<PAGE>
U.S. Securities and Exchange Commission
Washington, D.C. 20549
Form 10-KSB
Annual Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934 (Fee Required)
For the Fiscal Year Ended December 31, 1996
Commission File No. 0-9478
Spectrum Laboratories, Inc.
(Name of small business issuer in its charter)
California 95-3557359
- ------------------- --------------------
(State or other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
23022 La Cadena Drive
Laguna Hills, California 92653
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (714) 581-3880
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock
(Title of Class)
Check 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 ___
Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation S-B is not contained in this form and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-KSB or any amendment to this Form 10-KSB [ X ].
State issuer's revenues for its most recent fiscal year: $8,698,794
The aggregate market value of voting stock held by nonaffiliates of the
registrant is $304,344 as of December 31, 1996, based on the $.34 per share
closing price for the Common Stock in the over-the-counter market on such
date, representing 895,132 shares held by nonaffiliates.
Number of shares of Common Stock outstanding as of December 31, 1996:
12,834,394
This report includes a total of 36 consecutive numbered pages; the exhibit
index of documents incorporated by reference is on page 34.
1
<PAGE>
TABLE OF CONTENTS
FORM 10-KSB ANNUAL REPORT
FOR THE YEAR ENDED DECEMBER 31, 1996
SPECTRUM LABORATORIES, INC.
Item No. Page
- -------- ----
Part I
1. Description of Business...................................-3-
2. Description of Property...................................-8-
3. Legal Proceedings.........................................-9-
4. Submission of Matters to a Vote of Security Holders.......-9-
Part II
5. Market for Common Equity and Related Shareholder Matters..-9-
6. Management's Discussion and Analysis of Financial
Condition and Results of Operation........................-9-
7. Financial Statements.....................................-12-
8. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure......................-30-
Part III
9. Directors, Executive Officers, Promoters and Control
Persons; Compliance with Section 16(a) of the
Exchange Act.............................................-30-
10. Executive Compensation...................................-31-
11. Security Ownership of Certain Beneficial Owners
and Management...........................................-32-
12. Certain Relationships and Related Transactions...........-33-
13. Exhibits and Reports on Form 8-K.........................-34-
2
<PAGE>
This Annual Report Form 10-KSB contains certain forward-looking statements,
the realization of which may be impacted by certain important factors which
are discussed in "Additional Factors That May Affect Future Results," under
Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
Part I
Item 1. Description of Business
GENERAL
- -------
Spectrum Laboratories, Inc. (the "Company") was incorporated in California
on June 5, 1980 under the name Immutron, Inc., as a successor to a joint
venture organized in October 1978 by Nuclear Medical Systems, Inc., and Life
Studies, Incorporated. On November 23, 1982, the Company changed its name
to Spectrum Laboratories, Inc.
HOLLOW FIBER MEMBRANE DEVICES
Hollow fiber membrane products fall into three different categories:
laboratory products, OEM and private label products and process products.
Laboratory products, comprising approximately 25% of sales volume in fiscal
1995 and 1996 of hollow fiber membrane products, are small compact membrane
devices and are utilized in general laboratory filtration. These are
generally sold through distributors.
OEM and private label products are special versions of the laboratory
products sold under private label or to manufacturers of medical devices or
water treatment systems. Application areas include: point-of-use water
filtration; gas filtration for semiconductor blow-off guns, plasma gas
cauterizing devices, insufflator kits for endoscopic surgery; drug
filtration for surgical eyewash solutions, and pain management parenterals.
These products comprise approximately 30% of sales volume in fiscal 1995 and
1996, and are sold direct to third party manufacturers for resale to the end
users.
Process products are tangential flow membrane devices that allow components
that are retained by the membrane to be concentrated. Hollow fiber membrane
process products are sold direct to pharmaceutical and diagnostic
manufacturers in the U.S. Overseas sales are both direct and through
distributors depending on the region. Process products account for
approximately 45% of hollow fiber membrane device sales in fiscal 1995 and
1996.
CELL EXPANSION
On October 1, 1996, the Company through its wholly-owned subsidiary Spectrum
Laboratories, Inc. Acquisition Corp. purchased certain assets of Cellco,
Inc., a Delaware Corporation located in Germantown, Maryland. Cellco
provides artificial capillary systems to academic, pharmaceutical,
laboratory and clinical research markets involved in the expansion and
maintenance of human and animal cells.
3
<PAGE>
MICROBIOLOGICAL SAMPLING AND TRANSPORT PRODUCTS (See note 12 in Financial
Statements-Subsequent Events)
The sampling and transport products include swabs sold under the trade names
"Calgiswab", "Rayswab" and "Dacroswab" and transport products sold under the
name "Transette". All swab and Transette products are used primarily by
physicians for sample collection of disease organisms for diagnostic
purposes and sell for under $1 each.
The Calgiswab is the leading calcium alginate-tipped swab in the United
States. Other Swab products are marketed with wood, plastic, aluminum or
stainless steel shafts and cotton, dacron or rayon tips, depending upon use
or user preference.
Transettes are sterile sample collection and transport systems consisting of
a swab and a plastic pouch
containing growth media to protect the sample during shipment. Transettes
are available with any of the swabs marketed by the Company and also in
disease-specific form wherein the growth media is designed specifically to
support the type of organism being tested. A disease-specific Transette is
available for gonorrhea testing.
MEDICAL DISPOSABLE DEVICES
Hydro-Med Products, Inc. ("Hydro-Med") is a wholly-owned subsidiary of the
Company. Hydro-Med is primarily a manufacturer of medical disposable
devices such as sterile surgical drapes for orthopedic and arthroscopic
surgical procedures, sterile camera covers, rubber elastic bandages (sterile
and nonsterile), esmark bandages, and a tamper-resistant container system
for use in harvesting bone and tissue for human transplantation, and other
surgical specialty products.
MARKETS AND METHODS OF DISTRIBUTION
- -----------------------------------
HOLLOW FIBER MEMBRANE DEVICES
The Company has over 225 active customers, comprised of pharmaceutical and
diagnostic manufacturers, medical device manufacturers, laboratories,
laboratory distributors and research institutions for its Microgon products.
Approximately 20% of its sales are from non U.S. customers.
CELL EXPANSION
Cellco has over 300 active customers comprised of academic, research,
pharmaceutical, laboratory, and clinical research companies and institutes.
Domestic sales are made with a direct sales force and foreign sales are made
through direct sales and laboratory products distributors.
MICROBIOLOGICAL SAMPLING AND TRANSPORT PRODUCTS
The Company's microbiological sampling and transport product lines have
approximately 275 active customers, of which approximately 30 are domestic
and foreign distributors, including Baxter Scientific Products, Fisher
Scientific, VWR Scientific and Curtin Matheson Scientific. Direct sales are
also made to physician's offices and research and government laboratories.
4
<PAGE>
The Company relies primarily upon unaffiliated distributors, advertising in
the distributor catalogs, and direct mailings through product postcards and
flyers to market its products. The Company's swab and Transette product
lines are prominently displayed in the Baxter Scientific Products
advertising literature.
MEDICAL DISPOSABLE DEVICES
Hydro-Med has over 600 active customers, the most active of which are 450
hospitals and 100 hospital supply dealers. Export and O.E.M. accounts are
currently confined to a select few products, mostly for orthopedics. Hydro-
Med does not employ its own sales force but uses commissioned manufacturers'
representatives to call on end users such as hospitals and doctors, as well
as stocking distributors capable of supplying product delivery on a local
level.
RAW MATERIALS AND SUPPLIES
- --------------------------
HOLLOW FIBER MEMBRANE DEVICES
The Company purchases common raw membrane polymers and casting solvents from
a variety of sources. Membranes are assembled into housings that are molded
from commonly available plastic resins by third party plastic molders, using
tooling owned by the Company. Membranes are affixed to the housings by
means of proprietary potting resins supplied by two different suppliers who
are covered by an industry cooperative disaster recovery plan which allows
manufacturers to manufacture the resins in the event of an interruption of
supply.
