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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, 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) dentification 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 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. [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes [ ] No [X]
The aggregate market value of the 800,000 shares of registrant's voting
stock held by non-affiliates of the registrant as of June 30, 2003 (the last day
of the registrant's most recently completed second fiscal quarter) was
approximately $128,000 based on the closing price of the registrant's common
stock on the National Quotation Bureau's Pink Sheets or $0.16 per share.
The number of shares outstanding of the registrant's sole class of
common stock, par value $0.01 per share, as of March 25, 2004, the latest
practicable date, was 13,974,087.
DOCUMENTS INCORPORATED BY REFERENCE
None.
CELL TECH INTERNATIONAL INCORPORATED
FORM 10-K ANNUAL REPORT
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
TABLE OF CONTENTS
PART I...................................................................................................1
ITEM 1. BUSINESS....................................................................................1
ITEM 3. LEGAL PROCEEDINGS..........................................................................14
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS......................................15
PART II.................................................................................................16
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS....................................................................................16
ITEM 6. SELECTED FINANCIAL DATA....................................................................19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION.......................................................................19
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK............................. ...31
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................................................31
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.......................................................................31
ITEM 9A. CONTROLS AND PROCEDURES....................................................................31
PART III................................................................................................32
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.........................................32
ITEM 11. EXECUTIVE COMPENSATION.....................................................................34
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.............................40
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.............................................41
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.....................................................42
PART IV.................................................................................................42
ITEM 15. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K.........................42
SIGNATURES..............................................................................................46
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 recent accounting pronouncements;
o the outcome of regulatory and litigation matters; and
o the assumptions described in this report underlying such
forward-looking statements.
o 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.
PART I
ITEM 1. BUSINESS
OVERVIEW
We are a natural and nutritional products company. 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 Business Associates ("Business Associates"). We currently offer
over sixty products that are intended to appeal to health-conscious consumers.
We divide our products into three major product lines including nutritional
supplements and foods, skin and hair care products, and animal and plant care.
We harvest SBGA and manufacture several of our products at our modern production
facilities in Klamath Falls, Oregon. We market our products through independent
Business Associates located in all fifty states, the District of Columbia, Guam,
Puerto Rico, American Samoa, the Virgin Islands, Federated States of Micronesia,
Marshall Islands, Northern Mariana Islands, Palau and Canada. We encourage our
Business Associates to recruit interested people as new Business Associates for
our products. We place these recruits beneath the recruiting Business Associates
in the "network" and we refer to them as the associates' "downlines" or
"networks." Business Associates earn commissions on sales by their organizations
as well as on the sales they generate directly. We assist Business Associates in
establishing their own businesses and provide support programs such as a
comprehensive, information-packed website (www.celltech.com), audio and
videotapes for training, a national Training tour, Regional Sales Meetings,
seminars and an annual convention called the August Celebration.
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 our reorganization, to the
historical operations of HumaScan and (b) for periods following our
reorganization, to the operations of Cell Tech International Incorporated,
including its wholly owned subsidiaries The New Earth Company, Inc. ("NEC") and
The New Algae Company, Inc. ("NAC"). NEC is now an inactive corporation.
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(TM) Device in December 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,
because 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. We transferred
certain assets related to the licensed business to Scantek and we issued
additional shares of common stock 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 we applied to some of our other outstanding obligations.
On July 16, 1999, we entered into an Agreement and Plan of Reorganization with
Daryl J. Kollman and Marta C. Carpenter (formerly known as Marta C. Kollman).
The agreement provided for the exchange of all the outstanding shares of NEC and
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). We completed the reorganization on August 6, 1999. On August 10, 1999,
we changed our name to Cell Tech International Incorporated.
1
Marta C. Carpenter and Daryl J. Kollman formed Cell Tech, Inc. and NEC 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, Ms.
Carpenter and Mr. Kollman formed NAC, 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, and our telephone number at that address is (541) 882-5406. Our
internet address is WWW.CELLTECH.COM; however, the information on our website
does not constitute part of this Annual Report on Form 10-K and is not
incorporated herein unless otherwise indicated in this report. You may obtain,
free of charge, our annual, quarterly and current reports, and any amendments
thereto on the Securities and Exchange Commission's website at WWW.SEC.GOV.
INDUSTRY OVERVIEW
With the significant expansion of our product line, in the last two quarters of
2003, we are addressing two large markets. The first is the market for
nutritional supplements, particularly those to which industry analysts refer as
"herbal supplements", though, in fact, we have very few actual herbs in our
product lines. The second market is natural personal care and, in particular,
natural skin care.
Though these markets are related by their emphases on natural ingredients and by
generally similar market demographics, they are very different markets, with
very different growth prospects. Simply, the market for herbal supplements is
growing, if at all, much slower than the market for natural personal care.
This is why our strategy is to maintain and revitalize our traditional
supplement business, while we establish ourselves as a significant and
distinctive player in the market for natural personal care.
Scott Van Winkle, CFA, is a principal at the Boston-based investment bank of
Adams, Harkness & Hill, who researches the natural & organic food, specialty
food and nutrition industries. In a recent article in Natural Products Industry
Insider, he said,
"Given the return to positive growth in the mass market and our ongoing
confidence in growth in the direct, natural food, and specialty segments; we are
forecasting that the category has broadly recovered from the herbal-led decline,
and we forecast low, single-digit growth in the United States going forward...
We forecast 2-percent to 5-percent growth in the nutritional category over the
next several years driven by the constant aging of the demographic, combined
with .5-percent population growth, recovering consumer confidence, and the
occasional new product class adding to the category.
"We believe that the category has already bottomed and the future outlook is
brighter. Some supply and industry structure-related issues still persist, but
demand is the single most important aspect of any consumer product category, and
it has improved."
We agree with his assessment, and with his further assertion that,
"The direct channel of the nutritional supplement industry, specifically network
marketing, could be aided by the rising unemployment and lack of income growth
in the United States. The theory forwarded by most in this industry is that the
strong economy and high employment rate pared back the potential market for
network marketing distributors in the late '90s. With unemployment on the rise
over the last 12 to 24 months, and a constant flow of layoffs coming daily, the
network marketing channel could, and probably should, see growth of new
distributors."
2
So, we have faith in the future of this market, and we will continue to position
ourselves, with new products and new presentations, to benefit from its
inevitable resurgence. On the other hand, we are aggressively establishing a
position in the natural personal care industry, which has experienced
double-digit growth for the last few years, and which has robust opportunity
going forward.
According to THE U.S. MARKET FOR NATURAL PERSONAL CARE PRODUCTS,
"The boom in natural grooming products is a phenomenon that mainstream Health
and Beauty Care marketers must heed: natural/organic skincare, hair care and
cosmetic items are breaking the $3.9 billion mark at retail in 2003, and shall
rocket to a $5.8 billion by 2008,"
The Nutrition Business Journal states that,
"Analysis of Nutrition Business Journal's survey of natural personal care
manufacturers, and other data sources indicate that natural personal care
products grew $4.1 billion in consumer sales in 2002, or 11% of the $37.3
billion U.S. health & beauty care market. Growth in natural personal care was
10% over 2001, as manufacturers reaped the benefits of growing consumer
interest, gains in mass-market distribution, successful new products, revamped
packaging and savvier marketing.
"In 2002, the aggregate growth rate of the top 10 core natural personal care
companies listed in Nutrition Business Journal's annual ranking was 14%, six
points higher than just one year before.
"The natural personal care category is enjoying healthy growth, fueled by
consumer demand that is attracting attention not only from core natural product
manufacturers but from mainstream cosmetic companies as well. While the
mainstream cosmetic and personal care product market is growing at a sluggish,
low single-digit pace, the natural personal care market has become a beacon of
light in a foggy nutrition industry."
Cell Tech is particularly well suited to benefit from this market growth,
because our network marketing system enables us to add new products quickly and
incrementally, and because our existing supplement products and expertise are
directly relevant to product development in the natural personal care arena.
GROWTH STRATEGY
In the last several years, widely publicized reports and medical research
findings, indicating a correlation between the consumption of nutrients and the
reduced incidence of certain diseases, have heightened the public awareness of
the positive effects of nutritional supplements on health. 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, questions about the efficacy and
safety of nutritional supplements may have and may continue to affect sales of
such supplements. The recent controversies over the efficacy of St. John's Wort
and Kava, and the recent concerns about the safety of Ephedra illustrate this
point.
However, 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 above. The United
States Bureau of the Census projects the 35-and-older age group of consumers,
which represents a large majority of the regular users of vitamin and mineral
supplements, to grow significantly faster than the general United States
population through 2010.
Further, the $1.6 billion market for Natural Personal Care products, including
skin and hair care, is growing at double-digit rates, according to the Nutrition
Business Journal. We are particularly well suited to participate in this market
because one of the key drivers of growth in this market is consumer interest in
personal care products which include ingredients like blue-green algae, enzymes,
coenzyme Q10, grape seed and grape seed extracts and beta glucan, among others.
3
All of these ingredients, and more, are already available in our nutritional
supplements, and our consumer base is already attuned to their effectiveness as
internal and external supplements.
Our growth strategy is to capitalize on the increased interest in nutritional
supplements and natural personal care described above by dramatically expanding
our product lines, increasing product sales through existing distribution
channels in the U.S. and Canada and by 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 develop new product
lines to complement our current products. We more than doubled our
entire product line in the second half of 2003. Most of these new
products were skin care and hair care products, which complement and
leverage our existing supplement lines. We have introduced five new
product lines (Essential Matrix, Grape Synergy, CoQskin, Golden Lily
and a new line of supplements in packets, which we call Essentials)
and we are actively working on introducing additional products.
o We have introduced a revised compensation plan and other promotion and
recognition programs to provide additional incentives to our Business
Associates. Our ability to increase sales is significantly dependent
on our ability to attract, motivate and retain Business Associates. 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 Business Associate training and support,
no sign-up costs, inventory requirements, and low monthly purchase
requirements. We intend to reach potential new Business Associates
through increased advertising, teleconferencing and regional sales and
training meetings. Successful management of Business Associates
supports the marketing of products as well as the recruitment of new
Business Associates.
o We believe that growth potential exists in international markets. We
intend to tackle international markets by entering into marketing
distribution agreements for Europe and Asia.
o We intend to engage government relations personnel to assist our
international expansion. We will engage government relations personnel
who will take a systematic, proactive approach to working with
government and licensing agencies in new markets to ensure that our
products and distribution model comply 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
Business Associates with new products that complement our existing
product lines.
PRODUCT OVERVIEW
Our product line consists primarily of consumable products that we target to
consumers interested in natural alternatives for health, nutrition, and personal
care. In developing our product line, we have emphasized natural ingredients and
processing, quality, purity, potency, and safety. We offer a line of over sixty
products that we divide into three categories: Nutritional Supplements and
Foods, Skin and Hair Care, and Animal and Plant Foods.
NUTRITIONAL SUPPLEMENTS AND FOODS
Our nutritional supplements and foods include a naturally harvested and
processed form of Aphanizomenon flos-aqua, which we call Super Blue Green(R)
Algae (SBGA). We also offer a wide range of other nutritional supplements,
including digestive enzymes, probiotics, and nutrients like Coenzyme Q10,
WGP(TM) Beta Glucan, and Grape Seed and Grape Skin extracts.
4
We also provide a range of nutritional drinks, including liquid versions of
SBGA, two of which are fortified with Lutein, for vision support, or WGP(TM)
Beta Glucan, for immune system support. We also market a nutritional food bar,
called the BG Bar.
SKIN AND HAIR CARE
Since June of 2003, we added over thirty new products in this category. They are
primarily skin care products, ranging from basic bath and body care (Essential
Matrix, Grape Synergy and CoQskin) to spa and salon quality, premium skin care
(Professional Formulas, Golden Lily).
These products are uniquely natural and high-performance, with ingredients that
include a number of our dietary supplements, like Super Blue Green(R) Algae and
WGP(TM) Beta Glucan, which have significant benefits for the skin when applied
topically or when ingested. We have also introduced a new package of supplements
that contain each of the key performance ingredients in our skin and hair care
lines. These are Super Blue Green(R) Algae, Grape Synergy(TM) grape seed and
grape skin extracts, ImmuSun(TM) WGP(TM) Beta Glucan and Coenzyme Q10. We call
them Natural Beauty Essentials.
ANIMAL AND PLANT FOODS
In addition to our soil amendment, which we call PLANeT Food, we have a series
of animal supplements, for cats, dogs, horses, and other small animals.
BUSINESS ASSOCIATES AND OUR NETWORK MARKETING SYSTEM
We distribute our products through a network marketing system of Business
Associates. Business Associates are independent contractors who purchase
products directly from us for resale to retail consumers. Business Associates
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 ongoing personal contact between retail consumers and
Business Associates, most of whom use our products, strengthen sales of such
products. Currently, we have Business Associates in all fifty states, the
District of Columbia, Guam, Puerto Rico, American Samoa, Virgin Islands and
Canada.
Each Business Associate has the opportunity to sponsor additional Business
Associates, which can enhance the original Business Associate's income, as
described below. Each new sponsored Business Associate, as well as his or her
own "downline" groups, becomes a member of the Business Associate's network or
"downline."
COMMISSION SYSTEM
We currently offer two categories of membership. We call the first category
"Business Associate" and the other "Preferred Customer." Business Associates are
interested in receiving commissions for their own purchases as well as for
purchases made by members enrolled in their "downline." A Preferred Customer is
a customer who is interested in consuming our products, but is not interested in
the business opportunity we offer to our Business Associates. Many Preferred
Customers eventually become Business Associates. Both categories of membership
purchase our products at wholesale prices.
We compensate our Business Associates through a Business Associate commission
system that encourages both retail selling and sales organization management.
