<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 January 3, 1998
Commission File No. 0-9478
SPECTRUM LABORATORIES, INC.
(Name of small business issuer in its charter)
California 95-3557539
---------- ----------
(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: $8,135,420
The aggregate market value of voting stock held by nonaffiliates of the
registrant is $241,690 as of March 31, 1998, based on the $.27 per share closing
price for the Common Stock in the over-the-counter market on such date,
representing 895,149 shares held by nonaffiliates.
Number of shares of Common Stock outstanding as of March 31, 1998: 12,834,394
This report includes a total of 37 consecutive numbered pages; the exhibit index
of documents incorporated by reference is on page 34.
<PAGE>
TABLE OF CONTENTS
FORM 10-KSB ANNUAL REPORT
FOR THE YEAR ENDED JANUARY 3, 1998
SPECTRUM LABORATORIES, INC.
Item No. Page
- -------- ----
PART I
1. Description of Business...........................................-3-
2. Description of Property...........................................-7-
3. Legal Proceedings.................................................-7-
4. Submission of Matters to a Vote of Security Holders...............-7-
PART II
5. Market for Common Equity and Related Shareholder Matters..........-8-
6. Management's Discussion and Analysis of Financial
Condition and Results of Operation................................-8-
7. Financial Statements.............................................-11-
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.
BUSINESS
- --------
The Company is a leader in the development, manufacturing and sale of a
comprehensive proprietary line of hollow fiber membrane disposable products for
use by research laboratories, biotechnology and pharmaceutical companies. The
Company's products, derived from a platform technology of mass transfer hollow
fiber membranes are used for existing and emerging life sciences applications
such as molecular/biological separations, fluid purification and cell
expansion/bioreactors. The Company's platform technology allows it to create
membranes and devices to meet a wide range of performance criteria and to
integrate the devices into systems for life sciences applications.
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 1996 and
approximately 17 % of sales for 1997, of hollow fiber membrane products, which
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 1996 and 39% in 1997, 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 filtration products accounted for approximately 45% of hollow
fiber membrane device sales in 1996 and 44% in 1997.
CELL EXPANSION
On October 1, 1996, the Company through its wholly-owned subsidiary SLI
Acquisition Corp. ("SLIAC"), purchased certain assets of Cellco, Inc., a
Delaware Corporation located in Germantown, Maryland. SLIAC 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>
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), Esmarch 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 hollow fiber membrane products.
Approximately 20% of its sales are from non-U.S. customers for fiscal years 1996
and 1997.
CELL EXPANSION
SLIAC 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.
MEDICAL DISPOSABLE DEVICES
Hydro-Med manufactures and distributes three major product lines: Operating Room
Equipment Drapes, Orthopedic Soft Goods and Esmarch Bandages.
Hydro-Med distributes its products through a number of channels including
important National and Regional Catalog Houses, OEM & Private Label Accounts,
Regional OR Specialty Distributors, Custom Procedure Tray Manufacturers, Direct
Sales to Institutions and International Distributors. Nearly all Operating Room
Equipment Drapes are sold in sterile ready-to-use format. OR Drapes are sold
primarily through OEM & Private label accounts, through Regional OR Specialty
Distributors and through Regional and National Catalog Houses. Over the past two
and one half years, the importance of OR Specialty Dealer has declined while the
proportion of OEM, Private Label and Catalog House sales has increased. OR
drapes constitute nearly all international sales and approximately half of
direct sales. Orthopedic Soft Goods are primarily are sold primarily through
Regional and National Catalog Houses and Procedure Tray Manufacturers.
Approximately one third of Orthopedic Soft Goods sales are in non-sterile, bulk
format primarily to Tray Manufacturers. Essentially no Soft Goods and Esmarch
Bandages are sold internationally. Esmarch Bandages are sold through both
Catalog Houses, Regional OR Specialty Distributors and Procedure Tray
Manufacturers.
Hydro-Med has over 250 active customers, the most active of which are over 100
hospitals and over 150 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
4
<PAGE>
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
SLIAC purchases hollow fiber membrane devices from commercially available device
suppliers. SLIAC is dependent on a limited number of suppliers for hollow follow
membrane devices but 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.
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
SLIAC acquired the rights to the Cellmark trademark and all related patents,
including one for "Serum-free production of packaged viral vector."
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 recently been audited by the
FDA with no deficiencies noted. 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 to
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.
5
<PAGE>
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.
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, 1996 and January 3, 1998, 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
Millipore are the major competitors. It is estimated that market share is less
than 5% in every market served.
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 faces distinctly different competitors among its different product
lines. Significant consolidation has taken place recently in the OR Equipment
Drape business. The major competitors offering a full line of OR Equipment
Drapes include Microtek Medical, Medical Technique Instruments, MTI, Zeiss,
Advance Medical Designs and Deka Medical. Each manufacturer has niches in either
a specific type of equipment drape or specific accounts with the exception of
Microtek which, with over 50% of the market share, is the market leader with a
strong presence in all niches and a direct sales force. Hydro-Med has been most
effective in competing with its Video Camera Drape line particularly on the
basis of quality and price. Orthopedic Soft Goods are similarly consolidating by
remains very fragmented. Major competitors include Alba, Balfour, Technol and
DeRoyal Industries among others. Esmarch Elastic Bandage is produced by a small
number of non-medical rubber producers who then sell bulk non-sterile product to
medical device firms for packaging and sterilization. As a result there are
numerous competitors distributing Esmarch Bandages but the range of offerings is
relatively limited with competition being primarily driven by price.
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 the market.
6
<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 ACE(TM) bandages, Johnson & Johnson, producers of
Dyna-Flex(TM) and Kendall, producers of Tensor(TM), all of which have greater
resources than the Company.
RESEARCH AND DEVELOPMENT
The Company incurred research and development expenses of $537,486 in 1997 and
$411,095 in 1996. Research and development are particularly important for the
Company's future growth.
EMPLOYEES
On January 3, 1998, the Company had 64 employees, of which 45 were in production
and manufacturing support, 11 were administrative personnel, 6 were marketing
and customer service representatives and 2 were in research and development. 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.,
("SMI") an affiliate of the Company, controlled by Roy T. Eddleman, Chairman of
the Company, with a portion sublet to the Company. The space is used by the
Company for general, administration and executive offices. The Company also
shares production and warehousing space with SMI under sub-leases with SMI in
facilities owned by Mr. Eddleman. Total rent paid in fiscal 1997 by the Company
for the aforementioned facilities was $152,422.
