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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
FORM 10-Q
[X] Quarterly Report Under Section 13 or 15(d) of
the Securities Exchange Act of 1934.
For the quarterly period ended: June 30, 2003
Commission File No. 1-16119
---------------------
SFBC INTERNATIONAL, INC.
------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 59-2407464
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
11190 BISCAYNE BLVD.
MIAMI, FL 33181
(305) 895-0304
--------------
(Address and telephone number
of principal executive offices)
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.
{X} Yes { } No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes ...x... No .....
The registrant has 7,765,540 shares of common stock outstanding as of August 5,
2003
INDEX
PART I - FINANCIAL INFORMATION
Page
ITEM 1. Financial Statements
Condensed Consolidated Balance Sheets
as of June 30, 2003 (unaudited) and December 31, 2002 1
Condensed Consolidated Statements of Earnings
for the three and six months ended June 30, 2003 and 2002 (unaudited) 2
Condensed Consolidated Statements of Cash Flows
for the six months ended June 30, 2003 and 2002 (unaudited) 3 - 4
Notes to Unaudited Condensed Consolidated Interim Financial Statements 5 - 12
ITEM 2. Management's Discussion and Analysis of Interim Financial
Condition and Results of Operations 12 - 25
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 25 - 26
ITEM 4. Controls and Procedures 26
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings 27
ITEM 2. Change in Securities 27
ITEM 3. Defaults upon Senior Securities 27
ITEM 4. Submission of Matters to a Vote of Security Holders 27
ITEM 5. Other Information 27
ITEM 6. Exhibits and Reports on Form 8-K 28
SFBC INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
JUNE 30, 2003 AND DECEMBER 31, 2002
========================================================================================================================
ASSETS (Unaudited)
June 30, December 31,
2003 2002
Current Assets
Cash and cash equivalents 3,975,133 6,361,496
Investment in marketable securities 1,330,735 2,413,522
Accounts receivable, net 26,780,989 21,753,778
Income tax receivable 150,489 290,221
Loans receivable from officers/stockholders 236,152 343,400
Prepaids and other current assets 4,956,399 4,256,584
----------- -----------
Total current assets 37,429,897 35,419,001
Loans receivable from officers 600,000 600,000
Property and equipment, net 18,671,171 16,612,579
Goodwill, net 30,151,148 30,151,148
Other intangibles, net 2,090,692 2,662,603
Deferred income taxes 1,198,199 283,665
Other assets, net 212,777 230,444
----------- -----------
Total assets 90,353,884 85,959,440
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable 5,649,262 6,323,414
Accrued liabilities 1,768,415 3,041,087
Advance billings 3,027,984 3,802,754
Income taxes payable -- --
Deferred income taxes 85,308 85,308
Line of credit 1,800,000 --
Notes payable, current portion 1,619,825 1,361,231
----------- -----------
Total current liabilities 13,950,794 14,613,794
Notes payable 2,713,191 2,786,956
Stockholders' equity
Preferred stock. $0.10 par value, 5,000,000 shares authorized, none issued -- --
Common stock, $0.001 par value, 20,000,000 shares authorized, 7,240,044 and
7,408,682 shares issued and outstanding as of June 30, 2003 and December 31, 7,240 7,409
2002
Additional paid-in capital 56,070,187 58,068,002
Retained earnings 16,608,781 12,641,431
Accumulated other comprehensive earnings 1,003,691 18,332
Common stock held in treasury, at cost - 0 shares at June 30, 2003
and 204,300 shares at December 31, 2002 -- (2,176,484)
----------- -----------
Total stockholders' equity 73,689,899 68,558,690
----------- -----------
Total liabilities and stockholders' equity 90,353,884 85,959,440
=========== ===========
The accompanying notes are an integral part of these financial statements.
1
SFBC INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2003 AND 2002
========================================================================================================================
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
---- ---- ---- ----
Net revenue $ 22,483,553 $ 14,720,863 $ 41,153,589 $ 24,303,419
Costs and expenses
Direct costs 12,688,984 8,454,030 23,257,575 13,315,774
Selling, general and administrative expenses 7,232,418 4,766,890 13,047,278 7,597,955
------------ ------------ ------------ ------------
Total costs and expenses 19,921,402 13,220,920 36,304,853 20,913,729
Earnings from operations 2,562,151 1,499,943 4,848,736 3,389,690
Other income (expense)
Interest income 37,670 112,036 89,686 297,296
Interest expense (102,581) (87,022) (177,021) (115,554)
------------ ------------ ------------ ------------
Total other income (expense) (64,911) 25,014 (87,335) 181,742
------------ ------------ ------------ ------------
Earnings before taxes 2,497,240 1,524,957 4,761,401 3,571,432
Income tax expense 473,174 169,919 794,051 886,589
------------ ------------ ------------ ------------
Net earnings $ 2,024,066 $ 1,355,038 $ 3,967,350 $ 2,684,843
============ ============ ============ ============
Earnings per share:
Basic $ 0.28 $ 0.19 $ 0.55 $ 0.39
============ ============ ============ ============
Diluted $ 0.27 $ 0.18 $ 0.52 $ 0.36
============ ============ ============ ============
Shares used in computing earnings per share:
Basic 7,228,034 7,079,480 7,223,819 6,890,302
============ ============ ============ ============
Diluted 7,567,525 7,459,428 7,575,035 7,404,560
============ ============ ============ ============
The accompanying notes are an integral part of these statements.
