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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, 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 JANUARY 31, 2004: 14,367,279
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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 14
Item 3. Quantitative and Qualitative Disclosure about Market
Risk 22
Item 4. Controls and Procedures 22
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 24
Signatures 25
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SYNTHETECH, INC.
BALANCE SHEETS
(unaudited)
DECEMBER 31, MARCH 31,
2003 2003
------------ ------------
ASSETS
Current Assets:
Cash and cash equivalents $ 3,866,000 $ 5,965,000
Accounts receivable, less allowance
for doubtful accounts of $15,000
for both periods 745,000 966,000
Inventories, net 4,322,000 4,032,000
Prepaid expenses 622,000 450,000
Deferred income taxes 403,000 403,000
------------ ------------
Total Current Assets 9,958,000 11,816,000
Property, Plant and Equipment, net 11,993,000 12,452,000
------------ ------------
Total Assets $ 21,951,000 $ 24,268,000
============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
OF THESE CONDENSED FINANCIAL STATEMENTS.
3
SYNTHETECH, INC.
BALANCE SHEETS
(continued)
(unaudited)
DECEMBER 31, MARCH 31,
2003 2003
------------ ------------
Liabilities and Shareholders' Equity
Current Liabilities:
Current portion of long term obligations $ 23,000 $ 22,000
Accounts payable 1,110,000 754,000
Accrued compensation 127,000 122,000
Income taxes payable 180,000 180,000
Other accrued liabilities 25,000 67,000
------------ ------------
Total Current Liabilities 1,465,000 1,145,000
Deferred income taxes 473,000 473,000
Long term obligations, net of current portion 58,000 75,000
Other long term liabilities 45,000 23,000
------------ ------------
Total Liabilities 2,041,000 1,716,000
------------ ------------
Shareholders' Equity:
Common stock, $.001 par value; authorized
100,000,000 shares; issued and outstanding,
14,367,000 and 14,339,000 shares 14,000 14,000
Paid-in capital 8,993,000 8,991,000
Deferred compensation (31,000) (58,000)
Retained earnings 10,934,000 13,605,000
------------ ------------
Total Shareholders' Equity 19,910,000 22,552,000
------------ ------------
Total Liabilities and Shareholders' Equity $ 21,951,000 $ 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 NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------------------ ------------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Revenue $ 2,914,000 $ 3,991,000 $ 6,530,000 $ 8,867,000
Cost of revenue 2,612,000 2,001,000 7,309,000 6,995,000
------------ ------------ ------------ ------------
Gross income (loss) 302,000 1,990,000 (779,000) 1,872,000
Research and development 167,000 207,000 539,000 524,000
Selling, general and administrative 489,000 444,000 1,373,000 1,464,000
------------ ------------ ------------ ------------
Total operating expense 656,000 651,000 1,912,000 1,988,000
------------ ------------ ------------ ------------
Operating income (loss) (354,000) 1,339,000 (2,691,000) (116,000)
Interest income 6,000 15,000 26,000 49,000
Interest expense (2,000) (3,000) (6,000) (7,000)
------------ ------------ ------------ ------------
Income (loss) before income taxes (350,000) 1,351,000 (2,671,000) (74,000)
Provision (benefit) for income taxes -- 513,000 -- (28,000)
------------ ------------ ------------ ------------
Net income (loss) $ (350,000) $ 838,000 $ (2,671,000) $ (46,000)
============ ============ ============ ============
Net income (loss) per common share:
Basic and diluted income (loss) per share $ (0.02) $ 0.06 $ (0.19) $ (0.00)
============ ============ ============ ============
Weighted average shares outstanding:
Basic 14,364,000 14,322,000 14,345,000 14,315,000
============ ============ ============ ============
Diluted 14,364,000 14,350,000 14,345,000 14,315,000
============ ============ ============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
OF THESE CONDENSED FINANCIAL STATEMENTS.
5
SYNTHETECH, INC.