The Company has production and warehouse space in Dallas, Texas and locations it
occupies in Los Angeles and Orange Counties, California. The following table
summarizes the terms of the leases of 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 Partnership Spectrum Laboratories, 8,830 12/1/94 12/31/98 49 $8,830
23152 Verdugo Dr. Inc.
Laguna Hills, CA Light Manufacturing
R&D and Offices
Herschel Brown Spectrum Laboratories, 20,000 1/1/95 12/31/98 48 $5,416
2930 Ladybird Lane Inc.
Dallas, Texas
</TABLE>
ITEM 3. LEGAL PROCEEDINGS
There are 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.
7
<PAGE>
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 following table sets forth the high and low market prices for the last two
years. The quotations shown represent inter-dealer prices without adjustment for
retail markups, markdowns or commissions and do not necessarily reflect actual
transactions.
1997 High Low
-------------- ------ ------
First Quarter $ 5/8 $ 3/16
Second Quarter 1/2 3/16
Third Quarter 1/2 3/16
Fourth Quarter 1/2 3/16
1996
--------------
First Quarter 7/16 3/16
Second Quarter 7/16 3/16
Third Quarter 3/4 1/4
Fourth Quarter 3/4 1/4
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 January 3, 1998, the number of holders of record of the Company's Common
Stock was 826.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
The following discussion relates to the Company, its wholly owned subsidiaries,
SLI Acquisition Corp. ("SLIAC") and Hydro-Med Products, Inc. ("Hydro-Med") and
its partially owned subsidiary, Spectrum Europe B.V. ("Spectrum B.V."). The
Company has consolidated the financial position and operations of Spectrum B.V.
for all periods presented.
RESULTS OF OPERATIONS - FISCAL YEAR 1997 COMPARED TO FISCAL YEAR 1996
Net sales for 1997 were $8,135,420 and were 6% below 1996 sales of $8,698,794.
An increase in sales due to the cell expansion product line acquired from
Cellco, Inc. at the beginning of the last quarter of 1996 was more than offset
by decreased sales resulting from the sale of the microbiological sampling and
transport product line (See Note 11 of Notes to Consolidated Financial
Statements) and, to a lesser extent, a decrease in sales of hollow fiber
membrane devices.
Cost of sales as a percentage of sales was 60% for both years.
A 24% increase in selling expense and a 31% increase in research and development
costs over 1996 were primarily attributable to the retention of key personnel as
a result of the Cellco acquisition.
General and administrative expenses increased 19% over 1996, partially due to
the Cellco acquisition, but primarily due to an increase in personnel.
The increase in interest expense was primarily due to a higher level of debt in
1997.
8
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
During the current fiscal year, there was a net cash outflow from operations of
approximately $780,000 which was primarily the result of a loss from operating
activities for the year. Cash of approximately $1,100,000 was generated due to
the sales of two product lines. Cash of approximately $3,760,000 was generated
through borrowings but was primarily used to pay off existing debt and for
principal payments on the new loan agreement. The Company believes that funds
anticipated to be generated from operations and funds on hand are sufficient for
operating requirements in fiscal 1998. However, provisions of the Company's loan
agreement with the bank require principal and interest payments of approximately
$1,200,000 on May 1, 1998. On April 29, 1998, the Company obtained an extension
to July 1, 1998. The Company intends to refinance this debt prior to its
maturity. In the event the Company has to repay such debt with existing cash
balances, any potential shortfall in available cash at that time would be funded
by Roy T. Eddleman, the Company's majority shareholder.
YEAR 2000 MATTERS
The Year 2000 issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Company's
hardware or computer programs that have time-sensitive software may recognize a
date using "00" as the year 1900 rather than the Year 2000. This could result in
a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices, or engage in similar normal business activities.
In 1997, the Company initiated a conversion from existing hardware and
accounting software to hardware and software programs that are Year 2000
compliant. Management has determined that the year 2000 issue will not pose
significant operational problems for its computer systems. As a result, all
costs associated with this conversion are being expensed as incurred.
The Company is in the process of initiating formal communications with all of
its significant suppliers and large customers to determine the extent to which
the Company's interface systems are vulnerable to those third parties' failure
to remediate their own Year 2000 issue. There can be no guarantee that the
systems of other companies on which the Company's systems rely will be timely
converted and would not have an adverse effect on the Company's systems.
The Company will utilize both internal and external resources to reprogram, or
replace, and test the software and equipment for Year 2000 modifications. The
Company anticipates completing the Year 2000 project within 6 months, but not
later than June 30, 1999. The total cost of the Year 2000 project is estimated
at $25,000 and is being funded through operating cash flows.
The costs of the project and the date on which the Company believes it will
complete the Year 2000 modifications are based on management's best estimates,
which were derived from assumptions of future events, including the continued
availability of certain resources, third-party modification plans and other
factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those anticipated.
Specific factors that might cause such material differences include, but are not
limited to, the availability and cost of personnel trained in this area, the
ability to locate and correct all relevant computer codes and hardware, and
similar uncertainties.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income,"
which establishes standards for reporting and display of comprehensive income
and its components (revenue, expenses, gains and losses) in a full set of
general-purpose financial statements. The Company will adopt SFAS No. 130 in its
fiscal year 1998.
9
<PAGE>
In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of
Enterprise and Related Information," which changes the way public companies
report information about operating segments.
SFAS No. 131, which is based on the management approach to segment reporting,
establishes requirements to report selected segment information quarterly and to
report entity-wide disclosures about products and services, major customers and
the material countries in which the entity holds assets and reports revenue.
Management is reviewing the impact of this statement on its reporting of segment
information. The Company will adopt SFAS No. 131 in its fiscal year 1998.
10
<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 January 3, 1998, and the
related consolidated statements of operations, shareholders' equity and cash
flows for the years ended January 3, 1998 and December 31, 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 January 3, 1998 and the results of their consolidated
operations and their consolidated cash flows for the years ended January 3, 1998
and December 31, 1996 in conformity with generally accepted accounting
principles.
/s/ Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
March 27, 1998,
(except for Note 6, as to which the dates
are April 20 and April 29, 1998)
Costa Mesa, California
11
<PAGE>
SPECTRUM LABORATORIES, INC.
