SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT
PURSUANT TO SECTIONS 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
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(MARK ONE)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
COMMISSION FILE NO. 000-22400
STRATEGIC DIAGNOSTICS INC.
(Exact name of Registrant as specified in its charter)
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DELAWARE 56-1581761
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) identification no.)
111 PENCADER DRIVE
NEWARK, DELAWARE 19702
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (302) 456-6789
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 Par Value
(Title of class)
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Indicate by check mark if the Registrant is a well-known seasoned
issuer, as defined in Rule 405 of the Securities Act. Yes |_| No |X|
Indicate by check mark if the Registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes |_| No |X|
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 |_|
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |X|
Indicate by check mark whether the Registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act.
Large Accelerated Filer |_| Accelerated Filer |_| Non-Accelerated Filer |X|
Indicate by check mark whether the Registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act. Yes |_| No |X|
The aggregate market value of the common stock held by non-affiliates of
the Registrant was $44,044,603, calculated by using the number of shares
outstanding and the closing price of the common stock on June 30, 2006 (the last
business day of the Registrant's most recently completed second fiscal quarter).
As of March 19, 2007 there were 20,179,779 shares outstanding of the
Registrant's common stock, par value $.01 per share.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement (the "Definitive Proxy
Statement") to be filed no later than April 29, 2007 with the Securities and
Exchange Commission relative to the Company's 2007 Annual Meeting of
Stockholders are incorporated by reference into Part III of this Report.
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PART I 1
ITEM 1. BUSINESS 1
OVERVIEW 1
GENOMIC ANTIBODIES(TM) TECHNOLOGY 2
IMMUNOASSAY TECHNOLOGY 3
BACTERIOPHAGE TECHNOLOGY 4
BIOLUMINESCENCE TECHNOLOGY 4
MARKETS AND PRODUCTS 5
SALES AND MARKETING STRATEGY 12
COMPETITION 12
REGULATORY APPROVALS 13
MANUFACTURING 14
RESEARCH AND DEVELOPMENT 15
PROPRIETARY TECHNOLOGY AND PATENTS 16
EMPLOYEES 18
ITEM 1A. RISK FACTORS 18
ITEM 1B. UNRESOLVED STAFF COMMENTS 22
ITEM 2. PROPERTIES 22
ITEM 3. LEGAL PROCEEDINGS 22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 22
PART II 23
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES
OF EQUITY SECURITIES 23
STOCK PERFORMANCE GRAPH 24
ITEM 6. SELECTED FINANCIAL DATA 25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 26
FORWARD-LOOKING STATEMENTS 26
OVERVIEW 26
RESULTS OF OPERATIONS 28
YEAR ENDED DECEMBER 31, 2006 VERSUS YEAR ENDED DECEMBER 31, 2005 28
YEAR ENDED DECEMBER 31, 2005 VERSUS YEAR ENDED DECEMBER 31, 2004 30
LIQUIDITY AND CAPITAL RESOURCES 32
OFF BALANCE SHEET ARRANGEMENTS 34
CONTRACTUAL OBLIGATIONS 34
CRITICAL ACCOUNTING POLICIES 34
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 38
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 39
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE 39
ITEM 9A. CONTROLS AND PROCEDURES 39
ITEM 9B. OTHER INFORMATION 39
PART III 40
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE 40
ITEM 11. EXECUTIVE COMPENSATION 41
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS 41
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS,
AND DIRECTOR INDEPENDENCE 42
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES 42
PART IV 42
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES 42
PART I
ITEM 1. BUSINESS
OVERVIEW
Strategic Diagnostics Inc. ("the Company" or "SDI") is a Delaware
corporation formed in 1990.
The Company develops, manufactures and markets antibodies, antibody
products and analytical test kits to a diverse customer base, across multiple
industrial and human health markets. By applying its core competencies of
creating custom antibodies and assay development, the Company produces unique,
sophisticated diagnostic testing and reagent systems that are responsive to
customer diagnostic and information needs. Customers benefit with quantifiable
"return on investment" by reducing time, labor, and/or material costs associated
with applications for which the Company's products are used. In addition, the
Company believes its tests provide high levels of accuracy, reliability and
actionability of essential test results as compared to alternative products. The
Company is focused on sustaining profitable growth by leveraging its expertise
in immunology, proteomics, bio-luminescence and other bio-reactive technologies
to successfully develop proprietary products and services that enhance the
competitive advantage of its customers.
The Company believes that its competitive position has been enhanced
through the combination of talent, technology and resources resulting from the
business development activities it has pursued since its inception. The Company
has achieved meaningful economies of scale for the unique products it offers
through the utilization of its consolidated facilities in Newark, Delaware, for
the manufacture of test kits and antibodies, and its facilities located in
Dallas, Texas and Windham, Maine for the manufacture of antibodies.
The Company currently meets its customers' needs through two divisions,
bio-services and industrial bio-detection services, which are described as
follows:
BIO-SERVICES
SDI is a leader in providing a wide array of custom antibodies, bulk
antibodies and antibody services, including the complete outsourcing of the
production of monoclonal and polyclonal antibodies embedded in commercialized
products offered by leading diagnostic and pharmaceutical companies. Through its
Strategic BioSolutions(TM) (SBS) brand, SDI serves the research, human
diagnostic and pharmaceutical industries.
The use of antibodies is a proven methodology used in research and
diagnostics, and is of particular importance in proteomics, a rapidly growing
segment of the Life Sciences market which involves the large-scale study of
proteins, particularly as they relate to human conditions such as, among others,
cancer, cardiovascular disease and neurological disorders.
INDUSTRIAL BIO-DETECTION TESTS
SDI's detection technologies allow industrial customers to rapidly and
cost-effectively identify the presence of pollutants, such as chemical toxins,
biological pathogens and other contaminants, that can compromise human or
environmental safety, and/or financially impact efficiencies of production
processes. Many of SDI's products in this area are in the form of single use
test devices, sample prep materials and reagents, thus creating recurring
revenue opportunities. Specific industry applications include:
o FOOD AND BEVERAGE MANUFACTURING: Systems for high efficiency
testing for the identification of pathogens and toxins in food,
water and the manufacturing environment.
o WATER UTILITIES: Drinking water tests for chemical toxins,
metals, and pathogens. Pollution control tests for effluent
toxicity, pesticides, metals and efficiency maintenance in
biological processing systems.
o ENVIRONMENTAL MANAGEMENT: On-site testing systems to increase
the speed and accuracy of environmental remediation of soil and
ground water pollutants.
o AGRICULTURE AND AGRO-SCIENCE: Systems for the detection,
identity preservation, and quantification testing of genetically
modified organisms, and test systems for feed and grain safety
testing, including for the presence of mycotoxins.
1
By leveraging its expertise in immunology, proteomics, bio-luminescence
and other bio-reactive technologies with innovative application and production
capabilities, the Company is able to provide sophisticated diagnostic testing
and reagent systems to a diverse customer base serving multiple vertical
markets.
In addition to this annual report on Form 10-K, the Company files
periodic and current reports, proxy statements and other information with the
SEC. The Company will provide these documents to you, free of charge, if you
request copies by sending a letter to the Company's Investor Relations
Department at the address set forth on the cover of this report. The Company can
also be contacted through its Internet home page, WWW.SDIX.COM. You may also
read and copy any document the Company files with the SEC at the SEC's Public
Reference Room at 100 F Street, NE, Washington, DC 20549. Please call the SEC at
(800) SEC-0330 for further information about the public reference facilities.
These documents also may be accessed through the SEC's electronic data
gathering, analysis and retrieval system ("EDGAR") via electronic means,
including the SEC's home page on the Internet, WWW.SEC.GOV.
The Company has adopted a Code of Ethics, within the meaning of
applicable SEC rules, applicable to its Chief Executive Officer, Chief Financial
Officer, Controller and other corporate officers and directors. The Code of
Ethics is available on the Company's internet home page and is further
available, free of charge, by sending a written request to the Company's
Investor Relations Department. If the Company makes any amendments to this Code
(other than technical, administrative, or other non-substantive amendments), or
waives (explicitly or implicitly) any provision of the Code of Ethics to the
benefit of our Chief Executive Officer, Chief Financial Officer, Controller and
other corporate officers and directors, it intends to disclose the nature of the
amendment or waiver, its effective date and to whom it applies in the investor
relations portion of the website, or in a report on Form 8-K that filed with the
SEC.
GENOMIC ANTIBODIES(TM) TECHNOLOGY
Genomic Antibodies(TM) are antibodies that result from the process of
immunizing an animal with a gene that then instructs the animal to produce an
antigen (referred to as genetic immunization or DNA immunization). Traditional
methods of antibody production use protein-based antigens that are produced in
the laboratory and injected into animals resulting in the production of
antibodies. The most popular forms of protein-based antigens include
recombinantly produced protein and synthetic peptides. Producing protein-based
antigens is a limitation in antibody production because the antigen is often of
poor quality. Producing quality protein antigen is very expensive, time
consuming and difficult to automate. The Genomic AntibodicsTM technology
promotes high quality antigen expression allowing for the production of high
performance antibodies on a high throughput, cost effective basis.
In principle, DNA immunization technology has been developed over more
than 15 years and offers many advantages over the traditional method. DNA is
inherently far easier, and less expensive to manufacture than protein allowing
high throughput and faster production, uniform lots and a high success rate. The
resulting antigen that is expressed from the DNA is superior to the traditional
recombinant protein or peptides in terms of the ability to generate antibodies
that recognizes the natural target protein.
Although DNA immunization is known to many researchers, it has not been
widely utilized because known approaches produced very low yields of antibodies.
The Genomic AntibodicsTM technology differs from previous DNA immunization
technologies in that it has been extensively optimized to produce high levels of
antibodies. The system that has been developed at SDI contains multiple
proprietary components. These include; antigen design, DNA design and
construction, antigen expression plasmids, adjuvants to boost the antibody
yields, DNA delivery methods, immunization protocols, and a system for
generating protein used to test the antibody. Immunoassay platforms to validate
the resulting antibody, methods to purify the antibody, and procedures for
generating labeled- antibody reagents have also been developed and are all
integral components of high throughput proteomic assay platforms such as
microarrays. The system covers all aspects of antibody production from target
sequence selection through to delivery of highly characterized antibody reagents
ready for use in an immunoassay. The high throughput nature of the technology
coupled with SDI's extensive animal facilities gives the Company the capability
to produce antibodies to proteins from any gene from any organism in
unprecedented numbers and speed. High throughput and superior quality make
Genomic Antibodies ideal for use in biomarker discovery and pharmaceutical drug
target discovery and validation programs.
2
IMMUNOASSAY TECHNOLOGY
An immunoassay is an analytical test that uses antibodies to detect the
presence of a target compound in a complex sample matrix with high degrees of
precision and accuracy.
The technology was first developed more than 30 years ago and is a
cornerstone of laboratory diagnostic testing in the medical industry.
Therapeutic drug monitoring, drugs of abuse testing, hormone tests, infectious
disease testing (e.g., AIDS and hepatitis) and pregnancy testing are all based
on immunoassay and employ antibodies as critical reagents. The Company has taken
this same technology that has developed in the medical diagnostics arena and
applied it to a variety of industrial and agricultural applications. As with
medical applications, immunoassay technology has demonstrated its value in these
markets by virtue of its ability to yield reliable, accurate, cost-effective and
timely results in a manner previously unavailable.
The major attributes of immunoassay technology can be summarized as
follows:
Sensitivity: Immunoassays can measure extremely low concentrations of
compounds (routinely as low as parts per billion; i.e.,
one-millionth of one gram in a liter of liquid).
Specificity: Immunoassays can measure one specific compound out of a
chemical "soup," reducing the need for sample
preparation.
Speed: Total time to obtain a test result ranges from one
minute to several hours as compared to several days to
several weeks with many competing laboratory testing
methods.
Cost: The price-per-test for immunoassays ranges from $1 to
$50, industry wide; the price-per-test for similar
laboratory testing can range from $5 to $1,000.
Accuracy: Immunoassays are typically as, or more, accurate than
their laboratory counterparts.
Flexibility: Immunoassays can be developed in a wide variety of test
formats including; multiple sample laboratory-based
tests, disposable, single-use units and large automated
instruments. They can be designed for use by
non-technical persons on-site under a variety of field
conditions for testing of diverse sample types.
Immunoassay technology relies on the specific binding characteristics of
antibodies. Antibodies are proteins made by cells within the bodies of animals
as part of the immune system response to invasion by foreign substances such as
bacteria and viruses. Antibodies are found in high concentrations in the blood
of immunized animals. The attributes of antibodies that are useful in diagnostic
tests are: that they physically bind only to the substance that elicited their
production and that the binding is very strong. This characteristic of specific
binding (specificity) makes antibodies useful tools for detecting substances in
complex samples such as blood and other human samples, plant tissue, soil and
water. Strong binding enables detection of substances at very low concentrations
(sensitivity). Methods exist for isolating and purifying antibodies from
immunized animals, and labeling them in such a way that they can be used as
components, or reagents, within a test to detect the presence of the substance
of interest. Immunoassay technology has advanced to the point that antibodies
can be made to a wide variety of substances including microorganisms, drugs,
hormones, proteins, polymers, environmental pollutants and other chemicals.
Once an antibody reagent that has the desired performance
characteristics (sensitivity and specificity) has been identified, it can be
incorporated into a test format that is appropriate for the customer's
application. In the human clinical diagnostic market, antibodies are employed as
reagents on large, automated instruments that can analyze hundreds of samples
per hour. In contrast, antibodies also can be packaged into single use,
disposable formats such as home pregnancy tests. Immunoassays can be designed to
be highly quantitative or yield a simple yes/no result. The type of test format
chosen for any given application depends on the needs of the customer and may
include factors such as ease-of-use, cost-per-test, number of samples to be
tested, location where the test will be performed and experience of the user.
The Company's expertise with multiple immunoassay formats, coupled with a
thorough understanding of the needs of a market and specific customer
applications, has allowed the Company to develop a diverse array of immunoassay
products designed to meet the analytical needs of multiple, sizable markets.
The products that the Company manufactures and markets using this
technology include TraitChek(TM), MycoChek(TM), RapidChek(R), SeedChek(TM),
FeedCheck(TM), RaPID Assay(R), EnviroGard(R), and D TECH(R).
3
BACTERIOPHAGE TECHNOLOGY
Bacteriophage, or phage, are viruses that infect bacteria. They are
highly specific for the type of bacteria that they infect and do not infect any
other living cell from any other organism including animal, plant, fungus or
yeast. The specificity of phage is so high that a given phage will only infect
certain types of bacteria. The life cycle of certain bacteriophage, known as
lytic phage, involves binding of phage to bacterial cells and injection of their
genetic material into the bacteria where it commandeers the host's cellular
processes. The phage genes direct the production of large numbers of new phage
particles and ultimately cause the bacterial cell to burst, or lyse, releasing
large numbers of new phage to the surrounding environment. In the process of
replication, lytic bacteriophage kill their bacterial host and rapidly amplify
their numbers. The replication cycle may be as short as 20 minutes and the
number of phage released from an infected cell may be anywhere from 10 to
10,000. Subsequent rounds of replication result in an exponential increase in
the number of infectious phage and a rapid and dramatic decline in contaminating
bacteria.
Because lytic bacteriophage specifically kill their bacterial hosts and
not other living cells, purified preparations of phage have been used
medicinally to treat bacterial infections of plants and animals, including
humans. The Company has filed patent applications claiming the use of specific
lytic bacteriophage to control contaminating bacteria in large scale industrial
fermentation processes such as ethanol production. In these processes, a
production organism, such as yeast in the case of ethanol production, is used to
convert sugar derived from non-sterile feedstocks like ground corn into ethanol.
Normal soil bacteria contaminating the corn also thrive in these conditions,
compete for nutrients, release unwanted byproducts into the reaction and reduce
process efficiency and yield. The large-scale use of antibiotics to control
harmful bacteria can have a negative effect on the production organism, is
undesirable because it leads to bacterial resistance to important antibiotics,
and is limited by federal regulations governing their use. The Company's
scientists are actively engaged in the development of specific bacteriophage
reagents to control bacterial contamination in large-scale industrial processes.
The Company is also applying its bacteriophage technology in its test
kit products for the detection of bacterial food pathogens, including its newly
commercialized Salmonella product. The process of testing food for the presence
of pathogenic bacteria requires that a food sample be cultured in a liquid
growth medium for some requisite time prior to testing with an analytical method
such as the Company's proprietary immunoassays. During this "enrichment" phase,
the target pathogenic bacteria are encouraged to grow and multiply, however,
other non-pathogenic bacteria also present in the sample grow and compete for
nutrients. Often when present, pathogenic bacteria occur in very low numbers in
food and in a background of much greater numbers of non-pathogenic bacteria. In
such instances, the non-pathogenic bacteria can out-compete the pathogenic
bacteria, leaving them undetectable by the analytical method and giving rise to
falsely negative results. In other cases, the analytical method may "crossreact"
with non-pathogenic bacteria giving rise to false positive results. The Company
has filed patent applications claiming the use of bacteriophage to control
competing and crossreacting bacteria, thereby reducing false positive and
negative results and improving analytical test performance.
BIOLUMINESCENCE TECHNOLOGY
Bioluminescence technology uses certain strains of luminescent bacteria,
which possess attributes that support their use as biosensors for toxicity
testing. These strains divert up to 10% of their respiratory energy into a
specific metabolic pathway, which converts chemical energy into visible light.
Bioluminescence technology is based upon exposing a living organism to a
test sample for the purpose of determining whether or not a sample is toxic and
if so, how toxic. This technology provides a quick and inexpensive way to assess
the bioreactivity of various substances.
By using a naturally occurring microorganism that gives off light as a
by-product of its respiration, a temperature controlled precision photometer can
then measure the change in light output with (sample) and without (control)
toxin. The reduction in light output is proportional to the toxicity
(bioreactivity) of the substance tested. A data collection and reduction system
can then analyze the results of a dose-response test procedure and print out a
report quantifying sample toxicity.
The major attributes of bioluminescence technology can be summarized as
follows:
Sensitivity: Response of the system compares favorably with
traditional bioassay procedures, tissue culture tests
and other chemical/life interactions.
4
Standardized: Standardized reagents and test procedures make
test/test and lab/lab comparisons possible.
Speed: Samples can be tested in 30 minutes.
Cost: Cost per test is significantly lower than lab testing
methods.
Accuracy: Provides a reproducible, quantitative measure of
toxicity or bioreactivity.
Flexibility: Bioassay organisms are handled as a chemical reagent.
Response is monitored instrumentally and presented as
digital output or graphical data. No special operator
skills are required.
The Company manufactures and markets its Microtox(R) and Deltatox(R)
toxicity test systems using this technology.
MARKETS AND PRODUCTS
The Company sells products in the food safety, water quality and
antibody market categories through its U.S. direct sales force, a network of
over 50 distributors in Canada, Mexico, Latin America, Europe and Asia and its
corporate partners. This section describes the Company's current markets,
products and competition.
GEOGRAPHIC AND CUSTOMER INFORMATION
The following table sets forth sales by geographic region:
Twelve Months
Ended December 31,
- -------------------------------------------------------------------------
2006 2005 2004
- -------------------------------------------------------------------------
United States $ 19,498 $ 18,368 $ 16,852
Rest of the world 6,024 6,477 6,853
- -------------------------------------------------------------------------
Total $ 25,522 $ 24,845 $ 23,705
=========================================================================
The Company's basis for identifying sales by country is the ship-to
location. There were no individual countries outside of the United States that
represented more than 10% of the total revenues of the Company. There are no
significant long-lived assets located outside the United States.
ANTIBODY PRODUCTS & SERVICES
The Company, under its Strategic BioSolutions(TM) (SBS) brand, develops,
manufactures and markets a broad range of monoclonal and polyclonal antibody
products and services. Specific expertise includes hybridoma development, cell
culture techniques, large-scale ascites and antisera production, large-scale
antibody purification, chemical modification of immunogens and antibodies,
characterization of antibodies and a complete array of related services. The
Company also manufactures a line of human-serum-based calibrators that are
assayed for many serum protein markers for which the Company manufactures and
markets the corresponding antisera products.
These products are sold to a wide range of customers including
pharmaceutical, biotechnology and diagnostic companies, and major biomedical
research centers in the United States, European Union and Pacific Rim. The
Company believes it is one of the largest independent custom antibody service
providers in the world. The Company has many significant commercial antibody
supply agreements with major clients in each market segment. The proprietary
nature of the subjects of these agreements precludes public disclosure. Such
agreements are typically limited to only a portion of the customers' needs for
such services, and the Company believes there is significant upside potential to
expand supply services within customer organizations, as well as add new
customers for the products and services provided. The Company believes the size
of the custom antibody service market is approximately $150 million on an annual
basis, and it is highly fragmented. The Company expects to garner more
5
business from companies that currently employ in-house production sources
through its continuously improving quality manufacturing methods. In 2004, SBS
became the first custom antibody supplier to implement a proprietary web-access
service to allow customers to view and manage their projects on a 24/7 basis.
Future enhancements to its service offerings could lead to increased market
share in the custom antibody service market niche and beyond.
The human genome project carried out over the past 15 years has been a
major driving factor in the emergence of the study of proteomics. With a new
knowledge of genomes (human and other species), the biomedical research
community is exploring many new proteins, their functions and the clues they
reveal about human and animal health. The study of gene and protein
functionality often requires the use of antibodies, which naturally bind to
proteins. The Company believes that proteomics research, and products developed
out of the proteomics effort, offer the Company an attractive opportunity to
explore new initiatives to build revenues in the antibody product group around
proteomics. Antibodies are used by customers as tools on the path to discovery
as well as the key component in some products.
In March 2005, the Company announced a strategic initiative to develop a
high throughput antibody reagent production service designed to enable rapid
discovery and commercialization of products for customers in the proteomics,
pharmaceutical, diagnostics and biological research industries. The Company
estimates the total market opportunity for antibody services available to SDI,
through SBS, to be $300 million. Management anticipates that adjacent
technologies have the potential to substantially expand this opportunity as the
market evolves. The Company has hired two leading scientists widely recognized
for their work in the development of genetic immunization and associated
processing technologies for the high throughput production of high purity, high
reactivity antibodies to oversee this initiative out of the Company's molecular
biology research and production facility in Dallas, Texas.
