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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003.
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 FOR THE TRANSITION PERIOD FROM ______________ TO ________________
Commission File No. 333-22997
SPECTRUM ORGANIC PRODUCTS, INC.
----------------------------------------------------
(Exact name of registrant as specified in its charter)
California 94-3076294
---------------------- --------------------
(State of incorporation) (I.R.S. Employer
Identification Number)
5341 Old Redwood Highway, Suite 400
Petaluma, California 94954 (707)778-8900
-------------------------------------- -------------------------
(Address of principal executive offices) (Issuer's telephone number)
Check whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEEDING FIVE YEARS:
Check whether the registrant filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan conformed by court. Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: Common Stock, no par value,
45,705,571 shares as of May 9, 2003.
Transitional Small Business Disclosure Format: Yes[ ] No [X]
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
- -----------------------------
SPECTRUM ORGANIC PRODUCTS, INC.
BALANCE SHEETS
ASSETS
(Unaudited)
March 31, December 31,
2003 2002
------------ ------------
Current Assets:
Cash $ 1,000 $ 1,000
Accounts receivable, net 3,665,400 3,075,200
Inventories, net 7,235,000 5,269,600
Prepaid expenses and other current assets 176,500 79,600
------------ ------------
Total Current Assets 11,077,900 8,425,400
Property and Equipment, net 3,702,500 3,447,400
Other assets, net 301,700 313,900
------------ ------------
Total Assets $ 15,082,100 $ 12,186,700
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Bank overdraft $ 760,200 $ 589,300
Line of credit 3,840,000 2,479,800
Accounts payable 4,290,400 3,330,000
Accrued expenses 730,100 722,500
Income taxes payable 37,800 176,000
Current maturities of notes payable and capitalized lease
obligations 257,600 256,000
Current maturities of notes payable, former stockholder 187,500 187,500
Current maturities of notes payable, stockholders 89,900 87,600
------------ ------------
Total Current Liabilities 10,193,500 7,828,700
Notes payable and capitalized lease obligations, less
current maturities 214,100 278,900
Notes payable, former stockholder, less current maturities 634,700 676,800
Notes payable, stockholders, less current maturities 105,000 128,400
Deferred rent 25,300 --
------------ ------------
Total Liabilities 11,172,600 8,912,800
------------ ------------
Stockholders' Equity:
Preferred stock, 5,000,000 shares authorized, no shares
issued or outstanding -- --
Common stock, no par value, 60,000,000 shares authorized,
45,705,571 issued and outstanding at March 31, 2003
and December 31, 2002 9,430,100 9,430,100
Accumulated deficit (5,520,600) (6,156,200)
------------ ------------
Total Stockholders' Equity 3,909,500 3,273,900
------------ ------------
Total Liabilities and Stockholders' Equity $ 15,082,100 $ 12,186,700
============ ============
The accompanying notes are an integral part
of the financial statements.
2
SPECTRUM ORGANIC PRODUCTS, INC.
STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended
March 31, March 31,
2003 2002
------------ ------------
Net Sales $ 10,308,600 $ 11,279,400
Cost of Goods Sold 7,235,800 8,334,500
------------ ------------
Gross Profit 3,072,800 2,944,900
------------ ------------
Operating Expenses:
Sales and Marketing 1,432,600 1,610,500
General and Administrative 897,600 822,500
------------ ------------
Total Operating Expenses 2,330,200 2,433,000
------------ ------------
Income from Operations 742,600 511,900
------------ ------------
Other Income (Expense):
Interest Expense (70,400) (167,300)
Other, net 1,200 (13,300)
------------ ------------
Total Other Expenses (69,200) (180,600)
------------ ------------
Income Before Taxes 673,400 331,300
Provision for Income Taxes (37,800) --
------------ ------------
Net Income $ 635,600 $ 331,300
============ ============
Basic and Fully Diluted Income Per Share $ 0.01 $ 0.01
============ ============
Basic Weighted Average Shares Outstanding 45,705,571 45,698,661
============ ============
Fully Diluted Weighted Average Shares Outstanding 46,108,429 46,120,930
============ ============
The accompanying notes are an integral part
of the financial statements.
