneath the recruiting distributor in our network of
distributors. We pay our distributors commissions based on their personal sales
and the sales of distributors beneath them. We assist distributors in
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CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
establishing their own businesses and provide them with support programs such as
audio and videotapes for training, seminars and an annual convention at our
headquarters. We have approximately 35,608 active distributors as of June 30,
2003 compared to approximately 43,393 active distributors as of June 30, 2002.
Active distributors are those who have purchased products in the last six
months.
Our loss per share was $0.12 for the six months ended June 30, 2003 compared to
net income of $0.01 per share for the same period in 2002. We primarily relate
the net loss for the six months ended June 30, 2003 of $1,632,533 to a decrease
in revenue without corresponding decreases in administrative costs and selling
expenses. Additionally, the write down in value of the assets we are holding for
sale was substantial in the second quarter of 2003.
CRITICAL ACCOUNTING POLICIES
INVENTORY VALUATION
We have a significant investment in algae inventory. Our sole source of
blue-green algae is Klamath Lake. Algae grow naturally in Klamath Lake and like
any plants are subject to variation due to environmental conditions. The volume
of annual harvests varies depending on weather and precipitation conditions. As
a result, we carry additional supplies of inventory to sustain operations
through low yield harvest years. In addition, we regularly review the amount of
blue-green algae on hand and evaluate the likelihood that we will be able to
realize the value of our inventory. If we determine that we will not realize all
or a portion of our inventory value, adjustments are made to the carrying value
through a valuation allowance. The decision to write down a portion of the
carrying value of inventory could have a significant adverse effect on our
operating results.
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS
We utilize significant amounts of equipment in our operations to harvest and
process blue-green algae from Klamath Lake. During 2001, we developed an
alternative method of harvesting algae from Klamath Lake that yields raw algae
at a lower total cost for the quantity harvested than the previous harvest
method at the A Canal site. As a result, we have taken out of service certain
equipment previously used to harvest algae from the canal site. We have
written-off equipment taken out of service that we cannot remove from the canal
site and has no other use. We have scheduled for auction in September most of
the remaining idle equipment. We regularly review our property and equipment
offered for sale and if we cannot realize any portion of the carrying value, we
make adjustments to reduce the carrying value to its fair value. Due to the
nature of auction sales, we are recognizing the potential decrease in value by
writing off an additional $528,632 in equipment values during the second
quarter. We also regularly review property and equipment used in our operation
and test for impairment if conditions indicate we may not recover the carrying
value of the property and equipment. If we determine that we will not recover
the carrying value and that assets are impaired, we adjust the carrying value
through a valuation allowance. The decision to write down a portion of the
carrying value of property and equipment used in our operations or offered for
sale could have a significant adverse effect on our operating results.
SALES INCENTIVES
In November 2001, the Emerging Issues Task Force (the "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." 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. We pay commissions to our
distributors as compensation for sales and marketing activities as evidenced by
downline growth and sales volume and accordingly classify these expenses as a
cost, rather than as a reduction of revenue. There was no effect on the
consolidated financial position, results of operations or cash flows as a result
of implementation of this pronouncement.
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CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
RESULTS OF OPERATIONS
The following table summarizes our unaudited operating results as a percentage
of net sales for each of the periods indicated.
