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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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 October 31, 1998, 9,005,420 shares of Common Stock were outstanding.
Transitional Small Business Disclosure Format: Yes [_] No [X]
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SYNBIOTICS CORPORATION
INDEX
Page
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Part I - Financial Information
Item 1. Financial Statements
Condensed Consolidated Statement of Operations and Comprehensive
Income - Three and nine months ended September 30, 1998 and 1997 2
Condensed Consolidated Balance Sheet - September 30, 1998 and
December 31, 1997 3
Condensed Consolidated Statement of Cash Flows - Nine months
ended September 30, 1998 and 1997 4
Notes to Condensed Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis or Plan of Operation 8
Part II - Other Information 15
-1-
PART I. FINANCIAL INFORMATION
-----------------------------
Item 1. Financial Statements
--------------------
Synbiotics Corporation
Condensed Consolidated Statement of Operations and Comprehensive Income
(unaudited)
- --------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -------------------------
1998 1997 1998 1997
---------- ---------- ----------- -----------
Net sales $6,735,000 $6,146,000 $24,472,000 $17,929,000
Cost of sales 3,820,000 3,387,000 11,725,000 9,648,000
---------- ---------- ----------- -----------
Gross Profit 2,915,000 2,759,000 12,747,000 8,281,000
---------- ---------- ----------- -----------
Operating expenses:
Research and development 590,000 541,000 1,703,000 1,154,000
Selling and marketing 1,428,000 1,058,000 4,591,000 3,382,000
General and administrative 1,546,000 774,000 3,665,000 2,138,000
Patent litigation settlement 4,601,000
---------- ---------- ----------- -----------
3,564,000 2,373,000 14,560,000 6,674,000
---------- ---------- ----------- -----------
(Loss) income from operations (649,000) 386,000 (1,813,000) 1,607,000
Other income (expense):
License fees and other 89,000 79,000 229,000 234,000
Interest, net (358,000) (324,000) (873,000) (218,000)
---------- ---------- ----------- -----------
(Loss) income before income taxes (918,000) 141,000 (2,457,000) 1,623,000
(Benefit from) provision for income taxes (175,000) 261,000 (792,000) 898,000
---------- ---------- ----------- -----------
Net (loss) income (743,000) (120,000) (1,665,000) 725,000
Cumulative translation adjustment 616,000 (753,000) 556,000 (753,000)
---------- ---------- ----------- -----------
Comprehensive (loss) $ (127,000) $ (873,000) $(1,109,000) $ (28,000)
========== ========== =========== ===========
Basic net (loss) income per share $ (.09) $ (.02) $ (.21) $ .09
========== ========== =========== ===========
Diluted net (loss) income per share $ (.09) $ (.02) $ (.21) $ .09
========== ========== =========== ===========
See accompanying notes to condensed consolidated financial statements.
-2-
Item 1. Financial Statements (continued)
--------------------
Synbiotics Corporation
Condensed Consolidated Balance Sheet
- --------------------------------------------------------------------------------
September 30, December 31,
1998 1997
------------- ------------
(unaudited) (audited)
Assets
Current assets:
Cash and equivalents $ 4,507,000 $ 2,190,000
Securities available for sale 1,615,000 3,394,000
Accounts receivable 4,097,000 4,396,000
Inventories 5,490,000 5,187,000
Deferred tax assets 218,000 303,000
Other current assets 732,000 359,000
------------ -----------
Total current assets 16,659,000 15,829,000
Property and equipment, net 1,614,000 1,102,000
Goodwill 14,028,000 11,542,000
Deferred tax assets 7,356,000 6,417,000
Deferred debt issuance costs 701,000 905,000
Other assets 5,644,000 5,832,000
------------ -----------
$ 46,002,000 $41,627,000
============ ===========
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable and accrued expenses $ 4,889,000 $ 3,546,000
Current portion of long-term debt 2,000,000 1,000,000
Income taxes payable 25,000
------------ -----------
Total current liabilities 6,889,000 4,571,000
------------ -----------
Long-term debt 6,920,000 7,543,000
Other liabilities 1,341,000
------------ -----------
8,261,000 7,543,000
------------ -----------
Mandatorily redeemable common stock 2,847,000 2,756,000
------------ -----------
Non-mandatorily redeemable common stock and other
shareholders' equity:
Common stock, no par value, 24,800,000 shares authorized,
9,005,000 and 7,426,000 shares issued and outstanding at
September 30, 1998 and December 31, 1997, respectively 38,123,000 35,659,000
Common stock warrants 1,003,000 1,003,000
Cumulative translation adjustment 405,000 (151,000)
Accumulated deficit (11,526,000) (9,754,000)
------------ -----------
Total non-mandatorily redeemable common stock and other
shareholders' equity 28,005,000 26,757,000
------------ -----------
$ 46,002,000 $41,627,000
============ ===========
See accompanying notes to condensed consolidated financial statements.
