- --------------------------------------------------------------------------------
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 JUNE 26, 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 July 30, 2004: 5,312,468
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT
YES [ ] NO [X]
- --------------------------------------------------------------------------------
PAGE
----
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheet as of June 26, 2004 3
Consolidated Statements of Income for the Three and
Six Months Ended June 26, 2004 and June 28, 2003 4
Consolidated Statements of Cash Flows for the Three
Months Ended June 26, 2004 and June 28, 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 11
Part II - OTHER INFORMATION
Item 1. Legal Proceedings 11
Item 2. Changes in Securities 11
Item 3. Defaults Upon Senior Securities 11
Item 4. Submission of Matters to a Vote of Security Holders 11
Item 5. Other Information 11
Item 6. Exhibits and Reports on Form 8-K 11
Signature 12
Exhibits Certifications - Chief Executive Officer and
Chief Financial Officer 13
2
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
SPECTRUM LABORATORIES, INC.
Consolidated Balance Sheet
AS OF JUNE 26, 2004
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 3,447
Accounts receivable 2,119
Inventories 2,680
Prepaid expenses 155
Deferred financing costs 130
Deferred taxes 579
------------
Total current assets 9,110
INVESTMENT IN MARKETABLE SECURITIES 1,197
EQUIPMENT AND LEASEHOLD IMPROVEMENTS 2,524
GOODWILL 1,122
DEFERRED TAXES 1,011
PATENTS, subject to amortization, net of accumulated amortization of $197 538
OTHER ASSETS 33
------------
Total assets $ 15,535
============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term debt $ 960
Accounts payable 447
Accrued expenses and other current liabilities 455
------------
Total current liabilities 1,862
LONG-TERM DEBT, net of current maturities 1,305
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 8,627
Accumulated other comprehensive income 718
Retained earnings 1,215
------------
Total stockholders' equity 10,613
------------
Total liabilities and stockholders' equity $ 15,535
============
See Notes to Consolidated Financial Statements.
3
SPECTRUM LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended Six Months Ended
----------------------------- ------------------------------
June 26, 2004 June 28, 2003 June 26, 2004 June 28, 2003
-------------- -------------- -------------- --------------
NET SALES $ 3,512 $ 3,327 $ 6,602 $ 6,785
COSTS AND EXPENSES
Cost of sales 1,909 1,772 3,716 3,566
Selling, general and administrative 957 1,083 1,899 2,138
Research and development 171 212 394 418
Other expense, primarily interest 20 36 43 72
-------------- -------------- -------------- --------------
Total costs and expenses 3,057 3,103 6,052 6,194
-------------- -------------- -------------- --------------
Income before provision of income taxes 455 224 550 591
Provision for income taxes 140 62 165 172
-------------- -------------- -------------- --------------
Net Income $ 315 $ 162 $ 385 $ 419
============== ============== ============== ==============
Earnings per share:
Basic $ 0.06 $ 0.03 $ 0.07 $ 0.08
============== ============== ============== ==============
Diluted $ 0.06 $ 0.03 $ 0.07 $ 0.08
============== ============== ============== ==============
Weighted average shares outstanding:
Basic 5,312 5,312 5,312 5,312
============== ============== ============== ==============
Diluted 5,523 5,396 5,518 5,384
============== ============== ============== ==============
See Notes to Consolidated Financial Statements.
4
SPECTRUM LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 26, 2004 AND JUNE 28, 2003
(IN THOUSANDS)
(UNAUDITED)
2004 2003
------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 385 $ 419
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 412 376
Noncash compensation 6 6
Change in working capital components:
(Increase) Decrease in accounts receivable (456) 200
(Increase) in inventories (18) (341)
Decrease (Increase) in prepaid expenses 63 (64)
(Decrease) in accounts payable (175) (101)
Increase (Decrease) in accrued expenses 41 (12)
------------- --------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 258 483
------------- --------------
CASH FLOWS (USED IN) INVESTING ACTIVITIES:
Acquisition of equipment and leasehold improvements (168) (300)
------------- --------------
CASH FLOWS (USED IN) FINANCING ACTIVITIES:
Principal payments of long-term debt (480) (463)
------------- --------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (390) (280)
CASH AND CASH EQUIVALENTS, beginning of period 3,837 5,109
------------- --------------
CASH AND CASH EQUIVALENTS, end of period $ 3,447 $ 4,829
============= ==============
See Notes to Consolidated Financial Statements.
5
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 June 26, 2004 and the results of its
operations and its cash flows for the six months ended June 26, 2004 and June
28, 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.
