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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2000
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 registrant 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)
Registrant's telephone number, including area code: (858) 451-3771
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
As of May 15, 2000, 9,372,662 shares of Common Stock were outstanding.
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SYNBIOTICS CORPORATION
INDEX
Page
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Part I Condensed Consolidated Statement of Operations and Comprehensive Loss -
Three months ended March 31, 2000 and 1999 1
Condensed Consolidated Balance Sheet -
March 31, 2000 and December 31, 1999 2
Condensed Consolidated Statement of Cash Flows -
Three months ended March 31, 2000 and 1999 3
Notes to Condensed Consolidated Financial Statements 4
Management's Discussion and Analysis of Financial Condition and Results of Operations 8
Quantitative and Qualitative Disclosures About Market Risk 15
Part II Other Information 16
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Synbiotics Corporation
Condensed Consolidated Statement of Operations and Comprehensive Loss (unaudited)
- ---------------------------------------------------------------------------------
Three Months Ended March 31,
----------------------------------------
2000 1999
------------------ -------------------
Revenues:
Net sales $ 9,158,000 $ 9,390,000
Internet revenues 2,000
License fees 61,000 61,000
Royalties 2,000 3,000
------------------ -------------------
9,223,000 9,454,000
------------------ -------------------
Operating expenses:
Cost of sales 4,933,000 4,080,000
Research and development 547,000 560,000
Selling and marketing 2,541,000 2,018,000
General and administrative 1,726,000 1,414,000
------------------ -------------------
9,747,000 8,072,000
------------------ -------------------
(Loss) income from operations (524,000) 1,382,000
Other income (expense):
Interest, net (332,000) (327,000)
------------------ -------------------
(Loss) income before income taxes (856,000) 1,055,000
(Benefit from) provision for income taxes (22,000) 465,000
------------------ -------------------
(Loss) income before extraordinary item (834,000) 590,000
Early extinguishment of debt, net of tax 116,000
------------------ -------------------
Net (loss) income (834,000) 706,000
Cumulative translation adjustment (108,000) (904,000)
------------------ -------------------
Comprehensive loss $ (942,000) $ (198,000)
================== ===================
Basic (loss) income per share:
(Loss) income from continuing operations $ (0.09) $ 0.06
Early extinghuishment of debt, net of tax 0.01
------------------ -------------------
Net (loss) income $ (0.09) $ 0.07
================== ===================
Diluted (loss) income per share:
(Loss) income from continuing operations $ (0.09) $ 0.06
Early extinghuishment of debt, net of tax 0.01
------------------ -------------------
Net (loss) income $ (0.09) $ 0.07
================== ===================
See accompanying notes to condensed consolidated financial statements.
-1-
Item 1. Financial Statements (continued)
Synbiotics Corporation
Condensed Consolidated Balance Sheet
March 31, December 31,
2000 1999
------------- -------------
(unaudited) (audited)
Assets
Current assets:
Cash and equivalents $ 2,726,000 $ 2,260,000
Securities available for sale 1,516,000 3,443,000
Accounts receivable 5,570,000 4,517,000
Inventories 5,226,000 5,178,000
Deferred tax assets 508,000 505,000
Other current assets 1,734,000 1,570,000
------------- -------------
Total current assets 17,280,000 17,473,000
Property and equipment, net 1,839,000 1,744,000
Goodwill 14,835,000 12,137,000
Deferred tax assets 8,092,000 8,055,000
Deferred debt issuance costs 398,000 447,000
Other assets 3,766,000 4,191,000
------------- -------------
$ 46,210,000 $ 44,047,000
============= =============
Liabilities and Shareholders' Equity:
Current liabilities:
Accounts payable and accrued expenses $ 5,814,000 $ 5,921,000
Current portion of long-term debt 1,000,000 1,000,000
Deferred revenue 242,000 242,000
------------- -------------
Total current liabilities 7,056,000 7,163,000
------------- -------------
Long-term debt 8,568,000 5,914,000
Deferred revenue 909,000 969,000
Other liabilities 1,573,000 1,546,000
------------- -------------
11,050,000 8,429,000
------------- -------------
Mandatorily redeemable common stock 2,444,000 2,412,000
------------- -------------
Non-mandatorily redeemable common stock and other shareholders' equity:
Common stock, no par value, 24,800,000 share authorized,
9,366,000 and 8,576,000 shares issued and outstanding at
March 31, 2000 and December 31, 1999 40,015,000 39,424,000
Common stock warrants 1,003,000 1,003,000
Accumulated other comprehensive loss (1,024,000) (916,000)
Accumulated deficit (14,334,000) (13,468,000)
------------- -------------
Total non-mandatorily redeemable common stock and other shareholders' equity 25,660,000 26,043,000
------------- -------------
$ 46,210,000 $ 44,047,000
============= =============
See accompanying notes to condensed consolidated financial statements.
