FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 1997 Commission file number 000-19495
----------
Embrex, Inc.
(Exact name of registrant as specified in its charter)
North Carolina 56-1469825
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
1035 Swabia Court, Durham, North Carolina 27703
(Address of principal executive offices) (Zip Code)
(919) 941-5185
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 Par Value Per Share (and Rights Attached Thereto)
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes _X_ No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not 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-K or any amendment to this
Form 10-K. |_|
As of February 27, 1998, the aggregate market value of the voting stock held by
non-affiliates was $43.9 million based on a price per common share of $5.50 at
the close of business on that date.
As of February 27, 1998, there were 8,224,046 shares of the registrant's common
stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Document Where Incorporated
Proxy Statement with respect to the Annual Part III
Meeting of Shareholders to be held on May 21,
1998, to be filed with the Securities and
Exchange Commission
INDEX
PAGE
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PART I
ITEM 1. BUSINESS.......................................................
ITEM 2. PROPERTIES.....................................................
ITEM 3. LEGAL PROCEEDINGS..............................................
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS............................................
ITEM 6. SELECTED FINANCIAL DATA........................................
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS............................
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA....................
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE............................
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT..............
ITEM 11. EXECUTIVE COMPENSATION..........................................
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT......................................................
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..................
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K.....................................................
SIGNATURES..................................................................
2
PART I
ITEM 1. BUSINESS
GENERAL
Embrex, Inc. ("Embrex" or the "Company") develops and markets biological
delivery technology and biological products to increase the productivity and
profitability of the global poultry industry. The Company was incorporated in
1985 in North Carolina.
Embrex has developed and commercialized the INOVOJECT(R) system, a proprietary,
automated in-the-egg injection system which can inoculate 20,000 to 50,000 eggs
per hour and eliminates the need for manual, post-hatch injection of certain
vaccines. The INOVOJECT(R) system is designed to inject vaccines and other
compounds in precisely calibrated volumes into targeted compartments within the
egg. Embrex markets the INOVOJECT(R) system to commercial poultry producers,
charging a fee for each egg injected.
In addition to the INOVOJECT(R) system, Embrex has developed and is marketing
its Viral Neutralizing Factor ("VNF(R)") antibody, useful in the development of
certain avian vaccines. The Company also has developed and is marketing
Bursaplex(TM), a VNF(R)-based vaccine for protection against avian Infectious
Bursal Disease ("IBD"). Embrex also is developing various other proprietary
pharmaceutical and biological products to improve bird health, reduce bird
production costs and provide other economic benefits to the poultry industry.
These compounds include vaccines, immune enhancers, performance modifiers and
genetic materials designed to increase poultry productivity and health while
reducing costs. These products are in various stages of development, and some
are being developed in collaboration with major drug companies, the United
States Department of Agriculture (the "USDA"), and several leading universities
in the field of avian science. These compounds are being designed to be
delivered through the INOVOJECT(R) system, and some may also be administered via
post-hatch injection.
EXISTING PRODUCTS
Patented Egg Injection System (INOVOJECT(R))
Embrex has developed and commercialized a proprietary, automated in-the-egg
injection system which can inoculate 20,000 to 50,000 eggs per hour and
eliminates the need for manual, post-hatch injection of certain vaccines. This
proprietary system, called INOVOJECT(R), is designed to inject vaccines and
other compounds in precisely calibrated volumes into targeted compartments
within the egg. Embrex markets the INOVOJECT(R) system to commercial poultry
producers, charging a fee for each egg injected.
In 1997, the Company converted a number of hatcheries to the INOVOJECT(R) system
and continued operations of INOVOJECT(R) systems in hatcheries converted prior
to 1997. As a result, at December 31, 1997, Embrex had over 300 INOVOJECT(R)
systems installed in the United States ("U.S.") and Canada, as compared with
over 250 at year end 1996. The Company estimates that its INOVOJECT(R) system
inoculates in excess of 80% of all eggs produced for the North America broiler
poultry market and, therefore, expects only modest INOVOJECT(R) system revenue
growth in this market.
During 1997, the Company also placed a number of INOVOJECT(R) systems for trial
and on contract at locations outside the U.S. and Canada. The Company's
expansion outside the U.S. and Canada has been focused initially on Europe, the
Middle East, Africa and, during the second half of 1997, on Asia. At year end,
the Company had INOVOJECT(R) systems either installed or on trial in the United
Kingdom, Ireland, France, Spain, the Netherlands, Belgium, Italy, the Czech
Republic, Israel, Egypt, South Africa, Turkey, Australia, South Korea and
Thailand. Overall, the placement of INOVOJECT(R) systems outside the U.S. and
Canada is dependent on market acceptance of various in ovo ("in the egg")
vaccines and obtaining regulatory approval of these vaccines in numerous
countries.
Certain poultry diseases are more prevalent in some geographic regions than in
others. For example, Marek's disease, for which the INOVOJECT(R) system is used
in the U.S., is not as widespread in Europe as in North America. Similarly,
Infectious Bursal Disease or IBD (also known as Gumboro disease) is prevalent
both in the United States and in Northern
3
Europe and Asia. The Company expects that primary usage of its INOVOJECT(R)
systems will vary by geographic region according to the prevailing diseases and
regulatory approval of vaccines for in ovo delivery.
Viral Neutralizing Factor (VNF(R))
Embrex has developed and commercialized a Viral Neutralizing Factor technology
which permits single-dose immunization of the avian embryo effective for the
life of the bird. By combining VNF(R), an antibody, with a vaccine virus,
immunization is provided in a single step, reducing or eliminating many of the
multiple vaccinations carried out in the industry. VNF(R) can neutralize a
virulent vaccine virus without impairing the virus' ability to stimulate an
immune response. By using VNF(R) in this manner, the virulent vaccine virus can
be made into a safe and effective vaccine which can be used in ovo or after
hatching.
The VNF(R) technology is the subject of two issued U.S. patents, a pending U.S.
patent application, and several foreign patents and foreign patent applications.
The U.S. patents are owned by the University of Arkansas and exclusively
licensed to Embrex on a royalty basis for the life of the patents. Embrex also
is researching application of VNF(R) for other avian disease vaccines, including
Newcastle's disease and infectious bronchitis, although there is no assurance
such research will result in product opportunities.
To date, the Company's research efforts with its VNF(R) compound have been
focused on avian uses. Based on initial experimental data, the Company now
believes that the potential exists for VNF(R) to be used in several non-avian
species. The Company is in the early stages of exploring collaborative
relationships with other companies for the development and licensing of VNF(R)
for non-avian uses. Embrex has not initiated any regulatory approval processes
with respect to non-avian uses of VNF(R), nor is there any assurance that its
efforts in this area will result in products or collaborative agreements. During
1997, the Company obtained a patent for the use of VNF(R) vaccines in all
non-primate mammals.
Infectious Bursal Disease (IBD) Vaccines
VNF(R) is especially useful in vaccines against avian IBD, which weakens a
bird's immune system. Birds infected by IBD typically exhibit poor growth or can
succumb to other diseases because of a compromised immune system. This disease
is widespread in the U.S., Northern Europe and Asia. To date, IBD has been
treated post-hatch via manually delivered vaccines or in drinking water.
Existing vaccines are associated, however, with certain limitations, and some
cannot be used safely or effectively in ovo. The Company estimates the worldwide
market for IBD vaccines to be approximately $60 million annually.
In January 1995, USDA approval was obtained for post-hatch administration of
Bursaplex(TM), the Company's VNF(R)-based vaccine for IBD in broiler chickens.
USDA approval was obtained in January 1997 for in ovo use of Bursaplex(TM),
specifically for administration via Embrex's INOVOJECT(R) egg injection systems.
During 1997, the Company conducted clinical trials of Bursaplex(TM) involving
more than 43.5 million birds, which Embrex believes demonstrated clear economic
benefits of this IBD vaccine.
In August 1995, the Company entered into an agreement with Cyanamid Websters
("Websters"), a unit of Ft. Dodge Animal Health, which is a division of American
Home Products Corp., for the joint development of another IBD vaccine containing
VNF(R), which will be marketed by Websters in Europe, the Middle East, and
Africa under Websters' trade name "Bursamune(TM)" upon receipt of regulatory
approvals. In June 1997, the Company announced that Ft. Dodge Animal Health
indicated that its application for U.K. in ovo regulatory approval of
Bursamune(TM) had been provisionally refused. Both the Company and Ft. Dodge had
anticipated approval by the middle of 1997, however, Ft. Dodge indicated that
the U.K. regulatory authority requested that further data be supplied. The
Company is working with Ft. Dodge and Websters, which are responsible for
obtaining the necessary approvals for Bursamune(TM) in both the U.K. and other
European Community markets, to respond to the U.K. regulatory authority requests
for data with respect to Bursamune(TM). The Company anticipates that regulatory
approval in the U.K., as well as some other European Community markets, will
occur during summer of 1998.
Embrex intends to seek regulatory approval in selected Latin American and Asian
markets for in ovo and post-hatch use of Bursaplex(TM). Although Embrex is
beginning to initiate this process, there is no assurance that any such
regulatory approvals will be obtained. Moreover, the placement of INOVOJECT(R)
systems outside the U.S. and Canada is
4
dependent on regulatory approval and market acceptance of various in ovo
vaccines. To date, regulatory approval for Bursaplex(TM) has been received in
Peru, Ecuador, Pakistan and, on a provisional basis, in South Korea.
PRODUCTS UNDER DEVELOPMENT
Embrex is developing individually and in collaboration with others additional
products which address poultry health and performance needs when administered in
ovo. These additional products are in various stages of development. There can
be no assurance that Embrex will successfully develop or market any of these
products. Marketing products developed jointly with others may require royalty
or other payments by Embrex to its co-developers. Embrex has not initiated the
regulatory approval process for any of these potential products, and there is no
assurance regulatory approval will be obtained.
In Ovo Products for Control of Coccidiosis
In 1995, the Company began an initiative aimed at development of a novel in ovo
biological control method for coccidiosis. Coccidiosis is caused by a protozoan
parasite which attacks the gut of the chicken, causing significant problems with
the intake and digestion of feed and, therefore, the physical and economic
performance of the bird. Currently, virtually all broiler chickens, and most
poultry in general, receive anti-coccidiosis compounds called coccidiostats
incorporated into poultry feed. Over the years, coccidia have developed levels
of resistance to these coccidiostats and thus effectiveness has been somewhat
reduced. A limited number of live vaccines have also been developed and are
administered orally soon after hatch. However, due to difficulties in providing
a precise oral dose to each bird, growth depression can occur in broiler flocks.
Therefore, such live vaccines are used primarily in parent stock. Using its
INOVOJECT(R) technology and its knowledge of avian embryology, the Company has
begun this initiative to develop a novel, efficacious and cost-effective means
of preventing coccidiosis in broiler chickens, aimed at overcoming many of the
problems associated with current practices. In 1997, the Company established the
feasibility of an in ovo biological control method for coccidiosis. Further
development of this project will involve extensive clinical trials. Embrex
intends to pursue this research with collaborative partners. There can be no
assurances that any of these development efforts will be successful. Embrex has
not initiated the regulatory approval process with respect to these development
efforts, and does not expect for any coccidiosis product developed by the
Company to reach the market in the near future.
Other Products Under Development
During 1997, Embrex continued the evaluation process for several compounds which
the Company believes may have the potential to yield improvements in the areas
of feed conversion, muscle mass and leanness within broiler chickens. These
compounds need to be administered in the first several days of embryonic
development in order to have the desired effect. While the Company plans to
continue its research efforts in this area in 1998, there is no assurance that
these efforts will yield product opportunities.
Embrex also is researching technology alternatives to enhance or automate sexing
and gender sorting practices for poultry. Early gender sorting improves
processing plant efficiencies by enabling gender-specific feed rations and
improved feed conversion. There is no assurance, however, that such research
will result in product opportunities.
Embrex routinely enters into collaborative agreements with various animal health
companies, pharmaceutical companies and research and academic institutions to
evaluate the utility of certain of their compounds or devices when delivered or
applied in ovo. Depending upon the outcome of these tests, Embrex may or may not
proceed with these collaborations for further development. There is no assurance
that these efforts will yield products or further collaborations.
PATENTS AND PROPRIETARY RIGHTS
Embrex controls (either through direct ownership or exclusive license) 21 issued
U.S. patents, 10 pending U.S. patent applications, and over 34 issued foreign
patents and 42 pending foreign patent applications. In addition, Embrex has
executed confidentiality agreements with its employees, collaborators,
subcontractors and directors.
The INOVOJECT(R) system utilizes a process of injecting viral, bacterial or
fungal vaccines into avian eggs that was patented in the U.S. by the USDA in
1984. Embrex holds the exclusive license to this patent through its expiration
in
5
2002. Embrex has supplemented the USDA patent with five additional issued U.S.
patents (and multiple foreign patents and patent applications) covering specific
design features of the INOVOJECT(R) system. See Item 3, "Legal Proceedings,"
below.
Embrex also owns or licenses method-of-use patents for the in ovo administration
of VNF(R) vaccines and other compounds to elicit various beneficial responses in
poultry. Two U.S. patents for methods of treating IBD virus infections using
VNF(R) vaccines, including by in ovo administration, were issued to Embrex in
March 1995. A U.S. patent application claiming the use of VNF(R) vaccines in all
non-primate animals was allowed in 1997. These patents and additional patent
applications encompass the use of the compounds regardless of the source of the
compound.
Embrex additionally owns or licenses composition-of-matter patents for VNF(R)
vaccines against IBD virus disease. A U.S. patent application with
composition-of-matter claims to VNF(R) vaccines for combating viral diseases in
non-primate animals was allowed in1997. These patent claims cover the vaccine
preparation, regardless of the manner in which the preparation is used.
In 1997, two additional U.S. patent applications were filed covering various
aspects of in ovo technology.
Embrex continues its efforts to patent methods of delivering compounds in ovo,
including early intervention methods and devices. In 1997, two U.S. patents with
claims to methods of delivering compounds to avian embryos in ovo were allowed
or issued.
