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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
-------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period From ___________ to __________
Commission File Number 000-22400
STRATEGIC DIAGNOSTICS INC.
------------------------------------------------------
(Exact name of Registrant as specified in its charter)
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
--------------------
Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report: None
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 whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act).
Yes _____ No __X__
As of September 30, 2003 there were 19,069,344 outstanding shares of
the Registrant's common stock, par value $.01 per share.
STRATEGIC DIAGNOSTICS INC.
INDEX
Item Page
- ---- ----
PART I FINANCIAL INFORMATION
ITEM 1. Financial Statements (Unaudited)
Consolidated Balance Sheets - September 30, 2003 and
December 31, 2002 2
Consolidated Statements of Operations - Three months and
Nine months ended September 30, 2003 and 2002 3
Consolidated Statement of Stockholders' Equity and
Comprehensive Income - Nine months ended
September 30, 2003 4
Consolidated Statements of Cash Flows - Nine months ended
September 30, 2003 and 2002 5
Notes to Consolidated Interim Financial Statements 6
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 19
ITEM 4. Controls and Procedures 19
PART II OTHER INFORMATION 19
ITEM 6. Exhibits and Reports on Form 8-K 20
SIGNATURES 22
1
ITEM 1. FINANCIAL STATEMENTS
PART I
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
(unaudited)
September 30, December 31,
- -------------------------------------------------------------------------------------------------------------------------
2003 2002
- -------------------------------------------------------------------------------------------------------------------------
ASSETS
- -------------------------------------------------------------------------------------------------------------------------
Current Assets:
Cash and cash equivalents $ 4,040 $ 2,098
Receivables, net 4,248 3,956
Inventories 6,649 6,821
Deferred tax asset 852 1,009
Other current assets 673 499
- -------------------------------------------------------------------------------------------------------------------------
Total current assets 16,462 14,383
- -------------------------------------------------------------------------------------------------------------------------
Property and equipment, net 3,720 4,013
Other assets 8 40
Deferred tax asset 7,368 7,664
Intangible assets, net 6,997 7,066
- -------------------------------------------------------------------------------------------------------------------------
Total assets $ 34,555 $ 33,166
=========================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
- -------------------------------------------------------------------------------------------------------------------------
Current Liabilities:
Accounts payable $ 707 $ 1,024
Accrued expenses 1,545 665
Current portion of long term debt 257 211
- -------------------------------------------------------------------------------------------------------------------------
Total current liabilities 2,509 1,900
- -------------------------------------------------------------------------------------------------------------------------
Long-term debt 1,036 1,212
- -------------------------------------------------------------------------------------------------------------------------
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,
19,069,344 and 18,937,330 issued and outstanding
at September 30, 2003 and December 31, 2002, respectively 191 190
Additional paid-in capital 35,731 35,312
Accumulated deficit (4,598) (5,408)
Deferred compensation (319) -
Cumulative translation adjustments 5 (40)
- -------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 31,010 30,054
- -------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 34,555 $ 33,166
=========================================================================================================================
The accompanying notes are an integral part of these statements.
2
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
(unaudited)
Three Months Nine Months
Ended September 30, Ended September 30,
- ----------------------------------------------------------------- --------------------------
2003 2002 2003 2002
================================================================= ==========================
NET REVENUES
- ----------------------------------------------------------------- --------------------------
Product related $ 6,614 $ 5,821 $ 19,196 $ 16,959
Contract and other 2 198 117 480
- ----------------------------------------------------------------- --------------------------
Total net revenues 6,416 6,119 19,313 17,439
- ----------------------------------------------------------------- --------------------------
OPERATING EXPENSES:
Manufacturing 3,045 2,707 8,762 8,736
Research and development 652 804 1,986 2,448
Selling, general and administrative 2,266 2,434 7,268 7,938
- ----------------------------------------------------------------- --------------------------
Total operating expenses 5,963 5,945 18,016 19,122
- ----------------------------------------------------------------- --------------------------
Operating income (loss) 453 174 1,297 (1,683)
Interest expense, net (11) (18) (34) (51)
Gain on sale of assets - - - 374
- ----------------------------------------------------------------- --------------------------
Income (loss) before taxes 442 156 1,263 (1,360)
- ----------------------------------------------------------------- --------------------------
Income tax expense (benefit) 178 35 453 (561)
- ----------------------------------------------------------------- --------------------------
Net income (loss) 264 121 810 (799)
- ----------------------------------------------------------------- --------------------------
Basic net income (loss) per share $ 0.01 $ 0.01 $ 0.04 $ (0.04)
================================================================= ==========================
Shares used in computing basic
net income (loss) per share 18,989,000 18,581,000 18,957,000 18,244,000
================================================================= ==========================
Diluted net income (loss) per share $ 0.01 $ 0.01 $ 0.04 $ (0.04)
================================================================= ==========================
Shares used in computing diluted
net income (loss) per share 19,541,000 18,941,000 19,526,000 18,244,000
================================================================= ==========================
The accompanying notes are an integral part of these statements.
