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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 2003
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
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Commission File No. 333-22997
Spectrum Organic Products, Inc.
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(Name of Registrant as specified in its Charter)
California 94-3076294
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(State of incorporation) (I.R.S. Employer
Identification Number)
5341 Old Redwood Highway, Suite 400
Petaluma, California 94954
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(Address of principal executive offices)
Issuer's telephone number: (707) 778-8900
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Without Par Value Common Stock
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(Title of Class)
Indicate by check mark whether the Registrant (1) filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
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Indicate by check mark if there is no disclosure contained herein of delinquent
filers pursuant to Item 405 of Regulation S-K, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or by
amendment to this Form 10-K. [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes No X
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As of March 22, 2004 there were 46,296,277 shares of the Registrant's common
stock outstanding.
As of March 22, 2004 the aggregate market value of the Registrant's no par value
common stock, excluding shares held by affiliates, was $9,843,016 based upon a
closing bid price of $0.80 per share of common stock on the OTC Bulletin Board
System.
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Page 1
PART I
ITEM 1. BUSINESS
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Introduction
Spectrum Organic Products, Inc. ("Spectrum", the "Registrant" or the "Company")
competes primarily in three business segments: natural and organic foods under
the Spectrum Naturals(R) brand, essential fatty acid nutritional supplements
under the Spectrum Essentials(R) brand, and industrial ingredients for use by
other manufacturers sold under the Spectrum Ingredients name. The vast majority
of the Company's products are oil-based and the Company has positioned itself as
"The Good Fats Company".
Within the natural and organic foods segment, the Company's products include
olive oils and other culinary oils, salad dressings, condiments and
butter-substitutes such as Spectrum Organic Margarine(R) and Spectrum Spread(R).
All of the Company's culinary products feature healthy fats, contain no
hydrogenated or trans fats and are offered in a variety of sizes and flavors in
both organic and conventional, non-GMO offerings.
Within the nutritional supplement segment, the Company's products include
organic flax oils, evening primrose oil, borage oil, Norwegian fish oil and
other essential fatty acids in both liquid and capsule forms. The Spectrum
Essentials(R) products are cold-pressed, nutritionally rich sources of Omega-3
and Omega-6 essential fatty acids and are also offered in a variety of sizes and
styles.
The Spectrum Ingredients(R) (formerly known as Spectrum Commodities, Inc.)
segment includes organic and conventional non-GMO culinary oils, organic
vinegar, condiments and nutritional oils offered to other manufacturers for use
in their products. In addition, they bring incremental purchasing power to the
Company resulting in higher margins for the consumer branded products.
This Form 10-K contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. These forward-looking
statements are subject to risks and uncertainties that may cause actual results
to differ materially.
Business Combination and Subsequent Divestitures
The Company was formed on October 6, 1999 by the four-way reverse merger of
three private companies: Spectrum Naturals, Inc. ("SNI"), its affiliate Spectrum
Commodities, Inc. ("SCI") and Organic Ingredients, Inc. ("OI"), into the public
company Organic Food Products, Inc. ("OFPI"). OFPI was the Registrant prior to
the merger, but since a controlling interest in the Company is held by former
SNI stockholders, the merger was accounted for as a reverse acquisition, with
SNI and SCI as the acquirer and OI and OFPI as acquirees.
On June 11, 2001 the Company sold the OFPI tomato-based product lines to Acirca,
Inc., an unrelated third party. Accordingly, operating results for 2001 include
the results associated with the OFPI disposed product lines from January 1 until
the date of sale.
On April 25, 2002 the Company sold the OI industrial ingredient product lines in
fruits, vegetables, concentrates and purees to Acirca. Accordingly, operating
results for 2002 include the operating results associated with the OI disposed
product lines from January 1 until the date of sale. The two dispositions have
significantly strengthened the Company from a liquidity and working capital
standpoint. Additionally, the Company can now focus its resources on its core
business in healthy oils, butter substitutes and essential fatty acid nutrition.
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History
SNI was incorporated in 1980 to bring nutrition and quality into the vegetable
oil category. In the beginning natural oils were manufactured and distributed in
bulk. Six years later the Spectrum Naturals(R) brand was launched. Over time SNI
expanded its product lines to include condiments and salad dressings under the
Spectrum Naturals(R) brand and nutritional supplements under the Spectrum
Essentials(R) brand. The brands are positioned as premium, healthy alternatives
to conventional products as a result of the organic sourcing of raw ingredients
and the chemical-free extraction of the oils utilizing mechanical (expeller)
pressing techniques. SNI has been a leading innovator in the development and
marketing of expeller-pressed and certified organic vegetable oils. The Company
has also been a leading proponent of testing and verifying the absence of
genetically modified organisms in its culinary oils. SNI has marketed natural
mayonnaise since 1987, organic vinegar since 1989 and healthy fat salad
dressings since 1996. Spectrum Spread(R), a healthy alternative to butter or
margarine in baking applications was introduced in 1993.
Expanding into the nutritional supplement product category, Spectrum
participated in areas of nutritional research and product development, becoming
the first company to market organic flax oil in the United States. Spectrum also
implemented the proprietary technology known as SpectraVac. SpectraVac, in use
since 1989, is an organic method of fresh oil extraction from seed without the
use of chemicals that also minimizes the impact of oxygen, light and heat. The
SpectraVac system also employs micron filtration technology which eliminates
impurities without stripping out the beneficial compounds in the oil. The result
is a true, cold-pressed nutritionally rich oil that resists flavor reversion.
In 1995 the Company formed Spectrum Commodities, Inc. to serve other natural
food manufacturers with similar bulk ingredient needs. SCI's mission was to
improve the integrity of ingredients used in food manufacturing. SCI offered
expeller-pressed oils in place of those made with petroleum solvents. Organic
and non-GMO oils are often preferred over their conventional counterparts. SCI
also secured exclusive distribution rights to new products such as organic palm
and coconut oils. SCI works with a distribution network that has railcar pumping
stations and warehouses on both coasts. SCI provides industrial quantities of
organic and expeller-pressed culinary and nutritional oils and organic vinegar
to manufacturers, co-packers, private label and food service accounts. The SCI
product lines are now offered for sale under the Spectrum Ingredients ("SI")
name.
OFPI went public in August 1997 and was traded on the NASDAQ Small Cap Market
until being delisted in May 1999 due to non-compliance with the net tangible
assets requirement. Since then the Company's common stock has traded on the OTC
Bulletin Board System under the ticker symbol "OFPI" until the October 1999
merger, after which the Company changed its name to Spectrum Organic Products,
Inc. and its ticker symbol to "SPOP."
The Company offers its products here in the United States as well as
internationally to natural and mainstream retailers and manufacturers. Retail
products are sold in, but not limited to, stores such as Whole Foods, Wild Oats,
Raley's and Trader Joe's.
SPECTRUM NATURALS(R) CULINARY SEGMENT
The Company introduces and discontinues products on a regular basis, consistent
with customary practices of other firms in the processed food industry. The
Company's current culinary products, which include organic and Orthodox Union
certified products, include the following:
Culinary Oils
The Company's largest culinary product line is olive oil. Spectrum markets
organic and conventional extra virgin olive oil in various sizes. The Company
also offers olive oils from various geographic regions including Greece, Spain,
Italy, Argentina and California.
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Spectrum also markets other refined, unrefined, blended and organic cooking oils
under the Spectrum Naturals(R) brand. The other culinary oils include almond,
apricot, avocado, canola, coconut, corn, peanut, grapeseed, safflower, sesame,
soy, sunflower and walnut. In 2003 the Company introduced three new toasted nut
oils: walnut, hazelnut and pumpkin seed.
Condiments
The Company also markets condiments under the Spectrum Naturals brand name.
There is both a "lite" and a regular mayonnaise made from expeller-pressed
canola oil. The Company introduced the first organic mayonnaise during 2000.
Spectrum also markets a vinegar line that is third party certified organic,
which includes: apple cider, brown rice, red wine, white wine and balsamic.
There is also non-organic balsamic vinegar from Modina, Italy. Spectrum also
markets two types of spreads for use as a healthy alternative to butter or
margarine: Spectrum Naturals Canola Spread and Essential Omega Spread made with
organic flax and soy oils. Spectrum also introduced the first organic margarine
during 2000.
Salad Dressings
The Company also markets organic salad dressings in full-fat, low-fat and
fat-free versions in various flavors and sizes. The salad dressing line also
includes three Omega-3 vinaigrettes, which are functional full-fat dressings
made with organic flax and soy oil to help consumers achieve recommended daily
allowances of Omega-3 essential fatty acids in a tasteful product.
Cooking Sprays
There are five six-ounce cooking sprays that compete with their mass-market
counterpart "Pam". The Spectrum Super Canola Spray Oil is made from high-oleic
canola oil and the Extra Virgin Olive Spray Oil is made from a blend of extra
virgin olive oil and canola oil. Also available in the six-ounce size are Canola
Spray Oil with Butter Flavor, Grapeseed Spray Oil and Extra Virgin Olive Spray
Oil with Garlic Flavor. There is also a 16-ounce version of the Spectrum Super
Canola Spray Oil.
Shortening
Spectrum markets a non-hydrogenated organic palm shortening that can be used in
any cooking application where butter, margarine or shortening is called for. The
Spectrum Naturals(R) shortening is a healthy alternative to hydrogenated
shortening and partially hydrogenated oils.
IQF Whole Frozen Fruits and Vegetables
There are eight Individually Quick Frozen whole frozen fruits offered by the
Company for sale in foodservice sizes: bananas, raspberries, strawberries,
peaches, mango, papaya, blueberries and pineapple. IQF vegetables include peas
and corn.
SPECTRUM ESSENTIALS(R) NUTRITIONAL SUPPLEMENT SEGMENT
Spectrum markets essential fatty acid nutritional supplements under the Spectrum
Essentials(R) brand. The supplements are available in both liquid and capsule
forms. The essential fatty acid supplement oils include Flax, Borage, Evening
Primrose, Norwegian Fish and Wheat Germ oils in various sizes, flavors and
blends. The Spectrum Essentials(R) brand also includes two fiber supplements for
colon care.
SPECTRUM INGREDIENTS/PRIVATE LABEL SEGMENT
The Company offers a wide variety of certified organic and non-organic
industrial ingredients to other food manufacturers, including olive oils and
numerous other vegetable cooking oils in both refined and unrefined states,
vinegar, mayonnaise, shortening and nutritional oils (primarily flax oil) sold
in institutional sizes and bulk capsules.
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The private label product lines include programs for natural and organic food
retailers such as Whole Foods, Wild Oats and Trader Joe's. These programs
include canola oil, mayonnaise, olive oil, flax oil, various fruit juices and
tomato-based products. The Company has announced is intention to discontinue the
private label fruit juice and tomato-based products, effective April 16, 2004.
Sales and Distribution
Spectrum sells its consumer branded products primarily through distributors,
independent commissioned food brokers and specialty food brokers to natural food
and specialty food stores, retail chains and independent grocery stores.
Currently Spectrum products are offered in over 6,000 health food stores
nationwide and 2,000 grocery stores located throughout the United States and
Canada. In order to increase its distribution and sales, Spectrum offers special
promotional pricing and occasionally may pay "slotting fees", which are payments
made by food processors and distributors to retail stores in order to acquire
retail shelf space for their food products.
In 2003 United Natural Foods, Inc. ("UNFI") accounted for approximately 36% of
the Company's net sales, versus 50% in 2002 and 39% in 2001. The loss of UNFI as
a customer would have a material adverse effect on Spectrum's operations. The
Company has one independent Director, Thomas B. Simone, who also serves as Vice
Chair and Lead Independent Director of the Board of United Natural Foods, Inc.
UNFI's percentage of sales decreased in 2003 because of the growth of the
Spectrum Ingredients Division as a percent of total sales. The Spectrum
Ingredients product lines are sold to domestic food manufacturers.
A broker incentive plan has been implemented based on annual quotas to motivate
brokers to increase their sales of Spectrum products. Spectrum has also entered
into arrangements with certain retail store chains to obtain closer working
relationships and enhanced retail merchandising and promotional support.
To date the Company has focused on its core natural foods distribution network.
Spectrum will enter into new distribution arrangements with mass-market accounts
where profitable. Management believes there is an opportunity to enter
conventional supermarkets as they become more committed to providing a variety
of organic and natural food products, and as consumers become more health
conscious.
Marketing and New Product Development
Spectrum's product marketing emphasizes organic, all natural and healthy oil
products containing no hydrogenated fats as a healthy and good-tasting
alternative to similar traditional food products. Each brand is targeted toward
specific consumer segments with appropriate products, flavor variations, images
and messages. Spectrum promotes all its brands to natural food and health food
stores and the specialty or gourmet departments of grocery stores. Spectrum
utilizes a pricing strategy in which its organic food products are offered at
prices only slightly higher than their non-organic counterparts through
strategic everyday value pricing programs with key retailers.
The Company primarily uses outside resources in developing its new consumer
branded products. Research and development expenses are included in general and
administrative expense.
Manufacturing Facilities and Suppliers
Spectrum manufactures the Spectrum Essentials flax oil products in a leased
facility located at 133 Copeland Street, Petaluma, California. On July 14, 2003
the Company disassembled its bottling line at Copeland Street and relocated and
reconfigured the line at its new bottling co-packer, Interpac Technologies, Inc.
("Interpac"), also located in Petaluma. Interpac provides custom bottling
services to the Company utilizing the Company's bottling equipment.
On June 2, 2003 the Company relocated its third party warehousing and
distribution facility from Southern California to a new facility operated by
Interpac in Woodland, California.
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Spectrum uses co-packers to process and package its vinegars, condiments,
dressings, mayonnaise, shortening, spreads and encapsulated nutritional
products. The Company's primary co-packer of branded products represented
approximately 11% of the cost of goods sold in 2003 versus 11% in 2002 and 6% in
2001. While a change in co-packers could cause a delay in production and a
possible loss of sales, the Company believes other manufacturers are available
who could provide processing at similar prices and terms.
Organic raw materials are available from a limited number of sources. The
Company had one vendor of canola oil that supplied approximately 16% of
Spectrum's raw material purchases in 2003 versus 11% in 2002 and 6% in 2001. The
Company believes that other suppliers are available who could provide products
at similar prices and terms. A change in suppliers, however, could cause a delay
in manufacturing and a possible loss of sales, which could adversely affect
operating results.
Competition
The natural food and health food industries in general and the condiment,
culinary oil and nutritional supplement businesses in particular, are highly
competitive and there are numerous multinational, regional and local firms that
currently compete, or are capable of competing, with Spectrum. In the natural
foods category Spectrum's principal competitors are private label offerings and
Hain Pure Foods. Spectrum competes with numerous brands in the non-organic
vegetable oil category including Puritan and Wesson. In the organic culinary oil
category, competitors include Colavita, Hain and Dal Raccolto. The nutritional
supplement competitors include Health From The Sun and Barleans. The Company
also faces competition in the natural food condiment market from Eden, Canoleo,
Nasoya, Annie's and Braggs. Competitors in the non-organic condiments market
include H.J. Heinz Company and International Home Foods, which markets Best
Foods Mayonnaise.
Competitive factors in the specialty foods industry include price, quality,
brand image and flavor. Spectrum positions its product lines to be slightly more
expensive than their non-organic food counterparts but consistent with prices
charged by other organic food marketers. Management believes its products
compete favorably against other organic foods with respect to quality and
flavor.
Trade Names and Trademarks
The Company has federal registration for its Spectrum Naturals, Spectrum
Essentials, Spectrum Spread and Veg Omega-3 trademarks. However, there can be no
assurance that any trademark or trade name will not be copied or challenged by
others.
Government Regulation
The Company is subject to various federal, state and local regulations relating
to cleanliness, maintenance of food production equipment, food storage and food
handling and the Company is subject to unannounced on-site inspections of its
manufacturing facilities. As a manufacturer and distributor of foods, the
Company is subject to regulation by the United States Food and Drug
Administration ("FDA"), the Federal Trade Commission ("FTC"), the United States
Department of Agriculture ("USDA") and the Occupational Safety and Health
Administration ("OSHA") in connection with the manufacture, sale, safety,
advertising, handling, storage, transportation, labeling and processing of food
products. In order to offer organic and kosher food products, the Company is
also subject to inspection and regulation by third party certification agencies.
The USDA adopted regulations with respect to the labeling and certification of
organic foods which were implemented on October 21, 2002. The Company has made
the required label revisions and is in compliance with the additional
requirements for third party organic certification.
In response to the terrorist attacks against the United States on September 11,
2001 the government has taken aggressive action to protect the nation's food
supplies. In June 2002 the FDA enacted the Public Health Security and
Bioterrorism Preparedness and Responsive Act of 2002 (the "Bioterrorism Act").
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The Bioterrorism Act mandated that all food companies comply with four new
requirements with regards to the importation of food products to the United
States as of December 2003:
1. Registration of all domestic and importing manufacturers directly with
the FDA.
2. Pre-notification of inbound food shipments with the Bureau of Customs
and Border Protection (the "BCBP").
3. Maintenance of documentation to support the importation of any food
product, by lot, as it flows from the importer to the ultimate
customer for a minimum of two years.
4. Detention of food products at the port of entry at the discretion of
the FDA, in connection with its efforts to protect the nation's food
supply.
Spectrum, as a regulated organic producer, has been subject to annual audits to
retain its organic certification and maintains records of organic and
conventional shipments, by lot, for a minimum of five years. Accordingly,
compliance with the Bioterrorism Act has been relatively seamless for the
Company. The increased amount of time required to clear items through the port
with the BCBP has required the Company to carry higher levels of raw materials
in inventory, however.
Additionally, the BCBP has initiated a key cooperative program with the importer
community called Customs-Trade Partnership Against Terrorism ("C-TPAT"). The
BCBP provides participating companies with guidelines for security enhancement
throughout the supply chain and encourages their voluntary enrollment into
C-TPAT. The Company has applied for membership in the C-TPAT program, which will
lower the Company's risk profile with BCBP and improve the efficiency of the
importation of raw materials by the Company.
The Spectrum Essentials(R) brand of nutritional supplements are subject to the
Dietary Supplement Health and Education Act of 1994 or "DSHEA", which went into
effect in March 1999. DSHEA defines dietary supplements as a new category of
food, separate from conventional food. DSHEA requires specific nutritional
labeling requirements for dietary supplements and permits substantiated,
truthful and non-misleading statements of nutritional support to be made in
labeling, such as statements describing general well-being resulting from
consumption of a dietary ingredient, or the role of a nutrient or dietary
ingredient in affecting or maintaining a structure or function of the body.
Regulations in new markets and future changes in the regulations may adversely
impact the Company by raising the cost to manufacture and deliver the Company's
products or by affecting the perceived healthfulness of the Company's products.
A failure to comply with one or more regulatory requirements could interrupt the
Company's operations and result in a variety of sanctions, including fines and
the withdrawal of the Company's products from store shelves. The Company holds
all material licenses and permits required to conduct its operations.
The Company is also subject to federal and state laws establishing minimum wages
and regulating overtime and working conditions.
Employees
As of March 22, 2004 Spectrum had 59 full-time employees. Spectrum's employees
are not covered by a collective bargaining agreement and the Company considers
its employee relations to be satisfactory.
ITEM 2. PROPERTY
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The Company leases three facilities in Petaluma, California to house
manufacturing and the administrative offices. The Petaluma facilities occupy a
total of 53,800 square feet at a combined monthly rent of $41,600. In December
2002 the Company consolidated its office space into its new headquarters
facility at 5341 Old Redwood Highway, Suite 400, Petaluma, California. The
headquarters facility lease is a non-cancelable operating lease which expires on
December 31, 2007. While Management believes that the headquarters facility is
adequate for the Company's needs, it was actively evaluating other locations for
its manufacturing facility at the time this report was filed.
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ITEM 3. PENDING LITIGATION
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Industrial Accident
On February 4, 2004 the Company pleaded no contest to two misdemeanor counts of
violations under California Labor Code Section 6425, violation of a regulation
issued by the California Occupational Health and Safety Administration
("CAL-OSHA"), requiring employers to provide, maintain and ensure employees use
required confined space equipment. The plea arose in connection with a tragic
production accident on April 25, 2002 that resulted in the death of two of the
Company's employees. Under the Terms of Settlement and Probation entered into
with the plea, the Company will pay a fine of $150,000 in three annual
installments of $50,000 each on June 30, 2004, 2005 and 2006. In addition the
Company paid $150,000 in restitution to the California District Attorneys
Association Workers Safety Training Account to assist in the prosecution of
worker safety cases in the State of California. The Company also reimbursed
costs of $25,000 each to the Petaluma Police Department, the Petaluma Fire Dept.
and the Sonoma County District Attorney's Office. Finally, an additional fine of
$250,000 under California Labor Code Section 6425 was suspended conditioned upon
the Company's compliance with the terms of court supervised probation for three
years. Accordingly, the Company accrued an expense of $375,000 against the year
ended December 31, 2003 to cover the net present value of the above payments,
plus estimated attorney's fees to reach agreement on the plea with the District
Attorney's Office. Total expenses directly attributable to the industrial
accident were $410,200 and $254,100 for the years ended December 31, 2003 and
2002, respectively.
At December 31, 2003 the remaining outstanding issues in connection with the
industrial accident were the CAL-OSHA proposed penalties of $137,900 which have
been appealed by the Company, and appeals filed by the estates of the two
employees with the Workers Compensation Appeals Board of California for serious
and willful misconduct penalties of $107,500 in total. The Company intends to
defend itself vigorously and believes it has meritorious defenses, since the
CAL-OSHA citations did not include any willful penalties. It actually litigated,
the workers compensation appeals are an all-or-nothing proposition under which
the Company will either be liable for $107,500 or nothing. Based on the advice
of counsel, the Company expects the workers compensation appeals to be settled
rather than litigated. The Company had a reserve of $141,900 at December 31,
2003 to cover the anticipated settlement of these outstanding issues plus
attorney's fees, which Management believes will be adequate.
Proposition 65 Complaint
On November 26, 2003 the Company was notified by attorneys for the Environmental
Law Foundation (the "ELF") that the Spectrum Naturals(R) Organic Balsamic
Vinegar contains lead in excess of the allowable quantities under the Safe
Drinking Water and Toxic Enforcement Act of 1986, also known as Proposition 65.
The ELF is a California non-profit organization that represents itself as
dedicated to the preservation of human health and the environment.
ELF's attorneys filed a Complaint for Civil Penalties, Statutory, Equitable and
Injunctive Relief (the "Complaint") against Cost Plus, Inc., Safeway, Inc.,
Trader Joe's Company, Williams-Sonoma, Inc., Whole Foods, Inc. and unspecified
defendants one through 100 in the Superior Court of the State of California on
May 20, 2003 alleging violation of Proposition 65 for the sale of various
products that contain lead in excess of the allowable limits without the
required warning label. ELF's attorneys later notified Spectrum and dozens of
other retailers, importers and manufacturers of vinegar that they would be
included as one of the 100 unspecified defendants included in the Complaint.
