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SECURITES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 27, 2004
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE EXCHANGE ACT
COMMISSION FILE NUMBER 0-9478
__________________________
SPECTRUM LABORATORIES, INC.
(Exact name of small business registrant as specified in its charter)
DELAWARE 95-4718363
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
18617 BROADWICK STREET, RANCHO DOMINGUEZ, CALIFORNIA 90220
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (310) 885-4600
Indicate by check mark whether the issuer (1) filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act during the past 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 [ ]
Number of shares of Common Stock outstanding as of April 30, 2004: 5,312,468
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT
YES [ ] NO [X]
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Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheet as of March 27, 2004 3
Consolidated Statements of Income for the Three Months Ended
March 27, 2004 and March 29, 2003 4
Consolidated Statements of Cash Flows for the Three Months Ended
March 27, 2004 and March 29, 2003 5
Notes to Consolidated Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 9
Item 3. Controls and Procedures 10
Part II - OTHER INFORMATION
Item 1. Legal Proceedings 10
Item 2. Changes in Securities 10
Item 3. Defaults Upon Senior Securities 10
Item 4. Submission of Matters to a Vote of Security Holders 10
Item 5. Other Information 10
Item 6. Exhibits and Reports on Form 8-K 10
Signature 11
Exhibits Certifications - Chief Executive Officer and Chief Financial
Officer 12
2
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEET
AS OF MARCH 27, 2004
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 3,355
Accounts receivable 2,003
Inventories 2,739
Prepaid expenses 186
Deferred financing costs 130
Deferred taxes 579
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Total current assets 8,992
INVESTMENT IN MARKETABLE SECURITIES 1,160
EQUIPMENT AND LEASEHOLD IMPROVEMENTS 2,670
GOODWILL 1,122
DEFERRED TAXES 1,026
PATENTS, subject to amortization, net of accumulated
amortization of $197 553
OTHER ASSETS 33
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Total assets $15,556
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LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term debt $ 960
Accounts payable 589
Accrued expenses and other current liabilities 434
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Total current liabilities 1,983
LONG-TERM DEBT, net of current maturities 1,545
MINORITY INTEREST 1,755
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value, 25,000,000 shares authorized;
5,312,468 shares issued and outstanding 53
Preferred stock, par value $.01; 10,000,000 shares authorized;
none issued and outstanding --
Additional paid-in capital 8,624
Accumulated other comprehensive income 696
Retained earnings 900
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Total stockholders' equity 10,273
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Total liabilities and stockholders' equity $15,556
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See Notes to Consolidated Financial Statements.
3
SPECTRUM LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS ENDED MARCH 27, 2004 AND MARCH 29, 2003
(IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
(UNAUDITED)
March 27, March 29,
2004 2003
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NET SALES $3,090 $3,458
COSTS AND EXPENSES
Cost of sales 1,807 1,794
Selling, general and administrative 942 1,055
Research and development 223 206
Other expense, primarily interest 23 36
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Total costs and expenses 2,995 3,091
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Income before provision of income taxes 95 367
Provision for income taxes 25 110
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Net Income $ 70 $ 257
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Earnings per share:
Basic $ 0.01 $ 0.05
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Diluted $ 0.01 $ 0.05
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Weighted average shares outstanding:
Basic 5,312 5,312
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Diluted 5,513 5,373
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See Notes to Consolidated Financial Statements.
4
SPECTRUM LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 27, 2004 AND MARCH 29, 2003
(IN THOUSANDS)
(UNAUDITED)
2004 2003
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 70 $ 257
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 206 187
Noncash compensation 3 3
Change in working capital components:
(Increase) in accounts receivable (340) (187)
(Increase) in inventories (77) (59)
Decrease (Increase) in prepaid expenses 32 (46)
(Decrease) in accounts payable (33) (25)
Increase in accrued expenses 20 194
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NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (119) 324
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CASH FLOWS (USED IN) INVESTING ACTIVITIES:
Acquisition of equipment and leasehold improvements (123) (178)
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CASH FLOWS (USED IN) FINANCING ACTIVITIES:
Principal payments of long-term debt (240) (223)
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NET DECREASE IN CASH AND CASH EQUIVALENTS (482) (77)
CASH AND CASH EQUIVALENTS, beginning of period 3,837 5,109
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CASH AND CASH EQUIVALENTS, end of period $ 3,355 $ 5,032
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See Notes to Consolidated Financial Statements.