Business Associates may derive income from several sources. First, Business
Associates may receive revenues by purchasing our products at wholesale prices
and selling them to customers at retail prices. Second, Business Associates earn
the right to receive bonuses (commissions) based upon purchases by members of
their "downline" or sales marketing organization. Each new Business Associate
that a Business Associate sponsors becomes a member of his selling organization
or "downline." We refer to the Business Associates that a Business Associate
directly sponsors as his "first generation" or "first level."
5
In June 2002, we revised our commission system to better suit our long-term
growth objectives of attracting new Business Associates and appropriately
rewarding the Business Associates that work to increase their business with us.
Our goal was to redistribute our commission expense to those Business Associates
who demonstrate to us that they are actively contributing to our growth. We
believe we have designed a commission system that is suited to achieve these
goals as is demonstrated by the decrease in commission expense from 47.8% of
revenue in 2001 to 43.7% of revenue in 2002 and 42.5% of revenue in 2003. The
changes to our system that took effect in June 2002, are as follows:
o We reduced the personal volume percentage paid to Members to 5% from
10%. This change did not affect titles above Member. Once a Member
reaches the title of Representative, the commission on personal volume
is 15% and 5% on any volume of Members in the Representative's
network.
o We reduced generation 4, 5, and 6 payout percentages to 3%, 2%, and 1%
from 4%, 3%, and 2%, respectively. We did not affect the titles of
Amethyst, Ruby and Sapphire by this change.
The first level is "Member" and the highest level is "Executive." Business
Associates may attain "Member" status by purchasing any product from us. There
are two intermediary levels between Member and Executive: Representative and
Leader. A Business Associate achieves higher levels in the bonus structure
primarily through increased purchases by Business Associates sponsored directly
by them (their first level) and in their personal group. The requirements for a
Business Associate 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 Business Associate 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 Business Associate must qualify at
that level for us to pay at that level. The advantage to this is that the
Business Associates must remain active in purchasing and sponsoring to retain
their bonuses, but if they do not qualify in a certain month, we only reduce
their income that one month.
The Business Associate commission system includes three kinds of bonuses, as
described below:
o STANDARD BONUS. The standard bonus is available to any Business
Associate who has an "active" status with us. Business Associates may
attain the title of "Assistant Leader" by purchasing a minimum of $50
of products in a month. We base the percentages used to determine the
bonus and the number of levels in the organization the Business
Associate receives bonuses upon on the individual's title with us. The
standard bonus grants rebates to the Business Associate as he consumes
and sells our products to others.
o 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, Business Associates receive a
percentage of such Executives' standard bonus as an additional bonus.
o 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 Business Associates to earn bonuses
contributes significantly to our ability to retain our productive Business
Associates. The Business Associate commission system encourages promotion to
higher commission levels by enabling Business Associates to earn commissions on
a deeper sales base (i.e., more levels of their organization). We believe this
will encourage sponsoring growth (depth) in an organization and not just
acquiring customers personally.
To become a Business Associate, a person must simply sign an agreement to comply
with our policies and procedures. No investment is necessary to become a
Business Associate. We consider, as of February 29, 2004, approximately 32,000
of our Business Associates to be "active," that is, an individual Business
Associate who has ordered at least $50 of our products during the preceding
six-month period.
6
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 Business Associates about our product line and selling
techniques. Business Associates give presentations relating to their experiences
with our products and the methods by which they have developed their own
organization of Business Associates. We offer motivation to participants in the
form of recognition, promotions, excursions and tours, which we intend to foster
an atmosphere of excitement throughout the Business Associate organization.
Prospective Business Associates are educated about the structure, dynamics and
benefits of our network marketing system.
We continually develop marketing strategies and programs to motivate Business
Associates. We design these programs to increase Business Associates' monthly
product sales and the recruiting of new Business Associates.
BUSINESS ASSOCIATE SUPPORT
As part of our program to maintain constant communication with our Business
Associate network, we offer the following support programs to our Business
Associates:
o ASSOCIATIONS/TEAMS/ADVISORY BOARD. Several associations and teams
support Business Associates' efforts, including the Leadership
Alliance, an association of those Business Associates 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 sixteen 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 Business
Associates 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. Business Associates may learn more about our
products, our history, Business Associate organization building,
management techniques and related matters through our website,
www.celltech.com. In addition, we produce color catalogues and
brochures for our Business Associates 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 Business Associates via
temporary, permanent and super groups. A direct access telephone line
allows Business Associates 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 Business Associates
with news bulletins, product literature and articles of interest via
facsimile.
RESEARCH AND DEVELOPMENT
We spent $197,266 on research and development in 2003, $193,310 in 2002 and
$190,884 in 2001. We continually seek to identify, develop and introduce
innovative, effective and safe products. We have introduced approximately forty
new products since 1997. Management believes that our ability to introduce new
products increases our Business Associates' 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.
We derive new product ideas from a number of sources, including trade
publications, scientific and health journals, management, and independent
consultants. We maintain our own quality assurance/quality control staff,
consisting of two full time employees, but rely upon independent research,
consultants and others for ingredient research, development and formulation
services. When we identify a new product concept or when we must reformulate an
7
existing product for introduction into a new or existing market, we generally
submit the new product concept or reformulation 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 2003, we began formulating and testing various new products, including skin
and hair care products, which are designed to compliment our existing product
lines.
We are currently developing additional products, including new skin and hair
care products, antioxidants, 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 Business Associate from whom they
purchased it from within 90 days of their purchase. The Business Associate is
required to refund the purchase price to the consumer. The Business Associate
may then return the unused portion of the product to us for an exchange of equal
value. If a Business Associate requests a refund in lieu of an exchange, we will
issue a check or credit the appropriate amount to the Business Associate's
credit card.
We warrant all of our products against defect. Our experience has been that
returns are 1/2 of 1 percent of sales. We have a reserve of $14,600 for sales
returns at December 31, 2003.
RAW MATERIALS AND SUPPLIERS
Our primary raw material is APHANIZOMENON FLOS-AQUAE, which we harvest from
Upper Klamath Lake using 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 a unique (patent pending) on-lake harvester. Because of this method
of harvesting, we can gather APHANIZOMENON FLOS-AQUAE directly from the lake.
This development of our harvesting techniques 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. We believe that harvesting directly from Upper Klamath Lake 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 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 DRYING. We gently remove all cellular water in a low temperature
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 we can encapsulate or tabletize and seal to retain freshness and
viability.
8
In years when there has been no harvest, we rely on our inventory of frozen and
freeze-dried SBGA. As of December 31, 2003, we had 900,157 pounds of frozen
algae inventory for use in capsules and tablets and 1,660,511 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 expanded our harvesting capacity ten-fold. 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.
From time to time, a toxic species of algae called MICROCYSTIS AERUGINOSA blooms
in Upper Klamath Lake and can contaminate 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. Our experience
indicates that our harvest method helps 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.
We encapsulate and bottle algae 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 2003, 2002, and 2001,
one vendor supplied approximately 42%, 45% and 55%, respectively, of the
products that we purchased. This vendor was our source of enzymes and
probiotics. We place significant emphasis on quality control with all of our
products. All nutritional supplements, raw materials and finished products are
subject to sample testing, weight testing and purity testing by independent
laboratories. 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
We package most products under our "private label." At December 31, 2003, 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 Business Associate
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/A, no other person has claimed infringement
based on our use of the name "Cell Tech," but there can be no assurance that it
would not make such a claim 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, greater name recognition and financial resources than us.
In addition, consumers can purchase nutritional supplements 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.
9
Several companies harvest algae from the Upper Klamath Lake. However, we are the
largest harvester and the supply of algae is substantially more than the total
amount harvested by all companies. We also have access to Upper Klamath Lake
that is in close proximity to our freezer facility.
We also compete in the nutritional supplements market and for new Business
Associates 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 Business Associates based on 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
Business Associates. Given that the pool of individuals interested in direct
selling tends to be limited in each market, the potential pool of Business
Associates 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 Business Associates, 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 Business Associates, 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 Food and Drug Administration
("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 we manufacture, distribute and sell our products.
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 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 we make it.
10
In January 2000, the FDA published a final rule that defines the types of
statements companies can make 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. Without prior FDA review, a product may not bear a claim that
it 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 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. To
date, the FDA has not issued a guidance document, and we have continued our
ongoing efforts to ensure that our 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 use of terminology
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 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 significant scientific agreement supports the claim
and the FDA pre-approves it.
STATE REGULATION
As a result of certain conditions, a toxic strain of algae called MICROCYSTIS
AERUGINOSA occasionally blooms in Klamath Lake and can contaminate a portion of
our harvest of blue-green algae with microcystin, a toxin. In 1994, we began to
test the algae harvested at this facility for possible contamination. We have
regularly measured, at various levels, the existence of MICROCYSTIS AERUGINOSA.
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
that we cannot use 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 therefore, may have an adverse
impact on our ability to realize the carrying value of our inventories. We have
recognized that an impairment of our inventory exists and therefore have
recorded our best estimate of the effect by establishing a reserve for
$4,000,000 at December 31, 2002. During 2003 we destroyed certain inventory that
was least sellable thus reducing the inventory reserve to $2,565,000 by year
end. The Oregon Department of Agriculture has taken no regulatory actions
against our products under this Rule to date.
11
FOREIGN MARKETS
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 Business Associate compensation made to prospective
Business Associates constitute fair, reasonable and timely disclosure and that
it meets other legal requirements of the Federal Competition Act. After a review
of our revised compensation plan, 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. They design the licensing to maintain the standards of the
direct selling industry and to protect the consumer. Some provinces require
licenses for both our Business Associates and us. We are in the process of
obtaining all of the required provincial or territorial direct sellers'
licenses.
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.
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 the substantiation of any claims. 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 Business Associates as to the scope of permissible and
impermissible activities in each market. We also investigate allegations of
Business Associate misconduct. However, our Business Associates generally are
independent contractors, and we are unable to monitor directly all of their
activities. Consequently, we cannot be sure that our Business Associates comply
with applicable regulations. Misconduct by Business Associates could 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. However, they could require: (1) the
reformulation of some products we may not able to reformulate; (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.
12
NETWORK MARKETING SYSTEM REGULATION
Our Business Associate 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 the ultimate sale of products to
consumers. Further, they ensure that advancement within the organizations be
based on the sales of products, rather than from the recruitment of additional
Business Associates, 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.
EMPLOYEES
At February 28, 2004, we employed approximately 75 persons, of which 3 were
part-time. These numbers do not include our Business Associates, 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 we group it 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) 2003 2002 2001
----------------- ----------------- -----------------
United States ....................... $19,935 93.9% $26,696 94.3% $28,310 94.3%
Canada .............................. $ 1,286 6.1% $ 1,498 5.7% $ 1,702 5.7%
------- ----- ------- ----- ------- -----
Total ............................... $21,221 100.0% $26,194 100.0% $30,012 100.0%
======= ===== ======= ===== ======= =====
We believe that our profit margin on export sales is not significantly different
from that realized on sales in the United States. We consummate all foreign
product sales transactions in U.S. dollars.
Item 2. Properties.
Currently, our headquarters and all of our operating facilities are located in
Klamath Falls, Oregon. We leased approximately 100,000 square feet of office,
processing, freezer and storage space directly from two of our principal
stockholders during 2003. Most of these leases are year-to-year or
month-to-month with the exception of one lease that will expire in 2005. We
believe that we lease the space from our shareholders and their affiliate at or
below fair market rates.
We have made a decision to vacate approximately 33,000 square feet of office and
warehouse space during the first half of 2004 that we have been leasing from
those principal stockholders. We have other owned and leased properties that are
adequate for our continuing operational needs. Vacating those properties will
save the company approximately $11,480 per month in rent expense. It will also
lead to the early expensing of leasehold improvements in the approximate amount
of $540,000 during the first two quarters of 2004.
We also lease an additional 21 acres from an independent third party, on which
we have built an alga processing and storage facility that is currently standing
idle and being held for sale. 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.
13
ITEM 3. LEGAL PROCEEDINGS.
On February 6, 1998, Oregon Freeze Dry, Inc., a vendor, filed a complaint
against us alleging that we wrongfully terminated a contract with Oregon Freeze
Dry, Inc. On December 20, 2002, the parties signed a settlement agreement and
they dismissed the lawsuit. The parties agreed that we will pay $1,885,917 to
Oregon Freeze Dry, Inc. Payments are to be $50,000 per month. No interest will
accrue to this note as long as we are timely in the note payments. $1,019,920 is
included in notes payable in the accompanying balance sheet at December 31,
2003. As of December 31, 2003, we are current on the payment obligations to
them. Additionally, we are obligated to use them for all of our freeze-drying
needs. If we choose to use a bulk drying method other than freeze-drying, then
we will pay a fee of 25 cents per pound to them for a period of up to 10 years,
but not to exceed $2,500,000, for algae dried using such alternative method.
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 were seeking monetary
damages of approximately $226,345 for all causes specified in our complaint. The
matter was settled in February 2004 resulting in the defendant agreeing to pay
$80,000 to us for damages.
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, which judgment was entered in April 2003. 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 confidential settlement provides for making partial refunds
to certain of our California customers. The Superior Court approved the
confidential settlement and vacated the judgment on August 25, 2003. 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, one of our principal shareholders, filed
two separate Notices of Claim of Lien upon Chattels against us, NAC and Marta
Carpenter and others, in the Circuit Court of the State of Oregon, 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 personal property from the real 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 or about May 31, 2002, Daryl Kollman filed an action in the Circuit Court of
Klamath County (Case No. 02-01956CV) seeking to evict us from certain real
property owned by him and Marta Carpenter. Mr. Kollman later added a claim for
allegedly unpaid rent exceeding $558,000. On or about October 31, 2002, the
Court dismissed Mr. Kollman's eviction claim. Mr. Kollman's claim for unpaid
rent is currently pending. 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.