-3-
Item 1. Financial Statements (continued)
--------------------
Synbiotics Corporation
Condensed Consolidated Statement of Cash Flows (unaudited)
- --------------------------------------------------------------------------------
Nine Months Ended
September 30,
-------------------------
1998 1997
----------- ------------
Cash flows from operating activities:
Net (loss) income $(1,665,000) $ 725,000
Adjustments to reconcile net income to net cash
provided by (used for) operating activities:
Depreciation and amortization 1,428,000 1,056,000
Changes in assets and liabilities:
Accounts receivable 299,000 (874,000)
Inventories (303,000) 1,811,000
Deferred taxes (854,000) 463,000
Other assets (301,000) 690,000
Accounts payable and accrued expenses 1,343,000 154,000
Income taxes payable (25,000) 274,000
Other liabilities 1,341,000 (650,000)
----------- ------------
Net cash provided by (used for) operating activities 1,263,000 3,649,000
----------- ------------
Cash flows from investing activities:
Acquisition of property and equipment (357,000) (224,000)
Investment in securities available for sale (188,000)
Proceeds from sale of securities available for sale 1,779,000
Acquisition of Prisma Acquisition Corp. (133,000)
Acquisition of Synbiotics Europe SAS (10,659,000)
----------- ------------
Net cash provided by (used for) investing activities 1,289,000 (11,071,000)
----------- ------------
Cash flows from financing activities:
Proceeds from issuance of long-term debt, net 133,000 11,493,000
Payments of long-term debt (883,000) (1,743,000)
Debt issuance costs (949,000)
Mandatorily redeemable stock issuance costs (16,000) (493,000)
Proceeds from issuance of common stock, net (25,000) (151,000)
----------- ------------
Net cash provided by (used for) financing activities (791,000) 8,157,000
----------- ------------
Net increase in cash and equivalents 1,761,000 735,000
Effect of exchange rate changes on cash 556,000 (753,000)
Cash and equivalents - beginning of year 2,190,000 3,050,000
----------- ------------
Cash and equivalents - end of period $ 4,507,000 $ 3,032,000
=========== ============
See accompanying notes to condensed consolidated financial statements.
-4-
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 September 30, 1998 and the
consolidated statements of operations and comprehensive income and of cash flows
for the three and nine month periods ended September 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 - Patent Litigation Settlement:
In September 1997, Barnes-Jewish Hospital of St. Louis (the "Hospital") filed a
lawsuit against the Company claiming that the Company infringed 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 calling for the Company to 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. $1,000,000, representing the common
stock portion of the settlement is considered a non-cash financing activity for
purposes of the statement of cash flows.
Note 3 - 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.
-5-
Item 1. Financial Statements (continued)
--------------------
Synbiotics Corporation
Notes to Condensed Consolidated Financial Statements (unaudited)
- --------------------------------------------------------------------------------
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 convertible debt, common stock and common stock option portion
of the purchase price and liabilities assumed, is considered a non-cash
financing activity for purposes of the statement of cash flows.