CONSOLIDATED BALANCE SHEET
AS OF JANUARY 3, 1998
- --------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,023,443
Receivables - trade, net of allowance for doubtful
accounts of $132,500 1,025,061
Due from affiliates (Note 8) 553,411
Inventories, net (Note 3) 881,418
Prepaid expenses and other current assets 82,709
------------
Total current assets 3,566,042
PROPERTY AND EQUIPMENT, net (Note 4) 780,048
OTHER ASSETS:
Deferred income taxes (Note 5) 377,185
Intangible and other assets (Note 2) 145,550
Goodwill (Notes 1 and 2) 2,891,078
------------
Total other assets 3,413,813
------------
$ 7,759,903
============
See accompanying notes to consolidated financial statements.
12
<PAGE>
SPECTRUM LABORATORIES, INC.
CONSOLIDATED BALANCE SHEET
AS OF JANUARY 3, 1998 (Continued)
- --------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 586,594
Accrued expenses 550,615
Income taxes payable 51,441
Current portion of long-term debt (Note 6) 1,623,258
------------
Total current liabilities 2,811,908
LONG-TERM DEBT, less current portion (Note 6) 2,174,532
MINORITY INTEREST (Note 1) 2,037,939
SHAREHOLDERS' EQUITY (Note 7):
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 (4,591,683)
Unrealized loss on foreign currency translation (38,985)
------------
Total shareholders' equity 735,524
------------
$ 7,759,903
============
See accompanying notes to consolidated financial statements.
13
<PAGE>
SPECTRUM LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------
Years ended
----------------------------
January 3, December 31,
1998 1996
NET SALES (Notes 8 and 10) $ 8,135,420 $ 8,698,794
COSTS AND EXPENSES (Note 8):
Cost of sales 4,880,691 5,229,422
Selling 1,402,492 1,127,080
General and administrative 1,811,912 1,517,860
Research and development 537,486 411,095
In-process research and development costs (Note 2) 1,700,000
Other expense, net (primarily interest) 362,922 287,677
------------- -------------
Total costs and expenses 8,995,503 10,273,134
GAIN ON SALE OF PRODUCT LINES (Note 11) 803,059
------------- -------------
LOSS BEFORE MINORITY INTEREST IN INCOME
OF SUBSIDIARY AND PROVISION FOR INCOME TAXES (57,024) (1,574,340)
MINORITY INTEREST IN LOSS (INCOME) OF
SUBSIDIARY (Note 1) 9,050 (56,512)
------------- -------------
LOSS BEFORE FOR INCOME TAX PROVISION (47,974) (1,630,852)
INCOME TAX PROVISION (Note 5) 25,399 62,339
------------- -------------
NET LOSS $ (73,373) $ (1,693,191)
============= =============
BASIC AND DILUTED NET LOSS PER COMMON SHARE $ (0.01) $ (0.13)
============= =============
BASIC AND DILUTED WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING 12,834,394 12,834,394
============= =============
See accompanying notes to consolidated financial statements.
14
<PAGE>
SPECTRUM LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Unrealized
Unrealized loss on
Common stock Additional gains on foreign
--------------------- paid-in investment currency Accumulated
Shares Amount capital securities translation deficit Total
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE,
January 1,
1996 12,834,394 $128,344 $5,237,848 $ 12,920 $ (33,076) $(2,825,119) $2,520,917
Unrealized
investment
losses, net of
tax (12,920) (12,920)
Foreign currency
translation loss (4,842) (4,842)
Net loss (1,693,191) (1,693,191)
---------- -------- ---------- --------- ---------- ------------ -----------
BALANCE,
December 31,
1996 12,834,394 128,344 5,237,848 (37,918) (4,518,310) 809,964
Foreign currency
translation loss (1,067) (1,067)
Net loss (73,373) (73,373)
---------- -------- ---------- --------- ---------- ------------ -----------
BALANCE,
January 3,
1998 12,834,394 $128,344 $5,237,848 $ - $ (38,985) $(4,591,683) $ 735,524
========== ======== ========== ========= ========== ============ ===========
</TABLE>
See accompanying notes to consolidated financial statements.
15
<PAGE>
SPECTRUM LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Years ended
----------------------------
January 3, December 31,
1998 1996
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (73,373) $(1,693,191)
Adjustments to reconcile net loss to net cash (used in) provided by
operating activities:
Depreciation and amortization 468,962 399,896
Gain on sale of product lines (803,059)
Minority interest in income (loss) of subsidiary (9,050) 56,512
Deferred income taxes 1,750
In-process research and development costs 1,700,000
Changes in operating assets and liabilities:
Decrease (increase) in trade receivables 157,626 (24,940)
(Increase) decrease in due from affiliates (221,647) 310,821
Decrease in inventories 392,226 341,325
Decrease (increase) in prepaid expenses and other current asset 22,789 (38,195)
Decrease (increase) in other assets 4,327 (19,401)
(Decrease) increase in accounts payable and accrued expenses (695,435) 347,297
(Decrease) increase in income taxes payable (19,850) 33,205
Other (1,067) (17,762)
------------ ------------
Net cash (used in) provided by operating activities (777,551) 1,397,317
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment (37,814) (242,406)
Proceeds from sale of product lines 1,097,400
Decrease in investments 63,180
------------ ------------
Net cash provided by (used in) investing activities 1,059,586 (179,226)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on debt (3,611,446) (908,709)
Proceeds relating to advances from affiliates and issuances of debt 3,761,000 200,000
------------ ------------
Net cash provided by (used in) financing activities 149,554 (708,709)
------------ ------------
</TABLE>
See accompanying notes to consolidated financial statements.
16
<PAGE>
SPECTRUM LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
- --------------------------------------------------------------------------------
Years ended
---------------------------
January 3, December 31,
1998 1996
NET INCREASE IN CASH AND CASH EQUIVALENTS $ 431,589 $ 509,382
CASH AND CASH EQUIVALENTS, beginning of year 591,854 82,472
----------- -----------
CASH AND CASH EQUIVALENTS, end of year $1,023,443 $ 591,854
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for:
Income taxes $ 53,370 $ 4,415
=========== ===========
Interest $ 426,444 $ 274,455
=========== ===========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES: The Company
recorded unrealized losses of $12,920 on its investment portfolio for the year
ended December 31, 1996.
