EXCERPTS FROM THE SEC FILING BY CELL TECH;
Links:
SEC filing: CELL TECH INTERNATIONAL INC - EFLI Annual Report (10-K) ITEM 1. BUSINESS
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Cell Tech website: http://www.celltech.com/ Cell Tech Sued for False Advertising The suit below, filed in October 2001, charged Cell Tech International with falsely advertising its algae products. In February 2003, the judge agreed that ..... www.mlmwatch.org/04C/CT/suit.html




TEM 1. BUSINESSOVERVIEW We are a natural and nutritional products company and we develop and distribute a wide range of products made with Aphanizomenon flos-aquae (trade name Super Blue Green(R)) Algae ("SBGA") and other nutrients and ingredients through a network of independent distributors ("Distributors"). We currently offer twenty-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. We harvest SBGA and manufacture several of our products at our modern production facilities in Klamath Falls, Oregon. We market our products through independent Distributors located in all fifty states, the District of Columbia, Guam, Puerto Rico, American Samoa, the Virgin Islands, Federated States of Micronesia, Marshall Islands, Northern Mariana Islands, Palau and Canada. We encourage our Distributors to recruit interested people as new Distributors for our products. We place these recruits beneath the recruiting Distributor in the "network" and we refer to them as the distributor's "downline" or "network." Distributors earn commissions on sales by their organizations as well as retail profits on the sales they generate directly. We assist Distributors in establishing their own businesses and provide support programs such as a comprehensive, information-packed website (www.celltech.com), audio and videotapes for training, empowerment teams, 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/A (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. 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/A and is not incorporated herein. 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 The Natural Foods Merchandiser reports that the natural foods and nutrition industry topped $64 billion in 2002. The Nutrition Business Journal has predicted that the nutritional products industry will continue to grow at 4% to 6% annually through 2004. The Natural Foods Merchandiser has also reported that overall sales of natural foods and nutritional products grew approximately 7% in 2002. Most of this growth was in the functional foods sector (including nutrition bars and drinks) and the sports nutrition sector. The growth of traditional supplements, including herbals, continued to decline in 2002. The primary distribution channels in the nutritional supplements industry consist of mass-market retailers (including mass merchandisers, drug stores, supermarkets, discount and convenience stores), health and natural food stores, direct sales and mail order organizations, practitioners and the Internet. Natural foods retail is the largest of these channels, accounting for almost 50% of total sales, according to The Natural Foods Merchandiser. The Mass-market retail channel includes food stores, drugstores and mass merchandisers. Direct selling accounted for about 15% of sales during 2002. The Nutrition Business Journal also reported that the potential for natural and healthier products to penetrate mainstream product categories looks promising--and is still largely untapped. Dietary supplements sales of $16.7 billion are less than 10% of over-the-counter medicine and prescription drug sales. Natural and organic food sales of $11.8 billion represent barely 2% of the U.S. food industry (only 1.5% when food service is included). Functional foods sales at $17.2 billion, even when broadly defined as manufactured foods with any ingredient added specifically for health purposes, still account for only 3.5% of the U.S. food industry. Natural personal care products, even more loosely and broadly defined than natural food, had sales of $3.6 billion in 2000 and are just 10% of total health & beauty care spending. The $50 billion nutrition industry accounted for just 7% of the $680 billion food, medicine, health and personal care products market in the United States in 2000. Due to the greater fragmentation that exists in the international nutritional supplement market compared to the domestic market, industry data is not readily available. However, many of the demographic and other trends and events present in the domestic market are also present in the international market. GROWTH STRATEGY 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 supplement 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. Our growth strategy is to capitalize on the increased interest in nutritional supplements described