2
SFBC INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2003 AND 2002
=========================================================================================================================
2003 2002
---- ----
Cash flows from operating activities
Net earnings 3,967,350 2,684,845
Adjustments to reconcile net earnings to net cash provided by
(used in) operating activities:
Depreciation and amortization 2,159,800 1,024,607
Provision for bad debt (140,000) --
Common stock options issued as compensation -- 35,417
Changes in assets and liabilities
Accounts receivable (3,870,559) (1,069,896)
Income tax receivable 139,732 (746,125)
Prepaid expenses and other current assets (207,933) (695,343)
Other assets 99,670 (163,241)
Accounts payable (1,269,979) (46,223)
Accrued liabilities 929,658 (55,826)
Advance billings (945,395) (718,114)
Income taxes payable -- (1,046,420)
Deferred income taxes (617,252) (906,571)
------------ ------------
Total adjustments (3,722,258) (4,387,735)
------------ ------------
Net cash provided by (used in) operating activities 245,092 (1,702,890)
------------ ------------
Cash flows from investing activities
Cash consideration - acquisitions, net of cash acquired (2,772,703) (22,047,577)
Purchase of property and equipment (2,155,449) (1,229,971)
Purchase of / change in long term investment - marketable securities 465,321 --
Loans to officers/stockholders 107,248 131,321
------------ ------------
Net cash used in investing activities (4,355,583) (23,146,227)
------------ ------------
Cash flows from financing activities
Borrowings against bank line of credit 1,800,000 --
Principal payments on notes payable (464,551) (62,093)
Proceeds from the issuance/exercise of warrants and common stock 178,500 1,504,004
------------ ------------
Net cash provided by financing activities 1,513,949 1,441,911
------------ ------------
Net effect of exchange rate changes on cash 210,179 --
------------ ------------
Net decrease in cash and cash equivalents (2,386,363) (23,407,206)
Cash and cash equivalents at beginning of period 6,361,496 39,103,139
------------ ------------
Cash and cash equivalents at end of period $ 3,975,133 $ 15,695,933
============ ============
The accompanying notes are an integral part of these statements.
3
SFBC INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (Continued)
FOR THE SIX MONTHS ENDED JUNE 30, 2003 AND 2002
========================================================================================================================
2003 2002
---- ----
Supplemental disclosures:
Interest paid $ 177,021 $ 115,554
Income taxes paid $ 883,855 $ 2,844,897
Supplemental disclosures of non-cash investing and finance activities:
Fair value of net assets (liabilities) assumed in connection with acquisition of business $ 1,573,430 $12,104,260
Common stock issued in connection with acquisition of business $ -- $ 3,255,443
Professional fees accrued in connection with acquisition of business $ -- $ 658,362
Common stock options issued as compensation $ -- $ 35,417
The accompanying notes are an integral part of these statements.
4
SFBC INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
================================================================================
- --------------------------------------------------------------------------------
NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION
- --------------------------------------------------------------------------------
PRINCIPLES OF CONSOLIDATION AND ORGANIZATION
The consolidated financial statements include the accounts of SFBC
International, Inc. (the "Company") and its wholly owned United States
subsidiaries, South Florida Kinetics, Inc. ("SFBC Miami"), SFBC New
Drug Services, Inc., (which includes the operations of SFBC Charlotte,
Inc. effective April 1, 2003) SFBC Ft. Myers, Inc., SFBC Analytical
Laboratories, Inc.; and Canadian subsidiaries SFBC Canada, Inc.,
Anapharm Inc. and SynFine Research, Inc. All financial information
presented in this report relating to Canadian subsidiaries has been
converted to United States dollars.
During the three and six month periods ended June 30, 2003, Anapharm
owned a 49% interest in Danapharm Clinical Research (Danapharm)
located in London, Ontario Canada. For these periods Danapharm's
results, which were not material, were reported on the equity method
of accounting. On July 7, 2003, Anapharm purchased the remaining 51%
interest of Danapharm (see Note 3 to the Condensed Consolidated
Financial Statements).
On August 1, 2003, the Company acquired Clinical Pharmacology
Associates ("CPA") and merged it into its South Florida Kinetics
subsidiary (see Note 3 to the Condensed Consolidated Financial
Statements).
BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with accounting principles generally
accepted in the United States of America for interim financial
information and with the instructions to Form 10-Q for quarterly
reports under section 13 of the Securities Exchange Act of 1934.
Accordingly, they do not include all of the information and footnotes
required by accounting principles generally accepted in the United
States of America for complete financial statements. In the opinion of
management, all adjustments necessary for a fair presentation have
been made. Operating results for the three and six month periods ended
June 30, 2003 are not necessarily indicative of the results that may
be expected for the remaining quarters and for the year ending
December 31, 2003.
- --------------------------------------------------------------------------------
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- --------------------------------------------------------------------------------
The accompanying condensed consolidated financial statements have been
prepared in accordance with the accounting policies described in the
Company's Annual Report Form 10-KSB for the year ended December 31,
2002, and should be read in conjunction with the consolidated
financial statements and notes which appear in that Report. These
statements
5
do not include all of the information and footnotes required by
accounting principles generally accepted in the United States of
America for complete financial statements.
The preparation of the Company's financial statements in conformity
with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of
the financial statements and revenues and expenses during the period.
Future events and their effects cannot be determined with absolute
certainty; therefore, the determination of estimates requires the
exercise of judgment. Actual results inevitably will differ from those
estimates, and such differences may be material to our financial
statements. Management continually evaluates its estimates and
assumptions, which are based on historical experience and other
factors that are believed to be reasonable under the circumstances.
These estimates and the Company's actual results are subject to the
risk factors listed in "Forward Looking Statements."
NET EARNINGS PER SHARE
The Company applies Statement of Financial Accounting Standards No.
128, "Earnings Per Share" (FAS 128) which requires dual presentation
of net earnings per share: Basic and Diluted. Basic earnings per share
is computed using the weighted average number of common shares
outstanding during the period. Diluted earnings per share is computed
using the weighted average number of common shares outstanding during
the period adjusted for incremental shares attributed to outstanding
options and warrants to purchase approximately 800,200 and 777,051
shares of common stock for the three and six month periods ended June
30, 2003, and 824,013 and 950,485 shares for the three and six month
period ended June 30, 2002, respectively; less the assumed repurchase
of shares in accordance with the treasury stock method of
approximately 460,709 and 425,835 shares for the three and six month
periods ended June 30, 2003, and 444,065 ad 436,227 shares for the
three and six month period ended June 30, 2002, respectively.
On July 17, 2002, we announced a common stock buyback plan of up to
750,000 shares. As of December 31, 2002, we had purchased 204,300
shares in various open market purchases at an average price of
approximately $10.65 per share, or a total expenditure of
approximately $2,176,484. These shares are presented as common stock
held in treasury at December 31, 2002 and were retired in February
2003. We have not made any additional treasury share purchases since
December 31, 2002. We may continue to purchase our shares, or may
discontinue the buyback at any time depending on the selling price of
our common stock, the viability of potential acquisition targets, and
our cash flows from operations and on hand cash balances.
