<PAGE>

                     U.S. SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   FORM 10-KSB

                     ANNUAL REPORT UNDER SECTION 13 OR 15(d)
              OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED)

                    For the Fiscal Year Ended January 3, 1998

                           Commission File No. 0-9478

                           SPECTRUM LABORATORIES, INC.
                 (Name of small business issuer in its charter)

        California                                           95-3557539
        ----------                                           ----------
(State or other Jurisdiction of                           (I.R.S. Employer
 Incorporation or Organization)                          Identification No.)

        23022 La Cadena Drive
        Laguna Hills, California                                92653
        (Address of principal executive offices)              (Zip Code)

         Issuer's telephone number, including area code: (714) 581-3880

       Securities registered under Section 12(b) of the Exchange Act: None

         Securities registered under Section 12(g) of the Exchange Act:

                                  Common Stock
                                (Title of Class)

        Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.

                                  Yes X  No
                                     ---   ---

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB [ X ].

       State issuer's revenues for its most recent fiscal year: $8,135,420

The aggregate market value of voting stock held by nonaffiliates of the
registrant is $241,690 as of March 31, 1998, based on the $.27 per share closing
price for the Common Stock in the over-the-counter market on such date,
representing 895,149 shares held by nonaffiliates.

Number of shares of Common Stock outstanding as of March 31, 1998:  12,834,394

This report includes a total of 37 consecutive numbered pages; the exhibit index
of documents incorporated by reference is on page 34.


<PAGE>


                                TABLE OF CONTENTS

                            FORM 10-KSB ANNUAL REPORT
                       FOR THE YEAR ENDED JANUARY 3, 1998
                           SPECTRUM LABORATORIES, INC.
Item No.                                                                    Page
--------                                                                    ----

   PART I
   1.      Description of Business...........................................-3-
   2.      Description of Property...........................................-7-
   3.      Legal Proceedings.................................................-7-
   4.      Submission of Matters to a Vote of Security Holders...............-7-

   PART II
   5.      Market for Common Equity and Related Shareholder Matters..........-8-
   6.      Management's Discussion and Analysis of Financial
           Condition and Results of Operation................................-8-
   7.      Financial Statements.............................................-11-
   8.      Changes in and Disagreements with Accountants on
           Accounting and Financial Disclosure..............................-30-


        PART III
   9.      Directors, Executive Officers, Promoters and Control
           Persons; Compliance with Section 16(a) of the Exchange Act.......-30-
   10.     Executive Compensation...........................................-31-
   11.     Security Ownership of Certain Beneficial Owners and
           Management.......................................................-32-
   12.     Certain Relationships and Related Transactions...................-33-
   13.     Exhibits and Reports on Form 8-K.................................-34-


                                        2
<PAGE>


THIS ANNUAL REPORT FORM 10-KSB CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS, THE
REALIZATION OF WHICH MAY BE IMPACTED BY CERTAIN IMPORTANT FACTORS WHICH ARE
DISCUSSED IN "ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS," UNDER ITEM 7,
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS."

                                     PART I

ITEM 1. DESCRIPTION OF BUSINESS

GENERAL
-------

Spectrum Laboratories, Inc. (the "Company") was incorporated in California on
June 5, 1980 under the name Immutron, Inc., as a successor to a joint venture
organized in October 1978 by Nuclear Medical Systems, Inc., and Life Studies,
Incorporated. On November 23, 1982, the Company changed its name to Spectrum
Laboratories, Inc.

BUSINESS
--------

The Company is a leader in the development, manufacturing and sale of a
comprehensive proprietary line of hollow fiber membrane disposable products for
use by research laboratories, biotechnology and pharmaceutical companies. The
Company's products, derived from a platform technology of mass transfer hollow
fiber membranes are used for existing and emerging life sciences applications
such as molecular/biological separations, fluid purification and cell
expansion/bioreactors. The Company's platform technology allows it to create
membranes and devices to meet a wide range of performance criteria and to
integrate the devices into systems for life sciences applications.

HOLLOW FIBER MEMBRANE DEVICES

Hollow fiber membrane products fall into three different categories: laboratory
products, OEM and private label products and process products.

Laboratory products, comprising approximately 25% of sales volume in 1996 and
approximately 17 % of sales for 1997, of hollow fiber membrane products, which
are small compact membrane devices and are utilized in general laboratory
filtration. These are generally sold through distributors.

OEM and private label products are special versions of the laboratory products
sold under private label or to manufacturers of medical devices or water
treatment systems. Application areas include: point-of-use water filtration; gas
filtration for semiconductor blow-off guns, plasma gas cauterizing devices,
insufflator kits for endoscopic surgery; drug filtration for surgical eyewash
solutions, and pain management parenterals. These products comprise
approximately 30% of sales volume in 1996 and 39% in 1997, and are sold direct
to third party manufacturers for resale to the end users.

Process products are tangential flow membrane devices that allow components that
are retained by the membrane to be concentrated. Hollow fiber membrane process
products are sold direct to pharmaceutical and diagnostic manufacturers in the
U.S. Overseas sales are both direct and through distributors depending on the
region. Process filtration products accounted for approximately 45% of hollow
fiber membrane device sales in 1996 and 44% in 1997.

CELL EXPANSION

On October 1, 1996, the Company through its wholly-owned subsidiary SLI
Acquisition Corp. ("SLIAC"), purchased certain assets of Cellco, Inc., a
Delaware Corporation located in Germantown, Maryland. SLIAC provides artificial
capillary systems to academic, pharmaceutical, laboratory and clinical research
markets involved in the expansion and maintenance of human and animal cells.


                                        3
<PAGE>


MEDICAL DISPOSABLE DEVICES

Hydro-Med Products, Inc. ("Hydro-Med") is a wholly-owned subsidiary of the
Company. Hydro-Med is primarily a manufacturer of medical disposable devices
such as sterile surgical drapes for orthopedic and arthroscopic surgical
procedures, sterile camera covers, rubber elastic bandages (sterile and
nonsterile), Esmarch bandages, and a tamper-resistant container system for use
in harvesting bone and tissue for human transplantation, and other surgical
specialty products.

MARKETS AND METHODS OF DISTRIBUTION
-----------------------------------

HOLLOW FIBER MEMBRANE DEVICES

The Company has over 225 active customers, comprised of pharmaceutical and
diagnostic manufacturers, medical device manufacturers, laboratories, laboratory
distributors and research institutions for its hollow fiber membrane products.
Approximately 20% of its sales are from non-U.S. customers for fiscal years 1996
and 1997.

CELL EXPANSION

SLIAC has over 300 active customers comprised of academic, research,
pharmaceutical, laboratory, and clinical research companies and institutes.
Domestic sales are made with a direct sales force and foreign sales are made
through direct sales and laboratory products distributors.

MEDICAL DISPOSABLE DEVICES

Hydro-Med manufactures and distributes three major product lines: Operating Room
Equipment Drapes, Orthopedic Soft Goods and Esmarch Bandages.

Hydro-Med distributes its products through a number of channels including
important National and Regional Catalog Houses, OEM & Private Label Accounts,
Regional OR Specialty Distributors, Custom Procedure Tray Manufacturers, Direct
Sales to Institutions and International Distributors. Nearly all Operating Room
Equipment Drapes are sold in sterile ready-to-use format. OR Drapes are sold
primarily through OEM & Private label accounts, through Regional OR Specialty
Distributors and through Regional and National Catalog Houses. Over the past two
and one half years, the importance of OR Specialty Dealer has declined while the
proportion of OEM, Private Label and Catalog House sales has increased. OR
drapes constitute nearly all international sales and approximately half of
direct sales. Orthopedic Soft Goods are primarily are sold primarily through
Regional and National Catalog Houses and Procedure Tray Manufacturers.
Approximately one third of Orthopedic Soft Goods sales are in non-sterile, bulk
format primarily to Tray Manufacturers. Essentially no Soft Goods and Esmarch
Bandages are sold internationally. Esmarch Bandages are sold through both
Catalog Houses, Regional OR Specialty Distributors and Procedure Tray
Manufacturers.

Hydro-Med has over 250 active customers, the most active of which are over 100
hospitals and over 150 hospital supply dealers. Export and O.E.M. accounts are
currently confined to a select few products, mostly for orthopedics. Hydro-Med
does not employ its own sales force but uses commissioned manufacturers'
representatives to call on end users such as hospitals and doctors, as well as
stocking distributors capable of supplying product delivery on a local level.

