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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 September 30, 2003
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
PO Box 646
Albany, Oregon 97321
(Address of Principal Executive Offices)
(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]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Class: Common Stock, $0.001 par value
Shares outstanding as of November 4, 2003: 14,364,279
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SYNTHETECH, INC
INDEX
Page
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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 13
Item 3. Quantitative and Qualitative Disclosure about Market
Risk 20
Item 4. Controls and Procedures 21
Part II. Other Information
Item 4. Submission of Matters to a Vote of
Security-Holders 23
Item 6. Exhibits and Reports on Form 8-K 23
Signatures 24
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
SYNTHETECH, INC.
Balance Sheets
(unaudited)
September 30, March 31,
2003 2003
------------ ------------
Assets
Current Assets:
Cash and cash equivalents $ 3,833,000 $ 5,965,000
Accounts receivable, less allowance
for doubtful accounts of $15,000 for
both periods 969,000 966,000
Inventories, net 4,336,000 4,032,000
Prepaid expenses 153,000 450,000
Deferred income taxes 403,000 403,000
------------ ------------
Total Current Assets 9,694,000 11,816,000
Property, Plant and Equipment, net 12,196,000 12,452,000
------------ ------------
Total Assets $ 21,890,000 $ 24,268,000
============ ============
The accompanying notes are an integral part of these condensed financial
statements.
3
SYNTHETECH, INC.
Balance Sheets
(continued)
(unaudited)
September 30, March 31,
2003 2003
------------ ------------
Liabilities and Shareholders' Equity
Current Liabilities:
Current portion of long term obligations $ 23,000 $ 22,000
Accounts payable 714,000 754,000
Accrued compensation 112,000 122,000
Income taxes payable 180,000 180,000
Other accrued liabilities 33,000 67,000
------------ ------------
Total Current Liabilities 1,062,000 1,145,000
Deferred income taxes 473,000 473,000
Long term obligations, net of current portion 63,000 75,000
Other long term liabilities 38,000 23,000
------------ ------------
Total Liabilities 1,636,000 1,716,000
------------ ------------
Shareholders' Equity:
Common stock, $.001 par value;
authorized 100,000,000 shares;
issued and outstanding,14,354,000
and 14,339,000 shares 14,000 14,000
Paid-in capital 8,991,000 8,991,000
Deferred compensation (35,000) (58,000)
Retained earnings 11,284,000 13,605,000
------------ ------------
Total Shareholders' Equity 20,254,000 22,552,000
------------ ------------
Total Liabilities and Shareholders' Equity $ 21,890,000 $ 24,268,000
============ ============
The accompanying notes are an integral part of these condensed financial
statements.
4
SYNTHETECH, INC.
Statements of Operations
(unaudited)
For the Three Months Ended For the Six Months Ended
September 30, September 30,
---------------------------- ----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Revenue $ 1,843,000 $ 2,025,000 $ 3,616,000 $ 4,876,000
Cost of revenue 2,496,000 3,100,000 4,697,000 4,994,000
------------ ------------ ------------ ------------
Gross loss (653,000) (1,075,000) (1,081,000) (118,000)
Research and development 176,000 161,000 372,000 317,000
Selling, general and administrative 403,000 443,000 884,000 1,020,000
------------ ------------ ------------ ------------
Total operating expense 579,000 604,000 1,256,000 1,337,000
------------ ------------ ------------ ------------
Operating loss (1,232,000) (1,679,000) (2,337,000) (1,455,000)
Interest income 8,000 18,000 20,000 34,000
Interest expense (2,000) (2,000) (4,000) (4,000)
------------ ------------ ------------ ------------
Loss before income taxes (1,226,000) (1,663,000) (2,321,000) (1,425,000)
Benefit for income taxes - (632,000) - (541,000)
------------ ------------ ------------ ------------
Net loss $ (1,226,000) $ (1,031,000) $ (2,321,000) $ (884,000)
============ ============ ============ ============
Net loss per common share:
Basic and diluted loss per share $ (0.09) $ (0.07) $ (0.16) $ (0.06)
============ ============ ============ ============
Weighted average shares outstanding:
Basic and Diluted 14,345,000 14,314,000 14,342,000 14,309,000
============ ============ ============ ============
The accompanying notes are an integral part of these condensed financial
statements.