STOCK BASED COMPENSATION
At June 30, 2003, the Company had one stock based compensation plan
and had entered into a limited number of stock option agreements,
which have been disclosed in the Company's annual report on Form
10-KSB for the year ended December 31, 2002 and its proxy statement
for the 2003 annual meeting filed with the Securities and Exchange
Commission. The Company accounts for stock-based compensation using
the intrinsic value method. Accordingly, compensation cost for stock
options issued is measured as the excess, if any, of the fair value of
the Company's common stock at the date of grant
6
over the exercise price of the options. The Company's net earnings and
earnings per share would have been changed to the pro forma amounts
indicated below had compensation cost for the stock option plans and
non-qualified options issued to employees been determined based on the
fair value of the options at the grant dates consistent with the
method of SFAS 123.
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
Net earnings:
As reported ............... $ 2,024,067 $ 1,355,038 $ 3,967,350 $ 2,684,843
Pro forma ................. $ 1,486,758 $ 817,729 $ 2,892,731 $ 1,610,224
Basic earnings per share:
As reported ............... $ .28 $ .19 $ .55 $ .39
Pro forma ................. $ .21 $ .12 $ .40 $ .23
Diluted earnings per share:
As reported ............... $ .27 $ .18 $ .52 $ .36
Pro forma ................. $ .20 $ .11 $ .38 $ .22
The above pro forma disclosures may not be representative of the
effects on reported net earnings for future years as options vest over
several years and the Company may continue to grant options to
employees. In accordance with the requirements of SFAS 123, the fair
value of each option grant was estimated on the date of grant using a
binomial option-pricing model with the following weighted-average
assumptions used for grants in 2003 and 2002, respectively: no
dividend yield for all years; expected volatility of 75% for 2003 and
2002; risk-free interest rates of 3% in 2003 and 2002; and expected
holding periods of 5 years in 2003 and 2002.
NEW ACCOUNTING PRONOUNCEMENTS
In June 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"). SFAS 146
applies to costs associated with an exit activity (including
restructuring) or with a disposal of long-lived assets. Those
activities can include eliminating or reducing product lines,
terminating employees and contracts and relocating plant facilities or
personnel. SFAS 146 is effective prospectively for exit or disposal
activities initiated after December 31, 2002, with earlier adoption
encouraged. The Company does not believe the adoption of this standard
will have a material impact on the financial statements.
In December 2002, the FASB issued Statement No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure" ("SFAS 148"). SFAS
148 amends FASB Statement No. 123, "Accounting for Stock-Based
Compensation", to provide alternative methods of transition for an
entity that voluntarily changes to the fair value based method
7
of accounting for stock-based employee compensation and to require
prominent disclosures about the effects on reported net income of an
entity's accounting policy decisions with respect to stock-based
employee compensation. SFAS 148 also amends APB Opinion No. 28,
"Interim Financial Reporting," to require disclosures about those
effects in interim financial information. The Company currently
accounts for its stock-based compensation awards to employees and
directors under the accounting prescribed by Accounting Principles
Board Opinion No. 25 and provides the disclosures required by SFAS No.
123. The Company currently intends to continue to account for its
stock-based compensation awards to employees and directors under the
accounting prescribed by Accounting Principles Board Opinion No. 25
and adopted the additional disclosure provisions of SFAS 148 in
December 2002.
In November 2002, the FASB issued Interpretation 45 (FIN 45),
Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others. For a
guarantee subject to FASB Interpretation 45, a guarantor is required
to:
o measure and recognize the fair value of the guarantee at
inception (for many guarantees, fair value will be
determined using a present value method); and
o provide new disclosures regarding the nature of any
guarantees, the maximum potential amount of future guarantee
payments, the current carrying amount of the guarantee
liability, and the nature of any recourse provisions or
assets held as collateral that could be liquidated and allow
the guarantor to recover all or a portion of its payments in
the event guarantee payments are required.
The disclosure requirements of this Interpretation are effective for
financial statements for fiscal years ending after December 15, 2002
and did not have a material effect on the Company's financial
statements. The initial recognition and measurement provisions are
effective prospectively for guarantees issued or modified on or after
January 1, 2003, which should not have a material effect on the
Company's financial statements.
- --------------------------------------------------------------------------------
NOTE 3. ACQUISITIONS
- --------------------------------------------------------------------------------
During 2002 we acquired the common stock of Anapharm, Inc. and the
assets of New Drug Services, Inc. ("NDS"). The terms of these
acquisitions are described in our Form 10-KSB for the year ended
December 31, 2002.
On March 26, 2003, SFBC, through its wholly-owned subsidiary,
Anapharm, acquired the common stock of SynFine, an Ontario
corporation. Earlier in 2003, SynFine acquired the assets of
PDI-Research Laboratories, ("PDI"), located in suburban Toronto,
Canada. The business of PDI (now SynFine) provides synthesized
research compounds used by bioanalytical laboratories. Prior to the
acquisition, both Anapharm and SFBC Analytical were customers of PDI.
8
We paid approximately $1.6 million for SynFine's net assets comprised
primarily of scientific equipment, customer lists and real estate.
Additionally, SynFine assumed certain operating liabilities and bank
debt. No goodwill was recorded on this transaction since the fair
value of the net assets was in excess of the $1.6 million paid by the
Company. Anapharm used its own cash without borrowing any funds to
consummate the transaction. All of the 12 employees of SynFine have
remained as employees. This new business unit within Anapharm is
pursuing the same research activities and same business as PDI under
the new name of SynFine Research. This acquisition did not have a
material impact on Anapharm's revenues or earnings during the three
month period ended June 30, 2003 and is not expected to have a
material impact for the remainder of 2003.
The Company originally had anticipated entering into the synthesis
business during late 2004. However, we accelerated our entry into this
market due to the availability of PDI's scientific expertise and
personnel, and the availability of PDI's equipment, customer list and
real estate at a favorable price.
ACQUISITION OF DANAPHARM
On July 7, 2003, SFBC, through its wholly owned subsidiary, Anapharm,
acquired the 51 percent of the common stock that it did not already
own of Danapharm of London, Ontario, Canada for a total purchase
consideration of approximately $1.6 million. This was comprised of
approximately $336,000 in cash and 8,142 shares of SFBC common stock
valued at approximately $144,000 paid at closing; and the remaining
purchase consideration of approximately $1,120,000 is comprised of
approximately $785,000 in cash and $335,000 in stock (18,984 shares)
payable in four equal payments during the next four years. Anapharm
used its own cash to make the cash payment at closing, and issued a
note payable to the 51% shareholders for the remaining cash
consideration. The 18,984 shares issued were placed in escrow due over
the next four years. In return, Anapharm received approximately
$300,000 in net assets.
