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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2002
OR
[_] 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 0-12992
SYNTHETECH, INC.
(Exact name of registrant as specified in its charter)
OREGON 84-0845771
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
1290 Industrial Way, Albany, Oregon 97322
(Address of Principal Executive Offices) (Zip Code)
(541) 967-6575
(Registrant's Telephone Number, Including Area Code)
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 Exchange Act).
Yes No X
--- ---
The number of shares of the registrant's common stock, $.001 par value,
outstanding as of February 3, 2003 was 14,322,094
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SYNTHETECH, INC
INDEX
Page
----
Part I. Financial Information
Item 1. Condensed Financial Statements
Balance Sheets 3
Statements of Operations 5
Statements of Cash Flows 6
Notes to Unaudited Condensed Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosure about
Market Risk 17
Item 4. Controls and Procedures 18
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K 19
Signatures 20
Certification of President and Chief Executive Officer 21
Certification of Vice President Finance and Chief Financial
Officer 22
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
SYNTHETECH, INC.
Balance Sheets
- --------------------------------------------------------------------------------
(unaudited)
December 31, March 31,
2002 2002
------------ ------------
Assets
- -------------------------------------------------
Current Assets:
Cash and cash equivalents $ 5,325,000 $ 4,214,000
Accounts receivable, less allowance
for doubtful accounts of $15,000 for
both periods 1,164,000 2,167,000
Inventories, net 4,030,000 4,398,000
Income tax receivable 703,000 672,000
Prepaid expenses 609,000 426,000
Deferred income taxes 116,000 116,000
Other current assets 4,000 7,000
------------ ------------
Total Current Assets 11,951,000 12,000,000
Property, Plant and Equipment, net 12,429,000 12,229,000
------------ ------------
Total Assets $ 24,380,000 $ 24,229,000
============ ============
The accompanying notes are an integral part of these financial statements.
3
SYNTHETECH, INC.
Balance Sheets
(continued)
- --------------------------------------------------------------------------------
(unaudited)
December 31, March 31,
2002 2002
------------ ------------
Liabilities and Shareholders' Equity
- -------------------------------------------------
Current Liabilities:
Current portion of long term obligations $ 21,000 $ 20,000
Accounts payable 538,000 465,000
Accrued compensation 163,000 138,000
Deferred revenue 21,000 --
Other accrued liabilities 101,000 61,000
------------ ------------
Total Current Liabilities 844,000 684,000
Deferred Income Taxes 463,000 463,000
Long Term Obligations, net of current portion 81,000 97,000
Other Long Term Liabilities -- 15,000
Shareholders' Equity:
Common stock, $.001 par value; authorized
100,000,000 shares; issued and outstanding,
14,322,000 and 14,307,000 shares 14,000 14,000
Paid-in capital 8,975,000 8,933,000
Deferred compensation (65,000) (61,000)
Retained earnings 14,053,000 14,099,000
------------ ------------
Total Shareholders' Equity 22,977,000 22,985,000
------------ ------------
Total Liabilities and Shareholders' Equity $ 24,380,000 $ 24,229,000
============ ============
The accompanying notes are an integral part of these financial statements.
4
SYNTHETECH, INC.
Statements of Operations
- --------------------------------------------------------------------------------
(unaudited)
For the Three Months Ended For the Nine Months Ended
December 31, December 31,
---------------------------- ----------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Revenue $ 3,991,000 $ 3,138,000 $ 8,867,000 $ 7,869,000
Cost of Sales 2,001,000 2,281,000 6,995,000 7,677,000
----------- ----------- ----------- -----------
Gross Profit 1,990,000 857,000 1,872,000 192,000
Research and Development 207,000 166,000 524,000 464,000
Selling, General and Administrative 444,000 384,000 1,464,000 1,210,000
----------- ----------- ----------- -----------
Operating Expense 651,000 550,000 1,988,000 1,674,000
----------- ----------- ----------- -----------
Operating Income (Loss) 1,339,000 307,000 (116,000) (1,482,000)
Other Income 15,000 23,000 49,000 112,000
Interest Expense (3,000) (3,000) (7,000) (9,000)
----------- ----------- ----------- -----------
Income (Loss) Before Income Taxes 1,351,000 327,000 (74,000) (1,379,000)
Provision (Benefit) for Income Taxes 513,000 124,000 (28,000) (524,000)
----------- ----------- ----------- -----------
Net Income (Loss) $ 838,000 $ 203,000 $ (46,000) $ (855,000)
=========== =========== =========== ===========
Basic Earnings (Loss) Per Share $ 0.06 $ 0.01 $ 0.00 $ (0.06)
=========== =========== =========== ===========
Diluted Earnings (Loss) Per Share $ 0.06 $ 0.01 $ 0.00 $ (0.06)
=========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements.