RAW MATERIALS AND SUPPLIES
--------------------------

HOLLOW FIBER MEMBRANE DEVICES

The Company purchases common raw membrane polymers and casting solvents from a
variety of sources. Membranes are assembled into housings that are molded from
commonly available plastic resins by third party plastic molders, using tooling
owned by the Company. Membranes are affixed to the housings by means of


                                        4
<PAGE>


proprietary potting resins supplied by two different suppliers who are covered
by an industry cooperative disaster recovery plan which allows manufacturers to
manufacture the resins in the event of an interruption of supply.

CELL EXPANSION

SLIAC purchases hollow fiber membrane devices from commercially available device
suppliers. SLIAC is dependent on a limited number of suppliers for hollow follow
membrane devices but has not experienced any difficulty in obtaining necessary
supplies.

MEDICAL DISPOSABLE DEVICES

The principal raw materials used by Hydro-Med in producing sterile surgical
drapes and elastic bandages are yarn, natural latex and plastic film. There are
several suppliers in the United States for yarn. Hydro-Med is dependent on one
or a limited number of suppliers for plastic film but has not experienced any
difficulty in obtaining necessary supplies, and none are presently anticipated.

PATENTS AND TRADEMARKS
----------------------

HOLLOW FIBER MEMBRANE DEVICES

The Company holds patents for hollow fiber syringe tip filters and trademarks
for, DynaFibre, DynaGard, KrosFlo, MediaKap, MiniKap and MiniKros. Fundamental
technology is kept as trade secrets. Employees and vendors are covered by
suitable non-disclosure agreements.

CELL EXPANSION

SLIAC acquired the rights to the Cellmark trademark and all related patents,
including one for "Serum-free production of packaged viral vector."

MEDICAL DISPOSABLE DEVICES

Hydro-Med is the assignee of two U.S. patents. The patents are for "Apparatus
for Forming a Rolled Tubular Fabric Article" and "Surgical Extremity Drape".
Hydro-Med is also the assignee of trademark rights to Dry Docks and
Strap-Stroll.

A finding of invalidity or unenforceability of certain of the Company's patents,
may have a materially adverse effect on the Company's business.

GOVERNMENT REGULATIONS
----------------------

The Food and Drug Administration (the "FDA") and the California Food and Drug
Bureau ("CFDB") regulate the manufacture and quality control procedures of
certain of the Company's products. The Company has recently been audited by the
FDA with no deficiencies noted. Compliance with FDA and CFDB regulations is a
significant expense but the Company believes that such expenses are costs of
doing business in the industry and that the Company's expenses are similar to
those of other companies in the business.

HOLLOW FIBER MEMBRANE DEVICES

In addition to regulations enforced by the FDA and the CFDB, the Company is also
subject to regulations under the Environmental Protection Act, the Occupational
Safety and Health Act, and other present and potential supranational, foreign,
Federal, state and local regulations. Compliance with any of these has not had a
material effect on the capital expenditures, operations or competitive position
of the Company to date.


                                        5
<PAGE>

The Company cannot predict whether future changes in government regulations
might increase its cost of conducting business or affect the time required to
develop and introduce new products.

DEPENDENCE UPON FEW CUSTOMERS
-----------------------------

The Company does not believe that its business would be adversely affected by
the loss of any individual customer or small group of customers. During the
years ending December 31, 1996 and January 3, 1998, no customer accounted for
more 10% or more of the Company's total net combined sales.

SEASONAL ASPECTS
----------------

The Company's business is not subject to significant seasonal fluctuations in
sales.

COMPETITIVE FACTORS
-------------------

HOLLOW FIBER MEMBRANE DEVICES

The Company's hollow fiber membrane devices compete with Gelman Sciences,
Millipore, and Nalge in the laboratory products area. OEM and private label
products are long-term supply contracts where competition for continuing
business is limited. Laboratory products are price and performance competitive
with other products for media sterilization. OEM and private label products
offer high surface area in compact housings in comparison with competing
products. Process products are offered as disposables in competition with
traditional tangential flow devices which are cleaned and re-used. Tangential
flow products are attractive to users who have critical applications where
single-use will ensure optimum performance and/or simplify the validation of the
process for FDA approval. In the process area, Millipore and Amicon division of
Millipore are the major competitors. It is estimated that market share is less
than 5% in every market served.

CELL EXPANSION

The company has several competitors for hollow fiber membrane devices including
Cellex Bioscience, Unisyn Technologies and Integra Bioscience.

MEDICAL DISPOSABLE DEVICES

Hydro-Med faces distinctly different competitors among its different product
lines. Significant consolidation has taken place recently in the OR Equipment
Drape business. The major competitors offering a full line of OR Equipment
Drapes include Microtek Medical, Medical Technique Instruments, MTI, Zeiss,
Advance Medical Designs and Deka Medical. Each manufacturer has niches in either
a specific type of equipment drape or specific accounts with the exception of
Microtek which, with over 50% of the market share, is the market leader with a
strong presence in all niches and a direct sales force. Hydro-Med has been most
effective in competing with its Video Camera Drape line particularly on the
basis of quality and price. Orthopedic Soft Goods are similarly consolidating by
remains very fragmented. Major competitors include Alba, Balfour, Technol and
DeRoyal Industries among others. Esmarch Elastic Bandage is produced by a small
number of non-medical rubber producers who then sell bulk non-sterile product to
medical device firms for packaging and sterilization. As a result there are
numerous competitors distributing Esmarch Bandages but the range of offerings is
relatively limited with competition being primarily driven by price.

Companies such as Johnson & Johnson and Baxter Travenol, who include surgical
extremity drapes as part of an integrated "procedure pack," both custom and
standard, for specific types of procedures, (e.g., orthopedic surgery or
arthroscopic or cardiovascular surgical cases), dominate the market.


                                        6
<PAGE>


Hydro-Med manufactures a rubber elastic bandage that does not require the need
for metal clips. Currently, the market is dominated by such competitors as
Becton Dickinson, producers of ACE(TM) bandages, Johnson & Johnson, producers of
Dyna-Flex(TM) and Kendall, producers of Tensor(TM), all of which have greater
resources than the Company.

RESEARCH AND DEVELOPMENT

The Company incurred research and development expenses of $537,486 in 1997 and
$411,095 in 1996. Research and development are particularly important for the
Company's future growth.

EMPLOYEES

On January 3, 1998, the Company had 64 employees, of which 45 were in production
and manufacturing support, 11 were administrative personnel, 6 were marketing
and customer service representatives and 2 were in research and development. The
company believes it has good relations with its employees.

ITEM 2.  DESCRIPTION OF PROPERTY

The Company's executive offices are located at 23022 La Cadena Dr., Laguna
Hills, California. The building is rented by Spectrum Medical Industries, Inc.,
("SMI") an affiliate of the Company, controlled by Roy T. Eddleman, Chairman of
the Company, with a portion sublet to the Company. The space is used by the
Company for general, administration and executive offices. The Company also
shares production and warehousing space with SMI under sub-leases with SMI in
facilities owned by Mr. Eddleman. Total rent paid in fiscal 1997 by the Company
for the aforementioned facilities was $152,422.

The Company has production and warehouse space in Dallas, Texas and locations it
occupies in Los Angeles and Orange Counties, California. The following table
summarizes the terms of the leases of properties leased by the Company.

<TABLE>
<CAPTION>

Lessor & Location           Lessee & Usage              Sq. Feet    Begin        End      Term Mths.       Rental
-----------------           --------------              --------    -----        ---      ----------       ------
<S>                         <C>                           <C>      <C>         <C>            <C>          <C>
Gick Family Partnership     Spectrum Laboratories,         8,830   12/1/94     12/31/98       49           $8,830
23152 Verdugo Dr.           Inc.
Laguna Hills, CA            Light Manufacturing
                            R&D and Offices

Herschel Brown              Spectrum Laboratories,        20,000    1/1/95     12/31/98       48           $5,416
2930 Ladybird Lane          Inc.
Dallas, Texas
</TABLE>


ITEM 3. LEGAL PROCEEDINGS

There are no material pending legal proceedings to which the Company is a party
or of which any of its property is the subject. The Company knows of no legal
proceedings contemplated by any governmental authority or agency.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.


                                        7
<PAGE>


                                     PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

The Company's Common Stock is currently traded on the over-the -counter market
with trading prices quoted in the Over the Counter (OTC) Bulletin Board.

The following table sets forth the high and low market prices for the last two
years. The quotations shown represent inter-dealer prices without adjustment for
retail markups, markdowns or commissions and do not necessarily reflect actual
transactions.