3
SPECTRUM ORGANIC PRODUCTS, INC.
STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
March 31, March 31,
2003 2002
------------ ------------
Cash Flows from Operating Activities:
Net Income $ 635,600 $ 331,300
Adjustments to Reconcile Net Income to Net
Cash Used in Operating Activities:
Provision for uncollectible receivables 21,300 164,400
Provision for inventory obsolescence 74,700 (29,500)
Depreciation and amortization 103,700 105,000
Imputed interest on note payable, former stockholder 4,700 5,500
Imputed interest on common stock purchase warrants -- 13,800
Changes in Assets and Liabilities:
Accounts receivable (611,500) (1,171,100)
Inventories (2,083,100) (49,100)
Prepaid expenses and other current assets (96,900) (105,300)
Other assets 10,900 --
Accounts payable 1,003,400 373,100
Income taxes payable 138,200 --
Accrued expenses and other liabilities 33,000 155,000
------------ ------------
Net Cash Used in Operating Activities (1,042,400) (218,700)
------------ ------------
Cash Flows from Investing Activities:
Purchase of property and equipment (357,600) (103,600)
------------ ------------
Net Cash Used in Investing Activities (357,600) (103,600)
------------ ------------
Cash Flows From Financing Activities:
Increase in bank overdraft 170,900 549,000
Proceeds from line of credit 11,039,300 10,050,400
Repayment of line of credit (9,679,100) (10,142,300)
Repayment of notes payable, former stockholder (46,900) (46,900)
Repayment of notes payable, stockholders (21,100) (31,300)
Repayment of bank term notes payable (51,600) (51,600)
Repayment of capitalized lease obligations (11,500) (16,800)
------------ ------------
Net Cash Provided by Financing Activities 1,400,000 310,500
------------ ------------
Net Increase in Cash -- --
Cash, beginning of the year 1,000 1,200
------------ ------------
Cash, end of the period $ 1,000 $ 1,200
============ ============
Supplemental Disclosure of Cash Flow Information:
Cash paid for income taxes $ 176,000 $ --
Cash paid for interest $ 69,800 $ 158,100
The accompanying notes are an integral part
of the financial statements.
4
SPECTRUM ORGANIC PRODUCTS, INC.
NOTES TO FINANCIAL STATEMENTS
1. Basis of Presentation:
These are unaudited interim financial statements and include all
adjustments (consisting of normal recurring accruals) which, in the opinion
of Management, are necessary in order to make the financial statements not
misleading. These financial statements have been prepared in accordance
with the instructions to Form 10-Q and do not include certain disclosures
required by accounting principles generally accepted in the United States
of America. Accordingly, the statements should be read in conjunction with
Spectrum Organic Products, Inc. financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2002. Operating results for the three-month period ended March
31, 2003 are not necessarily indicative of the results that may be expected
for the entire year ending December 31, 2003 or future periods.
Certain reclassifications have been made to the prior year unaudited
interim financial statements to be consistent with the presentation at
March 31, 2003. These reclassifications had no impact on net income or
retained earnings.
2. Inventories:
Inventories consisted of the following:
March 31, December 31,
2003 2002
---------- ----------
Finished goods $6,021,500 $4,409,500
Raw materials 914,400 1,350,500
Deposits on inventory 619,300 57,600
---------- ----------
Total Inventories 7,555,200 5,817,600
Less: Reserve for obsolete inventory (320,200) (548,000)
---------- ----------
Net Inventories $7,235,000 $5,269,600
========== ==========
Deposits on inventory primarily represents flaxseed paid for prior to its
receipt at the Company's production facility.
3. Commitments and Contingencies:
Pending Litigation
------------------
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 issued in the United States that
pertain to particular fat compositions suitable for human ingestion. The
patent holder exclusively licensed each of these patents to GFA. Management
believes that the margarine does not infringe upon either patent, and
further, that the patents are unenforceable. Management engaged legal
counsel that specializes in this area and received an opinion letter in
5
February 2001 confirming that, in the opinion of counsel, the manufacture
or sale of Spectrum Naturals(R) Organic Margarine does not infringe upon
the GFA patents, either literally or under the doctrine of equivalents.