5
SYNTHETECH, INC.
Statements of Cash Flows
- --------------------------------------------------------------------------------
(unaudited)
For The Nine Months Ended December 31, 2002 2001
- -------------------------------------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (46,000) $ (855,000)
Adjustments to reconcile net loss to
net cash provided by (used in) operating activities:
Depreciation and amortization expense 776,000 2,157,000
Loss on retirement of equipment 114,000 --
Amortization of deferred compensation 19,000 21,000
(Increase) decrease in assets:
Accounts receivable, net 1,003,000 (1,331,000)
Inventories, net 368,000 (307,000)
Income tax receivable (31,000) (526,000)
Prepaid expenses (183,000) (149,000)
Other current assets 3,000 (6,000)
Increase (decrease) in liabilities:
Accounts payable, accrued compensation,
accrued liabilities and other long term liabilities 153,000 (291,000)
Deferred revenue 21,000 (17,000)
----------- -----------
Net cash provided by (used in) operating activities 2,197,000 (1,304,000)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property, plant and equipment purchases (1,090,000) (1,595,000)
----------- -----------
Net cash used in investing activities (1,090,000) (1,595,000)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments under long-term debt obligations (15,000) (41,000)
Proceeds from stock purchase plan 19,000 18,000
----------- -----------
Net cash provided by (used in) financing activities 4,000 (23,000)
----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,111,000 (2,922,000)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 4,214,000 5,389,000
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 5,325,000 $ 2,467,000
=========== ===========
NON-CASH INVESTING ACTIVITIES:
Issuance of stock options at below fair value $ 23,000 $ 13,000
The accompanying notes are an integral part of these financial statements.
6
SYNTHETECH, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
(Information as of December 31, 2002 and for the three and nine-month
periods ended December 31, 2002 is unaudited)
NOTE A. GENERAL AND BUSINESS
Synthetech, Inc. (Company), an Oregon corporation, specializes in developing and
producing Peptide Building Blocks (PBBs), which are chemically modified forms of
natural amino acids, and synthetic non-natural amino acids (Specialty Amino
Acids) using a combination of organic chemistry and biocatalysts. The Company's
PBBs are used predominantly by pharmaceutical companies to make a wide range of
peptide-based drugs under development and on the market for the treatment of
AIDS, cancer, cardiovascular and other diseases. The Company has established a
worldwide reputation in a unique product and technology area as a leading
supplier for all phases of the drug development cycle from discovery through
market launch.
The summary financial statements included herein have been prepared, without
audit, pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations, although Synthetech management believes that the disclosures are
adequate to make the information presented not misleading. The Company suggests
that these summary financial statements be read in conjunction with the
financial statements and the notes thereto included in the Company's Annual
Report on Form 10-K for the year ended March 31, 2002.
The interim period information included herein reflects all adjustments,
consisting of normal recurring adjustments, that are, in the opinion of the
Company's management, necessary for a fair statement of the results of the
respective interim periods. Results of operations for interim periods are not
necessarily indicative of results to be expected for an entire year.
NOTE B. PROPERTY, PLANT AND EQUIPMENT LIVES
Based upon the results of an independent review of the estimated lives of
certain categories of its machinery and equipment and laboratory equipment, the
Company reassessed the useful lives of certain of these assets as of the
beginning of the first quarter of fiscal 2003. The Company initiated the review
as it became evident after several years of use that certain Company equipment
may have longer usefulness, both functionally and from a technology perspective,
than originally anticipated. The changes in estimated useful lives, which are
indicated in the table below, reduced total depreciation expense and resulted in
an after-tax increase to net income of approximately $223,000, or $0.02 per
share, and an after-tax decrease to net loss of approximately $682,000, or $0.05
per share, for the third quarter and first nine months of fiscal 2003,
respectively.