                     1997                        High             Low
                --------------                  ------           ------
                First Quarter                   $ 5/8            $ 3/16
                Second Quarter                    1/2              3/16
                Third Quarter                     1/2              3/16
                Fourth Quarter                    1/2              3/16

                     1996
                --------------
                First Quarter                     7/16             3/16
                Second Quarter                    7/16             3/16
                Third Quarter                     3/4              1/4
                Fourth Quarter                    3/4              1/4

No dividends have been declared or paid by the Company since inception.
Additionally, the Company's financing agreements with the bank prohibit the
payment of dividends without the bank's approval. The Company intends to employ
all available funds for development of its business and, accordingly, does not
intend to pay cash dividends in the foreseeable future.

As of January 3, 1998, the number of holders of record of the Company's Common
Stock was 826.

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATION

The following discussion relates to the Company, its wholly owned subsidiaries,
SLI Acquisition Corp. ("SLIAC") and Hydro-Med Products, Inc. ("Hydro-Med") and
its partially owned subsidiary, Spectrum Europe B.V. ("Spectrum B.V."). The
Company has consolidated the financial position and operations of Spectrum B.V.
for all periods presented.

RESULTS OF OPERATIONS - FISCAL YEAR 1997 COMPARED TO FISCAL YEAR 1996

Net sales for 1997 were $8,135,420 and were 6% below 1996 sales of $8,698,794.
An increase in sales due to the cell expansion product line acquired from
Cellco, Inc. at the beginning of the last quarter of 1996 was more than offset
by decreased sales resulting from the sale of the microbiological sampling and
transport product line (See Note 11 of Notes to Consolidated Financial
Statements) and, to a lesser extent, a decrease in sales of hollow fiber
membrane devices.

Cost of sales as a percentage of sales was 60% for both years.

A 24% increase in selling expense and a 31% increase in research and development
costs over 1996 were primarily attributable to the retention of key personnel as
a result of the Cellco acquisition.

General and administrative expenses increased 19% over 1996, partially due to
the Cellco acquisition, but primarily due to an increase in personnel.

The increase in interest expense was primarily due to a higher level of debt in
1997.


                                        8
<PAGE>


LIQUIDITY AND CAPITAL RESOURCES

During the current fiscal year, there was a net cash outflow from operations of
approximately $780,000 which was primarily the result of a loss from operating
activities for the year. Cash of approximately $1,100,000 was generated due to
the sales of two product lines. Cash of approximately $3,760,000 was generated
through borrowings but was primarily used to pay off existing debt and for
principal payments on the new loan agreement. The Company believes that funds
anticipated to be generated from operations and funds on hand are sufficient for
operating requirements in fiscal 1998. However, provisions of the Company's loan
agreement with the bank require principal and interest payments of approximately
$1,200,000 on May 1, 1998. On April 29, 1998, the Company obtained an extension
to July 1, 1998. The Company intends to refinance this debt prior to its
maturity. In the event the Company has to repay such debt with existing cash
balances, any potential shortfall in available cash at that time would be funded
by Roy T. Eddleman, the Company's majority shareholder.

YEAR 2000 MATTERS

The Year 2000 issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Company's
hardware or computer programs that have time-sensitive software may recognize a
date using "00" as the year 1900 rather than the Year 2000. This could result in
a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices, or engage in similar normal business activities.

In 1997, the Company initiated a conversion from existing hardware and
accounting software to hardware and software programs that are Year 2000
compliant. Management has determined that the year 2000 issue will not pose
significant operational problems for its computer systems. As a result, all
costs associated with this conversion are being expensed as incurred.

The Company is in the process of initiating formal communications with all of
its significant suppliers and large customers to determine the extent to which
the Company's interface systems are vulnerable to those third parties' failure
to remediate their own Year 2000 issue. There can be no guarantee that the
systems of other companies on which the Company's systems rely will be timely
converted and would not have an adverse effect on the Company's systems.

The Company will utilize both internal and external resources to reprogram, or
replace, and test the software and equipment for Year 2000 modifications. The
Company anticipates completing the Year 2000 project within 6 months, but not
later than June 30, 1999. The total cost of the Year 2000 project is estimated
at $25,000 and is being funded through operating cash flows.

The costs of the project and the date on which the Company believes it will
complete the Year 2000 modifications are based on management's best estimates,
which were derived from assumptions of future events, including the continued
availability of certain resources, third-party modification plans and other
factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those anticipated.
Specific factors that might cause such material differences include, but are not
limited to, the availability and cost of personnel trained in this area, the
ability to locate and correct all relevant computer codes and hardware, and
similar uncertainties.

NEW ACCOUNTING PRONOUNCEMENTS

In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income,"
which establishes standards for reporting and display of comprehensive income
and its components (revenue, expenses, gains and losses) in a full set of
general-purpose financial statements. The Company will adopt SFAS No. 130 in its
fiscal year 1998.


                                        9
<PAGE>


In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of
Enterprise and Related Information," which changes the way public companies
report information about operating segments.

SFAS No. 131, which is based on the management approach to segment reporting,
establishes requirements to report selected segment information quarterly and to
report entity-wide disclosures about products and services, major customers and
the material countries in which the entity holds assets and reports revenue.
Management is reviewing the impact of this statement on its reporting of segment
information. The Company will adopt SFAS No. 131 in its fiscal year 1998.


                                       10
<PAGE>



INDEPENDENT AUDITORS' REPORT



To the Board of Directors and Shareholders of
 Spectrum Laboratories, Inc.:


We have audited the accompanying consolidated balance sheet of Spectrum
Laboratories, Inc. and subsidiaries (the Company) as of January 3, 1998, and the
related consolidated statements of operations, shareholders' equity and cash
flows for the years ended January 3, 1998 and December 31, 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all
material respects, the consolidated financial position of Spectrum Laboratories,
Inc. and subsidiaries at January 3, 1998 and the results of their consolidated
operations and their consolidated cash flows for the years ended January 3, 1998
and December 31, 1996 in conformity with generally accepted accounting
principles.


/s/ Deloitte & Touche LLP

DELOITTE & TOUCHE LLP

March 27, 1998,
  (except for Note 6, as to which the dates
  are April 20 and April 29, 1998)
Costa Mesa, California




                                       11
<PAGE>


SPECTRUM LABORATORIES, INC.

CONSOLIDATED BALANCE SHEET
AS OF JANUARY 3, 1998
--------------------------------------------------------------------------------

ASSETS

CURRENT ASSETS:
Cash and cash equivalents                                           $ 1,023,443
Receivables - trade, net of allowance for doubtful
  accounts of $132,500                                                1,025,061
Due from affiliates (Note 8)                                            553,411
Inventories, net (Note 3)                                               881,418
Prepaid expenses and other current assets                                82,709
                                                                    ------------
    Total current assets                                              3,566,042

PROPERTY AND EQUIPMENT, net (Note 4)                                    780,048

OTHER ASSETS:
Deferred income taxes (Note 5)                                          377,185
Intangible and other assets (Note 2)                                    145,550
Goodwill (Notes 1 and 2)                                              2,891,078
                                                                    ------------
    Total other assets                                                3,413,813
                                                                    ------------

                                                                    $ 7,759,903
                                                                    ============

See accompanying notes to consolidated financial statements.                  



                                       12
<PAGE>


SPECTRUM LABORATORIES, INC.

CONSOLIDATED BALANCE SHEET
AS OF JANUARY 3, 1998 (Continued)
--------------------------------------------------------------------------------


LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
Accounts payable                                                    $   586,594
Accrued expenses                                                        550,615
Income taxes payable                                                     51,441
Current portion of long-term debt (Note 6)                            1,623,258
                                                                    ------------
    Total current liabilities                                         2,811,908

LONG-TERM DEBT, less current portion (Note 6)                         2,174,532

MINORITY INTEREST (Note 1)                                            2,037,939

SHAREHOLDERS' EQUITY (Note 7):
Common stock, par value $.01; 25,000,000 shares authorized;
  12,834,394 shares issued and outstanding                              128,344
Additional paid-in capital                                            5,237,848
Accumulated deficit                                                  (4,591,683)
Unrealized loss on foreign currency translation                         (38,985)
                                                                    ------------
    Total shareholders' equity                                          735,524
                                                                    ------------

                                                                    $ 7,759,903
                                                                    ============


See accompanying notes to consolidated financial statements.                  