above by increasing product sales through existing distribution channels in the U.S. and Canada and 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 expand our existing product lines to complement our current products. We have introduced five new products; the BG Bar, NaturaLight(TM) (for healthy weight management), ImmuSun(TM) (for immune system support), Contain(TM) (for the relief of occasional heartburn) and OsteoSun(TM) (for healthy bone support) and we are actively working on introducing additional products. o We intend to introduce alternative distribution channels through infomercials. Our ability to establish distribution through infomercials will be dependent upon our ability to increase our working capital in order to pay for the costs associated with infomercials. Our product distribution strategy is to provide complementary marketing methods for our Distributors (as defined below). o We have introduced a revised compensation plan and other promotion and recognition programs to provide additional incentives to our Distributors. Our ability to increase sales is significantly dependent on our ability to attract, motivate and retain Distributors. We utilize an innovative marketing program that we believe is competitive with programs offered by many other network marketing companies. This program provides financial incentives, including several forms of commission (bonus), optional Distributor training and support, no sign-up costs, inventory requirements, and low monthly purchase requirements. We intend to reach potential new Distributors through increased advertising, teleconferencing and regional sales and training meetings. Successful management of Distributors supports the marketing of products as well as the recruitment of new Distributors. o We intend to tackle international markets by entering into marketing distribution agreements for Europe and Asia. We believe that growth potential exists in international markets and will seek to enter into international distribution agreements. o We intend to engage government relations personnel to assist our international expansion. We will engage government relations personnel throughout the world who will take a systematic, proactive approach to working with government and licensing 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 Distributors 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 and nutrition. In developing our product line, we have emphasized quality, purity, potency, and safety. We offer a line of approximately twenty-two products that we divide into five categories, including Daily Health Maintenance, Digestive Health, Defensive Health, Powdered Drinks and Snacks, and Animal and Plant Food, as further described below the chart. The following chart lists our products and the categories targeted by each, as of March 31, 2003 <TABLE> <CAPTION> <S> <C> <C> <C> <C> <C> Daily Health Digestive Defensive Powered Drinks Animal and Maintenance Health Health and Snacks Plant Food -------------- ----------- ----------- ----------------- ------------ Super Blue Green(R)Alpha Sun(R) x X Super Blue Green(R)Omega Sun(R) x X Acidolphilus x Bifudus x Spectrabiotic(R) x Internal Cleansing System x Super Blue Green(R)Enzyme x SBG Anytime X X X Super Q10 X x x Super Sprouts & Algae X x X Alpha Gold Promoting Physical Well-being X x Omega Gold Enhancing Mental Well-being X x Super Sun Smoothies x Mazama Mix X Cell Tech Essentials X X X Super Blue Green(R)Animal Food X NaturaLight(TM) X X OsteoSun(TM) X ImmuSun(TM) X Contain(TM) X BG Bar X X X X PLANeT Food(R) X </TABLE> DAILY HEALTH MAINTENANCE o SUPER BLUE GREEN(R) ALPHA SUN(R). Super Blue Green(R)Alpha Sun(R) is whole, complete algae. Because its cell walls contain a high percentage of floridan starch, it provides natural sugars critical to the health and vitality of tissues and cells. Super Blue Green(R) Alpha Sun(R) also contains high concentrations of easily assimilated vital minerals. It is available in capsules and tablets. o SUPER BLUE GREEN(R) OMEGA SUN(R). Super Blue Green(R) Omega Sun(R) is the heart of the algae with the cell wall carefully removed through a special separation process. This super-concentrated food contains a higher overall amino acid content than Super Blue Green(R) Alpha Sun(R). It is a source of raw materials for building the neuro-peptides associated with brain activity. It is available in capsules and tablets. o CELL TECH ESSENTIALS. Cell Tech Essentials, named for our most essential products, is a repackaging of such products. It attains a new level of convenience and effectiveness and a new level of value. Each bag contains 30 packets and each packet contains the following capsules: one Super Blue Green(R) Alpha Sun(R), one Super Blue Green(R) Omega Sun(R), one Acidophilus, one