5
SYNTHETECH, INC.
Statements of Cash Flows
(unaudited)
For The Six Month Period Ended September 30, 2003 2002
- -------------------------------------------- ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (2,321,000) $ (884,000)
Adjustments to reconcile net loss to
net cash provided by (used in) operating
activities:
Depreciation and amortization expense 536,000 511,000
Loss on retirement of equipment 5,000 111,000
Amortization of deferred compensation 8,000 12,000
(Increase) decrease in assets:
Accounts receivable, net (3,000) 481,000
Inventories, net (304,000) 520,000
Income tax receivable - (541,000)
Prepaid expenses 297,000 155,000
Increase (decrease) in liabilities:
Accounts payable (40,000) (121,000)
Accrued compensation (10,000) (28,000)
Other accrued liabilities (34,000) 76,000
Other long term liabilities 15,000 -
Deferred revenue - 400,000
------------ ------------
Net cash provided by (used in)
operating activities (1,851,000) 692,000
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property, plant and equipment purchases (285,000) (865,000)
------------ ------------
Net cash used in investing activities (285,000) (865,000)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments under long-term debt
obligations (11,000) (9,000)
Proceeds from stock purchases 15,000 19,000
------------ -------------
Net cash provided by (used in)
financing activities 4,000 10,000
------------ -------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (2,132,000) (163,000)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 5,965,000 4,214,000
------------ -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 3,833,000 $ 4,051,000
============ ============
NON-CASH FINANCING ACTIVITIES:
Forfeiture of stock options issued
below fair value $ 21,000 -
Deferred compensation on stock options granted
below fair value $ 6,000 $ 23,000
The accompanying notes are an integral part of these condensed financial
statements.
6
SYNTHETECH, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
(Information as of September 30, 2003 and for the three and six-month
periods ended September 30, 2003 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 or 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 accounting principles generally
accepted in the United States 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, 2003.
The interim period information included in this Report 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. NEW ACCOUNTING PRONOUNCEMENTS
Accounting For Certain Financial Instruments with Characteristics of Both
- -------------------------------------------------------------------------
Liabilities and Equity:
- -----------------------
In May 2003, the FASB approved SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity." SFAS No. 150
establishes standards for how to classify and measure financial instruments with
characteristics of both liabilities and equity. It requires financial
instruments that fall within its scope to be classified as liabilities. SFAS No.
150 is effective for financial instruments entered into or modified after May
31, 2003 and, for pre-existing financial instruments, as of July 1, 2003. The
Company does not have any financial instruments that fall under the guidance of
SFAS No. 150 and, therefore, the adoption did not have any effect on the
Company's financial position or results of operations.
7
NOTES TO FINANCIAL STATEMENTS (continued)
Accounting For Derivative Instruments and Hedging Activities:
- -------------------------------------------------------------
In May 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 addresses certain
accounting issues related to hedging activity and derivative instruments
embedded in other contracts. In general, the amendments require contracts with
comparable characteristics to be accounted for similarly. In addition, SFAS No.
149 provides guidance as to when a financing component of a derivative must be
given special reporting treatment in the statement of cash flows. SFAS No. 149
is effective for contracts entered into or modified after June 30, 2003. The
Company does not utilize derivative or hedging instruments and, therefore, the
adoption of SFAS No. 149 did not have any effect on the Company's financial
position, results of operations or cash flows.
Variable Interest Entities:
- ---------------------------
In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),
"Consolidation of Variable Interest Entities, An Interpretation of ARB No. 51."
FIN 46 provides guidance on: 1) the identification of entities for which control
is achieved through means other than through voting rights, known as "variable
interest entities" (VIEs); and 2) which business enterprise is the primary
beneficiary and when it should consolidate the VIE. This new model for
consolidation applies to entities: 1) whose equity investors, if any, do not
have a controlling financial interest; or 2) whose equity investment at risk is
insufficient to finance that entity's activities without receiving additional
subordinated financial support from other parties. In addition, FIN 46 requires
that both the primary beneficiary and all other enterprises with a significant
variable interest in a VIE make additional disclosures. FIN 46 is effective for
all new VIEs created or acquired after January 31, 2003. For VIEs created or
acquired prior to February 1, 2003, FIN 46 must be applied for the first interim
or annual period beginning after June 15, 2003. Certain disclosures are
effective immediately. The Company does not have any VIEs and therefore, the
adoption of FIN 46 does not have any effect on the Company's financial position
or results of operations.