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NOTES TO CONSOLIDATED STATEMENTS
Note 1
Basis of Presentation - The accompanying unaudited financial statements
consolidate the accounts of Spectrum Laboratories, Inc. and its subsidiaries,
SLI Acquisition Corp., Spectrum Europe B.V. and Spectrum Chromatography
(collectively, the Company). All significant intercompany transactions have been
eliminated in consolidation. In the opinion of management, the accompanying
unaudited interim consolidated financial statements contain all adjustments
(consisting only of normal recurring adjustments) necessary to present fairly
the financial position of the Company as of March 27, 2004 and the results of
its operations and its cash flows for the three months ended March 27, 2004 and
March 29, 2003. Certain information and footnote disclosures normally included
in the financial statements have been condensed or omitted pursuant to rules and
regulations of the Securities and Exchange Commission, although the Company
believes that the disclosures in the unaudited interim financial statements are
adequate to make the information presented not misleading.
Determining Impairment on Long-lived Assets - The Company recognizes impairment
losses for long-lived assets used in operations when indicators of impairment
are present and the future undiscounted cash flows are not sufficient to recover
the assets' carrying amount. Management believes there has been no impairment of
the value of such assets. The analysis of indicators of impairment and future
cash flows are estimates made by management.
Patents - The Company has acquired patents utilized within the various
manufacturing processes. These patents are amortized over their respective
lives, typically 17 years. Management believes there has been no impairment in
the value of these patents.
Estimates & Reserves - The Company's principal reserves relate to accounts
receivable and inventory. A detailed review of these reserves is done annually
with a general review quarterly. Based on the most recent annual review the
Company believes these reserve are adequate and the amounts consistent with
prior year's level. A significant estimate is made in the annual impairment
testing of goodwill. Changes in management's estimate of fair value of the
Company could result in future impairment charges.
Accounting for Stock-based Compensation - The Company accounts for stock-based
employee compensation under the requirements of Accounting Principles Board
(APB) Opinion No. 25, which does not require compensation to be recorded if the
consideration to be received is at least equal to fair value at the measurement
date. Nonemployee stock-based transactions are accounted for under the
requirements of the Financial Accounting Standards Board's (FASB) Statement of
Financial Accounting Standards (SFAS) No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION, which requires compensation to be recorded based on the fair value
of the securities issued or the services received, whichever is more reliably
measurable.
SFAS No. 123 requires the disclosure of pro forma net income and earnings per
share had the Company adopted the fair value method. Under SFAS No. 123, the
fair value of stock-based awards to employees is calculated through the use of
option-pricing models, even though such models were developed to estimate the
fair value of freely tradable, fully transferable options with vesting
restrictions which significantly differ from the Company's stock option awards.
These models also require subjective assumptions, including future stock price
volatility and expected time to exercise, which greatly affect the calculated
value.
The calculations are based on a single-option valuation approach and forfeitures
are recognized as they occur. The following table illustrates the effect on net
income and earnings per share had compensation cost for stock-based compensation
been determined based on the grant date fair values of awards (refer to next
page for table):
6
Note 1 Accounting for Stock-based Compensation (Continued)
Three Months Ended
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2004 2003
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Net income (loss):
As reported $ 70,000 $ 257,000
Add total stock-based employee compensation
expense determined under APB opinion 25,
net of related tax effects 3,000 3,000
(Deduct) total stock-based employee compensation
expense determined under fair value based for all
awards, net of related tax benefits (15,000) (16,000)
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Pro forma $ 58,000 $ 244,000
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Basic earnings (loss) per share:
As reported $ 0.01 $ 0.05
Pro forma $ 0.01 $ 0.05
Diluted earnings (loss) per share:
As reported $ 0.01 $ 0.05
Pro forma $ 0.01 $ 0.05
Note 2 - Inventories
Inventories are stated at the lower of cost, determined using the first-in,
first-out method, or net realizable value and are composed of the following (in
thousands):
Raw materials $2,292
Work in process 360
Finished goods 729
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3,381
Less reserve for slow moving & obsolete items 642
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$2,739
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Note 3 - Earnings per Share
Basic earnings per share is computed by dividing the net income attributable to
the common stockholders by the weighted average number of common shares
outstanding during the period. There is no adjustment in the net income
attributable to common stockholders. Diluted earnings per share reflect the
potential dilution that could occur from common shares issuable through stock
options and warrants (201,351 and 60,621 equivalent shares in the first quarter
of fiscal 2004 and fiscal 2003 respectively).
Note 4 - Income Taxes
In assessing the realizability of deferred tax assets, management has estimated
that it is likely that approximately $1,500,000 will not be realized. This
valuation allowance represents a portion of net operating loss carryforwards
attained through a prior business acquisition. As further discussed below, tax
law limits the use of an acquired entity's net operating loss carryforwards to
subsequent taxable income of the consolidated entity. Management will continue
to evaluate the realizability of the deferred tax assets by assessing the need
for and amount of a valuation allowance.
