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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-------------
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997
OR
[_] TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-11303
SYNBIOTICS CORPORATION
(Exact name of small business issuer as specified in its charter)
California 95-3737816
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
11011 Via Frontera
San Diego, California 92127
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (619) 451-3771
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [_]
As of October 31, 1997, 8,184,803 shares of Common Stock were outstanding.
Transitional Small Business Disclosure Format: Yes [_] No [X]
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SYNBIOTICS CORPORATION
INDEX
Page
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Part I - Financial Information
Item 1. Financial Statements
Condensed Consolidated Statement of Operations - Three and
nine months ended September 30, 1997 and 1996 2
Condensed Consolidated Balance Sheet - September 30, 1997
and December 31, 1996 3
Condensed Consolidated Statement of Cash Flows - Nine months
ended September 30, 1997 and 1996 4
Notes to Condensed Financial Statements 5
Item 2. Management's Discussion and Analysis or Plan of Operation 9
Part II - Other Information
Item 1. Legal Proceedings 15
Item 2. Changes in Securities 15
Item 3. Defaults Upon Senior Securities 16
Item 4. Submission of Matters to a Vote of Security Holders 16
Item 5. Other Information 16
Item 6. Exhibits and Reports on Form 8-K 16
-1-
PART I. FINANCIAL INFORMATION
------------------------------
Item 1. Financial Statements
--------------------
Synbiotics Corporation
Condensed Consolidated Statement of Operations (unaudited)
- --------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -------------------------
1997 1996 1997 1996
---------- ---------- ----------- -----------
Net sales $6,146,000 $3,747,000 $17,929,000 $14,598,000
Cost of sales 3,387,000 2,285,000 9,648,000 7,620,000
---------- ---------- ----------- -----------
Gross Profit 2,759,000 1,462,000 8,281,000 6,978,000
---------- ---------- ----------- -----------
Operating expenses:
Research and development 541,000 261,000 1,154,000 721,000
Selling and marketing 1,058,000 961,000 3,382,000 3,320,000
General and administrative 774,000 794,000 2,138,000 1,649,000
---------- ---------- ----------- -----------
2,373,000 2,016,000 6,674,000 5,690,000
---------- ---------- ----------- -----------
Income (loss) from operations 386,000 (554,000) 1,607,000 1,288,000
Other income (expense):
License fees and other 79,000 77,000 234,000 307,000
Interest, net (324,000) 77,000 (218,000) 132,000
Gain on sale of securities
available for sale 1,159,000
---------- ---------- ----------- -----------
Income (loss) before income
taxes 141,000 (400,000) 1,623,000 2,886,000
Provision (benefit) for
income taxes 261,000 (5,000) 898,000 113,000
---------- ---------- ----------- -----------
Net income (loss) $ (120,000) $ (395,000) $ 725,000 $ 2,773,000
========== ========== =========== ===========
Net income (loss) per share $ (.02) $ (.07) $ .09 $ .46
========== ========== =========== ===========
Weighted average shares
outstanding 7,790,000 6,000,000 7,759,000 6,013,000
========== ========== =========== ===========
Net income (loss) per share was computed based upon the weighted average
number of shares outstanding, including common stock equivalents.
See accompanying notes to condensed financial statements.
-2-
Item 1. Financial Statements (continued)
--------------------
Synbiotics Corporation
Condensed Consolidated Balance Sheet
- --------------------------------------------------------------------------------
September 30, December 31,
1997 1996
------------- ------------
(unaudited) (audited)
Assets
Current assets:
Cash and equivalents $ 3,032,000 $ 3,050,000
Securities available for sale 3,060,000 2,872,000
Accounts receivable 3,281,000 1,363,000
Inventories 5,592,000 5,213,000
Deferred tax assets 372,000 1,045,000
Other current assets 1,323,000 1,353,000
----------- -----------
Total current assets 16,660,000 14,896,000
Property and equipment, net 914,000 656,000
Goodwill 15,648,000 5,347,000
Deferred tax assets 6,323,000 6,113,000
Other assets 1,480,000 1,555,000
----------- -----------
$41,025,000 $28,567,000
=========== ===========
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable and accrued expenses $ 3,305,000 $ 2,241,000
Current portion of long-term debt 1,000,000
Income taxes payable 276,000
Other current liabilities 650,000
----------- -----------
Total current liabilities 4,581,000 2,891,000
----------- -----------
Long-term debt 7,029,000
----------- -----------
Mandatorily redeemable common stock 2,754,000
----------- -----------
Non-mandatorily redeemable common stock and
other shareholders' equity:
Common stock, no par value, 24,800,000 shares
authorized, 7,426,000 and 7,392,000 shares
issued and outstanding at September 30, 1997
and December 31, 1996, respectively 35,613,000 35,566,000
Common stock warrants 1,003,000
Cumulative translation adjustment (753,000)
Accumulated deficit (9,202,000) (9,890,000)
----------- -----------
Total non-mandatorily redeemable common
stock and other shareholders' equity 26,661,000 25,676,000
----------- -----------
$41,025,000 $28,567,000
=========== ===========
See accompanying notes to condensed financial statements.