NOTE C. STOCK-BASED COMPENSATION
In December 2002, the FASB issued SFAS No. 148 "Accounting for Stock-Based
Compensation-Transition and Disclosure." SFAS No. 148 amends SFAS No. 123,
"Accounting for Stock-Based Compensation," and was effective immediately upon
issuance. SFAS No. 148 provides alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation as well as amending the disclosure requirements of
Statement No. 123 to require interim and annual disclosure about the method of
accounting for stock-based compensation and the effect of the method used on
reported results.
As permitted by SFAS No. 123, as amended by SFAS No. 148, the Company elected to
continue to apply the provisions of APB Opinion No. 25, "Accounting for Stock
Issued to Employees," and related interpretations in accounting for its employee
stock option plan and employee stock purchase
8
NOTES TO FINANCIAL STATEMENTS (continued)
plan (ESPP). The Company is generally not required under APB Opinion No. 25 and
related interpretations to recognize compensation expense in connection with its
employee stock option and stock purchase plans. The Company is required by SFAS
No. 123 to present, in the Notes to Financial Statements, the pro forma effects
on reported net income and earnings per share as if compensation expense had
been recognized based on the fair value method of accounting prescribed by SFAS
No. 123.
If compensation expense had been determined based on the grant date fair value
as computed under the Black-Scholes option pricing model for awards outstanding
in the second quarter and first six months of fiscal 2004 and 2003 in accordance
with the provisions of SFAS No. 123, the Company's net loss and net loss per
share would have changed to the pro forma amounts indicated below:
Three Months Ended Six Months Ended
September 30, September 30,
---------------------------- ----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Net loss, as reported $ (1,226,000) $ (1,031,000) $ (2,321,000) $ (884,000)
Add: Stock-based employee
compensation expense included in
reported net loss, net of related
tax effects 4,000 4,000 8,000 7,000
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of related tax
effects (43,000) (33,000) (75,000) (66,000)
------------ ------------ ------------ ------------
Pro forma net loss $ (1,265,000) $ (1,060,000) $ (2,388,000) $ (943,000)
============ ============ ============ ============
Net loss per share:
Basic and Diluted - as reported $ (0.09) $ (0.07) $ (0.16) $ (0.06)
============ ============ ============ ============
Basic and Diluted - pro forma $ (0.09) $ (0.07) $ (0.17) $ (0.07)
============ ============ ============ ============
9
NOTES TO FINANCIAL STATEMENTS (continued)
Using the Black-Scholes methodology, the total value of options granted during
the first six months of fiscal 2004 and 2003 was $130,000 and $326,000,
respectively, which would be amortized to expense on a pro forma basis over the
vesting period of the options.
In calculating pro forma compensation, the fair value of each stock option grant
and stock purchase right is estimated on the date of grant using the
Black-Scholes option pricing model and the following weighted average
assumptions:
Three Months Ended Six Months Ended
September 30, September 30,
---------------------------- ----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Stock Options:
Dividend yield None None None None
Expected volatility 50% 52% 50% 52%
Risk-free interest rate 3.50% 3.68% 3.50% 3.63%
Expected life (in years) 7.00 7.00 7.00 6.88
ESPP:
Dividend yield None None None None
Expected volatility 36% 36% 36% 36%
Risk-free interest rate 0.90% 1.25% 0.90% 1.25%
Expected life (in years) 0.50 0.50 0.50 0.50
Weighted-Average fair value of
Options granted:
At market value $ 0.44 None $ 0.70 $ 1.15
Below market value $ 0.68 $ 0.90 $ 0.68 $ 1.39
All options granted $ 0.54 $ 0.90 $ 0.69 $ 1.16
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 loss was equal to net loss
for all periods presented.
10
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE E. EARNINGS PER SHARE
Basic earnings per share (EPS) are computed by dividing net income 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. For all periods presented, the Company reported a net
loss, therefore all common stock equivalents are considered antidilutive.
