-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TZvESxPz5NWlhx/YSlkNtcAUwxWZ0uPoNgGKbF9dX0TZ54kZjE0WsFsOJTMpGRPg V0dMaRWHsOkPzyGYQhQ+dg== 0001000096-04-000394.txt : 20040810 0001000096-04-000394.hdr.sgml : 20040810 20040810130116 ACCESSION NUMBER: 0001000096-04-000394 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20040630 FILED AS OF DATE: 20040810 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SPECTRUM ORGANIC PRODUCTS INC CENTRAL INDEX KEY: 0001034992 STANDARD INDUSTRIAL CLASSIFICATION: CANNED, FRUITS, VEG & PRESERVES, JAMS & JELLIES [2033] IRS NUMBER: 943076294 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-22231 FILM NUMBER: 04963829 BUSINESS ADDRESS: STREET 1: 5341OLD REDWOOD HIGHWAY STREET 2: 4TH FLOOR CITY: PETALUMA STATE: CA ZIP: 94954 BUSINESS PHONE: 7077788900 MAIL ADDRESS: STREET 1: 5341 OLD REDWOOD HIGHWAY STREET 2: 4TH FLOOR CITY: PETALUMA STATE: CA ZIP: 94954 FORMER COMPANY: FORMER CONFORMED NAME: ORGANIC FOOD PRODUCTS INC DATE OF NAME CHANGE: 19970304 10-Q 1 spectrum6302004.txt FORM 10-Q (6-30-2004) 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 JUNE 30, 2004. [ ] 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 executive offices) (Issuer's telephone number) Indicate by check mark 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 [ ] Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [ ] No [ X ] APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEEDING FIVE YEARS: Indicate by check mark 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 a 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, 46,386,943 shares issued and outstanding as of August 2, 2004. Transitional Small Business Disclosure Format: Yes [ ] No [ X ] PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS - ----------------------------- SPECTRUM ORGANIC PRODUCTS, INC. BALANCE SHEETS
ASSETS (Unaudited) June 30, December 31, 2004 2003 ------------- ------------ Current Assets: Cash $ 4,500 $ 7,300 Accounts receivable, net 4,272,400 4,163,200 Inventories, net 8,832,800 8,007,200 Deferred income taxes - current 764,300 514,200 Prepaid expenses and other current assets 499,100 297,500 ------------ ------------ Total Current Assets 14,373,100 12,989,400 Property and Equipment, net 4,819,600 4,338,700 Other Assets: Deferred income taxes - long-term 797,000 1,087,700 Intangible assets, net 585,800 586,800 Other assets 231,200 218,300 ------------ ------------ Total Assets $ 20,806,700 $ 19,220,900 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Bank overdraft $ 21,700 $ 513,800 Line of credit 6,033,000 4,833,000 Accounts payable, trade 5,357,300 4,168,000 Accrued expenses 718,300 1,307,700 Current maturities of term notes payable and capital lease obligations 364,600 322,300 Current maturities of notes payable, related parties 252,100 275,200 Income taxes payable -- 9,900 ------------ ------------ Total Current Liabilities 12,747,000 11,429,900 Notes payable and capitalized lease obligations, less current maturities 1,372,100 1,104,200 Notes payable, related parties, less current maturities 441,600 549,200 Deferred rent 43,800 50,700 ------------ ------------ Total Liabilities 14,604,500 13,134,000 ------------ ------------ Commitments and Contingencies Stockholders' Equity: Preferred stock, 5,000,000 shares authorized, no shares issued or outstanding -- -- Common stock, no par value, 60,000,000 shares authorized, 46,386,943 and 46,254,777 issued and outstanding at June 30, 2004 and December 31, 2003, respectively 9,625,400 9,579,500 Accumulated deficit (3,423,200) (3,492,600) ------------ ------------ Total Stockholders' Equity 6,202,200 6,086,900 ------------ ------------ Total Liabilities and Stockholders' Equity $ 20,806,700 $ 19,220,900 ============ ============ The accompanying notes are an integral part of the financial statements. 2 SPECTRUM ORGANIC PRODUCTS, INC. STATEMENTS OF OPERATIONS (Unaudited) (Unaudited) Three Months Ended Six Months Ended June 30, June 30, June 30, June 30, 2004 2003 2004 2003 ------------ ------------ ------------ ------------ Net Sales $ 12,811,400 $ 11,380,800 $ 25,544,500 $ 21,689,400 Cost of Goods Sold 9,851,900 8,414,900 19,682,300 15,650,700 ------------ ------------ ------------ ------------ Gross Profit 2,959,500 2,965,900 5,862,200 6,038,700 ------------ ------------ ------------ ------------ Operating Expenses: Sales and Marketing 1,722,900 1,632,100 3,704,800 3,064,800 General and Administrative 874,400 917,700 1,903,800 1,815,300 ------------ ------------ ------------ ------------ Total Operating Expenses 2,597,300 2,549,800 5,608,600 4,880,100 ------------ ------------ ------------ ------------ Income from Operations 362,200 416,100 253,600 1,158,600 ------------ ------------ ------------ ------------ Other Income (Expense): Interest Expense (77,800) (82,700) (151,800) (153,100) Other 12,900 9,300 13,900 10,500 ------------ ------------ ------------ ------------ Total Other Expenses (64,900) (73,400) (137,900) (142,600) ------------ ------------ ------------ ------------ Income Before Income Taxes 297,300 342,700 115,700 1,016,000 Provision for Income Taxes (118,900) (26,500) (46,300) (64,300) ------------ ------------ ------------ ------------ Net Income $ 178,400 $ 316,200 $ 69,400 $ 951,700 ============ ============ ============ ============ Basic and Fully Diluted Income Per Share $ 0.00 $ 0.01 $ 0.00 $ 0.02 ============ ============ ============ ============ Weighted Average Shares Outstanding 46,321,295 45,705,571 46,298,426 45,705,571 ============ ============ ============ ============ Fully Diluted Average Shares Outstanding 48,464,066 46,023,029 48,739,211 46,059,234 ============ ============ ============ ============ The accompanying notes are an integral part of the financial statements. 3 SPECTRUM ORGANIC PRODUCTS, INC. STATEMENTS OF CASH FLOWS (Unaudited) Six Months Ended June 30, June 30, 2004 2003 ------------ ------------ Cash Flows from Operating Activities: Net Income $ 69,400 $ 951,700 Adjustments to Reconcile Net Income to Net Cash used in Operating Activities: Provision for uncollectible receivables 20,000 36,700 Provision for inventory obsolescence 105,600 74,700 Depreciation and amortization 302,200 211,200 Imputed interest on note payable, related party 10,100 9,400 Changes in Assets and Liabilities: Accounts receivable (129,200) (876,100) Inventories (931,200) (3,398,600) Other assets (173,900) (80,200) Accounts payable 1,189,300 2,948,600 Accrued expenses and other liabilities (606,100) (186,100) ------------ ------------ Net Cash Used in Operating Activities (143,800) (308,700) ------------ ------------ Cash Flows from Investing Activities: Purchase of property and equipment (782,200) (915,000) Purchase of intellectual property -- (275,000) ------------ ------------ Net Cash Used in Investing Activities (782,200) (1,190,000) ------------ ------------ Cash Flows from Financing Activities: Decrease in bank overdraft (492,100) (152,100) Proceeds from line of credit 11,198,100 22,676,600 Repayment of line of credit (9,998,100) (20,754,600) Proceeds from note payable 460,000 -- Repayment of bank term notes payable (140,800) (103,100) Repayment of capitalized lease obligations (24,800) (24,600) Repayment of notes payable, related parties (125,000) (136,500) Proceeds from exercise of stock options 45,900 -- ------------ ------------ Net Cash Provided by Financing Activities 923,200 1,505,700 ------------ ------------ Net Increase (Decrease) in Cash (2,800) 7,000 Cash, beginning of the year 7,300 1,000 ------------ ------------ Cash, end of the period $ 4,500 $ 8,000 ============ ============ Supplemental Disclosure of Cash Flow Information: Cash paid for income taxes $ 16,000 $ 266,000 Cash paid for interest $ 144,500 $ 156,300 Non-Cash Financing Activities: Purchase of intellectual property with debt $ -- $ 275,000 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 that, in the opinion of Management, are necessary in order to make the financial statements not misleading. The 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.'s financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2003. Operating results for the six month period ended June 30, 2004 are not necessarily indicative of the results that may be expected for the entire year ending December 31, 2004 or future periods. Certain reclassifications have been made to the prior year unaudited interim financial statements to be consistent with the presentation at June 30, 2004. These reclassifications had no impact on net income or retained earnings. 2. Nature of Operations and Business Segments: 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. 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: 5
Three Months Ended June 30, 2004 2003 % Change ---- ---- -------- Net Sales: Spectrum Naturals(R) $ 6,092,300 $ 5,059,200 +20% Spectrum Essentials(R) 2,130,500 2,530,300 -16% Spectrum Ingredients/Other 4,588,600 3,791,300 +21% ----------- ----------- ---- Total Net Sales $12,811,400 $11,380,800 +13% =========== =========== ==== Gross Profit: Spectrum Naturals(R) $ 1,515,100 $ 1,362,700 +11% Spectrum Essentials(R) 942,700 1,175,100 -20% Spectrum Ingredients/Other 501,700 428,100 +17% ----------- ----------- ---- Total Gross Profit $ 2,959,500 $ 2,965,900 -- =========== =========== ==== Six Months Ended June 30, 2004 2003 % Change ---- ---- -------- Net Sales: Spectrum Naturals(R) $11,909,900 $ 9,657,200 +23% Spectrum Essentials(R) 4,799,300 4,976,600 -4% Spectrum Ingredients/Other 8,835,300 7,055,600 +25% ----------- ----------- ---- Total Net Sales $25,544,500 $21,689,400 +18% =========== =========== ==== Gross Profit: Spectrum Naturals(R) $ 2,920,200 $ 2,716,200 +8% Spectrum Essentials(R) 2,008,700 2,374,500 -15% Spectrum Ingredients/Other 933,300 948,000 -2% ----------- ----------- ---- Total Gross Profit $ 5,862,200 $ 6,038,700 -3% =========== =========== ====