-2-
Item 1. Financial Statements (continued)
Synbiotics Corporation
Condensed Consolidated Statement of Cash Flows (unaudited)
Three Months Ended March 31,
---------------------------------
2000 1999
------------- -------------
Cash flows from operating activities:
Net (loss) income $ (834,000) $ 706,000
Adjustments to reconcil net (loss) income to net cash (used for) provided by
operating activities:
Depreciation and amortization 602,000 608,000
Early extinguishment of debt (200,000)
Changes in assets and liabilities:
Account receivable (1,053,000) (1,253,000)
Inventories (48,000) (490,000)
Deferred taxes (40,000) 355,000
Other assets 57,000 577,000
Accounts payable and accrued expenses 374,000 1,637,000
Income taxes payable 113,000
Deferred revenue (60,000) 1,393,000
Other liabilities 27,000 29,000
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Net cash (used for) provided by operating activities (975,000) 3,475,000
------------- -------------
Cash flows from investing activities:
Acquisition of property and equipment (238,000) (343,000)
Proceeds from sale of securities available for sale 1,927,000 241,000
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Net cash provided by (used for) investing activities 1,689,000 (102,000)
------------- -------------
Cash flows from financing activities:
Payments of long-term debt (250,000) (1,050,000)
Proceeds from issuance of common stock, net 110,000 138,000
------------- -------------
Net cash used for financing activities (140,000) (912,000)
------------- -------------
Net increase in cash and equivalents 574,000 2,461,000
Effect of exchange rates on cash (108,000) (904,000)
Cash and equivalents - beginning of period 2,260,000 4,357,000
------------- -------------
Cash and equivalents - end of period $ 2,726,000 $ 5,914,000
============= =============
See accompanying notes to condensed consolidated financial statements.
-3-
Item 1. Financial Statements (continued)
SYNBIOTICS CORPORATION
Notes to Condensed Consolidated Financial Statements (unaudited)
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Note 1 - Interim Financial Statements:
The accompanying condensed consolidated balance sheet as of March 31, 2000 and
the condensed consolidated statements of operations and comprehensive loss and
of cash flows for the three months ended March 31, 2000 and 1999 have been
prepared by Synbiotics Corporation (the "Company") and have not been audited.
The condensed consolidated financial statements of the Company include the
accounts of its wholly-owned subsidiaries Synbiotics Europe SAS and W3COMMERCE.
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,
1999. 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 January 12, 2000, the Company acquired W3COMMERCE LLC, a privately-held
Internet systems and services provider based in San Diego, CA. The consideration
paid was $2,913,000, which consisted of $100,000 in cash and a 5 year,
$2,813,000 note, which bears interest at 6.21% and is convertible into 1,000,000
shares of the Company's common stock beginning January 12, 2002. Upon
conversion, any accrued interest will be forgiven. The former shareholders of
W3COMMERCE may receive up to an additional 800,000 shares of the Company's
common stock if certain per share stock price targets for the Company's common
stock are reached prior to January 12, 2003.
The transaction was accounted for as a purchase. Goodwill arising from the
transaction totalled $3,064,000 which is being amortized over an estimated
useful life of 10 years utilizing the straight-line method. The convertible debt
portion of the of the purchase price and liabilities assumed totalling
$2,893,000 is considered a non-cash financing activity for purposes of the
statement of cash flows.
The Company's statement of operations includes the results of operations of
W3COMMERCE for the period January 1, 2000 to March 31, 2000. The following are
pro forma results of operations as if the W3COMMERCE transaction had been
consummated on January 1, 1999:
Three Months
Ended
March 31, 1999
--------------
(unaudited)
Revenues:
As Reported $ 9,454,000
==============
Pro forma $ 9,456,000
==============
Net income:
As reported $ 706,000
==============
Pro forma $ 429,000
==============
-4-
Item 1. Financial Statements (continued)
SYNBIOTICS CORPORATION
Notes to Condensed Consolidated Financial Statements (unaudited)
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Three Months
Ended
March 31, 1999
------------------
(unaudited)
Basic net income per share:
As reported $ 0.07
==================
Pro forma $ 0.04
==================
Diluted net income per share:
As reported $ 0.07
==================
Pro forma $ 0.04
==================
Note 3 - Inventories:
Inventories consist of the following:
March 31, December 31,
2000 1999
-------------- ---------------
(unaudited) (audited)
Inventories:
Raw materials $ 3,013,000 $ 2,320,000
Work in process 122,000 589,000
Finished goods 2,091,000 2,269,000
-------------- ---------------
$ 5,226,000 $ 5,178,000
============== ===============
Note 4 - (Loss) Income per Share:
The following is a reconciliation of net (loss) income and share amounts used in
the computations of (loss) income per share:
Three Months Ended March 31,
-----------------------------------
2000 1999
-----------------------------------
Basic and diluted net (loss) income used:
(Loss) income from continuing operations $ (834,000) $ 590,000
Less accretion of mandatorily redeemable common stock (32,000) (31,000)
------------- -------------
(Loss) income from continuing operations used in computing
basic (loss) income from continuing operations per share (866,000) 559,000
Early extinguishment of debt, net of tax 116,000
------------- -------------
Net (loss) income used in computing basic and diluted net (loss)
income per share $ (866,000) $ 675,000
============= =============
-5-
Item 1. Financial Statements (continued)
SYNBIOTICS CORPORATION
Notes to Condensed Consolidated Financial Statements (unaudited)
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Three Months Ended March 31,
-------------------------------------
2000 1999
---------------- ---------------
Shares used:
Weighted average common shares outstanding used in computing basic
(loss) income per share 9,281,000 8,920,000
Weighted average options and warrants to purchase common stock as
determined by the treasury method 349,000
---------------- ---------------
Shares used in computing diluted (loss) income per share 9,281,000 9,269,000
================ ===============
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 1,337,000 shares have
been excluded from the shares used in computing diluted net (loss) income per
share for the three months ended March 31, 2000 as their effect is anti-
dilutive. In addition, warrants to purchase 265,000 and 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 months ended March
31, 2000 and 1999, respectively, 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 March 31, 2000 and 1999.