Additionally, Embrex has federally registered the trademarks EMBREX(R),
INOVOJECT(R), and VNF(R), and has applied for federal registration of the
trademarks Bursaplex(TM) and Fortimune(TM).
COMPETITION
The primary competition for the INOVOJECT(R) system is the manual, post-hatch
administration of biological products. As most of Embrex's products and
potential products are being designed to be administered through the
INOVOJECT(R) system, the INOVOJECT(R) system must continue to be accepted within
the poultry industry and operate as intended under long-term commercial
conditions in order for these potential products to be marketed successfully.
The Company holds the exclusive license to the U.S. patent for injecting
vaccines into an avian embryo. Embrex has supplemented this patent with five
additional U.S. patents covering specific design features of the INOVOJECT(R)
system. In addition, Embrex relies on numerous foreign patents to protect its
intellectual properties and to afford a competitive advantage. See "Patents and
Proprietary Rights," above. There can be no assurance, however, that a
competitive delivery method, either within or outside the United States, will
not be developed and gain commercial acceptance. Embrex continues to monitor for
the presence of any competitive in ovo administration systems worldwide. See
Item 3, "Legal Proceedings," below.
Competitive success for Embrex will be based primarily on commercial acceptance
of its products, achieving and retaining scientific expertise and technological
superiority, identifying and pursuing scientifically feasible and commercially
viable opportunities, obtaining proprietary protection for its research
achievements, obtaining adequate funding and timely regulatory approvals, and
attracting corporate sponsors or partners in developing, testing, producing, and
marketing products, none of which can be assured. In addition, a primary
competitive factor affecting Embrex is its ability to conduct research and
development. Embrex's ability to compete also is dependent on its ability to
attract and retain key personnel. Maintaining financial and human resources,
therefore, are important factors for success.
PRODUCTION, MARKETING AND DISTRIBUTION
Production
Embrex currently subcontracts the production of substantially all of its
mechanical and biological products and expects to continue to do so for the
foreseeable future. The Company believes that alternative sources of manufacture
and supply generally exist.
6
INOVOJECT(R) System
Embrex's in-house engineering staff designs the INOVOJECT(R) system, which
incorporates proprietary mechanical, pneumatic and electronic sub-systems and
concepts. The Company uses a single contract manufacturer to fabricate its
INOVOJECT(R) systems. While other machine fabricators exist and have constructed
limited numbers of INOVOJECT(R) systems, a change in fabricators could cause a
delay in manufacturing and a possible delay in the timing of future INOVOJECT(R)
installations and revenues from those installations.
VNF(R) (Viral Neutralizing Factor)
In 1993, Embrex signed multi-year agreements with SPAFAS, Inc., a subsidiary of
Charles River Laboratories, Inc., under which SPAFAS will supply the active
ingredient in VNF(R). In connection with this agreement, Embrex maintains
appropriate inventory levels and places orders with SPAFAS to allow Embrex to
satisfy anticipated customer demand for VNF(R). The regulatory approval granted
by the USDA for Bursaplex(TM) in January 1997 specifically covers the vaccine
produced with SPAFAS-manufactured VNF(R).
The Company has granted Select Laboratories, Inc. ("Select"), a wholly-owned
subsidiary of Rhone Merieux SA, exclusive rights to manufacture Infectious
Bursal Disease vaccines containing Embrex's VNF(R) product, known as
Bursaplex(TM), for Embrex to market in North America, Latin America and Asia.
Embrex has also granted Websters (a unit of American Home Products Corp.)
exclusive rights to manufacture IBD vaccines containing the Company's VNF(R)
product, known as Bursamune(TM), to be marketed in Europe, the Middle East and
Africa. The manufacture of the IBD vaccines being produced by Select and
Websters, and the Company's VNF(R) product, generally must be performed in
licensed facilities or under approved regulatory methods. Although there are
other manufacturers who are capable of manufacturing IBD products and producing
products such as VNF(R), a change of supplier for the Company could adversely
affect Embrex's future operating results due to the time it would take a new
supplier to obtain regulatory approval of its production process or
manufacturing facilities.
Marketing and Distribution
Because of the geographical and industrial concentration of the poultry industry
in the U.S., Embrex markets its products and provides ongoing service directly
to the industry. Embrex's marketing is focused principally on the broiler
chicken segment of the poultry industry, but the Company also has adapted its
products for use by and initiated trials and entered into commercial contracts
with a limited number of turkey producers.
In order to encourage proper use of the INOVOJECT(R) system technology within an
appropriate production environment, Embrex leases and licenses INOVOJECT(R)
systems to hatcheries. The agreements cover the use of the mechanical equipment
and ongoing field service, maintenance and technical support. The agreements
also include a license with royalty fees for use of Embrex's proprietary
injection process. Products which are delivered in ovo are sold separately.
The Company also is initiating arrangements for international distribution of
IBD vaccines, subject in each case to the availability of required regulatory
approvals. In 1996, the Company entered into agreements with other parties to
distribute Bursaplex(TM) in Israel, Chile, Ecuador, Peru and Pakistan. The
agreement for Israel also entitles the distributor to manufacture a VNF(R)-based
IBD vaccine. Subject to these agreements, the Company also will conduct
international marketing directly.
Other significant poultry markets exist in Asia and Latin America. Embrex has
held a number of discussions regarding marketing and distribution in each of
these markets. In 1997, the Company entered into agreements with other parties
to distribute Bursaplex(TM) in South Korea, Malaysia, Taiwan, Japan and Vietnam,
subject to regulatory approvals. Embrex also hired management for selected Asian
and Latin American markets and installed INOVOJECT(R) systems on a commercial or
trial basis in certain Asian markets.
Embrex has initiated activities necessary for the commercialization of its
technology in Japan. In 1992, Embrex entered into a distribution agreement with
Ishii Company, Ltd. ("Ishii"), a leading chick producer and the dominant
supplier of hatchery equipment in Japan. Upon veterinary medical device
regulatory approval by the Japanese Ministry of Agriculture, Fisheries and
Forestry, Ishii intends to distribute the INOVOJECT(R) egg injection system to
poultry producers throughout Japan.
7
The Company's revenues attributable to international operations in 1997, 1996
and 1995 were 9%, 10% and 6% of the Company's consolidated revenues,
respectively. The company's identifiable assets attributable to international
operations in 1997, 1996 and 1995 were 16%, 13% and 5% of the Company's
consolidated assets, respectively.
RESEARCH AND DEVELOPMENT
In February 1998, Embrex opened a 12,800 square foot research and testing
facility near the Company's headquarters. This new facility is expected to
increase the Company's clinical trial capabilities and reduce reliance on
contract research. Research and development expense was $3.4 million in 1995,
$3.7 million in 1996 and $3.8 million in 1997. The increase in research and
development expense from 1995 to 1997 largely reflects increases in outside
contract research, supplies consumption, and INOVOJECT(R) design and development
activity. Research and development is principally Company sponsored and funded
primarily from internal sources.
GOVERNMENTAL REGULATION
Regulation by governmental authorities in the U.S. and other countries is a
significant factor in the production and marketing of Embrex's products and in
its on-going research and development activities. Although the use of the
INOVOJECT(R) system is not subject to regulatory approval in the U.S., animal
health products being developed by Embrex must receive approval for marketing
from either the USDA or the Food and Drug Administration (the "FDA") and from
similar agencies in foreign countries where the Company has begun or
contemplates doing business. These countries may also require approval of the
INOVOJECT(R) system. Regulatory agencies require that products be tested in
animals and demonstrate appropriate levels of safety and efficacy. Generally,
with respect to animal health products, the USDA has regulatory authority over
products which are biological in origin or which stimulate or affect an animal's
immune system, and the FDA has authority over all other products. The time and
cost of USDA approvals are generally less than those for FDA approvals. FDA
approval generally requires more extensive animal and toxicology testing than
USDA approvals and may take five or more years to obtain, whereas USDA approvals
generally require one to three years to obtain. Embrex's VNF(R) technology
received USDA approval in January 1995 for IBD applications post hatch, and for
in ovo use in January 1997. Of Embrex's products currently under development,
only the growth enhancing compounds and certain gene therapy products (depending
on the nature of the genetic material and the response induced) are known to
require FDA approval. Embrex believes all of its other products under
development will be subject only to USDA approval. Embrex's existing products
have received all necessary governmental approvals in the U.S. The Company's
products also are subject to regulatory approval in other countries.
Management believes that compliance with environmental regulations currently has
no material adverse effect on the Company's capital expenditures, earnings or
competitive position.
EMPLOYEES
At December 31, 1997, Embrex employed 121 persons, 115 of whom were full-time
employees, an increase of 14 persons from the 101 full-time employees at
December 31, 1996.
SIGNIFICANT CUSTOMERS
Tyson Foods, Inc., including Hudson Foods which was acquired by Tyson in January
1998 ("Tyson"), accounted for approximately 28% of Embrex's consolidated 1997
revenues. Based on millions of pounds of ready-to-cook poultry meat produced in
1997, Tyson accounted for approximately 26% of the broilers grown in the U.S.
During 1997, Tyson extended its contract with Embrex through 2004. There are no
customers besides Tyson that represent 10 percent or greater of total revenues.
However, Perdue Farms and ConAgra Poultry accounted for approximately 8% and 7%,
respectively, of consolidated 1997 revenues.
8
ITEM 2. PROPERTIES
Embrex leases its corporate headquarters and research and development
facilities, which occupy approximately 23,000 square feet and are located
adjacent to Research Triangle Park, North Carolina. Two-thirds of the space is
devoted to research and development. The lease is for a 15-year term expiring
March 31, 2002. Embrex paid an annual rent of approximately $215,000 during
1997. Annual rent increases thereafter amount to approximately 3%. In addition
to research and development activities conducted at its corporate headquarters,
Embrex opened a new 12,800 square foot research and testing facility near its
headquarters in February 1998. The lease is for a 10-year term expiring November
14, 2007, with a 5-year renewal option. The annual rent is approximately
$135,000, with annual increases of approximately 3% through the first 10 years
and approximately 4% during the 5-year renewal term.
Embrex leases approximately 3,000 square feet of warehouse space in Springdale,
Arkansas, on a year-to-year basis, which is used to support the Embrex customer
service function in the region. The Company also leases offices of 1,250 square
feet and warehouse space of 850 square feet in Great Dunmow, Essex, England.
Embrex is in the process of negotiating a new 2,500 square foot warehouse
facility near its offices in England that will replace the 850 square foot
facility. The warehouse will provide additional operating space and a close
proximity to the headquarters office. The incremental rent for the replacement
warehouse is not expected to exceed $13,000 annually. Embrex also has access to
facilities at certain universities. The use of these facilities is important to
Embrex's ongoing research and development efforts. Embrex has had agreements
with North Carolina State University ("NCSU") providing access to facilities
used for incubating eggs and growing live birds and for research and testing
purposes. Reliance on the NCSU facilities is expected to decline as a result of
Embrex's new research and testing facility. Embrex believes that suitable
alternative facilities exist if the above agreements are not renewed.
ITEM 3. LEGAL PROCEEDINGS
In September 1996, Embrex filed a patent infringement suit in the United States
District Court for the Eastern District of North Carolina against Service
Engineering Corporation, a Maryland corporation, and Edward G. Bounds, Jr., a
Maryland resident and officer of Service Engineering Corporation. The suit
alleged that each of the defendants' development of an in ovo injection device,
designed to compete with Embrex's patented INOVOJECT(R) injection method,
infringes at least one claim of the U.S. patent No. 4,458,630 exclusively
licensed to Embrex for the in ovo injection of vaccines into an avian embryo
(the "Sharma Patent"). Further, Embrex claims that the defendants have violated
the terms of a Consent Judgment and Settlement Agreement entered into with
Embrex in November 1995 in which prior litigation was concluded with Service
Engineering and Bounds agreeing not to engage in future activities violating the
Sharma Patent. Embrex sought injunctive relief to prevent infringement of the
Sharma Patent as well as monetary damages. In November 1996, Service Engineering
Corporation and Edward G. Bounds responded to Embrex's patent infringement suit
by asserting various affirmative defenses and denying the substantive
allegations in Embrex's complaint. This suit is still pending and final
disposition is expected in 1998.
In November 1996, Embrex filed a patent infringement suit in the United States
District Court for the Eastern District of North Carolina against IGI, Inc., a
Delaware corporation. The suited alleged that IGI, Inc., through its activities
with Service Engineering Corporation and Edward G. Bounds, Jr., an officer of
Service Engineering Corporation, is engaging in activities that constitute
infringement of the Sharma Patent. Embrex sought injunctive relief to prevent
infringement of the Sharma Patent as well as monetary damages. In January 1997,
IGI, Inc. responded to Embrex's patent infringement suit by asserting various
affirmative defenses and denying the substantive allegations in Embrex's
complaint. This suit was concluded by agreement between Embrex and IGI, Inc. in
January 1998.
In March 1997, Service Engineering Corporation, a Maryland corporation, and
Edward G. Bounds, Jr., a Maryland resident and an officer of Service Engineering
Corporation, filed suit against the United States Department of Agriculture in
the United States District Court for the District of Maryland with respect to
its grant to Embrex of an exclusive license for the Sharma Patent. The complaint
alleges that the USDA did not adequately comply with statutory and regulatory
requirements in making the grant to Embrex of an exclusive license to the Sharma
Patent, the revision of the exclusive license in 1991 and the revision of the
exclusive license in 1994, which extended the period of exclusivity, originally
set to terminate on December 31, 1996, through the patent expiration date.
Plaintiffs allege that in December 1996 (after Embrex had instituted the above
referenced action for patent infringement and breach of contract), the
Plaintiffs requested the USDA to grant them a license of the Sharma Patent. The
Plaintiffs allege that the USDA refused to do so because the USDA said that the
license was not available and that the Plaintiffs had no basis for relief.