Note 4 - Securities Available for Sale:
Included in current assets are securities available for sale which consist
primarily of short-term commercial paper.
Note 5 - Inventories:
Inventories consist of the following:
September 30, December 31,
1998 1997
------------- ------------
Raw materials $2,921,000 $2,639,000
Work in process 778,000 1,235,000
Finished goods 1,791,000 1,313,000
---------- ----------
$5,490,000 $5,187,000
========== ==========
-6-
Item 1. Financial Statements (continued)
--------------------
Synbiotics Corporation
Notes to Condensed Consolidated Financial Statements (unaudited)
- --------------------------------------------------------------------------------
Note 6 - 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 Nine Months Ended
September 30, September 30,
------------------------ -------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
(unaudited) (unaudited) (unaudited) (unaudited)
Net (loss) income used:
Net (loss) income $(743,000) $(120,000) $(1,665,000) $ 725,000
Less accretion of mandatorily
redeemable common stock (37,000) (36,000) (107,000) (36,000)
--------- --------- ----------- ---------
Net (loss) income used in computing
basic and diluted net (loss)
income per share $(780,000) $(156,000) $(1,772,000) $ 689,000
========= ========= =========== =========
Shares used:
Weighted average common shares
outstanding used in computing
basic net (loss) income per share 8,838,000 7,790,000 8,632,000 7,591,000
Weighted average options and warrants
to purchase common stock as
determined by application of the
treasury method 372,000
--------- --------- ----------- ---------
Shares used in computing diluted net
(loss) income per share 8,838,000 7,790,000 8,632,000 7,963,000
========= ========= =========== =========
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 722,000 shares, 373,000
shares and 672,000 shares have been excluded from the shares used in computing
diluted net (loss) income per share for the three months ended September 30,
1998 and 1997 and the nine months ended September 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) income per share for the three and nine months
ended September 30, 1998 and 1997 as their exercise price is higher than the
weighted average market price for those periods, and in addition their effect is
anti-dilutive for the three months ended September 30, 1998 and 1997 and for the
nine months ended September 30, 1998.
-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 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 infringed 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 calling for the Company to 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.
-8-
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. Due to the
settlement with the Hospital, the Company will report a loss for 1998.
Synbiotics has incurred a consolidated accumulated deficit of $11,526,000 at
September 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 now believes it has adequate levels of these bulk fluids to meet its
manufacturing requirements through the first quarter of 1999. 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 second quarter of 1999, 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.
-9-
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 higher
in the first half of the year, the time period in which distributors purchase
canine heartworm diagnostic products to sell to veterinarians for the heartworm
season, than in the second half of the year. 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.
-10-
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. In 1997, the Hospital
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 is 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.
-11-
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 third quarter of 1998 increased by $589,000 or 10% over the
third quarter of 1997. The increase in net sales comprises an increase in
diagnostic product sales of $127,000 or 3% and an increase in vaccine product
sales of $462,000 or 26%. The increased diagnostic product sales were due to a
33% increase in companion animal diagnostic sales, resulting primarily from the
introduction of the Company's WITNESS(R) products in the U.S., offset by a
decrease in large animal diagnostics. This decrease comprises a decrease in
sales of tuberculin diagnostic products resulting from contract renegotiations
with the USDA, and from initial distributor loading in the third quarter of 1997
as a result of the SBIO-E acquisition. The increased vaccine sales comprises an
increase of 36% in sales of vaccines to private label partners and an increase
of 117% in sales of bulk feline leukemia vaccine (related to the timing of
shipments as requested by OEM customers), offset by a 54% 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 ethical 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 nine months ended September 30, 1998 increased by $6,543,000
or 36% over the nine months ended September 30, 1997. The increase in net sales
is due to $3,821,000 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 $2,035,000 and an increase in vaccine product sales of
$687,000. The increase in the sales of non-SBIO-E diagnostic products is due to
an increase in canine heartworm diagnostics sales of 25% and an increase in
feline diagnostics sales of 30%. The increased canine heartworm diagnostics
sales were due to products acquired in conjunction with the acquisition of SBIO-
E, the introduction of the Company's WITNESS(R) product in the U.S. and further
increases in DiroCHEK(R) and ICT Gold(TM). 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 42% 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 a
42% decrease in sales of other vaccine products resulting from the phase-out of
sales of most Synbiotics-label vaccines.