The Company recorded SMI's minority interest in the income (loss) of Spectrum
B.V. of $(9,050) and $56,512 for the years ended January 3, 1998 and December
31, 1996, respectively.
During 1996, SLIAC acquired substantially all the net assets of Cellco, Inc.
(Note 2). 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
===========
See accompanying notes to consolidated financial statements.
17
<PAGE>
SPECTRUM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996
- --------------------------------------------------------------------------------
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 Corp. (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 disposable cellulose nitrate and cellulose acetate hollow
fiber microfiltration modules. 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. 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.
CHANGE IN FISCAL YEAR - Effective November 1997, the Company changed its
fiscal year end to the Saturday nearest December 31. The years ended
January 3, 1998 and December 31, 1996 each consist of approximately 52
weeks.
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.
18
<PAGE>
SPECTRUM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996 (Continued)
- --------------------------------------------------------------------------------
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.
INVENTORIES - Inventories are stated at the lower of cost, determined
using the first-in, first-out method, or market value.
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, Inc. (Cellco) (Note 2)
acquisition during 1996 and Microgon, Inc. acquisition during 1995.
Goodwill is being amortized on a straight-line basis over a 15- and
20-year period for Cellco and Microgon, Inc., respectively. The Company
believes there is no impairment of goodwill. Accumulated amortization of
goodwill amounted to $393,190 at January 3, 1998.
LONG-LIVED ASSETS - The Company accounts for the impairment and
disposition of long-lived assets in accordance with 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. There was no impairment of the
value of such assets for the year ended January 3, 1998.
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.
19
<PAGE>
SPECTRUM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996 (Continued)
- --------------------------------------------------------------------------------
LOSS PER COMMON SHARE - The Company has adopted SFAS No. 128, EARNINGS PER
SHARE, which replaces the presentation of "Primary" earnings per share
with "Basic" earnings per share and the presentation of "Fully Diluted"
earnings per share with "Diluted" earnings per share. Prior periods have
been restated to reflect the change in presentation and assumed exercise
of outstanding options into common stock have been excluded due to their
antidilutive nature.
Basic earnings per share amounts are based on the weighted-average number
of common shares outstanding. Diluted earnings per share amounts are based
on the weighted-average number of common and common equivalent shares for
each period presented. Common equivalent shares include stock options, if
dilutive, using the treasury stock method.
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 January 3, 1998; therefore, management believes the carrying amount of
the outstanding borrowings at January 3, 1998 approximates fair market
value.
ACCOUNTING FOR STOCK-BASED COMPENSATION - SFAS No. 123, ACCOUNTING FOR
STOCK-BASED COMPENSATION, 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.
The Company has elected to continue to account for such transactions under
Accounting Principles Board (APB) Opinion No. 25, ACCOUNTING FOR STOCK
ISSUED TO EMPLOYEES, but is required to disclose in a note to the
financial statements pro forma net loss and loss per share as if the
Company had applied the fair value method of accounting (Note 7).
NEW ACCOUNTING PRONOUNCEMENTS - In June 1997, the Financial Accounting
Standards Board (FASB) issued SFAS No. 130, REPORTING COMPREHENSIVE
INCOME, which is effective for annual and interim periods beginning after
December 15, 1997. This statement requires that all items that are
required to be recognized under accounting standards as comprehensive
income be reported in a financial statement that is displayed with the
same prominence as other financial statements.
20
<PAGE>
SPECTRUM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996 (Continued)
- --------------------------------------------------------------------------------
In June 1997, FASB issued SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN
ENTERPRISE AND RELATED INFORMATION, which is effective for annual and
interim periods beginning after December 15, 1997. This statement
establishes standards for the method that public entities report
information about operating segments in annual financial statements and
requires that those enterprises report selected information about
operating segments in interim financial reports issued to shareholders. It
also establishes standards for related disclosures about product and
services, geographical areas, and major customers.
In February 1998, FASB issued SFAS No. 132, EMPLOYERS' DISCLOSURE ABOUT
PENSIONS AND OTHER POSTRETIREMENT BENEFITS, which is effective for annual
and interim, periods beginning after December 15, 1997. This statement
standardized the disclosure requirements for pensions and other
postretirement benefits to the extent practicable, requires additional
information on changes in the benefit obligations and fair values of plan
assets that will facilitate financial analysis and eliminates certain
disclosures that are no longer as useful as they were under previous
statements.
RECLASSIFICATIONS - Certain December 31, 1996 balances have been
reclassified to conform with the January 3, 1998 presentation.
2. ACQUISITIONS
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 preferred shares are nonvoting and have preference
over common shareholders as to dividends and liquidation.
21
<PAGE>
SPECTRUM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996 (Continued)
- --------------------------------------------------------------------------------
The following unaudited consolidated pro forma results of operations for
the year ended December 31, 1996 assume that the acquisition of the
operations of Cellco occurred at the beginning of fiscal year 1996. These
unaudited consolidated pro forma results 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
Net revenues $ 9,571,992
==============
Net loss $ (2,610,540)
==============
Basic and diluted net loss per common share $ (0.20)
==============
Basic and diluted weighted average number of common shares 12,834,394
==============
3. INVENTORIES
Inventories consist of the following at January 3, 1998:
Raw materials $ 611,475
Work-in-progress 43,488
Finished goods 402,708
--------------
1,057,671
Less reserve for obsolescence (176,253)
--------------
$ 881,418
==============
22
<PAGE>
SPECTRUM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996 (Continued)
- --------------------------------------------------------------------------------
4. PROPERTY AND EQUIPMENT
Property and equipment consist of the following at January 3, 1998:
Equipment $ 3,764,862
Furniture 394,418
Leasehold improvements 483,876
------------
4,643,156
Less accumulated depreciation and amortization (3,863,108)
------------
$ 780,048
============
5. INCOME TAXES
The Company's current income tax provision consists of the following:
1997 1996
Federal $ - $ -
State 33,520 40,795
Foreign (8,121) 21,544
--------- ---------
$ 25,399 $ 62,339
========= =========
23
<PAGE>
SPECTRUM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996 (Continued)
- --------------------------------------------------------------------------------
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:
1997 1996
Statutory federal income tax benefit $ (16,791) $(570,798)
Goodwill amortization 54,784 54,784
Nondeductible meals and entertainment 5,013 2,324
State income taxes, net 21,991 26,337
(Decrease) increase in valuation allowance (5,218) 565,907
Effect of foreign taxes (16,215)
Tax rate benefit (39,902)
Other 5,522
---------- ----------
Income tax provision $ 25,399 $ 62,339
========== ==========
The components of the Company's net deferred income tax asset as of
January 3, 1998 are as follows:
Deferred state taxes $ 10,785
Depreciation (19,877)
Research and development expenses 627,704
Reserves not currently deductible 165,642
Operating loss carryforwards 3,517,698
Other 88,691
-----------
4,390,643
Valuation allowance (4,013,458)
-----------
Net deferred tax asset $ 377,185
===========
The Company's valuation allowance of $4,013,458 at January 3, 1998 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 decreased $184,270 during 1997.
