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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 June 30, 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 August 4, 1998, 9,003,041 shares of Common Stock were outstanding.
Transitional Small Business Disclosure Format: Yes [ ] No [X]
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SYNBIOTICS CORPORATION
INDEX
Page
----
Part I. Condensed Consolidated Statement of Operations and
Comprehensive Income - Three and six months ended
June 30, 1998 and 1997 3
Condensed Consolidated Balance Sheet - June 30, 1998
and December 31, 1997 4
Condensed Consolidated Statement of Cash Flows -
Six months ended June 30, 1998 and 1997 5
Notes to Condensed Consolidated Financial Statements 6
Management's Discussion and Analysis or Plan of Operation 9
Part II. Other Information 16
-2-
PART I. FINANCIAL INFORMATION
-----------------------------
Item 1. Financial Statements
--------------------
Synbiotics Corporation
Condensed Consolidated Statement of Operations and Comprehensive Income
- -----------------------------------------------------------------------
(unaudited)
- -----------
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ ------------------------
1998 1997 1998 1997
------------------------ ------------------------
Net sales $ 8,936,000 $ 4,840,000 $17,737,000 $11,781,000
Cost of sales 3,859,000 2,877,000 7,905,000 6,259,000
----------- ----------- ----------- -----------
Gross profit 5,077,000 1,963,000 9,832,000 5,522,000
----------- ----------- ----------- -----------
Operating expenses:
Research and development 592,000 306,000 1,113,000 613,000
Selling and marketing 1,572,000 1,025,000 3,163,000 2,324,000
General and administrative 880,000 700,000 2,119,000 1,364,000
Patent litigation settlement 4,601,000 4,601,000
----------- ----------- ----------- -----------
7,645,000 2,031,000 10,996,000 4,301,000
----------- ----------- ----------- -----------
(Loss) income from operations (2,568,000) (68,000) (1,164,000) 1,221,000
Other income (expense):
License fees and other 65,000 76,000 139,000 154,000
Interest, net (258,000) 47,000 (515,000) 106,000
----------- ----------- ----------- -----------
(Loss) income before income taxes (2,761,000) 55,000 (1,540,000) 1,481,000
(Benefit from) provision for income taxes (1,148,000) 41,000 (618,000) 637,000
----------- ----------- ----------- -----------
Net (loss) income (1,613,000) 14,000 (922,000) 844,000
Cumulative translation adjustment 188,000 (60,000)
----------- ----------- ----------- -----------
Comprehensive (loss) income $(1,425,000) $ 14,000 $ (982,000) $ 844,000
=========== =========== =========== ===========
Basic net (loss) income per share $ (.19) $ .00 $ (.12) $ .11
=========== =========== =========== ===========
Diluted net (loss) income per share $ (.19) $ .00 $ (.12) $ .11
=========== =========== =========== ===========
See accompanying notes to condensed consolidated financial statements.
-3-
Item 1. Financial Statements (continued)
--------------------
Synbiotics Corporation
Condensed Consolidated Balance Sheet
- --------------------------------------------------------------------------------
June 30, December 31,
1998 1997
------------ -------------
(unaudited) (audited)
Assets
Current assets:
Cash and equivalents $ 3,168,000 $ 2,190,000
Securities available for sale 3,527,000 3,394,000
Accounts receivable 6,126,000 4,396,000
Inventories 5,534,000 5,187,000
Deferred tax assets 407,000 303,000
Other current assets 568,000 359,000
------------ -------------
Total current assets 19,330,000 15,829,000
Property and equipment, net 1,611,000 1,102,000
Goodwill 13,937,000 11,542,000
Deferred tax assets 6,976,000 6,417,000
Deferred debt issuance costs 757,000 905,000
Other assets 5,507,000 5,832,000
------------ ------------
$ 48,118,000 $ 41,627,000
============ ============
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable and accrued expenses $ 5,140,000 $ 3,546,000