Bifidus, and two Super Blue Green(R) Enzymes. o NATURALIGHT(TM). NaturaLight(TM) is a herbal supplement designed to work with the metabolism to help users reach their weight loss goals. Formulated with enzymes, botanicals, and other complementary ingredients, this product works with user's metabolisms to help them reach their weight loss goals. We believe that consumers can use this herbal supplement exclusively, or use it in concert with any other weight loss program. We believe that, combined with proper diet and exercise, NaturaLight(TM) can help reduce cravings, increase energy, and improve mental clarity and attitude. The goal of this new product is to help the body reduce fat and lose weight while maintaining lean muscle mass. It is available in capsules. o SBGANYTIME. SBGAnytime supplies Super Blue Green(R) Algae in a convenient chewable form, providing support to body and mind any time. It's designed for people on the go, young (and not-so-young) finicky eaters, and those who have difficulty swallowing capsules and tablets. Each wafer contains a 150 mg mix of Super Blue Green(R) Alpha Sun(R) and Super Blue Green(R) Omega Sun(R) Algae, orange juice, honey, and other natural sweeteners. o BG BAR. BG Bar is a food bar made with quality organic ingredients, fortified with sprouted grains, greens, and Super Blue Green(R) Algae. It has an almond butter texture with minced almonds on top. We believe that consumers will find it attractive and a useful source of nutrition. Each bar weighs 56 grams. DIGESTIVE HEALTH o ACIDOPHILUS. Acidophilus (Lactobacillus acidophilus) is the first of our probiotic products and operates in the small intestine. Without proper cleansing, the small intestine can fill with wastes and harmful by-products that impair natural digestive functions. Our Acidophilus helps process food quickly and eliminate waste. It is a single-strain beneficial bacterium called DDS-1a Acidophilus, which helps keep harmful bacteria out by colonizing the walls of the small intestine and by secreting substances that prevent the growth of unfriendly bacteria. Each capsule is carefully micro blended with 85 milligrams of Super Blue Green(R) Omega Sun(R) Algae. o BIFIDUS. Bifidus (Bifidobacterium bifidum) is the second of our probiotic products. While Acidophilus serves the small intestine, Bifidus is for the large intestine. The large intestine absorbs the water from food and passes the remaining waste out of the body. A good intestinal flora in the large intestine can help prevent gas, bloating and diarrhea. Our Bifidus helps repopulate the large intestine with friendly bacteria, restoring the healthful environment it needs to do its job well. Each capsule is micro blended with 85 milligrams of Super Blue Green(R) Omega Sun(R) Algae. o SPECTRABIOTIC(R). Spectrabiotic(R) is designed to complement Acidophilus and Bifidus in providing a complete system for building and maintaining healthy intestinal flora. In the Spectrabiotic(R) formula, eight key "good bacteria" are micro blended with 85 milligrams of Super Blue Green(R) Omega Sun(R) Algae, providing the entire digestive tract with probiotic support, especially when combined with a regular program of Acidophilus and Bifidus. Spectrabiotic(R) also contains Jerusalem artichoke, acerola, and rose hips. o INTERNAL CLEANSING SYSTEM. The New Seasons Cleansing System is a two-product program that is designed to assist the body's natural elimination systems. The Herbal Formula supports the processes that remove toxins from the tissues of the body; then the Fiber Formula helps the body eliminate those toxins. o SUPER BLUE GREEN(R) ENZYMES. Our Super Blue Green(R) Enzymes contains a full range of food enzymes to help break down all types of foods, including fats, carbohydrates, protein and fiber. Super Blue Green(R) Enzymes is micro blended with 25 milligrams of Super Blue Green(R) Alpha Sun(R), adding specific vitamins and minerals many enzymes need for optimum functioning. o SUPER SPROUTS & ALGAE. Super Sprouts & Algae is a unique product combining the nutritional benefits of three "superfoods" from three natural environments -- land, lake and sea: a super concentration of custom-grown wheat sprouts; Super Blue Green(R) Alpha Sun(R) Algae; and Super Red Beta Algae (Dunaleilla salina), a strain of marine algae. These three superfoods together supply the body with antioxidant nutrition to neutralize the effects of highly unstable, reactive molecules known as free radicals. Two tablets of Super Sprouts & Algae provide over 100% of the RDA for vitamin A. Each tablet contains 540 milligrams of wheat sprouts, 60 milligrams of Super Blue Green(R) Alpha Sun(R) Algae and 25 milligrams of Super Red Beta Algae. o SUPER Q10. Super Q10 contains Super Blue Green(R) Alpha Sun(R) and a