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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
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 April 30, 1998, 8,644,311 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. Condensed Consolidated Statement of Operations and Comprehensive
Income - Three months ended March 31, 1998 and 1997............. 3
Condensed Consolidated Balance Sheet -
March 31, 1998 and December 31, 1997............................ 4
Condensed Consolidated Statement of Cash Flows -
Three months ended March 31, 1998 and 1997...................... 5
Notes to Condensed Consolidated Financial Statements.............. 6
Management's Discussion and Analysis or Plan of Operation......... 8
Part II. Other Information................................................. 14
-2-
Item 1. Financial Statements (continued)
--------------------
Synbiotics Corporation
Condensed Consolidated Statement of Operations and Comprehensive Income
- -----------------------------------------------------------------------
(unaudited)
- -----------
Three Months Ended
March 31,
-----------------------
1998 1997
---------- ----------
Net sales $8,801,000 $6,940,000
Cost of sales 4,046,000 3,382,000
---------- ----------
Gross Profit 4,755,000 3,558,000
---------- ----------
Operating expenses:
Research and development 521,000 307,000
Selling and marketing 1,591,000 1,300,000
General and administrative 1,239,000 664,000
---------- ----------
3,351,000 2,271,000
---------- ----------
Income from operations 1,404,000 1,287,000
Other income (expense):
License fees and other 74,000 79,000
Interest, net (258,000) 60,000
---------- ----------
Income before income taxes 1,220,000 1,426,000
Provision for income taxes 530,000 596,000
---------- ----------
Net income 690,000 830,000
Cumulative translation adjustment (247,000)
---------- ----------
Comprehensive income $ 443,000 $ 830,000
========== ==========
Basic net income per share $ .08 $ .11
========== ==========
Diluted net income per share $ .07 $ .11
========== ==========
See accompanying notes to condensed consolidated financial statements.
-3-
Item 1. Financial Statements (continued)
--------------------
Synbiotics Corporation
Condensed Consolidated Balance Sheet
- -------------------------------------------------------------------------------
March 31, December 31,
1998 1997
------------ -------------
(unaudited) (audited)
Assets
Current assets:
Cash and equivalents $ 3,084,000 $ 2,190,000
Securities available for sale 2,980,000 3,394,000
Accounts receivable 5,852,000 4,396,000
Inventories 4,549,000 5,187,000
Deferred tax assets 321,000 303,000
Other current assets 512,000 359,000
----------- -----------
Total current assets 17,298,000 15,829,000
Property and equipment, net 1,244,000 1,102,000
Goodwill 14,532,000 11,542,000
Deferred tax assets 5,905,000 6,417,000
Deferred debt issuance costs 819,000 905,000
Other assets 5,568,000 5,832,000
----------- -----------
$45,366,000 $41,627,000
=========== ===========
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable and accrued expenses $ 4,651,000 $ 3,546,000
Current portion of long-term debt 2,000,000 1,000,000
Income taxes payable 48,000 25,000
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Total current liabilities 6,699,000 4,571,000
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Long-term debt 7,306,000 7,543,000
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Mandatorily redeemable common stock 2,774,000 2,756,000
----------- -----------
Non-mandatorily redeemable common stock
and other shareholders' equity:
Common stock, no par value, 24,800,000 shares
authorized, 8,643,000 and 7,426,000 shares
issued and outstanding at March 31, 1998 and
December 31, 1997 37,082,000 35,659,000
Common stock warrants 1,003,000 1,003,000
Accumulated other comprehensive income (398,000) (151,000)
Accumulated deficit (9,100,000) (9,754,000)
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Total non-mandatorily redeemable common
stock and other shareholders' equity 28,587,000 26,757,000
----------- -----------
$45,366,000 $41,627,000
=========== ===========
See accompanying notes to condensed consolidated financial statements.