The high throughput, high efficiency processes SDI is developing are
aimed at enabling customers to achieve more rapid discovery by providing faster,
cost effective access to very large numbers of high sensitivity and specific
antibodies, or families of antibodies, that will collectively advance the
customer's research, development and commercialization efforts.
In 2006, the Company further developed products and service offerings
designed to be valuable tools for the target markets. The Company experienced
substantial progress in the Genomic Antibodies(TM) technology demonstrating that
the antibodies made by SDI's exclusive proprietary technology were superior to
those made by conventional methods. Several high profile customers found success
with Genomic Antibodies(TM) after having none with conventional methods. These
antibodies went on to be key tools that enhanced their research or product
development efforts.
The Company believes that its technology for this genetic antibody
service is unique in the U.S. and that this technology will enable research
organizations in target market segments to increase their success rate of
identifying potential therapeutic or diagnostic protein targets by providing
large numbers of unique antibody reagents generated from customer-specified
genetic sequences. The exponential increase in genetic information available
from all types of living organisms has created a need for large numbers of
antibody reagents to detect the proteins produced by these genes.
Traditional methods of making antibodies to proteins require that the
protein of interest be produced and purified in relatively large quantities
prior to injection for in-vivo production of a specific antibody. This
traditional process is cumbersome and inefficient. The Genomic Antibodies(TM)
process eliminates this requirement. Instead, synthetic DNA, representing the
genetic sequence(s) of interest, is introduced directly, via a proprietary
process that produces antibodies to the protein encoded by the DNA and produced
directly by the immunized cells. The Genomic Antibodies(TM) process SDI is
developing has demonstrated the ability to produce antibodies that are purer,
and more reactive to the native protein, than antibodies raised against other
immunogens, and easier to produce in large numbers, thus facilitating
large-scale research involved in drug development and academic research.
In January 2006, the Company announced a positive conclusion to initial
customer trials involving the Genomic Antibodies(TM) product. These "beta" tests
have validated the high throughput, highly optimized production processes for
mouse polyclonal antibody reagents for use in research and discovery. These
antibody reagents are the first products the Company has released on this
important new technology platform.
6
FOOD SAFETY
The Company's food safety product line includes enrichment media and
rapid tests to detect food pathogens, including E. COLI O157:H7, LISTERIA and
SALMONELLA. The Company is a leader in tests for targeted traits in genetically
engineered plants, tests to detect Genetically Modified (GM) traits in food
ingredients and food fractions, tests to detect naturally occurring fungi in
grains (mycotoxins) and tests for and products to detect prohibited animal
proteins in animal feed (ruminant feed testing).
FOOD PATHOGEN TESTING
Pathogen specific testing is an increasingly important part of
microbiology testing performed in the global food industry. The world-wide
market for rapid method pathogen tests is estimated to be between $200 and $300
million according to independent studies and the Company's own market research.
The market for proprietary enrichment media is estimated to be between $50 and
$100 million. According to several independent studies, the market for pathogen
tests has been growing at an average annual rate of 8% through 2006. However,
market research also suggests that annual growth has slowed in this segment.
Growth in pathogen testing is driven primarily by regulatory changes, customer
sampling practices, industry consolidation, and globalization of the world's
food supply.
Since 2001, the Company has invested in the development and market
introduction of products for the detection of pathogenic microorganisms in food.
In 2002, the Company introduced its first test method for the pathogen E. COLI
O157:H7. This product has received ongoing market acceptance in the United
States. In 2005, the Company was notified that its RapidChek E. COLI O157:H7
assay had been selected as the assay method of choice for the National School
Lunch Program for screening raw and frozen beef for the organism. The National
School Lunch Program is a federally-assisted meal program that operates in over
97,000 public and non-profit private schools and residential childcare
institutions. The United States Department of Agriculture (USDA) is responsible
for determining that the meat produced for the National School Lunch Program is
safe. In addition, the RapidChek test for detection of E. COLI O157:H7 was
selected by the Food Safety Inspection Service (FSIS) as an approved methodology
for screening of the organism in raw beef samples. The FSIS section of the USDA
conducted a rigorous evaluation of rapid methods that are currently on the
market for screening pathogens, including polymerase chain reaction (PCR), and
automated/manual immunoassays and benchmarked kit performance against the
current USDA traditional cultural method. The RapidChek E. COLI O157:H7 method
was evaluated and determined to be the "best in class" against the other
immunological methods tested. RapidChek has been placed on the approved USDA
list as one of only two immunoassays that is recognized for use for screening
raw beef for E. COLI O157:H7. The Company believes that the acceptance of its
method by the agencies regulating Food Safety will increase sales as producers
seek to use methods that have been evaluated and accepted by the regulatory
agencies.
In June 2004, the Company launched its test for detection of LISTERIA.
This test system received AOAC Research Institute (AOAC, AOAC-RI) approval for
both food and environmental samples, as opposed to several competitive methods
on the market that have AOAC approval for food samples only. As a result of new
regulations enacted by the USDA in 2003, environmental samples account for
approximately 80% of all LISTERIA testing. The LISTERIA test incorporates the
use of a proprietary enrichment procedure that provides results in 40 hours,
8-12 hours faster than most other methods on the market. In addition, the
proprietary enrichment system does not require a transfer step, providing
significant labor savings compared to other methods on the market. As with all
pathogen systems, food companies require internal evaluations prior to adoption.
In these evaluations, the Company's LISTERIA test system demonstrated superior
performance, and improvements in efficiency and productivity compared to most
competitive methods on the market. As a result of improvements in performance
and cost-in-use, the Company has had the LISTERIA product adopted by a number of
very large food processors. When larger food companies adopt a particular
method, it usually gains credibility in the marketplace.
In August 2006, the Company launched its new RapidChek SELECT SALMONELLA
test with AOAC-RI approval at the International Association of Food Protection
Meeting (IAFP) in Calgary, Canada. This novel test is based on a patent pending
phage technology combined with SDI's next generation lateral flow technology and
is set to revolutionize the SALMONELLA testing arena. The RapidChek SELECT test
was developed to meet some of the challenges faced in SALMONELLA testing,
including high false positive and negative rates, which can be particularly
prevalent in high burden samples. The patent claims technology that increases
both the specificity and sensitivity of rapid pathogen tests. The SALMONELLA
SELECT test has been evaluated and adopted by several large food producers and
with several additional evaluations underway, this successful rate of adoption
for 2007 is expected to continue.
7
In September 2006, the RapidChek SELECT SALMONELLA test was the first lateral
flow test approved for the National Poultry Improvement Plan (NPIP), and will
provide an attractive alternative to current methods used such as labor
intensive cultural methodologies. This same patent also makes important claims
for composition and methodology associated with the enrichment and control of
production organisms in large scale industrial bio-processing applications. The
Company intends to develop these applications for licensing purposes during
early 2007.
AGRICULTURAL TESTING
GENETICALLY MODIFIED("GM") CROPS
Tests for GM traits are generally used to determine whether the sample
tested contains the protein associated with the genetic modification. Seeds,
grain or leaf tissue are typically tested. The tests may be employed by users
desiring to ensure that seed or grain lots are either GM-free or, in other
cases, that they contain a specified amount of the GM material in order to meet
certain GM requirements. Among the commodities typically tested with the
Company's products are corn, soybeans, rice and cotton.
Crop varieties developed by genetic engineering were first introduced
for commercial production in 1996 with approximately four million acres of GM
crops grown. Based on the latest report from the International Service for the
Acquisition of Agri-Biotech Applications, in 2006 GM crops were planted on more
than 252 million acres worldwide, an increase of 13% or 30 million acres from
2005. Globally in 2006, six principal countries were responsible for 96% of the
GM crop area. They include the U.S. at 135 million acres (54% of the global
total), Argentina at 44.5 million acres (18%), Brazil at 28.4 million acres
(11%), Canada at 15 million acres (6%), China at 8.6 million acres (3%) and
India at 8.6 million acres (3%). The Company has distribution arrangements in
place with respect to customer operations in each of these GM crop producing
countries. Not all the seed produced by a genetically engineered seed or plant
contains the gene for the desired trait and, therefore, not all the plants
arising from a batch of seed will express the desired characteristic. The
Company has developed a simple "one-step" test that is used at the point of
testing to determine if an individual plant contains the targeted genetic trait.
Commercial seed producers use these products to ensure the quality of their
products. This type of test also can be used in crops for enforcement purposes
to expose unlicensed application of the genetic technology.
Agricultural biotechnology companies, including Monsanto and Bayer
CropScience, are currently developing additional genetically engineered traits
in plants. Acceptance of GM crops has increased and as the development of new
traits has risen, there are many countries that have adopted strict regulations
on biotech crops. In 2004, the European Union adopted strict regulations
regarding labeling and traceability of GM food and feed with enforcement
beginning in April 2004. The regulatory tolerance for EU-authorized GM traits is
0.9%, and 0.5% for unauthorized GM traits that have already received a favorable
risk assessment from various U.S. regulatory agencies. However, traceability
systems must be in place and must demonstrate that any traces of GM traits are
adventitious and are technically avoidable. The Company believes that the impact
of regulations may be stricter testing of grain and grain exports from countries
growing GM crops, and an increase in testing to meet these new regulations.
Conversely, widespread acceptance of GM crops may reduce the need for grain
testing.
During 2000, a genetic trait used in corn, known as Cry9C, or
StarLink(R), which had been approved by the U.S. Environmental Protection Agency
(USEPA) only for non-food uses, was discovered in food products. StarLink(R) was
the first, and to date, the only, genetic trait to have been introduced for
animal, but not human, consumption. The impact of this discovery resulted in the
need for growers, handlers, processors, shippers and exporters to test corn for
the presence of StarLink(R). In addition, the United States Department of
Agriculture (USDA) changed its policies to assure that new grain traits were
certified as safe through the entire food chain. The Company's Bt9 TraitChek(TM)
test was the first GM test validated by the USDA. The Company worked closely
with key grain processors worldwide to provide significant volumes of tests to
meet the high market and regulatory demand, selling more than 2 million Bt9
tests in 2001, making it the Company's largest selling product. With the removal
of StarLink(R) corn from the U.S. grain supply during 2000 and 2001, the
Company's sales of tests to detect StarLink(R) corn diminished significantly
over the period from 2002 through 2006.
Due to the StarLink(R) incident described above and consumers'
sensitivity to the issue, there were very few new GM traits introduced into the
marketplace in 2001 and 2002. During 2003, there was a renewed interest and
introduction of new traits, and the Company has continued to work closely with
the major agricultural biotechnology companies toward development and
commercialization of tests in line with their trait commercialization schedules.
In 2003, the Company began to recognize broader adoption of testing for traits
that had been commercialized in
8
years prior. Tests for the Cry3Bb insecticidal protein have grown and are
expected to continue growing. In 2005, the Company introduced the first
multi-trait corn test strip that can detect both the Cry1Ab and Cry3Bb
insecticidal proteins and the CP4EPSPS protein for resistance to the herbicide
Roundup(R). During 2006, the Company introduced tests for the detection of an
unapproved LibertyLink ("LL") trait in rice found in the U.S. The TraitChek LL
Bulk Rice test kit was the first lateral flow test strip certified by the USDA
Grain Inspection, Packers & Stockyards Administration (GIPSA) for the detection
of the LL trait in rice.
The Company has had strong sales efforts in Brazil since 2000. Brazil is
a major agricultural country and the leading exporter of soybeans in the world,
surpassing the U.S. in 2006 with over 25 million tons exported. Brazil has
temporary laws in place making it legal to grow GM crops. Brazil's Agriculture
Ministry reported that an estimated 23.2 million acres or 43 percent of the
country's 2005-2006 crop were sown with GMO soybeans, up from approximately 12.4
million or 21 percent last year. Due to the previous GM ban, countries importing
non-GM soy products such as China and those from the European Union have
increased their imports from Brazil. To assure that their raw commodities are
free of GM, testing is done at many grain elevators and crushing facilities
throughout Brazil. Brazil is now the leading customer for the Company's GM
soybean test for Roundup Ready(R) herbicide tolerance.
Trends in world food production include the use of second generation
genetic technologies to give plants specific nutritional or other high-value
consumer characteristics, collectively referred to as output traits. If these
traits gain acceptance, food companies will be able to provide consumers with
value-added products they will demand and food manufacturers will source these
specialty products on world markets. The Company believes that it is well
positioned to provide the analytical tools to allow food companies to purchase
such premium products with confidence, due to its existing relationships with
large agricultural biotechnology companies and the current success of its
technology, particularly in the area of GM traits.
WATER QUALITY
The Company's water quality product line includes analytical tests for
drinking water, industrial process water and wastewater analysis, and analytical
tests for soil and other waste matrices for use at environmental remediation
projects, hazardous waste operations and other applications.
MICROTOX(R)
The Microtox(R) test system is a unique rapid acute toxicity test that
detects a broad range of toxins and chemical agents in water. Microtox(R) makes
toxicity analysis simple and easy to perform and results can be generated in as
little as 30 minutes. Microtox(R) toxicity testing technology is used in
drinking water, wastewater, environmental remediation and research and
industrial applications around the world. With nearly 650 peer-reviewed
scientific articles and more than 2,200 instruments sold worldwide, the Company
believes that the Microtox(R) toxicity test system is the standard for rapid
toxicity screening and analysis.
The Company is currently working with drinking water utilities, food
processors and other customers as they develop and implement monitoring
processes to reduce their risk from contamination of water supplies. In the
U.S., approximately 125 drinking water utilities and six food processors are
currently using the Microtox(R) toxicity testing technology as part of their
early warning or emergency response programs to detect contamination of their
water supplies. The rapid response of the Microtox(R) toxicity assay allows
users to rapidly detect--and quickly respond to--any changes in water quality.
It is for this reason that the technology is viewed by many national and
international experts as an effective means for detecting toxins in water
applications.
The Company also markets a portable version of the Microtox(R)
technology known as Deltatox(R). Departments of Health in a number of states,
the largest private water utility in the country and the United States
Environmental Protection Agency (USEPA) emergency response teams are using
Deltatox(R) technology as part of their emergency response programs.
The Company believes that, although there are new entrants in this
market space, no other companies have meaningful marketing efforts for rapid,
bioluminescence-based, toxicity testing. There are only a few other companies
who market a rapid toxicity test that the Company considers to be competitive
with Microtox(R).
The USEPA is currently reviewing the technical capabilities of
Microtox(R) in consideration of adding the method to the approved list of
toxicity test methods under the Whole Effluent Toxicity testing program. The
9
USEPA submitted the addition of Microtox(R) to the Federal Register for National
Pollutant Discharge Elimination System (NPDES) permit compliance testing. This
is the regulatory program under which permitted waste dischargers, including a
large number of municipal sewage treatment plants, are mandated to test their
effluents on a regular basis and comply with regulated toxicity discharge
limits. When and if the Whole Effluent Toxicity (WET) testing method becomes
approved, that will open up a significant market for Microtox(R). The size of
this testing market is estimated to be between $25 and $30 million. The Company
believes, however, that this action will also likely stimulate the entrance of
additional competitors into this market.
In February 2006, the Company announced that its Microtox(R) bioassay
technology was awarded the Designation and Certification as an "Approved Product
for Homeland Security" under the Support Anti-Terrorism by Fostering Effective
Technologies Act of 2002 (the SAFETY Act), by the Department of Homeland
Security, or DHS. The SAFETY Act legislation was designed to encourage the
development and rapid deployment of life-saving anti-terrorism technologies by
providing manufacturers or sellers with limited risk of legal liability. It was
also designed to harness the nation's scientific and technological resources to
provide federal, state, and local officials with the technology and capabilities
to protect the United States from terrorist acts. One area of focus for DHS is
catastrophic terrorism threats to the nation's security that could result in
large-scale loss of life and major economic impact. The SAFETY Act fosters
research of technologies to counter threats both by evolutionary improvements to
current capabilities and development of revolutionary, new capabilities. As a
biosensor-based method for the detection of toxic compounds, which include toxic
industrial chemicals and heavy metals, in water and other matrices, the
Microtox(R) bioassay technology is ideally suited to meet the anti-terrorism
initiative objectives of DHS. The Company believes that having this DHS
Designation and Certification has added significant value to the Company's
Microtox(R) product by virtue of increasing its customer base and facilitating
additional penetration into the drinking water utility market.
PESTICIDES
The entrance of pesticides into the water supply as a result of
agricultural and residential runoff has been occurring for many years. In areas
of substantial agricultural activity, drinking water is tested for pesticides to
protect drinking water supplies and to comply with federal and state
regulations. The Company's pesticide test kits are used extensively by water
quality researchers, resource managers, drinking water system operators, federal
agencies such as the U.S. Geological Survey and Department of Agriculture, state
environmental and health departments, drinking water utilities and environmental
engineering companies for surface and groundwater monitoring, drinking water
source and supply management, soil analysis and chemical fate and transport
studies.
The RaPID Assay(R) test kit marketed by the Company for one of these
pesticides--Atrazine--was validated by the USEPA under the Environmental
Technology Verification program. The report confirmed the accuracy and
reliability of the Company's RaPID Assay(R) test format for Atrazine and, in the
Company's evaluation of the data, is one of only two immunoassay products
validated by this program showing acceptable performance for this application.
ENVIRONMENTAL CONTAMINANT TEST PRODUCTS
The Company sells different format immunoassay products into the
environmental market. Each of the four different test formats has performance
characteristics that make them more or less suited for a particular customer
application. The Company positions the sale of all of its products to provide
the customer with whichever product is best suited to its specific application.
All of the environmental test kits include components for the extraction of
target analytes from the sample matrix (typically soil or water) and subsequent
analysis. Sample preparation time is typically less than five minutes per
sample. All of the Company's environmental test kits are capable of analyzing
multiple samples and some allow analysis of as many as 40 samples per hour.
The Company's key user segments in these applications have been the
largest environmental engineering and construction firms, the Department of
Defense (including the US Army Corps of Engineers), the Department of Energy,
the National Aeronautics and Space Administration (NASA), the National Oceanic &
Atmospheric Administration (NOAA), and many other major federal and state
regulatory and research agencies. The USEPA and U.S. Army Corps of Engineers are
jointly promoting what they call the "Triad Approach," which uses immunoassay
and other field analytical systems to increase the accuracy and reduce costs on
environmental projects. Typical contaminants of concern at contaminated sites
include petroleum and fuel-derived products, polycyclic aromatic hydrocarbons
(PAHs), polychlorinated biphenyls (PCBs), dioxins, explosives, pesticides, and
chlorinated solvents.
10
The Company is currently marketing test kits for all of these contaminant
classes, and has been able to expand its product offering through distribution
agreements to accommodate new technologies.
The environmental testing market is large, with hundreds of companies
providing testing products and services. In 2006 the Company revised its channel
to market for these products, supported by new technology, training and
application support. The Company believes the overall market for remediation
products has continued to decline due to lower levels of Federal funding to
support remediation projects in this area, and that the testing market is very
competitive due to under utilized capacity in the laboratory services sector.
OTHER ASSAYS
COLITAG(TM)
In April 2006, the Company announced that it started distributing
Colitag for E. COLI and coliform testing in drinking water through a distributor
agreement with CPI International. Testing for total coliform by water utilities
is regulated by the Safe Drinking Water Act. Colitag is EPA approved for Total
Rule Coliform (TCR) compliance monitoring, both Presence/Absence and Most
Probable Number (MPN) enumerations. The inclusion of Colitag in the Company's
portfolio of products for water utilities better positions the Company to fully
meet the needs of these utilities for reliable testing products that deliver
confident results.
TOXKIT MICROBIOTESTS(TM)
In December 2004, the Company announced the signing of an exclusive
distribution agreement with a European supplier of toxicity testing systems,
Microbiotests (MBT). Under the terms of the agreement, the Company now markets
MBT's line of rapid maintenance free bioassays in North America. The agreement
continues to position SDI as the single source solution for rapid, on-site
toxicity and environmental tests. The product line offers customers requiring
cultural methods an alternative to expensive and labor intensive protocols,
allowing users to save both time and money while maintaining quality test
results.
MTI METALS(TM)
In September 2004, the Company announced the signing of an exclusive
distribution agreement with Monitoring Technologies International (MTI). Under
the terms of the agreement, SDI will market and sell in the United States MTI's
PDV-6000 heavy metal analyzer and reagents, which are designed to rapidly detect
multiple metal contaminants on-site in water, soil and food matrices. The system
has recently been verified by the USEPA's Advanced Monitoring Systems Center,
and validated under the USEPA's SITE Program, where it met or exceeded all
requirements for sensitivity and precision. SDI has initially focused its sales
efforts on the environmental assessment and remediation market, a market in
which it currently has relationships with 22 of the top 25 environmental
consulting and engineering firms. Both the MBT and MTI agreements allow SDI to
present a more complete solution to its customers involved in environmental
management.
RUMINANT TESTING
In February 2003, the Company introduced its screening test for the
detection of meat and bone meal in animal feed, which is linked to the
transmission of BSE, commonly known as mad cow disease. The transmission of mad
cow disease is believed to be linked to the use of rendered meat and bone meal
as a protein supplement in animal feed. Meat and bone meal made from cattle has
been banned for use in cattle feed since 1997 in both Canada and the U.S., but
it can be used legally in feed for poultry, swine and household pets, none of
which are known to contract mad cow disease.
Since 2003, publicized cases of "mad cow" have been found in countries
including the United States, Canada and Japan. The market and regulatory
environment in these countries continues to be in a state of flux. Although feed
testing is the only definitive means to certify compliance, the current industry
practice is to rely solely on paper certification. The Company is not making a
significant sales effort or investing in additional development given the
current regulatory environment.
11
SALES AND MARKETING STRATEGY
The Company markets and sells products in the food safety, water quality
and life science antibody market categories through a small U.S. direct sales
force, Internet presence and a network of over 50 distributors in Canada,
Mexico, Latin America, Europe and Asia and its corporate partners. The Company
also has a European office and sales operation near London, England.