At December 27, 2003, the Company had approximately $6.1 million in net
operating loss carryforwards for federal income tax purposes available to offset
future taxable income. Certain of these loss carryforwards are limited to
approximately $298,000 annually. Any unused net operating loss is carried
forward. As a result of the limitation discussed above, it is probable that
approximately $4.5 million of the Company's net operating loss will expire
without utilization.
7
Note 5 - Product Group Information
The Company's product groups are based on specific product characteristics and
are grouped into laboratory products and operating room disposable products.
Laboratory products consist primarily of: (1) membranes used to concentrate,
separate and purify dissolved or suspended molecules that are sold primarily to
laboratories and (2) hollow fiber membrane devices that allow components
retained by a membrane to be concentrated including filters utilized for micro
and ultrafiltration separations that are sold to biotech and pharmaceutical
companies. Operating room disposable products consist primarily of sterile
plastic surgical drapes and cloth bandages that are sold primarily to hospitals.
Revenue by product group is as follows (in thousands):
2004 2003
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Laboratory products 2,666 3,038
Operating room disposable products 424 420
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$3,090 $3,458
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Note 6 - Option Plan
The Company had two options plans referred to as the 1995 Option Plan and the
2000 Option Plan with 200,000 and 300,000 shares of common stock, respectively
reserved for option grants to key employees, directors and consultants. In July
2002, the shareholders approved merging the 1995 Option Plan and the 2000 Option
Plan into one plan to be referred to as the 2000 Option Plan (the "2000 Option
Plan"). In addition, shareholders approved an increase to the number of shares
available to grant under the 2000 Option Plan by 100,000 to a total of 600,000.
As of March 27, 2004, there were 433,100 options outstanding under the 2000
Option Plan. There were no grants or cancellations of options during the three
months ended March 27, 2004.
Note 7 - Spectrum Chromatography Sale
The Company entered into an agreement, dated February 27, 2004, (the
"Agreement") to potentially sell its subsidiary Spectrum Chromatography, Inc.
("SCI"). The parties have been unable to finalize the negotiations related to
SCI and thus the Agreement has been terminated.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion should be read in conjunction with the Consolidated
Financial Statements of Spectrum Laboratories, Inc. and Notes thereto contained
elsewhere within this Report on Form 10-QSB. Except for the historical
information contained herein, the following discussion may contain
forward-looking statements that involve risks and uncertainties. The actual
future results of the Company could differ materially from those discussed here.
Factors that could cause or contribute to such differences include, but are not
limited to, those discussed in this report and those factors discussed in the
Company's Form 10-KSB for the year ended December 27, 2003 as filed with the
Securities and Exchange Commission and, from time to time, in the Company's
other reports on file with the Commission.
Results of Operations
Sales
Sales for the first quarter ended March 27, 2004 were lower by $368,000 (10.6%),
primarily due to volume, when compared to the first quarter of 2003. The decline
in sales related to the laboratory product group and was primarily related to
two distributors, one domestic and the other foreign.
Gross Margin
Gross margin for the first quarter was $1,283,000 (41.5%) versus $1,664,000
(48.4%) for the first quarter of 2003. The decline in gross margin percentage
was primarily due to Spectrum's distribution to its Original Equipment Market
("OEM"). Spectrum accepted a significant OEM order from one customer which
generated approximately $300,000 in sales during the 1st quarter. Although these
sales were at lower than normal gross margin, Spectrum anticipates enhancing the
production process in the future to take advantage of economies of scale to
improve its margin not only on future shipments related to this specific order
but also for anticipated future orders. Margin was also impacted by a higher
than normal scrap rate during the quarter.
8
Selling, General & Administrative ("SG&A") and Research & Developmental Expenses
("R&D")
R&D expenses were $223,000 for the first quarter, an increase of $17,000 (8.3%)
over prior year. Spectrum continues to spend on R&D as reflected by the increase
in expenditures of $26,000 related to outside consultants. SG&A expenditures in
the first quarter of 2004 declined $113,000 (10.7%) as compared to first quarter
of 2003. The decline principally related to advertising related expenditures of
$66,000 as Spectrum has currently curtailed monies spent on its BioProcessor
newsletter and has delayed issuing an updated printed catalog versus focusing on
the maintenance of its WEB site which management believes is more cost
effective.