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 requests 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 its opposition to
that motion, however, the motion to transfer venue was granted in January
2002. The case is currently in the discovery phase. Markman briefs, in
which each side presents its arguments on how the patent claims should be
construed, are due from both GFA and Spectrum in July. In most patent
infringement cases, the court's determination of how the patent claims
should be interpreted is the central issue. A settlement hearing has been
tentatively scheduled by the court for July 21, 2003.
Management believes the Company has meritorious defenses and that a loss is
not probable on the patent infringement complaint at this time.
Accordingly, no provision for loss has been recorded at March 31, 2003.
Safety Violations and Workers' Compensation Appeals
---------------------------------------------------
On April 25, 2002 a tragic industrial accident occurred at the Company's
manufacturing facility located in Petaluma, California in which two
employees died from asphyxiation during regular routine maintenance of
empty oil tanks. An investigation has been completed by the State of
California Division of Occupational Safety and Health ("CAL-OSHA") and the
Petaluma Police Department. On October 18, 2002 Management met with
CAL-OSHA and received their report and notice of proposed penalties. 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.
In addition, 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 an additional
death benefit of $62,500 each, to be paid by the Company, should the
estates successfully establish that the Company intentionally and willfully
allowed unsafe working conditions to exist. The report from CAL-OSHA did
not include any willful citations against the Company, therefore, the
Company intends to defend itself vigorously and believes it has meritorious
defenses. As of March 31, 2003 the Company had an industrial accident
reserve of $145,500 to cover the anticipated settlement of these issues
plus attorney's fees.
4. Subsequent Event:
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
6
techniques for the benign extraction of oil from oil-bearing 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 which 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 outright for $550,000 to be paid in two equal installments on
April 30, 2003 and October 30, 2003. In exchange the Company will no longer
be obligated to pay royalties to Tenere effective April 1, 2003. Final
royalties paid to Tenere for the three months ended March 31, 2003 were
$50,700. Royalties paid during the years ended December 31, 2002 and 2001
were $162,500 and $152,000, respectively.
5. Stock-based Compensation:
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"), established a fair value method of
accounting for stock-based compensation plans and for transactions in which
an entity acquires goods or services from non-employees in exchange for
equity instruments. 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". 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.
Compensation expense arising from options granted to non-employees is
recorded over the service period at the estimated fair value of the options
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, there is no related compensation expense recorded in the
Company's financial statements. Had compensation expense 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 and net
income per share for the three months ended March 31, 2003 and 2002 would
have been adjusted to the pro-forma amounts presented below:
Three months ended March 31, 2003 2002
--------------------------------------------------------------------------
Net income as reported $635,600 $331,300
Less: Total compensation expense under
fair value method for all stock-based
awards, net of related tax effects
(68,000) (50,000)
-------- --------
Pro-forma net income $567,600 $281,300
======== ========
Basic and diluted income per share:
As reported $ 0.01 $ 0.01
Pro-forma $ 0.01 $ 0.01
7
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 214%.
ITEM 2. 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.
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 such forward-looking statements.
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 and availability 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 the common stock.
Introduction:
Spectrum Organic Products, Inc. ("SPOP" or the "Company") competes
primarily in three product categories: 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
8
Spread(R). All of the Company's culinary products feature healthy fats,
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 oils, 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 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. On April 25, 2002 the Company sold
the OI industrial ingredient business in fruits, vegetables, concentrates
and purees to Acirca. Accordingly, results for the three months ended March
31, 2002 include the operating results associated with the OI disposed
product lines.
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:
9
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
$437,300 at March 31, 2003 on gross trade accounts receivable of
$4,046,600. 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 $320,200 at March 31,
2003 on total gross inventories of $7,598,200. 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, 2002 the
Company had deferred tax assets of $1,997,900 primarily resulting from net
operating loss carryforwards ("NOLS"). At December 31, 2002 the NOLS
consisted of $5,200,000 of Federal NOLS that expire at various times
through 2021, and $2,800,000 of state NOLS that expire at various times
through 2012. 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 is unable to determine whether it is more
likely than not that the net deferred tax assets will be realized.