STATEMENTS OF CASH FLOWS
(unaudited)
For The Nine Month Period Ended December 31, 2003 2002
- -------------------------------------------- ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (2,671,000) $ (46,000)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization expense 806,000 776,000
Loss on retirement of equipment 9,000 114,000
Amortization of deferred compensation 12,000 19,000
(Increase) decrease in assets:
Accounts receivable, net 221,000 1,006,000
Inventories, net (290,000) 368,000
Income tax receivable -- (31,000)
Prepaid expenses (172,000) (183,000)
Increase (decrease) in liabilities:
Accounts payable 356,000 73,000
Accrued compensation 5,000 25,000
Other accrued liabilities (42,000) 40,000
Other long term liabilities 22,000 15,000
Deferred revenue -- 21,000
------------ ------------
Net cash provided by (used in) operating activities (1,744,000) 2,197,000
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property, plant and equipment purchases (356,000) (1,090,000)
------------ ------------
Net cash used in investing activities (356,000) (1,090,000)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments under long-term debt obligations (16,000) (15,000)
Proceeds from stock purchases 17,000 19,000
------------ ------------
Net cash provided by financing activities 1,000 4,000
------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (2,099,000) 1,111,000
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 5,965,000 4,214,000
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 3,866,000 $ 5,325,000
============ ============
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 December 31, 2003 and for the
three and nine-month periods ended
December 31, 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 of America 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 Form 10-Q 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. In December 2003, the FASB modified FIN 46 (FIN 46R) to
clarify some requirements, and ease some implementation problems. The Company
must apply the new requirements by the end of the first reporting period
beginning after December 15, 2003, but at a minimum apply the unmodified
provisions of the Interpretation to entities that were considered
"special-purpose entities" in practice and under the FASB literature prior to
the issuance of the Interpretation by the end of the first reporting period
ending after December 15, 2003. 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.
Revenue Recognition:
- --------------------
In December 2003, the SEC issued Staff Accounting Bulletin No. 104, Revenue
Recognition (SAB 104), which updates the previously issued revenue recognition
guidance in SAB 101, based on the Emerging Issues Task Force Issue 00-21,
Revenue Arrangements with Multiple Deliverables. If the deliverables in a sales
arrangement constitute separate units of accounting according to the EITF's
separation criteria, the revenue-recognition policy must be determined for each
identified unit. If the arrangement is a single unit of accounting under the
separation criteria, the revenue-recognition policy must be determined for the
entire arrangement. The issuance of SAB 104 has not had any impact on the
financial results of the Company.
8
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
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 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
(loss) and earnings (loss) 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 nine months of fiscal 2004 and 2003 in
accordance with the provisions of SFAS No. 123, the Company's net income (loss)
and net income (loss) per share would have changed to the pro forma amounts
indicated below:
THREE MONTHS ENDED DECEMBER 31, NINE MONTHS ENDED DECEMBER 31,
---------------------------- ----------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Net income (loss), as reported $ (350,000) $ 838,000 $(2,671,000) $ (46,000)
Add: Stock-based employee
compensation expense included in
reported net loss, net of related
tax effects 4,000 4,000 12,000 12,000
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) (118,000) (99,000)
----------- ----------- ----------- -----------
Pro forma net income (loss) $ (389,000) $ 809,000 $(2,777,000) $ (133,000)
=========== =========== =========== ===========
Net income (loss) per share:
Basic and Diluted - as reported $ (0.02) $ 0.06 $ (0.19) $ 0.00
=========== =========== =========== ===========
Basic and Diluted - pro forma $ (0.03) $ 0.06 $ (0.19) $ (0.01)
=========== =========== =========== ===========
9
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Using the Black-Scholes methodology, the total value of options granted during
the first nine 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. No options were granted during the three months
ended December 31, 2003 and 2002.
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:
NINE MONTHS ENDED
DECEMBER 31,
---------------------
2003 2002
---- ----
STOCK OPTIONS:
Dividend yield None None
Expected volatility 50% 52%
Risk-free interest rate 3.50% 3.63%
Expected life (in years) 7.00 6.88
ESPP:
Dividend yield None None
Expected volatility 36% 36%
Risk-free interest rate 0.90% 1.25%
Expected life (in years) 0.50 0.50
Weighted-Average fair value of
Options and awards granted:
At market value $ 0.70 $ 1.15
Below market value $ 0.36 $ 0.74
All options granted $ 0.65 $ 1.09
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 net income or loss was equal
to net income or loss for all periods presented.