Note 5 - Segment Information and Significant Customers:
The Company has determined that it has only one reportable segment based on the
fact that all of its products are animal health products. Although the Company
sells diagnostic, vaccine and instrument products, it does not base its business
decision making on a product category basis.
The following are revenues for the Company's diagnostic, vaccine and instrument
products:
Three Months Ended March 31,
--------------------------------------
2000 1999
---------------- ----------------
(unaudited) (unaudited)
Diagnostics $ 6,536,000 $ 7,390,000
Vaccines 2,039,000 1,758,000
Instruments 579,000 242,000
Other revenues 69,000 64,000
---------------- ----------------
$ 9,223,000 $ 9,454,000
================ ================
The following are revenues and long-lived assets information by geographic area:
Three Months Ended March 31,
---------------------------------------
2000 1999
---------------- -----------------
(unaudited) (unaudited)
Revenues:
United States $ 6,498,000 $ 6,396,000
France 1,292,000 1,404,000
Other foreign countries 1,433,000 1,654,000
---------------- -----------------
$ 9,223,000 $ 9,454,000
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-6-
Item 1. Financial Statements (continued)
SYNBIOTICS CORPORATION
Notes to Condensed Consolidated Financial Statements (unaudited)
- ---------------------------------------------------------------------------------------------------------------------
March 31, December 31,
2000 1999
------------------ ------------------
(unaudited) (audited)
Long-lived assets:
United States $ 14,831,000 $ 12,079,000
France 5,988,000 6,440,000
Other foreign countries 19,000
------------------ ------------------
$ 20,838,000 $ 18,519,000
================== ==================
The Company had sales to one customer totalling $1,053,000 during the three
months ended March 31, 2000. During the three months ended March 31, 1999,
sales to one customer totalled $1,806,000.
NOTE 6 - SUBSEQUENT EVENTS:
On April 21, 2000, the Company acquired the poultry diagnostic product line from
Kirkegaard & Perry Laboratories, Inc. The consideration paid was $3,500,000
in cash upon closing, with an additional $1,000,000 due upon the earlier of the
transfer of manufacturing or one year from the date of closing. In addition,
the Company will be required to pay up to $1,500,000, three years from the date
of closing, based upon its sales of the acquired products, which will be
recorded as additional purchase price as the related sales are recognized.
In April 2000, the Company refinanced its outstanding Banque Paribas debt with
Imperial Bank ("Imperial"). The new debt agreement includes a $6,000,000 term
loan, which is due in April 2005, bears interest at the rate of prime plus
0.50%, is payable in monthly installments, beginning in May 2000, of $100,000 of
principal plus accrued interest and is secured by substantially all of the
Company's assets.
In addition, the debt agreement includes a $4,000,000 revolving line of credit
which bears interest at the rate of prime plus 0.50%, with interest only
payments to be made monthly beginning in May 2000. Any outstanding principal is
due in April 2002. The Company is required to pay a quarterly commitment fee
equal to 0.50% per annum on the average unused portion of the line of credit
facility.
Imperial 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 Imperial's consent.
The Company will record an approximately $1,000,000 extraordinary loss on early
extinguishment of debt in the second quarter of 2000, which represents the
remaining unamortized debt issuance costs and debt discount on the Banque
Paribas debt.
-7-
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The information contained in this Management's Discussion and Analysis of
Financial Condition and Results of Operations and elsewhere in this Quarterly
Report on Form 10-Q contains both historical financial information and forward-
looking statements. We do not provide forecasts of future financial performance.
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 our forward-looking statements and assessing our future financial
condition, results of operations and cash flows:
The market in which we operate is intensely competitive, even with regard to our
key canine heartworm diagnostic products, and many of our competitors are larger
and more established
The market for animal health care products is extremely competitive. Companies
in the animal health care market compete to develop new products, to market and
manufacture products efficiently, to implement effective research strategies,
and to obtain regulatory approval. Our current competitors include significantly
larger companies such as Pfizer Animal Health, Merial S.A.S. (the successor to
Rhone-Merieux), Schering-Plough and IDEXX Laboratories. These companies are
substantially larger and have greater financial, manufacturing, marketing, and
research resources than we do. Our current competitors also have extensive
expertise in conducting pre-clinical and clinical testing of new products and in
obtaining the necessary regulatory approvals to market products. In addition,
IDEXX Laboratories prohibits its distributors from selling competitors'
products, including ours. Further, additional competition could come from new
entrants to the animal health care market. We cannot assure you that we will be
able to compete successfully in the future or that competition will not harm our
business.
Our canine heartworm products constitute 39% of our sales. In addition to our
historic competition with IDEXX Laboratories, the sales leader in this product
category, our sales were substantially affected in 1999 by a new heartworm
product from Heska Corporation. We have filed a lawsuit against Heska, claiming
that its heartworm product infringes our patent. Also, Abbott Laboratories
entered the canine heartworm diagnostic market in March 2000, and our market
share and average selling prices may decline, perhaps significantly.
We have a history of losses and an accumulated deficit
We did not achieve profitability for the years ended December 31, 1998 and 1999,
and we have had a history of losses. We have incurred a consolidated accumulated
deficit of $14,334,000 at March 31, 2000. We may not achieve profitability again
and if we are profitable in the future there can be no assurance that
profitability can be sustained. The additional expenses which we anticipate we
will incur while building W3COMMERCE's business may prevent us from being
profitable, even if our traditional animal health business were to be
profitable.