CELL EXPANSION
Cellco purchases hollow fiber membrane devices from Spectrum Laboratories or
other commercially available hollow fiber membrane devices. Cellco is
dependent on a limited number of suppliers for hollow follow membrane
devices but has not experienced any difficulty in obtaining necessary
supplies.
MICROBIOLOGICAL SAMPLING AND TRANSPORT PRODUCTS
The principal raw materials used by the Company in its microbiological
products include calcium alginate and several widely available substances
such as plastic, cotton, rayon, dacron and aluminum. There are sources of
calcium alginate located in France and in the United States, and the Company
feels it could supply its need from these sources. The Company orders large
quantities of certain raw materials to obtain competitive pricing or to meet
its vendors' minimum order requirements. The Company is not dependent upon
any one or a limited number of sources for any other raw materials and has
not experienced any difficulty in obtaining necessary supplies.
MEDICAL DISPOSABLE DEVICES
The principal raw materials used by Hydro-Med in producing sterile surgical
drapes and elastic bandages are yarn, natural latex and plastic film. There
are several suppliers in the United States for yarn. Hydro-Med is dependent
on one or a limited number of suppliers for plastic film but has not
experienced any difficulty in obtaining necessary supplies, and none are
presently anticipated.
5
<PAGE>
PATENTS AND TRADEMARKS
- ----------------------
HOLLOW FIBER MEMBRANE DEVICES
The Company holds patents for hollow fiber syringe tip filters and
trademarks for, DynaFibre, DynaGard, KrosFlo, MediaKap, MiniKap and
MiniKros. Fundamental technology is kept as trade secrets. Employees and
vendors are covered by suitable non-disclosure agreements.
CELL EXPANSION
Cellco is the assignee of the trademark right to Cellmax. Cellco is the
assignee of eight patents, including one for "Serum free production of
packaged viral vector."
MICROBIOLOGICAL SAMPLING AND TRANSPORT PRODUCTS
The Company is the assignee of the trademark right to Calgiswab.
MEDICAL DISPOSABLE DEVICES
Hydro-Med is the assignee of two U.S. patents. The patents are for
"Apparatus for Forming a Rolled Tubular Fabric Article" and "Surgical
Extremity Drape". Hydro-Med is also the assignee of trademark rights to Dry
Docks and Strap-Stroll.
A finding of invalidity or unenforceability of certain of the Company's
patents, may have a materially adverse effect on the Company's business.
GOVERNMENT REGULATIONS
- ----------------------
The Food and Drug Administration (the "FDA") and the California Food and
Drug Bureau ("CFDB") regulate the manufacture and quality control procedures
of certain of the Company's products. The Company has been audited by the
FDA and all items noted during their audit have been addressed or released.
Compliance with FDA and CFDB regulations is a significant expense but the
Company believes that such expenses are costs of doing business in the
industry and that the Company's expenses are similar those of other
companies in the business.
HOLLOW FIBER MEMBRANE DEVICES
In addition to regulations enforced by the FDA and the CFDB, the Company is
also subject to regulations under the Environmental Protection Act, the
Occupational Safety and Health Act, and other present and potential
supranational, foreign, Federal, state and local regulations. Compliance
with any of these has not had a material effect on the capital expenditures,
operations or competitive position of the Company to date.
The Company cannot predict whether future changes in government regulations
might increase its cost of conducting business or affect the time required
to develop and introduce new products.
6
<PAGE>
DEPENDENCE UPON FEW CUSTOMERS
- -----------------------------
The Company does not believe that its business would be adversely affected
by the loss of any individual customer or small group of customers. During
the years ending December 31, 1995 and December 31, 1996, no customer
accounted for more 10% or more of the Company's total net combined sales.
SEASONAL ASPECTS
- ----------------
The Company's business is not subject to significant seasonal fluctuations
in sales.
COMPETITIVE FACTORS
- -------------------
HOLLOW FIBER MEMBRANE DEVICES
The Company's hollow fiber membrane devices compete with Gelman Sciences,
Millipore, and Nalge in the laboratory products area. OEM and private label
products are long-term supply contracts where competition for continuing
business is limited. Laboratory products are price and performance
competitive with other products for media sterilization. OEM and private
label products offer high surface area in compact housings in comparison
with competing products. Process products are offered as disposables in
competition with traditional tangential flow devices which are cleaned and
re-used. Tangential flow products are attractive to users who have
critical applications where single-use will ensure optimum performance
and/or simplify the validation of the process for FDA approval. In the
process area, Millipore and Amicon division of W.R. Grace are the major
competitors. It is estimated that market share is less than 5% in every
market served.
MICROBIOLOGICAL SAMPLING AND TRANSPORT PRODUCTS
The Company competes with two major companies, Johnson & Johnson and Becton
Dickinson, in the sale of its swab products other than Calgiswab, which
competes only with a product marketed by Hardwood Products and Purfybr.
The primary competitive factors affecting the sale of microbiological
products are price and quality, and the Company believes that the price and
quality of its microbiological products compare favorably with products sold
by other companies having greater resources than the Company.
CELL EXPANSION
The company has several competitors for hollow fiber membrane devices
including Cellex Bioscience, Unisyn Technologies and Integra Bioscience.
MEDICAL DISPOSABLE DEVICES
Hydro-Med has several competitors for its sterile video camera drape, the
largest of whom is considered to be the Xomed Company, a division of
Bristol-Meyers. Sterile extremity drapes for surgical procedures are
produced by several manufacturers. Companies such as Johnson & Johnson and
Baxter Travenol, who include surgical extremity drapes as part of an
integrated "procedure pack", both custom and standard, for specific types of
procedures, (e.g., orthopedic surgery or arthroscopic or cardiovascular
surgical cases), dominate that market.
7
<PAGE>
Hydro-Med manufactures a rubber elastic bandage that does not require the
need for metal clips. Currently, the market is dominated by such
competitors as Becton Dickinson, producers of ACEJ bandages, Johnson &
Johnson, producers of Dyna-FlexJ and Kendall, producers of TensorJ, all of
which have greater resources than the Company.
RESEARCH AND DEVELOPMENT
The Company incurred research and development expenses of $411,095 in 1996
and $186,078 in 1995. Research and development are particularly important
for the Company's hollow fiber membrane devices.
EMPLOYEES
On December 31, 1996, the Company had 66 employees, of which 45 were
production workers, 16 were manufacturing support and administrative
personnel and 5 were marketing and customer service representatives. The
company believes it has good relations with its employees.
Item 2. Description of Property
The Company's executive offices are located at 23022 La Cadena Dr., Laguna
Hills, California. The building is rented by Spectrum Medical Industries,
Inc., an affiliate of the Company, controlled by Roy T. Eddleman with a
portion sublet to the Company. The space is used by the Company for storage
and general, administration and executive offices. The Company pays a
monthly rent of $3,174 based upon square footage used by the Company. The
Company's sub lease expires on December 31, 1997.
The Company has production and warehouse space in Dallas and locations it
occupies in Los Angeles and Orange Counties, California. The following
table summarizes the terms of the leases of other properties leased by the
Company.
<TABLE>
<caption
Lessor & Location Lessee & Usage Sq. Feet Begin End Term Mths. Rental
- ----------------- -------------- -------- ----- --- ---------- ------
<S> <C> <C> <C> <C> <C> <C>
Gick Family Microgon, Inc. 8,830 12/1/94 12/31/97 12 $4,840(1)
Partnership Light Manufacturing
23152 Verdugo Dr. R&D and Offices
Laguna Hills, CA
Herschel Brown Spectrum Laboratories, 20,000 1/1/95 12/31/97 36 $4,823(2)
2930 Ladybird Lane Inc.
Dallas, Texas
Andrew Barrett Cellco, Inc. 2,217 1/1/96 12/31/97 12 $4,393
12321 Middlebrook
Germantown, MD
</TABLE>
(1) Increases to $5,324 for 1997.
(2) Increases to $5,083 for 1997.
8
<PAGE>
Item 3. Legal Proceedings
There is no material pending legal proceedings to which the Company is a
party or of which any of its property is the subject. The Company knows of
no legal proceedings contemplated by any governmental authority or agency.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Part II
Item 5. Market for Common Equity and Related Shareholder Matters
The Company's Common Stock is currently traded on the over-the-counter
market with trading prices quoted in the Over the Counter (OTC) Bulletin
Board.