3
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
(in thousands)
(unaudited)
Additional Cumulative
Common Paid-in Accumulated Deferred Translation
Stock Capital Deficit Compensation Adjustments Total
- ------------------------------------------------------------------------------------------------------------------------------------
Balance,
December 31, 2002 $ 190 35,312 (5,408) - (40) $30,054
- ------------------------------------------------------------------------------------------------------------------------------------
Employee stock purchase plan - 13 - - - 13
Exercises of stock options - 78 - - - 78
Restricted stock awards 1 328 - (329) - -
Amortization of deferred compensation - - - 10 - 10
Currency translation adjustment - - - - 45 45
Net income - - 810 - - 810
-------
Total comprehensive income 855
-------
- ------------------------------------------------------------------------------------------------------------------------------------
Balance,
September 30, 2003 $ 191 35,731 (4,598) (319) 5 $31,010
====================================================================================================================================
The accompanying notes are an integral part of these statements.
4
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Nine Months
Ended September 30,
- ----------------------------------------------------------------------------------------------------------------
2003 2002
================================================================================================================
Cash Flows from Operating Activities:
Net income (loss) $ 810 $ (799)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization 632 654
Stock compensation expense 10 -
Deferred income tax provision 453 (561)
Gain on sale/disposal of assets - (374)
(Increase) decrease in:
Receivables (292) 53
Inventories 172 734
Other current assets (174) (301)
Other assets 32 114
Increase (decrease) in:
Accounts payable (317) (641)
Accrued expenses 880 (668)
- ----------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 2,206 (1,789)
Cash Flows from Investing Activities:
Purchase of property and equipment (200) (883)
Purchase of intangible assets (70) -
- ----------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (270) (883)
Cash Flows from Financing Activities:
Proceeds from exercise of incentive stock options 78 168
Proceeds from employee stock purchase plan 13 33
Proceeds from sale of stock - 1,464
Proceeds from issuance of long and short term debt 372 1,947
Proceeds from sale/disposal of assets - 956
Repayments on financing obligations (502) (2,945)
- ----------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities (39) 1,623
Effect of exchange rate changes on cash 45 -
Net increase (decrease) in Cash and Cash Equivalents 1,942 (1,049)
Cash and Cash Equivalents, Beginning of Period 2,098 2,379
- ----------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents, End of Period $ 4,040 $ 1,330
================================================================================================================
Supplemental Cash Flow Disclosure:
Cash paid for taxes 4 3
Cash paid for interest 52 72
================================================================================================================
Non-cash investing and financing activity:
Note receivable in connection with the sale of assets - 300
Common stock issued for the purchase of
Molecular Circuitry Inc. - 2,502
================================================================================================================
The accompanying notes are an integral part of these statements
5
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(in thousands, except share and per share data)
(unaudited)
1. BACKGROUND:
Business
Strategic Diagnostics Inc. and its subsidiaries (the "Company") develop,
manufacture and market immunoassay and bioluminescence-based test kits for rapid
and cost-effective detection of a wide variety of substances in the food safety
and water quality markets and provides antibody and immunoreagent research,
development and production services.
Basis of Presentation and Interim Financial Statements
The accompanying unaudited consolidated interim financial statements of the
Company have been prepared by the Company pursuant to the rules and regulations
of the Securities and Exchange Commission regarding interim financial reporting.
Accordingly, they do not include all the information and footnotes required by
generally accepted accounting principles for complete financial statements and
should be read in conjunction with the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 2002. In the opinion of management, the
accompanying financial statements include all adjustments (all of which are of a
normal recurring nature) necessary for a fair presentation of the results of
operation.
Revenue Recognition
Product related revenues are composed of the sale of immunoassay-based test kits
and the sale of certain antibodies and immunochemical reagents. Revenue from
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. For the nine months ended September 30,
2003 and 2002, revenues from these sales represented 78% and 83%, respectively,
of total Company revenues.
Revenues from sales of certain antibodies and immunochemical reagents are
recognized under the percentage of completion method and are recorded based on
the percentage of costs or time incurred through the reporting date versus the
estimate for the entire contract or project. For the nine months ended September
30, 2003 and 2002, revenues from these sales represented 21% and 14%,
respectively, of total Company revenues.
Contract revenues are recognized upon the completion of contractual milestones.
For the nine months ended September 30, 2003 and 2002 these sales represented 1%
and 3%, respectively, of total Company revenues.
6
New Accounting Pronouncements
In April 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Standard No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" ("SFAS No. 149"). SFAS No. 149
amends Statement of Financial Accounting Standard No. 133 "Accounting for
Derivative Instruments and Hedging Activities" and Statement of Financial
Accounting Standard No. 138 "Accounting for Certain Derivative Instruments and
Certain Hedging Activities" and is related to certain derivatives embedded in
other contracts and for hedging activities under Statement of Financial
Accounting Standard 133. SFAS No. 149 is effective for contracts entered into or
modified after September 30, 2003 and is to be applied prospectively. SFAS No.
149 currently has not had an impact on our financial position, results of
operations or cash flows.
In May 2003, the FASB issued Statement of Financial Accounting Standard No. 150,
"Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity" ("SFAS No. 150"). SFAS No. 150 establishes standards for
how companies classify and measure, in their statement of financial position,
certain financial instruments with characteristics of both liabilities and
equities. SFAS No. 150 is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning of the
first interim period beginning after September 15, 2003. SFAS No. 150 currently
has not had an impact on our financial position, results of operations or cash
flows.