10
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
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 (loss) per share:
For the Three Months For the Nine Months
Ended December 31, Ended December 31,
---------------------- ----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Weighted average shares
outstanding for Basic EPS 14,364,000 14,322,000 14,345,000 14,315,000
Dilutive effect of common stock
options issuable under treasury
stock method -- 28,000 -- --
---------- ---------- ---------- ----------
Weighted average common and
common equivalent shares
outstanding for Diluted EPS 14,364,000 14,350,000 14,345,000 14,315,000
========== ========== ========== ==========
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,
---------------------- ----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Common stock options outstanding 1,109,000 1,020,000 1,109,000 1,102,000
========== ========== ========== ==========
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,
- -------------------------------- ---------------------- ----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Interest $ 2,000 $ 2,000 $ 6,000 $ 7,000
11
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE G. INVENTORIES
The major components of inventories, net of reserves, are as follows:
December 31, March 31,
2003 2003
---------- ----------
Finished products $1,761,000 $1,815,000
Work in process 1,237,000 968,000
Raw materials 1,324,000 1,249,000
---------- ----------
$4,322,000 $4,032,000
========== ==========
NOTE H. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
December 31, March 31,
2003 2003
----------- -----------
Land $ 241,000 $ 241,000
Buildings 6,839,000 6,793,000
Machinery and equipment 14,581,000 15,135,000
Laboratory equipment 1,005,000 938,000
Furniture and fixtures 363,000 423,000
Vehicles 149,000 149,000
Construction in Progress -- 132,000
----------- -----------
23,178,000 23,811,000
Less:
Accumulated depreciation 11,185,000 11,359,000
----------- -----------
$11,993,000 $12,452,000
=========== ===========
12
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
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 nine months of fiscal 2004.
NOTE J. LINE OF CREDIT
During the third quarter of fiscal 2004, the Company entered
into a line of credit facility with a bank that provides for
borrowings of up to $1 million. Interest is payable at prime
with an annual facility fee of 0.5 percent. The agreement is
collateralized by cash and cash equivalents, accounts
receivable, inventories and equipment. The agreement requires
the Company to maintain various financial and other covenants.
As of December 31, 2003, the Company has no borrowings
outstanding under the credit agreement.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS RESULTS OF OPERATIONS
Overview
- --------
Synthetech is currently supporting a wide variety of peptide- and small-molecule
based projects for major pharmaceutical and other companies. The Company
supplies an intermediate product that the customer further processes to its
final form. Most customer projects are in the early phases of development and
testing and do not represent large-scale projects for Synthetech.
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,
------------------ ------------------
2003 2002 2003 2002
------ ------ ------ ------
Revenue 100.0% 100.0% 100.0% 100.0%
Cost of revenue 89.6 50.2 (111.9) 78.9
----- ----- ----- -----
Gross profit (loss) 10.4 49.8 (11.9) 21.1
Research and development 5.7 5.2 8.3 5.9
Selling, general and administrative 16.8 11.1 21.0 16.5
----- ----- ----- -----
Operating expense 22.5 16.3 29.3 22.4
Operating income (loss) (12.1) 33.5 (41.2) (1.3)
Interest income 0.1 0.4 0.4 0.6
Interest expense (0.0) (0.0) (0.1) (0.1)
----- ----- ----- -----
Income (loss) before income taxes (12.0) 33.9 (40.9) (0.8)
Provision (benefit) for income taxes -- 12.9 -- (0.3)
----- ----- ----- -----
Net income (loss) (12.0)% 21.0% (40.9)% (0.5)%
===== ===== ===== =====
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
Revenue
- -------
Revenue of $2.9 million in the third quarter of fiscal 2004 decreased by $1.1
million, or 27.0%, from revenue of $4.0 million in the third quarter of fiscal
2003. Revenue of $6.5 million in the first nine months of fiscal 2004 decreased
by $2.4 million, or 26.4%, from revenue of $8.9 million in the first nine months
of fiscal 2003. The Company expects fourth quarter revenue to exceed third
quarter revenue for fiscal 2004. Changes in revenue for the specified periods
primarily relate to revenue arising from large-scale customer projects.
Revenue from large-scale customer projects was $2.1 million and $4.2 million in
the third quarter and first nine months of fiscal 2004, respectively, compared
to $3.3 million and $6.9 million in the same periods of fiscal 2003. Large-scale
project revenue during the third quarter and first nine months of fiscal 2004
and 2003 included revenue from two ongoing customer projects which involved
manufacturing PBB's to support a marketed drug and a drug in clinical trials.
The third quarter of fiscal 2004 and the first nine months of fiscal 2004 and
2003 also include PBB shipments to support an established product in the
cosmeceutical sector. The Company did not ship product to the cosmeceutical
sector during the third quarter of fiscal 2003. A cosmeceutical is a product
that makes no therapeutic claims but is intended for topical use by humans.
A major source of large-scale project revenue in the third quarter and first
nine months of fiscal 2003 related to a drug that was in phase 2 clinical trials
which has subsequently progressed to phase 3 testing. 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 third quarter and first
nine months of fiscal 2003. Fiscal 2004 customer requirements, if any, for this
product are dependent on future outcomes of phase 3 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 nine months 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 $399,000 and $1.4 million for the
third quarter and first nine months of fiscal 2004, respectively, compared to
$567,000 and $1.4 million for the third quarter and first nine months of fiscal
2003, respectively. International sales, like all Company revenues, are subject
to significant quarterly fluctuations.
