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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, 2004
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ____________ to _____________
Commission File Number 0-11997
Carrington Laboratories, Inc.
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(Exact name of Registrant as specified in its charter)
Texas 75-1435663
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(State of Incorporation) (IRS Employer ID No.)
2001 Walnut Hill Lane, Irving, Texas 75038
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(Address of principal executive offices)
Registrant's telephone number, including area code: (972) 518-1300
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of exchange on which registered
------------------- ------------------------------------
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock ($.01 par value)
(Title of class)
Preferred Share Purchase Rights
(Title of class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K (S229.405 of this chapter) is not contained
herein, and will not be contained, to the best of the Registrant's
knowledge, in definitive proxy or information statements incorporated
by reference in Part III of this Form 10-K or any amendment to this Form
10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes [ ] No [ X ]
The aggregate market value of the voting and non-voting common equity
held by non-affiliates of the Registrant (treating all executive officers
and directors of the Registrant and holders of 10% or more of shares
outstanding, for this purpose, as if they may be affiliates of the
Registrant) was $42,399,538, computed by reference to the price at which
common equity was sold on June 30, 2004 of $4.45 per share.
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of the latest practicable date: 10,727,977
shares of Common Stock, par value $.01 per share, were outstanding on March
21, 2005.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's proxy statement for its annual meeting of
shareholders to be held on May 19, 2005 are incorporated by reference into
Part III hereof, to the extent indicated herein.
PART I
ITEM 1. BUSINESS.
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General
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Incorporated in Texas in 1973, Carrington Laboratories, Inc. ("Carrington"
or the "Company") is a research-based biopharmaceutical, medical device,
raw materials and nutraceutical company engaged in the development,
manufacturing and marketing of naturally-derived complex carbohydrates and
other natural product therapeutics for the treatment of major illnesses,
the dressing and management of wounds and nutritional supplements. The
Company's research and proprietary product portfolios are based primarily on
complex carbohydrates isolated from the Aloe vera L. plant. The Company is
comprised of three business segments. See Note Thirteen to the consolidated
financial statements in this Annual Report for financial information about
these business segments: the Medical Services Division, Consumer Services
Division and DelSite Biotechnologies Inc., ("DelSite"). The Company sells
prescription and nonprescription medical products through its Medical
Services Division and provides manufacturing services to customers in
medical markets. Through its Consumer Services Division, formerly referred
to as Caraloe, Inc., the Company sells consumer and bulk raw material
products and also provides product development and manufacturing services
to customers in the cosmetic and nutraceutical markets. DelSite was
incorporated in 2001 as a wholly-owned subsidiary. DelSite operates
independently from the Company's research and development program and is
responsible for the research, development and marketing of the Company's
proprietary GelSite[R] technology for controlled release and delivery of
bioactive pharmaceutical ingredients.
Medical Services Division
-------------------------
Carrington's Medical Services Division offers a comprehensive line of wound
management products. Carrington products are used in a wide range of acute
and chronic wounds, for skin conditions and incontinence care. The primary
marketing emphasis for Carrington's wound and skin care products is directed
toward hospitals, nursing homes, alternate care facilities, cancer centers,
home health care providers and managed care organizations. The wound and
skin care product lines are being promoted primarily to physicians and
specialty nurses, for example, enterostomal therapists.
In response to changing market conditions and to improve the Company's
competitive position, the Company decided during 2000 to redirect the
distribution of its Medical Services products from multiple distributors to
a single, sole-source distributor. As a result of this decision, the
Company entered into an exclusive Distributor and License Agreement
effective December 1, 2000 with Medline Industries, Inc. ("Medline"). The
agreement provides that the Company will continue to manufacture its
existing line of products and sell them to Medline at specified prices. The
prices are subject to adjustment not more than once each year to reflect
increases in manufacturing cost. The agreement requires Medline to pay the
Company a base royalty totaling $12,500,000 in quarterly installments that
began on December 1, 2000. In addition to the base royalty, if Medline
elects to market any other products under any of the Company's trademarks,
Medline must pay the Company a royalty of between one percent and five
percent of the annual sales of the trademarked products, depending on the
aggregate amount of the net sales under this agreement to Medline. The
Company and Medline amended the Distributor and License Agreement in April
2004 to extend the term of the agreement through November 30, 2008. The
amended agreement specified an advance payment of $1,250,000, which the
Company has received.
The Company maintains control of certain national pricing agreements which
cover hospitals, alternate care facilities, home health care agencies and
cancer centers. These agreements allow Medline representatives to make
presentations in member facilities throughout the country. In order to
promote continued brand-name recognition, the Company engages in limited
marketing and advertising to bolster Medline's efforts in these areas.
The Company entered into a Supply Agreement with Medline effective December
1, 2000, which among other things, provides that the Company will
manufacture Medline brand dermal management products. The Supply Agreement
is co-terminus with the amended Distributor and License Agreement.
The Medical Services Division has several distribution and licensing
agreements for the sale of its products into international markets. The
Division also sells wound care products into international markets on a non-
contract, purchase order basis. Opportunities in the Internet market are
also addressed through the Company's websites, www.carringtonlabs.com and
www.woundcare.com.
The Medical Services Division also produces Acemannan Immunostimulant[TM], a
biologic fully licensed by the United States Department of Agriculture
("USDA") as an adjuvant therapy for certain cancers in dogs and cats. This
product, in addition to several wound and skin care products developed
specifically for the veterinary market, are marketed and distributed through
an exclusive distribution arrangement with Farnam Companies, Inc., a leading
veterinary marketing company.
The Medical Services Division is actively involved in developing and
promoting the SaliCept[R] line of products, which includes an oral rinse,
patches for oral wounds and extraction sites, and other products. The
SaliCept[R] line is supported by a dedicated sales representative and the
Company is actively seeking a strategic sales/distribution partner for this
line.
Consumer Services Division
--------------------------
The Consumer Services Division, formerly referred to as Caraloe, Inc.,
markets or licenses consumer products and bulk raw materials utilizing the
Company's patented complex carbohydrate technology into the consumer health
and beauty care product markets. The premier product is Manapol[R] powder,
a bulk raw material rich in polymeric acetylated mannans. Manapo1[R] powder
is marketed to manufacturers of food and nutritional products who desire
quality, clinically-proven ingredients for their finished products for
immune system enhancement. In addition, the Consumer Services Division
markets the bulk raw material Hydrapol[TM] powder to manufacturers of bath,
beauty and skin care products.
The Consumer Services Division also markets finished products containing
Manapol[R] powder into domestic health and nutritional products markets
through health food stores, internet marketing services at www.aloevera.com,
direct consumer sales, and to the international marketplace on a non-
contract, purchase order basis.
In 1997, the Company signed a non-exclusive supply agreement with
Mannatech, Inc. to supply Manapol[R] powder. In 2003, Natural Alternatives
International, Inc. ("Natural Alternatives") was added as a party to the
supply agreement as a manufacturing supplier for Mannatech and purchaser of
the Manapol[R] powder from the Company. This agreement was renewed through
November 2005 and contains monthly minimum purchase requirements. During
2004, 2003, and 2002 sales of Manapol[R] powder under this agreement
represented 47%, 39%, and 35% respectively, of the Company's total revenues.
Due to the nature of the product and the Company's relationship with this
customer, the Company expects this supply agreement will be renewed at the
end of November 2005. However, due to the fact that the non-renewal of this
contract would have a substantial impact on the Company and its revenues,
the Company is continually seeking to expand its customer base in this area.
The Consumer Services Division also provides product development and
manufacturing services to customers in the cosmetic and nutraceutical
markets. In June 2001 a development group was formed to concentrate efforts
on providing these services. The scope of services provided by this group
includes taking projects from formulation design through manufacturing,
manufacturing and filling according to customer-provided formulations and
specifications, filling customer-provided packaging components and
assembling custom kits for customers.
In December 2002, the Company acquired certain assets of the Custom Division
of Creative Beauty Innovations, Inc. ("CBI"), including specialized
manufacturing customer information, intellectual property, equipment and
selected inventories. CBI is a privately held manufacturer of skin and
cosmetic products with operations in Fort Worth, Texas.
Under the agreement, the Company paid CBI $1.6 million, including $0.6
million for related inventory. In addition, for the five-year period ending
in December 2007, the Company agreed to pay CBI an amount equal to 9.0909%
of Carrington's net sales of CBI products to CBI's transferring customers up
to $6.6 million per year, and 8.5% of its net sales of CBI products to CBI's
transferring customers over $6.6 million per year. The Company recorded
expenses of $271,000 and $383,000 in 2004 and 2003, respectively, for
royalties due under the agreement. The acquired assets include equipment and
other physical property previously used by CBI's Custom Division to compound
and package cosmetic formulations of liquids, creams, gels and lotions into
bottles, tubes or cosmetic jars. The Company uses these assets in a
substantially similar manner. The Company provides services to these
customers through its specialty manufacturing group of the Consumer Services
Division. Specialty manufacturing sales through both acquired and other
customers represented 15.1% and 21.8% of total company revenue in 2004 and
2003.
To finance the acquisition, the Company entered into an agreement with
Medline for accelerated payment of $2.0 million of the royalties due under
the Distributor and License Agreement. The royalty acceleration agreement
provides for each of the remaining quarterly royalty payments due to be paid
to the Company by Medline to be reduced by equal amounts, the sum of which
offsets the royalty advance. In addition, the Company will pay Medline
interest on the $2.0 million at the rate of 6.5% per year on the outstanding
balance of the advance.
DelSite Biotechnologies, Inc.
-----------------------------
In 2001, the Company incorporated a wholly-owned subsidiary named DelSite
Biotechnologies, Inc. DelSite operates independently from the Company's
research and development program, which supports the activities associated
with the Company's Medical Services and Consumer Services Divisions, and was
formed to commercialize innovations discovered by scientists at Carrington.
DelSite is responsible for the research, development and marketing of the
Company's proprietary drug delivery technology based on GelSite[R] polymer,
a new and unique complex carbohydrate, which was isolated in 1998 from Aloe
vera L. DelSite commenced operations in January 2002 and is currently
developing new technologies for controlled delivery of vaccines as well as
bioactive protein and peptide therapeutics.
DelSite's business plan is to partner with biotechnology and pharmaceutical
companies to provide novel delivery solutions for their drugs and vaccines.