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 and deferred tax assets. Actual results could differ
from those estimates.
2. BASIC AND DILUTED INCOME (LOSS) PER SHARE:
Basic earnings (loss) per share (EPS) is computed by dividing net income or loss
available for common shareholders 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 converting preferred
stock and exercising stock options and warrants into common shares. Basic loss
per share excludes potentially dilutive securities.
In the nine months ended September 30, 2002, the effect of approximately 600,000
equivalent shares of stock options and warrants were excluded from the diluted
shares calculation, because
7
they were anti-dilutive. As of September 30, 2003, options to purchase 2,329,000
shares were outstanding, with options to purchase approximately 1,436,000 shares
exercisable. Listed below are the basic and diluted share calculations.
Three Months Nine Months
Ended September 30, Ended September 30,
2003 2002 2003 2002
---------- ---------- ---------- ----------
Average common shares outstanding 18,988,923 18,580,855 18,956,842 18,243,870
Shares used in computing basic
net income (loss) per share 18,988,923 18,580,855 18,956,842 18,243,870
=========== =========== =========== ===========
Stock options 550,614 358,841 568,142 --
Warrants 1,040 1,040 1,040 --
----------- ----------- ----------- -----------
Shares used in computing diluted
net income (loss) per share 19,540,577 18,940,736 19,526,024 18,243,870
=========== =========== =========== ===========
3. STOCK-BASED COMPENSATION
The Company applies the intrinsic-value-based method of accounting prescribed by
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued
to Employees," and related interpretations including FASB Interpretation No. 44,
"Accounting for Certain Transactions involving Stock Compensation," an
interpretation of APB Opinion No. 25, issued in March 2000, to account for its
fixed-plan stock options. Under this method, compensation expense is recorded on
the date of grant only if the current market price of the underlying stock
exceeds the exercise price. SFAS No. 123, "Accounting for Stock-Based
Compensation," established accounting and disclosure requirements using a
fair-value-based method of accounting for stock-based employee compensation
plans. As allowed by SFAS No. 123, the Company has elected to continue to apply
the intrinsic-value-based method of accounting described above, and has adopted
only the disclosure requirements of SFAS No. 123. Under the Company's employee
share option plans, the Company grants employee and outside directors stock
options at an exercise price equal to the fair market value at the date of
grant. No compensation expense is recorded with respect to such stock option
grants. Compensation expense with respect to stock awards granted to all others
is measured based upon the fair value of such awards and is charged to expense
over the vesting period. The following table illustrates the effect on net
income or loss and earnings or loss per share if the fair value based method had
been applied to all outstanding and unvested awards in each period.
8
Three Months Ended Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
--------- --------- -------- --------
Net income (loss), as reported $ 264 $ 121 $ 810 $ (799)
Add: Stock-based employee compensation expense
included in reported net income, net of related
tax effects 7 -- 8 1
Deduct: Total stock-based employee compensation
determined under fair value based method for all
awards, net of related tax effects (189) (101) (495) (304)
-------- --------- -------- --------
Pro forma net income (loss) $ 82 $ 20 $ 323 $ (1,102)
======== ========= ======== ========
Earnings (loss) per share:
Basic -- as reported $ 0.01 $ 0.01 $ 0.04 $ (0.04)
======== ========= ======== ========
Basic -- pro forma $ -- $ -- $ 0.02 $ (0.06)
======== ========= ======== ========
Diluted -- as reported $ 0.01 $ 0.01 $ 0.04 $ (0.04)
======== ========= ======== ========
Diluted -- pro forma $ -- $ -- $ 0.02 $ (0.06)
======== ========= ======== ========
4. INVENTORIES:
The Company's inventories, which consist primarily of test kit components, bulk
serum and antibody products, are valued at the lower of cost or market. Cost is
determined using the first in, first out method. At September 30, 2003 and
December 31, 2002, inventories consisted of the following:
September 30, 2003 December 31, 2002
------------------ -----------------
Raw materials $ 3,197 $ 2,969
Work in progress 842 911
Finished goods 2,610 2,941
- --------------------------------------------------------------------------------
$ 6,649 $ 6,821
================================================================================
5. INTANGIBLE ASSETS:
September 30, 2003 December 31, 2002
------------------ -----------------
Goodwill $ 5,168 $ 5,168
Other 2,800 2,730
Less - accumulated amortization (971) (832)
- --------------------------------------------------------------------------------
Net intangible assets $ 6,997 $ 7,066
================================================================================
9
DEBT:
On May 5, 2000, the Company entered into a financing agreement with a commercial
bank. This agreement provides for a $4,000 term loan, all of which had been paid
on or before December 31, 2002, and for a revolving line of credit with
availability of up to $5,000, based on eligible assets, none of which was
outstanding and approximately $3,036 of which was available at September 30,
2003.
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 3.86% at September 30, 2003.
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 provides for up to $1,500 in financing, $1,247 of which
was outstanding at September 30, 2003, and is repayable over seven years, with
principal payments having begun on October 1, 2002. The loan bears a variable
interest rate of between 2.0% and 3.0% 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 September 30, 2003 was approximately 4.11%.