Estimated Useful Lives:
(in years) 2003 2002
--------------------------- ----------------- ----------------
Machinery and equipment 5 - 17 5
Laboratory equipment 5 - 7 5
--------------------------- ----------------- ----------------
7
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE C. NEW ACCOUNTING PRONOUNCEMENTS
In August 2001, the FASB approved SFAS No. 143, "Accounting for Asset Retirement
Obligations." SFAS No. 143 addresses the financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. SFAS No. 143 is effective for fiscal years
beginning after June 15, 2002. The Company does not expect the adoption of SFAS
No. 143 to have a significant impact on the Company's financial condition or
results of operations.
In October 2001, the FASB approved SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets," which supersedes SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of" and the accounting and reporting provisions of APB No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions" for the disposal of a segment of a business. SFAS No. 144 retains
many of the fundamental provisions of SFAS No. 121, but resolves certain
implementation issues associated with that Statement.
SFAS No. 144 is effective for the Company beginning in fiscal 2003. The adoption
of SFAS No. 144 has not had a significant impact on the Company's financial
condition or results of operations.
In July 2002, the FASB approved SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 addresses the financial
accounting and reporting for obligations associated with an exit activity,
including restructuring, or with a disposal of long-lived assets. Exit
activities include, but are not limited to, eliminating or reducing product
lines, terminating employees and contracts and relocating plant facilities or
personnel. SFAS No. 146 specifies that a company will record a liability for a
cost associated with an exit or disposal activity only when that liability is
incurred and can be measured at fair value. Therefore, commitment to an exit
plan or a plan of disposal expresses only management's intended future actions
and, therefore, does not meet the requirement for recognizing a liability and
the related expense. SFAS No. 146 is effective prospectively for exit or
disposal activities initiated after December 31, 2002. The Company does not
anticipate that the adoption of SFAS No. 146 will have a material effect on its
financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock Based
Compensation - Transition and Disclosure - an Amendment of SFAS 123." SFAS No.
148 provides additional transition guidance for those entities that elect to
voluntarily adopt the provisions of SFAS No. 123, "Accounting for Stock Based
Compensation." Furthermore, SFAS No. 148 mandates new disclosures in both
interim and year-end financial statements of the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. SFAS No. 148 is effective for fiscal years beginning after December 15,
2002. The Company intends to adopt SFAS No. 148 on April 1, 2003. The Company
does not expect to change to using the fair value based method of accounting for
stock-based employee compensation; and therefore, adoption of SFAS No. 148 is
expected to impact only the future disclosures, not the financial results, of
the Company.
8
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE D. COMPREHENSIVE INCOME OR LOSS
The Company has no material components of comprehensive income or loss other
than net income or loss. Accordingly, comprehensive income/loss was equal to net
income/loss for all periods presented.
NOTE E. EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share (EPS) are computed by dividing net income (loss)
by the weighted average number of shares of common stock outstanding during the
period. Diluted earnings per share are computed by dividing net income by the
weighted average number of shares of common stock and common stock equivalents
outstanding during the period, calculated using the treasury stock method as
defined in SFAS No. 128. The following is a reconciliation of the shares used to
calculate basic earnings (loss) per share and diluted earnings per share:
For the Three Months For the Nine Months
Ended December 31, Ended December 31,
---------------------------- ----------------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Weighted average shares
outstanding for Basic EPS 14,322,094 14,290,383 14,314,595 14,284,836
Dilutive effect of common stock
options issuable under treasury
stock method 28,092 23,390 -- --
---------- ---------- ---------- ----------
Weighted average common and
common equivalent shares
outstanding for Diluted EPS 14,350,186 14,313,773 14,314,595 14,284,836
========== ========== ========== ==========
The following common stock equivalents were excluded from the earnings per share
computation because their effect would have been anti-dilutive:
For the Three Months For the Nine Months
Ended December 31, Ended December 31,
---------------------------- ----------------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Common stock options outstanding 1,020,300 212,100 1,102,300 275,100
========== ========== ========== ==========
9
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE F. STATEMENTS OF CASH FLOWS
Supplemental cash flow disclosures:
For the Three Months For the Nine Months
Cash Paid Ended December 31, Ended December 31,
---------------- -------------------- --------------------
2002 2001 2002 2001
------ ------ ------ ------
Income Taxes $3,000 $ -- $3,000 $1,000
Interest $2,000 $3,000 $7,000 $9,000
NOTE G. INVENTORIES
The major components of inventories are as follows:
December 31, March 31,
2002 2002
---------- ----------
Raw materials $1,049,000 $1,126,000
Work in process 1,049,000 1,281,000
Finished products 1,932,000 1,991,000
---------- ----------
$4,030,000 $4,398,000
========== ==========
The December 31, 2002 and March 31, 2002 inventory is net of a $702,000 and
$25,000 inventory loss reserve, respectively. The Company recorded a charge of
$652,000 ($404,000 after tax) in the quarterly period ended September 30, 2002,
related to the valuation of impaired inventory.