Six Months Ended June 30, Three Months Ended June 30,
--------------------------------- ----------------------------------
2003 2002 2003 2002
--------------- --------------- --------------- ----------------
REVENUE 100.0 % 100.0 % 100.0 % 100.0 %
COST OF SALES 31.3 28.6 31.1 29.0
--------------- --------------- --------------- ----------------
GROSS PROFIT 68.7 71.4 68.9 71.0
COMMISSIONS 42.2 46.0 41.7 45.2
--------------- --------------- --------------- ----------------
GROSS PROFIT AFTER COMMISSIONS 26.5 25.4 27.2 25.8
SHIPPING AND HANDLING EXPENSES 6.4 5.4 6.4 5.3
SELLING EXPENSES 18.8 14.0 18.9 14.6
RESEARCH AND DEVELOPMENT 0.9 0.6 0.8 0.7
GENERAL AND ADMINISTRATIVE 9.6 4.4 11.2 5.2
ASSET WRITE-DOWN 4.6 - 9.3 -
--------------- --------------- --------------- ----------------
OPERATING INCOME (LOSS) (13.8) 1.0 (19.4) -
OTHER INCOME 1.1 0.9 (0.6) 1.5
INTEREST EXPENSE (2.4) (0.7) (2.0) (0.7)
--------------- --------------- --------------- ----------------
NET INCOME (LOSS) BEFORE TAXES (15.0) 1.2 (21.9) 0.8
INCOME TAX BENEFIT - - - -
--------------- --------------- --------------- ----------------
NET INCOME (LOSS) (15.0 ) 1.2 (21.9) 0.8
=============== =============== =============== ================
THREE MONTHS ENDED JUNE 30, 2003 COMPARED WITH THE THREE MONTHS ENDED JUNE 30,
2002
Net sales for the three months ended June 30, 2003 were $5,667,933, a decrease
of $1,087,182 or 16.1% from net sales of $6,755,115 for the three months ended
June 30, 2002. We directly relate the decrease in sales to a 22.1% decrease in
orders for the same period. Average order size increased to $126 from $118 over
the same period. The average number of distributors for the three months ended
June 30, 2003 decreased to an average of 36,124, which was 18.4% lower than the
average of 44,260 distributors for the three months ended June 30, 2002. We make
sales of our food supplement products through a multi-level marketing network of
distributors, so we positively link sales 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 68.9% of net sales during the three
months ended June 30, 2003 from 71.0% of net sales during the same period in
2002. This decrease was due to continuing production and maintenance costs
against a lower sales volume and the agreement with a vendor, which requires the
payment of additional fees for use by us of another vendor to dry algae,
resulting in a non-inventoriable expense during the period of $58,711.
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AND SUBSIDIARIES
Gross profit after commissions represents gross profit less commission expense.
Commission expense for the three months ended June 30, 2003 and 2002 was
$2,361,022 and $3,053,187, respectively, a decrease of $692,165 or 22.7%. We are
a multi-level marketing organization. Distributors make up our sales force.
Distributors buy algae products for their own consumption and 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. Commission expense as a percentage of sales was 41.7% and
45.2% during the three months ended June 30, 2003 and 2002, respectively. The
decrease in the expense as a percentage of sales is due primarily to the
implementation of revisions to the commission system in June of 2002.
Operating expenses include shipping and handling expenses, selling expenses,
research and development expenses and general and administrative expenses. In
total, operating expenses increased $900,211 or 51.6% to $2,643,835 for the
three months ended June 30, 2003 from $1,743,624 for the three months ended June
30, 2002. We discuss the components of operating expenses discussed below.
o Shipping and handling expenses increased $4,320 or 1.2%, to $363,408 in
2003 from $359,088 in 2002. The increase was due to an increase in
payroll expenses in 2003. Shipping and handling expenses as a percent
of net sales increased to 6.4% for the three months ended June 30, 2003
from 5.3% for the three months ended June 30, 2002.
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 increased $82,299
between 2003 and 2002 to $1,072,359 from $990,060. This increase was
primarily due to an increase in insurance for product liability of
$50,000, an increase in advertising expenses of $35,000, an increase in
payroll expense of $20,000. We partially offset these increases by a
decrease in the credit card merchant fees of $24,000. Selling expenses
as a percent of net sales were 18.9% for the three months ended June
30, 2003 and 14.6% of sales for the three months ended June 30, 2002.
o Research and development expenses remained constant at $46,165 during
the three months ended June 30, 2003 from $46,263 during the same
period in 2002, which constituted 0.8% and 0.7% of net sales,
respectively.
o General and administrative expenses increased by $285,058, or 81.8%,
between 2003 and 2002 to $633,271 from $348,213. For the three months
ended June 30, 2003, general and administrative expenses averaged 11.2%
of sales while they were 5.2% of sales for the three months ended June
30, 2002. The increase between 2003 and 2002 is attributable to an
increase in legal fees and costs of $258,000 and an increase in payroll
costs of $24,000.
o Asset write-down expense increased to $528,632 for the three months
ended June 30, 2003 from no related expense in the three months ended
June 30, 2002. The additional loss of value for the idle equipment was
due to the decision to sell the equipment at auction rather than wait
for opportunity to sell the equipment on the open market.