3. Amendment to Loan and Security Agreement: On June 4, 2004 the Company entered into the First Amendment (the "Amendment") to the Loan and Security Agreement (the "Credit Facility") with its primary lender, Comerica Bank. The Amendment provides the Company with additional borrowing capacity and flexibility via four significant changes to the Credit Facility: a) The maturity date of the Credit Facility was extended an additional twelve months to June 30, 2006. b) The maximum borrowing available under the revolving line of credit was increased from $7,000,000 to $9,000,000, subject to eligible collateral levels. c) The maximum borrowings available for eligible inventory under the revolving line of credit was increased from $1,500,000 in excess of eligible accounts receivable to $2,000,000 in excess of eligible accounts receivable. 6 d) The drawdown period under the Company's $1,000,000 capital expenditures term note was extended an additional six months to December 31, 2004. During the six months ended June 30, 2004 proceeds received under this note were $460,000. The Amendment continues to require that the Company meet various financial covenants for 2004 and beyond related to profitability levels, debt service coverage, and the ratio of total liabilities to tangible net worth. As of June 30, 2004 the Company was in compliance with all requirements under the Credit Facility. A copy of the Amendment has been filed as Exhibit 10.55 with this quarterly report on Form 10-Q. 4. Manufacturing Facility Relocation and Reconfiguration: During the first quarter of 2004, the Company began the implementation of its plan to relocate its SpectraVac manufacturing operation from its leased facility at 133 Copeland Street, Petaluma, California to a leased facility located in Cherokee, Iowa managed by American Natural Soy Processors, LLC ("ANS"). The SpectraVac operation utilizes the Company's intellectual property purchased on April 15, 2003 for the benign extraction of oil from vegetable seeds, and is currently used primarily for the production of flax oil. The Company is replacing most of the equipment currently used in the SpectraVac operation in Petaluma with new, more efficient equipment in Cherokee and will operate both facilities in parallel prior to shutting down the Petaluma facility. The Company plans to disassemble and relocate most of the Petaluma equipment to Cherokee after the shutdown. ANS will provide labor and management services to the Company for the SpectraVac operation in Cherokee under contract. The Company will continue to own the equipment and also intends to enter into other oil seed crushing arrangements with ANS under a strategic alliance. During the six months ended June 30, 2004 capital spending in Cherokee associated with the Iowa relocation was $492,000. Additionally, the Company incurred $81,200 in consulting fees associated with the relocation to Iowa, which was included in general and administrative expense. The Company anticipates that additional capital spending of approximately $250,000 and moving expenses of approximately $400,000 will be incurred during the third and fourth quarters to complete the relocation to Iowa. 5. Industrial Accident: On February 4, 2004 the Company pleaded no contest to two misdemeanor counts of violations under California Labor Code Section 6425 ("CLCS 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 under CLCS 6425 of $150,000 in three annual installments of $50,000 each on June 1, 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 7 Department, the Petaluma Fire Department and the Sonoma County District Attorney's Office. Finally, an additional fine of $250,000 under CLCS 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 during the year ended December 31, 2003 to cover the net present value of the above payments, plus attorney's fees. Total payments made during the six months ended June 30, 2004 in connection with the plea were $275,000. On May 25, 2004 the Company settled one of the appeals filed with the Workers' Compensation Appeals Board for $35,000 which was paid on June 3, 2004 and charged against the industrial accident reserve. As of June 30, 2004 the Company had a remaining reserve of $197,600 to cover the remaining fine under CLCS 6425 of $100,000, the anticipated penalties from CAL-OSHA, the remaining appeal filed 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 remaining workers compensation appeal is for an additional death benefit of $62,500, payable by the Company to the dependents of the deceased worker 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 compensation appeal is an all-or-nothing proposition under which the Company will either be liable for $62,500 or nothing. Based on the advice of counsel, the Company expects the remaining workers compensation appeal to be settled rather than litigated. Management believes the remaining reserve of $197,600 will be adequate to cover the remaining two installments under the CLCS 6425 fine of $50,000 each, the settlement of the CAL-OSHA penalties, the workers compensation appeal and related attorney's fees. 6. Inventories: Inventories consisted of the following: June 30, December 31, 2004 2003 ---------- ---------- Finished goods $6,950,500 $6,853,400 Raw materials 1,839,400 1,166,100 Deposits on inventory 319,500 236,200 ---------- ---------- Total Inventories 9,109,400 8,255,700 Less: Reserve for obsolete inventory 276,600 248,500 ---------- ---------- Net Inventories $8,832,800 $8,007,200 ========== ========== Deposits on inventory primarily represent flaxseed paid for prior to its receipt at the Company's production facility. 8 7. 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. Final royalties paid during the three months ended March 31, 2003 were $50,700. 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 evaluates 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. No impairment charges have been required to date. 8. Commitments and Contingencies: Pending Litigation - 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 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. 9 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 June 30, 2004. Pending Litigation - 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. 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. 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, or attorney's fees. 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. On July 16, 2004 counsel for the Company and GFA verbally agreed to settle the case with respect to the first patents by a joint stipulation to dismiss all claims without prejudice to either party, with a provision that the Markman ruling will continue to be binding between the Company and GFA in the event of any future litigation. 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. 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. 10 There is no infringement by the Company of the second patent since the Company immediately ceased the production of the margarine upon notification of the patent's issuance. Accordingly, no provision for loss has been recorded at June 30, 2004. 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 CLCS 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. 9. 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 three and six month periods ended June 30, 2004 and 2003 would have been adjusted to the pro-forma amounts presented below: 11
Three Months Ended Six Months Ended ------------------------- -------------------------- June 30, June 30, June 30, June 30, 2004 2003 2004 2003 --------- --------- --------- --------- Net income as reported $ 178,400 $ 316,200 $ 69,400 $ 951,700 Less: Total compensation expense under fair value method for all stock-based awards, net of related tax effects 103,700 52,900 174,000 120,900 --------- --------- --------- --------- Pro-Forma net income (loss) $ 74,700 $ 263,300 $(104,600) $ 830,800 ========= ========= ========= ========= Basic and diluted income (loss) per share: As reported $ 0.00 $ 0.01 $ 0.00 $ 0.02 Pro-forma $ 0.00 $ 0.01 $ (0.00) $ 0.02