The 1996 and 1995 bid and ask quotations are the over-the-counter market
quotations obtained from a market maker as of the last day of each quarter
during the respective year. The quotations shown represent inter-dealer
prices without adjustment for retail markups, markdowns or commissions and
do not necessarily reflect actual transactions.
1996 Bid Asked
---- --- -----
March 31 3/8 2
June 30 3/8 5/8
September 30 3/8 9/16
December 30 5/16 7/16
1995 Bid Asked
---- --- -----
March 31 3/8 1/2
June 30 3/8 5/8
September 30 3/8 9/16
December 29 5/16 7/16
No dividends have been declared or paid by the Company since inception.
Additionally, the Company's financing agreements with the bank prohibit the
payment of dividends without the bank's approval. The Company intends to
employ all available funds for development of its business and, accordingly,
does not intend to pay cash dividends in the foreseeable future.
As of December 31, 1996, the approximate number of holders of record of the
Company's Common Stock was 380.
Item 6. Management's Discussion and Analysis of Financial Condition and
Results of Operation.
The following discussions relate to the Company, its wholly owned
subsidiaries, SLI Acquisition Corporation ("SLI AC"), and Hydro-Med Products
("Hydro-Med") and Microgon, Inc. ("Microgon") and its partially owned
subsidiary, Spectrum Europe B.V. ("Spectrum B.V."). During 1995, the
Company acquired Microgon, Inc. under a transaction accounted for as a step
acquisition. The Company has consolidated the financial position and
operations of Spectrum B.V. for all periods presented. On March 31, 1997
the Company sold its Microbiological sampling and transport products
business for $800,000.00 plus the value of inventory. See Note 1 of Notes
to the Consolidated Financial Statements.
9
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NET SALES
- ---------
Net sales for 1996 were $8,698,794 compared to net sales of $6,478,299 for
1995, an increase of 34.3%. Substantially all of the increase in sales is
attributable to an increase in sales of hollow fiber membrane devices as a
result of the acquisition of Microgon in August 1995. Additionally, the
Company experienced a minor sales increase of $271,277 due to the purchase
of Cellco by the company's wholly-owned subsidiary SLI AC.
EXPORT SALES AND MAJOR CUSTOMERS
- --------------------------------
Foreign sales to customers in foreign countries, primarily Europe, amounted
to $1,826,127 and $1,963,007 in 1996 and 1995, respectively. This increase
was caused by continued penetration of Spectrum B.V. into the European
markets. Major customers change from year to year depending upon the level
of purchasers. In 1996 and 1995, no one customer accounted for 10% or more
of combined sales.
COST OF SALES
- -------------
Gross margins were 39.9% for 1996 and 31.9% for 1995. The gross margin
increased in 1996 primarily because of increased sales of hollow fiber
membrane devices that yield higher gross margins.
SELLING EXPENSES
- ----------------
Selling expenses increased to $1,127,080 in 1996 from $952,577 in 1995, an
increase of 18.2%. Selling expenses increased due to higher selling costs
of hollow fiber membrane products and Cellco products, and the publishing of
"Spectrum Updates" for use as a marketing tool.
GENERAL AND ADMINISTRATIVE EXPENSES
- -----------------------------------
Combined general and administrative expenses increased to approximately
$615,207 to 17% of net sales in 1996 from 14% of net sales in 1995. The
increase in general and administrative expenses relates to the acquisitions
in 1995 and 1996 of Microgon and Cellco, respectively, and some
implementation costs for a new management information system.
RESEARCH AND DEVELOPMENT
- ------------------------
Research and development costs increased to $411,095 in 1996 from $186,078
in 1995. Research and development for 1996 was 121% of net sales. The
increase in research and development expenses was due primarily to an
increase in costs of research materials and salaries of researchers to
develop and test potential new hollow fiber membrane products. In-process
research and development costs were a portion of the purchase price of the
acquisition of Cellco by SLIAC. The $1,700,000 was allocated to in-process
research and development costs based upon an independent appraisal.
OTHER INCOME, EXPENSE
- ---------------------
Other expense increased approximately $165,000 in 1996 as compared to 1995.
The increase relates to interest incurred on borrowings to finance the
Microgon acquisition.
10
<PAGE>
NET INCOME, LOSS
- ----------------
In 1996, the Company incurred a loss of $1,693,191 as compared to net losses
of $269,352 in 1995. The 1996 loss results primarily from the one time
write off of $1,700,000 in process research and development costs related to
the Cellco acquisition.
PROVISION FOR INCOME TAXES
- --------------------------
The provision for income taxes in 1995 and 1996 relates primarily to minimum
state taxes and taxes on earnings of the Company's foreign subsidiary.
LIQUIDITY
- ---------
At December 31, 1996, the Company had cash and cash equivalents of $591,854.
Total working capital was $1,144,054. During 1996, $1,397,317 cash was
provided by operating activities, net of the effect of acquisition, and
approximately $242,000 was expended for property acquisitions.
Historically, the Company has relied on cash flows from operations and
financing from outside sources and/or affiliates to fund its activities and
expects to do so in the future. At December 31, 1996, the Company had
outstanding borrowings from a bank for $1,942,857, Microgon acquisition
related borrowings of $219,076 and Cellco borrowings of $180,803. At
December 31, 1996, the Company was not in compliance with certain financial
covenants relating to the $1,942,857 loan from the bank. On February 28,
1997, the Company refinanced its notes payable with a $3,600,000 term loan
requiring 60 monthly installments of $60,000 starting April 1, 1997 bearing
interest at 9.14%. The term loan is collateralized by substantially all of
the assets of the Company and is guaranteed by the majority shareholder.
The Company believes that cash flow from operations will be sufficient for
the Company to meet its obligations through December 1997.
11
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Spectrum Laboratories, Inc.:
We have audited the accompanying consolidated balance sheet of Spectrum
Laboratories, Inc. and subsidiaries (the Company) as of December 31, 1996
and the related consolidated statements of operations, shareholders' equity
and cash flows for the years ended December 31, 1995 and 1996. These
financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements
based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the consolidated financial position of Spectrum
Laboratories, Inc. and subsidiaries at December 31, 1996 and the results of
their consolidated operations and their consolidated cash flows for the
years ended December 31, 1995 and 1996 in conformity with generally accepted
accounting principles.
DELOITTE & TOUCHE LLP
March 14, 1997
Costa Mesa, California
12
<PAGE>
SPECTRUM LABORATORIES, INC.
CONSOLIDATED BALANCE SHEET
AS OF DECEMBER 31, 1996
- ----------------------------------------------------------------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 591,854
Receivables - trade, net of allowance for doubtful
accounts of $52,921 1,182,687
Due from affiliates (Note 8) 331,764
Inventories, net (Note 3) 1,431,102
Prepaid expenses and other current assets 105,498
--------------
Total current assets 3,642,905
PROPERTY AND EQUIPMENT, net (Note 4) 1,152,834
OTHER ASSETS:
Deferred income taxes (Note 6) 377,185
Intangible and other assets (Note 2) 179,877
Goodwill (Notes 1 and 2) 3,056,323
--------------
Total other assets 3,613,385
--------------
$ 8,409,124
==============
See accompanying notes to consolidated financial statements.
13
<PAGE>
SPECTRUM LABORATORIES, INC.
CONSOLIDATED BALANCE SHEET
AS OF DECEMBER 31, 1996 (Continued)
- ----------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 843,895
Accrued compensation 239,140
Accrued other 322,503
Income taxes payable 71,291
Due to affiliates (Note 8) 264,999
Current portion of long-term debt (Notes 2 and 7) 757,023
--------------
Total current liabilities 2,498,851
LONG-TERM LIABILITIES:
Long-term debt (Notes 2 and 7) 1,652,377
Long-term debt - affiliates (Notes 2 and 7) 1,238,836
Other long-term liabilities 162,107
--------------
Total long-term liabilities 3,053,320
MINORITY INTEREST (Note 1) 2,046,989
SHAREHOLDERS' EQUITY (Note 5):
Common stock, par value $.01; 25,000,000 shares authorized;
12,834,394 shares issued and outstanding 128,344
Additional paid-in capital 5,237,848
Accumulated deficit (4,518,310)
Unrealized loss on foreign currency translation (37,918)
--------------
Total shareholders' equity 809,964
--------------
$ 8,409,124
==============
See accompnaying notes to consolidated financial statements.