10
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE H. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
December 31, March 31,
2002 2002
----------- -----------
Land $ 241,000 $ 91,000
Buildings 6,620,000 6,330,000
Machinery and equipment 15,122,000 14,800,000
Laboratory equipment 878,000 1,005,000
Furniture and fixtures 412,000 372,000
Vehicles 149,000 125,000
Construction in Progress 66,000 276,000
----------- -----------
23,488,000 22,999,000
Less:
Accumulated depreciation 11,059,000 10,770,000
----------- -----------
$12,429,000 $12,229,000
=========== ===========
11
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage of
revenues represented by each item included in the Statements of Operations.
Percentage of Revenues
- ------------------------------------------------------------------------------------------------
For the Three Months For the Nine Months
Ended December 31, Ended December 31,
-------------------- --------------------
2002 2001 2002 2001
----- ----- ----- -----
Revenues 100.0% 100.0% 100.0% 100.0%
Cost of Sales 50.2 72.7 78.9 97.6
----- ----- ----- -----
Gross Profit 49.8 27.3 21.1 2.4
Research and Development 5.2 5.3 5.9 5.9
Selling, General and Administrative 11.1 12.2 16.5 15.4
----- ----- ----- -----
Operating Expense 16.3 17.5 22.4 21.3
Operating Income (Loss) 33.5 9.8 (1.3) (18.9)
Other Income 0.4 0.7 0.6 1.4
Interest Expense (0.0) (0.1) (0.1) (0.1)
----- ----- ----- -----
Income (Loss) Before Income Taxes 33.9 10.4 (0.8) (17.6)
Provision (Benefit) For Income Taxes 12.9 4.0 (0.3) (6.7)
----- ----- ----- -----
Net Income (Loss) 21.0% 6.4% (0.5)% (10.9)%
===== ===== ===== =====
- ------------------------------------------------------------------------------------------------
12
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, (continued)
Revenues
- --------
Revenues of $4.0 million in the third quarter of fiscal 2003 increased by
$853,000, or 27.2%, compared to $3.1 million in the third quarter of fiscal
2002. Revenues of $8.9 million for the first nine months of fiscal 2003
increased $1.0 million, or 12.7%, compared to revenues of $7.9 million in the
same period of fiscal 2002. Revenues in the third quarter and first nine months
of fiscal 2003, included $2.4 million and $5.5 million, respectively, of
shipments of peptide building blocks (PBBs) to two customers to support
production of two large-scale drug projects in clinical development. Shipments
to these same two customers totaled $2.2 million and $4.2 million, for the third
quarter and first nine months of fiscal 2002, respectively. Revenues in the
third quarter of fiscal 2003 also included shipments to a major pharmaceutical
company for $1.0 million, to support a drug project in early development. The
Company did not ship product to the cosmeceutical sector during the third
quarter of fiscal 2003. Shipments to the cosmeceutical sector totaled $538,000
in the first nine months of fiscal 2003. During the third quarter and first nine
months of fiscal 2002, shipments to the cosmeceutical sector totaled $423,000
and $1.4 million, respectively. A cosmeceutical is a product that makes no
therapeutic claims but is intended for topical use by humans.
International sales, mainly to Europe, were $567,000 and $1.4 million for the
third quarter and first nine months of fiscal 2003, respectively, compared to
$109,000 and $1.2 million for the third quarter and first nine months of fiscal
2002, respectively. International sales, like all Company revenues, are subject
to significant quarterly fluctuations.
During the third quarter of fiscal 2003, the Company received, among other
orders, two orders for PBB's totaling $4.4 million. The orders are in support of
a major pharmaceutical company which is preparing a drug for market launch and a
cosmeceutical company with an established marketed product. The Company
anticipates that shipments will extend into the fourth quarter of fiscal 2004.