Accordingly, Management maintains a 100% valuation allowance against the
net deferred tax assets for all periods presented in the financial
statements. This valuation allowance is highly uncertain because its value
depends upon the future taxable income of the Company. It will continue to
be evaluated during 2003 in light of the Company's operating results to
determine whether it should be fully or partially reversed at some future
point.
Industrial Accident Reserve - During the second quarter of 2002, the
Company established a reserve of $200,000 to cover anticipated future
expenses associated with an industrial accident that occurred on April 25,
2002 (see Note 3). The reserve was established to cover anticipated
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. As of March 31, 2003 there was $145,500 remaining in the
industrial accident reserve. This reserve is highly 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 $125,000 in total or nothing.
The Company does not anticipate that the Workers' Compensation Appeals will
be litigated, based upon the advice of its attorneys. Furthermore, the
reserve does not cover potential criminal penalties against the Company
which the Sonoma County District Attorney's office can levy for up to three
years following the accident. There have been no criminal actions filed
against the Company as of the date of this report, however, the possibility
does exist and Management is unable to reasonably estimate the potential
financial impact of a criminal filing as of the date of this report.
10
---------------------------------------------------------------------------
Results of Operations for the Three Month Periods Ending March 31, 2003 and
March 31, 2002
---------------------------------------------------------------------------
Summary of Results:
Management believes that Earnings Before Interest, Taxes, Depreciation and
Amortization ("EBITDA") is an important measure of the Company's operating
performance. For the three months ended March 31, 2003 EBITDA was $846,300
compared to $616,900 for the prior year, an increase of $229,400 or 37%.
The improved performance in 2003 is discussed below and was primarily
attributable to increased gross profit and lower sales and marketing
expense, partially offset by increased general and administrative expenses.
While Management believes that EBITDA 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 may be different from the calculation used by other companies,
thereby limiting comparability.
The Company's calculations to arrive at EBITDA are detailed in the
following table:
Three Months Ended March 31,
-------------------------
2003 2002
-------- --------
Income from Operations $742,600 $511,900
Add back depreciation and amortization 103,700 105,000
-------- --------
EBITDA $846,300 $616,900
======== ========
Revenues:
SPOP's net sales for the three months ended March 31, 2003 were $10,308,600
compared to $11,279,400 for 2002, a decrease of $970,800 or 9%. The
decrease in 2003 was entirely due to the lost sales associated with the OI
product lines which were sold in April 2002. Comparable net sales (after
the elimination of disposed or discontinued product lines from both
periods) increased by 14% as detailed in the following table:
Three Months Ended March 31,
----------------------------
2003 2002 % Change
---- ---- --------
Spectrum Naturals(R)Culinary Products $ 4,598,100 $ 3,796,000 +21%
Spectrum Essentials(R)Nutritional Supplements 2,446,300 2,450,000 0%
Spectrum Ingredients/Private Label Products 3,212,000 2,775,100 +16%
----------- ----------- -----
Comparable Net Sales 10,256,400 9,021,100 +14%
Disposed/Discontinued Product Lines 52,200 2,258,300 -98%
----------- ----------- -----
Total Net Sales $10,308,600 $11,279,400 -9%
=========== =========== =====
11
Within the Spectrum Naturals(R) culinary products, sales were significantly
higher than prior year in packaged oils (+20%), salad dressings and dips
(+26%) and packaged mayonnaise (+16%). The Company introduced eight new
flavors of dressings and dips in new packaging during the fourth quarter of
2002. The Company's culinary oils continued to benefit from increased
consumer awareness of the importance of healthy fats in one's diet.
Spectrum Essentials(R) nutritional supplement sales were flat versus the
prior year, as a result of lower promotional activity as the Company
rebuilt its safety stocks. During the fourth quarter of 2002, the Company
was unable to meet its demand for flax oil due to a shortage of flaxseed.