Other income decreased by $131,671 to a net expense of $33,083 for the three
months ended June 30, 2003 from income of $98,588 for the three months ended
June 30, 2002 due primarily to a decrease in management fees charged to Klamath
Cold Storage, Inc. of $34,000 and to the termination of a vendor service
agreement that resulted in income of $77,000 in 2002 that was not recurring in
2003.
Net interest expense increased to $111,310 for the three months ended June 30,
2003 from $48,589 for the three months ended June 30, 2002. This increase was
due primarily to interest charges recorded in connection with the settlement of
vendor litigation and the resulting note payable. Net interest expense
represented 2.0% and 0.7% of sales for each of the three months ended June 30,
2003 and 2002, respectively.
Net income decreased by $1,295,969 resulting in a loss of $1,243,482 for the
three months ended June 30, 2003 from net income of $52,487 for the comparable
period in 2002. As a percentage of net sales, net income decreased to a net loss
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CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
of 21.9% of revenue from net income of 0.8% of revenue for the comparable period
in 2002. The decrease in net income was due to net sales decreasing by 16.1% and
operating costs increasing by 51.6%. The write down of idle equipment was the
largest contributing factor in the increased expenses.
SIX MONTHS ENDED JUNE 30, 2003 COMPARED WITH THE SIX MONTHS ENDED JUNE 30, 2002
Net sales for the six months ended June 30, 2003 were $11,600,925, a decrease of
$2,259,894 or 16.3% from net sales of $13,860,819 for the six months ended June
30, 2002. We directly relate the decrease in sales to a 21.5% decrease in orders
for the same period. Average order size increased to $124 from $119 over the
same period. The average number of distributors for the six months ended June
30, 2003 decreased to an average of 37,809, which was 19% lower than the average
of 46,902 distributors for the six months ended June 30, 2002. We make sales of
our food supplement products through a multi-level marketing network of
distributors, so we positively link sales 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 68.7% of net sales during the six
months ended June 30, 2003 from 71.4% of net sales during the same period in
2002. This decrease was due to continuing production and maintenance costs
against a lower sales volume and our agreement with a vendor, which requires the
payment of additional fees for use by us of another vendor to dry algae,
resulting in a noninventoriable expense during the period of $169,911.
Gross profit after commissions represents gross profit less commission expense.
Commission expense for the six months ended June 30, 2003 and 2002 was
$4,896,457 and $6,380,258, respectively, a decrease of $1,483,801 or 23%. We are
a multi-level marketing organization. Distributors make up our sales force.
Distributors buy algae products for their own consumption and 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. Commission expense as a percentage of sales was 42.2% and
46.0% during the six months ended June 30, 2003 and 2002, respectively. The
decrease in the expense as a percentage of sales is due primarily to the
implementation of revisions to the commission system in June of 2002 and
continued revisions in 2003.
Operating expenses include shipping and handling expenses, selling expenses,
research and development expenses and general and administrative expenses. In
total, operating expenses increased $1,300,212 or 38.5% to $4,675,923 for the
six months ended June 30, 2003 from $3,375,711 for the six months ended June 30,
2002. We discuss the components of operating expenses discussed below.
o Shipping and handling expenses increased $4,988 or 0.6%, to $747,012 in
2003 from $742,024 in 2002. The increase was due to an increase in
payroll expenses in 2003. Shipping and handling expenses as a percent
of net sales increased to 6.4% for the six months ended June 30, 2003
from 5.4% for the six months ended June 30, 2002.