While lead has been shown to cause cancer and reproductive toxicity in humans,
the Proposition 65 consumption quantity defined as no significant risk level for
cancer was set at 15 micrograms per day. Lead is a naturally occurring element
in all vinegars. Based on the Company's tests, a person would need to consume
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somewhere between 1.3-2.6 cups (270-630ml) daily of the Company's various
vinegar products to reach the Proposition 65 lead level. The small lead content
in vinegar occurs naturally in the soil and is absorbed by the grapes used to
make vinegar. The level of lead in vinegar is not affected by the manufacturing
process and, therefore, is not subject to regulation under Proposition 65.
The Spectrum Naturals(R) brand was built on the premise of providing consumers
with organic healthy oils and condiments. Management does not believe the
consumption of its various vinegar products as condiments or salad dressings
poses any increased risk for cancer or reproductive toxicity.
The Company has joined a Joint Defense Group established by attorneys
representing several of the defendants in the Complaint. The initial fee to join
was a $5,000 retainer, which the Company paid on February 17, 2004. Management
believes the Complaint will eventually be shown to be without merit.
Accordingly, no provision for loss or future attorney's fees has been recorded
at December 31, 2003.
Patent Infringement Complaint
In October 2000 the Company was notified by counsel for GFA Brands, Inc. ("GFA")
that nutritional claims pertaining to Spectrum Naturals(R) Organic Margarine
were infringing upon two patents (the "first patents") issued in the United
States that pertain to particular fat compositions suitable for human
consumption. The patent holder, Brandeis University, exclusively licensed each
of these patents to GFA. GFA demanded that the Company cease the manufacture and
sale of the margarine and threatened legal action if the Company failed to
comply.
Management engaged legal counsel that specializes in this area and received an
opinion letter in February 2001 confirming that, in the opinion of counsel, the
manufacture or sale of Spectrum Naturals(R) Organic Margarine did not infringe
upon the GFA patents, either literally or under the doctrine of equivalents.
It has always been Management's view that the formula for Spectrum Naturals
Organic Margarine(R) fell outside the claims made in the Brandeis University
patents. Despite numerous attempts, the Company was unable to convince GFA that
its formula for the margarine fell outside the claims of the first patents.
Therefore, the Company filed a complaint against GFA for declaratory judgment of
non-infringement and invalidity of the two patents on August 28, 2001 in the
U.S. District Court for Northern California. The complaint requested a
declaratory judgment that the margarine does not infringe either patent, a
declaratory judgment that both patents are invalid, that GFA be enjoined from
threatening or asserting any action for infringement of either patent, and
attorney's fees.
GFA subsequently filed a motion to transfer venue to the U.S. District Court for
New Jersey (the "court"). The Company filed an opposition to that motion;
however, the motion to transfer venue was granted in January 2002.
A settlement hearing between GFA, its counsel, the Company and its counsel took
place on July 31, 2003. There was discussion amongst the parties regarding a
potential resolution of the case without resorting to a trial. A settlement
between the parties could not be reached.
Markman briefs, in which each side presents its arguments on how the patent
claims should be construed, were submitted by both GFA and Spectrum in July
2003. In most patent infringement cases, the court's determination of how the
patent claims should be interpreted is the central issue. A Markman hearing was
held by the court on October 16, 2003. The court issued its ruling on the
Markman hearing on December 3, 2003 in favor of the Company's interpretation of
the patent claims. The favorable ruling will assist the Company in settling the
complaint with respect to the first patents.
Meanwhile, unbeknownst to the Company, Brandeis University had filed for an
additional patent (the "second patent") with the U.S. Patent Office which
included patent claims that did encompass the Company's formula for Spectrum
Naturals Organic Margarine(R). Unlike trademark law, patents are issued in the
United States without pre-publication or notice which would allow for comment or
appeal by potentially affected parties. Instead, the United States Patent Office
is the sole arbiter of the merits of any patent application. Once a patent is
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issued, the burden to contest it falls on any affected party to pursue its
rights via the courts. On October 7, 2003 the U.S. Patent Office granted the
second patent to Brandeis University. On the advice of counsel, the Company
ceased the production of the margarine immediately thereafter and is currently
evaluating its options with regards to the second patent.
Management believes the Company has meritorious defenses and that a loss is not
probable on the patent infringement complaint with regard to the first patents
at this time. Accordingly, no provision for loss has been recorded at December
31, 2003.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
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None.
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Page 10
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
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MATTERS
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General
The Company's common stock was traded on the NASDAQ Small Cap Market under the
symbol "OFPI" from August 1997 to May 1999 when it was delisted due to
non-compliance with the minimum net book value requirement. Thereafter it traded
on the OTC Bulletin Board System and still does under the new symbol "SPOP".
The following table sets forth the range of high and low closing prices of the
Company's common stock as reported by the OTC Bulletin Board for the periods
indicated.
Price
-----
High Low
---- ---
Fiscal Year Ended December 31, 2003:
First Quarter $ 0.40 $ 0.27
Second Quarter 0.45 0.21
Third Quarter 0.72 0.41
Fourth Quarter 0.85 0.58
Fiscal Year Ended December 31, 2002:
First Quarter $ 0.44 $ 0.18
Second Quarter 0.48 0.24
Third Quarter 0.60 0.36
Fourth Quarter 0.47 0.28
The last recorded sale price of the Company's common stock was $0.80 per share
on the OTC Bulletin Board System on March 22, 2004.
As of March 22, 2004 the Company had approximately 750 record and beneficial
stockholders.
Dividend Policy
The Company has not in the past nor does it intend to pay cash dividends on its
common stock in the future. The Company intends to retain earnings, if any, for
use in the operation and expansion of its business. The amount of future
dividends, if any, will be determined by the Board of Directors based upon the
Company's earnings, financial condition, capital requirements, general economic
conditions and such other factors as the Board deems relevant. Moreover, the
Company's Credit and Security Agreement with its primary lender prohibits the
payment of dividends without the prior approval of the lender.
- --------------------------------------------------------------------------------
Page 11
Shares Issued During the Years Ended December 31, 2003, 2002 and 2001
During the years ended December 31, 2003, 2002 and 2001, the Company issued
shares of its common stock as follows for the reasons indicated:
Cash and
Month Shares Non-Cash
Issued Issued Proceeds
------ ------ --------
Year Ended December 31, 2003:
Shares issued for the exercise of common stock
purchase warrants under the private placement
notes Various 405,456 $ 90,000
Shares issued for the exercise of common stock
options by former employees Dec. 2003 143,750 59,400
--------- ---------
Totals for the Year Ended December 31, 2003 549,206 $ 149,400
========= =========
Year Ended December 31, 2002:
Shares issued for the net exercise of common
stock purchase warrants under the private
placement notes Nov. 2002 6,910 $ --
========= ==========
Year Ended December 31, 2001:
Shares issued to a non-executive Director of
the Company, under a private sale Feb. 2001 160,000 $ 50,000
Shares issued to two non-executive Directors of
the Company, in lieu of cash compensation for
Board fees earned during 2000 Feb. 2001 64,000 20,000
Shares issued to four note holders under the
private placement conversion offer to convert
the notes to equity Various 630,000 168,200
Common stock purchase warrants exercised by the
note holders under the private placement notes Various 230,883 --
Shares issued to the Chapter 7 estate of Sunny
Farms Corp. in final settlement of litigation Dec. 2001 117,950 93,700
--------- ---------
Totals for the Year Ended December 31, 2001 1,202,833 $ 331,900
========= =========
All the shares except those issued to the Chapter 7 estate of Sunny Farms Corp.
and the shares issued under the Company's Stock Option Plan were issued under
Regulation D of the Securities Act of 1933 (the "Act"), with resale of such
shares permitted only pursuant to Rule 144 of the Act. All certificates
representing the unregistered shares were endorsed with restrictive legends
identifying them as unregistered under the Act.
Shares Authorized for Issuance Under Equity Compensation Plans
The Company's Amended 1995 Stock Option Plan is the only compensation plan under
which equity securities of the Company are issued. That plan has been approved
by the Company's shareholders and the following table provides information
regarding its status as of December 31, 2003:
- --------------------------------------------------------------------------------
Page 12
Available Shares
Shares to be Issued Weighted Average Remaining for Future
Upon Exercise of Exercise Price of Issuance Under Equity
Outstanding Options Outstanding Options Compensation Plan
------------------- ------------------- ---------------------
Equity Compensation Plan
Approved by Security
Holders 4,152,115 $ 0.33 2,704,135
ITEM 6. SELECTED FINANCIAL DATA
- --------------------------------------------------------------
The selected consolidated financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Conditions
and Results of Operations" and the consolidated financial statements of the
Company and the notes thereto included in Item 8 of this Form 10-K.
Years Ended December 31,
------------------------
In thousands except per share data 2003 2002 2001 2000 1999
- ---------------------------------- ---- ---- ---- ---- ----
Operating Data:
Net Sales $45,677 $40,579 $41,019 $41,442 $29,161
Gross Profit 11,870 10,756 11,009 9,418 8,202
EBITDA as adjusted 2,437 2,289 2,400 1,212 1,486
Income (Loss) from Operations 1,526 1,776 (4,251) (688) 762
Net Income (Loss) 2,664 1,120 (5,206) (2,002) (113)
Weighted Average Shares Outstanding:
Basic 45,845 45,700 45,279 44,234 35,095
Fully Diluted 47,840 46,306 45,279 44,234 35,095
Net Income (Loss) per Share:
Basic $ 0.06 $ 0.02 $ (0.12) $ (0.05) $ (0.00)
Fully Diluted 0.06 0.02 (0.12) (0.05) (0.00)
Cash Dividends Declared per Share 0.00 0.00 0.00 0.00 0.00
Cash Flow Data:
Cash Provided by (Used in) Operating
Activities $(1,206) $ 717 $ (858) $ 360 $ (172)
Cash Provided by (Used in) Investing
Activities (1,831) 2,344 2,294 20 (1,530)
Cash Provided by (Used in) Financing
Activities 3,032 (3,075) (1,418) (379) 1,702
As of December 31,
------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Balance Sheet Data:
Working Capital (Deficit) $ 1,560 $ 597 $(1,030) $(4,257) $(3,323)
Total Tangible Assets 18,634 12,156 12,776 13,057 14,654
Total Assets 19,221 12,198 14,300 22,841 24,974
Total Long-term Debt 1,653 1,084 1,708 2,001 2,788
Total Stockholders' Equity 6,087 3,274 2,098 6,850 8,413
As described in Note 1 to the financial statements, the Company was formed on
October 6, 1999 by the merger of Spectrum Naturals, Inc., its affiliate Spectrum
Commodities, Inc. and Organic Ingredients, Inc. with and into Organic Food
Products, Inc. Effective with the merger the newly combined entity changed its
name to Spectrum Organic Products, Inc. Since a controlling interest in the
combined Company is held by former SNI stockholders, the merger was accounted
for as a reverse acquisition, with SNI as accounting acquirer and OI and OFPI as
accounting acquirees. The number of shares outstanding and per-share amounts
have been retroactively restated where applicable for all periods presented.
- --------------------------------------------------------------------------------
Page 13
Accordingly, the selected financial data presented above reflects the historical
results of SNI and SCI only for all periods presented through October 5, 1999
and the combined entity from the October 6, 1999 merger date forward. On June
11, 2001 the Company sold the OFPI product lines to a third party; therefore,
results for 2001 include the OFPI product lines from January 1 to the date of
sale. On April 25, 2002 the Company sold the OI product lines to a third party;
therefore, results for 2002 include the OI product lines from January 1 to the
date of sale.
As a result of the 1999 merger and subsequent divestitures of the product lines
acquired in the merger in 2001 and 2002, the net sales data in the selected
financial data table above requires additional disclosures. The Company has
posted significant annual sales growth within its core categories of healthy
oils, butter substitutes and nutritional supplements. The following table
discloses net sales by segment and comparable net sales (excluding the impact of
acquired and subsequently disposed product lines) for the last five years
(dollars in thousands):
Years Ended December 31,
------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Spectrum Naturals(R)Culinary
Products $ 20,606 $ 17,268 $ 15,221 $ 13,121 $ 13,197
Spectrum Essentials(R)
Nutritional Supplements 10,354 9,031 7,777 6,626 5,842
Spectrum Ingredients/Private
Label Products 14,443 11,066 8,294 8,749 7,639
------- -------- -------- -------- --------
Comparable Net Sales 45,403 37,365 31,292 28,496 26,678
Disposed/Discontinued Product
Lines 274 3,214 9,727 12,946 2,483
-------- -------- -------- -------- --------
Total Net Sales $ 45,677 $ 40,579 $ 41,019 $ 41,442 $ 29,161
======== ======== ======== ======== ========
EBITDA as adjusted reflects earnings before interest, taxes, depreciation,
amortization, non-cash losses on asset writedowns, the gain or loss from the
sales of product lines and the industrial accident. Management believes this is
an important measure of the Company's operating performance, however, EBITDA as
adjusted may not be comparable to similar measures presented by other companies.
The calculations to arrive at EBITDA as adjusted are detailed in the following
table (dollars in thousands):
Years Ended December 31,
------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Net income (loss) as reported $ 2,664 $ 1,120 $(5,206) $(2,002) $ (113)
Provision (benefit) for income
taxes (1,567) 190 -- 4 96
Interest expense 404 481 913 1,382 749
Depreciation and amortization 525 454 419 531 437
Amortization of goodwill -- -- 521 910 222
(Gain) loss on sales of product lines -- (210) 4,803 (50) --
Industrial accident expenses 410 254 -- -- --
Asset impairment writedowns
and plant closure -- -- 950 437 95
-------- -------- -------- -------- --------
EBITDA as adjusted $ 2,436 $ 2,289 $ 2,400 $ 1,212 $ 1,486
======== ======== ======== ======== ========
- --------------------------------------------------------------------------------------------------------------
Page 14
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- -------------------------------------------------------------------------------
OF OPERATIONS
- -------------
The following discussion should be read in conjunction with the financial
statements and related notes and other information included in this report. The
financial results reported herein are not necessarily indicative of the
financial results that may be achieved by the Company in any future period.
The Company's operating results could vary from period to period as a result of
a number of factors. These factors include, but are not limited to, the
purchasing patterns of significant customers, the timing of new product
introductions by the Company and its competitors, the amount of slotting fees,
new product development and advertising expenses incurred by the Company,
variations in sales by distribution channel, fluctuations in market prices of
raw materials, competitive pricing policies and situations that the Company
cannot foresee. These factors could cause the Company's performance to differ
from investor expectations, resulting in volatility in the price of its common
stock.
Investors should carefully consider the following information as well as other
information contained in this Report. Information included in this Report
contains forward-looking statements which can be identified by the use of
forward-looking terminology such as "believes", "expects", "may", "should" or
"anticipates" or the negative thereof or other variations thereon or comparable
terminology, or by discussions of strategy. No assurance can be given that the
future results covered by the forward-looking statements will be achieved. The
following matters constitute cautionary statements identifying important factors
with respect to such forward-looking statements, including certain risks and
uncertainties that could cause actual results to vary materially from the future
results covered in such forward-looking statements. Other factors could also
cause actual results to vary materially from the future results covered in the
forward-looking statements.
Introduction:
Spectrum Organic Products, Inc. ("Spectrum", the "Company", or the "Registrant")
competes primarily in three segments: natural and organic foods sold under the
Spectrum Naturals(R) brand, nutritional supplements sold under the Spectrum
Essentials(R) brand, and industrial ingredients sold by the Spectrum Ingredients
sales force for use by other manufacturers. The vast majority of the Company's
products are oil-based and the Company has positioned itself as "The Good Fats
Company".
Within the Spectrum Naturals(R) brand, the Company's products include olive oils
and other culinary oils, salad dressings, condiments and butter-substitutes such
as Spectrum Organic Margarine(R) and Spectrum Spread(R). All of the Company's
culinary products feature healthy oils, contain no hydrogenated fats and are
offered in a variety of sizes and flavors in both organic and conventional
offerings.
Within the Spectrum Essentials(R) brand, the Company's products include organic
flax oil, borage oil, Norwegian fish oil and other essential fatty acids in both
liquid and capsule forms. The Spectrum Essentials(R) products are cold-pressed,
nutritionally rich sources of Omega-3 and Omega-6 essential fatty acids and are
also offered in a variety of sizes and styles.
The Spectrum Ingredients (formerly known as Spectrum Commodities, Inc.) sales
force offers organic culinary oils, vinegar and nutritional oils to other
manufacturers for use in their products. In addition, they bring incremental
purchasing power to the Company resulting in higher margins for the consumer
branded product lines.
The Company was formed on October 6, 1999 by the four-way reverse merger of
Spectrum Naturals, Inc. ("SNI"), its affiliate Spectrum Commodities, Inc.
("SCI"), Organic Ingredients, Inc. ("OI"), with and into Organic Food Products,
Inc. ("OFPI"). OFPI was the Registrant prior to the merger, but since a
controlling interest in the Company is held by former SNI stockholders, the
merger was accounted for as a reverse acquisition, with SNI and SCI as the
acquirer and OI and OFPI as acquirees.
- --------------------------------------------------------------------------------
Page 15
On June 11, 2001 the Company sold the OFPI tomato-based product lines to Acirca,
Inc., an unrelated third party. On April 25, 2002 the Company sold the OI
industrial ingredient business in fruits, vegetables, concentrates and purees to
Acirca. Accordingly, results for 2001 and 2002 include the operating results
associated with the disposed product lines until the date of sale.
The two dispositions have significantly strengthened the Company from a
liquidity and working capital standpoint. The Company now plans to focus its
resources on its core business in healthy oils, butter substitutes and essential
fatty acid nutrition.
Critical Accounting Policies and Estimates:
The following discussion and analysis of the Company's financial condition and
results of operations is based upon the Company's financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of these financial statements
requires the Company to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses. The Company bases its
estimates on historical experience and various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for the carrying values of assets and liabilities that are not readily
apparent from other sources. On an on-going basis, the Company re-evaluates all
of its estimates, including those related to accounts receivable allowances,
inventory reserves, the industrial accident reserve and the deferred tax asset
valuation allowance. Actual results may differ materially from these estimates
under different assumptions or conditions and as additional information becomes
available in future periods.
The Company believes the following are the more significant judgments and
estimates used in the preparation of its financial statements:
Accounts Receivable Allowances - The Company provides allowances against
accounts receivable for estimated bad debts, returns and deductions by customers
for trade promotions and programs. These allowances are based upon the Company's
historical experience with bad debt write-offs and customer deductions, customer
creditworthiness, payment trends and general economic conditions. Allowances for
bad debts and customer deductions were $450,000 at December 31, 2003 on gross
trade accounts receivable of $4,604,800. While this estimate is one of the more
significant estimates the Company makes in the preparation of its financial
statements, Management does not consider it to be highly uncertain.
Inventory Reserves - The Company establishes reserves for obsolete, excess and
slow-moving inventories in order to properly value its inventory at the lower of
cost or market. The reserve estimates are based upon historical inventory usage,
spoilage, current market conditions, and anticipated future demand. Reserves for
obsolete inventories were $248,500 at December 31, 2003 on total gross
inventories of $8,255,700. While this estimate is one of the more significant
estimates the Company makes in the preparation of its financial statements,
Management does not consider it to be highly uncertain.
Deferred Tax Asset Valuation Allowance - As of December 31, 2003 the Company had
net deferred tax assets of $1,601,900 primarily resulting from net operating
loss carryforwards ("NOLs"), which consisted of $4,431,000 of Federal NOLs that
expire at various times through 2020, and $3,150,000 of state NOLs that expire
at various times through 2010. The majority of the NOLs originated from the
pre-merger operations of OFPI. As a result of OFPI's acquisition by SNI, OFPI
experienced an ownership change in excess of 50% for federal and state income
tax purposes. Therefore, an annual limitation is placed by the taxing
authorities on the Company's right to realize the benefit of the pre-merger
NOLs. Management eliminated the deferred tax asset valuation reserve that had
been maintained since the 1999 merger as of December 31, 2003. The reserve was
reversed because the Company has reported taxable income to the various taxing
authorities for 2001 and 2002 and will do so again for 2003. Additionally,
Management believes that it is more likely than not that the Company will
continue to report sufficient taxable income in the foreseeable future, allowing
utilization of 100% of its deferred tax assets. Management will continue to
evaluate the Company's deferred tax assets in the future to determine whether a
deferred tax asset reserve should be reinstated at some future point.
- --------------------------------------------------------------------------------
Page 16
Industrial Accident Reserve - During the fourth quarter of 2003 the Company
accrued an expense of $375,000 to record the Terms of Settlement and Probation
(the "Settlement") entered into on February 4, 2004 with the Sonoma County
District Attorney's Office with regards to an industrial accident that occurred
on April 25, 2002 (see Note 2 to the financial statements). The additional
accrual increased the industrial accident reserve to $516,900 at December 31,
2003. In addition to covering the District Attorney Settlement, the reserve also
covers the estimated settlement of citations and fines from CAL-OSHA,
applications to the Workers' Compensation Appeals Board of the State of
California for serious and willful misconduct penalties to be levied against the
Company, and attorney's fees. This reserve is somewhat uncertain because the
CAL-OSHA proposed fines of $137,900 have been appealed and the applications to
the Workers' Compensation Appeals Board for serious and willful misconduct
penalties, if litigated, are an all-or-nothing proposition under which the
Company will either be liable for $107,500 in total or nothing. The Company does
not anticipate that the Workers' Compensation Appeals will be litigated, based
upon the advice of its attorneys, however expenses in excess of the reserve
could be incurred if the Worker's Compensation Appeals are litigated.
- --------------------------------------------------------------------------------
Results of Operations for the Year Ended December 31, 2003 Compared to the Year
Ended December 31, 2002
- --------------------------------------------------------------------------------
Summary Discussion:
In general 2003 was another good year for the Company, featuring strong
comparable net sales growth (+22%) and 6% growth in EBITDA as adjusted. The
Company benefited from the additional media attention paid to the dangers of
hydrogenated oils with respect to obesity and cardiovascular health. Obesity has
been recognized as an epidemic by many health care providers. The Centers for
Disease Control and Prevention estimates that 64% of Americans over age 20 are
overweight and 24% are obese. Morbid obesity, defined as a body mass index over
40, now afflicts over 2% of the United States population and has tripled since
1990. As a result, several Fortune 500 food companies issued press releases
during 2003 featuring a commitment to reduce or eliminate hydrogenated oils from
their products. The trend to reduce or eliminate hydrogenated oils from packaged
foods plays directly to the strength of the Spectrum Ingredients Division, which
delivered 31% net sales growth in 2003.