The fair value of the option grants for 2004 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 2.0%, no dividend yield and volatility of 95%. The weighted average fair value of the option grants during the first quarter of 2004 was $0.61 per share. The fair value of the 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 weighted average fair value of the option grants during the first quarter of 2003 was $0.25 per share. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- General: 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 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. 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 12 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. 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. 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: 13 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 $470,000 at June 30, 2004 on gross trade accounts receivable of $4,735,500. 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 $276,600 at June 30, 2004 on total gross inventories of $9,109,400. 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. 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 5 to the financial statements). As of June 30, 2004 the industrial accident reserve was $197,600. In addition to covering the Settlement, the reserve also covers the estimated settlement of citations and fines from CAL-OSHA, the remaining application 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 application to the Workers' Compensation Appeals Board for serious and willful misconduct penalties, if litigated, is an all-or-nothing proposition under which the Company will either be liable for $62,500 in total or nothing. The Company does not anticipate that the Workers' Compensation Appeal 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 Appeal is litigated. 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 Company has reported taxable income to the various taxing authorities for 2001 and 2002 and will do so again for 2003. The reserve was reversed because 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. 14 - -------------------------------------------------------------------------------- Results of Operations for the Three Month Periods Ending June 30, 2004 and June 30, 2003 - -------------------------------------------------------------------------------- Summary Discussion: In general, the Company continued to benefit from the ongoing trend away from hydrogenated culinary oils towards a healthier alternative during the second quarter. The Company's Spectrum Naturals(R) brand of expeller-pressed oils, condiments and butter substitutes delivered 20% net sales growth in the second quarter. Additionally, small and medium sized food manufacturers continued their push to eliminate partially hydrogenated oils from their products which drove the Spectrum Ingredients industrial sales up 21% versus the prior year. The Spectrum Essentials(R) brand of nutritional supplements posted a decline in net sales of 16% versus the prior year, as a result of increased competition in that category. The Company will be responding later this year with new positioning and packaging to strengthen the brand's position in this category. The Company reported net income of $178,400 for the second quarter, which was down 44% versus the prior year. The reduced profitability was primarily due to margin pressure on the Spectrum Naturals(R) and Spectrum Essentials(R) branded consumer product lines as a result of increased raw material costs for certain key organic raw materials such as olive oil, canola oil and flaxseed. Gross margin (gross profit expressed, as a percentage of net sales) was down three points versus the prior year. The Company has increased its selling prices in certain culinary product lines and has announced another price increase to the trade effective August 15, 2004. Also contributing to the reduced profitability for the second quarter was increased spending on several new sales and marketing initiatives in 2004. In particular, there was increased spending on the Company's new advertising campaign and increased sponsorships. Management believes that Earnings Before Interest, Taxes, Depreciation and Amortization ("EBITDA") is an important measure of the Company's operating performance. Management incentive compensation is earned, in part, based on the achievement of EBITDA targets that are established and approved by the Company's Board of Directors prior to the beginning of the year. For the three months ended June 30, 2004 EBITDA was $529,100 compared to $532,900 for the prior year, a decrease of $3,800 or 1%. The reduced performance in 2004 is discussed in detail below, but was primarily attributable to the decreased gross profit and increased sales and marketing 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. 15 The Company's calculations to arrive at EBITDA are detailed in the following table: Three Months Ended June 30, 2004 2003 -------- -------- Net income $178,400 $316,200 Add back: Provision for income taxes 118,900 26,500 Interest expense 77,800 82,700 Depreciation and amortization expense 154,000 107,500 -------- -------- EBITDA $529,100 $532,900 ======== ======== The following is Managements' 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 three months ended June 30, 2004 were a new quarterly record of $12,811,400 compared to $11,380,800 for 2003, an increase of $1,430,600 or 13%. The increase is detailed by segment in the following table:
Three Months Ended June 30, 2004 2003 % Change ---- ---- -------- Spectrum Naturals(R)Culinary Products $ 6,092,300 $ 5,059,200 +20% Spectrum Essentials(R)Nutritional Supplements 2,130,500 2,530,300 -16% Spectrum Ingredients/Other 4,588,600 3,791,300 +21% ----------- ----------- ---- Total Net Sales $12,811,400 $11,380,800 +13% =========== =========== ====
Within the Spectrum Naturals(R) culinary products, sales were significantly higher than prior year in olive oil (+94%), food service oils (+23%), vinegar (+53%) and packaged mayonnaise (+18%). The Company's culinary oils continued to benefit from increased consumer awareness of the importance of avoiding hydrogenated oils. Spectrum Essentials(R) nutritional supplement sales decreased 16% versus the prior year, primarily as a result of increased competition in the organic flax oil category. Packaged liquid supplements, which encompass the majority of the Spectrum Essentials(R) line, decreased by 18% versus the prior year. Sales of encapsulated nutritional supplements, primarily flax and fish oil, increased 6% versus the prior year. The Spectrum Ingredients sales were up 21% versus the prior year on the strength of increased customer demand for non hydrogenated oils. Many small and mid-sized food manufacturers are eliminating partially hydrogenated oils from their products, which lends itself directly to the Spectrum Ingredients product offerings. Cost of Goods Sold: The Company's cost of goods sold for the three months ended June 30, 2004 was $9,851,900 versus $8,414,900 for the prior year, an increase of 17%. The increase was primarily volume-related with respect to the Spectrum Ingredients segment and both volume and rate driven in the Spectrum Naturals(R) and Spectrum Essentials(R) segments, as detailed in the following table: 16
Three Months Ended June 30, 2004 2003 % Change ---- ---- -------- Spectrum Naturals(R)Culinary Products $4,577,200 $3,694,300 +24% Spectrum Essentials(R)Nutritional Supplements 1,187,800 1,355,200 -12% Spectrum Ingredients/Other 4,086,900 3,365,400 +21% ---------- ---------- ---- Total Cost of Goods Sold $9,851,900 $8,414,900 +17% ========== ========== ==== Cost of goods sold as a percent of net sales increased to 76.9% in 2004 versus 73.9% in 2003. The increase was primarily due to increased raw material costs in most of the Company's consumer packaged product lines and an unfavorable sales mix that featured a higher concentration of Spectrum Ingredients products, the Company's lowest margin items. Raw material costs were higher in the Company's Spectrum Essentials(R) products as the remaining high cost flaxseed purchased from China in 2003 sold through in April. Imported olive oil from Europe was sharply higher than the prior year as a result of the dollar's weakness versus the euro, which drove the cost of the Spectrum Naturals(R) packaged olive oils up. Finally, organic canola oil, a key raw material in many of the culinary products, was also higher as a result of increased demand and the dollar's weakness versus the Canadian dollar. Gross Profit: Gross profit for the three months ended June 30, 2004 was $2,959,500 versus $2,965,900 for the prior year, a decrease of less than 1%. The decrease was primarily attributable to the raw material cost increases described above, offset by significant volume increases in the Spectrum Naturals(R) and Spectrum Ingredients segments, as detailed in the following table: Three Months Ended June 30, 2004 2003 % Change ---- ---- -------- Spectrum Naturals(R)Culinary Products $1,515,100 $1,362,700 +11% Spectrum Essentials(R)Nutritional Supplements 942,700 1,175,100 -20% Spectrum Ingredients/Other 501,700 428,100 +17% ---------- ---------- ---- Total Gross Profit $2,959,500 $2,965,900 -- ========== ========== ====
Gross profit as a percent of net sales (gross margin) was 23.1% for 2004 versus 26.1% for 2003, primarily as a result of the increased raw material costs in the Company's consumer packaged product lines and the unfavorable sales mix. Sales and Marketing Expenses: The Company's sales and marketing expenses for the three months ended June 30, 2004 were $1,722,900 or 13.4% of net sales, versus $1,632,100 or 14.3% of net sales for the prior year. The increase in spending of $90,800 is detailed in the following table which reconciles sales and marketing spending for the second quarter of 2004 versus 2003, and discloses the significant variances by spending category: 17 Total sales and marketing expenses, second quarter 2003 $ 1,632,100 Increased advertising 231,000 Decreased broker commissions (77,100) Decreased market research (62,500) All other, net (600) ----------- Total sales and marketing expenses, second quarter 2004 $ 1,722,900 =========== The increased advertising spending was related to the launch of the new "I am Spectrum" campaign for 2004. The decreased broker commissions were related to the decreased sales of the Spectrum Essentials(R) products. The decreased market research spending was primarily the result of focus group research conducted during the prior year. General and Administrative Expenses: The Company's general and administrative expenses for the three months ended June 30, 2004 were $874,400 or 6.8% of net sales, versus $917,700 or 8.1% of