-4-
Item 1. Financial Statements (continued)
--------------------
Synbiotics Corporation
Condensed Consolidated Statement of Cash Flows (unaudited)
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
-------------------------
1998 1997
----------- -----------
Cash flows from operating activities:
Net income $ 690,000 $ 830,000
Adjustments to reconcile net income to net cash
used for operating activities:
Depreciation and amortization 534,000 264,000
Changes in assets and liabilities:
Accounts receivable (1,454,000) (3,566,000)
Inventories 638,000 490,000
Deferred taxes 493,000 554,000
Other assets (149,000) 273,000
Accounts payable and accrued expenses 496,000 (44,000)
Income taxes payable 23,000
Other liabilities (650,000)
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Net cash provided by (used for) operating activities 1,271,000 (1,849,000)
----------- -----------
Cash flows from investing activities:
Acquisition of property and equipment (212,000) (68,000)
Proceeds from sale of securities available for sale 414,000 658,000
Acquisition of Prisma Acquisition Corp. (1,000,000)
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Net cash (used for) provided by investing activities (798,000) 590,000
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of long-term debt 1,000,000
Payments of long-term debt (250,000)
Mandatorily redeemable common stock issuance costs (16,000)
Proceeds from issuance of common stock, net (66,000) (40,000)
----------- -----------
Net cash provided by (used for) financing activities 668,000 (40,000)
----------- -----------
Net increase (decrease) in cash and equivalents 1,141,000 (1,299,000)
Effect of exchange rates on cash (247,000)
Cash and equivalents - beginning 2,190,000 3,050,000
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Cash and equivalents - end of period $ 3,084,000 $ 1,751,000
=========== ===========
See accompanying notes to condensed consolidated financial statements.
-5-
Item 1. Financial Statements (continued)
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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 March 31, 1998 and the
consolidated statements of operations and comprehensive income and of cash flows
for the three month periods ended March 31, 1998 and 1997 have been prepared by
Synbiotics Corporation (the "Company") and have not been audited. The
consolidated financial statements of the Company include the accounts of its
wholly-owned subsidiary Synbiotics Europe SAS. All significant intercompany
transactions and accounts have been eliminated in consolidation. 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, 1997. Interim operating
results are not necessarily indicative of operating results for the full year.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Note 2 - Acquisition:
On March 6, 1998 the Company acquired by merger Prisma Acquisition Corp.
("Prisma"), a privately-held company located in Rome, NY, which develops,
manufactures and markets instruments and reagents used by veterinarians to
measure blood chemistry information at the point-of-care. The consideration
paid to the stockholders of Prisma was a $1,000,000 convertible note, 458,000
newly issued, unregistered shares of the Company's common stock valued at
$1,490,000 (based on the average closing price of Synbiotics' common stock for
the thirty trading days prior to March 6, 1998, which was $3.25) and the
issuance of options to purchase 157,000 shares of the Company's common stock for
$.0016 per share in replacement of Prisma's outstanding stock options. The
157,000 stock options were valued at $609,000 using the Black-Scholes option
pricing model.
The convertible note (which was issued to only one of the Prisma stockholders)
is due March 5, 1999, bears interest at the rate of 5% per year and is
unsecured. The note is convertible at any time, at the option of the Company,
into a number of unregistered shares of the Company's common stock equal to the
outstanding principal and accrued interest divided by the average closing price
of the Company's common stock for the thirty trading days immediately prior to
the conversion. The note is subordinate to the Company's notes payable to
Banque Paribas, which were issued in conjunction with the July 1997 acquisition
of the veterinary diagnostics business of Rhone-Merieux, S.A.S.
The transaction was accounted for as a purchase. Goodwill arising from the
transaction totalled $3,336,000 which is being amortized over an estimated
useful life of 15 years utilizing the straight-line method. $2,347,000,
representing the common stock and common stock option portion of the of the
purchase price and liabilities assumed, is considered a non-cash financing
activity for purposes of the statement of cash flows.