Together with its collaborators and contractors, DelSite has the following
capabilities:
* Formulation development
* Feasibility studies
* Preclinical development
* Clinical supply production
* Product scale-up
* Technology transfer
In 2002, DelSite formed a strategic collaboration with Southern Research
Institute, Inc. of Birmingham, Alabama, ("Southern Research") to assist in
the development of an injectable drug delivery system based on the
GelSite[R] polymer. Southern Research is an independent, not-for-profit
center for scientific research affiliated with the University of Alabama at
Birmingham. Under the three-year collaborative agreement, DelSite retains
all product rights plus intellectual property rights to its existing
technology as well as any discoveries made by DelSite or Southern Research,
either jointly or individually, as a result of any project undertaken as
part of the agreement. Southern Research will receive fees and royalties
when undertaking certain specified projects on behalf of DelSite. In
addition, a second five-year collaborative agreement with Southern Research
was signed in April 2003. Under this agreement the two companies will
jointly develop an injectable long-term delivery system for proteins and
peptides. The companies will jointly own intellectual property that
originates from this relationship. In January 2005, the three-year
collaborative agreement was extended through January 26, 2006 and Southern
Research transferred both agreements to its affiliate, Brookwood
Pharmaceuticals, Inc.
In March 2004, the National Institute of Allergy and Infectious Diseases
("NIAID") awarded a Small Business Innovation Research ("SBIR") Biodefense
Grant to DelSite of up to $888,000 over two years, based on satisfactory
progress of the project. The grant proposal will fund additional development
of the GelVac[TM] intranasal powder vaccine delivery platform technology.
In July 2004, DelSite leased over 5,000 square feet of new laboratory and
office space in the Texas A&M University Research Park in College Station,
Texas. DelSite also completed a 3,000 square foot expansion of its
facilities in Irving, Texas.
In October 2004, NIAID awarded DelSite a $6 million grant to develop an
inactivated influenza nasal powder vaccine against the H5N1 strain commonly
known as avian or bird flu. The grant was awarded under a biodefense and
SARS product development initiative and will fund a three-year preclinical
program utilizing the Company's proprietary GelVac[TM] nasal powder delivery
system.
Research and Development
------------------------
General
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Carrington has developed proprietary processes for obtaining materials from
Aloe vera L. The Company intends to seek approval of the Food and Drug
Administration (the "FDA") and other regulatory agencies to sell products
containing materials obtained from Aloe vera L. in the United States and in
foreign countries. For a more comprehensive listing of the type, indication
and status of products currently under development by the Company, see
"Research and Development - Summary" below. The regulatory approval
process, both domestically and internationally, can be protracted and
expensive, and there is no assurance that the Company will obtain approval
to sell its products for any treatment or use (see "Governmental Regulation"
below).
The Company expended approximately $4,737,000, $3,660,000 and $3,580,000 on
research and development in fiscal 2004, 2003 and 2002, respectively.
Research activities associated with DelSite accounted for 81% of the 2004,
75% of the 2003 and 52% of the 2002 research and development expenditures.
DelSite Research and Development
--------------------------------
The Company believes that DelSite's products' functionality and/or
pharmacological activity make them potential candidates for further
development as pharmaceutical or therapeutic agents. In 2005, DelSite
intends to focus its research and development activities on its preclinical
development program for an intranasal powder delivery system for influenza
vaccine as well as developing further basic research data for potential
pharmaceutical and vaccine partners. There is no assurance, however, that
DelSite will be successful in its efforts.
The Company sponsors research and development activities at Texas A&M
University in association with the College of Veterinary Medicine to support
research activities of the Company and its DelSite subsidiary. Pursuant to
this arrangement, the Company has access to leading authorities in the life
sciences, as well as facilities and equipment to help further the Company's
research programs. DelSite also has a research relationship with the
University of Southern Mississippi where it sponsors research in the
university's School of Polymer Science. In July 2004, DelSite entered into a
master research agreement with The Texas A&M University System Health
Science Center College of Medicine through the Texas A&M Research Foundation
that allows DelSite to conduct multiple research projects in association
with the Center in the areas of virology and bacteriology for vaccine
delivery.
DelSite is developing a new platform technology based on its proprietary
GelSite[R] polymer for controlled delivery of vaccines as well as bioactive
protein and peptide therapeutics. Basic research is continuing on this
material, which includes both injectable delivery of therapeutic proteins
and peptides and delivery of protein and particle antigens as vaccines using
its proprietary GelVac[TM] intranasal powder vaccine delivery system.
Selected studies have been completed through sponsored research at Texas
A&M and Southern Research Institute. Pilot scale production has been
accomplished and scale-up studies are in progress. The technology has
varied utility, but the primary focus of research is in the area of
injectable and intranasal delivery of bioactive agents. Four patents
covering this invention have been issued to DelSite with one patent pending.
The first composition and process patent was issued in 1999.
Specialized Research and Development
------------------------------------
The Company also has a separate, specialized research team to support
research and in-house development for Carrington products as well as to
provide services to customers in the medical, nutraceutical and cosmetic
markets. These services typically include research and development of
a formulation from the customer's initial concept and specifications.
Development efforts also include packaging design, label design and, where
required by regulations, production validation.
During 2003, the specialized research and development group contributed to
the successful transfer and start-up of the technologies and products
acquired from CBI. These activities included proof of formulation
capabilities and technology transfer services to assist in production
of initial quantities of products in the manufacturing facility. The
specialized research and development group provides the necessary technology
support to successfully meet the requirements of new customers for new
cosmetic and nutraceutical products.
In 2003, several wound care projects were also initiated in the general area
of wound infection control, which Carrington's marketing partners have
identified as a potentially significant addition to its wound care product
line.
In 2004, several wound care projects were initiated in the general area of
chronic wound care. Carrington's marketing partners have continued to
develop a marketing presence for products designed to help treat complex and
chronic dermal wounds.
Human Clinical Studies
----------------------
The Company's new product programs for its operating segments do not require
clinical trials for clearance or approval prior to commercial distribution.
However, the Company intends to support its existing products and new
products with clinical studies that will support the product claims and
indications for use and thereby demonstrate the product's features and
benefits. The Company initiated several such studies in 2004 and intends to
initiate several such clinical studies during 2005. DelSite's development
program may require human clinical trials prior to further development of
its novel drug delivery systems for potential partners. DelSite intends to
initiate such a clinical study for its GelVac[TM] vaccine delivery system in
2005.
Research and Development Summary
--------------------------------
The following table outlines the status of the products and potential
indications of the Company's products developed, planned or under
development. There is no assurance of successful development, completion or
regulatory approval of any product not yet on the market.
PRODUCTS AND POTENTIAL INDICATIONS DEVELOPED,
PLANNED OR UNDER DEVELOPMENT
PRODUCT OR POTENTIAL
POTENTIAL INDICATION MARKET APPLICATIONS STATUS
-------------------- ------------------- ------
Topical
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Dressings Pressure and Vascular Ulcers Marketed
Dressings Diabetic Ulcers, Surgical Wounds Marketed
Cleansers Wounds Marketed
Anti-fungal Cutaneous Fungal Infection Marketed
Hydrocolloids Wounds Marketed
Alginates Wounds Marketed
Anti-infective Wounds Development
Sunscreens Skin Marketed
Oral
----
Human
Pain Reduction Mucositis Marketed
Dental
Pain Reduction Aphthous Ulcers, Oral Wounds Marketed
Post Extraction Wounds Oral Surgery Marketed
Injectable
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Human
Neutropenia Neutropenia associated with Discovery
cancer
GelSite[R] polymer (CR1013) Drug delivery Preclinical
Veterinary
Adjunct for cancer Fibrosarcoma Marketed
Intranasal
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GelSite[R] polymer (CR1013) Vaccine delivery Clinical
Nutraceuticals
--------------
Immune Enhancing Product Manapol[R]/Maitake Gold 404[R] Marketed
Immune Enhancing Product Manapol[R]/Calcium Enriched Clinical
Evaluation
Licensing Strategy
------------------
The Company expects that prescription pharmaceutical products containing
certain defined drug substances will require a substantial degree of
developmental effort and expense. Before governmental approval to market
any such product is obtained, the Company may license these products for
certain indications to other pharmaceutical companies in the United States
or foreign countries and require such licensees to undertake the steps
necessary to obtain marketing approval in a particular country or for
specific indications.
Similarly, the Company intends to license third parties to market products
containing defined chemical entities for certain human indications when it
lacks the expertise or financial resources to market such products
effectively. If the Company is unable to enter into such agreements, it may
undertake marketing the products itself for such indications. The Company's
ability to market these products for specific indications will depend
largely on its financial condition at the time and the results of related
clinical trials. There is no assurance that the Company will be able to
enter into any license agreements with third parties or that, if such
license agreements are concluded, they will contribute to the Company's
overall profits.
Raw Materials and Processing
----------------------------
The principal raw material used by the Company in its operations is the leaf
of the plant known as Aloe vera L. Through patented processes, the Company
obtains several bulk freeze-dried extracts from the central portion of
the Aloe vera L. leaf known as the gel. A basic bulk mannan, Acemannan
Hydrogel[R], is used as an ingredient in certain of the Company's
proprietary wound and skin care products.
The Company owns a 410-acre farm in the Guanacaste province of northwest
Costa Rica which currently has approximately 33 acres planted with Aloe vera
L. The Company is currently performing a land reclamation project on the
farm to increase productive acreage. The Company's current need for leaves
exceeds the supply of harvestable leaves from the Company's farm, requiring
the purchase of leaves from other sources in Costa Rica at prices comparable
to the cost of acquiring leaves from the Company's farm. The Company has
entered into several supply agreements with local suppliers near the
Company's factory to provide leaves. From time to time the Company also
imports leaves from Central and South America at prices comparable to
those in the local market. The Company anticipates that the suppliers it
currently uses will be able to meet all of its requirements for leaves in
2005.
The Company has a 23% ownership interest in Aloe and Herbs International,
Inc., ("Aloe & Herbs"), a Panamanian corporation formed for the purpose of
establishing an Aloe vera L. farm in Costa Rica. The Company purchases
leaves from Rancho Aloe, S.A., ("Rancho Aloe") a wholly-owned subsidiary of
Aloe & Herbs, which has a 5,000-acre farm in close proximity to the
Company's farm, at a market price per kilogram of leaves supplied.
As of December 31, 2004, Rancho Aloe was providing an average of 87% of the
Company's monthly requirement of leaves. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources" for further information regarding the Company's
relationship with Aloe & Herbs.
Manufacturing
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Since 1995, the Company's manufacturing facility has been located in the
Company's headquarters in Irving, Texas. The Company believes that this
manufacturing facility has sufficient capacity to provide for the present
line of products and to accommodate new products and sales growth. Final
packaging of certain of the Company's wound care products is completed by
outside vendors. The Company's calcium alginates, films, hydrocolloids,
foam dressings, gel sheets, tablets, capsules, and freeze-dried products are
being provided by third parties.