As with any orders, these orders may be cancelled prior to shipment.
A substantial portion of revenues for any given quarter is typically comprised
of orders relating to a few projects, and the delay or loss of any key project
would have a significant negative impact on the Company's results of operations
for that quarter.
Management expects that operating results for fiscal 2003 will be relatively
flat in terms of revenue, compared to fiscal 2002, but with a reduced net loss
for fiscal 2003. Management believes that a more favorable sales mix and the
reduction of depreciation expense from the reassessment of useful lives of
certain machinery and equipment will be the primary contributing factors to the
expected reduction in net loss between fiscal 2003 and 2002.
Gross Profit
- ------------
The gross profit for the third quarter of fiscal 2003 was $2.0 million, or 50%
of revenues, compared to $857,000, or 27% of revenues, for the third quarter of
fiscal 2002. The gross profit for the first nine months of fiscal 2003 was $1.9
million, or 21% of revenues, compared to $192,000, or 2% of revenues, for the
first nine months of fiscal 2002. The improvement in gross profit in the third
quarter of fiscal 2003 was primarily the result of a more favorable product mix
and increased sales. The mix of products shipped in the third quarter of fiscal
2003 had an unusually high gross profit. In future periods, the Company does not
expect to achieve the level of profitability experienced in the third quarter at
this level of revenues.
13
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
As further discussed in Note B to the attached financial statements, at the
beginning of fiscal 2003, the Company reassessed the useful lives of certain of
its machinery and equipment. The extension in asset lives decreased depreciation
expense which increased gross profit for the third quarter and first nine months
of fiscal 2003 by approximately $359,000 and $1.1 million, respectively.
Gross profit for the third quarter and the first nine months of fiscal 2003
reflect inventory write-offs totaling $136,000 and $1.0 million, respectively.
This compares to inventory write-offs totaling $122,000 and $563,000,
respectively, in the corresponding periods of fiscal 2002. The Company routinely
develops manufacturing processes to produce new products or refine procedures
for existing products. It is not unusual for manufacturing costs associated with
new processes to exceed the selling price for the initial batches of product,
which results in an inventory write-off. A significant portion of the write-offs
for the first nine months of fiscal 2003 and 2002 related to material which
failed to meet customer specifications or was associated with the early stages
of development and production of products not previously manufactured by the
Company. Factors identified in the following paragraph also played a role in the
write-off of certain items.
The gross profit for the first nine months of fiscal 2003 contains a reserve for
impaired inventory of $677,000, of which $25,000 and $652,000 were recorded in
the first and second quarters of fiscal 2003, respectively. The international
fine chemicals industry, where the Company is a niche participant, has been
marked by overcapacity and a resulting downward pressure on pricing. In
addition, it has become increasingly difficult to rework certain raw materials
on a cost effective basis. Accordingly the value of the Company's inventory was
adversely impacted by these and other factors, including, among other things:
material related to customer projects which have been discontinued or are on
hold; and changes in customer preferences towards products that contain no
animal content.
Management evaluates the Company's inventory for impairment whenever indicators
of impairment exist. Factors contributing to inventory impairment include, but
are not limited to, decreases in selling price; changes in customer
specifications; a customer terminates a project or places a project on-hold;
material produced by the Company varies from customer specifications; and the
cost to produce material exceeds the current market price. Management will then
write-down the Company's inventories to reflect an estimate for impairment. The
amount of the write-down is equal to the difference between the cost of
inventory and the estimated market value based upon assumptions about future
demand and market conditions. If actual market conditions are less favorable
than those projected by management, additional inventory write-downs may be
required in the future. Any such write-downs would be reflected as a charge to
earnings in the relevant period.
Cost of revenues included an increase in property taxes and insurance costs of
$123,000, or 49%, during the first nine months of fiscal 2003 compared to the
same period of fiscal 2002. The increase is the result of the Company's plant
expansions, the expiration of a property tax exemption, and general increases in
the cost of insurance. Losses on the retirement of machinery and equipment
totaled $114,000 in the first nine months of fiscal 2003, which were included in
cost of revenues.
Cost of revenues includes raw materials consumed, all labor, facility and
similar expenses incurred by the Company's manufacturing department during the
period, including expenses not directly allocated to manufacturing the products
sold during the period, and adjustments to inventory.