                                       13
<PAGE>


SPECTRUM LABORATORIES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
--------------------------------------------------------------------------------


                                                             Years ended
                                                    ----------------------------
                                                      January 3,    December 31,
                                                         1998           1996

NET SALES (Notes 8 and 10)                          $ 8,135,420     $ 8,698,794

COSTS AND EXPENSES (Note 8):
Cost of sales                                         4,880,691       5,229,422
Selling                                               1,402,492       1,127,080
General and administrative                            1,811,912       1,517,860
Research and development                                537,486         411,095
In-process research and development costs (Note 2)                    1,700,000
Other expense, net (primarily interest)                 362,922         287,677
                                                   -------------   -------------
    Total costs and expenses                          8,995,503      10,273,134

GAIN ON SALE OF PRODUCT LINES (Note 11)                 803,059
                                                   -------------   -------------
LOSS BEFORE MINORITY INTEREST IN INCOME
  OF SUBSIDIARY AND PROVISION FOR INCOME TAXES          (57,024)     (1,574,340)

MINORITY INTEREST IN LOSS (INCOME) OF
  SUBSIDIARY (Note 1)                                     9,050         (56,512)
                                                   -------------   -------------
LOSS BEFORE FOR INCOME TAX PROVISION                    (47,974)     (1,630,852)

INCOME TAX PROVISION (Note 5)                            25,399          62,339
                                                   -------------   -------------
NET LOSS                                           $    (73,373)   $ (1,693,191)
                                                   =============   =============
BASIC AND DILUTED NET LOSS PER COMMON SHARE        $      (0.01)   $      (0.13)
                                                   =============   =============
BASIC AND DILUTED WEIGHTED AVERAGE COMMON
  SHARES OUTSTANDING                                 12,834,394      12,834,394
                                                   =============   =============


See accompanying notes to consolidated financial statements.                 



                                       14
<PAGE>


SPECTRUM LABORATORIES, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>

                                                                    Unrealized
                                                        Unrealized   loss on
                         Common stock        Additional  gains on    foreign
                      ---------------------   paid-in   investment   currency   Accumulated
                        Shares     Amount     capital   securities  translation   deficit      Total
<S>                   <C>         <C>        <C>         <C>        <C>         <C>          <C>
BALANCE,
  January 1,
  1996                12,834,394  $128,344   $5,237,848  $ 12,920   $ (33,076)  $(2,825,119) $2,520,917

Unrealized
  investment
  losses, net of
  tax                                                     (12,920)                              (12,920)

Foreign currency
  translation loss                                                     (4,842)                   (4,842)

Net loss                                                                         (1,693,191) (1,693,191)
                      ----------  --------   ----------  ---------  ----------  ------------ -----------
BALANCE,
  December 31,
  1996                12,834,394   128,344    5,237,848               (37,918)   (4,518,310)    809,964

Foreign currency
  translation loss                                                     (1,067)                   (1,067)

Net loss                                                                            (73,373)    (73,373)
                      ----------  --------   ----------  ---------  ----------  ------------ -----------
BALANCE,
  January 3,
  1998                12,834,394  $128,344   $5,237,848  $      -   $ (38,985)  $(4,591,683) $  735,524
                      ==========  ========   ==========  =========  ==========  ============ ===========
</TABLE>


See accompanying notes to consolidated financial statements.                   



                                       15
<PAGE>


SPECTRUM LABORATORIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>


                                                                              Years ended
                                                                    ----------------------------
                                                                      January 3,    December 31,
                                                                         1998           1996

<S>                                                                 <C>             <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss                                                            $   (73,373)    $(1,693,191)
Adjustments to reconcile net loss to net cash (used in) provided by
  operating activities:
  Depreciation and amortization                                         468,962         399,896
  Gain on sale of product lines                                        (803,059)
  Minority interest in income (loss) of subsidiary                       (9,050)         56,512
  Deferred income taxes                                                                   1,750
  In-process research and development costs                                           1,700,000
  Changes in operating assets and liabilities:
    Decrease (increase) in trade receivables                            157,626         (24,940)
    (Increase) decrease in due from affiliates                         (221,647)        310,821
    Decrease in inventories                                             392,226         341,325
    Decrease (increase) in prepaid expenses and other current asset      22,789         (38,195)
    Decrease (increase) in other assets                                   4,327         (19,401)
    (Decrease) increase in accounts payable and accrued expenses       (695,435)        347,297
    (Decrease) increase in income taxes payable                         (19,850)         33,205
    Other                                                                (1,067)        (17,762)
                                                                    ------------    ------------
      Net cash (used in) provided by operating activities              (777,551)      1,397,317
                                                                    ------------    ------------
CASH FLOWS FROM INVESTING ACTIVITIES: 
Acquisition of property and equipment                                   (37,814)       (242,406)
Proceeds from sale of product lines                                   1,097,400
Decrease in investments                                                                  63,180
                                                                    ------------    ------------
      Net cash provided by (used in) investing activities             1,059,586        (179,226)
                                                                    ------------    ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on debt                                           (3,611,446)       (908,709)
Proceeds relating to advances from affiliates and issuances of debt   3,761,000         200,000
                                                                    ------------    ------------
      Net cash provided by (used in) financing activities               149,554        (708,709)
                                                                    ------------    ------------
</TABLE>


See accompanying notes to consolidated financial statements.                  



                                       16
<PAGE>


SPECTRUM LABORATORIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
--------------------------------------------------------------------------------


                                                            Years ended
                                                     ---------------------------
                                                     January 3,    December 31,
                                                        1998           1996

NET INCREASE IN CASH AND CASH EQUIVALENTS            $  431,589     $  509,382

CASH AND CASH EQUIVALENTS, beginning of year            591,854         82,472
                                                     -----------    -----------
CASH AND CASH EQUIVALENTS, end of year               $1,023,443     $  591,854
                                                     ===========    ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION 
  Cash paid for:
    Income taxes                                     $   53,370     $    4,415
                                                     ===========    ===========
    Interest                                         $  426,444     $  274,455
                                                     ===========    ===========


SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES: The Company
recorded unrealized losses of $12,920 on its investment portfolio for the year
ended December 31, 1996.

The Company recorded SMI's minority interest in the income (loss) of Spectrum
B.V. of $(9,050) and $56,512 for the years ended January 3, 1998 and December
31, 1996, respectively.

During 1996, SLIAC acquired substantially all the net assets of Cellco, Inc.
(Note 2). In conjunction with the acquisition, liabilities were assumed as
follows:


   Fair value of assets acquired                                     $  773,407
   Intangibles                                                          211,698
   In-process research and development costs                          1,700,000
   Preferred stock issued in exchange for assets (Note 2)            (2,000,000)
                                                                     -----------

   Liabilities assumed                                               $  685,105
                                                                     ===========


See accompanying notes to consolidated financial statements.                  


                                       17

<PAGE>


SPECTRUM LABORATORIES, INC.

                                                                          
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996
--------------------------------------------------------------------------------


1.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

      NATURE OF OPERATIONS AND BASIS OF PRESENTATION - Spectrum Laboratories,
      Inc. (Spectrum or the Company), its wholly-owned subsidiaries, SLI
      Acquisition Corp. (SLIAC) (Note 2) and Hydro-Med Products, Inc.
      (Hydro-Med), and its partially-owned subsidiary, Spectrum Europe B.V.
      (Spectrum B.V.), are engaged in a single business segment: the
      development, manufacture and sale of medical products. Spectrum's product
      lines consist of disposable cellulose nitrate and cellulose acetate hollow
      fiber microfiltration modules. SLIAC's product lines consist of systems
      and products for use in cell culture and cellular therapeutics.
      Hydro-Med's product lines consist of surgical drapes, rubber elastic
      bandages, sterile camera covers and a tamper-resistant container system
      for use in harvesting bone and tissue for human transplantation. All
      products are for sale primarily to the pharmaceutical, biotechnology and
      medical industries. The Company operates primarily in the United States,
      with sales in the European market through Spectrum B.V. Spectrum is 79%
      owned by Spectrum Medical Industries, Inc. (SMI), an affiliated entity
      through common ownership.

      CHANGE IN FISCAL YEAR - Effective November 1997, the Company changed its
      fiscal year end to the Saturday nearest December 31. The years ended
      January 3, 1998 and December 31, 1996 each consist of approximately 52
      weeks.