net sales for the prior year. The decrease in spending of $43,300 is detailed in the following table which reconciles general and administrative spending for the second quarter of 2004 versus 2003, and discloses significant variances by spending category: Total general and administrative expenses, second quarter 2003 $ 917,700 Iowa relocation expenses 31,600 Decreased compensation and benefits expense (98,800) All other, net 23,900 --------- Total general and administrative expenses, second quarter 2004 $ 874,400 ========= The Iowa relocation expenses were primarily associated with consulting in conjunction with the Company's upcoming relocation of its manufacturing facility to Cherokee, Iowa. The decreased compensation and benefits expense was primarily associated with reduced accruals in 2004 for incentive compensation as a result of the lower profitability of the Company versus the prior year. Interest Expense: The Company's interest expense for the three months ended June 30, 2004 was $77,800 versus $82,700 for the prior year. The decrease of $4,900 or 6% is detailed in the following table which reconciles interest expense for 2004 versus 2003, and discloses the significant variances by type of debt: Total interest expense, second quarter 2003 $ 82,700 Increased interest on bank term notes payable 11,100 Decreased interest on revolving line of credit (11,900) All other, net (4,100) -------- Total interest expense, second quarter 2004 $ 77,800 ======== The increased interest on the bank term notes payable was the result of the refinancing of the Company's variable-rate term debt effective July 11, 2003 with the change in primary lenders to Comerica Bank. The decreased interest on the revolving line of credit was due to the lower rates available to the Company under the Comerica relationship, partially offset by higher average borrowings in 2004 to support the increased level of operations. The Company's weighted average effective interest rate under the line of credit was 3.6% in 2004 versus 5.5% in 2003. 18 Provision for Income Taxes: The Company recorded a provision for income taxes of $118,900 for the three months ended June 30, 2004 versus a provision for state income taxes of $26,500 for the prior year. The provision for 2004 was estimated at 40% of the Company's income before income taxes. - -------------------------------------------------------------------------------- Results of Operations for the Six Month Periods Ending June 30, 2004 and June 30, 2003 - -------------------------------------------------------------------------------- Summary Discussion: Management believes that Earnings Before Interest, Taxes, Depreciation and Amortization ("EBITDA") is an important measure of the Company's operating performance. For the six months ended June 30, 2004 EBITDA was $569,700 compared to $1,380,300 for the prior year, a decrease of $810,600 or 59%. The reduced performance in 2004 is discussed in detail below, but was primarily attributable to decreased gross profit and increased sales and marketing 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: Six Months Ended June 30, 2004 2003 ---------- ---------- Net income $ 69,400 $ 951,700 Add back: Provision for income taxes 46,300 64,300 Interest expense 151,800 153,100 Depreciation and amortization expense 302,200 211,200 ---------- ---------- EBITDA $ 569,700 $1,380,300 ========== ========== 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 six months ended June 30, 2004 were $25,544,500 compared to $21,689,400 for 2003, an increase of $3,855,100 or 18%. The increase is detailed by segment in the following table: 19
Six Months Ended June 30, 2004 2003 % Change ---- ---- -------- Spectrum Naturals(R) Culinary Products $11,909,900 $ 9,657,200 +23% Spectrum Essentials(R) Nutritional Supplements 4,799,300 4,976,600 -4% Spectrum Ingredients/Other 8,835,300 7,055,600 +25% ----------- ----------- ---- Total Net Sales $25,544,500 $21,689,400 +18% =========== =========== ==== Within the Spectrum Naturals(R) culinary products, sales were significantly higher than prior year in olive oil (+62%), food service oils (+27%), packaged culinary oils (+24%), vinegar (+35%) and packaged mayonnaise (+18%). The Company's culinary oils continued to benefit from increased consumer awareness of the importance of avoiding hydrogenated oils. Spectrum Essentials(R) nutritional supplement sales decreased 4% versus the prior year, primarily as a result of increased competition in the organic flax oil category. Packaged liquid supplements, which encompass the majority of the Spectrum Essentials(R) line, decreased by 8% versus the prior year. Sales of encapsulated nutritional supplements, primarily flax and fish oil, increased 16% versus the prior year. The Spectrum Ingredients sales were up 25% versus the prior year on the strength of increased customer demand for non hydrogenated oils. Many small and mid-sized food manufacturers are eliminating partially hydrogenated oils from their products, which lends itself directly to the Spectrum Ingredients product offerings. Cost of Goods Sold: The Company's cost of goods sold for the six months ended June 30, 2004 was $19,682,300 versus $15,650,700 for the prior year, an increase of 26%. The increase was primarily volume-related with respect to the Spectrum Ingredients segment and both volume and rate driven in the Spectrum Naturals(R) and Spectrum Essentials(R) segments, as detailed in the following table: Six Months Ended June 30, 2004 2003 % Change ---- ---- -------- Spectrum Naturals(R)Culinary Products $ 8,989,700 $ 6,938,800 +29% Spectrum Essentials(R)Nutritional Supplements 2,790,600 2,602,100 +7% Spectrum Ingredients/Other 7,902,000 6,109,800 +29% ----------- ----------- ---- Total Cost of Goods Sold $19,682,300 $15,650,700 +26% =========== =========== ==== Cost of goods sold as a percent of net sales increased to 77.1% in 2004 versus 72.2% in 2003. The increase was primarily due to increased raw material costs in most of the Company's consumer packaged product lines and an unfavorable sales mix that featured a higher concentration of Spectrum Ingredients products, the Company's lowest margin items. Raw material costs were higher in the Company's Spectrum Essentials(R) products as the remaining high cost flaxseed purchased from China in 2003 sold through during the first four months of 2004. Imported olive oil from Europe was sharply higher than the prior year as a result of the dollar's weakness versus the euro, which drove the cost of the Spectrum Naturals(R) packaged olive oils up. Finally, organic canola oil, a key raw material in many of the culinary products, was also higher as a result of increased demand and the dollar's weakness versus the Canadian dollar. 20 Gross Profit: Gross profit for the six months ended June 30, 2004 was $5,862,200 versus $6,038,700 for the prior year, a decrease of 3%. The decrease was primarily attributable to the raw material cost increases described above, partially offset by significant volume increases in the Spectrum Naturals(R) and Spectrum Ingredients segments, as detailed in the following table: Six Months Ended June 30, 2004 2003 % Change ---- ---- -------- Spectrum Naturals(R)Culinary Products $2,920,200 $2,716,200 +8% Spectrum Essentials(R)Nutritional Supplements 2,008,700 2,374,500 -15% Spectrum Ingredients/Other 933,300 948,000 -2% ---------- ---------- ---- Total Gross Profit $5,862,200 $6,038,700 -3% ========== ========== ====
Gross profit as a percent of net sales (gross margin) was 22.9% for 2004 versus 27.8% for 2003, primarily as a result of the increased raw material costs in the Company's consumer packaged product lines and the unfavorable sales mix. Sales and Marketing Expenses: The Company's sales and marketing expenses for the six months ended June 30, 2004 were $3,704,800 or 14.5% of net sales, versus $3,064,800 or 14.1% of net sales for the prior year. The increase in spending of $640,000 is detailed in the following table which reconciles sales and marketing spending for 2004 versus 2003, and discloses the significant variances by spending category: Total sales and marketing expenses, first half 2003 $ 3,064,800 Increased advertising 438,100 Increased compensation and benefits 133,800 Increased trade show spending 65,200 Increased sponsorships 34,500 All other, net (31,600) ----------- Total sales and marketing expenses, first half 2004 $ 3,704,800 =========== The increased advertising spending was related to the launch of the new "I am Spectrum" campaign for 2004. The increased compensation and benefits was primarily associated with increased staffing of three positions in the Marketing Department. The increased trade show spending and sponsorships has enabled the Company to maintain a greater presence within the industry. General and Administrative Expenses: The Company's general and administrative expenses for the six months ended June 30, 2004 were $1,903,800 or 7.5% of net sales, versus $1,815,300 or 8.4% of net sales for the prior year. The increase in spending of $88,500 is detailed in the following table which reconciles general and administrative spending for 2004 versus 2003, and discloses significant variances by spending category: 21 Total general and administrative expenses, first half 2003 $ 1,815,300 Iowa relocation expenses 81,200 Increased professional fees 33,200 Decreased compensation and benefits expense (104,000) All other, net 78,100 ----------- Total general and administrative expenses, first half 2004 $ 1,903,800 =========== The Iowa relocation expenses were primarily