Under the terms of the above financings, the Company is required to meet certain
quarterly financial covenants. The Company was in breach of certain of the these
financial covenants for all four quarters during 2002, and received a waiver and
suspension of these loan covenants for all four quarters of 2002. The loan
covenants were modified to a minimum quick ratio (cash and cash equivalents plus
accounts receivable divided by total current liabilities) of 2.25 and a minimum
tangible net worth ratio (total stockholder's equity less intangible assets) of
$22,500 for the first three quarters of 2003. Beginning with the fourth quarter
of 2003, the original provisions of the loan agreement regarding financial
covenants will be operative, namely a ratio of EBITDA to current maturities of
debt plus interest and cash paid for taxes and a ratio of funded debt to EBITDA.
The Company was in compliance with the minimum quick ratio and minimum tangible
net worth requirements at September 30, 2003 and expects to be in compliance
with the relevant financial covenants at December 31, 2003.
As of September 30, 2003, the outstanding balance on all of the Company's
commercial bank debt was approximately $1,247. This indebtedness is secured by
substantially all of the Company's assets.
In March 2003, the Company entered into an agreement to finance its 2003
insurance premiums with a commercial lender. The agreement provides for $329 in
insurance premium financing, of which approximately $46 was outstanding at
September 30, 2003. Payments are due in nine equal monthly payments ending
November 1, 2003. This insurance premium loan bears a fixed annual interest rate
of 5.82%.
10
7. GAIN ON SALE AND DISPOSAL OF ASSETS:
In March 2002, the Company sold most of the remaining assets of its antibody
production facility near San Diego, California. The Company received proceeds of
$600 for the sale of the property, which included a $300 cash payment and a
one-year note from the purchaser for the remaining $300. The note carried an
interest rate of 5% annually, and was payable in three monthly installments of
interest only payments, with the balance being paid over an additional nine
months of principal and interest payments. The note was repaid in full in August
2002. The Company recorded a gain on sale of $131, which represents the amount
the Company received above the carrying value of the assets sold.
In March 2002, the Company reached an agreement with its insurance carrier in
settlement of costs related to a building fire on its Maine property. The
Company has received proceeds of $359 and is carrying an additional $19 on its
balance sheet in accounts receivable as an amount due for the balance of the
insurance settlement. The Company recorded a gain on disposal of $243, which
represents the amount the Company received above its investment in the assets
destroyed.
8. ACQUISITIONS:
On July 8, 2002, the Company purchased certain assets of Molecular Circuitry,
Inc. ("MCI"). The purchased assets consist primarily of various proprietary
media technology that will be used in combination with the Company's new
diagnostic tests for food-borne pathogens including Salmonella and E. coli. The
assets purchased also include the sales and marketing rights to the ruminant
feed test product line that the Company and MCI had been jointly developing in
collaboration with McDonald's Corporation.
In consideration for these and other related assets, the Company issued to MCI
600,000 unregistered shares of the Company's common stock with a value of $4.17
per share or $2,502 in the aggregate, computed by averaging the closing price of
the Company's common stock for the period beginning on the two business days
before the acquisition and ending two business days after the acquisition. In
addition the Company will also pay MCI a continuing royalty for ten years on
sales of specified products and/or components of products, which will be charged
to operations if and when incurred.
The assets of MCI were valued by AUS Consultants Valuation Services of New
Jersey (AUS). AUS determined the value of the assets purchased to be $261 in
laboratory equipment (tangible assets) and approximately $2,280 for the
intellectual and property rights to the MCI developed Express Media, Chromagenic
Media and Ruminant Feed Test product lines (intangible assets).
The intangible assets were valued using the income approach. This method
estimates market value as the present value of future economic benefits to be
derived from the exploitation of these assets or product lines. This methodology
requires a forecast of net cash flow from each product line, an estimate of the
relative risk of achieving that income stream, and an estimate as to the
duration of the income. An economic life of twenty years was used in the above
calculations utilizing a discount rate of approximately 25%.
11
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward-Looking Statements
This Form 10-Q contains certain forward-looking statements reflecting the
current expectations of Strategic Diagnostics Inc. and its subsidiaries (the
"Company"). When used in this Form 10-Q, 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, the successful integration and
consolidation of the Maine production facilities, inability to obtain or delays
in obtaining third party approvals, including American Organization of
Analytical Chemists Research Institute ("AOAC"), 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.
Background
The Company develops, manufactures and markets immunoassay and
bioluminescence-based test kits for rapid and cost-effective detection of a wide
variety of substances in the food safety and water quality markets, and also
provides antibody and immunoreagent research, development and production
services.
Since its inception, the Company and its predecessors have, in addition to
conducting internal research and development of new products, entered into
research and development agreements with multiple partners that have led to the
introduction of various products to the food safety, water quality and other
markets. The Company believes that its competitive position has been enhanced
through the combination of talent, technology and resources resulting from the
relationships it developed and the acquisitions it concluded during the past
five years. These relationships and acquisitions have enabled the Company to
achieve 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, its facility located in Oceanside,
California, for the manufacture of instruments, and its facility located in
Windham, Maine for the manufacture of antibodies.