All of the Company's proprietary bulk pharmaceutical products and freeze-
dried Aloe vera L. extracts are produced in its processing plant in Costa
Rica. This facility has the ability to supply the bulk aloe raw materials
requirements of the Company's current product lines and bulk material
contracts for the foreseeable future. Certain liquid nutraceutical products
which the Company provides to customers on a custom manufacturing basis are
also produced at the Costa Rica facility. In addition, production of the
Salicept[R] Patch has been transferred to the plant in Costa Rica to better
meet anticipated market demands for the product for post-extraction wounds
and aphthous ulcers.
On January 21, 2005, the Company's wholly-owned subsidiary in Costa Rica
entered into a Manufacturing Agreement with Miradent Products of Costs Rica
("Miradent"). Under the terms of the agreement, the Company will manufacture
proprietary dental products for Miradent for a period of five years. The
Company expects revenues in the first twelve months of this agreement to be
approximately $200,000 to $500,000.
Competition
-----------
DelSite and Research and Development. The biopharmaceutical field is
expected to continue to undergo rapid and significant technological change.
Potential competitors in the United States and abroad are numerous and
include pharmaceutical, chemical and biotechnology companies. Many of these
companies have substantially greater capital resources, research and
development staffs, facilities and expertise (in areas including research
and development, manufacturing, testing, obtaining regulatory approvals and
marketing) than the Company. This competition can be expected to become
more intense as commercial applications for biotechnology and pharmaceutical
products increase. Some of these companies may be better able than the
Company to develop, refine, manufacture and market products which have
application to the same indications as the Company is exploring. The
Company understands that certain of these competitors are in the process of
conducting human clinical trials of, or have filed applications with
government agencies for approval to market certain products that will
compete with the Company's products, both in its present wound care market
and in markets associated with products the Company currently has under
development.
Medical Services Division and Consumer Services Division. The Company
competes against many companies that sell products which are competitive
with the Company's products, with many of its competitors using very
aggressive marketing efforts. Many of the Company's competitors are
substantially larger than the Company in terms of sales and distribution
networks and have substantially greater financial and other resources. The
Company's ability to compete against these companies will depend in part on
the expansion of the marketing network for its products. The Company
believes that the principal competitive factors in the marketing of its
products are their quality, and that they are naturally based and
competitively priced.
Governmental Regulation
-----------------------
The production and marketing of the Company's products, and the Company's
research and development activities, are subject to regulation for safety,
efficacy and quality by numerous governmental authorities in the United
States and other countries. In the United States, drug devices for human
use are subject to rigorous FDA regulation. The Federal Food, Drug and
Cosmetic Act, as amended (the "FFDC Act"), the regulations promulgated
thereunder, and other federal and state statutes and regulations govern,
among other things, the testing, manufacture, safety, effectiveness,
labeling, storage, record keeping, approval, advertising and promotion of
the Company's products. For marketing outside the U.S., the Company is
subject to foreign regulatory requirements governing human clinical trials
and marketing approval for drugs and devices. The requirements governing
the conduct of clinical trials, product licensing, pricing and reimbursement
may vary widely from country to country.
Food and Drug Administration. The contents, labeling and advertising of
many of the Company's products are regulated by the FDA. The Company is
required to obtain FDA approval before it can study or market any proposed
prescription drugs and may be required to obtain such approval for proposed
nonprescription products. This procedure involves extensive clinical
research, and separate FDA approvals are required at various stages of
product development. The approval process requires, among other things,
presentation of substantial evidence to the FDA, based on clinical studies,
as to the safety and efficacy of the proposed product.
After approval, manufacturers must continue to expend time, money and effort
in production and quality control to assure continual compliance with the
current Good Manufacturing Practices regulations. Also, under the new
program for harmonization between Europe and the United States, the Company
is required to meet the requirements of the International Committee on
Harmonization and the ISO 13485 regulations, for OTC drugs and medical
devices, respectively. A company can, under certain circumstances after
application, have a new drug approved under a process known as
centralization rather than having to go through a country-by-country
approval in the European Union.
Certain of the Company's wound and skin care products are registered with
the FDA as medical devices pursuant to the regulations under Section 510(k)
of the FFDC Act (known as Premarket Notification). A medical device is a
product whose primary intended medical purpose, such as to cover a wound, is
accomplished without a chemical or pharmacological action. A medical device
which is substantially equivalent to an existing product will be reviewed by
the FDA and if clearance to market is granted, then the device can be sold
in the United States without additional developmental studies. A medical
device which is not substantially equivalent is subject to an FDA approval
process similar to that required for a new drug, beginning with an
Investigational Device Exemption and culminating in a Premarket Approval.
The Company has sought and obtained all its device approvals under Section
510(k). The Company currently markets eight (8) products which require a
prescription as medical devices.
Other Regulatory Authorities. The Company's advertising and sales practices
are subject to regulation by the Federal Trade Commission (the "FTC"), the
FDA and state agencies. The Company's processing and manufacturing plants
are subject to federal, state and foreign laws and to regulation by the
Bureau of Alcohol, Tobacco and Firearms of the Department of the Treasury
and by the Environmental Protection Agency (the "EPA"), as well as the FDA
and USDA.
The Company believes that it is in substantial compliance with all
applicable laws and regulations relating to its operations, but there is no
assurance that such laws and regulations will not be changed. Any such
change may have a material adverse effect on the Company's operations.
The manufacturing, processing, formulating, packaging, labeling and
advertising of products of the Company's Consumer Services Division, are
also subject to regulation by one or more federal agencies, including the
FDA, the FTC, the USDA and the EPA. These activities are also regulated by
various agencies of the states, localities and foreign countries to which
the Company's products are distributed and in which the Company's products
are sold. The FDA, in particular, regulates the formulation, manufacture
and labeling of vitamin and other nutritional supplements.
The Dietary Supplement Health and Education Act of 1994 ("DSHEA") revised
the provisions of the FFDC Act concerning the composition and labeling of
dietary supplements and, in the judgment of the Company, is favorable to the
dietary supplement industry. The legislation created a new statutory class,
entitled dietary supplement, which includes vitamins, minerals, herbs, amino
acids and other dietary substances for human use to supplement the diet.
DSHEA grandfathered, with certain limitations, dietary ingredients on the
market before October 15, 1994. A dietary supplement which contains a new
dietary ingredient, one not on the market before October 15, 1994, requires
evidence of a history of use or other evidence of safety establishing that
it will reasonably be expected to be safe. The majority of the products
marketed by the Consumer Services Division are classified as dietary
supplements under DSHEA.
Both foods and dietary supplements are subject to the Nutrition Labeling and
Education Act of 1990 (the "NLEA"), which prohibits the use of any health
claim for foods, including dietary supplements, unless the health claim is
supported by significant scientific agreement and is either pre-approved by
the FDA or the subject of substantial government scientific publications and
a notification to the FDA. To date, the FDA has approved the use of only
limited health claims for dietary supplements. However, among other things,
DSHEA amended, for dietary supplements, the NLEA by providing that
statements of nutritional support may be used in labeling for dietary
supplements without FDA pre-approval if certain requirements, including
prominent disclosure on the label of the lack of FDA review of the relevant
statement, possession by the marketer of substantiating evidence for the
statement and post-use notification to the FDA, are met. Such statements
may describe how particular nutritional supplements affect the structure,
function or general well-being of the body (e.g., "promotes cardiovascular
health").
Advertising and label claims for dietary supplements and conventional foods
have been regulated by state and federal authorities under a number of
disparate regulatory schemes. There can be no assurance that a state will
not interpret claims presumptively valid under federal law as illegal under
that state's regulations, or that future FDA regulations or FTC decisions
will not restrict the permissible scope of such claims.
Governmental regulations in foreign countries where the Consumer Services
Division plans to commence or expand sales may prevent or delay entry into
the market, or prevent or delay the introduction of, or require the
reformulation of, certain of the Consumer Services Division's products.
Compliance with such foreign governmental regulations is generally the
responsibility of the Consumer Service Division's distributors for those
countries. These distributors are independent contractors over which the
Consumer Services Division has limited control.
As a result of efforts to comply with applicable statutes and regulations,
the Consumer Services Division has from time to time reformulated,
eliminated or relabeled certain of its products and revised certain
provisions of its sales and marketing program. The Consumer Services
Division cannot predict the nature of any future laws, regulations,
interpretations or applications, nor can it determine what effect additional
governmental regulations or administrative orders, when and if promulgated,
would have on its business in the future. They could, however, require the
reformulation of certain products to meet new standards, the recall or
discontinuance of certain products not capable of reformulation, additional
record keeping, expanded documentation of the properties of certain
products, expanded or different labeling, and/or scientific substantiation.
Any or all of such requirements could have a material adverse effect on the
Company's results of operations and financial condition.
Compliance with the provisions of national, state and local environmental
laws and regulations has not had a material adverse effect upon the capital
expenditures, earnings, financial position, liquidity or competitive
position of the Company.
Patents and Proprietary Rights
------------------------------
As is industry practice, the Company has a policy of using patents,
trademarks and trade secrets to protect the results of its research and
development activities and, to the extent it may be necessary or advisable,
to exclude others from appropriating the Company's proprietary technology.
The Company's policy is to aggressively protect its proprietary technology
by seeking and enforcing patents in a worldwide program.
The Company has obtained patents or filed patent applications in the United
States and approximately 26 other countries in three series regarding the
compositions of acetylated mannan derivatives, the processes by which they
are produced and the methods of their use. The first series of patent
applications, relating to the compositions of acetylated mannan derivatives
and certain basic processes of their production, was filed in a chain of
U.S. patent applications and its counterparts in the other 26 countries.
The first U.S. patent application in this first series, covering the
composition claims of acetylated mannan derivatives, matured into U.S.
Patent No. 4,735,935 (the "935 Patent"), which was issued on April 5, 1988.
U.S. Patent No. 4,917,890 (the "890 Patent") was issued on April 17,
1990 from a divisional application to the 935 Patent. This divisional
application pertains to most of the remaining claims in the original
application not covered by the 935 Patent. The 890 Patent generally relates
to the basic processes of producing acetylated mannan derivatives, to
certain specific examples of such processes and to certain formulations of
acetylated mannan derivatives. Two other divisional applications covering
the remaining claims not covered by the 890 Patent matured into patents, the
first on September 25, 1990, as U.S. Patent No. 4,959,214, and the second on
October 30, 1990, as U.S. Patent No. 4,966,892. Foreign patents that are
counterparts to the foregoing U.S. patents have been granted in some of the
member states of the European Union and several other countries.