special enzyme enhancer called coenzyme Q10. This nutrient has been shown to be beneficial for functioning of the heart, muscles, and the nervous and immune systems. It is especially important in helping the mitochondria, or powerhouses of cells, to generate energy. Super Q10 is a synergistic combination of pure premium coenzyme Q10 with 85 milligrams of Super Blue Green(R) Alpha Sun(R) Algae and is a way to assist cells in converting nutrients into energy. DEFENSIVE HEALTH o ALPHA GOLD PROMOTING PHYSICAL WELL-BEING. Alpha Gold contains a carefully chosen group of ingredients, each with documented health benefits, that works synergistically with Super Blue Green(R) Algae to facilitate overall good health. Alpha Gold contains bee pollen to increase stamina, vitality and athletic performance; noni to help stimulate the immune system; turmeric to help protect against environmental contaminants; and gluten-free sprouted wheat grass juice, which contributes a variety of assimilative enzymes. This product is available in capsules or powder. o OMEGA GOLD ENHANCING MENTAL WELL-BEING. In addition to the ingredients found in Alpha Gold, Omega Gold also contains ginkgo biloba, which increases circulation to the brain and has effects upon memory, clarity and mental alertness. We add Siberian ginseng to stimulate both mental and physical performance. This product is available in capsules or powder. o IMMUSUN(TM). A natural part of the human diet for thousands of years, the complex carbohydrate WGP(TM) beta glucan used in ImmuSun(TM) has been shown to fortify the immune system. o CONTAIN(TM). For occasional heartburn, consumers now have a healthy choice. Contain(TM) is formulated with a superior combination of alginate (from seaweed), Super Blue Green(R) Algae, enzymes, and other soothing natural ingredients. o OSTEOSUN(TM). A new, natural, unique and scientifically proven non-calcium dietary supplement, formulated to promote bone health.1 POWDERED DRINKS AND SNACKS o SUPER SUN SMOOTHIES. Super Sun Smoothies are all-vegetable powder shake mixes. We make Super Sun Smoothies with premium ingredients that are dairy free and contain no preservatives, yeast artificial flavorings or colorings. They also provide the "superfood" benefits of 500 milligrams of Super Blue Green(R) Alpha Sun(R) and 500 milligrams of Super Blue Green(R) Omega Sun(R) Algae blended into every scoop. o MAZAMA MIX. Mazama Mix is a nutrient-rich green drink derived from all-natural whole food sources. It contains minerals and trace minerals that we believe are essential for the proper functioning of the body. We designed this product to help enhance overall health, vitality and energy levels. _________ 1The Food and Drug Administration has not evaluated the statements we make regarding any of our products. We do not intend any of our products to diagnose, treat, cure, or prevent any disease. 6 <PAGE> ANIMAL AND PLANT FOOD o SUPER BLUE GREEN(R) ANIMAL FOOD. Super Blue Green(R) Animal Food is a blend of coarse-grade Super Blue Green(R) Alpha Sun(R) and Super Blue Green(R) Omega Sun(R) Algae, providing the fundamental building blocks for strengthening the immune system of animals. The broad spectrum of organic minerals, vitamins, amino acids, enzymes and the supply of beta carotene and chlorophyll found in Super Blue Green(R) Algae is readily absorbed by animals. Super Blue Green(R) Animal Food is sprinkled over the pets' food. o PLANeT FOOD(R). We designed PLANeT FOOD(R) to add trace minerals and other components to soils. It is a mixture of volcanic rock dust from Colorado and algae from Klamath Lake for use on potted plants, lawns, gardens, and trees and for composting. DISTRIBUTORS AND OUR NETWORK MARKETING SYSTEM We distribute our products through a network marketing system of Distributors. Distributors are independent contractors who purchase products directly from us for resale to retail consumers. Distributors may elect to work on a full-time or a part-time basis. We believe that our network marketing system is well suited to marketing our nutritional supplements and other products because ongoing personal contact between retail consumers and Distributors, most of whom use our products, strengthen sales of such products. Currently, we have Distributors in all fifty states, the District of Columbia, Guam, Puerto Rico, American Samoa, Virgin Islands and Canada. Each Distributor has the opportunity to sponsor additional Distributors, which can enhance the original Distributor's income, as described below. Each new sponsored Distributor, as well as his or her own "downline" groups, becomes a member of the Distributor's network or "downline." COMMISSION SYSTEM We currently offer two categories of membership. We call the first category a "Distributor" and the other a "Preferred