-3-
Item 1. Financial Statements (continued)
--------------------
Synbiotics Corporation
Condensed Consolidated Statement of Cash Flows (unaudited)
- --------------------------------------------------------------------------------
Nine Months Ended
September 30,
--------------------------
1997 1996
----------- -----------
Cash flows from operating activities:
Net income $ 725,000 $ 2,773,000
Adjustments to reconcile net income to net cash
provided by (used for) operating activities:
Depreciation and amortization 1,056,000 599,000
Gain on sale of securities available for sale (1,159,000)
Changes in assets and liabilities:
Accounts receivable (1,918,000) (633,000)
Inventories (379,000) (1,658,000)
Deferred taxes 463,000
Other assets (8,175,000) (192,000)
Accounts payable and accrued expenses 1,064,000 514,000
Income taxes payable 276,000
Other liabilities (650,000) (38,000)
----------- -----------
Net cash (used for) provided by operating activities (7,538,000) 206,000
----------- -----------
Cash flows from investing activities:
Acquisition of property and equipment (420,000) (96,000)
Investment in securities available for sale (188,000) (3,940,000)
Proceeds from sale of securities available for sale 4,727,000
----------- -----------
Net cash (used for) provided by investing activities (608,000) 691,000
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of long-term debt, net 10,775,000
Payments of long-term debt (1,743,000)
Proceeds from issuance of common stock, net (151,000) (25,000)
----------- -----------
Net cash provided by (used for) financing activities 8,881,000 (25,000)
----------- -----------
Net increase in cash and equivalents 735,000 872,000
Effect of exchange rate changes on cash (753,000)
Cash and equivalents - beginning of year 3,050,000 1,017,000
----------- -----------
Cash and equivalents - end of period $ 3,032,000 $ 1,889,000
=========== ===========
See accompanying notes to condensed financial statements.
-4-
Item 1. Financial Statements (continued)
--------------------
SYNBIOTICS CORPORATION
Notes to Condensed Consolidated Financial Statements (unaudited)
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Note 1 - Interim Financial Statements:
The accompanying consolidated balance sheet as of September 30, 1997 and the
consolidated statements of operations and of cash flows for the nine month
periods ended September 30, 1997 and 1996 have been prepared by Synbiotics
Corporation (the Company) and have not been audited. These financial
statements, in the opinion of management, include all adjustments (consisting
only of normal recurring accruals) necessary for a fair presentation of the
financial position, results of operations and cash flows for all periods
presented. The financial statements should be read in conjunction with the
financial statements and notes thereto included in the Company's Annual Report
on Form 10-KSB filed for the year ended December 31, 1996. Interim operating
results are not necessarily indicative of operating results for the full year.
Note 2 - Acquisition:
On July 9, 1997 the Company acquired the worldwide veterinary diagnostic
business of Rhone Merieux S.A.S. ("RMD") pursuant to purchase agreements dated
May 14, 1997 and amended July 9, 1997. The consideration paid to Rhone Merieux
was $10,659,000 in cash and 759,000 shares of newly issued, unregistered
Synbiotics common stock valued at $3,178,000 (based upon the closing price of
Synbiotics' Common Stock on July 9, 1997 which was $4.1875 per share) (Note 6).
The shares issued by the Company include 230,000 shares which have been placed
in escrow pending certain U.S. regulatory approvals and subsequent sales of
related products. The cash portion of the consideration was provided by a series
of loans obtained from Banque Paribas (Note 5). Depending on performance of the
combined business in the three years following the acquisition, Synbiotics may
also pay up to $3,600,000 in contingent cash payments. The transaction was
accounted for as a purchase. Goodwill arising from the transaction totalled
$10,604,000 which is being amortized over an estimated useful life of 15 years
utilizing the straight-line method. $3,918,000 of the purchase price is
considered a non-cash financing activity for purposes of the statement of cash
flows.
Rhone Merieux and Synbiotics also entered into related agreements covering the
supply of various products and services, collaborative research and development,
licenses of Rhone Merieux patents, and the distribution of certain of the
acquired products by Rhone Merieux. The collaborative research agreement gives
Synbiotics a right of first refusal to acquire technology or products emanating
from Rhone Merieux's future research efforts that have potential veterinary
diagnostic applications.
The Company's condensed consolidated statement of operations include the results
of operations related to RMD for the period July 9, 1997 to September 30, 1997.
The following are unaudited pro forma results of operations as if the
transaction had been consummated on January 1, 1996:
-5-
Item 1. Financial Statements (continued)
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SYNBIOTICS CORPORATION
Notes to Condensed Financial Statements (unaudited)
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Nine Months Ended
Three Months Ended September 30,
September 30, --------------------------
1996 1997 1996
------------------ ----------- -----------
Net Sales:
As reported $3,747,000 $17,929,000 $14,598,000
========== =========== ===========
Pro forma $4,217,000 $19,339,000 $16,008,000
========== =========== ===========
Net income (loss):
As reported $(395,000) $ 725,000 $ 2,773,000
========== =========== ===========
Pro forma $(370,000) $ 800,000 $ 2,848,000
========== =========== ===========
Net income (loss) per share:
As reported $ (.07) $ .09 $ .46
========== =========== ===========
Pro forma $ (.06) $ .10 $ .45
========== =========== ===========
Note 3 - Securities Available for Sale:
Included in current assets are securities available for sale which consist
primarily of short-term commercial paper and U.S. Government Treasury
securities.
Note 4 - Inventories:
Inventories consist of the following:
September 30, December 31,
1997 1996
------------- ------------
Raw materials $4,391,000 $1,970,000
Work in process 13,000 8,000
Finished goods 1,188,000 3,235,000
---------- ----------
$5,592,000 $5,213,000
========== ==========
-6-
Item 1. Financial Statements (continued)
--------------------
SYNBIOTICS CORPORATION
Notes to Condensed Financial Statements (unaudited)
- --------------------------------------------------------------------------------
Note 5 - Long-Term Debt:
In conjunction with the acquisition of RMD (Note 2), the Company obtained a
series of loans from Banque Paribas as follows: 1) $5,000,000, due May 31, 2002,
bearing interest at the rate of prime plus .75% (effectively 9.25% at September
30, 1997), payable quarterly beginning August 31, 1997 in the amount of $250,000
of principal plus accrued interest, and secured by substantially all of the
Company's assets; and 2) $5,000,000, due May 31, 2003, bearing interest at the
rate of prime plus 1.25% (effectively 9.75% at September 30, 1997), interest
only payable quarterly beginning August 31, 1997, and secured by
substantially all of the Company's assets.