Plaintiffs also
9
allege that the USDA wrongfully consented to Embrex's bringing suit against the
Plaintiffs. Plaintiffs are seeking to have the court set aside the extension of
the exclusive license, the USDA's grant of permission for Embrex to sue Service
Engineering Corporation, Edwards G. Bounds, Jr. and IGI, Inc. for patent
infringement, the USDA's refusal to grant to Service Engineering Corporation a
non-exclusive license to the Sharma Patent and the USDA's refusal to act
favorably upon Service Engineering Corporation's appeal from the refusal to
grant it a non-exclusive license. In addition, Plaintiffs seek to have the court
issue an order requiring the USDA, prior to granting any exclusive license under
the Sharma Patent, including by extending the term of a pre-existing exclusive
license, to observe the procedures set forth under laws and regulations
governing the grant of licenses to patents owned by the USDA, and to remand the
matter to the USDA to take action in accordance with the order. Plaintiffs also
seek attorneys' fees and costs from the USDA. This suit was stayed in January
1998 for 60 days pending resolution of the suit between Embrex and Service
Engineering Corporation and Edward G. Bounds, Jr. See "Risk Factors" filed as
Exhibit 99 to this report.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1997.
10
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock trades on the Nasdaq National Market System under the
symbol EMBX. The quarterly trading ranges of the Company's Common Stock for the
last two fiscal years were as shown in the table below:
Common Stock
Price Per Share
----------------------
Quarter Ended High Low
------------- ---- ---
March 31, 1996...................... 8 1/4 5 1/2
June 30, 1996....................... 7 7/8 6
September 30, 1996.................. 7 3/8 6
December 31, 1996................... 7 3/4 6
March 31, 1997...................... 7 13/16 6 3/8
June 30, 1997....................... 7 3/8 6 3/16
September 30, 1997.................. 7 3/8 5 15/16
December 31, 1997................... 7 5
At February 27, 1998 (the most recent practicable date), there were 504 holders
of record of the Common Stock. The Company has paid no dividends on any stock
since inception and has no plans to pay dividends on its Common Stock in the
foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
Summary of Operations by Quarters (Unaudited)
(Dollars In Thousands,
Except Per Share Amounts) 1997 1996
- ----------------------------- -----------------------------------------------------------------------------------------------
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
------- ------- ------- ------- ------- ------- ------- -------
Revenues..................... $5,925 $5,922 $6,531 $6,412 $4,595 $5,068 $5,641 $ 5,328
Operating Expenses........... 2,577 $2,403 2,585 2,230 1,628 1,848 2,155 2,180
Net income (loss)............ 262 417 540 542 58 193 203 (113)
Net income (loss) per share
of Common Stock
Basic................. $ 0.03 $ 0.05 $ 0.06 $ 0.07 $ 0.01 $ 0.03 $ 0.03 $ (0.01)
Diluted............... $ 0.03 $ 0.05 $ 0.06 $ 0.07 $ 0.01 $ 0.03 $ 0.03 $ (0.01)
Number of Shares Used
in Per Share Calculation
(thousands)
Basic................ 8,058 8,203 8,236 8,238 6,820 7,017 7,213 7,821
Diluted............... 8,278 8,380 8,369 8,331 7,158 7,347 7,452 7,821
11
5-Year Summary of Selected Financial Data
(Dollars In Thousands, Except Per Share Amounts)
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(Restated)
Statements of Operations Data
Revenues ........................................... $ 24,789 $ 20,632 $ 13,719 $ 6,897 $ 2,159
Research and development expenses .................. 3,793 3,673 3,416 4,271 3,763
Other operating expenses ........................... 6,002 4,138 3,836 3,561 4,248
Net income (loss) .................................. 1,760 341 (4,512) (6,710) (7,307)
Net income (loss) per share of Common
Stock (thousands)
Basic ....................................... $ 0.21 $ 0.05 $ (0.73) $ (1.19) $ (1.61)
Diluted ..................................... $ 0.21 $ 0.06 $ (0.73) $ (1.19) $ (1.61)
Number of Shares Used in Per Share
Calculation (thousands)
Basic ....................................... 8,184 7,218 6,187 5,645 4,552
Diluted ..................................... 8,339 7,520 6,187 5,645 4,552
Balance Sheet Data
Working capital .................................... $ 7,581 $ 7,552 $ 5,934 $ 1,608 $ 9,370
Total assets ....................................... 25,161 25,554 21,789 13,379 14,997
Long-term liabilities .............................. 3,278 5,814 10,966 3,093 1,377
Accumulated deficit ................................ (38,933) (40,693) (41,034) (36,522) (29,812)
Shareholders' equity ............................... 15,741 13,309 5,909 5,323 11,996
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
Company's financial statements and related notes appearing elsewhere in this
report.
Consolidated net income for 1997 was $1.8 million compared to $341,000 in 1996
and a net loss of $4.5 million, on a restated basis, in 1995. Diluted earnings
per share increased from a net loss of $0.73 in 1995, on a restated basis, and a
profit of $0.05 in 1996, to net income of $0.21 in 1997. For the year ended
1997, shares outstanding on a diluted basis were 8.3 million, up from 7.5 and
6.2 million at year-end 1996 and 1995, respectively.
Revenues
Consolidated revenues in 1997 totaled $24.8 million, representing an increase of
20% over 1996 revenues of $20.6 million, which were 50% over 1995 revenues of
$13.7 million. INOVOJECT(R) revenues totaled $23.6 million in 1997 compared to
$19.3 million in 1996 and $12.8 million in 1995, representing increases of 22%
from 1996 to 1997, and 50% from 1995 to 1996, with the 1997 increase coming
principally from increased placement and throughput of INOVOJECT(R) systems in
North America and Europe.
The 1997 revenues include INOVOJECT(R) lease fees derived from multi-year
contracts and paid trials in the U.S. and foreign countries, and the sale of
INOVOJECT(R) systems to distributors. At December 31, 1997, Embrex had over 300
INOVOJECT(R) systems installed and operating under lease agreements worldwide,
up from over 250 systems at December 31, 1996, and 235 at December 31, 1995.
Additionally, Embrex estimates that as of December 31, 1997, it was vaccinating
in excess of 80% of the estimated 8.0 billion broiler birds grown in the U.S. in
1997, as well as
12
approximately 80% in 1996, and 66% in 1995. Given its market penetration, the
Company expects only moderate INOVOJECT(R) systems revenue growth in this
market.
Management anticipates moderate revenue and earnings growth in 1998 from
existing INOVOJECT(R) operations in the United States and Canada, new
INOVOJECT(R) system leases in other countries, and sales of Bursaplex(TM)
product to poultry producers. However, the rate at which the marketplace will
accept the INOVOJECT(R) technology outside the United States and Canada, the
timing of regulatory approvals of third-party vaccines for in ovo use outside
the United States and Canada, start-up costs in new markets, possible
variability in U.S. hatchery bird production as a result of grain price
fluctuations, and possible variability in the demand for U.S. poultry and
poultry products outside the U.S., will impact the pace of revenue growth, if
any, and the sustaining of profitability from the installation and operational
throughputs of INOVOJECT(R) systems. In any event, any revenue and earnings
growth in 1998 is not anticipated to begin prior to the third and fourth
quarters.
Sales of Bursaplex(TM), the Company's proprietary vaccine for the treatment of
avian Infectious Bursal Disease, was the principal source of $1.1 million of
product revenues in 1997. The previously discussed delay associated with
obtaining U.K. regulatory approval for the sale of Bursamune(TM) in the U.K.
reduced the sale of the Company's proprietary VNF(R) product, which is a key
component of Bursamune(TM), to Ft. Dodge Animal Health, a division of American
Home Products Corp. See "Business -- Existing Products," above. This offset
initial sales of Bursaplex(TM) during 1997 and consequently resulted in a
$155,000 decrease in product revenue from 1996. Sales of VNF(R) for inclusion in
IBD vaccines were the principal source of previous years' product revenues,
which generated $1.2 million and $817,000 in 1996 and 1995, respectively.
Cost of Product Sales and INOVOJECT(R) Revenues
Cost of revenues as a percentage of revenues decreased from 53% and 64% of total
revenues in 1996 and 1995, respectively, to 49% of total revenues in 1997. The
improvement in 1997 is primarily attributable to INOVOJECT(R) system-related
cost reductions.
Operating Expenses
Operating expenses totaled $9.8 million in 1997 compared to $7.8 million in
1996, and $7.3 million in 1995.
General and administrative ("G&A") expenses were $5.5 million in 1997, up 49%
from $3.7 million in 1996, and up 11% from $3.3 million in 1995. The 1997 G&A
increase was primarily attributable to development costs in Asia and Latin
America as well as legal expenses incurred in connection with various patent
infringement lawsuits filed by the Company. The 1996 increase over 1995 was
largely due to increased legal expenses associated with the implementation of a
shareholder rights plan in March 1996 and amendments to the Company's Articles
of Incorporation approved at the annual meeting of shareholders in May 1996.
Sales and marketing expenses totaled $522,000 in 1997 compared to $455,000 and
$525,000 in 1996 and 1995, respectively. Fluctuations during these periods
resulted from various levels of activity in the Company's sales and customer
service functions to support market expansion and field support of INOVOJECT(R)
systems, as well as stepped-up international activity, principally in Europe.
Certain 1997, 1996, and 1995 operating expenses were reclassified to cost of
revenues to conform to the presentation format adopted in the fourth quarter of
1996 and during 1997. These reclassifications had no effect on previously
reported net income or loss or shareholders' equity in 1995, 1996, or 1997.
Research and development ("R&D") expenses were $3.8 million in 1997 compared to
$3.7 million in 1996 and $3.4 million in 1995. The increase in R&D expense from
1995 to 1997 largely reflects an increase in outside contract research, supplies
consumption, and INOVOJECT(R) design and development activity. The Company
continues to manage its research and development effort to leverage its
know-how, patent position, market presence and expenditures.
13
Other Income and Expense
Interest income totaled $488,000, $355,000, and $389,000 in years 1997, 1996,
and 1995, respectively. The 1997 increase relative to 1996 resulted principally
from higher cash balances, while the decrease in 1996 relative to 1995 was a
function of lower interest rates.
Interest expense totaled $1.1 million in 1997 compared to $1.6 million in 1996,
and $2.7 million, on a restated basis, in 1995. In 1997, the decrease in
interest expense reflected the repayment of approximately $3.3 million of
external financing, primarily in the form of equipment leases. In 1996 and 1995,
the amount of expense was principally attributable to the Company's funding of
its growing installed base of INOVOJECT(R) systems with the use of capital lease
financing and, in 1995, the issuance of convertible debentures. Additionally,
interest expense for 1995 has been restated to reflect a one-time charge
associated with recognizing $1,019,000 of interest expense attributable to the
difference between the market price of the Company's Common Stock and the
conversion price of the debentures issued in 1995. See "Liquidity and Capital
Resources" and Note 12 to the Company's financial statements. Management expects
to continue to rely on the use of internally generated funds to finance the cost
of additional INOVOJECT(R) systems in 1998, as was the case in 1997.
Effect of Inflation
Management expects cost of product sales and INOVOJECT(R) systems revenues,
operating expenses and capital equipment costs to change in line with periodic
inflationary changes in price levels. While Management generally believes that
the Company will be able to offset the effect of price level changes by
adjusting selling/lease prices and effecting operating efficiencies, any
material unfavorable changes in price levels could have a material adverse
affect on its results of operations.
Year 2000 Issue
Embrex's general ledger and primary financial accounting software is a DOS-based
application that operates on a client- server network. This application uses
only two digits to identify a year in the date field. The Company intends to
replace this application during 1998 with a Windows(TM)-based system.
Irrespective of the Year 2000 issue, the Company needs to upgrade its accounting
system to meet the demands of its business. The Company is in the process of
developing the implementation plan for this upgrade. The Company believes that
the additional costs associated with the Year 2000 aspects of the upgrade will
be immaterial.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company's cash and short-term investment balances
totaled $8.6 million compared to $9.9 million and $7.3 million at December 31,
1996 and 1995, respectively. The decrease reflected the ability of the Company
to fund capital expenditures with internal cash instead of equipment lease
financing. Working capital remained unchanged at $7.6 million in both 1997 and
1996, as a decrease in cash was offset by a reduction in the short-term portions
of both capital lease obligations and long-term debt.
During 1997, operating activities generated $6.1 million in cash, primarily due
to non-cash depreciation, and net income. Within investing activities,
INOVOJECT(R) systems, the Company's new research and testing facility, and
equipment purchases required $4.9 million, while the sale of short-term
investments, provided an offsetting $0.9 million. In addition, $3.1 million was
used to repay long-term debt and capital lease obligations.
During 1997, $425,000 of outstanding debentures along with $139,000 of accrued
interest were converted into 98,267 shares of Common Stock net of unamortized
debt issuance costs totaling $1,000. In addition, 419 shares of Embrex Common
Stock were issued pursuant to the non-cash exercise of warrants related to the
initial sale of the debentures in May 1995. As of December 1, 1997, all
debentures had been converted into Common Stock.
As of December 31, 1997, the Company had outstanding purchase commitments of
approximately $2.5 million related to the production of the Company's
Bursaplex(TM) product, and materials and supplies for construction and
maintenance of INOVOJECT(R) egg injection systems. This commitment included the
obligation related to a January 1996 agreement
14
reached with Select Laboratories, requiring the Company to purchase all existing
inventories of raw materials, Bursaplex(TM), and related materials from Select
within 30 months following the January 1997 receipt of in ovo approval of the
Bursaplex(TM) product being manufactured for Embrex. In January 1998, the
Company fulfilled its obligation to Select under the January 1996 agreement.
The Company maintains a $2.0 million secured line of credit with a bank in the
United Kingdom, which may be used to finance the construction of additional
INOVOJECT(R) systems for Europe, the Middle East and Africa. The Company
utilized $0.3 million of this line in 1997, with the balance of $1.7 available
at year end. A remaining commitment of $2.0 million for utilization by Embrex
under a collaterized equipment financing arrangement expired in June 1997.
Based on its current operations, management believes that its available cash and
short-term investments, together with cash flow from operations, will be
sufficient to meet its foreseeable cash requirements.