Customer." Distributors are interested in receiving commissions for their own purchases as well as for purchases made by members enrolled in their "downline." A Preferred Customer is a customer who is interested in consuming our products, but is not interested in the business opportunity we offer to our Distributors. Many Preferred Customers eventually become Distributors. Both categories of membership purchase our products at wholesale prices. We compensate our Distributors through a Distributor commission system that encourages both retail selling and sales organization management. Distributors may derive income from several sources. First, Distributors may receive revenues by purchasing our products at wholesale prices and selling them to customers at retail prices. Second, Distributors earn the right to receive bonuses (commissions) based upon purchases by members of their "downline" or sales marketing organization. Each new Distributor that a Distributor sponsors becomes a member of his selling organization or "downline." We refer to the Distributors that a Distributor directly sponsors as his "first generation" or "first level." In June 2002, we revised our commission system to better suit our long-term growth objectives of attracting new Distributors and appropriately rewarding the Distributors that work to increase their business with us. Our goal was to redistribute our commission expense to those Distributors who demonstrate to us that they are actively contributing to our growth. 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 44.6% of revenue in 2002. 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." Distributors may attain "Member" status by purchasing any product from us. There are two intermediary levels between Member and Executive: Representative and Leader. A Distributor achieves higher levels in the bonus structure primarily through increased purchases by Distributors sponsored directly by them (their first level) and in their personal group. The requirements for a Distributor to reach the first "Executive" level are monthly personal purchases of at least $100 and monthly group volume of $500. For each "Executive" level attained thereafter, the Distributor must maintain monthly personal purchases of at least $100 and monthly group volume of at least $500. The program is such that each month a Distributor must qualify at that level for us to pay at that level. The advantage to this is that the Distributors must remain active in purchasing and sponsoring to retain their bonuses, but if they do not qualify in a certain month, we only reduce their income that one month. The Distributor commission system includes three kinds of bonuses, as described below: o STANDARD BONUS. The standard bonus is available to any Distributor who has an "active" status with us. Distributors may attain the title of "Assistant Leader" by purchasing a minimum 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 Distributor receives bonuses upon on the individual's title with us. The standard bonus grants rebates to the Distributor 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, Distributors 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 Distributors to earn bonuses contributes significantly to our ability to retain our productive Distributors. The Distributor commission system encourages promotion to higher commission levels by enabling Distributors to earn commissions on a deeper sales base (i.e., more levels of their organization). We believe this will encourage sponsoring growth (depth) in an organization and not just acquiring customers personally. To become a Distributor, a person must simply sign an agreement to comply with our policies and procedures. No investment is necessary to become a Distributor. We consider, as of February 28, 2003, approximately 37,000 of our Distributors to be "active," that is, an individual Distributor who has ordered at least $50 of our products during the preceding six-month period. TRAINING We support opportunity meetings in various key cities and participate in motivational and training events in various market areas, designed to inform prospective and existing Distributors about our product line and selling techniques. Distributors give presentations relating to their experiences with our products and the methods by which they have developed their own organization of Distributors. 