In the U.S., the primary sales channel is through a direct sales force
comprised of geographically based field sales professionals. The sales force is
augmented by a customer service team, and applied marketing specialists which
assure that all elements of the customer's buying experience meet and exceed
their performance expectations.
On the basis of its strengthening proprietary position, the Company is
focused on developing channels to market, and accelerating predictability and
sustainability of revenues. SDI is investing in its direct sales force through
both the addition of new sales representatives and increased sales and technical
training. The Company continually measures sales performance and maintains
discipline in the balance between the addition of new sales resources and
ongoing efforts to continually improve sales efficiency and effectiveness of
existing resources.
The Company is also focusing on its network of quality distributors. In
2006, the Company added its first distributor for Genomic Antibodies(TM).
Oriental Yeast Company, a Japanese life sciences company, was uniquely
positioned to represent this technology in the Japanese market and in September
of 2006, signed an exclusive distribution agreement. The Company is working to
develop similar relationships in other European, Asian, and Latin American
markets.
The Company developed further distribution for environmental and water
quality test kits during 2006. Distribution was expanded in China, South Korea
and Eastern Europe during the year.
In 2005, the company signed an exclusive distribution agreement with
DuPont Qualicon for the representation of the Company's immunoassays for food
pathogen detection. This agreement was predicated on achievement of specific
sales goals that were not met. The Company has now begun to identify additional
distribution partners for this product line and will take a much more aggressive
role in marketing these methods outside the United States in 2007.
The Company has invested in providing additional support to
distributors, which participate in annual global training seminars. The Company
evaluates various sales and service models that can contribute to the profitable
growth of business. In addition, identifying the most effective channels to
market will allow the Company to better allocate resources to both new and
existing growth opportunities.
COMPETITION
Many of the Company's potential competitors are large companies with
substantially greater financial and other resources than the Company. To the
extent that any such companies enter into one or more of the Company's markets,
the Company's operations could be materially adversely affected. The Company
anticipates increased competition as potential competitors perceive that the
Company's markets have become commercially proven, or if the Company cannot
maintain competitive differentiation.
The Company competes for GM testing market share with three companies
that offer rapid, immunoassay-based methods. They include EnviroLogix, Inc. and
Agdia, Inc., both privately held companies, and Neogen Corp., a publicly-held
company. EnviroLogix markets a wide range of GM tests and also offers strip
tests for the detection of aflatoxin (mycotoxin) in corn and cotton. Agdia sells
a wide line of tests for plant viruses and pathogens. Neogen, though a leader in
mycotoxin analysis, has not been able to gain a significant share in the GM
testing arena. Neogen has an extensive record of mycotoxin sales and has the
largest line of products, applications and approvals.
Other companies may be developing additional products for one or more of
the Company's markets that could be competitive with the Company's products. The
Company believes none of these competitors have products that compete with all
of the Company's products in the food safety market. The Company believes that
the breadth of its product offerings in the food safety market, the expertise it
has accumulated in developing tests for the food safety market, the Phage
technology and the extensive customer relationships it has assembled throughout
the agricultural seed, grain and food processing industries are all significant
competitive advantages.
12
In food pathogen testing, the Company is among the more recent entrants
to the market and faces a broad base of competition. The world-wide market for
pathogen tests is estimated to be between $200 and $300 million annually and as
such has drawn competitive products. The Company's RapidChek(R) E. COLI O157
including H7, SALMONELLA and LISTERIA tests compete globally with numerous
competitive rapid testing systems. Instrument-based tests are offered by
bioMerieux SA and DuPont Qualicon among others. Competitive lateral flow tests
are offered by Neogen Corp., BioControl Systems, Inc., and others. In addition,
traditional lab culture methods offer indirect competition. The Company hopes to
gain market share from competitive methods and with new users due to key product
advantages such as speed of result, ease-of-use, accuracy and an overall lower
cost-in-use.
The Company believes there are no meaningful direct competitors for the
Company's Microtox(R) product line in the United States. In Europe and other
parts of the world, the Company competes against Checklight, Ltd., which is an
Israeli-based company, and one other instrument based test method produced by
Dr. Bruno Lange GmbH & CO, an affiliate of The Danaher Corporation, which has
greater technical and marketing resources than the Company. The Company believes
its products have a number of competitive advantages including the comprehensive
screening for general toxicity and competes effectively on superior features and
functions. With the addition of the Toxkit Microbiotests, the Company believes
that there is no other company that can provide the complete solution offering
of the Company.
With respect to the environmental contaminant test products, the Company
currently receives the greatest competition from fixed site environmental
laboratories. Traditional analytical methods for environmental contamination are
often utilized for confirmation and closure of environmental sites. For metals
analysis, a number of companies compete directly against the PDV-6000 analyzer
and reagents with XRF technologies. The Company believes that the PDV-6000 can
provide a number of advantages allowing for greater benefits to current
customers.
In the antibody product line, competitors include large pharmaceutical,
research and diagnostics organizations, some which have significantly greater
revenues than the Company. These companies may produce these products internally
and purchase similar products from SBS. Additionally, there are a number of
smaller companies that offer competing products. The Company believes that the
scale of its operations and the breadth of its product lines, among other
things, are significant competitive advantages.
Competitors in the market as third party providers of custom antibody
production include Covance (public), Harlan (private), Lampire (private) and
Scantibodies (private). Many of SBS' competitors include small companies, or
small operating divisions of larger companies, using similar antibody production
methods.
REGULATORY APPROVALS
The environmental legislation and regulations that the Company believes
are most applicable to its current business are the Research Conservation and
Recovery Act (RCRA), Comprehensive Environmental Response, Compensation and
Liability Act (CERCLA), Toxic Substances Control Act (TSCA), Federal
Insecticide, Fungicide and Rodenticide Act (FIFRA) and the Pure Food and Drug
Act. For analysis of water and wastewater, the Safe Drinking Water Act, the
Clean Water Act and the NPDES permitting program acceptance under the Clean
Water Act also will be significant to the Company's business. As the utility of
the Company's Microtox(R) products continues to be widely recognized in drinking
water security applications, regulations and mandates associated with Homeland
Security programs may also have an impact on the Company's business.
Collectively, these programs regulate the management, disposal and clean-up of
hazardous substances and protect the nation's ground and surface water and
drinking water supplies. In addition, regulatory responsibilities in a number of
areas have been delegated to state agencies and state and local laws and
regulations impose additional restrictions and requirements. While environmental
regulations overseas vary, many countries, particularly those in Europe, have
counterparts to the U.S. legislation.
The Company believes that the validation and acceptance of its products
by regulatory agencies, though not required for the use of its products in most
cases, is a significant factor in gaining market acceptance. There are two main
areas in which the Company is seeking regulatory acceptance for its products by
federal and state agencies: environmental contaminant testing methods and water
testing methods. The EPA and some state agencies have evaluated certain of the
Company's analytical methods and accepted their use for certain remediation and
monitoring activities.
The Company received AAALAC (Association for the Assessment and
Accreditation of Laboratory Animal Care) accreditation at its Delaware facility
in 1993 and at its Maine facility in 2000. The Company volunteers to
13
participate in the AAALAC's program, in addition to complying with the local,
state and federal laws that regulate animal research. In order to maintain these
accreditations, the Company undergoes regular inspections and reviews. The
Company also holds approval from the OLAW (Office of Laboratory Animal Welfare)
and the National Institutes of Health, further validating the stewardship of the
Company in proper laboratory animal care.
During 2004, the European Union implemented Regulation 1774 governing
the shipment of products derived from ruminant animals. The Company worked with
regulators to obtain the necessary facility registrations to comply with these
new guidelines and product shipments to the European Union are moving normally.
WATER TOXICITY TESTING. In February 2006, the Company announced that its
Microtox(R) bioassay technology was awarded the Designation and Certification as
an "Approved Product for Homeland Security" under the SAFETY Act of 2002, by the
Department of Homeland Security, or DHS. The SAFETY Act legislation was designed
to encourage the development and rapid deployment of life-saving anti-terrorism
technologies by providing manufacturers or sellers with limited risk of legal
liability. It was also designed to harness the nation's scientific and
technological resources to provide federal, state, and local officials with the
technology and capabilities to protect the United States from terrorist acts.
One area of focus for DHS is catastrophic terrorism threats to the nation's
security that could result in large-scale loss of life and major economic
impact. The SAFETY Act fosters research of technologies to counter threats both
by evolutionary improvements to current capabilities and development of
revolutionary, new capabilities. As a biosensor-based method for the detection
of toxic compounds, which include toxic industrial chemicals and heavy metals,
in water and other matrices, the Microtox(R) bioassay technology is ideally
suited to meet the anti-terrorism initiative objectives of DHS. Having this DHS
Designation and Certification has added significant value to the Company's
Microtox value for its customer base and has facilitated additional penetration
into the Drinking Water utility market.
ENVIRONMENTAL CONTAMINANT TESTING METHODS. EPA SW-846 is the compendium
of analytical and test methods published by the EPA's Office of Solid Waste
(OSW). SW-846 is a guidance document listing those analytical methods that have
been validated by the EPA for a stated purpose. Some states also recognize the
use of SW-846 methods under their hazardous waste programs. SW-846 methods are
technically only applicable to regulatory programs under RCRA, however, other
federal, state and local environmental programs, including CERCLA and TSCA,
often refer to and rely on SW-846 methods for purposes of remediation and
monitoring.
The Company currently has more than 30 SW-846 validated methods and has
submitted applications to achieve validation on others, including tests for
dioxins.
OTHER TESTING METHODS. Tests for bacterial food pathogens, mycotoxins,
genetically engineered traits in plants and water treatment polymers are
currently unregulated. However, agencies such as the EPA, the FDA and the FSIS
of the U.S. Department of Agriculture are engaged in testing and, together with
the AOAC, maintain compilations of official methods for use in testing in
certain market segments. Some of these organizations also issue procedures and
guidelines for validating new methods. Although not required, official methods
adopted by these agencies sometimes have the impact of regulations because
commercial facilities tend to follow the practice of the agency.
MANUFACTURING
The Company manufactures test kits for the detection of a wide array of
analytes in five immunoassay formats and one bioluminescence format. The five
formats are: one step lateral flow tests; coated tubes; latex particles;
magnetic particles; and micro-titer plates. The Company manufactures a
biological supplement that enhances the detection of certain analytes and
improves overall performance of certain assay formats. In addition to test kits,
the Company supplies ancillary equipment and supplies including test evaluation
instruments, reagents, sample media, spectrophotometers, pipettes, balances and
timers.
The key critical reagent manufacturing technologies are conjugation
chemistries, antibody formulations, calibrator preparation, lateral flow strip
production, microbiological and immunoassay processes. Kit production processes
include filling and dispensing liquids, subcomponent and finished goods
assembly, in-process testing, quality control, packaging and shipping. The
critical reagents and production assembly groups produce test kits in the
Newark, Delaware laboratories. Biological materials are primarily developed and
produced in-house; however, some reagents are licensed from third parties or
purchased from commercial sources. A crucial step in the Company's manufacturing
process is the stabilization of the immunoreagents utilizing proprietary
lyophilization techniques. In general, raw materials used by the Company in its
products are obtainable from multiple sources. The Company purchases instruments
and ancillary equipment from outside vendors. A number of the instruments sold
14
by the Company were developed to be used exclusively with the Company's products
and are subject to specific supply agreements. The Company believes that the raw
materials, instruments and equipment used in the manufacture of its products are
sufficiently available for the Company's current and foreseeable manufacturing
needs.
The Company manufactures its products in accordance with the FDA's Good
Manufacturing Practices guidelines and has implemented data-driven problem
solving and statistical process controls to troubleshoot and continuously
improve quality and performance. The Company utilizes a formal sales and
operations planning process and an integrated Manufacturing Resource Planning
(MRP) tool to control all elements of the supply chain and manufacturing
processes; including raw material procurement, inventory management, capacity
planning and production scheduling, work-in-process tracking, order processing
and fulfillment, shipping and customer invoicing. The Company believes the
existing facilities and equipment are sufficient to support a significantly
larger manufacturing base. Industrial bio-detection services manufacturing
operations are currently running one shift.
The Company also supplies a wide array of custom antibody products and
services to the in-vitro diagnostic, academic and medical research industries.
Antibodies are developed and produced using animals or cell culture methods.
Laboratories are maintained to prepare immunogens, perform chemical
conjugations, purify antibodies, fragment antibodies, and perform a range of
quality control procedures. The cell culture laboratories support the
development of hybridomas and manufacture of monoclonal antibodies. The cell
culture laboratories also provide services to enhance the productivity of cell
lines, establish FDA-compliant Master Cell Banks, and store cell lines in secure
fail-safe cryogenic systems.
Animal facilities house specific-pathogen-free animals that are tested
routinely to assure they are maintained under the highest health standards. Both
the polyclonal production facilities in Windham, Maine and the monoclonal
facility in Newark, Delaware are accredited by AAALAC. Current capacity
utilization in antibody production is approximately 70%, and there is additional
land and zoning clearance on the 64-acre site in Windham, Maine to expand
operations.
In 2005, the Company established a research and manufacturing center in
Dallas, Texas. This facility is designed for gene building and protein
chemistry. The Dallas operation houses the technical elements of the Genomic
Antibodies(TM) product offering. The Genomic Antibodies(TM) offering is
supported by a robust high throughput operation that is initiated in Dallas and
completed in either Maine or Delaware depending upon the end product.
RESEARCH AND DEVELOPMENT
The Company engages in substantial research and development activities
(R&D) involving development of products and services for its target markets. In
the three years ended December 31, 2006, 2005 and 2004, the Company incurred
approximately $2.6 million, $3.0 million and $2.1 million, respectively, in
research and development expenditures. Research and development expenses in
support of the Company's proprietary Genomic Antibodies(TM) and bacteriophage
technology platforms continued to increase in 2006 and accounted for just over
half of the total R&D effort. In addition, significant effort was expended in
the first half of the year in the Food Safety arena to complete the development
and validation of the Company's SALMONELLA SELECT product offering. R&D spending
in support of agricultural and water quality test products in 2006 continued at
levels similar to the prior year.
The Company's primary laboratory facilities located in Newark, Delaware
were designed and built specifically for conducting research and development
relating to antibody and immunoassay technology. These facilities include
state-of-the art, cGMP, AAALAC-approved, antibody development and large-scale
production facilities. The Company has assembled a scientific staff with
extensive experience in the development, production and purification of
monoclonal and polyclonal antibodies. The Company also has extensive expertise
in the development and production of reagents from the antibodies it produces,
as well as commercial immunoassays employing those reagents.
In 2005, the Company undertook an initiative to reposition itself in the
large and expanding Proteomics market by developing new high throughput antibody
development capabilities that complement its existing core antibody and
immunoassay technology. As part of this initiative, the Company hired two
additional scientists recognized for their work in the development of genetic
immunization to oversee its Genomic Antibodies(TM) effort located in the
Company's research and production facility in Dallas, Texas. Initial R&D
activities focused on
15
increasing the amount of antibody that is made over typical genetic immunization
procedures, and protocols for eliciting high titer antisera in multiple animal
species, including mice and rabbits, and have been developed successfully.
In 2006, novel antibodies were produced to hundreds of proteins using
the Company's proprietary Genomic Antibodies(TM) technology. The high throughput
capacity of the platform was successfully demonstrated by simultaneously
producing 96 different antibodies to breast cancer markers. To further enhance
the high throughput nature of the Genomic Antibodies(TM) platform, the Company's
scientists have developed procedures for characterizing the large numbers of
antibodies being produced using robotic liquid-handling equipment. Large scale
animal facilities, proprietary high throughput antibody development technology,
state-of-the-art purification and reagent production capabilities, extensive
assay development expertise, and established commercial manufacturing have been
integrated to create an antibody development, characterization and production
capacity unique in all the world.
In addition to developing its Genomic Antibodies(TM) platform, the
Company spent significant effort in 2006 developing its proprietary
bacteriophage technology. The SALMONELLA SELECT test product launched in August
contains bacteriophage that prevent the growth of specific bacteria that can
interfere with test performance. The use of bacteriophage to improve the
specificity and sensitivity of testing methods is unique to the Company and the
subject of published U.S. and world-wide patent applications.
The Company also has patents pending for the use of bacteriophage to
control the growth of harmful bacteria in large scale industrial fermentation
production processes including ethanol production. Early in the third quarter of
the year, the Company announced an agreement with Broin Companies to develop
commercial bacteriophage reagents and protocols for controlling bacteria
contaminating Broin's proprietary BPX ethanol production process. Significant
progress was achieved on the program in 2006 and the project continues on
schedule.
The Company's research and development personnel are expert in many
advanced research disciplines in the life sciences, including molecular biology,
synthetic organic chemistry, protein chemistry, biochemistry, immunology,
immunochemistry and microbiology. In addition to the technical expertise
resident within the research and development organization, the Company's
technical manufacturing organization is expert in large-scale cGMP production,
bioprocessing, purification and quality control of antibodies and reagents.
Research and development activities are focused on developing
proprietary technology and products to expand the Company's manufacturing base
and leverage its sales and marketing organizations. The Company is a recognized
leader in the field of contract antibody and assay development services
primarily for large chemical, diagnostic and pharmaceutical companies, and the
development of rapid test kits in the food, water quality and agricultural
sectors based on immunoassay technology. In addition, the Company has extensive
expertise, facilities and equipment relating to the development and manufacture
of one-step lateral flow tests.
The Company's research and development organization consists of
approximately 16 individuals, 9 of whom hold advanced academic degrees. In
addition, approximately one-third of the Company's employees are involved in
technical job functions.
PROPRIETARY TECHNOLOGY AND PATENTS
The Company's products are based on the use of proprietary reagents,
technology and test systems developed by Company scientists or acquired
externally. Accordingly, the Company has implemented a number of procedures to
safeguard the proprietary nature of its technology. The Company requires its
employees and consultants to execute confidentiality agreements upon the
commencement of an employment or consulting relationship with the Company and
all employees are required to assign to the Company all rights to any inventions
made during their employment or relating to the Company's activities.
Additionally, the Company seeks to protect its technology and processes through
the patent process. The Company currently holds 29 issued U.S. patents,
including three U.S. patents licensed for exclusive use by the Company, and
eight U.S. patent applications are pending.
16
U.S. PATENT TITLE
- ----------- ------------------------------------------------------------------
4,999,286 Sulfate reducing bacteria determination and control
5,426,035 Method for compensating toxicity test data
5,427,955 Photochemical determination of organic compounds (license)
5,429,952 Marking of products to establish identity and source (license)
5,449,611 Polyaromatic hydrocarbon (PAH) immunoassay method, its components
and a kit for use in performing the same
5,484,709 Immunoassay method for detecting an immunologically non-remarkable
compound
5,541,079 Monoclonal and polyclonal antibodies and test method for
determination of organophosphates (license)
5,547,877 Methods for the rapid detection of toxic halogenated hydrocarbons
and kits useful in
performing the same
5,593,850 Monitoring of industrial water quality using monoclonal antibodies
to polymers
5,618,681 Polyaromatic hydrocarbon (PAH) immunoassay method, its components
and a kit for use in performing the same
5,658,463 Kits and processes for extraction of analytes from solid materials
5,679,574 Quantitative test for oils, crude oil, hydrocarbon, or other
contaminants in soil and a kit for performing the same
5,691,148 A petroleum immunoassay method, its components and a kit for
performing the same
5,780,250 Immunoassay standards for polyaromatic hydrocarbon detection
5,834,222 Polychlorinated Biphenyls (PCB) immunoassay method
5,858,692 PCB immunoassay
5,874,216 Indirect label assay device for detecting small molecules and
method of use thereof
5,891,657 Immunoassay standards for volatile analytes with benzene rings
5,919,645 Method for the direct determination of the toxicity of particulate
solids
5,994,145 Reagents, methods and kits for detecting TCE and PCE
6,096,563 Dual particle immunoassay method & kit
6,146,903 Determination method
6,190,922 Substrate supported liquid extraction
6,376,195 Indirect label assay device for detecting small molecules and
method of use thereof
6,420,530 Determination method
6,524,810 Method of making bioluminescent assay reagent based on non-viable
E. coli
6,663,833 Integrated Assay Device and Methods of Production and Use
6,750,328 Antibodies for detection of water treatment polymers
6,911,534 Method for determination of water treatment polymers
The Company believes that low-cost, easy-to-use, rapid tests have the
potential to be significant products in multiple large markets and, therefore,
has licensed rights to patents relating to immunochromatographic devices. The
Company has one pending U.S. patent application for tests that can detect
genetically modified crops and two applications that deal with tests for the
detection of animal proteins in animal feed. In the field of food pathogen
testing, the Company has one application that relates to isolation of pathogenic
microorganisms from food using lateral flow strips. One application deals with
the use of bacteriophage as selective agents and one relates to detection and
control of water treatment polymers. One of the Company's applications involves
a process for manufacturing test strips and another is regarding an assay
reagent for detecting toxicity in water.
There can be no assurance that the Company's patent applications will
result in the issuance of any patent or that any patents issued to the Company
would provide protection that is sufficiently broad to protect the Company's
technology and products. In addition, the Company cannot be certain that it was
the first creator of inventions covered by pending patent applications or that
it was the first to file patent applications for such inventions. In addition to
seeking patent protection for the Company's proprietary information, the Company
also relies upon trade secrets, know-how and continuing technical innovation to
maintain competitiveness for its products and services. The Company has
developed a number of proprietary technologies which it has chosen not to
patent, including
17
stabilization systems for reagents, chemical syntheses for conjugates,
immunogens and analyte analogs, and strategies relating to antibody development.
Regarding the latter, the Company's extensive expertise has enabled it to
develop antibodies and products that are unique to the industry including
antibodies to pathogenic food microorganisms, transgenic plant proteins,
mycotoxins, water treatment polymers and environmental contaminates. In
addition, the Company has developed and continues to develop proprietary media
formulations designed to enrich the selective growth of pathogenic food
microorganisms.
EMPLOYEES
As of December 31, 2006, the Company employed 150 full time and three
part time employees. The workforce was supplemented by nine agency provided
contractors. All of the Company's employees have executed agreements with the
Company agreeing not to disclose the Company's proprietary information and
assigning to the Company all rights to inventions made during their employment.