The second series of patent applications related to preferred processes for
the production of acetylated mannan derivatives. One of them matured into
U.S. Patent No. 4,851,224, which was issued on July 25, 1989. This patent
is the subject of a Patent Cooperation Treaty application and national
foreign applications in several countries. An additional U.S. patent based
on the second series was issued on September 18, 1990, as U.S. Patent No.
4,957,907.
The third series of patent applications, relating to the uses of acetylated
mannan derivatives, was filed subsequent to the second series. Three of
them matured into U.S. Patent Nos. 5,106,616, issued on April 21, 1992;
5,118,673, issued on June 2, 1992, and 5,308,838, issued on May 3, 1994.
The Company has filed a number of divisional applications to these patents,
each dealing with specific uses of acetylated mannan derivatives. Patent
Cooperation Treaty applications based on the parent U.S. applications have
been filed designating a number of foreign countries where the applications
are pending.
The Company has obtained a patent in the United States relating to a
therapeutic device made from freeze-dried complex carbohydrate hydrogel
(U.S. Patent No. 5,409,703, issued on April 25, 1995). A Patent Cooperation
Treaty application based on the parent U.S. application has been filed
designating a number of foreign countries where the applications are
pending.
The Company has obtained patents in the United States (U.S. Patent No.
5,760,102, issued on June 2, 1998) and Taiwan (Taiwan Patent No. 89390,
issued on August 21, 1997) related to the uses of a denture adhesive and
also a patent in the United States relating to methods for the prevention
and treatment of infections in animals (U.S. Patent No. 5,703,060, issued on
December 30, 1997).
The Company obtained a patent in the United States (U.S. Patent
No.5,902,796, issued on May 11, 1999) related to the process for obtaining
bioactive material from Aloe vera L. The Company obtained an additional
patent in the United States (U.S. Patent No. 5,929,051, issued on July 27,
1999) related to the composition and process for a new complex carbohydrate
(pectin) isolated from Aloe vera L. Also obtained was a U.S. patent (U.S.
Patent No. 5,925,357, issued on July 20, 1999) related to the process for a
new Aloe vera L. product that maintains the complex carbohydrates with the
addition of other substances normally provided by "Whole Leaf Aloe."
Additionally, the Company obtained a Japanese letters-patent (Patent No.
2888249, having a Patent Registration Date of February 19, 1999) for the use
of acemannan (a) in a vaccine product; (b) in enhancing natural kill cell
activity and in enhancing specific tumor cell lysis by white cells and/or
antibodies; (c) in correcting malabsorption and mucosal cell maturation
syndromes in man or animals; and (d) in reducing symptoms associated with
multiple sclerosis.
The Company also received the grant of European Patent Application under No.
0611304, having the date of publication and mention of the grant of the
patent of September 15, 1999. This European Letters Patent claims the use
of acetylated mannan for the regulation of blood cholesterol levels and for
the removal of plaque in blood vessels. A patent was also issued in South
Korea and Canada.
In addition, the Company obtained an Australian Patent (Patent No. 718631,
having an Accepted Journal Date of April 20, 2000) and a South Korean Patent
(No. 463469), issued December 16, 2004 on Uses of Denture Adhesive
Containing Aloe Extract. On June 20, 2000, Singapore granted the Company a
patent on Bioactive Factors of Aloe Vera Plants (P-No. 51748) and on
February 6, 2004, under Patent No. 419354, South Korea issued a patent for
the same.
The Company received the grant of two U.S. patents (Patent No. 6,274,548
issued August 14, 2001, and Patent No. 6,313,103 issued November 6, 2001)
associated with the use of pectins for purification, stabilization and
delivery of certain growth factors. Other U.S. PCT applications on aloe
pectin are pending. A U.S. patent application on growth factor and protease
enzyme is also pending.
The Company obtained on September 25, 2002, a European Patent (Patent No.
0884994) which was validated in Great Britain, Germany (No. 69715827.6),
France, Italy and Portugal associated with the uses of denture adhesive
containing Aloe Vera L. extract.
In addition, the Company was issued on August 13, 2002, a Canadian Patent
(No. 2,122,604) associated with the process for preparation of aloe
products.
The Company also obtained on June 24, 2002, a Korean Patent (No. 343293) and
on June 5, 2002, European Patent (No. 0705113) which was validated in Great
Britain, France, Germany (No. 69430746.7-08), Italy and Austria associated
with dried hydrogel from hydrophilic hygroscopic polymer.
The Company also obtained, on May 28, 2003, a European Patent (No. 966294),
which was validated in Great Britain, France, Italy, Sweden, and Germany
(No. 69815071.6) associated with the bifurcated method to process aloe whole
leaf.
Also, the Company was issued, on July 23, 2003 a European Patent (No.
965346), which was validated in France, Great Britain, Italy, and Germany
(No. 69133298.3), associated with uses of acetylated mannan derivatives in
treating chronic respiratory disease.
The Company also received, on August 17, 2004, a U.S. patent (No. 6,777,000)
relating to the use of pectin in-situ gelling formulations for the delivery
and sustained release of physiologically active agents such as drugs and
vaccines.
The Company has filed and intends to file patent applications with respect
to subsequent developments and improvements when it believes such protection
is in the best interest of the Company. The scope of protection which
ultimately may be afforded by the patents and patent applications of the
Company is difficult to quantify. There can be no assurance that (i) any
additional patents will be issued to the Company in any or all appropriate
jurisdictions, (ii) litigation will not be commenced seeking to challenge
the Company's patent protection or such challenges will not be successful,
(iii) processes or products of the Company do not or will not infringe upon
the patents of third parties or (iv) the scope of patents issued to the
Company will successfully prevent third parties from developing similar and
competitive products. It is not possible to predict how any patent
litigation will affect the Company's efforts to develop, manufacture or
market its products.
The Company also relies upon, and intends to continue to rely upon, trade
secrets, unpatented proprietary know-how and continuing technological
innovation to develop and maintain its competitive position. The Company
typically enters into confidentiality agreements with its scientific
consultants, and the Company's key employees have entered into agreements
with the Company requiring that they forbear from disclosing confidential
information of the Company and assign to the Company all rights in any
inventions made while in the Company's employ relating to the Company's
activities.
The technology applicable to the Company's products is developing rapidly.
A substantial number of patents have been issued to other biopharmaceutical
companies. In addition, competitors have filed applications for, or have
been issued, patents and may obtain additional patents and proprietary
rights relating to products or processes competitive with those of the
Company. To the Company's knowledge, acetylated mannan derivatives do not
infringe any valid, enforceable U.S. patents. A number of patents have been
issued to others with respect to various extracts of the Aloe vera L. plant
and their uses and formulations, particularly in respect to skin care and
cosmetic uses. While the Company is not aware of any existing patents which
conflict with its current and planned business activities, there can be no
assurance that holders of such other Aloe vera L.-based patents will not
claim that particular formulations and uses of acetylated mannan derivatives
in combination with other ingredients or compounds infringe, in some
respect, on these other patents. In addition, others may have filed patent
applications and may have been issued patents relating to products and
technologies potentially useful to the Company or necessary to commercialize
its products or achieve their business goals. There is no assurance that
the Company will be able to obtain licenses of such patents on acceptable
terms.
On December 15, 2004, DelSite filed an Opposition proceeding in the European
Patent Office against EP Patent EP 0 975 367. This EP patent was granted
March 31, 2004 and assigned to West Pharmaceutical Services Drug Delivery &
Clinical Research Centre Limited ("West"). A similar U.S. Patent No.
6,432,440 issued to West on August 13, 2002, and similar West patents have
been granted or applications are pending in several non-European countries,
such as Australia, Japan, New Zealand, and South Africa.
The claims of the West patents are directed to aqueous liquid compositions
for delivering drugs which contain therapeutic agents and pectins and can
form therapeutic agent-containing gels when applied to mucosal surfaces.
The West patents also claim methods of using and manufacturing the liquid
pharmaceutical compositions, and the pharmaceutical gel compositions formed
by "in-situ" gellation processes.
DelSite also desires to clear a legal path so that potential DelSite
products can be sold for administration in liquid form in the future. The
objective of the DelSite opposition to the West EP patent is to force legal
revocation of the West patent in Europe, or a significant narrowing of the
West claims, by legally demonstrating that, in view of prior art not
considered by the patent examiners, the current claims of the EP patent
should not have been granted and/or are invalid. Completion of the EP
opposition proceedings is anticipated to take as long as three to six years.
The Company has given the trade name Carrasyn[R] to certain of its products
containing acetylated mannans. The Company has filed a selected series of
domestic and foreign trademark applications for the marks Manapol[R] powder,
Carrisyn[R], Carrasyn[R] and CarraGauze[R]. Further, the Company has
registered the trademark AVMP[TM] Powder and the trade name Carrington[R] in
the United States. In 1999, the Company obtained four additional registered
trademarks in Brazil.
In June 2000 the Company obtained registration in the United States of its
mark AloeCeuticals[R] for its skin care and nutritional supplement products.
In September 2002 the Company obtained registration in the United States of
its mark CaraKlenz[R] for its proprietary wound cleanser product with that
name.
In addition, applications for the registration of the marks GelVac[TM]
and OraPatch[TM] are pending in the United States. Application for the
registration of the mark GelVac[TM] and SaliCept[R] are pending in Europe.
In November 2003 the Company obtained registration in the United States of
its mark "Delsite and design[TM]" for its research and development of dry
stabilization and delivery systems for customers in the field of
pharmaceuticals and diagnostic reagents.
In September 2004 the Company obtained registrations in the United States of
its marks GelSite[R] and Salicept[R].
In August 2004 the Company obtained registrations in Japan and in November
2004, South Korea of its mark GelVac[TM].
Employees
---------
As of February 28, 2005, the Company employed 324 persons, of whom 59 were
engaged in the operation and maintenance of its Irving, Texas processing
plant, 206 were employed at the Company's facility in Costa Rica and the
remainder were executive, research, quality assurance, manufacturing,
administrative, sales, and clerical personnel. Of the total number of
employees, 116 were located in Texas, 206 in Costa Rica, one in Puerto Rico
and one in Europe. The Company considers relations with its employees to be
good. The employees are not represented by a labor union.
Available Information
---------------------
The Company's Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q,
Current Reports on Form 8-K and other reports, and amendments to these
reports, that the Company files with or furnishes to the Securities and
Exchange Commission ("SEC") are available free of charge at the Company's
website www.carringtonlabs.com, as soon as reasonably practicable, after the
Company electronically files such reports with, or furnishes such reports
to, the SEC. The posting of these reports on the Company's website does not
constitute incorporation by reference of the other information contained on
the website, and such other information on the Company's website should not
be considered part of such reports unless the Company expressly incorporates
such other information by reference. The Company will also furnish copies of
such reports free of charge upon written request to the Company's Investor
Relations department.