Net Income
Considering the above discussed shortfall in sales and the negative impact on
gross margin partially offset by reduced expenditures in SG&A, net income for
the quarter was $70,000.
Liquidity and Capital Resources
Cash used by operations for the first quarter was $119,000 as the above
discussed net income of $70,000 plus non cash depreciation expenses were more
than offset by the increase in accounts receivable of $340,000. The increase in
receivables definitely appears as timing as the Company believes there are no
material collection issues. In addition the increase appears customer orientated
as Spectrum's receivables have historically increased in the first quarter over
the past 5 years.
The above discussion of cash used from operating activities was also impacted by
$240,000 in bank loan payments and $123,000 for the acquisition of equipment.
This resulted in a net decrease in cash for the period of approximately $482,000
to a cash balance at March 27, 2004 of $3,355,000.
The Company was in violation of one covenant at March 27, 2004 that related to
cash flow to debt coverage for which Spectrum received a covenant waiver from
its bank.
In December of 2001 Spectrum entered into a specific research, licensing,
manufacturing and supply agreements (the "Agreements") with an unrelated
company, now known as Arbios Systems, Inc. ("Arbios"). These Agreements, among
other aspects, resulted in Spectrum being granted 362,669 shares of Arbios.
Arbios became a public company on October 30, 2003 and originally traded on the
Pink Sheets electronic trading system under the symbol of ABOS.PK. Arbios is now
listed on the OTC Bulleting Board under the symbol of ABOS.OB. Arbios is an
early-stage biomedical device company engaged in the discovery, acquisition and
development of proprietary liver assist devices and new technologies useful in
the diagnosis and treatment of acute liver failure. In compliance with SFAS 115
based on the listed trade price of $2.50 per share Spectrum allocated $907,000
as the fair market value reflecting this amount as accumulated other
comprehensive income on its balance sheet as of December 27, 2003. Based on
Arbios most recent trade price of $3.20, as of March 27, 2004, Spectrum
reflected an increase in fair market value of $253,000 to $1,160,000 on its
balance sheet as of March 27, 2004. Spectrum has classified this amount as a non
current asset as it realizes there have been limited trades in Arbios and the
potential to sell the stock may be limited. In addition Arbios being an early
stage developmental company this investment may be subject to significant
adjustments.
The Company is obligated under the terms of various operating lease agreements
for manufacturing, warehouse and office facilities. Certain of these leases
provide for rent escalation adjustments. Minimum future rental payments under
these operating lease agreements for the final three quarters ending December
28, 2004 and the subsequent years ending December 31 are as follows: final three
quarters 2004 $369,000; years ending 2005 $336,000; and 2006 $106,000 (total
$811,000).
During the first quarter the Company did issue warrants to an Independent
Company (the Warrant Holder) to purchase 125,000 shares of common stock at $1.70
per share through February 4, 2010. The Warrant Holder is entitled to purchase
an additional 125,000 shares of common stock at $1.70 upon having assisted
Spectrum in raising at least $2.5 million in gross proceeds form one or more
private or public equity financings originated or facilitated by the Warrant
Holder through February 3, 2010.
Spectrum's calculations for the 125,000 warrants granted were made using the
Black-Scholes warrant-pricing model with the following weighted average
assumptions: expected life of three years; stock volatility of 66%; risk-free
interest rate 2.5%; and no dividends during the expected term. Based on the
Black-Scholes warrant-pricing model Spectrum has recorded $130,000 in Deferred
Financing Costs as of March 27, 2004 associated with the 125,000 warrants issued
during the first quarter.
9
Item 3. Controls and Procedures
As of the end of the period covered by this report, the Company conducted an
evaluation, under the supervision and with the participation of the principal
executive officer and principal financial officer, of the Company's disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934 (the "Exchange Act")). Based on this evaluation,
the principal executive officer and principal financial officer concluded that
the Company's disclosure controls and procedures are effective to ensure that
information required to be disclosed by the Company in reports that it files or
submits under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in Securities and Exchange Commission rules
and forms. There was no change in the Company's internal control over financial
reporting during the Company's most recently completed fiscal quarter that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Change in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31 (a) & (b) Rule 13a-14(a)/15d-14(a) Certifications
32 (a) & (b) 18 U.S.C. Section 1350 Certifications
(b) The Company filed no reports on Form 8-K during the quarter ended
March 27, 2004.
10
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized, on May 11, 2004.
SPECTRUM LABORATORIES, INC.
(Registrant)
/s/ F. Jesus Martinez
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Signature
F. Jesus Martinez
President
/s/ Brian A. Watts
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Signature
Brian A. Watts
Chief Financial Officer/Vice President of Finance
11