      PRINCIPLES OF CONSOLIDATION - The accompanying consolidated financial
      statements include the accounts of Spectrum, its wholly-owned subsidiaries
      SLIAC and Hydro-Med, and its partially-owned subsidiary, Spectrum B.V.
      Spectrum and SMI hold approximately 40% and 60% of the equity interest,
      respectively, of Spectrum B.V. For financial reporting purposes, the
      assets, liabilities, results of operations and cash flows of Spectrum B.V.
      are included in Spectrum's consolidated financial statements as Spectrum
      exercises significant financial and operational control over Spectrum B.V.
      through common ownership interest. SMI's interest in Spectrum B.V. and the
      preferred stock of SLIAC (Note 2) are reflected as a minority interest in
      the accompanying consolidated financial statements. All intercompany
      balances and transactions have been eliminated in consolidation.

      USE OF ESTIMATES - The preparation of the combined financial statements in
      conformity with generally accepted accounting principles requires
      management to make estimates and assumptions that affect the reported
      amounts of assets and liabilities and disclosure of contingent assets and
      liabilities at the date of the financial statements and the reported
      amounts of revenues and expenses during the reporting years. Actual
      results could differ from those estimates.

      CREDIT RISK - The Company sells its products nationally and
      internationally, primarily through distributors to medical equipment and
      medical supply companies. The Company performs ongoing credit evaluations
      of its customers and generally does not require collateral. The Company
      maintains reserves for potential credit losses.

      CASH AND CASH EQUIVALENTS - Cash and cash equivalents are comprised of
      demand deposit accounts with original maturities of 90 days or less.


                                       18
<PAGE>


SPECTRUM LABORATORIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996 (Continued)
--------------------------------------------------------------------------------

                                                                         
      INVESTMENTS - The Company accounts for its investments under the
      provisions of Statement of Financial Accounting Standards (SFAS) No. 115,
      ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES. Any
      unrealized gains or losses related to available for sale securities is
      recorded as a component of shareholders' equity, net of tax.

      INVENTORIES - Inventories are stated at the lower of cost, determined
      using the first-in, first-out method, or market value.

      PROPERTY AND EQUIPMENT - Furniture, equipment and leasehold improvements
      are stated at cost, net of accumulated depreciation and amortization.
      Depreciation of equipment is provided using the straight-line method over
      the estimated useful lives (generally five years) of the respective
      assets. Leasehold improvements are amortized on a straight-line basis over
      the lesser of the lease term or the estimated useful life of the asset.

      GOODWILL - Goodwill represents the excess of the purchase price over the
      fair value of net assets acquired from the Cellco, Inc. (Cellco) (Note 2)
      acquisition during 1996 and Microgon, Inc. acquisition during 1995.
      Goodwill is being amortized on a straight-line basis over a 15- and
      20-year period for Cellco and Microgon, Inc., respectively. The Company
      believes there is no impairment of goodwill. Accumulated amortization of
      goodwill amounted to $393,190 at January 3, 1998.

      LONG-LIVED ASSETS - The Company accounts for the impairment and
      disposition of long-lived assets in accordance with SFAS No. 121,
      ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED
      ASSETS TO BE DISPOSED OF. SFAS No. 121 requires impairment losses to be
      recognized for long-lived assets used in operations when indicators of
      impairment are present and the undiscounted cash flows are not sufficient
      to recover the assets' carrying amount. There was no impairment of the
      value of such assets for the year ended January 3, 1998.

      INCOME TAXES - The Company accounts for income taxes under the provision
      of SFAS No. 109, ACCOUNTING FOR INCOME TAXES. This statement requires the
      recognition of deferred tax assets and liabilities for the future
      consequences of events that have been recognized in the Company's
      financial statements or tax returns. Measurement of the deferred items is
      based on enacted tax laws. In the event the future consequences of
      differences between financial reporting bases and tax bases of the
      Company's assets and liabilities result in a deferred tax asset, SFAS No.
      109 requires an evaluation of the probability of being able to realize the
      future benefits indicated by such asset. A valuation allowance related to
      a deferred tax asset is recorded when it is more likely than not that some
      portion or all of the deferred tax asset will not be realized.

      REVENUE RECOGNITION - The Company records revenue at the time the related
      products are shipped.


                                       19
<PAGE>


SPECTRUM LABORATORIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996 (Continued)
--------------------------------------------------------------------------------


      LOSS PER COMMON SHARE - The Company has adopted SFAS No. 128, EARNINGS PER
      SHARE, which replaces the presentation of "Primary" earnings per share
      with "Basic" earnings per share and the presentation of "Fully Diluted"
      earnings per share with "Diluted" earnings per share. Prior periods have
      been restated to reflect the change in presentation and assumed exercise
      of outstanding options into common stock have been excluded due to their
      antidilutive nature.

      Basic earnings per share amounts are based on the weighted-average number
      of common shares outstanding. Diluted earnings per share amounts are based
      on the weighted-average number of common and common equivalent shares for
      each period presented. Common equivalent shares include stock options, if
      dilutive, using the treasury stock method.

      TRANSLATION OF FOREIGN CURRENCIES - Assets and liabilities of Spectrum
      B.V. are translated into U.S. dollars at year-end rates of exchange, and
      income and expenses are translated at average rates during the respective
      years. The functional currency of this subsidiary is the guilder;
      therefore, translation gains or losses are recorded as a separate
      component of shareholders' equity.

      FAIR VALUE OF FINANCIAL INSTRUMENTS - Management believes that the
      carrying amount of cash and cash equivalents, accounts receivable,
      accounts receivable due from affiliates, accounts payable and accrued
      expenses approximates fair value because of the short maturity of these
      financial instruments. A portion of long-term debt bears interest at a
      rate indexed to the prime rate, and the remaining long-term debt and notes
      payable to affiliated parties bears interest at a rate comparable to prime
      at January 3, 1998; therefore, management believes the carrying amount of
      the outstanding borrowings at January 3, 1998 approximates fair market
      value.

      ACCOUNTING FOR STOCK-BASED COMPENSATION - SFAS No. 123, ACCOUNTING FOR
      STOCK-BASED COMPENSATION, defines a fair value method of accounting for
      stock options and other equity instruments. Under the fair value method,
      compensation cost is measured at the grant date based on the fair value of
      the award and is recognized over the service period, which is usually the
      vesting period.

      The Company has elected to continue to account for such transactions under
      Accounting Principles Board (APB) Opinion No. 25, ACCOUNTING FOR STOCK
      ISSUED TO EMPLOYEES, but is required to disclose in a note to the
      financial statements pro forma net loss and loss per share as if the
      Company had applied the fair value method of accounting (Note 7).

      NEW ACCOUNTING PRONOUNCEMENTS - In June 1997, the Financial Accounting
      Standards Board (FASB) issued SFAS No. 130, REPORTING COMPREHENSIVE
      INCOME, which is effective for annual and interim periods beginning after
      December 15, 1997. This statement requires that all items that are
      required to be recognized under accounting standards as comprehensive
      income be reported in a financial statement that is displayed with the
      same prominence as other financial statements.


                                       20
<PAGE>


SPECTRUM LABORATORIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996 (Continued)
--------------------------------------------------------------------------------


      In June 1997, FASB issued SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN
      ENTERPRISE AND RELATED INFORMATION, which is effective for annual and
      interim periods beginning after December 15, 1997. This statement
      establishes standards for the method that public entities report
      information about operating segments in annual financial statements and
      requires that those enterprises report selected information about
      operating segments in interim financial reports issued to shareholders. It
      also establishes standards for related disclosures about product and
      services, geographical areas, and major customers.

      In February 1998, FASB issued SFAS No. 132, EMPLOYERS' DISCLOSURE ABOUT
      PENSIONS AND OTHER POSTRETIREMENT BENEFITS, which is effective for annual
      and interim, periods beginning after December 15, 1997. This statement
      standardized the disclosure requirements for pensions and other
      postretirement benefits to the extent practicable, requires additional
      information on changes in the benefit obligations and fair values of plan
      assets that will facilitate financial analysis and eliminates certain
      disclosures that are no longer as useful as they were under previous
      statements.

      RECLASSIFICATIONS - Certain December 31, 1996 balances have been
      reclassified to conform with the January 3, 1998 presentation.


2.    ACQUISITIONS

      On October 1, 1996, SLIAC entered into an Asset Purchase Agreement with
      Cellco, a Delaware corporation, and acquired the operating assets and
      liabilities of Cellco in exchange for 10,000 shares of SLIAC preferred
      stock valued at $2,000,000. The acquisition was recorded as a purchase for
      accounting purposes and the purchase price of $2,085,000 was allocated to
      assets acquired of $773,407, liabilities assumed of $685,105, intangible
      assets of $211,698, and purchased research and development costs of
      $1,700,000. The preferred shareholders of SLIAC have the right to put
      their stock to SLI at any time from October 1, 2000 to September 30, 2001
      for a price of $2,000,000. In the event the Company is combined with SMI
      and the combined company completes an underwritten offering, the preferred
      shareholders have the right to exchange such stock for 7% of the newly
      combined company. The preferred shares are nonvoting and have preference
      over common shareholders as to dividends and liquidation.