14
<PAGE>
SPECTRUM LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995
- ----------------------------------------------------------------------------
1996 1995
NET SALES (Notes 8 and 10) $ 8,698,794 $ 6,478,299
COSTS AND EXPENSES (Note 8):
Cost of sales 5,229,422 4,406,556
Selling 1,127,080 952,577
General and administrative 1,517,860 902,653
Research and development 411,095 186,078
In-process research and development costs
(Note 2) 1,700,000
Other expense, primarily interest 287,677 121,853
------------- -------------
Total costs and expenses 10,273,134 6,569,717
------------- -------------
LOSS BEFORE MINORITY INTEREST IN INCOME
OF SUBSIDIARY AND PROVISION FOR INCOME
TAXES (1,574,340) (91,418)
MINORITY INTEREST IN INCOME OF
SUBSIDIARY (Note 1) (56,512) (139,848)
------------- -------------
LOSS BEFORE PROVISION FOR INCOME TAXES (1,630,852) (231,266)
PROVISION FOR INCOME TAXES (Note 6) 62,339 38,086
------------- -------------
NET LOSS $ (1,693,191) $ (269,352)
============= =============
NET LOSS PER COMMON SHARE $ (0.13) $ (0.05)
============= =============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 12,834,394 5,014,328
============= =============
See accompnaying notes to consolidated financial statements.
15
<PAGE>
<TABLE>
SPECTRUM LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995
- ----------------------------------------------------------------------------
<CAPTION>
Unrealized
Unrealized loss on
Additional gains on foreign
Common stock paid-in investment currency Accumulated
Shares Amount capital securities translation deficit Total
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE,
January 1, 1995 2,200,000 $ 22,000 $4,712,000 $ 5,774 $ - $(2,555,767) $ 2,184,007
Net loss (269,352) (269,352)
Issuance of
common stock
in connection
with acquisition
of subsidiary
(Note 2) 10,634,394 106,344 525,848 632,192
Unrealized
investment
gains, net of
tax 7,146 7,146
Foreign currency
translation loss (33,076) (33,076)
---------- -------- ---------- --------- --------- ------------ ------------
BALANCE,
December 31,
1995 12,834,394 128,344 5,237,848 12,920 (33,076) (2,825,119) 2,520,917
Net loss (1,693,191) (1,693,191)
Unrealized
investment
losses, net of
tax (12,920) (12,920)
Foreign currency
translation loss (4,842) (4,842)
---------- -------- ---------- --------- --------- ------------ ------------
BALANCE,
December 31,
1996 12,834,394 $128,344 $5,237,848 $ - $(37,918) $(4,518,310) $ 809,964
========== ======== ========== ========= ========= ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
16
<PAGE>
SPECTRUM LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995
- ----------------------------------------------------------------------------
1996 1995
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (1,693,191) $ (269,352)
Adjustments to reconcile net loss to net
cash provided by operating activities,
net of effects of the acquisition:
Depreciation and amortization 399,896 244,264
Gain on sale of securities 4,805
Minority interest in income of subsidiary 56,512 139,848
Deferred income taxes 1,750
In-process research and development costs 1,700,000
Change in assets and liabilities, net of
effect of acquisition:
(Increase) decrease in receivable -
trade, net (24,940) 639,815
Decrease (increase) in due from affiliates 310,821 (530,585)
Decrease in inventories, net 341,325 43,130
(Increase) decrease in prepaid expenses and
other current assets (38,195) 84,769
(Increase) decrease in other assets (19,401) 1,667
Increase in accounts payable and accrued and
other liabilities 325,468 278,443
Increase in income taxes payable 33,205 38,086
Increase (decrease) in due to affiliates 21,829 (509,969)
Other (17,762) (33,076)
------------- -------------
Net cash provided by operating
activities 1,397,317 131,845
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment (242,406) (376,731)
Increase (decrease) in investments 63,180 (26,113)
Cash paid for acquisition, net of cash
acquired (Note 2) (3,708,353)
------------- -------------
Net cash used in investing activities (179,226) (4,111,197)
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on long-term debt (908,709) (302,640)
Proceeds relating to advances from affiliates
and issuances of long-term debt 200,000 3,705,502
------------- -------------
Net cash (used in) provided by
financing activities (708,709) 3,402,862
------------- -------------
See accompanying notes to consolidated financial statements.
17
<PAGE>
SPECTRUM LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 (Continued)
- ----------------------------------------------------------------------------
1996 1995
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS $ 509,382 $ (576,490)
CASH AND CASH EQUIVALENTS, beginning of year 82,472 658,962
------------- -------------
CASH AND CASH EQUIVALENTS, end of year $ 591,854 $ 82,472
============= =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION -
Cash paid for:
Income taxes $ 4,415 $ 18,871
============= =============
Interest $ 274,455 $ 242,242
============= =============
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
The Company recorded unrealized (losses) gains of $(12,920) and $7,146 on
its investment portfolio for the years ended December 31, 1996 and 1995,
respectively.
The Company recorded SMI's minority interest in the income of Spectrum B.V.
of $56,512 and $139,848 for the years ended December 31, 1996 and 1995,
respectively.
During 1996, SLIAC acquired substantially all the net assets of Cellco, Inc.
In conjunction with the acquisition, liabilities were assumed as follows:
Fair value of assets acquired $ 773,407
Intangibles 211,698
In-process research and development costs 1,700,000
Preferred stock issued in exchange for assets (Note 2) (2,000,000)
--------------
Liabilities assumed $ 685,105
==============
During 1995, the Company acquired all the capital stock of Microgon, Inc.
In conjunction with the acquisition, liabilities were assumed as follows:
Fair value of assets acquired $ 4,450,662
Cash paid for capital stock 3,764,089
--------------
Liabilities assumed $ 686,573
==============
In conjunction with the acquisition of Microgon (Note 2), $686,573 of notes
payable and common stock valued at $632,192 were assumed and/or issued to
the previous and current shareholders of SMI and Microgon.
See accompanying notes to consolidated financial statements.
18
<PAGE>
SPECTRUM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995
- ----------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS AND BASIS OF PRESENTATION - Spectrum Laboratories, Inc.
(Spectrum or the Company), its wholly-owned subsidiaries, SLI Acquisition
Corporation (SLIAC) (Note 2) and Hydro-Med Products, Inc. (Hydro-Med), and
its partially-owned subsidiary, Spectrum Europe B.V. (Spectrum B.V.), are
engaged in a single business segment: the development, manufacture and sale
of medical products. Spectrum's product lines consist of microbiological
sampling and transport systems. SLIAC's product lines consist of systems
and products for use in cell culture and cellular therapeutics. Hydro-Med's
product lines consist of surgical drapes, rubber elastic bandages, sterile
camera covers and a tamper-resistant container system for use in harvesting
bone and tissue for human transplantation. Microgon, Inc. (Microgon) was
purchased in 1995 (Note 2) and merged into the Company. Microgon's product
lines consist of disposable cellulose nitrate and cellulose acetate hollow
fiber microfiltration modules. All products are for sale primarily to the
pharmaceutical, biotechnology and medical industries. The Company operates
primarily in the United States with sales in the European market through
Spectrum B.V. Spectrum is 79% owned by Spectrum Medical Industries, Inc.
(SMI), an affiliated entity through common ownership.
PRINCIPLES OF CONSOLIDATION - The accompanying consolidated financial
statements include the accounts of Spectrum, its wholly-owned subsidiaries
SLIAC and Hydro-Med, and its partially-owned subsidiary, Spectrum B.V.