Current portion of long-term debt 2,000,000 1,000,000
Income taxes payable 25,000
Other current liabilities 2,600,000
------------ ------------
Total current liabilities 9,740,000 4,571,000
------------ ------------
Long-term debt 7,116,000 7,543,000
Other liabilities 1,322,000
------------ ------------
8,438,000 7,543,000
------------ ------------
Mandatorily redeemable common stock 2,810,000 2,756,000
------------ ------------
Non-mandatorily redeemable common stock and
other shareholders' equity:
Common stock, no par value, 24,800,000 shares
authorized, 8,670,000 and 7,426,000 shares
issued and outstanding at June 30, 1998 and
December 31, 1997 37,085,000 35,659,000
Common stock warrants 1,003,000 1,003,000
Accumulated other comprehensive income (211,000) (151,000)
Accumulated deficit (10,747,000) (9,754,000)
------------ ------------
Total non-mandatorily redeemable common
stock and other shareholders' equity 27,130,000 26,757,000
------------ ------------
$ 48,118,000 $ 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)
- --------------------------------------------------------------------------------
Six Months Ended
June 30,
------------------------
1998 1997
------------------------
Cash flows from operating activities:
Net (loss) income $ (922,000) $ 844,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 929,000 527,000
Changes in assets and liabilities:
Accounts receivable (1,680,000) (1,760,000)
Inventories (15,000) 1,001,000
Deferred taxes (664,000) 595,000
Other assets (177,000) 64,000
Accounts payable and accrued expenses 833,000 (480,000)
Income taxes payable (91,000)
Other liabilities 3,922,000 (650,000)
----------- -----------
Net cash provided by operating activities 2,135,000 141,000
----------- -----------
Cash flows from investing activities:
Acquisition of property and equipment (252,000) (96,000)
Investment in securities available for sale (133,000)
Proceeds from sale of securities available for sale 691,000
Acquisition of Prisma Acquisition Corp. (1,133,000)
----------- -----------
Net cash (used for) provided by investing activities (1,518,000) 595,000
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of long-term debt 1,133,000
Payments of long-term debt (633,000)
Mandatorily redeemable common stock issuance costs (16,000)
Proceeds from issuance of common stock, net (63,000) (134,000)
----------- -----------
Net cash provided by (used for) financing activities 421,000 (134,000)
----------- -----------
Net increase in cash and equivalents 1,038,000 602,000
Effect of exchange rates on cash (60,000)
Cash and equivalents - beginning 2,190,000 3,050,000
----------- -----------
Cash and equivalents - ending $ 3,168,000 $ 3,652,000
=========== ===========
See accompanying notes to condensed consolidated financial statements.
-5-
Item 1. Financial Statements (continued)
--------------------
Synbiotics Corporation
Notes to Condensed Consolidated Financial Statements (unaudited)
- --------------------------------------------------------------------------------
Note 1 - Interim Financial Statements:
The accompanying consolidated balance sheet as of June 30, 1998 and the
consolidated statements of operations and comprehensive income and of cash flows
for the three and six month periods ended June 30, 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 ("SBIO-E"). 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 $2,848,000 which is being amortized over an estimated
useful life of 15 years utilizing the straight-line method. $2,499,000,
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)
--------------------
Synbiotics Corporation
Notes to Condensed Consolidated Financial Statements (unaudited)
- --------------------------------------------------------------------------------
Note 3 - Securities Available for Sale:
Included in current assets are securities available for sale which consist
primarily of short-term commercial paper.
