UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(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
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to __________
Commission file number _000-50373__
SPECTRUM SCIENCES & SOFTWARE HOLDINGS CORP.
---------------------------------------
(Exact name of small business issuer
as specified in its charter)
DELAWARE 80-0025175
------------------------------ --------------------
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
91 HILL AVENUE NW,
FORT WALTON BEACH, FLORIDA 32548
(Address of principal executive offices)
(Zip Code)
Issuer's telephone number (850) 796-0909
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
As of June 30, 2004 there were 40,069,300 shares of the registrant's common
stock, par value $0.0001, issued and outstanding.
Transitional Small Business Disclosure Format (check one):
Yes [ ] No [X]
SPECTRUM SCIENCES & SOFTWARE HOLDINGS CORP.
JNUE 30, 2004 QUARTERLY REPORT ON FORM 10-QSB
TABLE OF CONTENTS
Special Note Regarding Forward Looking Statements 3
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheet as of June 30, 2004(unaudited) 4
Consolidated Statements of Operations for the three months ended
June, 2004 and 2003 (unaudited) 5
Consolidated Statements of Operations for the six months ended
June, 2004 and 2003 (unaudited) 6
Consolidated Statements of Changes in Stockholders'
Equity for the six months ended June 30, 2004 (unaudited) 7
Consolidated Statements of Cash Flows for the six months ended
June, 2004 and 2003 (unaudited) 8
Notes to Consolidated Financial Statements (unaudited) 9
Item 2. Management's Discussion and Analysis or Plan of Operations 18
Item 3. Controls and Procedures 25
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 2. Changes in Securities 28
Item 3. Defaults Upon Senior Securities 29
Item 4. Submission of Matters to a Vote of Security Holders 29
Item 5. Other Information 29
Item 6. Exhibits and Reports on Form 8-K 29
2
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
To the extent that the information presented in this Quarterly Report on
Form 10-QSB for the quarter ended June 30, 2004, discusses financial
projections, information or expectations about our products or markets, or
otherwise makes statements about future events, such statements are
forward-looking. We are making these forward-looking statements in reliance on
the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. Although we believe that the expectations reflected in these
forward-looking statements are based on reasonable assumptions, there are a
number of risks and uncertainties that could cause actual results to differ
materially from such forward-looking statements. These risks and uncertainties
are described, among other places in this Quarterly Report, in "Management's
Discussion and Analysis or Plan of Operations."
In addition, we disclaim any obligations to update any forward-looking
statements to reflect events or circumstances after the date of this Quarterly
Report. When considering such forward-looking statements, you should keep in
mind the risks referenced above and the other cautionary statements in this
Quarterly Report.
3
SPECTRUM SCIENCES & SOFTWARE HOLDINGS CORP.
Consolidated Balance Sheet
As of June 30, 2004
(Unaudited)
ASSETS
Current assets:
Cash and equivalents $ 6,049,442
Investments 22,543,386
Receivables 2,898,269
Inventories 372,610
Prepaid expenses 239,256
-------------
Total current assets 32,102,963
-------------
Property and equipment, net 2,042,653
Deferred tax asset 40,034
Cash surrender value of life insurance 38,665
Other assets and deposits 40,358
-------------
TOTAL ASSETS $ 34,264,673
=============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 744,877
Accrued expenses 927,138
Notes payable 1,702,981
-------------
Total current liabilities 3,374,996
-------------
Total liabilities 3,374,996
-------------
Stockholders' equity:
Preferred stock, $0.0001 par value; 20,000,000 shares
authorized, none issued -
Common stock, $0.0001 par value; 80,000,000 shares authorized,
40,069,300 issued and outstanding 4,007
Additional paid-in capital 72,104,521
Accumulated comprehensive income 13,781
Accumulated deficit (41,232,632)
-------------
Total stockholders' equity 30,889,677
-------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 34,264,673
=============
See accompanying notes to the consolidated financial statements.
4
SPECTRUM SCIENCES & SOFTWARE HOLDINGS CORP.
Consolidated Statements of Operations
For the three months ended June 30, 2004 and 2003
(Unaudited)
2004 2003
------------ ----------
Revenues 3,418,747 3,443,361
Cost of Revenues 3,054,924 3,011,137
------------ ----------
Gross Profit 363,823 432,224
Operating Expenses 27,053,790 275,170
Impairment Loss - 145,974
------------ ----------
Income (loss) from operations (26,689,967) 11,080
Other Income (expense) -
Interest Income 25,845 52
Building Rent 49,561 45,351
Other Income and Expense (2,871) (4,118)
Interest Expense (64,052) (80,365)
Penalties (31) (2,587)
------------ ----------
Total other income (expense) 8,452 (41,667)
------------ ----------
Loss before provision for income taxes (26,681,515) (30,587)
Income tax benefit - -
------------ ----------
Net loss (26,681,515) (30,587)
Unrealized gain on available for sale securities 13,781 -
------------ ----------
Total comprehensive loss (26,667,734) (30,587)
============ ==========
Weighted average common shares outstanding:
Basic and diluted 36,795,363 -
============ ==========
Loss per share:
Basic and diluted (.72) -
============ ==========
See accompanying notes to the consolidated financial statements.
5
SPECTRUM SCIENCES & SOFTWARE HOLDINGS CORP.
Consolidated Statements of Operations
For the six months ended June 30, 2004 and 2003
(Unaudited)
2004 2003
------------- ------------
Revenues $ 7,015,325 $ 6,716,390
Cost of revenues (6,329,305) (6,053,574)
------------- ------------
Gross profit 686,020 662,816
Operating expenses 41,005,374 439,640
Impairment Loss - 145,974
------------- ------------
Income (loss) from operations (40,319,354) 77,202
Other income and expense:
Interest income 26,210 -
Building rent 99,121 90,702
Other income 1,985 (19,164)
Interest expense (127,903) (149,145)
Other expenses (3,912) -
------------- ------------
Total other income (expense) (4,499) (77,607)
Net loss before provision for income taxes (40,323,853) (405)
Income tax benefit 61,330 -
------------- ------------
Net loss (40,262,523) (405)
Unrealized gain on available for sale securities 13,781 -
------------- ------------
Total comprehensive loss $(40,248,742) $ (405)
============= ============
Weighted average common shares outstanding 27,505,843 -
============= ============
Basic and diluted loss per share $ (1.46) -
============= ============
See accompanying notes to the consolidated financial statements.
6
SPECTRUM SCIENCES & SOFTWARE HOLDINGS CORP.
Consolidated Statements of Changes in Stockholders' Equity
For the six months ended June 30, 2004
(Unaudited)
Common Stock Accumulated
------------- -------------
Shares Comprehensive Accumulated
Outstanding Amount APIC Income Deficit Total
------------- ------------- ----------- --------------- ------------- -----------
Balance at January 1, 2004 18,851,000 $ 1,885 $ 79,426 $ (970,108) $ (888,797)
Stock options issued
for consulting services - 37,258,300 37,258,300
Exercise of stock options 21,178,300 2,118 37,095,567 37,097,685
Stock subscription receivable (2,520,126) (2,520,126)
Stock options issued under
employee stock option plan to a
consultant 125,358 125,358
Exercise of stock options 40,000 4 65,996 66,000
Unrealized gain on investments 13,781 13,781
Net loss (40,262,524) (40,262,524)
------------- ------------- ----------- --------------- ------------- -----------
Balances at June 30, 2004 40,069,300 $ 4,007 $72,104,521 $ 13,781 $(41,232,632) $30,889,677
============= ============= =========== =============== ============= ===========
See accompanying notes to the consolidated financial statements.