                                       21
<PAGE>


SPECTRUM LABORATORIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996 (Continued)
--------------------------------------------------------------------------------


      The following unaudited consolidated pro forma results of operations for
      the year ended December 31, 1996 assume that the acquisition of the
      operations of Cellco occurred at the beginning of fiscal year 1996. These
      unaudited consolidated pro forma results do not purport to be indicative
      of the results which would have occurred had the acquisition been made as
      of that date or of results which may occur in the future.


                                                                        1996

        Net revenues                                              $   9,571,992
                                                                  ==============
        Net loss                                                  $  (2,610,540)
                                                                  ==============
        Basic and diluted net loss per common share               $       (0.20)
                                                                  ==============
        Basic and diluted weighted average number of common shares   12,834,394
                                                                  ==============

3.    INVENTORIES

      Inventories consist of the following at January 3, 1998:

        Raw materials                                             $     611,475
        Work-in-progress                                                 43,488
        Finished goods                                                  402,708
                                                                  --------------
                                                                      1,057,671
        Less reserve for obsolescence                                  (176,253)
                                                                  --------------
    
                                                                  $     881,418
                                                                  ==============
                                                                  


                                       22
<PAGE>


SPECTRUM LABORATORIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996 (Continued)
--------------------------------------------------------------------------------

4.    PROPERTY AND EQUIPMENT

      Property and equipment consist of the following at January 3, 1998:


        Equipment                                                   $ 3,764,862
        Furniture                                                       394,418
        Leasehold improvements                                          483,876
                                                                    ------------
                                                                      4,643,156
        Less accumulated depreciation and amortization               (3,863,108)
                                                                    ------------

                                                                    $   780,048
                                                                    ============


5.    INCOME TAXES

      The Company's current income tax provision consists of the following:


                                                             1997        1996
 
        Federal                                            $      -    $      -
        State                                                33,520      40,795
        Foreign                                              (8,121)     21,544
                                                           ---------   ---------

                                                           $ 25,399    $ 62,339
                                                           =========   =========


                                       23
<PAGE>


SPECTRUM LABORATORIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996 (Continued)
--------------------------------------------------------------------------------

      The provision for income taxes differs from the amount computed by
      applying the statutory federal income tax rate of 35% to the consolidated
      loss before provision for income taxes, as follows:
                                                             1997        1996

        Statutory federal income tax benefit            $  (16,791)   $(570,798)
        Goodwill amortization                               54,784       54,784
        Nondeductible meals and entertainment                5,013        2,324
        State income taxes, net                             21,991       26,337
        (Decrease) increase in valuation allowance          (5,218)     565,907
        Effect of foreign taxes                                         (16,215)
        Tax rate benefit                                   (39,902)
        Other                                                5,522
                                                         ----------   ----------

        Income tax provision                             $  25,399    $  62,339
                                                         ==========   ==========

      The components of the Company's net deferred income tax asset as of
      January 3, 1998 are as follows:

        Deferred state taxes                                         $   10,785
        Depreciation                                                    (19,877)
        Research and development expenses                               627,704
        Reserves not currently deductible                               165,642
        Operating loss carryforwards                                  3,517,698
        Other                                                            88,691
                                                                     -----------
                                                                      4,390,643
        Valuation allowance                                          (4,013,458)
                                                                     -----------

        Net deferred tax asset                                       $  377,185
                                                                     ===========

      The Company's valuation allowance of $4,013,458 at January 3, 1998 results
      from the uncertainty of the Company's ability to utilize net operating
      loss and tax credit carryforwards to reduce future taxes. The valuation
      allowance decreased $184,270 during 1997.

      At January 3, 1998, the Company had net operating loss carryforwards for
      federal income tax purposes of $9,733,699 ($8,100,000 available to offset
      income of Microgon only), which expire at various dates from 1998 through
      2009. The utilization of Microgon's $8,100,000 federal net operating loss
      is limited to approximately $298,000 of Microgon income annually. Any
      unused net operating loss is carried forward. As a result of the
      limitation, it is possible that more than $5,000,000 of the Microgon loss
      may expire without utilization. The Company has an approximate $3,500,000
      state net operating loss carryforward, which expires at various dates
      beginning in 1998.


                                       24

<PAGE>


SPECTRUM LABORATORIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996 (Continued)
--------------------------------------------------------------------------------

6.    LONG-TERM DEBT

      Long-term debt consists of the following at January 3, 1998:

       Note payable to bank, with a maturity date of March 1, 2002,
        collateralized by substantially all of the assets of the 
        Company, guaranteed by the majority shareholder, due in 
        monthly principal installments of $60,000, plus an 
        installment of $678,621 due May 1, 1998. Interest is 
        payable monthly at a rate of 9.14% subject to the
        bank's yield maintenance agreement (9.14% at January 
        3, 1998)                                                     $3,000,000

       Note payable to a bank with a maturity date of May 1, 1998,
        collateralized by substantially all of the assets of the 
        Company, guaranteed by the majority shareholder. Interest 
        is payable monthly at a rate of prime plus .25% (8.75% at 
        January 3, 1998)                                                161,000

       8.75% note payable to shareholder, due in annual installments  
        of $100,000, beginning January 1, 2001, with final payment
        of $52,750 due on January 1, 2006                               552,750

       Noninterest-bearing notes payable on various dates through 
        January 31, 1999                                                 28,500

       Obligation under sales-leaseback transaction                      55,540
                                                                     -----------
 
                                                                      3,797,790
       Less current portion                                          (1,623,258)
                                                                     -----------

                                                                     $2,174,532
                                                                     ===========

      Aggregate maturities of long-term debt, including current portion, as of
      January 3, 1998 are as follows:

        1998                                                        $ 1,623,258
        1999                                                            740,403
        2000                                                            720,000
        2001                                                            261,379
        2002                                                            100,000
        Thereafter                                                      352,750
                                                                     -----------

                                                                     $3,797,790
                                                                     ===========



                                       25
<PAGE>


SPECTRUM LABORATORIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996 (Continued)
--------------------------------------------------------------------------------


      The notes payable to the bank include certain financial covenants and
      certain restrictions, including prohibiting the payment of dividends
      without prior approval of the bank. At January 3, 1998, the Company was in
      violation of certain debt covenants and on April 20, 1998 obtained a
      waiver from the bank. Provisions of the Company's loan agreement with the
      bank require principal and interest payments due May 1, 1998 of
      approximately $1,200,000. On April 29, 1998, the Company obtained an
      extension to July 1, 1998. The notes payable are collateralized by
      substantially all of the assets of the Company and are guaranteed by the
      majority shareholder.

      On April 1, 1995, the Company sold certain items of its laboratory
      equipment for $159,912. Concurrently, the Company leased the equipment
      back for a period of 48 months at a monthly rental of $4,311. The Company
      has the option to repurchase the equipment at the end of the lease for
      consideration equal to the greater of 10% of the sale price or the fair
      market value of the equipment at that time, as determined by an
      independent appraiser. As a result, the transaction has been recorded as a
      financing transaction rather than as a sale, and the equipment and related
      accounts continue to be recognized in the accompanying financial
      statements.

      The future lease payments under the related lease agreement are as
      follows:

        1998                                                           $ 51,732
        1999                                                              8,622
                                                                       ---------

                                                                         60,354
        Less amount representing interest                                (4,814)
                                                                       ---------

                                                                       $ 55,540
                                                                       =========

      The implicit interest rate under the related lease agreement is 14%.


7.    STOCK OPTION PLAN

      The Company has a Stock Option Plan (the Plan) providing for options to
      purchase up to 2,000,000 shares of its common stock. The Plan provides for
      the granting of options to qualified employees and consultants of the
      Company at prices which are not less than 85% of the fair market value of
      the shares as of the date of grant. The options become exercisable as
      specified in the Plan, expire not more than ten years from the date of
      grant, and become exercisable ratably over a four-year period (25% per
      year). No options have been exercised to date.