We depend on third party manufacturers
We contract for the manufacture of some of our products, including our vaccines,
our Witness(R) and VetRED(R) diagnostic kits, and our SCA 2000(TM) blood
coagulation timing instrument. We also expect that some of our anticipated new
products will be manufactured by third parties. In addition, some of the
products manufactured for us by third parties, including Witness(R) and
VetRED(R) are licensed to us by their manufacturers. There are a number of risks
associated with our dependence on third-party manufacturers including:
. reduced control over delivery schedules;
. quality assurance;
. manufacturing yields and costs;
. the potential lack of adequate capacity during periods of excess
demand;
. limited warranties on products supplied to us; and
-8-
. increases in prices and the potential misappropriation of our
intellectual property.
If our third party manufacturers fail to supply us with an adequate number of
finished products, our business would be significantly harmed. We have no long-
term contracts or arrangements with any of our vendors that guarantee product
availability, the continuation of particular payment terms or the extension of
credit limits.
In addition, sales of our feline leukemia virus ("FeLV") vaccine to Merial
S.A.S. and other distributors for resale in Europe will be at risk unless our
manufacturer, Bio-Trends International, Inc. ("Bio-Trends"), obtains European
Union regulatory approvals for its manufacturing facilities. Loss of these sales
would have a material adverse effect on our profitability and our cash flows.
If we encounter delays or difficulties in our relationships with our
manufacturers, the resulting problems could have a material adverse effect on
us. For example, all of our vaccine products (other than our FeLV vaccine
products) were manufactured using bulk antigen fluids that were supplied by a
third party. The supply agreement expired and we were unable to locate a
replacement supplier for these bulk antigen fluids. We decided to discontinue
the sales of the affected products once our remaining supplies were exhausted,
which occurred during the third quarter of 1999. Sales of the affected products
totaled $1,645,000, $2,073,000 and $1,596,000 during 1999, 1998 and 1997,
respectively.
We rely on third party distributors for a substantial portion of our sales, but
we are experiencing difficulties with the distribution channel
Because we have historically depended upon distributors for such a large portion
of our sales (although we did not have any customers representing 10% or more of
our net sales during 1999, sales to two distributors totaled 33% of our net
sales during 1998), our ability to establish and maintain an adequate
independent sales and marketing capability in any or all of our targeted markets
may be impaired. Our failure to independently sell and market our products could
materially harm our business. Further, distributor agreements render our sales
exposed to the efforts of third parties who are not employees of Synbiotics and
over whom we have no control. Their failure to generate significant sales of our
products could materially harm our business. Reduction by these distributors of
the quantity of our products which they distribute would materially harm our
business. In addition, IDEXX Laboratories' prohibition against its distributors
carrying competitors' products, including ours, has and could continue to make
some distributors unavailable to us. We adopted a similar policy in the second
quarter of 1999, which caused some of our distributors to abandon our product
line. Although we have rescinded this policy, and some of our former
distributors are again selling our products, we do not expect our sales to
distributors to reach their previous levels.We are also exposed to the risk that
any sales by us directly to veterinarians could alienate our current
distributors.
Our direct selling efforts may not succeed
We are increasing our efforts to sell our products directly to veterinarians,
including by telesales and over the Internet. We are inexperienced in large-
scale direct selling efforts and may not be able to successfully execute this
strategy. Also, veterinarians have traditionally relied on distributors, and the
number of veterinarians willing to purchase directly from manufacturers may be
smaller than we believe.
Our profitable vaccine sales in Europe may decline soon
Merial distributes in Europe our FeLV vaccine, which we obtain from Bio-Trends.
Our gross profit in 1999 and 1998 on these sales of FeLV vaccine to Merial in
Europe was $570,000 and $520,000, respectively. Merial has exercised a
contractual right which will enable it, in 2002, to introduce its own FeLV
vaccine product in Europe. If Merial does so, our sales to Merial in Europe
would probably decline sharply.
There is no assurance that acquired businesses can be successfully combined
There can be no assurance that the anticipated benefits of the April 2000
acquisition of the poultry product line from Kirkegaard & Perry Laboratories,
Inc., the January 2000 acquisition of W3COMMERCE, 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
-9-
Acquired Business, the diversion of management's attention from other business
concerns and the risks of entering markets in which we have no or limited direct
prior experience. In addition, there can be no assurance that the acquisitions
will not have a material adverse effect upon our business, results of
operations, financial condition or cash flows, 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 us, as well as operating and
development expenses inherent in the Acquired Business itself as opposed to
integration of the Acquired Business.
Our acquisition of W3COMMERCE may not prove profitable
There can be no assurance that our January 2000 acquisition of W3COMMERCE will
result in profits to us or that we will be able to recover the money we invest
in W3COMMERCE's operations. The efforts of W3COMMERCE to integrate our business
with the retailing of products over the Internet may not be successful, and this
may harm our business. Our acquisition of W3COMMERCE subjects us to risks
associated with the acquisition of any business, as well as the following risks
specifically associated with doing business over the Internet:
. W3COMMERCE's business model has not been demonstrated as profitable;
. W3COMMERCE's business model could be replicated by other companies if
it is perceived as being successful;
. larger, more established competitors may enter the online markets in
which we intend to operate;
. the Internet may not continue to grow as a focal point of business
transactions;
. the Internet may become subject to additional government regulation
that may harm our business;
. retail sale of products on the Internet has not been widely
demonstrated as profitable; and
. we do not have experience in marketing products other than animal
health products, yet W3COMMERCE's business plan calls for expansion
into other markets.