FORWARD-LOOKING STATEMENTS
Information set forth in this Annual Report on Form 10-K contains various
"forward looking statements" within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which
statements represent the Company's judgment concerning the future and are
subject to risks and uncertainties that could cause the Company's actual
operating results and financial position to differ materially. Such forward
looking statements can be identified by the use of forward looking terminology
such as "may," "will," "expect," "anticipate," "estimate," "believe," or
"continue," or the negative thereof or other variations thereof or comparable
terminology.
The Company cautions that any such forward looking statements are further
qualified by important factors that could cause the Company's actual operating
results to differ materially from those in the forward looking statements,
including without limitation the Company's ability to penetrate new markets, the
Company's dependence on certain customers; the ability of the Company, its
manufacturing and marketing partners and others to obtain regulatory approval
for products, which is dependent on a number of factors, including the results
of trials, the discretion of regulatory officials, and any potential changes in
regulations; the Company's ability to generate future cash flow from operations;
continued demand for the INOVOJECT(R) system; the successful outcome of patent
litigation; the Risk Factors described in Exhibit 99 to this report; and other
risks detailed from time to time in the Company's Securities and Exchange
Commission filings, including the Company's Forms 10-Q, 10-K, and 8-K.
15
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Auditors
The Board of Directors and Shareholders
Embrex Inc.
We have audited the accompanying consolidated balance sheets of Embrex, Inc. and
subsidiaries as of December 31, 1997 and 1996, and the related consolidated
statements of operations, shareholders' equity and cash flows for each of the
three years in the period ended December 31, 1997. 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 presentations.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Embrex, Inc. and
subsidiaries at December 31, 1997 and 1996, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1997, in conformity with generally accepted accounting
principles.
/s/ Ernst & Young LLP
Raleigh, North Carolina
February 20, 1998
16
Consolidated Balance Sheets
(Dollars in thousands)
December 31
---------------------------
ASSETS 1997 1996
-------- --------
Current Assets
Cash and cash equivalents ............................................................... $ 8,580 $ 9,036
Restricted Cash (Note 2) ................................................................ 275 0
Short-term investments (Note 3) ......................................................... 0 876
Inventories:
Materials and supplies .............................................................. 898 1,061
Product ............................................................................. 603 573
Accounts receivable - trade ............................................................. 2,772 2,313
Other current assets .................................................................... 595 124
-------- --------
Total Current Assets ................................................................ 13,723 13,983
INOVOJECT(R)Systems Under Construction ....................................................... 690 530
INOVOJECT(R)Systems .......................................................................... 21,024 18,193
Less accumulated depreciation ........................................................... (12,149) (8,499)
-------- --------
8,875 9,694
Equipment, Furniture and Fixtures ............................................................ 3,601 2,607
Less accumulated depreciation ................................................................ (2,041) (1,695)
-------- --------
1,560 912
Other Assets:
Patents and exclusive licenses of patentable technology
(net of accumulated amortization of $80 in 1997 and $58 in 1996) .................... 309 125
Other noncurrent assets ................................................................. 4 310
-------- --------
Total Assets ................................................................................. $ 25,161 $ 25,554
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable ........................................................................ $ 1,312 $ 1,355
Accrued expenses ........................................................................ 2,147 1,087
Current portion of capital lease obligations ............................................ 2,391 3,080
Current portion of long-term debt (Note 5) .............................................. 292 909
-------- --------
Total Current Liabilities ...................................................... 6,142 6,431
Capital Lease Obligations, less current portion (Note 4) ..................................... 3,269 5,806
Long-Term Debt, less current portion (Note 5) ................................................ 9 8
Shareholders' Equity (Notes 6, 7 and 8)
Common Stock, $.01 par value per share
Authorized - 30,000,000 shares
Issued and outstanding- 8,239,946 and 8,043,490 shares at
December 31, 1997 and 1996, respectively ....................................... 82 80
Additional paid-in capital .............................................................. 54,788 53,742
Currency translation adjustments ........................................................ (196) 180
Accumulated deficit ..................................................................... (38,933) (40,693)
-------- --------
Total Shareholders' Equity .......................................................... 15,741 13,309
-------- --------
Total Liabilities and Shareholders' Equity ................................................... $ 25,161 $ 25,554
======== ========
17
Consolidated Statements of Operations
(In thousands, except per share amounts)
Year ended December 31,
--------------------------------------------------
1997 1996 1995
-------- -------- --------
(Restated)
Revenues
INOVOJECT(R)revenue ............................................. $ 23,614 $ 19,263 $ 12,806
Product revenue ................................................. 1,062 1,217 817
Other revenue ................................................... 113 152 96
-------- -------- --------
Total Revenues .............................................. 24,789 20,632 13,719
Cost of Product Sales and INOVOJECT(R)Revenues ...................... 12,244 11,032 8,714
-------- -------- --------
12,545 9,600 5,005
Operating Expenses
General and administrative ...................................... 5,480 3,683 3,311
Sales and marketing ............................................. 522 455 525
Research and development ........................................ 3,793 3,673 3,416
-------- -------- --------
Total Operating Expenses .................................... 9,795 7,811 7,252
-------- -------- --------
Operating Income (Loss) ............................................. 2,750 1,789 (2,247)
Other Income (Expense)
Interest income ................................................. 488 355 389
Interest expense ................................................ (1,070) (1,608) (2,654
Other ........................................................... 14 0 0
-------- -------- --------
Total Other Expense ......................................... (568) (1,253) (2,265)
-------- -------- --------
Income (Loss) Before Taxes .................................. 2,182 536 (4,512)
Income Taxes (Note 10) .............................................. 422 195 0
-------- -------- --------
Net Income (Loss) ................................................... $ 1,760 $ 341 $ (4,512)
======== ======== ========
Net Income (loss) per share of Common Stock
Basic ....................................................... $ 0.21 $ 0.05 $ (0.73)
Diluted ..................................................... $ 0.21 $ 0.06 $ (0.73)
Number of Shares Used in Per Share Calculation
Basic ....................................................... 8,184 7,218 6,187
Diluted ..................................................... 8,339 7,520 6,187
See accompanying notes.
18
Consolidated Statements of Cash Flows
(Dollars in thousands) Year ended December 31,
----------------------------------------
1997 1996 1995
-------- -------- --------
(Restated)
Operating Activities
Net income (loss) ............................................................. $ 1,760 $ 341 $ (4,512)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Depreciation and amortization ............................................. 4,043 4,021 3,443
Changes in operating assets and liabilities:
Accounts receivable, inventories and other current assets ............ (797) (515) (1,610)
Accounts payable and accrued expenses ................................ 1,083 119 (64)
-------- -------- --------
Net Cash Provided By (Used In) Operating Activities ................................ 6,089 3,966 (2,743)
Investing Activities
Purchases of short-term investments ........................................... 0 0 (147)
Sales of short-term investments ............................................... 876 1,096 0
Collateralization of Lease (Note 2) ........................................... (275) 0 0
Purchases of INOVOJECT(R)systems, equipment, furniture and fixtures ........... (3,962) (4,888) (7,330)
Reductions to patents and other noncurrent assets ............................. 280 93 111
-------- -------- --------
Net Cash Provided By (Used In) Investing Activities ................................ (3,081) (3,699) (7,366)
Financing Activities
Issuance of Common Stock ...................................................... 257 3,438 927
Issuance of long-term debt .................................................... (119) 476 6,403
Proceeds from capital lease obligations ....................................... 102 2,139 7,101
Payments on capital lease obligations ......................................... (3,328) (2,818) (1,771)
-------- -------- --------
Net Cash Provided By (Used In) Financing Activities ................................ (3,088) 3,235 12,660
-------- -------- --------
Increase (Decrease) In Cash And Cash Equivalents ................................... (80) 3,502 2,551
Currency Translation Adjustments ................................................... (376) 180 --
Cash and cash equivalents at beginning of period ................................... 9,036 5,354 2,803
-------- -------- --------
Cash and Cash Equivalents at End of Period ......................................... $ 8,580 $ 9,036 $ 5,354
======== ======== ========
Supplemental Disclosure of Cash Flow Information
Total interest paid was $1,070,000, $1,593,000 and $1,635,000 for the years
ended December 31, 1997, 1996, and 1995, respectively.
Total income taxes paid was $70,000, $170,000 and $0 for the years ended
December 31, 1997, 1996 and 1995, respectively.
Supplemental Schedule of Noncash Financing Activity:
In May 1995, American Cyanamid Company, a subsidiary of American Home Products
Corp., converted the promissory note issued by Embrex, Inc. to American Cyanamid
in 1991. The $1.2 million note, which would have been due on May 27, 1995, was
converted into 320,000 shares of Common Stock.
Also, during the 1995 period, $3.0 million of the debentures issued in May 1995,
along with $34,000 of accrued interest, were converted into 507,678 shares of
Common Stock net of unamortized debt issuance costs totaling $211,000.
During 1996, an additional $3.3 million of the debentures, along with $258,000
of accrued interest, were converted into 612,061 shares of Common Stock net of
unamortized debt issuance costs totaling $111,000.
19
During 1997, $425,000 of outstanding debentures along with $139,000 of accrued
interest were converted into 98,267 shares of Common Stock net of unamortized
debt issuance costs totaling $1,000. In addition, 419 shares of Embrex Common
Stock were issued pursuant to the non-cash exercise of warrants related to the
initial sale of the debentures in May 1995. As of December 1, 1997, all
debentures had been converted into Common Stock.
On May 27, 1997, 34,320 shares of Common Stock were issued in exchange for
substantially all of the assets of Agrimatic Corporation.
Consolidated Statements of Shareholders' Equity
(Dollars in thousands)
Additional Currency
Common Paid-in Translation Accumulated
Stock Capital Adjustments Deficit Total
-------- ---------- ----------- ----------- --------
Balance at December 31, 1994 ............................. $ 41,624 $ 221 $ 0 $(36,522) $ 5,323
-------- -------- -------- -------- --------
Stock issued:
Upon exercise of options ........................ 134 134
Under employee stock purchase plan .............. 80 80
Upon conversion of long-term debt
(net of issuance costs of $232) ............ 3,554 450 4,004
Upon exercise of warrants ....................... 730 730
Warrants issued on May 1, 1995 ...................... 150 150
Net loss ............................................ (4,512) (4,512)
-------- -------- -------- -------- --------
Balance at December 31, 1995 (as restated) ............... 46,122 821 0 (41,034) 5,909
Stock issued:
Upon exercise of options ........................ 286 286
Under employee stock purchase plan .............. 68 68
Upon conversion of long-term debt
(net of issuance cost of $1) ............... 2,947 494 3,441
Upon exercise of warrants ....................... 3,084 3,084
Establishment of $.01 par value
(Note 6) ................................. (52,427) 52,427
Currency translation adjustments .................... 180 180
Net income .......................................... 341 341
-------- -------- -------- -------- --------
Balance at December 31, 1996 ............................. 80 53,742 180 (40,693) 13,309
Stock issued:
Upon exercise of options ........................ 1 201 202
Under employee stock purchase plan .............. 55 55
Upon conversion of long-term debt
(net of issuance costs of $111) ............ 1 563 564
Upon issuance of shares for
Agrimatic acquisition ...................... 227 227
Currency translation adjustments .................... (376) (376)
Net income .......................................... 1,760 1,760
-------- -------- -------- -------- --------
Balance at December 31, 1997 ............................. $ 82 $ 54,788 $ (196) $ 38,933 $ 15,741
======== ======== ======== ======== ========
20
Notes to Consolidated Financial Statements
1. Significant Accounting Policies
Nature of Business
Embrex, Inc. has developed and commercialized the INOVOJECT(R) system, a
proprietary, automated, in-the-egg injection system which eliminates the need
for manual vaccination of newly hatched broiler chicks. Embrex also develops and
markets patented pharmaceutical and biological products to improve bird health,
reduce bird production costs and provide economic value to the global poultry
industry.
Acquisition
On May 27, 1997, the Company issued 34,320 shares of Common Stock in exchange
for substantially all of the assets of Agrimatic Corporation. This transaction
had an immaterial effect on the operations of Embrex.
Principles of Consolidation
The consolidated financial statements include the accounts of Embrex, Inc. and
its wholly owned subsidiaries, Embrex Europe Limited and Embrex Sales, Inc. (the
"Company"). All significant intercompany transactions and accounts have been
eliminated. Currently, foreign operations account for less than 10% of the
Company's revenues.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
Inventories
Items recorded as inventory are generally purchased from others and recorded at
the lower of cost or market using the average cost method. Materials and
supplies inventories include spare parts for the INOVOJECT(R) systems as well as
laboratory and general supplies. Product inventories are comprised of biological
compounds, principally the Company's viral neutralizing factor product (VNF(R)).
INOVOJECT(R) Systems
INOVOJECT(R) systems are comprised of egg injection and related equipment
available for lease to customers. The equipment is recorded at the lower of cost
or estimated net realizable value. Depreciation is computed principally by using
accelerated methods over the estimated useful life of the equipment and
commences after construction is complete and the equipment is placed in service.
Equipment, Furniture and Fixtures
Equipment, furniture and fixtures are recorded at cost. Depreciation is computed
principally by using accelerated methods over the estimated useful lives of the
assets placed in service.
Patents and Exclusive Licenses of Patentable Technology
Costs incurred to acquire exclusive licenses of U.S. patentable technology and
to apply for and obtain U.S. patents on internally developed technology are
capitalized and amortized using the straight-line method. Exclusive license
agreements are amortized over the period of the license. Patents are amortized
over the shorter of the useful or legal life of the patent.
21
Foreign Currency Translation
All assets and liabilities in the balance sheets of the Company's foreign
subsidiary, Embrex Europe Limited, and its Asian operations, are translated at
year-end exchange rates except shareholders' equity which is translated at
historical rates. Revenues, costs and expenses are recorded at average rates of
exchange during the year. Translation gains and losses are accumulated as a
component of shareholders' equity. Foreign currency transaction gains and losses
are included in determining net income.
Revenue Recognition
INOVOJECT(R) system fees are recognized based on eggs processed during the
period. Product sales are recognized when the products are shipped. Contract
research revenue is recognized on a straight-line basis over the term of the
contract. Revenue received, but not yet earned, is classified as deferred
revenue.