The other 49 percent of Danapharm was acquired through the acquisition
of Anapharm in March 2002. Founded in 1994, Danapharm provides drug
development research services for Phase II-IV clinical trials to the
biotech and pharmaceutical industry.
The Company's purchase price of $1,600,000 results in excess purchase
price over the acquired net assets of $300,000. SFBC is currently in
the process of obtaining preliminary independent appraisals of the
fair values of the acquired property plant and equipment, and
identified intangible assets, and their remaining useful lives.
Accordingly, the allocation of the purchase price, including the
related goodwill has not yet been determined and will be based on the
final determination of appraised and other fair values, and related
tax effects.
ACQUISITION OF CLINICAL PHARMACOLOGY ASSOCIATES
On August 4, 2003 we acquired 100% of the common stock of CPA, a
private company, focused primarily on Phase I clinical research
development services, based in Miami, FL.
9
CPA provides specialized, outsourced drug development research
services to the pharmaceutical and biotechnology industries.
Under the terms of the agreement we acquired CPA for $7.5 million in
cash and 443,072 shares of SFBC common stock. Of the sums paid, $1
million in cash and approximately 94,000 shares in common stock have
been placed in escrow and will be released over the next three years,
in six month increments to the shareholders of the seller. In return
we received CPA's clinic operations building valued at $750,000 and an
additional $750,000 in net assets comprised of cash and accounts
receivables, less accounts payable payable and accrued liabilities.
Also, the shareholders of CPA will have an opportunity over a three
year period to earn up to a total $9,000,000 in additional
consideration, one-half in cash and one-half in common stock, based
upon attaining certain revenue milestones.
For the year ended December 31, 2002, CPA's net revenue was
approximately $8.1 million and pre-tax income was approximately $3.9
million.
SFBC has retained all of CPA's employees and entered into three-year
employment agreements with key CPA senior management.
SFBC is currently in the process of obtaining preliminary independent
appraisals of the fair values of the acquired property plant and
equipment, and identified intangible assets, and their remaining
useful lives. Accordingly, the allocation of the purchase price,
including the related goodwill has not yet been determined and will be
based on the final determination of appraised and other fair values,
and related tax effects.
Due to the recent nature of this acquisition, it was not practicable
to provide further disclosures under SFAS No. 141.
UNAUDITED PRO FORMA RESULTS
Unaudited pro forma results of operations after giving effect to
certain adjustments resulting from the 2002 acquisitions were as
follows for the three and six month period ended June 30, 2003 and
June 30, 2002 as if the business combinations had occurred at the
beginning of each period presented. The pro forma results do not
include the operations of SynFine as this acquisition did not have a
material impact on the Company's consolidated operations.
10
THREE MONTHS ENDED JUNE 30 SIX MONTHS ENDED JUNE 30
-------------------------- -------------------------
2003 2002 2003 2002
---- ---- ---- ----
Net revenue $ 22,483,553 $ 16,881,019 $ 41,153,589 $ 32,567,444
Net earnings $ 2,024,067 $ 1,488,495 $ 3,967,350 $ 3,399,047
Earnings per share $ .28 $ .20 $ .55 $ .47
- basic
Earnings per share $ .27 $ .19 $ .52 $ .44
- diluted
The pro forma data is provided for information purposes only and does
not purport to be indicative of results which actually would have been
obtained if the combinations had been effected at the beginning of
each period presented, or of those results which may be obtained in
the future.
- --------------------------------------------------------------------------------
NOTE 4. GOODWILL AND INTANGIBLE ASSETS
- --------------------------------------------------------------------------------
In connection with adopting SFAS 142, the Company also reassessed the
useful lives and the classifications of its identifiable intangible
assets and determined that they continue to be appropriate. The
components of the Company's intangible assets subject to amortization
are approximately as follows:
June 30, 2003 December 31, 2002
-------------------------------- --------------------------
Weighted
Average Gross Gross
Life Carrying Accumulated Carrying Accumulated
Years Amount Amortization Amount Amortization
----- ----------- ------------ ----------- ------------
Methodologies 3.5 $ 1,721,000 $ (615,000) $ 1,721,000 $ (377,000)
Employment
Agreement 5 590,000 (224,000) 590,000 (162,000)
Subject Database 4 900,000 (281,000) 900,000 (169,000)
Customer backlog .75 290,000 (290,000) 290,000 (130,000)
----------- ----------- ----------- ----------
$ 3,501,000 $(1,410,000) $ 3,501,000 $ (838,000)
=========== =========== =========== ===========
Amortization expense for intangible assets during the three and six
month period ended June 30, 2003 was approximately $293,000 and
$596,000, respectively, and $210,000 and $278,000 for the three and
six month period ending June 30, 2002, respectively. The following
table provides information regarding estimated amortization expense
for each of the following years ended December 31:
2003 $ 987,000
2004 826,000
2005 725,000
2006 125,000
---------
$2,663,000
==========
11
As of June 30, 2003, all intangible assets except goodwill were
subject to amortization expense.
The Company assesses its goodwill for impairment annually as of the
1st of January of each year. No impairment was recorded in 2003 or
2002.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF INTERIM FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
As used in the quarterly report on Form 10-Q, "we", "our", "us", the
"Company" and "SFBC" refer to SFBC International, Inc. and its
subsidiaries unless the context otherwise requires.
The following discussion of our financial condition and results of
operations should be read together with the financial statements and
related notes included in this Report. This discussion contains
forward-looking statements that involve risks and uncertainties. Our
actual results may differ materially from those anticipated in those
forward-looking statements as a result of certain factors, including,
but not limited to, those contained in the discussion on
forward-looking statements that follows this section.
OVERVIEW
We are a provider of specialized drug development services to the
pharmaceutical and biotechnology industries. We specialize in
recruiting for and conducting Phase I and Phase II clinical trials
including participants from special populations. We also provide our
clients with bioanalytical service for Phase I and II clinical trials.