On July 8, 2002, the Company purchased certain assets of Molecular Circuitry,
Inc. (MCI). The purchased assets consist primarily of various proprietary growth
media technology that are used in combination with the Company's diagnostic
tests for food-borne pathogens, including Salmonella and E. coli. The assets
purchased also include the sales and marketing rights to the ruminant feed
12
test product line that the Company and MCI had been jointly developing in
collaboration with McDonald's Corporation. In consideration for these and other
related assets, the Company issued to MCI 600,000 unregistered shares of the
Company's common stock with a value of $4.17 per share, or approximately $2.5
million in the aggregate. The per share price was computed by averaging the
closing price of the Company's common stock on the Nasdaq National Market for
the period beginning two business days before the acquisition and ending two
business days after the acquisition, plus an additional $40,000 in transaction-
related costs. In addition, the Company will pay MCI a continuing royalty for 10
years on sales of specified products and/or components of products, which
royalty will be charged to operations if and when incurred.
On September 28, 2001, the Company acquired AZUR Environmental (AZUR), a
privately-held manufacturer of proprietary rapid test systems, including the
Microtox(R) toxicity test system, which measures toxicity in drinking and
process water. Mentioned in more than 500 peer-reviewed scientific articles and
with more than 1,700 instruments sold worldwide, the Microtox(R) toxicity test
system has been approved in regulations or standards in Canada, eight European
countries, and has been submitted to the U.S. Environmental Protection Agency
for approval. Under the terms of the merger agreement with AZUR, the Company
issued 700,000 shares of Series C preferred stock, with a fair market value of
approximately $3.0 million in the aggregate, as determined by an independent
valuation firm. On November 2, 2001 the 700,000 Series C preferred shares were
automatically converted into 700,000 shares of the Company's common stock in
accordance with their original terms.
With the 1999 acquisitions of HTI BioProducts, Inc. and certain assets of
Atlantic Antibodies, the Company formed Strategic BioSolutions (SBS), which has
since become one of the largest producers of antibodies in the United States.
The mission of Strategic BioSolutions is to supply monoclonal and polyclonal
antibodies, immunochemical reagents and related services to medical diagnostic
and pharmaceutical companies, as well as research institutions.
In September 2003 the Company's Chief Executive Officer announced that the
Company will be performing an internal strategic assessment, including but not
limited to, its organizational structure, its product lines, and its channels to
market. This strategic assessment may result in, but not limited to, the Company
exiting or discontinuing certain less profitable product lines to focus on
higher margin products and growth opportunities in the future.
Results of Operations
Three Months Ended September 30, 2003 vs. September 30, 2002
Net revenues for the third quarter of 2003 were $6.4 million versus $6.1 million
in the third quarter of 2002, an increase of $297,000 or 5%.
Food safety revenues in the third quarter of 2003 increased 31% to $2.1 million
from $1.6 million in the third quarter of 2002. Sales of the Company's products
to detect genetically modified (GM) crops grew significantly during the quarter,
when compared to the same period in the prior year, primarily driven by the
Company's increasing penetration into the cottonseed market, in cooperation with
its partners. When comparing the third quarter 2003 to the third quarter 2002,
the Company continued to experience a decline in StarLink(TM) test kit sales.
However, when
13
comparing the third quarter 2003 to the second quarter 2003, the Company
experienced an increase in StarLink(TM) test kit sales. The Company believes
that this increase was driven by increased corn yields this year when compared
to last, which increased the volume of testing, and corn price increases which
may have led to increased testing due to concerns about StarLink(TM) corn
entering the grain supply from stockpiled inventories. Although the Company
experienced an increase of StarLink(TM) test kit sales in the third quarter 2003
when compared to the third quarter 2002, the Company expects that on a full year
basis, StarLink(TM) test kits will continue to decline.
The Company has seen the introduction of new commercial products by its
partners, including traits to protect corn crops from the corn rootworm, a pest
more prevalent than the European corn bore and herbicide resistant corn. The
Company has developed, validated and begun to sell tests to detect these traits.
While the Company expects small volumes in the first year, it anticipates sales
will grow as these products gain acceptance in 2004 and thereafter. The USDA
Grain Inspection Packers and Stockyards Administration (GIPSA) recently
certified the performance claims of the Company's TraitChek(TM) lateral flow
strip tests for the detection of Cry1F Herculex(TM) I and Cry3Bb YieldGard(R)
Rootworm. The Company believes that this trend of new trait introduction will
continue, as our partners have publicly stated their commitment and investment
in this technology area.
Also, the dynamics in the Brazilian market continue to change, as the government
there has recently announced that it has opened its regulations to the planting
of genetically modified soy. The Company believes that this new development will
increase the amount of testing undertaken in the market.
As a demonstration of the Company's continued commitment to innovation and
customer focus, the Company will shortly be introducing a new comb strip test
with the ability to test up to six corn traits in one single corn extraction.
This product format significantly reduces the amount of time required to run
multiple tests since our sample is used for all six tests, compared to the prior
method of six discrete samples for each trait. This allows the grain processor
to get the information they need while reducing transfer times and improving
their workflow processes.