7
SPECTRUM SCIENCES & SOFTWARE HOLDINGS CORP.
Consolidated Statements of Cash Flows
For the six months ended June 30, 2004 and 2003
(Unaudited)
2004 2003
------------- ----------
Cash flows from operating activities:
Net income (loss) $(40,262,523) $ (405)
Adjustments to reconcile net income (loss) to net cash flows
from operating activities:
Impairment Loss 145,974
Deferred taxes (28,594)
Depreciation and amortization 72,083 39,603
Amortization of investment bond premium 8,496
Accrued interest payable due to related parties 9,792 -
Issuance of common stock options to related party
for consulting services 37,258,300 -
Issuance of common stock options under employee stock option plan 125,358
Investor relations expenses paid by a related party 2,057,500 -
(Increase) decrease in:
Receivables (1,170,385) 272,470
Inventories (250,218) 62,572
Prepaid expenses (220,533) (67,527)
Other assets (26,999) 1,000
Increase (decrease) in:
Accounts payable (525,982) (338,790)
Accrued expenses 368,557 (180,122)
Contract deposits (50,000) (30,788)
Deferred revenues (36,967) -
------------- ----------
Net cash flows used in operating activities (2,672,115) (96,013)
------------- ----------
Cash flows from investing activities:
Net purchases of available for sale investments (22,538,101)
Purchase of property and equipment (109,993) (20,395)
------------- ----------
Net cash used in investing activities (22,648,094) (20,395)
------------- ----------
Cash flows from financing activities:
Principal payments on notes payable and lines of credit (753,318) (272,011)
Net repayment on bank line of credit - 16,479
Repayment of short term debt (307,726) -
Repayments on advances from related parties (52,500) -
Advances from related parties 672,551 2,863
Proceeds from the exercise of stock options 31,113,685 -
------------- ----------
Net cash provided by (used in) financing activities 30,672,692 (252,669)
------------- ----------
Net increase (decrease) in cash 5,352,483 (369,077)
Cash at beginning of period 696,959 633,909
------------- ----------
Cash at end of period $ 6,049,442 $ 264,832
============= ==========
Supplemental disclosures of cash flow information:
Cash paid during the quarter for:
Interest $ 127,903 $ 149,393
============= ==========
Supplemental schedule of non-cash financing and investing activities:
Reduction in due to related party in lieu of cash payment
for exercise of stock options. $ 3,529,873 $ -
============= ==========
Unrealized gain on available for sale securities $ 13,781 $ -
============= ==========
See accompanying notes to the consolidated financial statements.
8
Notes to the Consolidated Financial Statements
Three and Six Months ended June 30, 2004 (Unaudited)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
(A) Organization and Nature of Business
Silva Bay International, Inc., a Delaware corporation, was formed in 1998 for
the purpose of locating and recovering rare and valuable aircraft. Silva Bay
International, Inc. had no operations and no revenue from inception in 1998 to
the time of the acquisition of Spectrum Sciences & Software, Inc. in April,
2003.
Spectrum Sciences & Software, Inc. was incorporated in the State of Florida on
October 8, 1982. Headquartered in Fort Walton Beach, Florida, the Company has
three reportable segments - management services, manufacturing, and engineering
and information technology services. Management services include providing
engineering, technical, and operational services in the area of defense range
management specializing in bombing and gunnery training range operation and
maintenance. Manufacturing operations include the design and construction of
munitions ground support equipment and containers for the shipping and storage
of munitions and equipment. The Company's engineering and information technology
services segment consists of the sale of computer software developed to assist
in hazard management and weapons impact analysis.
On April 2, 2003, Silva Bay International, Inc. acquired Spectrum Sciences &
Software, Inc., a Florida corporation, in exchange for the issuance of 2,500,000
shares of common stock (taking into account the forward two for one stock split
of April 9, 2003) (see Note 3). Spectrum Sciences & Software, Inc. is now the
wholly owned subsidiary of Silva Bay International, Inc. (now collectively
referred to as the "Company").
On April 8, 2003, Silva Bay International, Inc. changed its name to Spectrum
Sciences & Software Holdings Corp. On April 9, 2003, the Company effectuated a
two for one forward split of its common stock. On November 4, 2003, the
Company's registration statement as a reporting company under the Exchange Act
became effective.
The Company's contracts are primarily fixed price contracts with the United
States Department of Defense (DOD). During the three months and six months ended
June 30, 2004, 99% of the Company's revenues were derived from such contracts.
(B) Income Taxes
The Company accounts for income taxes utilizing the asset and liability method.
This approach requires the recognition of deferred tax assets and liabilities
for the expected future tax consequences attributable to temporary differences
between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases and operating loss and tax credit
carryforwards. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enacted date. Valuation allowances are
established when necessary to reduce deferred tax assets to the amount expected
to be realized.
9
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
(B) Income Taxes, Continued
The Company currently has a net operating loss carryforward of $40,300,000,
which would equate to a deferred tax asset of approximately $16,000,000 at June
30, 2004. The Company has not recorded that federal tax benefit in the
accompanying financial statements, as management does not have sufficient
information to estimate when or to the extent to which the Company will realize
the tax benefit.
(C) Earnings (Loss) Per Share
The Company reports its earnings (loss) per share in accordance with Financial
Accounting Standards Board (FASB) Statement No. 128, "Earnings Per Share."
Statement No. 128 requires the presentation of basic and diluted loss per share
on the face of the statement of operations. Net income (loss) per common share
is computed by dividing the net income (loss) by the weighted average number of
common shares outstanding for the period. Diluted net income (loss) per common
share reflects the potential dilution that could occur if stock options were
exercised.
The weighted average number of common shares outstanding for computing basic and
diluted net income (loss) per common share for the six months ended June 30,
2004 was 27,505,843.
(D) Financial Instruments
The Company considers all highly liquid interest-earning investments with a
maturity of three months or less at the date of purchase to be cash equivalents.
All cash and investments are classified as available for sale and are recorded
at market value using the specific identification method; unrealized gains and
losses are reflected in Other Comprehensive Income ("OCI").
Investments consist of debt instruments. Debt securities are classified as
available for sale and are recorded at market using the specific identification
method. Unrealized gains and losses (excluding other-than-temporary
impairments) are reflected in OCI.
10
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
2. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements for the three and
six month periods ended June 30, 2004 and 2003 have been prepared in accordance
with accounting principles generally accepted in the United States of America
for interim financial information and pursuant to the rules and regulations of
the Securities and Exchange Commission for Form 10-QSB. Accordingly, they do
not include all the information and footnotes required by accounting principles
generally accepted in the United States of America for complete financial
statements. In the opinion of management, the accompanying unaudited
consolidated financial statements contain all adjustments, consisting only of
normal recurring accruals, considered necessary for a fair presentation of the
Company's financial position, results of operations, and cash flows for the
periods presented.
The results of operations for the interim periods ended June 30, 2004 and 2003
are not necessarily indicative of the results to be expected for the full year.
These interim consolidated financial statements should be read in conjunction
with the December 31, 2003 consolidated financial statements.
11
3. ACQUISITION OF SPECTRUM SCIENCES & SOFTWARE, INC.:
On April 3, 2003, Spectrum Sciences & Software Holdings Corp. (formerly Silva
Bay International, Inc.) entered into an amended and restated agreement and plan
of merger with Spectrum Sciences & Software, Inc., pursuant to which Spectrum
Sciences & Software, Inc. became Spectrum Sciences & Software Holdings Corp.'s
wholly owned subsidiary. As part of this agreement, 2,500,000 shares of the
Company's common stock were issued to Donal Myrick, the sole stockholder of
Spectrum Sciences & Software, Inc.