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 increased $240,903
between 2003 and 2002 to $2,182,396 from $1,941,493. This increase was
primarily due to an increase in insurance for product liability of
$101,000, an increase in promotional expenses of $110,000, an increase
in payroll expense of $63,000. We partially offset these increases by a
decrease in the credit card merchant fees of $54,000. Selling expenses
as a percent of net sales were 18.8% for the six months ended June 30,
2003 and 14.0% of sales for the six months ended June 30, 2002.
o Research and development expenses increased 28.7% to $105,724 during
the six months ended June 30, 2003 from $82,143 during the same period
in 2002, which constituted 0.9% and 0.6% of net sales, respectively.
The increase related to an increase in payroll cost and laboratory
testing.
o General and administrative expenses increased by $502,108 between 2003
and 2002 to $1,112,159 from $610,051. For the six months ended June 30,
2003, general and administrative expenses averaged 9.6% of sales while
15
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
they were 4.4% of sales for the six months ended June 30, 2002. The
increase between 2003 and 2002 is primarily attributable to an increase
in legal fees and costs of $271,000, increase in payroll costs of
$45,000 and increase in loss on sale of assets of $87,000.
o Asset write-down expense increased to $528,632 for the six months ended
June 30, 2003 from no related expense in the six months ended June 30,
2002. The additional loss of value for the equipment we held for sale
was due to the decision to sell the equipment at auction rather than
wait for opportunity to sell the equipment on the open market.
Other income increased by $13,201 to $133,386 for the six months ended June 30,
2003 from $120,185 for the six months ended June 30, 2002 due primarily to the
settlement with The Nature Conservancy resulting in income of $161,000 offset by
a decrease in management fees charged to Klamath Cold Storage, Inc. of $34,000
and to the termination of a vendor service agreement that resulted in income of
$77,000 in 2002 that was not recurring in 2003.
Net interest expense increased to $276,037 for the six months ended June 30,
2003 from $95,735 for the six months ended June 30, 2002. This increase was due
primarily to interest charges recorded in connection with the settlement of the
Oregon Freeze Dry litigation and the resulting note payable. Net Interest
expense represented 2.4% and 0.7% of sales for each of the six months ended June
30, 2003 and 2002, respectively.
Net income decreased by $1,904,093 resulting in a loss of $1,742,533 for the six
months ended June 30, 2003 from net income of $161,560 for the comparable period
in 2002. As a percentage of net sales, net income decreased by 16.2% for the six
months ended June 30, 2003 resulting in a net loss of 15.0% of revenue from net
income of 1.2% of revenue for the comparable period in 2002. The dollar decrease
was due to net sales decreasing by 16.3% and by the increase in operating costs
of 38.5%.
LIQUIDITY AND CAPITAL RESOURCES
We had net losses of $3,497,387, $5,015,350 and $2,783,939 for the years ended
December 31, 2002, 2001 and 2000, respectively and had a working capital deficit
of $4,282,898 and $6,437,186 at December 31, 2002 and 2001, respectively. As a
result, our independent certified public accountants have included in our annual
report an explanatory paragraph in their report covering those periods, which
expresses substantial doubt about our ability to continue as a going concern.
Working capital deficit at June 30, 2003 amounted to $3,773,865, which
represents an increase in working capital of $509,033 from a working capital
deficit of $4,282,898 as of December 31, 2002. At June 30, 2003, we had a bank
overdraft of $554,885 versus a bank overdraft of $468,008 as of December 31,
2002.
In September 2002, La Jolla Loans, Inc. ("La Jolla Loans") purchased and took an
assignment of our financing facility with Coast Business Credit. At the same
time, we entered into a Forbearance and Extension Agreement with La Jolla Loans.
Under the terms of the forbearance agreement, La Jolla Loans agreed not to
declare a default until June 30, 2003, when the entire principal is due. La
Jolla Loans extended the forbearance period to June 30, 2004 by payment of a
$75,000 renewal fee. Interest of $24,208 at an effective rate of 14% is payable
monthly along with additional monthly impound payments of approximately $65,000.