In addition, the Company also obtained a revolving line of credit from Banque
Paribas whereby the Company may borrow up to $5,000,000 as determined by a
borrowing base calculation. The line of credit bears interest at the rate of
prime plus .75% (effectively 9.25% at September 30, 1997), with interest only
payments to be made quarterly beginning August 31, 1997. Any outstanding
principal is due May 31, 2002, although a portion of the outstanding principal
may become due and payable as determined by a monthly borrowing base
calculation. There were no borrowings outstanding under the line of credit at
September 30, 1997.
Principal payments scheduled during the next five years and thereafter are as
follows: 1997- $250,000, 1998 -$1,000,000, 1999 - $1,000,000, 2000 - $1,000,000,
2001 - $1,000,000, 2002 - $500,000, 2003 - $5,000,000.
Note 6 - Mandatorily Redeemable Common Stock:
The 759,000 shares issued in conjunction with the acquisition of RMD (Note 2)
are subject to certain registration rights as well as put and call
provisions. The put option gives Rhone Merieux the right, beginning on July 9,
2001, to sell all or any portion of its shares to the Company at a price of $5
per share. The call option gives the Company the right to acquire, at any time,
all or any portion of the shares then owned by Rhone Merieux at a per share
price of the greater of the average closing sale price of the Company's common
stock for the 30 day period prior to the call or $5. Should the Company
exercise its call option prior to July 9, 2001 at a call option price greater
than $5 per share, the agreement requires the difference between the per share
call option price and $5 to be shared by the Company and Rhone Merieux on a
sliding scale basis. In addition, should Rhone Merieux sell all or any portion
of the shares to a third party prior to July 9, 2001 at a price greater than $5
per share, the agreement requires the difference between the per share sales
price and $5 to be shared by the Company and Rhone Merieux on a sliding scale
basis. The Company has classified the shares on the balance sheet as
mandatorily redeemable and is accreting the value of the shares to the put
option price, using the interest method, with the accretion being charged
directly to retained earnings.
Note 7 - Common Stock Warrants:
In conjunction with the acquisition of RMD (Note 2), the Company issued to
Banque Paribas a warrant to purchase 240,000 unregistered shares of the
Company's common stock at an exercise price of $.01 per share. The warrant is
exercisable at any time through May 31, 2007 and contains certain anti-dilution
provisions and registration rights. The Company has valued the warrant at
$1,003,000 using the Black-Scholes option pricing model with the following
-7-
Item 1. Financial Statements (continued)
--------------------
SYNBIOTICS CORPORATION
Notes to Condensed Financial Statements (unaudited)
- --------------------------------------------------------------------------------
weighted-average assumptions: dividend yield of 0%; expected volatility of
57.8%; risk-free interest rate of 6.52%; and expected life of 10 years.
Note 8 - Earnings per Share:
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share". SFAS
128, which applies to entities with publicly held common stock or potential
common stock, establishes standards for computing and presenting earnings per
share ("EPS"), simplifies the standards for computing EPS previously found in
Accounting Principles Board ("APB") Opinion No. 15 and makes EPS comparable to
international EPS standards. It replaces the presentation of primary EPS with a
presentation of basic EPS. It also requires dual presentation of basic and
diluted EPS on the face of the statement of operations for all entities with
complex capital structures and requires a reconciliation of the numerator and
denominator of the basic EPS computation to the numerator and denominator of the
diluted EPS computation.
Basic EPS excludes dilution and is computed by dividing income available to
common shareholders by the weighted-average number of common shares outstanding
for the period. Diluted EPS reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock or resulted in the issuance of common stock that then shared
in the earnings of the entity. Diluted EPS is computed similarly to fully
diluted EPS pursuant to APB 15.
The following are unaudited pro forma EPS for the three and nine month periods
ended September 30, 1997 and 1996 assuming that SFAS 128 were in effect as of
January 1, 1996:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
1997 1996 1997 1996
----------- ----------- ----------- -----------
(unaudited) (unaudited) (unaudited) (unaudited)
As reported:
Primary EPS $(.02) $(.07) $ .09 $ .46
===== ===== ===== =====
Pro forma:
Basic EPS $(.02) $(.07) $ .09 $ .47
===== ===== ===== =====
Diluted EPS $(.02) $(.07) $ .09 $ .45
===== ===== ===== =====
-8-
Item 2. Management's Discussion and Analysis or Plan of Operation
---------------------------------------------------------
The information contained in this Management's Discussion and Analysis or Plan
of Operation contains both historical financial information and forward-looking
statements. Synbiotics does not provide forecasts of future financial
performance. While management is optimistic about the Company's long-term
prospects, the historical financial information may not be indicative of future
financial performance. In fact, future financial performance may be materially
different than the historical financial information presented herein. Moreover,
the forward-looking statements about future business or future results of
operations are subject to significant uncertainties and risks, which could cause
actual future results to differ materially from what is suggested by the
forward-looking information. The following risk factors should be considered in
evaluating the Company's future financial performance:
Patent Litigation Involving the Company's Canine Heartworm Diagnostic Products
- ------------------------------------------------------------------------------
Barnes-Jewish Hospital of St. Louis (the "Hospital") has filed a lawsuit against
the Company claiming that the Company infringes a patent owned by the Hospital
(see Part II, Item 1) and is seeking unspecified damages. As previously reported
by Synbiotics, the Hospital is the owner of a patent which the Hospital alleges
covers the Company's canine heartworm diagnostic products. The Company is also
the owner of several patents which cover its canine heartworm diagnostic
products. The Company believes that it does not infringe the Hospital's patent,
and also believes that the Hospital's patent is invalid. However, in the event
that the Company were to lose the lawsuit or enter into an unfavorable
settlement agreement, there would be a materially adverse effect on the
Company's financial condition and results of operations. In addition, patent
litigation is likely to be costly and disruptive even if the Company were to
prevail in the litigation.