The acquisition was accounted for under the purchase method of accounting;
accordingly, the purchase price has been allocated to reflect the fair value of
assets and liabilities acquired at the date of acquisition. Due to the
composition of the majority of the governing body and senior management of the
Company being the same as Spectrum Sciences & Software, Inc. prior to the April
3, 2003 acquisition, Spectrum Sciences & Software, Inc. has been deemed to be
the accounting acquirer (a reverse acquisition).
The financial statements of the Company prior to April 3, 2003 are those of
Spectrum Sciences & Software, Inc. The results of operation of the acquired
business have been included in the accompanying consolidated financial
statements from the date of acquisition.
4. CASH AND INVESTMENTS:
Cash and investments consist of the following at June 30, 2004:
Unrealized Unrealized Recorded
Cost Basis Gains Losses Basis
---------- ---------- ---------- -----------
June 30, 2004
Cash and equivalents:
Cash $ 1,572,445 $ - $ - $ 1,572,445
Money market mutual funds 4,476,997 - - 4,476,997
---------- ---------- ---------- -----------
Cash and equivalents 6,049,442 - - 6,049,442
---------- ---------- ---------- -----------
Investments:
Certificate of deposit 500,000 500,000
U.S. government and agency securities 21,927,654 13,781 - 21,941,435
Bond premium, net of amortization 101,951 - - 101,951
---------- ---------- ---------- -----------
Total, investments $22,529,605 $ 13,781 $ - $22,543,386
========== ========== ========== ===========
5. RECEIVABLES:
Receivables, which are primarily comprised of amounts due to the Company for
work performed on contracts directly related to the U.S. Department of Defense
and through U.S. Department of Defense contractors, consisted of the following
at June 30, 2004:
Contracts - billed $ 2,591,838
Contracts - unbilled 298,355
Other receivables 8,076
---------------
$ 2,898,269
===============
12
6. INVENTORIES:
Inventories are valued at the lower of cost or market. Cost is determined using
the first-in, first-out method. The major components of inventories at June 30,
2004 are summarized as follows:
Raw materials, net of reserve $ 113,888
Work in process 258,722
-------------
Total inventories 372,610
=============
7. PROPERTY AND EQUIPMENT:
Property and equipment at June 30, 2004 is summarized as follows:
Land $ 175,000
Buildings and improvements 1,633,520
Furniture and fixtures 28,721
Equipment 990,787
Vehicles 55,390
Investment property 220,900
-------------
3,104,318
Less accumulated depreciation (1,061,665)
-------------
Property and equipment, net $ 2,042,653
=============
8. ACCRUED EXPENSES:
The major components of accrued expenses at June 30, 2004 are summarized as
follows:
Accrued salaries and related benefits $ 764,409
Payroll related taxes 17,457
Accrued vacation and sick leave 116,976
Accrued interest payable 11,965
Accrued property taxes 16,331
-------------
Total accrued expenses $ 927,138
=============
9. LONG TERM DEBT:
Long term debt at June 30, 2004 consists of the following:
Note payable to a bank, due in monthly installments of $14,870, including
interest at 8.50%. Final balloon payment of $1,476,298 due April 1, 2005,
collateralized by real estate and a personal guarantee of the former Company
President. $ 1,514,491
Note payable to a bank, due in monthly installments of $1,588, including
interest at 8.75%. Final Balloon payment due April 1, 2005, collateralized by a
condominium and a personal guarantee of the former Company President. 188,490
----------------
1,702,981
Less current portion (1,702,981)
----------------
Total long-term debt $ -
================
13
10. RELATED PARTY TRANSACTIONS:
Transactions related to BG Capital Group Limited, Endeavor Group, LLC and
--------------------------------------------------------------------------------
Related Stockholder
--------------------
The Company was provided management consulting services by Endeavor Capital
Group, LLC, which is owned by one of the stockholders of the Company. The terms
of the original consulting agreement between Endeavor Capital Group, LLC and the
Company was from March 1, 2003, to March 1, 2004. Consulting fees of $4,000 a
month for January and February, 2004 and expenses of $15,106 are reported as
consulting fees in the accompanying financial statements.
On March 11, 2004, the Company entered into a new consulting agreement with the
stockholder. The term of the agreement was for a one year period, and the
stockholder is tasked with bringing to the Company's attention potential or
actual opportunities which meet its business objectives or logical extensions
thereof, alert the Company to new or emerging high potential forms of production
and distribution, comment on corporate development, identify respective suitable
merger or acquisition candidates and related due diligence and other such
planning and development services as shall be requested by the Company.
On March 11, 2004, as a result of execution of the new consulting agreement, the
stockholder received options to purchase 9,000,000 shares of the Company's
common stock at a per share exercise price equal to the lesser of $1.65 or
the fair market value at the time of exercise. In accordance with FASB
Statement No. 123, Accounting for Stock-based Compensation, the Company recorded
consulting expense of $11,418,038 in the first quarter of 2004, based on the
fair value of the stock options at the date of grant using the Black-Scholes
pricing model.
On April 16, 2004, the Company and the stockholder amended and restated the
March 11, 2004, consulting agreement. The amended agreement extended the term of
the contract to April 19, 2006, and contains an exclusivity provision. As part
of that agreement, the stockholder was issued options to acquire an additional
9,000,000 shares of common stock at a per share exercise price equal to the
lesser of $1.95 or 60% of the closing price on the day preceding notice to
exercise. In addition, the stockholder was issued options to acquire 5,000,000
shares of common stock at an exercise price equal to the lesser of a $1.65 or
the fair market value at the time of exercise as a result of his role in the
Inland Fabricators LLC (IFAB) transaction which is further described in Part II,
Item 1 of this filing. In accordance with FASB Statement No. 123, the Company
recorded consulting expense of $25,840,262 in the second quarter of 2004, based
on the fair value of the stock options at the date of grant using the
Black-Scholes pricing model. The total options granted to the stockholder during
the six months ended June 30, 2004, were 23,000,000.
14
10. RELATED PARTY TRANSACTIONS, Continued
Transactions related to BG Capital Group Limited, Endeavor Group, LLC and
--------------------------------------------------------------------------------
Related Stockholder, Continued
--------------------
The stockholder exercised 21,178,300 options during the first six months of 2004
with an aggregate exercise price of $37,097,685. The Company received
$31,047,685 of cash from the stockholder and converted outstanding debt of
$3,529,873 owed to the stockholder and related companies in lieu of cash for
exercise of these options. The Company owed the stockholder $792,030 at
December 31, 2003. The stockholder had advanced the Company $672,551 during the
first four months of 2004 to pay operating expenses, and the Company had accrued
interest of $7,792 on two interest-bearing notes in the first quarter of 2004.
In addition, the stockholder paid for certain investor relations expenses
totaling $2,065,000 during the first quarter of 2004 on behalf of the Company.
During the second quarter of 2004 the Company reversed $7,500 of those expenses
bringing the total investor relations expense paid by the stockholder on behalf
of the Company to $2,057,500. As a result of these transactions the Company is
owed $2,520,126 by the stockholder at June 30, 2004 which amount has been netted
against stockholder equity.