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 Distributor organization. Prospective Distributors are educated about the structure, dynamics and benefits of our network marketing system. We continually develop marketing strategies and programs to motivate Distributors. We design these programs to increase Distributors' monthly product sales and the recruiting of new Distributors. DISTRIBUTOR SUPPORT As part of our program to maintain constant communication with our Distributor network, we offer the following support programs to our Distributors: o ASSOCIATIONS/TEAMS/ADVISORY BOARD. Several associations and teams support Distributors' efforts, including the Leadership Alliance, an association of those Distributors having reached the top levels of our Marketing Plan, which was formed in order to allow interaction among the Network's "top level" group for discussion of business issues, development of solutions and methods to improve the sales success and growth of downlines and the Network as a whole. In addition, the Field Advisory Board is an advisory team representing the entire field organization and brings issues, recommendations, and other ideas to us for discussion. The Field Advisory Board participates in bi-monthly teleconferences with our marketing and operations executives. o AUGUST CELEBRATION. For the past thirteen years, we have sponsored and held the August Celebration, which is our annual convention. o ORDERING SUPPORT. We offer a variety of methods to order product and support materials, including toll-free telephone operator access, "Order Express" (a toll-free automated telephone system that Distributors can call 24 hours a day to place orders or to access their records), and our website at http://www.celltech.com. o INFORMATION SUPPORT. Distributors may learn more about our products, our history, distributor organization building, management techniques and related matters through our website. In addition, we produce color catalogues and brochures for our Distributors and produce a monthly publication called "Networker's Edge" focused on business building. We also maintain our ATG Technologies Voice Mail System, which includes options for broadcasting messages to our Distributors via temporary, permanent and super groups. A direct access telephone line allows Distributors to access our most recent announcements sent through the ATG Technologies System to our Network. Finally, a 24-hour toll-free "Fax-on-Demand" system provides Distributors with news bulletins, product literature and articles of interest via facsimile. RESEARCH AND DEVELOPMENT We spent approximately $193,310 on research and development in 2002, $190,884 in 2001 and $456,098 in 2000. We continually seek to identify, develop and introduce innovative, effective and safe products. We have introduced sixteen new products since 1997. Management believes that our ability to introduce new products increases our Distributors' product visibility and competitiveness in the marketplace. We also continuously evaluate "existing" products for viability and it is our policy to discontinue products that are not selling satisfactorily. We derive new product ideas from a number of sources, including trade publications, scientific and health journals, management, independent consultants, and our sponsored university research projects. We maintain our own quality assurance/quality control staff, consisting of two full time employees as of March 31, 2002 and December 31, 2001, but rely upon independent research, consultants and others for ingredient research, development and formulation services. When we identify a new product concept or when we must reformulate an 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 2002, we began formulating and testing three new products, ImmuSun(TM), Contain(TM) and OsteoSun(TM), designed to compliment our existing product line and began selling them to our Distributors in June 2002, October 2002 and February 2003, respectively. IMMUSUN(TM). ImmuSun(TM), an all-natural supplement, contains the active ingredient WGP(TM) beta glucan, a patented form of the complex carbohydrate beta glucan, which is found in the cell walls of baker's yeast (Saccharomyces cerevisiae). Scientists discovered the immune-boosting properties of beta glucan in the 1960s. Since then, they have documented its potential as an immunity booster in numerous studies conducted at such prestigious research institutions as Massachusetts Institute of Technology, Harvard University, and Johns Hopkins University. These studies have proven WGP(TM) beta glucan's ability to activate macrophages, a type of white blood cell that is the body's first line of defense. Macrophages circulate throughout the body engulfing and digesting foreign antigens, thus triggering a cascading effect that mobilizes the body's arsenal of defenses. The result is a stronger immune system. CONTAIN(TM). Contain(TM)'s orange-flavored chewable tablets are made with a superior combination of alginate (from seaweed), Super Blue Green(R) Algae, enzymes, and other soothing natural ingredients that join forces to help "contain" stomach acid. Upon contact with gastric juices, the