We depend on key executives and personnel
Our future success will depend, to a significant extent, on the ability of our
management to operate effectively, both individually and as a group. Competition
for qualified personnel in the animal health care products industry is intense,
and even more intense in the Internet marketing business, and we may not be
successful in attracting and retaining such personnel. There are only a limited
number of persons with the requisite skills to serve in those positions and it
may become increasingly difficult to hire such persons.
The loss of the services of any of our key personnel or the inability to attract
or retain qualified personnel could harm our business.
We rely on new and recent products
In our animal health business we rely to a significant extent on new and
recently developed products, and expect that we will need to continue to
introduce new products to be successful in the future. There can be no assurance
that we will obtain and maintain market acceptance of our products. There can be
no assurance that future 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 we are unable to
produce internally, or to contract for, a sufficient supply of our new products
on acceptable terms, or if we should encounter delays or difficulties in our
relationships with manufacturers, the introduction of new products would be
delayed, which could have a material adverse effect on our business.
-10-
We may need additional capital in the future
We currently anticipate that our existing cash balances and short term
investments and cash flow expected to be generated from future operations will
be sufficient to meet our liquidity needs for at least the next twelve months.
However, we may need to raise additional funds if our estimates of revenues,
working capital and/or capital expenditure requirements change or prove
inaccurate or in order for us to respond to unforeseen technological or
marketing hurdles or to take advantage of unanticipated opportunities.
Further, our future capital requirements will depend on many factors beyond our
control or ability to accurately estimate, including the expenses of building
W3COMMERCE's Internet business, continued scientific progress in our product 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. In addition, we expect to review potential acquisitions that would
complement our existing product offerings or enhance our technical capabilities.
While we have no current agreements with respect to any such acquisition, any
future transaction of this nature could require potentially significant amounts
of capital. Such funds may not be available at the time or times needed, or
available on terms acceptable to us. If adequate funds are not available, or are
not available on acceptable terms, we may not be able to take advantage of
market opportunities, to develop new products, or to otherwise respond to
competitive pressures. This inability could materially harm our business.
In April 2000, we refinanced our outstanding Banque Paribas debt with Imperial
Bank ("Imperial"). The new Imperial debt agreement includes a $6,000,000 term
loan and a $4,000,000 revolving line of credit.
The term loan is due in April 2005, bears interest at the rate of prime plus
0.50%, is payable beginning in May 2000 in monthly installments of $100,000 of
principal plus accrued interest and is secured by substantially all our assets.
The line of credit bears interest at the rate of prime plus 0.50%, with interest
only payments to be made monthly beginning in May 2000. Any outstanding
principal under the line of credit is due in April 2002. The Company is required
to pay a quarterly commitment fee equal to 0.50% per annum on the average unused
portion of the line of credit facility.
Imperial requires us to maintain certain financial ratios and levels of tangible
net worth and also restricts our ability to pay dividends and make loans,
capital expenditures or investments without Imperial's consent.
We will record an approximately $1,000,000 extraordinary loss on early
extinguishment of debt in the second quarter of 2000, which represents the
remaining unamortized debt issuance costs and debt discount on the Banque
Paribas debt.
If adequate funds are not available to us, or if they are not available on terms
reasonably favorable to us, we may need to delay, reduce, or eliminate one or
more of our research and development programs. Any of these events would impair
our competitive position and harm our business.
Our canine heartworm business is seasonal
Our operations are seasonal due to the timing of sales of our canine heartworm
diagnostic products. Our sales and profits tend to be concentrated in the first
half of the year as our distributors prepare for the heartworm season by
purchasing diagnostic products for resale to veterinarians. The operations of
SBIO-E have reduced our seasonality as sales of their large animal diagnostic
products tend to occur evenly throughout the year. We believe that increased
sales of our instrument products, our newly acquired poultry diagnostic products
and our Internet business will also reduce our seasonality.
-11-
Our failure to adequately establish or protect our proprietary rights may
adversely affect us
We rely on a combination of patent, copyright, and trademark laws, and on trade
secrets and confidentiality provisions and other contractual provisions to
protect our proprietary rights. These measures afford only limited protection.
We currently have 11 issued U.S. patents and several pending patent
applications. Our means of protecting our proprietary rights in the U.S. or
abroad may not be adequate and competitors may independently develop similar
technologies. Our future success will depend in part on our ability to protect
our proprietary rights and the technologies used in our principal products.
Despite our efforts to protect our proprietary rights, unauthorized parties may
attempt to copy aspects of our products or to obtain and use trade secrets or
other information that we regard as proprietary. In addition, the laws of some
foreign countries do not protect our proprietary rights as fully as do the laws
of the U.S. Issued patents may not preserve our proprietary position. Even if
they do, competitors or others may develop technologies similar to or superior
to our own. If we do not enforce and protect our intellectual property, our
business will be harmed.
From time to time, third parties, including our competitors, have asserted
patent, copyright, and other intellectual property rights to technologies that
are important to us. We expect that we will increasingly be subject to
infringement claims as the number of products and competitors in the animal
health care market increases.