In the food pathogen area, the Company's E. coli tests continue to gain
acceptance in the marketplace. The E. coli test system, which includes both an
enrichment media and a rapid assay, continues to display superior sensitivity
and specificity to E. coli O157 and, as a screening method, allows customers to
avoid using slower, more costly methods on the vast majority of their samples.
Other developments include a recently completed government-sponsored study that
demonstrated the Company's E. coli enrichment media outperformed the standard
method. Also, the Company is participating in an evaluation by the National
Cattlemen's Beef Association, which is looking at the Company's entire E. coli
testing system, including the enrichment media and immunoassay test.
In August 2003, the Company received AOAC validation to expand the applications
of its Salmonella test to a variety of foods. Although customer validations and
development of quality system protocols are still continuing for these unique
food matrices, the Company, subsequent to the end of the third quarter 2003,
added $250,000 worth of new Salmonella business.
14
During the quarter, the Company continued its product development efforts with
its Listeria product in an effort to ensure compliance with the October 2003
Food Safety and Inspection Service directives regarding environmental testing.
In addition, the Company wants to make sure that it has identified and developed
the product features and benefits that would deliver greatest competitive
advantage to the marketplace in either the enrichment phase or the assay itself
or both. The Company's focus on all food pathogen testing is to give the
customer a lower total cost of ownership by providing the required specificity
and sensitivity, while enhancing ease of use, time to result and work flow
management.
During 2003, cases of "mad cow" have been found in Canada and Japan. The market
and regulatory environment in the United States, Canada and Japan continues to
be in a state of flux. Food, feed and regulatory agencies are looking at the
adequacy of current approaches but there have been no significant policy
revisions or decisions to date. The Company continues to support and participate
in policy discussions around the testing of animal feed. The Company has met
with regulators and industry leaders to try and facilitate policy making. The
Company's product to detect unapproved animal proteins in feed has been included
in a regulatory protocol in Canada and has recently been provided to
governmental testing agencies in Japan for their evaluation.
Water quality revenues decreased 11% to $1.6 million in the third quarter 2003
compared to $1.8 million in the third quarter of 2002. The decrease in the third
quarter 2003 was primarily driven by approximately $100,000 of sales the Company
earned in the second quarter 2003 that it had expected in the third quarter
2003. Additionally, the Company's sales force was less productive in the third
quarter 2003 due to the organizational structure earlier in the year, when the
sales force was organized by geographic region and not product and industry
expertise. As the Company announced in June, its sales force has been
reorganized to align its customers in each of the Company's business units and
the Company is beginning to experience an increase in the productivity in the
water quality sales efforts. Although the Company completed sales of 13
instruments during the quarter, it experienced a decline in the rate of increase
in Microtox(R) instrument sales.
The Company continues to develop the market for water security in the food and
beverage industry. Six food companies are involved in various evaluations and
pilots designed to develop application methodologies and services to screen
water as a key product ingredient. The Company had been participating in an EPA
Battelle validation study and a Navy project. The Battelle study has now been
completed and data from the results is expected to be released in late November
2003. The Navy project is continuing, and the results to-date has validated the
technology in certain security applications. The Navy is presently evaluating an
extension of the original project to include additional security applications.
Antibody revenues increased 8% to $2.8 million in the third quarter of 2003
compared to $2.6 million in the third quarter of 2002. This increase continues
to reflect the attraction of new customers and the growth of sales to existing
accounts, which have been among the benefits of the consolidation of the
Company's production facilities in Maine, which was completed in 2002, but was
the Company's slowest rate of increase so far in 2003. The Company believes its
customers are in part purchasing less due to a cautious business environment.
15
The decline in contract and other revenues from $198,000 in the third quarter
2002 to $2,000 in the third quarter 2003 reflects the Company continued emphasis
on devoting research and development resources on internal projects rather than
contract research projects for third parties.
Manufacturing expenses increased $338,000, or 12%, to $3.0 million for the third
quarter of 2003 compared to $2.7 million in the third quarter 2002. The increase
were primarily driven by the 8% increase in product-related revenues (total
revenues less contract and other revenue), for the third quarter ended September
30, 2003, and by higher manufacturing expenses associated with the cost of the
Company's food safety products versus the lower costs of its Microtox(R) family
of products.
Gross profits (total revenues less manufacturing costs) decreased $41,000 to
$3.4 million in the third quarter of 2003 compared to $3.4 million in the third
quarter 2002, and gross margin percentages decreased to 53% in the third quarter
2003 compared to 56% for the third quarter 2002. The decrease in gross profits
and gross margins for the third quarter 2003 was primarily driven by the product
mix of higher volumes of lower margin food-safety products as compared to higher
margin Microtox(R) products, as discussed above.
Research and development expenses decreased $152,000, or 19%, to $652,000 in the
third quarter of 2003 compared to $804,000 in the third quarter 2002, primarily
due to higher expenses in the prior year associated with the development efforts
of the Company's food pathogen and animal feed test, and continued emphasis on
devoting research and development resources to internal projects rather than
undertaking contract research projects for third parties.
Selling, general and administrative expenses decreased $168,000, or 7%, to $2.3
million for the third quarter of 2003 compared to $2.4 million in the third
quarter 2002, primarily due to the actions taken by the Company in late 2002 and
early 2003 to streamline its operations.