The Hospital had previously sued IDEXX Laboratories, Inc., the Company's primary
competitor for canine heartworm diagnostics, for patent infringement under the
Hospital's patent; IDEXX's defense involved an assertion that the patent is
invalid. On September 28, 1997, IDEXX announced a settlement of this suit for
$5,500,000 (an undisclosed portion of which represents royalties on prior sales)
and future royalties.
No Assurance that Acquired Businesses Can Be Successfully Combined
- ------------------------------------------------------------------
There can be no assurance that the anticipated benefits of the acquisition of
the veterinary diagnostics business of Rhone Merieux S.A.S. ("RMD") (completed
in July 1997), the 1996 acquisition of the business of International Canine
Genetics, Inc. ("ICG"), or any other future acquisitions (collectively, the
"Acquired Business"') will be realized. Acquisitions of businesses involve
numerous risks, including difficulties in the assimilation of the operations,
technologies and products of the Acquired Business, introduction of different
distribution channels, potentially dilutive issuances of equity and/or increases
in leverage and risk resulting from issuances of debt securities, the need to
establish internally operating functions which had been previously provided pre-
acquisition by a corporate parent, accounting charges, operating companies in
different geographic locations with different cultures, the potential loss of
key employees of the Acquired Business, the diversion of management's attention
from other business concerns and the risks of entering markets in which
Synbiotics has no or limited direct prior experience. In addition, there can be
no assurance that the acquisitions will not have a material adverse effect upon
Synbiotics' business, results of operations or financial condition, particularly
in the quarters immediately following the consummation of the acquisition due to
operational disruptions, unexpected expenses and accounting charges which may be
associated with the integration of the Acquired Business and Synbiotics.
Competition
- -----------
Competition in the animal health care industry is intense. Many competitors,
such as Pfizer Animal Health, Merial Limited (the successor to Rhone Merieux)
and IDEXX Laboratories, have substantially greater financial, manufacturing,
marketing and product research resources than the Company. Large companies in
particular have
-9-
extensive expertise in conducting pre-clinical and clinical testing of new
products and in obtaining the necessary regulatory approvals to market products.
Competition is based on test sensitivity, accuracy and speed; product price; and
similar factors. IDEXX Laboratories requires its distributors not to carry the
products of competitors such as Synbiotics. There can be no assurance that such
competition will not adversely affect Synbiotics' results of operations or
ability to maintain or increase sales and market share.
History of Operating Losses; Accumulated Deficit
- ------------------------------------------------
Although the Company's operations were profitable in the nine month periods
ended September 30, 1997 and 1996 and for the year ended December 31, 1996, the
Company has had a history of losses. Synbiotics has incurred a consolidated
accumulated deficit of $9,202,000 at September 30, 1997, even after the release
in 1996 of a $7,158,000 valuation allowance related to deferred tax assets.
There can be no assurance that Synbiotics can generate sufficient revenue to
sustain profitability.
Reliance on Third Party Manufacturers
- -------------------------------------
Certain of Synbiotics' products (including its ICT Gold(TM) diagnostic kits and
all of its vaccines) are, and certain anticipated new products are expected to
be, manufactured by third parties under the terms of distribution and/or
manufacturing agreements. The ICT Gold(TM) products and feline leukemia virus
vaccine are licensed to Synbiotics by their respective outside manufacturers. In
the event that these third parties are unable (due to operational, licensing,
financial or other reasons) to supply Synbiotics with sufficient finished
products, Synbiotics would suffer significant disruption of its business.
Synbiotics has the right, under certain circumstances, pursuant to the
agreements to use alternate manufacturing sources. In some circumstances,
however, the Company would lack such a right.
If Synbiotics should encounter delays or difficulties in its relationships with
manufacturers, the resulting problems could have a material adverse effect on
Synbiotics.
Sales and Marketing
- -------------------
The Company's product distribution strategy results in a large percentage of
sales being to only a few customers. During the year ended December 31, 1996,
sales to two distributors totalled 37% of the Company's gross revenues. In
addition, RMD's products are presently sold through distributors. There can be
no assurance that Synbiotics will be able to establish an adequate sales and
marketing capability in any or all targeted markets or that it will be
successful in gaining market acceptance of its products. To the extent
Synbiotics enters into distributor arrangements, any revenues received by
Synbiotics will be dependent on the efforts of third parties and there can be no
assurance that such efforts will be successful. IDEXX Laboratories' requirement
that its distributors not carry the products of competitors such as Synbiotics
has induced certain distributors to stop doing business with Synbiotics in order
to carry IDEXX products instead. In addition, Synbiotics' sales of products, on
a private-label basis, toward the over-the-counter market may cause an adverse
reaction among Synbiotics' regular distributor and veterinarian customers.
Attraction of Key Employees
- ---------------------------
The success of Synbiotics is highly dependent, in part, on its ability to retain
highly qualified personnel, including senior management and scientific
personnel. Competition for such personnel is intense and the inability to
retain additional key employees or the loss of one or more current key employees
could adversely affect Synbiotics. Although Synbiotics has been successful in
retaining required personnel to date, there can be no assurance that Synbiotics
will be successful in the future.
-10-
Reliance on New and Recent Products
- -----------------------------------
Synbiotics relies to a significant extent on new and recently developed
products, and expects that it will need to continue to introduce new products to
be successful in the future. There can be no assurance that Synbiotics will
obtain and maintain market acceptance of its products. With respect to future
products, there can be no assurance that such products will meet applicable
regulatory standards, be capable of being produced in commercial quantities at
acceptable cost or be successfully commercialized.
There can be no assurance that new products can be manufactured at a cost or in
quantities necessary to make them commercially viable. If Synbiotics were
unable to produce internally, or to contract for, a sufficient supply of its new
products on acceptable terms, or if it should encounter delays or difficulties
in its relationships with manufacturers, the introduction of new products would
be delayed, which could have a material adverse effect on Synbiotics.