Research and Development Costs
Research and development costs, including costs incurred to complete contract
research, are charged to operations when incurred and are included in operating
expenses.
Income Taxes
The Company accounts for income taxes under the provisions of Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS
109). SFAS 109 requires recognition of deferred tax assets and liabilities for
the expected future tax consequences of temporary basis differences that have
arisen between financial statement and income tax reporting.
Net Income (Loss) Per Share
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement No. 128, "Earnings per Share" which established new standards for
computing and presenting net income per share information. As required, the
Company adopted the provisions of Statement No. 128 in its 1997 financial
statements and has restated all prior year net income per share information.
Basic net income per share was determined by dividing net income available for
common shareholders by the weighted average number of common shares outstanding
during each year. Diluted net income per share reflects the potential dilution
that could occur assuming conversion or exercise of all convertible securities
and issued and unexercised stock options. A reconciliation of the net income
available for common shareholders and number of shares used in computing basic
and diluted net income per share is in Note 13.
Use of Estimates
The presentation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from these estimates.
Principal Customers
Tyson Foods, Inc. ("Tyson") accounted for approximately 28 percent of
consolidated 1997 revenues. Based on the millions of pounds of ready-to-eat
poultry meat produced in 1997, Tyson accounted for approximately 26 percent of
the broilers grown in the U.S. In 1997, Tyson was the only customer that
represented greater than 10 percent of total revenues.
Concentration of Credit Risk
The Company's principal financial instrument, subject to potential concentration
of credit risk, is accounts receivable which are unsecured. The Company's
exposure to credit loss in the event payment is not received equals the
outstanding accounts receivable balance. As of December 31, 1997, Tyson Foods,
Inc. accounted for approximately
22
23% of consolidated accounts receivable, and substantially all of the Company's
accounts receivable are due from companies in the poultry industry.
Sources of Supply
The Company has developed a strategic relationship with a single contract
manufacturer to fabricate its INOVOJECT(R) systems. While other machine
fabricators exist and have constructed limited numbers of INOVOJECT(R) systems,
a change in fabricators could cause a delay in manufacturing and a possible
delay in the timing of future INOVOJECT(R) installations and revenues from those
installations.
The Company has granted Select Laboratories, Inc. ("Select"), a subsidiary of
Rhone Merieux SA, exclusive rights to manufacture bursal disease vaccines
containing Embrex's proprietary VNF(R) product for Embrex to market in North
America, Latin America and Asia under the trade name Bursaplex(TM). In 1995,
Embrex granted Cyanamid Websters ("Websters"), a unit of Ft. Dodge Animal
Health, which is a division of American Home Products Corp., exclusive rights to
manufacture and market bursal disease vaccines containing the Company's VNF(R)
product to be marketed in Europe, the Middle East and Africa under the trade
name Bursamune(TM). Additionally, the Company has one contract supplier of its
VNF(R) product. The manufacture of the bursal disease vaccines being produced by
Select and Websters and the Company's VNF(R) product generally must be performed
in licensed facilities and/or under regulatory approved methods. Although there
are other manufacturers who are capable of manufacturing bursal disease products
and producing products such as VNF(R), a change of suppliers could adversely
effect the Company's future operating results due to the time it would take a
new supplier to obtain regulatory approval of its production process and/or
manufacturing facilities. The Company seeks to minimize this exposure through
multi-year supply agreements and the maintenance of adequate inventories.
Reclassification
Certain 1997, 1996, and 1995 amounts in the accompanying financial statements
have been reclassified to conform to the presentation adopted in the fourth
quarter of 1996 and during 1997. These reclassifications had no effect on
previously reported net income or loss or shareholders' equity in 1995, 1996 or
1997.
Impact of Recently Issued Accounting Standards
In 1997, the FASB issued Statements No. 130, "Reporting Comprehensive Income"
("SFAS 130") and No. 131, "Disclosures About Segments of an Enterprise and
Related Information" ("SFAS 131"), which are both effective for fiscal years
beginning after December 15, 1997. SFAS 130 addresses reporting amounts of other
comprehensive income and SFAS 131 addresses reporting segment information. The
Company does not believe that the adoption of these new standards will have a
material impact on its financial statements.
2. Restricted Cash
On October 13, 1997, the Company executed a ten-year collateralized lease
relative to the facilities housing the Company's new research and testing
facility. Such collateral exists in the form of a certificate of deposit, which
is required to be maintained at least through the end of the seventh year of the
lease.
3. Short-Term Investments
Management determines the appropriate classification of its investments in debt
securities at the time of purchase and reevaluates such determination at each
balance sheet date. Debt securities for which the Company has both the intent
and ability to hold to maturity are classified as held to maturity. These
securities are carried at amortized cost. At December 31, 1997, the Company had
no investments that qualified as trading or available for sale.
23
At December 31, 1996, the Company's investments in debt securities were
classified as cash and cash equivalents and short-term investments. The Company
maintains cash and cash equivalents and short-term investments principally of
United States treasury securities and commercial paper with a maturity date less
than twelve months with various financial institutions. The Company performs
periodic evaluations of the relative credit standing of those financial
institutions that are considered in the Company's investment strategy which is
designed to limit exposure to any one institution.
At December 31, 1997, the Company held no short-term investments. At year-end
1996, the Company held short-term investments totaling $876,000, of which
$251,000 was held in commercial paper, and $625,000 in repurchase agreements.
The Company's short-term investment balances are maintained in accounts at
various financial institutions. In connection with the secured line of credit,
the Company has deposited $298,000 as a compensating cash balance with the
lender.
4. Leases
At December 31, 1997 and 1996, the Company had assets totaling $14.0 million and
$13.9 million, respectively, financed by capital lease agreements which expire
through October 2000. Accumulated depreciation and amortization includes $10.1
million and $8.2 million of amortization related to these assets at December 31,
1997 and 1996, respectively. Amortization of assets financed by capital leases
is included with depreciation expense. As of December 31, 1996, the Company has
used $9.2 million ($0 in 1997 and $2.1 million in 1996) of the $11.2 million
capital lease financing closed in 1995 to fund construction of INOVOJECT(R)
systems principally under contract with North American customers in the United
States. At December 31, 1996, the Company had available $2.0 million of
aggregate unutilized capital financing capacity for use in the construction of
INOVOJECT(R) systems. This unused commitment expired in June 1997.
The Company leases its facilities under a number of operating leases extending
through November 2007. The Company has the option to cancel the operating lease
agreement with the payment of a $180,000 penalty. Total rent expense was
$312,000, $334,000, and $426,000 for the years ended December 31, 1997, 1996,
and 1995, respectively.
At December 31, 1997, the Company's minimum future commitments under capital and
operating leases were as follows:
Operating Capital
Leases Leases
------ ------
1998................................................................... $ 407,000 $3,018,000
1999................................................................... 351,000 2,940,000
2000................................................................... 337,000 637,000
2001................................................................... 346,000 0
2002................................................................... 185,000 0
Beyond................................................................. 696,000 0
---------- ----------
Total.................................................................. $2,322,000 $6,595,000
==========
Less amounts representing interest........................................................... (935,000)
----------
Present value of future minimum lease payments............................................... $5,660,000
==========
5. Long-Term Debt
During 1997, $425,000 of outstanding debentures along with $66,000 of accrued
interest were converted into 98,267 shares of Common Stock net of unamortized
debt issuance costs totaling $1,000. In addition, 419 shares of Embrex Common
Stock were issued pursuant to the non-cash exercise of warrants related to the
initial sale of such debentures.
On May 1, 1995, the Company closed on a private placement offering of
convertible debentures ("the debentures") resulting in net proceeds to the
Company of $5.4 million (as adjusted for the August 1995 rescission of the
issuance of $225,000 of the debentures). The debentures were payable on May 1,
1997. Through June 13, 1995, the holders of the debentures were entitled to
convert the debentures into Common Stock of the Company at a conversion price
equal to
24
the average market price at the time of issuance. Commencing on June 14, 1995,
the holders of the debentures were entitled to convert the debentures into
Common Stock of the Company at a conversion price of the lesser of the market
price at the time of issuance ($5.00 per share) or 85 percent of the average
closing bid price of the Company's Common Stock for the five trading days ending
on the conversion date. The debentures accrued interest, payable at maturity, at
a rate of 8 percent per annum. The accrued interest was convertible into Common
Stock of the Company at the same conversion price as the debenture principal.
The Company had the right to demand conversion of the debentures and any accrued
interest after April 30, 1996. Additionally, at any time, the Company had the
right to redeem the debentures for cash equal to the closing bid of the
Company's Common Stock at the date of redemption multiplied by the underlying
shares into which the debentures would have been convertible. In conjunction
with this offering, the Company incurred issuance costs totaling $540,000 and
recorded $1.0 million of interest expense related to the 15% discount from
market upon conversion (See Note 12). The issuance costs were amortized as a
component of interest expense over the term of the debentures.
In 1995, $3.0 million of the debentures' principal and related discount was
converted into 517,910 shares of Common Stock, net of unamortized debt issuance
costs totaling $215,000. During 1996, an additional $3.3 million debentures and
related discount, along with $258,000 of accrued interest were converted into
612,061 shares of Common Stock, net of unamortized debt issuance costs totaling
$111,000.
As part of its compensation for the sale of the convertible debentures, the
Company's placement agent received a 6.5 percent commission, which is included
in the $540,000 total issuance costs, and warrants to purchase 96,000 shares of
Common Stock at a price of $6.00 per share. The estimated value of these
warrants, $150,600, has been recorded as additional paid-in capital, while their
cost was included within the $540,000 total issuance costs discussed above.
On May 29, 1991, the Company issued a four-year convertible term note (the
"note") to American Cyanamid Company, now a subsidiary of American Home Products
Corporation, in exchange for $1.2 million. During May 1995, at the election of
American Cyanamid, the note was converted into 320,000 shares of Common Stock of
the Company. Contemporaneous with the conversion, the Company paid to American
Cyanamid $160,000 of accrued interest due on the note.
6. Shareholders' Equity
On May 16, 1996, the Company's shareholders approved an increase in the number
of authorized shares of Common Stock from 15,000,000 to 30,000,000 shares and an
increase in the amount of authorized Preferred Stock from 20,000 to 15,000,000
shares. In addition, the Company changed the par value of the Common Stock and
Series A Participating Preferred Stock from no par value to par value stock,
with a par value of $.01 per share.
At December 31, 1997, the Company had reserved a total of 1,840,382 shares of
its Common Stock for future issuance as follows:
For exercise of warrants to purchase Common Stock................. 390,775
For exercise of Common Stock options.............................. 1,396,300
For possible future issuance to employees and others
under employee stock purchase plans............................... 53,307
---------
Total reserved..................................................... 1,840,382
=========
25
At December 31, 1997, the Company had issued and outstanding warrants to
purchase Common Stock as follows:
Date through
Exercise Price Shares Reserved for Which Warrants
Per Share Exercise of Warrants are Exercisable
-------------- -------------------- ---------------
$8.07.................... 188,197 7/28/98
$9.02.................... 31,578 1/28/99
$9.50.................... 30,000 12/31/00
$9.50.................... 15,000 6/9/01
$6.00.................... 96,000 4/30/00
$7.28.................... 30,000 10/30/01
-------
390,775
=======
7. Stock Option Plans
The Company's stock option plans provide for option grants designated as either
nonqualified or incentive stock options. The options generally vest over a
four-year period and expire ten years from the date of grant. In general, the
exercise price of stock options is the closing price of the Company's Common
Stock on the date of grant.
Most U.S. employees and certain employees outside the U.S. are eligible to
receive a grant of stock options periodically with the number of shares
generally determined by the employee's salary grade and performance level. In
addition, certain management and professional level employees may receive a
stock option grant upon hire. Non-employee directors of the Company receive
annual grants of stock options in amounts specified in the applicable plan.
Stock option information with respect to all of the Company's stock option plans
follows:
Number Option Price Range Expiration
of Shares per Share Date
--------- ------------------ ----------
Balance at December 31, 1994, outstanding options.................. 713,402 $2.00 to $8.75 1998-2004
Granted....................................................... 314,370 $5.875 to $6.50 2005
Exercised..................................................... (59,444) $2.00 to $7.875
Canceled...................................................... (59,207) $2.00 to $8.75
---------
Balance at December 31, 1995, outstanding options.................. 909,121 $2.00 to $8.375 1998-2005
Granted....................................................... 111,980 $6.125 to $7.625 2006
Exercised..................................................... (66,873) $2.00 to $7.00
Canceled...................................................... (87,814) $6.125 to $2.00
--------
Balance at December 31, 1996, outstanding options.................. 866,414 $2.00 to $8.375 1998-2006
Granted....................................................... 279,525 $6.063 to $7.125 2007
Exercised..................................................... (53,779) $2.00 to $7.00
Canceled...................................................... (53,568) $6.125 to $7.00
---------
Balance at December 31, 1997, outstanding options.................. 1,038,592 $2.00 to $8.75 1998-2007
=========
At December 31, 1997, options to purchase 1,038,592 shares of Common Stock were
exercisable at prices ranging from $2.00 to $8.375 per share.
The Company has elected to follow Accounting Principles Board Option No. 25,
"Accounting for Stock Issued to Employees" (APB 25) and related Interpretations
in accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under FASB Statement No. 123,
"Accounting for Stock-Based Compensation," requires use of option valuation
models that were not developed for use in valuing employee stock options. Under
APB 25, because the exercise price of the Company's employee stock options
equals the market price of the underlying stock on the date of grant, no
compensation expense is recognized.
26
The Company's 1996 Amendment to its 1993 Incentive Stock Option Plan increases
the authorized grant of options to company personnel from 500,000 shares of
common stock up to 1.2 million shares. All options granted have 10 year terms
and vest and become fully exercisable at the end of 4 years of continued
employment.