The response to the obesity epidemic is expected to continue to drive consumer
interest in healthy foods. The FDA is in the process of revising the daily food
guide pyramid, which currently promotes a carbohydrate-based diet and recommends
limiting proteins and oils. Many health care providers are now recommending that
consumers reduce their intake of carbohydrates in response to the obesity
epidemic. Indeed, the FDA is expected to revise the food guide pyramid in a
manner which decreases the emphasis on carbohydrates and increases the emphasis
on healthy oils.
The result of all the above was that the average consumer became much more aware
of the dangers of hydrogenated oils, which directly benefits the Company's
product offerings. The Company's Spectrum Naturals(R) brand of culinary oils,
condiments, dressings and butter substitutes delivered 19% net sales growth in
2003.
Consumer awareness of the importance of essential fatty acid nutrition also rose
during 2003, albeit not as significantly as with hydrogenated oils. Still, there
was increased awareness of the importance of Omega-3 and Omega-6 essential fatty
acids to overall health, which is the foundation supporting the Company's
Spectrum Essentials(R) line of nutritional supplements. As a result the
Company's Spectrum Essentials(R) brand of flax oil and other nutritional
supplements delivered 15% net sales growth in 2003.
Management believes that earnings before interest, taxes, depreciation,
amortization, expenses associated with the industrial accident and gains on the
sales of product lines ("EBITDA as adjusted") is an important measure of the
- --------------------------------------------------------------------------------
Page 17
Company's operating performance. Management incentives are earned, in part,
based on the achievement of EBITDA as adjusted targets. Additionally, EBITDA as
adjusted eliminates the impact of a number of unusual transactions and events
that Management believes are unlikely to recur. Therefore, EBITDA as adjusted is
useful to investors since it discloses the on-going economic performance of the
Company in the absence of the unusual transactions and events. For the year
ended December 31, 2003 EBITDA as adjusted was $2,436,100 compared to $2,288,500
for the prior year, an increase of $147,600 or 6%. The increase in 2003 is
discussed in detail below, but was primarily attributable to increased sales,
partially offset by pressure on gross margins and increased operating expenses
in 2003.
While Management believes that EBITDA as adjusted is a useful measure of the
Company's financial performance, it should not be construed as an alternative to
income from operations, net income or cash flows from operating activities as
determined in accordance with accounting principles generally accepted in the
United States of America. Furthermore, the Company's calculation of EBITDA as
adjusted, which is detailed in the following table, may be different from the
calculation used by other companies, thereby limiting comparability:
Years Ended December 31,
------------------------
2003 2002
---- ----
Net income as reported $ 2,663,600 $ 1,120,000
Provision (benefit) for income taxes (1,566,600) 189,800
Interest expense 404,200 480,600
Depreciation and amortization 524,700 454,300
Industrial accident expenses 410,200 254,100
Gain on sales of product lines -- (210,300)
----------- -----------
EBITDA as adjusted $ 2,436,100 $ 2,288,500
=========== ===========
The following is Management's discussion and analysis of the significant line
items within the financial statements and the reasons behind the trends and
variances versus the prior year:
Revenues:
Spectrum's net sales for the year ended December 31, 2003 were $45,676,500
compared to $40,579,300 for 2002, an increase of $5,097,200 or 13%. The increase
in net sales was primarily volume-related and was driven by significant
increases in all three of the Company's segments, as detailed in the following
table:
Years Ended December 31,
------------------------
2003 2002 % Change
---- ---- --------
Spectrum Naturals(R)Culinary Products $ 20,606,100 $ 17,268,200 +19%
Spectrum Essentials(R)Nutritional Supplements 10,353,900 9,030,400 +15%
Spectrum Ingredients/Private Label Products 14,443,400 11,065,900 +31%
------------ ------------ ------
Comparable Net Sales 45,403,400 37,364,500 +22%
Disposed/Discontinued Product Lines 273,100 3,214,800 -92%
------------ ------------ ------
Total Net Sales $ 45,676,500 $ 40,579,300 +13%
============ ============ ======
Within the Spectrum Naturals(R) culinary products, sales were significantly
higher than prior year in consumer packaged oils (+42%), institutional and food
service oils (+34%) olive oils (+22%) and mayonnaise (+28%). All of Spectrum's
culinary oils are expeller-pressed and contain no trans fatty acids as a result
of hydrogenation. Therefore, the Company's culinary oils continued to benefit
from increased consumer awareness of the dangers of hydrogenated oils with
regards to obesity and cardiovascular disease.
- --------------------------------------------------------------------------------
Page 18
Spectrum Essentials(R) nutritional supplement sales increased 15% versus the
prior year, primarily as a result of increased demand for organic flax oil and
refined coconut oil sold as a health and beauty aid. Liquid flax oil sales,
which represented approximately 65% of the Spectrum Essentials(R) sales during
2003 were up 15% versus the prior year as a result of increased demand and the
non-recurrence of out-of-stocks during the fourth quarter of 2002 as a result of
a flaxseed shortage.
The Spectrum Ingredients sales increased 31% versus the prior year on the
strength of increased customer demand for non-hydrogenated culinary oils. During
2003 there was prominent media coverage of commitments by several Fortune 500
companies to eliminate or sharply reduce hydrogenated oils from their products.
Cost of Goods Sold:
The Company's cost of good sold for the year ended December 31, 2003 was
$33,806,800 versus $29,823,000 for 2002, an increase of 13%. The increase was
primarily volume-related and was driven by significant increases in all three of
the Company's primary segments, as detailed in the following table:
Years Ended December 31,
------------------------
2003 2002 % Change
---- ---- --------
Spectrum Naturals(R)Culinary Products $ 15,240,600 $ 12,882,800 +18%
Spectrum Essentials(R)Nutritional Supplements 5,694,200 4,706,500 +21%
Spectrum Ingredients/Private Label Products 12,725,300 9,854,700 +29%
------------ ------------ ------
Comparable Cost of Goods Sold 33,660,100 27,444,000 +23%
Disposed/Discontinued Product Lines 146,700 2,379,000 -94%
------------ ------------ ------
Total Cost of Goods Sold $ 33,806,800 $ 29,823,000 +13%
============ ============ ======
Cost of goods sold as a percent of net sales increased during 2003 to 74.0%
compared to 73.5% for 2002. The increase was due primarily to increased raw
material costs in the Company's flax oil, olive oil and mayonnaise product
lines, a $50,300 write-down incurred for the obsolete bottling equipment that
was not relocated to Interpac and an unfavorable sales mix. The flax oil
products continued to be impacted by higher flaxseed costs in 2003 while olive
oil imported from Europe was impacted by all-time lows in the dollar versus euro
exchange rate.
Gross Profit:
Gross profit for 2003 was $11,869,700 versus $10,756,300 for 2002, an increase
of $1,113,400 or 10%. The increase was primarily volume-related and was driven
by significant increases in all three of the Company's primary segments, as
detailed in the following table:
Years Ended December 31,
------------------------
2003 2002 % Change
---- ---- --------
Spectrum Naturals(R)Culinary Products $ 5,365,500 $ 4,385,400 +22%
Spectrum Essentials(R)Nutritional Supplements 4,659,700 4,323,900 +8%
Spectrum Ingredients/Private Label Products 1,718,100 1,211,200 +42%
------------ ------------ ------
Comparable Gross Profit 11,743,300 9,920,500 +18%
Disposed/Discontinued Product Lines 126,400 835,800 -85%
------------ ------------ ------
Total Gross Profit $ 11,869,700 $ 10,756,300 +10%
============ ============ ======
Gross profit as a percentage of net sales (gross margin) was 26.0% for 2003
versus 26.5% for 2002, primarily as a result of the increased raw material costs
in the Company's flax oil, olive oil and mayonnaise product lines, the bottling
line relocation and an unfavorable sales mix. The Company implemented price
increases on certain product lines effective November 1, 2003 in order to pass
on some of the raw material cost increases to consumers. Partially offsetting
the increased costs was improved management of sales discounts and promotions,
particularly with respect to the Spectrum Naturals(R) segment.
- -----------------------------------------------------------------------------------------------
Page 19
Sales and Marketing Expenses:
The Company's sales and marketing expenses for 2003 were $6,204,600 or 13.6% of
net sales, versus $5,987,500 or 14.8% of net sales for 2002. The increase in
spending of $217,100 in 2003 is detailed in the following table which reconciles
sales and marketing spending for 2003 versus 2002 and discloses the significant
variances by spending category:
Total sales and marketing expense for 2002 $ 5,987,500
Increased broker commissions 325,000
Increased market research expenses 161,600
Increased trade show expenses 74,000
Increased spending on label revisions 40,500
Increased spending on Company website 42,800
Increased spending on public relations 35,300
Decreased advertising (289,400)
Decreased compensation and benefits (137,500)
All other, net (35,200)
-----------
Total sales and marketing expense for 2003 $ 6,204,600
===========
The increased broker commissions were attributable to the double-digit sales
growth in both branded product lines in 2003. The increase in market research
expenses in 2003 was primarily attributable to a focus group conducted on the
Spectrum Essentials(R) product line for the first time in the Company's history.
The increased spending on trade shows, label revisions, the website and public
relations was primarily attributable to upgrades made by the Company's marketing
staff. The decreased advertising spending was the result of a new advertising
campaign that was under development during 2003 to improve the Company's
advertising message and its overall consistency. The decreased compensation and
benefits was primarily attributable to the elimination of eleven full-time
employees formerly associated with the OI product lines that were sold on April
25, 2002. Partially offsetting that were three full-time positions added to the
Marketing Department during 2003.
General and Administrative Expenses:
The Company's general and administrative expenses for 2003 were $3,729,100 or
8.2% of net sales, versus $2,949,500 or 7.3% of net sales for 2002. The increase
in spending of $779,600 is detailed in the following table which reconciles
general and administrative spending for 2003 versus 2002 and discloses the
significant variances by spending category:
Total general and administrative expense for 2002 $ 2,949,500
Increased compensation and benefits 346,700
Increased rent expense 149,700
Increased board expenses 88,900
Increased consulting and site evaluation 83,900
Increased legal fees 45,100
Increased telephone expense 41,100
All other, net 24,200
-----------
Total general and administrative expense for 2003 $ 3,729,100
===========
The increased compensation and benefits were primarily attributable to increased
executive compensation expense in 2003, $34,800 of expense in connection with a
shareholder advance that was forgiven, a severance payment to a former officer
and increased incentive accruals for 2003. The increase in rent expense was
primarily associated with the move to the Company's new headquarters in December
2002. The increased board expenses were the result of cash compensation paid to
the external board members for the first time since the merger. The consulting
and site evaluation expenses were incurred in connection with the evaluation of
alternative locations for the Company's SpectraVac flax oil manufacturing
- --------------------------------------------------------------------------------
Page 20
operation. The increased spending in legal fees was primarily attributable to an
S-8 filing with the SEC and employment law advice related to the relocation of
the bottling line to Interpac. The increase in telephone spending was due to a
change in phone service providers and early termination of the previous
contract.
Industrial Accident Expenses:
During 2003 the Company incurred $410,200 in expenses associated with an
industrial accident that occurred on April 25, 2002. Two of the Company's
employees died due to asphyxiation in a confined space accident. Included in the
$410,200 was an accrual of $375,000 at December 31, 2003 to record the Terms of
Settlement and Probation entered into on February 4, 2004 with a plea of no
contest to two misdemeanor violations of a regulation issued by the California
Occupational Health and Safety Administration ("CAL-OSHA"). Under the Terms of
Settlement and Probation, the Company will pay a fine of $150,000 in three
annual installments of $50,000 each on June 30, 2004, 2005 and 2006. In addition
the Company paid $150,000 in restitution to the California District Attorneys
Association Workers Safety Training Account to assist with the prosecution of
worker safety cases in the State of California. The Company also reimbursed
costs of $25,000 each to the Petaluma Police Department, the Petaluma Fire
Department and the Sonoma County District Attorney's Office.
During 2002 the Company incurred expenses of $254,100 in connection with the
same industrial accident. Included in that amount was a remaining reserve of
$141,900 at December 31, 2003 to cover anticipated penalties from CAL-OSHA,
appeals filed by the dependants of the two employees with the Worker's
Compensation Appeals Board of California, and related attorney's fees.
Gain on Sales of Product Lines:
The Company recorded a net gain from the sales of product lines during 2002 of
$210,300 which consisted primarily of the collection of the remaining escrowed
funds from the sale of OI. The transactions which gave rise to the gain are
detailed in Note 6 to the financial statements.
Interest Expense:
The Company's interest expense for 2003 was $404,200 versus $480,600 for 2002.
The decrease of $76,400 or 16% is detailed in the following table which
reconciles interest expense for 2003 versus 2002 and discloses the significant
variances by item:
Total interest expense for 2002 $ 480,600
Decreased interest on private placement notes (75,500)
Decreased interest on fixed long-term debt (51,000)
Early termination fee paid to former primary lender 62,400
Increased interest on revolving line of credit 10,600
All other, net (22,900)
---------
Total interest expense for 2003 $ 404,200
=========
The decreased interest on the private placement notes was due to the early
retirement of the notes on December 27, 2002. The decreased interest on fixed
long-term debt was due to principal payments made during 2003 on the related
party notes. The early termination fee was a contractual obligation due to the
Company's former primary lender as a result of terminating that credit facility
prior to its maturity date of October 6, 2004. The increased interest expense
under the revolving line of credit was primarily due to increased average
borrowings during 2003 to finance the higher levels of inventory, partially
offset by the lower rates available during the second half of 2003 from Comerica
Bank. On July 11, 2003 the Company entered into a new banking relationship with
Comerica which lowered the Company's interest rate on term debt by 1% per annum
and lowered the effective interest rate under the line of credit by
approximately 1.5% per annum.
- --------------------------------------------------------------------------------
Page 21
Provision for Income Taxes:
At December 31, 2003 the Company reversed the 100% valuation allowance that had
been maintained against its deferred tax assets since the merger. As a result,
the Company recorded a net benefit for income taxes of $1,566,600 for 2003. The
Company has federal net operating loss carryovers sufficient to offset all
federal income taxes due on its estimated taxable income for 2003 with the
exception of $9,900 due as a result of the alternative minimum tax. However, the
State of California imposed a two-year moratorium on the use of net operating
loss carryovers, as a result of a budget crisis, for 2002 and 2003.
Consequently, the Company paid $176,000 in estimated state income taxes due for
2002 during the first quarter of 2003 and made estimated state income tax
payments for 2003 of $140,400.
Deferred Tax Assets:
At December 31, 2003 the Company eliminated the 100% reserve against its
deferred tax assets that had been maintained since the 1999 merger. The Company
reported taxable income to the various taxing authorities for 2001 and 2002 and
will do so again for 2003. Management believes it is more likely than not that
the Company will continue to report sufficient taxable income in the foreseeable
future, allowing utilization of 100% of its deferred tax assets. Accordingly,
Management reinstated $1,601,900 of net deferred tax assets on its balance sheet
as of December 31, 2003.
Seasonality:
Historically, the Company has experienced little seasonal fluctuation in
revenues. With regards to product purchasing, the Company will seasonally
contract for certain raw materials for the entire year at harvest time or at
planting time. These purchases take place annually from early spring to
mid-summer and are affected to reduce the risk of price swings due to demand
fluctuations. These annual purchases can create temporary overages and shortages
in inventory.
Liquidity and Capital Resources:
As disclosed in Note 3 to the financial statements, the Company entered into a
new Credit Facility with Comerica Bank ("Comerica") that expires on June 30,
2005 unless renewed earlier. The new Credit Facility includes a revolving line
of credit up to a maximum of $7,000,000, a term loan for $1,250,000 and a
capital expenditure term loan of $1,000,000. The new Credit Facility is secured
by substantially all assets of the Company and enables the Company to borrow
below prime, using a LIBOR rate option.
The new Credit Facility with Comerica substantially enhanced the Company's
available borrowing capacity during 2003 as a result of refinancing the existing
term debt and more liberal definitions of eligible inventory to secure the
borrowing base under the revolving line of credit.
The Company could not operate its business without the Credit Facility with
Comerica or one similar to it. The Credit Facility calls for continued
satisfaction of various financial covenants for 2003 and beyond related to
profitability levels, debt service coverage, and the ratio of total liabilities
to tangible net worth. As of December 31, 2003 the Company was in compliance
with all financial covenants and other requirements called for under the Credit
Agreement.
At December 31, 2003 the Company had working capital of $1,559,500 which
reflected an improvement of $962,800 versus the prior year. The increase was
primarily attributable to higher accounts receivable and inventory levels as a
result of the double-digit sales growth and the reinstatement of $527,400 of net
short-term deferred tax assets, partially offset by increased levels of trade
payables and borrowings outstanding under the line of credit to finance the
higher inventories.
During 2003 the Company utilized $1,206,400 in operating activities, compared to
generating $717,400 during 2002. The change was primarily due to the increased
levels of inventory and accounts receivable to support the higher sales base and
- --------------------------------------------------------------------------------
Page 22
increased levels of operations in general. Inventories were significantly higher
than the prior year primarily as a result of a flaxseed shortage in 2002 which
resulted in severe out-of-stocks on the Company's flax oil products during the
fourth quarter of 2002. Also contributing to the higher inventories were the
longer lead times required to clear imported food products through United States
Customs as a result of the Bioterrorism Act.
Cash used in investing activities during 2003 was $1,831,100 compared to cash
provided of $2,343,900 in 2002. The change was primarily due to increased
investment in property and equipment and the intellectual property purchase
during 2003, contrasted by the non-recurring proceeds from the sale of product
lines in 2002 of $3,215,200. The increased investment in property and equipment
in 2003 was primarily attributable to a new labeler and conveying equipment for
the Company's bottling line.
Cash provided by financing activities was $3,032,100 in 2003 versus cash used of
$3,075,100 in 2002. The change was primarily due to the proceeds from term notes
under the new Credit Facility with Comerica and increased borrowings under the
line of credit to finance the higher inventories. As of December 31, 2003 the
Company had $2,105,800 in available borrowing capacity under its line of credit
versus $1,696,700 at December 31, 2002 primarily as a result of the more liberal
definitions of eligible inventory under the Comerica Credit Facility.
Management believes that future cash flows from operations should provide
adequate funds to meet the Company's estimated cash requirements for the
foreseeable future. The Company competes primarily in the natural products
industry which has benefited from the increased interest by consumers in healthy
food and organic products. While an economic downturn could decrease demand for
the Company's products, which in turn could impact the Company's ability to meet
its obligations to its creditors, Management believes that to be unlikely.
Recent history has shown the three primary categories the Company competes in to
be recession-resistant. Each category has featured double-digit annual sales
growth for the last few years and Management believes the Company's product
offerings compete favorably with regards to taste and overall quality.
The Company has contractual cash obligations for future periods in excess of
twelve months primarily with regards to debt service, non-cancelable leases and
the terms of settlement with the Sonoma County District Attorney in connection
with the industrial accident. The following table discloses the Company's
expected cash obligations for future periods in connection with contractual
commitments extending beyond twelve months:
Contractual Cash Obligations ($ Thousands)
------------------------------------------
2004 2005 2006 2007 2008 2011
---- ---- ---- ---- ---- ----
Long-term Debt $ 556 $ 540 $ 327 $ 311 $ 156 $ 513
Operating Leases 378 282 282 282 -- --
Industrial Accident 275 50 50 -- -- --
Capital Leases (1) 52 20 -- -- -- --
------ ----- ----- ----- ----- -----
Total Contractual Cash Obligations $1,261 $ 892 $ 659 $ 593 $ 156 $ 513
====== ===== ===== ===== ===== =====
(1) Includes amounts representing interest
In addition to the above, the Company had outstanding commitments for raw
material purchases in 2004 of $9,820,900 at December 31, 2003. None of the raw
material purchase commitments were in excess of normal requirements or at prices
in excess of current market prices available to the Company.
Related Party Transactions and Other Financing Arrangements:
During the year ended December 31, 2003 there were significant transactions with
two related parties:
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Page 23
1) Consulting fees of $99,000 were paid to Running Stream Food and Beverage,
Inc. ("RSFB") for private label sales and management services. RSFB is
owned and operated by a non-executive Director of the Company. The RSFB
consulting fees and commission rates were negotiated by the Company as part
of the sale of the OI product lines and mirror the arrangements made
between RSFB and Acirca, Inc. (an unrelated party) for similar consulting
services. The consulting contract between the Company and RSFB covers the
period from April 16, 2002 through April 16, 2004 and calls for monthly
consulting fees of $8,250 plus expenses incurred. On January 23, 2004 the
Company notified RSFB of its intention to terminate the contract on April
16, 2004 in order to focus its resources on its core business in healthy
oils.
2) On July 29, 2003 the Compensation Committee of the Company's Board of
Directors unanimously approved forgiving the $20,000 shareholder advance
that had been outstanding for several years to the Company's Chairman of
the Board as income to him for 2003 and grossing the amount up for taxes.
Accordingly, the Company incurred $34,800 of compensation expense, which
was included in general and administrative expenses, to forgive the
shareholder advance.
The Company does not utilize off-balance sheet financing arrangements. There
were no transactions with special purpose entities that gave the Company access
to assets or additional financing or carry debt that is secured by Company
assets or guarantees. The Company does not engage in trading activities
involving commodity contracts.
New Applicable Accounting Pronouncements:
In July 2002 the Financial Accounting Standards Board ("FASB") issued SFAS No.
146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS
146"). SFAS 146 requires that a liability for expenses associated with an exit
or disposal activity be recognized when the liability is incurred. SFAS 146 also
establishes that fair value is the objective for initial measurement of the
liability. Severance pay under SFAS 146, in many cases, would be recognized over
time rather than up front. The provisions of SFAS 146 are effective for exit or
disposal activities that are initiated after December 31, 2002. The Company's
relocation and outsourcing of its bottling operation to the Interpac Petaluma
facility became effective on July 14, 2003. Exit and disposal costs associated
with the bottling operation relocation and outsourcing of $50,300 were
recognized during 2003 in accordance with SFAS 146.
In November 2002 the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45"), which is effective for financial statements
issued after December 15, 2002. Under FIN 45, a guarantor is required to measure
and recognize the fair value of certain guarantees at inception. Additionally, a
guarantor must provide new disclosures regarding the nature of any guarantees,
potential amount of future guarantee payments, the current carrying amount of
the guarantee liability, and the nature of any recourse provisions or assets
held as collateral. The initial recognition and measurement provisions under FIN
45 are effective for guarantees issued or modified on or after January 1, 2003
for the Company. The disclosure requirements are effective as of December 31,
2002 for the Company. There have been no new guaranties entered into during 2003
and therefore no valuation necessary under FIN 45. However, the Company is the
continuing guarantor for a portion of a line of credit for The Olive Press, LLC,
an unrelated third party, in the amount of $25,000.