associated with consulting in conjunction with the Company's upcoming relocation of its manufacturing facility to Cherokee, Iowa. The increased professional fees were primarily associated with increased tax consulting services. The decreased compensation and benefits expense was primarily associated with reduced accruals in 2004 for incentive compensation as a result of the lower profitability levels achieved by the Company in 2004. Interest Expense: The Company's interest expense for the six months ended June 30, 2004 was $151,800 versus $153,100 for the prior year. The decrease of $1,300 is detailed in the following table which reconciles interest expense for 2004 versus 2003, and discloses the significant variances by type of debt: Total interest expense, first half 2003 $ 153,100 Increased interest on bank term notes payable 20,100 Decreased interest on revolving line of credit (18,900) All other, net (2,500) --------- Total interest expense, first half 2004 $ 151,800 ========= The increased interest on the bank term notes payable was the result of the refinancing of the Company's variable-rate term debt effective July 11, 2003 with the change in primary lenders to Comerica Bank. The decreased interest on the revolving line of credit was due to the lower rates available to the Company under the Comerica relationship, partially offset by higher average borrowings in 2004 to support the increased level of operations. The Company's weighted average effective interest rate under the line of credit was 3.6% in 2004 versus 5.5% in 2003. Provision for Income Taxes: The Company recorded a provision for income taxes of $46,300 for the six months ended June 30, 2004 versus a provision for state income taxes of $64,300 for the prior year. The provision for 2004 was estimated at 40% of the Company's income before income taxes. 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 overages and shortages in inventory. 22 Liquidity and Capital Resources: On June 4, 2004 the Company entered into the First Amendment to its Credit Facility with Comerica Bank ("Comerica") that extends the maturity date of the Credit Facility to June 30, 2006. The Amendment also increases the revolving line of credit up to a maximum of $9,000,000, and extends the drawdown period under the capital expenditure term loan of $1,000,000 by six months to December 31, 2004. The 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 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 2004 and beyond related to profitability levels, debt service coverage, and the ratio of total liabilities to tangible net worth. As of June 30, 2004 the Company was in compliance with all requirements under the Credit Facility. At June 30, 2004 the Company had working capital of $1,626,100 which reflected an improvement of $1,555,400 versus June 30, 2003. The increase was primarily attributable to higher accounts receivable as a result of the double-digit sales growth and the reinstatement of $764,300 of net short-term deferred tax assets, partially offset by increased borrowings outstanding under the line of credit to finance the higher level of operations in general. During 2004 the Company used $143,800 in cash from operating activities, compared to using $308,700 in cash in 2003. The decrease in cash used in 2004 was primarily due to the lower profitability levels in 2004, partially offset by reductions in the cash used for working capital items. During 2003 the Company was required to hold significant quantities of flaxseed in inventory prior to production, which was no longer necessary in 2004. Cash used in investing activities was $782,200 in 2004 compared to $1,190,000 in 2003. In 2004 the cash was primarily invested in the new production facility in Iowa. In 2003 the cash was invested in the purchase of the SpectraVac intellectual property and in machinery and equipment, primarily a new rotary labeler and six used expeller presses, which were subsequently installed in the new Iowa facility. Cash provided by financing activities was $923,200 in 2004 compared to cash provided of $1,505,700 in 2003. The cash provided in 2004 was primarily from proceeds under the revolving line of credit and the capital expenditures term note. The cash provided in 2003 was primarily 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. Excess borrowing capacity under the revolving line of credit was $967,000 and $1,722,900 at June 30, 2004 and 2003, respectively. 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. 23 Related Party Transactions and Other Relationships: There was one significant transaction with a related party during the six months ended June 30, 2004. The Company paid consulting fees of $33,000, plus expenses incurred, to Running Stream Food and Beverage, Inc. ("RSFB"). RSFB provided private label consulting and management services to the Company until April 16, 2004 and is owned and operated by John R. Battendieri, a non-executive Director of the Company until his resignation from the Board of Directors effective April 1, 2004 (see Item 5 - Other Information in this report). The Company elected to terminate the consulting services agreement with RSFB at the end of its two-year term on April 16 in order to focus on its core business in healthy oils and nutritional supplements. 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"). UNFI is the Company's largest customer, representing approximately 36% of the Company's net sales for the year ended December 31, 2003. 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. The Company will occasionally purchase inventories in foreign currencies; however, in most cases payment is made at the time title to the inventory passes to the Company. Therefore, any foreign currency gain or loss has been immaterial to date. The book value of all financial instruments approximates fair value. For trade accounts receivable and trade accounts payable, the book value approximates fair value due to the short-term maturity of these items. The Company's interest-bearing term 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. Throughout the course of its fiscal year, the Company utilizes a variable interest rate line of credit at various borrowing levels. For the six months ended June 30, 2004 the average outstanding balance under the line of credit was $5,126,900 with a weighted average effective interest rate of 3.6% per annum. For the six months ended June 30, 2003 the average outstanding balance under the line of credit was $4,072,700 with a weighted average effective interest rate of 5.5% per annum. Effective July 11, 2003 with the change in the primary banking relationship to Comerica Bank, the line of credit agreement called for the interest rate to float at the prime rate or LIBOR plus 2.25%, at the Company's option. The previous line of credit agreement called for the interest rate to float at the prime rate plus 1.0%. Certain other debt items are also sensitive to changes in interest rates. The following table summarizes estimated fair values, future principal payments and related weighted average interest rates by expected maturity date for long-term debt, excluding capital leases ($ thousands): 24
Expected Future Principal Payments (Years Ended December 31) 2004 2005 2006 2007 2008 2011 Total Fair Value ---- ---- ---- ---- ---- ---- ----- ---------- Long Term Debt: Fixed Rate $ 134.3 $ 228.2 $ 15.6 -- -- -- $ 378.1 $ 378.1 Avg. Int. Rate 9.3% 9.2% 9.0% -- -- -- 9.2% Variable Rate $ 214.0 $ 426.3 $ 426.3 $ 426.3 $ 301.4 -- $ 1,705.3 $ 1,705.3 Avg. Int. Rate Var. Var. Var. Var. Var. -- Var. Imputed Rate -- -- -- -- -- $ 513.3 $ 513.3 $ 315.5 Avg. Int. Rate -- -- -- -- -- 6.5% 6.5%
The fair value of all long-term debt is equal to the sum of the expected future principal payments with the exception of the non-interest bearing note payable due in one lump sum of $513,300 on December 31, 2011. Interest has been imputed on that note at an effective rate of 6.5% per annum, leaving a fair value at June 30, 2004 of $315,500. 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 June 30, 2004 these future commitments approximated fair value because they 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. 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. 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 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 six months ended June 30, 2004. Management is not aware of any significant deficiencies in the design or operation of internal controls. 25 PART II - OTHER INFORMATION Item 1. Legal Proceedings - -------------------------- Industrial Accident On February 4, 2004 the Company pleaded no contest to two misdemeanor counts of violations under CLCS 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 1, 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 CLCS 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 payments made in connection with the plea during the six months ended June 30, 2004 were $275,000. At June 30, 2004 the remaining unsettled issues in connection with the industrial accident were the CAL-OSHA proposed penalties of $137,900 which have been appealed by the Company, and one remaining appeal filed with the Workers' Compensation Appeals Board of California for serious and willful misconduct penalties of $62,500. The Company intends to defend itself vigorously and believes it has meritorious defenses, since the CAL-OSHA citations did not include any willful penalties. If actually litigated, the workers compensation appeal is an all-or-nothing proposition under which the Company will either be liable for $62,500 or nothing. Based on the advice of counsel, the Company expects the workers compensation appeal to be settled rather than litigated. The Company had a reserve of $197,600 at June 30, 2004 to cover the anticipated settlement of these outstanding issues plus attorney's fees and the two remaining installments of $50,000 each under the CLCS 6425 fine, 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. 