Our clients include pharmaceutical manufacturers including the largest
in the world, generic drug companies, biotechnology companies and
other drug development companies such as ourselves. Our principal
clinical operations are located in Miami, Florida and Anapharm's
facilities in Quebec and Montreal, Canada. Our Miami Phase I and II
clinic is, we believe, the largest Phase I and Phase II clinic in the
United States. We very recently opened our new expanded Phase I
through IV clinical trial facility in Ft. Myers, Florida. In addition
we provide data management, regulatory submissions, and Phase III and
IV clinical trials management services in targeted therapeutic areas.
Our services help reduce the amount of time and expense associated
with drug development and enable our clients to bring new drugs to
market faster.
Our revenues consist primarily of fees earned under contracts with
pharmaceutical and biotechnology company clients. Typically, a portion
of our contract fee is due upon signing of the contract, and the
majority of the contract fee is generally paid in installments upon
the achievement of certain agreed upon performance milestones over the
duration of the clinical trial.
All financial information presented in this report relating to
Anapharm has been converted to United States dollars.
12
CRITICAL ACCOUNTING POLICIES
----------------------------
Revenue and Cost Recognition
----------------------------
Revenues from contracts are generally recognized as services are
performed on the percentage-of-completion method of accounting with
performance generally assessed using output measures, such as
units-of-work performed to date as compared to the total units-of-work
contracted. Contracts may contain provisions for renegotiation in the
event of cost overruns due to changes in the level of work scope.
Renegotiated amounts are included in revenue when the work is
performed and realization is assured. Provisions for losses to be
incurred on contracts are recognized in full in the period in which it
is determined that a loss will result from performance of the
contractual arrangement.
Direct costs include all direct costs related to contract performance.
Costs are not deferred in anticipation of contracts being awarded, but
instead are expensed as incurred. Changes in job performance and
estimated profitability may result in revisions to costs and income
and are recognized in the period in which the revisions are
determined. Due to the inherent uncertainties in estimating costs, it
is at least reasonably possible that the estimates used will change in
the near term and the change could be material.
Included in accounts receivable are unbilled amounts, which represent
revenue recognized in excess of amounts billed. Advance billings
represent amounts billed in excess of revenue recognized.
Collectibility of Accounts Receivable
-------------------------------------
The Company's allowance for doubtful accounts and allowance for
changes in contracts are based on management's estimates of the
creditworthiness of its clients, analysis of subsequent changes in
contracts, analysis of delinquent accounts, the payment histories of
the accounts and management's judgment with respect to current
economic conditions and, in the opinion of management, is believed to
be an amount sufficient to respond to normal business conditions.
Management sets reserves for customers based upon historical
collection experience, and sets specific reserves for customers whose
accounts have aged significantly beyond this historical collection
experience. Should business conditions deteriorate or any major client
default on its obligations to the Company, this allowance may need to
be significantly increased, which would have a negative impact upon
the Company's operations.
The allowance for changes in contracts is an estimate established
through reductions to net revenue while the allowance for doubtful
accounts is an estimate established through charges to selling,
general and administrative expenses.
Income Taxes
------------
Significant management judgment is required in developing the
Company's provision for income taxes, including the determination of
foreign tax liabilities, deferred tax assets and liabilities and any
valuation allowances that might be required against the deferred tax
assets. The Company evaluates quarterly its ability to realize its
deferred tax assets and adjusts the amount of its valuation allowance,
if necessary. The Company operates within multiple taxing
jurisdictions and is subject to audit in those jurisdictions. Because
of the complex issues involved, any claims can require an extended
period to resolve. In management's opinion, adequate provisions for
income taxes have been made.
13
Impairment of Assets
--------------------
The Company reviews long-lived assets and certain identifiable
intangibles held and used for possible impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. In evaluating the fair value and future
benefits of its intangible assets, management performs an analysis of
the anticipated undiscounted future net cash flows of the individual
assets over the remaining amortization period. The Company will
recognize an impairment loss if the carrying value of the asset
exceeds the expected future cash flows.
In 2002, the Company began to perform an annual test for impairment of
goodwill. This test is performed on the 1st of January of each year by
comparing, at the reporting unit level, the carrying value of goodwill
to its fair value. The Company assesses fair value based upon its best
estimate of the present value of future cash flows that it expects to
generate by the reporting unit. The tests performed for 2003 and 2002
did not identify any instances of impairment. However, changes in
expectations as to the present value of a reporting unit's future cash
flows might impact a subsequent year's assessments of impairment.
Other Estimates
---------------
The Company makes a number of other estimates in the ordinary course
of business. Historically, past changes to these estimates have not
had a material impact on our financial condition. However,
circumstances could change which may alter future expectations.
RESULTS OF OPERATIONS
During the three months ended June 30, 2002 we had operations in
Miami, Charlotte, Ft. Myers, Philadelphia (SFBC Analytical) and Canada
(Anapharm). In contrast this year we had operations in all of the
mentioned locations for the full quarter including the results of
operations from NDS.
During the six months ended June 30, 2002 we had operations in Miami,
Charlotte, Ft. Myers, Philadelphia (SFBC Analytical) and Canada
(Anapharm) for three and one-half months. For the same period ended
June 30, 2003, we had operations in all of the mentioned locations for
the full six months including NDS.
ACQUSITIONS
On March 26, 2003, SFBC, through its wholly-owned subsidiary,
Anapharm, acquired the common stock of SynFine, an Ontario
corporation. Earlier in 2003, SynFine acquired the assets of
PDI-Research Laboratories, ("PDI"), located in suburban Toronto,
Canada. The business of PDI (now SynFine) provides synthesized
research compounds used by bioanalytical laboratories. Prior to the
acquisition, both Anapharm and SFBC Analytical were customers of PDI.
We paid approximately $1.6 million for SynFine's net assets comprised
primarily of scientific equipment, customer lists and real estate.
Additionally, SynFine assumed
14
certain operating liabilities and bank debt. No goodwill was recorded
on this transaction since the fair value of the net assets was in
excess of the $1.6 million paid by the Company. Anapharm used its own
cash without borrowing any funds to consummate the transaction. All of
the 12 employees of SynFine have remained as employees. This new
business unit within Anapharm is pursuing the same research activities
and same business as PDI under the new name of SynFine Research. This
acquisition did not have a material impact on Anapharm's revenues or
earnings during the three month period ended June 30, 2003 and is not
expected to have a material impact for the remainder of 2003.