Additionally, the Company's corporate governance code of business conduct
and ethics and the charters of the Company's Board Committees, including the
Audit, Board Governance, Compensation and Executive Committees are available
on the Company's website. The Company will also furnish copies of such
information free of charge upon written request to the Company's Investor
Relations department. Individuals can contact the Company's Investor
Relations department at:
Carrington Laboratories, Inc., 2001 Walnut Hill Lane, Irving, TX 75038,
Attention: Maria Mitchell.
ITEM 2. PROPERTIES.
----------
The Company believes that all its farming property, manufacturing and
laboratory facilities, as described below, and material farm, manufacturing
and laboratory equipment are in satisfactory condition and are adequate for
the purposes for which they are used, except that the farm is not adequate
to supply all of the Company's needs for Aloe vera L. leaves. (See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" for more information regarding the Company's arrangements to
purchase Aloe vera L. leaves.)
Walnut Hill Facility. The Company's corporate headquarters and principal
U.S. manufacturing facility occupy all of the 41,400 square foot office and
manufacturing building (the "Walnut Hill Facility"), which is situated on an
approximately 6.6 acre tract of land located in the Las Colinas area
of Irving, Texas. The Company owns the land and the building. The
manufacturing operations occupy approximately 17,300 square feet of the
facility, administrative offices occupy approximately 16,100 square feet and
with an additional 8,000 square feet undeveloped.
Laboratory and Warehouse Facility. The Company has leased a 51,200 square
foot building in close proximity to the Walnut Hill facility for a ten-year
term to house its Research and Development, Quality Assurance and Quality
Control Departments. Laboratories and offices for DelSite are also located
in this facility. In addition, the Company utilizes a portion of the
building as warehouse space. The Company relocated those functions to this
facility in the third quarter of 2001. During 2004, the Company completed a
3,000 square feet expansion of the DelSite facilities at this location.
Warehouse and Distribution Facility. In February 2003, the Company leased a
58,130 square foot building for a term of five years for additional
warehouse space. In addition, the Company relocated its distribution
operations to this new facility.
Texas A & M University Research Park Facility. In July 2004, DelSite leased
over 5,000 square feet of new laboratory and office space in the Texas A&M
University Research Park in College Station, Texas for a term of 24 months.
DelSite will use this facility primarily for vaccine delivery research and
development.
Costa Rica Facility. The Company owns approximately 410 acres of land in
the Guanacaste province of northwest Costa Rica. This land is being used
for the farming of Aloe vera L. plants and as the site for a 30,700 square
foot processing plant to produce bulk pharmaceutical and injectable mannans
and freeze-dried extracts from Aloe vera L. used in the Company's
operations. The processing plant became operational in 1993. The Company
also produces liquid nutraceutical products and proprietary dental products
at this facility.
ITEM 3. LEGAL PROCEEDINGS.
-----------------
On April 3, 2001, Arthur Singer, a former employee of the Company (the
"Plaintiff"), filed a lawsuit entitled Arthur Singer vs. Carrington
Laboratories, Inc. and Carlton Turner, CV-01-2084 in the United States
District Court for the Eastern District of New York, Long Island Division,
alleging multiple causes of action against the Company and its chief
executive officer (the "Defendants") and seeking damages in excess of $4.0
million, plus legal fees and expenses. The Plaintiff, who was formerly
employed by the Company as a sales representative, alleged in substance that
the Company failed to pay the full amount of commissions owed to him; that
the Defendants breached an alleged contract of employment with him; that the
Company deprived him of the opportunity to exercise some vested stock
options, prevented some of his unvested stock options from vesting and
caused all of his options to expire earlier than they otherwise would have;
and that the Defendants misrepresented that the Company intended to retain
him as an employee, fraudulently induced him to remain in its employ and
breached alleged covenants of fair dealing.
On May 31, 2001, the Defendants filed a motion seeking to have the complaint
dismissed or to have the case transferred to Texas. On August 28, 2001, the
Defendants' motion to transfer was granted, and the case was transferred to
the United States District Court for the Northern District of Texas, Dallas
Division, as Case No. 01-CV-1776.
The Defendants and Plaintiff then both filed motions for summary judgment.
On October 3, 2003, the court denied the Plaintiffs motion for summary
judgment and granted Defendants motion for summary judgment for all
complaints except three, the alleged damages for which totaled approximately
$56,000.
On January 5, 2004, a jury trial was held to settle the remaining claims,
with the jury finding for the Plaintiff on one claim, awarding $28,162, plus
interest, for unpaid commissions, and finding for the Defendants on a second
claim. The judge dismissed the third claim at the end of testimony, citing
lack of sufficient evidence to support the Plaintiff's claim. The court
awarded no legal fees or expenses to the Plaintiff. Total judgment was for
approximately $35,000, which was recorded as of the period ended December
31, 2003 and paid during 2004.
On June 23, 2004, the United States District Court denied the Plaintiff's
appeal for reasonable legal fees. On July 7, 2004, the Plaintiff filed a
motion of appeal with the Fifth Circuit Court regarding all judgments
entered by the District Court. Oral arguments on the motion to appeal were
heard by the Court on March 8, 2005. On March 10, 2005, the Fifth Circuit
Court affirmed the ruling of the District Court.
On June 22, 2001, a lawsuit styled Swiss-American Products, Inc. v. G. Scott
Vogel and Carrington Laboratories Inc., Cause No. 01-5163-A, was filed in
the 193rd Judicial District Court of Dallas County, Texas. On June 25,
2001, the Company was served with this lawsuit, an Ex Parte Temporary
Restraining Order, and an Order Appointing Independent Third Party Expert
Pursuant to Temporary Restraining Order. The suit alleges, among other
things, that Mr. Vogel (the Company's former Vice President, Operations)
improperly obtained proprietary information of Swiss-American Products, Inc.
("Plaintiff") from a former employer that manufactured products under
contract for Plaintiff, and used that information on behalf of the Company,
in breach of certain common law duties and a confidentiality agreement
between his former employer and Plaintiff. The suit further alleges that
Mr. Vogel and the Company ("Defendants") conspired to unlawfully disclose,
convert and misappropriate Plaintiff's trade secrets.
The suit seeks permanent injunctive relief, including a permanent injunction
prohibiting Defendants from disclosing or using to Plaintiff's disadvantage
any confidential proprietary information belonging to Plaintiff which Mr.
Vogel allegedly obtained from his former employer, or from developing or
marketing products based on Plaintiff's formulas or other information
allegedly taken from Mr. Vogel's former employer. The suit also seeks to
recover damages in an unspecified amount from Defendants.
Following a hearing on July 30, 2001, the trial court entered an order
setting the case for trial on July 30, 2002 and granted a temporary
injunction that prohibits Defendants from (i) disclosing or using any of
Plaintiff's confidential, proprietary or trade secret information; (ii)
developing or marketing a wound cleanser product that is the same or
substantially the same as reflected in a formula that is at issue in the
lawsuit (although this prohibition expressly does not apply to products
actively manufactured and sold by the Company before January 1, 2001 using
the exact same formula then in effect); and (iii) destroying, concealing,
altering, removing or disposing of any documents, files, computer data or
other things relating to Plaintiff or Mr. Vogel's former employer, or
containing or referring to trade secrets or confidential or proprietary
information of Plaintiff or Mr. Vogel's former employer.
A trial was held on October 7, 2003. Three days into the proceeding a
mistrial was declared due to juror misconduct. The trial judge subsequently
ordered the two parties to mediate the suit and such mediation was held on
May 17, 2004. Despite the efforts of the mediator, the parties were unable
to reach a settlement. Although a trial date had been set for June 1, 2004,
the court later moved the trial start date to September 21, 2004.
Due to the Court's striking of the economic damage model provided by the
Plaintiff's expert witness, a motion for continuance was filed and accepted
by the Court, with the trial start date subsequently moved to June 21, 2005.
The Company believes that Plaintiff's claims are without merit and intends
to vigorously defend against those claims.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
---------------------------------------------------
The Company did not submit any matter to a vote of security holders during
the fourth quarter of the fiscal year covered by this Annual Report.
PART II
-------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
---------------------------------------------------------------------
The Common Stock of the Company is traded on the NASDAQ National Market
under the symbol "CARN". The following table sets forth the high and low
sales prices per share of the Common Stock for each of the periods
indicated.
Fiscal 2004 High Low
----------- ---- ----
First Quarter $5.48 $3.72
Second Quarter 5.41 3.52
Third Quarter 4.55 3.02
Fourth Quarter 6.90 3.73
Fiscal 2003 High Low
----------- ---- ----
First Quarter $1.08 $0.91
Second Quarter 2.80 0.95
Third Quarter 6.20 2.18
Fourth Quarter 4.68 3.35
At March 21, 2005, there were 870 holders of record (including brokerage
firms) of Common Stock and the closing price of the Company's Common Stock
was $5.05.
The Company has not paid any cash dividends on the Common Stock and
presently intends to retain all earnings for use in its operations. Any
decision by the Board of Directors of the Company to pay cash dividends in
the future will depend upon, among other factors, the Company's earnings,
financial condition and capital requirements.
ITEM 6. SELECTED FINANCIAL DATA.
-----------------------
The selected consolidated financial data below should be read in conjunction
with the consolidated financial statements of the Company and notes thereto
and "Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations." The selected consolidated financial information
for the five years ended December 31, 2004, is derived from the consolidated
financial statements of the Company, of which the Statements for the years
ended December 31, 2000 through 2002, have been audited by Ernst & Young
LLP, and for the years ended December 31, 2003 and 2004 have been audited by
Grant Thornton LLP.