Future Capital Needs; Uncertainty of Additional Funding
- -------------------------------------------------------
The development and commercialization of Synbiotics' products requires
substantial funds. Synbiotics' future capital requirements will depend on many
factors, including cash flow from operations, the need to finance further
acquisitions, if any, continued scientific progress in its products and
development programs, the cost of manufacturing scale-up, the costs involved in
preparing, filing, prosecuting, maintaining and enforcing patent claims, the
cost involved in patent infringement litigation, competing technological and
market developments, and the cost of establishing effective sales and marketing
arrangements. Synbiotics anticipates that its existing, available cash, cash
equivalents and short-term investments will be adequate to satisfy its current
capital requirements and fund its current operations, although any large
acquisition would require additional capital resources. There can be no
assurance that additional financing, if required, will be available on
acceptable terms or at all. If additional funds are raised by issuing equity
securities, further dilution to then existing shareholders may result. Debt
financing would result in increased leverage and risk. In July 1997 the Company
obtained $15,000,000 of debt financing from Banque Paribas, of which $11,493,000
was used in connection with the acquisition of RMD. The $15,000,000 included a
$5,000,000 revolving line of credit. However, draws on the line of credit are
subject to certain requirements and can be used only for certain purposes. If
adequate funds are not available, Synbiotics may be required, among other
things, to delay, scale back or eliminate one or more of its research and
development programs or seek to obtain funds through arrangements with
collaborative partners or others even if the arrangements would require
Synbiotics to relinquish certain rights to certain of its technologies, product
candidates or products that Synbiotics would not otherwise relinquish.
Seasonality
- -----------
Synbiotics has experienced some seasonality in its business, with sales highest
in December to April, the time period in which distributors purchase canine
heartworm diagnostic products to sell to veterinarians for the heartworm season.
There can be no assurance that such seasonality will not have a material adverse
impact on Synbiotics' operations.
Patents and Proprietary Technology
- ----------------------------------
Synbiotics generally has sought and will continue to seek to protect its
interests by treating its particular variations in the production of monoclonal
antibodies as trade secrets. Synbiotics also has pursued and intends to
continue aggressively to pursue protection for new products, new methodological
concepts, and compositions of matter through the use of patents and trademarks
where obtainable. At present, Synbiotics has been granted eleven U.S. patents.
There can be no assurance that Synbiotics will be issued any additional patents
or that, if any patents are issued, they will provide Synbiotics with
significant protection or will not be challenged. Even if such patents are
enforceable, Synbiotics anticipates that any attempt to enforce its patents
would be time consuming and costly. Moreover, the
-11-
laws of some foreign countries do not protect Synbiotics' proprietary rights in
its products to the same extent as do the laws of the United States.
The patent positions of biotechnology companies, including Synbiotics, are
uncertain and involve complex legal and factual issues. Additionally, the
coverage claimed in a patent application can be significantly reduced before the
patent is issued. As a consequence, there can be no assurance that any of
Synbiotics' future patent applications will result in the issuance of patents
or, if any patents issue, that they will provide significant proprietary
protection or will not be circumvented or invalidated. Because patent
applications in the United States are maintained in secrecy until patents issue
and publication of discoveries in the scientific or patent literature often lag
behind actual discoveries, Synbiotics cannot be certain that it was the first
inventor of inventions covered by its pending patent applications or that it was
the first to file patent applications for such inventions. Moreover, Synbiotics
may have to participate in interference proceedings declared by the U.S. Patent
and Trademark Office to determine priority of invention that could result in
substantial cost to Synbiotics, even if the eventual outcome is favorable to
Synbiotics. There can be no assurance that Synbiotics' patents would be held
valid by a court of competent jurisdiction. An adverse outcome of any patent
litigation could subject Synbiotics to significant liabilities to third parties,
require disputed rights to be licensed from or to third parties or require
Synbiotics to cease using the technology in dispute. A patentholder has filed a
lawsuit asserting that the Company's key canine heartworm diagnostic tests
infringe its patent (see Part II, Item 1).
There can be no assurance that such patentholder or other third parties will not
assert other infringement claims against Synbiotics in the future or that any
such assertions will not result in costly litigation or require Synbiotics to
obtain a license to intellectual property rights of such parties. There can be
no assurance that any such licenses would be available on terms acceptable to
Synbiotics, if at all. Furthermore, parties making such claims may be able to
obtain injunctive or other equitable relief that could effectively block
Synbiotics' ability to further develop, or commercialize, its products in the
United States and abroad. Such claims could result in the award of substantial
damages. Defense of any lawsuit or failure to obtain any such license could have
a material adverse effect on Synbiotics. Finally, litigation, regardless of
outcome, could result in substantial cost to, and a diversion of efforts by,
Synbiotics.
Government Regulation
- ---------------------
Synbiotics' business is subject to substantial regulation by the United States
government. See "Business--Government Regulation" in the Company's Annual
Report on Form 10-KSB for the year ended December 31, 1996, which is hereby
incorporated by reference. In addition, Synbiotics' operations may be subject
to future legislation and/or rules issued by domestic or foreign governmental
agencies with regulatory authority relating to Synbiotics' business. There can
be no assurance that Synbiotics will be found in compliance with any of the
various regulations to which it is subject.
For marketing outside the United States, Synbiotics will be subject to foreign
regulatory requirements in such foreign jurisdictions, which vary widely from
country to country. There can be no assurance that Synbiotics will meet and
sustain compliance with any such requirements.
Product Liability and Insurance
- -------------------------------
The design, development and manufacture of Synbiotics' products involve an
inherent risk of product liability claims and associated adverse publicity.
Synbiotics has obtained liability insurance for potential product liability
associated with the commercial sale of its products. There can be no assurance,
however, that Synbiotics will be able to obtain or maintain such insurance.
Although Synbiotics currently maintains general liability insurance, there can
be no assurance that the coverage limits of Synbiotics' insurance policies will
be adequate. Product liability insurance is expensive, difficult to obtain and
may not be available in the future on acceptable terms or at all. A successful
claim
-12-
brought against Synbiotics in excess of Synbiotics' insurance coverage could
have a material adverse effect upon Synbiotics.