The Company originally had anticipated entering into the synthesis
business during late 2004. However, we accelerated our entry into this
market due to the availability of PDI's scientific expertise and
personnel, and the availability of PDI's equipment, customer list and
real estate at a favorable price.
ACQUISITION OF DANAPHARM
On July 7, 2003, SFBC, through its wholly owned subsidiary, Anapharm,
acquired the 51 percent of the common stock that it did not already
own of Danapharm of London, Ontario, Canada for a total purchase
consideration of approximately $1.6 million. This was comprised of
approximately $336,000 in cash and 8,142 shares of SFBC common stock
valued at approximately $144,000 paid at closing; and the remaining
purchase consideration of approximately $1,120,000 is comprised of
approximately $785,000 in cash and $335,000 in stock (18,984 shares)
payable in four equal payments during the next four years. Anapharm
used its own cash to make the cash payment at closing, and issued a
note payable to the 51% shareholders for the remaining cash
consideration The 18,984 shares issued were placed in escrow due over
the next four years. In return, Anapharm received approximately
$300,000 in net assets.
The other 49 percent of Danapharm was acquired through the acquisition
of Anapharm in March 2002. Founded in 1994, Danapharm provides drug
development research services for Phase II-IV clinical trials to the
biotech and pharmaceutical industry.
The Company's purchase price of $1,600,000 results in excess purchase
price over the acquired net assets of $300,000. SFBC is currently in
the process of obtaining preliminary independent appraisals of the
fair values of the acquired property plant and equipment, and
identified intangible assets, and their remaining useful lives.
Accordingly, the allocation of the purchase price, including the
related goodwill has not yet been determined and will be based on the
final determination of appraised and other fair values, and related
tax effects.
ACQUISITION OF CLINICAL PHARMACOLOGY ASSOCIATES
On August 4, 2003 we acquired 100% of the common stock of CPA, a
private company, focused primarily on Phase I clinical research
development services, based in Miami, FL. CPA provides specialized,
outsourced drug development research services to the pharmaceutical
and biotechnology industries.
15
Under the terms of the agreement we acquired CPA for $7.5 million in
cash and 443,072 shares of SFBC common stock. Of the sums paid, $1
million in cash and approximately 94,000 shares in common stock have
been placed in escrow and will be released over the next three years,
in six month increments to the shareholders of the seller. In return
we received CPA's clinic operations building valued at $750,000 and an
additional $750,000 in net assets comprised of cash and accounts
receivables, less accounts payable payable and accrued liabilities.
Also, the shareholders of CPA will have an opportunity over a three
year period to earn up to a total $9,000,000 in additional
consideration, one-half in cash and one-half in common stock, based
upon attaining certain revenue milestones.
For the year ended December 31, 2002, CPA's net revenue was
approximately $8.1 million and pre-tax income was approximately $3.9
million.
SFBC has retained all of CPA's employees and entered into three-year
employment agreements with key CPA senior management.
SFBC is currently in the process of obtaining preliminary independent
appraisals of the fair values of the acquired property plant and
equipment, and identified intangible assets, and their remaining
useful lives. Accordingly, the allocation of the purchase price,
including the related goodwill has not yet been determined and will be
based on the final determination of appraised and other fair values,
and related tax effects.
Due to the recent nature of this acquisition, it was not practicable
to provide further disclosures under SFAS No. 141.
PRO FORMA DISCLOSURE
The following table reflects our actual results of operations for the
three and six months ended June 30, 2003 and our pro forma results of
operations for the same periods. The pro forma adjustments reflect the
application of $684,682 and $1,435,011, respectively for the three and
six month periods ended June 30, 2003 in Canadian tax credits, to the
costs which generated the credit. Under United States generally
accepted accounting principles ("GAAP"), the tax credits are applied
as a credit to "Income Tax Expense" on the income statement.
Under the U.S. GAAP approach, net income before taxes is reduced by
the amount of all of the direct costs and selling, general and
administrative expenses. Under the pro forma approach credits are
added back increasing the income tax expense. The end result is that
the net income is identical under both the actual and pro forma
approaches.
We believe that the above pro forma presentation, which is a non-GAAP
financial measure as defined by Regulation G of the Securities and
Exchange Commission, is more indicative of income from operations and
operating margins; it also assists management in calculating earnings
before income taxes, depreciation and amortization ("EBITDA") and
comparing EBITDA to other companies in our sector. For these reasons,
we believe the pro forma table is useful to investors.
16
SFBC INTERNATIONAL, INC. AND SUBSIDIARIES
SELECTED PROFORMA QUARTERLY DISCLOSURES
FOR THE THREE AND SIX-MONTH PERIOD ENDED JUNE 30, 2003 (all in $USD)
Recast proforma income statement to reflect the impact
of Canadian tax credits
ADJUSTED
PROFORMA
INCOME
CANADIAN REFLECTING
REPORTED TAX CANADIAN
ACTUAL CREDIT TAX CREDITS
RESULTS FOR RECLASS FOR FOR THE
THE THREE THE THREE THREE
MONTH PERIOD MONTH PERIOD MONTH PERIOD
ENDED PERIOD ENDED
6/30/03 6/30/03 6/30/03
(A) (B)
Net revenue $22,483,553 100.0% $ 22,483,553 100.0%
Costs and expenses
Direct costs 12,688,983 56.4% $ (549,936) 12,139,047 54.0%
Selling, general and administrative expenses 7,232,417 32.2% (134,926) 7,097,491 31.6%
----------- ---------------------------
Total costs and expenses 19,921,400 88.6% (684,862) 19,236,538 85.6%
Earnings from operations 2,562,153 11.4% 684,862 3,247,015 14.4%
Other income (expense)
Interest income 37,670 37,670
Interest expense (102,581) (102,581)
----------- -----------
Total other income (expense) (64,911) -- (64,911)
----------- ---------------------------
Earnings before taxes 2,497,242 684,862 3,182,104
Income tax expense 473,174 18.9% 684,862 1,158,036 36.4%
----------- ---------------------------
Net earnings $ 2,024,068 9.0% $ -- $ 2,024,068 9.0%
=========== ===========================
Earnings per share:
Basic $ 0.28 $ 0.28
=========== ===========
Diluted $ 0.27 $ 0.27
=========== ===========