Pro forma information regarding net income (loss) and income (loss) per
share is required by SFAS 123, and has been determined as if the Company
accounted for its employee stock options granted subsequent to December 31, 1994
under the fair value method of SFAS 123. The fair value for these options was
estimated at the date of grant using a Black-Scholes option pricing model with
the following weighted average assumptions:
1997 1996 1995
----- ----- ----
Risk free interest rate............... 6.13 6.42 6.13
Dividends........................... -- -- --
Volatility factor................... 0.358 0.421 0.358
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
changes in the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its employee stock
options.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information follows:
For the year ended December 31
--------------------------------------------
1997 1996 1995
----- ----- ----
Pro forma net income (loss)....................... $1,241,310 $51,513 $(4,574,000)
Pro forma income (loss) per share................. $ 0.15 $ 0.01 $ (0.72)
Exercise prices for options outstanding as of December 31, 1997 ranged from
$2.00 to $8.75.
The weighted average remaining contractual life of those options is 8.42 years.
The weighted average exercisable price of outstanding options at December 31,
1996 is $6.52.
8. Employee Stock Purchase Plan
The Company has an Employee Stock Purchase Plan (the "Purchase Plan") to provide
its employees with an additional opportunity to share in the ownership of the
Company. Under terms of the Purchase Plan, all regular full-time employees of
the Company may make voluntary payroll contributions thereby enabling them to
purchase Common Stock at a price to be determined by the Compensation Committee
of the Board, but not less than 85 percent of the lower of the fair market value
as of the beginning or end of the twelve-month offering period. Contributions
are limited to 20 percent of an employee's compensation. Up to 100,000 shares of
Common Stock may be issued under the Purchase Plan.
Under the Purchase Plan, during 1997, 1996 and 1995, 9,764, 11,028, and 17,041
shares of Common Stock, respectively, were purchased.
9. 401(k) Retirement Savings Plan
The Company has a 401(k) plan which covers all employees upon employment who are
at least 18 years of age. Employer contributions are voluntary at the discretion
of the Company. There were no Company contributions for the years ended December
31, 1997, 1996, and 1995.
27
10. Income Taxes
The components of income tax expense for the year ended December 31, 1997 are as
follows:
Current:
Federal.................................................... $ 59,000
State...................................................... 84,000
Foreign.................................................... 279,000
--------
$422,000
========
The Company's consolidated effective tax rate differed from the statutory rate
as set forth below for the year ended December 31, 1997:
Federal taxes at statutory rate............................... $742,000
State and local income taxes, net of Federal benefit.......... 84,000
Non-deductible expenses....................................... 24,000
Foreign losses for which no benefit has been recognized....... 346,000
Change in valuation allowance................................. 125,000
Utilization of net operating loss carryforwards............... (1,238,000)
Alternative minimum and foreign withholding taxes............. 338,000
Other......................................................... 1,000
----------
$422,000
==========
Deferred income taxes reflect the net effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. The Company has no deferred tax
liabilities. Significant components of the Company's deferred tax assets are as
follows:
At December 31,
--------------------------------
1997 1996
----------- -----------
Deferred tax assets:
Book over tax depreciation........................................ $718,000 $790,000
Net operating loss carryforwards.................................. 11,430,000 12,800,000
Research and experimental tax credit carryforwards................ 1,915,000 1,725,000
Charitable contributions carryfoward.............................. 16,000 16,000
Other............................................................. 158,000 170,000
----------- -----------
Total deferred tax assets..................................... 14,237,000 15,501,000
Valuation allowance for deferred tax assets............................ (14,237,000) (15,501,000)
----------- -----------
Net deferred tax assets........................................... $0 $0
== ==
During 1997 and 1996, the valuation allowance decreased by ($1,264,000) and
($255,000), respectively.
At December 31, 1997, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $34 million which are available to
offset future taxable income. These net operating loss carryforwards expire
during the years 2000 through 2010. As a result of the changes in ownership
percentages which occurred with the 1991 Initial Public Offering (IPO), the
future utilization of the net operating loss carryforwards incurred prior to the
1991 IPO is limited to approximately $2.1 million per year. Any loss
carryforward amounts exceeding the limitation can be carried forward to future
years within the carryforward period. The net operating loss carryforwards
incurred subsequent to the 1991 IPO are not subject to these change in ownership
limitations.
In addition, the Company has Research and Experimental Tax Credit carryforwards
totaling approximately $1.9 million which are available to offset future federal
income taxes. These credits expire during the years 2000 through 2012.
28
11. Commitments
As of December 31, 1997, the Company had outstanding purchase commitments of
approximately $2.5 million related to the production of the Company's
Bursaplex(TM) product, and materials and supplies for the construction and
maintenance of INOVOJECT(R) egg injection systems.
12. Restatement
At the annual meeting of the American Institute of Certified Public Accountants
(AICPA) in January 1997 and at the March 1997 staff meeting of the Emerging
Issues Task Force of the Financial Accounting Standards Board (FASB), the
Securities and Exchange Commission staff stated that a charge to income is
appropriate in situations where a registrant has issued debt securities
convertible to Common Stock at the lower of a conversion rate fixed at issuance
or a fixed discount to the Common Stock's market price at the date of
conversion.
In accordance with the SEC's position, the Company has restated its 1995
financial statements to record additional interest expense of $1.1 million
related to the conversion feature at a 15% discount included in the 1995
debentures (see Note 4). The restatement resulted in an increase of $1.0 million
in the previously reported 1995 net loss and an increase in 1995 net loss per
share from $.57 per share to $.73 per share. In addition, at December 31, 1995,
long-term debt was increased by $569,000 and shareholders equity was decreased
by $569,000 to reflect the conversion discount related to outstanding debentures
that had not been converted.
29
13. Net Income (Loss) Per Share
The following table sets forth the computation of basic and diluted net income
(loss) per share (in thousands, except per share amounts):
1997 1996 1995
------- ------- -------
Numerator:
Net Income (Loss) Available To
Common Stockholders ........................ $ 1,760 $ 341 $(4,512)
Effect of dilutive securities:
Regulation S Debentures .................. 9 122 --
------- ------- -------
Numerator for diluted earnings
per share-income available to
common stockholders after
assumed Conversions .................... $ 1,769 $ 463 $(4,512)
======= ======= =======
Denominator:
Denominator for basic net income per
share--weighted-average shares ............. 8,184 7,218 6,187
Effect of Dilutive Securities:
Employee Stock Options ................. 143 188 --
Warrants ............................... 8 12 --
Convertible Debentures ................. 4 102 --
------- ------- -------
Dilutive Potential Shares ............ 155 302 --
Denominator for diluted net income
per share--adjusted weighted-
average shares and assumed
conversions ............................ 8,339 7,520 6,187
======= ======= =======
Basic net income per share ...................... $ 0.21 $ 0.05 $ (0.73)
======= ======= =======
Diluted net income per share .................... $ 0.21 $ 0.06 $ (0.73)
======= ======= =======
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
30
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information on the executive officers and directors is incorporated by reference
from the Company's Proxy Statement (under the headings "Management" and
"Proposal I: Election of Directors," respectively), with respect to the Annual
Meeting of Shareholders to be held on May 21, 1998, to be filed with the
Securities and Exchange Commission.
ITEM 11. EXECUTIVE COMPENSATION
This information is incorporated by reference from the Company's Proxy Statement
(under the heading "Executive Compensation"), with respect to the Annual Meeting
of Shareholders to be held on May 21, 1998, to be filed with the Securities and
Exchange Commission.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
This information is incorporated by reference from the Company's Proxy Statement
(under the heading "Share Ownership of Management and Certain Beneficial
Owners"), with respect to the Annual Meeting of Shareholders to be held on May
21, 1998, to be filed with the Securities and Exchange Commission.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
31
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1). The financial statements listed below are included in Item 8 of
this report. All financial statement schedules normally required under
Regulation S-X are omitted as the required information is inapplicable.
Report of Independent Auditors
Financial Statements
Consolidated Balance Sheets at
December 31, 1996 and 1997
Consolidated Statements of Operations
for each of the three fiscal years ended
December 31, 1995, 1996 and 1997
Consolidated Statements of Cash Flows
for each of the three fiscal years ended
December 31, 1995, 1996 and 1997
Consolidated Statements of Shareholders'
Equity for each of the three fiscal
years ended December 31, 1995, 1996 and 1997
Notes to Consolidated Financial Statements
(a)(2). The financial statements of the Company's Employee Stock Purchase
Plan listed below are filed herewith, pursuant to Form 10-K, General
Instruction F.
Report of Independent Auditors
Financial Statements
Statements of Net Assets Available for Plan
Benefits at December 31, 1996 and 1997
Statements of Changes in Net Assets Available
for Plan Benefits for the three years ended
December 31, 1997
Notes to Financial Statements
32
(a)(3). The exhibits listed below are filed as part of this report.
Executive compensation plans and arrangements are listed in Exhibits 10.14
through 10.32.
Exhibits Description
- -------- -----------
3.1(1) Restated Articles of Incorporation
3.2(2) Articles of Amendment to Restated Articles of
Incorporation, effective March 21, 1996
3.3(3) Articles of Amendment to Restated Articles of
Incorporation, effective May 28, 1996
3.4 Amended and Restated Bylaws, effective March 27,
1998
4.1 Reference is made to Exhibits 3.1, 3.2, 3.3 and 3.4
4.2(4) Specimen of Common Stock Certificate
4.3(5) Notices to holders of outstanding warrants regarding
adjustments in warrant terms resulting from
Regulation S private placement
4.4(6) Form of Registration Rights Agreement
4.5(5) Form of Regulation S Securities Subscription
Agreement
4.6(5) Form of Embrex 8% Convertible Debenture due May 1,
1997
4.7(5) Warrant to Purchase Common Stock of Embrex issued to
Schwartz Investments, Inc.
4.8(7) Rights Agreement dated as of March 21, 1996 between
Embrex and Branch Banking and Trust Company, as
Rights Agent
10.1(8) Exchange Agreement dated May 28, 1991, between
Embrex and American Cyanamid Company, Advent First
Limited Partnership A, Biotechnology Venture Fund
S.A., Biotechnology Investments Limited, Domain
Partners, L.P., Elf Technologies, Inc., Prince
Venture Partners III, L.P., 3I Securities
Corporation, and Charles E. Austin
10.2(8) Form of Stock Purchase Warrant exercisable for the
purchase of 180,003 shares of Common Stock
10.3(8) License Agreement dated December 11, 1991, between
Embrex and the National Technical Information
Service, a primary operating unit of the United
States Department of Commerce
10.4(8) Collaborative Research Agreement dated January 17,
1989 between Embrex and the University of Arkansas
10.5(8) License Agreement dated October 1, 1988, between
Embrex and the National Technical Information
Service, a primary operating unit of the United
States Department of Commerce
10.6(8) Lease Agreement dated December 9, 1986 between
Embrex, as tenant, and Imperial Center Partnership
and Petula Associates, Ltd., as landlord, as amended
by First Amendment dated June 11, 1987, Second
Amendment dated December 1, 1988, and Third
Amendment dated May 2, 1989
33
Exhibits Description
- -------- -----------
10.7(4) Fourth Amendment of Lease dated October 1, 1994
between the Company and Glaxo Inc. (as successor in
interest to Imperial Center Partnership and Petula
Associates, Ltd.)
10.8(4) Fifth Amendment of Lease dated December 13, 1996
between the Company and Glaxo Wellcome Inc. (as
successor in interest to Glaxo Inc.)
10.9 Lease for Royal Center II dated October 13, 1997
between the Company and Petula Associates, Ltd.
10.10(8) Facility Agreement dated March 1, 1991, between
Embrex and Mississippi Agriculture and Forestry
Experiment Station, Mississippi State University
10.11(8) Unrestricted Grant Agreement dated April 1, 1988,
between Embrex and North Carolina State University,
as amended by Amendment dated September 15, 1989 and
Amendment dated April 22, 1991
10.12(8) Unrestricted Grant Agreement dated November 1, 1986,
between Embrex and North Carolina State University,
as amended by Amendment dated May 3, 1989, Amendment
dated September 15, 1989, and Amendment dated April
22, 1991
10.13(8) Basic Research Agreement dated October 24, 1989,
between Embrex and University of Arkansas, as
amended on October 23, 1990, February 1, 1991 and
July 22, 1991
10.14(8) 1988 Incentive Stock Option Plan and form of
Incentive Stock Option Agreement
10.15(8) 1989 Nonstatutory Stock Option Plan and form of
Nonstatutory Stock Option Agreement
10.16(8) 1991 Nonstatutory Stock Option Plan and form of
Nonstatutory Stock Option Agreement
10.17(9) Incentive Stock Option and Nonstatutory Stock Option
Plan and forms of Stock Option Agreements - June
1993
10.18(3) Amendment dated May 16, 1996 to Incentive Stock
Option and Nonstatutory Stock Option Plan - June
1993
10.19(4) Amended and Restated Employee Stock Purchase Plan
10.20(8) Employment Agreement dated November 15, 1989,
between Embrex and Randall L. Marcuson
10.21(4) Amendment to Employment Agreement dated May 21, 1996
between Embrex and Randall L. Marcuson
10.22(4) Change In Control Severance Agreement dated May 21,
1996 between Embrex and Randall L. Marcuson
10.23(8) Employment Agreement dated October 16, 1989, between
Embrex and Catherine A. Ricks
10.24(4) Change In Control Severance Agreement dated May 21,
1996 between Embrex and Catherine A. Ricks
10.25(2) General Provisions to Employment Agreement between
Embrex and Brian V. Cosgriff dated August 18, 1995
34
Exhibits Description
- -------- -----------
10.26(4) Charge In Control Severance Agreement dated May 21,
1996 between Embrex and Brian V. Cosgriff
10.27(2) Terms and Conditions of Employment between Embrex
Europe Limited and David M. Baines dated May 12,
1994
10.28(4) Change In Control Severance Agreement dated June 9,
1996 between Embrex and David M. Baines
10.29(4) Letter Agreement and General Provisions to
Employment Agreement dated August 20, 1996 between
Embrex and Don T. Seaquist and Amendment to
Employment Agreement dated September 9, 1996 between
Embrex and Don T. Seaquist
10.30(4) Change In Control Severance Agreement dated
September 9, 1996 between Embrex and Don T. Seaquist
10.31(4) Letter Agreement and General Provisions to
Employment Agreement dated August 26, 1996 between
Embrex and Rick L. Ryan and Amendment to Employment
Agreement dated August 26, 1996 between Embrex and
Rick L. Ryan
10.32(4) Change In Control Severance Agreement dated August
26, 1996 between Embrex and Rick L. Ryan
10.33(8) Shareholders' Agreement dated August 14, 1991 by and
among Embrex, Advent Euroventures Limited
Partnership, and Plant Resource Venture Fund II
Limited Partnership
10.34 INOVOJECT(R) Egg Injection System Lease, Limited
License, Supply and Service Agreement dated
September 1, 1994 between Embrex and Tyson Foods,
Inc. (asterisks located within the exhibit denote
information which has been deleted pursuant to a
request for confidential treatment filed with the
Securities and Exchange Commission)
10.35 Amendment dated March 26, 1997 to the INOVOJECT(R)
Egg Injection System Lease, Limited License, Supply
and Service Agreement dated September 1, 1994
between Embrex and Tyson Foods, Inc. (asterisks
located within the exhibit denote information which
has been deleted pursuant to a request for
confidential treatment filed with the Securities and
Exchange Commission)
10.36(10) Master Lease Agreement dated December 3, 1993
between Embrex and Capital Associates International,
Inc. with a form of equipment schedule and
collateral assignment of lease attached
10.37(10) Master Lease Agreement dated January 28, 1994
between Embrex and Aberlyn Capital Management
Limited Partnership with a form of lease schedule
and collateral assignment of lease attached
10.38(10) Agreement to Issue Warrant dated January 28, 1994
between Embrex and Aberlyn Capital Management
Limited Partnership
10.39(10) Common Stock Purchase Warrant issued to Aberlyn
Capital Management Limited Partnership
10.40(10) Agreement to Issue Warrant dated January 28, 1994
between Embrex and Aberlyn Holding Company, Inc.