Spectrum and SMI hold approximately 40% and 60% of the equity interest,
respectively, of Spectrum B.V. For financial reporting purposes, the
assets, liabilities, results of operations and cash flows of Spectrum B.V.
are included in Spectrum's consolidated financial statements as Spectrum
exercises significant financial and operational control over Spectrum B.V.
through common ownership interest. SMI's interest in Spectrum B.V. and the
preferred stock of SLIAC (Note 2) are reflected as a minority interest in
the accompanying consolidated financial statements. All intercompany
balances and transactions have been eliminated in consolidation.
USE OF ESTIMATES - The preparation of the combined financial statements in
conformity with generally accepted accounting principles requires management
to make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting years. Actual results could differ from those
estimates.
CREDIT RISK - The Company sells its products nationally and internationally,
primarily through distributors to medical equipment and medical supply
companies. The Company performs ongoing credit evaluations of its customers
and generally does not require collateral. The Company maintains reserves
for potential credit losses.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents are comprised of
demand deposit accounts with original maturities of 90 days or less.
19
<PAGE>
SPECTRUM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 (Continued)
- ----------------------------------------------------------------------------
INVENTORIES - Inventories are stated at the lower of cost, determined using
the first-in, first-out method, or market value.
INVESTMENTS - The Company accounts for its investments under the provisions
of Statement of Financial Accounting Standards (SFAS) No. 115, Accounting
for Certain Investments in Debt and Equity Securities. Any unrealized gains
or losses related to available for sale securities is recorded as a
component of shareholders' equity, net of tax.
PROPERTY AND EQUIPMENT - Furniture, equipment and leasehold improvements are
stated at cost, net of accumulated depreciation and amortization.
Depreciation of equipment is provided using the straight-line method over
the estimated useful lives (generally five years) of the respective assets.
Leasehold improvements are amortized on a straight-line basis over the
lesser of the lease term or the estimated useful life of the asset.
GOODWILL - Goodwill represents the excess of the purchase price over the
fair value of net assets acquired from the Cellco Incorporated (Cellco)
(Note 2) acquisition during 1996 and Microgon acquisition during 1995.
Goodwill is being amortized on a straight-line basis over a 15- and 20-year
period for Cellco and Microgon, respectively. The Company measures the
recoverability of goodwill annually by comparing undiscounted expected
future cash flows from the related operations to the carrying value of
goodwill. Accumulated amortization of goodwill amounted to $226,403 at
December 31, 1996.
INTANGIBLE ASSETS - On January 1, 1996, the Company adopted SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of. SFAS No. 121 requires impairment losses to be recognized
for long-lived assets used in operations when indicators of impairment are
present and the undiscounted cash flows are not sufficient to recover the
assets' carrying amount. The Company measures the recoverability of
intangibles annually by comparing undiscounted expected future cash flows
from the related operations to the carrying value of intangibles.
Accumulated amortization of intangibles amounted to $459,549 at December 31,
1996.
INCOME TAXES - The Company accounts for income taxes under the provision of
SFAS No. 109, Accounting for Income Taxes. This statement requires the
recognition of deferred tax assets and liabilities for the future
consequences of events that have been recognized in the Company's financial
statements or tax returns. Measurement of the deferred items is based on
enacted tax laws. In the event the future consequences of differences
between financial reporting bases and tax bases of the Company's assets and
liabilities result in a deferred tax asset, SFAS No. 109 requires an
evaluation of the probability of being able to realize the future benefits
indicated by such asset. A valuation allowance related to a deferred tax
asset is recorded when it is more likely than not that some portion or all
of the deferred tax asset will not be realized.
REVENUE RECOGNITION - The Company records revenue at the time the related
products are shipped.
20
<PAGE>
SPECTRUM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 (Continued)
- ----------------------------------------------------------------------------
NET LOSS PER COMMON SHARE - Net loss per common share is computed using the
weighted average number of shares of common shares outstanding divided by
the net loss. Assumed exercise of outstanding options and the assumed
conversion of debt to affiliates into common stock have been excluded due to
their anti-dilutive nature.
TRANSLATION OF FOREIGN CURRENCIES - Assets and liabilities of Spectrum B.V.
are translated into U.S. dollars at year-end rates of exchange, and income
and expenses are translated at average rates during the respective years.
The functional currency of this subsidiary is the guilder; therefore,
translation gains or losses are recorded as a separate component of
shareholders' equity.
FAIR VALUE OF FINANCIAL INSTRUMENTS - Management believes that the carrying
amount of cash and cash equivalents, accounts receivable, accounts
receivable due from affiliates, accounts payable and accrued expenses
approximates fair value because of the short maturity of these financial
instruments. A portion of long-term debt bears interest at a rate indexed
to the prime rate, and the remaining long-term debt and notes payable to
affiliated parties bears interest at a rate comparable to prime at
December 31, 1996; therefore, management believes the carrying amount of the
outstanding borrowings at December 31, 1996 approximates fair market value.
STOCK OPTIONS - In October 1995, the Financial Accounting Standards Board
issued SFAS No. 123, Accounting for Stock-Based Compensation, which requires
adoption of the disclosure provisions no later than years beginning after
December 15, 1995 and adoption of the recognition and measurement provisions
for nonemployee transactions no later than after December 15, 1995. The new
standard defines a fair value method of accounting for stock options and
other equity instruments. Under the fair value method, compensation cost is
measured at the grant date based on the fair value of the award and is
recognized over the service period, which is usually the vesting period.
Pursuant to the new accounting standard, companies are encouraged, but are
not required, to adopt the fair value method of accounting for employee
stock-based transactions. Companies are also permitted to continue to
account for such transactions under Accounting Principles Board (APB)
Opinion No. 25, Accounting for Stock Issued to Employees, but are required
to disclose in a note to the financial statements pro forma net income and
earnings per share as if the Company had applied the new method of
accounting. The Company has determined that it will not change to the fair
value method and will continue to use APB Opinion No. 25 for measurement and
recognition of employee stock-based transactions (Note 5).
RECLASSIFICATIONS - Certain 1995 balances have been reclassified to conform
with the 1996 presentation.
21
<PAGE>
SPECTRUM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 (Continued)
- ----------------------------------------------------------------------------
2. ACQUISITIONS
On August 1, 1995, Spectrum acquired all of the outstanding common stock of
Microgon in exchange for 10,634,394 shares of Spectrum common stock. The
acquisition, which was accounted for as a step acquisition as of August 1,
1995, was valued at $5,082,854. The purchase price was paid through the
issuance of subordinated notes payable of $686,473, issuance of common stock
to a Microgon shareholder with a carryover basis of $632,192, and a cash
payment of $3,764,089. The notes payable were due in January 1997, bore
interest at 9% annually and were guaranteed by the majority shareholder in
SMI. Such notes were paid in 1997. The acquisition was financed through
borrowings by the Company of $2,500,000 (Note 7) from a bank and $1,105,000
from two significant shareholders of SMI (Note 7).
On October 1, 1996, SLIAC entered into an Asset Purchase Agreement with
Cellco, a Delaware corporation, and acquired the operating assets and
liabilities of Cellco in exchange for 10,000 shares of SLIAC preferred stock
valued at $2,000,000. The acquisition was recorded as a purchase for
accounting purposes and the purchase price of $2,085,000 was allocated to
assets acquired of $773,407, liabilities assumed of $685,105, intangible
assets of $211,698, and purchased research and development costs of
$1,700,000. The preferred shareholders of SLIAC have the right to put their
stock to SLI at any time from October 1, 2000 to September 30, 2001 for a
price of $2,000,000. In the event the Company is combined with SMI and the
combined company completes an underwritten offering, the preferred
shareholders have the right to exchange such stock for 7% of the newly
combined company. The right of exchange will be increased to 10% of the
newly combined company in the event SLIAC concludes certain contract
negotiations within 120 days of the public offering. The preferred shares
are non-voting and have preference over common shareholders as to dividends
and liquidation.
The following unaudited consolidated pro forma results of operations for the
years ended December 31, 1996 and 1995 assume the acquisition Cellco and
Microgon occurred at the beginning of the respective years. These unaudited
consolidated pro forma results have been prepared for comparative purposes
only and do not purport to be indicative of the results which would have
occurred had the acquisition been made as of that date or of results which
may occur in the future.