26 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. 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 June 30, 2004. 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. 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. 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, or attorney's fees. 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. On July 16, 2004 counsel for the Company and GFA verbally agreed to settle the case with respect to the first patents by a joint stipulation to dismiss all claims without prejudice to either party, with a provision that the Markman ruling will continue to be binding between the Company and GFA in the event of any future litigation. 27 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. 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. There is no infringement by the Company of the second patent since the Company immediately ceased the production of the margarine upon notification of the patent's issuance. Accordingly, no provision for loss has been recorded at June 30, 2004. Item 2. Changes in Securities and Use of Proceeds - -------------------------------------------------- During the six months ended June 30, 2004 the Company issued 132,200 shares of its common stock for the exercise of stock options. Total proceeds received by the Company were $45,900. 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 - ------------------------------------------------------------ An annual meeting of shareholders was held on April 29, 2004 at the Company's headquarters in Petaluma, California. A definitive Proxy Statement was filed with the SEC on April 1, 2004 and is incorporated herein by reference. There were four matters brought before the shareholders for their approval: 1. To elect six Director Nominees to another term. 2. To amend the Company's Amended and Restated Articles of Incorporation to increase the number of common shares authorized for issuance from 60,000,000 to 100,000,000 and to increase the number of preferred shares authorized for issuance from 5,000,000 to 10,000,000. 3. To amend the Company's Amended and Restated Articles of Incorporation to effect a reverse stock split at one of two ratios, to be selected by the Board of Directors, in order to reduce the aggregate number of shares of common stock outstanding: A) One new share for each five currently held B) One new share for each ten currently held 28 4. To ratify the appointment of Grant Thornton, LLP as the Company's independent certified public accountants for the current fiscal year. All four matters were approved by the shareholders. The following table summarizes the results of the voting:
For Against Abstain Total Votes ---------- --------- ------- ----------- 1. Election of Director Nominees: Jethren P. Phillips 38,260,679 1,517,976 12,000 39,790,655 Neil G. Blomquist 38,260,679 1,517,976 12,000 39,790,655 Phillip L. Moore 38,264,081 1,514,574 12,000 39,790,655 Charles A. Lynch 38,260,679 1,517,976 12,000 39,790,655 Thomas B. Simone 38,260,679 1,517,976 12,000 39,790,655 Conrad W. Hewitt 38,260,679 1,517,976 12,000 39,790,655 2. Increase Shares Authorized for Issuance 32,861,288 1,537,900 -- 34,399,188 3. Reverse Stock Split: A) one-for-five 38,252,255 1,538,400 -- 39,790,655 B) one-for-ten 38,253,255 1,537,400 -- 39,790,655 4. Ratification of Grant Thornton, LLP 39,778,655 12,000 -- 39,790,655
Mr. John R. Battendieri was included in the definitive Proxy Statement as a Director Nominee; however, Mr. Battendieri elected to resign from the Company's Board of Directors effective April 1, 2004. Item 5. Other Information - -------------------------- Effective April 1, 2004 Mr. John R. Battendieri resigned as a non-executive Director of the Company's Board of Directors. Mr. Battendieri's decision to resign was not the result of any disagreement between himself and the Company or the Company's other Board members. Mr. Battendieri has also served the Company as a consultant for the past two years, managing the Company's private label product offerings. As a result, Mr. Battendieri does not meet the requirements of the Securities and Exchange Commission as an independent director, and would be required to meet a three year "cooling off" period, during which time he could not be compensated in any way by the Company beyond board fees. The Company intends to upgrade its stock listing to an AMEX or NASDAQ small-cap listing as soon as it meets the requirements for such. An independent Board of Directors is required by both exchanges and Mr. Battendieri's resignation will assist the Company toward meeting that requirement. Item 6. Exhibits and Reports on Form 8-K - ----------------------------------------- (a) Exhibits: 10.55 First Modification to Loan and Security Agreement dated June 4, 2004 by and between Spectrum Organic Products, Inc. and Comerica Bank. 31.07 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 29 31.08 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.07 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.08 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 June 30, 2004: The Company filed a Current Report on Form 8-K on May 11, 2004 disclosing the Company's unaudited financial position and results of operations as of and for the three months ended March 31, 2004. 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: August 2, 2004 SPECTRUM ORGANIC PRODUCTS, INC. By: /s/ Robert B. Fowles ---------------------------------- Robert B. Fowles Duly Authorized Officer & Chief Financial Officer 30 EX-10.55 2 spectrumexhib1055-063004.txt FIRST MODIFICATION TO LOAN AND SECURITY AGREEMENT Exhibit 10.55 FIRST MODIFICATION TO LOAN AND SECURITY AGREEMENT AND PROMISSORY NOTE This First Modification to Loan and Security Agreement and Promissory Note (this "Modification") is entered into by and between SPECTRUM ORGANIC PRODUCTS, INC., a California corporation ("Borrower") and COMERICA BANK, successor by merger to Comerica Bank-California ("Bank"), whose Western Division Headquarters is located at 333 West Santa Clara Street, San Jose, California as of June 4, 2004. RECITALS -------- This Modification is entered into upon the basis of the following facts and understandings of the parties, which facts and understandings are acknowledged by the parties to be true and accurate: Bank and Borrower previously entered into that certain Loan and Security Agreement (Accounts and Inventory), dated June 12, 2003. The Loan and Security Agreement (Accounts and Inventory) as such may be modified, amended, restated, revised, supplemented or replaced from time to time prior to the date hereof shall collectively be referred to herein as the "Agreement." Contemporaneously with the Agreement, Borrower has entered into that certain Variable Rate-Single Payment Note (Advancing-Optional Advances), dated June 12, 2003 in the original principal amount of One Million Dollars ($1,000,000). The certain Variable Rate-Single Payment Note (Advancing-Optional Advances), as such may be modified, amended, restated, revised, supplemented or replaced from time to time prior to the date hereof shall collectively be referred to herein as the "Note." NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as set forth below. AGREEMENT --------- 1. Incorporation by Reference. The Recitals and the documents referred to therein are incorporated herein by this reference. Except as otherwise noted, the terms not defined herein shall have the meaning set forth in the Agreement. 2. Modification to the Agreement. Subject to the satisfaction of the conditions precedent as set forth in Section 4 hereof, the Agreement is hereby modified as set forth below. (a) The definition of "Borrowing Base" set forth in Section 1.7 of the Agreement hereby is deleted in its entirety and replaced with the following: "1.7 "Borrowing Base" shall mean the sum of: (1) Eighty percent (80%) of the net amount of Eligible Accounts after deducting therefrom all payments, adjustments and credits applicable thereto; and (2) The lesser of (i) sixty percent (60%) of the net amount of Eligible Inventory after deducting therefrom all applicable Growers' Payables incurred in connection with the acquisition of such Eligible Inventory and after all adjustments for age and seasonality or other factors affecting the value of such Inventory, or (ii) One Million Five Hundred Thousand Dollars ($1,500,000) in excess of the aggregate amount of all outstanding Indebtedness consisting of that portion of the Credit advanced to Borrower on the basis of Eligible Accounts; provided, however, that, commencing on the first date following June 30, 2004 on which Borrower shall have delivered satisfactory evidence to Bank of Borrower's compliance with the minimum Net Income covenant set forth in Section 6.17 c. of this Agreement, the maximum amount of all advances on the basis of Eligible Inventory shall be Two Million Dollars ($2,000,000) in excess of the aggregate amount of all outstanding Indebtedness advanced on the basis of Eligible Accounts. Anything contained in the foregoing to the contrary notwithstanding, that at all times that the aggregate amount of