Note 4 - Inventories:
Inventories consist of the following:
June 30, December 31,
1998 1997
---- ----
Raw materials $ 2,907,000 $ 2,639,000
Work in process 871,000 1,235,000
Finished goods 1,756,000 1,313,000
----------- -----------
$ 5,534,000 $ 5,187,000
=========== ===========
Note 5 - 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 June 30, Six Months Ended June 30,
------------------------------ ---------------------------
1998 1997 1998 1997
---- ---- ---- ----
(unaudited) (unaudited) (unaudited) (unaudited)
Net (loss) income used:
Net (loss) income $ (1,613,000) $ 14,000 $ (922,000) $ 844,000
Less accretion of mandatorily
redeemable common stock (37,000) (72,000)
------------ ------------ ------------ ------------
Net income used in computing
basic and diluted net (loss)
income per share (1,650,000) 14,000 (994,000) 844,000
============ ============ ============ ============
-7-
Item 1. Financial Statements (continued)
--------------------
Synbiotics Corporation
Notes to Condensed Consolidated Financial Statements (unaudited)
- --------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
------------------------------ ---------------------------
1998 1997 1998 1997
---- ---- ---- ----
(unaudited) (unaudited) (unaudited) (unaudited)
Shares used:
Weighted average common shares
outstanding used in computing
basic net income per share $ 8,669,000 $ 7,394,000 $ 8,508,000 $ 7,393,000
Weighted average options and warrants
to purchase common stock as
determined by application of the 133,000 133,000
treasury method ------------ ------------ ------------ ------------
Shares used in computing diluted net
income per share 8,669,000 7,527,000 8,508,000 7,526,000
============ ============ ============ ============
Weighted average options and warrants to purchase common stock as determined by
the application of the treasury method and weighted average shares of common
stock issuable upon assumed conversion of debt totalling 680,000 shares and
674,000 shares have been excluded from the shares used in computing diluted net
loss for the three and six months ended June 30, 1998, respectively, as their
effect is anti-dilutive. In addition, warrants to purchase 284,000 shares of
common stock at $4.54 per share have been excluded from the shares used in
computing diluted net loss per share for the three and six months ended June 30,
1998 and 1997 as their exercise price is higher than the weighted average market
price for those periods, as well as their effect is anti-dilutive.
In July 1998, the Company issued 333,000 newly issued and unregistered shares of
the Company's common stock in conjunction with the settlement of patent
litigation (Note 6).
Note 6 - Subsequent Event:
In September 1997, Barnes-Jewish Hospital of St. Louis (the "Hospital") filed a
lawsuit against the Company claiming that the Company infringes a patent owned
by the Hospital which covers the Company's canine heartworm diagnostic products.
On July 28, 1998, the Company entered into a settlement agreement with the
Hospital whereby the Company will pay the Hospital or its affiliates $1,600,000
in cash, 333,000 shares of the Company's common stock, and undisclosed future
payments and royalties. The Company recorded a one-time pre-tax charge of
approximately $3,922,000 in the quarter ended June 30, 1998, and reclassified
$463,000 and $679,000 of legal expenses related to the patent litigation during
the three and six months ended June 30, 1998, respectively, from general and
administrative expenses.
-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 and elsewhere in this Quarterly Report on Form 10-QSB 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
- ------------------------------------------------------------------------------
In October 1997, Barnes-Jewish Hospital of St. Louis (the "Hospital") filed a
lawsuit against the Company claiming that the Company infringes a patent owned
by the Hospital which covers the Company's canine heartworm diagnostic products.
On July 28, 1998, the Company entered into a settlement agreement with the
Hospital whereby the Company will pay the Hospital or its affiliates $1,600,000
in cash, 333,000 shares of the Company's common stock, and undisclosed future
payments and royalties. The Company recorded a one-time pre-tax charge of
approximately $3,922,000 in the quarter ended June 30, 1998. The charge will be
materially adverse to the Company's results of operations for the year ending
December 31, 1998.
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.
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.
-9-
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 $10,747,000 at June 30, 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.
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
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.
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
-11-
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. In 1997, a patentholder
filed a lawsuit asserting that the Company's key canine heartworm diagnostic
tests infringe its patent. The lawsuit was settled in July 1998 (see above).
There can be no assurance that 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, 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.
-12-
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 second quarter of 1998 increased by $4,096,000 or 85% over the
second quarter of 1997. The increase in net sales is due to $1,650,000 in sales
of diagnostic products acquired in conjunction with the July 1997 acquisition of
SBIO-E, an increase in the sales of non-SBIO-E diagnostic products of $2,097,000
and an increase in vaccine product sales of $349,000. The increase in the sales
of non-SBIO-E diagnostic products is due to an increase in canine heartworm
diagnostics sales of 133% and an increase in feline diagnostics sales of 25%.