Years ended December 31,
(Dollars and numbers of shares in -----------------------------------------
thousands except per share amounts) 2004 2003 2002 2001 2000
------------------------------------------------------------------------------
OPERATIONS STATEMENT INFORMATION:
Revenues:
Net product sales $27,584 $26,636 $15,571 $15,115 $22,833
Royalty income 2,470 2,467 2,470 2,479 270
Grant income 767 - - - -
------ ------ ------ ------ ------
Total revenues 30,821 29,103 18,041 17,594 23,103
Costs and expenses:
Cost of product sales 18,250 18,806 11,739 9,803 12,782
Selling, general and
administrative 7,560 8,017 6,040 5,016 10,162
Research and development 911 899 1,701 2,442 2,979
Research and development,
DelSite 3,826 2,761 1,879 - -
Research and development,
Aliminase[TM] clinical
trial expenses - - - - 623
Charges related to Oregon
Freeze Dry, Inc. - - - - 223
Other expense (income), net (92) (123) 19 (13) (110)
Interest expense (income), net 205 249 41 (32) (80)
------ ------ ------ ------ ------
Income (loss) before income taxes 161 (1,506) (3,378) 378 (3,476)
Provision for income taxes 125 - - - -
------ ------ ------ ------ ------
Net income (loss) $ 36 $(1,506) $(3,378) $ 378 $(3,476)
====== ====== ====== ====== ======
Net income (loss) per common share
- basic and diluted(1) $ 0.00 $ (0.15) $ (0.34) $ 0.04 $ (0.36)
====== ====== ====== ====== ======
BALANCE SHEET INFORMATION (as of December 31):
Working capital $ 2,244 $ 3,019 $ 3,989 $ 6,315 $ 6,275
Total assets 23,017 22,784 22,159 21,217 20,702
Total shareholders' equity 13,371 12,619 13,689 16,929 16,440
(1) For a description of the calculation of basic and diluted net income
(loss) per share, see Note Twelve to the consolidated financial
statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS.
---------------------
Company Overview
----------------
The Company is a research-based biopharmaceutical, medical device, raw
materials and nutraceutical company engaged in the development,
manufacturing and marketing of naturally-derived complex carbohydrates and
other natural product therapeutics for the treatment of major illnesses, the
dressing and management of wounds and nutritional supplements. The Company
is comprised of three business segments. The Company generates revenues
through the sales of prescription and non-prescription medical products
through its Medical Services Division. It also generates revenues through
the sales of consumer and bulk raw material nutritional products and sales
of specialized product development and manufacturing services to customers
in the cosmetic and nutraceutical markets through its Consumer Services
Division, formerly referred to as Caraloe, Inc. In addition, the Company
generates revenues from research grant awards through its DelSite subsidiary
that is engaged in the research, development and marketing of the Company's
proprietary GelSite[R] technology for controlled release and delivery of
bioactive pharmaceutical ingredients.
Products sold through the Medical Services Division include hydrogels, wound
cleansers, hydrocolloids, advanced wound covering products, incontinence-
care products and two lines of condition-specific products. Many products
sold through this division contain the Company's proprietary, medical-grade
raw material, Acemannan Hydrogel[TM]. The Company regularly engages in
development projects to create line extensions and other new products for
this category. Products sold through the Consumer Services Division include
Manapol[R] and other proprietary and non-proprietary raw materials sold to
nutraceutical and cosmetic customers; nutritional products sold under the
AloeCeuticals[R] brand; skin care products sold under the Snow or Sun[TM]
brand and private-labeled products manufactured to customer specifications,
including powders, creams, liquids, gels, lotions, drinks, tablets and
capsules for various customers.
Prior to 1996, the Company generated most of its revenues from product sales
in its Medical Services Division. In 1996, the Company launched its line of
raw materials, including Manapol[R] powder, through its Consumer Services
Division. In 2001, the Company created its specialty manufacturing group to
provide services to cosmetic and nutraceutical markets. In December 2002,
the Company acquired the assets of the custom division of CBI, which
substantially increased revenues for the Consumer Services Division. In
2004 approximately 34% of the Company's revenues were generated through
product sales, services and royalties in its Medical Services Division, 64%
through sales of products and services in its Consumer Services Division and
2% through U.S. Federal grant income in its DelSite research and development
subsidiary.
Revenues
-------- Year-over- Year-over-
Year Year
2004 2003 Growth Growth
($) (%)
-----------------------------------------------------------------------
Net product sales $27,584 $26,636 $ 948 3.6%
Royalty income 2,470 2,467 3 0.1%
Grant income 767 0 767 100%
------ ------ ------ ----
Total revenues $30,821 $29,103 $ 1,718 5.9%
====== ====== ====== ====
Grant Awards
------------
In March 2004 DelSite received a SBIR grant award of up to $888,000 over a
two-year period. The grant will fund additional development of GelVac[TM],
DelSite's intranasal vaccine delivery platform technology. In October 2004
DelSite received notification of a $6 million grant over a three-year period
from the National Institute of Allergy and Infectious Diseases. The $6
million grant is to fund the development of an inactivated influenza nasal
powder vaccine against the H5N1 strain, commonly known as bird flu,
utilizing the Company's proprietary GelVac[TM] delivery system. The grant
was awarded under a biodefense and SARS product development initiative and
will fund a three-year preclinical program.
Cash Flow
--------- Year-over- Year-over-
Year Year
2004 2003 Growth Growth
($) (%)
-----------------------------------------------------------------------
Net cash provided by (used
in) operating activities $ 2,412 $(1,288) $3,700 287.3%
Net cash used in investing
Activities (2,172) (1,472) (700) (47.6%)
Net cash provided by financing
Activities 270 1,044 (774) (74.1%)
The increase in net cash provided by operating activities was primarily
related to a $1.1 million decrease in inventory levels in 2004, as the
Company initiated programs to reduce inventory levels to improve inventory
months on hand. The 2004 decrease is compared to a $1.8 million increase in
inventory during 2003. Additionally, net income increased by $1.54 million,
with net income of $36,000 in 2004 as compared to a net loss of $1.5 million
in 2003. The Company also received an additional $1.2 million in the form
of advanced royalty payments from Medline. See Note 15 "Deferred Revenue"
in the Consolidated Financial Statements for further information regarding
Medline. These items were partially offset by a decrease in accounts payable
and accrued liabilities of $639,000 in 2004 as compared to a $927,000
increase in 2003. The increase in net cash used in investing activities
resulted from an increased investment in facilities and equipment primarily
to support the Company's DelSite subsidiary. Cash provided by financing
activities in 2004 reflects increased principal payments on debt and capital
lease obligations and only $650,000 of new debt incurred as compared to $1.5
million of new debt in 2003.
The Company's costs and expenses generally fall into four broad categories:
cost of product sales; sales and distribution expenses in support of product
sales; general and administrative expenses; product support and DelSite
research and development expenses. In recent years, the Company has shifted
a greater percentage of its overall research and development expenses to its
DelSite subsidiary. General and administrative expenses represent corporate
infrastructure costs, such as accounting, human resources and information
systems, and executive management expenses. In addition to its operating
expenses, the Company also incurs interest expense arising from the debt
portion of its capital structure.
Costs and Expenses
------------------ Year-over- Year-over-
Year Year
2004 2003 Growth Growth
($) (%)
-----------------------------------------------------------------------
Cost of product sales $18,250 $18,806 $ (556) (3.0%)
Selling, general and
administrative 7,560 8,017 (457) (5.7%)
Research and development 911 899 12 1.3%
Research and development,
DelSite 3,826 2,761 1,065 38.6%
Other expenses (income) (92) (123) 31 25.2%
Interest expense (income), net 205 249 (44) (17.7%)
The Company utilizes the cash flow generated from its manufacturing and
sales operations and borrowings to fund additional capital projects in
support of manufacturing operations and to fund the research activities of
its wholly-owned subsidiary, DelSite. DelSite, which was incorporated in
2001, operates separately from the Company's product-support research and
development program and is responsible for the research, development and
marketing of the Company's proprietary GelSite[R] technology for controlled
release and delivery of bioactive pharmaceutical ingredients. DelSite's
business plan is to develop its data in support of it technologies and then
partner with biotechnology and pharmaceutical companies to provide novel
delivery solutions for their drugs and vaccines.
Key Performance Indicators
--------------------------
The following table illustrates the key performance indicators that the
Company uses to measure the performance and manage the business.
FISCAL YEARS ENDED
------------------
2004 2003
------ ------
Days Sales Outstanding:
Accounts Receivable $ 3,325 $ 3,098
Fourth Quarter Sales 7,761 6,705
Divided by 90 days equals
Average Daily Sales 86.2 74.5
------ ------
Accounts Receivable divided by
Average Daily Sales equals
Days Sales Outstanding 38.6 41.6
====== ======
Months Inventory on Hand:
Inventory $ 4,614 $ 5,960
Fourth Quarter Cost of Product Sales 4,473 4,551
Divided by 3 equals
Average Monthly Cost of Product Sales 1,491 1,517
------ ------
Inventory divided by Average
Monthly Cost of Product Sales equals
Months Inventory on Hand 3.1 3.9
====== ======
Current Ratio:
Current Assets $10,566 $11,231
Divided by
Current Liabilities 8,322 8,212
------ ------
Equals Current Ratio 1.27 1.37
====== ======
Quick Ratio:
Quick Assets $ 5,755 $ 5,018
Divided by
Current Liabilities 8,322 8,212
------ ------
Equals Quick Ratio 0.69 0.61
====== ======
Debt to Equity:
Current Liabilities $ 8,322 $ 8,212
Long Term Debt 1,324 1,953
------ ------
Total Debt $ 9,646 $10,165
Divided by Equity 13,371 12,619
------ ------
Equals Debt to Equity 0.72 0.80
====== ======
Long-term Debt to Equity:
Long Term Debt $ 1,324 $ 1,953
Divided by Equity 13,371 12,619
------ ------
Equals Long-term Debt to
Equity 0.10 0.15
====== ======
Working Capital:
Current Assets $10,566 $11,231
Less Current Liabilities 8,322 8,212
------ ------
Equals Working Capital $ 2,244 $ 3,019
====== ======
Liquidity and Capital Resources
-------------------------------
The following table summarizes the Company's contractual obligations at
December 31, 2004 (amounts in thousands):
Payments Due by Period
---------------------------------------
Less than One to Four to More than
One Three Five Five
Total Year Years Years Years
----------------------------------------------------------------------------
Contractual Obligations
Notes Payable
Line of Credit with
Comerica Bank (5.75% at
December 31, 2004) $ 1,887 $ 1,887 $ - $ - $ -
Comerica Bank note payable
(5.75% at December 31,2004) 717 200 400 117 -
Medline note payable
(6.5% at December 31, 2004) 582 582 - - -
Bancredito notes payable
(U.S. prime plus 2.5% at
December 31, 2004) 754 90 199 227 238
Other
Capital leases 250 127 86 34 3
Operating leases 4,852 986 1,688 1,274 904
------ ------ ------ ------ ------
Total contractual
obligations $ 9,042 $ 3,872 $ 2,373 $ 1,652 $ 1,145
====== ====== ====== ====== ======
The Company has historically depended on operating cash flows, bank
financing, advances on royalty payments under certain of its existing
contracts and equity financing to fund its operations, capital projects and
research and development projects, with the majority of funds generated from
operating cash flows. The Company also has available to it various leasing
arrangements for financing equipment purchases, and is seeking additional
grant awards and other potential collaborative or sponsorship funding for
DelSite projects and potential licensing revenues for product lines or
DelSite projects.