At January 3, 1998, the Company had net operating loss carryforwards for
federal income tax purposes of $9,733,699 ($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 $298,000 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.
24
<PAGE>
SPECTRUM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996 (Continued)
- --------------------------------------------------------------------------------
6. LONG-TERM DEBT
Long-term debt consists of the following at January 3, 1998:
Note payable to bank, with a maturity date of March 1, 2002,
collateralized by substantially all of the assets of the
Company, guaranteed by the majority shareholder, due in
monthly principal installments of $60,000, plus an
installment of $678,621 due May 1, 1998. Interest is
payable monthly at a rate of 9.14% subject to the
bank's yield maintenance agreement (9.14% at January
3, 1998) $3,000,000
Note payable to a bank with a maturity date of May 1, 1998,
collateralized by substantially all of the assets of the
Company, guaranteed by the majority shareholder. Interest
is payable monthly at a rate of prime plus .25% (8.75% at
January 3, 1998) 161,000
8.75% note payable to shareholder, due in annual installments
of $100,000, beginning January 1, 2001, with final payment
of $52,750 due on January 1, 2006 552,750
Noninterest-bearing notes payable on various dates through
January 31, 1999 28,500
Obligation under sales-leaseback transaction 55,540
-----------
3,797,790
Less current portion (1,623,258)
-----------
$2,174,532
===========
Aggregate maturities of long-term debt, including current portion, as of
January 3, 1998 are as follows:
1998 $ 1,623,258
1999 740,403
2000 720,000
2001 261,379
2002 100,000
Thereafter 352,750
-----------
$3,797,790
===========
25
<PAGE>
SPECTRUM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996 (Continued)
- --------------------------------------------------------------------------------
The notes payable to the bank include certain financial covenants and
certain restrictions, including prohibiting the payment of dividends
without prior approval of the bank. At January 3, 1998, the Company was in
violation of certain debt covenants and on April 20, 1998 obtained a
waiver from the bank. Provisions of the Company's loan agreement with the
bank require principal and interest payments due May 1, 1998 of
approximately $1,200,000. On April 29, 1998, the Company obtained an
extension to July 1, 1998. The notes payable are collateralized by
substantially all of the assets of the Company and are guaranteed by the
majority shareholder.
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:
1998 $ 51,732
1999 8,622
---------
60,354
Less amount representing interest (4,814)
---------
$ 55,540
=========
The implicit interest rate under the related lease agreement is 14%.
7. 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.
26
<PAGE>
SPECTRUM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996 (Continued)
- --------------------------------------------------------------------------------
Option activity under the Plan is as follows:
Weighted
average
Number of exercise
shares price
OUTSTANDING, January 1, 1996 639,000 $.32
Granted (weighted average fair value of $.23) 282,000 .30
---------
OUTSTANDING, December 31, 1996 921,000 .32
Granted (weighted average fair value of $.11) 378,000 .21
Terminated (324,000) .26
---------
OUTSTANDING, January 3, 1998 975,000 .29
=========
At January 3, 1998, outstanding options had a range of exercise prices
from $.19 to $.75 per share and weighted average contractual life of 8.3
years. At January 3, 1998, 310,250 options were exercisable with a
weighted average exercise price of $.32 per share. At January 3, 1998,
1,025,000 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, 92% in 1997 and 108% in 1996; risk-free interest rate, 5.8% in
1997 and 6% in 1996; 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 1997 and 1996 awards had been amortized to expense over the vesting
period of the awards, pro forma net loss would have been $139,599 ($.01
per basic and diluted share) in 1997 and $1,697,000 ($.13 per basic and
diluted share) in 1996.
27
<PAGE>
SPECTRUM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996 (Continued)
- --------------------------------------------------------------------------------
8. AFFILIATED-ENTITIES TRANSACTIONS
The Company had additional transactions with affiliates and related
parties as follows:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Rent paid to a company controlled by the majority shareholder $ 152,422 $ 36,000
Legal fees paid to a member of the Board of Directors 63,986 27,080
Purchases from a company controlled by the majority shareholder - 103,173
Sales to a company controlled by the majority shareholder - 23,685
</TABLE>
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 $553,411 at January 3, 1998.
9. COMMITMENTS
The Company rents manufacturing, warehousing and office facilities under
lease agreements requiring monthly payments. Rent expense under operating
leases was $322,632 and $218,939 in 1997 and 1996, respectively, of which
$152,422 and $36,000, respectively, was paid to an affiliated entity. All
facility leases expire on December 31, 1998. Such facility leases require
payments of $334,000 in 1998, except for the facility lease that expires
on January 31, 2003. Rent payments for this lease are approximately
$22,000 in 1998; $24,700 in 1999; $25,300 in 2000; $25,900 in 2001;
$26,500 in 2002; and $2,214 in 2003.
10. FOREIGN SALES
Sales to customers in foreign countries, primarily Europe, amounted to
approximately $2,302,000 and $1,826,000 in 1997 and 1996, respectively.
28
<PAGE>
SPECTRUM LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996 (Continued)
- --------------------------------------------------------------------------------
11. GAIN ON SALE OF PRODUCT LINES
In March 1997, the Company sold its microbiological sampling and
transports product line, including related inventory and production
equipment, for approximately $969,000, resulting in a gain of $768,488. In
November 1997, the Company sold its microscope drapes product line,
including related inventory and production equipment, for approximately
$128,000, resulting in a gain of $34,571.
12. PROPOSED MERGER
The Company is currently investigating the possibility of a merger with
SMI. No definitive agreement has been reached as of March 27, 1998.
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 58 July 30, 1982 Chairman, CEO
& Director
Jack Whitescarver, Ph.D. 60 April 1, 1985 Director
Executive Officers of The Company
- ---------------------------------
Roy T. Eddleman 58 July 30, 1982 Chairman & CEO
F. Jesus Martinez 58 ---- President
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 twenty 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
six 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.