Hazardous Materials
- -------------------
Synbiotics' research and development involves the controlled use of hazardous
materials, chemicals and various radioactive compounds. Although Synbiotics
believes that its safety procedures for handling and disposing of such materials
comply with the standards prescribed by local state and federal regulations, the
risk of accidental contamination or injury from these materials cannot be
completely eliminated. In the event of such an accident, Synbiotics could be
held liable for any damages that result and any such liability could exceed the
resources of Synbiotics. Synbiotics may incur substantial costs to comply with
environmental regulations.
Results of Operations
Net sales for the third quarter of 1997 increased by $2,399,000 or 64% over the
quarter ended September 30, 1996, and increased for the nine months ended
September 30, 1997 by $3,331,000 or 23% over the nine months ended September
1996. The increase in net sales during the third quarter of 1997 is primarily
due to $2,029,000 in sales of diagnostic products acquired in conjunction with
the acquisition of RMD in July 1997 and $292,000 in sales of the canine breeding
diagnostic products acquired from ICG in October 1996. In addition, the sales
of non-RMD and non-ICG diagnostic products increased 12% during the third
quarter of 1997, offset by a 7% decrease in sales of vaccine products. The
decrease in the vaccine sales is due to decreased sales of bulk feline leukemia
vaccine (related to the timing of shipments as requested by OEM customers),
offset by an increase in sales of vaccines to private label partners. The
increase in product sales during the nine months ended September 30, 1997 is
primarily due to $2,029,000 in sales of diagnostic products acquired in
conjunction with the acquisition of RMD in July 1997 and $942,000 in sales of
the canine breeding diagnostic products acquired from ICG in October 1996.
The cost of sales as a percentage of product revenue decreased to 55% during the
third quarter of 1997 compared to 61% for the quarter ended September 30, 1996.
The decrease is due to the fact that the RMD sales in the 1997 period had a 76%
gross margin. The high gross margin is a direct result of the products being
manufactured by RMD rather than by third party manufacturers. In comparison, the
Company's sales, exclusive of the RMD sales, in the 1997 period had a 33% gross
margin. The reduced margin on non-RMD sales is due to the fact that a larger
percentage of product sales during 1997 were generated from products which are
manufactured for the Company by third parties. The Company's manufacturing costs
are predominantly fixed costs. Among the Company's major products, DiroCHEK(R)
canine heartworm diagnostic products are manufactured at Company facilities,
whereas ICT GOLD(TM) HW and all vaccines are manufactured by third parties. In
addition to affecting gross margins, this shift in product mix renders the
Company relatively more dependent on the third-party manufacturers. Vaccines
(other than feline leukemia virus vaccine) have particularly been a drain on
profitability. The cost of sales as a percentage of product revenue increased to
54% for the nine months ended September 30, 1997 compared to 52% for the nine
months ended September 30, 1996. The increase is primarily due to factors
similar to those discussed in the quarterly comparison, but with the
approximately three months of RMD sales having a relatively smaller beneficial
impact. Gross margin during the nine months ended September 30, 1997 was also
affected by a decrease in the average selling prices for the Company's canine
heartworm products during the first six months of 1997 due to severe price
competition from IDEXX Laboratories, the Company's main diagnostic competitor,
as well as a decrease in average selling prices for certain potentially short-
dated vaccines during the first quarter of 1997.
Research and development expenses during the third quarter of 1997 increased by
$280,000 or 107% over the quarter ended September 30, 1996, and increased during
the nine months ended September 30, 1997 by $433,000 or 60% over the nine months
ended September 30, 1996. The increases are primarily due to the acquisition of
RMD, which has its own research and development group, as well as increased
contracted research and development expenses and legal expenses related to
patent filings. Research and development expenses as a percentage of net sales
were 9%
-13-
and 7% during the quarter ended September 30, 1997 and 1996, respectively, and
were 6% and 5% during the nine months ended 30, 1997 and 1996, respectively.
Selling and marketing expenses during the third quarter of 1997 increased by
$97,000 or 10% over the quarter ended September 30, 1996, and remained
relatively unchanged during the nine months ended September 30, 1997 as compared
to the nine months ended September 30, 1996. The increase during the third
quarter is due primarily to the acquisition of RMD, which has its own sales and
marketing group. Selling and marketing expenses as a percentage of net sales
were 17% and 26% during the quarter ended September 30, 1997 and 1996,
respectively, and were 19% and 23% during the nine months ended September 30,
1997 and 1996, respectively.
General and administrative expenses during the third quarter of 1997 remained
relatively unchanged during the third quarter of 1997 as compared to the quarter
ended September 30, 1996 due to the non-recurrence of exit compensation related
to the retirement of the Company's previous President on July 31, 1996, offset
by goodwill amortization related to the acquisitions of ICG and RMD. General and
administrative expenses increased during the nine months ended September 30,
1997 by $489,000 or 30% over the nine months ended September 30, 1996. The
increase during the nine months ended September 30, 1997 are due primarily to
amortization of goodwill and additional payroll costs related to the acquisition
of both RMD and the operations of ICG. General and administrative expenses as a
percentage of net sales were 13% and 21% during the quarter ended September 30,
1997 and 1996, respectively, and were 12% and 11% during the nine months ended
September 30, 1997 and 1996, respectively.