These transactions are summarized in the following table:
Amount owed to stockholder & related entities at December 31, 2003 $ 792,030
Advances by stockholder during January through April, 2004, to pay operating expenses 672,552
Interest accrued on outstanding notes payable 7,792
Investor relations expenses paid by stockholder 2,057,500
Stock exercise - executed for debt on March 12, 2004 (1,485,000)
Stock exercise - executed for debt on March 19, 2004 (1,650,000)
Stock exercise - executed April 15, 2004, for which no payment was received
(1,815,000)
Stock exercise - partially executed for debt on April 16, 2004 (1,100,000)
------------
Total $(2,520,126)
============
On April 28, 2004, the Company was informed the SEC was conducting an informal
inquiry into the Company as further described in Part II, Item 5 of this filing.
As a result of this inquiry, on May 4, 2004, the Company suspended the
consulting agreement with this stockholder.
Transactions related to the spouse of the President of the Company
----------------------------------------------------------------------------
The Company in the second quarter of 2004 repaid $52,500 to the spouse of the
President of the Company. $50,000 was funds advanced to cover operating
expenses in 2003 and $2,500 represented interest.
15
11. STOCK OPTION PLAN:
On March 11, 2004, the board of directors approved and adopted a 2004
Non-Statutory Stock Option Plan for 10,000,000 shares of common stock to be
granted to employees, non-employee Directors, consultants and advisors. The
vesting and terms of all of the options are determined by the Board of Directors
and may vary by optionee; however, the term may be no longer than 10 years from
the date of grant. On April 16, 2004, the Board of Directors amended and
restated the stock option plan by increasing the number of shares from
10,000,000 to 30,000,000.
As of June 30, 2004, 23,000,000 options were granted to a non-employee
stockholder who provided consulting services to the Company as described in Note
10. FASB Statement No. 123, Accounting for Stock-based Compensation, requires
these options be valued at fair value at the date of grant. The fair value of
the first 9,000,000 options issued was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions: risk-free interest rate of 1%; no dividend yields; volatility
factors of the expected market price of our common stock of 0.62; and an
expected life of the options of 2 years. This generates a price of $1.27 per
option at the date of grant, which was March 11, 2004. As a result, $11,418,038
of consulting expense and additional paid-in capital was recorded at the date of
grant. The fair value of the remaining 14,000,000 options issued was estimated
at the date of grant using the Black-Scholes option pricing model with the
following weighted-average assumptions: risk-free interest rate of 1%; no
dividend yields; volatility factors of the expected market price of our common
stock of 0.67; and an expected life of the options of 2 years. This generates a
price of $1.85 per option at the date of grant, which was April 20, 2004. As a
result, $25,840,261 of consulting expense and additional paid-in capital was
recorded at the date of grant.
On April 20, 2004, the Company awarded 677,500 stock options to certain
employees, consultants, officers and directors for services rendered. The
Company applied the intrinsic value method of recognition and measurement under
Accounting Principles Board Opinion No. 25 (APB No. 25), "Accounting for Stock
Issued to Employees," to 602,500 stock options. As such no compensation expense
related to 602,500 employee stock options at the date of grant is reflected in
net income.
The remaining 75,000 options were issued to an individual who is a consultant to
the company. On April 28, 2004, that consultant exercised 40,000 options and the
company received $66,000 of cash at exercise. These options were valued at the
fair market value at the date of grant in accordance with FASB statement 123,
Accounting for Stock Compensation. The fair value of these options issued was
estimated at the date of grant using the Black-Scholes option pricing model with
the following weighted average assumptions: risk free interest rate 1%; no
dividend yields; volatility factors of the expected market price of our common
stock of .67; and an expected life of the option of one year. This generates a
price of $1.67 per option at the date of grant. As a result, $125,358 of
consulting expense and additional paid in capital were recorded at the date of
grant.
12. SEGMENT INFORMATION:
Segment information has been presented on a basis consistent with how business
activities are reported internally to management. Management evaluates
operating profit by segment taking into account direct costs of each segment's
products and services as well as an allocation of indirect corporate overhead
costs. The Company has three operating segments - management services,
manufacturing, and engineering and information technology. Management services
include providing engineering, technical, and operational services in the area
of defense range management specializing in bombing and gunnery training range
operation and maintenance. Manufacturing operations include the design and
16
construction of munitions ground support equipment and containers for the
shipping and storage of munitions and equipment. The Company's engineering and
information technology segment consists of the sale of computer software
developed to assist in hazard management and weapons impact analysis.
The following is a summary of certain financial information related to the three
segments during the six months ended June 30, 2004, and 2003:
Six months June 30
2004 2003
------------- -----------
Total revenues by segment
Management Services $ 5,006,801 $4,637,617
Engineering and Information Technology 767,903 763,981
Manufacturing 1,240,621 1,314,792
------------- -----------
Total Revenues $ 7,015,325 $6,716,390
============= ===========
Operating profit (loss) by segment
Management Services $ 45,008 $ 172,388
Engineering and Information Technology 429,728 315,180
Manufacturing 211,284 175,248
Operating Expenses not allocable to segments (41,005,374) (439,640)
Impairment Loss (145,974)
Interest income (expense) net (101,693) (149,145)
Other income (expense), net 97,194 71,538
------------- -----------
Net loss before provision for income taxes (40,323,853) (405)
============= ===========
During the six months ended June 30, 2004 and 2003, all of the Company's revenue
was generated in the United States of America (USA). As of June 30, 2004, all of
the Company's long-lived assets are located in the USA.
13. Commitments and Contingencies:
On March 31, 2004, the Company signed a letter of intent to acquire all of the
issued and outstanding membership interests of Inland Fabricators, LLC (IFAB) as
further described in Part II, Item 1 of this filing. The letter of intent was
not binding and the transaction was subject to the execution of a definitive
acquisition agreement by both parties.
On May 6, 2004, the Company provided guarantees in the amount of $500,000 to
secure an Irrevocable Letter of Credit(LOC) in favor of a major international
construction firm. The LOC provided the necessary performance guarantee for
IFAB under a previously negotiated Purchase Order with that major international
construction firm. No draws on the LOC have been made as of June 30, 2004. The
LOC expires May, 2005.
17
On May 6, 2004, a creditor group filed a suit against IFAB for certain sums owed
to the creditor group by IFAB as a successor to Thomas Inland Marine, LLC,
Pipeworks, Inc., Pipeworks Reserve, Inc. and Pipeworks Venezuela.
The Company also has a $25,000 deposit with IFAB at June 30, 2004, in relation
to the letter of intent. The letter of intent expired on June 30, 2004. The
Board of Directors and company management are considering the expiration of the
letter of intent, the structure of the offer and the impact of the outcome of
Inland's pending litigation. The status of negotiations with IFAB is further
described in Part II, Item 1 of this filing.
Robert Genovese, the stockholder described in Note 10 to the accompanying
financial statements, has submitted an additional $903,711 of expenses related
to investor relations services paid by him or related companies on behalf of the
Company. However, the Company has not been provided adequate support
documentation such as invoices, contracts, examples of work performed, and
cancelled checks to support these expenses. In addition, legal concerns exist
with regard to these expenses based on language in the revised consulting
agreement and the SEC informal inquiry. This matter is further discussed in
Part II, Item 1.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
You should read the following discussion and analysis in conjunction with the
unaudited financial statements (and notes thereto) and other financial
information of our company appearing elsewhere in this report.