-6-
Item 1.Financial Statements (continued)
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SYNBIOTICS CORPORATION
Notes to Condensed Consolidated Financial Statements (unaudited)
- --------------------------------------------------------------------------------
Note 3 - Inventories:
Inventories consist of the following:
March 31, December 31,
1998 1997
---------- ------------
Raw materials $2,743,000 $2,639,000
Work in process 839,000 1,235,000
Finished goods 967,000 1,313,000
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$4,549,000 $5,187,000
========== ==========
Note 4 - Earnings per Share:
The following is a reconciliation of net income and share amounts used in the
computations of earnings per share:
Three Months Ended March 31,
1998 1997
---- ----
(unaudited) (unaudited)
Net income used:
Net income $690,000 $830,000
Less accretion of mandatorily redeemable
common stock (36,000)
---------- ----------
Net income used in computing basic net income
per share 654,000 830,000
Add interest upon assumed conversion of debt 2,000
---------- ----------
Net income used in computing diluted net income
per share $656,000 $830,000
========== ==========
Shares used:
Weighted average common shares outstanding used
in computing basic net income per share 8,414,000 7,392,000
Weighted average options and warrants to purchase
common stock as determined by application of the
treasury method 444,000 269,000
Weighted average shares of common stock issued
upon assumed conversion of debt 321,000
---------- ----------
Shares used in computing diluted net income
per share 9,179,000 7,661,000
========== ==========
-7-
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 and elsewhere in this Annual Report on Form 10-KSB 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
forward-looking statements:
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
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 1998 acquisition
of Prisma, the 1997 acquisition of the veterinary diagnostics business of SBIO-
E, the 1996 acquisition of the business of 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, as well as
operating and development expenses inherent in the Acquired Business itself as
opposed to integration of the Acquired Business.
-8-
Competition
- -----------
Competition in the animal health care industry is intense. Many competitors,
such as Pfizer Animal Health, Merial Animal Health (the successor to Rhone
Merieux), Schering-Plough and IDEXX Laboratories, have substantially greater
financial, manufacturing, marketing and product research resources than the
Company. Large companies in particular have 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 for the years ended December
31, 1997 and 1996, the Company has had a history of losses. Synbiotics has
incurred a consolidated accumulated deficit of $9,100,000 at March 31, 1998,
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), VetRED(R) and
WITNESS(R) 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), VetRED(R) and
WITNESS(R) 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. In fact, a majority of the Company's vaccine products (exclusive of
its feline leukemia vaccine products) are manufactured using bulk antigen fluids
that have been supplied by a third party. The supply agreement has expired and
the Company is currently seeking a replacement supplier for these fluids. The
Company believes it has adequate levels of these bulk fluids to meet its
manufacturing requirements through the third quarter of 1998. In the event that
the Company is unable to locate a replacement supplier, sales of the Company's
private label vaccine products, beginning in the fourth quarter of 1998, will be
materially adversely affected.
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, 1997,
sales to two distributors totalled 40% of the Company's net sales. In addition,
SBIO-E's small animal products are presently sold through distributors, while
its large animal products are sold directly to laboratories. 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.
-9-
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.
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
SBIO-E. 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. Additionally, Banque Paribas requires the
Company to maintain certain financial ratios and levels of tangible net worth
and also restricts the Company's ability to pay dividends and make loans,
capital expenditures or investments without the Bank's consent.
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.
-10-
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.
This seasonality may be somewhat reduced by the acquisition of SBIO-E, which is
relatively less seasonal. 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 where
obtainable. At present, Synbiotics has been granted eleven U.S. patents and has
three U.S. patents pending.
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 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 above).