Interest expense decreased 39% to $11,000 in the third quarter of 2003 from
$18,000 in the third quarter of 2002. This decrease is primarily attributable to
the lower levels of outstanding debt during the 2003 period.
Income before taxes totaled $442,000 in the third quarter 2003 compared to
$156,000 in the third quarter 2002. Net income totaled $264,000 in the third
quarter 2003 compared to $121,000 in the third quarter 2002.
Nine Months Ended September 30, 2003 vs. September 30, 2002
Net revenues for the nine months ended September 30, 2003 were $19.3 million
versus $17.4 million in the nine months ended September 30, 2002, an increase of
$1.9 million or 11%. Food safety revenues in the nine months ended September 30,
2003 increased 19%, to $5.1 million from $4.3 million in the nine months ended
September 30, 2002, as the Company saw stronger demand for both food pathogen
and GM trait tests. Water quality revenues increased 4% to $5.4 million in the
nine months ended September 30, 2003 compared to $5.2 million in the nine months
ended September 30, 2002, as the Company saw higher sales of the Microtox
toxicity screening systems. Antibody revenues increased 16% to $8.8 million in
the nine months ended September 30, 2003
16
compared to $7.5 million in the nine months ended September 30, 2002, which
reflects the results of several new or expanded relationships established in
2002 as customers and prospects had the opportunity to validate manufacturing
and quality procedures at our expanded manufacturing facilities in Maine.
Contract and other revenues decreased to $117,000 in the nine months ended
September 30, 2003 compared to $480,000 in the nine months ended September 30,
2002, as the Company continued to place greater emphasis on devoting research
and development resources on internal projects.
Manufacturing expenses increased $26,000 to $8.8 million in the nine months
ended September 30, 2003, compared to $8.7 million in the nine months ended
September 30, 2002. The increase was primarily driven by the 13% increase in
product-related revenues (total revenues less contract and other revenue), for
the nine months ended September 30, 2003.
Gross profits (total revenues less manufacturing costs) increased $1.9 million,
or 21%, to $10.6 million in the nine months ended September 30, 2003 compared to
$8.7 million in the nine months ended September 30, 2002, and gross margin
percentages increased to 55% for the nine months ended September 30, 2003
compared to 50% for the nine months ended September 30, 2002. The increase in
gross profits and gross margin percentage was primarily driven by the $1.9
million increase in product sales in the nine months ended September 30, 2003
and the leveraging of fixed manufacturing expenses on higher production volumes.
Research and development expenses decreased $462,000, or 19%, to $2.0 million
for the nine months ended September 30, 2003 compared to $2.4 million for the
nine months ended September 30, 2002, primarily due to higher expenses in the
prior year associated with the development efforts of the Company's food
pathogen and animal feed test.
Selling, general and administrative expenses decreased $670,000, or 8%, to $7.3
million for the nine months ended September 30, 2003 compared to $7.9 million
for the nine months ended September 30, 2002, primarily due to the actions taken
by the Company in late 2002 and early 2003 to streamline its operations and the
effect of the consolidation of its antibody facilities in Maine, which was
completed in 2002. Included in the selling, general and administrative expenses
of $7.3 million for the nine months ended September 30, 2003 is a $315,000
provision for severance and related expenses associated with the Company's
termination of its former CEO in May 2003.
Interest expense decreased 33% to $34,000 in the nine months ended September 30,
2003 from $51,000 in the nine months ended September 30, 2002. This decrease is
primarily attributable to the lower levels of outstanding debt during the 2003
period.
Income before taxes totaled $1.3 million for the nine months ended September 30,
2003 compared to a loss before taxes of $1.4 million for the nine months ended
September 30, 2002. Net income totaled $810,000 for the nine months ended
September 30, 2003 compared to a net loss of $799,000 for the nine months ended
September 30, 2002.
17
Liquidity and Capital Resources
Net cash provided by operating activities of $2.1 million for the nine months
ended September 30, 2003 compared favorably to net cash used in operating
activities of $1.8 million in the nine months ended September 30, 2002. The
improvement was primarily the result of the fact that the Company had a pretax
loss in the nine months ended September 30, 2002 of $1.4 million, but had a
pretax income of $1.3 million in the first nine months of 2003.
The Company's working capital, current assets less current liabilities,
increased to $14.0 million at September 30, 2003, compared to $12.5 million at
December 31, 2002. Outstanding debt decreased $130,000 from $1.4 million at
December 31, 2002 to $1.3 million on September 30, 2003, primarily due to
scheduled repayments under the Company's bank term debt.