Other income (expense) during the third quarter of 1997 decreased $399,000 from
the third quarter of 1996 due primarily to interest expense related to the debt
incurred in conjunction with the acquisition of RMD. Other income (expense)
during the nine months ended September 30, 1997 decreased $423,000 from the nine
months ended September 30, 1996. The decrease was due to the interest related to
the debt incurred in conjunction with the acquisition of RMD, as well as the
non-recurrence of license fees received in conjunction with an exclusive
distribution agreement with Daiichi Pharmaceutical Co., Ltd. for the
distribution of the Company's vaccine and diagnostic products in Japan. The
Daiichi arrangement is not expected to generate significant product sales
revenues until 1998 at the earliest. The increased interest expense was
partially offset by an increase in interest revenue due to an increased level of
invested cash resulting from the sale of the Company's investment in Texas
Biotechnology Corporation ("TBC") in the first and second quarters of 1996. The
total proceeds received from the sale were $4,727,000. Sales of TBC stock
resulted in a $1,159,000 gain during the nine months ended September 30, 1996.
The provision for income taxes during the nine months ended September 30, 1997
increased by $785,000 or 695% over the nine months ended September 30, 1996. The
income tax provision for 1997 includes $411,000 in foreign income taxes
resulting from the RMD operations. The combined Federal and state effective tax
rate was 51% during the nine months ended September 30, 1997 as compared to 4%
during the nine months ended September 30, 1996. The income tax provision during
the nine months ended September 30, 1997, in addition to the foreign income
taxes, comprises a current income tax provision of $21,000 and a deferred income
tax provision of $466,000. The income tax provision during the nine months ended
September 30, 1997 comprises only a current income tax provision of $113,000.
The current provision for income taxes during the nine months ended September
30, 1997 and 1996 arose from alternative minimum taxes due to the utilization of
net operating loss carryforwards. The increase in the deferred provision for
income taxes is due to the fact that as of September 30, 1996 the Company
provided a deferred tax asset valuation allowance for deferred tax assets which
management determined were "more likely than not" to be unrealizable based on
recent trends in operating results. At the end of 1996, the Company released the
valuation allowance related to its deferred tax assets based on management's
assessment that it was "more likely than not" that the Company would realize
those assets in future periods due to improvements in the Company's operating
results. As a result, $466,000 (representing the tax effect of the change in the
carrying amount of the deferred tax assets) was included in the 1997 statement
of operations because, unlike in 1996, there was no longer any valuation
allowance left to release it from. The deferred tax provision reduces the
Company's deferred tax assets, but the amount of the deferred tax provision does
not actually have to be paid to the Government.
-14-
Because RMD is such a large part of the post-acquisition Company, and because of
the significant amount of long-term debt the Company incurred in connection with
the acquisition, historical results of operations will not necessarily be fairly
comparable to results of operations in the near-term future.
Financial Condition
Management believes that the Company's present capital resources, which included
working capital of $12,079,000 at September 30, 1997, are sufficient to meet its
current working capital needs and service the debt related to the acquisition of
RMD.
The Company's operations have become seasonal due to the success of its canine
heartworm diagnostic products. Sales and profits tend to be concentrated in the
December to April time period, as distributors prepare for the heartworm season
by purchasing diagnostic products for resale to veterinarians. This seasonality
may be somewhat reduced by the acquisition of RMD, which is relatively less
seasonal.
PART II. OTHER INFORMATION
---------------------------
Item 1. Legal Proceedings
-----------------
Barnes-Jewish Hospital v. Synbiotics Corporation - United States District Court
- -------------------------------------------------------------------------------
for the Eastern District of Missouri, Eastern Division
- ------------------------------------------------------
As previously reported by Synbiotics, Barnes-Jewish Hospital of St. Louis (the
"Hospital") is the owner of a patent which the Hospital alleges covers the
Company's canine heartworm diagnostic products. The Company is also the owner of
several patents which cover its canine heartworm diagnostic products. The
Company believes that it does not infringe the Hospital's patent, and also
believes that the Hospital's patent is invalid. On September 29, 1997, the
Hospital sued the Company in the United States District Court for the Eastern
District of Missouri for patent infringement, seeking unspecified damages.
The Company has also brought an action, seeking a declaratory judgment that the
Company does not infringe the Hospital's patent and/or that the Hospital's
patent is invalid, against the Hospital in the United States District Court for
the Southern District of California.
The Hospital had previously sued IDEXX Laboratories, Inc., the Company's primary
competitor for canine heartworm diagnostics, for patent infringement under the
Hospital's patent; IDEXX's defense involved an assertion that the patent is
invalid. IDEXX announced a settlement of this suit on September 28, 1997.
Item 2. Changes in Securities
---------------------
On July 9, 1997, the Company issued 759,018 shares of newly issued unregistered
Synbiotics common stock to Rhone Merieux S.A.S. as partial consideration for the
acquisition of RMD. In conjunction with the acquisition of RMD, the Company
issued to Banque Paribas, from whom the Company obtained a series of loans to
finance the cash portion of the RMD acquisition, a warrant to purchase 239,950
shares of unregistered Synbiotics common stock at an exercise price of $.01 per
share. The shares of common stock issued or issuable in conjunction with both of
these transactions were exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933.
-15-
Item 3. Defaults Upon Senior Securities
-------------------------------
None.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
The Annual Meeting of Shareholders was held on July 24, 1997. The following
matters were submitted to a vote, with the results indicated below:
(a) Election of directors:
Broker
Nominee For Against Abstain Withheld Non-votes
------- --------- ------- ------- -------- ---------
Patrick Owen Burns 6,163,432 n/a n/a 376,003 0
Kenneth M. Cohen 6,164,632 n/a n/a 374,803 0
James C. DeCesare 6,164,532 n/a n/a 374,903 0
Brenda D. Gavin, DVM 6,161,182 n/a n/a 378,253 0
M. Blake Ingle, Ph.D. 6,164,082 n/a n/a 375,353 0
Donald E. Phillips 6,164,182 n/a n/a 375,253 0
(b) Approval of the amendment of the Company's 1995 Stock Option/Stock
Issuance Plan:
For: 3,320,312 Against: 854,081 Abstain: 94,740
Item 5. Other Information
-----------------
None.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
-------
2.4 Asset Purchase Agreement between Rhone Merieux, Inc. and the
Registrant, dated May 14, 1997./(1)/
2.4.1 Amendment No. 1 to Asset Purchase Agreement between Rhone
Merieux, Inc. and the Registrant, dated July 9, 1997/(2)/.