The Company arranged new sources of flaxseed supply during the first
quarter of 2003 and was able to meet demand for its flax oil products. The
cost of the flaxseed was sharply higher than the prior year, however.
The Spectrum Ingredients sales were up 16% versus the prior year on the
strength of increased customer demand for trans fat free oils. During the
first quarter there was additional media coverage of commitments by several
Fortune 500 companies to eliminate hydrogenated fats from their products.
Cost of Goods Sold:
The Company's cost of goods sold decreased sharply as a percent of net
sales for the three-month period ended March 31, 2003 to 70.2% compared to
73.9% for the same period in 2002. The decrease was due primarily to the
disposed OI industrial ingredient product lines in April 2002 which
featured lower margins than the Company's branded product lines, which more
than offset increased costs in the Company's flax oil product lines as a
result of the higher cost of flaxseed.
Gross Profit:
Gross profit for 2003 was $3,072,800 versus $2,944,900 for 2002, an
increase of $127,900 or 4%. Gross profit as a percentage of net sales
(gross margin) was 29.8% for 2003 versus 26.1% for 2002, as a result of the
disposed OI product lines, which more than offset the margin erosion in the
Spectrum Essentials(R) product lines as a result of the higher flaxseed
cost.
Sales and Marketing Expenses:
The Company's sales and marketing expenses for 2003 were $1,432,600 or
13.9% of net sales, versus $1,610,500 or 14.3% of net sales for 2002. The
decrease in spending of $177,900 in 2003 was primarily attributable to the
elimination of eleven full time employees formerly associated with the OI
product lines disposed of on April 25, 2002.
General and Administrative Expenses:
The Company's general and administrative expenses for 2003 were $897,600 or
8.7% of net sales, versus $822,500 or 7.3% of net sales for 2002. The
increase in spending of $75,100 was primarily attributable to increased
rent and the expenses associated with the move to the Company's new
headquarters facility.
12
Interest Expense:
The Company's interest expense for 2003 was $70,400 versus $167,300 for
2002. The reduction of $96,900 or 58% was primarily attributable to lower
borrowing levels under the Company's line of credit as a result of the
April 2002 sale of the OI product lines. Average borrowings outstanding
during 2003 were $1,817,000 lower than 2002. The weighted average effective
interest rate under the line of credit was approximately 150 basis points
lower in 2003, primarily as a result of financial targets achieved by the
Company in 2001, which lowered the premium over the prime rate assessed by
its primary lender effective April 1, 2002.
Also contributing to the reduced interest expense in 2003 was the non-cash
interest expense on the private placement notes of $13,800 during the prior
year, which did not recur since the notes were retired one year early in
December 2002.
Provision for Income Taxes:
During the three months ended March 31, 2003 the Company recorded a
provision for state income taxes of $37,800 versus zero for 2002. The
Company has federal net operating loss carryovers sufficient to offset all
federal income taxes due on its estimated taxable income for 2003. However,
the State of California recently announced 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 paid $176,000 in estimated state
income taxes due for 2002 during the first quarter and will owe state
income taxes for 2003 estimated at 9% of its taxable income. The Company
estimates that its taxable income for the first quarter of 2003 was
approximately $420,000.
Due to continued uncertainty regarding the Company's realization of
deferred tax assets, the Company maintained a 100% reserve at March 31,
2003 against the Company's net deferred tax assets. In light of the
Company's operating results, this reserve will continue to be evaluated
during 2003 to determine whether it should be fully or partially reversed
at some future point.
Net Income:
The Company reported net income of $635,600 versus net income of $331,300
for the three-month periods ended March 31, 2003 and 2002, respectively.
The improvement in 2003 was primarily due to higher gross profit, lower
operating expenses and lower interest expense, partially offset by the
provision for state income taxes necessary in 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 effected to reduce the risk of price swings due to
demand fluctuations. These annual purchases can create overages and
shortages in inventory.
Liquidity and Capital Resources:
The Company maintains a credit facility (the "Credit Agreement") with its
primary lender, Wells Fargo Business Credit ("WFBC"), consisting of a
$9,000,000 revolving line of credit and term debt that bear interest at
13
prime plus 1% and 1.25%, respectively. The Credit Agreement is secured by
substantially all assets of the Company and life insurance policies on the
CEO and Chairman of the Board. Advances under the revolving line of credit
are limited to a borrowing base consisting of certain eligible accounts
receivable and inventory.