Key personnel have signed agreements prohibiting them from competing with the
Company. None of the Company's employees are covered by collective bargaining
agreements. The Company believes that its relations with its employees are good.
ITEM 1A. RISK FACTORS
The following is a discussion of certain significant risk factors that
could have an adverse impact our financial condition, performance and prospects.
OUR PRODUCTS MUST GAIN MARKET ACCEPTANCE FOR US TO INCREASE REVENUE.
Any product that we sell or develop must compete for market acceptance
and market share. An important factor will be the timing of market introduction
of competitive products. Accordingly, the relative speed with which we and
competing companies can develop products, complete any required approval
processes, and supply commercial quantities of the products to the market will
be an important element of market success.
Significant competitive factors include:
o timing and scope of regulatory approval;
o product availability;
o awareness and acceptance of our products and their application;
o channels to market;
o marketing and sales capabilities;
o product attributes relative to their cost;
o price; and
o exclusivity, through patent protection or otherwise.
OUR RESEARCH, DEVELOPMENT AND COMMERCIALIZATION EFFORTS MAY NOT SUCCEED OR OUR
COMPETITORS MAY DEVELOP AND COMMERCIALIZE MORE EFFECTIVE OR SUCCESSFUL
DIAGNOSTIC PRODUCTS.
In order to remain competitive, we must regularly commit substantial
resources to research and development and the commercialization of new products
and/or antibody services.
The research and development process generally takes a significant
amount of time from inception to commercial product launch. This process is
conducted in various stages. During each stage there is a substantial risk that
we will not achieve our goals on a timely basis, or at all, and we may have to
abandon a product or technology platform in which we have invested substantial
amounts.
Other companies have products that compete with our products, and also
may develop effective and commercially successful products. Our competitors may
succeed in developing or commercializing products that are either more effective
than ours, or that they market before we market new products that we may
develop.
18
There may be additional competitive products about which we are not
aware. If our competitors are able to reach the commercial market before we are,
this could have a material adverse effect on our ability to reach the commercial
market and sell our products.
Many of the organizations competing with us have substantially greater
capital resources, larger research and development staffs and facilities,
greater experience in product development and in obtaining regulatory approvals,
and greater manufacturing and marketing capabilities than we do. These
organizations also compete with us to license proprietary technology.
IF WE FAIL TO OBTAIN OR MAINTAIN THE REGULATORY APPROVALS NECESSARY TO SELL OUR
PRODUCTS, SALES COULD BE NEGATIVELY IMPACTED.
Generally, at this time, our test kits do not require pre-market
approval by the U.S. Food and Drug Administration (the "FDA") or any other
regulatory agency. However, agencies such as the EPA, FDA and the FSIS of the
U.S. Department of Agriculture are engaged in testing environmental samples and,
together with the AOAC, maintain compilations of official methods for use in
testing for environmental contaminants in certain market segments, along with
procedures and guidelines for validating new methods. The failure of these
programs to accept the Company's products could have an adverse impact on our
business. The environmental legislation and regulations that the Company
believes are most applicable to its current business are RCRA, CERCLA, TSCA,
FIFRA and the Pure Food and Drug Act. For analysis of water and wastewater, the
Safe Drinking Water Act, the Clean Water Act and the NPDES permitting program
under the Clean Water Act also will be significant to the Company's business. As
the utility of the Company's Microtox(R) products continues to be widely
recognized in drinking water security applications, regulations and mandates
associated with Homeland Security programs may also have an impact on the
Company's business.
Although the Company's products may not be regulated, the industry
segments into which its products are sold may be regulated, and demand for the
Company's products may be driven by these regulations or the lack thereof. These
regulations vary from country to country. The regulatory environments in which
we compete could change dramatically, which may require us to incur significant
costs in obtaining or maintaining regulatory approvals. If we do not obtain or
maintain regulatory approvals to enable us to market our products in the United
States or elsewhere, or if the approvals are subject to significant
restrictions, the demand for our products maybe negatively impacted.
IF WE DO NOT MATCH OUR PRODUCT MANUFACTURING CAPABILITY TO CUSTOMER DEMAND IN A
COST-EFFECTIVE MANNER, OUR PRODUCT SALES MAY SUFFER.
Our product sales depend upon, among other things, our ability to
manufacture our products in commercial quantities and in a cost-effective
manner. To the extent there is a dramatic increase in demand for our products,
we may not be able to manufacture the products in a quick and cost-effective
manner. Our manufacturing success also depends, in part, on our ability to
transition products from research and development into commercial scale
manufacturing. If we are not successful in this transition, our ability to
produce products may suffer.
OUR BUSINESS COULD SUFFER IF WE CANNOT ATTRACT, RETAIN AND MOTIVATE SKILLED
PERSONNEL.
Our success depends on our continued ability to attract, retain and
motivate highly qualified personnel, including our current executive officers
and other key employees. If such executive officers or other key employees were
to leave and the Company were unable to obtain adequate replacements, the
Company's operating results could be adversely affected. In addition, the
Company's growth depends on its ability to attract, retain and motivate skilled
employees, and on the ability of its officers and key employees to manage growth
successfully.
IT IS DIFFICULT AND COSTLY TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, AND WE
CANNOT ENSURE THE PROTECTION OF THESE RIGHTS; WE MAY BE SUED BY OTHERS FOR
INFRINGING THEIR INTELLECTUAL PROPERTY RIGHTS.
Our commercial success will depend in part on obtaining patent
protection on our products and successfully defending these patents against
third party challenges. The patent positions of technology driven companies can
be highly uncertain and involve complex legal and factual questions.
Accordingly, we cannot predict the breadth of claims allowed in our patents.
19
Others have filed, and in the future are likely to file, patent
applications covering products and technologies that are similar, identical or
competitive to ours, or important to our business. We cannot be certain that any
patent application owned by a third party will not have priority over patent
applications filed or licensed by us, or that we or our licensors will not be
involved in interference proceedings before the United States Patent and
Trademark Office.
Although no third party claims of infringement are outstanding against
the Company, others may hold proprietary rights that will prevent our product
candidates from being marketed unless we can obtain a license to those
proprietary rights. Any patent related legal action against our collaborators or
us claiming damages and seeking to enjoin commercial activities relating to our
products and processes could subject us to potential liability for damages and
require us to obtain a license to continue to manufacture or market the affected
products and processes. We cannot predict whether we would prevail in any of
these actions or that any license required under any of these patents would be
made available on commercially acceptable terms, if at all. If we become
involved in litigation, it could consume substantial managerial and financial
resources.
We rely on trade secrets to protect technology in cases where we believe
patent protection is not appropriate or obtainable. However, trade secrets are
difficult to protect. While we require certain employees and suppliers to enter
into confidentiality agreements, we may not be able to protect adequately our
trade secrets or other proprietary information. If we cannot maintain the
confidentiality of our technology, our ability to receive patent protection or
protect our proprietary information may be imperiled.
IF PRODUCT LIABILITY LAWSUITS ARE SUCCESSFULLY BROUGHT AGAINST US, WE MAY INCUR
SUBSTANTIAL LIABILITIES AND MAY HAVE TO LIMIT OR CEASE COMMERCIALIZATION OF OUR
PRODUCTS.
The testing and marketing of our products gives rise to an inherent risk
of product liability. If we cannot successfully defend ourselves against product
liability claims, we may incur substantial liabilities or be required to limit
or cease commercialization of our products. We currently carry product liability
insurance at a level we believe is commercially reasonable, although there is no
assurance that it will be adequate to cover claims that may arise. In certain
customer contracts we indemnify third parties for certain product liability
claims related to our products. These indemnification obligations may cause us
to pay significant sums of money for claims that are covered by these
indemnifications.
IF OUR COMPANY DOES NOT PRODUCE FUTURE TAXABLE INCOME, OUR ABILITY TO REALIZE
THE BENEFITS OF DEFERRED TAX ASSETS COULD BE IMPAIRED.
As of December 31, 2006, the Company had federal net operating loss
carryforwards, including those acquired in the Company's past acquisitions, of
approximately $15.4 million, which, if not utilized, begin to expire as follows:
Amount of NOL
Year (in thousands)
-------------------------------------------
2009 $ 3,132
2010 5,109
2017 760
2018 1,327
2019 550
2020 121
2021 135
2022 2,345
2024 1,880
-------------------------------------------
Total $ 15,359
===========================================
20
Based on the best information available to the Company today, the
Company expects to have sufficient future taxable income to utilize such NOLs
prior to the expiration of the net operating loss carry forwards.
The Tax Reform Act of 1986 (the Act) limits the annual use of net
operating loss and research and development tax credit carryforwards (after
certain ownership changes, as defined by the Act). The application of these
limits could significantly restrict our ability to utilize carryforwards. Of our
total net operating loss carryforwards, approximately $11.0 million is subject
to limitations, since a cumulative change in ownership of more than 50% has
occurred within a three year period with respect to those net operating loss
carryforwards. Because United States tax laws limit the time period during which
these carryforwards may be applied against future taxes, we may not be able to
take full advantage of these attributes for Federal income tax purposes if we do
not have future taxable income against which to use the carryforwards before
they expire.
OUR RESULTS OF OPERATIONS MAY FLUCTUATE, WHICH COULD CAUSE VOLATILITY IN OUR
STOCK PRICE.
Our results of operations may fluctuate significantly in the future as a
result of a number of factors, many of which are outside of our control. These
factors include, but are not limited to:
o unanticipated events associated with regulatory changes;
o general economic conditions;
o seasonality;
o acceptance of our products; o the success of products
competitive with ours;
o expenses associated with development and protection of
intellectual property matters;
o establishing or maintaining commercial scale manufacturing
capabilities;
o the timing of expenses related to commercialization of new
products; and
o the timing and success in building our distribution channels.
The results of our operations may fluctuate significantly from quarter to
quarter and may not meet expectations of securities analysts and investors. This
may cause our stock price to be volatile.
IF WE USE HAZARDOUS MATERIALS IN A MANNER THAT CAUSES INJURY OR VIOLATES LAWS,
WE MAY BE LIABLE FOR DAMAGES.
Our research and development activities involve the controlled use of
potentially harmful biological materials as well as hazardous materials,
chemicals and various radioactive compounds. We use radioactivity in conducting
biological assays and we use solvents that could be flammable in conducting our
research and development activities. We cannot completely eliminate the risk of
accidental contamination or injury from the use, storage, handling or disposal
of these materials. We do not maintain a separate insurance policy for these
types of risks. In the event of contamination or injury, we could be held liable
for damages that result, and any liability could exceed our resources. We are
subject to federal, state and local laws and regulations governing the use,
storage, handling and disposal of these materials and specified waste products.
The cost of compliance with these laws and regulations could be significant.
OUR ANTIBODY PRODUCTION PROCESS UTILIZES VARIOUS SPECIES OF ANIMALS THAT COULD
CONTRACT DISEASE OR DIE, INTERRUPTING BUSINESS OPERATIONS.
Our antibody production process utilizes animals to produce antibodies.
We cannot completely eliminate the risks of animals contracting disease or a
disaster that could cause death to valuable production animals. Disease or death
on a broad scale could interrupt business operations as animals are a key part
of the antibody production operation.
21
THE DIFFICULTIES OF OPERATING IN INTERNATIONAL MARKETS MAY HARM SALES OF OUR
PRODUCTS.
The international nature of our business subjects us and our
representatives, agents and distributors to the laws and regulations of the
jurisdictions in which they operate, and in which our products are sold. The
types of risks that we face in international operations include, but are not
limited to:
o the imposition of governmental controls;
o logistical difficulties in managing international operations;
and
o fluctuations in foreign currency exchange rates.
Our international sales and operations may be limited or disrupted if we cannot
successfully meet the challenges of operating internationally.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
The Company is headquartered in Newark, Delaware, and occupies
approximately 29,000 square feet of space under an operating lease expiring in
December 2007. The Company also leases approximately 26,000 square feet of
manufacturing and research space, in Newark, Delaware, under an operating lease
expiring in December 2007. The Company owns and occupies approximately 75,000
square feet of manufacturing, research and animal facility space and
approximately 64 acres of farmland in Windham, Maine. The Company leases
approximately 1,900 square feet of manufacturing and research space in Dallas,
Texas under an operating lease expiring in January 2009. The Company leases
regional sales offices near London, England expiring in June 2011. The Company
believes that its equipment and facilities are adequate for its present
purposes.
The Company's inactive subsidiary, AZUR Environmental Limited, is the
lessee for two real property leases located in the United Kingdom. In 2001, the
landlord of the two properties gave AZUR Environmental Limited its consent to
allow AZUR to assign the lease and its related obligations to a third party. As
inducement to the landlord to grant the assignment, AZUR was required to
guarantee performance under the original lease terms if the third party fails to
perform. Both lease terms expire in November 2016 and provide for annual
principal rent payments of approximately $300,000 in the aggregate. The Company
believes that based on its assessment of the current financial strength of the
third party, no liability is required to be recorded with regard to the
guarantee or lease obligation.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's stockholders during
the fourth quarter of the fiscal year ended December 31, 2006.
22
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
The Company's Common Stock is traded on The NASDAQ Global Market under
the symbol "SDIX." Set forth below are the quarterly high and low bid prices for
the shares of Common Stock of the Company as reported by The NASDAQ Global
Market without retail mark-up, mark-down or commission and may not necessarily
represent actual transactions:
COMMON STOCK
PRICE RANGE
----------------
FISCAL YEAR ENDED HIGH LOW
------- -------
December 31, 2006:
Fourth Quarter.......................................... $ 3.80 $ 3.06
Third Quarter........................................... 4.20 2.75
Second Quarter.......................................... 4.21 2.35
First Quarter........................................... 4.17 3.04
December 31, 2005:
Fourth Quarter.......................................... $ 4.06 $ 3.05
Third Quarter........................................... 4.26 3.20
Second Quarter.......................................... 3.58 2.32
First Quarter........................................... 3.70 2.85
On March 19, 2007, there were approximately 24,174 holders (330 holders
of record) of the common stock of the Company. The Company has never paid any
cash dividends on its common stock and pursuant to the Company's financing
agreement with PNC Bank, Delaware, the Company's commercial bank, no dividends
or distributions may be paid on account of its common stock.
23
STOCK PERFORMANCE GRAPH
The following line graph compares for the fiscal years ended December
31, 2001 through 2006 (i) the yearly cumulative total shareholder return on the
Common Stock with (ii) the cumulative total return of the NASDAQ Composite Index
and with (iii) a Peer Group Index consisting of NASDAQ Medical Equipment Stocks.
[PERFORMACE GRAPH APPEARS HERE
COMPARISON OF CUMULATIVE TOTAL RETURN
Strategic Diagnostics Inc., NASDAQ Composite and NASDAQ Medical Equipment Peer
Group Indices
- ------------------------------------------------------------------------------
12/01 12/02 12/03 12/04 12/05 12/06
- ------------------------------------------------------------------------------
Strategic Diagnostics Inc. 100.00 46.49 66.20 49.30 51.27 53.24
NASDAQ Composite 100.00 68.85 101.86 112.16 115.32 127.52
NASDAQ Medical Equipment 100.00 84.87 123.91 150.24 162.73 173.66
24
ITEM 6. SELECTED FINANCIAL DATA
Year Ended December 31,
-------------------------------------------------------------------------
2006 2005 2004 2003 2002
Revenues: (in thousands, except share and per share data)
Product related $ 25,522 $ 24,845 $ 23,705 $ 25,692 $ 22,968
Contract and other - - - 117 517
-------------------------------------------------------------------------
Total revenues 25,522 24,845 23,705 25,809 23,485
-------------------------------------------------------------------------
Operating expenses:
Manufacturing 11,721 11,416 10,779 14,807 12,784
Research and development 2,630 3,034 2,157 2,203 2,784
Selling, general and administrative 10,591 9,722 9,211 10,046 10,277
-------------------------------------------------------------------------
Total operating expenses 24,942 24,172 22,147 27,056 25,845
-------------------------------------------------------------------------
Operating income (loss) 580 673 1,558 (1,247) (2,360)
Interest income (expense), net 386 207 53 (40) (50)
Gain on sale of assets - - - - 374
-------------------------------------------------------------------------
Income (loss) before taxes 966 880 1,611 (1,287) (2,036)
Income tax expense (benefit) 282 296 232 (634) (986)
-------------------------------------------------------------------------
Net income (loss) applicable to
common stockholders $ 684 $ 584 $ 1,379 $ (653) $ (1,050)
=========================================================================
Basic net income (loss) per share
applicable to common stockholders $ 0.03 $ 0.03 $ 0.07 $ (0.03) $ (0.06)
=========================================================================
Shares used in computing basic net income (loss)
per share applicable to common stockholders 20,032,000 19,741,000 19,242,000 18,999,000 18,419,000
=========================================================================
Diluted net income (loss) per share
applicable to common stockholders $ 0.03 $ 0.03 $ 0.07 $ (0.03) $ (0.06)
=========================================================================
Shares used in computing diluted net income (loss)
per share applicable to common stockholders 20,109,000 19,870,000 19,495,000 18,999,000 18,419,000
=========================================================================
Year Ended December 31,
-------------------------------------------------------------------------
2006 2005 2004 2003 2002
-------------------------------------------------------------------------
BALANCE SHEET DATA:
Cash and cash equivalents $ 10,892 $ 10,009 $ 8,096 $ 5,158 $2,098
Working capital 16,731 15,552 13,525 11,567 12,039
Total assets 37,953 36,661 34,873 33,073 32,889
Long-term debt 351 562 773 983 1,212
Stockholders' equity 35,262 33,778 31,766 29,876 29,778
25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD LOOKING STATEMENTS
This annual report contains certain forward-looking statements
reflecting the current expectations of Strategic Diagnostics Inc. and its
subsidiaries (the "Company" or "SDI"). In addition, when used in this annual
report, the words "anticipate," "enable," "estimate," "intend," "expect,"
"believe," "potential," "may," "will," "should," "project" and similar
expressions as they relate to the Company are intended to identify said
forward-looking statements. Investors are cautioned that all forward-looking
statements involve risks and uncertainties, which may cause actual results to
differ from those anticipated at this time. Such risks and uncertainties
include, without limitation, changes in demand for products, delays in product
development, delays in market acceptance of new products, retention of
customers, attraction and retention of management and key employees, adequate
supply of raw materials, inability to obtain or delays in obtaining third party
approvals, or required government approvals, the ability to meet increased
market demand, competition, protection of intellectual property,
non-infringement of intellectual property, seasonality, the ability to obtain
financing and other factors more fully described in the Company's public filings
with the U.S. Securities and Exchange Commission.
OVERVIEW
The Company is a leading provider of antibody products and analytical
test kits for a broad range of food, water, agricultural, industrial,
environmental and scientific applications.
The Company believes that its competitive position has been enhanced
through the combination of talent, technology and resources resulting from the
business development activities it has pursued since its inception. The Company
has achieved meaningful economies of scale for the products it offers through
the utilization of its consolidated facilities in Newark, Delaware, for the
manufacture of test kits and antibodies and its facilities located in Windham,
Maine and Dallas, Texas for the manufacture of antibodies.
The Company believes that by applying its core competency of creating
custom antibodies to assay development, the Company produces unique,
sophisticated diagnostic testing and reagent systems that are responsive to
customer diagnostic and information needs. Customers benefit with quantifiable
"return on investment" by reducing time, labor and/or material costs associated
with applications for which the Company's products are used. In addition, the
Company believes its tests provide high levels of accuracy, reliability and
actionability of essential test results as compared to alternative products. The
Company is focused on sustaining this competitive advantage by leveraging its
expertise in immunology, proteomics, bio-luminescence and other bio-reactive
technologies to continue its successful customer-focused research and
development efforts. The Company believes that an established product base,
quality manufacturing expertise, experienced sales and marketing organization,
established network of distributors, corporate partner relationships and proven
research and development expertise will be critical elements of its potential
future success.
In 2006, the Company continued the transition from having too many
products and a fragmented marketing strategy to becoming a focused company, with
proven, proprietary technologies tied directly to its customers' needs. The
transition is most evident in the Genomic Antibody(TM) initiative and food
pathogen detection products, where significant progress is being made.
The Company continues to develop and introduce new methods for the
detection of food pathogens that deliver a strong competitive advantage to its
customers. In 2005, the Company filed a patent for new technology to be used in
proprietary enrichments of its food pathogen testing methods. The patent covers
technology for increasing the specificity and sensitivity of the Company's
immunoassay test methods. The patent also makes claims for the application of
the technology in large scale bio-production/bio-fermentation processes, such as
those used in the production of amino acids, ethanol, enzymes and other
processes using microbiological production methods.
The Company continued to develop multiple channels to market worldwide
through an approach that includes direct sales, inside sales, distributors and
agents. The Company increased distribution for its environmental products in
Eastern Europe and Asia where there is growing demand for environmental
stewardship.
26
The Company believes it is making progress in most of its business
efforts, and as the deployment of new initiatives is accelerated, building on
the Company's leadership position in food pathogens and expanding its unique
positioning in the emerging area of genomic antibodies, the Company anticipates
that the revenue lost to market changes in its legacy businesses will be
replaced and the Company will develop a stronger, more predictable, revenue
base.
The Company expects the Genomic Antibodies(TM) and food pathogen
products to be its primary growth drivers in the future, and that the Company's
competencies and the competitive positions these two areas provide are the
strongest in the Company's history.
CORPORATE AND GROWTH INITIATIVES:
The following provides an update on the business development activities
related to the Genomic Antibodies(TM) initiative and the new Salmonella product
in the food pathogen area, which utilizes a patent-pending enrichment media
technology.
GENOMIC ANTIBODIES(TM): The Company announced an initiative to develop
technology for the high throughput production of genetic antibodies early in
2005, and in January 2006, opened a new facility for molecular biology and hired
two scientists that had been leading the development of this technology. In
January 2006, the Company announced the commercial introduction of the lead
product, mouse polyclonal antibodies, and the establishment of a new website,
www.genomicantibodies.com.