Shares used in computing earnings per share:
Basic 7,228,034 7,228,034
=========== ===========
Diluted 7,567,525 7,567,525
=========== ===========
17
ADJUSTED
PROFORMA
INCOME
CANADIAN REFLECTING
REPORTED TAX CANADIAN
ACTUAL CREDIT TAX CREDITS
RESULTS FOR RECLASS FOR THE
THE SIX THE SIX SIX
MONTH PERIOD MONTH PERIOD MONTH PERIOD
ENDED PERIOD ENDED
6/30/03 6/30/03 6/30/03
(A) (B)
Net revenue $41,153,589 100.0% $ 41,153,589 100.0%
Costs and expenses
Direct costs 23,257,574 56.5% $ (1,185,498) 22,072,076 53.6%
Selling, general and administrative expenses 13,047,277 31.7% $ (249,513) 12,797,764 31.1%
------------ -----------------------------
Total costs and expenses 36,304,851 88.2% (1,435,011) 34,869,840 84.7%
Earnings from operations 4,848,738 11.8% 1,435,011 6,283,749 15.3%
Other income (expense)
Interest income 89,686 89,686
Interest expense (177,021) (177,021)
------------ -----------
Total other income (expense) (87,335) -- (87,335)
------------ -----------------------------
Earnings before taxes 4,761,403 1,435,011 6,196,414
Income tax expense 794,051 16.7% $ 1,435,011 2,229,062 36.0%
------------ -----------------------------
Net earnings $ 3,967,352 9.6% $ -- $ 3,967,352 9.6%
============ =============================
Earnings per share:
Basic $ 0.55 $ 0.55
============ ==========
Diluted $ 0.52 $ 0.52
============ ==========
Shares used in computing earnings per share:
Basic 7,223,819 7,223,819
============ ==========
Diluted 7,575,035 7,575,035
============ ==========
(A) The Canadian government encourages R&D activities by subsidizing them
through tax credits. Under US generally accepted accounting principles ("GAAP")
these credits are applied against "Income tax expense" on the income statement
rather than against the underlying "Direct costs" or "Selling, general and
administrative expenses" that generated the credit. The Company's current
statutory rate on profits for US operations is approximately 40%. The statutory
tax rate in the Quebec Province in Canada where the Company operates is
approximately 33% (before the application of the tax credits).
18
(B) During the three and six-month periods ended June 30, 2003, Anapharm
generated $684,862 and $1,435,011, respectively, in tax credits . This column
shows the pro-forma impact on the Company's operating results and ratios as if
these credits were applied against the underlying expense line items that
generated the credit rather than applying the credits against Income tax
expense. The Company believes that this presentation is more indicative of
earnings from operations, operating margins and for calculating EBITDA when
compared to other companies within its sector.
Net revenue by geographic region
THE THREE THE SIX
MONTH PERIOD MONTH PERIOD
ENDED PERIOD
6/30/03 6/30/03
Net revenue from foreign operations $10,324,940 $ 19,167,810
Net revenue from US operations 12,158,613 21,985,779
Total $22,483,553 $ 41,153,589
============ ==============
19
Net Revenues
------------
Net revenue increased from $14,720,863 for the three months ended June
30, 2002 to $22,483,553 for the three months ended June 30, 2003, and
from $24,303,419 for the six months ended June 30, 2002 to $41,153,589
for the six months ended June 30, 2003, an increase of 52.7% and
69.3%, respectively. The increase for both the three and six month
periods is primarily attributable to the significant growth of SBFC's
business at Anapharm, and SFBC Miami, and due the inclusion of six
months of revenue at Anapharm for the six month period ended June 30,
2003, compared to three and one-half's months of revenues at Anapharm
for the same six month period ended June 30, 2002.
On a pro forma basis, if the Company had owned all of its subsidiaries
as of January 1, 2002, net revenue for the three and six months month
period ended June 30, 2003 increased approximately 24.9% and 20.9%,
respectively, over the same three and six months period ended June 30,
2002. We believe that this pro forma comparison permits us to more
accurately track our growth rate. We believe it is also more
meaningful to investors since the inclusion of the results of
operations from our two acquisitions since the date of the
acquisitions does not provide a fair comparison.
For the three and six month periods ended June 30, 2003 net revenues
from foreign operations (substantially all from Anapharm) included in
total revenues, were $10,324,940, and $19,167,810, respectively.
Gross Profit Margins
--------------------
Gross profit increased from $6,266,833 to $9,794,570 for the three
months ended June 30, 2003 and from $10,987,645 to $17,896,014 for the
six months ended June 30, 2003, an increase of 56.3% and 62.9%
respectively from the corresponding periods in the prior year. As a
percentage of net revenue, gross profit increased from 42.6% to 43.6%
for the three months ended June 30, 2003 and decreased from 45.2% to
43.5% for the six months ended June 30, 2003 as compared to the
corresponding periods in the prior year.
The increase for the three month period ended June 30, 2003 compared
to the same period in 2002 is primarily attributable to the increase
in higher gross margin Phase I, Miami contracts as a ratio of overall
business compared to lower margin Phase III business at SFBC NDS.
This decrease in our gross profit margins for the six month period
ended June 30, 2003 compared to the same six month period in 2002 is
primarily attributable to the inclusion of six months of Anapharm's
operations in 2003 compared to approximately three and one-half months
during the same three month period in 2002. Anapharm's gross profit
margins are lower due to the nature of Anapharm's business in the
generic market where it employs a high number of research and
development employees and incurs higher direct costs as a percentage
of revenues than our United States operations. The Canadian government
subsidizes a portion of these additional expenses through tax credits.
Under United States GAAP, these credits are applied against income tax
expense rather than against the underlying direct cost that generated
the credit. The overall impact on our
20
operations is that the direct cost and S,G&A expenses as a percentage
of revenues will be permanently higher and our effective tax rate will
be permanently lower than in the past. Our net income is not affected
by this method. See Pro Forma Disclosure.
Additionally, to a lesser extent, the decrease in our gross margins is
attributable to the mix of our contracts which changes from quarter to
quarter. In August 2003 we purchased CPA and merged it into our Miami
operation. Historically, CPA's unaudited gross margins have been
higher than SFBC's. As a result, for the remainder of the year we
expect our gross margins to be between 43-45%.