-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 now
believes it has adequate levels of these bulk fluids to meet its manufacturing
requirements through the first quarter of 1999. 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 second quarter of 1999, will be materially
adversely affected.
The cost of sales as a percentage of net sales was 57% during the third quarter
of 1998 compared to 55% during the third quarter of 1997 (i.e., gross margin
decreased to 43% from 45%). The lower gross margin is due to the increased
sales of bulk vaccine to an OEM distributor which have no margin; instead,
Company receives a royalty on the sales of the OEM distributor's product. The
gross margin, exclusive of the no margin bulk vaccine sales, would have been 48%
and 47% for the third quarter of 1998 and 1997, respectively. The cost of sales
as a percentage of net sales was 48% during the nine months ended September 30,
1998 compared to 54% during the nine months ended September 30, 1997 (i.e.,
gross margin increased to 52% from 46%). 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 nine months end September 30, 1998 had a 50% gross margin as
compared to 43% during the nine months ended September 30, 1997. 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 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 third quarter of 1998 increased by
$49,000 or 9% over the third quarter of 1997, and increased during the nine
months ended September 30, 1998 by $549,000 or 48% over the nine months ended
September 30, 1997. The increases are primarily due to the acquisitions of
SBIO-E and Prisma, which have their 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 9% during the third
quarter of 1998 and 1997, and were 7% and 6% during the nine months ended
September 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 third quarter of 1998 increased by
$370,000 or 35% over the third quarter of 1997, and increased during the nine
months ended September 30, 1998 by $1,209,000 or 36% over the nine months ended
September 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 21% and 17% during the third quarter
of 1998 and 1997, respectively, and were 19% during the nine months ended
September 30, 1998 and 1997.
General and administrative expenses during the third quarter of 1998 increased
by $627,000 or 81% over the third quarter of 1997, and increased during the nine
months ended September 30, 1998 by $1,382,000 or 65% over the nine months ended
September 30, 1997. The increases are due primarily to amortization of goodwill
and additional payroll costs related to the acquisitions of SBIO-E and Prisma,
as well as increased legal expenses. General and administrative expenses as a
percentage of net sales were 21% and 13% during the third quarter of 1998 and
1997, respectively, and were 14% and 12% during the nine months ended September
30, 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.
-13-
On July 28, 1998, the Company entered into a settlement agreement with the
Hospital calling for the Company to 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 third quarter of 1998 decreased by $24,000
from the third quarter of 1997, and decreased during the nine months ended
September 30, 1998 by $660,000 from the nine months ended September 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 $792,000 during the nine
months ended September 30, 1998, as compared to a provision for income taxes of
$898,000 for the nine months ended September 30, 1997. The benefit from income
taxes in 1998 is a result of a deferred tax asset related to the patent
litigation settlement , offset by 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 $9,770,000 at September 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
first half of the year, 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
second quarter of 1999. 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. However, the Company has also
determined that its current information system is inadequate to meet its growth
goals and objectives. The Company is currently in the process of evaluating
-14-
enterprise resource planning systems, and expects to make its final selection in
the fourth quarter of 1998. The capital expenditure related to the new system
will be material to the Company's financial condition in 1999.
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. The Company has sent letters
requesting the status of the suppliers and vendors year 2000 compliance, and has
yet to receive any responses. 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
---------------------------
Item 1. Legal Proceedings
-----------------
None.