14
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 (Case No. 02-02040CV) 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, certain of our officers, directors and counsel in the
Circuit Court for the State of Oregon for Klamath County (Case No. 02-03774CV).
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 no less than $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. We intend to vigorously defend the
direct claims asserted in this lawsuit, and we have filed a motion to disqualify
Mr. Kollman as a proper plaintiff for the derivative claims, which motion is
currently pending. 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.
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
was dismissed in January 2003. The net effect of this is an increase to net
income during the first quarter of 2003 of $161,956.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS.
None.
15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
PRICE RANGE OF COMMON STOCK
On August 14, 1996, HumaScan completed its initial public offering and our
common stock began trading on the NASDAQ Small Cap Market under the symbol
"HMSC." Prior to the IPO there was no established public trading market for our
common stock. On March 4, 1999, the NASDAQ Small Cap Market delisted our common
stock and it commenced trading on the OTC Bulletin Board. On August 10, 1999, as
part of our reorganization, we executed a 1 for 10.8520933 reverse stock split
and changed our name to Cell Tech International Incorporated, trading symbol
"EFLI." On July 24, 2000, the NASD suspended trading in our common stock on the
OTC Bulletin Board because our 1934 Act filings were past due and the National
Quotation Bureau's Pink Sheets subsequently quoted our common stock. The
following table lists the bid prices at the end of each period obtained from the
National Quotation Bureau's Pink Sheet service and is adjusted for subsequent
stock dividends and stock splits. Prices do not include retail mark-ups,
mark-downs or commissions and may not represent actual transactions. Trading in
our common stock is limited and sporadic and you should not deem such quotations
to constitute an established public trading market.
HIGH BID PRICE LOW BID PRICE
FOR PERIOD ($) FOR PERIOD ($)
-------------- --------------
2003
First Quarter....................... .25 .16
Second Quarter...................... .25 .15
Third Quarter ...................... .25 .12
Fourth Quarter...................... .20 .20
2002
First Quarter....................... .40 .20
Second Quarter...................... .45 .20
Third Quarter ...................... .52 .17
Fourth Quarter...................... .50 .20
At February 29, 2004, 13,974,087 shares of our common stock were issued and
outstanding and approximately 141 stockholders of record held our stock.
DIVIDENDS
In 1999, before our reorganization, we distributed certain real estate valued at
$1,050,000 to Marta C. Carpenter and Daryl J. Kollman, and paid previously
declared dividends of $7.6 million to Ms. Carpenter and Mr. Kollman. 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. Currently, the Board of
Directors believes that we should retain all of our earnings, if any, for the
development of our business.
16
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 in a private placement to
Zubair 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 defined by Regulation D of the Securities Act of 1933, as amended,
and did not involve a general solicitation. We effected the above transaction
pursuant to Section 4(2) of the Securities Act of 1933, as amended.
We are obligated to issue to Mr. 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 March 31, 2003, we had not filed a
registration statement and consequently, Mr. Kazi was entitled to an additional
3,333,192 penalty shares of common stock and warrants. During the second quarter
of 2003, we issued to Mr. Kazi 3,333,192 shares of common stock and we converted
the 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 at that time and have
not yet been issued. During the last three quarters of 2003, additional
liability was recognized under the agreement in the amount of $82,537, based on
the fair value of the securities at the respective measurement dates. We have
accrued and will continue to accrue additional penalties until the shares are
registered. The total expense accrued for the year ended December 31, 2003, was
$139,037 and 453,863 shares and 3,787,055 warrants are issuable to Mr. Kazi.
We are obligated, upon the effective date of our next registration statement
(First reset date), to issue additional securities to Mr. Kazi in accordance
with the following reset rights:
o 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 we shall issue to Mr. Kazi
additional securities so that the initial ratio and the first reset
ratio are equal and pursuant to the following formula:
- Amount of additional purchased securities = ((First Reset
Ratio)/(Initial Ratio)-1) times 1,157,895.
In addition, if Kazi 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.
Kazi is entitled to five additional reset dates that 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 we have not yet filed our first registration statement, the first reset
date has not yet occurred.
17
EQUITY COMPENSATION PLANS
Below represents information concerning our equity compensation plans as of
December 31, 2003 (note 9):
(A) (B) (C)
------------------------- ---------------------- ------------------------
NUMBER OF SECURITIES
AVAILABLE FOR FUTURE
NUMBER OF SECURITIES TO WEIGHTED-AVERAGE ISSUANCE UNDER EQUITY
BE ISSUED UPON EXERCISE EXERCISE PRICE OF COMPENSATION PLANS
OF OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, (EXCLUDING SECURITIES
WARRANTS AND RIGHTS WARRANTS AND RIGHTS REFLECTED IN COLUMN (A))
------------------------- ---------------------- ------------------------
Equity Compensation Plans
Approved by Shareholders ........... 25,802 $3.05 - $142.49 38,702
Equity Compensation Plans Not
Approved by Shareholders ........... 180,000 $0.15 - $0.50 520,000
------- --------
Total ................................. 205,802 558,702
======= =======
18
ITEM 6. SELECTED FINANCIAL DATA.
We have derived the selected financial data as of and for the five years ended
December 31, 2002 from our audited consolidated financial statements and related
notes. You should read the selected financial and operating data in conjunction
with Management's Discussion and Analysis of Results of Operations and Financial
Condition and the consolidated financial statements and related notes.
Years ended December 31,
-------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
($ in thousands, except per share data)
RESULTS OF OPERATIONS
Revenue $ 22,286 $ 26,194 $ 30,012 $ 38,977 $ 54,488
Gross Profit 15,138 16,731 20,488 27,488 39,739
Gross Profit after Commissions 5,670 5,271 6,146 9,855 15,306
Operating Income (Loss) (5,322) (3,516) (4,985) (2,436) (4,439)
Net Income (Loss) (5,651) (3,497) (5,015) (2,784) (4,141)
Net Income (Loss) per common share
Basic and Diluted $ (0.40) $ (0.27) $ (0.47) $ (0.26) $ (0.45)
Weighted Average Shares Outstanding
Basic and Diluted 14,049,055 12,864,643 10,640,895 10,640,895 9,280,431
Cash dividend per common share $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ 0.82 (1)
SELECTED BALANCE SHEET DATA
Cash & Cash Equivalents $ -- $ -- $ -- $ -- $ --
Current Assets 2,750 3,259 2,788 3,881 5,505
Total Assets 9,184 15,814 19,975 27,250 41,099
Current Liabilities 6,450 7,542 9,225 11,223 8,577
Total Liabilities 6,958 8,561 9,225 11,485 14,266
Shareholders' Equity 2,226 7,252 10,750 15,765 18,549
- ----------
(1) In 1999, before our reorganization, we paid a previously declared dividend
of $7.6 million to Marta C. Carpenter and Daryl J. Kollman. See
"Dividends."
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION.
From time to time, our representatives or we 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. We discuss these factors in
19
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.
GOING CONCERN
We have experienced recurring net losses and have negative working capital at
December 31, 2003 and March 15, 2004. In September 2002, 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 would not declare a default until June 30, 2003, when the entire principal
is due. The forbearance period was extended to June 30, 2004 with our payment of
a $75,000 renewal fee. We have tentatively agreed with the lender to extend the
loan until June 30, 2005. However, there can be no assurance that additional
financing will be available when the extension period ends in June of 2004. We
are also experiencing some difficulty in generating sufficient cash flows to
meet our obligations on a month-to-month basis. 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.
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.
OFF-BALANCE SHEET ARRANGEMENTS
None.
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 15 of this Annual Report on Form 10-K/A, beginning on page
F-8. Note that our preparation of this Annual Report on Form 10-K/A 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.
- - REVENUE RECOGNITION
The Company recognizes revenue from the sale of its products upon shipment, at
which time title passes. The Company estimates an allowance for sales returns
based on historical experience with product returns.
- 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 we estimate to generate by those assets are less than
the carrying amount of those items. We base our cash flow estimates on
historical results adjusted to reflect our best estimate of future market and
operating conditions. We reduce the net carrying value of assets not recoverable
to fair
20
value. Our estimates of fair value represent our best estimate based on industry
trends and reference to market rates and transactions. During 2003 we recorded
impairment expenses for various assets designated as held for sale. The former
harvest building is no longer being used and after the auction we held in
September of 2003 we determined that the building would not be suitable for its
original purposes and reviewed its net book value. After reviewing estimated
replacement costs and listings of comparable properties in the area we
determined the impairment to be $2.2 million. This was reported in our 3rd
quarter report. Additionally, there are still several pieces of equipment being
held for sale that were not disposed of at auction. Additional impairment of
$64,646 was recorded on those assets to recognize them at auction value per a
certified appraisal taken in December of 2002 (note 5).
- 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. During
the last quarter of 2003 we determined that a certain portion of our inventory
is excess or obsolete, and accordingly, we expensed its carrying value in the
amount of $544,233.
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.
- COMMISSIONS
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. We pay commissions to our distributors as compensation for
sales and marketing activities and based on their personal sales volumes and the
sales of distributors they have recruited into our network. Accordingly, we
classify these expenses as a cost and not a reduction of revenue.
- 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." We develop our assessment 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.
21
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) and other nutrients and ingredients through a network of independent
distributors ("Distributors"). We currently offer twenty-two different products
intended to appeal to health-conscious consumers. We divide our products 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 ability to attract and retain new Distributors,
enter new markets and to introduce additional and new products into our markets.
YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002
Net sales for the year ended December 31, 2003 were $22,285,975, a decrease of
15% from net sales of $26,193,747 for the year ended December 31, 2002. We
directly relate the decrease in sales to a decrease in the number of Business
Associates and orders for the same period partially offset by an increase in the
average order size to $125 from $123 over the same period. The increase in
average order size was likely due to a price increase that was implemented on
some of our products during the spring of 2003. The number of Business
Associates in 2003 decreased to an average of 37,563, which was 14% lower than
the average of 43,761 Business Associates in 2002. We make sales of our food
supplement and personal care products through a multi-level marketing network of
Business Associates, so we positively link sales with the number of business
associates. 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 increased to 67.9% from 63.2% of
net sales for the years ended December 31, 2003 and 2002, respectively. The
increase in the gross profit margin is due primarily to price increases and a
reduction in the amount of inventory charged off as unsaleable in 2003. In 2002,
$3.1 million was charged against income for potentially unsaleable inventory and
in 2003, $544,000 was charged off as potentially unsaleable.
Gross profit after commissions represents gross profit less commission expense.
Commission expense for 2003 and 2002 was 42.5% and 44.6% of net sales,
respectively. We are a multi-level marketing organization. Business Associates
make up our sales force. Business Associates buy algae products for their own
consumption plus they actively recruit other Business Associates into our
network. Business Associates are paid commissions based upon their personal
sales volumes and the sales of Business Associates beneath them in their
network. Commission expense as a percentage of sales decreased in 2003 due to
changes in the commission plan.
Operating expenses include shipping and handling expenses, selling expenses,
research and development expenses, general and administrative expenses and asset
write-down expense. In total, operating expenses increased $2,830,272, or 34%,
to $11,198,391 for the year ended December 31, 2003 from $8,368,119 for the year
ended December 31, 2002. We discuss the components of operating expenses below.
o Shipping and handling expenses includes purchasing, receiving, and
materials management. Shipping and handling expenses decreased
$66,505, or 4%, to $1,448,853 in 2003, from $1,515,358 in 2002. The
decrease was due primarily to a decrease in freight expense in 2003
due to the overall decrease in sales volumes. Shipping and handling
expenses, as a percent of net sales, were 6.5% for the year ended
December 31, 2003 and 5.8% for the year ended December 31, 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 decreased $19,868
between 2003 and 2002 to $4,001,866 from $4,021,734. This decrease was
primarily due to decreases in transaction costs associated with credit
card processing of $104,000, reduced depreciation expense of $104,000
and other miscellaneous expense reductions. These reductions were
offset by increases in insurance expense of $59,000 and advertising
costs of $134,000. Selling expenses were
22
18.0% of sales for the year ended December 31, 2003 and 15.4% for the
year ended December 31, 2002.
o Research and development expenses increased 2% to $197,266 in 2003
from $193,310 in 2002, which constituted 0.8% and 0.7% of net sales,
respectively.
o General and administrative expenses increased by $1,521,571 or 86%
between 2003 and 2002 to $3,285,760 from $1,764,189. General and
administrative expenses averaged 14.7% and 6.7% of sales for the years
ended December 31, 2003 and December 31, 2002, respectively. The
increase between 2003 and 2002 is attributable primarily to an
increase in loss on sale of assets of $805,000 and in legal fees of
$444,000.
o Asset write-downs increased by $1,391,118 or 159% from $873,528 for
the year ended December 31, 2002 to $2,264,646 for the year ended
December 31, 2003. An additional reserve was recorded during the year
ended December 31, 2003 to adequately reserve for the impaired value
of fixed assets identified as being held for sale and not continuing
to be used for production (note 5).
Other income decreased to $274,266 for the year ended December 31, 2003 from
$283,834 for the year ended December 31, 2002, principally due to a decrease in
sundry income collected from Business Associates and to a decrease in management
fees charged to Klamath Cold Storage. Interest expense increased to $397,183 in
2003 from $265,047 in 2002. This increase was due primarily to the note payable
to Oregon Freeze Dry, Inc. that resulted from our settlement with them in
December of 2002.
Net loss for 2003 increased 62% to $5,651,029 from $3,497,387 reported in the
prior year or a loss of $0.40 per share for 2003 compared to a loss of $0.27 per
share for 2002. The increase was primarily due to an increase in asset
impairment charges in 2003, as well as other causes detailed above.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Net sales for the year ended December 31, 2002 were $26,193,747, a decrease of
12.7% from net sales of $30,012,076 for the year ended December 31, 2001. We
directly relate the decrease in sales to a decrease in the number of Business
Associates and orders for the same period partially offset by an increase in the
average order size to $123 from $116 over the same period. The number of
Business Associates in 2002 decreased to an average of 43,761, which was 17%
lower than the average of 52,761 Business Associates in 2001. We make sales of
our food supplement products through a multi-level marketing network of Business
Associates, so we positively link sales with the number of Business Associates.