1996 1995
Net revenues $ 9,571,992 $ 9,059,828
============= =============
Net loss $ (2,610,540) $ (3,545,524)
============= =============
Net loss per common share $ (0.20) $ (0.28)
============= =============
Weighted average number of common shares
used in per share computation 12,834,394 12,834,394
============= =============
22
<PAGE>
SPECTRUM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 (Continued)
- ----------------------------------------------------------------------------
3. INVENTORIES
Inventories consist of the following at December 31, 1996:
Raw materials $ 525,934
Work in progress 72,507
Finished goods 1,035,897
--------------
1,634,338
Less reserve for obsolescence (203,236)
--------------
$ 1,431,102
==============
4. PROPERTY AND EQUIPMENT
Property and equipment consist of the following at December 31, 1996:
Equipment $ 4,051,044
Furniture 642,615
Leasehold improvements 764,441
--------------
5,458,100
Less accumulated depreciation and amortization (4,305,266)
--------------
$ 1,152,834
==============
5. STOCK OPTION PLAN
The Company has a Stock Option Plan (the Plan) providing for options to
purchase up to 2,000,000 shares of its common stock. The Plan provides for
the granting of options to qualified employees and consultants of the
Company at prices which are not less than 85% of the fair market value of
the shares as of the date of grant. The options become exercisable as
specified in the Plan, expire not more than ten years from the date of
grant, and become exercisable ratably over a four-year period (25% per
year). No options have been exercised to date.
23
<PAGE>
SPECTRUM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 (Continued)
- ----------------------------------------------------------------------------
Option activity under the Plan is as follows:
Weighted
average
Number of exercise
shares price
OUTSTANDING, January 1, 1995 - $ -
Granted (weighted average fair
value of $.24) 639,000 $.32
-------
OUTSTANDING, December 31, 1995 639,000 .32
Granted (weighted average fair
value of $.23) 282,000 .30
-------
OUTSTANDING, December 31, 1996 921,000 .32
=======
At December 31, 1996, 1,461,338 shares were available for future grants
under the Plan.
SFAS No. 123 requires the disclosure of pro forma net income and earnings
per share had the Company adopted the fair value method as of the beginning
of fiscal year 1995. 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 values.
The Company's calculations were made using the Black-Scholes option-pricing
model with the following weighted average assumptions: expected life, 48
months following complete vesting; stock volatility, 108%; risk-free
interest rate, 6%; and no dividends during the expected term. The Company's
calculations are based on a single option valuation approach, and
forfeitures are recognized as they occur. If the computed fair values of
the 1996 and 1995 awards had been amortized to expense over the vesting
period of the awards, pro forma net loss would have been $1,697,007 ($.13
per share) in 1996 and would have no effect on net loss and loss per share
in 1995. However, the impact of outstanding non-vested stock options
granted prior to 1995 has been excluded from the pro forma calculation;
accordingly, the 1996 and 1995 pro forma adjustments are not indicative of
future period pro forma adjustments, when the calculation will apply to all
applicable stock options.
24
<PAGE>
SPECTRUM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 (Continued)
- ----------------------------------------------------------------------------
6. INCOME TAXES
The Company's current income tax provision consists of the following:
1996 1995
Federal $ - $ -
State 40,795 7,200
Foreign 21,544 30,886
--------- ---------
$ 62,339 $ 38,086
========= =========
The provision for income taxes differs from the amount computed by applying
the statutory federal income tax rate of 35% to the consolidated loss before
provision for income taxes as follows:
1996 1995
Statutory federal income tax benefit $ (570,798) $(80,943)
Goodwill amortization 54,784 23,116
Non-deductible meals and entertainment 2,324 6,824
State income taxes, net 26,337 4,680
Increase in valuation allowance 565,907 53,573
Effect of foreign taxes (16,215) 30,836
----------- ---------
Income tax provision $ 62,339 $ 38,086
=========== =========
The components of the Company's net deferred income tax asset as of
December 31, 1996 are as follows:
Deferred state taxes $ (5,759)
Depreciation (31,475)
Research and development expenses 752,185
Reserves not currently deductible 166,503
Operating loss carryforwards 3,618,481
Other 74,979
-----------
4,574,914
Valuation allowance (4,197,729)
-----------
Net deferred tax asset $ 377,185
===========
25
<PAGE>
SPECTRUM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 (Continued)
- ----------------------------------------------------------------------------
The Company's valuation allowance of $4,197,729 at December 31, 1996 results
from the uncertainty of the Company's ability to utilize net operating loss
and tax credit carryforwards to reduce future taxes. The valuation
allowance increased $1,162,193 during 1996.
At December 31, 1996, the Company had net operating loss carryforwards for
federal income tax purposes of $9,693,261 ($8,100,000 available to offset
income of Microgon only), which expire at various dates from 1998 through
2009. The utilization of Microgon's $8,100,000 federal net operating loss
is limited to approximately $230,000 of Microgon income annually. Any
unused net operating loss is carried forward. As a result of the
limitation, it is possible that more than $5,000,000 of the Microgon loss
may expire without utilization. The Company has an approximate $3,500,000
state net operating loss carryforward, which expires at various dates
beginning in 1998.
7. LONG-TERM DEBT
Long-term debt to unaffiliated entities consists of the following at
December 31, 1996:
Note payable to bank, collateralized by substantially
all of the assets of the Company, guaranteed by the
majority shareholder, due in monthly principal
installments of $29,762 through November 29, 2000,
plus a final installment equal to the entire unpaid
principal balance and accrued interest on the
termination date. Interest is payable monthly at a
bank's prime rate (9% at December 31, 1996), plus
.75% per annum. $1,942,857
9% subordinated acquisition notes payable, including
accrued interest, guaranteed by the majority
shareholder, principal and accrued interest due
on January 1, 1997 219,076
Noninterest-bearing notes payable due on various
dates through January 1, 1998 81,749
Obligation under sales-leaseback transaction 99,054
-----------
2,342,736
Less current portion (690,359)
-----------
$1,652,377
===========
26
<PAGE>
SPECTRUM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 (Continued)
- ----------------------------------------------------------------------------
Aggregate maturities of long-term debt as of December 31, 1996 are as
follows:
1997 $ 690,359
1998 423,807
1999 357,144
2000 871,426
--------------
$ 2,342,736
==============
The note payable to the bank includes certain financial covenants, restricts
the Company from purchasing property and making loans to affiliates in
excess of specified amounts, and prohibits the payment of dividends without
prior approval of the bank. The Company was not in compliance with various
covenants at December 31, 1996. On February 28, 1997, the Company
refinanced its notes payable with a $3,600,000 term loan requiring 60
monthly installments of $60,000 starting April 1, 1997, bearing interest at
9.14%. The term loan is collateralized by substantially all of the assets
of the Company and is guaranteed by the majority shareholder. Due to the
refinancing of notes payable subsequent to December 31, 1996, management has
classified the current portion of notes payable under the terms of the
original agreement.
On April 1, 1995, the Company sold certain items of its laboratory equipment
for $159,912. Concurrently, the Company leased the equipment back for a
period of 48 months at a monthly rental of $4,311. The Company has the
option to repurchase the equipment at the end of the lease for consideration
equal to the greater of 10% of the sale price or the fair market value of
the equipment at that time, as determined by an independent appraiser. As a
result, the transaction has been recorded as a financing transaction rather
than as a sale, and the equipment and related accounts continue to be
recognized in the accompanying financial statements.
The future lease payments under the related lease agreement are as follows:
Year ending December 31:
1997 $ 51,732
1998 51,732
1999 12,933
----------
116,397
Less amount representing interest (17,343)
----------
$ 99,054
==========
The implicit interest rate under the related lease agreement is 14%.