Item 2. Changes in Securities
---------------------
On August 4, 1998, the Company issued 333,333 shares of newly issued
unregistered Synbiotics common stock to Barnes-Jewish Hospital Foundation as
partial consideration for the settlement of a patent infringement lawsuit. The
shares of common stock were exempt from registration pursuant to Section 4(2) of
the Securities Act of 1933; however, the shares were later registered for resale
on a Registration Statement on Form S-3 which was declared effective on
September 25, 1998.
Item 3. Defaults Upon Senior Securities
-------------------------------
None.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
The Annual Meeting of Shareholders was held on July 30, 1998. The following
matters were submitted to a vote, with the results indicated below:
(a) Election of directors:
Broker
Nominee For Against Abstain Withheld Non-votes
------- --- ------- ------- -------- ---------
Patrick Owen Burns 7,623,841 n/a n/a 489,098 0
Kenneth M. Cohen 7,624,041 n/a n/a 488,898 0
James C. DeCesare 7,248,422 n/a n/a 864,517 0
Brenda D. Gavin, DVM 7,245,772 n/a n/a 867,167 0
M. Blake Ingle, Ph.D. 7,624,241 n/a n/a 488,698 0
Donald E. Phillips 7,622,141 n/a n/a 490,798 0
- -15-
(b) Approval of the amendment of Article Fourth of the Company's
Restated Articles of Incorporation (creation of "blank check"
Preferred Stock"):
For: 4,411,332 Against: 1,286,521 Abstain: 30,075
Broker Non-votes: 2,916,382
Item 5. Other Information
-----------------
On September 8, 1998 Mr. Skip Klein was elected to the Board of Directors. Mr.
Klein, 37, is a health care analyst for The Kaufmann Fund, which he joined in
June of 1998. Previously, Mr. Klein was the portfolio manager of the T. Rowe
Price Health Sciences Fund since its inception in 1995, and a health care
analyst at T. Rowe Price since 1989.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
--------
3.1.1 Certificate of Amendment of Articles of Incorporation, filed
August 4, 1998.
10.64.1 Waiver and First Amendment to $15,000,000 Credit Agreement
Among the Registrant, the Banks Named Therein and Banque
Paribas, as Agent, dated March 6, 1998.
10.70 Settlement Agreement, Stipulation to Settlement Order Under
Seal, Release and License Between Barnes-Jewish Hospital and
the Registrant, dated as of July 28, 1998./(1)/
27 Financial Data Schedule (for electronic filing purposes
only).
-----------------------------
(1) Certain confidential portions of this exhibit have been
omitted by means of blacking out the text (the "Mark"). This
exhibit has been filed separately with the Secretary of the
Commission without the Mark pursuant to the Company's
Application Requesting Confidential Treatment under Rule 24b-
2 under the Securities Exchange Act of 1934, as amended.
(b) Reports on Form 8-K
-------------------
None.
-16-
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
SYNBIOTICS CORPORATION
Date: November 13, 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)
-17-
EXHIBIT INDEX
Exhibit No. Exhibit
- ----------- -------
3.1.1 Certificate of Amendment of Articles of Incorporation, filed August
4, 1998.
10.64.1 Waiver and First Amendment to $15,000,000 Credit Agreement Among
the Registrant, the Banks Named Therein and Banque Paribas, as
Agent, dated March 6, 1998.
10.70 Settlement Agreement, Stipulation to Settlement Order Under Seal,
Release and License Between Barnes-Jewish Hospital and the
Registrant, dated as of July 28, 1998./(1)/
27 Financial Data Schedule (for electronic filing purposes only).
-------------------------
(1) Certain confidential portions of this exhibit have been
omitted by means of blacking out the text (the "Mark"). This
exhibit has been filed separately with the Secretary of the
Commission without the Mark pursuant to the Company's
Application Requesting Confidential Treatment under Rule 24b-
2 under the Securities Exchange Act of 1934, as amended.