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 Item 1 - Business--Government Regulation of the Company's Annual
Report on Form 10-KSB for the year ended December 31, 1997,
-11-
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 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 first quarter of 1998 increased by $1,861,000 or 27% over the
first quarter of 1997. The increase in net sales is primarily due to $2,321,000
in sales of diagnostic products acquired in conjunction with the July 1997
acquisition of SBIO-E. However, the sales of non-SBIO-E diagnostic products
decreased 6% during the first quarter of 1998 due to a decrease in canine
heartworm diagnostics sales of 12%, offset by an increase in feline diagnostics
sales of 69%. The decreased canine heartworm diagnostics sales were due to the
non-recurrence of distributor promotional programs which were in place during
the first quarter of 1997, although this factor was somewhat offset by a general
price increase in January 1998. Rather than utilizing promotional programs to
provide incentive for distributors to buy in anticipation of the heartworm
season, the Company has implemented an incentive program based on the growth of
annual distributor sales. One object of this incentive program, in addition to
growing the Company's sales to its distributors, is to reduce the seasonality of
the sales of its heartworm products. The increase in feline diagnostic sales was
due to the introduction of the Company's feline heartworm diagnostic test and
WITNESS(R) feline leukemia diagnostic test. Sales of vaccine products during the
first quarter of 1998 decreased $147,000 or 8% as compared to the first quarter
of 1997. The decreased vaccine sales comprises an increase of 44% in sales of
vaccines to private label partners during the first quarter of 1998, offset by a
30% decrease in other vaccine sales due to decreased sales of bulk feline
leukemia vaccine (related to the timing of shipments as requested by OEM
customers), and the phase-out of sales of most Synbiotics-label vaccines. Sales
of vaccines have been negatively impacted by severe competition from Pfizer,
Fort Dodge and Solvay who manufacture their own vaccine products, whereas the
Company's vaccines are all manufactured by third parties. During the fourth
quarter of 1997, the Company stopped selling its vaccines (except for its feline
leukemia vaccines) to distributors and focused its efforts on selling vaccines
to private label partners for resale to the over-the-counter market and through
catalogs.
-12-
A majority of the Company's vaccine products (exclusive of its feline leukemia
vaccine products) are manufactured using bulk antigen fluids that have been
supplied by a third party. The supply agreement has expired and the
Company is currently seeking a replacement supplier for these fluids. The
Company believes it has adequate levels of these bulk fluids to meet its
manufacturing requirements through the third quarter of 1998. In the event that
the Company is unable to locate a replacement supplier, sales of the Company's
private label vaccine products, beginning in the fourth quarter of 1998, will be
materially adversely affected.
The cost of sales as a percentage of net sales was 46% during the first quarter
of 1998 compared to 49% during the first quarter of 1997 (i.e., gross margin
increased to 54% from 51%). The higher gross margin is a direct result of two
factors: i) the fact that 86% of SBIO-E's sales relate to products manufactured
by SBIO-E rather than by third party manufacturers, and ii) the Company's
domestic sales (i.e., exclusive of the SBIO-E sales), during the first quarter
of 1998 had a 56% gross margin as compared to 51% during the first quarter of
1997. The increased margin on 1998 domestic sales is due primarily to the non-
recurrence of a decrease in average selling prices for certain potentially
short-dated vaccines during the first quarter of 1997, as well as the general
price increase discussed above. 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, VetRED(R), WITNESS(R) and all vaccines are manufactured
by third parties. In addition to affecting gross margins, outsourcing of
manufacturing renders the Company relatively more dependent on the third-party
manufacturers.
Research and development expenses during the first quarter of 1998 increased
$214,000 or 70% over the first quarter of 1997. The increase is primarily due
to the acquisition of SBIO-E, which has its own research and development group,
as well as increased contracted research and development expenses. Research and
development expenses as a percentage of net sales were 6% and 4% during the
first quarter of 1998 and 1997, respectively. The Company expects its research
and development expenses to increase during the remainder of 1998 due to further
development of Prisma's product line.
Selling and marketing expenses during the first quarter of 1998 increased by
$291,000 or 22% over the first quarter of 1997. The increase is due primarily to
the acquisition of SBIO-E, which has its own sales and marketing group. Selling
and marketing expenses as a percentage of net sales were 18% and 19% during the
first quarter of 1998 and 1997, respectively.