27
<PAGE>
SPECTRUM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 (Continued)
- ----------------------------------------------------------------------------
Long-term debt - affiliates consists of the following at December 31, 1996:
Convertible notes payable to shareholders, payable
in five equal annual installments aggregating
$200,000 plus interest, beginning January 1, 2001,
with a final installment of $105,000 plus interest,
due on January 1, 2006; interest accrues at the rate
of 8.75% per annum. The notes may be converted to
shares of common stock at a conversion price of $.31
per share and contain antidilution provisions. $ 1,105,500
Promissory note to shareholder, payable in 24 monthly
installments aggregating $8,333 plus interest,
beginning May 1, 1997, with a final payment of $8,333
plus interest, due on April 30, 1999; interest accrues
at the rate of 10% per annum. 200,000
-------------
1,305,500
Less current portion (66,664)
-------------
$ 1,238,836
=============
Interest expense to affiliates amounted to $119,495 and $41,446 in 1996 and
1995, respectively.
8. AFFILIATED-ENTITIES TRANSACTIONS
The Company had additional transactions with affiliates as follows:
1996 1995
Rent paid to a company partially owned by a
member of the Board of Directors $ 36,000 $ 36,000
Legal fees to a firm which employs a member
of the Board of Directors 27,080 70,027
Purchases from a company controlled by the
majority shareholder 103,173 687,539
Sales to a company controlled by the majority
shareholder 23,685 189,687
Consulting fees paid to a company controlled
by the majority shareholder 91,133
28
<PAGE>
SPECTRUM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 (Continued)
- ----------------------------------------------------------------------------
Companies controlled by and affiliated with the majority shareholder share
various facilities and services, including office space, manufacturing,
administrative and marketing staff assistance, and data processing
capabilities. The expenses and revenues associated with staff assistance,
services and data processing capabilities are allocated to the respective
companies based on time devoted to each company. Overhead costs for shared
manufacturing and assembly facilities are allocated based on space utilized.
In connection with the shared services and facilities, the Company had
amounts due from affiliates of $331,764 and amounts due to affiliates of
$264,999 at December 31, 1996.
9. COMMITMENTS
The Company rents manufacturing and office facilities under lease agreements
requiring payments of $197,112 in 1997. Rent expense under operating leases
was $218,939 and $195,343 in 1996 and 1995, respectively, of which $36,000
was paid to an affiliated entity in 1996 and 1995.
10. FOREIGN SALES
Sales to customers in foreign countries, primarily Europe, amounted to
$1,826,127 and $1,963,007 in 1996 and 1995, respectively.
11. PROPOSED MERGER
The Company is currently investigating the possibility of a merger with SMI.
No definitive agreement has been reached as of March 14, 1997.
12. SUBSEQUENT EVENT
On January 29, 1997, the Company signed a letter of intent to sell the
sample collection product line of Hydro-Med for $800,000 plus the value of
inventory, approximately $169,000. Such sale closed on March 31, 1997.
29
<PAGE>
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None
Part III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act
Directors
- ---------
Named below are directors serving until an Annual Meeting of Shareholders
and until their respective successors are elected and qualify.
Name Age Director Since Position
- ---- --- -------------- --------
Roy T. Eddleman 57 July 30, 1982 Chairman, CEO
& Director
John J. Driscoll 48 July 30, 1982 Director,
Secretary
Jack Whitescarver 59 April 1, 1985 Director
Executive Officers of The Company
- ---------------------------------
Roy T. Eddleman 57 July 30, 1982 Chairman & CEO
F. Jesus Martinez 57 ---- President
Bruce R. Peasland 51 --- Chief Financial
Officer
Business Experience of Directors and Executive Officers
- -------------------------------------------------------
Roy T. Eddleman was elected Chairman of the Board and Chief Executive
Officer of the Company on July 30, 1982. Mr. Eddleman has been engaged
primarily as a private investor and entrepreneur for more than five years.
He owns interests ranging from a minority investment to control in
approximately 10 privately held companies, the majority of which are engaged
in the manufacture and sale of products.
John J. Driscoll has been employed as an attorney in private practice for
over six years.
Jack Whitescarver is the Deputy Director for the Office of AIDS Research at
the National Institutes of Health in Bethesda, Maryland and has been there
more than 5 years.
F. Jesus Martinez has been Chief Operating Officer and President of the
Company since September, 1995. Mr. Martinez held the position of Vice
President of R&D and Operations from August 1989 to September 1995. He has
held senior management positions at Baxter Healthcare Corporation, National
Medical Care, Minntech Corporation and is inventor or co-inventor of over
twenty patents in medical devices. Mr. Martinez holds graduate and
undergraduate degrees in Engineering Sciences and Medical Physiology from
Emory University and has over 28 years of extensive experience in membrane
filtration devices for the medical, laboratory and industrial markets.
30
<PAGE>
Bruce R. Peasland, the chief financial officer, has been employed by the
Company since May 1996. Prior to such date, Mr. Peasland was the Executive
Vice President and Chief Financial Officer for Intervest Industries from
1989.
There are no family relationships between any of the Company's directors and
officers. There are no arrangements or understandings between any director
and any other person pursuant to which any person was elected or nominated
as a director.
The Company had no pension, retirement, annuity, savings or similar benefit
plans in 1996. Directors are not compensated for their services on the
Company's Board of Directors.
Item 10. Executive Compensation
The following table sets forth the annual compensation paid and accrued by
the Company during its last three fiscal years to executive officer to whom
it paid in excess of $100,000 including cash and issuance of securities:
<TABLE>
<CAPTION>
Annual Compensation Restricted Long Term Compensation
------------------- ----------------------------------
Name and Position Year Salary Bonus Stock SAR's LTIP All
Awards Other
- -------------------- ----- --------- --------- ------------------------------------
<S> <C> <C> <C> <C>
Roy Eddleman 1996 $160,000 $75,000
Chief Executive Officer 1995 $160,000 $82,000
1994 0 $60,000
F. Jesus Martinez 1996 $145,000 $55,000
President 1995 $84,180 $88,753(1) 240,000
1994 $120,000 $20,000
</TABLE>
(1) A payment of $88,753 was made in connection with the sale of Microgon
to the Company.
31
<PAGE>
Item 11. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock at December 31, 1996 by (i) all
persons known by management to be beneficial owners of more than 5% of its
Common Stock, (ii) all nominees for directors and (iii) all officers and
nominees for directors of the Company as a group:
<TABLE>
<CAPTION>
Amount and Nature of Beneficial Ownership (A)
Name Directly Owned Percent Indirectly Owned with Percent
with Sole Power of Class Shared Power of Voting of Class(1)
of Voting and and/or Disposition
Disposition
----------- --------- --------------------- ------------
<S> <C> <C> <C> <C>
Roy T. Eddleman (B)
32022 La Cadena Drive
Laguna Hills, California 901,907 7.0% 11,037,338 85.9%
Spectrum Medical Industries, Inc.
23022 La Cadena Drive
Laguna Hills, California 10,135,431 78.9% - -
Thomas Gerardi
1126 Wilshire Boulevard
Los Angeles, CA 90017 901,907 7.0% - -
Jack Whitescarver (C) - - - -
John J. Driscoll (C) - - - -
All directors and officers as a
group (5 in number) 901,907 7.0% - -
</TABLE>
(1) 12,834,394 shares outstanding as of December 31, 1996.
(A) Unless otherwise noted, all shares listed are owned of record.
(B) Mr. Eddleman is the principal shareholder, executive officer and
director of Spectrum Medical Industries, Inc. As such, he may be deemed to
control investment power of the 10,135,431 shares of the Company's Common
Stock owned by Spectrum Medical Industries. Such shares are included in the
indirect beneficial holdings of Mr. Eddleman set forth in the above table.
(C) In 1991 Messrs. Whitescarver and Driscoll each received options to
purchase 8,333 shares of the Company's Common Stock at an exercise price of
$0.60 per share. No options have been exercised to date. In 1995, Mr.
Driscoll was granted 50,000 options at an exercise price of $.32 per share.