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. 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 Six Months Ended
------------------------------- -------------------------------
June 26, 2004 June 28, 2003 June 26, 2004 June 28, 2003
-------------- -------------- --------------- --------------
Net income:
As reported $ 315,000 $ 162,000 $ 385,000 $ 419,000
Add total stock-based employee
compensation expense determined
under APB opinion 25, net of
related tax effects 3,000 3,000 6,000 6,000
(Deduct) total stock-based employee
compensation expense determined
under fair value based for all
awards, net of related tax benefits (14,000) (17,000) (29,000) (33,000)
-------------- -------------- --------------- --------------
Pro forma $ 304,000 $ 148,000 $ 362,000 $ 392,000
============== ============== =============== ==============
Basic earnings per share:
As reported $ 0.06 $ 0.03 $ 0.07 $ 0.08
Pro forma $ 0.06 $ 0.03 $ 0.07 $ 0.07
Diluted earnings per share:
As reported $ 0.06 $ 0.03 $ 0.07 $ 0.08
Pro forma $ 0.06 $ 0.03 $ 0.07 $ 0.07
Weighted average shares outstanding:
Basic 5,312,000 5,312,000 5,312,000 5,312,000
============== ============== =============== ==============
Diluted 5,523,000 5,396,000 5,518,000 5,384,000
============== ============== =============== ==============
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):
INVENTORY - PER INVENTORY LEAD SCHEDULE
Raw materials $ 2,273
Work in process 285
Finished goods 726
----------
3,284
Less reserve for slow moving & obsolete items 604
----------
$ 2,680
==========
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 (210,345 and 205,848 equivalent shares in the fiscal year
2004 three and six month periods respectively and 83,122 and 71,872 shares in
fiscal year 2003 three and six month periods, respectively).
7
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.
Note 5 - Product Group Information
While management has determined the Company operates as a single reportable
segment, the Company's product groups are based on specific product
characteristics and are grouped into bioprocessing products ("BioProcessing"),
formerly referred to as laboratory products, and disposable operating room
products ("OR"). BioProcessing products consist primarily of membranes and
modules used to filter, extract, concentrate, separate and purify. These
products are sold primarily to laboratories, research institutions, biotech and
pharmaceutical companies. OR products consist primarily of sterile surgical
drapes and bandages that are sold primarily to hospitals and their suppliers.
Revenue by product group is as follows (in thousands):
SEGMENT SALES:
Three Months Ended Six Months Ended
----------------------------- ------------------------------
June 26, 2004 June 28, 2003 June 26, 2004 June 28, 2003
------------- ------------- ------------- -------------
BioProcessing 3,108 2,904 5,774 5,942
OR 404 423 828 843
----------- ----------- ----------- -----------
$ 3,512 $ 3,327 $ 6,602 $ 6,785
=========== =========== =========== ===========
Note 6 - Option Plan
The Company has an option plan referred to as the 2000 Option Plan (the "2000
Option Plan" or "Plan") with 600,000 shares of common stock reserved for option
grants to key employees, directors and consultants. Exercise prices for the
stock options will not be less than 100% of the fair market value of the stock
on the date of grant. Options under the Plan expire not more than ten years from
date of grant. Options under the Plan become exercisable over a 5 year period
(20% per year). As of June 26, 2004, there were 425,050 options outstanding
under the 2000 Option Plan. In addition to the 2000 Option Plan there are
265,624 non qualified stock options outstanding. There were no grants of options
during the six months ended June 26, 2004 while 8,050 options were forfeited.
8
Note 7- Comprehensive Income
Comprehensive income is comprised of net income and Other Comprehensive Income
("OCI"). OCI includes certain changes in stockholders' equity that are excluded
from net income. Specifically, the Company includes in OCI changes in the fair
value of unrealized gains and losses on Spectrum's available for sale
securities. The activity in comprehensive income during the three and six month
periods ended June 26, 2004 was as follows (in thousands):
Three Months Six Months
Ended June 26, Ended June 26,
2004 2004
----------- -----------
Net Income $ 315 $ 385
Unrealized gain on investment in
marketable securities 37 290
Tax expense (15) (116)
----------- -----------
Comprehensive income $ 337 $ 559
=========== ===========
The activity in accumulated OCI, net of taxes for the six months ended June 26,
2004 was as follows (in thousands):
Unrealized gain on securities available for sale (net of tax
effect of $363 at the beginning of the year) $ 544
Change in unrealized gain on securities available for sale
(net of tax effect of $116) 174
----------
Unrealized gain on securities available for sale as of
June 26, 2004, (net of tax effect of $479) $ 718
==========
Spectrum did not have any securities available for sale during the six months
ended June 28, 2003.