The results of any litigated matter are inherently uncertain. In the event of
an adverse result in any litigation with third parties that could arise in the
future, we could be required to:
. pay substantial damages, including treble damages if we are held to
have willfully infringed;
. cease the manufacture, use and sale of infringing products;
. expend significant resources to develop non-infringing technology; or
. obtain licenses to the infringing technology.
Licenses may not be available from any third party that asserts intellectual
property claims against us on commercially reasonable terms, or at all.
Also, litigation is costly regardless of its outcome and can require significant
management attention. For example, in 1997, Barnes-Jewish Hospital (the
"Hospital") filed an action against us claiming that our canine heartworm
diagnostic products infringe their patent. We settled this lawsuit, but there
can be no assurance that we would be able to resolve similar incidents in the
future.
Also, because our patents and patent applications cover novel diagnostic
approaches,
. the patent coverage which we receive could be significantly narrower
than the patent coverage we seek in our patent applications; and
. our patent positions involve complex legal and factual issues which
can be hard for patent examiners or lawyers asserting patent coverage
to successfully resolve.
Because of this, our patent position could be vulnerable and our business could
be materially harmed.
The U.S. patent application system also exposes us to risks. In the United
States, the first party to make a discovery is granted the right to patent it
and patent applications are maintained in secrecy until the underlying patents
issue. For these reasons, we can never know if we are the first to discover
particular technologies. Therefore, we can never be certain that our
technologies will be patented and we could become involved in lengthy,
expensive, and distracting disputes concerning whether we were the first to make
the disputed discovery. Any of these events would materially harm our business.
Our business is regulated by the United States and various foreign governments
Our business is subject to substantial regulation by the United States
government, most notably the United States Department of Agriculture, and the
French government. In addition, our operations may be subject to future
legislation and/or rules issued by
-12-
domestic or foreign governmental agencies with regulatory authority relating to
our business. There can be no assurance that we will continue to be in
compliance with any of these regulations.
For marketing outside the United States, we, and our suppliers, are subject to
foreign regulatory requirements, which vary widely from country to country.
There can be no assurance that we, and our suppliers, will meet and sustain
compliance with any such requirements. In particular, our sales of feline FeLV
vaccine to Merial S.A.S. or other distributors for resale in Europe will be at
risk unless Bio-Trends, our supplier, obtains European Union regulatory
approvals for its manufacturing facilities.
Our liability insurance may prove inadequate
Our products carry an inherent risk of product liability claims and associated
adverse publicity. While we have maintained product liability insurance for
such claims to date, we cannot be certain that this type of insurance will
continue to be available to us or, if it is available, that it can be obtained
on acceptable terms. Also, our current coverage limits may not be adequate.
Any claim against us which results in our having to pay damages in excess of our
coverage limits will materially harm our business. Even if such a claim is
covered by our existing insurance, the resulting increase in insurance premiums
or other charges would increase our expenses and harm our business.
We use hazardous materials
Our business requires that we store and use hazardous materials and chemicals,
including radioactive compounds. Although we believe that our procedures for
storing, handling, and disposing of these 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.
If any of these materials were mishandled, or if an accident with them occurred,
the consequences could be extremely damaging and we could be held liable for
them. Our liability for such an event would materially harm our business and
could exceed all of our available resources for satisfying it.
Results of Operations
Our net sales for the first quarter of 2000 decreased by $236,000 or 2% from the
first quarter of 1999. The decrease reflects a decrease in our sales of
diagnostic products of $854,000, an increase in our vaccine product sales of
$281,000 and an increase in our instrument product sales of $337,000. The
decrease in our sales of diagnostic products is primarily due to a promotional
program in the United States. While our sales in units have increased, these
sales were at reduced average selling prices. Our U.S. heartworm sales in units
during the first quarter of 2000 increased by 10% over the first quarter of
1999, yet our sales in dollars for these products decreased by 9%. In Europe,
sales of our large animal diagnostic products decreased 14% due to increased
competition, and a change in the timing of mandated disease eradication testing
required by certain European governmental authorities. Tests that used to be
required annually are now only required to be performed every other year. The
weakening of the French Franc against the U.S. dollar also negatively impacted
our European diagnostic sales. Our increased vaccine sales reflected an increase
of 139% in sales of bulk FeLV vaccine (related to the timing of shipments as
requested by our OEM customer), offset by a 77% decrease in sales of vaccines to
private label partners. Our instrument product sales increased primarily due to
sales of our SCA 2000 blood coagulation timing instrument, which we introduced
during the second quarter of 1999.
All of our vaccine products (exclusive of our FeLV vaccine products) were
manufactured using bulk antigen fluids that were supplied by a third party. The
supply agreement expired and we were unable to locate a replacement supplier for
these bulk antigen fluids. We decided to discontinue the sales of the affected
products once our remaining supplies were exhausted, which occurred during the
third quarter of 1999. Sales of the affected products totaled $1,645,000 and
$2,073,000 during 1999 and 1998, respectively.
Although veterinary products manufacturers, including us, have traditionally
relied on distributors, we have been increasing our direct sales of products to
veterinarians via telesales and the Internet as part of a focused strategy. In
addition, we stopped selling to several distributors and to Vedco, Inc., a
distributor co-op, in the second quarter of 1999.