La Jolla Loans will defer the difference between the minimum interest payment of
$45,000 under the agreement with Coast Business Credit and the $24,500 minimum
interest payments under the forbearance agreement for the forbearance period. If
we fully perform under the terms and conditions of the forbearance agreement and
no default occurs during the forbearance period, La Jolla Loans will release us
from any obligation to pay that portion of the minimum monthly interest payments
in excess of $24,208. The outstanding principal balance at June 30, 2003 was
$2,075,000.
We believe that our existing capital resources and bank borrowings are adequate
to fund our operations for at least the next 12 months. We have no present
commitments or agreements with respect to any acquisitions or purchases of
manufacturing facilities or new technologies. Any future changes in our
operations could utilize our available capital resources faster than
anticipated. Our capital requirements depend on numerous factors, including:
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CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
o the introduction of new products;
o change in the number of distributors and the retention of our current
distributor base; and
o research and development efforts.
If existing capital resources are insufficient to meet our capital requirements,
we will be required to raise additional funds, which we cannot assure will be
available on favorable terms, if at all, or reduce costs which could impair our
ability to conduct ongoing business operations.
CASH FLOWS
Net cash flows provided by operating activities for the six months ended June
30, 2003 amounted to $366,727 compared to cash flows provided by operations of
$1,215,520 for the six months ended June 30, 2002. The decrease in cash flows
generated by operations is primarily due to a $1,904,093 decrease in net income
between the six months ended June 30, 2003 and 2002 and changes in current
assets and liabilities.
Cash flows used in investing activities for the six months ended June 30, 2003
was $39,636, representing a decrease of $289,147 from net cash used for
investing activities of $328,783 for the six months ended June 30, 2002, due to
a decrease in equipment purchases during the six months ended June 30, 2003
offset by proceeds received from the sale of equipment previously identified as
idle assets.
Net cash flows used for financing activities was $327,091 for the six months
ended June 30, 2003 versus net cash used for financing activities of $886,737
during 2002. This change is principally due to net repayments of long-term debt
of $559,203 partially offset by decreases in the bank overdraft and related
party debt. The decrease in long-term debt was due primarily to payments to a
vendor and to the settlement with The Nature Conservancy.
RECENT FINANCIAL ACCOUNTING STANDARDS BOARD STATEMENTS
In November 2002, the FASB issued FIN No. 45 "Guarantor's Accounting and
Disclosure Requirements for Guarantees, including Indirect Guarantees of
Indebtedness of Others -- an interpretation of FASB Statements No. 5, 57 and 107
and rescission of FIN 34." The following is a summary of our agreements that we
have determined are within the scope of FIN 45.
Under our bylaws, we have agreed to indemnify our officers and directors for
certain events or occurrences arising as a result of the officer or director's
serving in such capacity. The term of the indemnification period is for the
officer's or director's lifetime. We have a separate indemnification agreement
with each of our directors that requires us, subject to certain exceptions, to
indemnify him or her to the fullest extent authorized or permitted by our bylaws
and the Delaware Corporation Code. The maximum potential amount of future
payments we could be required to make under these indemnification agreements is
unlimited. However, we have a directors and officer liability insurance policy
that limits our exposure and enables us to recover a portion of any future
amounts paid. As a result of our insurance policy coverage, we believe the
estimated fair value of these indemnification agreements is minimal and have no
liabilities recorded for these agreements as of December 31, 2002 or June 30,
2003.
We enter into indemnification provisions under (i) our agreements with other
companies in our ordinary course of business, typically with business partners,
contractors, customers and landlords and (ii) our agreements with investors.