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 63.2% from 67.5% of net sales
between the years ended December 31, 2002 and 2001, respectively. The decrease
in the gross profit margin is due primarily to the recording of an additional
reserve of $3.1 million for potentially unsaleable inventories. We determined
that the sales of our plant food and agricultural products was less than
previously anticipated and recorded this reserve against the carrying value of
our inventory designated for plant food and agricultural uses. The decrease in
the gross profit margin as a result of recording the additional reserve for
potentially unsaleable inventory was offset by a decrease in depreciation
expense previously recorded on the harvest site fixed assets. We suspended this
depreciation expense when management made the decision to cease harvesting of
algae on the A-Canal and classifying certain of the fixed assets as "held for
sale". The related depreciation expense that we did not record in 2002 was
$1,144,370. In addition, because of our harvesting algae in 2002, we have
capitalized certain harvest costs in ending inventory whereas in prior years
when no harvesting of algae took place, we expensed such costs. Costs
capitalized in ending inventory in 2002 were approximately $585,450.
Gross profit after commissions represents gross profit less commission expense.
Commission expense for 2002 and 2001 was 44.6% and 47.8% of net sales,
respectively. We are a multi-level marketing organization. Business Associates
make up our sales force. Business Associates buy algae products for their own
consumption plus they actively recruit other Business Associates into our
network. Business Associates are paid commissions based upon
23
their personal sales volumes and the sales of other Business Associates 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 Business
Associates and to decrease commission expense.
Operating expenses include shipping and handling expenses, selling expenses,
research and development expenses and general and administrative expenses. In
total, operating expenses decreased $2,544,873 or 23.3% to $8,368,119 for the
twelve months ended December 31, 2002 from $10,912,992 for the twelve months
ended December 31, 2001. We discuss the components of operating expenses below.
o Shipping and handling expenses includes purchasing, receiving, and
materials management. Shipping and handling expenses decreased
$131,267 or 8%, to $1,515,358 in 2002 from $1,646,625 in 2001. The
decrease was due to a decrease in freight expenses and supplies in
2002 due to the overall decrease in sales volumes, partially offset by
an increase in postal rates. Shipping and handling expenses as a
percent of net sales increased to 5.8% for the year ended December 31,
2002 from 5.5% for the year ended December 31, 2001.
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 $38,248 or
0.9% between 2002 and 2001 to $4,021,734 from $4,059,982. This
decrease was primarily due to a decrease in leased equipment costs,
consulting expenses, merchant expense, utilities and depreciation
costs of $324,518 partially offset by an increase in insurance expense
of $79,852 and promotional expense of $231,000. Selling expenses were
15.4% of sales for the year ended December 31, 2002 and 13.5% of sales
for the year ended December 31, 2001.
o Research and development expenses increased 1% to $193,310 in 2002
from $190,884 in 2001, which constituted 0.7% and 0.6% of net sales,
respectively.
o General and administrative expenses decreased by $661,372 or 27%
between 2002 and 2001 to $1,764,189 from $2,425,561. General and
administrative expenses averaged 6.7% and 8.1% of sales for the years
ended December 31, 2002 and December 31, 2001, respectively. The
decrease between 2002 and 2001 is attributable to a decrease of
$830,000 in costs associated with licenses, insurance, consulting fees
and depreciation expense partially offset by an increase in legal fees
of $62,000.
o Asset write-downs decreased by $1,716,412 or 66% from $2,589,940 for
the year ended December 31, 2001 to $873,528 for the year ended
December 31, 2002. An additional reserve was recorded during the year
ended December 31, 2002 to adequately reserve for the deteriorating
value of fixed assets identified as being held for sale, and was
ascertained by having an independent appraisal done of that equipment.
Other income decreased to $283,834 for the year ended December 31, 2002 from
$591,787 for the year ended December 31, 2001 principally due to a decrease in
sundry income collected from Business Associates and by the additional recording
of fair value cost of penalty shares and warrants we owe to an investor of
$243,120. Interest expense decreased to $265,047 in 2002 from $622,235 in 2001.
This decrease was due to the assignment of our previous financing facility to La
Jolla Loans during the third quarter ended September 30, 2002, resulting in the
elimination of previously required minimum interest payments.
Net loss for 2002 decreased 30% to $3,497,387 from $5,015,350 reported in the
prior year or a loss of $0.27 per share for 2002 compared to a loss of $0.43 per
share for 2001. The decrease was primarily due to reduced commission expense
because of the changes to the commission structure implemented during 2001,
reduced operating expenses because of the cost-cutting efforts of management in
2002, and the reduced asset write-down expense of approximately $1.7 million
during 2002. We offset the decrease in these expenses by the increase in cost of
sales as previously described.
24
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,
2003 amounted to $113,102 compared to cash flows provided by operations of
$1,277,926 for the year ended December 31, 2002. The decrease in cash flows
provided by operations is primarily due to sales revenue decreasing at a faster
rate than the associated expenses and working capital requirements to sustain
those revenues.
Cash flows provided by investing activities for the year ended December 31, 2003
was $550,621, net of $665,705 of proceeds from sales of equipment. This is an
increase of $1,127,922 from net cash used for investing activities of $577,301
for the year ended December 31, 2002, due to a decrease in equipment purchases
related to the construction of the on-lake harvester during the fiscal year
ended December 31, 2002 and to the auction of unused equipment during 2003.
Net cash flows used for financing activities was $663,723 for the year ended
December 31, 2003 versus net cash used for financing activities of $700,625
during 2002. This change is principally due to payments on long-term debt offset
by increases in related party debt during 2003.
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 La Jolla Loans, Inc. ("La Jolla Loans"). Currently, the Board of
Directors believes that we should retain all of our earnings, if any, for the
development of our business.
Working capital deficit at December 31, 2003 amounted to $3,699,942, a decrease
of $582,956 from a working capital deficit of $4,282,898 as of December 31,
2002. At December 31, 2003, we had a bank overdraft of $481,496 versus a bank
overdraft of $468,008 as of December 31, 2002.
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 incurred interest at a rate equal to
the prime rate plus 2.5% per annum, effectively 7.5% at December 31, 2001, and
expired June 30, 2002. The Term Loans and Equipment Acquisition Loans incurred
interest at a rate equal to the prime rate plus 2.75% at December 31, 2002, and
were repayable in 60 monthly installments by July 1, 2004.
In September 2002, La Jolla Loans purchased and took an assignment of our
financing facility with Coast Business Credit. In connection with this
transaction, Coast Business Credit assigned its security interest in real and
personal property and assigned all associated security and loan documents to La
Jolla Loans. 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 would not declare a default until June 30, 2003, when the entire
principal was due. We extended the loan to June 30, 2004 under the terms of the
loan agreement by paying an extension fee of $75,000. The extension fee of
$75,000 was recorded a prepaid asset and is being expensed over the twelve
months of the loan extension period. Interest of $18,225 at an effective rate of
14% is payable monthly along with additional monthly impound payments of
approximately $19,000 to be used to pay insurance, property taxes and lease
payments on collateralized property during the forbearance period. La Jolla
Loans has also agreed to defer, during the forbearance period, 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. 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 minimum monthly interest payments in
excess of $24,500. The outstanding principal balance at December 31, 2003 is
$1,562,164.
25
We are in compliance with all loan covenants as of March 31, 2004. We have
classified all outstanding debt to the lender as a current liability.
La Jolla Loan has agreed in principle to further extend the loan at June 30,
2004 upon payment of approximately $100,000 in fees and associated expenses.
CONTRACTUAL OBLIGATIONS AND CONTINGENT LIABILITIES AND COMMITMENTS
The following table aggregates the Company's expected minimum contractual
obligations and commitments subsequent to December 31, 2003
CONTRACTUAL OBLIGATIONS LESS THAN
TOTALS 1 YEAR 1-2 YEARS 3-5 YEARS
---------- ---------- ---------- ----------
Long term debt $1,019,920 $ 512,064 $ 507,856 $ --
Short term borrowings 1,562,164 1,562,164 -- --
Capital lease commitments -- -- -- --
Operating lease commitments 412,843 168,203 201,506 43,134
---------- ---------- ---------- ----------
Total contractual cash commitments $2,994,927 $2,242,431 $ 709,362 $ 43,134
========== ========== ========== ==========
Not included in the table above are normal recurring accounts payable or accrued
expenses that are presented on the accompanying consolidated financial
statements.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2002, FASB issued Statement No. 146 (SFAS No. 146), "Accounting for
Costs Associated with Exit or Disposal Activities," effective for activities
that we initiate after December 31, 2002, with early application encouraged.
This Statement addresses financial accounting and reporting for costs associated
with exit or disposal activities and nullifies Emerging Issues Task Force (EITF)
Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." We adopted SFAS No. 146 in January 2003 and it did not have a
material effect on our financial position or results of operations.
In December 2002, FASB issued Statement No. 148 (SFAS No. 148), "Accounting for
Stock-Based Compensation -- Transition and Disclosure -- An Amendment of FASB
Statement No. 123." SFAS No. 148 amends SFAS No. 123, "Accounting for
Stock-Based Compensation," to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, SFAS No. 148 amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results. We
are required to follow the prescribed format and provide the additional
disclosures required by SFAS No. 148 in our annual financial statements for the
year ended December 31, 2002 and must also provide the disclosures in our
quarterly reports containing condensed financial statements for interim periods
beginning with the quarterly period ended March 31, 2003. The adoption of SFAS
No. 148 did not have a material effect on our financial position or results of
operations.
In May 2003, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 150, ACCOUNTING FOR CERTAIN INSTRUMENTS
WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY ("FAS 150"), which
establishes standards for classifying and measuring certain financial
instruments with characteristics of both liabilities and equity. FAS 150
requires an issuer to classify a financial instrument that is within its scope,
which may have previously been reported as equity, as a liability (or an asset
in some circumstances). This statement is effective at the beginning of the
first interim period beginning after June 15, 2003 for public companies. We
adopted this Statement as of July 1, 2003 and it had no material impact on our
financial statements.
26
In April 2003, the FASB issued SFAS No. 149, "AMENDMENT OF STATEMENT 133 ON
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES" ("FAS No. 149"). FAS No. 149
amends and clarifies the accounting guidance on derivative instruments
(including certain derivative instruments embedded in other contracts) and
hedging activities that fall within the scope of FAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." FAS No. 149 also amends certain
other existing pronouncements, which will result in more consistent reporting of
contracts that are derivatives in their entirety or that contain embedded
derivatives that warrant separate accounting. This Statement is effective for
contracts entered into or modified after June 30, 2003, with certain exceptions,
and for hedging relationships designated after June 30, 2003. We do not have any
contracts that are derivatives or that contain embedded derivatives.
In January 2003, the FASB issued FASB Interpretation No. 46, CONSOLIDATION OF
VARIABLE INTEREST ENTITIES, an interpretation of Accounting Research Bulletins
("ARB") No. 51, CONSOLIDATED FINANCIAL STATEMENTS ("FIN 46"). FIN 46 clarifies
the application of ARB No. 51 to certain entities in which equity investors do
not have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. We do not believe
the adoption of FIN 46 will have a material impact on our financial position and
results of operations.
RISKS AND UNCERTAINTIES
VARIABILITY OF RESULTS
Our annual sales were in excess of $200 million in 1996. Subsequent to 1996,
sales have decreased substantially each year. 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 business associates, loss of
services of certain existing distributors, and competition. Our inability to
adjust our operating expenses to compensate fully for the decrease in sales
contributes to our negative 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 satisfy our financial obligations.
EFFECTS OF CLINICAL STUDIES, SCIENTIFIC REVIEW, AND PUBLICITY
We believe that the national media attention to recent scientific research that
highlights potential health benefits of consuming certain vitamins and
nutritional supplements drives the increasing interest generally in vitamins,
nutritional supplements and similar products. While we have concluded from
extensive independent research that SBGA, the principal ingredient in our
products, has 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 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.
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. However, different factors, including consumers'
acceptance of innovative products and our compliance with governmental
regulatory laws, condition the success of these products. 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.
27
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 the massive quantities sufficient for harvesting. Although we may
not depend on third-party suppliers for sources, we determine our reserve of
SBGA 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. Despite a water shortage in 2000 and 2001, which precluded a
harvest from the "A" canal, we began harvesting directly from Upper Klamath Lake
in July 2001 with a uniquely designed harvester. In 2002, we added 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.
As a result of certain conditions MICROCYSTIS, a toxic algae, occasionally
blooms in Klamath Lake at the same time blue-green 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 blue-green 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 algae that we can
harvest.
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.
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 BUSINESS ASSOCIATES
We rely almost exclusively on a network marketing system of independent Business
Associates to sell our products. The success of our operations depends on our
ability to attract new Business Associates and maintain business relationships
with existing Business Associates. We compete with other network marketing
companies for Business Associates and can experience high turnover among our
Business Associates. Because some of these companies may have a longer history
of operations and superior resources, their ability to appeal to a large base of
Business Associates is greater. There can be no assurance that existing Business
Associates will not terminate their services to us or that the number of
Business Associates for our products will remain steady or increase.
Moreover, our revenue is dependent on the ability of the Business Associates to
attract and retain customers. A decrease in the productivity of existing
Business Associates would adversely affect our financial conditions. We cannot
28
assure you that the Business Associates will maintain or increase their
productivity. We also cannot accurately predict the future productivity of the
Business Associates since their operations depend on their ability to sponsor,
train, and motivate new Business Associates.