The Company could not operate its business without the Credit Agreement
with WFBC or one similar to it. At March 31, 2003 the Company satisfied all
financial covenants and all other requirements under the Credit Agreement.
The Credit Agreement calls for continued satisfaction of various financial
covenants for 2003 and beyond.
During 2003 the Company used $1,042,400 in cash from operating activities,
compared to using $218,700 in cash in 2002. The increase in cash used was
primarily due to increased inventory levels as the Company rebuilt its
safety stock of flax oil products in the wake of the flaxseed shortage
during late 2002. Seed inventories were sharply higher as a result of
higher costs and the requirement to pay for seed in advance prior to
shipment due to intense competition. Partially offsetting the increased
inventories were higher levels of accounts payable associated with the same
issues.
Cash used in investing activities was $357,600 in 2003 compared to $103,600
in 2002. The cash was invested by the Company in machinery and equipment,
primarily for a new rotary labeler and six used expeller presses.
Cash provided by financing activities was $1,400,000 in 2003 compared to
$310,500 in 2002. The increase in funds provided from financing during 2003
primarily reflected increased borrowing under the revolving line of credit
to finance the equipment purchases and the cash used for operating
activities.
Management believes that future cash flows from operations and available
borrowing capacity under the revolving line of credit should provide
adequate funds to meet the Company's estimated cash requirements for the
foreseeable future. Available borrowing capacity under the revolving line
of credit was $1,908,500 and $1,220,500 at, March 31, 2003 and 2002,
respectively. The Company relocated to a new leased headquarters facility
in December 2002 which represented a significant upgrade to the Company's
office facilities. The new office is rented under a five year fixed
operating lease. Rental expense for the year ended December 31, 2003 is
expected to be $185,600.
During the first quarter of 2003, the Company announced its intention to
relocate its third-party warehousing and distribution from Rancho
Cucamongo, California to a new third-party facility in Woodland, California
effective June 2, 2003. In addition, the Company intends to out-source its
bottling operation to the same third-party, Interpac Technologies, Inc.
during the third quarter. Management does not anticipate that these changes
will significantly impact the company's financial condition, cash flows or
results of operations during 2003.
The Company does not utilize off-balance sheet financing arrangements.
There were no transactions with special purpose entities that give the
Company access to assets or additional financing or carry debt that is
secured by the Company. There was one significant transaction with a
related party during the three months ended March 31, 2003. The Company
paid consulting fees of $24,800, plus expenses incurred, to Running Stream
Food and Beverage, Inc. ("RSFB"). RSFB provides private label consulting
and management services to the Company and is owned and operated by John R.
14
Battendieri, a non-executive Director of the Company. In the opinion of
Management, the consulting fees paid to RSFB were fair, reasonable and
consistent with terms the Company could have obtained from an unaffiliated
third party.
Mr. Thomas Simone is one of the Company's external Directors and also sits
on the Board of United Natural Foods, Inc. UNFI is the Company's largest
customer by far, representing approximately 50% of the Company's net sales
for the year ended December 31, 2002.
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 and availability 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 the common stock.
New Applicable Accounting Pronouncements:
In July 2002 the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 146 ("SFAS 146"),
"Accounting for Costs Associated with Exit or Disposal Activities". 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 has announced the upcoming relocation of its bottling
operation and warehousing and distribution center. Severance costs, if any,
will be recognized when a liability is incurred.
In November 2002 the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others", which is effective for financial
statements issued after December 15, 2002. The Company has various
guarantees included in contracts in the normal course of business primarily
in the form of indemnities. However, these guarantees do not represent
significant commitments or contingent liabilities in connection with the
indebtedness of others.
In December 2002 the FASB issued SFAS 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure", 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,
"Accounting for Stock-Based Compensation". 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. Accordingly, Management does not expect the adoption of SFAS
15
148 to have a material impact on the Company's financial condition or
results of operations. The additional interim disclosures required under
SFAS 148 are included in this report.