Our cost of sales as a percentage of our net sales was 54% during the first
quarter of 2000 compared to 43% during the first quarter of 1999 (i.e., our
gross margin decreased to 46% from 57%). The lower gross margin is a direct
result of three factors: i) the overall decrease in our sales, ii) the increased
sales of no margin bulk FeLV vaccine to Merial, which are at cost, and iii) the
fact that a significant portion of our manufacturing costs are fixed costs. Our
gross margin, exclusive of the no margin bulk FeLV vaccine sales, would have
been 52% and 59% for the first quarter of 2000 and 1999, respectively. Among
our major products, our DiroCHEK(R)
-13-
canine heartworm diagnostic products and the ProChem(R) analyzer are
manufactured at our facilities, whereas our WITNESS(R), VetRED(R), all vaccines
and the SCA 2000(TM) are manufactured by third parties. In addition to affecting
our gross margins, outsourcing of manufacturing renders us relatively more
dependent on the third-party manufacturers.
In March 1999, we amended (effective July 1, 1998) our FeLV vaccine supply
agreement with Merial Limited ("Merial"). Since 1992, we have supplied FeLV
vaccine to Merial in the United States. This has included shipments to Merial at
our cost, while Merial has paid a royalty to us on their sales of Merial-labeled
FeLV vaccine. In exchange for $1,500,000 in cash ($1,453,000 of which we are
recognizing ratably over the remaining term of the supply agreement, and the
remainder of which was applied to royalties receivable from Merial), the revised
supply agreement broaden Merial's U.S. distribution rights (which were an area
of ongoing discussions) and eliminate the royalty. In addition, we will work
with Merial to try to have Bio-Trends supply FeLV vaccine directly to Merial for
U.S. distribution. Our FeLV vaccine sales to Merial totalled $2,431,000 and
$2,029,000 during 1999 and 1998, respectively. In the meantime, we will continue
to resell Bio-Trends-supplied FeLV vaccine to Merial at cost for the U.S. Sales
of our own VacSyn FeLV vaccine product, our sales to Merial S.A.S. in France,
which are at a profit rather than at cost, and the collaborative research
relationship between Merial Limited and us were not affected by this amendment.
Our research and development expenses did not change significantly during the
first quarter of 2000 as compared to the first quarter of 1999. Our research
and development expenses as a percentage of our net sales were 6% during the
first quarters of 2000 and 1999. We expect our research and development
expenses to increase during the remainder of 2000 due to further development of
our instrument product line and our newly acquired poultry diagnostic product
line.
Our selling and marketing expenses during the first quarter of 2000 increased by
$523,000 or 26% over the first quarter of 1999. The increase is due primarily
to the acquisition of W3COMMERCE and increase in our direct-to-veterinarian
telemarketing group. Our selling and marketing expenses as a percentage of our
net sales were 28% and 21% during the first quarter of 2000 and 1999,
respectively. We will continue to increase our investment in sales and
marketing to expand our field sales force and our telemarketing and Internet
sales efforts.
Our general and administrative expenses during the first quarter of 2000
increased by $312,000 or 22% over the first quarter of 1999. The increase is
due primarily to legal expenses related to our patent litigation with Heska,
increased use tax, resulting from a state use tax audit, and foreign currency
losses related to our intercompany receivable from SBIO-E. Our general and
administrative expenses as a percentage of our net sales were 19% and 15% during
the first quarter of 2000 and 1999, respectively.
Our combined effective tax rate was 3% during the first quarter of 2000 as
compared to 44% during the first quarter of 1999. The decrease in our effective
rate is due primarily to the net operating loss in the first quarter of 2000,
offset by a change in our deferred tax assets and state income tax expense
resulting from certain states' taxes being calculated on our net worth rather
than our net income.
Financial Condition
We believe that our present capital resources, which included working capital of
$10,224,000 at March 31, 2000, are sufficient to meet our current working
capital needs and service our debt for at least the next twelve months. As of
March 31, 2000, we had outstanding principal balances on our Banque Paribas debt
of $7,250,000, and outstanding principal balances on our convertible debt issued
in conjunction with the acquisition of W3COMMERCE of $2,813,000.
In April 2000, we refinanced our outstanding Banque Paribas debt with Imperial
Bank ("Imperial"). The new Imperial debt agreement includes a $6,000,000 term
loan and a $4,000,000 revolving line of credit.
The term loan is due in April 2005, bears interest at the rate of prime plus
0.50%, is payable beginning in May 2000 in monthly installments of $100,000 of
principal plus accrued interest and is secured by substantially all our assets.
The line of credit bears interest at the rate of prime plus 0.50%, with interest
only payments to be made monthly beginning in May 2000. Any outstanding
principal under the line of credit is due in April 2002. We are required to pay
a quarterly commitment fee equal to 0.50% per annum on the average unused
portion of the line of credit facility.
Imperial requires us to maintain certain financial ratios and levels of tangible
net worth and also restricts our ability to pay dividends and make loans,
capital expenditures or investments without Imperial's consent.
-14-
We will record an approximately $1,000,000 extraordinary loss on early
extinguishment of debt in the second quarter of 2000, which represents the
remaining unamortized debt issuance costs and debt discount on the Banque
Paribas debt.
Our operations are seasonal due to the timing of sales of our canine heartworm
diagnostic products. Our sales and profits tend to be concentrated in the first
half of the year, as our distributors prepare for the heartworm season by
purchasing diagnostic products for resale to veterinarians. The operations of
SBIO-E have reduced our seasonality as sales of their large animal diagnostic
products tend to occur evenly throughout the year. We believe that Increased
sales of our instruments and supplies, our newly acquired poultry diagnostic
products and success in our Internet marketing business will also reduce our
seasonality.