In the same announcement, it was reported that beta tests had been
successfully completed and the high throughput production processes for mouse
polyclonal antibody reagents validated. Some of the other findings from these
beta tests and the work that has taken place since the product's commercial
launch are:
o The technology completely eliminates a customer's need to
prepare and provide an antigen.
o An antibody that recognizes the user's target has been
successfully produced, in the assay format the user chooses, 80%
of the time.
o The process is successfully producing antibodies to some of the
most difficult research targets, including trans-membrane
proteins, membrane associated proteins, and other highly
conserved proteins.
o A reagent is delivered to a customer in 76 days or less. This
represents a saving of as much as 50% when compared to the time
required for delivery of antibody developed using traditional
methods.
The antibody product group is strategically important to the growth of
the Company, and to transforming the Company into a biotech company with much
greater opportunities to access the human health market with proteomic tools and
solutions. With a relatively modest investment, and great speed, the Company
produced a platform technology with potential for new and greater value
creation. In the first quarter of 2006 we began commericialization of Genomic
Antibodies(TM).
SALMONELLA PRODUCT: The new test for the detection of SALMONELLA entered
prototype evaluations in the first quarter of 2006. This test incorporates
several new and proprietary technology advancements, and to date all planned
prototype studies have been successfully completed with outstanding results.
This work has set the stage for entering beta test evaluations of the full
method in the second quarter of 2006, along with AOAC validation. The Company
had a full commercial launch in August 2006.
One of the technologies that made the new SALMONELLA product possible is
the subject of a patent filed by the Company during the fourth quarter of 2005.
The patent claims the use of bacteria phage for the growth and detection of a
target bacterium in an environment that is contaminated by competing and cross
reacting bacteria. This new technology solves the problem of singling out the
harmful pathogen among many other bacteria by creating an optimized environment
for rapid growth of the targeted pathogen while dramatically suppressing other
competing bacteria or bacteria that can interfere with the fidelity of the test
method. This technology will be the subject of three papers accepted for
presentation at the International Association for Food Protection annual meeting
in 2007. As the Company experienced with its LISTERIA test, superior accuracy,
ease of use and lower cost in use should lead to rapid market acceptance.
27
OTHER INITIATIVES:
INDUSTRIAL BIO-PROCESSING: The Company believes that the same technology
used in the Salmonella product has application in other bio-processing
environments, including industrial bio-processing. There are many large scale
industrial processes where a manufacturer is attempting to manage the yield of a
production organism in an environment contaminated by competing bacteria. These
are applications like ethanol production, amino acid production, bio plastics,
and others. The Company claims such application in our patent. The Company is
currently working to demonstrate the application of these technologies in
various industrial applications. In 2006 we announced an agreement to develop a
commercial application of this technology with Broin Industries, a major
producer of ethanol in the United States.
WATER SECURITY: The Company is planning to increase spending associated
with marketing efforts in support of the water quality products, specifically
the Microtox(R) and Deltatox(R) technologies. This investment follows the recent
announcement that both platforms have received designation as an anti-terror
technology by the Department of Homeland Security. SAFETY Act designation allows
users a safe harbor from liability associated with the use of the technology in
the prevention, response or recovery from a terrorist action. The Company
believes that this point alone focuses new attention on the preventative value
of the technology.
The Company has a robust new product pipeline with technology that
provides sustainable differentiation to address larger markets. Sales and
marketing professionals are being hired in anticipation of new product launches
and the opportunities identified. The Company continues to be focused on key
customers and prospects in target markets: food, drinking water, pharma,
in-vitro diagnostics, and biotech. Continuously improving the efficiency of our
manufacturing and supply chain processes and improving the overall quality of
our products and service remains critical to success.
ECONOMIC AND INDUSTRY-WIDE FACTORS
o As industry continues to look for ways to reduce costs, the
Company believes there will be a continual shift from testing
that requires highly trained personnel, expensive equipment and
lengthy turnaround times for test results, to more rapid,
accurate and cost-effective testing which can be performed by
less highly trained personnel and completed in minutes or hours.
o The global market for food pathogen testing continues to
increase due to the globalization of the food supply, the
establishment of harmonized quality standards, the consumer's
desire for fresher, more ready-to-eat foods and foods from
diverse geographies, and increasing regulatory and media
scrutiny.
o The trend of increasing acceptance of GM crops and the
introduction of new traits may drive additional demand for the
Company's products in order to maintain identity preservation
and tracking.
o Currently, the research tools portion of the biomarker and drug
target discovery market is estimated to be between $600 million
and $1 billion dollars, and is expected to grow at a compounded
annual rate of more than 15% over the next 10 years to exceed
$3.5 billion dollars.
SEASONALITY
Sales levels for certain agricultural products may be impacted by
seasonal demand trends. The demand for these test kits is typically higher in
the first and third quarters due to harvesting patterns.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2006 VERSUS YEAR ENDED DECEMBER 31, 2005
Revenues: Revenues for the year ended December 31, 2006 increased 2.7%
to $25.5 million, compared to $24.8 million for the same period in 2005. The
following table sets out revenues by product category.
28
Year Ended
December 31,
--------------------------- Increase Percent
2006 2005 (Decrease) Change
- ------------------------------------------------------------------------------
(in thousands, except percentages)
Water quality $ 5,203 $ 5,139 $ 64 1.2%
Food safety 9,215 8,981 234 2.6%
Antibody 11,104 10,725 379 3.5%
- ------------------------------------------------------------------------------
Net revenues $ 25,522 $ 24,845 $ 677 2.7%
==============================================================================
WATER AND ENVIRONMENTAL PRODUCTS
Water and environmental products revenue increased 1.2% to $5.2 million
for the year ended December 31, 2006, compared to $5.1 million for 2005 and
increased 2.2% to $1.22 million for the fourth quarter of 2006, compared to
$1.19 million for the same quarter in 2005.
Sales of water and environmental products increased 10% in foreign
markets, excluding the effects of foreign currency translation, for the year
ended December 31, 2006 when compared to the year ended December 31, 2005. This
increase was primarily due to increased sales of water testing equipment and
supplies into China. The increased sales into foreign markets were partially
offset by a 3.2% decline in sales in the U.S. domestic market during the
comparable year period.
FOOD SAFETY PRODUCTS
For the year ended December 31, 2006, food safety revenues were $9.2
million, compared to $9.0 million for 2005, an increase of 2.6%. Food safety
revenues were $2.8 million in the fourth quarter of 2006, compared to $2.3
million in the fourth quarter of 2005, an increase of 21.1%.
Sales of tests for food pathogens grew 14.5% from $3.3 million to $3.7
million when comparing the years ended December 31, 2005 and December 31, 2006.
This increase is due primarily to increased sales of the Company's tests for
Listeria which the Company launched in mid-2004.
Since 2001, sales of the Company's product for the StarLinkR trait have
dropped from $5.4 million to approximately $871,000 in 2006. The Company expects
sales of this product to ultimately cease entirely.
ANTIBODY PRODUCTS
Antibody revenues increased 3.5% to $11.1 million in the year ended
December 31, 2006, compared to $10.7 million for 2005, and increased 24.2% to
$3.0 million for the fourth quarter of 2006, compared to $2.4 million for the
same quarter in 2005.
The fourth quarter 2006 increase resulted from an increase in demand for
monoclonal products and services, an increase in demand for bulk antibody
products and deliveries of custom Genomic Antibodies(TM) projects. Management is
encouraged by the overall increase in volume and margin but continues to
recognize that the "bulk" monoclonal and polyclonal segments of the business
have inconsistent order patterns and may produce periodic spikes in revenue.
Overall, production capacity and utilization of production capacity increased in
2006; a trend that is expected to continue.
OTHER AREAS
Gross profit for the year ended December 31, 2006 totaled $13.8 million,
as compared to $13.4 million for 2005. Gross margins were 54.1% for both years
presented.
For the year ended December 31, 2006, operating expenses increased 3.2%
to $24.9 million, compared to $24.17 million in the same period in 2005.
For the year ended December 31, 2006, research and development spending
was $2.6 million, or 10.3% of revenues, compared to $3.0 million, or 12.2% of
revenues, for 2005. This decrease was primarily the result of approximately
$398,000 in spending during 2005 related to upgrades to the Microtox(R)
equipment software.
Selling, general and administrative expenses were $10.6 million for the
year ended December 31, 2006, compared to $9.7 million for 2005. This increase
is primarily attributable to marketing efforts utilized to launch the
29
Genomic Antibodies(TM) product and the cost of a detailed review of the
Company's business and opportunities for growth by an outside consulting group.
INTEREST, NET: The Company recorded interest income of $386,000 during
2006 compared to interest income of $207,000 during 2005. This increase is
primarily due to increased interest rates received on invested funds in 2006.
Pre-tax income totaled $966,000 for the year ended December 31, 2006,
compared to $880,000 for 2005.
INCOME TAXES: The Company's annual effective tax rate of 29.2% for 2006
primarily reflects the federal statutory rate of 34%, state income taxes net of
U.S. Federal benefit of 6.2% and research and development credits of 14.6%.
Net income for the year ended December 31, 2006 was $684,000, or $0.03
per diluted share, compared to $584,000, or $0.03 per diluted share, for 2005.
Diluted shares totaling 20.1 million and 19.9 million were used in the
computations for 2006 and 2005, respectively.
YEAR ENDED DECEMBER 31, 2005 VERSUS YEAR ENDED DECEMBER 31, 2004
Revenues: Revenues decreased $1.1 million or 4.8% in 2005 over 2004. The
following table sets out revenues by product category.
Year Ended
December 31,
-------------------------- Increase Percent
2005 2004 (Decrease) Change
- -----------------------------------------------------------------------------
(in thousands, except percentages)
Water quality $ 5,139 $ 5,911 $ (772) -13.1%
Food safety 8,981 7,634 1,347 17.6%
Antibody 10,725 10,160 565 5.6%
- -----------------------------------------------------------------------------
Net revenues $ 24,845 $ 23,705 $ 1,140 4.8%
=============================================================================
WATER AND ENVIRONMENTAL PRODUCTS
Water and environmental products revenue decreased 13.1% to $5.1 million
for the year ended December 31, 2005, compared to $5.9 million for 2004 and
decreased 24.2% to $1.2 million for the fourth quarter of 2005, compared to $1.6
million for the same quarter in 2004.
FOOD SAFETY PRODUCTS
For the year ended December 31, 2005, food safety revenues were $8.9
million, compared to $7.6 million for 2004, an increase of 17.6%. Food safety
revenues were $2.3 million in the fourth quarter of 2005, compared to $2.2
million in the fourth quarter of 2004, an increase of 2.7%. These increases were
driven by food pathogen test sales in both the fourth quarter of 2005 and the
year ended December 31, 2005, which were up 84.0% and 107.3%, respectively,
compared to the same periods of 2004.
ANTIBODY PRODUCTS
Antibody revenues increased 5.6% to $10.7 million in the year ended
December 31, 2005, compared to $10.2 million for 2005, but decreased 5.5% to
$2.4 million for the fourth quarter of 2005, compared to $2.5 million for the
same quarter in 2004. The decline in the fourth quarter was primarily due to a
cyclical reduction in demand for bulk antibodies, as well as a reduction in new
projects for custom monoclonal antibody production.
In 2004, the Company recorded revenue totaling approximately $360,000
associated with the sale of previously written off inventories that represented
the Company's discontinued catalog in bulk polyclonal antibodies.
OTHER AREAS
Gross profit for the year ended December 31, 2005 totaled $13.4 million,
as compared to $12.9 million for 2004. Gross margins were 54.1% for 2005 and
54.5% for 2004.
30
For the year ended December 31, 2005, operating expenses increased 9.1%
to $24.2 million, compared to $22.2 million in the same period in 2004,
partially due to research expenses incurred of $590,000 related to the Company's
investment in the commercialization of new technologies and high throughput
production of antibodies and the investment in a software upgrade for the
Microtox(R) equipment totaling $398,000.
For the year ended December 31, 2005, research and development spending
was $3.03 million, or 12.2% of revenues, compared to $2.2 million, or 9.1% of
revenues, for 2004.
Selling, general and administrative expenses were $9.7 million for the
year ended December 31, 2005, compared to $9.2 million for 2004. In 2005, the
Company recorded approximately $275,000 of costs related to the previously
announced restatement of prior years' financial statements as a result of a
determination by the Company, following discussions with the U.S. Securities and
Exchange Commission, to revise its revenue recognition policy for custom
antibody projects.
INTEREST, NET: The Company recorded interest income of $207,000 during
2005 compared to interest income of $53,000 during 2004 primarily due to higher
levels of invested cash when comparing 2005 to 2004.
Pre-tax income totaled $880,000 for the year ended December 31, 2005,
compared to $1.6 million for 2004.
INCOME TAXES: The Company's annual effective tax rate of 33.6% for 2005
primarily reflects the federal statutory rate of 34%, foreign net operating
losses not previously benefited of 5.5% and research and development credits of
11.0%.
Net income for the year ended December 31, 2005 was $584,000, or $0.03
per diluted share, compared to $1.4 million, or $0.07 per diluted share, for
2004. Diluted shares totaling 19.9 million and 19.5 million were used in the
computations for 2005 and 2004, respectively.
31
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is our ability to generate sufficient cash flows from
operating activities to meet the Company's obligations and commitments, or
obtain appropriate financing. Currently our liquidity needs arise primarily from
debt service on indebtedness, working capital requirements and capital
expenditures.
The following is a summary of selected cash flow information:
Year Ended
December 31,
------------------------
2006 2005
------------------------
(in thousands)
Net cash provided by operating activities $ 1,667 $ 2,119
Net cash used in investing activities (1,111) (1,234)
Net cash provided by financing activities 198 1,152
Effect of exchange rate changes on cash 129 (124)
------------------------
Net increase in cash and cash equivalents $ 883 $ 1,913
========================
The net cash provided by operating activities of $1.7 million and $2.1
million for 2006 and 2005, respectively, was primarily the result of earnings
before interest, taxes, depreciation and amortization (EBITDA) for the periods
ending December 31, 2006 and 2005 of $1.6 million in each period. See "Non-GAAP
Financial Measures" below.
Net cash used in investing activities in 2006 of $1.1 million compares
to net cash used in investing activities of $1.2 million for 2005. These cash
outflows were primarily the result of capital purchases which totaled $1.0
million in 2006 versus $1.2 million in 2005. The capital expenditures for 2006
primarily relate to manufacturing and lab equipment purchases. The capital
expenditures for 2005 primarily relate to investments in a parcel of land
adjacent to our antibody manufacturing facility in Maine.
Net cash provided by financing activities of $198,000 for 2006 and $1.2
million for 2005 was primarily driven by proceeds from the exercise of stock
options, which was partially offset by net repayments of outstanding debt.
The Company's working capital (current assets less current liabilities)
increased approximately $1.2 million to $16.7 million at December 31, 2006 from
$15.6 million at December 31, 2005, primarily due to the increase of $883,000 in
cash and cash equivalents generated during the 2006 period. Outstanding debt
decreased $211,000 from $773,000 at December 31, 2005 to $562,000 on December
31, 2006, due to scheduled repayments.
On May 5, 2000, the Company entered into a financing agreement with a
commercial bank. This agreement provides for up to a $5.0 million revolving line
of credit, none of which was outstanding and approximately $3.0 million of which
was available at December 31, 2006, based on eligible assets.
The revolving line of credit bears a variable interest rate of between
1.75% and 2.75% over LIBOR depending upon the ratio of the Company's funded debt
to EBITDA, and is subject to a borrowing base determined by the Company's
eligible accounts receivable. The Company's annual effective rate of interest on
this line of credit, taking into account the variable interest rate and LIBOR,
was approximately 7.07% at December 31, 2006.
On December 13, 2001, the Company entered into an agreement with a
commercial bank to finance the construction of new facilities at its Windham,
Maine location. This agreement provided for up to $1.5 million in financing,
$562,000 of which was outstanding at December 31, 2006, and is repayable over
seven years, with principal payments that began on October 1, 2002. The loan
bears a variable interest rate of between 2% and 3% over LIBOR depending upon
the ratio of the Company's funded debt to EBITDA. Payments are due monthly, with
equal amortization of principal payments plus interest. The Company's annual
effective rate of interest on this loan at December 31, 2006, was approximately
7.32%.
Under the terms of the above financing, the Company is required to meet
certain quarterly financial covenants that include a ratio of EBITDA to current
maturities of debt plus interest and cash paid for taxes greater than 1.50 and a
ratio of funded debt to EBITDA not to exceed 3.25. At December 31, 2006, the
Company met all of its financial covenants with respect to this indebtedness.
32
For the year ended December 31, 2006, the Company satisfied all of its
cash requirements from the net cash provided by operating activities, cash
available and on-hand and from the financing agreements described above. At
December 31, 2006, the Company had $351,000 in long-term debt and stockholders'
equity of $35.3 million. Although the Company has no material commitments for
capital expenditures at December 31, 2006, it does anticipate that it may spend
approximately $1.6 million in 2007 to upgrade or expand certain manufacturing,
research and development and office systems.
NON-GAAP FINANCIAL MEASURES
The Company presents an EBITDA measure as the Company believes this
provides investors and the Company's management with additional information to
measure the Company's liquidity. EBITDA measures are not a measure of
performance under GAAP and, therefore, should not be considered in isolation or
as a substitute for net income or cash flows from operations. Additionally, the
Company's EBITDA calculations may differ from the EBITDA calculations for other
companies.
The calculation of the Company's EBITDA measure (as discussed above),
and the reconciliation of the Company's EBITDA measure to net cash provided by
operating activities for years ended December 31, 2006 and 2005, respectively,
is as follows (amounts in thousands):
Twelve Months Ended December 31,
--------------------------------
2006 2005
- --------------------------------------------------------------------------------
(in thousands)
Net cash provided by operating activities $ 1,667 $ 2,119
Changes in assets and liabilities:
Receivables 436 135
Inventories (34) (6)
Other current assets 130 (5)
Other assets (26) 1
Accounts payable (77) 404
Accrued expenses (16) (184)
Deferred revenue 74 (207)
Net change in deferred income tax 158 18
Loss on disposal of fixed assets (42) (228)
Stock compensation expense (277) (243)
Interest income, net (386) (207)
- --------------------------------------------------------------------------------
EBITDA $ 1,607 $ 1,597
================================================================================
33
OFF-BALANCE SHEET ARRANGEMENTS
As of December 31, 2006 the Company did not have any off-balance sheet
arrangements as defined in Item 304(a) (4) (ii) of Regulation S-K.
CONTRACTUAL OBLIGATIONS
The Company is committed to making cash payments in the future on two
types of contracts: our long-term indebtedness and leases. The Company has no
off-balance sheet debt or other such unrecorded obligations. Below is a schedule
of the future payments that the Company was obligated to make based on
agreements in place as of December 31, 2006.
Payments Due by Year
2012 and
2007 2008 2009 2010 2011 Beyond Total
- -------------------- -----------------------------------------------------------------------------------
(in thousands)
Long-term debt (1) $ 211 211 140 - - - 562
Operating leases (2) $ 654 66 48 38 19 0 825
- -------------------- -----------------------------------------------------------------------------------
Total contractual
cash obligations $ 865 277 188 38 19 0 1,387
==================== ===================================================================================
(1) See discussion in Note 5 of the Notes to the Consolidated Financial
Statements for additional information on long-term debt.
(2) See discussion of operating leases in Note 8 of the Notes to the
Consolidated Financial Statements.
Based upon its cash on hand, credit facilities, current product sales
and the anticipated sales of new products, the Company believes it has, or has
access to, sufficient resources to meet its operating requirements at least
through the next 12 months.
The Company's ability to meet its long-term capital needs will depend on
a number of factors, including compliance with existing and new loan covenants,
the success of its current and future products, the focus and direction of its
research and development program, competitive and technological advances, future
relationships with corporate partners, government regulation, the Company's
marketing and distribution strategy, its successful sale of additional common
stock and/or the Company successfully locating and obtaining other financing,
and the success of the Company's plan to make future acquisitions. Accordingly,
no assurance can be given that the Company will be able to meet the long-term
liquidity requirements that may arise from these inherent and similar
uncertainties.
CRITICAL ACCOUNTING POLICIES
The Company's accounting policies are described in Note 1 of the Notes
to the Consolidated Financial Statements. The Consolidated Financial Statements
are prepared in conformity with U.S. generally accepted accounting principles,
which require the Company to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosures of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the year. On an on-going basis, the Company
evaluates its estimates, including those related to bad debts, inventories,
deferred taxes and long-lived assets. The Company bases its estimates on
historical experience and on various other assumptions that the Company believes
are reasonable under the circumstances. The results form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results could differ from those
estimates. The Company considers the following policies to be most critical in
understanding the judgments that are involved in preparing the Consolidated
Financial Statements and the uncertainties that could impact the consolidated
results of operations, financial condition and cash flows.
34
VALUATION OF ACCOUNTS RECEIVABLE - Accounts receivable as of December
31, 2006 and December 31, 2005, were net of an allowance for doubtful accounts
of $134,000 and $117,000, respectively. The recorded allowance is continually
evaluated based on current market conditions, an analysis of customer-specific
facts and circumstances, and the size and composition of the overall portfolio.
If receivables become uncollectible, these write-offs are charged against the
allowance.
VALUATION OF INVENTORIES - Inventories are valued at the lower of cost
or market.
For inventories that consist primarily of test kit components, bulk
antibody serum and antibody products, cost is determined using the first in,
first out method. Realization of inventories is dependent upon the successful
marketing of our products. Judgments are made regarding the carrying value of
inventory based on current market conditions. Market conditions may change
depending upon competitive product introductions and customer demand. If market
conditions change or if the introduction of new products by the Company impacts
the market for previously released products, the Company may be required to
write-down the cost of its inventory.
For inventories that consist of costs associated with the production of
custom antibodies, cost is determined using the specific identification method.
Realization of such inventories is dependent upon the successful completion of a
project in accordance with customer specifications. Losses on projects in
progress are recorded in the period such losses become likely and estimable.
DEFERRED TAXES - In assessing the realizablity of deferred tax assets,
management considers whether it is more likely than not that some portion or all
of the deferred tax assets will not be realized. The ultimate realization of
deferred tax assets is dependent upon the generation of future taxable income
during the period in which those temporary differences become deductible.