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 Six Months
Ended September 30, Ended September 30,
---------------------------- ----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Common stock options outstanding 1,181,000 1,102,000 1,181,000 1,102,000
============ ============ ============ ============
NOTE F. STATEMENTS OF CASH FLOWS
Supplemental cash flow disclosures:
For the Three Months For the Six Months
Cash Paid Ended September 30, Ended September 30,
------------ -------------------------- --------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Interest $ 2,000 $ 2,000 $ 4,000 $ 4,000
NOTE G. INVENTORIES
The major components of inventories, net of reserves, are as follows:
September 30, March 31,
2003 2003
------------ ------------
Finished products $ 2,205,000 $ 1,815,000
Work in process 1,052,000 968,000
Raw materials 1,079,000 1,249,000
------------ ------------
$ 4,336,000 $ 4,032,000
============ ============
11
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE H. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
September 30, March 31,
2003 2003
------------ ------------
Land $ 241,000 $ 241,000
Buildings 6,793,000 6,793,000
Machinery and equipment 15,352,000 15,135,000
Laboratory equipment 998,000 938,000
Furniture and fixtures 428,000 423,000
Vehicles 149,000 149,000
Construction in Progress 88,000 132,000
------------ -------------
24,049,000 23,811,000
Less:
Accumulated depreciation 11,853,000 11,359,000
------------ -------------
$ 12,196,000 $ 12,452,000
============ =============
NOTE I. SHARE REPURCHASE PROGRAM
On March 20, 2003 the Board of Directors approved a share repurchase
program and authorized the purchase of up to 500,000 shares of the
Company's common stock in the open market over the succeeding year. No
shares were repurchased during the first six months of fiscal 2004.
NOTE J. LINE OF CREDIT
The Company's $2 million line of credit expired on August 31, 2003 and
was not renewed by the bank.
12
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 Six Months
Ended September 30, Ended September 30,
---------------------------- ----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Revenue 100.0% 100.0% 100.0% 100.0%
Cost of revenue 135.4 153.1 129.9 102.4
------------ ------------ ------------ ------------
Gross loss (35.4) (53.1) (29.9) (2.4)
Research and development 9.5 8.0 10.3 6.5
Selling, general and administrative 21.9 21.8 24.4 20.9
------------ ------------ ------------ ------------
Operating expense 31.4 29.8 34.7 27.4
Operating loss (66.8) (82.9) (64.6) (29.8)
Interest income 0.4 0.9 0.6 0.7
Interest expense (0.1) (0.1) (0.1) (0.1)
------------ ------------ ------------ ------------
Loss before income taxes (66.5) (82.1) (64.1) (29.2)
Benefit for income taxes - (31.2) - (11.1)
------------ ------------ ------------ ------------
Net loss (66.5)% (50.9)% (64.1)% (18.1)%
============ ============ ============ ============
- ---------------------------------------------------------------------------------------------------------------
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS, (CONTINUED)
Revenue
- -------
Revenue of $1.8 million in the second quarter of fiscal 2004 decreased by
$182,000, or 9.0%, from revenue of $2.0 million in the second quarter of fiscal
2003. Revenue of $3.6 million in the first half of fiscal 2004 decreased by $1.3
million, or 25.8%, from revenue of $4.9 million in the first half of fiscal
2003. Changes in revenue for the specified periods primarily relate to revenue
arising from large-scale customer projects.
Revenue from large-scale customer projects was $1.1 million and $2.1 million in
the second quarter and first half of fiscal 2004, respectively, compared to $1.2
million and $3.6 million in the same periods of fiscal 2003. Large-scale project
revenue during the second quarter and first half of fiscal 2004 arose from two
ongoing customer projects that also contributed to large-scale project revenue
in the second quarter and first half of fiscal 2003. One of those projects
involved manufacturing PBBs to support a marketed drug. The other included PBB
shipments to support an established product in the cosmeceutical sector. A
cosmeceutical is a product that makes no therapeutic claims but is intended for
topical use by humans.