all Dilution (as calculated by Bank on the basis of Bank's most recent audit of Borrower's Books conducted under Section 6.25 hereof), as a percentage of all Accounts, is five percent (5%) or less, then the percentage of Eligible Accounts that shall be included in the Borrowing Base shall be increased to eighty five percent (85%) of the net amount of Eligible Accounts after deducting therefrom all payments, adjustments and credits applicable thereto." (b) The definition of "Credit Limit" set forth in Section 1.13 of the Agreement hereby is deleted in its entirety and replaced with the following: "1.13 "Credit Limit" shall mean Seven Million Dollars ($7,000,000); provided, however, that, commencing on the first date following June 30, 2004 on which Borrower shall have delivered satisfactory evidence to Bank of Borrower's compliance with the minimum Net Income covenant set forth in Section 6.17 c. of this Agreement, the Credit Limit shall be Nine Million Dollars ($9,000,000)." (c) The definition of "Maturity Date" set forth in Section 1.38 of the Agreement hereby is deleted in its entirety and replaced with the following: "1.38 "Maturity Date" shall mean June 30, 2006." (d) Section 2.5 c. of the Agreement hereby is deleted in its entirety and replaced with the following: "c. Drawings under Non-Revolving Loan shall be available from the date of this Agreement through December 31, 2004, at which time the entire outstanding principal amount of all such drawings shall be repaid in forty eight (48) fully amortizing payments plus interest, due and payable on the last day of each month through December 31, 2008. The interest rate, payment terms, maturity date and certain other terms of Non-Revolving Loan shall be contained in a promissory note dated the date of this Agreement, as such may be amended or replaced from time to time." (e) Section 2.6 b. of the Agreement hereby is deleted in its entirety and replaced with the following: "b. In connection with the financial accommodations provided under Section 2.5 of this Agreement, an unused commitment fee in an amount equal to one eighth percent (0.125%) per annum shall be due and payable on the last day of each quarter through the quarter ending December 31, 2004. The unused commitment fee shall be calculated on the difference between the average Daily Balance of the Credit consisting of loans Non-Revolving Loans made under Section 2.5 and One Million Dollars ($1,000,000) and shall be fully earned and non-refundable on the date of payment thereof." (f) Section 6.17 b. of the Agreement hereby is deleted in its entirety and replaced with the following: "b. Cash Flow Coverage Ratio of not less than 1.25:1.00, measured quarterly as of the end of each fiscal quarter of Borrower; and" (g) The following new Section 10.7 hereby is inserted into the Agreement in its entirety immediately following existing Section 10.6 thereof, and shall read as follows, and each subsequent section of the Agreement shall be renumbered accordingly, mutatis, mutandis: "10.7 Reference Provision. a. The parties prefer that any dispute between them be resolved in litigation subject to a Jury Trial Waiver as set forth in the Loan Documents (defined below), but the availability of that process is in doubt because of the opinion of the California Court of Appeal in Grafton Partners LP v. Superior Court, 9 Cal.Rptr.3d 511. This Reference Provision will be applicable until the California Supreme Court completes its review of that case, and will continue to be applicable if either that court or a California Court of Appeal publishes a decision holding that a pre-dispute Jury Trial Waiver provision similar to that contained in the Loan Documents is invalid or unenforceable. Delay in requesting appointment of a referee pending review of any such decision, or participation in litigation pending review, will not be deemed a waiver of this Reference Provision. b. Other than (i) nonjudicial foreclosure of security interests in real or personal property, (ii) the appointment of a receiver or (iii) the exercise of other provisional remedies (any of which may be initiated pursuant to applicable law), any controversy, dispute or claim (each, a "Claim") between the parties arising out of or relating to this Agreement or any other document, instrument or agreement between the Bank and the undersigned (collectively in this Section, the "Loan Documents"), will be resolved by a reference proceeding in California in accordance with the provisions of Section 638 et seq. of the California Code of Civil Procedure ("CCP"), or their successor sections, which shall constitute the exclusive remedy for the resolution of any Claim, including whether the Claim is subject to the reference proceeding. Except as otherwise provided in the Loan Documents, venue for the reference proceeding will be in the Superior Court or Federal District Court in the County or District where the real property, if any, is located or in a County or District where venue is otherwise appropriate under applicable law (the "Court"). c. The referee shall be a retired Judge or Justice selected by mutual written agreement of the parties. If the parties do not agree, the referee shall be selected by the Presiding Judge of the Court (or his or her representative). A request for appointment of a referee may be heard on an ex parte or expedited basis, and the parties agree that irreparable harm would result if ex parte relief is not granted. The referee shall be appointed to sit with all the powers provided by law. Each party shall have one peremptory challenge pursuant to CCP ss.170.6. Pending appointment of the referee, the Court has power to issue temporary or provisional remedies. d. The parties agree that time is of the essence in conducting the reference proceedings. Accordingly, the referee shall be requested to (a) set the matter for a status and trial- setting conference within fifteen (15) days after the date of selection of the referee, (b) if practicable, try all issues of law or fact within ninety (90) days after the date of the conference and (c) report a statement of decision within twenty (20) days after the matter has been submitted for decision. Any decision rendered by the referee will be final, binding and conclusive, and judgment shall be entered pursuant to CCP ss.644. e. The referee will have power to expand or limit the amount and duration of discovery. The referee may set or extend discovery deadlines or cutoffs for good cause, including a party's failure to provide requested discovery for any reason whatsoever. Unless otherwise ordered, no party shall be entitled to "priority" in conducting discovery, depositions may be taken by either party upon seven (7) days written notice, and all other discovery shall be responded to within fifteen (15) days after service. All disputes relating to discovery which cannot be resolved by the parties shall be submitted to the referee whose decision shall be final and binding. f. Except as expressly set forth in this Agreement, the referee shall determine the manner in which the reference proceeding is conducted including the time and place of hearings, the order of presentation of evidence, and all other questions that arise with respect to the course of the reference proceeding. All proceedings and hearings conducted before the referee, except for trial, shall be conducted without a court reporter, except that when any party so requests, a court reporter will be used at any hearing conducted before the referee, and the referee will be provided a courtesy copy of the transcript. The party making such a request shall have the obligation to arrange for and pay the court reporter. Subject to the referee's power to award costs to the prevailing party, the parties will equally share the cost of the referee and the court reporter at trial. g. The referee shall be required to determine all issues in accordance with existing case law and the statutory laws of the State of California. The rules of evidence applicable to proceedings at law in the State of California will be applicable to the reference proceeding. The referee shall be empowered to enter equitable as well as legal relief, provide all temporary or provisional remedies, enter equitable orders that will be binding on the parties and rule on any motion which would be authorized in a trial, including without limitation motions for summary judgment or summary adjudication . The referee shall issue a decision at the close of the reference proceeding which disposes of all claims of the parties that are the subject of the reference. The referee's decision shall be entered by the Court as a judgment or an order in the same manner as if the action had been tried by the Court. The parties reserve the right to appeal from the final judgment or order or from any appealable decision or order entered by the referee. The parties reserve the right to findings of fact, conclusions of laws, a written statement of decision, and the right to move for a new trial or a different judgment, which new trial, if granted, is also to be a reference proceeding under this provision. h. If the enabling legislation which provides for appointment of a referee is repealed (and no successor statute is enacted), any dispute between the parties that would otherwise be determined by reference procedure will be resolved and determined by arbitration. The arbitration will be conducted by a retired judge or Justice, in accordance with the California Arbitration Act ss.1280 through ss.1294.2 of the CCP as amended from time to time. The limitations with respect to discovery set forth above shall apply to any such arbitration proceeding. i. THE PARTIES RECOGNIZE AND AGREE THAT ALL DISPUTES RESOLVED UNDER THIS REFERENCE PROVISION WILL BE DECIDED BY A REFEREE AND NOT BY A JURY, AND THAT THEY ARE IN EFFECT WAIVING THEIR RIGHT TO TRIAL BY JURY IN AGREEING TO THIS REFERENCE PROVISION. AFTER CONSULTING (OR HAVING HAD THE OPPORTUNITY TO CONSULT) WITH COUNSEL OF THEIR OWN CHOICE, EACH PARTY KNOWINGLY AND VOLUNTARILY AND FOR THEIR MUTUAL BENEFIT AGREES THAT THIS REFERENCE PROVISION WILL APPLY TO ANY DISPUTE BETWEEN THEM WHICH ARISES OUT OF OR IS RELATED TO THIS AGREEMENT OR THE LOAN DOCUMENTS." (h) Schedule 6.5 to the Agreement hereby is deleted and replaced in its entirety with Amended and Restated Schedule 6.5, attached hereto as Exhibit A to this Modification and incorporated herein by this reference, and each reference to Schedule 6.5 contained in the Agreement shall be a reference thereto. 