Management considers the scheduled reversal of existing temporary differences,
projected future taxable income and tax planning strategies in making this
assessment. Based upon historical taxable income and projections for future
taxable income management believes it is more likely than not that the Company
will realize the benefits of these deductible differences, net of the existing
valuation allowances at December 31, 2006.
At December 31, 2006, management concluded that no valuation allowance
is necessary for federal deferred tax assets after considering the positive and
negative factors. In making this determination, the Company considered the
following positive evidence:
o positive net income before taxes in each of the last three
years;
o income before taxes of $1.2 million for the six month period
ended December 31, 2006;
o cumulative income before taxes of $3.5 million over the three
years ended December 31, 2006;
o use of annual election to capitalize research and
experimentation expenses under IRS code 59(e), which will then
be amortized over a ten year period;
o past and anticipated new product launches; and
o The operating efficiencies gained and to be gained from
automating labor intensive manufacturing processes and
improvements to supply chain management.
The Company also considered the following negative factors:
o the 2006 income before taxes was lower than 2006 expectations;
and
o federal net operating loss carry forwards begin to expire in
2009.
At December 31, 2006, management has concluded that a full valuation
allowance is necessary for deferred tax assets in certain state jurisdictions.
For the state jurisdictions, management has considered the same positive and
negative evidence as utilized for the federal deferred tax assets described
above. The Company has also considered the substantial reduction of its presence
in North Carolina and Pennsylvania since the time when the net operating losses
were incurred in those jurisdictions as additional negative evidence.
At December 31, 2006, the Company had approximately $6.3 million of net
operating loss carryforwards for tax purposes related to foreign operations in
the United Kingdom ("UK"). Management considered positive and negative
indicators in concluding that a substantial valuation allowance of $1.8 million
was necessary for the foreign deferred tax assets of $1.9 million. The positive
indicators included the contribution to income before taxes by the foreign
operations in the UK for 2006 and 2005, and the expected income before taxes in
the UK for 2007. The negative indicators include a history of substantial net
operating losses in the UK, the lack of income before taxes until 2004 and
limitations with regard to estimating income in the UK beyond 2006 resulting
from the rebuilding and expansion of the UK distributor network.
The net operating loss carryforwards differ from the accumulated
deficit, principally due to differences in the timing of recognition of certain
research and development expenses, depreciation and amortization, other
non-deductible reserves and limitations under federal and state regulations for
acquired net operating loss carryforwards.
35
As of December 31, 2006, the Company had Federal net operating loss
carryforwards, including those acquired in the Company's past acquisitions, of
approximately $15.4 million, which, if not utilized, begin to expire as follows:
Amount of NOL
Year (in thousands)
- ----------------------------------------------
2009 $ 3,132
2010 5,109
2017 760
2018 1,327
2019 550
2020 121
2021 135
2022 2,345
2024 1,880
- ----------------------------------------------
Total $ 15,359
==============================================
Based on the best information available to the Company today, the
Company expects to have sufficient future taxable income to utilize such NOLs
prior to the expiration of the U.S. net operating loss carry forwards.
REVENUE RECOGNITION -- Revenues composed of sales of immunoassay-based
test kits and certain antibodies and immunochemical reagents are recognized upon
the shipment of the product and transfer of title or when related services are
provided. Revenues associated with such products or services are recognized when
persuasive evidence of an order exists, shipment of product has occurred or
services have been provided, the price is fixed and determinable and,
collectibility is probable. Management is required to make judgments based on
actual experience about whether or not collectibility is reasonably assured.
The Company enters into contracts related to the production of custom
antibodies, which provide for the performance of defined tasks for a fixed
price, with delivery of the product upon completion of production. The standard
time to complete a project is typically longer than 30 days but less than 12
months and effort is expended over the life of the project. Revenues related to
sales of custom antibody projects are recognized when a project's specifications
have been met and/or the related materials have been shipped.
Fees associated with products and services added on to a custom antibody
project subsequent to delivery of the initial project are billed monthly and
recognized as revenue as the services and other deliverables are provided.
VALUATION OF LONG-LIVED ASSETS--Long-lived assets, such as property,
plant, and equipment, and purchased intangibles subject to amortization, are
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of
an asset to its estimated undiscounted future cash flows expected to be
generated by the asset. If the carrying amount of an asset exceeds its estimated
future cash flows, an impairment charge is recognized by the amount by which the
carrying amount of the asset exceeds the fair value of the asset. Goodwill and
intangible assets not subject to amortization are tested annually for
impairment, and are tested for impairment more frequently if events and
circumstances indicate that the asset might be impaired. An impairment loss is
recognized to the extent that the carrying amount exceeds an asset's fair value.
36
STOCK-BASED COMPENSATION -- the Company accounts for stock-based
compensation in accordance with SFAS No. 123 (revised 2004), "Share-Based
Payment," ("SFAS 123 (R)"). SFAS 123 (R) requires the Company to measure all
employee stock-based compensation awards using a fair value method and recognize
such expense in our consolidated financial statements. In addition, SFAS 123 (R)
requires additional accounting related to the income tax effects and additional
disclosure regarding the cash flow effects resulting from stock-based payment
arrangements. We adopted SFAS 123 (R) on January 1, 2006 using the modified
prospective transition method in which compensation cost is recognized beginning
January 1, 2006 for all stock-based awards granted on or after that date and for
all awards granted to employees prior to January 1, 2006 that remain unvested on
that date. Under this transition method, compensation cost recognized in fiscal
2006 includes: (a) compensation cost for all stock-based awards granted prior
to, but not yet vested as of January 1, 2006, based on the grant date fair value
estimated in accordance with the original provisions of SFAS 123, as adjusted
for an estimate of the number of awards that will be forfeited and (b)
compensation cost for all stock-based awards granted on or after January 1, 2006
based on the grant date fair value estimated in accordance with the provisions
of SFAS 123 (R).
Previously, we had recognized the impact of forfeitures as they
occurred. The grant date fair value of the awards generally vests over the
service period. The stock-based compensation expense is included in SG&A
expenses. SFAS 123 (R) requires management to make estimates and assumptions to
determine the underlying value of stock options and restricted stock awards,
including the vesting for restricted stock awards and options containing
performance-based vesting features, the expected term of stock options, an
estimate of future forfeitures and the volatility of our stock price in the
future. These assumptions have an impact on the valuation assigned to equity
awards and the associated recognition of expense.
On December 27, 2005, the Board of Directors of the Company approved the
accelerated vesting, effective as of December 31, 2005, of all unvested stock
options granted to employees and non-employee directors from 2002 through 2005
under the Company's 2000 Stock Incentive Plan, as well as options granted to the
Company's Chief Executive Officer under his original employment agreement. The
acceleration of vesting of these options reduced non-cash compensation expense
that would have been recorded in the Company's income statement in 2006 and
future periods in anticipation of the adoption of SFAS 123(R) in January 2006.
The Board's decision was based on such factors as: 48% of the options were "out
of the money"; the options generally vested over the next three years; and, the
Company has decided to rely, to a substantial degree, on restricted stock as
opposed to options in future incentive compensation awards.
NEW ACCOUNTING STANDARDS AND DISCLOSURES
In September 2006, the SEC issued Staff Accounting Bulletin ("SAB") No.
108, "Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements." SAB 108
37
provides guidance on the consideration of effects of the prior year
misstatements in quantifying current year misstatements for the purpose of a
materiality assessment. The SEC staff believes registrants must quantify errors
using both a balance sheet and income statement approach and evaluate whether
either approach results in quantifying a misstatement that, when all relevant
quantitative and qualitative factors are considered, is material. SAB 108 is
effective for the first annual period ending after November 15, 2006, which is
our fiscal 2006 report. For 2006, the application of SAB 108 had no impact on
the Company's Consolidated Financial Statements.
In September 2006, the FASB issued SFAS No. 157 "Fair Value
Measurements." SFAS 157 provides guidance for using fair value to measure assets
and liabilities and is intended to respond to investors' requests for expanded
information about the extent to which a company measures assets and liabilities
at fair value, the information used to measure fair value and the effect of fair
value measurements on income. SFAS 157 applies whenever other standards require
(or permit) assets or liabilities to be measured at fair value but does not
expand the use of fair value to any new circumstances. SFAS 157 also requires
expanded disclosure of the effect on income for items measured using
unobservable data, establishes a fair value hierarchy that prioritizes the
information used to develop those assumptions and requires separate disclosure
by level within the fair value hierarchy. The provisions of SFAS 157 are
effective for interim financial statements issued for fiscal years beginning
after November 15, 2007, or the Company's fiscal 2008. The Company is currently
evaluating the impact of adopting SFAS No. 157 on the Consolidated Financial
Statements.
In July 2006, the FASB issued Interpretation No. 48 ("FIN 48"),
"Accounting for Uncertainty in Income Taxes, an Interpretation of SFAS No. 109."
FIN 48 prescribes a recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position taken in a tax
return. The Company must determine whether it is at least more likely than not
that a tax position will be sustained upon examination based on the technical
merits of the position. FIN 48 is effective for fiscal years beginning after
December 15, 2006. The Company is currently evaluating the effect adoption of
FIN 48 will have on the Consolidated Financial Statements of the Company.
For further information related to new accounting standards and
disclosures, see Note 1 of the Notes to Consolidated Financial Statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has exposure to changing interest rates, and is currently
not engaged in hedging activities. Interest on $562,000 of outstanding
indebtedness is at a variable rate of between 2% to 3% over the published London
Interbank Offered Rate (LIBOR), based upon the Company's ratio of funded debt to
EBITDA, and was 2% over LIBOR on average for the year. At the Company's current
level of indebtedness, each 1% change in the variable interest rate will have an
effect of approximately $5,000 on the Company's annual interest expense charges.
The Company conducts operations in the United Kingdom. The consolidated
financial statements of the Company are denominated in U.S. dollars and changes
in exchange rates between foreign countries and the U.S. dollar will affect the
translation of financial results of foreign subsidiaries into U.S. dollars for
purposes of recording the Company's consolidated financial results.
Historically, the effects of translation have not been material to the
consolidated financial results.
38
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following consolidated financial statements and supplemental
quarterly financial data of the Company and its subsidiary are included as part
of this Form 10-K:
PAGE
-----
Report of Independent Registered Public Accounting Firm................ F-1
Consolidated Balance Sheets as of December 31, 2006 and 2005........... F-2
Consolidated Statements of Operations for each of the years
in the three-year period ended December 31, 2006.................... F-3
Consolidated Statements of Stockholders' Equity and Comprehensive
Income for each of the years in the three-year
period ended December 31, 2006...................................... F-4
Consolidated Statements of Cash Flows for each of the years in the
three-year period ended December 31, 2006........................... F-5
Notes to Consolidated Financial Statements............................. F-6
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer
and Chief Financial Officer, evaluated the effectiveness of our disclosure
controls and procedures, as defined in Rule 13a-15(e) under the Securities Act
of 1934, as amended, as of the end of the period covered by this report. Based
upon that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that our disclosure controls and procedures as of December 31, 2006,
were functioning effectively to provide reasonable assurance that the
information required to be disclosed by us in reports filed or submitted under
the Securities Exchange Act of 1934, as amended, is (i) recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms, and (ii) accumulated and communicated to our management, including our
principal executive and financial officers, or persons performing similar
functions, as appropriate to allow timely decisions regarding required
disclosure.
(b) Change in Internal Control over Financial Reporting
No change in our internal control over financial reporting occurred
during the quarter ended December 31, 2006 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
ITEM 9B. OTHER INFORMATION
None
39
PART III.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The applicable information set forth in the Company's Definitive Proxy
Statement is incorporated herein by reference.
IDENTIFICATION OF EXECUTIVE OFFICERS AND CERTAIN SIGNIFICANT EMPLOYEES
The executive officers of the Company, their positions with the Company,
their ages and a brief biography for each are as follows:
NAME AGE POSITION
- ---- --- --------
Matthew H. Knight 50 President and Chief Executive Officer
James W. Stave 52 VP - Research and Development and Chief
Science Officer
Stanley Fronczkowski 55 VP - Finance, Chief Financial Officer and
Corporate Secretary
Anthony J. Simonetta 59 VP - Finance, Chief Financial Officer and
Corporate Secretary (through January 5, 2007)
Richard M. Rumble 48 VP - Sales and Marketing (through July 7, 2006)
MATTHEW H. KNIGHT, age 50, joined SDI in September 2003 as President and
CEO, and also serves as a Director. Prior to joining SDI, Mr. Knight spent 23
years at Nalco Chemical Company. He began his career in field sales in 1980, and
advanced through a series of sales and marketing management positions over the
next 15 years. In 1996, Mr. Knight became General Manager of Nalco's European
operating group serving the water management needs of manufacturers, including
the food, beverage and pharmaceutical industries. In 1998, he was promoted to
General Manager of Nalco's largest water treatment business unit and in 2000 he
was promoted to Group Vice President and President of the company's Industrial
Division. Mr. Knight also served as Group Vice President, Sales Force
Optimization, focused on development of sales and sales management processes for
Nalco's global sales force. Mr. Knight is a graduate of Miami University of
Ohio, with a B.A. in Chemistry.
JAMES W. STAVE, age 52, joined SDI in March 1991 as a research group
leader. Subsequently, Dr. Stave was promoted to director of Research and
Development. In October 1993, Dr. Stave was promoted to Vice President--Research
and Development and Chief Technical Officer. Dr. Stave was elected Chief Science
Officer in 2006. Prior to joining SDI, Dr. Stave worked for DuPont, Molecular
Genetics, Inc. and the U.S. Department of Agriculture. Dr. Stave received his
Ph.D. in Microbiology from the University of Maryland and his B.S. in Biology
from Michigan Technological University.
STANLEY FRONCZKOWSKI, age 55, joined the Company in January 2007 as Vice
President - Finance, Chief Financial Officer and Corporate Secretary. Prior to
joining SDI, Mr. Fronczkowski spent 29 years with Keystone Foods. He began his
career with Keystone in 1978, rising to the position Vice President,
International Finance in 1988, and over the next 10 years, supported Keystone's
growth across multiple companies on four continents. In 1998, Mr. Fronczkowski
became COO for Keystone Europe, Middle East and Africa with full responsibility
for the operating results of this business group. Following Keystone's
reorganization to Strategic Business Units in Europe and North America, Mr.
Fronczkowski assumed his most recent assignment as Keystone's Vice President for
Finance, Asia-Pacific. Mr. Fronczkowski is a graduate of the State University of
New York at Cortland with a B.S in Political Science, the University of Delaware
with a B.S. in Accounting, and Widener University with a M.S. in Finance and
Taxation.
ANTHONY J. SIMONETTA, age 59, joined the Company in January 2005 as Vice
President--Finance, Chief Financial Officer and Corporate Secretary. Mr.
Simonetta worked for 28 years with KPMG, ascending to the role of partner in the
Philadelphia office. During his last three years with KPMG, Mr. Simonetta, a
Certified Public Accountant, managed the Philadelphia business advisory practice
group, consulting with numerous KPMG clients on business development tactics and
strategies. Prior to this assignment, Mr. Simonetta was an audit partner,
serving
40
both public and private clients in the development and execution of financial
audit plans. He left KPMG in 2002 and was consulting with non-KPMG clients on
business development strategy and execution. Mr. Simonetta is a graduate of
Hofstra University. Mr. Simonetta also serves as Chairman of the Board for The
Center for Autistic Children in Philadelphia.
RICHARD M. RUMBLE, age 48, joined SDI in December 2004 as Vice President
of Marketing. Prior to joining SDI, Mr. Rumble spent 23 years in the Medical
Device industry. He began his career in 1983 with 3M Canada, joining the company
in the capacity of Professional Service Supervisor, Microbiology Products, Over
the next 14 years Mr. Rumble progressed through a number of positions of
increased responsibility in both domestic and international sales and marketing
roles. In 1996 Mr. Rumble left 3M to assume the position of President and CEO,
MediVators Corporation, a company dedicated to the development, manufacture and
marketing of products used in the reprocessing of flexible endoscopes. Prior to
Joining SDI, Mr. Rumble held the position of Vice President and General Manager,
Healthcare Sterilization Products for STERIS Corporation the world leader in
sterile processing systems. Mr. Rumble is a graduate of the University of
Western Ontario with a B.Sc. in Biology and Immunology.
ITEM 11. EXECUTIVE COMPENSATION
The applicable information set forth in the Company's Definitive Proxy
Statement is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The applicable information set forth in the Company's Definitive Proxy
Statement is incorporated herein by reference.
EQUITY COMPENSATION
The table below presents certain information concerning securities
issuable in connection with equity compensation plans that have been approved by
the Company's shareholders and that have not been approved by the Company's
shareholders.
Number of Number of securities
securities to be remaining, available
issued upon Weighted-average for issuance under
exercise of exercise price of equity compensation
outstanding outstanding plans (excluding
options, warrants options, warrants securities reflected in
and rights and rights column a)
Plan Category (a) (b) (c)
- -------------------------------------------------------------------------------------------------------------------
Equity compensation plan
approved by security
holders ..................................... 1,169,729 $ 3.84 771,805
Equity compensation
not approved by
security holders ............................ 300,000 $ 4.00 -
---------------- ----------------
Total ............. 1,469,729 $ 3.87 771,805
================ ================
The 300,000 shares underlying options granted under equity compensation
not approved by security holders were granted in connection with the Company's
hiring, on September 2, 2003, of its new President and Chief Executive Officer,
Matthew H. Knight. The grant to Mr. Knight is a ten year non-qualified stock
option grant at an exercise price of $4.00 per share, the closing market price
on September 2, 2003.
41
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The applicable information set forth in the Company's Definitive Proxy
Statement is incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The applicable information set forth in the Company's Definitive Proxy
Statement is incorporated herein by reference.
PART IV.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
1. FINANCIAL STATEMENTS
(a) See the Consolidated Financial Statements which begin on page F-1 of
this Report
2. FINANCIAL STATEMENT SCHEDULES
Financial statement schedules are omitted because they are either not required
or not applicable or the required information is reflected in the financial
statements or notes thereto.
3. EXHIBITS
EXHIBIT
NUMBER DESCRIPTION REFERENCE
- ------- ---------------------------------------------------------------------- ---------
2.1 Agreement and Plan of Merger among the Company, AZUR Acquisition Corp.
and AZUR Environmental dated May 4, 2001 (1)
3.1 Fourth Amended and Restated Certificate of Incorporation of the Company (2)
3.2 Certificate of Powers, Designations, Preferences and Rights of the
Series C Convertible Preferred Stock of the Company filed with the
Secretary of the State of Delaware on September 27, 2001 (1)
3.3 Amended and Restated Bylaws of the Company (2)
4.1 Reference is made to Exhibits 3.1, 3.2 and 3.3
4.2 Forms of Warrants to Purchase Common Stock of the Company (2)
10.1 Stock Purchase Agreement among the Company and its outside directors
and certain of their affiliates dated August 16, 2002 (12)
10.2 Demand Registration Agreement among the Company and its outside
directors and certain of their affiliates dated August 16, 2002 (12)
10.3 EnSys Environmental Products, Inc. 1993 Stock Incentive Plan* (3)
10.4 Amended and Restated EnSys Environmental Products, Inc. 1995 Stock
Incentive Plan* (4)
10.5 EnSys Environmental Products, Inc. 401(k) Plan Adoption Agreement (3)
42
10.11 Agreement and Plan of Merger by and between EnSys and Strategic
Diagnostics Inc. dated as of October 11, 1996 (2)
10.15 Employment Agreement dated December 30, 1996 by and between Grover C.
Wrenn and the Company* (7)
10.18 Industrial Lease dated October 26, 1993, by and between Tober & Agnew
Properties, Inc. and Strategic Diagnostics Incorporated (6)
10.21 Lease agreement dated October 29, 1997 by and between Pencader
Courtyard, L.P. and Strategic Diagnostics Inc. (7)
10.22 1998 Employee Stock Purchase Plan (11)
10.27 Loan Agreement between the Company and PNC Bank, Delaware, dated May
5, 2000 (10)
10.28 Line of Credit Note between the Company and PNC Bank, Delaware, dated
May 5, 2000 (10)
10.29 Term Note between the Company and PNC Bank, Delaware, dated May 5, 2000 (10)
10.30 Employment Agreement dated September 2, 2003, by and between Matthew (13)
H. Knight and the Company*
10.31 Nonqualified Stock Option Agreement dated September 2, 2003, by and
between Matthew H. Knight and the Company* (13)
10.32 Restricted Stock Grant Agreement dated September 2, 2003, by and (13)
between Matthew H. Knight and the Company*
10.33 Employment Agreement dated January 1, 1997 by and between James W. (14)
Stave and the Company*
10.34 Exclusive Distribution and Supply Agreement, dated as of May 4, 2005, (15) (16)
by and between the Registrant and the DuPont Qualicon division
of E.I. du Pont de Nemours
10.35 Strategic Diagnostics Inc. Change of Control Severance Agreement* (17)
21.1 Subsidiaries of the Company
23.1 Consent of KPMG LLP, Independent Registered Public Accounting Firm
31.1 Certifications of the Chief Executive Officer of Strategic Diagnostics
Inc. required by Rule 13a-14(a) under the Securities Exchange Act of
1934
31.2 Certifications of the Chief Financial Officer of Strategic Diagnostics
Inc. required by Rule 13a-14(a) under the Securities Exchange Act of
1934
43
32.1 Certification of Matthew H. Knight pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002
32.2 Certification of Stanley Fronczkowski pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002
- --------------
(1) Incorporated by reference to the designated exhibit of the Company's
10-Q for the fiscal quarter ended September 30, 2001
(2) Incorporated by reference to the designated exhibit of the EnSys
Registration Statement on Form S-4 (No. 333-17505) filed on December 9,
1996
(3) Incorporated by reference to the designated exhibit of the EnSys
Registration Statement on Form S-1 (No. 33-68440) filed on September 3,
1993
(4) Incorporated by reference to Appendix F to the Joint Proxy
Statement/Prospectus contained in the EnSys Registration Statement on
Form S-4 (No. 333-17505) filed on December 9, 1996
(5) Incorporated by reference to the designated exhibit of the EnSys Form
10-K for the fiscal year ended December 31, 1994
(6) Incorporated by reference to the designated exhibit of the EnSys Form
10-Q for the fiscal quarter ended March 31, 1996
(7) Incorporated by reference to the designated exhibit of the Company's
Form 10-K for the fiscal year ended December 31, 1996
(8) Incorporated by reference to the designated exhibit of the Company's
Form 10-K for the fiscal year ended December 31, 1997
(9) Incorporated by reference to the identically numbered exhibit contained
in the Company's Form 8-K filed on May 26, 1999
(10) Incorporated by reference to the identically numbered exhibit contained
in the Company's Form 8-K filed on March 15, 1999
(11) Incorporated by reference to the designated exhibit of the Company's
Registration Statement on Form S-8 (No. 333- 68107) filed on November
30, 1998
(12) Incorporated by reference to the designated exhibit of the Company's
10-Q for the fiscal quarter ended September 30, 2002
(13) Incorporated by reference to the designated exhibit of the Company's
Form 10-Q for the fiscal quarter ended September 30, 2003.