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 second quarter ended June 26, 2004 increased $185,000 (5.6%), when
compared to the second quarter of 2003. The increase in sales related to the
BioProcessing product group with a second quarter sales increase of $204,000
(7.0%).
Sales on a year to date basis for 2004 were below prior year by $183,000
(2.7%) with both BioProcessing and OR products being short of prior year by
$168,000 (2.8%) and $15,000 (1.8%), respectively.
Gross Margin
Gross margin for the second quarter of 2004 was $1,603,000 (45.6%) versus prior
year second quarter margin of $1,555,000 (46.7%), an increase of $48,000 (3.1%).
On a year to date ("YTD") basis gross margin for 2004 was $2,886,000 (43.7%)
versus $3,219,000 (47.4%) for 2003 a decrease of $333,000 (10.3%). The decline
9
in gross margin percentage, as noted in Spectrum's first quarter 10QSB, was
principally attributed to one specific Spectrum product. Spectrum accepted a
significant order from one customer early in the first quarter which has
generated approximately $573,000 in sales during the first 6 months of 2004.
These sales have been at lower than normal gross margin although Spectrum
continues to review its options in attempting to improve its production process.
It should be noted these sales do assist Spectrum in improving its fixed
overhead absorption rate. Approximately $225,000 remains to be shipped relating
to this order as of June 26, 2004.
Selling, General & Administrative ("SG&A") and Research & Developmental Expenses
("R&D")
During the second quarter of 2004 R&D expenses were $171,000 while SG&A expenses
were $957,000 decreases of $41,000 (19.3%) and $126,000 (11.6%), respectively
when compared to 2003. The decrease in R&D principally relates to reduced
personnel offset partially by utilizing outside engineering consultants. The
decline in SG&A expenditures were principally related to reduced advertising
related expenditures of $94,000. On a year to date basis R&D expenses were
$394,000, a decrease of $24,000 (5.7%) versus prior year. As noted above, the
decrease is principally associated with reduced staffing offset by utilizing
expert engineering consultants. YTD SG&A expenses totaled $1,899,000 a reduction
of $239,000 (11.3%) compared to 2003, principally associated with advertising
related expenditures.
Net Income
Considering the above, net income for the quarter was $315,000 an increase of
$153,000 (94.4%) versus the second quarter of 2003. On a YTD basis net income
for 2004 was $385,000 slightly below prior year by $34,000 (8.1%).
Liquidity and Capital Resources
Cash provided by operations for the first six months of 2004 was $258,000.
Working capital components totaled $545,000 principally due to the increase in
accounts receivable of $456,000. The increase in receivables relates to timing
as the Company believes there are no material collection issues.
The above discussion of cash provided by operating activities was also impacted
by financing activity relating to $480,000 in bank loan payments and $168,000 in
investing activity associated with the acquisition of equipment. This resulted
in a net decrease in cash for the YTD period of approximately $390,000 to a cash
balance at June 26, 2004 of $3,477,000.
The Company was in violation of one covenant at June 26, 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 No.
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 $3.30, as of June 26, 2004, Spectrum reflected
an increase in fair market value of $290,000 to $1,197,000 on its balance sheet
as of June 26, 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, due to 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 two quarters ending December 28,
2004 and the subsequent years ending December 31 are as follows: final two
quarters 2004 $246,000; years ending 2005 $336,000; and 2006 $106,000 (total
$627,000).
During the first quarter of 2004 the Company issued warrants to a third party
(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 from one or more private or
public equity financings originated or facilitated by the Warrant Holder through
February 3, 2010.
10
Spectrum's estimate of the fair value of the first 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 associated with the 125,000 warrants issued during the
first quarter. Should Spectrum not raise the required $2.5 million in gross
proceeds the $130,000 in Deferred Financing Costs would be charged to expense.
If Spectrum is successful in raising the required $2.5 million the additional
125,000 warrants will vest immediately upon issuance The Company will measure
the warrants using the Black-Scholes warrant pricing model and the fair value of
the warrants will be charged against the proceeds. In addition, the current
deferred financing costs will be netted against the proceeds.
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
June 26, 2004.
11
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 August 10, 2004.
SPECTRUM LABORATORIES, INC.
(Registrant)
/S/ F. Jesus Martinez
- ---------------------
Signature
F. Jesus Martinez
President
/S/ Brian A. Watts
- ------------------
Signature
Brian A. Watts
Chief Financial Officer/Vice President of Finance
12