35
Exhibits Description
- -------- -----------
10.41(10) Common Stock Purchase Warrant issued to Aberlyn
Holding Company, Inc.
10.42(11) Master Equipment Lease Agreement dated as of
December 7, 1994 between Financing for Science
International, Inc. and Embrex with a Consent to
Assignment of Equipment Lease Agreement, Security
Agreement and Rental Schedule attached
10.43(11) License Agreement dated as of December 7, 1994
between Financing for Science International, Inc.
and Embrex with Sublicense Agreement attached
10.44(11) Common Stock Purchase Warrant dated January 17, 1995
issued to Financing for Science International, Inc.
10.45(11) Agreement for Sale of Equipment and Rights Under
User Agreement dated as of December 7, 1994 between
Financing for Science International, Inc. and Embrex
10.46(5) Letter of Agreement for $6.0 million Convertible
Regulation S Private Placement by and between the
Company and Swartz Investments, Inc., as placement
agent
10.47(2) Limited License and Supply Agreement dated as of
July 20, 1995 between Embrex and Webster
10.48(4) Amendments dated August 1, 1996 and November 11,
1996 to Limited License and Supply Agreement dated
as of July 20, 1995 between Embrex and Webster
10.49(2) Agreement dated as of January 22, 1996 between
Embrex and Select
10.50(2) Letter Agreement dated as of January 22, 1996
between Select and Embrex
10.51(2) License dated as of January 22, 1996 granted by
Select to Embrex
10.52(2) Commitment letter accepted June 14, 1995 between
Embrex and Financing for Science International, Inc.
for $2.0 million capital lease financing facility
10.53(2) Stock Purchase Warrant dated June 9, 1995 issued to
Financing for Science International, Inc.
10.54(2) Financing Agreement (Number 10783) dated as of
October 30, 1995 between Lease Management Services,
Inc. and Embrex, and Addendum thereto dated October
30, 1995 attached
10.55(2) License Agreement dated October 30, 1995 between
Embrex and Lease Management Services, Inc.
10.56(2) Sublicense Agreement dated as of October 30, 1995
between Embrex and Lease Management Services, Inc.
10.57(2) Movable Hypothec on Equipment and Contracts dated as
of October 30, 1995 between Embrex and Lease
Management Services, Inc.
10.58(2) Warrant to Purchase 30,000 Shares of Common Stock
dated October 30, 1995 issued to Lease Management
Services, Inc.
10.59(2) Intercreditor Agreement dated as of October 31, 1995
among Financing for Science International, Inc.,
Lease Management Services, Inc., and Embrex.
36
Exhibits Description
- -------- -----------
10.60(4) Embrex Europe Limited Loan Agreement dated April 3,
1996
21 Subsidiaries
23 Consent of Ernst & Young LLP to the inclusion of
their report dated February 20, 1998 with respect to
the consolidated financial statements of the Company
in this Form 10-K and the incorporation by reference
of such report into the Registration Statement on
Form S-3 (No. 333-18231), as filed with the
Securities and Exchange Commission on December 19,
1996, and into the Registration Statements under the
Securities Act of 1933 on Form S-8 (Registration
Nos. 33-51582, 33-63318 and 333-04109), as filed
with the Securities and Exchange Commission on
September 1, 1992, May 25, 1993, and May 20, 1996,
respectively, and to the incorporation by reference
in the Registration Statement on Form S-8
(Registration No. 33-63318) pertaining to the
Employee Stock Purchase Plan of their report dated
March 19, 1998 with respect to the financial
statements of the Embrex, Inc. Employee Stock
Purchase Plan included in this Form 10-K.
24 Powers of Attorney
27.1 Financial Data Schedule to the Company's Form 10-K
for the year ended December 31, 1997.
27.2 Amended Financial Data Schedule to the Company's
Form 10-Q for the quarter ended March 31, 1997 as
filed with the Securities and Exchange Commission
on May 7, 1997.
27.3 Amended and Restated Financial Data Schedule to the
Company's Form 10-K for the year ended December 31,
1996 as filed with the Securities and Exchange
Commission on March 31, 1997.
27.4 Amended and Restated Financial Data Schedule to the
Company's Form 10-Q for the quarter ended September
30, 1996 as filed with the Securities and Exchange
Commission on November 30, 1996.
27.5 Amended and Restated Financial Data Schedule to the
Company's Form 10-Q for the quarter ended June 30,
1996 as filed with the Securities and Exchange
Commission on August 12, 1996.
27.6 Amended and Restated Financial Data Schedule to the
Company's Form 10-Q for the quarter ended March 31,
1996 as filed with the Securities and Exchange
Commission on May 13, 1996.
99 Risk Factors relating to the Company
- ----------
(1) Exhibit to the Company's Form 10-K as filed with the Securities and
Exchange Commission for fiscal year ending December 31, 1991 and
incorporated herein by reference
(2) Exhibit to the Company's Form 10-K as filed with the Securities and
Exchange Commission for the fiscal year ending December 31, 1995 and
incorporated herein by reference
(3) Exhibit to the Company's Form 10-Q as filed with the Securities and
Exchange Commission for the three months ended June 30, 1996 and
incorporated herein by reference
(4) Exhibit to the Company's Form 10-K as filed with the Securities and
Exchange Commission for fiscal year ending December 31, 1996 and
incorporated herein by reference
(5) Exhibit to the Company's Form 10-Q as filed with the Securities and
Exchange Commission for the three months ended June 30, 1995 and
incorporated herein by reference
(6) Exhibit to the Company's Form 10-Q as filed with the Securities and
Exchange Commission for the three months ended March 31, 1995 and
incorporated herein by reference
(7) Exhibit to the Company's Registration Statement on Form 8-A as filed
with the Securities and Exchange Commission on March 22, 1996 and
incorporated herein by reference
37
(8) Exhibit to the Company's Registration Statement on Form S-1 as filed
with the Securities and Exchange Commission (Registration No.
33-42482) effective November 7, 1991 and incorporated herein by
reference
(9) Exhibit to the Company's Form 10-K as filed with the Securities and
Exchange Commission for the fiscal year ending December 31, 1992 and
incorporated herein by reference
(10) Exhibit to the Company's Form 10-KSB, as amended, as filed with the
Securities and Exchange Commission for the fiscal year ending December
31, 1993 and incorporated herein by reference
(11) Exhibit to the Company's Form 10-K as filed with the Securities and
Exchange Commission for the fiscal year ending December 31, 1994 and
incorporated herein by reference
(b). No reports on Form 8-K were filed during the last quarter of the fiscal
year ended December 31, 1997.
38
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this Annual Report on Form 10-K to
be signed on its behalf by the undersigned, thereunto duly authorized.
EMBREX, INC.
By: /s/ Randall L. Marcuson
---------------------------
Date: March 30, 1998 Randall L. Marcuson
President and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
/s/ Randall L. Marcuson President, Chief Executive Officer, March 30, 1998
- -------------------------------- and Director
Randall L. Marcuson
/s/ Don T. Seaquist
- -------------------------------- Vice President, Finance March 30, 1998
Don T. Seaquist and Administration (Principal
Financial and Accounting Officer)
* Chairman of the March 30, 1998
- -------------------------------- Board of Directors
Charles E. Austin
* Director March 30, 1998
- --------------------------------
C. Daniel Blackshear
* Director March 30, 1998
- --------------------------------
Lester M. Crawford, D.V.M. Ph.D.
* Director March 30, 1998
- --------------------------------
Kenneth N. May, Ph.D.
* Director March 30, 1998
- --------------------------------
Arthur M. Pappas
* By: /s/ Randall L. Marcuson
---------------------------------------
Randall L. Marcuson, as Attorney-in-Fact
39
Report of Independent Auditors
The Board of Directors
Embrex, Inc.
We have audited the accompanying statements of net assets available for plan
benefits of Embrex, Inc. Employee Stock Purchase Plan as of December 31, 1997
and 1996, and the related statement of changes in net assets available for plan
benefits for each of the three years in the period ended December 31, 1997.
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, the financial statements referred to above present fairly, in
all material respects, the net assets available for plan benefits of Embrex,
Inc. Employee Stock Purchase Plan at December 31, 1997 and 1996, and the changes
in net assets available for plan benefits for each of the three years in the
period ended December 31, 1997 in conformity with generally accepted accounting
principles.
/s/ Ernst & Young LLP
Raleigh, North Carolina
March 19, 1998
40
STATEMENTS OF NET ASSETS AVAILABLE FOR PLAN BENEFITS
EMBREX, INC. EMPLOYEE STOCK PURCHASE PLAN
At December 31,
1997 1996
---- ----
Receivable from Company........................... $ 38,666 $ 26,077
-------- --------
Net assets available for Plan benefits............ $ 38,666 $ 26,077
======== ========
See accompanying notes.
41
STATEMENTS OF CHANGES IN NET ASSETS AVAILABLE FOR PLAN BENEFITS
EMBREX, INC. EMPLOYEE STOCK PURCHASE PLAN
Years Ended December 31,
1997 1996 1995
------- ------- -------
Employee contributions................................... $ 87,189 $79,487 $90,880
Deductions:
Purchases of Common Stock................. 46,365 59,116 79,737
Withdrawals............................... 28,245 31,394 15,862
------- ------- -------
74,600 90,510 95,601
------- ------- -------
New (decrease) increase.................................. 12,589 (11,023) (4,721)
Net assets available for Plan benefits at
beginning of period....................... 26,077 37,100 41,821
------- ------- -------
Net assets available for Plan benefits at
end of period............................. $ 38,666 $26,077 $37,100
======= ======= =======
Shares of Common Stock purchased
during year............................... 8,209 11,028 17,041
======= ======= =======
42
EMBREX, INC. EMPLOYEE STOCK PURCHASE PLAN
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
NOTE 1 - BASIS OF PRESENTATION
The accompanying financial statements of the Embrex, Inc. Employee Stock
Purchase Plan ("the Plan") have been prepared on the accrual basis.
NOTE 2 - PLAN DESCRIPTION AND SUMMARY OF SIGNIFICANT PLAN PROVISIONS
The Board of Directors of Embrex, Inc. ("the Company") adopted the Plan on
January 28, 1993, and the Plan was approved by shareholders of the Company at
the Annual Meeting of Shareholders on May 20, 1993. The Plan became effective as
of June 1, 1993.
The purpose of this Plan is to provide the Company's employees with an
additional opportunity to share in the ownership of the Company. Under terms of
the Plan, all regular full-time employees of the Company may make voluntary
payroll contributions thereby enabling them to purchase Common Stock at a price
to be determined by the Compensation Committee of the Board, but not less than
85 percent of the lower of the fair market values as of the beginning or end of
the twelve month offering period.
Contributions are limited to 20 percent of an employee's compensation, and the
aggregate number of shares of Common Stock which may be purchased in total by
all Plan participants may not exceed 100,000 shares.
Contributions to the Plan are maintained in a non-interest bearing account until
such time as the participant exercises the option to purchase shares of Common
Stock from his or her available contributions, or withdraws from the account.
All amounts representing net Plan assets are considered general assets of the
Company and may be subject to the claims of creditors.
In addition to contributions, plan activity consists of voluntary purchases of
shares of Common Stock and withdrawals from participation in the Plan.
Participants may purchase whole shares of Common Stock during a Purchase Period
(generally a twelve month period ending each June 30th). A participant may
withdraw from the Plan and cease making contributions at any time.
The Plan is not subject to the provisions of the Employee Retirement Income
Security Act of 1974 ("ERISA") and is not qualified under Section 401(a) of the
Internal Revenue Code of 1986, as amended which relates to qualification of
certain pension, profit-sharing and stock bonus plans.
All costs to administer the Plan are paid by the Company.
43
Exhibits Description
- -------- -----------
3.1(1) Restated Articles of Incorporation
3.2(2) Articles of Amendment to Restated Articles of
Incorporation, effective March 21, 1996
3.3(3) Articles of Amendment to Restated Articles of
Incorporation, effective May 28, 1996
3.4 Amended and Restated Bylaws, effective March 27,
1998
4.1 Reference is made to Exhibits 3.1, 3.2, 3.3 and 3.4
4.2(4) Specimen of Common Stock Certificate
4.3(5) Notices to holders of outstanding warrants regarding
adjustments in warrant terms resulting from
Regulation S private placement
4.4(6) Form of Registration Rights Agreement
4.5(5) Form of Regulation S Securities Subscription
Agreement
4.6(5) Form of Embrex 8% Convertible Debenture due May 1,
1997
4.7(5) Warrant to Purchase Common Stock of Embrex issued to
Schwartz Investments, Inc.