(14) Incorporated by reference to the designated exhibit of the Company's
Form 10-K for the fiscal year ended December 31, 2004
(15) Confidential treatment has been requested as to certain portions of this
exhibit pursuant to Rule 24b-2 under the Securities Exchange Act of
1934, as amended.
(16) Incorporated by reference to the designated exhibit of the Company's
Form 10-Q for the fiscal quarter ended June 30, 2005, as amended.
(17) Incorporated by reference to the designated exhibit of the Company's
Form 10-Q for the fiscal quarter ended September 30, 2005.
* Management contract or compensatory plan.
44
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Strategic Diagnostics Inc.:
We have audited the accompanying consolidated balance sheets of
Strategic Diagnostics Inc. and subsidiaries as of December 31, 2006 and 2005,
and the related consolidated statements of operations, stockholders' equity and
comprehensive income and cash flows for each of the years in the three-year
period ended December 31, 2006. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Strategic
Diagnostics Inc. and subsidiaries as of December 31, 2006 and 2005, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2006 in conformity with U.S. generally
accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, the
Company adopted the provisions of Statement of Financial Accounting Standards
No. 123 (revised), "Share-Based Payment" effective January 1, 2006.
/s/ KPMG LLP
Philadelphia, Pennsylvania
April 2, 2007
F-1
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
DECEMBER 31, December 31,
- ---------------------------------------------------------------------------------------------
2006 2005
- ---------------------------------------------------------------------------------------------
ASSETS
Current Assets :
Cash and cash equivalents $ 10,892 $ 10,009
Receivables, net 3,678 3,242
Inventories 3,178 3,212
Deferred tax asset 831 1,048
Other current assets 492 362
- ---------------------------------------------------------------------------------------------
Total current assets 19,071 17,873
- ---------------------------------------------------------------------------------------------
Property and equipment, net 4,058 3,884
Other assets 3 3
Deferred tax asset 8,484 8,101
Intangible assets, net 6,337 6,800
- ---------------------------------------------------------------------------------------------
Total assets $ 37,953 $ 36,661
=============================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities :
Accounts payable $ 541 $ 464
Accrued expenses 1,455 1,439
Deferred revenue 133 207
Current portion of long term debt 211 211
- ---------------------------------------------------------------------------------------------
Total current liabilities 2,340 2,321
- ---------------------------------------------------------------------------------------------
Long-term debt 351 562
- ---------------------------------------------------------------------------------------------
Stockholders' Equity:
Preferred stock, $.01 par value, 20,920,648 shares authorized,
no shares issued or outstanding - -
Common stock, $.01 par value, 35,000,000 shares authorized,
20,192,402 and 19,916,635 issued and outstanding
at December 31, 2006 and December 31, 2005, respectively 202 200
Additional paid-in capital 38,605 37,936
Accumulated deficit (3,690) (4,374)
Cumulative translation adjustments 145 16
- ---------------------------------------------------------------------------------------------
Total stockholders' equity 35,262 33,778
- ---------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 37,953 $ 36,661
=============================================================================================
The accompanying notes are an integral part of these statements
F-2
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Year Ended December 31,
---------------------------------------------
2006 2005 2004
---------------------------------------------
Revenues:
Revenues $ 25,522 $ 24,845 $ 23,705
---------------------------------------------
Operating expenses:
Manufacturing 11,721 11,416 10,779
Research and development 2,630 3,034 2,157
Selling, general and administrative 10,591 9,722 9,211
---------------------------------------------
Total operating expenses 24,942 24,172 22,147
---------------------------------------------
Operating income 580 673 1,558
Interest income, net 386 207 53
---------------------------------------------
Income before taxes 966 880 1,611
Income tax expense 282 296 232
---------------------------------------------
Net income $ 684 $ 584 $ 1,379
=============================================
Basic net income per share
applicable to common stockholders $ 0.03 $ 0.03 $ 0.07
=============================================
Shares used in computing basic net income
per share applicable to common stockholders 20,032,000 19,741,000 19,242,000
=============================================
Diluted net income per share
applicable to common stockholders $ 0.03 $ 0.03 $ 0.07
=============================================
Shares used in computing diluted net income
per share applicable to common stockholders 20,109,000 19,870,000 19,495,000
=============================================
The accompanying notes are an integral part of these statements.
F-3
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
(IN THOUSANDS)
(in thousands)
Additional Cumulative
Preferred Common Paid-In Accumulated Deferred Translation
Stock Stock Capital Deficit Compensation Adjustments Total
- ----------------------------------------------------------------------------------------------------------------------------
Balance January 1,2004 - 192 36,140 (6,337) (192) 73 29,876
- ----------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net income - - - 1,379 - - 1,379
Currency translation adjustment - - - - - 67 67
------------------------------------------------------------------------------------
Total comprehensive income 1,446
Exercises of stock options - - 242 - - - 242
Employee stock purchase plan - - 18 - - - 18
Issuance of restricted stock awards - 2 150 - (152) - -
Deferred compensation amortization - - - - 145 - 145
Tax benefit of stock option exercises - - 46 - - - 46
Tax benefit of restricted stock awards - - - - (7) - (7)
- ----------------------------------------------------------------------------------------------------------------------------
Balance December 31, 2004 - 194 36,596 (4,958) (206) 140 31,766
- ----------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net income - - - 584 - - 584
Currency translation adjustment - - - - - (124) (124)
------------------------------------------------------------------------------------
Total comprehensive income 460
Exercises of stock options - 5 1,330 - - - 1,335
Employee stock purchase plan - - 37 - - - 37
Issuance of restricted stock awards - 1 213 - (214) - -
Deferred compensation amortization - - - - 238 - 238
Tax benefit of stock option exercises - - 73 - - - 73
Tax benefit of restricted stock awards - - - - (131) - (131)
- ----------------------------------------------------------------------------------------------------------------------------
Balance December 31, 2005 $ - $ 200 $ 38,249 $ (4,374) $ (313) $ 16 $ 33,778
- ----------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net income - - - 684 - - 684
Currency translation adjustment - - - - - 129 129
------------------------------------------------------------------------------------
Total comprehensive income 813
Exercises of stock options - 2 387 - - - 389
Employee stock purchase plan - - 30 - - - 30
Implementation of SFAS123R - - (313) - 313 - -
Deferred compensation amortization - - 273 - - - 273
Tax benefit of restricted stock awards - - (21) - - - (21)
- ----------------------------------------------------------------------------------------------------------------------------
Balance December 31, 2006 $ - $ 202 $ 38,605 $ (3,690) $ - $ 145 $ 35,262
============================================================================================================================
The accompanying notes are an integral part of these statements.
F-4
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Twelve Months
Ended December 31,
- ---------------------------------------------------------------------------------------------
2006 2005 2004
- ---------------------------------------------------------------------------------------------
Cash Flows from Operating Activities :
Net income $ 684 $ 584 $ 1,379
Adjustments to reconcile net income to net
cash provided by (used in) operating activities :
Depreciation and amortization 1,027 924 900
Stock-based compensation expense 277 243 152
Deferred income taxes 124 296 278
Loss on disposal of fixed assets 42 210 -
(Increase) decrease in :
Receivables (436) (135) 271
Inventories 34 6 189
Other current assets (130) 5 135
Other assets 26 (1) 1
Increase (decrease) in :
Accounts payable 77 (404) 80
Accrued expenses 16 184 40
Deferred revenue (74) 207 -
- ---------------------------------------------------------------------------------------------
Net cash provided by operating activities 1,667 2,119 3,425
- ---------------------------------------------------------------------------------------------
Cash Flows from Investing Activities :
Purchase of property and equipment (1,023) (1,217) (453)
Purchase of patent license (117) (17) (200)
Proceeds from sale / disposal of assets 29 - 49
- ---------------------------------------------------------------------------------------------
Net cash used in investing activities (1,111) (1,234) (604)
- ---------------------------------------------------------------------------------------------
Cash Flows from Financing Activities :
Proceeds from exercise of stock options 389 1,335 242
Proceeds from employee stock purchase plan 20 28 18
Proceeds from issuance of long and short term debt - - 551
Repayments on financing obligations (211) (211) (761)
- ---------------------------------------------------------------------------------------------
Net cash provided by financing activities 198 1,152 50
- ---------------------------------------------------------------------------------------------
Effect on exchange rate changes on cash 129 (124) 67
Net increase in Cash and Cash Equivalents 883 1,913 2,938
Cash and Cash Equivalents, Beginning of Year 10,009 8,096 5,158
- ---------------------------------------------------------------------------------------------
Cash and Cash Equivalents, End of Year $ 10,892 $ 10,009 $ 8,096
=============================================================================================
Supplemental Cash Flow Disclosure :
Cash paid (recieved) for taxes and tax refunds $ (13) $ (27) $ 6
Cash paid for interest 48 48 50
F-5
The accompanying notes are an integral part of these statements
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND CERTAIN BALANCE SHEET
INFORMATION:
BUSINESS
Strategic Diagnostics Inc. and its subsidiaries (the "Company")
develops, manufactures and markets antibody products and analytical test kits
for a broad range of food, water, agricultural, industrial, environmental and
scientific applications.
BASIS OF PRESENTATION
The historical financial statements presented herein include the
consolidated financial statements of Strategic Diagnostics Inc. and its
subsidiaries. All significant intercompany balances and transactions have been
eliminated in consolidation.
ACCOUNTS RECEIVABLE
As of December 31, 2006, 2005 and 2004, the allowance for doubtful
accounts was $134, $117, and $186 respectively. If receivables become
uncollectible, the Company's policy is to charge these write-offs against the
allowance. The Company continually reviews the realizablity of its receivables
and charges current period earnings for the amount deemed unrealizable. At
December 31, 2006, 2005 and 2004 net accounts receivable were $3,678, $3,242,
and $3,107 respectively.
A summary of the activity in the allowance for doubtful accounts for the
years ended December 31, 2006 and 2005 is as follows:
2006 2005 2004
- -------------------------------------------------------------------------------
Balance, January 1 $ 117 $ 186 $ 103
- -------------------------------------------------------------------------------
Additions-charged to costs and expenses 108 (44) 140
Deductions-written off as uncollectable (91) (25) (57)
- -------------------------------------------------------------------------------
Balance, December 31 $ 134 $ 117 $ 186
===============================================================================
INVENTORIES
The Company's inventories are valued at the lower of cost or market.
For inventories that consist primarily of test kit components, bulk
antibody serum and antibody products, cost is determined using the first in,
first out method.
For inventories that consist of costs associated with the production of
custom antibodies, cost is determined using the specific identification method.
Realization of such inventories is dependent upon the successful completion of a
project in accordance with customer specifications. Losses on projects in
progress are recorded in the period such losses become likely.
F-6
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31,2006
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
At December 31, inventories consisted of the following:
2006 2005
-------------------------------------------------------------------
Raw materials $ 1,221 $ 1,181
Work in progress 653 498
Finished goods 1,304 1,533
-------------------------------------------------------------------
Net inventories $ 3,178 $ 3,212
===================================================================
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation and amortization
are computed using the straight-line method over the estimated useful lives
(generally three to five years) of the assets. Leasehold improvements are
depreciated over the shorter of the lease term or the estimated useful life.
IMPAIRMENT OF GOODWILL AND LONG-LIVED ASSETS
Long-lived assets, such as property, plant, and equipment, and purchased
intangibles subject to amortization, are reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable. Recoverability of assets to be held and used is measured by
a comparison of the carrying amount of an asset to estimated undiscounted future
cash flows expected to be generated by the asset. If the carrying amount of an
asset exceeds its estimated future cash flows, an impairment charge is
recognized in the amount by which the carrying amount of the asset exceeds the
fair value of the asset. Goodwill and intangible assets not subject to
amortization are tested annually for impairment, and are tested for impairment
more frequently if events and circumstances indicate that the asset might be
impaired. An impairment loss is recognized to the extent that the carrying
amount exceeds the asset's fair value.
REVENUE RECOGNITION
Revenues composed of sales of immunoassay-based test kits and certain
antibodies and immunochemical reagents are recognized upon the shipment of the
product and transfer of title or when related services are provided. Revenues
associated with such products or services are recognized when persuasive
evidence of an order exists, shipment of product has occurred or services have
been provided, the price is fixed or determinable and, collectibility is
reasonably assured. Management is required to make judgments based on actual
experience about whether or not collectibility is reasonably assured.
The Company enters into contracts related to the production of custom
antibodies, which provide for the performance of defined tasks for a fixed
price, with delivery of the product upon completion of production. The standard
time to complete a project is typically longer than 30 days but less than 12
months and effort is expended over the life of the project. Revenues related to
sales of custom antibody projects are recognized when a project's specifications
have been met and/or the related materials have been shipped.
Fees associated with products and services added on to a custom antibody
project subsequent to delivery of the initial project are billed monthly and
recognized as revenue as the services and other deliverables are provided.
STOCK-BASED COMPENSATION
Under the Company's employee share option plans prior to 2006, the
Company granted employees and outside directors stock options at an exercise
price equal to the fair market value at the date of grant. Compensation expense
with respect to stock awards granted was measured based upon the fair value of
such awards at the date of grant and was amortized over the vesting period.
The Company adopted SFAS 123(revised 2004), share-based payment ("SFAS
123(R)") using the modified prospective basis on January 1, 2006 in which
compensation cost is recognized beginning January 1, 2006 for all stock-based
awards granted on or after that date and for all awards granted to employees
prior to January 1, 2006 that remain unvested on that date. SFAS 123(R)
F-7
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31,2006
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
requires compensation costs related to share-based payment transactions to be
recognized in the financial statements at fair value.
The following table illustrates the effect on net income (loss) and
earnings (loss) per share if the fair value based method had been applied to all
outstanding and unvested awards in each period.
Year
Ended December 31,
- ------------------------------------------------------------------------------
2005 2004
- ------------------------------------------------------------------------------
Net income (loss) $ 584 $ 1,379
Add: Stock-based employee
compensation expense included
in reported net income net of
related tax effects 160 125
Deduct: Total stock-based
employee compensation expense
determined under fair value
based method for all awards, net of
related tax effects (1,350) (559)
- ------------------------------------------------------------------------------
Pro forma net income (loss) $ (606) $ 945
==============================================================================
Earnings (loss) per share:
Basic - as reported $ 0.03 $ 0.07
==============================================================================
Basic--pro forma $ (0.03) $ 0.05
==============================================================================
Diluted - as reported $ 0.03 $ 0.07
==============================================================================
Diluted--pro forma $ (0.03) $ 0.05
==============================================================================
RESEARCH AND DEVELOPMENT
Research and development costs are charged to expense as incurred. From
time to time the Company makes acquisitions, which may include in-process
research and development, which is expensed when acquired.
ACCOUNTING FOR INCOME TAXES
Deferred income tax assets and liabilities are determined based on
differences between the financial statement and tax basis of assets and
liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse. The measurement of
deferred tax assets is reduced, if necessary, by a
F-8
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31,2006
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
valuation allowance for any tax benefits which are not expected to be realized.
The effect on deferred income tax assets and liabilities of a change in tax
rates is recognized in the period that such changes are enacted.
BASIC AND DILUTED INCOME (LOSS) PER SHARE
Basic earnings (loss) per share (EPS) is computed by dividing net income
or loss available for common stockholders by the weighted-average number of
common shares outstanding during the period. Diluted EPS is similar to basic
EPS, except that the dilutive effect of converting or exercising all potentially
dilutive securities is also included in the denominator. The Company's
calculation of diluted EPS includes the dilutive effect of exercising stock
options into common shares. Basic loss per share excludes potentially dilutive
securities.
Listed below are the basic and diluted share calculations for the years
ended December 31, 2006, 2005 and 2004:
- ----------------------------------------------------------------------------------------------------
2006 2005 2004
- ----------------------------------------------------------------------------------------------------
Average common shares outstanding 20,031,833 19,741,223 19,242,172
Shares used in computing basic net income
per share 20,031,833 19,741,223 19,242,172
- ----------------------------------------------------------------------------------------------------
Dilutive effect of stock options 76,855 127,733 252,620
- ----------------------------------------------------------------------------------------------------
Shares used in computing diluted net income
per share 20,108,688 19,868,956 19,494,792
====================================================================================================
FOREIGN CURRENCY TRANSLATION
The functional currency for the Company's United Kingdom branch
operation is the British pound. Assets and liabilities related to this foreign
operation are translated at the current exchange rates at the end of each
period. The resulting translation adjustments are accumulated as a separate
component of stockholders' equity. Revenues and expenses are translated at
average exchange rates in effect during the period with foreign currency
transaction gains and losses, if any, included in results of operations.
COMPREHENSIVE INCOME
Comprehensive income (loss) is comprised of net income (loss) and
currency translation adjustments and is presented in the consolidated statements
of changes in stockholders' equity.
USE OF ESTIMATES
The preparation of the consolidated financial statements requires the
management of the Company to make a number of estimates and assumptions relating
to the reported amount of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the consolidated financial statements and
the reported amounts of revenues and expenses during the period. These estimates
include those made in connection with assessing the valuation of accounts
receivable, inventories, deferred tax assets and long-lived assets. Actual
results could differ from those estimates.
STATEMENTS OF CASH FLOWS
The Company considers all highly liquid instruments purchased with an
original maturity of three months or less to be cash equivalents.
F-9
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31,2006
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NEW ACCOUNTING PRONOUNCEMENTS
In September 2006, the SEC issued Staff Accounting Bulletin ("SAB") No.
108, "Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements." SAB 108 provides guidance
on the consideration of effects of the prior year misstatements in quantifying
current year misstatements for the purpose of a materiality assessment. The SEC
staff believes registrants must quantify errors using both a balance sheet and
income statement approach and evaluate whether either approach results in
quantifying a misstatement that, when all relevant quantitative and qualitative
factors are considered, is material. SAB 108 is effective for 2006. The
application of SAB 108 had no impact on the Company's 2006 Consolidated
Financial Statements.
In September 2006, the FASB issued SFAS No. 157 "Fair Value
Measurements." SFAS No. 157 provides guidance for using fair value to measure
assets and liabilities and is intended to respond to investors' requests for
expanded information about the extent to which a company measures assets and
liabilities at fair value, the information used to measure fair value and the
effect of fair value measurements on income. SFAS No. 157 applies whenever other
standards require (or permit) assets or liabilities to be measured at fair value
but does not expand the use of fair value to any new circumstances. SFAS No. 157
also requires expanded disclosure of the effect on income for items measured
using unobservable data, establishes a fair value hierarchy that prioritizes the
information used to develop those assumptions and requires separate disclosure
by level within the fair value hierarchy. The provisions of SFAS No. 157 are
effective for interim financial statements issued for fiscal years beginning
after November 15, 2007, or the Company's fiscal 2008. The Company is currently
evaluating the impact of adopting SFAS No. 157 on the Consolidated Financial
Statements.
In July 2006, the FASB issued Interpretation No. 48 ("FIN 48"),
"Accounting for Uncertainty in Income Taxes, an Interpretation of SFAS No. 109".
FIN 48 prescribes a recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position taken in a tax
return. The Company must determine whether it is at least more likely than not
that a tax position will be sustained upon examination based on the technical
merits of the position. FIN 48 is effective for fiscal years beginning after
December 15, 2006. The Company is currently evaluating the effect adoption of
"FIN 48" will have on the Consolidated Financial Statements of the Company.
F-10
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31,2006
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
2. PROPERTY AND EQUIPMENT:
As of December 31, property and equipment consisted of the following:
2006 2005
- -------------------------------------------------------------------------------
Equipment $ 4,841 $ 4,233
Building improvements 3,039 3,036
Furniture and fixtures 95 103
Land 1,129 1,129
Leasehold improvements 750 876
- -------------------------------------------------------------------------------
Total property and equipment 9,854 9,377
Less - accumulated depreciation and amortization (5,796) (5,493)
- -------------------------------------------------------------------------------
Net property and equipment $ 4,058 $ 3,884
===============================================================================
Depreciation expense was $793, $710 and $735 in 2006, 2005 and 2004,
respectively.
3. INTANGIBLE ASSETS:
As of December 31, intangible assets consisted of the following:
2006 2005 Lives
----------------------------------------------------------------------------
Goodwill $ 4,822 $ 5,168 N/A
Other 3,134 3,017 2-20
Less - accumulated amortization (1,619) (1,385)
----------------------------------------------------------------------------
Net intangible assets $ 6,337 $ 6,800
============================================================================
The Company's goodwill principally relates to the 1999 acquisitions of
HTI BioProducts, Inc. and Atlantic Antibodies, whose products are a component of
the antibody product group, and the 2001 acquisition of Azur Environmental,
whose products are a component of the water quality product group. The reduction
in goodwill between the periods is due to the utilization of foreign tax
benefits from the 2001 acquisition of Azur Environmental. The Company continues
to sell the products acquired through these acquisitions at substantial margins.
The other intangible assets principally relate to intellectual and
property rights acquired from MCI. The technology acquired from MCI primarily
relates to proprietary growth media used by the Company in conjunction with the
Company's E. COLI and SALMONELLA test kits, and also technology used in the
Company's ruminant feed test kit. The Company launched sales of these products
during the year ended December 31, 2003 and expects continued launches of new
products in the future based upon this intellectual property.