COMPARISON OF THREE MONTHS ENDED JUNE 30, 2004 AND JUNE 30, 2003
Consolidated Overview:
For the three months ended June 30
--------------------------------------------
2004 2003
------------------- -----------------------
Revenue $ 3,418,747 100.0% $ 3,443,361 100.0%
Cost of Revenue 3,054,924 89.4% 3,011,137 87.4%
----------- ------ ----------- ------
Gross Profit $ 363,823 10.6% $ 432,224 12.6%
=========== ====== =========== ======
Overall, sales for the three-months ended June 30, 2004 decreased by less than
1% compared to the same period in 2003, primarily as a result of decreased sales
in the manufacturing segment, offset by slight increases in sales in the
management services and engineering and information technology services
segments. Gross profit as a percentage of sales was 10.6% for the 3 month
period ended June 30, 2004, compared to 12.6% for the prior year period,
primarily as a result of decrease in gross profit in the management services and
manufacturing segment, offset by an increase in gross profit margin of the
engineering and information technology services segment.
With the closeout of our Management Services contract at Gila Bend and the Barry
M. Goldwater Bombing Range (BMGR), scheduled for September 30, 2004 the Company
will experience a drop in revenue (and associated costs) that will not be
immediately replaced. The Gila Bend contract represents 69% of the company's
revenues and 6.5% of its gross profit. Overall company profit margins are
expected to increase based on the other two profitable segments. The company
will continue to look for business opportunities for our Management Services
group; however, the thrust will be for contracts with sufficient profitability
to support the effort of securing and managing the higher revenue projects.
Spectrum management has spent the last quarter positioning the company for the
future. The company has secured additional manufacturing space via a
lease/purchase agreement for a building adjacent to our corporate headquarters.
This increased capacity has added a metal treatment capability that the
manufacturing division did not previously possess. The company is actively
performing treatment on its own products (reducing overall costs of production)
and using the excess capacity to support local manufacturing concerns including
several large defense contractors in the area. Our ultimate goal is to have the
metal treatment capability revenues supporting the costs of the additional
building. With this new facility, we have increased our manufacturing space by
33,000 square feet. With this increased capacity we are positioning ourselves
for performance on several large multi-year manufacturing contracts we are
pursuing.
18
Our Engineering and Information Technology Division is receiving the first
increment of new development efforts which are a direct result of the Safe Range
Users Conference that Spectrum hosted for the Department of Defense earlier this
year. We expect further incremental contract awards as a result of that
conference. These awards will assure the next generation of the Safe Range
program's use in the Department of Defense over the coming years. The division
continues to market it's Safe Borders concept to appropriate government
agencies. Please see extended discussion of the status of Safe Borders in the
six months ending analysis section.
Management Services
For the three months ended June 30
--------------------------------------------
2004 2003
------------ ------ ---------- ----------
Revenue $ 2,365,770 100.0% 2,344,517 100.0%
Cost of Revenue 2,338,308 98.8% 2,254,082 96.1%
------------ ------ ---------- ------
Gross Profit $ 27,462 1.2% $ 90,435 3.9%
============ ====== ========== ======
Sales in the Management Services division increased approximately 1% for the
three-month period ended June 30, 2004 compared to 2003. However, gross profit
declined by approximately 69% due to increased expenses. The increases in
revenue and expense are primarily due to scheduled increases in reimbursable
labor cost under the Service Contract Act and collective bargaining agreement
for Spectrum's largest subcontractor, Washington Group International. In
addition, revenues and gross profit margins were adversely affected due to the
way the Company's largest range management contract was originally bid in 1999,
in that the fifth and final option year of the contract was bid at overall lower
rates in order to be successful in the contract award process. This bid
strategy is no longer employed by the company.
The Gila Bend contract represents 69% of the company's revenue and approximately
6.5% of the company's profit. The loss of this contract will have a
significant impact on the company's revenue that may not be immediately be
replaced. However, the impact of the loss of profits to the company will be
minimal. The company has determined to pursue more Operations & Maintenance
contracts that are of the Cost Plus Fixed Fee type in the future, versus a Firm
Fixed Price contract such as the Gila Bend contract.
Engineering and Information Technology Services
For the three months ended June 30
------------------------------------
2004 2003
-------- ------ --------- -------
Revenue $447,813 100.0% $ 434,628 100.0%
Cost of Revenue 169,877 37.9% 210,656 48.5%
-------- ------ --------- ------
Gross Profit $277,936 62.1% $ 223,972 51.5%
======== ====== ========= ======
19
Sales in the Engineering and Information Technology Services segment increased
3.0 % for the three month period ended June 30, 2004 as compared to the same
period in 2003.
Gross profit as a percent of sales was 62.1%, an increase of 24%. This increase
in gross profit was due to reductions of excess management salary costs
associated with the departure of Donald Garrison, Vice President, and the
restructuring of workflow and software production in the division. Please see
the six month ending M D & A section for greater discussion of Safe Borders and
other marketing activities of the division.
Manufacturing Segment
For the three months ended June 30,
----------------------------------
2004 2003
-------- ------ -------- ------
Revenue $605,164 100.0% $664,216 100.0%
Cost of Revenue 546,739 90.3% 546,399 82.3%
-------- ------ -------- ------
Gross Profit $ 58,425 9.7% $117,817 17.7%
======== ====== ======== ======
Sales in the Manufacturing segment decreased 8.8 % for the three-month period
ended June 30, 2004 as compared to the same period in 2003. The minor decrease
in sales is a direct result of programmed pursuit and acquisition of more
profitable engineering and prototype work. This focus effectively offset the
sales decrease while using the excess production capacity to perform long-term
developmental work, much of which is proprietary to Spectrum. During the same
period several Air Force and Navy multi-year, high margin contracts were awarded
to the company which will contribute to revenue in future periods.
Gross profit fell $59,392 for the three-month period ended June 30, 2004 as
compared to the same period in 2003. The superior performance by the division
in the second quarter of 2003 was based on specific repetitive contract work
that the division expects to secure more of in the near future.
The division has made a business development shift from job-type work to more
long term (multi-year) and advanced prototyping efforts. Our rapid response
capabilities permit us to accept and complete engineering design and prototype
manufacture of components required to complete on-going U.S. Air Force armament
systems test and development programs. In addition, improvements to
manufacturing processes and procedures were implemented which have enhanced and
streamlined our production efforts. These improvements have produced cost
efficiencies in overhead labor, purchasing, inventory management and overall
manufactured deliverables which will be reflected in the results of future
periods. Excess production capacity has been used to perform long-term
developmental work, much of which is proprietary to Spectrum.
Operating Expenses
June 30, 2004 June 30, 2003 Increase
-------------- -------------- ---------
Selling, general and
administrative expenses $ 27,053,790 $ 275,170 9,731%
============== ============== =========
20
Selling, general and administrative expenses Selling, general and administrative
("SG&A") expenses increased 9,731% for the three-month period ended June 30,
2004, as compared to the same period in 2003.
During the quarter ended June 30, 2004, there was $25,965,620 recorded for
stock-based consulting compensation. The impact caused an expense to the
Company; however, the grant of the options also increased additional paid-in
capital by $25,965,620. In addition, the Company recorded $101,348 of investor
relations expenses and $531,108 of legal and professional fees during the second
quarter of 2004. The significant increase in legal fees is associated with the
company's legal consultations and actions taken to respond to the SEC informal
inquiry.
These types of expenses were not present in the quarter ended June 30, 2003.
Other Income and Expenses
Interest income and expense, net - Net interest expense was $38,207 and $80,313
for the three-month period ended June 30, 2004 and 2003, respectively. The
reduction of $42,106 is due to the decrease of all principal balances due on
debt with SouthTrust Bank and other vendors, except that debt associated with
the real estate, and the significant interest income of $25,845 that was not
present in the quarter ended June 30, 2003.