REGULATION OF BUSINESS ASSOCIATES AND NETWORK MARKETING SYSTEM
Since the Business Associates 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 certain contractual rules of conduct govern the services
of the Business Associates to our business, it is difficult to monitor or
control the conduct of the sales associates of our Business Associates 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. However, we cannot provide assurance that any future changes to
laws and regulations of any particular jurisdiction will not affect our
operations. A court could also hold us civilly or criminally accountable based
on vicarious liability because of the actions of independent Distributors. We
are not aware of any such actions of independent distributors.
DEPARTURE OF BUSINESS ASSOCIATES
Certain Business Associates have severed their ties with us and are now
competing against us. This will adversely affect us in that these Business
Associates will no longer be generating revenues for us and furthermore, we can
expect the departing Business Associates 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. We designed this alternative distribution strategy to provide a
complementary marketing method for our Business Associates. While we believe the
infomercials will complement the sales efforts of our Business Associates, there
can be no assurance that it will have its intended effect with our Business
Associates and could create conflicts with our Business Associates that could
result in the loss of many of our Business Associates, 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 Business Associates, 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, new personnel challenges could confront us 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.
LIEN ON CARPENTER'S AND KOLLMAN'S STOCK
Our common stock owned by majority shareholders Daryl J. Kollman and Marta C.
Carpenter 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 our reorganization. The Internal Revenue Service has subordinated
the lien in favor of the lender for the Term Loan.
29
DISPUTE BETWEEN PRINCIPAL SHAREHOLDERS
Daryl J. Kollman and Marta C. Carpenter, shareholders who together own
approximately 62% of our outstanding shares of common stock, divorced in 2002.
Mr. Kollman and Ms. Carpenter jointly 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. Mr. 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, Ms. Carpenter petitioned the Circuit Court for the
State of Oregon with a motion seeking, among other court orders, to enjoin Mr.
Kollman from interfering with any future loan applications of Ms. Carpenter or
us and a self executing judgment provision whereby the court would sign a loan
application on behalf of Mr. Kollman. The court held that Mr. Kollman is to
cease and desist from any such endeavors of interfering with our loan
applications during the pendency of the dissolution proceedings and the order
prohibits him from writing letters or communicating orally with any lending
institutions unless requested to do so by the institution. The court also held
that Mr. 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 court heard
the matter at trial on December 10, 11, and 12, 2001. The Court ruled that Marta
Carpenter and Daryl Kollman were each entitled to an equal division of their
respective stock ownership in our common stock, thus resulting in no change in
our current ownership. The Court also ruled Mr. Kollman and Ms. Carpenter will
equally divide their joint ownership in certain real property assets leased by
us from them in each property and that they must sell the properties and
improvements to pay the indebtedness to the Internal Revenue Service. They will
equally share any remaining proceeds after the payment of Federal and State
taxes applicable to the sale.
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.
IMPACT OF GOVERNMENT REGULATION
The formulation, manufacture, labeling, and advertising of our products are
subject to extensive federal, state, and local governmental regulation. From
time to time, we have received formal and informal inquiries from governmental
regulators about our business and compliance with existing laws. On occasions,
we have 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 re-labeling 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 various factors, which include varying domestic
regulations, responsiveness of government authorities, cultural differences and
political uncertainties may limit our ability to enter effectively these
markets. 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.
30
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.
Marta C. Carpenter and Daryl J. Kollman 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 Internal
Revenue Service will release them upon the payment of Ms. Carpenter and Mr.
Kollman's federal income tax liabilities for various specified years. Ms.
Carpenter and Mr. Kollman will sell their shares as needed and allowed by
federal and state securities laws to make quarterly payments to the Internal
Revenue Service. Ms. Carpenter and Mr. Kollman retain all voting rights incident
to their shares while the trust holds the shares.
The Internal Revenue Service may seize Marta C. Carpenter and Daryl J. Kollman's
shares from trust if Ms. Carpenter and Mr. Kollman 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 Ms. Carpenter and
Mr. Kollman's 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 certified public accountants, and the Supplementary
Data required by this Item 8, are included elsewhere in Item 15.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM 9A. 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 the evaluation referenced in paragraph (a) above.
31
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 C. Carpenter 58 Chief Executive Officer, President,
Chief Accounting Officer and Director
Justin Straus 33 Chief Operating Officer and Director
Victor M. Bond 52 Vice President, Marketing and Strategy
Donald P. Hateley (1)(2) 46 Chairman of the Board
Christopher J. Blaxland (1)(2) 62 Director
Donald M. Anderson (1)(2) 55 Director
- ----------
(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.
MARTA C. CARPENTER 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. Carpenter also researched, harvested and marketed algae
to consumers. Ms. Carpenter 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 a director 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 of 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. Mr. Straus is
the son of Ms. Carpenter.
VICTOR M. BOND has served as our Vice President of 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.
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.
32
DR. CHRISTOPHER J. BLAXLAND has served as a director 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. Dr. Blaxland has worked in the biopharmaceutical industry for
over 30 years and since 2002 has been one of the Principals of Hunter Partners
LLC, a consultancy advising early stage biopharmaceutical and device companies.
DR. DONALD M. ANDERSON has served as a director 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
Our Board of Directors held nine meetings in 2003, ten meetings in 2002 and four
meetings in the year 2001. We maintain a standing Audit Committee and
Compensation Committee, but do not maintain a standing nominating committee.
Donald Hateley, Chris Blaxland and Donald Anderson serve on the Audit Committee
and on the Compensation Committee. There are no family relationships among our
directors or executive officers, except that Ms. Carpenter is the mother of Mr.
Straus.
Our Audit Committee conducted six meetings during 2003, four meetings in 2002,
and no meetings in 2001. The committee reviews the scope of the independent
annual audit, the independent certified 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
three meetings in 2003 and one meeting during 2001. It did not hold any
compensation committee meetings in 2002.
AUDIT COMMITTEE FINANCIAL EXPERT
Our board of directors has determined that at least one person serving on the
audit committee is an "audit committee financial expert" as defined under Item
401(h) of Regulation S-K. Don Hateley satisfies the "audit committee financial
expert" criteria established by the SEC and is independent as defined under Item
7(d)(3)(iv) of Schedule 14A of the Exchange Act.
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 2003 except
for Daryl Kollman who has not filed his initial Form 3.
CODE OF ETHICS
We have adopted a code of business conduct and ethics within the meaning of Item
406(b) of Regulation S-K. This code of ethics applies to our directors,
executive officers and employees, including our CEO and Controller. A copy of
our code of ethics is available to the public free of charge by sending a
written request to: Corporate Controller, Cell Tech International, 565 Century
Court, Klamath Falls, Oregon 97601.
33
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth, for the year ended December 31, 2003,
compensation paid by us to (a) each person serving as our Chief Executive
Officer during 2003 and (b) each of our other most highly compensated executive
officers (the "named executive officers") during 2003 who was serving as an
executive officer on December 31, 2003.
SUMMARY COMPENSATION TABLE
LONG TERM COMPENSATION
-----------------------------------------------
ANNUAL COMPENSATION AWARDS PAYOUTS
--------------------------------------------------------------------------------------
(A) (B) (C) (D) (E) (F) (G) (H) (I)
OTHER
NAME ANNUAL RESTRICTED SECURITIES ALL OTHER
AND COMPEN- STOCK UNDERLYING LTIP COMPEN-
PRINCIPAL SATION AWARD(S) OPTIONS/ PAYOUTS SATION
POSITION YEAR SALARY ($) BONUS ($) ($) ($) SARS (#) ($) ($)
- -----------------------------------------------------------------------------------------------------------------------------------
Marta C. Carpenter 2003 290,000 0 0 0 0 0 0
CHIEF EXECUTIVE 2002 290,000 0 3,000(1) 0 0 0 0
oFFICER & PRESIDENT 2001 290,000 0 3,000(1) 0 0 0 0
Victor Bond 2003 180,000 0 0 0 0 0 0
VICE PRESIDENT OF 2002 180,000 0 0 0 0 0 0
MARKETING & STRATEGY 2001 180,000 0 0 0 0 0 0
Justin Straus 2003 114,529 0 0 0 0 0 0
CHIEF OPERATING 2002 100,000 0 0 0 0 0 0
OFFICER 2001 100,000 0 0 0 0 0 0
- ----------------
(1) Estimated dollar value of pickup truck owned by us and used by Ms.
Carpenter.
34
The following table summarizes the number of shares and the terms of stock
options we granted to the named executive officers in our 2003 fiscal year.
OPTIONS/SARS GRANTS DURING YEAR ENDED DECEMBER 31, 2003
POTENTIAL REALIZABLE
VALUE AT ASSUMED
ANNUAL RATES OF
STOCK PRICE
APPRECIATION
INDIVIDUAL GRANTS FOR OPTION TERM(4)
---------------------------------------------------- ----------------------
NUMBER OF % OF
SECURITIES TOTAL
UNDERLYING OPTIONS/
OPTIONS/ SARS EXERCISE
SARS GRANTED TO OR BASE
GRANTED EMPLOYEES PRICE EXPIRATION
NAME (#)(1)(2) IN FISCALYEAR ($/SH)(3) DATE 5% ($) 10% ($)
------------------------------------------ --------------- -------------- ----------- -------------- ------- --------
Marta C. Carpenter......................... 0 0 N/A N/A N/A N/A
Justin Straus.............................. 0 0 N/A N/A N/A N/A
Victor Bond................................ 0 0 N/A N/A N/A N/A
35
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, 2003. None of the named executive officers exercised options in 2003.
AGGREGATE YEAR END OPTION VALUES
(DECEMBER 31, 2003)
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS AT
OPTIONS AT 12/31/03 12/31/02 ($)(1)
------------------------------------- ---------------------------------
SHARES
ACQUIRED ON
EXERCISE VALUE
NAME (#) REALIZED UNEXERCISABLE EXERCISABLE UNEXERCISABLE EXERCISABLE
---- ------------ -------- ------------- ----------- ------------- -----------
Marta C. Carpenter............... 0 0 0 0 0 0
Justin Straus.................... 0 0 0 0 0 0
Victor Bond...................... 0 0 0 0 0 0
(1) Represents the difference between the aggregate market value at December
31, 2003 and 2002, as applicable, of our common stock (based on a last sale
price of $0.20 and $0.20 on each such date, respectively) and the options'
aggregrate exercise price.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Donald P. Hateley, Chairman of the Board of Directors, Chris Blaxland, a
director and Dr. Donald M. Anderson, a director, served on the Compensation
Committee in 2003 and 2002. Marta C. Carpenter, 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. None of the
compensation committee members who served during 2003 were serving as officers
of the company during that time. The only member of the compensation committee
that has previously served as an officer is Chris Blaxland. He served as an
officer previous to August 6, 1999.
INTRODUCTION TO REPORT OF COMPENSATION COMMITTEE
The Compensation Committee of the Board of Directors (the "Committee") is
composed of Messrs. Blaxland, Anderson and Hateley. The Committee is responsible
for the establishment and oversight of our executive compensation programs. The
following report of the Committee discusses generally our executive compensation
objectives and policies and their relationship to our performance in 2003.
EXECUTIVE COMPENSATION PHILOSOPHY AND OBJECTIVES
We designed our executive compensation program 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.
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
36
companies, and a selected group of direct selling companies that are
approximately the same size as us. We place more emphasis on general industry
rather 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, 2003, our compensation of
our senior executives consisted of annual base salary. We did not pay any cash
incentive awards in 2003.
ANNUAL BASE SALARY. Base salaries for executive officers are determined with
reference to a salary range for each position. We determine salary ranges by
evaluating a particular employee's position and comparing it with what were
believe 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. We will provide Long-term incentive compensation 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 that our Board of
Directors will approve. 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
Donald P. Hateley
Chris J.M. Blaxland
Donald M. Anderson
COMPENSATION OF DIRECTORS
We do not separately compensate members of our Board of Directors who are our
officers 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 common stock, in each of 2000, 2001, 2002 and
2003, 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.
37
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 180,000 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 exercise prices varying 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. The options for
4,607 shares issued to a consultant expired unexercised during 2003. Options for
4,216 shares that we granted in prior years 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.
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.
38
[COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN GRAPH APPEARS HERE]
* 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.
12/31/98 12/31/99 12/31/00 12/31/01 12/31/02 12/31/03
-------- -------- -------- -------- -------- --------
Cell Tech International Incorporated.... 100.00 202.71 33.17 51.60 33.17 29.48
NASDAQ Stock Market (U.S.) ............. 100.00 190.62 127.67 70.42 64.84 91.16
Peer Group ............................. 100.00 45.13 25.19 42.78 57.69 123.27
- ----------
39
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 February 29, 2004, 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.
PERCENT OF NUNBER
SHARES OF
BENEFICIALLY SHARES
NAME AND ADDRESS OF BENEFICIAL OWNER OWNED(1) OUTSTANDING
- ------------------------------------ -------- -----------
Marta C. Carpenter 23.3% 4,341,498(2)
565 Century Court
Klamath Falls, Oregon 97601
Daryl J. Kollman 23.3% 4,341,498(3)
5534 South Sixth Street, PMB #225
Klamath Falls, Oregon 97603
Victor Bond * 0
565 Century Court
Klamath Falls, Oregon 97601
Donald P. Hateley 1.9% 360,000(4)
1800 Century Park East
Los Angeles, California 90067
Dr. Christopher J. Blaxland * 62,764(5) 509 County Line Road
Radnor, Pennsylvania 19087
Dr. Donald M. Anderson * 62,949(6) 6 Arrowhead Lane
Marion, Massachusetts 02738
Justin Straus * 0
565 Century Court
Klamath Falls, Oregon 97601
Zubair Kazi 48.3% 8,982,174(7)
3671 Sunswept Drive
Studio City, California 91604
All executive officers and directors as a group (6 persons) 25.9% 4,827,211(8)
- -----------------------
* Less than one percent.