Under these provisions, we generally indemnify and hold harmless the indemnified
party for losses suffered or incurred by the indemnified party as a result of
our activities or, in some cases, as a result of the indemnified party's
activities under the agreement. These indemnification provisions often include
indemnifications relating to representations made by us with regard to
intellectual property rights. These indemnification provisions generally survive
termination of the underlying agreement. In addition, in some cases, we have
agreed to reimburse employees for certain expenses. The maximum potential amount
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CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
of future payments we could be required to make under these indemnification
provisions is unlimited. We have not incurred material costs to defend lawsuits
or settle claims related to these indemnification agreements. As a result, we
believe the estimated fair value of these agreements is minimal. Accordingly, we
have no liabilities recorded for these agreements as of December 31, 2002 or
June 30, 2003.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest
Entities, an Interpretation of ARB 51." The primary objectives of FIN No. 46 are
to provide guidance on the identification of entities for which control is
achieved through means other than through voting rights ("variable interest
entities" or "VIEs") and how to determine when and which business enterprise
should consolidate the VIE. This new model for consolidation applies to an
entity for which either: (a) the equity investors (if any) do not have a
controlling financial interest; or (b) the equity investment at risk is
insufficient to finance that entity's activities without receiving additional
subordinated financial support from other parties. In addition, FIN No. 46
requires that both the primary beneficiary and all other enterprises with a
significant variable interest in a VIE make additional disclosures. We are
required to apply FIN No. 46 to all new variable interest entities created or
acquired after January 31, 2003. For variable interest entities created or
acquired prior to February 1, 2003, we are required to apply FIN No. 46
beginning on July 1, 2003. We do not anticipate that FIN No. 46 will materially
affect our consolidated financial statements.
In June 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This statement
established standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify the following financial instruments as
liabilities (or assets in some circumstances) in its financial statements:
instruments issued in the form of shares that are manditorily redeemable through
the transfer of the issuer's assets at a specified date or upon an event that is
likely to occur; an instrument (other than an outstanding share) that embodies
an obligation to repurchase the issuer's equity shares and that requires or may
require the issuer to settle the obligation through the transfer of assets; an
instrument that embodies an unconditional obligation; or an instrument (other
than an outstanding share) that embodies a conditional obligation that the
issuer must or may settle by issuing a variable number of equity shares. SFAS
No. 150 is effective for financial instruments entered into or modified after
May 31, 2003 and is otherwise effective at the beginning of the first interim
period beginning after June 15, 2003. We are currently assessing the impact of
this statement on our consolidated financial statements.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of our statements under "Legal Proceedings," "Management's Discussion and
Analysis of Financial Condition and Results of Operations," "Quantitative and
Qualitative Disclosures about Market Risk," "Other Information," 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 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.
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CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
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, we 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.
ITEM 3. 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.
Daryl Kollman and Marta C. Carpenter 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 a trust holds the shares and the trust will release the
shares upon Mr. Kollman and Ms. Carpenter's payment of their federal income tax
liabilities for various specified years. Mr. Kollman and Ms. Carpenter will sell
their shares as needed and allowed by federal and state securities laws to make
quarterly payments to the Internal Revenue Service. Mr. Kollman and Ms.
Carpenter retain all voting rights incident to their shares while a trust holds
the shares. The Internal Revenue Service may seize Mr. Kollman and Ms.
Carpenter's shares from the trust if Mr. Kollman and Ms. Carpenter 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
Mr. Kollman and Ms. Carpenter's tax liabilities as allowed by applicable law.
ITEM 4. CONTROLS AND PROCEDURES
(a) Under the supervision and with the participation of our management,
including our chief executive officer and chief accounting officer, we evaluated
the effectiveness of the design and operation of our disclosure controls and
procedures, as such term is defined under Rule 13a-14(c) promulgated under the
Securities Exchange Act of 1934, as amended, within the 90 day period prior to
the filing date of this report. Based on this evaluation, our chief executive
officer and chief accounting officer concluded that our disclosure controls and
procedures were effective as of that date.
(b) There have been no significant changes (including corrective actions with
regard to significant deficiencies or material weaknesses) in our internal
controls or in other factors that could significantly affect these controls
subsequent to the date of such evaluation referenced in paragraph (a) above.