At December 31, 2004 and 2003, the Company held cash and cash equivalents of
$2,430,000 and $1,920,000, respectively, an increase of $510,000. The
increase was primarily due to a $1.1 million decrease in inventory as the
Company implemented programs to reduce inventory levels, the receipt of $1.2
million from Medline as an advance payment of royalties; (See Note 15
"Deferred Revenue" in the Consolidated Financial Statements for further
information regarding Medline), the receipt of $650,000 in loan proceeds and
$716,000 in proceeds from stock option exercises and employee purchases of
shares. These cash receipts were partially offset by the Company's
investment in property plant and equipment of $2.2 million and debt
and capital lease obligation payments of $1.1 million. Customers with
significant accounts receivable balances at the end of 2004 include Natural
Alternatives ($2,205,000) and Medline ($688,000), and of these amounts
$2,814,000 has been collected as of February 28, 2005.
The Company has a line of credit with Comerica Bank ("Comerica") that
provides for borrowings of up to $3 million based on the level of qualified
accounts receivable and inventory. The line of credit is collateralized by
accounts receivable and inventory. Borrowings under the line of credit bear
interest at the bank's prime rate (5.25% at December 31, 2004) plus 0.5%.
As of December 31, 2004 there was $1,887,000 outstanding on the credit line
with $563,000 of credit available for operations, net of outstanding letters
of credit of $550,000.
Effective July 1, 2004, the Company and Comerica negotiated an amendment to
the Company's credit facilities, which, among other things, redefined the
covenants that require the Company to maintain certain financial ratios. As
of December 31, 2004 the Company is in compliance with all of the covenant
provisions. The new covenants and the Company's position at December 31,
2004 are as follows:
Covenant Covenant Requirement Company's Position
--------- -------------------- ------------------
Total Net Worth $12,200,000 $12,744,000
Current Ratio 1.60 1.76
Liquidity Ratio 1.75 2.21
The Total Net Worth, Current Ratio and Liquidity Ratio covenant amounts and
the Company's position are calculated as defined in the amendment. The
definition of the current ratio in the amendment is different from the
definition used in the Company's key performance indicators. The covenant
amounts for these ratios will remain at these same fixed amounts until
maturity of the loan.
In September 2004, the Company received a loan of $350,000 from Bancredito,
a Costa Rica bank, with interest and principal to be repaid in monthly
installments over eight years. The interest rate on the loan is the U.S.
Prime Rate (5.25%) plus 2.5%. The loan is secured by certain of the
Company's equipment. The proceeds of the loan were used in the Company's
operations. As of December 31, 2004, there was $343,000 outstanding on the
loan.
In July 2003, the Company received a loan of $1,000,000 from Comerica under
a variable rate installment note with interest and principal to be repaid in
monthly installments over five years. The interest rate on the loan is the
U.S. Prime Rate plus 0.5%. The loan is collateralized by the Company's
accounts receivable and inventory and by a first lien on the Company's
production facility in Irving, Texas. The proceeds of the loan were used in
the Company's operations. As of December 31, 2004, there was $717,000
outstanding on the loan. Both the line of credit and loan with Comerica are
cross-collateralized and cross-defaulted.
In March 2003 the Company received a loan of $500,000 from Bancredito, a
Costa Rica bank, with interest and principal to be repaid in monthly
installments over eight years. The interest rate on the loan is the U.S.
Prime Rate plus 2.0%. The loan is secured by a mortgage on an unused, 164-
acre parcel of land owned by the Company in Costa Rica plus a lien on
specified oral patch production equipment. The proceeds of the loan were
used in the Company's operations. As of December 31, 2004, there was
$410,000 outstanding on the loan.
In December 2002, the Company entered into an agreement with Medline for
accelerated payment of $2.0 million of the royalties due under the
Distributor and License Agreement. The royalty acceleration agreement
provides for each of the remaining quarterly royalty payments due to be paid
to the Company by Medline to be reduced by equal amounts, the sum of which
offsets the royalty advance. The Company has accounted for this transaction
in its financial statements as a loan, which bears interest at 6.5%. The
proceeds of the loan were used to fund the acquisition of the CBI assets.
As of December 31, 2004, there was $582,000 outstanding on the advance.
The Company had no additional material capital commitments as of that date
other than its leases and agreements with suppliers.
In July 1998 the Company provided a $187,000 cash advance to Rancho Aloe,
which is evidenced by a note receivable, due in installments, with payments
being made monthly based upon farm production. The Company also advanced
$300,000 to Rancho Aloe in November 1998 for the acquisition of an
irrigation system to improve production on the farm and allow harvesting of
leaves year-round. In the fourth quarter of 1998, the Company fully
reserved all amounts owed to it by Rancho Aloe, in the total amount of
$487,000, due to the start-up nature of the business. In 2004, the Company
received payments totaling $92,250 from Rancho Aloe against the amount due.
In December 2002, the Company acquired the assets of the custom division of
Cosmetic Beauty Innovations ("CBI") for $1.0 million plus a royalty on the
Company's sales to custom division customers for five years and $0.6 million
for useable inventories. The royalty amount is equal to 9.0909% of
Carrington's net sales of CBI products to CBI's transferring customers up to
$6.6 million per year and 8.5% of Carrington's net sales of CBI products to
CBI's transferring customers over $6.6 million per year. The Company
recorded expenses of $271,000 and $383,000 in 2004 and 2003, respectively,
for royalties due under the agreement. The CBI custom division provided
product development and manufacturing services to customers in the cosmetic
and skin care markets. Included in the purchase were intellectual property,
certain inventories and specified pieces of equipment. The Company provides
services to these customers through the Consumer Services Division
development and manufacturing services group. The Company began producing
products for the transferring CBI customers in February 2003 at its Irving,
Texas facility.
The Company anticipates capital expenditures in 2005 of approximately $1.0
million. The expenditures will primarily be comprised of production and
laboratory equipment and facility modifications.
Presently, the Company's debt/equity ratio is 0.72 to 1. Based on its
current estimates, management believes that the Company has the capacity to
incur additional debt, and, in 2005, the Company may seek additional
financing to be used as working capital to fund additional research and
development projects. The Company anticipates that any such borrowings,
together with the expected cash flows from operations and licensing
agreements and expected revenues from government grant programs, will
provide the funds necessary to finance its current operations, including
additional levels of research and development. However, the Company does
not expect that its current cash resources will be sufficient to finance
future major clinical studies and costs of filing new drug applications
which may be necessary to develop its products to their full commercial
potential. Additional funds, therefore, may need to be raised through
equity offerings, borrowings, licensing arrangements or other means.
Management believes that each of the enumerated financing avenues is
presently available to the Company. However, there is no assurance that the
Company will be able to obtain such funds on satisfactory terms when they
are needed.
In March 2001, the Board of Directors authorized the repurchase of up to
1,000,000 shares, or approximately 9.3% of the Company's outstanding Common
Stock, dependent on market conditions. Under the authorization, purchases
of Common Stock may be made on the open market or through privately
negotiated transactions at such times and prices as are determined jointly
by the Chairman of the Board and the President of the Company. The Board
authorized the repurchase program based on its belief that the Company's
stock is undervalued in light of the Company's future prospects and that it
would be in the best interest of Company and its shareholders to repurchase
some of its outstanding shares. As of March 2005, the Company had
repurchased 2,400 of its outstanding Common Stock under the program.
The Company is subject to regulation by numerous governmental authorities in
the United States and other countries. Certain of the Company's proposed
products will require governmental approval prior to commercial use. The
approval process applicable to pharmaceutical products and therapeutic
agents usually takes several years and typically requires substantial
expenditures. The Company and any licensees may encounter significant
delays or excessive costs in their respective efforts to secure necessary
approvals. Future United States or foreign legislative or administrative
acts could also prevent or delay regulatory approval of the Company's or any
licensee's products. Failure to obtain requisite governmental approvals or
failure to obtain approvals of the scope requested could delay or preclude
the Company or any licensees from marketing their products, or could limit
the commercial use of the products, and thereby have a material adverse
effect on the Company's liquidity and financial condition.
Results of Operations
---------------------
2004 was the third consecutive year of revenue growth and second consecutive
year of earnings growth for the Company. Revenues, product-related gross
margin and net income in 2004 increased from 2003 by 5.9%, 14.6%, and
102.4%, respectively. There were several key drivers for the increases in
revenue, product-related gross margin, and net income, including: (1)
increased sales of bulk raw material products by the Consumer Services
Division, (2) grant income from two NIAID awards received by DelSite, and
(3) cost reduction initiatives implemented to reduce freight costs, reduce
costs for raw material, packing materials and shipping supplies and reduce
administrative expenses.
The information presented in this financial review should be read in
conjunction with other financial information provided throughout this 2004
Annual Report. The following discussion of operating results focuses on the
Company's three reportable business segments: Medical Services Division,
Consumer Services Division and DelSite.
Net Revenue
-----------
Net revenues in 2004 were $30.8 million, a 5.9% increase from $29.1 million
in 2003. The 2004 revenue increase was the third consecutive year of revenue
growth for the Company. Included in the revenue growth of $1.7 million for
2004 was approximately $767,000 related to grant awards that were received
during 2004. Approximately $3.1 million in additional revenue resulted from
sales of the Company's bulk Manapol[R] powder in 2004. These were partially
offset by a decrease of $391,000 in medical services related revenue and
$1.69 million in specialty manufacturing sales.
Comparative net revenue information related to the Company's operating
segments is shown in the following tables.
2004 vs. 2003
Change
----------------
Net Revenue 2004 Total $ %
----------- ------ ----- ------ -----
Medical Services Division $10,391 33.7% $ (391) (3.6%)
Consumer Services Division 19,663 63.8% 1,342 7.3%
DelSite 767 2.5% 767 100.0%
------ ----- ------ -----
Total $30,821 100.0% $ 1,718 5.9%
====== ===== ====== =====
2003 vs. 2002
Change
----------------
Net Revenue 2003 Total $ %
----------- ------ ----- ------ -----
Medical Services Division $10,782 37.0% $ 1,312 13.8%
Consumer Services Division 18,321 63.0% 9,750 113.8%
DelSite 0 0.0% 0 0.0%
------ ----- ------ -----
Total $29,103 100.0% $11,062 61.3%
====== ===== ====== =====
The Medical Services Division revenues decreased $391,000, or 3.6%, in 2004
from 2003, primarily due to decreased demand of wound care products from
Medline, the Company's exclusive domestic distributor. Total sales of the
division's domestic wound care products decreased by $1.44 million to $4.10
million in 2004 from $5.54 million in 2003, as Medline decreased its
inventory stock levels. Additionally, the Division's products are facing
increasing competitive pressure from low-end, commodity-type products which
are eroding their market share. Educational efforts are underway to
support Medline's sales efforts in product differentiation, performance and
net cost of therapy to the customer. The Company has also initiated
selective advertisements to support its brand. Total sales of the Division's
international wound care products increased $396,000 to $844,000 in 2004
from $448,000 in 2003, with the sales increase due to increased European
sales. Additionally, sales of $2.97 million in 2004, compared to $2.33
million in 2003, were generated from products the Division produced for
Medline under a supply agreement entered into in December 2000, whereby the
company manufactures Medline's own branded dermal management products on a
non-exclusive basis. The Division also recorded royalty revenue of $2.47
million in each of 2004, 2003 and 2002 relating to the exclusive Licensing
and Distribution Agreement with Medline.