(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). Except
as otherwise indicated, voting and investment power relating to the
shares referenced in the table above is exercised solely by the
beneficial owner.
40
(2) The Internal Revenue Service has a security interest in all of Marta
C. Carpenter'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 payment of Ms. Carpenter and Daryl J.
Kollman's federal income tax liabilities for various specified years.
Ms. Carpenter will sell her shares as needed and allowed by federal
and state securities laws to make quarterly payments to the Internal
Revenue Service. While the trust holds the shares Ms. Carpenter
retains all voting rights incident to her shares. The Internal Revenue
Service may seize Ms. Carpenter's shares from trust if Ms. Carpenter
and Daryl J. Kollman 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 Ms. Carpenter and Mr. Kollman's tax liabilities as allowed by
applicable law.
(3) The Internal Revenue Service has a security interest in all of Daryl
J. Kollman's shares pursuant to a Notice of Determination dated June
18, 1999 under the terms of which the trust holds the shares and, upon
Marta C. Carpenter and Mr. Kollman's payment of their federal income
tax liabilities for various specified years, will be released. 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 trust holds the shares. The Internal Revenue Service
may seize Mr. Kollman's shares from trust if Ms. Carpenter and Mr.
Kollman 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 Ms.
Carpenter and Mr. Kollman's 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 60,000 shares
Mr. Hateley has the right to acquire pursuant to options exercisable
within 60 days of February 24, 2004.
(5) Represents 62,764 shares Dr. Blaxland has the right to acquire
pursuant to options exercisable within 60 days of February 24, 2004.
(6) Includes 60,000 shares Mr. Anderson has the right to acquire pursuant
to options exercisable within 60 days of February 24, 2004.
(7) Includes 4,491,087 shares already issued to Kazi and and 4,491,087
issuable to Mr. Kazi upon the exercise of his warrants.
(8) Includes 360,000 shares issuable upon the exercise of warrants and
62,764 shares issuable upon the exercise of options within 60 days of
February 24, 2004. See footnotes 4 through 6 above.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
We lease approximately 100,000 square feet of office, processing, freezer and
storage space directly from Marta C. Carpenter and Daryl Kollman, two of our
principal shareholders. 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 we lease from Ms. Carpenter and Mr. Kollman and the rent
we pay to them is at or below fair market values. Rental expense accrued for
rent to Ms. Carpenter and Mr. Kollman in 2003 was $627,280. We owe Ms. Carpenter
and Mr. Kollman $746,747 in accrued rental payments reflected on our balance
sheet as a related party payable as of December 31, 2003.
In 2003, we also received $68,617 in management fees and other income from
Klamath Cold Storage, Inc., a corporation owned jointly by Ms. Carpenter and Mr.
Kollman.
41
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The following table sets forth fees for services BDO Seidman, LLP provided
during fiscal years 2003 and 2002:
2003 2002
------------- -------------
Audit Fees(1) 121,458 141,920
Audit-related fees(2) - -
Tax fees(3) - -
All other fees(4) - -
------------- -------------
Total $ 121,458 $ 141,920
============= =============
- ----------------
(1) Represents fees for professional services provided in connection with the
audit of our annual financial statements and review of our quarterly
financial statements.
(2) During 2003 and 2002, we did not incur fees for assurance services related
to the audit of our financial statements and for services in connection
with audits of our benefit plans, which services would be reported in this
category.
(3) Represents fees for services and advice provided in connection with
preparation of our federal and state tax returns. (4) During 2003 and 2002,
we did not incur any other fees related to other services provided.
Our Audit Committee has determined that the provision of non-audit services by
BDO Seidman, LLP is compatible with maintaining BDO Seidman, LLP's independence,
and none of such services were pre-approved pursuant to the DE MINIMIS exception
provided in Section 10A(i)(1)(B) of the Securities Exchange Act of 1934.
Generally, the Audit Committee approves in advance audit and non-audit services
to be provided by BDO Seidman, LLP. In other cases, in accordance with Rule
2-01(c)(7) of Securities and Exchange Commission Regulation S-X, the Audit
Committee has delegated pre-approval authority to the Chairman of the Audit
Committee for matters which arise or otherwise require approval between
regularly scheduled meetings of the Audit Committee, provided that the Chairman
report such approvals to the Audit Committee at the next regularly scheduled
meeting of the Audit Committee.
PART IV
ITEM 15. 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. We have listed the Financial Statements and
Schedules 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)
42
(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)
(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)
(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)
43
(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 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)
44
(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 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 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)
45
(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)
(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*
(99) Additional Exhibits
(99.1) Internal Revenue Service Notice of Determination, dated July 18,
1999 (filed as Exhibit 99.1 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 99.2 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.
* Filed herewith.
46
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 April 13, 2004.
CELL TECH INTERNATIONAL INCORPORATED
By: /S/ MARTA C. CARPENTER
--------------------------------
Marta C. Carpenter, 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:/S/ MARTA C. CARPENTER President and Chief Executive March 30, 2004
----------------------- Officer and Director
Marta C. Killman (principal executive officer and
principal accounting officer)
By: /S/ DONALD P. HATELEY Chairman of the Board March 30, 2004
---------------------
Donald P. Hateley
By: /S/ JUSTIN STRAUS Chief Operating Officer March 30, 2004
-----------------
Justin Straus
By: /S/ CHRIS J.M. BLAXLAND Director March 30, 2004
-----------------------
Chris J.M. Blaxland
By: /S/ DONALD M. ANDERSON Director March 30, 2004
----------------------
Donald M. Anderson
47
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
Report of Independent Certified Public Accountants F-2
Consolidated Financial Statements
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-4
Consolidated Statement of Shareholders' Equity F-5
Consolidated Statements of Cash Flows F-6
Notes to Consolidated Financial Statements F-7
F-1
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, 2003 and 2002,
and the related consolidated statements of operations, shareholders' equity and
cash flows for each of the three years in the period ended December 31, 2003.
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, 2003 and 2002,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2003, 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 has experienced recurring losses, has negative
working capital at December 31, 2003, is experiencing difficulty in generating
sufficient cash flows to meet its obligations and faces potential significant
adverse litigation. 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 26, 2004
F-2
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
---------------------------
2003 2002
----------- -----------
ASSETS (Note 7)
CURRENT ASSETS
Receivables (Note 3) $ 284,648 $ 372,011
Current portion of inventories (Note 4) 1,900,000 2,300,000
Prepaid expenses 565,450 586,662
----------- -----------
Total current assets 2,750,098 3,258,673
INVENTORIES, net of current portion (Note 4) 2,816,471 3,824,298
PROPERTY AND EQUIPMENT, net of accumulated depreciation (Note 5) 2,460,237 6,801,389
IDLE PROPERTY AND EQUIPMENT HELD FOR SALE, net (Note 5) 916,355 1,382,570
OTHER ASSETS (Note 6) 240,851 546,846
----------- -----------
Total assets $ 9,184,012 $15,813,776
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Bank overdraft $ 481,496 $ 468,008
Accounts payable 685,146 594,329
Commissions payable 878,258 970,315
Sales taxes payable 67,588 69,797
Accrued payroll and related liabilities 296,506 291,140
Other accrued expenses 1,220,071 1,848,070
Current portion of long-term debt (Note 7) 2,074,229 2,872,145
Related party payable (Note 12) 746,747 427,767
----------- -----------
Total current liabilities 6,450,040 7,541,571
----------- -----------
LONG-TERM LIABILITIES
Long-term debt, net of current portion (Note 7) 507,855 1,019,920
----------- -----------
Total liabilities 6,957,895 8,561,491
----------- -----------
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,
13,974,087 shares issued and outstanding (Notes 9 and 10) 139,741 106,409
Additional paid-in capital 2,891,224 2,299,696
Retained earnings (deficit) (804,849) 4,846,180
----------- -----------
Total shareholders' equity 2,226,116 7,252,285
----------- -----------
Total liabilities and shareholders' equity $ 9,184,012 $15,813,776
=========== ===========
See accompanying notes to consolidated financial statements.
F-3
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 31,
--------------------------------------------
2003 2002 2001
------------ ------------ ------------
SALES $ 22,285,975 $ 26,193,747 $ 30,012,076
COST OF SALES 7,148,303 9,651,050 9,742,051
------------ ------------ ------------
GROSS PROFIT 15,137,672 16,542,697 20,270,025
COMMISSIONS 9,467,392 11,690,752 14,341,935
------------ ------------ ------------
GROSS PROFIT AFTER COMMISSIONS 5,670,280 4,851,945 5,928,090
SHIPPING AND HANDLING EXPENSES 1,448,853 1,515,358 1,646,625
SELLING EXPENSES 4,001,866 4,021,734 4,059,982
RESEARCH AND DEVELOPMENT 197,266 193,310 190,884
GENERAL AND ADMINISTRATIVE 3,285,760 1,764,189 2,425,561
IMPAIRMENT OF LONG-LIVED ASSETS
(NOTES 5 AND 6) 2,264,646 873,528 2,589,940
------------ ------------ ------------
OPERATING LOSS (5,528,111) (3,516,174) (4,984,902)
OTHER INCOME (NOTE 13) 274,266 283,834 591,787
INTEREST EXPENSE (397,183) (265,047) (622,235)
------------ ------------ ------------
NET LOSS $ (5,651,029) $ (3,497,38) $ (5,015,350)
============ =========== ============
BASIC AND DILUTED LOSS PER SHARE $ (0.40) $ (0.27) $ (.43)
============ =========== ============
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING USED TO CALCULATE
BASIC AND DILUTED LOSS PER SHARE 14,049,055 12,864,643 11,755,888
============ =========== ============
See accompanying notes to consolidated financial statements.
F-4
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
Common Stock Additional Retained
---------------------- Paid-In Earnings Shareholders'
Shares Amount Capital (Deficit) Equity
--------- ---------- ------------ ------------- ------------
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
---------- --------- ------------- ------------- -------------
Net loss -- -- -- (3,497,387) (3,497,387)
BALANCES, December 31, 2002 10,640,895 106,409 2,299,696 4,846,180 7,252,285
Net loss -- -- -- (5,651,029) (5,651,029)
Conversion of debt to equity 3,333,192 33,332 591,528 -- 624,860
---------- --------- ------------- ------------- -------------
BALANCES, December 31, 2003 13,974,087 $ 139,741 $ 2,299,696 $ (804,849) $ 2,226,116
========== ========= ============= ============= ============
See accompanying notes to consolidated financial statements.
F-5
CELL TECH INTERNATIONAL INCORPORATED
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31,
-------------------------------------------
2003 2002 2001
----------- ----------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(5,651,029) $(3,497,387) $ (5,015,350)
Adjustments to reconcile net loss to cash
provided by (used for) operating activities:
Depreciation and amortization 1,126,929 1,162,726 2,607,668
(Gain) loss on sale of fixed assets 806,734 (1,827) (15,175
Reserve for potentially unsaleable inventories 544,233 3,100,000 --
Impairment of fixed assets and intangibles 2,264,646 873,528 2,589,940
Changes in assets and liabilities:
Receivables 87,363 (44,928) 208,062
Inventories 863,594 80,480 1,871,221
Prepaid expenses 21,212 (125,802) 290,165
Other assets 305,995 (305,851) (70,374)
Accounts payable 90,817 (454,474) (370,606)
Commissions payable (92,057) (248,821) (649,999)
Sales tax payable (2,209) (12,546) (30,645)
Accrued payroll and payroll related liabilities 5,366 38,196 (39,883)
Other accrued expenses (3,139) 714,632 (2,188)
----------- ----------- ------------
Net cash provided by operating activities 368,455 1,277,926 1,372,836
----------- ----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment (115,084) (584,551) (253,662
Proceeds from sale of equipment 724,142 7,250 47,000
----------- ----------- ------------
Net cash provided by (used for) investing activities 609,058 (577,301) (206,662
----------- ----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Bank overdraft 13,488 (295,097) (547,446
Payments on long-term debt (1,309,981) (1,847,196) (963,357
Proceeds from debt financing -- 2,100,000 --
Net proceeds (repayments) from related party debt 318,980 (658,332) 344,629
----------- ----------- ------------
Net cash used for financing activities (977,513) (700,625) (1,166,174
----------- ----------- ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS -- -- --
CASH AND CASH EQUIVALENTS, beginning of year -- -- --
----------- ----------- ------------
CASH AND CASH EQUIVALENTS, end of year $ -- $ -- $ --
=========== =========== ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the year for Interest $ 397,183 $ 250,190 $ 602,570
NON-CASH TRANSACTIONS
Accrued liability for penalty shares was settled
during the quarter ended June 30,2003 by issuing
3,333,192 shares of common stock valued at $624,860 $ 624,860 -- --
=========== =========== ============
See accompanying notes to consolidated financial statements.
F-6
NOTE 1 -- SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Certain items reported in the prior year have been reclassified to follow the
company's current reporting practices.
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 and personal care 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."
BASIS OF CONSOLIDATION
The accompanying consolidated financial statements of the Company include the
accounts of the parent company, Cell Tech International Incorporated, and its
subsidiaries NAC and NEC. Intercompany transactions and balances have been
eliminated on consolidation.
MANAGEMENT ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities 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). Costs 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 that 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.
F-7
The Company evaluates impairment of its property and equipment on an individual
asset basis or by logical groupings of assets whenever circumstances indicate
that the carrying value may not be recoverable. Assets deemed to be impaired are
written down to their fair value using discounted future cash flows and, if
available, comparable market values. During 2003, certain assets were determined
to be impaired in value and the associated net book value was reduced
accordingly (see Note 5).
Gains on disposal of long-lived assets are recognized when earned, which is
generally at the time of closing. If a loss on disposal is expected, such losses
are recognized when the assets are reclassified as assets held for sale.
GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, the Company 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. Other intangible assets with finite lives,
consisting of trademarks with a carrying value of $57,302 at January 1, 2002,
will continue to be amortized over their estimated useful lives of 10 years. As
of the date of the adoption of the new accounting standards, there was no
remaining goodwill.
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, 2003 and 2002 approximates carrying value.
REVENUE RECOGNITION
The Company recognizes revenue from the sale of its products upon shipment, at
which time title passes. 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 $1,065,158, $1,263,622 and $1,443,692 in 2003,
2002 and 2001, 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.
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," 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. The Company pays commissions to its distributors as
compensation for sales and marketing activities and based on their personal
sales volumes and the sales of distributors they have recruited into the
Company's network. Accordingly, the Company classifies these expenses as a cost
and not 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.
F-8
INCOME TAXES
The Company accounts for income taxes using the liability method whereby the
Company recognizes 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. The Company records a valuation allowance to reduce deferred tax
assets to the amount that is more likely than not to be realized.
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).
F-9
We have adopted the disclosure only provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock Based Compensation", as
amended by Statement No. 148. If compensation expense for the stock options had
been determined using "fair value" at the grant date for awards in 2003, 2002
and 2001, consistent with the provisions of Statement of Financial Accounting
Standards No. 123, our net loss and loss per share would have been reduced to
the pro forma amounts indicated below.
Years ended December 31,
---------------------------------------------------
2003 2002 2001
-------------- ------------ -------------
NET (LOSS) AS REPORTED $ (5,651,029) $ (3,497,387) $ (5,015,350)
ADD: STOCK-BASED EMPLOYEE COMPENSATION EXPENSE INCLUDED
IN REPORTED INCOME - - -
DEDUCT: TOTAL STOCK-BASED EMPLOYEE COMPENSATION EXPENSE
DETERMINED UNDER FAIR VALUE BASED METHODS FOR ALL AWARDS 5,261 8,998 9,000
-------------- ------------ -------------
NET (LOSS) PRO FORMA $ (5,656,290) $ (3,506,385) $ (5,024,350)
-------------- ------------ -------------
LOSS PER DILUTED SHARE AS REPORTED $ (0.40) $ (0.27) $ (.43)
LOSS PER DILUTED SHARE PRO FORMA $ (0.40) $ (0.27) $ (.43)
The proforma calculations above are for informational purposes only. Future
calculations of the pro forma effects of stock options may vary significantly
due to changes in the assumptions described above as well as future grants, and
for forfeitures of stock options.
SEGMENT REPORTING
The Company operates in one segment, which is the production and sale of food
supplement and personal care products made from blue green algae. Approximately
6 percent of our sales are from International sources outside of the United
States, primarily Canada.
EARNINGS PER SHARE
The computations of the weighted-average common shares used in the computation
of basic and diluted net income (loss) per share is based on 14,049,055,
12,864,643 and 11,755,888 shares for the years ended December 31, 2003, 2002 and
2001. Potential dilutive securities were not included in the EPS calculation
since their effect would be antidilutive. In accordance with SFAS No. 128,
"Earnings Per Share," the Company has included in weighted average common shares
for the years ended December 31, 2001, 2002 and 2003, shares earned by Mr.
Zubair Kazi but not yet issued (see Note 10). Potential dilutive securities
consisted of outstanding stock options and convertible preferred stock and
common stock purchase warrants.
RESEARCH AND DEVELOPMENT
Research and development costs are expensed as incurred.
F-10
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2002, FASB issued Statement No. 146 (SFAS No. 146), "Accounting for
Costs Associated with Exit or Disposal Activities," effective for activities
that we initiate after December 31, 2002, with early application encouraged.
This Statement addresses financial accounting and reporting for costs associated
with exit or disposal activities and nullifies Emerging Issues Task Force (EITF)
Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." We adopted SFAS No. 146 in January 2003 and it did not have a
material effect on our financial position or results of operations.
In December 2002, FASB issued Statement No. 148 (SFAS No. 148), "Accounting for
Stock-Based Compensation -- Transition and Disclosure -- An Amendment of FASB
Statement No. 123." SFAS No. 148 amends SFAS No. 123, "Accounting for
Stock-Based Compensation," to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, SFAS No. 148 amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results. We
are required to follow the prescribed format and provide the additional
disclosures required by SFAS No. 148 in our annual financial statements for the
year ended December 31, 2002 and must also provide the disclosures in our
quarterly reports containing condensed financial statements for interim periods
beginning with the quarterly period ended March 31, 2003. The adoption of SFAS
No. 148 did not have a material effect on our financial position or results of
operations.
In November 2002, the FASB issued Interpretation No. 45 ("FIN No. 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN No. 45 expands on the
accounting guidance of Statements No. 5, 57, and 107 and incorporates without
change the provisions of FASB Interpretation No. 34, which is being superseded.
FIN No. 45 will affect leasing transactions involving residual guarantees,
vendor and manufacturer guarantees, and tax and environmental indemnities. All
such guarantees will need to be disclosed in the notes to the financial
statements starting with the period ending after December 15, 2002. For
guarantees issued after December 31, 2002, the fair value of the obligation must
be reported on the balance sheet. Existing guarantees will be grandfathered and
will not be recognized on the balance sheet. The Company has determined that
there has been no impact due to the application of FIN No. 45 on our financial
position and results of operations.
In May 2003, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 150, ACCOUNTING FOR CERTAIN INSTRUMENTS
WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY ("FAS 150"), which
establishes standards for classifying and measuring certain financial
instruments with characteristics of both liabilities and equity. FAS 150
requires an issuer to classify a financial instrument that is within its scope,
which may have previously been reported as equity, as a liability (or an asset
in some circumstances). This statement is effective at the beginning of the
first interim period beginning after June 15, 2003 for public companies. We
adopted this Statement as of July 1, 2003 and it had no material impact on our
financial statements.
In April 2003, the FASB issued SFAS No. 149, "AMENDMENT OF STATEMENT 133 ON
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES" ("FAS No. 149"). FAS No. 149
amends and clarifies the accounting guidance on derivative instruments
(including certain derivative instruments embedded in other contracts) and
hedging activities that fall within the scope of FAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." FAS No. 149 also amends certain
other existing pronouncements, which will result in more consistent reporting of
contracts that are derivatives in their entirety or that contain embedded
derivatives that warrant separate accounting. This Statement is effective for
contracts entered into or modified after June 30, 2003, with certain exceptions,
and for hedging relationships designated after June 30, 2003. We do not have any
contracts that are derivatives or that contain embedded derivatives.
F-11
In January 2003, the FASB issued FASB Interpretation No. 46, CONSOLIDATION OF
VARIABLE INTEREST ENTITIES, an interpretation of Accounting Research Bulletins
("ARB") No. 51, CONSOLIDATED FINANCIAL STATEMENTS ("FIN 46"). FIN 46 clarifies
the application of ARB No. 51 to certain entities in which equity investors do
not have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. We do not believe
the adoption of FIN 46 will have a material impact on our financial position and
results of operations.
NOTE 2--GOING CONCERN
During 2002, the Company was able to obtain new financing that allowed it to
repay the borrowings under the former line of credit. As of December 31, 2003,
the Company is 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 2003 and prior years. Although management believes that progress was
made during 2003 on issues affecting the Company's ability to continue as a
going concern, the Company has experienced recurring net losses, has negative
working capital at December 31, 2003 and faces potential significantly adverse
litigation (Note 10). These conditions give rise to substantial doubt about the
Company's 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 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 obtain or
service additional financing, or that if such financing were 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 at the
time of shipment, the Company does not record trade accounts receivable.
Receivables consist of the following:
December 31,
-------------------------------
2003 2002
---------- ----------
Credit card deposits in transit $ 136,154 $ 303,746
Miscellaneous receivables 148,494 68,265
---------- ----------
$ 284,648 $ 372,011
=========== ==========
F-12
NOTE 4 -- INVENTORIES
Inventories consist of the following: December 31,
--------------------------------------
2003 2002
-------------- ---------------
Work in progress $ 6,857,108 $ 9,520,527
Finished goods 418,999 588,586
Sales aids 5,904 15,185
-------------- ---------------
7,282,011 10,124,298
Less reserve for potentially unsaleable inventories (Note 12) (2,565,540) (4,000,000)
-------------- ---------------
4,716,471 6,124,298
Less current portion (1,900,000) (2,300,000)
$ 2,816,471 $ 3,824,298
-------------- ---------------
Certain of the Company's 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. The Company has
established reserves of $2,565,540 and $4,000,000 at December 31, 2003 and 2002,
respectively. During 2003, additional inventory of $544,233 was recognized as
impaired and the reserve was increased accordingly and $1,978,693 of inventory
that had been previously reserved for was destroyed in order to reduce costs
associated with maintaining frozen inventory.
Inventories that are in excess of the following year's estimated sales have been
classified as long-term inventories.
NOTE 5 -- PROPERTY AND EQUIPMENT
Property and equipment consist of the following: December 31,
--------------------------------------
2003 2002
-------------- ---------------
Land and improvements $ 17,817 $ 17,817
Buildings and improvements 1,709,931 6,254,180
Furniture and fixtures 692,743 741,754
Machinery and equipment 6,627,226 8,894,246
-------------- ---------------
9,047,717 15,907,997
Less accumulated depreciation (6,587,480) (9,106,608)
-------------- ---------------
$ 2,460,237 $ 6,801,389
================ ================
Depreciation expense aggregated $1,121,217, $1,111,629 and $2,386,418, for 2003,
2002 and 2001, respectively.
During the fourth quarter of 2003 it was determined that two buildings that were
being leased from shareholders were not required for continuing operations and
accordingly it was determined to terminate those leases. Both leases are on
month-to-month terms. Due to the shorter life of the leases than originally
expected, it is anticipated that the associated leasehold improvements of
$640,000 will be written off during a seven-month period beginning in December
of 2003. Accordingly there was an approximate $100,000 increase in depreciation
expense or a loss of $0.01 per share during 2003 and it is anticipated that
there will be an additional $540,000 of depreciation expense or a loss of $0.04
per share in 2004 due to these lease terminations. There are no other costs,
continuing or otherwise, associated with these lease terminations.
Idle property and equipment consists of buildings, machinery and equipment with
a carrying value of $916,355 and $1,382,570, a cost of $5,077,923 and
$9,981,028, and accumulated depreciation and valuation reserve of $4,161,568 and
$8,598,458 at December 31, 2003 and 2002, respectively. The Company is actively
attempting to sell these
F-13
assets and as a result, the assets have been written down to their fair value
and no depreciation has been recorded on these assets since the date they were
identified as being held for sale.
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 directly from Klamath Lake that increased
our likelihood of being able to harvest on a low water year in comparison to our
previous harvest method at the A Canal site. As a result, during 2001, 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 had an auction in September
2003 at which most of the remaining idle equipment was sold. For the equipment
that remained after the auction sale, we recognized $64,646 in impairment loss
to reduce its book value to appraised auction value. Due to the nature of
auction sales, we anticipated the potential decrease in value by writing off an
additional $528,632 in equipment values during the second quarter of 2003. The
impairment charge recorded in the second quarter was reclassified to loss on
sale of assets prior to year end to more accurately reflect the equipment sold
at auction during the year. After the equipment auction we determined that a
building that had been used for harvest processing would no longer be utilized
to the extent previously determined. We have determined that the asset is
impaired and, accordingly, we have recorded an impairment charge of $2.2 million
in the third quarter 2003 and have written the asset down to its estimated fair
value. The fair market value was determined based on estimated replacement
construction costs and per square foot market values of similar properties being
advertised for sale in the surrounding area. We continue to 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. We also regularly review property and equipment used in our operations
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.
The financial statements for the years ended December 31, 2003, 2002, and 2001
include adjustments due to the impairment of fixed assets of $2,264,646,
$873,529, and $2,589,940 respectively.
NOTE 6 -- OTHER ASSETS
Other assets consist of the following: December 31,
----------------------------------
2003 2002
----------- ------------
Trademarks, net of accumulated amortization of $44,690 and $38,978 $ 53,477 $ 57,196
Deposits 46,927 55,441
Restricted cash 62,031 198,963
Loan Fees 78,416 235,246
----------- ------------
$ 40,851 $ 546,846
=========== ============
Amortization expense aggregated $5,712, $51,097 and $221,250 for 2003, 2002 and
2001, respectively.
F-14
NOTE 7 -- LONG-TERM DEBT
Long-term debt consists of the following:
December 31,
--------------------------------
2003 2002
----------- -----------
Term loan secured by substantially all of the assets of the Company,
effective rate of interest is 14%. Payment is due in full in June 2004 $ 1,562,164 $ 2,100,000
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
Note payable to vendor issued in exchange for cancellation of accounts payable
to vendor. Note requires 37 monthly payments of $50,000 that began on October
11, 2002 and a final payment of
$35,917 due on November 1, 2005, with an implied discount rate of 11.13% 1,019,920 1,478,275
----------- -----------
2,582,084 3,892,065
Less current portion (2,074,229) (2,872,145)
----------- -----------
$ 507,855 $ 1,019,920
=========== ===========
In June 1999, the Company entered into a $15 million Line of Credit Agreement
with a financial institution. The agreement had four parts: Receivable Loans,
Advances and Inventory Loans, Term Loans, and Equipment Acquisition Loans. The
Receivable Loans and the Advances and Inventory Loans incurred interest at a
rate equal to the prime rate plus 2.5% per annum and expired June 30, 2002. The
Term Loans and Equipment Acquisition Loans incurred interest at a rate equal to
the prime rate plus 2.75% and were repayable in monthly installments.