Due to the slower than expected ramp-up of a major customer's newly marketed
drug, the customer has reduced the aggregate size of a large-scale order from
approximately $4.4 million to approximately $2.2 million, including the
cancellation of a $600,000 delivery scheduled for the fourth quarter of fiscal
2004. The customer also has delayed the originally scheduled delivery dates for
the remaining $2.2 million of the order to the second half of fiscal 2005. As a
result, the Company's large-scale order commitments for fiscal 2005 currently
are approximately $3.9 million.
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
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
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 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 income (loss)
- -------------------
The gross income for the third quarter of fiscal 2004 was $302,000, or 10% of
revenue, compared to gross income of $2.0 million, or 50% of revenue, for the
third quarter of fiscal 2003. The gross loss for the first nine months of fiscal
2004 was $779,000 or 12% of revenue, compared to gross income of $1.9 million,
or 21% of revenue, for the first nine months of fiscal 2003. Results for the
three months ended December 31, 2002 benefited from a product mix with an
unusually high gross profit, which the Company would not normally expect to
achieve at comparable levels of revenue.
On low sales volume, the Company generated a gross loss during each of the first
two quarters of fiscal 2004. Compared to the first two quarters of fiscal 2004,
the third quarter benefited from an increased level of revenue and cost
reductions which were implemented during the second quarter of fiscal 2004.
The lack of sales volume experienced in the first nine months of fiscal 2004
coupled with unabsorbed manufacturing costs had an unfavorable effect on the
Company's gross loss for this period. Compared to the first nine months of
fiscal 2004, the comparable period of fiscal 2003 benefited from a higher level
of sales with superior margin.
The gross income (loss) for the third quarter and first nine months of fiscal
2004 reflect charges for impaired inventory of $224,000 and $807,000,
respectively. This compares to charges for impaired inventory of $136,000 and
$1.7 million in the third quarter and first nine months of fiscal 2003,
respectively. For fiscal 2004, a large component of the charge for impaired
inventory relates to costs incurred in the development of new processes and
products. A significant portion of the charges for impaired inventory for the
first nine months of fiscal 2003 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.
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 a resulting downward pressure on pricing. It
remains difficult to rework certain materials on a cost effective basis.
Management evaluates the Company's inventory for impairment whenever it becomes
aware that 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.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
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.
Operating Expenses
- ------------------
Research and development (R&D) expense in the third quarter of fiscal 2004 was
$167,000, or 6% of revenue, compared to $207,000, or 5% of revenue, in the third
quarter of fiscal 2003. R&D expense in the first nine months of fiscal 2004 was
$539,000, or 8% of revenue, compared to $524,000, or 6% of revenue, for the
comparable period of fiscal 2003. The decrease in R&D expense for the third
quarter of fiscal 2004, compared to the same period in fiscal 2003 is due to the
transfer of personnel from the Company's R&D department to its process support
department, the net effect of changes in the Company's salary structure between
the two periods and a net reduction in other operating expenses.
Selling, general and administrative (SG&A) expense in the third quarter of
fiscal 2004 was $489,000, or 17% of revenue, compared to $444,000, or 11% of
revenue, in the third quarter of fiscal 2003. SG&A expense in the first nine
months of fiscal 2004 was $1.4 million or 21% of revenue, compared to $1.5
million, or 17% of revenue, for the comparable period of fiscal 2003. The
increase in SG&A expense in the third quarter of fiscal 2004, compared to the
same period in fiscal 2003 was primarily due to an increase in the Company's
marketing activities. The decrease in SG&A expense for the first nine months of
fiscal 2004, compared to the comparable period of fiscal 2003, is primarily due
to one-time costs recorded in the first quarter of fiscal 2003 relating to the
retirement of a Company officer, savings related to a temporary vacancy in a
senior administrative position, and salary reductions implemented in September
2003, partially offset by an increase in marketing costs.
Operating income (loss)
- -----------------------
Operating loss in the third quarter and first nine months of fiscal 2004 was
$354,000 and $2.7 million, respectively, compared with operating income in the
third quarter of fiscal 2003 of $1.3 million and operating loss in the first
nine months of fiscal 2003 of $116,000.
Interest Income
- ---------------
Interest income in the third quarter and first nine months of fiscal 2004 was
$6,000 and $26,000, respectively, compared to $15,000 and $49,000, respectively,
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 equivalents during the first nine
months of fiscal 2004 were 0.87%, compared to 1.43% during the comparable period
of fiscal 2003.