The Company enters into indemnification provisions under its agreements with
other companies in the ordinary course of business, typically with business
partners, suppliers, customers and its sublandlord. Under these provisions the
Company has agreed to generally indemnify and hold harmless the indemnified
party for losses suffered or incurred by the indemnified party as a result of
the Company's activities or, in some cases, as a result of the indemnified
party's activities under the agreement. These indemnification provisions
generally survive termination of the underlying agreement. The maximum potential
amount of future payments the Company could be required to make under these
indemnification provisions is unknown. To date, the Company has not incurred any
costs as there have been no lawsuits or other claims related to these
indemnification agreements. Accordingly, the Company has no liabilities recorded
for these indemnification provisions as of December 31, 2003.
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Page 24
In December 2002 the FASB issued SFAS 148, which provides alternative methods of
transition for a voluntary change to the fair value method of accounting for
stock-based employee compensation as prescribed in SFAS 123. Additionally, SFAS
148 requires more prominent and more frequent disclosures in financial
statements about the effects of stock-based compensation. The provisions of SFAS
148 are effective for fiscal years ending after December 15, 2002 with early
application permitted in certain circumstances. Management has evaluated the
benefits of changing to the fair value method of accounting for stock-based
compensation and has elected to continue to use the intrinsic value method. The
required financial disclosures under SFAS 148 are included in the Summary of
Significant Accounting Policies.
The FASB has published a revision to Interpretation 46 ("46R") to clarify some
of the provisions of FASB Interpretation No. 46, "Consolidation of Variable
Interest Entities", and to exempt certain entities from its requirements. The
additional guidance is being issued in response to input received from
constituents regarding certain issues arising in implementing Interpretation 46.
Under the new guidance, special effective date provisions apply to enterprises
that have fully or partially applied Interpretation 46 prior to issuance of this
revised Interpretation. Otherwise, application of Interpretation 46R (or
Interpretation 46) is required in financial statements of public entities that
have interests in structures that are commonly referred to as special-purpose
entities for periods ending after December 15, 2003. Application by public
entities, other than small business issuers, for all other types of variable
interest entities is required in financial statements for periods ending after
March 15, 2004. Application by small business issuers to variable interest
entities other than special-purpose entities and by nonpublic entities to all
types of variable interest entities is required at various dates in 2004 and
2005. In some instances, enterprises have the option of applying or continuing
to apply Interpretation 46 for a short period of time before applying this
revised Interpretation. The Company believes that adoption of Interpretation 46R
(or Interpretation 46) will have no effect on its financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS 150").
SFAS 150 provides new rules on the accounting for certain financial instruments
that, under previous guidance, would be accounted for as equity. It requires
that an issuer classify a financial instrument that is within its scope as a
liability. Such financial instruments include mandatorily redeemable shares,
instruments that require the issuer to buy back some of its shares in exchange
for cash or other assets, or obligations that can be settled with shares, the
monetary value of which is fixed. SFAS 150 shall be effective for financial
instruments entered into or modified after May 31, 2003 and otherwise shall be
effective at the beginning of the first interim period beginning after June 15,
2003. However certain modifications and FASB Staff Positions relating to SFAS
150 are being deliberated. The adoption of SFAS 150 has no effect on the
Company's financial statements.
- --------------------------------------------------------------------------------
Results of Operations for the Year Ended December 31, 2002 Compared to the Year
Ended December 31, 2001
- --------------------------------------------------------------------------------
Summary of Results:
As previously discussed, Management believes that earnings before interest,
taxes, depreciation, amortization, gains or losses on the sales of product lines
and the industrial accident ("EBITDA as adjusted") is an important measure of
the Company's operating performance and a useful indicator of on-going economic
performance to investors. For the year ended December 31, 2002 EBITDA as
adjusted was $2,288,500 compared to $2,399,700 for the prior year, a decrease of
$111,200 or 5%. The lower performance in 2002 was primarily attributable to
increased spending on marketing programs for the consumer branded product lines
and unabsorbed manufacturing overhead as a result of a shortage of flax seed due
to drought conditions in much of Canada during 2002 and the West Coast port
shutdown, which hampered the Company's ability to secure glass, partially offset
by reduced general and administrative expenses.
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Page 25
While Management believes that EBITDA as adjusted is a useful measure of the
Company's financial performance, it should not be construed as an alternative to
income from operations, net income or cash flows from operating activities as
determined in accordance with accounting principles generally accepted in the
United States of America. Furthermore, the Company's calculation of EBITDA as
adjusted, which is detailed in the following table, may be different from the
calculation used by other companies, thereby limiting comparability:
Years Ended December 31,
------------------------
2002 2001
---- ----
Net income (loss) $ 1,120,000 $(5,205,800)
Provision for income taxes 189,800 --
Interest expense 480,600 912,800
Depreciation and amortization 454,300 418,800
Amortization of Goodwill -- 520,700
Goodwill impairment writedown -- 950,000
(Gain) loss on sales of product lines (210,300) 4,803,200
Industrial accident expenses 254,100 --
----------- -----------
EBITDA as adjusted $ 2,288,500 $ 2,399,700
=========== ===========
Revenues:
Spectrum's net sales for the year ended December 31, 2002 were $40,579,300
compared to $41,019,200 for 2001, a decrease of $439,900 or 1%. The decrease was
attributable to the lost sales associated with the disposed product lines,
partially offset by healthy sales growth in each of the Company's three primary
segments. Comparable net sales (after eliminating the sales of disposed or
discontinued product lines from both periods) increased by 19%.
During the years ended December 31, 2002 and 2001, net sales by segment were as
follows:
2002 2001 % Change
---- ---- --------
Spectrum Naturals(R)Culinary Products $17,268,200 $15,220,700 +13%
Spectrum Essentials(R)Nutritional Supplements 9,030,400 7,776,900 +16%
Spectrum Ingredients/Private Label Products 11,065,900 8,293,900 +33%
----------- ----------- ----
Comparable Net Sales 37,364,500 31,291,500 +19%
Disposed/Discontinued Product Lines 3,214,800 9,727,700 -67%
----------- ----------- ----
Total Net Sales $40,579,300 $41,019,200 -1%
=========== =========== ====
Within the Spectrum Naturals(R) brand, net sales increased substantially versus
the prior year in culinary oils, mayonnaise and vinegar. The Spectrum
Essentials(R) brand net sales increased by 16%, driven by increased demand for
flax oil as consumer awareness of the importance of essential fatty acids to
overall health continued to rise. Net sales growth in the Spectrum Essentials
line would have been substantially higher in the absence of the flax seed
shortage during the fourth quarter, which left the Company unable to meet demand
until December. The Company identified alternative sources of supply for 2003
and did not experience difficulty in meeting demand for flax oil in 2003. The
Spectrum Ingredients net sales growth was driven by strong demand for
non-hydrogenated industrial culinary oils, particularly in the baked goods
industry.
- --------------------------------------------------------------------------------
Page 26
Cost of Goods Sold:
The Company's costs of goods sold for the year ended December 31, 2002 was
$29,823,000 versus $30,009,700 for 2001, a decrease of 1%. The decrease was
primarily attributable to the disposed product lines, partially offset by
volume-related increases in each of the Company's three primary segments, as
detailed in the following table:
Years Ended December 31,
------------------------
2002 2001 % Change
----------- ----------- ----
Spectrum Naturals(R)Culinary Products $12,882,800 $11,299,600 +14%
Spectrum Essentials(R)Nutritional Supplements 4,706,500 3,997,100 +18%
Spectrum Ingredients/Private Label Products 9,854,700 7,912,400 +25%
----------- ----------- ----
Comparable Cost of Goods Sold 27,444,000 23,209,100 +18%
Disposed/Discontinued Product Lines 2,379,000 6,800,600 -65%
----------- ----------- ----
Total Cost of Goods Sold $29,823,000 $30,009,700 -1%
=========== =========== ====
Cost of goods sold increased as a percent of net sales for the year ended
December 31, 2002 to 73.5% compared to 73.2% for the same period in 2001. The
increase was primarily due to the indirect effects of the April 2002 industrial
accident, which were mainly the impact of unabsorbed overhead as a result of the
plant shutdown following the accident. The Company's Copeland Street production
facility was completely idle for several weeks after the accident as the Company
conducted safety training and allowed engineers to make the changes necessary to
ensure such an accident could never recur.
Also contributing to the increase in cost of goods sold as a percent of net
sales versus the prior year was unabsorbed manufacturing overhead due to two
other factors beyond the Company's control. The West Coast port shutdown, as a
result of the longshoremen's strike, hampered the Company's ability to secure
glass to keep its bottling line running at full capacity and the flax seed
shortage, due to drought conditions in much of the growing area, shut down the
SpectraVac flax oil production system for much of the fourth quarter of 2002.
Gross Profit:
Gross profit for 2002 was $10,756,300 versus $11,009,500 for 2001, a decrease of
2%. The decrease was primarily associated with the lost profits from the
disposed product lines, partially offset by volume-related increases in each of
the Company's three primary segments, as detailed in the following table:
Years Ended December 31,
------------------------
2002 2001 % Change
----------- ----------- -----
Spectrum Naturals(R)Culinary Products $ 4,385,400 $ 3,921,100 +12%
Spectrum Essentials(R)Nutritional Supplements 4,323,900 3,779,800 +14%
Spectrum Ingredients/Private Label Products 1,211,200 381,500 +218%
----------- ----------- -----
Comparable Gross Profit 9,920,500 8,082,400 +23%
Disposed/Discontinued Product Lines 835,800 2,927,100 -71%
----------- ----------- -----
Total Gross Profit $10,756,300 $11,009,500 -2%
=========== =========== =====
Gross profit as a percent of net sales (gross margin) was 26.5% for 2002 versus
26.8% for the prior year. The reduction was primarily due to the indirect
effects of the industrial accident and the unabsorbed manufacturing overhead
detailed above, and an unfavorable sales mix which featured a greater
concentration of Spectrum Ingredients industrial sales.
- --------------------------------------------------------------------------------
Page 27
Sales and Marketing Expenses:
The Company's sales and marketing expenses for the year ended December 31, 2002
were $5,987,500 or 14.8% of net sales, versus $5,791,300 or 14.1% of net sales
for 2001. The increase in spending of $196,200 was primarily attributable to
higher spending on advertising, broker commissions, sampling and public
relations, partially offset by the elimination of eleven full-time employees
formerly associated with the OI product lines that were sold on April 25, 2002.
General and Administrative Expenses:
The Company's general and administrative expenses for the year ended December
31, 2002 were $2,949,500 or 7.3% of net sales, versus $3,194,900 or 7.8% of net
sales for 2001. The decrease in spending of $245,400 was primarily attributable
to reduced incentive compensation expense, lower professional fees, reduced bad
debt expense and lower telephone expense.
Amortization of Goodwill:
In accordance with SFAS 142, the Company ceased the amortization of goodwill
effective January 1, 2002. All remaining unamortized goodwill at January 1, 2002
was written-off in connection with the sale of the OI product lines on April 25,
2002. Amortization expense for the prior year was $520,700 based on an estimated
useful life of twelve years.
Industrial Accident Expenses:
During 2002 the Company incurred $254,100 in expenses directly associated with
an industrial accident on April 25, 2002 in which two of the Company's employees
died from asphyxiation in a confined space accident. Included in the $254,100
was an accrual to cover anticipated penalties from CAL-OSHA, appeals filed by
the dependants of the two employees with the Worker's Compensation Appeals Board
of California and related attorney's fees. The Company also incurred expenses
for safety consultants and engineers to ensure such an accident could never
recur.
Gain or Loss on Sales of Product Lines:
The Company recorded a net gain from the sales of product lines during the year
ended December 31, 2002 of $210,300 and a non-cash loss of $4,803,200 during the
prior year. The computations for both years are detailed in Note 6 to the
financial statements.
Goodwill Impairment Writedown:
Based on negotiations for the sale of the Organic Ingredients product lines that
were underway at the time, the Company knew that the net goodwill associated
with the OI product lines was impaired at December 31, 2001. Accordingly, the
Company recorded a non-cash writedown of $950,000 during 2001 to reduce the
goodwill to its net realizable value of $1,470,200.
Interest Expense:
The Company's interest expense for the year ended December 31, 2002 was $480,600
versus $912,800 for 2001. The reduction of $432,200 or 47% was primarily
attributable to lower borrowing levels under the line of credit as a result of
the sales of product lines and significant reductions in the prime rate during
2001. Non-cash interest expense of $49,500 and $96,100 was incurred during 2002
and 2001, respectively, for the value of the common stock purchase warrants
issued to the private placement note holders.
Provision for Income Tax Expense:
During the year ended December 31, 2002 the Company recorded a provision for
income taxes of $189,800 which represented final 2001 income taxes paid to the
State of California of $7,200 plus estimated state income taxes due for 2002 of
- --------------------------------------------------------------------------------
Page 28
$182,600. The Company had federal net operating loss carryovers sufficient to
offset all federal income taxes due on its taxable income for 2002. However, the
State of California enacted a two year moratorium on the use of net operating
loss carryovers, as a result of a budget crisis, effective January 1, 2002.
Consequently, the Company owed state income taxes estimated at $189,800 for 2002
as a result of the moratorium and alternative minimum taxes.
Related Party Transactions:
During the year ended December 31, 2002 there were significant transactions with
two related parties:
1) An investment banking fee for the sale of the OI product lines of $79,000
was paid to Moore Consulting, a sole proprietorship owned and operated by a
non-executive Director of the Company. Moore Consulting has provided
merger, acquisition and divestiture services to the Company for several
years. The fee paid represented 2.5% of the total transaction value.
2) Consulting fees of $66,000 were paid to Running Stream Food and Beverage,
Inc. ("RSFB") for private label sales and management services. RSFB is
owned and operated by a non-executive Director of the Company. The RSFB
fees were negotiated by the Company as part of the sale of the OI product
lines and mirror the arrangements made between RSFB and Acirca, Inc. (an
unrelated party) for similar consulting services. The consulting contract
between the Company and RSFB covers the period from April 16, 2002 through
April 16, 2004 and calls for monthly consulting fees of $8,250 plus
expenses incurred.
During the year ended December 31, 2001 there were significant transactions with
two related parties:
1) The Company paid consulting fees of $70,000 for management advisory
services rendered by Moore Consulting and an investment banking fee for the
sale of the OFPI product lines of $78,200 was also paid to Moore
Consulting. The fee paid represented 2.5% of the total transaction value
which, in the opinion of Management, was fair, reasonable and consistent
with terms the Company could have obtained from an unaffiliated investment
banker.
2) In February 2001 the Company sold 160,000 restricted shares under
Regulation D of the Securities Act of 1933 to a non-executive Director of
the Company for $0.3125 per share, the closing price of the Company's
common stock as quoted on the OTC Bulletin Board system on the day the
transaction was approved by the Company's disinterested members of the
Board of Directors. The Company applied the proceeds of $50,000 toward the
expansion of its proprietary SpectraVac technology. In addition, the
Company issued 160,000 common stock purchase warrants to the non-executive
Director at an exercise price of $0.3125 per share, which expire in
February 2006.
In the opinion of Management, all of the related party transactions during 2002
and 2001 were fair, reasonable and consistent with terms the Company could have
obtained from unaffiliated third parties.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- -------------------------------------------------------------------
The Company does not hold market risk sensitive trading instruments, nor does it
use financial instruments for trading purposes. All sales, operating items and
balance sheet data are denominated in U.S. dollars; therefore, the Company has
no foreign currency exchange rate risk.
Throughout the course of its fiscal year, the Company utilizes a variable
interest rate line of credit at various borrowing levels. For the year ended
December 31, 2003 the average outstanding balance under the line of credit was
approximately $4,707,700 with a weighted average effective interest rate of 4.6%
per annum. For the year ended December 31, 2002 the average outstanding balance
under the line of credit was approximately $3,153,000 with a weighted average
effective interest rate of 6.5% per annum. The increased average borrowing
- --------------------------------------------------------------------------------
Page 29
levels in 2003 reflect the funds necessary to finance the increased inventory
levels and increased level of operations in general. The reduction in the
weighted average effective interest rate reflects the lower interest rates
available under the new banking relationship with Comerica for the second half
of 2003.
Certain other debt items are also sensitive to changes in interest rates. The
following table summarizes principal cash flows and related weighted average
interest rates by expected maturity date for long-term debt, excluding capital
leases (dollars in thousands):
Expected Principal Payments
(Periods Ended December 31)
Outstanding --------------------------------------------------------------
Dec. 31, 2003 2004 2005 2006 2007 2008 2011
------------- ---- ---- ---- ---- ---- ----
Long Term Debt:
Fixed Rate $ 519.0 $ 275.2 $ 228.2 $ 15.6 -- -- --
Avg. Int. Rate 9.3% 9.3% 9.2% 9.0% -- -- --
Variable Rate $1,370.2 $ 280.7 $ 311.3 $ 311.3 $ 311.3 $ 155.6 --
Avg. Int. Rate 4.3% var. var. var. var. var. --
Imputed Rate $ 305.4 -- -- -- -- -- $ 305.4
Avg. Int. Rate 6.5% -- -- -- -- -- 6.5%
As discussed in Note 3 to the financial statements, the Company entered into a
new Loan and Security Agreement with Comerica Bank effective July 11, 2003. As a
result, all of the Company's variable rate long-term debt outstanding was
retired on July 11 and replaced with new variable rate long-term debt provided
by Comerica. The Company's fixed rate and imputed rate long-term debt
outstanding were not affected by the change to Comerica.
In the ordinary course of its business the Company enters into commitments to
purchase raw materials over a period of time, generally six months to one year,
at contracted prices. At December 31, 2003 these future commitments totaled
$9,820,900 and were not at prices in excess of current market, nor in quantities
in excess of normal requirements. The Company does not utilize derivative
contracts either to hedge existing risks or for speculative purposes.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ---------------------------------------------------
Spectrum Organic Products, Inc.
Financial Statements
Years Ended December 31, 2003, 2002 and 2001
Statement of Management Responsibility
Reports of Independent Certified Public Accountants
Financial Statements:
Balance Sheets
Statements of Operations
Statement of Stockholders' Equity
Statements of Cash Flows
Summary of Significant Accounting Policies
Notes to Financial Statements
Financial Statement Schedule:
Schedule II - Valuation and Qualifying Accounts
================================================================================
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Page 30
Statement of Management Responsibility
The management of Spectrum Organic Products, Inc. is responsible for the
preparation, integrity and objectivity of the financial statements and other
financial information presented in this report. The accompanying financial
statements have been prepared in conformity with accounting principles generally
accepted in the United States of America and reflect the effects of certain
estimates and judgments made by management.
Management maintains an effective system of internal control that is designed to
provide reasonable assurance that assets are safeguarded and transactions are
properly recorded and executed in accordance with management's authorization.
The system is continuously monitored by management. We select and train
qualified people who are provided with and expected to adhere to Spectrum
Organic Products' standards of business conduct. These standards, which set
forth strong principles of business ethics and conduct, are a key element of our
control system.
Our financial statements have been audited by Grant Thornton, LLP, independent
accountants for 2003 and by BDO Seidman, LLP, independent accountants for the
prior periods presented. Their audits were conducted in accordance with auditing
standards generally accepted in the United States of America, and included a
review of financial controls and tests of accounting records and procedures as
they considered necessary in the circumstances. Their respective reports follow
this statement by management.
The Audit Committee of the Board of Directors, which consists entirely of
independent directors, meets regularly with management and the independent
accountants to review accounting, reporting, auditing and internal control
matters. The Committee has direct and private access to both the Chief Financial
Officer and the independent accountants.
/s/ Neil G. Blomquist /s/ Robert B. Fowles
- --------------------------- ------------------------------------
Neil G. Blomquist Robert B. Fowles
President and Chief Financial Officer and
Chief Executive Officer Secretary
- --------------------------------------------------------------------------------
Page 31
Report of Independent Certified Public Accountants
To the Stockholders and Board of Directors of Spectrum Organic Products, Inc.
We have audited the accompanying balance sheet of Spectrum Organic Products,
Inc. (the "Company") as of December 31, 2003 and the related statements of
operations, stockholders' equity, and cash flows for the year then ended. 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 audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatements. 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 audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Spectrum Organic Products, Inc.
as of December 31, 2003 and the results of its operations and its cash flows for
the year then ended in conformity with accounting principles generally accepted
in the United States of America.
We have also audited Schedule II for the year ended December 31, 2003. In our
opinion, this schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.
/s/ Grant Thornton, LLP
- ------------------------
Grant Thornton, LLP
San Francisco, California
February 23, 2004
- --------------------------------------------------------------------------------
Page 32
Report of Independent Certified Public Accountants
To the Stockholders and Board of Directors of Spectrum Organic Products, Inc.
We have audited the accompanying balance sheet of Spectrum Organic Products,
Inc. as of December 31, 2002 and the related statements of operations,
stockholders' equity, and cash flows for each of the two years in the period
ended December 31, 2002. We have also audited the schedule listed in the
accompanying index for the years ended December 31, 2002 and 2001. These
financial statements and the schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and the schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements and the schedule are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements and the schedule. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall presentation of the financial statements and the
schedule. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Spectrum Organic Products, Inc.
as of December 31, 2002 and the results of its operations and its cash flows for
each of the two years in the period ended December 31, 2002 in conformity with
accounting principles generally accepted in the United States of America.
Also in our opinion, the related financial statement schedule, presents fairly,
in all material respects, the information set forth therein for 2002 and 2001.
As discussed in Note 16 to the financial statements, effective January 1, 2002
the Company adopted the provisions of SFAS No. 142, "Goodwill and Other
Intangible Assets", as required for the accounting of its goodwill and other
intangible assets.
/s/ BDO Seidman, LLP
- ----------------------------
BDO Seidman, LLP
San Francisco, California
February 21, 2003
- --------------------------------------------------------------------------------
Page 33
Spectrum Organic Products, Inc.