14
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, (continued)
Operating Expense
- -----------------
Research and development (R&D) expense in the third quarter of fiscal 2003 was
$207,000, or 5% of revenues, compared to $166,000, also 5% of revenues, in the
third quarter of fiscal 2002. R&D expense in the first nine months of fiscal
2003 was $524,000, or 6% of revenues, compared to $464,000, also 6% of revenues,
for the same period of fiscal 2002. The hiring of additional chemists is
primarily responsible for the reported increase in R&D expense.
Selling, general and administrative (SG&A) expense in the third quarter of
fiscal 2003 was $444,000, or 11% of revenues, compared to $384,000, or 12% of
revenues, in the third quarter of fiscal 2002. SG&A expense in the first nine
months of fiscal 2003 was $1.5 million, or 17% of revenues, compared to $1.2
million, or 15% of revenues, for the same period of fiscal 2002. The increases
in SG&A expense for the third quarter and first nine months of fiscal 2003
primarily reflect general increases in labor and employee benefit costs. SG&A
expense for the first nine months of fiscal 2003 includes one-time costs
relating to the retirement of a Company officer, which was recorded in the first
quarter of fiscal 2003.
Operating Income (Loss)
- -----------------------
Operating income in the third quarter of fiscal 2003 and 2002 was $1.3 million
and $307,000, respectively. Operating loss in the first nine months of fiscal
2003 and 2002 was $116,000 and $1.5 million, respectively. The increase in
operating income for the third quarter of fiscal 2003 and decrease in operating
loss for the first nine months of fiscal 2003 was primarily the result of a more
favorable product mix, increased sales and the reduction of depreciation expense
from the reassessment of useful lives of certain machinery and equipment.
Other Income
- ------------
Other income in the third quarter and first nine months of fiscal 2003 was
$15,000 and $49,000, respectively, compared to other income in the third quarter
and first nine months of fiscal 2002 of $23,000 and $112,000, respectively.
Other income is primarily comprised of interest earned on cash equivalents.
Interest expense
- ----------------
Interest expense was $3,000 and $7,000, respectively, for the third quarter and
first nine months of fiscal 2003, and $3,000 and $9,000 for the third quarter
and first nine months of fiscal 2002, respectively.
Provision (Benefit) for Income Taxes
- ------------------------------------
For all periods presented, the Company recorded an income tax provision
(benefit) at the statutory combined federal and state rate of 38%.
Net Income (Loss)
- -----------------
Net income for the third quarter of fiscal 2003 was $838,000, or 21% of revenue,
compared to $203,000, or 6% of revenue, for the third quarter of fiscal 2002.
Net loss for the first nine months of fiscal 2003 was $46,000, or 1% of revenue,
compared to a net loss of $855,000, or 11% of revenue, for the same period of
fiscal 2002. The effect on net income (loss) for the third quarter and first
nine months of fiscal 2003 from the extension of the useful lives of certain of
the
15
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, (continued)
Company's machinery and equipment, as discussed in Note B to the attached
financial statements, was to increase net income by approximately $223,000, or
$0.02 per share, and reduce the net loss by approximately $682,000, or $0.05 per
share, respectively.
INDUSTRY FACTORS
Market Factors
- --------------
The Company manufactures PBBs for use in synthetically manufactured peptide,
peptidomimetic small molecule and other drugs. The market for PBBs is driven by
the market for the drugs in which they are incorporated. The drug development
process is dictated by the marketplace, drug companies and the regulatory
environment. The Company has no control over the pace of these drug development
efforts, which drugs get selected for clinical trials, which drugs are approved
by the FDA, or other applicable regulatory agencies, or, even if approved, the
ultimate market potential of the drugs. The Company also manufactures PBBs for
use in a cosmeceutical, and faces similar factors in that market.
The three stages of the drug development process include: R&D or discovery
stage, clinical trial stage and marketed drug stage. Synthetech's customers can
spend years researching and developing new drugs, taking only a small percentage
to clinical trials and fewer yet to commercial market. A substantial amount of
the activity continues to occur at the earlier stages of research and
development and clinical trials. The market for peptide and peptidomimetic small
molecule drugs is still developing.