proprietary blend of plant extracts and other natural ingredients creates a temporary gel barrier that helps keep gastric contents from seeping into the esophagus. Meanwhile, the enzymes in the formulation work in the stomach to aid in the efficient breakdown of food, helping to minimize occasional indigestion at the outset. Contain(TM) differs from similar products on the market because it is formulated with enzymes to help reduce indigestion and also Contain(TM) includes Super Blue Green(R) Omega Sun(R) algae for added nutritional value. Contain(TM) acts only mildly to neutralize stomach acid--rather, it relieves symptoms of occasional heartburn naturally, by forming a protective buffer to help keep stomach acid where it belongs. Contain(TM) offers an ideal combination of beneficial ingredients that can help alleviate the stressful effects of occasional heartburn. OSTEOSUN(TM). Calcium alone is often not enough to maintain bone health. Studies have shown that OsteoSun(TM) can significantly increase bone mineral density. OsteoSun(TM)'s ingredients include a patented formulation of red yeast rice, a natural food product that - in this formulation only - the International Bone Laboratories have certified as "bone active." This is the only certified formulation of this natural product for bone health. OsteoSun(TM) also contains Super Blue Green(R) Omega Sun(R) algae, which, in addition to all its other benefits, aids the assimilation of red yeast rice and other helpful nutrients. We are currently developing additional products, including new 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 Distributor from whom they purchased it from within 90 days of their purchase. The Distributor is required to refund the purchase price to the consumer. The Distributor may then return the unused portion of the product to us for an exchange of equal value. If a Distributor requests a refund in lieu of an exchange, we will issue a check or credit the appropriate amount to the Distributor's credit card. We warrant all of our products against defect. RAW MATERIALS AND SUPPLIERS Our primary raw material is Aphanizomenon flos-aquae, which we harvest from Upper Klamath Lake using 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. In years when there has been no harvest, we rely on our inventory of frozen and freeze-dried SBGA. As of December 31, 2002, 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. We believe our harvest methods help us to minimize the amount of Microcystis aeruginosa in the harvested material, thus increasing the total amount of algae that we can release for production. 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 2002, 2001 and 2000, one vendor supplied approximately 45%, 55% and 27%, 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, 2002, we have six trademarks registered with the United States Patent and Trademark Office and one trademark application pending, and three trademarks registered and one application pending with the Canadian Intellectual Property Office of Trade Marks. In addition, we have registered trademarks in eleven foreign countries (and one application pending in a twelfth) for the mark "PLANeT Food." While we believe customer identification with our name and brand is important, we feel that our primary competitive edge arises from our Distributor network and our strategic location, which allows us to process algae immediately after its harvest, and not from any proprietary technology. We do not have a registered trademark for the name "Cell Tech." As of the date of this Annual Report on Form 10-K/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. 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 Distributors with other retail, multi-level marketing and direct selling companies in the nutritional supplements industry by emphasizing the proprietary nature, value, and the quality of our products and the convenience of our distribution system. We also compete with other direct selling organizations, many of which have longer operating histories and greater name recognition and financial resources than us. They include Amway Corporation, Nu Skin Enterprises, Inc., Body Wise International, Inc., Herbalife International, Inc., Mannatech Incorporated, Rexall Showcase International, and Forever Living Products, Inc. We compete for new Distributors 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 Distributors. Given that the pool of individuals interested in direct selling tends to be limited in each market, the potential pool of Distributors for our products is reduced to the extent other network marketing companies successfully recruit these individuals into their businesses. 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. 