The increased canine heartworm diagnostics sales were due to sales of
VetRED(R), acquired in conjunction with the acquisition of SBIO-E and the fact
that the Company's average selling prices of its canine heartworm diagnostic
products were reduced by 10% during the second quarter of 1997 as a result of
severe price competition from IDEXX Laboratories, the Company's main diagnostic
competitor. In addition there was a non-recurrence of distributor promotional
programs which were in place during the first quarter of 1997, as well as a
general price increase in January 1998. Rather than continuing to use
promotional programs to provide incentive for distributors to buy in
anticipation of the heartworm season, in 1998 the Company 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. The increased vaccine sales comprises an increase of
41% in sales of vaccines to private label partners and an increase of 35% in
sales of bulk feline leukemia vaccine (related to the timing of shipments as
requested by OEM customers), offset by an 89% decrease in sales of other vaccine
products resulting from 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.
Net sales for the six months ended June 30, 1998 increased by $5,956,000 or 51%
over the six months ended June 30, 1997. The increase in net sales is due to
$3,970,000 in sales of diagnostic products acquired in conjunction with the July
1997 acquisition of SBIO-E, an increase in the sales of non-SBIO-E diagnostic
products of $1,540,000 and an increase in vaccine product sales of $218,000.
The increase in the sales of non-SBIO-E diagnostic products is
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due to an increase in canine heartworm diagnostics sales of 28% and an increase
in feline diagnostics sales of 32%, for substantially the same reasons as the
increases for the second quarter of 1998. The increased vaccine sales comprises
an increase of 43% in sales of vaccines to private label partners and an
increase of 14% in sales of bulk feline leukemia vaccine (related to the timing
of shipments as requested by OEM customers), offset by an 89% decrease in sales
of other vaccine products resulting from the phase-out of sales of most
Synbiotics-label vaccines.
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 43% during the second quarter
of 1998 compared to 59% during the second quarter of 1997 (i.e., gross margin
increased to 57% from 41%). The higher gross margin is a direct result of two
factors: i) the fact that a high percentage 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 second
quarter of 1998 had a 57% gross margin as compared to 41% during the second
quarter of 1997. As discussed above, the increased margin on 1998 domestic
sales is due primarily to increases in the Company's average selling prices as a
result of the non-recurrence of the severe price competition encountered during
the second quarter of 1997, the non-recurrence of distributor promotional
programs and the general price increase in January 1998. The cost of sales as a
percentage of net sales was 45% during the six months ended June 30, 1998
compared to 53% during the six months ended June 30, 1997 (i.e., gross margin
increased to 55% from 47%). The higher gross margin is a direct result of two
factors: i) the fact that a high percentage 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 six
months end June 30, 1998 had a 56% gross margin as compared to 47% during the
six months ended June 30, 1997. The reasons for the improved margins during the
six months ended June 30, 1998 are substantially the same reasons as for the
increases for the second quarter of 1998. 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 second quarter of 1998 increased by
$286,000 or 93% over the second quarter of 1997, and increased during the six
months ended June 30, 1998 by $500,000 or 82% over the six months ended June 30,
1997. The increases are primarily due to the acquisitions of SBIO-E and Prisma,
which have its own research and development groups, as well as increased
contracted research and development expenses. Research and development expenses
as a percentage of net sales were 7% and 6% during the second quarter of 1998
and 1997, respectively, and were 6% and 5% during the six months ended June 30,
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 second quarter of 1998 increased by
$547,000 or 53% over the second quarter of 1997, and increased during the six
months ended June 30, 1998 by $839,000 or 36% over the six months ended June 30,
1997. The increases are 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 21% during the second quarter of 1998 and
1997, respectively, and were 18% and 20% during the six months ended June 30,
1998 and 1997, respectively.
General and administrative expenses during the second quarter of 1998 increased
by $180,000 or 26% over the second quarter of 1997, and increased during the six
months ended June 30, 1998 by $755,000 or 55% over the six
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months ended June 30, 1997. The increases are due primarily to amortization of
goodwill and additional payroll costs related to the acquisitions of SBIO-E and
Prisma. General and administrative expenses as a percentage of net sales were
10% and 14% during the second quarter of 1998 and 1997, respectively, and were
12% during the six months ended June 30, 1998 and 1997. The Company expects the
Prisma acquisition to increase its general and administrative expenses, without
commensurate sales increases, for the remainder of 1998.