In January 2003 the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which requires the consolidation of
certain special purpose or variable interest entities. FIN 46 is applicable
to financial statements issued after 2002. There are no entities that are
required to be consolidated with the Company's financial statements as a
result of FIN 46.
ITEM 3. 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 three
months ended March 31, 2003 the average outstanding balance under the line
of credit was approximately $3,614,000 with a weighted average effective
interest rate of 5.5% per annum. For the three months ended March 31, 2002
the average outstanding balance under the line of credit was approximately
$5,431,000 with a weighted average effective interest rate of 6.9% per
annum. Effective April 1, 2002 the line of credit agreement called for the
interest rate to float at the prime rate plus 100 basis points.
Certain other debt items are also sensitive to changes in interest rates.
The following table summarizes principal cash flows and related weighted
average interest rates by expected maturity date for long-term debt,
excluding capital leases ($ thousands):
Expected Maturity Date
Outstanding (Years Ended December 31)
March 31, 2003 2003 2004 2005 2006 2007 2011
-------------- ---- ---- ---- ---- ---- ----
Long Term Debt:
Fixed Rate $1,017.1 $207.2 $275.2 $228.2 $15.6 -- $290.9
Avg. Int. Rate 9.3% 9.3% 9.2% 9.0% 10.0% -- 6.5%
Variable Rate $377.4 $154.8 $185.8 $ 36.8 -- -- --
Avg. Int. Rate 5.5% 5.9% 6.8% 7.5% -- -- --
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 March 31, 2003 these future commitments
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 4. DISCLOSURE 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
16
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 three months ended March 31, 2003. Management is not aware of
any significant deficiencies in the design or operation of internal
controls.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
--------------------------
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 issued in the United States that
pertain to particular fat compositions suitable for human ingestion. The
patent holder exclusively licensed each of these patents to GFA. Management
believes that the margarine does not infringe upon either patent, and
further, that the patents are unenforceable. Management engaged legal
counsel that specialize 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 does not infringe upon
the GFA patents, either literally or under the doctrine of equivalents.
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 requests 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 its opposition to
that motion, however, the motion to transfer venue was granted in January
2002. The case is currently in the discovery phase. Markman briefs, in
which each side presents its arguments on how the patent claims should be
construed, are due from both GFA and Spectrum in July. In most patent
infringement cases, the court's determination of how the patent claims
should be interpreted is the central issue. A settlement hearing has been
tentatively scheduled by the court for July 21, 2003.
Management believes the Company has meritorious defenses and that a loss is
not probable on the patent infringement complaint at this time.
Accordingly, no provision for loss has been recorded at March 31, 2003.
Item 2. Changes in Securities and Use of Proceeds
--------------------------------------------------
During the three months ended March 31, 2003 the Company did not issue any
shares of its common stock.
17
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.
Item 3. Defaults Upon Senior Securities
----------------------------------------
None.
Item 4. Submission of Matters to a Vote of Security Holders
------------------------------------------------------------
None.
Item 5. Other Information
--------------------------
None.
Item 6. Exhibits and Reports on Form 8-K
-----------------------------------------
(a) Exhibits:
99.09 Certification of Chief Executive Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
99.10 Certification of Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K during the quarter ended March 31, 2003:
None.
SIGNATURES
Pursuant to the requirements 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.
Date: May 9, 2003 SPECTRUM ORGANIC PRODUCTS, INC.
By: /s/ Robert B. Fowles
-------------------------------
Robert B. Fowles
Duly Authorized Officer &
Chief Financial Officer
18
CERTIFICATIONS
I Neil G. Blomquist, Chief Executive Officer of the Company, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Spectrum Organic
Products, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 9, 2003
/s/ Neil G. Blomquist
-----------------------------------
Neil G. Blomquist
Chief Executive Officer
19
I Robert B. Fowles, Chief Financial Officer of the Company, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Spectrum Organic
Products, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 9, 2003
/s/ Robert B. Fowles
-----------------------------------
Robert B. Fowles
Chief Financial Officer
20