On May 5, 2000, the Company entered into a financing agreement with a commercial
bank. This agreement provides for a $4 million term loan, all of which had been
paid on or before December 31, 2002, and for up to a $5 million revolving line
of credit, none of which was outstanding and approximately $3.1 million of which
was available at September 30, 2003. 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, of which approximately $1.2 million was outstanding
at September 30, 2003, and is repayable over seven years, with principal
payments beginning on October 1, 2002. Under the terms of the financings, the
Company is required to meet certain quarterly financial covenants. The Company
was in breach of certain of these financial covenants for all four quarters
during 2002, and received a waiver and suspension of these loan covenants for
all four quarters of 2002. The loan covenants were modified to a minimum quick
ratio (cash and cash equivalents plus accounts receivable divided by total
current liabilities) of 2.25 and a minimum tangible net worth ratio (total
stockholder's equity less intangible assets) of $22,500 for the first three
quarters of 2003. Beginning with the fourth quarter of 2003, the original
provisions of the loan agreement regarding financial covenants will be
operative, namely a ratio of EBITDA to current maturities of debt plus interest
and cash paid for taxes and a ratio of funded debt to EBITDA. The Company was in
compliance with the minimum quick ratio and minimum tangible net worth
requirements at September 30, 2003 and expects to be in compliance with the
relevant financial covenants at December 31, 2003.
The Company believes it has, or has access to sufficient resources to meet its
operating requirements for the foreseeable future. The Company's ability to meet
its long-term capital requirements 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 and the success of the Company's plan to make future
acquisitions. In addition, the Company's current strategic review of its
business operations may result in changes in how the Company conducts such
operations. Accordingly, no assurance can be given that the Company will be able
to meet the future liquidity requirements that may arise from these inherent and
similar uncertainties.
18
Item 3. 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 approximately $1.2 million 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 3% 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 $12,000 on the Company's annual interest expense
charges.
The Company conducts operations in 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.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
Our management, with the participation of the our Chief Executive
Officer and Chief Financial Officer, evaluated the effectiveness of our
disclosure controls and procedures as of the end of the period covered by this
report. Based on that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures as of
the end of the period covered by this report are functioning effectively to
provide reasonable assurance that the information required to be disclosed by us
in reports filed under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms. A controls system, no matter how well designed and
operated, cannot provide absolute assurance that the objectives of the controls
system are met, and no evaluation of controls can provide absolute assurance
that all control issues and instances of fraud, if any, within a company have
been detected.
(b) Change in Internal Control over Financial Reporting
No change in our internal control over financial reporting occurred
during our most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
19
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.1* Employment Agreement dated September 2, 2003, by and between
Matthew H. Knight and the Company.
10.2* Nonqualified Stock Option Agreement dated September 2, 2003,
by and between Matthew H. Knight and the Company.
10.3* Restricted Stock Grant Agreement dated September 2, 2003, by
and between Matthew H. Knight and the Company.
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 (furnished herewith).
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 (furnished herewith).
32.1 Certifications of the Chief Executive Officer of Strategic
Diagnostics Inc. required by Rule 13a-14(b) under the
Securities Exchange Act of 1934, as amended. (This exhibit
shall not be deemed "filed" for purposes of Section 18 of the
Securities Exchange Act of 1934, as amended, or otherwise
subject to the liability of that section. Further, this
exhibit shall not be deemed to be incorporated by reference
into any filing under the Securities Act of 1933, as amended,
or the Securities Exchange Act of 1934, as amended.)
(furnished herewith)
32.2 Certifications of the Chief Financial Officer of Strategic
Diagnostics Inc. required by Rule 13a-14(b) under the
Securities Exchange Act of 1934, as amended. (This exhibit
shall not be deemed "filed" for purposes of Section 18 of the
Securities Exchange Act of 1934, as amended, or otherwise
subject to the liability of that section. Further, this
exhibit shall not be deemed to be incorporated by reference
into any filing under the Securities Act of 1933, as amended,
or the Securities Exchange Act of 1934, as amended.)
(furnished herewith)
* Management contract or compensatory plan.
(b) Reports on Form 8-K
On July 24, 2003, the Company furnished a report on Form
8-K pursuant to Item 7 and Item 9 announcing second
quarter 2003 financial results.
On August 6, 2003, the Company furnished a report on
Form 8-K pursuant to Item 7 and Item 9 announcing that
the USDA Grain Inspection Packers and Stockyards
Administration (GIPSA) recently certified the
performance claims
20
of the Company's TraitChek(TM) lateral flow strip test
for the detection of Cry3Bb YieldGard(R) Rootworm.
On August 18, 2003, the Company furnished a report on
Form 8-K pursuant to Item 7 and Item 9 announcing
that the USDA Grain Inspection Packers and Stockyards
Administration (GIPSA) recently certified the
performance claims of the Company's TraitChek(TM)
lateral flow strip test for the detection of Cry1F
Herculex(TM) I.
On August 25, 2003, the Company furnished a report on
Form 8-K pursuant to Item 7 and Item 9 announcing that
the AOAC Research Institute has certified the Company's
RapidChek(R) for Salmonella test for a variety of food
groups.
On September 4, 2003, the Company furnished a report on
Form 8-K pursuant to Item 7 and Item 9 announcing that
the Company's Board of Directors had appointed Matthew
H. Knight as President and Chief Executive Officer.
21
SIGNATURES
Pursuant to the requirements 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: November 14, 2003 /s/ Matthew H. Knight
----------------- ----------------------------------------------------
Matthew H. Knight
President, Chief Executive Officer
(Principal Executive Officer)
Date: November 14, 2003 /s/ Stanley J. Musial
----------------- ----------------------------------------------------
Stanley J. Musial
Vice President - Finance and Chief Financial Officer
(Principal Financial and Accounting Officer)
22