On July 28, 1998, the Company entered into a settlement agreement with the
Hospital whereby the Company will pay the Hospital or its affiliates $1,600,000
in cash, 333,000 shares of the Company's common stock, and undisclosed future
payments and royalties. The Company recorded a one-time pre-tax charge of
approximately $3,922,000 in the quarter ended June 30, 1998, and reclassified
$463,000 and $679,000 of legal expenses related to the patent litigation during
the three and six months ended June 30, 1998, respectively, from general and
administrative expenses.
Other income (expense) during the second quarter of 1998 decreased by $316,000
from the second quarter of 1997, and decreased during the six months ended June
30, 1998 by $636,000 from the six months ended June 30, 1997, due primarily to
interest expense related to the debt incurred in conjunction with the
acquisition of SBIO-E.
The Company recognized a benefit from income taxes of $618,000 during the six
months ended June 30, 1998, as compared to a provision for income taxes of
$637,000 for the six months ended June 30, 19987. The benefit from income taxes
in 1998 is a result of a deferred tax asset related to the patent litigation
settlement and the reduction the utilization of net operating loss carryforwards
resulting from the patent litigation settlement charge, offset by an 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.
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 $9,590,000 at June 30, 1998, are sufficient to meet its
current working capital needs, pay the patent litigation settlement 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
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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.
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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.
The Company is currently in the process of determining the year 2000 compliance
status of its major suppliers and customers. In the event that these suppliers
and customers fail to become year 2000 compliant, there could be a material
adverse impact on the Company's results of operations and financial condition
beginning in 2000.
PART II. OTHER INFORMATION
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Item 1. Legal Proceedings:
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Barnes-Jewish Hospital v. Synbiotics Corporation - United States District Court
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for the Eastern District of Missouri, Eastern Division
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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. 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. On July 28, 1998, the Company entered into a settlement
agreement with the Hospital whereby the Company will pay the Hospital or its
affiliates $1,600,000 in cash, 333,000 shares of the Company's common stock, and
undisclosed future payments and royalties. The Company recorded a one-time pre-
tax charge of approximately $3,922,000 in the quarter ended June 30, 1998.
Item 2. Changes in Securities:
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None.
Item 3. Defaults Upon Senior Securities:
--------------------------------
None.
Item 4. Submission of Matters to a Vote of Security Holders:
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None.
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Item 5. Other Information:
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The Securities and Exchange Commission has amended Rule 14a-4, which governs the
Company's use of its discretionary proxy voting authority with respect to a non-
Rule 14a-8 shareholder proposal (i.e., where a shareholder has not sought
inclusion of the proposal in the Company's proxy statement). The amended rule
sets a 45-day advance notice requirement whereby if a proponent fails to notify
the Company at least 45 days prior to the anniversary of the date the prior
year's proxy statement was mailed, then the management proxyholders would be
allowed to use their discretionary voting authority when the proposal is raised
at the annual meeting, without any discussion of the matter in the proxy
statement.
In addition, shareholders are advised that the Company's Bylaws have been
amended to, among other things, require a shareholder to give advance notice to
the Company in order to be allowed to bring any matter before an annual meeting
of shareholders or to nominate a director candidate. Notice that a matter will
be brought before an annual meeting must be given between 60 and 90 days before
the anniversary of the prior year's annual meeting. Notice that a shareholder
will nominate a particular director candidate must be given at least 90 days
before the anniversary of the prior year's annual meeting.
Item 6. Exhibits and Reports on Form 8-K:
---------------------------------
(a) Exhibits
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3.2 Bylaws, as amended.
27 Financial Data Schedule (for electronic filing purposes only).
(b) Reports on Form 8-K
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None.
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: August 14, 1998 /s/ Michael K. Green
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Michael K. Green
Vice President of Finance and Chief Financial Officer
(signing both as a duly authorized officer and as
principal financial officer)
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.
EXHIBITS
TO
FORM 10-QSB
UNDER
SECURITIES EXCHANGE ACT OF 1934
SYNBIOTICS CORPORATION
EXHIBIT INDEX
Exhibit No. Exhibit
- ----------- -------
3.2 By laws, as amended.
27 Financial Data Schedule (for electronic filing purposes only).