A third project also contributed to large-scale project revenue in the first
half of fiscal 2003. During the fourth quarter of fiscal 2003 the Company
experienced a substantial price decline on this project which was the largest
customer project in the first half of fiscal 2003. Fiscal 2004 customer
requirements, if any, for this product are dependent on future outcomes of
clinical trials and timing of the customer's drug development efforts.
In addition to large-scale projects, a significant number of other customer
projects contributed to revenue during the first half of fiscal 2004 and 2003.
While individually smaller in dollar value, these projects support a wide
variety of programs for our major pharmaceutical, emerging biopharmaceutical and
contract drug synthesis customers.
International sales, mainly to Europe, were $585,000 and $971,000 for the second
quarter and first half of fiscal 2004, respectively, compared to $403,000 and
$813,000 for the second quarter and first half of fiscal 2003, respectively.
International sales, like all Company revenues, are subject to significant
quarterly fluctuations.
The Company has expanded its marketing efforts with the objective of achieving a
greater level of penetration in the major pharmaceutical sector and an increased
presence with emerging biopharmaceuticals and contract drug synthesis customers.
Management anticipates that revenues from three large-scale projects will
approximate $4.7 million in the second half of fiscal 2004, which is in addition
to revenue from other projects. Two of the large-scale projects are in support
of marketed products and the third project supports a drug moving forward in
clinical trials. In addition, the Company's backlog for the first three quarters
of fiscal 2005 includes order commitments of approximately $4.8 million for PBBs
to support the two marketed products.
To the extent successful customer projects develop into larger volumes, either
during late stage clinical trials, pre-launch or as a marketed product, the
Company's per unit pricing may decline. There is a risk that the impact on
future sales and profitability from declines in pricing may not be offset by an
increase in volume.
The level of Synthetech's business from period to period is largely
unpredictable. Although PBB sales associated with marketed products are more
likely to provide a longer term, on-going revenue stream than sales associated
with drugs at the clinical or discovery stages, continuation of customer demand
for PBBs associated with marketed products remains subject to various market
conditions, including potential use of alternative manufacturing methods,
continued market demand for drugs that include
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS, (CONTINUED)
PBBs or the cosmeceutical, and competition from other suppliers of PBBs.
Accordingly, while significant orders related to marketed products provide
substantial and more predictable revenues, the Company expects revenues to
continue to fluctuate from period to period.
Gross Loss
- ----------
The gross loss for the second quarter of fiscal 2004 was $653,000, or 35% of
revenue, compared to a gross loss of $1.1 million, or 53% of revenue, for the
second quarter of fiscal 2003. The gross loss for the first half of fiscal 2004
was $1.1 million, or 30% of revenue, compared to a gross loss of $118,000, or 2%
of revenue, for the first half of fiscal 2003.
The lack of sales volume experienced in the second quarter and first six months
of fiscal 2004 coupled with unabsorbed manufacturing costs had an unfavorable
effect on the Company's gross loss. In response to difficult business
conditions, the Company reduced its workforce by seven employees, or
approximately 10%, during the second quarter of fiscal 2004 and has implemented
other cost reduction measures. Management estimates that total cost reductions
will result in annualized savings of approximately $700,000.
The gross loss for the second quarter and first half of fiscal 2004 reflect
charges for impaired inventory of $389,000 and $583,000, respectively. This
compares to charges for impaired inventory of $1.2 million and $1.6 million in
the second quarter and first half of fiscal 2003, respectively. The Company
routinely develops manufacturing processes to produce new products or to 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. The international
fine chemicals industry, where the Company is a niche participant, has been
marked by overcapacity and resulting downward pressure on pricing. It has become
increasingly difficult to rework certain materials on a cost effective basis. A
significant portion of the charges for impaired inventory for the second quarter
and the first half of fiscal 2003 and 2004 related to material that failed to
meet customer specifications or was associated with the early stages of
development and production of products not previously manufactured by the
Company. In addition, the Company's charges for impaired inventory in both
fiscal 2004 and 2003 include material related to customer projects that have
been discontinued or are on hold.
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; project terminations or holds; variations in material produced
by the Company from customer specifications; and production costs materially in
excess of current market price. Management writes down the Company's inventories
to reflect an estimate for impairment in an amount 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. Write-downs would be
reflected as a charge to earnings in the relevant period.