Balance Sheets
==========================================================================================================
As of December 31,
2003 2002
------------ ------------
Assets
Current Assets:
Cash $ 7,300 $ 12,700
Accounts receivable, net 4,163,200 3,075,200
Inventories, net 8,007,200 5,269,600
Deferred income taxes - current 514,200 --
Prepaid expenses and other current assets 297,500 79,600
------------ ------------
Total Current Assets 12,989,400 8,437,100
Property and Equipment, net 4,338,700 3,447,400
Other Assets:
Deferred income taxes - long-term 1,087,700 --
Intangible assets, net 586,800 42,000
Other assets 218,300 271,900
------------ ------------
Total Assets $ 19,220,900 $ 12,198,400
============ ============
Liabilities and Stockholders' Equity
Current Liabilities:
Bank overdraft $ 513,800 $ 601,000
Line of credit 4,833,000 2,479,800
Accounts payable, trade 4,168,000 3,176,300
Accrued expenses 1,307,700 876,200
Current maturities of notes payable & capital lease
obligations 322,300 256,000
Current maturities of notes payable, related parties 275,200 275,100
Income taxes payable 9,900 176,000
------------ ------------
Total Current Liabilities 11,429,900 7,840,400
Notes payable & capital lease obligations, less current
maturities 1,104,200 278,900
Notes payable, related parties, less current maturities 549,200 805,200
Deferred rent 50,700 --
------------ ------------
Total Liabilities 13,134,000 8,924,500
------------ ------------
Commitments and Contingencies
Stockholders' Equity:
Preferred stock, 5,000,000 shares authorized, no shares
issued or outstanding -- --
Common stock, without par value, 60,000,000 shares
authorized, 46,254,777 and 45,705,571 issued and
outstanding at December 31, 2003 and 2002, respectively 9,579,500 9,430,100
Accumulated deficit (3,492,600) (6,156,200)
------------ ------------
Total Stockholders' Equity 6,086,900 3,273,900
------------ ------------
Total Liabilities and Stockholders' Equity $ 19,220,900 $ 12,198,400
============ ============
See accompanying summary of significant accounting policies
and notes to financial statements.
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Spectrum Organic Products, Inc.
Statements of Operations
==============================================================================================
For the years ended December 31,
2003 2002 2001
------------ ------------ ------------
Net sales $ 45,676,500 $ 40,579,300 $ 41,019,200
Cost of goods sold 33,806,800 29,823,000 30,009,700
------------ ------------ ------------
Gross profit 11,869,700 10,756,300 11,009,500
------------ ------------ ------------
Operating Expenses:
Sales and marketing 6,204,600 5,987,500 5,791,300
General and administrative 3,729,100 2,949,500 3,194,900
Amortization of goodwill -- -- 520,700
Industrial accident expenses (Note 2) 410,200 254,100 --
(Gain) loss on sales of product
lines (Note 6) -- (210,300) 4,803,200
Goodwill impairment writedown (Note 7) -- -- 950,000
------------ ------------ ------------
Total operating expenses 10,343,900 8,980,800 15,260,100
------------ ------------ ------------
Income (Loss) From Operations 1,525,800 1,775,500 (4,250,600)
Other Income (Expense):
Interest expense (404,200) (480,600) (912,800)
Other, net (24,600) 14,900 (42,400)
------------ ------------ ------------
Income (Loss) Before Taxes 1,097,000 1,309,800 (5,205,800)
Benefit (Provision) for income taxes 1,566,600 (189,800) --
------------ ------------ ------------
Net Income (Loss) $ 2,663,600 $ 1,120,000 $ (5,205,800)
============ ============ ============
Basic and Fully Diluted Income (Loss) Per Share $ 0.06 $ 0.02 $ (0.12)
============ ============ ============
Weighted Average Shares Outstanding:
Basic 45,845,140 45,699,627 45,278,517
Fully Diluted 47,839,765 46,306,077 45,278,517
See accompanying summary of significant accounting policies
and notes to financial statements.
- ----------------------------------------------------------------------------------------------
Page 35
Spectrum Organic Products, Inc.
Statement of Stockholders' Equity
For the Years Ended December 31, 2001, 2002 and 2003
===============================================================================================================
Retained
Earnings Total
Common Stock (Accumulated Stockholders'
Shares Amount Deficit) Equity
----------- ----------- ----------- -----------
Balances, January 1, 2001 44,495,828 $ 8,920,400 $(2,070,400) $ 6,850,000
Restricted common shares issued to a non-executive
Director of the Company, under a private sale 160,000 50,000 -- 50,000
Restricted common shares issued to non-executive
Directors of the Company, in lieu of cash
compensation for Board fees earned during 2000 64,000 20,000 -- 20,000
Restricted common shares issued to four note holders
under the private placement conversion offer to
convert the notes to equity 630,000 168,200 -- 168,200
Warrants net exercised by the note holders under the
private placement 230,883 -- -- --
Warrants issued in connection with the private
placement notes -- 96,100 -- 96,100
Options issued to Global Natural Brands, Ltd. in final
settlement of litigation -- 25,300 -- 25,300
Shares issued to the Trustee for the Chapter 7 estate
of Sunny Farms in final settlement of litigation 117,950 93,700 -- 93,700
Net loss for the year -- -- (5,205,800) (5,205,800)
----------- ----------- ----------- -----------
Balances, December 31, 2001 45,698,661 $ 9,373,700 $(7,276,200) $ 2,097,500
Warrants net exercised by the note holders under the
private placement 6,910 -- -- --
Warrants issued in connection with the private
placement notes -- 49,500 -- 49,500
Non-qualified stock options issued -- 6,900 -- 6,900
Net income for the year -- -- 1,120,000 1,120,000
----------- ----------- ----------- -----------
Balances, December 31, 2002 45,705,571 $ 9,430,100 $(6,156,200) $ 3,273,900
Warrants exercised by the note holders under the
private placement 405,456 90,000 -- 90,000
Exercise of common stock options 143,750 59,400 -- 59,400
Net income for the year -- -- 2,663,600 2,663,600
----------- ----------- ----------- -----------
Balances, December 31, 2003 46,254,777 $ 9,579,500 $(3,492,600 $ 6,086,900
=========== =========== =========== ===========
See accompanying summary of significant accounting policies and notes to financial statements.
- ---------------------------------------------------------------------------------------------------------------
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Spectrum Organic Products, Inc.
Statements of Cash Flows
=============================================================================================================
For the years ended December 31,
2003 2002 2001
------------ ------------ ------------
Cash Flows From Operating Activities:
Net Income (Loss) $ 2,663,600 $ 1,120,000 $ (5,205,800)
Adjustments to Reconcile Net Income (Loss) to Net Cash
Provided by (Used in) Operating Activities:
Provision for allowances against receivables 103,400 47,000 68,300
Provision for inventory obsolescence 210,800 262,200 300,500
Provision for industrial accident 410,200 254,100 --
Depreciation and amortization 524,700 454,300 418,800
Amortization of goodwill -- -- 520,700
Goodwill impairment writedown -- -- 950,000
(Gain) Loss on sales of product lines -- (210,300) 4,803,200
Loss on asset disposals 50,300 -- 84,100
Imputed interest on notes payable and warrants issued 19,000 71,300 107,600
Imputed expense on non-qualified stock options -- 6,900 --
Directors fees paid via issuance of common stock -- -- 20,000
Changes in Assets and Liabilities:
Accounts receivable (1,191,400) 430,400 (524,500)
Inventories (2,948,400) (1,057,700) (420,600)
Deferred income taxes (1,601,900) -- --
Prepaid expenses and other assets (224,300) (54,300) 35,000
Accounts payable 871,700 (500,300) (2,203,900)
Accrued expenses (104,000) (282,200) 188,900
Income taxes payable 9,900 176,000 --
------------ ------------ ------------
Net Cash Provided by (Used in) Operating Activities (1,206,400) 717,400 (857,700)
------------ ------------ ------------
Cash Flows From Investing Activities:
Purchase of property and equipment (1,281,100) (719,300) (522,700)
Purchase of intellectual property (550,000) -- --
Proceeds from sales of product lines and related inventories -- 3,215,200 2,953,100
Transaction fees on sales of product lines -- (152,000) (139,700)
Proceeds from sale of assets -- -- 3,000
------------ ------------ ------------
Net Cash Provided by (Used in) Investing Activities (1,831,100) 2,343,900 2,293,700
------------ ------------ ------------
Cash Flows From Financing Activities:
Increase (decrease) in bank overdraft (87,200) 29,300 24,900
Proceeds from lines of credit 36,210,000 43,931,000 43,677,700
Repayment of lines of credit (33,856,600) (46,050,000) (44,511,000)
Repayment of notes payable, related parties (275,300) (371,200) (426,400)
Proceeds of notes payable 1,495,200 -- 132,700
Repayment of notes payable (553,800) (545,200) (287,500)
Repayment of capitalized lease obligations (49,600) (69,000) (78,600)
Restricted shares purchased by board member -- -- 50,000
Proceeds from exercise of common stock warrants 90,000 -- --
Proceeds from exercise of common stock options 59,400 -- --
------------ ------------ ------------
Net Cash Provided by (Used in) Financing Activities 3,032,100 (3,075,100) (1,418,200)
------------ ------------ ------------
Net Increase (Decrease) in Cash (5,400) (13,800) 17,800
Cash, beginning of the year 12,700 26,500 8,700
------------ ------------ ------------
Cash, end of the year $ 7,300 $ 12,700 $ 26,500
============ ============ ============
Supplemental Disclosure of Cash Flow Information:
Cash paid for income taxes $ 323,500 $ 13,800 $ 800
Cash paid for interest $ 384,400 $ 446,300 $ 805,200
Non-Cash Financing Activities:
Conversion of notes payable to common stock $ -- $ -- $ 168,200
See accompanying summary of significant accounting policies and notes to financial statements.
- -------------------------------------------------------------------------------------------------------------
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Spectrum Organic Products, Inc.
Summary of Significant Accounting Policies
================================================================================
Nature of Operations
The Company manufactures, packages and sells nutritional supplements and organic
and natural food products, including cooking and nutritional oils, condiments,
dressings and butter substitutes on a wholesale basis to distributors throughout
the United States, Canada, Europe and the Far East and to other manufacturers as
industrial organic ingredients. Company headquarters, principal manufacturing
facilities and industrial ingredient warehousing and distribution are located in
Petaluma, California. Warehousing and distribution of the Company's branded
product lines has been consolidated at a third party facility in Woodland,
California.
Basis of Presentation and Business Divestitures
The Company was formed on October 6, 1999 by the four-way reverse merger of
Spectrum Naturals, Inc. ("SNI"), its affiliate Spectrum Commodities, Inc.
("SCI"), Organic Ingredients, Inc. ("OI") with and into Organic Food Products,
Inc. ("OFPI"). On June 11, 2001 and April 25, 2002 the Company divested the OFPI
and OI product lines, respectively, in order to raise working capital and focus
on its core business in healthy fats and oils. Accordingly, results of
operations for the years ended December 31, 2001 and 2002 include the operating
results of the disposed product lines until the dates of sale.
Risk Factors
The Company is subject to a wide variety of risks in the ordinary course of its
business. Some of the more significant risks include heavy concentrations of
sales with a few key customers; heavy concentrations of raw material supply with
a few key suppliers; heavy reliance on several key processors for its dressings,
condiments and butter substitutes; reliance on one processor for bottling of its
oils as well as warehousing and distribution of its finished case goods;
regulation by various federal, state and local agencies with regards to the
manufacture, handling, storage and safety of food products; regulation of its
manufacturing facilities for cleanliness and employee safety; and regulation by
various agencies with regards to the labeling and certification of organic and
kosher foods. The Company is also subject to competition from other food
companies, the risk of crop shortages due to weather or other factors, and is
dependant on the continued demand for healthy oils and nutritional supplements
by consumers.
Business Segments
The Company operates in three primary business segments: Spectrum Naturals(R)
culinary products, Spectrum Essentials(R) nutritional supplements, and Spectrum
Ingredients industrial culinary products for use by other manufacturers and
private label products for key retailers. Operating results are captured by
segment to the gross profit level. However, operating statement data below gross
profit and balance sheet information have not been disaggregated and captured by
business segment since the information is presently unavailable to the Company's
chief operating decision maker.
Critical Accounting Estimates
The preparation of 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 the disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amounts of revenues and expenses during the reporting period. The
Company bases its estimates on historical experience and various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for the carrying values of assets and
liabilities that are not readily apparent from other sources. On an on-going
basis, the Company re-evaluates all of its estimates utilizing the most recent
information available to it. Actual results may differ materially from these
- --------------------------------------------------------------------------------
Page 38
estimates under different assumptions or conditions and as additional
information becomes available in future periods. The most significant estimates
made by the Company are those concerning reserves against accounts receivable
and inventory, the industrial accident reserve and the deferred tax asset
valuation allowance.
Stock-Based Compensation
Statement of Financial Accounting Standards ("SFAS") No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure" ("SFAS 148") issued in
December 2002 provides alternative methods of accounting for a voluntary
transition to the fair value method of accounting for stock-based employee
compensation as prescribed in SFAS 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"). Additionally, SFAS 148 requires more prominent and
more frequent disclosures in financial statements of the effects of stock based
compensation effective for fiscal years ending after December 15, 2002. As
permitted under SFAS 123, the Company has chosen to continue to account for
employee stock-based compensation using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25"). Accordingly, compensation expense for employee stock
options is measured as the excess, if any, of the fair market price of the
Company's stock at the date of grant over the amount an employee must pay to
acquire the stock. Options granted to non-employees are recorded over the
service period at the estimated fair value of the option granted.
All stock options issued to employees have an exercise price not less than the
fair market value of the Company's common stock on the date of grant. In
accordance with the accounting for such options utilizing the intrinsic value
method prescribed in APB 25, there is no related compensation expense recorded
in the Company's financial statements. Had compensation cost for stock-based
compensation been determined based on the fair value of the options at the grant
dates consistent with SFAS 123, the Company's net income or loss and net income
or loss per share for the years ended December 31, 2003, 2002 and 2001 would
have been adjusted to the pro-forma amounts presented below:
Years ended December 31,
2003 2002 2001
----------- ----------- -----------
Net income (loss) as reported $ 2,663,600 $ 1,120,000 $(5,205,800)
Less: Total compensation expense under fair value
method for all stock-based awards, net of related
tax effects 264,000 182,800 177,400
----------- ----------- -----------
Pro-forma net income (loss) $ 2,399,600 $ 937,200 $(5,395,200)
=========== =========== ===========
Basic and fully diluted income (loss) per share:
As reported $ 0.06 $ 0.02 $ (0.12)
Pro-forma $ 0.05 $ 0.02 $ (0.12)
The fair value of option grants for 2003 was estimated on the date of grant
utilizing the Black-Scholes option-pricing model, with the following
assumptions: expected life of five years, risk-free interest rate of 2.5%, no
dividend yield and volatility of 115%.
The fair value of option grants for 2002 was estimated on the date of grant
utilizing the Black-Scholes option-pricing model, with the following
assumptions: expected life of five years, risk-free interest rate of 2.5%, no
dividend yield and volatility of 142% to 214%.
The fair value of option grants for 2001 was estimated on the date of grant
utilizing the Black-Scholes option-pricing model, with the following
assumptions: expected life of five years, risk-free interest rates of 2.5% to
4.25%, no dividend yield and volatility of 188% to 201%.
- --------------------------------------------------------------------------------
Page 39
Accounts Receivable and Allowances for Doubtful Accounts
The majority of the Company's accounts receivable are due from distributors that
serve the natural products industry. Credit is extended based on evaluation of a
customers' financial condition. Credit terms of sale are generally net 30 days,
with a 2% cash discount offered for payment within ten days. The Company
provides allowances for estimated credit losses, product returns, spoilage and
other customer adjustments (for advertising allowances, etc.) at a level deemed
appropriate to adequately provide for known and inherent risks related to such
amounts. These allowances are based upon the Company's historical experience
with bad debt write-offs and customer deductions, customer creditworthiness,
payment trends and general economic conditions. The Company writes-off accounts
receivable when they are deemed uncollectible. Any subsequent recovery on such
receivables are recorded as an addition to the allowance for doubtful accounts.
Inventory
Inventory is stated at the lower of cost (first-in, first-out method) or market.
Reserves are maintained for obsolete or unsaleable inventories to reduce the
carrying cost of such inventories to market value. The reserve estimates are
based upon historical inventory usage, spoilage, current market conditions and
anticipated future demand.
Property and Equipment
Property and equipment are recorded at cost. Depreciation is provided using the
straight-line method over the estimated useful lives of the assets, ranging from
three to 25 years. Maintenance and repairs that neither significantly add to the
value of the property nor appreciably prolong its life are charged to expense as
incurred. Betterment or renewals are capitalized when incurred.
Goodwill and Intangible Assets
The excess of purchase consideration including transaction costs over the
identifiable tangible and intangible net assets of businesses acquired is
recorded as goodwill. Through December 31, 2001 goodwill was amortized under the
straight-line method over the estimated useful life of twelve years. In June
2001 the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS
142"). SFAS 142 changed the way that companies account for goodwill, in that
goodwill is no longer amortized but instead is tested (along with any other
unamortized intangible assets) for impairment at least annually. The Company
adopted the provisions of SFAS 142 and ceased the amortization of goodwill as of
January 1, 2002. On April 25, 2002 the Company sold the Organic Ingredients
product lines and related goodwill, which reduced goodwill to zero.
The Company evaluates whether events and circumstances have occurred that
indicate the intangible assets may have been impaired at least annually. An
impairment in the carrying value of an asset is assessed when the undiscounted,
expected future operating cash flows to be derived from the asset are less than
its carrying value. If the Company determines that intangible assets have been
impaired, the impairment is recorded based on the excess of the carrying value
of the intangible assets over their fair value.
Trademarks and other intangible assets without an indefinite life are amortized
under the straight-line method over their estimated useful lives.
Long-Lived Assets
Pursuant to applicable accounting rules, the Company periodically assesses
whether long-lived assets have been impaired. The Company deems an asset to be
impaired if the carrying amount of a long-lived asset exceeds the sum of the
undiscounted cash flows expected to result from the use and eventual disposition
of the asset. If the asset is deemed impaired, the Company then recognizes an
impairment loss for the amount by which the carrying amount of a long-lived
asset exceeds its fair value.
- --------------------------------------------------------------------------------
Page 40
Cash Surrender Value Life Insurance
The Company has one whole life insurance policy on its Chairman of the Board
which features cash surrender value. Monthly premiums on the policy are included
in general and administrative expense, with the amount of the premium that
serves to increase the cash surrender value of the policy recorded as a
non-current other asset.
Income Taxes
The Company accounts for corporate income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes", which requires an asset and liability approach.
This approach results in the recognition of deferred tax assets (future tax
benefits) and deferred tax liabilities for the expected future tax consequences
of temporary timing differences between the financial statement amounts and the
tax basis of assets and liabilities. Deferred tax assets are subject to a
valuation allowance in the event Management believes there is risk that the
future tax benefits may not be realized.
Deferred Rent
The difference between monthly rent payments and the simple average of the
minimum lease payments over the term of operating leases is recorded as deferred
rent. The deferred rent is then amortized to occupancy expense over the term of
the lease in a manner which equates the monthly rent payments with the
straight-line amortization of the total minimum lease payments during the lease
term.
Revenue Recognition and Sales Incentives to Customers
The Company recognizes revenue once there is evidence of an arrangement (such as
a customer purchase order), the price and terms are final, delivery has occurred
and collectibility is reasonably assured. Accordingly, sales and cost of goods
sold are recognized when goods are shipped, at which time title and risk of loss
have passed to the customer. The vast majority of the Company's sales are
shipped under customer-arranged freight terms. In all other cases, shipping
charges to customers are included in revenue with an offsetting expense included
in cost of sales.
The Company began accounting for sales incentives offered to customers such as
promotions, trade ads, slotting fees, and coupons as reductions of revenue
beginning in 2002. Reclassifications have been made to the prior period
financial statements to conform to the current year presentation. Total vendor
sales incentives now characterized as reductions of revenue that previously
would have been classified as sales and marketing costs were $731,400 and
$726,000 for 2002 and 2001, respectively.
Advertising
Magazine advertising is expensed at the on-stand date when the consumer or trade
is first exposed to the ad. Costs associated with the production of pamphlets
and similar advertising literature are expensed at the time of initial
distribution. Other advertising costs are expensed as incurred. Advertising
expenses for the years ended December 31, 2003, 2002 and 2001 were $882,700,
$1,172,100 and $810,300, respectively.
Fair Value of Financial Instruments
In accordance with SFAS No. 107, "Disclosures about Fair Value of Financial
Instruments," the Company is required to disclose the fair value of all
financial instruments that it is practical to estimate. In the Company's case,
the carrying amount of all financial instruments approximates fair value. For
trade accounts receivable and trade accounts payable, the carrying amount
approximates fair value due to the short-term maturity of these items. The
Company's notes payable and capital lease obligations approximate fair value
based on rates currently available for debt with similar terms and maturities.
The fair value of the line of credit approximates book value because the
interest rate fluctuates with changes in the LIBOR or prime rate. The Company's
commitments to purchase inventory approximate fair value because they do not
differ materially from current market prices available to the Company and they
do not exceed 12 months in duration.
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Net Income or Loss per Share
Basic income or loss per share is computed by dividing net income or loss
attributable to common shares by the weighted average number of common shares
outstanding during each period. Fully diluted income or loss per share is
similar to basic income or loss per share except that the weighted average
number of common shares outstanding is increased to reflect the dilutive effect
of potential common shares, such as those issuable upon the exercise of stock
options or warrants, as if they had been issued.
For fiscal years 2003 and 2002 there was no difference between basic and fully
diluted income per common share because the dilutive effect of the exercise of
common stock options and warrants was insignificant.
For fiscal year 2001 there was no difference between basic and fully diluted
loss per common share because the effects of the exercise of common stock
options and warrants were anti-dilutive, given the net loss incurred in that
year.
For each year presented, the following potential convertible common shares were
outstanding as of December 31:
2003 2002 2001
--------- --------- ---------
Stock Options 4,152,115 3,898,115 3,225,315
Stock Warrants 160,000 682,606 843,156
--------- --------- ---------
Total Potential Convertible Shares 4,312,115 4,580,721 4,068,471
========= ========= =========
New Applicable Accounting Pronouncements
In July 2002 the Financial Accounting Standards Board ("FASB") issued SFAS No.
146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS
146"). SFAS 146 requires that a liability for expenses associated with an exit
or disposal activity be recognized when the liability is incurred. SFAS 146 also
establishes that fair value is the objective for initial measurement of the
liability. Severance pay under SFAS 146, in many cases, would be recognized over
time rather than up front. The provisions of SFAS 146 are effective for exit or
disposal activities that are initiated after December 31, 2002. The Company's
relocation and outsourcing of its bottling operation to the Interpac Petaluma
facility became effective on July 14, 2003. Exit and disposal costs associated
with the bottling operation relocation and outsourcing of $50,300 were
recognized during 2003 in accordance with SFAS 146.
In November 2002 the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45"), which is effective for financial statements
issued after December 15, 2002. Under FIN 45, a guarantor is required to measure
and recognize the fair value of certain guarantees at inception. Additionally, a
guarantor must provide new disclosures regarding the nature of any guarantees,
potential amount of future guarantee payments, the current carrying amount of
the guarantee liability, and the nature of any recourse provisions or assets
held as collateral. The initial recognition and measurement provisions under FIN
45 are effective for guarantees issued or modified on or after January 1, 2003
for the Company. The disclosure requirements are effective as of December 31,
2002 for the Company. There have been no new guaranties entered into during 2003
and therefore no valuation necessary under FIN 45. However, the Company is the
continuing guarantor for a portion of a line of credit for The Olive Press, LLC,
an unrelated third party, in the amount of $25,000.