The following table sets forth options granted to named executive officers:
<TABLE>
<CAPTION>
Name No. of Securities Percent of Exercise Expiration Potential Realizable Value at
Underlying Total Options Price Date Assumed Annual Rates of
Options Stock Price Appreciation
- -------------- ------------------ -------------- --------- ----------- ----------------------------
<s. <C> <C> <C> <C> <C>
Roy T. Eddleman,
CEO -- -- -- -- --
F. Jesus Martinez,
President 240,000 30.7% .32 12/31/00 at 5% $103,200
at 10% $127,200
</TABLE>
32
<PAGE>
Item 12. Certain Relationships and Related Transactions
In 1996 and 1995, the Company has had transactions with related parties as
follows:
Years ended December 31,
1996 1995
Rent paid to a company owned by the
Board of Directors (the "Chairman") $36,000 $36,000
Fees for legal service paid to a law
firm which employs a member of the
Board of Directors $27,080 $70,027
Purchases from companies controlled
by and affiliated with the Chairman $103,173 $687,539
Sales to companies controlled and
affiliated with the Chairman $23,685 $189,687
Consulting fees paid to companies
controlled by and affiliated with
the Chairman 0 $91,133
33
<PAGE>
Item 13. Exhibits and Reports on Form 8-K
(a) Exhibits
- ------------
Exhibit No. Description
3.1 Articles of Incorporation of Registrant (incorporated by
reference to Exhibit 4.1 file with Registrant's Registration
Statement on Form S-2. Registration No. 2-68999
3.2 Amendment to Article I of the Articles of Incorporation of
Registrant (incorporated by reference to Exhibit 3.2 filed
with Registrant's Report on Form 10-K for the fiscal year ended
December 31, 1982, commission File No. 0-9478)
3.3 Bylaws of Registrant (incorporated by reference to Exhibit 4.2
filed with Registrant's Registration Statement on Form S-2,
Registration No. 2-68999)
3.4 Amendment to Article III, section 2 of Registrant's Bylaws
(incorporated by reference to Exhibit 3.3 filed with
Registrant's Report on Form 10-K for the fiscal year ended May
31, 1982, Commission File No. 0-9478)
3.5 Amendment to Article IV, Section 6 and Section 7 of the
Registrant's Bylaws (incorporated by reference to Exhibit 3.4
filed with Registrant's Report on Form 10-K for the fiscal
year ended May 31, 1982, Commission File No. 0-9478)
3.6 Articles of Amendment to Registrant's Articles of Incorporation
increasing authorized stock to 25,000,000 shares (incorporated
by reference to Registrant's Schedule 14C-2 Information
Statement, Exhibit A, filed with the Commission on October 19,
1996; Commission File NO. 0-9478
3.7 Certificate of Ownership of Microgon into Spectrum Laboratories
incorporated by reference to Exhibit 2B to the Registrant's
Form 8-K/A on October 15, 1996, Commission File No. 0-9478
10.1 Agreement for Sale of Assets dated as of August 1, 1982
between Registrant and Glenco Scientific, Inc. (incorporated by
reference to Exhibit 10.7 filed with Registrant's report on
form 10-K for the fiscal year ended December 31, 1982,
Commission File No. 0-9478)
10.2 Agreement for Sale of Assets dated as of August 1, 1982 between
Registrant and Spectrum Medical, Inc. (incorporated by
reference to Exhibit 10.8 filed with Registrant's Report on
Form 10-K for the fiscal year ended December 31, 1982,
commission File No. 0-9478)
10.3 Agreement for Sale of Assets Dated as of July 1, 1983 between
the Registrant and all the shareholders of Innometrics, Inc.
(incorporated by reference to Exhibit 10.8 filed with
Registrant's Report on Form 10-K for the fiscal year ended
December 31, 1983, Commission File No. 0-9478)
10.4 Agreement and Plan of Reorganization dated March 31, 1983
between the Registrant and all the shareholder of Innometrics,
Inc. (incorporated by reference to Exhibit 10.8 filed with
Registrant's Report on Form 10-K for the fiscal year ended
December 31, 1983, Commission File No. 0-9478)
34
<PAGE>
10.5 Sublease dated September 15, 1982, between Registrant and
Glenco Scientific, Inc. for facilities at 15413 Vantage Parkway
East, Houston, Texas (incorporated by reference to Exhibit
filed with Registrant's Report on Form 10-K for the fiscal
year ended December 31, 1983, Commission File No. 0-9478)
10.6 Registrants Stock Compensation Plan (incorporated by reference
to Exhibit 10.11 filed with Registrant's Report on Form 10-K
for the fiscal year ended December 31, 1983, Commission File
No. 0-9478)
10.7 Registrant's 1982 Stock Option Plan (incorporated by reference
to Exhibit 10.12 filed with Registrant's Report on Form 10-K
for the fiscal year ended December 31, 1983 Commission File No.
0-9478)
10.8 Purchase Agreement dated as of July 21, 1983 between Registrant
and Biotic Technologies, Inc. (incorporated by reference to
Exhibit 10.13 filed with Registrants Report on Form 10-K for
the fiscal year ended December 31, 1983, Commission File No. 0-
9478)
10.9 Closing Agreement dated as of October 26, 1983 between
Registrant, Arden A. Kelton and Environmental Diagnostics, Inc.
(incorporated by reference to Exhibit 10.14 with Registrant's
Report on Form 10-K for the fiscal year ended December 31,
1983, Commission File No. 0-9478)
10.10 Evaluation and Option Agreement dated August 17, 1984 between
Registrant and Instrumentation Laboratories, Inc. (incorporated
by reference to Exhibit 10.10 filed with Registrant's Report on
Form 10-K for the fiscal year ended December 31, 1984,
Commission File No. 0-9478)
10.11 Amendment to Investment and Loan Agreement dated August 1, 1995
among the Company, Microgon and certain preferred shareholders
of Microgon, incorporated by reference to Exhibit 2A to the
Registrant's Form 8K/A filed on October 15, 1995, Commission
File No. 0-9478
10.12 Stock Option Plan adopted October 11, 1996 (incorporated by
reference to Exhibit B to Registrant's filing of Schedule 14-2,
filed with the Commission on October 9, 1996.
10.13 City National Bank loan agreement dated as of February 28,
1997, between registrant, Spectrum Medical Industries, Inc.,
and City National Bank (incorporated by reference to Exhibit
10.13 filed with registrant's report on Form 10-KSB for fiscal
year ended December 31, 1996, Commission File No. 0-9478).
10.14 Registrant's purchase agreement of Cellco, Inc. (incorporated
by reference to Exhibit 10.14 with registrant's Form 8-K dated
November 1, 1996, Commission File No. 0-9478).
(b) During the quarter ended December 31, 1996, the Company filed a current
report in Form 8K dated November 1, 1996 reporting under Item 2 information
about the acquisition of Cellco, Inc. and under Item 7 as the financial
statement of Cellco, Inc., and Item 7(b) the pro forma consolidated
statement of operations to be filed at a future date.
35
<PAGE>
Signatures
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
Spectrum Laboratories, Inc.
By: /s/ Bruce R. Peasland
----------------------------
Bruce R. Peasland
Chief Financial Officer
Date:
By: /s/ Roy T. Eddleman
----------------------------
Roy T. Eddleman, President
Chief Executive Officer and Director
Date:
By: /s/ John J. Driscoll
-----------------------------
John J. Driscoll, Secretary and Director
Date:
36
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 591,854
<SECURITIES> 0
<RECEIVABLES> 1,235,608
<ALLOWANCES> 52,921
<INVENTORY> 1,431,102
<CURRENT-ASSETS> 3,642,905
<PP&E> 5,458,100
<DEPRECIATION> 4,305,266
<TOTAL-ASSETS> 8,409,124
<CURRENT-LIABILITIES> 2,498,851
<BONDS> 0
0
0
<COMMON> 128,344
<OTHER-SE> 681,620
<TOTAL-LIABILITY-AND-EQUITY> 8,409,124
<SALES> 8,698,794
<TOTAL-REVENUES> 8,698,794
<CGS> 5,229,422
<TOTAL-COSTS> 6,356,502
<OTHER-EXPENSES> 3,916,632
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 287,677
<INCOME-PRETAX> (1,630,852)
<INCOME-TAX> 62,339
<INCOME-CONTINUING> (1,693,191)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,693,191)
<EPS-PRIMARY> (0.13)
<EPS-DILUTED> (0.13)
</TABLE>