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 1997. Directors are not compensated for their services on the Company's
Board of Directors.
30
<PAGE>
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 AWARDS SAR'S LTIP ALL OTHER
- ----------------- ---- ------ ----- ------------ ----- ---- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Roy T. Eddleman 1997 $160,000
Chief Executive Officer 1996 $160,000 $75,000
1995 $160,000 $82,000
F. Jesus Martinez 1997 $150,200 $61,751 (1)
President 1996 $145,000 $55,000
1995 $84,180 $88,753 (1) 240,000
</TABLE>
(1) Includes payments of $13,626 and $88,753 in 1997 and 1995, respectively,
which were made in connection with the sale of Microgon, Inc. 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 January 3, 1998 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)
Directly Owned
with Sole Power Indirectly Owned with
of Voting and Percent Shared Power of Voting Percent
Name Disposition of Class and/or Disposition of Class (1)
- ---- ----------- --------- ------------------ ------------
<S> <C> <C> <C> <C>
Roy T. Eddleman (B)
23022 La Cadena Drive 901,907 7.0% 11,037,338 85.9%
Laguna Hills, California
Spectrum Medical Industries, Inc.
23022 La Cadena Drive 10,135,431 78.9% - -
Laguna Hills, California
Thomas Girardi, Esq.
1126 Wiltshire Boulevard 901,907 7.0% - -
Los Angeles, CA 90017
Jack Whitescarver, Ph.D. (C) - - - -
All directors and officers as a 901,907 7.0% - -
group (5 in number)
</TABLE>
(1) 12,834,394 shares outstanding as of January 3, 1998.
(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 Mr. Whitescarver 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.
The following table sets forth options granted to named executive officers:
<TABLE>
<CAPTION>
Name No. of Securities Percent of Exercise Expiration Potential Realizable Value
Underlying Options Total Options Price Date at Assumed Annual Rates of
Stock Price Appreciation
- ---- ------------------ ------------- -------- ---------- --------------------------
<S> <C> <C> <C> <C> <C>
Roy T. Eddleman, CEO -- -- -- -- --
F. Jesus Martinez, 240,000 30.7% .32 12/31/00 at 5% $103,200
President at 10% $127,200
</TABLE>
32
<PAGE>
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In 1997 and 1996, the Company has had transactions with related parties as
follows:
1997 1996
Rent paid to a company controlled by the $154,422 $36,000
majority shareholder
Legal fees paid to a member of the Board of $ 63,986 $27,080
Directors
Purchases from a company controlled by the $103,173
majority shareholder
Sales to a company controlled by the $23,685
majority shareholder
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).
10.15 First amendment, dated October 10, 1997, to the City National Bank loan
agreement dated as of February 28, 1997, between registrant, Spectrum
Medical Industries, Inc., and City National Bank.
10.16 Second amendment, dated May 7, 1998, to the City National Bank loan
agreement dated as of February 28, 1997, between registrant, Spectrum
Medical Industries, Inc., and City National Bank.
35
<PAGE>
(b) Reports on 8-K
- ------------------
No reports on Form 8-K were filed during the quarter ended January 3, 1998.
36
<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/ Roy T. Eddleman
----------------------------------
Roy T. Eddleman
Chairman and Chief Executive Officer
Date: May 14, 1998
By: /s/ F. Jesus Martinez
----------------------------------
F. Jesus Martinez
President
Date: May 14, 1998
By: /s/ Larry D. Womack
----------------------------------
Larry D. Womack
Controller
Date: May 14, 1998
37
<PAGE>
FIRST AMENDMENT TO CREDIT AGREEMENT
This First Amendment to Credit Agreement ("First Amendment") is entered
into as of October 10, 1997, by and between SPECTRUM MEDICAL INDUSTRIES, INC., a
California corporation and SPECTRUM LABORATORIES, INC,, a California
corporation, (collectively "Borrower") and CITY NATIONAL BANK, a national
banking association ("CNB").
RECITALS
A. Borrower and CNB are parties to that certain Credit Agreement,
dated as of February 28, 1997 ("Agreement").
B. Borrower and CNB desire to supplement and amend the Agreement as
hereinafter set forth.
NOW THEREFORE, the parties agree as follows:
1. DEFINITIONS. Capitalized terms used in this Amendment without
definition shall have the meanings set forth in the Loan Agreement.
2. AMENDMENTS. The Agreement is amended as follows:
2.1 Section 1. DEFINITIONS. is amended as follows:
2.1.1 Delete the definition of "NOTE" in its entirety and add the
following new definition:
"NOTES" means the Notes referenced in Section 2."
2.1.2 Delete the definition of "TERMINATION DATE" in its entirety and
replace it with:
""TERMINATION DATE" means May 1, 1998. Notwithstanding the
foregoing, CNB may, at its option, terminate this Agreement
pursuant to Section 7.3; the date of any such termination will
become the Termination Date as that term is used in this
Agreement."
2.2 Section 2. LOANS. is amended as follows:
2.2.1 Add the following new sections 2.1A, 2.1A.1, 2.1A.2, 2.1A.3 and
2.7 as follows:
"2.IA REVOLVING CREDIT LOANS. CNB agrees to make loans
("Revolving Credit Loans") to Borrower up to, but not
including, the Termination Date, at Borrower's
1
<PAGE>
request, up to the amount of Five Hundred Thousand and No/100
Dollars ($500,000.00) (the "Revolving Credit Commitment"). The
Revolving Credit Loans may be repaid and reborrowed at any time
up to the Termination Date; provided, however, that the
aggregate unpaid principal amount of outstanding Revolving
Credit Loans will at no time exceed the Revolving Credit
Commitment. Borrower will have a period of not less than thirty
(30) consecutive days during the twelve-month period ending on
the Termination Date during which time there will be no
outstanding Revolving Credit Loans. All Revolving Credit Loans
will be paid by Borrower to CNB on the Termination Date. The
Revolving Credit Loans will be evidenced by a promissory note
("Revolving Credit Note") in the form attached hereto as
Exhibit "B."