The Company enters into indemnification provisions under its agreements with
other companies in the ordinary course of business, typically with business
partners, suppliers, customers and its sublandlord. Under these provisions the
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Company has agreed to generally indemnify and hold harmless the indemnified
party for losses suffered or incurred by the indemnified party as a result of
the Company's activities or, in some cases, as a result of the indemnified
party's activities under the agreement. These indemnification provisions
generally survive termination of the underlying agreement. The maximum potential
amount of future payments the Company could be required to make under these
indemnification provisions is unknown. To date, the Company has not incurred any
costs as there have been no lawsuits or other claims related to these
indemnification agreements. Accordingly, the Company has no liabilities recorded
for these indemnification provisions as of December 31, 2003.
In December 2002 the FASB issued SFAS 148, which provides alternative methods of
transition for a voluntary change to the fair value method of accounting for
stock-based employee compensation as prescribed in SFAS 123. Additionally, SFAS
148 requires more prominent and more frequent disclosures in financial
statements about the effects of stock-based compensation. The provisions of SFAS
148 are effective for fiscal years ending after December 15, 2002 with early
application permitted in certain circumstances. Management has evaluated the
benefits of changing to the fair value method of accounting for stock-based
compensation and has elected to continue to use the intrinsic value method. The
required financial disclosures under SFAS 148 are included in the Summary of
Significant Accounting Policies.
The FASB has published a revision to Interpretation 46 ("46R") to clarify some
of the provisions of FASB Interpretation No. 46, "Consolidation of Variable
Interest Entities", and to exempt certain entities from its requirements. The
additional guidance is being issued in response to input received from
constituents regarding certain issues arising in implementing Interpretation 46.
Under the new guidance, special effective date provisions apply to enterprises
that have fully or partially applied Interpretation 46 prior to issuance of this
revised Interpretation. Otherwise, application of Interpretation 46R (or
Interpretation 46) is required in financial statements of public entities that
have interests in structures that are commonly referred to as special-purpose
entities for periods ending after December 15, 2003. Application by public
entities, other than small business issuers, for all other types of variable
interest entities is required in financial statements for periods ending after
March 15, 2004. Application by small business issuers to variable interest
entities other than special-purpose entities and by nonpublic entities to all
types of variable interest entities is required at various dates in 2004 and
2005. In some instances, enterprises have the option of applying or continuing
to apply Interpretation 46 for a short period of time before applying this
revised Interpretation. The Company believes that adoption of Interpretation 46R
(or Interpretation 46) will have no effect on its financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS 150").
SFAS 150 provides new rules on the accounting for certain financial instruments
that, under previous guidance, would be accounted for as equity. It requires
that an issuer classify a financial instrument that is within its scope as a
liability. Such financial instruments include mandatorily redeemable shares,
instruments that require the issuer to buy back some of its shares in exchange
for cash or other assets, or obligations that can be settled with shares, the
monetary value of which is fixed. SFAS 150 shall be effective for financial
instruments entered into or modified after May 31, 2003 and otherwise shall be
effective at the beginning of the first interim period beginning after June 15,
2003. However certain modifications and FASB Staff Positions relating to SFAS
150 are being deliberated. The adoption of SFAS 150 has no effect on the
Company's financial statements.
Reclassifications
Certain reclassifications have been made to the prior year financial statements
to be consistent with the current year presentation. These reclassifications had
no impact on net income or retained earnings for the prior years presented.
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Spectrum Organic Products, Inc.
Notes to Financial Statements
================================================================================
1. Business Combination and Subsequent Divestitures
The Company was formed on October 6, 1999 by the four-way reverse merger (the
"merger") of Spectrum Naturals, Inc. ("SNI"), its affiliate Spectrum
Commodities, Inc. ("SCI"), Organic Ingredients, Inc. ("OI"), with and into
Organic Food Products, Inc. ("OFPI"). OFPI was the registrant prior to the
merger, but since a controlling interest in the Company is held by former SNI
stockholders, the merger was accounted for as a reverse acquisition, with SNI as
accounting acquirer and OI and OFPI as accounting acquirees.
On June 11, 2001 the Company sold the OFPI tomato-based product lines to Acirca,
Inc., an unrelated third party. Accordingly, results for the year ended December
31, 2001 include the operating results associated with the OFPI disposed product
lines until the date of sale.
On April 25, 2002 the Company sold the OI industrial ingredient product lines in
fruits, vegetables, concentrates and purees to Acirca. Accordingly, results for
the year ended December 31, 2002 include the operating results associated with
the OI disposed product lines until the date of sale.
2. Industrial Accident
On February 4, 2004 the Company pleaded no contest to two misdemeanor counts of
violations under California Labor Code Section 6425, violation of a regulation
issued by the California Occupational Health and Safety Administration
("CAL-OSHA"), requiring employers to provide, maintain and ensure employees use
required confined space equipment. The plea arose in connection with a tragic
production accident on April 25, 2002 that resulted in the death of two of the
Company's employees. Under the Terms of Settlement and Probation entered into
with the plea, the Company will pay a fine of $150,000 in three annual
installments of $50,000 each on June 30, 2004, 2005 and 2006. In addition the
Company paid $150,000 in restitution to the California District Attorneys
Association Workers Safety Training Account to assist in the prosecution of
worker safety cases in the State of California. The Company also reimbursed
costs of $25,000 each to the Petaluma Police Department, the Petaluma Fire
Department and the Sonoma County District Attorney's Office. Finally, an
additional fine of $250,000 under California Labor Code Section 6425 was
suspended conditioned upon the Company's compliance with the terms of court
supervised probation for three years. Accordingly, the Company accrued an
expense of $375,000 against the year ended December 31, 2003 to cover the net
present value of the above payments, plus attorney's fees. Total expenses
incurred in 2003 as a result of the industrial accident were $410,200.
During 2002 the Company recorded expenses of $254,100 in connection with the
same industrial accident. Included in that amount was a remaining reserve of
$141,900 at December 31, 2003 to cover anticipated penalties from CAL-OSHA,
appeals filed by the dependants of the two employees with the Workers
Compensation Appeals Board of California, and related attorney's fees. CAL-OSHA
has completed their investigation of the accident and issued their report and
notice of proposed penalties on October 18, 2002. Their report included nine
citations for safety violations with total proposed penalties of $137,900. There
were no willful citations and the CAL-OSHA report acknowledged that all the
safety violations had been 100% abated prior to the report's issuance. The
Company has filed a formal appeal with CAL-OSHA in the hopes of reducing the
citations and proposed penalties. The workers compensation appeals are for an
additional death benefit of $107,500 in total, payable by the Company to the
dependents of the deceased workers if the dependents successfully establish that
the Company was guilty of serious and willful misconduct by allowing unsafe
working conditions to exist. The Company intends to defend itself vigorously and
believes it has meritorious defenses. If actually litigated, the workers
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Page 44
compensation appeals are an all-or-nothing proposition under which the Company
will either be liable for $107,500 or nothing. Based on the advice of counsel,
the Company expects the workers compensation appeals to be settled rather than
litigated. Management believes the remaining reserve of $141,900 will be
adequate to cover the settlement of the CAL-OSHA penalties, the workers
compensation appeals and related attorney's fees.
3. Change in Primary Banking Relationship
On July 11, 2003 the Company entered into a Loan and Security Agreement (the
"Credit Facility") with Comerica Bank ("Comerica"). The Credit Facility consists
of a $7,000,000 revolving line of credit, a $1,250,000 term loan and a
$1,000,000 capital expenditure term loan. The Credit Facility is secured by
substantially all assets of the Company and matures on June 30, 2005 unless
renewed earlier.
The revolving line of credit is subject to a borrowing base consisting of
certain eligible accounts receivable and inventory and bears interest at the
prime rate or LIBOR plus 2.25%, at the Company's option. As of December 31, 2003
the Company had $4,833,000 in outstanding borrowings under the line of credit
and $2,105,800 in available borrowing capacity under the line of credit.
The $1,250,000 term loan is secured by property and equipment, bears interest at
the prime rate plus 25 basis points (0.25%) and features a sixty-month
amortization schedule that commenced in July 2003. As of December 31, 2003 the
Company owed principal payments totaling $1,125,000 under the term loan.
The $1,000,000 capital expenditure term loan will finance the purchase of
additional new or used property and equipment, bears interest at the prime rate
plus 25 basis points (0.25%) and features a 12 month interest only draw down
period, converting to a 48 month amortization schedule thereafter. As of
December 31, 2003 the Company had $754,800 available to be drawn down against
the capital expenditure term loan.
The Credit Facility calls for continued satisfaction of various financial
covenants for 2003 and beyond in order to remain in compliance. As of December
31, 2003 the company was in compliance with the financial covenants and all
other requirements called for under the Credit Facility.
The Credit Facility with Comerica replaced a similar arrangement with Wells
Fargo Business Credit, Inc. ("WFBC"), the Company's former primary lender. All
amounts due to WFBC were retired on July 11, 2003 in the amount of $5,023,600.
Included in that amount was an early termination fee of $62,400 paid to WFBC for
terminating that credit facility prior to its maturity date of October 6, 2004.
The early termination fee and the remaining unamortized loan fee of $8,000
associated with the WFBC agreement were recorded as interest expense in 2003.
4. Intellectual Property Purchase
On April 15, 2003 the Company entered into an intellectual property purchase
agreement (the "IP Agreement") with Tenere Life Sciences, Inc. ("Tenere") and
Mr. Rees Moerman, both unaffiliated third parties. Mr. Moerman is an engineer
and lipid scientist who developed proprietary techniques for the benign
extraction of oil from vegetable seeds. The Company has utilized Mr. Moerman's
techniques under the SpectraVac and LOCET Technology License Agreement (the
"License Agreement") for the production of flax oil and other nutritional oils
since 1990. Under the License Agreement, the Company paid royalties to Mr.
Moerman on its sales of products that were manufactured utilizing the
intellectual property. Mr. Moerman assigned his rights to the intellectual
property to Tenere on January 21, 2003.
In accordance with the IP Agreement, the Company purchased the intellectual
property for $550,000 which was paid in two equal installments on April 30, 2003
and October 7, 2003. As a result, the Company is no longer obligated to pay
royalties to Tenere effective April 1, 2003. Royalties paid during the years
ended December 31, 2002 and 2001 were $162,500 and $152,000, respectively.
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In accordance with Statement of Financial Accounting Standard No. 142, "Goodwill
and Other Intangible Assets" ("SFAS 142"), the Company has determined that the
IP Agreement has an indefinite useful life since it represents trade secrets
utilized in the manufacture of flax oil and other nutritional oils. Accordingly,
there is no periodic amortization expense. The Company will evaluate the
intangible asset carrying value of $550,000 for impairment in relation to the
anticipated future cash flows of its nutritional oils at least annually.
5. Bottling Equipment Relocation and Reconfiguration
On July 14, 2003 the Company disassembled its bottling line at its leased
manufacturing facility located at 133 Copeland Street, Petaluma, California and
relocated and reconfigured the line at its new co-packer, Interpac Technologies,
Inc. ("Interpac"), also located in Petaluma. Interpac provides custom bottling
services to the Company utilizing the Company's bottling equipment. As a result,
there were thirteen positions eliminated from the Company's bottling and
warehouse operation at Copeland Street. Of those thirteen positions, eight
people accepted similar positions at Interpac, three accepted severance packages
and two people were on a leave of absence at the time. The severance payments
were included in cost of sales for 2003 and were not significant.
The bottling line was reconfigured for better efficiency and higher bottling
speeds and included a new labeler and new conveying equipment. As a result,
there was $30,600 in net book value of equipment at Copeland Street which was
scrapped rather than being relocated. Additionally, the Company recorded a
writedown of $19,700 to reduce the net book value of equipment that has been
sold or is being held for sale to its estimated market value. The combined
amount of $50,300 was included in cost of sales for 2003.
6. Sales of Product Lines
On April 25, 2002 the Company entered into an Asset Purchase Agreement with
Acirca, Inc. pursuant to which the Company sold certain product lines from the
Company's Aptos-based industrial ingredients business. The product lines sold
included the Organic Ingredients ("OI") business in fruits, vegetables,
concentrates and purees as well as certain key retailer private label product
lines. The Spectrum Ingredients product lines consisting of culinary oils,
vinegars and nutritional supplements were not part of the sale.
The total consideration was $3,167,000 in cash, which included $1,417,000 for
saleable inventory sold to Acirca. Also included in the total consideration
received was $250,000 that was deposited into an escrow account to be applied
towards indemnity claims of Acirca or, to the extent not utilized for any
indemnity claims of Acirca, to be released to the Company in two equal
installments on August 30, 2002 and December 31, 2002. The first installment of
$125,000 was received in full on September 3, 2002. The final installment of
$124,700 was received on January 31, 2003 and consisted of $125,000 plus
interest earned on the escrowed funds less the escrow agent fees.
On June 11, 2001 the Company sold its tomato-based consumer product lines to
Acirca for $3,128,100 in cash which included $778,100 for saleable inventory and
$350,000 that was deposited into an escrow account to be applied towards
indemnity claims of Acirca. To the extent the escrowed funds were not utilized
for any indemnity claims of Acirca, they were to be released to the Company in
two equal installments at the six month and one year anniversaries of the sale.
The first installment of $175,000 was received in full in December 2001. The
final installment of $173,200 was received on July 17, 2002 and consisted of
$175,000 plus interest earned on the escrowed funds less $6,700 paid to Acirca
in full satisfaction of their indemnity claims. Due to the contingent nature of
the escrowed funds on both sales, they were not recorded as consideration until
constructive receipt.
Since both product line sales comprised all of the remaining assets of both OI
and OFPI, the remaining net goodwill associated with the reverse acquisition of
both companies in October 1999 was written off as a result of the sales.
Accordingly, the Company recorded the following gains and losses on the product
line sales for the years ended December 31, 2002 and 2001:
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Sales of Product Lines
2002 2001
----------- -----------
Total consideration $ 3,167,000 $ 3,128,100
Less escrowed funds included above (250,000) (350,000)
----------- -----------
Net cash proceeds from sales 2,917,000 2,778,100
Assets sold:
Inventories (1,417,000) (778,100)
Fixed assets, net of accumulated depreciation (8,600) (10,500)
Goodwill, net of accumulated amortization (1,470,200) (6,776,200)
Other assets (6,300) --
Transaction costs (152,000) (139,700)
Reserve for remaining inventories not sold (75,500) (51,800)
----------- -----------
Loss before collection of previously escrowed funds (212,600) (4,978,200)
Subsequent collection of escrowed funds 422,900 175,000
----------- -----------
Net Gain (Loss) on Sales of Product Lines $ 210,300 $(4,803,200)
=========== ===========
Included in accounts receivable at December 31, 2002 was $124,700 of the
escrowed funds on the sale of OI, which was contractually due at December 31,
2002 and received on January 31, 2003 after final negotiations between the
parties were completed. After accounting for the escrowed funds and the OI
goodwill impairment writedown recorded in December 2001 (see Note 7), the final
net loss on the sale of OI was $912,900.
After accounting for the final collection of the escrowed funds and related
interest on the 2001 sale of the OFPI product lines, which were not recorded at
the time of the sale due to their contingent nature, the final net loss on the
sale of the OFPI product lines was $4,630,000.
The transaction costs represented investment banking, legal fees and other
expenses associated with closing the sales. Investment banking fees totaling
$157,200 were paid to Moore Consulting, a sole proprietorship owned and operated
by a non-executive Director of the Company. The fees were 2.5% of the total
consideration on both sales. The reserve recorded for remaining inventories
represented losses incurred or anticipated on inventories previously sold by the
Company under the disposed product lines that were not purchased by Acirca.
7. Goodwill Impairment Writedown
As a result of negotiations that were underway at December 31, 2001 for the sale
of the Organic Ingredients product lines, the Company determined that the net
goodwill associated with the Organic Ingredients product lines was impaired.
Accordingly, the Company recorded a non-cash writedown of $950,000 to reduce the
goodwill carrying amount at December 31, 2001 to its estimated net realizable
value of $1,470,200 (see Note 6).
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8. Accounts Receivable
Accounts receivable consisted of the following:
As of December 31,
2003 2002
---------- ----------
Trade $4,604,800 $3,306,800
Stockholder -- 20,000
Other 8,400 164,400
---------- ----------
Total accounts receivable 4,613,200 3,491,200
Less allowance for doubtful accounts and customer
allowances 450,000 416,000
---------- ----------
Net Accounts Receivable $4,163,200 $3,075,200
========== ==========
During 2003 the Company had one customer that accounted for approximately 36% of
net sales and approximately 25% of trade accounts receivable at December 31,
2003. During 2002 that same customer accounted for approximately 50% of net
sales and approximately 23% of trade accounts receivable at December 31, 2002.
During 2001 the same customer accounted for approximately 39% of net sales and
approximately 11% of trade accounts receivable at December 31, 2001. The sales
to this customer consisted of Spectrum Naturals(R) and Spectrum Essentials(R)
consumer packaged products only. The loss of this customer would have a material
adverse effect on the Company's operations and cash flows.
During 2003, 2002 and 2001 foreign sales comprised 4%, 7% and 6%, respectively,
of total net sales and approximately 4%, 4% and 6% of trade accounts receivable
at December 31, 2003, 2002 and 2001, respectively. All foreign sales were
denominated in United States dollars.
9. Inventories
Inventories consisted of the following:
As of December 31,
2003 2002
---------- ----------
Finished goods $6,853,400 $4,351,900
Raw materials 1,166,100 1,408,100
Deposits on Inventory 236,200 57,600
---------- ----------
Total inventories 8,255,700 5,817,600
Less provision for obsolete inventory 248,500 548,000
---------- ----------
Net Inventories $8,007,200 $5,269,600
========== ==========
For 2003, 2002 and 2001 the Company had one supplier of raw materials that
accounted for approximately 16%, 11% and 6%, respectively, of total purchases of
raw materials and one supplier of processing that accounted for approximately
11%, 11% and 6%, respectively, of total cost of sales. At December 31, 2003,
2002 and 2001 approximately $954,500, $564,500, and $244,300 was owed to these
suppliers and included in accounts payable.
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10. Property and Equipment
Property and equipment consisted of the following:
As of December 31,
2003 2002
---------- ----------
Machinery and equipment $5,434,200 $4,338,600
Furniture and fixtures 978,900 873,500
Construction in progress 227,400 442,200
Leasehold improvements 310,400 244,600
Vehicles 84,000 84,000
---------- ----------
Total property and equipment 7,034,900 5,982,900
Less accumulated depreciation 2,696,200 2,535,500
---------- ----------
Net Property and Equipment $4,338,700 $3,447,400
========== ==========
During the years ended 2003, 2002 and 2001, the Company capitalized interest of
$24,500, $27,800 and $49,200 respectively, on construction in progress. There
was one significant project at December 31, 2003 for an ethanol fractionating
tower which Management has placed on hold while it evaluates other sites for its
manufacturing facility. Spending on the ethanol fractionating tower totaled
$155,000 at December 31, 2003. Management estimates that an additional $200,000
of expenditures are necessary to complete the project. No depreciation expense
is recorded on construction in progress until the asset is placed in service.
Depreciation expense was $519,600, $442,300 and $405,100 for 2003, 2002 and
2001, respectively.
11. Intangible Assets
Intangible assets consisted of the following:
As of December 31,
2003 2002
-------- --------
Intellectual property $550,000 $ --
Trademarks 74,100 74,100
Label Development -- 80,800
Covenant-not-to-compete -- 76,500
-------- --------
Total intangible assets 624,100 231,400
Less accumulated amortization 37,300 189,400
-------- --------
Net Intangible Assets $586,800 $ 42,000
======== ========
Amortization expense was $5,100, $12,000 and $13,700 for the years ending
December 31, 2003, 2002 and 2001, respectively. The label development costs and
covenant-not-to-compete became fully amortized during 2003 and 2002,
respectively, and were removed from the balance sheet at December 31, 2003. The
trademarks are being amortized over a 30 year life. The intellectual property
will be evaluated annually for potential impairment based on the forecasted
future cash flows of the Company's flax oil products.
12. Line of Credit
The Company has available a $7,000,000 revolving line of credit, subject to a
borrowing base limitation based upon a percentage of eligible accounts
receivable and inventory, bearing interest at the prime rate or LIBOR plus 2.25%
which expires on June 30, 2005 unless renewed earlier. Borrowings under the
revolving line of credit totaled $4,833,000 at December 31, 2003 versus
$2,479,800 at December 31, 2002. The credit line is secured by substantially all
assets of the Company.
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As of December 31, 2003 the Company had $2,105,800 in excess borrowing capacity
available under the line of credit versus $1,696,700 at December 31, 2002.
The line of credit calls for the Company to maintain compliance with certain
financial covenants. At December 31, 2003 the Company was in compliance with all
covenants and other requirements under the Credit Agreement.
13. Notes Payable and Capital Lease Obligations
Notes payable and capital lease obligations consisted of the following:
As of December 31,
2003 2002
---------- ----------
Term notes payable to bank secured by substantially all
assets of the Company (a) $1,370,200 $ 429,000
Capital lease obligations secured by the related
property and equipment (b) 56,300 105,900
---------- ----------
Total Notes Payable and Capital Lease Obligations 1,426,500 534,900
Less current maturities 322,300 256,000
---------- ----------
Long-term Portion of Notes Payable and Capital Lease
Obligations $1,104,200 $ 278,900
========== ==========
(a) As disclosed in Note 3, the Company entered into a new banking relationship
during 2003 with Comerica Bank. Under the Comerica relationship, the
Company has a $1,250,000 term note with equal 60-month amortization and a
capital expenditure facility that features a 12-month draw down period
ending June 30, 2004 with 48-month amortization thereafter. Both notes bear
interest at prime plus 25 basis points (4.25% at December 31, 2003). Under
the previous banking relationship, there were three separate term notes
payable to the bank as of December 31, 2002, two with 60-month terms and
one with 36-month terms, all of which bore interest at prime plus 1.25%.
(b) The cost of assets securing the capital lease obligations was $243,000 and
$438,900 at December 31, 2003 and 2002, with accumulated amortization of
$83,100 and $240,000 at December 31, 2003 and 2002, respectively.
Aggregate maturities or principal payments required on notes payable and capital
lease obligations for each of the succeeding years are included in Note 14.