Cost of revenue 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.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS, (CONTINUED)
Operating Expenses
- ------------------
Research and development (R&D) expense in the second quarter of fiscal 2004 was
$176,000, or 10% of revenue, compared to $161,000, or 8% of revenue, in the
second quarter of fiscal 2003. R&D expense in the first half of fiscal 2004 was
$372,000, or 10% of revenue, compared to $317,000, or 7% of revenue, for the
comparable period of fiscal 2003. The increase in R&D expense for the second
quarter of fiscal 2004, compared to the same period in fiscal 2003 is primarily
due to an increase in lab supplies. The increase in R&D expense for the first
half of fiscal 2004 reflects approximately $30,000 in employee relocation costs
in addition to increases in labor, employee benefits, and general operating
expenses. In September 2003, the Company implemented a 5% salary reduction which
impacted all of the Company's R&D employees.
Selling, general and administrative (SG&A) expense in the second quarter of
fiscal 2004 was $403,000, or 22% of revenue, compared to $443,000, or 22% of
revenue, in the second quarter of fiscal 2003. SG&A expense in the first half of
fiscal 2004 was $884,000, or 24% of revenues, compared to $1.0 million, or 21%
of revenues, for the comparable period of fiscal 2003. The decrease in SG&A
expense in the second quarter of fiscal 2004, compared to the same period in
fiscal 2003 was due to a temporary vacancy in a senior commercial position and
to a lesser extent a 5% cut in administrative salaries which was implemented in
September 2003. The decrease in SG&A expense for the first half of fiscal 2004
includes the temporary vacancy and administrative salary cuts, but is primarily
due to one-time costs relating to the retirement of a Company officer, which
were recorded in the first quarter of fiscal 2003.
Operating Loss
- --------------
Operating loss in the second quarter and first half of fiscal 2004 was $1.2
million and $2.3 million, respectively, compared with operating loss in the
second quarter and first half of fiscal 2003 of $1.7 million and $1.5 million,
respectively.
Interest Income
- ---------------
Interest income in the second quarter and first half of fiscal 2004 was $8,000
and $20,000, respectively, compared to $18,000 and $34,000 in the comparable
periods of fiscal 2003. The Company's interest income is primarily derived from
earnings on the Company's cash equivalents. The changes in interest income for
the periods presented were due to the amount of cash equivalents and the
interest rates in effect during the periods. Average rates of interest earned on
the Company's cash and cash equivalents during the first half of fiscal 2004
were 0.88%, compared to 1.55% during the first half of fiscal 2003.
Interest expense
- ----------------
Interest expense was $2,000 and $4,000, respectively, for the second quarter and
first half of both fiscal 2004 and 2003.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS, (CONTINUED)
Benefit for Income Taxes
- ------------------------
Based on the Company's recent history of losses, its near-term outlook and
management's evaluation of available tax planning strategies, the Company has
concluded that it may be unable to recognize a deferred tax benefit related to
losses incurred during the first half of fiscal 2004, continuing for an
uncertain period of time. For the second quarter and first half of fiscal 2003,
the Company recorded a benefit for income taxes at the statutory combined
federal and state rate of 38%.
Net Loss
- --------
Net loss for the second quarter of fiscal 2004 was $1.2 million, or 67% of
revenue, compared to a net loss of $1.0 million, or 51% of revenue, for the
second quarter of fiscal 2003. Net loss for the first half of fiscal 2004 was
$2.3 million, or 64% of revenue, compared to a net loss of $884,000, or 18% of
revenue, for the comparable period of fiscal 2003.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
- ------------------------------------------
The discussion and analysis of Synthetech's financial condition and results of
operations are based upon its financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires Synthetech to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses and related disclosure of contingent assets and
liabilities. On an on-going basis, Synthetech evaluates its estimates, including
those related to inventory realizability, allowance for doubtful accounts and
revenue recognition. Synthetech bases its estimates on historical experience and
on various other assumptions. Actual results may differ from these estimates
under different assumptions or conditions. Synthetech believes the following
critical accounting policies and the related judgments and estimates affect the
preparation of its financial statements.