2.1A.1 INTEREST ON REVOLVING CREDIT LOINS. Each Revolving
Credit Loan will bear interest from disbursement until due
(whether at stated maturity, by acceleration or otherwise) at a
fluctuating rate equal to the Prime Rate plus one quarter
percent (0.25%) per annum. Interest will be payable monthly in
arrears on the first day of each month, starting on November 1,
1997, and on the date the Revolving Credit Loans are paid in
full.
2.1A.2 REVOLVING COMMITMENT Fee. Borrower shall pay CNB a
non-refundable fee ("Revolving Commitment Fee") equal to one
quarter percent (1/4%) of the Revolving Credit Commitment at
the time the Revolving Credit Commitment is extended to
Borrower.
2.1A.3 PROCEDURE FOR REVOLVING CREDIT LOANS. Each Revolving
Credit Loan may be made by CNB at the oral or written request
of anyone who is authorized in writing by Borrower to request
Revolving Credit Loans until written notice of the revocation
of such authority is received by CNB."
"2.7 CASH/SECURITIES COLLATERAL. Borrower agrees that the
aggregate principal amount of the Cash/Securities Collateral
shall at no time be less than One Million Sixty-Six Thousand
and No/100 Dollars ($1,066,000.00)."
2.2.3 Section 2.1.3 ADDITIONAL TERM LOAN PAYMENT. is amended by
deleting the date "June 1, 1997" from both the first sentence
and the last sentence and replacing it with a new date of
"December 1, 1997" in both the first sentence and in the last
sentence.
2.3 Section 4. REPRESENTATION AND WARRANTIES. is amended as
follows:
At the end of Section 4.8 USE OF PROCEEDS. add the following
sentence: "Borrower will use the proceeds of the Revolving
Credit Loans for Borrower's general working capital needs."
2
<PAGE>
3. CONDITIONS PRECEDENT. This Amendment shall become effective upon the
fulfillment of all of the following conditions to CNB's satisfaction:
3.1 CNB shall have received this Amendment duty executed by
Borrower;
3.2 CNB shall have received the Revolving Credit Note duly executed
by Borrower; and
3.3 CNB shall have received the non-refundable Revolving Commitment
Fee of $1,250.00.
4. EXISTING AGREEMENT. Except as expressly amended herein, the Loan
Agreement shall remain in full force and effect, and in all other
respects is affirmed.
5. COUNTERPARTS. This Amendment may be executed in any number of
counterparts, and all such counterparts taken together shall be deemed
to constitute one and the same instrument.
6. GOVERNING LAW. This Amendment and the rights and obligations of the
parties hereto shall be construed in accordance with, and governed by
the laws of the State of California.
IN WITNESS WHEREOF, the parties have executed this Amendment as of the
day and year first above written.
SPECTRUM MEDICAL INDUSTRIES, INC.,
a California corporation
By: /s/ Roy T. Eddleman
----------------------------
Roy T. Eddleman, Chairman
SPECTRUM LABORATORIES, INC.,
a Califonia corporation
By: /s/ Roy T. Eddleman
----------------------------
Roy T. Eddleman, Chairman
CITY NATIONAL BANK, a national banking association
By: /s/ Ben A. Sottile
----------------------------
Ben A. Sottile, Vice President
3
<PAGE>
GUARANTORS CONSENT
By: /s/ Roy T. Eddleman
---------------------------------
Roy T. Eddleman
SPECTRUM MOLECULAR SEPARATIONS, INC.
By: /s/ Roy T. Eddleman
---------------------------------
Roy T. Eddleman
Title: Chairman and Chief Executive Officer
HYDRO-MED PRODUCTS, INC.
By: /s/ Roy T. Eddleman
---------------------------------
Roy T. Eddleman
Title: Chairman and Chief Executive Officer
SLI ACQUISITION CORP.
By: /s/ Roy T. Eddleman
---------------------------------
Roy T. Eddleman
Title: Chairman and Chief Executive Officer
SPECTRUM EUROPE B.V.
By: /s/ Roy T. Eddleman
---------------------------------
Roy T. Eddleman
Title: Chairman and Chief Executive Officer
4
<PAGE>
EXHIBIT B
REVOLVING CREDIT NOTE
$500,000.00
La Mirada, California
October 10, 1997
For Value Received, the undersigned, SPECTRUM MEDICAL INDUSTRIES, INC., A
CALIFORNIA CORPORATION AND SPECTRUM LABORATORIES, INC., A CALIFORNIA CORPORATION
("Borrower"), promises to pay on the Termination Date to the order of CITY
NATIONAL BANK, a national banking association ("CNB"), at its Office located at
14241 East Firestone Blvd., La Mirada, CA 90638-5568, the principal amount of
Five Hundred Thousand and no/100 DOLLARS ($500,000.00) or so much thereof as may
be advanced and be outstanding, with interest thereon to be computed on each
Revolving Credit Loan from the date of its disbursement at a rate computed on
the basis of a 360-day year, actual days elapsed, at the rates, times and in
accordance with the terms of that certain Credit Agreement between Borrower and
CNB, dated as of February 28, 1997, as may be amended from time to time (the
"Credit Agreement"). Capitalized terms not defined herein shall have the
meanings given them in that certain Credit Agreement.
All or any portion of the principal of this Revolving Credit Note ("Note")
may be borrowed, repaid and reborrowed from time to time prior to the
Termination Date, provided at the time of any borrowing no default exists under
this Note and no Event of Default or Potential Event of Default exists under the
terms and conditions of the Credit Agreement and provided, further that the
total borrowings outstanding at any one time shall not exceed the Revolving
Credit Commitment. Each borrowing and repayment of a Revolving Credit Loan shall
be noted in the books and records of CNB. The excess of borrowings over
repayments as noted on such books and records shall constitute presumptive
evidence of the principal balance due hereon from time to time and at any time.
If payment on this Note becomes due and payable on a non-business day, the
maturity thereof shall be extended to the next business day and, with respect to
payments of principal or interest thereon shall be payable during such extension
at the then applicable rate. Upon the occurrence of one or more of the Events of
Default specified in the Credit Agreement, all amounts remaining unpaid on this
Note may become or be declared to be immediately payable as provided in the
Credit Agreement, without presentment, demand or notice of dishonor, all of
which are expressly waived. Borrower agrees to pay all costs of collection of
this Note and reasonable attorneys' fees (including attorneys' fees allocable to
CNB's in-house counsel) in connection therewith, irrespective of whether suit is
brought thereon.
This is the Revolving Credit Note referred to in the Credit Agreement and
is entitled to the benefits thereof.