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14. Notes Payable, Related Parties
Notes payable with related parties consisted of the following:
As of December 31,
2003 2002
---------- ----------
Note payable with interest due monthly at 9% per
annum. Principal is due in monthly installments of
$15,625 until paid in full. The note is secured by
a collateral assignment of a life insurance policy
on the majority stockholder and unissued shares of
common stock in an amount equivalent to the unpaid
principal and interest due under the note. The
note is subordinated to the line of credit and all
notes payable to the bank. (a) $ 390,600 $ 578,100
Non-interest bearing, unsubordinated and unsecured
note due on December 31 of the fourth year
following the calendar year which includes the
final payment on the above note, expected to be
2011. Interest has been imputed at an effective
interest rate of 6.5% per annum. 305,400 286,200
Unsecured, subordinated note due in monthly
installments of $4,300 including principal and
interest at 10% per annum. 85,300 125,600
Unsecured, unsubordinated notes due in monthly
installments of $8,500 including principal and
interest at 10% per annum. 43,100 90,400
---------- ----------
Total Notes Payable - Related Parties 824,400 1,080,300
Less current maturities 275,200 275,100
---------- ----------
Long-term Portion of Notes Payable - Related Parties $ 549,200 $ 805,200
========== ==========
(a) Under the Seventh Amendment to the Redemption Agreement entered into on
November 1, 2002 the note holder retains the unilateral right to revert to
monthly principal payments of $31,250 upon 60 days prior written notice to
the Company. The note holder has indicated in writing to the Company that
it is not her intent to increase the monthly principal payments at the time
of this report. Consequently, the principal payments included in the
current maturities of notes payable, related parties for this note was
$187,500 at December 31, 2003.
Aggregate maturities or principal payments required on all types of long-term
debt and capital lease obligations for each of the succeeding years are as
follows:
Related
Bank Term Party Cap. Lease Total
Years Ended December 31, Notes Notes Obligations Long-Term Debt
- ------------------------ ---------- ---------- ---------- ----------
2004 $ 280,700 $ 275,100 $ 51,900 $ 607,700
2005 311,300 228,300 20,100 559,700
2006 311,300 15,600 -- 326,900
2007 311,300 -- -- 311,300
2008 155,600 -- -- 155,600
2011 -- 513,300 -- 513,300
---------- ---------- ---------- ----------
Total Future Payments 1,370,200 1,032,300 72,000 2,474,500
Less amounts representing interest -- 207,900 15,700 223,600
---------- ---------- ---------- ----------
Total Long-Term Debt, including
current maturities $1,370,200 $ 824,400 $ 56,300 $2,250,900
========== ========== ========== ==========
- --------------------------------------------------------------------------------------
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15. Provision for Income Taxes and Deferred Income Taxes
At December 31, 2003 the Company reversed the 100% valuation allowance that had
been maintained against its deferred tax assets since the merger. As a result,
the Company recorded a net benefit from income taxes of $1,566,600 for 2003. For
the years ended December 31, 2003, 2002 and 2001 the provision or benefit from
income taxes consisted of the following:
2003 2002 2001
----------- ----------- -----------
Current:
Federal $ 9,900 $ -- $ --
State 25,400 189,800 --
----------- ----------- -----------
Subtotal Current 35,300 189,800 --
----------- ----------- -----------
Deferred:
Federal (1,409,100) -- --
State (192,800) -- --
----------- ----------- -----------
Subtotal Deferred (1,601,900) -- --
----------- ----------- -----------
Total Provision (Benefit) for Income Taxes $(1,566,600) $ 189,800 $ --
=========== =========== ===========
A reconciliation of the federal statutory rate to the tax provision for the
years ended December 31 follows:
2003 2002 2001
----------- ----------- -----------
Tax expense (benefit) at effective federal
statutory rate (34%) $ 373,000 $ 445,300 $(1,772,900)
Disposal of non-deductible goodwill -- 499,900 2,303,900
Impairment loss on non-deductible goodwill -- -- 323,000
Goodwill amortization -- -- 177,100
Other non-deductible expense 53,800 11,800 57,700
State income tax expense, net of federal
effect 71,500 51,600 94,000
Valuation allowance (1,997,900) (867,200) (1,104,200)
Tax credits and other (67,000) 48,400 (78,600)
----------- ----------- -----------
Total Provision (Benefit) for Income Taxes $(1,566,600) $ 189,800 $ --
=========== =========== ===========
Deferred tax assets and liabilities consisted of the following:
As of December 31,
2003 2002
----------- -----------
Deferred Tax Assets:
Federal net operating loss carryovers $ 1,506,500 $ 1,761,400
Inventory allowances 84,500 182,300
Accounts receivable allowances 153,000 141,400
Accrued compensation 63,500 51,100
State income taxes 192,800 335,000
Accruals and reserves 88,900 --
Other 50,500 13,800
----------- -----------
Total Deferred Tax Assets 2,139,700 2,485,000
Deferred Tax Liabilities:
Depreciation and fixed asset write-down (537,800) (443,800)
Other -- (43,300)
----------- -----------
Net Deferred Tax Assets, Before Allowance 1,601,900 1,997,900
Valuation allowance -- (1,997,900)
----------- -----------
Net Deferred Tax Assets $ 1,601,900 $ --
=========== ===========
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As of December 31, 2003 the Company had federal net operating loss carryforwards
("NOLs") totaling approximately $4,431,000 that expire at various times through
2020. For state purposes, the Company had net operating loss carryforwards
totaling approximately $3,150,000 which expire at various times through 2010.
The majority of the NOLs originated primarily from pre-merger operations of
OFPI. As a result of OFPI's acquisition by SNI (Note 1), OFPI experienced a more
than 50% change in ownership for federal and state income tax purposes.
Therefore, an annual limitation is placed upon the Company's ability to realize
the benefit of the pre-merger NOLs. Management believes that it is more likely
than not that the Company will continue to report sufficient taxable income in
the foreseeable future, allowing utilization of 100% of its deferred tax assets.
16. Goodwill
The Company recorded goodwill for the excess of the purchase consideration and
transaction costs versus the identifiable net assets of the businesses acquired
in the 1999 merger. During 2001 and 2002 the Company divested the businesses
acquired in the merger in order to raise working capital. The following table
sets forth the transactions affecting goodwill for the years ended December 31,
2001 and 2002.
OFPI OI TOTAL
----------- ----------- -----------
Balances, January 1, 2001 $ 7,045,500 $ 2,671,600 $ 9,717,100
Amortization expense for 2001 (269,300) (251,400) (520,700)
Sale of OFPI product lines (Note 6) (6,776,200) -- (6,776,200)
Writedown of OI goodwill to net realizable
value (Note 7) -- (950,000) (950,000)
----------- ----------- -----------
Balances, December 31, 2001 -- 1,470,200 1,470,200
Sale of OI product lines (Note 6) -- (1,470,200) (1,470,200)
----------- ----------- -----------
Balances, December 31, 2002 $ -- $ -- $ --
=========== =========== ===========
In accordance with SFAS 142, the Company ceased the amortization of the
remaining goodwill as of January 1, 2002. Had SFAS 142 been in effect prior to
January 1, 2002 reported results for the year ended December 31, 2001 would have
been adjusted as follows:
Net loss as reported $ 5,205,800
Goodwill amortization 520,700
-------------
Adjusted net loss $ 4,685,100
=============
Basic and fully diluted net loss per share:
As reported $ 0.12
Effect of goodwill amortization 0.01
-------------
Adjusted basic and fully diluted net loss per share $ 0.11
=============
17. 401(k) Plan
The Company provides a defined contribution plan covering substantially all
employees meeting certain age and service requirements. Plan contributions are
made at the discretion of Management and totaled $33,500, $34,800 and $47,300
for the years ended December 31, 2003, 2002 and 2001, respectively.
- --------------------------------------------------------------------------------
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18. Common Stock Options
Prior to the merger discussed in Note 1, SNI had an Equity Incentive Plan under
which options were granted to one officer in 1998. As a result of the merger,
the Company assumed the options outstanding under OFPI's 1995 Stock Option Plan
(the "1995 Plan"). Because OFPI was the surviving legal entity after the merger,
SNI's existing options were absorbed into the 1995 Plan and restated at their
equivalent number of shares and strike price using the merger conversion ratio,
and the SNI Equity Incentive Plan was discontinued.
The Company subsequently amended the 1995 Plan twice, increasing the aggregate
number of shares of common stock which could be issued under the 1995 Plan to
7,000,000. Both amendments were approved by a vote of the Company's
shareholders.
Under the amended 1995 Plan, each option represents the right to purchase one
share of the Company's common stock at a fixed price per share at some future
date. The option strike price shall not be less than the fair market value on
the date of grant and options expire unless exercised within ten years after the
date of grant. Options generally vest ratably over four years for employees and
two years for directors.
The following table summarizes the activity under the 1995 Plan for the years
ended December 31, 2003, 2002 and 2001:
2003 2002 2001
----------------------- ---------------------- ---------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
---------- -------- ---------- -------- ---------- --------
Outstanding, beginning
of year 3,898,115 $ 0.34 3,225,315 $ 0.48 2,010,115 $ 0.41
Options granted 809,500 0.31 1,325,000 0.30 1,256,400 0.59
Options exercised (143,750) 0.41 -- -- -- --
Options expired (411,750) 0.34 (652,200) 0.21 (41,200) 0.44
---------- -------- ---------- -------- ---------- --------
Outstanding, end of year 4,152,115 $ 0.33 3,898,115 $ 0.34 3,225,315 $ 0.48
========== ======== ========== ======== ========== ========
Options exercisable at year end 2,368,973 $ 0.34 1,784,282 $ 0.35 1,457,448 $ 0.67
========== ======== ========== ======== ========== ========
Weighted average fair value of
options granted during the year $ 0.25 $ 0.30 $ 0.21
======== ======== ========
The following table discloses exercise prices and remaining lives of options
outstanding or exercisable as of December 31, 2003:
Options Outstanding Options Exercisable
------------------- -------------------
Weighted Weighted
Average Average
Remaining Weighted Remaining Weighted
Range of Number Contractual Average Number Contractual Average
Exercise Outstanding Life Exercise Exercisable Life Exercise
Prices at 12/31/03 (Years) Price at 12/31/03 (Years) Price
- ----------- ----------- ----------- ----------- ----------- ----------- -----------
$0.01-$0.25 1,091,800 7.9 $ 0.24 670,067 7.8 $ 0.24
$0.26-$0.50 3,047,315 7.3 0.35 1,685,906 6.2 0.36
$0.51-$2.50 13,000 3.4 2.50 13,000 3.4 2.50
- ----------- ----------- ----------- ----------- ----------- ----------- -----------
$0.01-$2.50 4,152,115 7.4 $ 0.33 2,368,973 6.6 $ 0.34
=========== =========== =========== =========== =========== =========== ===========
As of December 31, 2003 there were 2,704,135 options remaining that are
available for future issuance under the 1995 Plan.
- --------------------------------------------------------------------------------
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19. Common Stock Warrants
Each common stock warrant represents the right to purchase one share of the
Company's common stock at a fixed price per share at some future date. At the
date of the merger the Company assumed outstanding common stock purchase
warrants of OFPI totaling 590,656. All of those warrants were issued at exercise
prices ranging from $2.00 to $4.00 per share and all expired unexercised during
the ensuing years. Also in connection with the merger, the Company issued
400,000 penny warrants in conjunction with a private placement of unsecured
subordinated notes necessary to close the merger. All of the penny warrants were
subsequently exercised during 2000 and 2001. In addition, in connection with the
renegotiation of the private placement notes, the Company issued quarterly
common stock purchase warrants at the closing bid price of Spectrum shares at
each quarter-end starting December 31, 2000 and ending on December 31, 2002 as a
result of the early retirement of the private placement notes. All of those
warrants were exercised during 2002 and 2003.
The following table discloses the activity related to common stock purchase
warrants for the years ended December 31, 2003, 2002 and 2001:
2003 2002 2001
--------------------------- -------------------------- ---------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Warrants Price Warrants Price Warrants Price
----------- ----------- ----------- ----------- ----------- -----------
Outstanding, beginning of year 682,606 $ 0.50 843,156 $ 1.43 608,156 $ 1.78
Private placement warrants
issued -- -- 200,200 0.32 337,500 0.26
IPO warrants expired (60,656) 2.63 (330,000) 2.79 -- --
Private placement warrants
exercised (a) (461,950) 0.28 (30,750) 0.33 (262,500) 0.05
Warrants issued in connection
with restricted stock
purchase (b) -- -- -- -- 160,000 0.31
----------- ----------- ----------- ----------- ----------- -----------
Outstanding, end of year 160,000 $ 0.31 682,606 $ 0.50 843,156 $ 1.43
=========== =========== =========== =========== =========== ===========
(a) These warrants included a net exercise feature which enabled the holder to
convert the net equity in the warrants into common stock in a cash-less
transaction. Accordingly, common shares issued in connection with the
exercise of the warrants were 405,456, 6,910 and 230,883 for the years
ended December 31, 2003, 2002 and 2001, respectively.
(b) These warrants were issued in February 2001 in connection with the purchase
of 160,000 shares of Spectrum restricted common stock by a non-executive
Director of the Company. Since the shares were purchased at the closing
market price for the Company's unrestricted common stock, the Company also
issued 160,000 common stock purchase warrants at the same price, which
expire five years from the date issued.
As of December 31, 2003 the remaining common stock warrants outstanding were
issued at an exercise price of $0.31 per share with an expiration date of
February 15, 2006.
20. Business Segments
Management has evaluated the Company's operations and has determined that the
Company operates in three primary business segments: Spectrum Naturals(R)
culinary products, Spectrum Essentials(R) nutritional supplements and Spectrum
Ingredients industrial culinary products for use by other manufacturers and
private label products for key retailers. The Spectrum Naturals(R) culinary
- --------------------------------------------------------------------------------
Page 55
products is the Company's largest segment, representing approximately 45% of
total net sales. The Spectrum Naturals(R) culinary products are manufactured on
behalf of the Company by third parties and are sold primarily through
distributors and specialty food brokers to natural food and specialty food
stores.
The Spectrum Essentials(R) nutritional supplements segment represents
approximately 23% of total net sales and is sold through the same distribution
and broker network as the Spectrum Naturals(R) products. However, the Company
manufactures the majority of the Spectrum Essentials(R) products at its leased
manufacturing facility at 133 Copeland Street in Petaluma. The gross margins of
the two consumer product line segments are also markedly different, with the
Spectrum Essentials(R) brand delivering higher gross margins.
The final segment identified by Management is the Spectrum Ingredients and
private label product lines. The Spectrum Ingredients products are sold directly
to other food manufacturers in industrial sizes for use in their products at
substantially lower margins than the two branded consumer products segments. The
private label products are sold directly to key retailers such as Whole Foods,
Wild Oats and Trader Joe's and also feature lower margins than the branded
consumer products segment.
Operating data is captured by segment to the gross profit level. However,
operating statement data below gross profit and balance sheet data have not been
disaggregated and captured by business segment since the information is
presently unavailable to the Company's chief operating decision maker.
Accordingly, the following segment information is currently captured by the
Company:
Years Ended December 31,
2003 2002 2001
---- ---- ----
Net Sales:
Spectrum Naturals(R) $20,606,100 $17,268,200 $15,220,700
Spectrum Essentials(R) 10,353,900 9,030,400 7,776,900
Spectrum Ingredients 14,443,400 11,065,900 8,293,900
All Other 273,100 3,214,800 9,727,700
----------- ----------- -----------
Total Net Sales $45,676,500 $40,579,300 $41,019,200
=========== =========== ===========
Gross Profit:
Spectrum Naturals(R) $ 5,365,500 $ 4,385,400 $ 3,921,100
Spectrum Essentials(R) 4,659,700 4,323,900 3,779,800
Spectrum Ingredients 1,718,100 1,211,200 381,500
All Other 126,400 835,800 2,927,100
----------- ----------- -----------
Total Gross Profit $11,869,700 $10,756,300 $11,009,500
=========== =========== ===========
Included in the all other category are the disposed and discontinued product
lines associated with the OI business sold on April 25, 2002 and the OFPI
business sold on June 11, 2001.
21. Commitments and Contingencies
Lease Agreements
The Company has the right to terminate the operating lease for its production
facility at 133 Copeland Street upon six months prior written notice. The
Copeland Street lease includes a provision for base rent increases tied to
changes in the consumer price index. The Company's operating lease for its
corporate headquarters at 5341 Old Redwood Highway is a non-cancelable operating
lease that terminates on December 31, 2007. Total monthly rent payments for
these leases were $41,600 at December 31, 2003.
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Rent expense for 2003, 2002 and 2001 was $488,400, $360,800 and $391,200,
respectively.
Future minimum lease payments under the non-cancelable operating lease for the
corporate headquarters facility and the six-month notice required for the
production facility are as follows:
2004 $ 378,300
2005 281,700
2006 281,700
2007 281,700
---- ----------
Total $1,223,400
===== ==========
Royalty Agreements
The Company has entered into royalty agreements with various unrelated parties
for licensed technologies which provide for a percentage royalty to be paid on
sales of certain products. Included in accrued expenses were royalties of
$23,800 and $51,700 as of December 31, 2003 and 2002, respectively, in
connection with these agreements. Royalty expense included in cost of sales
under these agreements for the years ended December 31, 2003, 2002 and 2001 was
$134,000, $243,500 and $216,600, respectively.
Inventory Purchase Commitments
In the ordinary course of business, the Company enters into commitments to
purchase raw materials over a period of time, generally six months to a year, at
contracted prices. At December 31, 2003 and 2002 these future commitments, which
are at prices not in excess of those currently obtainable nor in quantities in
excess of normal requirements, aggregated approximately $9,820,900 and
$6,623,000, respectively.
Pending Litigation
On November 26, 2003 the Company was notified by attorneys for the Environmental
Law Foundation (the "ELF") that the Spectrum Naturals(R) Organic Balsamic
Vinegar contains lead in excess of the allowable quantities under the Safe
Drinking Water and Toxic Enforcement Act of 1986, also known as Proposition 65.
The ELF is a California non-profit organization that represents itself as
dedicated to the preservation of human health and the environment.
ELF's attorneys filed a Complaint for Civil Penalties, Statutory, Equitable and
Injunctive Relief (the "Complaint") against Cost Plus, Inc., Safeway, Inc.,
Trader Joe's Company, Williams-Sonoma, Inc., Whole Foods, Inc. and unspecified
defendants one through 100 in the Superior Court of the State of California on
May 20, 2003 alleging violation of Proposition 65 for the sale of various
products that contain lead in excess of the allowable limits without the
required warning label. ELF's attorneys later notified Spectrum and dozens of
other retailers, importers and manufacturers of vinegar that they would be
included as one of the 100 unspecified defendants in the Complaint.
While lead has been shown to cause cancer and reproductive toxicity in humans,
the Proposition 65 consumption quantity defined as no significant risk level for
cancer was set at 15 micrograms per day. Lead is a naturally occurring element
in all vinegars. Based on the Company's tests, a person would need to consume
somewhere between 1.3-2.6 cups (270-630ml) daily of the Company's various
vinegar products to reach the Proposition 65 lead level. The small lead content
in vinegar occurs naturally in the soil and is absorbed by the grapes used to
make vinegar. The level of lead in vinegar is not affected by the manufacturing
process and, therefore, is not subject to regulation under Proposition 65.
The Spectrum Naturals(R) brand was built on the premise of providing consumers
with organic healthy oils and condiments. Management does not believe the
consumption of its various vinegar products as condiments or salad dressings
poses any increased risk for cancer or reproductive toxicity.
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The Company has joined a Joint Defense Group established by attorneys
representing several of the defendants in the Complaint. The initial fee to join
was a $5,000 retainer, which the Company paid on February 17, 2004. Management
believes the Complaint will eventually be shown to be without merit.
Accordingly, no provision for loss or future attorney's fees has been recorded
at December 31, 2003.
In October 2000 the Company was notified by counsel for GFA Brands, Inc. ("GFA")
that nutritional claims pertaining to Spectrum Naturals(R) Organic Margarine
were infringing upon two patents (the "first patents") issued in the United
States that pertain to particular fat compositions suitable for human
consumption. The patent holder, Brandeis University, exclusively licensed each
of these patents to GFA. GFA demanded that the Company cease the manufacture and
sale of the margarine and threatened legal action if the Company failed to
comply.
Management engaged legal counsel that specializes in this area and received an
opinion letter in February 2001 confirming that, in the opinion of counsel, the
manufacture or sale of Spectrum Naturals(R) Organic Margarine did not infringe
upon the GFA patents, either literally or under the doctrine of equivalents.
It has always been Management's view that the formula for Spectrum Naturals
Organic Margarine(R) fell outside the claims made in the Brandeis University
patents. Despite numerous attempts, the Company was unable to convince GFA that
its formula for the margarine fell outside the claims of the first patents.
Therefore, the Company filed a complaint against GFA for declaratory judgment of
non-infringement and invalidity of the two patents on August 28, 2001 in the
U.S. District Court for Northern California. The complaint requested a
declaratory judgment that the margarine does not infringe either patent, a
declaratory judgment that both patents are invalid, that GFA be enjoined from
threatening or asserting any action for infringement of either patent, and
attorney's fees.
GFA subsequently filed a motion to transfer venue to the U.S. District Court for
New Jersey (the "court"). The Company filed an opposition to that motion;
however, the motion to transfer venue was granted in January 2002.
A settlement hearing between GFA, its counsel, the Company and its counsel took
place on July 31, 2003. There was discussion amongst the parties regarding a
potential resolution of the case without resorting to a trial. A settlement
between the parties could not be reached.
Markman briefs, in which each side presents its arguments on how the patent
claims should be construed, were submitted by both GFA and Spectrum in July
2003. In most patent infringement cases, the court's determination of how the
patent claims should be interpreted is the central issue. A Markman hearing was
held by the court on October 16, 2003. The court issued its ruling on the
Markman hearing on December 3, 2003 in favor of the Company's interpretation of
the patent claims. The favorable ruling will assist the Company in settling the
complaint with respect to the first patents.
Meanwhile, unbeknownst to the Company, Brandeis University had filed for an
additional patent (the "second patent") with the U.S. Patent Office which
included patent claims that did encompass the Company's formula for Spectrum
Naturals Organic Margarine(R). Unlike trademark law, patents are issued in the
United States without pre-publication or notice which would allow for comment or
appeal by potentially affected parties. Instead, the United States Patent Office
is the sole arbiter of the merits of any patent application. Once a patent is
issued, the onus falls on the affected party to pursue its rights via the court
system. On October 7, 2003 the U.S. Patent Office granted the second patent to
Brandeis University. On the advice of counsel, the Company ceased the production
of the margarine immediately thereafter and is currently evaluating its options
with regards to the second patent.
Management believes the Company has meritorious defenses and that a loss is not
probable on the patent infringement complaint with regard to the first patents
at this time. Accordingly, no provision for loss has been recorded at December
31, 2003.