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 may exist and therefore have recorded our best estimate of the effect by establishing a reserve for $4,000,000 at December 31, 2002, for the possible effects of inventories, which may become unsaleable under this Rule. The Oregon Department of Agriculture has taken no regulatory actions against our products under this Rule to date. FOREIGN MARKETS In Canada, both national and provincial law regulates our network marketing system. Under Canada's Federal Competition Act, we must make sure that any representations relating to Distributor compensation made to prospective distributors constitute fair, reasonable and timely disclosure and that it meets other legal requirements of the Federal Competition Act. 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 Distributors 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 Distributors as to the scope of permissible and impermissible activities in each market. We also investigate allegations of Distributor misconduct. However, our Distributors generally are independent contractors, and we are unable to monitor directly all of their activities. Consequently, we cannot be sure that our Distributors comply with applicable regulations. Misconduct by Distributors 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. NETWORK MARKETING SYSTEM REGULATION Our Distributor commission system constitutes a network marketing system. A number of federal and state statutes and regulations apply to this system, including those administered by the FTC. The legal requirements that apply to network marketing organizations ensure 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 Distributors, investment in the organization, or non-retail sale criteria. Where required by law, we must obtain regulatory approval of our network marketing system. If such approval is not required, the favorable opinion of local counsel will suffice. Finally, in addition to these regulations, the FTC regulates trade practices related to network marketing systems. EMPLOYEES At February 28, 2003, we employed approximately 85 persons, of which 4 were part-time. These numbers do not include our Distributors, who are generally independent contractors rather than our employees. None of our employees are represented by a labor union and we have never experienced any business interruption as a result of any labor disputes. We believe that our relationship with our employees is good. INDUSTRY SEGMENTS AND EXPORT SALES We have no assets outside of the United States. Our business consists of one industry segment and 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: <TABLE> <CAPTION> <S> <C> <C> <C> (DOLLARS IN THOUSANDS) 2001 2001 2000 ---- ---- ---- United States $26,696 94.3% $28,310 94.3% $36,796 94.4% Canada $1,498 5.7% $1,702 5.7% $2,181 5.6% ------ ---- ------ ---- ------ ---- Total $26,194 100.0% $30.012 100.0% $38,977 100.0% ======= ====== ======= ====== ======= ====== </TABLE> 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 lease approximately 250,000 square feet of office, processing, freezer and storage space directly from our principal stockholders or their affiliates. Most of these leases are year-to-year, although we do rent some space on a month-to-month basis and one lease will expire in 2005. We believe that we lease the space from our shareholders and their affiliate at below or at fair market rates. We also lease an additional 21 acres from an independent third party, on which we have built our algae processing and storage facility. Our lease with the independent third party will terminate in 2020, at which time we have the option to renew for an additional 25 years. At the termination of such lease, ownership of the facility will revert to the lessor. We believe that the above-described properties will provide sufficient space to meet our currently planned future needs and that comparable space is readily available to meet any unforeseen circumstances. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. We lease approximately 250,000 square feet of office, processing, freezer and storage space directly from Marta C. Carpenter and Daryl Kollman, our principal shareholders, or their affiliate, Klamath Cold Storage, Inc. Most of these leases are year-to-year, although we do rent some space on a month-to-month basis and one lease will expires in 2005. We believe that the space we lease from Ms. Carpenter and Mr. Kollman and Klamath Cold Storage, Inc and the rent we pay to them is at below or at fair market values. Rental payments to Ms. Carpenter and Mr. Kollman or Klamath Cold Storage, Inc in 2002 were $740,097. We currently owe Ms. Carpenter and Mr. Kollman or Klamath Cold Storage, Inc $531,146 in accrued rental payments and we show it on our balance sheet as a related party payable.