2.4.2 Amendment No. 2 to Asset Purchase Agreement between Rhone
Merieux, Inc. and the Registrant, dated July 9, 1997/(3)/.
2.5 Stock Purchase Agreement between Rhone Merieux S.A., Institut
De Selection Animale S.A., Rhone Merieux Diagnostics S.A.S.
and the Registrant, dated May 14, 1997./(4)/
-16-
2.5.1 Amendment No. 1 to Stock Purchase Agreement between Rhone
Merieux S.A.S., Institut De Selection Animale S.A., R.M. -
Diagnostics S.A.S. and the Registrant, dated July 9,
1997/(5)/.
2.5.2 Amendment No. 2 to Stock Purchase Agreement between Rhone
Merieux S.A.S., Institut De Selection Animale S.A., R.M. -
Diagnostics S.A.S. and the Registrant, dated July 9,
1997/(6)/.
10.64 Credit Agreement among the Registrant, the Banks Named Herein
and Banque Paribas as Agent, dated as of July 9, 1997/(7)/.
10.65 Stock Restriction and Rights Agreement between the Registrant
and Rhone Merieux S.A.S., dated as of July 9, 1997.
10.66 Warrant Agreement between the Registrant and Banque Paribas,
dated as of July 9, 1997.
11.1 Computation of Earnings Per Share.
27 Financial Data Schedule (for electronic filing purposes only).
------------
(1) Incorporated herein by reference to Exhibit 2.4 to the
Registrant's Current Report on Form 8-K dated July 9, 1997.
(2) Incorporated herein by reference to Exhibit 2.4.1 to the
Registrant's Current Report on Form 8-K/A dated July 9, 1997.
(3) Incorporated herein by reference to Exhibit 2.4.2 to the
Registrant's Current Report on Form 8-K/A dated July 9, 1997.
(4) Incorporated herein by reference to Exhibit 2.5 to the
Registrant's Current Report on Form 8-K dated July 9, 1997.
(5) Incorporated herein by reference to Exhibit 2.5.1 to the
Registrant's Current Report on Form 8-K/A dated July 9, 1997.
(6) Incorporated herein by reference to Exhibit 2.5.2 to the
Registrant's Current Report on Form 8-K/A dated July 9, 1997.
(7) Incorporated herein by reference to Exhibit 10.64 to the
Registrant's Current Report on Form 8-K dated July 9, 1997.
(b) Reports on Form 8-K
-------------------
The Company filed a report on Form 8-K dated July 9, 1997 reflecting
the acquisition of the worldwide veterinary diagnostic business of
Rhone Merieux S.A.S. pursuant to purchase agreements dated May 14,
1997 and amended July 9, 1997. The report on Form 8-K was subsequently
amended.
-17-
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
SYNBIOTICS CORPORATION
Date: November 14, 1997 /s/ Michael K. Green
-------------------------------
Michael K. Green
Vice President of Finance and
Chief Financial Officer
(signing both as a duly authorized
officer and as principal financial
officer)
-18-
EXHIBIT INDEX
Exhibit No. Exhibit
- ----------- -------
2.4 Asset Purchase Agreement between Rhone Merieux, Inc. and the
Registrant, dated May 14, 1997./(1)/
2.4.1 Amendment No. 1 to Asset Purchase Agreement between Rhone Merieux,
Inc. and the Registrant, dated July 9, 1997/(2)/.
2.4.2 Amendment No. 2 to Asset Purchase Agreement between Rhone Merieux,
Inc. and the Registrant, dated July 9, 1997/(3)/.
2.5 Stock Purchase Agreement between Rhone Merieux S.A., Institut De
Selection Animale S.A., Rhone Merieux Diagnostics S.A.S. and the
Registrant, dated May 14, 1997./(4)/
2.5.1 Amendment No. 1 to Stock Purchase Agreement between Rhone Merieux
S.A.S., Institut De Selection Animale S.A., R.M. - Diagnostics
S.A.S. and the Registrant, dated July 9, 1997/(5)/.
2.5.2 Amendment No. 2 to Stock Purchase Agreement between Rhone Merieux
S.A.S., Institut De Selection Animale S.A., R.M. - Diagnostics
S.A.S. and the Registrant, dated July 9, 1997/(6)/.
10.64 Credit Agreement among the Registrant, the Banks Named Herein and
Banque Paribas as Agent, dated as of July 9, 1997/(7)/.
10.65 Stock Restriction and Rights Agreement between the Registrant and
Rhone Merieux S.A.S., dated as of July 9, 1997.
10.66 Warrant Agreement between the Registrant and Banque Paribas, dated
as of July 9, 1997.
11.1 Computation of Earnings Per Share.
27 Financial Data Schedule (for electronic filing purposes only).
------------
(1) Incorporated herein by reference to Exhibit 2.4 to the
Registrant's Current Report on Form 8-K dated July 9, 1997.
(2) Incorporated herein by reference to Exhibit 2.4.1 to the
Registrant's Current Report on Form 8-K/A dated July 9, 1997.
(3) Incorporated herein by reference to Exhibit 2.4.2 to the
Registrant's Current Report on Form 8-K/A dated July 9, 1997.
(4) Incorporated herein by reference to Exhibit 2.5 to the
Registrant's Current Report on Form 8-K dated July 9, 1997.
(5) Incorporated herein by reference to Exhibit 2.5.1 to the
Registrant's Current Report on Form 8-K/A dated July 9, 1997.
(6) Incorporated herein by reference to Exhibit 2.5.2 to the
Registrant's Current Report on Form 8-K/A dated July 9, 1997.
(7) Incorporated herein by reference to Exhibit 10.64 to the
Registrant's Current Report on Form 8-K dated July 9, 1997.