Inventories
Inventories are valued at the lower of cost or market, determined on the
first-in first-out (FIFO) basis. Costs include direct material, direct labor,
applicable manufacturing overhead, and other direct costs.
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; project terminations or holds; variations in material produced
by the Company from customer specifications; production costs materially in
excess of current market price. Management writes down the Company's inventories
to reflect an estimate for impairment in an amount 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. Write-downs would be
reflected as a charge to earnings in the relevant period.
17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS, (CONTINUED)
Long-Lived Asset Impairment
Management regularly evaluates long-lived assets for impairment in accordance
with Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets," which requires a review of
long-lived assets for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset might not be recoverable,
utilizing an undiscounted cash flow analysis. Based on this analysis, the
Company did not recognize an impairment on long-lived assets during the current
period. If circumstances related to long-lived assets change, the Company may
record an impairment charge in the future.
In addition, the useful lives of long-lived assets are an estimate and may
change based on the Company's experience with the actual lives. If circumstances
related to the Company's estimate of useful lives changes, depreciation expense
could materially change.
Revenue Recognition
The Company recognizes revenues including shipping and handling charges billed
to customers, upon shipment of product when title and risk of loss pass to
customers. Shipping and handling costs are classified as part of cost of
revenues.
Allowance for Doubtful Accounts
Credit limits for customers are established through a process of reviewing the
financial history and stability of each customer. The Company regularly
evaluates the collectability of its trade receivable balances by monitoring past
due balances. If the Company determines that a customer will be unable to meet
its financial obligation, the Company will record a specific reserve for bad
debt to reduce the related receivable to the amount the Company expects to
recover. Bad debts have not historically been significant. If circumstances
related to specific customers change, the Company's estimates of the
recoverability of receivables could materially change.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS, (CONTINUED)
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, 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, and take only a small
percentage to clinical trials and fewer yet to commercial market. A substantial
amount of 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. Because of the
high cancellation rate for drug development programs, there is 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
customer orders relating to specific drug development programs vary
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 remains subject to
many uncertainties, including 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 that may not include the Company's PBBs as an
intermediate. The international fine chemicals industry, where the Company is a
niche participant, has been marked by overcapacity and a resulting downward
pressure on pricing. Finally, with longer-term, significant or large-scale
orders, the Company expects increased competition to supply these PBBs.
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" are reduced.
Due to the foregoing industry factors the Company cannot predict future demand
beyond its current order base. Until there is stable demand for its products,
the Company is likely to continue to experience significant fluctuations in its
periodic results.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS, (CONTINUED)
Production Factors
- ------------------
Synthetech has a full cycle "grams to tons" production capability and has made
over 400 products. With over 15 years of experience, 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 for existing products may result in significantly lower than expected
yields and extended processing time, and may require substantial rework to meet
the required specification. These factors could cause increased costs and
delayed shipments, either of which could negatively affect periodic operating
results.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2003, the Company had working capital of $8.6 million. The
Company's cash and cash equivalents at September 30, 2003 totaled $3.8 million.
Net cash used in operating activities was $1.9 million for the first half of
fiscal 2004. Purchases of property, plant and equipment totaled $285,000 and
principal payments on long-term debt totaled $11,000 for the first half of
fiscal 2004. The Company's bank declined to renew its line of credit which
expired on August 31, 2003. The Company is interviewing other financial
institutions and believes that a new credit facility will be in place during the
third quarter of fiscal 2004. The Company believes that its existing cash and
cash equivalents, and funds generated from future operations will be sufficient
to support operations for the foreseeable future.
Accounts receivable at September 30, 2003, totaled $969,000. Inventory totaled
$4.3 million at September 30, 2003. The Company has increased its inventory
primarily due to the need to increase finished products to support future
shipments.
On March 20, 2003, the Company's Board of Directors approved a share repurchase
program and authorized the purchase of up to 500,000 shares of the Company's
common stock in the open market over the succeeding year. As of September 30,
2003, the Company has not repurchased any of its shares.