Recurring sales of PBBs for development programs are sporadic. The high
cancellation rate for drug development programs results in a significant
likelihood that there will be no subsequent or "follow-on" PBB sales for any
particular drug development program. Accordingly, the level and timing of orders
by the Company's customers relating to specific drug development programs varies
substantially from period to period and the Company cannot rely on any one
customer as a constant source of revenue.
The size of PBB orders for marketed drugs can be substantially larger than those
for the discovery or clinical trial stages. Sales of PBBs for marketed drugs can
also provide an opportunity for continuing longer-term sales. While not subject
to the same high cancellation rate faced by discovery and clinical trial stage
drug development programs, the demand for the approved drugs, however, remains
subject to many uncertainties, including, without limitation, market acceptance,
the drug price, the drug side effects and the existence of other competing
drugs. These factors, which are outside of the control of the Company, affect
the level of demand for the drug itself and, therefore, the demand for PBBs.
Also, industry cost pressures can cause pharmaceutical companies to explore and
ultimately adopt alternative manufacturing processes which may not include the
Company's PBBs as an intermediate. The Company experiences intense competition
to supply PBBs, particularly with longer-term, larger-scale orders. Competition
may lead to the loss of customers and is creating downward price pressure for
some of the Company's products. In addition, the price per unit of Company
products for a given project generally decreases as volume demand for the
project increases. These factors may lead to reduced margins for certain
products.
Similar dynamics affect the cosmeceutical development process and market, except
that the regulatory oversight and, consequently, the typical length of a
product's "time to market" is reduced. Cosmeceutical products make no
therapeutic claims and, accordingly, the more extensive and time-consuming
clinical trials to establish efficacy are not required.
16
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
The foregoing industry factors create an inability for the Company to predict
future demand beyond its current order base. Until the Company develops a stable
base load of demand, the Company is likely to continue to experience significant
fluctuations in its periodic results.
Production factors
- ------------------
Synthetech has a full cycle "grams to tons" production capability and has made
over 400 products. Synthetech has developed extensive PBB process technology and
is recognized as one of the leaders in this area. Nevertheless, initial batches
of new products and scaling up production processes of existing products may
result in significantly lower than expected yields, extended processing time and
may require substantial rework to meet the required specification. These factors
could cause increased costs and delay shipments and, thus, affect periodic
operating results.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2002, the Company had working capital of $11.1 million, compared
to $11.3 million at March 31, 2002. The Company's cash and cash equivalents at
December 31, 2002 totaled $5.3 million, compared to $4.2 million at March 31,
2002. The Company has a $2 million bank line of credit, collateralized by
accounts receivable, of which there was no amount outstanding at December 31,
2002. The line of credit expires on August 31, 2003. Net cash provided by
operating activities was $2.2 million for the first nine months of fiscal 2003.
Purchases of property plant and equipment totaled $1.1 million and principal
payments on long-term debt totaled $15,000 for the first nine months of fiscal
2003. The Company believes that its existing cash and cash equivalents, its bank
line of credit and funds generated from operations will be sufficient to support
operations for the next twelve months and the foreseeable future.
The decrease in accounts receivable to $1.2 million at December 31, 2002 from
$2.2 million at March 31, 2002 primarily reflects differences in the timing and
amount of shipments between the periods. The decrease in inventory to $4.0
million at December 31, 2002, from $4.4 million at March 31, 2002, is primarily
the result of a $677,000 provision for impaired inventory.
The Company incurred $1.1 million of capital expenditures during the first nine
months of fiscal 2003, of which $285,000 was expended on an automated process
control system which became functional in July 2002. During July 2002, the
Company also purchased property adjacent to its present manufacturing facilities
in Albany, Oregon. The adjacent property includes office and warehouse space.
The initial purchase price and related closing costs were $347,000, and the
Company expended an additional $106,000 preparing the facility for occupancy.
During the fourth quarter of fiscal 2003, the Company plans to complete a
remodel of its Quality Control Department budgeted at $200,000 and plans to
complete an extension of its fire suppression system for $115,000. The Company's
capital budget for fiscal 2003 is $1.5 million. The Company expects to finance
all capital expenditures from internal cash flow and existing financial
resources and does not anticipate the need for any new debt or equity financing.
Item 3. Quantitative and Qualitative Disclosure about Market Risk
The Company's primary financial market risk exposure is the impact of interest
rate fluctuations on interest income earned on our cash deposits and cash
equivalents. The risks associated with market, liquidity and principal are
mitigated by investing in high-quality credit securities and limiting
concentrations of issuers and maturity dates. Derivative financial instruments
are not part of the Company's investments.