In September 2002, the Company's financing facility with the financial
institution was purchased by and assigned to La Jolla Loans, Inc ("La Jolla
Loans"). In connection with this transaction, the financial institution's
security interest in real and personal property and all associated security and
loan documents were assigned to La Jolla Loans. At the same time, the Company
entered into a Forbearance and Extension Agreement with La Jolla Loans. Under
the terms of the forbearance agreement, La Jolla Loans would not declare a
default until June 30, 2003, when the entire principal would be due. The
forbearance period was extended to June 30, 2004 by the Company's payment of a
$75,000 renewal fee in June 2003. Interest of $18,225 at an effective rate of
14% is payable monthly along with additional monthly impound payments of
approximately $19,000 to be used to pay insurance, property taxes and lease
payments on collateralized property during the forbearance period. La Jolla
Loans has also agreed to defer, during the forbearance period, 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. If the Company fully performs under the terms and conditions of the
forbearance agreement and no default occurs during the forbearance period, La
Jolla Loans will release the Company from any obligation to pay minimum monthly
interest payments in excess of $24,500. The outstanding principal balance at
December 31, 2003 is $1,562,164. The Company is in compliance with all loan
covenants as of December 31, 2003.
La Jolla Loan has agreed in principle to further extend the loan at June 30,
2004 upon payment of approximately $100,000 in fees and associated expenses.
The Company has classified all outstanding debt to the lender as a current
liability.
F-15
NOTE 8 -- INCOME TAX
The Company is subject to Federal income taxes subsequent to June 20, 1999. As
the Company has experienced operating losses for the years 2003, 2002 and 2001,
no income tax expense has been provided.
At December 31, 2003, the Company had state and federal net operating loss
carryforwards available to offset future taxable income of approximately $ 21.4
million that expire at various dates through 2023.
The primary components of temporary differences that compose the Company's net
deferred tax assets and liabilities as of December 31, 2003 and 2002 are as
follows:
December 31,
---------------------------------
2003 2002
------------ ------------
Deferred tax assets (liability):
Inventory adjustments $ 984,000 $ 1,600,000
Accrued expenses 633,000 806,000
Other 31,000 18,000
------------ ------------
Current deferred tax assets, net 1,648,000 2,424,000
------------ ------------
Net operating losses and credits 8,234,000 4,150,000
Property, equipment and intangible assets 1,768,000 695,000
------------ ------------
Non-current deferred tax assets, net 10,002,000 4,845,000
------------ ------------
Net deferred tax assets 11,650,000 7,269,000
Less: valuation allowance (11,650,000) (7,269,000)
------------ ------------
$ -- $ --
=========== ==============
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, 2003 and 2002,
the Company recorded a valuation allowance as a result of the uncertainty
relating to the realizability of the net deferred tax asset. In addition to
utilization of net operating losses being limited by future income, the net
operating loss carry forward utilization could be significantly impaired by a
change in ownership under IRC section 382, which may occur due to issuance of
shares to or conversions of warrants by Mr. Kazi as noted in Notes 9 and 10, or
if there is any change in ownership pursuant to the discussion at "lien on
company stock" in Note 10. The net operating loss benefit is fully reserved via
the deferred tax asset valuation allowance above.
F-16
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
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 that amounted to $134,375, to Pacific Basin Capital for
their services. Warrant activity during the years ended December 31, 2003, 2002
and 2001 is summarized as follows:
Shares Price
---------------- ------------------
Outstanding at December 31, 2000 2,268,324 $ 0.075 - 84.65
Granted - -
Expired - -
Exercised - -
---------------- -----------------
Outstanding at December 31, 2001 2,268,324 0.075 - 84.65
Granted - -
Expired (128,926) -
Exercised - -
---------------- -----------------
Outstanding at December 31, 2002 2,139,398 0.075 - 84.65
Granted - -
Expired (39,623) -
Exercised - -
---------------- -----------------
Outstanding at December 31, 2003 2,099,775 $ 0.075 - 84.65
================ =================
The above warrants have a weighted average remaining years at December 31, 2003.
F-17
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, 2000 25,802 $ 3.05 - 142.49
Granted - -
Expired - -
Exercised - -
--------------- -------------------
Outstanding, December 31, 2001 25,802 3.05 - 142.49
Granted - -
Expired - -
Exercised - -
--------------- -------------------
Outstanding, December 31, 2002 25,802 3.05 - 142.49
Granted - -
Expired - -
Exercised - -
--------------- -------------------
Outstanding, December 31, 2003 25,802 $ 3.05 - 142.49
=============== ==================-
The above options have a weighted average remaining contractual life of 1.5
years as of December 31, 2003.
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 that expired during 2003. The options for 4,607 shares
issued to a consultant expired unexercised during 2003. These outstanding
options at December 31, 2003 have a weighted average remaining contractual life
of 2.6 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 granted or awarded as restricted stock under the 2000 Plan is 700,000 shares
in aggregate of common stock of the Company. 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.
F-18
During December 2003, 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.
Shares Price
--------------- ---------------
Outstanding, December 31, 2000 45,000 $ .20
Granted 45,000 -
Expired - -
Exercised - -
--------------- -------------
Outstanding, December 31, 2001 90,000 .20
Granted 45,000 -
Expired - -
Exercised - -
--------------- -------------
Outstanding, December 31, 2002 135,000 .20
Granted 45,000 -
Expired - -
Exercised - -
--------------- -------------
Outstanding, December 31, 2003 180,000 $ .20
============== =============
The above options have a weighted average remaining contractual life of 8.6
years as of December 31, 2003.
NOTE 10 -- COMMITMENTS AND CONTINGENCIES
MICROCYSTIS
As a result of certain conditions, Microcystis, a toxic algae occasionally
blooms in Klamath Lake at the same time blue-green algae is harvested. The
Company regularly tests the algae it harvests for possible contamination. Algae
that does not meet the Company's 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 blue-green algae. The Oregon Department of
Agriculture has raised no questions about the Company's products under this
rule.
In some years, the presence of Microcystis may reduce the quantity of algae that
the Company can harvest.
LITIGATION
On February 6, 1998, Oregon Freeze Dry, Inc., a vendor, filed a complaint
against us alleging that we wrongfully terminated a contract with it. On
December 20, 2002, the parties signed a settlement agreement and they dismissed
the lawsuit. The parties agreed that we will pay $1,885,917 to it. Payments are
to be $50,000 per month. No interest will accrue to this note as long as we are
timely in the note payments. $1,019,920 is included in notes payable at December
31, 2003. As of December 31, 2003, we are current on the payment obligations to
them. Additionally, we are obligated to use them for all of our freeze-drying
needs. If we chooses to use a bulk drying method other than freeze-drying, then
we will pay a fee of 25 cents per pound to them for a period of up to 10 years,
but not to exceed $2,500,000 for algae dried using such alternative method.
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
F-19
formula, and failing to refund our money. We were seeking monetary damages of
approximately $226,345 for all causes specified in our complaint. The matter was
settled in February 2004 resulting in the defendant agreeing to pay $80,000 to
us for damages.
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, which judgment was entered in April 2003. 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 confidential settlement provides for making partial refunds
to certain of our California customers. The Superior Court approved the
confidential settlement and vacated the judgment on August 25, 2003. 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 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 personal property from the real 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 or about May 31, 2002, Daryl Kollman filed an action in the Circuit Court of
Klamath County (Case No. 02-01956CV) seeking to evict us from certain real
property owned by him and Marta Carpenter. Mr. Kollman later added a claim for
allegedly unpaid rent exceeding $558,000. On or about October 31, 2002, the
Court dismissed Mr. Kollman's eviction claim. Mr. Kollman's claim for unpaid
rent is currently pending. 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 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 (Case No. 02-02040CV) 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, certain of our officers, directors and counsel in the
Circuit Court for the State of Oregon for Klamath County (Case No. 02-03774CV).
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 no less than $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. We intend to vigorously defend the
direct claims asserted in this lawsuit, and we have
F-20
filed a motion to disqualify Mr. Kollman as a proper plaintiff for the
derivative claims, which motion is currently pending. 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.
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
was dismissed in January 2003. The net effect of this was an increase to net
income during 2003 of $161,956.
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.
LIEN ON COMPANY STOCK
The Company stock owned by majority shareholders Daryl J. Kollman and Marta C.
Carpenter 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 Term Loan (Note
7).
DISPUTE BETWEEN PRINCIPAL SHAREHOLDERS
Daryl Kollman and Marta C. Carpenter, shareholders who together own
approximately 62% of our outstanding shares of common stock, divorced during
2002. Daryl Kollman and Marta Carpenter jointly are lessors of a substantial
portion 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 Court ruled
Daryl Kollman and Marta Carpenter's joint ownership in these real property
assets 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. The disposition of these properties pursuant to the divorce could have
an adverse or disruptive effect on our operations, if the party who purchases 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 Carpenter, to spend a portion of her time devoted to handling
matters related to the divorce decree. 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
Carpenter 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 Carpenter 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, must first raise his objections 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 Carpenter 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. Any remaining proceeds from the sale of real
estate 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-21
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 has not maintained
shareholders' equity of $20,000,000.
As of March 31, 2003, we had not filed a registration statement and
consequently, Mr. Kazi was entitled to an additional 3,333,192 penalty shares of
common stock and warrants. Subsequent to March 31, 2003, we issued to Mr. Kazi
3,333,192 shares of common stock and we converted the accrued liability of
$624,860 to equity. Warrants to purchase an additional 3,333,192 shares of
common stock are also due to Mr. Kazi and have not yet been issued. We have
accrued and will continue to accrue additional penalties until the shares are
registered. The accrued liability related for the issuance of these shares and
warrants is $82,537 at December 31, 2003.
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 period from October
20, 2000 to December 31, 2003.
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:
o 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.
o 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:
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-22
LEASES
The Company has noncancelable operating leases (Note 12), primarily for
facilities space, office equipment and phone systems, which expire at various
times over the next five years and thereafter. Future minimum lease payments
under operating leases are summarized as follows:
Years ending December 31, AMOUNT
- ----------------------------- -----------
2004 $ 98,978
2005 56,678
2006 14,378
2007 14,378
2008 14,378
Thereafter 201,292
-----------
$ 400,082
============
Rent expense for 2003, 2002 and 2001 aggregated $629,739, $841,712 and
$1,178,496, 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 $51,451, $47,459 and $52,614 in 2003, 2002 and 2001, respectively.
NOTE 12 -- RELATED PARTY TRANSACTIONS
The lease agreements described and summarized in Note 10 include certain
building and equipment leases in which the lessors are shareholders of the
Company. Rental payments to the shareholders for 2003, 2002 and 2001 aggregated
$624,200, $766,910 and $1,127,855, respectively.
The amount payable to a related party at December 31, 2003 and 2002 is due to
shareholders Marta C. Carpenter and Daryl J. Kollman and relates to unpaid rent
on properties owned by them.
The Company also received management fees and other income of $68,617, $192,762,
and $196,218 from Marta C. Carpenter, Daryl J. Kollman and Klamath Cold Storage
during 2003, 2002, and 2001 respectively, which is included in other income in
the consolidated statement of operations.
The Company paid consulting fees to a non-employee director of $35,035, $31,873
and $32,500 during 2003, 2002 and 2001, respectively.
F-23
NOTE 13 -- OTHER INCOME
Other income insists of the following:
Years ended December 31,
------------------------------------------------------
2003 2002 2001
------------- ------------- -------------
August celebration sales $ 17,451 $ 18,024 $ 16,058
Genealogy fee income 60,572 74,811 102,924
Interest income 6,325 32,831 37,981
Miscellaneous income (expense) 260,338 208,526 313,846
Management fee income from a related party 68,617 192,762 196,217
Stock penalties (139,037) (243,120) (75,239)
------------- ------------- -------------
$ 274,266 $ 283,834 $ 591,787
============= ============== ============
NOTE 14 -- CONCENTRATION OF CUSTOMERS AND SUPPLIERS
No customers accounted for more than 10% of sales during the years ended
December 31, 2003, 2002 and 2001. One vendor supplied approximately 42%, 45% and
55% of the products that the Company purchased for the years then ended.
F-24
NOTE 15 -- QUARTERLY RESULTS (UNAUDITED)
Quarterly results for the years ended December 31, 2003 and 2002 are reflected
below:
FIRST SECOND THIRD(A) FOURTH(B) TOTAL
- ----------------------------------------------------------------------------------------------------------
2003
Revenue $ 5,932,992 $ 5,667,933 $ 5,451,089 $ 5,233,961 $ 22,285,975
Operating income/(loss) $ (447,045) $ (1,099,089) $ (2,782,070) $ (993,408) $ (5,321,612)
Net income/(loss) $ (499,051 $ (1,243,482) $ (2,917,517) $ (990,979) $ (5,651,029)
Net income/(loss) per share
- basic and
diluted $ (0.03) $ (0.09) $ (0.21) $ (0.07) $ (0.40)
2002
Revenue $ 7,105,704 $ 6,755,115 $ 6,450,650 $ 5,882,277 $ 26,193,747
Operating loss $ 141,410 $ 2,867 $ (2,960,149) $ (702,129) $ (3,518, 001)
Net loss $ 109,073 $ 52,487 $ (2,971,264) $ (687,683) $ (3,497,387)
Net loss per share - basic and diluted $ 0.01 $ 0.01 $ (0.23) $ (0.05) $ (0.27)
(a) Includes third quarter adjustments.
During the third quarter of 2002, we recorded an adjustment to decrease our net
income by $3,100,000. The adjustment was to record an additional provision for
unsaleable inventories.
During the third quarter of 2003, we recorded an adjustment to decrease net
income by $2,200,000. The adjustment was to record the impaired fair market
value of our old harvest building. (b) Includes fourth quarter adjustments.
During the fourth quarter of 2002, we recorded an adjustment that increased its
net loss by $873,529. The adjustment was a charge to Write-down expense for the
impairment of certain Property, Plant & Equipment.
During the fourth quarter of 2003, we recorded an adjustment to decrease net
income by $544,233. The adjustment was to record additional provision for
unsaleable inventories.
F-25