Other income and expense, net - Net other income was $46,659 and $38,646 for
the three-month period ended June 30, 2004 and 2003, respectively. The increase
of $8,013 is attributed primarily to an increase in rental income from L-3
Communications in 2004.
COMPARISON OF SIX MONTHS ENDED JUNE 30, 2004 AND JUNE 30, 2003
Consolidated Overview:
For the six months ended June 30
-----------------------------------------
2004 2003
----------- ------ ----------- -------
Revenue $ 7,015,325 100.0% $ 6,716,390 100.0%
Cost of Revenue 6,329,305 90.2% 6,053,574 90.1
----------- ------ ----------- ------
Gross Profit $ 686,020 9.8% $ 662,816 9.9%
=========== ====== =========== ======
Overall, sales for the six-months ended June 30, 2004 increased by 4.5% compared
to the same period in 2003 due to increased marketing activity and the
Management Services segment's growth of 7.9%. Gross profit as a percentage of
sales remained fairly constant at 9.8 % for the 6 month period ended June 30,
2004. The increases in revenue are primarily due to scheduled increases in
reimbursable labor cost under the Service Contract Act in the management
services division.
21
Management Services
For the six months ended June 30,
------------------------------------------
2004 2003
------------ ------ ------------ ------
Revenue $ 5,006,801 100.0% 4,637,617 100.0%
Cost of Revenue 4,961,793 99.1% 4,465,229 96.3%
------------ ------ ------------ ------
Gross Profit $ 45,008 0.9% $ 172,388 3.7%
============ ====== ============ ======
Sales in the Management Services segment increased approximately 7.9% while
expenses increased 11.1% for the six-month period ended June 30, 2004 compared
to 2003. In addition, the establishment of the collective bargaining agreement
for the fire department which is run by Spectrum's largest subcontractor,
Washington Group International, has increased costs for the period.
Engineering and Information Technology Services
For the six months ended June 30,
-----------------------------------
2004 2003
-------- ------ --------- ------
Revenue $767,903 100.0% $ 763,981 100.0%
Cost of Revenue 338,175 44.0% 448,801 58.7%
-------- ------ --------- ------
Gross Margin $429,728 56.0% $ 315,180 41.3%
======== ====== ========= ======
Sales in the Engineering and Information Technology Services segment remained
constant for the period ended June 30, 2004 as compared to the same period in
2003.
Second quarter revenues accelerated and made up the deficit recorded in first
quarter revenues, which resulted in the flattening of the revenues year to date.
Second quarter revenue increases were attributable to a ramp up in production
and delivery of software enhancements and modifications as demand for these
products continues to increase. Divisional revenues are projected to increase
even more over the next quarter as Government "fall out" funding is identified
to fund "unfunded" requirements generated at the Safe Range Users Conference
held in May and as software license sales are realized
Gross profit as a percent of sales was 56%, an increase of more than 36% as
compared to the same period in 2003. This increase in gross profit is
attributable to the elimination of excess management salary costs associated
with the departure of Donald Garrison, Vice President, and the restructuring of
workflow and software production in the division. The segment also continues to
enjoy high profit margin potential of firm-fixed priced contracts used to
procure required software products. In addition, costs of revenues produced
continues to decline as consultant staff are converted to company employees and
strict financial management processes are put in place.
22
Marketing and Status of Safe Borders
-----------------------------------------
As of the end of second quarter, 2004, we have developed a core capability in
three (3) of the five (5) basic modules for our Safe Borders product, as
designed. The three modules with core capabilities are the: 1) Detection
Analyses module, 2) Sensor Planning module, and 3) Airborne Mission Planning
module. The core capabilities in the three developed modules are robust and
functionally effective in their current state. The functionality, as built
today, could be used by a mission planner to perform detection analysis,
sensor planning or airborne mission planning.
To date, Safe Borders represents approximately 10,000 Lines of Code (LOC). It is
designed and developed as an object oriented (OO) application and is written in
Delphi's development environment. By comparison Safe Range represents 70,000
LOC (structured), but this must be qualified by the fact that Safe Range is not
an OO application. By being written as an OO application, much efficiency is
realized in the OO LOC metric. Object oriented applications (OO) provide
numerous other benefits.
Safe Borders is being designed as a component-based application framework. This
will allow custom applications to be built quickly, providing a rapid response
to new user requirement and/or changing user requirements.
At the beginning of the program in 2003, Safe Borders had limited functionality
(or proof-of-concept) prototypes. These prototypes were used to elicit market
reaction and market requirements. Today, we have a fairly robust demonstration
product, as well as supporting collateral, web site and customer lead lists.
Promising third quarter activities include delivering a Safe Borders
presentation/demonstration at a joint meeting of the Customs and Border
Protection (CBP), Applied Technology Division and the Immigrations and Customs
Enforcement, Office of Air and Marine Interdiction, C2ISR (Command, Control
Intelligence Surveillance Reconnaissance) section at the invitation of the
Acting Assistant Commissioner, CBP. In addition, Spectrum will be attending an
Industry Days function (by specific invitation) conducted by the U.S. Coast
Guard (USCG), Deepwater Program, August 31 - September 2, 2004. The Deepwater
Program is the USCG's multi-billion dollar program to replace all ships and
aircraft (to include Unmanned Aerial Vehicles - UAVs) over the next 10 years.
Manufacturing Segment
For the six months ended June 30,
--------------------------------------
2004 2003
---------- ------ ---------- ------
Revenue $1,240,621 100.0% $1,314,792 100.0
Cost of Revenue 1,029,337 81.9% 1,139,544 86.7%
---------- ------ ---------- ------
Gross Profit $ 211,284 18.1% $ 175,248 13.3%
========== ====== ========== ======
Sales in the Manufacturing segment decreased 5.6% for the six-month period ended
June 30, 2004 as compared to the same period in 2003. We are currently
producing several First Articles items, such as specialized containers and
aircraft maintenance stands. We have also been qualified on numerous First
Article Acceptance Tests. A First Article item is similar to a prototype
developed under an awarded contract and must be approved by the customer prior
to full production. An Acceptance Test is a verification of our manufacturing
and quality control procedures to ensure that the product being delivered meets
23
all customer requirements and specifications. Once full production begins on
these items; notably the Advanced Medium Range Air-to-Air Missile (AMRAAM)
container and the AMRAAM component containers, among others, sales are expected
to increase.
Gross profits improved significantly by 20.5% during this same six-month
reporting period based primarily on a conscious business decision to
continuously improve every facet of our manufacturing processes. While subtly
shifting to the pursuit of more profitable longer-term contracts, other
improvements were implemented; such as "In-Time Manufacturing", and processes
were revised to further enhance the quality, efficiency, and cost-effectiveness
of our operations. All manufacturing personnel completed a 16-hour course of
instruction on Lean Manufacturing and Quality Principles during June, funded by
the State of Florida. Spectrum continues to apply judicious cost reduction and
sound fiscal management practices necessary to reduce overall expense while
ensuring delivery and quality standards are maintained
The shift in marketing emphasis to the acquisition of substantially more
profitable prototype manufacturing efforts requires a great deal of recurring
engineering and rapid manufacturing support. Coupled with the pursuit of
prototype and developmental work, business development personnel are
concentrating on long-term, multi-year type contract vehicles, which will
provide a smoother workflow while at the same time providing opportunities to
accept variable quick-reaction/rapid response workload.