Impact of the Year 2000 Issue
We did not incur any disruption of our operations related to the year 2000
issue, nor are we aware of any disruption in the operations of our major
suppliers and customers due to the year 2000 issue.
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
Our market risk consists primarily of changes interest rates and foreign
currency exchange rates.
Interest Rate Risk
The fair value of our investments available for sale at March 31, 2000 was
$1,516,000, all of which consists of fixed interest rate securities. The
objectives of our investment policy are the safety and preservation of invested
funds, and liquidity of investments that is sufficient to meet cash flow
requirements. Our policy is to place our cash, cash equivalents, and investments
available for sale with high credit quality financial institutions, commercial
companies, and government agencies in order to limit the amount of credit
exposure.
The fair value of our long-term debt at March 31, 2000 was $10,063,000, of which
$2,813,000 has a fixed interest rate of 6.21%, and the remaining $7,250,000 has
a variable interest rate based on the prime rate.
A 5% change in interest rates would have no material impact on our financial
condition, results of operations or cash flows as it relates to our securities
available for sale. However, a 5% change in interest rates would have a
material impact on our financial condition, results of operations and cash flows
as it relates to our variable rate long-term debt.
Foreign Currency Exchange Rate Risk
Our foreign currency exchange rate risk relates to the operations of SBIO-E as
it transacts business in Euros, its local currency. However, this risk is
limited to our intercompany receivable from SBIO-E and the conversion of its
financial statements into the U.S. dollar for consolidation. There is no foreign
currency exchange rate risk related to SBIO-E's transactions outside of the
European Union as those transactions are denominated in Euros. Similarly, all of
the foreign transactions of our U.S. operations are denominated in U.S. dollars.
-15-
We do not hedge our cash flows on intercompany transactions. As a result, the
effects of a 5% change in exchange rates, would have a material impact on our
financial condition, results of operations and cash flows, but only to the
extent that it relates to the conversion of SBIO-E's financial statements,
including its intercompany payable, into the U.S. dollar for consolidation.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
No material changes.
Item 2. Changes in Securities
On January 12, 2000, in conjunction with our acquisition of W3COMMERCE LLC, we
issued convertible promissory notes convertible into an aggregate of 1,000,000
shares of our common stock. This was a Section 4(2) private offering, involving
no underwriters.
On January 28, 2000 we issued 134,503 shares of Common Stock to designees of
Barnes-Jewish Hospital as required by our 1998 settlement agreement of patent
infringement litigation which the Hospital brought against us. This was a
Section 4(2) private offering, involving no underwriters and no new
consideration to us.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
During the first quarter of 2000 we began a solicitation of written consent to
approve an amendment of our articles of incorporation to change our name. This
solicitation was not completed by the end of the first quarter.
Item 5. Other Information
On April 21, 2000, we acquired the poultry diagnostic product line from
Kirkegaard & Perry Laboratories, Inc. The consideration paid was $3,500,000 in
cash upon closing, with an additional $1,000,000 due upon the earlier of the
transfer of manufacturing or one year from the date of closing. In addition, we
will be required to pay up to $1,500,000, three years from the date of closing,
based upon our sales of the acquired products, which will be recorded as
additional purchase price as the related sales are recognized.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
--------
2.8 Exchange Agreement between the Registrant and the Individual
Members of W3COMMERCE LLC, dated January 12, 2000.
-16-
10.70 Non-Competition Agreement between the Registrant and Colin
Lucas-Mudd, dated January 12, 2000.
10.71/+/ Employment Agreement between W3COMMERCE LLC and Colin Lucas-
Mudd, dated January 12, 2000.
10.72 Convertible Promissory Note from the Registrant to Colin
Lucas-Mudd, dated January 12, 2000.
10.73 Convertible Promissory Note from the Registrant to Rigdon
Currie, dated January 12, 2000.
27 Financial Data Schedule (for electronic filing purposes
only).
____________________________
+ Management contract.
(b) Reports on Form 8-K
-------------------
On February 4, 2000, we filed a Form 8-K announcing our January 12,
2000 acquisition of W3COMMERCE LLC.
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: May 22, 2000 /s/ Michael K. Green
--------------------------------------------------
Michael K. Green
Senior Vice President and Chief Financial Officer
(signing both as a duly authorized officer and as
principal financial officer)
-17-
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.
EXHIBITS
TO
FORM 10-Q
UNDER
SECURITIES EXCHANGE ACT OF 1934
SYNBIOTICS CORPORATION
EXHIBIT INDEX
Exhibit No. Exhibit
- ----------- -------
2.8 Exchange Agreement between the Registrant and the Individual
Members of W3COMMERCE LLC, dated January 12, 2000.
10.70 Non-Competition Agreement between the Registrant and Colin Lucas-
Mudd, dated January 12, 2000.
10.71/+/ Employment Agreement between W3COMMERCE LLC and Colin Lucas-Mudd,
dated January 12, 2000.
10.72 Convertible Promissory Note from the Registrant to Colin Lucas-
Mudd, dated January 12, 2000.
10.73 Convertible Promissory Note from the Registrant to Rigdon Currie,
dated January 12, 2000.
27 Financial Data Schedule (for electronic filing purposes only).
_________________________
+ Management contract.