3. Modification to the Agreement. Subject to the satisfaction of the conditions precedent as set forth in Section 4 hereof, the Note is hereby modified as set forth below. (a) The Maturity Date (as that term is defined in the Note) hereby is extended from June 30, 2008 to December 31, 2008. (b) The end date of the Draw Period (as that term is defined in Addendum "A" to the Note) hereby is extended from June 30, 2004 to December 31, 2004. 4. Legal Effect. Except as specifically set forth in this Modification, all of the terms and conditions of the Agreement and the Note remain in full force and effect. Except as expressly set forth herein, the execution, delivery, and performance of this Modification shall not operate as a waiver of, or as an amendment of, any right, power, or remedy of Bank under the Agreement or the Note, as in effect prior to the date hereof. Borrower ratifies and reaffirms the continuing effectiveness of all promissory notes, guaranties, security agreements, mortgages, deeds of trust, environmental agreements, and all other instruments, documents and agreements entered into in connection with the Agreement and the Note. Borrower represents and warrants that the Representations and Warranties contained in the Agreement and the Note are true and correct as of the date of this Modification, and that no Event of Default has occurred and is continuing. The effectiveness of this Modification and each of the documents, instruments and agreements entered into in connection with this Modification, including without limit any replacement promissory note entered into in connection herewith, is conditioned upon receipt by Bank of this Modification, any other documents which Bank may require to carry out the terms hereof, and including but not limited to each of the following: (a) A non-refundable legal documentation fee of $750, plus any Bank expenses incurred through the date of this Modification. 5. Miscellaneous Provisions. (a) This is an integrated Modification and supersedes all prior negotiations and agreements regarding the subject matter hereof. All amendments hereto must be in writing and signed by the parties. (b) This Modification may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one instrument. IN WITNESS WHEREOF, the parties have agreed as of the date first set forth above. SPECTRUM ORGANIC PRODUCTS, INC., COMERICA BANK a California corporation By: /s/ Robert B. Fowles By: /s/ Misako Noda -------------------- --------------- Name: Robert B. Fowles Name: Misako Noda Title: Chief Financial Officer Its: Vice President - Western Division Exhibit A --------- Amended and Restated Schedule 6.5 Collateral Locations Address Owner/Lessor of Mortgagee ------- --------------- --------- Location -------- Borrower Locations ------------------ 5341 Old Redwood Highway Spectrum Organic Products, Inc. N/A Petaluma, California 94954 133 Copeland Street Spectrum Organic Products, Inc. N/A Petaluma, California 94952 260 North Pioneer Avenue Interpac Technologies, Inc. N/A Woodland, California 95776 1250 North McDowell Blvd. Interpac Technologies, Inc. N/A Petaluma, California 95954 BIOWA Nutraceuticals, LLC American Natural Soy N/A 1510 South Second Street Processors, LLC Cherokee, Iowa 51012 3345 Warbler Avenue American Natural Soy N/A Hartley, Iowa 51346 Processors, LLC Bailee Locations ---------------- Adobe Creek Storage Same N/A 3800 Lakeville Highway Petaluma, California 94954 American Natural Soy Same N/A 1510 South 2nd Street Cherokee, Iowa 51012 The Barlow Company Same N/A 200 Morris Street Sebastopol, California 94573 Blossom Valley Foods Same N/A 20 Casey Street Gilroy, California 95020 Specialty Distributing Same N/A 207 Tobin Crescent Saskatoon, Canada Catania-Spagna Corp. Same N/A 1 Nemco Way Ayer, Massachusetts 01432 Custom Park Same N/A 620 Spring Street North Dighton, Massachusetts 02764 Cotati Egg Farm Same N/A 441 Houser Street Cotati, California 94931 Follmer Development Co. Same N/A 850 Tourmaline Drive Newbury Park, California 91320 Liberty Vegetable Oil Same N/A 15306 So. Carmenita Road Santa Fe Springs, California 90670 Address Owner/Lessor of Mortgagee ------- --------------- --------- Location -------- Manzana Products Same N/A 9141 Green Valley Road Sebastopol, California 95473 Partners Mira Loma Old Storage Same N/A 4705 Brook Hollow Circle Mira Loma, California 92509 Q & B Foods Same N/A 15547 First Street Irwindale, California 91706 Robinson Pharma Same N/A 3330 S. Harbor Boulevard Santa Ana, California 92704 Swiss Caps Same N/A 14193 S.W. 119th Avenue Miami, Florida 33186 U.S. Cold Storage Same N/A 33400 Dowe Avenue Union City, California 94587 Terminal Freezers Same N/A 908 East 3rd Street Oxnard, California 93030 Triple H Food Processors Same N/A 5821 Wilderness Avenue Riverside, California 92504 Wilbur-Ellis Seed Storage Same N/A 10660 Houston Avenue Hanford, California 93230 EX-31.07 3 spectrum6302004exh3107.txt CERTIFICATIONS REQUIRED UNDER SECTION 302 Exhibit 31.07 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 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 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 report; 3. Based on my knowledge, the financial statements and other financial information included in this 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 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-15(e) and 15d-15(e) for the registrant and we have: a) designed such disclosure controls and procedures or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's control over financial reporting. 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: a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; 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 over financial reporting. Date: August 2, 2004 /s/ Neil G. Blomquist ------------------------- Neil G. Blomquist Chief Executive Officer EX-31.08 4 spectrum6302004exh3108.txt CERTIFICATIONS REQUIRED UNDER SECTION 302 Exhibit 31.08 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 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 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 report; 3. Based on my knowledge, the financial statements and other financial information included in this 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 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-15(e) and 15d-15(e) for the registrant and we have: a) designed such disclosure controls and procedures or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's control over financial reporting. 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: a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; 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 over financial reporting. Date: August 2, 2004 /s/ Robert B. Fowles ------------------------------ Robert B. Fowles Chief Financial Officer EX-32.07 5 spectrum6302004exh3207.txt CERTIFICATIONS REQUIRED UNDER SECTION 906 Exhibit 32.07 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 In connection with the Quarterly Report on Form 10-Q of Spectrum Organic Products, Inc. (the "Company") for the quarterly period ended June 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Neil G. Blomquist, Chief Executive Officer of the Company, certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and 2) the information contained in the Report presents fairly, in all material respects, the financial condition and results of operations of the Company. /s/ Neil G. Blomquist ----------------------------------- Neil G. Blomquist Chief Executive Officer August 2, 2004 A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 has been provided to the Company and will be furnished to the Securities and Exchange Commission or its staff upon request. EX-32.08 6 spectrum6302004exh3208.txt CERTIFICATIONS REQUIRED UNDER SECTION 906 Exhibit 32.08 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 In connection with the Quarterly Report on Form 10-Q of Spectrum Organic Products, Inc. (the "Company") for the quarterly period ended June 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Robert B. Fowles, Chief Financial Officer of the Company, certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and 2) the information contained in the Report presents fairly, in all material respects, the financial condition and results of operations of the Company. /s/ Robert B. Fowles -------------------------------- Robert B. Fowles Chief Financial Officer August 2, 2004 A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 has been provided to the Company and will be furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----