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Safety Violations and Workers' Compensation Appeals
In connection with the industrial accident that occurred on April 25, 2002 the
Company received nine citations from CAL-OSHA for safety violations with total
proposed penalties of $137,900. The Company has filed an appeal with CAL-OSHA in
the hopes of reducing the citations and proposed penalties. Also, the estates of
the deceased employees have both filed applications to the Workers' Compensation
Appeals Board of the State of California for an increased death benefit for
serious and willful misconduct by the Company. These two applications are for a
total additional death benefit of $107,500 to be paid by the Company, should the
estates successfully establish that the Company intentionally and willfully
allowed unsafe working conditions to exist. The Company intends to defend itself
vigorously and believes it has meritorious defenses. As of December 31, 2003 the
Company had a reserve of $141,900 to cover the anticipated settlement of these
issues plus attorney's fees.
Court Supervised Probation
Also in connection with the industrial accident on April 25, 2002 the Company
entered a plea of no contest to two misdemeanor counts of violations under
California Labor Code Section 6425, violation of a regulation issued by the
California Occupational Health and Safety Administration, requiring employers to
provide, maintain and ensure employees use required confined space equipment.
Under the Terms of Settlement and Probation entered into with the plea, the
Company received a suspended fine of $250,000 conditioned upon the Company's
compliance with the terms of court supervised probation for three years. The
probation terms require that the Company submit to a warrant-less search of its
premises during business hours by any local or state law enforcement, safety or
health officer; and that the Company shall be of good conduct and obey all laws,
particularly those laws relating to worker safety and health. Should the Company
fail to honor the probation terms, the suspended fine of $250,000 may be
reimposed by the Sonoma County District Attorney.
22. Related Party Transactions
The Company has one member of its Board of Directors who also serves as Vice
Chair and Lead Independent Director of the Board of United Natural Foods, Inc.
UNFI is the Company's largest single customer, representing 36% of total net
sales in 2003.
On July 29, 2003 the Compensation Committee of the Company's Board of Directors
unanimously approved forgiving the $20,000 shareholder advance that had been
outstanding for several years to the Company's Chairman of the Board. The
advance was imputed as income to him for 2003 and grossed-up to include the
income tax impact. Accordingly, the Company incurred $34,800 of compensation
expense, which was included in general and administrative expenses, to forgive
the shareholder advance.
In connection with the sale of the Organic Ingredients product lines, the
Company entered into a private label consulting agreement with Running Stream
Food and Beverage, Inc. ("RSFB"). RSFB is owned and operated by a non-executive
Director of the Company. During 2003 and 2002 the Company paid fees of $99,000
and $66,000, respectively, plus expenses incurred to RSFB for private label
consulting and management services.
The Company paid consulting fees of $15,000 and $70,000 during the years ended
December 31, 2002 and 2001, respectively, for management advisory services
rendered by Moore Consulting, a firm owned and operated by a non-executive
Director of the Company. In addition, the Company paid Moore Consulting
investment banking fees of $79,000 in 2002 in connection with the sale of the OI
product lines and $78,200 in 2001 in connection with the sale of the OFPI
product lines as described in Note 6.
The Company paid interest at 10% per annum under notes payable to several major
stockholders, one of whom is also a non-executive Director of the Company, of
$18,700, $27,900 and $38,300 for the years ended December 31, 2003, 2002 and
2001, respectively.
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Page 59
In February 2001 the Company sold 160,000 restricted shares under Regulation D
of the Securities Act of 1933 to a non-executive Director of the Company for
$0.3125 per share, the closing price of the Company's common stock as quoted on
the OTC Bulletin Board system on the day the transaction was approved by the
Company's disinterested members of the Board of Directors. The Company applied
the proceeds of $50,000 toward the expansion of its proprietary SpectraVac
technology. In addition, the Company issued common stock purchase warrants to
the non-executive Director for an additional 160,000 shares at an exercise price
of $0.3125 per share, which expire in February 2006.
23. Quarterly Information (Unaudited)
The summarized quarterly financial data presented below reflects all adjustments
which, in the opinion of Management, are of a normal and recurring nature and
necessary to present fairly the results of operations for the periods presented.
In thousands, First Second Third Fourth Full
except per share data Quarter Quarter Quarter Quarter Year
- ----------------------------- --------- --------- --------- --------- ---------
Year ended December 31, 2003:
Net Sales $ 10,309 $ 11,381 $ 12,169 $ 11,818 $ 45,677
Gross Profit 3,073 2,966 3,100 2,731 11,870
Operating Income (Loss) 743 416 506 (139) 1,526
Net Income 636 316 325 1,387 2,664
Basic and Fully Diluted
Income per Share $ 0.01 $ 0.01 $ 0.01 $ 0.03 $ 0.06
Year ended December 31, 2002:
Net Sales $ 11,279 $ 10,078 $ 9,718 $ 9,504 $ 40,579
Gross Profit 2,945 2,325 2,746 2,740 10,756
Operating Income 512 54 671 539 1,776
Net Income (Loss) 331 (51) 575 265 1,120
Basic and Fully Diluted Income (Loss)
per Share $ 0.01 $ (0.00) $ 0.01 $ 0.00 $ 0.02
Year ended December 31, 2001:
Net Sales $ 10,130 $ 10,545 $ 10,510 $ 9,834 $ 41,019
Gross Profit 2,668 3,044 2,772 2,526 11,010
Operating Income (Loss) 95 (4,477) 374 (243) (4,251)
Net Income (Loss) (168) (4,726) 196 (508) (5,206)
Basic and Fully Diluted Income (Loss)
per Share $ 0.00 $ (0.10) $ 0.00 $ (0.02) $ (0.12)
- ------------------------------------------------------------------------------------------------------------
Page 60
Schedule II
Spectrum Organic Products, Inc.
Valuation and Qualifying Accounts
For the Years ended December 31, 2001, 2002 and 2003
Reserve for Allowances Reserve for
Obsolete Against Industrial
Inventories Receivables Accident
--------- --------- ---------
Balances, January 1, 2001 $ 565,500 $ 569,000 $ --
Additions charged to profit and loss 300,500 68,300 --
Deductions for amounts written-off against reserves (516,000) (162,300) --
--------- --------- ---------
Balances, December 31, 2001 350,000 475,000 --
Additions charged to profit and loss 262,200 47,000 254,100
Deductions for amounts written-off against reserves (64,200) (106,000) (100,400)
--------- --------- ---------
Balances, December 31, 2002 548,000 416,000 153,700
Additions charged to profit and loss 210,800 103,400 410,200
Deductions for amounts written-off against reserves (510,300) (69,400) (47,000)
--------- --------- ---------
Balances, December 31, 2003 $ 248,500 $ 450,000 $ 516,900
========= ========= =========
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH INDEPENDENT AUDITORS ON ACCOUNTING
- ----------------------------------------------------------------------------
AND FINANCIAL DISCLOSURE
- ------------------------
BDO Seidman, LLP was previously the Company's independent public accountants. On
April 15, 2003 the Board of Directors unanimously accepted the recommendation of
the Audit Committee and appointed Grant Thornton, LLP as its independent public
accountants for 2003 from a group of three finalist audit firms which included
BDO Seidman, LLP. BDO Seidman's reports on the Company's financial statements
for each of the three fiscal years ended December 31, 2000, 2001 and 2002 did
not contain an adverse opinion or disclaimer of opinion, nor were they qualified
or modified as to uncertainty, audit scope or accounting principles. During the
fiscal years ended December 31, 2000, 2001 and 2002 and the subsequent interim
period through April 15, 2003 there were (1) no disagreements with BDO Seidman
on any matter of accounting principles or practices, financial statement
disclosures, or auditing scope or procedure which, if not resolved to BDO
Seidman's satisfaction, would have caused BDO Seidman to make reference to the
matter in connection with its report on the Company's financial statements for
such years; and (2) no reportable events as defined in Item 304(a)(1)(v) of
Regulation S-K promulgated under the Securities Exchange Act of 1934.
The Company requested that BDO Seidman furnish a letter addressed to the
Securities and Exchange Commission stating whether or not BDO Seidman agreed
with the above statements. The Company filed a copy of such letter, in which BDO
Seidman stated their agreement, as an exhibit to a Current Report on Form 8-K
filed with the Securities and Exchange Commission on April 21, 2003.
During the three fiscal years of the Company ended December 31, 2002, 2001 and
2000, the Company did not consult with Grant Thornton regarding any matter
whatsoever.
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ITEM 9A. CONTROLS AND PROCEDURES
- ---------------------------------
The Company's Chief Executive Officer and Chief Financial Officer have evaluated
the effectiveness of both the design and the operation of its disclosure
controls and procedures and have found them to be adequate. The Company has
formed a Disclosure Review Committee (the "DRC") which consists of various
senior managers from each functional area of the Company. The DRC considers the
materiality of new information and reports to the Company's Chief Financial
Officer.
There were no material changes in the Company's internal control system during
the year ended December 31, 2003. Management is not aware of any significant
deficiencies in the design or operation of internal controls.
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PART III
ITEMS 10, 11, 12, 13 AND 14
- ---------------------------
Incorporated by reference to the Registrant's definitive proxy statement to be
filed with the Securities and Exchange Commission pursuant to Regulation 14A
with respect to the Registrant's 2004 annual meeting of shareholders.
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PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
- ------------------------------------------------------------------------
(a) Documents filed as part of this Report:
(1) Index to Financial Statements: Page
Statement of Management Responsibility 31
Reports of Independent Certified Public Accountants 32-33
Balance Sheets as of December 31, 2003 and 2002 34
Statements of Operations for the years ended
December 31, 2003, 2002 and 2001 35
Statement of Stockholders' Equity for the years ended
December 31, 2003, 2002 and 2001 36
Statements of Cash Flows for the years ended
December 31, 2003, 2002 and 2001 37
Summary of Significant Accounting Policies 38-43
Notes to Financial Statements 44-60
(2) Index to Financial Statement Schedules:
Schedule II - Valuation and Qualifying Accounts 61
(3) Exhibits:
Exhibit
No. Description
------- -----------
1.01 Form of Representatives' Warrant (1)
1.02 Form of Amended Representatives' Warrant (1)
2.03 Asset Purchase Agreement dated June 11, 2001 by
and between Spectrum Organic Products, Inc. and
Acirca, Inc. (7)
2.04 Escrow and Security Agreement dated June 11, 2001
by and among Spectrum Organic Products, Inc.,
Acirca, Inc. and Webster Trust Company, NA. (7)
2.05 Transition Services Agreement dated June 11, 2001
by and between Spectrum Organic Products, Inc. and
Acirca, Inc. (7)
2.06 License Agreement dated June 11, 2001 by and
between Spectrum Organic Products, Inc. and
Acirca, Inc. (7)
2.07 Noncompetition Agreement dated June 11, 2001 by
and among Spectrum Organic Products, Inc., Acirca,
Inc., Jethren Phillips, and John Battendieri. (7)
2.08 Assignment and Assumption Agreement dated June 11,
2001 by and between Spectrum Organic Products,
Inc. and Acirca, Inc. (7)
2.10 Asset Purchase Agreement dated April 25, 2002 by
and among Spectrum Organic Products, Inc., Organic
Ingredients, Inc. and Acirca, Inc. (9)
2.11 Escrow and Security Agreement dated April 25, 2002
by and among Spectrum Organic Products, Inc.,
Organic Ingredients, Inc. and Webster Trust
Company, NA. (9)
2.12 Transition Services Agreement dated April 25, 2002
by and between Spectrum Organic Products, Inc. and
Acirca, Inc. (9)
2.13 Non-competition Agreement dated April 25, 2002 by
and among Spectrum Organic Products, Inc., Organic
Ingredients, Inc., Jethren Phillips, and Neil
Blomquist. (9)
2.14 Sales Representative Services Agreement dated
April 25, 2002 by and between Spectrum Organic
Products, Inc. and Organic Ingredients, Inc. (9)
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2.15 Assignment and Assumption Agreement dated April
25, 2002 by and between Spectrum Organic Products,
Inc. and Organic Ingredients, Inc. (9)
3.01 Amended and Restated Articles of Incorporation of
Spectrum Organic Products, Inc. (4)
3.03 Audit Committee Charter of the Registrant (2)
3.04 Amended Bylaws of Spectrum Organic Products, Inc.
3.05 Nominating and Governance Committee Charter of the
Registrant
10.09 Form of Subscription Agreement, Promissory Note
and Warrant for Bridge Loan (1)
10.13 Agreement and Plan of Merger and Reorganization
dated May 14, 1999 by and between Organic Food
Products, Inc. and Organic Ingredients, Inc. (4)
10.14 Agreement and Plan of Merger and Reorganization
dated May 14, 1999 by and between Organic Food
Products, Inc. and Spectrum Naturals, Inc. (4)
10.15 Form of Organic Food Products, Inc. Employment
Agreement which continues to serve as the
Employment Agreement between Spectrum Organic
Products, Inc. and Jethren P. Phillips. (4)
10.16 Form of Organic Food Products, Inc. Shareholder
Lock-up Agreement (4)
10.17 Form of Voting Agreement dated May 14, 1999
between Spectrum Naturals, Inc. and certain
shareholders of Organic Food Products, Inc. (4)
10.18 October 6, 1999 Credit and Security Agreement by
and between Organic Food Products, Inc., Organic
Ingredients, Inc., Spectrum Naturals, Inc. and
Spectrum Commodities, Inc. and Wells Fargo
Business Credit, Inc. (5)
10.19 September 23, 1999 Private Placement Memorandum by
Organic Food Products, Inc. (5)
10.22 Fifth Amendment to Redemption Agreement dated
October 6, 1999 by and between Spectrum Naturals,
Inc., Organic Food Products, Inc., Jethren
Phillips and Debora Bainbridge Phillips. (6)
10.23 Fourth Amendment to Redemption Agreement dated
July 12, 1999 by and between Spectrum Naturals,
Inc., Jethren Phillips and Debora Bainbridge
Phillips. (6)
10.24 Third Amendment to Redemption Agreement dated July
9, 1999 by and between Spectrum Naturals, Inc.,
Jethren Phillips and Debora Bainbridge Phillips.
(6)
10.25 Second Amendment to Redemption Agreement dated
July 2, 1999 by and between Spectrum Naturals,
Inc., Jethren Phillips and Debora Bainbridge
Phillips. (6)
10.26 First Amendment to Redemption Agreement dated
September 11, 1998 by and between Spectrum
Naturals, Inc., and Debora Bainbridge Phillips.
(6)
10.27 Redemption Agreement dated November 1, 1996 by and
between Spectrum Naturals, Inc. and Debora
Bainbridge Phillips. (6)
10.28 Guaranty Agreement dated June 6, 1997 by and
between Spectrum Naturals, Inc., Debora Bainbridge
Phillips and Jethren Phillips. (6)
10.29 Pledge Agreement dated June 6, 1997 by and between
Spectrum Naturals, Inc., Debora Bainbridge
Phillips and Richard W. Abbey, Attorney at Law.
(6)
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10.30 Promissory Note dated June 6, 1997 by and between
Spectrum Naturals, Inc. and Debora Bainbridge
Phillips. (6)
10.34 Letter dated February 16, 2001 from Spectrum
Organic Products, Inc. to the note holders under
the private placement completed on October 6,
1999, offering them the option of converting their
notes, which were in default, to equity or a new
note with a three year payment schedule with
interest at 10% and common stock purchase
warrants. (6)
10.35 First Amendment to Credit and Security Agreement
dated October 18, 2001 by and between Spectrum
Organic Products, Inc. and Wells Fargo Business
Credit, Inc. (8)
10.37 Sixth Amendment to Amended and Restated Redemption
Agreement dated June 13, 2001 by and between
Spectrum Organic Products, Inc., Debora Bainbridge
Phillips and Jethren P. Phillips. (2)
10.38 Employment Agreement effective as of October 1,
2002 by and between Spectrum Organic Products,
Inc. and Neil G. Blomquist. (3)
10.39 Second Amendment to Credit and Security Agreement
dated October 30, 2002 by and between Spectrum
Organic Products, Inc. and Wells Fargo Business
Credit, Inc. (3)
10.40 Seventh Amendment to Amended and Restated
Redemption Agreement and Amended and Restated
Promissory Note effective November 1, 2002 by and
between Spectrum Organic Products, Inc., Debora
Bainbridge Phillips and Jethren P. Phillips. (3)
10.41 Sublease Agreement dated October 23, 2002 by and
between Spectrum Organic Products, Inc. and
Alcatel USA Sourcing, L.P. (3)
10.42 Consent to Sublease Agreement dated November 13,
2002 by and between Spectrum Organic Products,
Inc., Alcatel USA Sourcing, L.P. and Redwood
Business Park IV, LLC. (3)
10.43 Agreement for Purchase and Sale of Intellectual
Property dated April 15, 2003 by and between
Spectrum Organic Products, Inc. Tenere Life
Sciences, Inc. and Rees Moerman. (11)
10.44 Loan and Security Agreement dated June 12, 2003
effective as of July 11, 2003 by and between
Spectrum Organic Products, Inc. and Comerica Bank.
(12)
10.45 LIBOR Addendum to Loan and Security Agreement
dated June 12, 2003 effective as of July 11, 2003
by and between Spectrum Organic Products, Inc. and
Comerica Bank. (12)
10.46 Variable Rate-Installment Note dated June 12, 2003
effective as of July 11, 2003 by and between
Spectrum Organic Products, Inc. and Comerica Bank.
(12)
10.47 Variable Rate-Single Payment Note dated June 12,
2003 effective as of July 11, 2003 by and between
Spectrum Organic Products, Inc. and Comerica Bank.
(12)
10.48 Subordination Agreement dated June 12, 2003
effective as of July 11, 2003 by and between
Debora Bainbridge Phillips Trust, Spectrum Organic
Products, Inc. and Comerica Bank. (12)
10.49 Subordination Agreement dated June 12, 2003
effective as of July 11, 2003 by and between
Steven Reedy, Spectrum Organic Products, Inc. and
Comerica Bank. (12)
10.50 Amended 1995 Stock Option Plan of the Registrant
(13)
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Page 66
10.51 Form of Incentive Stock Agreement used in
connection with the Amended 1995 Stock Option Plan
(13)
10.52 Form of Non-qualified Stock Option Agreement used
in connection with the Amended 1995 Stock Option
plan (13)
10.53 First Amendment to Sublease Agreement dated
November 15, 2003 by and between Spectrum Organic
Products, Inc. and Alcatel USA Sourcing, L.P.
10.54 Spectrum Organic Products, Inc. "Standards of
Business Ethics" as adopted in 2003.
23.02 Consent of Independent Certified Public
Accountants dated March 24, 2003 by BDO Seidman,
LLP, San Francisco, CA. (3)
23.03 Consent of Independent Certified Public
Accountants dated March 24, 2004 by Grant
Thornton, LLP, San Francisco, CA.
23.04 Consent of Independent Certified Public
Accountants dated March 24, 2004 by BDO Seidman,
LLP, San Francisco, CA.
31.03 Certification of Chief Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
31.04 Certification of Chief Financial Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
32.03 Certification of Chief Executive Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
32.04 Certification of Chief Financial Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
99.01 Joint press release of Acirca, Inc. and Spectrum
Organic Products, Inc. dated June 12, 2001 titled
"Acirca Acquires Millina's Finest Sauces". (7)
99.02 Press release of the Company dated May 1, 2002
titled "Spectrum Organic Products Reports Sale of
Organic Ingredients". (9)
99.05 Press release of the Company dated August 29, 2002
titled "Spectrum Organic Products, Inc. appoints
new CEO". (10)
99.06 Press release of the Company dated February 4,
2004 titled "Spectrum Organic Products, Inc.
Announces Settlement with Sonoma County District
Attorney". (14)
99.07 Press release of the Company dated March 1, 2004
titled "Spectrum Organic Products Reports Record
Sales and Profits for 2003". (15)
(1) Incorporated by reference to the Registrant's Registration
Statement on Form SB-2, File No. 333-22997, declared
effective on August 11, 1997.
(2) Incorporated by reference to exhibits filed with the
Registrant's Form 10-K on March 20, 2002.
(3) Incorporated by reference to exhibits filed with the
Registrant's Form 10-K on March 17, 2003.
(4) Incorporated by reference to annexes filed with the
Registrant's Joint Proxy Registration Statement on Form S-4,
File No. 333-83675, declared effective July 30, 1999.
(5) Incorporated by reference to exhibits filed with the
Registrant's Form 10-KSB on October 13, 1999.
(6) Incorporated by reference to exhibits filed with the
Registrant's Form 10-KSB on April 2, 2001.
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Page 67
(7) Incorporated by reference to exhibits filed with the
Registrant's Form 8-K on June 26, 2001.
(8) Incorporated by reference to exhibits filed with the
Registrant's Form 10-Q on November 6, 2001.
(9) Incorporated by reference to exhibits filed with the
Registrant's Form 8-K on May 9, 2002.
(10) Incorporated by reference to exhibits filed with the
Registrant's Form 8-K on September 6, 2002.
(11) Incorporated by reference to exhibits filed with the
Registrant's Form 10-Q on May 14, 2003.
(12) Incorporated by reference to exhibits filed with the
Registrant's Form 10-Q on November 6, 2003.
(13) Incorporated by reference to exhibits filed with the
Registrant's Registration Statement on Form S-8 on October
1, 2003.
(14) Incorporated by reference to exhibits filed with the
Registrant's Form 8-K on February 5, 2004.
(15) Incorporated by reference to exhibits filed with the
Registrant's Form 8-K on March 2, 2004.
(b) Reports on Form 8-K during the quarter ended December 31, 2003:
None.
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Page 68
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized, in Petaluma, California on
March 22, 2004.
Spectrum Organic Products, Inc.
By: /s/ Robert B. Fowles
--------------------------------
Robert B. Fowles
Chief Financial Officer
and Secretary
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Signature Title Date
--------- ----- -------
/s/ Jethren P. Phillips Chairman of the Board of Directors 3/22/04
- -----------------------------
JETHREN P. PHILLIPS
/s/ Neil G. Blomquist President and Chief Executive 3/22/04
- ----------------------------- Officer, Director
NEIL G. BLOMQUIST
/s/ Robert B. Fowles Chief Financial Officer and 3/22/04
- ----------------------------- Secretary
ROBERT B. FOWLES
/s/ Larry D. Lawton Controller (Principal Accounting 3/22/04
- ----------------------------- Officer)
LARRY D. LAWTON
/s/ John R. Battendieri Director 3/22/04
- -----------------------------
JOHN R. BATTENDIERI
/s/ Phillip L. Moore Director 3/22/04
- -----------------------------
PHILLIP L. MOORE
/s/ Charles A. Lynch Director 3/22/04
- -----------------------------
CHARLES A. LYNCH
/s/ Thomas B. Simone Director 3/22/04
- -----------------------------
THOMAS B. SIMONE
/s/ Conrad W. Hewitt Director 3/22/04
- -----------------------------
CONRAD W. HEWITT
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