Interest expense
- ----------------
Interest expense was $2,000 and $6,000, respectively, for the third quarter and
first nine months of fiscal 2004 compared to $3,000 and $7,000, respectively, in
the comparable period of fiscal 2003.
17
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 is more likely than not the Company may be unable to recognize
a deferred tax benefit related to losses incurred during the first nine months
of fiscal 2004, continuing for an uncertain period of time. For the third
quarter and first nine months 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 third quarter of fiscal 2004 was $350,000, or 12% of revenue,
compared to net income of $838,000, or 21% of revenue, for the third quarter of
fiscal 2003. Net loss for the first nine months of fiscal 2004 was $2.7 million,
or 41% of revenue, compared to a net loss of $46,000, or 1% 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 of
America. 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 deferred tax asset realization, inventory
realization, allowance for doubtful accounts and long-lived asset impairments.
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 it becomes
aware that 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 reduces 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. Write-downs would be reflected as a
charge to earnings in the relevant period.
18
ITEM 2. 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 change, depreciation expense
could materially change.
REVENUE RECOGNITION
The Company recognizes revenues including shipping and handling charges billed
to customers when the following criteria are met:
o Persuasive evidence of an arrangement exists,
o Delivery has occurred or services have been rendered,
o The Company's price to our customer is fixed or determinable, and
o Collectibility is reasonably assured.
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.
19
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, and existing orders may be subject to
cancellation or delay by customers. Until there is stable demand for its
products, the Company is likely to continue to experience significant
fluctuations in its periodic results.
20
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 December 31, 2003, the Company's working capital was $8.5 million. The
Company's cash and cash equivalents at December 31, 2003 totaled $3.9 million.
Net cash used in operating activities was $1.7 million for the first nine months
of fiscal 2004. The principal component of net cash used in operating activities
for the nine month period ended December 31, 2003 was the net loss of $2.7
million. Purchases of property, plant and equipment totaled $356,000 related
primarily to machinery and equipment and principal payments on long-term debt
totaled $16,000 for the first nine months of fiscal 2004. The net decrease in
cash and cash equivalents for the first nine months of fiscal 2004 was $2.1
million.
During the third quarter of fiscal 2004, the Company entered into a new $1
million line of credit with a bank. Interest is payable at prime with an annual
facility fee of 0.5 percent. The agreement is collateralized by cash and cash
equivalents, accounts receivable, inventories and equipment. Financial covenants
contained in the agreement require the Company to maintain a quick ratio of 1.5
to 1 and a tangible net worth of $19 million. The Company has no borrowings
outstanding under the credit agreement as of December 31, 2003.
Accounts receivable at December 31, 2003, totaled $745,000 compared to $966,000
at March 31, 2003. The change in accounts receivable between the two periods
primarily relates to the timing of shipments and related customer payments
during the quarter. Inventory totaled $4.3 million at December 31, 2003 compared
to $4.0 million at March 31, 2003. The Company has increased its work in process
inventory primarily to support future shipments. Accounts payable at December
31, 2003, totaled $1.1 million compared to $754,000 at March 31, 2003. The
increase in accounts payable between the two periods relates to the purchase of
raw materials to support future shipments.
The Company's capital budget for fiscal 2004 is $600,000. Purchases of property,
plant and equipment for the first nine months of fiscal 2004 total $356,000 and
are comprised of a variety of projects.
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 December 31,
2003, the Company has not repurchased any of its shares.
The Company believes that its existing cash and cash equivalents, funds
generated from future operations and availability under the Company's line of
credit will be sufficient to support operations and capital expenditures for the
foreseeable future.
21
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.
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 was
not a party to any forward exchange contracts as of December 31, 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 December
31, 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 change in the Company's internal control over financial
reporting during the fiscal quarter ended December 31, 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.
22
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 revenue for the fourth quarter of fiscal 2004 and order commitments
for 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
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, risks
described elsewhere in this report and the following: the uncertain market for
our products, potential loss of a significant customer or customers, customer
concentration, potential termination or suspension by customers of large-scale
projects or cancellation or delays of orders prior to shipment, potential period
to period revenue 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, 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.
23
PART II. OTHER INFORMATION
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 10.1 Loan and Security Agreement dated as of
December 31, 2003 between Synthetech, Inc.
and Silicon Valley Bank
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 November 4, 2003, Synthetech, Inc. furnished a report on Form 8-K under
Item 12 announcing its second quarter fiscal 2004 financial results.
24
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: February 3, 2004 /s/ M. Sreenivasan
---------------------
M. Sreenivasan
President & C.E.O.
Date: February 3, 2004 /s/ Gary A. Weber
---------------------
Gary A. Weber
Vice President Finance &
Chief Financial Officer
25