                                       26
<PAGE>


SPECTRUM LABORATORIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996 (Continued)
--------------------------------------------------------------------------------

      Option activity under the Plan is as follows:

                                                                       Weighted
                                                                        average
                                                           Number of   exercise
                                                            shares       price

        OUTSTANDING, January 1, 1996                        639,000       $.32
          Granted (weighted average fair value of $.23)     282,000        .30
                                                           ---------

        OUTSTANDING, December 31, 1996                      921,000        .32
          Granted (weighted average fair value of $.11)     378,000        .21
          Terminated                                       (324,000)       .26
                                                           ---------

        OUTSTANDING, January 3, 1998                        975,000        .29
                                                           =========

      At January 3, 1998, outstanding options had a range of exercise prices
      from $.19 to $.75 per share and weighted average contractual life of 8.3
      years. At January 3, 1998, 310,250 options were exercisable with a
      weighted average exercise price of $.32 per share. At January 3, 1998,
      1,025,000 shares were available for future grants under the Plan.

      SFAS No. 123 requires the disclosure of pro forma net income and earnings
      per share had the Company adopted the fair value method as of the
      beginning of fiscal year 1995. Under SFAS No. 123, the fair value of
      stock-based awards to employees is calculated through the use of
      option-pricing models, even though such models were developed to estimate
      the fair value of freely tradable, fully transferable options with vesting
      restrictions, which significantly differ from the Company's stock option
      awards. These models also require subjective assumptions, including future
      stock price volatility and expected time to exercise, which greatly affect
      the calculated values. The Company's calculations were made using the
      Black-Scholes option-pricing model with the following weighted average
      assumptions: expected life, 48 months following complete vesting; stock
      volatility, 92% in 1997 and 108% in 1996; risk-free interest rate, 5.8% in
      1997 and 6% in 1996; and no dividends during the expected term. The
      Company's calculations are based on a single-option valuation approach,
      and forfeitures are recognized as they occur. If the computed fair values
      of the 1997 and 1996 awards had been amortized to expense over the vesting
      period of the awards, pro forma net loss would have been $139,599 ($.01
      per basic and diluted share) in 1997 and $1,697,000 ($.13 per basic and
      diluted share) in 1996.


                                       27

<PAGE>


SPECTRUM LABORATORIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996 (Continued)
--------------------------------------------------------------------------------

8.    AFFILIATED-ENTITIES TRANSACTIONS

      The Company had additional transactions with affiliates and related
      parties as follows:

<TABLE>
<CAPTION>

                                                                          1997         1996

        <S>                                                            <C>           <C>  
        Rent paid to a company controlled by the majority shareholder  $ 152,422     $ 36,000

        Legal fees paid to a member of the Board of Directors             63,986       27,080

        Purchases from a company controlled by the majority shareholder       -       103,173

        Sales to a company controlled by the majority shareholder             -        23,685
</TABLE>

                                                                              
      Companies controlled by, and affiliated with, the majority shareholder
      share various facilities and services, including office space,
      manufacturing, administrative and marketing staff assistance, and data
      processing capabilities. The expenses and revenues associated with staff
      assistance, services and data processing capabilities are allocated to the
      respective companies based on time devoted to each company. Overhead costs
      for shared manufacturing and assembly facilities are allocated based on
      space utilized. In connection with the shared services and facilities, the
      Company had amounts due from affiliates of $553,411 at January 3, 1998.


9.    COMMITMENTS

      The Company rents manufacturing, warehousing and office facilities under
      lease agreements requiring monthly payments. Rent expense under operating
      leases was $322,632 and $218,939 in 1997 and 1996, respectively, of which
      $152,422 and $36,000, respectively, was paid to an affiliated entity. All
      facility leases expire on December 31, 1998. Such facility leases require
      payments of $334,000 in 1998, except for the facility lease that expires
      on January 31, 2003. Rent payments for this lease are approximately
      $22,000 in 1998; $24,700 in 1999; $25,300 in 2000; $25,900 in 2001;
      $26,500 in 2002; and $2,214 in 2003.


10.   FOREIGN SALES

      Sales to customers in foreign countries, primarily Europe, amounted to
      approximately $2,302,000 and $1,826,000 in 1997 and 1996, respectively.



                                       28
<PAGE>


SPECTRUM LABORATORIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 3, 1998 AND DECEMBER 31, 1996 (Continued)
--------------------------------------------------------------------------------


11.   GAIN ON SALE OF PRODUCT LINES

      In March 1997, the Company sold its microbiological sampling and
      transports product line, including related inventory and production
      equipment, for approximately $969,000, resulting in a gain of $768,488. In
      November 1997, the Company sold its microscope drapes product line,
      including related inventory and production equipment, for approximately
      $128,000, resulting in a gain of $34,571.


12.   PROPOSED MERGER

      The Company is currently investigating the possibility of a merger with
      SMI. No definitive agreement has been reached as of March 27, 1998.


                                       29
<PAGE>




ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE

None

                                    PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
        WITH SECTION 16(A) OF THE EXCHANGE ACT

Directors
---------

Named below are directors serving until an Annual Meeting of Shareholders and
until their respective successors are
elected and qualify.

Name                        Age          Director Since           Position
----                        ---          --------------           --------
Roy T. Eddleman             58           July 30, 1982          Chairman, CEO
                                                                  & Director

Jack Whitescarver, Ph.D.    60           April 1, 1985          Director


Executive Officers of The Company
---------------------------------

Roy T. Eddleman             58           July 30, 1982          Chairman & CEO

F. Jesus Martinez           58               ----               President


Business Experience of Directors and Executive Officers
-------------------------------------------------------

Roy T. Eddleman was elected Chairman of the Board and Chief Executive Officer of
the Company on July 30, 1982. Mr. Eddleman has been engaged primarily as a
private investor and entrepreneur for more than twenty years.

Jack Whitescarver is the Deputy Director for the Office of AIDS Research at the
National Institutes of Health in Bethesda, Maryland and has been there more than
six years.

F. Jesus Martinez has been Chief Operating Officer and President of the Company
since September, 1995. Mr. Martinez held the position of Vice President of R&D
and Operations from August 1989 to September 1995. He has held senior management
positions at Baxter Healthcare Corporation, National Medical Care, Minntech
Corporation and is inventor or co-inventor of over twenty patents in medical
devices.

There are no family relationships between any of the Company's directors and
officers. There are no arrangements or understandings between any director and
any other person pursuant to which any person was elected or nominated as a
director.

The Company had no pension, retirement, annuity, savings or similar benefit
plans in 1997. Directors are not compensated for their services on the Company's
Board of Directors.



                                       30
<PAGE>


ITEM 10.  EXECUTIVE COMPENSATION

The following table sets forth the annual compensation paid and accrued by the
Company during its last three fiscal years to executive officer to whom it paid
in excess of $100,000 including cash and issuance of securities:
<TABLE>
<CAPTION>

                                     ANNUAL COMPENSATION                   RESTRICTED LONG TERM COMPENSATION
                                     -------------------                   ---------------------------------
NAME AND POSITION            YEAR          SALARY        BONUS    STOCK AWARDS     SAR'S       LTIP    ALL OTHER
-----------------            ----          ------        -----    ------------     -----       ----    ---------
<S>                          <C>         <C>           <C>            <C>              <C>         <C>     <C>
Roy T. Eddleman              1997        $160,000
Chief Executive Officer      1996        $160,000      $75,000
                             1995        $160,000      $82,000

F. Jesus Martinez            1997        $150,200      $61,751 (1)
President                    1996        $145,000      $55,000
                             1995         $84,180      $88,753 (1)    240,000
</TABLE>

(1) Includes payments of $13,626 and $88,753 in 1997 and 1995, respectively,
which were made in connection with the sale of Microgon, Inc. to the Company.


                                       31
<PAGE>


ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock at January 3, 1998 by (i) all persons
known by management to be beneficial owners of more than 5% of its Common Stock,
(ii) all nominees for directors and (iii) all officers and nominees for
directors of the Company as a group:
<TABLE>
<CAPTION>
                                                    Amount and Nature of Beneficial Ownership (A)

                                       Directly Owned
                                       with Sole Power                    Indirectly Owned with
                                        of Voting and     Percent         Shared Power of Voting         Percent
Name                                     Disposition     of Class          and/or Disposition          of Class (1)
----                                     -----------     ---------         ------------------          ------------
 <S>                                   <C>                <C>                 <C>                         <C>   
 Roy T. Eddleman  (B)
 23022 La Cadena Drive                    901,907          7.0%               11,037,338                  85.9%
 Laguna Hills, California

 Spectrum Medical Industries, Inc.
 23022 La Cadena Drive                 10,135,431         78.9%                       -                      -
 Laguna Hills, California

 Thomas Girardi, Esq.
 1126 Wiltshire Boulevard                 901,907          7.0%                       -                      -
 Los Angeles, CA  90017

 Jack Whitescarver, Ph.D.  (C)                 -             -                        -                      -

 All directors and officers as a          901,907          7.0%                       -                      -
 group (5 in number)
</TABLE>

(1)     12,834,394 shares outstanding as of January 3, 1998.