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AND SUBSIDIARIES
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In October of 2001, Teachers for Truth in Advertising filed an action in the
Superior Court of Tulare County, California alleging that we, erroneously sued
as Cell Tech Products, Inc., engaged in unfair business practices and misleading
advertising. In January 2003, the Superior Court of Tulare County issued a
tentative decision stating that Teachers for Truth in Advertising was entitled
to an injunction prohibiting us from making deceptive representations in its
advertising or literature disseminated in California and ordering us to refund
the purchase price paid by California customers for our algae products from the
date four years prior to the filing of the action through the trial date in
November of 2002. In response to the tentative decision, our counsel filed a
Request for Statement of Decision on January 23, 2003. On February 20, 2003, the
Superior Court issued its final decision, which essentially affirms the
tentative decision. Plaintiff has submitted a proposed judgment to the court
consistent with the tentative and final Decisions. The parties mediated this
matter on May 9, 2003 before a retired Orange County, California Superior Court
judge and agreed to submit a proposed confidential settlement to the Superior
Court within 60 days, which they have done. The Superior Court has scheduled a
hearing on the matter in late August. We do not believe that the proposed refund
to California customers will be in an amount that would have a material adverse
impact on our business and financial position.
On February 19, 2002, Daryl Kollman filed two separate Notices of Claim of Lien
upon Chattels against, NAC, Marta Carpenter, others and us, in Klamath County,
Oregon. Mr. Kollman alleges, among other things, that we owe him approximately
$705,693 in past due rent. Mr. Kollman also claims that we owe Klamath Cold
Storage, Inc. ("KCS"), a company owned by Mr. Kollman and Ms. Carpenter,
approximately $717,900 in past due rent. Mr. Kollman asserts that we are not
entitled to remove our property from property owned by him, Ms. Carpenter and
KCS and seeks to subject our property to foreclosure proceedings. We intend to
vigorously defend against these liens. We cannot predict the amount of loss, if
any, that could result from these liens, but do not believe that an unfavorable
outcome would have a material adverse impact upon our financial condition, cash
flow, or results of operations.
On March 27, 2002, the Nature Conservancy filed an action against us in the
Circuit Court for the State of Oregon for Klamath County, alleging, among other
things, that our wholly owned subsidiary, The New Earth Company, was in default
on a promissory note and a trust deed. The Nature Conservancy was seeking
$375,000, the principal amount due under the promissory note, plus interest and
certain leasehold rights. We had previously recorded the net present value of
the promissory note, which had a balance of $313,790 and had been included in
the current portion of long-term debt in the December 31, 2002 consolidated
balance sheet. The parties signed a settlement agreement and the court action
dismissed in January 2003. The net effect of this is an increase to net income
during the first quarter of 2003 by $161,956.
On June 6, 2002, Daryl Kollman filed a lawsuit in the name of KCS in the Circuit
Court for the State of Oregon for Klamath County to evict us from property owned
by KCS. In this lawsuit, Mr. Kollman also alleges that we have not paid
approximately $1,050,000 in rent. We have voluntarily vacated all of the KCS
property, as we do not need it to support our current operations. We contend
that we have paid all rents owing and intend to vigorously defend this lawsuit.
We cannot predict the amount of loss, if any, that could result from this
lawsuit but an unfavorable outcome could have a material adverse effect on our
financial condition.
On October 7, 2002, Daryl Kollman, one of our principal stockholders, filed a
lawsuit against and certain of our officers, directors, counsel and us in the
Circuit Court for the State of Oregon for Klamath County. The complaint makes a
number of individual and derivative claims. Mr. Kollman makes two claims against
us. First, Mr. Kollman alleges that we breached an agreement to register our
stock for public sale and seeks damages of an amount he has to prove at trial,
but not less than $9,282,000. Second, Mr. Kollman claims that we conspired with
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CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
Marta C. Carpenter (formerly known as Marta C. Kollman), a principal stockholder
and our President, Chief Executive Officer and one of our directors; Donald P.