In June, the manufacturing division expanded into a new facility at 97 Hill
Avenue adjacent to the corporate headquarters at 91 Hill Avenue. This move
increases our entire manufacturing space by 33,000 square feet. It adds a new
capability for a full metal treatment line and doubles our painting capacity.
June 30, 2004 June 30, 2003 Increase
-------------- -------------- ---------
Selling, general and
administrative expenses $ 41,005,374 $ 439,640 9,227%
============== ============== =========
Selling, general and administrative expenses - Selling, general and
administrative ("SG&A") expenses increased 9,227% for the six-month period ended
June 30, 2004, as compared to the same period in 2003.
During the quarter ended June 30, 2004, there was $25,965,620 recorded for
stock-based consulting compensation. In the quarter ended March 31, 2004, the
company previously recorded $11,418,038 for stock-based consulting compensation.
The impact caused an expense to the Company; however, the grant of the options
year-to-date also increased additional paid-in capital by $37,161,563. In
addition, the Company recorded $2,266,545 of investor relations expenses as of
June 30, 2004. These expenses were not present in the same quarter ended 2003.
24
The Company had increased legal costs of $420,840, accounting fees of $104,131
and director's fees and expenses of $45,445 year to date. All of these costs
are associated with the public filings with the Securities and Exchange
Commission, the costs of management of a public company and the response to the
SEC informal inquiry.
These types of expenses were not present in the quarter ended June 30, 2003.
Other Income and Expenses
Interest income and expense, net - Net interest expense was $101,693 and
$149,145 for the six-month period ended June 30, 2004 and 2003, respectively.
The reduction of $47,452, or a reduction of 31.8%, is due to the decrease of all
principal balances eliminated except the debt on the real estate, as well as the
increased interest income earned on the funds held in near-term investments.
Other income and expense, net - Net other income was $97,194 and $71,538 for the
six-month period ended June 30, 2004 and 2003, respectively. The increase of
other income in the amount of $25,656 is attributed primarily to the decrease of
monthly expenses associated with corporate consultants for 2004 as compared to
the same period in 2003.
Capital and liquidity
During the six months ending June 30, 2004 cash and equivalents increased
$5,352,483, as compared to December 31, 2003. At June 30, 2004, cash and
equivalents totaled $6,049,442, as compared with $264,832 at June 30, 2003. As
of June 30, 2004, the Company had $22,543,386 in certificates of deposit and
short-term government-backed securities as a result investing funds received
from the exercise of stock options by Robert Genovese.
At June 30, 2004, working capital was $28,727,967, as compared to negative
working capital of <$1,182,912> at December 31, 2003.
At June 30, 2004, the current ratio was 9.52, as compared to a ratio of 0.68 at
December 31, 2003.
ITEM 3. CONTROLS AND PROCEDURES
Our principal executive and financial officers evaluated the effectiveness of
our disclosure controls and procedures in place as of June 30, 2004. Based on
this evaluation, our principal executive and financial officers concluded that
our controls and procedures are effective in providing reasonable assurance that
the information required to be disclosed in our reports filed with the
Securities and Exchange Commission is accurate and complete and has been
recorded, processed, summarized and reported in a timely manner. Subsequent to
the date of this evaluation, there have not been any significant changes in our
internal controls over financial reporting that have materially affected, or are
reasonably likely to affect, our internal controls over financial reporting.
Consistent with Section 10A(i)(2) of the Securities Exchange Act of 1934, as
added by Section 202 of the Sarbanes-Oxley Act of 2002, we are required to
disclose the non-audit services approved by our Board of Directors to be
performed by Tedder, James, Worden & Associates, P.A. our external auditor.
Non-audit services are defined as services other than those provided in
connection with an audit or a review of our financial statements. Our Board of
Directors currently has not approved the engagement of Tedder, James, Worden &
Associates, P.A. to perform any non-audit services in 2004.
25
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Harassment Suit
----------------
In December 2002, three Spectrum Sciences and Software, Inc. employees each
filed complaints for violation of civil rights, discrimination, harassment,
hostile work environment and retaliation in the United States District Court,
District of Arizona. The case numbers for these complaints are: CIV '02 2621PHX
MHM; CIV '02 2619 PHX DKD; and CIV '02 2620 PHX FJM. In January 2003, Spectrum
filed answers to all three complaints, denying all allegations of wrongdoing.
All three plaintiffs are claiming "undue stress and anxiety" from Spectrum's
actions. There are no damage amounts specified in any of the actions. The
plaintiffs are requesting the following: Compensatory damages, plus special
incidental damages in such a sum as may be proven at trial; punitive damages in
such a sum as may be proven at trial; for cost for the suit; for attorney's
fees; and for other such relief as the Court deems just and proper. The Company
intends to vigorously defend its position. The cases have progressed through
the establishment of a case management plan with the courts and a consolidation
of all the cases into a single action. Plaintiff and Defendant Depositions were
taken and additional discovery is continuing. It is anticipated that the final
pretrial conference will be scheduled during the first two weeks of September
2004. The Company currently does not know what the outcome of this litigation
will be.
Section 16 (b) Claim
-----------------------
On July 16, 2004, a complaint was filed in the United States District Court,
Southern District of Florida by Todd Augenbaum [Plaintiff] against Robert
Genovese, Endeavor Capital Group, LLC, BG Capital Group, Ltd, and Spectrum
Sciences and Software Holdings Corp. The suit alleges that Mr. Genovese and his
affiliated companies beneficially owned more than 10% of the outstanding common
stock of Spectrum and that Mr. Genovese acted as an officer and director of the
Company. Based on these assertions, the suit claims that Mr. Genovese was a
statutory insider of Spectrum, and as such, is presumed to have had access to
material non-public information concerning the Company's operations and future
business prospects, and is therefore subject to the provisions of Section 16(b)
of the Exchange Act. The action was brought by the Plaintiff in order to obtain
a recovery for the Company of short-swing profits alleged to have been
unlawfully obtained by Mr. Genovese through the purchase and sale of Company
securities. The Company is a nominal defendant in the action and has no
liability for the claims asserted therein against the other defendants. The
Company is investigating and analyzing the allegations and issues raised by the
action. The Company's answer or other pleading responsive to the complaint is
currently due August 26, 2004. The Company cannot currently make any prediction
of what the outcome of the litigation will be.
26
Inland Fabricators
-------------------
On March 31, 2004, Spectrum Sciences & Software Holdings Corp. (the "Company")
offered a Letter of Intent (LOI) to acquire all of the issued and outstanding
membership interests (the "Members") of Inland Fabricators, LLC, a Limited
Liability Company organized under the laws of Louisiana ("IFAB"), or its
nominees or assignees, or acquire IFAB by merger with a subsidiary of Acquiror.
The LOI was not binding, and the transaction would be subject to the execution
of a definitive acquisition agreement by both parties. The Letter of Intent
expired on June 30, 2004. The Spectrum Board of Directors and company
management are considering this and the restructuring of a new offer.
Under the March 31 LOI, if the acquisition went forward, the Company would issue
shares of its common stock to the Members in consideration for their interests
in IFAB. As the transaction was proposed in the LOI, the Company would place
4,000,000 shares of common stock in escrow and the shares would be released from
escrow in amounts and from time to time as based on an agreed formula. The
Board of Directors is reconsidering the structure of this offer.
On May 6, 2004, the Company provided guarantees in the amount of $500,000 to
secure an Irrevocable Letter of Credit ("LOC") in favor of a major international
construction firm. The LOC provided the necessary performance guarantee for
IFAB under a previously negotiated Purchase Order with that major international
construction firm.