(A) Unless otherwise noted, all shares listed are owned of record.

(B) Mr. Eddleman is the principal shareholder, executive officer and
    director of Spectrum Medical Industries, Inc. As such, he may be deemed
    to control investment power of the 10,135,431 shares of the Company's
    Common Stock owned by Spectrum Medical Industries. Such shares are
    included in the indirect beneficial holdings of Mr. Eddleman set forth
    in the above table.

(C) In 1991 Mr. Whitescarver received options to purchase 8,333 shares of
    the Company's Common Stock at an exercise price of $0.60 per share. No
    options have been exercised to date.

The following table sets forth options granted to named executive officers:
<TABLE>
<CAPTION>

Name                   No. of Securities     Percent of     Exercise   Expiration    Potential Realizable Value
                       Underlying Options   Total Options     Price       Date       at Assumed Annual Rates of
                                                                                      Stock Price Appreciation
----                   ------------------   -------------   --------   ----------    --------------------------

<S>                         <C>                 <C>           <C>       <C>                <C>    
Roy T. Eddleman, CEO           --                --            --          --                    --

F. Jesus Martinez,          240,000             30.7%         .32       12/31/00           at 5% $103,200
President                                                                                  at 10% $127,200
</TABLE>



                                       32
<PAGE>


ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

In 1997 and 1996, the Company has had transactions with related parties as
follows:


                                                                1997      1996
          Rent paid to a company controlled by the           $154,422   $36,000
            majority shareholder
          Legal fees paid to a member of the Board of        $ 63,986   $27,080
            Directors
          Purchases from a company controlled by the                   $103,173
            majority shareholder
          Sales to a company controlled by the                          $23,685
            majority shareholder


                                       33
<PAGE>


ITEM 13.  EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits
------------

Exhibit No.                         Description

3.1      Articles of Incorporation of Registrant (incorporated by reference to
         Exhibit 4.1 file with Registrant's Registration Statement on Form S-2.
         Registration No. 2-68999

3.2      Amendment to Article I of the Articles of Incorporation of Registrant
         (incorporated by reference to Exhibit 3.2 filed with Registrant's
         Report on Form 10-K for the fiscal year ended December 31, 1982,
         commission File No. 0-9478)

3.3      Bylaws of Registrant (incorporated by reference to Exhibit 4.2 filed
         with Registrant's Registration Statement on Form S-2, Registration No.
         2-68999)

3.4      Amendment to Article III, section 2 of Registrant's Bylaws
         (incorporated by reference to Exhibit 3.3 filed with Registrant's
         Report on Form 10-K for the fiscal year ended May 31, 1982, Commission
         File No. 0-9478)

3.5      Amendment to Article IV, Section 6 and Section 7 of the Registrant's
         Bylaws (incorporated by reference to Exhibit 3.4 filed with
         Registrant's Report on Form 10-K for the fiscal year ended May 31,
         1982, Commission File No. 0-9478)

3.6      Articles of Amendment to Registrant's Articles of Incorporation
         increasing authorized stock to 25,000,000 shares (incorporated by
         reference to Registrant's Schedule 14C-2 Information Statement, Exhibit
         A, filed with the Commission on October 19, 1996; Commission File NO.
         0-9478

3.7      Certificate of Ownership of Microgon into Spectrum Laboratories
         incorporated by reference to Exhibit 2B to the Registrant's Form 8-K/A
         on October 15, 1996, Commission File No. 0-9478

10.1     Agreement for Sale of Assets dated as of August 1, 1982 between
         Registrant and Glenco Scientific, Inc. (incorporated by reference to
         Exhibit 10.7 filed with Registrant's report on form 10-K for the fiscal
         year ended December 31, 1982, Commission File No. 0-9478)

10.2     Agreement for Sale of Assets dated as of August 1, 1982 between
         Registrant and Spectrum Medical, Inc. (incorporated by reference to
         Exhibit 10.8 filed with Registrant's Report on Form 10-K for the fiscal
         year ended December 31, 1982, commission File No. 0-9478)

10.3     Agreement for Sale of Assets Dated as of July 1, 1983 between the
         Registrant and all the shareholders of Innometrics, Inc. (incorporated
         by reference to Exhibit 10.8 filed with Registrant's Report on Form
         10-K for the fiscal year ended December 31, 1983, Commission File No.
         0-9478)

10.4     Agreement and Plan of Reorganization dated March 31, 1983 between the
         Registrant and all the shareholder of Innometrics, Inc. (incorporated
         by reference to Exhibit 10.8 filed with Registrant's Report on Form
         10-K for the fiscal year ended December 31, 1983, Commission File No.
         0-9478)


                                       34
<PAGE>

10.5     Sublease dated September 15, 1982, between Registrant and Glenco
         Scientific, Inc. for facilities at 15413 Vantage Parkway East, Houston,
         Texas (incorporated by reference to Exhibit filed with Registrant's
         Report on Form 10-K for the fiscal year ended December 31, 1983,
         Commission File No. 0-9478)

10.6     Registrants Stock Compensation Plan (incorporated by reference to
         Exhibit 10.11 filed with Registrant's Report on Form 10-K for the
         fiscal year ended December 31, 1983, Commission File No. 0-9478)

10.7     Registrant's 1982 Stock Option Plan (incorporated by reference to
         Exhibit 10.12 filed with Registrant's Report on Form 10-K for the
         fiscal year ended December 31, 1983 Commission File No. 0-9478)

10.8     Purchase Agreement dated as of July 21, 1983 between Registrant and
         Biotic Technologies, Inc. (incorporated by reference to Exhibit 10.13
         filed with Registrants Report on Form 10-K for the fiscal year ended
         December 31, 1983, Commission File No. 0-9478)

10.9     Closing Agreement dated as of October 26, 1983 between Registrant,
         Arden A. Kelton and Environmental Diagnostics, Inc. (incorporated by
         reference to Exhibit 10.14 with Registrant's Report on Form 10-K for
         the fiscal year ended December 31, 1983, Commission File No. 0-9478)

10.10    Evaluation and Option Agreement dated August 17, 1984 between
         Registrant and Instrumentation Laboratories, Inc. (incorporated by
         reference to Exhibit 10.10 filed with Registrant's Report on Form 10-K
         for the fiscal year ended December 31, 1984, Commission File No.
         0-9478)

10.11    Amendment to Investment and Loan Agreement dated August 1, 1995 among
         the Company, Microgon and certain preferred shareholders of Microgon,
         incorporated by reference to Exhibit 2A to the Registrant's Form 8K/A
         filed on October 15, 1995, Commission File No. 0-9478

10.12    Stock Option Plan adopted October 11, 1996 (incorporated by reference
         to Exhibit B to Registrant's filing of Schedule 14-2, filed with the
         Commission on October 9, 1996.

10.13    City National Bank loan agreement dated as of February 28, 1997,
         between registrant, Spectrum Medical Industries, Inc., and City
         National Bank (incorporated by reference to Exhibit 10.13 filed with
         registrant's report on Form 10-KSB for fiscal year ended December 31,
         1996, Commission File No. 0-9478).

10.14    Registrant's purchase agreement of Cellco, Inc. (incorporated by
         reference to Exhibit 10.14 with registrant's Form 8-K dated November 1,
         1996, Commission File No. 0-9478).

10.15    First amendment, dated October 10, 1997, to the City National Bank loan
         agreement dated as of February 28, 1997, between registrant, Spectrum
         Medical Industries, Inc., and City National Bank.

10.16    Second amendment, dated May 7, 1998, to the City National Bank loan
         agreement dated as of February 28, 1997, between registrant, Spectrum
         Medical Industries, Inc., and City National Bank. 

                                       35

<PAGE>

(b) Reports on 8-K
------------------

No reports on Form 8-K were filed during the quarter ended January 3, 1998.


                                       36
<PAGE>


SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.

SPECTRUM LABORATORIES, INC.




By: /s/  Roy T. Eddleman
   ----------------------------------
Roy T. Eddleman
Chairman and Chief Executive Officer
Date: May 14, 1998





By: /s/  F. Jesus Martinez
   ----------------------------------
F. Jesus Martinez
President
Date: May 14, 1998





By: /s/  Larry D. Womack
   ----------------------------------
Larry D. Womack
Controller
Date: May 14, 1998



                                       37