Hateley, our Chairman of the Board of Directors; and others to prevent the
registration of Mr. Kollman's stock and to cause other financial injury to him.
As a result, Mr. Kollman seeks $32,931,976 against the defendants. Mr. Kollman
also seeks millions of dollars in damages on his own behalf and on behalf of us
against Ms. Carpenter, Mr. Hateley and others based on a variety of legal
theories, many of which either have been or are being litigated in other cases.
We intend to vigorously defend the direct claims asserted in this lawsuit, and
are currently evaluating the claims that Mr. Kollman has asserted on our behalf.
We cannot predict the amount of loss, if any, which could result from this
lawsuit, and an unfavorable outcome could have a material adverse impact upon
our financial condition, cash flow, or results of operations.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At our Annual Meeting of Stockholders on July 25, 2003, we submitted
and, by vote, our stockholders approved the following actions:
(1) Election of five directors;
(2) Ratification of the Board's selection of BDO Seidman LLP as
our independent certified public accountants; and
(3) Approval of our 2000 Stock Incentive Plan.
A total of 8,899,875 shares (approximately 63%) of the issued and
outstanding shares of the Company were represented by proxy or in person at the
meeting. Our stockholders voted these shares on the matters described above as
follows:
1. For the directors as follows:
NUMBER
OF SHARES NUMBER OF SHARES
NAME FOR ABSTAINING/WITHHELD
------------------------------------ ------------- ---------------------
Donald P. Hateley, Esq., CPA 8,886,575 3,300
Marta C. Carpenter 8,886,564 3,311
Justin Straus 8,886,575 3,300
Christopher J. Blaxland, D.V.M. 8,886,575 3,300
Donald M. Anderson, Ph.D. 8,886,575 3,300
2. For the ratification of the Board's selection of BDO Seidman LLP as our
independent certified public accountants as follows:
NUMBER OF
SHARES NUMBER OF SHARES NUMBER OF SHARES
FOR AGAINST ABSTAINING/WITHHELD
------------------ -------------------- -----------------------
8,886,485 3,390 0
3. For the ratification of the Board's approval of our 2000 Stock Incentive Plan
as follows:
NUMBER OF
NUMBER OF SHARES SHARES NUMBER OF SHARES
FOR AGAINST ABSTAINING/WITHHELD
-------------------- ------------------- ------------------------
8,884,116 5,575 184
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ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits required by Item 601 of Regulation S-K
Exhibit Number Description
3.1 Certificate of Incorporation, as amended, incorporated by reference to
the Registration Statement on Form SB-2 dated June 21, 1996.
3.2 Certificate of Amendment of Certificate of Incorporation, incorporated
by reference to the Current Report on Form 8-K dated November 19,
1999.
3.3 Certificate of Designations, Preferences and Rights of Series B
Convertible Preferred Stock incorporated by reference to the Current
Report on Form 8-K dated August 2, 1999.
3.4 Amended and Restated Bylaws incorporated by reference to the
Registration Statement on Form SB-2 dated June 21, 1996.
(31) Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
(31.1) Certification pursuant to Item 601(b)(31) of Regulation S-K, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, of
the Chief Executive Officer of Cell Tech International Incorporated*
(31.2) Certification pursuant to Item 601(b)(31) of Regulation S-K, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, of
the Chief Accounting Officer of Cell Tech International Incorporated*
(32) Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
(32.1) Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of the
Chief Executive Officer of Cell Tech International Incorporated*
(32.2) Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of the
Chief Accounting Officer of Cell Tech International Incorporated*
(b) Current Reports on Form 8-K
On April 1, 2003, we filed a current report on Form 8-K to disclose
the tentative decision of the Superior Court in the Teachers for
Truthful Advertising lawsuit.
* Filed herewith.
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CELL TECH INTERNATIONAL INCORPORATED
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CELL TECH INTERNATIONAL INCORPORATED
August 14, 2003 /s/ Marta C. Carpenter
----------------------
Marta C. Carpenter
President and Chief Executive Officer
23