17
Item 3. Quantitative and Qualitative Disclosure about Market Risk
(continued)
Substantially all of the Company's purchases and sales are denominated in U.S.
dollars, and as a result, it has relatively little exposure to foreign currency
exchange risk with respect to any of its purchases and sales. The Company does
not currently hedge against foreign currency rate fluctuations. Management
believes the effect of an immediate 10 percent change in exchange rates would
not have a material impact on the Company's operating results or cash flows.
Item 4. Controls and Procedures
The Company maintains a system of disclosure controls and procedures designed to
provide reasonable assurance as to the reliability of the Company's published
financial statements and other disclosures included in the Company's reports
under the Securities Exchange Act of 1934. Within the 90-day period prior to the
date of this report, the Company evaluated the effectiveness of the design and
operation of its disclosure controls and procedures pursuant to Rule 13a-14 of
the Securities Exchange Act of 1934. Based upon that evaluation, the Company's
Chief Executive Officer and the Chief Financial Officer concluded that the
Company's disclosure controls and procedures are effective in timely alerting
them to material information relating to the Company and required to be included
in the Company's Exchange Act reports.
There have been no significant changes in the Company's internal controls or in
other factors which could significantly affect these internal controls,
including any corrective actions with regard to significant deficiencies and
material weaknesses, subsequent to the date that the Company completed its
evaluation.
- --------------------------------------------------------------------------------
This Report on Form 10-Q includes "forward-looking" information (as defined in
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934), including, without limitation, statements regarding:
future performance, growth and operating results of the Company, including
results for fiscal 2003; the timing of shipments and orders; the adequacy of
reserves against potential future impairment of inventory; the sufficiency of
existing and anticipated funds to support future operations; the Company's
anticipated capital expenditures and financing thereof; and the effect any
change in foreign currency exchange rates would have on the Company's operating
results. Investors are cautioned that forward-looking statements involve risks
and uncertainties, and various factors could cause actual results to differ
materially from those in the forward-looking statements. Forward-looking
statements include, without limitation, any statement that may predict,
forecast, indicate or imply future results, performance or achievements, and may
contain the words "believe," "anticipate," "expect," "estimate," "project,"
"will be," "will continue," "will likely result," or words or phrases of similar
meanings. The risks and uncertainties include, but are not limited to, the
following: the uncertain market for our products, potential loss of a
significant customer, customer concentration, potential termination or
suspension by customer of significant projects, potential period-to-period
revenue or expense fluctuations, production factors, industry cost factors,
competition, government regulation, labor disputes, technological change, and
international business risks. Investors are directed to the Company's filings
with the Securities and Exchange Commission, including the Company's Annual
Report on Form 10-K for the fiscal year ended March 31, 2002, for a further
description of risks and uncertainties related to forward-looking statements
made by the Company as well as to other aspects of the Company's business.
18
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
Exhibits.
Exhibit 3.1 Articles of Incorporation of the Company, as amended,
incorporated by reference to the exhibits filed with
the Company's Annual Report on Form 10-K for the
fiscal year ended March 31, 1991.
Exhibit 3.2 Bylaws of the Company, as amended, incorporated by
reference to the exhibits filed with the Company's
Quarterly Report on Form 10-Q for the fiscal quarter
ended September 30, 2001.
Exhibit 99.1 Chief Executive Officer Certification Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 99.2 Chief Financial Officer Certification Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K.
None
19
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.
SYNTHETECH, INC.
Date: February 3, 2003 /s/ M. Sreenivasan
------------------------
M. Sreenivasan
President & C.E.O.
Date: February 3, 2003 /s/ Gary A. Weber
------------------------
Gary A. Weber
Vice President Finance &
Chief Financial Officer
20
CERTIFICATION
President and Chief Executive Officer
I, M. Sreenivasan, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Synthetech, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: February 3, 2003 By: /s/ M. Sreenivasan
Title: President & C.E.O.
21
CERTIFICATION
Vice President Finance & Chief Financial Officer
I, Gary A. Weber, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Synthetech, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report; 4.
The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: February 3, 2003 By: /s/ Gary A. Weber
Title: Vice President
Finance & Chief Financial
Officer
22