On May 6, 2004, a Creditors Group consisting of Modern Valve, Inc., Thomas Pipe
& Steel, LLC, Radnor Alloys, Inc., Portable Machine Works, Inc., Analytic Stress
Relieving, Inc. and Custom Blast Services, Inc. filed suit no. 519924 in the
19th Judicial District court, Parish of East Baton Rouge, State of Louisiana
against various individuals and Members of IFAB. Spectrum Sciences & Software
Holdings Corporation was not named as a party to the suit, however, mention was
made of Spectrum's LOI for the proposed purchase of Inland Fabricators. LLC.
The suit alleges amongst other issues that IFAB as successor to Thomas Inland
Marine LLC, Pipeworks, Inc., Pipeworks Reserve, Inc., and Pipeworks Venezuela
owes certain sums to the Creditor Group based on debt incurred by Thomas Inland
Marine and Pipeworks et al. Due diligence is continuing on the potential
acquisition and the potential outcome of the Creditors suit and its impact on
the potential transaction is undetermined at this time
Contract for Operations and Maintenance of the Gila Bend Air Force Auxiliary
--------------------------------------------------------------------------------
Field (AFAF) and the Barry M. Goldwater Range (BMGR)
------------------------------------------------------------
The Company is the current contractor providing services to the Air Force at
Gila Bend AFAF and the BMGR (Barry m. Goldwater Bombing Range). The contract
runs through September 30, 2004. The Government solicited for a new contract
under Solicitation F02604-03-R0041. As the incumbent contractor, Spectrum
submitted a bid for continued services for the five year period starting October
1, 2004. On July 21, 2004, Spectrum was notified via certified mail that the
contract had been awarded to another firm. On July 26, 2004, Spectrum filed a
protest with the General Counsel, Government Accountability Office (GAO)
asserting that the source selection was materially flawed and that Spectrum's
proposal was not properly evaluated in accordance with the criteria set forth in
the solicitation. On August 10, 2004, Spectrum was notified that the GAO had
dismissed the protest and Spectrum management has determined not to request
reconsideration by the GAO at this time. Spectrum's contract at Gila Bend and
the BMGR will end on September 30, 2004. The company does not foresee any
significant costs associated with closing out this contract.
27
ITEM 2. CHANGES IN SECURITIES
Robert Genovese was awarded options to purchase 9,000,000 shares of Spectrum
stock on March 11, 2004. As of March 31, 2004, Mr. Genovese filed Notices of
Exercise for 2,800,000 options. Those shares had an exercise price of $1.65.
The first exercise was on March 12, 2004 for 900,000 shares. The company
elected to convert debt in lieu of cash for approximately $1,485,000. This
first exercise completely eliminated all past non-investor relations debt to Mr.
Genovese. The second Notice of Exercise was on March 15, 2004 for 900,000
shares. The company received $1,485,000 in cash from Mr. Genovese for those
shares. On March 19, 2004, Mr. Genovese presented the company with a Notice of
Exercise for 1,000,000 shares. This third exercise of shares was paid for by a
second debt conversion of $1,650,000 by Mr. Genovese for his company Endeavor
Capital. This $1,650,000 in debt to Endeavor Capital Corp. is debt directly
related to all invoices presented to Spectrum by Endeavor Capital Corp. for its
work performed in the area of investor relations and publicity.
On April 16, 2004, the Company and Mr. Genovese amended and restated the March
11, 2004, consulting agreement. The amended agreement extended the term of the
contract to April 19, 2006, and contains an exclusivity provision. As part of
that agreement, the stockholder was issued options to acquire an additional
9,000,000 shares of common stock at a per share exercise price equal to the
lesser of $1.95 or 60% of the closing price on the day preceding notice to
exercise. In addition, the stockholder was issued options to acquire 5,000,000
shares of common stock at an exercise price equal to the lesser of a $1.65 or
the fair market value at the time of exercise as a result of his role in the
Inland Fabricators LLC (IFAB) transaction which is further described in Part II,
Item 1 of this filing. In accordance with FASB Statement No. 123, the Company
recorded consulting expense of $25,840,262 in the second quarter of 2004, based
on the fair value of the stock options at the date of grant using the
Black-Scholes pricing model. The total options granted to the stockholder during
the six months ended June 30, 2004, were 23,000,000.
The stockholder exercised 21,178,300 options during the first six months of 2004
with an aggregate exercise price of $37,097,685. The Company received
$31,047,685 of cash from the stockholder and converted outstanding debt of
$3,529,873 owed to the stockholder and related companies in lieu of cash for
exercise of these options. The Company owed the stockholder $792,030 at
December 31, 2003. The stockholder had advanced the Company $672,551 during the
first four months of 2004 to pay operating expenses, and the Company had accrued
interest of $7,792 on two interest-bearing notes in the first quarter of 2004.
In addition, the stockholder paid for certain investor relations expenses
totaling $2,065,000 during the first quarter of 2004 on behalf of the Company.
During the second quarter of 2004 the Company reversed $7,500 of those expenses
bringing the total investor relations expense paid by the stockholder on behalf
of the Company to $2,057,500. As a result of these transactions the Company is
owed $2,520,126 by the stockholder at June 30, 2004. This amount has been
presented as a component of additional paid in capital since it is considered a
stock subscription receivable at June 30, 2004.
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ITEM 3. DEFAULTS IN SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
On April 28, 2004, Spectrum Sciences & Software Holdings Corp. was informed by
the Securities and Exchange Commission (SEC), Division of Enforcement that they
were conducting an informal inquiry into the Company. In conjunction with that
inquiry, the SEC has requested the Company to voluntarily provide the SEC with
the documents and information they requested. More specifically, the SEC has
requested, among other things:
- All documents concerning Robert Genovese ("Genovese"), Endeavor Capital
Group Ltd., and B.G. Capital Group Ltd.;
- All documents concerning any purchase or sales of the Company's stock by
Genovese, Endeavor, B.G. Capital, or any Company officer, director or
manager, or any related party;
- All documents concerning stock options in the Company held by Genovese,
Endeavor, B.G Capital, or any other related persons or parties;
- All documents concerning press releases or public announcements issued by
the Company;
- All documents concerning statements made by the Company to securities
analysts or in the media;
- All documents concerning any promotional materials concerning the Company's
stock;
- All documents concerning the resignation of Donal Myrick.
On May 17, 2004, the SEC broadened its request for information to include:
- All information relating to the Company's decision to list on any foreign
exchange;
- All documents relating to the listing of the Company's stock on any foreign
exchange;
- Any information relating to any transfers of stock that the Company may be
aware that were directed overseas.
Subsequent to the notification of the initial inquiry, the Board of Directors
elected to suspend the current consulting agreement between the Company and
Robert Genovese pending the outcome of the SEC inquiry. The Company is fully
cooperating with the SEC inquiry.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits: None
b) Reports on Form 8-K: None
29
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, as amended, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized, on this 18th day of
May 2004.
SPECTRUM SCIENCES & SOFTWARE HOLDINGS CORP
Date: August 16, 2004
/s/ William H. Ham
By: -------------------------------------
William H. Ham,
Chief Executive Officer and President
The undersigned, the Chief Financial Officer of the Registrant, certifies that
this report complies with all of the requirements of section 13(a) and 15(d) of
the Exchange Act and the information contained in this report fairly presents,
in all material respects, the financial condition and results of operations of
the Registrant.
Date: August 16, 2004
/s/ Nancy C. Gontarek
-------------------------------------
Nancy C. Gontarek,
Chief Financial Officer
30