General and administrative expenses during the first quarter of 1998 increased
by $575,000 or 87% over the first quarter of 1997. The increase is due primarily
to amortization of goodwill, additional payroll costs related to the acquisition
of SBIO-E and legal expenses related to the Hospital patent litigation. General
and administrative expenses as a percentage of net sales were 15% and 10% during
the first quarter of 1998 and 1997, respectively. The Company expects the Prisma
acquisition to increase its general and administrative expenses, without
commensurate sales increases, for the remainder of 1998.
Other income (expense) during the first quarter of 1998 decreased by $323,000
from the first quarter of 1997 due primarily to interest expense related to the
debt incurred in conjunction with the acquisition of SBIO-E.
The combined effective tax rate was 43% during the first quarter of 1998 as
compared to 42% during the first quarter of 1997. The increase in the effective
rate is due to a decrease in deferred state tax assets resulting from enacted
tax rate changes, as well as foreign income taxes related to the operations of
SBIO-E.
The Company believes that earnings before interest, taxes, depreciation and
amortization ("EBITDA") is an important and meaningful tool in comparing its
performance from year to year. While there are many interpretations in the
financial community as to the proper calculation of EBITDA, the Company
calculates EBITDA as net income plus the sum of 1) interest expense, 2) income
tax expense, 3) depreciation expense and 4) amortization expense. However, it
should be noted that EBITDA is not an equivalent of, nor a substitute for, cash
flow. EBITDA for the
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first quarter of 1998 was $1,869,000 as compared to $1,690,000 for the first
quarter of 1997, an increase of $179,000 or 11%. The increase is due, in
addition to the above factors, to the interest on the debt issued in conjunction
with the acquisition of SBIO-E and a larger amount of goodwill amortization
during the first quarter of 1998 (due to the amortization related to the SBIO-E
and Prisma acquisitions). Because SBIO-E 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 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 $10,490,000 at March 31, 1998, are sufficient to meet its
current working capital needs and service the debt related to the acquisitions
of SBIO-E and Prisma through 1998. However, pursuant to a debt agreement with
Banque Paribas, the Company is required to maintain certain financial ratios and
levels of tangible net worth and is also restricted in its ability to pay
dividends and make loans, capital expenditures or investments without Banque
Paribas' consent.
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 newly acquired European operations and later by
the Prisma instrumentation business, which are relatively less seasonal.
Impact of the Year 2000 Issue
- -----------------------------
The year 2000 issue is the result of computer programs being written using two
digits rather than four digits to define the applicable year. Any of the
Company's computer programs that have date-sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000. This could result
in a system failure or miscalculation causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices or engage in similar normal business activities.
The Company has determined that the financial and manufacturing systems used in
its U.S. operations are not year 2000 compliant. However, the software
manufacturer has provided the necessary software to make the systems year 2000
compliant, and the Company plans on implementing the software changes in the
third quarter of 1998. As the Company has an ongoing maintenance agreement with
the software vendor, which includes the year 2000 software changes, the Company
does not expect to have a material impact on its results of operations related
to implementing the software changes.
The computer systems of SBIO-E are not affected by the year 2000 issue as new
systems had to be acquired subsequent to the acquisition and those systems were
already year 2000 compliant.
PART II. OTHER INFORMATION
---------------------------
Item 1. Legal Proceedings:
------------------
No material developments.
-14-
Item 2. Changes in Securities:
----------------------
In conjunction with the March 6, 1998 acquisition of Prisma, the Company issued
458,345 shares of newly issued unregistered Synbiotics common stock to the
former shareholders of Prisma, issued stock options to purchase 157,053
shares of unregistered Synbiotics common stock at an exercise price of $.0016
per share to the employees of Prisma, and issued a $1,000,000 note to one of the
former Prisma shareholders which is convertible into the number of unregistered
shares of Synbiotics common stock equal to the outstanding principal and accrued
interest divided by the average closing price of the Company's common stock for
the thirty trading days immediately prior to the conversion. The shares of
common stock issued or issuable in conjunction with this transaction were exempt
from registration pursuant to Section 4(2) of the Securities Act of 1933.