The Company's capital budget for fiscal 2004 is $600,000. The Company expects to
finance all capital expenditures from internal cash flow and existing financial
resources and does not anticipate the need for new debt or equity financing for
these purposes.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company's primary market risk exposure is the impact of interest rate
fluctuations on interest income earned on the Company's cash deposits and cash
equivalents. The risks associated with market, liquidity and principal are
mitigated by investing in high-credit quality securities and limiting
concentrations of issuers and maturity dates. Derivative financial instruments
are not part of the Company's investments.
20
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. Should the Company
enter into a significant transaction denominated in a foreign currency the
Company may enter into a forward exchange contract at that time. The Company is
not a party to any forward exchange contracts as of September 30, 2003. With
regards to existing Company transactions denominated in a foreign currency, the
effect of an immediate 10% change in relevant 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. An evaluation was performed under the
supervision and with the participation of management, including the Company's
Chief Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of its disclosure controls and procedures as of September
30, 2003. Based upon that evaluation, the Company's Chief Executive Officer and
the Chief Financial Officer concluded that the Company's disclosure controls and
procedures were effective to ensure that material information required to be
included in the Company's Exchange Act reports would be made known to management
by others within the Company.
There has been no significant change in the Company's internal control over
financial reporting during the fiscal quarter ended September 30, 2003 that has
materially affected or is reasonably likely to materially affect the Company's
internal control over financial reporting.
The Company's Chief Executive Officer and Chief Financial Officer do not expect
that the Company's disclosure controls and internal controls will prevent all
error and all fraud. A control system, no matter how well conceived and
operated, can provide only reasonable, not absolute, assurance that the
objectives of the system are met. Further, the design of a control system must
reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs. Because of the inherent
limitations in all control systems, no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any,
within the company have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty, and that breakdowns
can occur because of simple mistake or error. Additionally, controls can be
circumvented by the individual acts of some persons, by collusion of two or more
people, or by management override of the control. The design of any system of
controls also is based partly on certain assumptions about the likelihood of
future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions.
21
Forward-Looking Statements
- --------------------------
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
projected large-scale project revenue for the second half of fiscal 2004 and
order commitments for the first three quarters of fiscal 2005; results of the
Company's cost reduction measures; the adequacy of reserves against potential
future impairment of inventory; the sufficiency of existing and anticipated
funds to support future operations; the Company's ability to enter into a new
credit facility during the third quarter of fiscal 2004; 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 customers of large-scale projects or cancellation of orders prior
to shipment, potential period to period revenue fluctuations, production
factors, industry cost factors, competition, unwillingness by financial
institutions to provide a credit facility to the Company on acceptable terms,
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, 2003, 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. The Company
expressly disclaims any obligation or undertaking to release publicly any
updates or revisions to any forward-looking statements contained in this Report
to reflect any change in the Company's expectations with respect to them or any
change in events, conditions or circumstances on which any such statement is
based.
22
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
The Company held its Annual Meeting of Shareholders on July 17, 2003.
At the Meeting, the shareholders elected the following Class III Directors for a
term expiring at the Company's 2006 Annual Meeting of Shareholders:
Votes For Votes Withheld
--------- --------------
Howard L. Farkas 13,338,889 252,831
M. "Sreeni" Sreenivasan 13,287,537 304,183
The terms of the following directors continued after the Meeting:
Class II Directors (term expiring in 2005)
David R. Clarke
Charles B. Williams
Class I Directors (term expiring in 2004)
Paul C. Ahrens
Daniel T. Fagan
Page E. Golsan, III
Edward M. Giles resigned as a Company Director in July 2003.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) 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 31.1 Rule 13a-14(a) Certification of Chief Executive
Officer
Exhibit 31.2 Rule 13a-14(a) Certification of Chief Financial
Officer
Exhibit 32.1 Section 1350 Certification of Chief Executive
Officer
Exhibit 32.2 Section 1350 Certification of Chief Financial
Officer
(b) Reports on Form 8-K.
On July 31, 2003, Synthetech, Inc. furnished a report on Form 8-K under
Item 12 announcing its first quarter fiscal 2004 financial results.
23
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.
(Registrant)
Date: November 5, 2003 /s/ M. Sreenivasan
-------------------------------
M. Sreenivasan
President & C.E.O.
Date: November 5, 2003 /s/ Gary A. Weber
-------------------------------
Gary A. Weber
Vice President Finance &
Chief Financial Officer
24