A director of the Company was majority shareholder of MCI and MCI
continues to receive royalties from the Company. Royalties paid in 2006, 2005
and 2004 were $210, $172 and $131 respectively.
F-11
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31,2006
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Amortization of these intangible assets is on a straight line basis over
their useful lives and was $234, $214 and $165 in 2006, 2005 and 2004,
respectively. The following table is a schedule of the expected amortization
expense in each of the next five years:
Year Amount
- ---------------------------------------------
2007 $ 240
2008 237
2009 156
2010 119
2011 119
4. ACCRUED EXPENSES:
As of December 31, accrued expenses consisted of the following:
2006 2005
- --------------------------------------------------------------------------------
Royalties $ 202 $ 167
Compensation 583 552
Professional fees 204 420
Purchases 305 146
Other 161 154
- --------------------------------------------------------------------------------
Total accrued expenses $1,455 $1,439
================================================================================
5. LONG-TERM DEBT:
On May 5, 2000, the Company entered into a financing agreement with a
commercial bank. This agreement provides for up to a $5,000 revolving line of
credit, none of which was outstanding and approximately $3,029 of which was
available at December 31, 2006, based on eligible assets. The revolving line of
credit bears a variable interest rate of between 1.75% and 2.75% over LIBOR
depending upon the ratio of the Company's funded debt to EBITDA, and is subject
to a borrowing base determined by the Company's eligible accounts receivable.
The Company's annual effective rate of interest on this line of credit, taking
into account the variable interest rate and LIBOR, was approximately 7.07% at
December 31, 2006.
On December 13, 2001, the Company entered into an agreement with a
commercial bank to finance the construction of new facilities at its Windham,
Maine location. This agreement provided for up to $1,500 in financing, $562 of
which was outstanding at December 31, 2006, and is repayable over seven years,
with principal payments that began on October 1, 2002. The loan bears a variable
interest rate of between 2% and 3% over LIBOR depending upon the ratio of the
Company's funded debt to EBITDA, as defined. Payments are due monthly, with
equal amortization of principal payments plus interest. The Company's annual
effective rate of interest on this loan at December 31, 2006, was approximately
7.32%. Under the terms of this financing, the Company is required to meet
certain quarterly financial covenants that include a ratio of EBITDA to current
maturities of debt plus interest and cash paid for taxes greater than 1.50 and a
ratio of funded debt to EBITDA not to exceed 3.25. At December 31, 2006, the
Company met all of its financial covenants with respect to this indebtedness.
As of December 31, 2006, the outstanding balance on all of the Company's
commercial bank debt was $562. This indebtedness is secured by substantially all
of the Company's assets.
F-12
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31,2006
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The following table is a schedule of the principal payments required
under the Company's long-term indebtedness:
2007 211
2008 211
2009 140
- ---------------------------------------------------------------------------
562
Less - current portion of long-term debt obligations (211)
- ---------------------------------------------------------------------------
Long-term debt $ 351
===========================================================================
Interest expense was $48, $47 and $50 in 2006, 2005 and 2004,
respectively.
6. STOCK OPTIONS AND AWARD PLANS:
Under various plans, executives, key employees and outside directors
receive awards of options to purchase common stock. The Company has a stock
option plan (the "2000 Plan") which authorizes the granting of incentive and
nonqualified stock options. Incentive stock options are granted at not less than
100% of fair market value at the date of grant (110% for stockholders owning
more than 10% of the Company's common stock). Nonqualified stock options are
granted at not less than 85% of fair market value at the date of grant. A
maximum of 4,000,000 shares of common stock are issuable under the 2000 Plan.
Certain additional options have been granted outside the 2000 Plan. These
options generally follow the provisions of the 2000 Plan. The Company issues New
Shares to satisfy option excercises and the vesting of restricted stock units.
On December 27, 2005, the Board of Directors of the Company approved the
accelerated vesting, effective as of December 31, 2005, of all unvested stock
options granted to employees and non-employee directors from 2002 through 2005
under the Company's 2000 Stock Incentive Plan, as well as options granted to the
Company's Chief Executive Officer under his original employment agreement. The
acceleration of vesting of these options reduced non-cash compensation expense
that would have been recorded in the Company's income statement in 2006 and
future periods due to the adoption of Financial Accounting Standards Board
Statement 123(R) in January 2006.
As a result of the acceleration, options to purchase approximately
381,000 shares of the Company's common stock (which represented 23% of the
Company's outstanding stock options) became exercisable on December 31, 2005.
The accelerated options ranged in exercise price from $2.51 to $4.12 per share
and the weighted average exercise price of the accelerated options was $3.41 per
share. Of the 381,000 shares that became exercisable, approximately 199,000 of
these shares were "in the money" as of December 27, 2005, meaning that the
exercise price was at or below the price of the Company's common stock on that
date. The weighted average exercise price of the "in the money" shares on that
date was $3.02. The options subject to acceleration included options to purchase
approximately 222,000 shares held in the aggregate by executive officers and
approximately 48,000 shares held in the aggregate by non-employee directors of
the Company. Of these 270,000 shares, approximately 147,000 were "in the money"
as of December 27, 2005. The grant date fair value of the unvested portion of
accelerated options at December 31, 2005 totaled $975,000 and would have been
recognized as compensation expense in accordance with SFAS 123(R) in future
years as follows: $682,000 in 2006, $228,000 in 2007 and $65,000 in 2008.
Share-based compensation expense recorded in 2006 is summarized as
follows:
For the year ended
December 31, 2006
- --------------------------------------------------------------------------------
Stock options $ 78
Restricted Stock Units 199
- --------------------------------------------------------------------------------
Total share-based compensation expense $277
The deferred income tax benefit related to share-based compensation
expense for the year ended December 31, 2006 was $105. Share-based compensation
expense is a component of selling, general and administrative expense, and is
recorded as a non-cash expense in the operating activities section of the
consolidated statement of cash flows.
F-13
Information with respect to the stock options granted under the 2000
Plan and options granted separately from the 2000 Plan is summarized as follows:
Weighted Aggregate
Number Average Remaining Instrinsic
of Shares Price Range Contractual term Value
- ----------------------------------------------------------------------------------------------------------------
Balance, December 31, 2003 2,212,398 $ 0.19 - $ 7.63
- -------------------------------------------------------------------------
Granted 198,000 $ 2.61 - $ 4.12
Cancelled / forfeited (129,139) $ 0.64 - $ 7.63
Exercised (182,032) $ 0.19 - $ 3.46
- -------------------------------------------------------------------------
Balance, December 31, 2004 2,099,227 $ 0.19 - $ 6.94
- -------------------------------------------------------------------------
Granted 166,500 $ 2.51 - $ 3.35
Cancelled / forefeited (105,067) $ 3.05 - $ 4.69
Exercised (500,160) $ 0.19 - $ 3.65
- -------------------------------------------------------------------------
Balance, December 31, 2005 1,660,500 $ 1.88 - $ 6.94
- -------------------------------------------------------------------------
Granted 100,895 $ 3.80 - $ 4.00
Cancelled / forfeited (109,666) $ 2.51 - $ 4.08
Exercised (182,000) $ 1.88 - $ 2.65
- -----------------------------------------------------------------------------------------------------------
Balance, December 31, 2006 1,469,729 $ 1.88 - $ 6.94 5.9 years $ (139)
===========================================================================================================
Vested and excercisable at
December 31, 2006 1,387,462 $ 1.88 - $ 6.94 5.3 years $ (129)
===========================================================================================================
Expected to vest as of
December 31, 2006 1,469,729 $ 1.88 - $ 6.94 5.9 years $ (139)
===========================================================================================================
As of December 31, 2006, options covering 1,387,462 shares were
exercisable with a weighted average exercise price of $3.87 per share, and
771,805 shares were available for future grant under the 2000 Plan.
For options granted in 2006, the Company recognized as compensation
expense, the fair value of the option granted, amortized over the vesting period
of the options. As of December 31, 2006 there was $178 of unrecognized
compensation expense related to non-vested stock options that is expected to be
recognized over a weighted average period of 2.4 years.
The total aggregate intrinsic value of options exercised during the
years ended December 31, 2006, 2005 and 2004 was $272, $282 and $229
respectively. Cash received from the exercises during the years ended December
31, 2006, 2005 and 2004 was $389, $1,335 and $242 and are included within the
financing activity section of the consolidated statements of cash flows.
F-14
The following table provides additional information about the Company's
stock options outstanding at December 31, 2006:
Options Outstanding Options Exercisable
------------------------------------------------------ ----------------------------------
Weighted Average
------------------------------------ Wtd. Average
Range of Number of Remaining Exercise Number of Exercise
Exercise Prices Shares Contractual Life Price Shares Price
- -------------------------- ---------------- ---------------------- ----------- ---------------- ----------------
$ 1.88 - $ 2.65 112,334 4.5 Years $ 2.26 112,334 $ 2.26
$ 2.88 - $ 4.69 1,206,145 6.2 Years $ 3.73 1,123,878 $ 3.72
$ 5.17 - $ 6.94 151,250 4.5 Years $ 6.23 151,250 $ 6.23
---------------- ----------------
$ 1.88 - $ 6.94 1,469,729 5.9 Years $ 3.87 1,387,462 $ 3.87
========================== ================ ====================== =========== ================ ================
The weighted average fair value at the date of grant for options granted
during 2006, 2005 and 2004 is estimated at $2.50, $2.09 and $2.51 per share,
respectively, using the Black-Scholes pricing model. The assumptions used in the
Black-Scholes model are as follows: dividend yield of 0%, expected volatility of
69% in 2006, 85% in 2005 and 88% in 2004, risk-free interest rate of 4.57% in
2006, 3.93% in 2005 and 3.44% in 2004, and an expected option life of 6 years in
2006, and 5 years in 2005 and in 2004.
The Company grants restricted stock units (RSU), which is the right to
receive shares. The fair value of RSU's is based on the market price for the
stock at the date of grant. RSU's generally vest over periods of two to five
years. The cost of the grant is charged to operations over the vesting period.
The following table summarizes the changes in non-vested restricted
stock units for the three year period ending December 31, 2006:
Weighted Average
Grant Date Aggregate
Shares Fair Value Intrinsic Value
- --------------------------------------------------------------------------------
Non-vested RSU's at December 31, 2003 88,384 $ 4.11
===============================================================
Granted 46,116 $ 3.30
Vested (34,500) $ 3.77
- ---------------------------------------------------------------
Non-vested RSU's at December 31, 2004 100,000 $ 3.55
===============================================================
Granted 77,296 $ 3.35
Vested (56,856) $ 3.73
Cancelled / forfeited (11,430) $ 3.94
- ---------------------------------------------------------------
Non-vested RSU's at December 31, 2005 109,010 $ 3.55
===============================================================
Granted 53,535 $ 3.87
Vested (51,989) $ 3.92
Cancelled / forfeited (25,334) $ 3.06
- --------------------------------------------------------------------------------
Non-vested RSU's at December 31, 2006 85,222 $ 3.71 $ 316
================================================================================
The Company recorded compensation expense of $199, $237 and $145 for the
year ended December 31, 2006, 2005 and 2004 for RSU's. This expense is a
component of selling, general and administrative expenses, and is recorded as a
non-cash expense in the operating activities section of the consolidated
statement of cash flows.. As of December 31, 2006, all of the above non-vested
RSU's are expected to vest and there is approximately $243 of unrecognized
compensation expense related to non-vested RSU's that are expected to vest over
a weighted average of 2.3 years.
7. SEGMENT, GEOGRAPHIC AND CUSTOMER INFORMATION:
Financial Accounting Standards Board Statement No. 131, "Disclosure
about Segments of an Enterprise and Related Information" ("SFAS 131") requires
that companies report separately in the financial statements certain financial
and descriptive information about operating segments profit or loss, certain
specific revenue and expense items and segment assets. Additionally, companies
are required to report information about the revenue derived from their products
and service groups, about geographic areas in which the Company earns revenue
and holds assets, and about major customers.
F-15
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31,2006
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
GEOGRAPHIC:
The following table sets forth revenues by geographic region:
Twelve Months
Ended December 31,
- --------------------------------------------------------------------
2006 2005 2004
- --------------------------------------------------------------------
United States $19,498 $18,368 $16,852
Rest of the world 6,024 6,477 6,853
- --------------------------------------------------------------------
Total $25,522 $24,845 $23,705
====================================================================
The Company's basis for identifying sales by country is the ship-to
location. There were no individual countries outside of the United States that
represented more than 10% of the total revenues of the Company. There are no
significant long-lived assets located outside the United States.
PRODUCTS AND SERVICES:
The following table sets out revenues by product category.
Year Ended
December 31,
- ----------------------------------------------------------------
2006 2005 2004
- ----------------------------------------------------------------
Water quality $ 5,203 $ 5,139 $ 5,911
Food safety 9,215 8,981 7,634
Antibody 11,104 10,725 10,160
- ----------------------------------------------------------------
Net revenues $25,522 $24,845 $23,705
================================================================
F-16
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31,2006
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
8. COMMITMENTS AND CONTINGENCIES:
The Company leases its office and manufacturing facilities and other
equipment under operating leases. Rent expense for the years ended December 31,
2006, 2005 and 2004, was $738, $710 and $691, respectively. Future commitments
under non-cancelable leases at December 31 are as follows:
2007 $ 654
2008 66
2009 48
2010 38
2011 19
2012 and thereafter -
------------------------------------------------
$ 825
================================================
The Company's subsidiary, AZUR Environmental Limited, is the lessee for
two real property leases located in the United Kingdom. In 2001, the landlord of
the two properties gave AZUR Environmental Limited its consent to allow AZUR to
assign the lease and its related obligations to a third party. As inducement to
the landlord to grant the assignment, AZUR was required to guarantee performance
under the original lease terms if the third party fails to perform. Both lease
terms expire in November 2016 and provide for annual principal rent payments of
approximately $300 in the aggregate. The Company believes that based on its
assessment of the current financial strength of the third party, no liability is
required to be recorded with regard to the guarantee or lease obligation, and no
amounts have been included in the non-cancelable lease table above.
The Company is subject to various claims arising in the ordinary course
of business. Although the ultimate outcome of these matters is presently not
determinable, management does not believe that the outcome of these matters will
have a material adverse effect on the Company's financial position or results of
operations.
9. RETIREMENT SAVINGS PLAN:
The Company maintains a retirement savings plan qualified under Section
401(k) of the Internal Revenue Code. The plan allows for eligible employees to
contribute a portion of their gross wages to the plan. The Company matches
employees' contributions on a 50% basis up to 6% of gross wages. In 2006, 2005
and 2004, the Company recognized expense of $153, $153 and $136, respectively,
associated with this plan.
10. INCOME TAXES:
The components of income before tax expense as of December 31 are as
follows:
2006 2005 2004
---------------------------------------
United States $ 790 $ 719 $1,236
Rest of the world 176 161 375
---------------------------------------
Total 966 880 1,611
---------------------------------------
F-17
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31,2006
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The income tax expense (benefit) consists of the following:
2006 2005 2004
- ----------------------------------------------------------------------------
Federal current $ 56 $ - $ (69)
deferred 82 179 468
- ----------------------------------------------------------------------------
138 179 399
- ----------------------------------------------------------------------------
State current 90 18 23
deferred 1 99 (90)
- ----------------------------------------------------------------------------
91 117 (67)
- ----------------------------------------------------------------------------
Foreign current 53 - -
deferred - - (100)
- ----------------------------------------------------------------------------
53 - (100)
- ----------------------------------------------------------------------------
Total $ 282 $ 296 $ 232
============================================================================
The following table summarizes the significant differences between the
U.S. Federal statutory rate and the Company's effective tax rate for financial
statement purposes:
2006 2005 2004
- ----------------------------------------------------------------------------
Statutory tax rate 34.0% 34.0% 34.0%
State taxes, net of U.S. Federal benefit 6.2% 8.8% (2.8%)
Foreign NOL not previously recorded 0.0% (5.5%) (14.3%)
Research and development credits (14.6%) (11.0%) (5.1%)
Other, net 3.6% 7.3% 2.6%
- ----------------------------------------------------------------------------
Total 29.2% 33.6% 14.4%
============================================================================
Significant components of the Company's deferred tax assets as of
December 31 are as follows:
2006 2005
- -----------------------------------------------------------------------------
Net operating loss carryforwards $ 7,501 $ 9,213
Credit carryforwards 848 556
Amortization and depreciation 2,531 1,217
Deferred compensation 34 41
Non-deductible reserves 35 33
Inventory costs not currently deductible 178 258
- -----------------------------------------------------------------------------
Total deferred tax assets 11,127 11,318
Valuation allowance (1,812) (2,169)
- -----------------------------------------------------------------------------
Net deferred tax assets $ 9,315 $ 9,149
=============================================================================
F-18
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31,2006
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
At December 31, 2006, management concluded that no valuation allowance
is necessary for federal deferred tax assets after considering the positive and
negative evidence. In making this determination, the Company considered the
following positive factors:
o positive net income before taxes in each of the last three
years;
o income before taxes of $1.2 million for the six month period
ending December 31, 2006;
o cumulative income before taxes of $3.5 million over the three
years ended December 31, 2006;
o use of annual election to capitalize research and
experimentation expenses under IRS code 59(e), which will then
be amortized over a ten year period;
o past and anticipated new product launches; and
o The operating efficiencies gained and to be gained from
automating labor intensive manufacturing processes and
improvements to supply chain management.
The Company also considered the following negative factors:
o the 2006 income before taxes was lower than 2006 expectations;
and
o federal net operating loss carry forwards begin to expire in
2009.
At December 31, 2006, management has concluded that a full valuation
allowance is necessary for deferred tax assets in certain state jurisdictions.
For the state jurisdictions, management has considered the same positive and
negative evidence as utilized for the federal deferred tax assets described
above. The Company has also considered the substantial reduction of its presence
in North Carolina and Pennsylvania since the time when the net operating losses
were incurred in those jurisdictions as additional negative evidence.
At December 31, 2006, the Company had approximately $6.3 million of net
operating loss carryforwards for tax purposes related to foreign operations in
the United Kingdom ("UK"). Management considered positive and negative
indicators in concluding that a substantial valuation allowance of $1.8 million
was necessary for the foreign deferred tax assets of $1.9 million. The positive
indicators included the contribution to income before taxes by the foreign
operations in the UK for 2006 and 2005, and the expected income before taxes in
the UK for 2007. The negative indicators include a history of substantial net
operating losses in the UK, the lack of income before taxes until 2004 and
limitations with regard to estimating income in the UK beyond 2007 resulting
from the rebuilding and expansion of the UK distributor network.
The net operating loss carryforwards differ from the accumulated
deficit, principally due to differences in the timing of recognition of certain
research and development expenses, depreciation and amortization, other
non-deductible reserves and limitations under federal and state tax regulations
for acquired net operating loss carryforwards.
As of December 31, 2006, the Company had Federal net operating loss
carryforwards, including those acquired, of approximately $15.4 million, which
begin to expire as follows:
F-19
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31,2006
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Amount of NOL
Year (in thousands)
- ------------------------------------------------
2009 $ 3,132
2010 5,109
2017 760
2018 1,327
2019 550
2020 121
2021 135
2022 2,345
2024 1,880
- ------------------------------------------------
Total $ 15,359
================================================
Based on the best information available to the Company today, the
Company expects to have sufficient future taxable income to utilize such NOLs
prior to the expiration of the net operating loss carry forwards.
Of the total net operating loss carryforward, $10,998 is subject to
federal tax regulations concerning limitations as to utilization of net
operating loss carryforwards since a cumulative change in ownership of more than
50% has occurred within a three year period with respect to those net operating
loss carryforwards. The Company does not expect net operating loss carryforwards
to expire unused.
F-20
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31,2006
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
11. QUARTERLY FINANCIAL DATA (UNAUDITED):
Three Months Ended,
- ----------------------------------------------------------------------------------------------
March 31 June 30 September 30 December 31
- ----------------------------------------------------------------------------------------------
(In thousands except per share data)
2006
Revenues $ 6,268 $ 5,640 $ 6,624 $ 6,990
Gross profit (1) 3,328 2,912 3,659 3,902
Net income (loss) 92 (231) 332 491
Basic earnings (loss) per share - (0.01) 0.02 0.02
Diluted earnings (loss) per share - (0.01) 0.02 0.02
2005
Revenues $ 6,677 $ 6,178 $ 6,094 $ 5,896
Gross profit (1) 3,860 3,280 3,332 2,957
Net income (loss) 419 138 319 (292)
Basic earnings (loss) per share 0.02 0.01 0.02 (0.01)
Diluted earnings (loss) per share 0.02 0.01 0.02 (0.01)
(1) Gross profit is revenues less manufacturing expenses.
Sales levels for certain agricultural products may be impacted by seasonal
demand trends. The demand for these test kits is typically higher in the first
and third quarters due to harvesting patterns.
F-21
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
STRATEGIC DIAGNOSTICS INC.
Date: April 2, 2007 /s/ Matthew H. Knight
-----------------------------------------------
Matthew H. Knight
President, Chief Executive Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Date: April 2, 2007 /s/ Grover C. Wrenn
-----------------------------------------------
Grover C. Wrenn
Chairman of the Board of Directors
Date: April 2, 2007 /s/ Matthew H. Knight
-----------------------------------------------
Matthew H. Knight
President, Chief Executive Officer and Director
(Principal Executive Officer)
Date: April 2, 2007 /s/ Stanley Fronczkowski
-----------------------------------------------
Stanley Fronczkowski
Vice President - Finance and Chief Financial
Officer (Principal Financial and Accounting
Officer)
Date: April 2, 2007 /s/ Morton Collins
-----------------------------------------------
Morton Collins
Director
Date: April 2, 2007 /s/ Richard J. Defieux
-----------------------------------------------
Richard J. Defieux
Director
Date: April 2, 2007 /s/ Herbert Lotman
-----------------------------------------------
Herbert Lotman
Director
Date: April 2, 2007 /s/ Clifford L. Spiro
-----------------------------------------------
Clifford L. Spiro
Director
Date: April 2, 2007 /s/ Stephen L. Waechter
-----------------------------------------------
Stephen L. Waechter
Director