Item 3. Defaults Upon Senior Securities:
--------------------------------
None.
Item 4. Submission of Matters to a Vote of Security Holders:
----------------------------------------------------
None.
Item 5. Other Information:
------------------
None.
Item 6. Exhibits and Reports on Form 8-K:
---------------------------------
(a) Exhibits
--------
2.1 Agreement and Plan of Reorganization By and Among the
Registrant, Prisma Acquisition Corp. and the Stockholders and an
Optionholder of Prisma Acquisition Corp., dated as of February
27, 1998/(1)/.
2.2 Agreement of Merger By and Between Prisma Acquisition Corp. and
the Registrant, dated as of March 6, 1998/(2)/.
10.67 Note Purchase Agreement By and Between the Registrant and
BioQuest Venture Leasing Partnership, L.P., dated as of March 6,
1998/(3)/.
10.68 Convertible Promissory Note By the Registrant to BioQuest
Venture Leasing Partnership, L.P., dated March 6, 1998/(4)/.
10.69 Employment Agreement between the Registrant and Robert A.
Behrens, dated as of March 6, 1998.
27 Financial Data Schedule (for electronic filing purposes only).
_______________
-15-
(1) Incorporated herein by reference to Exhibit 2.1 to the
Registrant's Current Report on Form 8-K dated March 6, 1998.
(2) Incorporated herein by reference to Exhibit 2.2 to the
Registrant's Current Report on Form 8-K dated March 6, 1998.
(3) Incorporated herein by reference to Exhibit 99.1 to the
Registrant's Current Report on Form 8-K dated March 6, 1998.
(4) Incorporated herein by reference to Exhibit 99.2 to the
Registrant's Current Report on Form 8-K dated March 6, 1998.
(b) Reports on Form 8-K
-------------------
The Company filed a report on Form 8-K dated March 6, 1998 reflecting
the acquisition of Prisma Acquisition Corp. pursuant to an agreement
and plan of reorganization dated February 27, 1998 and agreement of
merger dated March 6, 1998.
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereto duly
authorized.
SYNBIOTICS CORPORATION
Date: May 15, 1998 /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)
-16-
EXHIBIT INDEX
Exhibit No. Exhibit
- ----------- -------
2.1 Agreement and Plan of Reorganization By and Among the Registrant,
Prisma Acquisition Corp. and the Stockholders and an Optionholder
of Prisma Acquisition Corp., dated as of February 27, 1998/(1)/.
2.2 Agreement of Merger By and Between Prisma Acquisition Corp. and
the Registrant, dated as of March 6, 1998/(2)/.
10.67 Note Purchase Agreement By and Between the Registrant and BioQuest
Venture Leasing Partnership, L.P., dated as of March 6, 1998/(3)/.
10.68 Convertible Promissory Note By the Registrant to BioQuest Venture
Leasing Partnership, L.P., dated March 6, 1998/(4)/.
10.69 Employment Agreement between the Registrant and Robert A. Behrens,
dated as of March 6, 1998.
27 Financial Data Schedule (for electronic filing purposes only).
___________________
(1) Incorporated herein by reference to Exhibit 2.1 to the Registrant's Current
Report on Form 8-K dated March 6, 1998.
(2) Incorporated herein by reference to Exhibit 2.2 to the Registrant's Current
Report on Form 8-K dated March 6, 1998.
(3) Incorporated herein by reference to Exhibit 99.1 to the Registrant's
Current Report on Form 8-K dated March 6, 1998.
(4) Incorporated herein by reference to Exhibit 99.2 to the Registrant's
Current Report on Form 8-K dated March 6, 1998.