4.8(7) Rights Agreement dated as of March 21, 1996 between
Embrex and Branch Banking and Trust Company, as
Rights Agent
10.1(8) Exchange Agreement dated May 28, 1991, between
Embrex and American Cyanamid Company, Advent First
Limited Partnership A, Biotechnology Venture Fund
S.A., Biotechnology Investments Limited, Domain
Partners, L.P., Elf Technologies, Inc., Prince
Venture Partners III, L.P., 3I Securities
Corporation, and Charles E. Austin
10.2(8) Form of Stock Purchase Warrant exercisable for the
purchase of 180,003 shares of Common Stock
10.3(8) License Agreement dated December 11, 1991, between
Embrex and the National Technical Information
Service, a primary operating unit of the United
States Department of Commerce
10.4(8) Collaborative Research Agreement dated January 17,
1989 between Embrex and the University of Arkansas
10.5(8) License Agreement dated October 1, 1988, between
Embrex and the National Technical Information
Service, a primary operating unit of the United
States Department of Commerce
10.6(8) Lease Agreement dated December 9, 1986 between
Embrex, as tenant, and Imperial Center Partnership
and Petula Associates, Ltd., as landlord, as amended
by First Amendment dated June 11, 1987, Second
Amendment dated December 1, 1988, and Third
Amendment dated May 2, 1989
10.7(4) Fourth Amendment of Lease dated October 1, 1994
between the Company and Glaxo Inc. (as successor in
interest to Imperial Center Partnership and Petula
Associates, Ltd.)
10.8(4) Fifth Amendment of Lease dated December 13, 1996
between the Company and Glaxo Wellcome Inc. (as
successor in interest to Glaxo Inc.)
44
Exhibits Description
- -------- -----------
10.9 Lease for Royal Center II dated October 13, 1997
between the Company and Petula Associates, Ltd.
10.10(8) Facility Agreement dated March 1, 1991, between
Embrex and Mississippi Agriculture and Forestry
Experiment Station, Mississippi State University
10.11(8) Unrestricted Grant Agreement dated April 1, 1988,
between Embrex and North Carolina State University,
as amended by Amendment dated September 15, 1989 and
Amendment dated April 22, 1991
10.12(8) Unrestricted Grant Agreement dated November 1, 1986,
between Embrex and North Carolina State University,
as amended by Amendment dated May 3, 1989, Amendment
dated September 15, 1989, and Amendment dated April
22, 1991
10.13(8) Basic Research Agreement dated October 24, 1989,
between Embrex and University of Arkansas, as
amended on October 23, 1990, February 1, 1991 and
July 22, 1991
10.14(8) 1988 Incentive Stock Option Plan and form of
Incentive Stock Option Agreement
10.15(8) 1989 Nonstatutory Stock Option Plan and form of
Nonstatutory Stock Option Agreement
10.16(8) 1991 Nonstatutory Stock Option Plan and form of
Nonstatutory Stock Option Agreement
10.17(9) Incentive Stock Option and Nonstatutory Stock Option
Plan and forms of Stock Option Agreements - June
1993
10.18(3) Amendment dated May 16, 1996 to Incentive Stock
Option and Nonstatutory Stock Option Plan - June
1993
10.19(4) Amended and Restated Employee Stock Purchase Plan
10.20(8) Employment Agreement dated November 15, 1989,
between Embrex and Randall L. Marcuson
10.21(4) Amendment to Employment Agreement dated May 21, 1996
between Embrex and Randall L. Marcuson
10.22(4) Change In Control Severance Agreement dated May 21,
1996 between Embrex and Randall L. Marcuson
10.23(8) Employment Agreement dated October 16, 1989, between
Embrex and Catherine A. Ricks
10.24(4) Change In Control Severance Agreement dated May 21,
1996 between Embrex and Catherine A. Ricks
10.25(2) General Provisions to Employment Agreement between
Embrex and Brian V. Cosgriff dated August 18, 1995
10.26(4) Charge In Control Severance Agreement dated May 21,
1996 between Embrex and Brian V. Cosgriff
10.27(2) Terms and Conditions of Employment between Embrex
Europe Limited and David M. Baines dated May 12,
1994
45
Exhibits Description
- -------- -----------
10.28(4) Change In Control Severance Agreement dated June 9,
1996 between Embrex and David M. Baines
10.29(4) Letter Agreement and General Provisions to
Employment Agreement dated August 20, 1996 between
Embrex and Don T. Seaquist and Amendment to
Employment Agreement dated September 9, 1996 between
Embrex and Don T. Seaquist
10.30(4) Change In Control Severance Agreement dated
September 9, 1996 between Embrex and Don T. Seaquist
10.31(4) Letter Agreement and General Provisions to
Employment Agreement dated August 26, 1996 between
Embrex and Rick L. Ryan and Amendment to Employment
Agreement dated August 26, 1996 between Embrex and
Rick L. Ryan
10.32(4) Change In Control Severance Agreement dated August
26, 1996 between Embrex and Rick L. Ryan
10.33(8) Shareholders' Agreement dated August 14, 1991 by and
among Embrex, Advent Euroventures Limited
Partnership, and Plant Resource Venture Fund II
Limited Partnership
10.34 INOVOJECT(R) Egg Injection System Lease, Limited
License, Supply and Service Agreement dated
September 1, 1994 between Embrex and Tyson Foods,
Inc. (asterisks located within the exhibit denote
information which has been deleted pursuant to a
request for confidential treatment filed with the
Securities and Exchange Commission)
10.35 Amendment dated March 26, 1997 to the INOVOJECT(R)
Egg Injection System Lease, Limited License, Supply
and Service Agreement dated September 1, 1994
between Embrex and Tyson Foods, Inc. (asterisks
located within the exhibit denote information which
has been deleted pursuant to a request for
confidential treatment filed with the Securities and
Exchange Commission)
10.36(10) Master Lease Agreement dated December 3, 1993
between Embrex and Capital Associates International,
Inc. with a form of equipment schedule and
collateral assignment of lease attached
10.37(10) Master Lease Agreement dated January 28, 1994
between Embrex and Aberlyn Capital Management
Limited Partnership with a form of lease schedule
and collateral assignment of lease attached
10.38(10) Agreement to Issue Warrant dated January 28, 1994
between Embrex and Aberlyn Capital Management
Limited Partnership
10.39(10) Common Stock Purchase Warrant issued to Aberlyn
Capital Management Limited Partnership
10.40(10) Agreement to Issue Warrant dated January 28, 1994
between Embrex and Aberlyn Holding Company, Inc.
10.41(10) Common Stock Purchase Warrant issued to Aberlyn
Holding Company, Inc.
10.42(11) Master Equipment Lease Agreement dated as of
December 7, 1994 between Financing for Science
International, Inc. and Embrex with a Consent to
Assignment of Equipment Lease Agreement, Security
Agreement and Rental Schedule attached
46
Exhibits Description
- -------- -----------
10.43(11) License Agreement dated as of December 7, 1994
between Financing for Science International, Inc.
and Embrex with Sublicense Agreement attached
10.44(11) Common Stock Purchase Warrant dated January 17, 1995
issued to Financing for Science International, Inc.
10.45(11) Agreement for Sale of Equipment and Rights Under
User Agreement dated as of December 7, 1994 between
Financing for Science International, Inc. and Embrex
10.46(5) Letter of Agreement for $6.0 million Convertible
Regulation S Private Placement by and between the
Company and Swartz Investments, Inc., as placement
agent
10.47(2) Limited License and Supply Agreement dated as of
July 20, 1995 between Embrex and Webster
10.48(4) Amendments dated August 1, 1996 and November 11,
1996 to Limited License and Supply Agreement dated
as of July 20, 1995 between Embrex and Webster
10.49(2) Agreement dated as of January 22, 1996 between
Embrex and Select
10.50(2) Letter Agreement dated as of January 22, 1996
between Select and Embrex
10.51(2) License dated as of January 22, 1996 granted by
Select to Embrex
10.52(2) Commitment letter accepted June 14, 1995 between
Embrex and Financing for Science International, Inc.
for $2.0 million capital lease financing facility
10.53(2) Stock Purchase Warrant dated June 9, 1995 issued to
Financing for Science International, Inc.
10.54(2) Financing Agreement (Number 10783) dated as of
October 30, 1995 between Lease Management Services,
Inc. and Embrex, and Addendum thereto dated October
30, 1995 attached
10.55(2) License Agreement dated October 30, 1995 between
Embrex and Lease Management Services, Inc.
10.56(2) Sublicense Agreement dated as of October 30, 1995
between Embrex and Lease Management Services, Inc.
10.57(2) Movable Hypothec on Equipment and Contracts dated as
of October 30, 1995 between Embrex and Lease
Management Services, Inc.
10.58(2) Warrant to Purchase 30,000 Shares of Common Stock
dated October 30, 1995 issued to Lease Management
Services, Inc.
10.59(2) Intercreditor Agreement dated as of October 31, 1995
among Financing for Science International, Inc.,
Lease Management Services, Inc., and Embrex.
10.60(4) Embrex Europe Limited Loan Agreement dated April 3,
1996
21 Subsidiaries
47
Exhibits Description
- -------- -----------
23 Consent of Ernst & Young LLP to the inclusion of
their report dated February 20, 1998 with respect to
the consolidated financial statements of the Company
in this Form 10-K and the incorporation by reference
of such report into the Registration Statement on
Form S-3 (No. 333-18231), as filed with the
Securities and Exchange Commission on December 19,
1996, and into the Registration Statements under the
Securities Act of 1933 on Form S-8 (Registration
Nos. 33-51582, 33-63318 and 333-04109), as filed
with the Securities and Exchange Commission on
September 1, 1992, May 25, 1993, and May 20, 1996,
respectively, and to the incorporation by reference
in the Registration Statement on Form S-8
(Registration No. 33-63318) pertaining to the
Employee Stock Purchase Plan of their report dated
March 19, 1998 with respect to the financial
statements of the Embrex, Inc. Employee Stock
Purchase Plan included in this Form 10-K.
24 Powers of Attorney
27.1 Financial Data Schedule to the Company's Form 10-K
for the year ended December 31, 1997.
27.2 Restated Financial Data Schedule to the Company's
Form 10-Q for the quarter ended September 30, 1997
as filed with the Securities and Exchange
Commission on November 10, 1997 due to the change in
the earnings per share calculation as a result of
the adoption of Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" on December
31, 1997.
27.3 Restated Financial Data Schedule to the Company's
Form 10-Q for the quarter ended June 30, 1997 as
filed with the Securities and Exchange Commission
on August 12, 1997, due to the change in the
earnings per share calculation as a result of the
adoption of Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" on
December 31, 1997.
27.4 Restated Financial Data Schedule to the Company's
Form 10-Q for the quarter ended March 31, 1997 as
filed with the Securities and Exchange Commission
on May 7, 1997, due to the change in the
earnings per share calculation as a result of the
adoption of Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" on
December 31, 1997, and to reflect a restatement of
the Company's _____________ for such quarter.
27.5 Restated Financial Data Schedule to the Company's
Form 10-K for the year ended December 31, 1996 as
filed with the Securities and Exchange Commission
on March 31, 1997, due to the change in the
earnings per share calculation as a result of the
adoption of Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" on
December 31, 1997.
27.6 Restated Financial Data Schedule to the Company's
Form 10-Q for the quarter ended September 30, 1996
as filed with the Securities and Exchange Commission
on November 30, 1996, due to the change in the
earnings per share calculation as a result of the
adoption of Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" on December
31, 1997.
27.7 Restated Financial Data Schedule to the Company's
Form 10-Q for the quarter ended June 30, 1996
as filed with the Securities and Exchange Commission
on August 12, 1996, due to the change in the
earnings per share calculation as a result of the
adoption of Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" on December
31, 1997.
27.8 Restated Financial Data Schedule to the Company's
Form 10-Q for the quarter ended March 31, 1996
as filed with the Securities and Exchange Commission
on May 13, 1996, due to the change in the
earnings per share calculation as a result of the
adoption of Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" on December
31, 1997.
99 Risk Factors relating to the Company
- ----------
(1) Exhibit to the Company's Form 10-K as filed with the Securities and
Exchange Commission for fiscal year ending December 31, 1991 and
incorporated herein by reference
(2) Exhibit to the Company's Form 10-K as filed with the Securities and
Exchange Commission for the fiscal year ending December 31, 1995 and
incorporated herein by reference
(3) Exhibit to the Company's Form 10-Q as filed with the Securities and
Exchange Commission for the three months ended June 30, 1996 and
incorporated herein by reference
(4) Exhibit to the Company's Form 10-K as filed with the Securities and
Exchange Commission for fiscal year ending December 31, 1996 and
incorporated herein by reference
(5) Exhibit to the Company's Form 10-Q as filed with the Securities and
Exchange Commission for the three months ended June 30, 1995 and
incorporated herein by reference
(6) Exhibit to the Company's Form 10-Q as filed with the Securities and
Exchange Commission for the three months ended March 31, 1995 and
incorporated herein by reference
(7) Exhibit to the Company's Registration Statement on Form 8-A as filed
with the Securities and Exchange Commission on March 22, 1996 and
incorporated herein by reference
(8) Exhibit to the Company's Registration Statement on Form S-1 as filed
with the Securities and Exchange Commission (Registration No.
33-42482) effective November 7, 1991 and incorporated herein by
reference
(9) Exhibit to the Company's Form 10-K as filed with the Securities and
Exchange Commission for the fiscal year ending December 31, 1992 and
incorporated herein by reference
48
(10) Exhibit to the Company's Form 10-KSB, as amended, as filed with the
Securities and Exchange Commission for the fiscal year ending December
31, 1993 and incorporated herein by reference
(11) Exhibit to the Company's Form 10-K as filed with the Securities and
Exchange Commission for the fiscal year ending December 31, 1994 and
incorporated herein by reference
49