1
<PAGE>
EXHIBIT B
Upon CNB's written notice to Borrower of the occurrence of an Event of
Default, the outstanding principal balance (and interest, to the extent
permitted by law) shall bear additional interest from the date of such notice at
the rate of Five Percent (5.0%) per annum higher than the interest rate as
determined and computed above, and continuing thereafter until the Event of
Default is cured.
This Note shall be governed by the laws of the State of California. If this
Note is executed by more than one Borrower, all obligations are joint and
several.
"BORROWER"
SPECTRUM MEDICAL INDUSTRIES, INC.,
A CALIFORNIA CORPORATION
By:/s/ Roy T. Eddleman
------------------------
Roy T. Eddleman, Chmn./CEO
SPECTRUM LABORATORIES, INC.,
A CALIFORNIA CORPORATION
By:/s/ Roy T. Eddleman
------------------------
Roy T. Eddleman, Chmn./CEO
2
<PAGE>
CITY NATIONAL BANK
SECOND AMENDMENT TO CREDIT AGREEMENT
This Second Amendment to Credit Agreement is entered into as of May 7,
1998, by and between SPECTRUM MEDICAL INDUSTRIES, INC., a California corporation
and SPECTRUM LABORATORIES, INC., a California corporation ("Borrower") and CITY
NATIONAL BANK, a national banking association ("CNB").
RECITALS
A. Borrower and CNB are parties to that certain Credit Agreement, dated as
of February 28, 1997, as amended by that certain First Amendment to Credit
Agreement dated as of October 10, 1997, (the Credit Agreement, as herein
amended, hereinafter the "Credit Agreement").
B. Borrower and CNB desire to supplement and amend the Credit Agreement as
hereinafter set forth.
NOW, THEREFORE, the parties agree as follows:
1. DEFINITIONS. Capitalized terms used in this Amendment without definition
shall have the meanings set forth in the Credit Agreement.
2. AMENDMENTS. The Credit Agreement is amended as follows:
2.1 Delete the definition of "TERMINATION DATE" in its entirety and
replace it with:
"TERMINATION DATE" means July 1, 1998. Notwithstanding the
foregoing, CNB may, as its option, terminate this Agreement
pursuant to Section 7.3; the date of any such termination will
become the Termination Date as that term is used in this Agreement"
2.2 Section 2.1.3 ADDITIONAL TERM LOAN PAYMENT. is amended by
deleting the date "DECEMBER 1, 1997" from both the first sentence
and the last sentence and replacing it with a new date of "JULY
1, 1998" in both the first sentence and in the last sentence.
3. EXISTING AGREEMENT. Except as expressly amended herein, the Credit
Agreement shall remain in full force and effect, and in all other respects
is affirmed.
4. Conditions Precedent. This Amendment shall become effective upon the
fulfillment of all of the following conditions to CNB's satisfaction:
4.1 CNB shall have received this Amendment duly executed by Borrower
and
1
<PAGE>
acknowledged by the Guarantors.
5. COUNTERPARTS. This Amendment may be executed in any number of
counterparts, and all such counterparts taken together shall be deemed to
constitute one and the same instrument.
6. GOVERNING LAW. This Amendment and the rights and obligations of the
parties hereto shall be construed in accordance with, and governed by the
laws of the State of California.
IN WITNESS WHEREOF, the parties have executed this Amendment as of the day
and year first above written.
"Borrower" SPECTRUM MEDICAL INDUSTRIES, INC.,a
California corporation
By: /s/ Roy T. Eddleman
------------------------------
Roy T. Eddleman, Chairman/CEO
SPECTRUM LABORATORIES, INC., a
California corporation
By: /s/ Roy T. Eddleman
------------------------------
Roy T. Eddleman, Chairman/CEO
"CNB" CITY NATIONAL BANK, a national
banking association
By: /s/ Roland Pascua
------------------------------
Roland Pascua, Vice President
CONSENT OF GUARANTORS:
2
<PAGE>
The undersigned have previously guaranteed the indebtedness of Spectrum
Medical Industries, Inc., a California corporation and Spectrum Laboratories,
Inc., a California corporation owed to CNB. The undersigned confirm that their
respective guaranties and the security given in connection therewith, if any,
shall continue in full force and effect and that each guaranty shall be a
separate and distinct obligation and apply to the indebtedness arising from the
Credit Agreement as amended herein, subject to the overall limitation as to the
amount guaranteed.
/s/ Roy T. Eddleman
----------------------------
Roy T. Eddleman
Spectrum Molecular Separations, Inc., a
Delaware corporation
By: /s/ Roy T. Eddleman
------------------------------
Roy T. Eddleman, Chairman/CEO
HYDRO-MED PRODUCTS, INC., a
Texas corporation
By: /s/ Roy T. Eddleman
------------------------------
Roy T. Eddleman, Chairman/CEO
SLI ACQUISITION CORP., a
Delaware corporation
By: /s/ Roy T. Eddleman
------------------------------
Roy T. Eddleman, Chairman/CEO
SPECTRUM EUROPE B.V.,a
Netherlands corporation
By: /s/ Roy T. Eddleman
------------------------------
Roy T. Eddleman, Chairman/CEO
3
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JAN-03-1998
<PERIOD-START> JAN-01-1997
<PERIOD-END> JAN-03-1998
<CASH> 1,023,443
<SECURITIES> 0
<RECEIVABLES> 1,157,561
<ALLOWANCES> 132,500
<INVENTORY> 881,418
<CURRENT-ASSETS> 3,566,042
<PP&E> 4,643,156
<DEPRECIATION> 3,863,108
<TOTAL-ASSETS> 7,759,903
<CURRENT-LIABILITIES> 2,811,908
<BONDS> 2,174,532
0
0
<COMMON> 128,344
<OTHER-SE> 607,180
<TOTAL-LIABILITY-AND-EQUITY> 7,759,903
<SALES> 8,135,420
<TOTAL-REVENUES> 8,135,420
<CGS> 4,880,691
<TOTAL-COSTS> 8,995,503
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 73,883
<INTEREST-EXPENSE> 399,239
<INCOME-PRETAX> (47,974)
<INCOME-TAX> 25,399
<INCOME-CONTINUING> (73,373)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (73,373)
<EPS-PRIMARY> (.01)
<EPS-DILUTED> (.01)
</TABLE>