The Medical Services Division's revenues increased 13.8% in 2003 from 2002.
This sales growth resulted primarily from additional products being added to
the Supply Agreement including the production of Medline's dermal management
products, sales of which increased by $1.28 million to $2.33 million in 2003
from $1.05 million in 2002.
The Company's Consumer Services Division recorded an increase in revenues of
$1.34 million, or 7.3%, to $19.66 million in 2004 over revenues of $18.32
million in 2003. Sales of bulk Manapol[R] powder grew $3.11 million to
$14.56 million in 2004 from $11.46 million in 2003. The Division currently
sells bulk Manapol[R] powder to Natural Alternatives under a one-year, non-
exclusive supply and licensing agreement with Natural Alternatives and
Mannatech, Inc., that commenced in 1997 and extends to November 2005. Total
sales to this customer were $14.41 million, $11.35 million and $6.37 million
for the years 2004, 2003 and 2002, respectively. Sales for the Division's
specialty manufacturing business, which develops and manufactures a variety
of gels, creams, lotions and drinks for customers in the cosmetic, skin care
and nutraceutical industries, decreased $1.69 million to $4.66 million in
2004 from $6.35 million in 2003, due in part to intensifying competition
in the specialty manufacturing market. Of this decrease, $529,000 was
attributable to the cancellation of a single product manufactured for a
major customer, and $171,000 was due to a decrease in international sales of
drinks manufactured for Japan, Taiwan and Korea. Additionally, sales of the
Division's Aloeceuticals[R] line of immune-enhancing dietary supplements
decreased by $77,000 to $442,000 in 2004 from $519,000 in 2003.
The Consumer Services Division's revenues increased 113.8% in 2003 from
2002. The 2003 revenue growth of $9.75 million was primarily attributable
to sales of the Division's bulk Manapol[R] powder, which increased by $4.95
million to $11.46 million in 2003 from $6.51 million in 2002, and to $4.11
million of sales of products the Company produced for former customers of
CBI in the first year after the acquisition. Additionally, an $846,000
increase was attributable to the addition of a single product manufactured
for a major customer. These increases were partially offset by an
international sales decrease of $137,000 for drinks manufactured for Japan,
Taiwan and Korea.
Revenues from the Company's DelSite subsidiary were $767,000 in 2004, the
first year that DelSite has recorded revenues. These revenues represent two
grant awards received from NIAID. In March 2004 DelSite received a Small
Business Innovation Research grant award of up to $888,000 over a two-year
period. Revenue of $447,000 was recognized in 2004 from this grant. In
October 2004 DelSite received a $6 million grant award from NIAID under a
biodefense and SARS product development initiative that will fund a three-
year preclinical program. Revenue of $320,000 was recognized in 2004 from
this grant.
Product Related Gross Margin
----------------------------
The product-related gross margins of $11.80 million in 2004 reflect a $1.51
million, or 14.6%, increase over 2003. The increase in product-related
gross margins reflects the increased revenue levels for the Consumer
Services Division plus cost reduction programs that led to improvements in
capacity utilization and production efficiencies. Product-related gross
margins of $10.30 million in 2003 were 63.4% higher than the $6.30 million
received in 2002. This increase was primarily the result of increased sales
levels and improved capacity utilization.
Comparative product-related gross margin information related to the
Company's business segments is shown in the following table.
2004 vs. 2003
Change
----------------
Product Related Gross Margin 2004 Total $ %
---------------------------- ------ ----- ------ -----
Medical Services Division $ 2,550 21.6% $ (465) (15.4%)
Consumer Services Division 9,254 78.4% 1,971 27.1%
------ ----- ------ -----
Total $11,804 100.0% $ 1,506 14.6%
====== ===== ====== =====
2003 vs. 2002
Change
----------------
Product Related Gross Margin 2003 Total $ %
---------------------------- ------ ----- ------ -----
Medical Services Division $ 3,014 29.3% $ 5 0.2%
Consumer Services Division 7,283 70.7% 3,990 121.1%
------ ----- ------ -----
Total $10,297 100.0% $ 3,995 63.4%
====== ===== ====== =====
Product-related gross margin for the Medical Services Division, which
includes $2.47 million of royalty revenue for each year presented, decreased
15.4% to $2.55 million in 2004 from $3.01 million in 2003. The reduction in
product-related gross margin in 2004 was primarily the result of increased
sales of Medline-branded dermal management products which have dramatically
lower product-related gross margins than the Carrington-branded wound care
products the Company produces. The increased production of these products
improved the capacity utilization and thereby helped to reduce manufacturing
variances in the Irving manufacturing facility. Product-related gross
margins in 2003 increased 0.2% from 2002.
The Consumer Services Division reported an increase of $1.97 million, or
27.1%, in product-related gross margins in 2004 compared to 2003. The
increase was primarily due to the increase in sales noted above. In
addition, the Division experienced reductions in the direct cost of
packaging components and a shift in product mix toward higher margin product
sales. The segment's 2003 product-related gross margin increased 121.1%
over 2002 primarily as a result of increased sales of cosmetic products
manufactured from the CBI acquisition, increased sales of bulk Manapol[R]
powder, and ongoing discretionary cost reduction programs.
DelSite's 2004 revenues were $767,000. DelSite has no direct cost of goods
sold, only research and development cost.
Selling, General and Administrative Expenses
--------------------------------------------
The Company experienced a decrease of 5.7% in selling, general and
administrative expenses during 2004. These expenses totaled $7.56 million
in 2004, a decrease of $457,000 from $8.02 million in 2003. The Company
recorded a decrease in distribution-related expenses of $254,000 to $2.03
million in 2004 from $2.29 million in 2003. The reduction was primarily
related to consolidated shipping programs and reduced freight rates achieved
through improved negotiations with freight carriers. Additionally, the
Company experienced a $74,000 decrease in selling expenses to $2.06
million in 2004 from $2.13 million in 2003. This decrease was primarily
attributable to headcount reductions in Aloeceuticals[R] sales personnel.
The Company also recorded a decrease of $128,000 in administrative expenses
to $3.47 million in 2004 from $3.60 million in 2003 as the Company more
efficiently managed these expenses.
In 2003, the Company experienced a $1.98 million, or 32.8% increase in
selling, general and administrative expenses from $6.04 million in 2002.
Distribution-related expenses increased by $1.09 million in 2003 due to
increased shipping volume and increased facility costs associated with the
growing business. Selling expenses increased by $403,000 and administrative
costs increased by $480,000 primarily in the areas of salary, professional
fees and information systems expenses to support the increased level of
operations and to improve the infrastructure of the Company.
Research and Development
------------------------
Specialized research and development expenses in support of the Company's
ongoing operations rose by 1.3%, increasing to $911,000 in 2004 from
$899,000 in 2003. These expenses decreased by 52.8% in 2003 from $1.70
million in 2002. The significant decrease in 2003 was a result of the
Company's efforts to refocus the activities of this group toward services in
support of manufacturing, including formulation design, formulation
modifications and re-engineering, technology transfer to the manufacturing
suite and stability studies.
DelSite operates independently from the Company's specialized research and
development program and is responsible for the research, development and
marketing of the Company's proprietary GelSite[R] technology for controlled
release and delivery of bioactive pharmaceutical ingredients. DelSite began
operations in January 2002 and its expenses totaled $3.83 million in 2004.
The 2004 expenditures were a 38.6% increase over the 2003 expenditures of
$2.76 million. The 2003 expenditures were a 47.7% increase over the 2002
expenditures of $1.87 million.
Combined research and development expenses totaled $4.74 million, $3.66
million and $3.58 million for the years 2004, 2003 and 2002, respectively.
Other Expense (Income)
----------------------
Other expense or income primarily consists of collections the Company has
received from Rancho Aloe against a fully reserved note receivable balance.
Interest Expense
----------------
Net interest expense of $205,000 was recorded in 2004 versus net interest
expense of $249,000 in 2003, with the decrease of $44,000 due to lower
outstanding debt balances throughout 2004. Net interest expense increased
by $208,000 in 2003, rising from $41,000 in 2002 to $249,000. The increase
was due to increased Company borrowings in 2003.
Income Taxes
------------
The Company incurred $125,000 of foreign income tax expense related to the
Company's operations in Costa Rica in 2004. This was the first year that
these activities were subject to income taxes. The Company commenced
operations in Costa Rica in July 1992 and was granted a 100% exemption for
the first twelve years of operation and a 50% exemption for the next six
years of operation. The Company's current tax rate in Costa Rica is 15% and
will increase to 30% effective July 1, 2010.
There was no benefit or expense for U.S. income taxes in 2004, 2003 or 2002
as the Company has provided a valuation allowance against all U.S. deferred
tax asset balances at December 31 of each year due to the uncertainty
regarding realization of the asset.
Net Earnings and Earnings Per Share
-----------------------------------
Net earnings of $36,000, or basic and diluted earnings per share of $0.00,
were at a three-year high in 2004. Net loss was $1.50 million in 2003, or
basic and diluted loss per share of $(0.15), compared to a loss of $3.38
million, or basic and diluted loss per share of $(0.34) in 2002. Basic and
diluted average shares outstanding for 2004 were 10,590,062 and 11,171,305,
respectively, compared to basic and diluted average shares outstanding for
2003 of 10,120,147. Basic and diluted average shares outstanding for 2002
were 9,888,759. The increase in basic and diluted average shares outstanding
was primarily due to additional stock option grants that are in-the-money at
year end and employee share purchases.
Impact of Inflation
-------------------
The Company does not believe that inflation has had a material impact on its
results of operations.
Critical Accounting Policies
----------------------------
The Company has identified the following accounting policies as critical.
The Company's accounting policies are more fully described in Note Two
of the Financial Statements. The preparation of consolidated financial
statements requires the Company to make estimates and judgments that affect
the reported