Selling, General and Administrative Expenses
--------------------------------------------
Selling, general and administrative expenses ("S,G&A") increased from
$4,766,890 to $7,232,418 for the three months ended June 30, 2003 and
from $7,597,955 to $13,047,278 for the six months ended June 30, 2003,
an increase of 51.7% and 71.7%, respectively, over the same periods in
the prior year. As a percentage of net revenue, our S,G&A expenses
increased from 32.4% to 32.2% for the three months ended June 30, 2003
and from 31.3% to 31.7% for the six months ended June 30, 2003 as
compared to the corresponding periods in the prior year. The increase
in total S,G&A expenses for the three and six month period ended June
30, 2003 compared to the same periods of 2002 is primarily due to (I)
our continuing increased sales and marketing efforts, (ii) the hiring
of new personnel, increased depreciation and amortization expense and
other expenses consistent with the growth of the Company, and (iii)
the inclusion of Anapharm's and NDS' S,G&A expenses for six months
compared to three and one-half's months of S,G&A expenses at Anapharm
and zero expenses at NDS during the same period in 2002. Additionally,
during the three months ended June 30, 2003, due to the rapid
strengthening of the Canadian dollar against the US dollar, Anapharm
incurred a foreign exchange loss of approximately $550,000 compared to
a foreign exchange loss of $152,000 during the same three month period
ended June 30, 2002. We believe that the large foreign exchange loss
incurred during the three months ended June 30, 2003 is non-recurring
in nature and for the remaining six months of 2003 any foreign
currency gain or loss will not be material, although there can be no
assurances that we will be correct.
The increase in S,G&A expenses as a percentage of revenues for the six
month period is primarily due to the inclusion of Anapharm's expenses,
in S,G&A for six months during 2003 compared to three and one-half
months during the same period in 2002. As noted above in the "Gross
Profit Margins" section and shown in the "Pro Forma Disclosure" above,
Anapharm also receives tax credits for certain S,G&A expenses. These
credits are accounted in the same manner as direct costs.
Net Earnings
------------
Net income increased from $1,355,038 to $2,024,067 for the three
months ended June 30, 2003 and from $2,684,845 to $3,967,350 for the
six months ended June 30, 2003, an increase of 49.4% and 47.8%
respectively over the same periods in the prior year. On a fully
diluted basis, our earnings per share increased from $.18 to $.27 for
the three-month period ended June 30, 2003 and from $.36 to $.52 for
the six-month period ended June 30, 2003 as compared to the
corresponding periods in the prior year. The weighted average number
of shares outstanding used in computing earnings per share on a fully
diluted basis increased from 7,459,428 to 7,567,525 for the
three-month period
21
ended June 30, 2003 and from 7,404,560 to 7,575,035 for the six month
period ended June 30, 2003 as compared to the corresponding period in
the prior year. The increase in the number of shares in both three and
six month periods resulted primarily from the issuance of 167,375
shares to Anapharm on March 18, 2002, and 234,060 shares to NDS on
September 6, 2003 as acquisition consideration, the exercise of
options and warrants, and the change in our stock price (which causes
additional unexercised options to be included in the calculation for
diluted shares outstanding), offset by the share repurchases described
below.
On July 17, 2002, we announced a common stock buyback plan of up to
750,000 shares. As of December 31, 2002, we had purchased 204,300
shares in various open market purchases at an average price of
approximately $10.65 per share, or a total expenditure of
approximately $2,176,484. These shares are presented as common stock
held in treasury at December 31, 2002 and were retired in February
2003. We have not made any additional treasury share purchases since
December 31, 2002. We may continue to purchase our shares, or may
discontinue the buyback at any time depending on the selling price of
our common stock, the viability of potential acquisition targets, and
our cash flows from operations and on hand cash balances.
The Company's effective tax rate for the three month period ended June
30, 2003 was 18.9% compared to 11.1% for the same three-month period
ended June 30, 2002, respectively. The increase in the effective tax
rate for the three months ended June 30, 2003 compared to the prior
year, is due to the increase in profitability of U.S. subsidiaries
(primarily SFBC Miami) as a ratio of overall consolidated net income.
For the six months ended June 30, 2003, the Company's effective tax
rate was 16.7% compared to 24.8% for the same period in 2002. This
decrease is primarily attributable to Anapharm's strong operating
results as a ratio of overall consolidated net income and Anapharm's
significantly lower tax rate, compared to the non-inclusion of
Anapharm's tax rate during the first two and one-half months of 2002.
As described throughout this report, Anapharm receives significant
certain non-cash tax credits from the government of Canada for
incurring research and development expenses. These credits lower the
Company's effective tax rate. The Company expects the nature of
Anapharm's business and the generation of significant tax credits to
continue, however, there can be no assurance on the amount of these
credits on a quarterly or annual basis.
The future effective tax rate will be dependent on the amount of the
credits Anapharm receives and Anapharm's relative contribution to our
consolidated pre-tax income. For the remainder of 2003 we expect our
effective tax rate to be between 20 and 23%, and an annual rate of
between 19-21% compared to the 2002 tax rate of 24% which included
Anapharm's lower tax rate for nine and one-half months. The higher tax
rate we anticipate for the balance of the year gives effect to the
fact that our Phase I and II business in the United States
historically is substantially stronger in the second half of the year,
particularly in the fourth quarter. We expect this cyclical trend to
continue.
Whenever commercially practical, we refer Phase I and Phase II studies
and bioanalytical contracts to our Canadian operations benefit from
the lower operating costs and lower tax rates in Canada, and the
availability of tax credits. Excluding the impact of tax credits,
SFBC's effective tax rate in Canada is approximately 33% compared to
approximately 40% in the United States. There will be some practical
limitations which prevent us from referring some studies to Anapharm
including differing areas of expertise, the availability of a special
population groups or client preferences on where the work should be
performed.
22
LIQUIDITY AND CAPITAL RESOURCES
For the six months ended June 30, 2003, net cash provided by operating
activities was $245,092 in contrast to $1,702,890 of net cash used in
operations for the corresponding period in 2002. The change is
primarily attributable to the increase in net earnings and
depreciation and amortization resulting from the growth of our
business, offset by a substantial increase in our accounts receivable
and decrease in accounts payable.
For the six months ended June 30, 2003, net cash used in investing
activities was $4,355,583 compared to $23,146,227 used in investing
activities for the corresponding period in 2002. The decrease is
primarily attributable to the use of approximately $22,000,000 of net
cash to acquire Anapharm, Inc. in March of 2002 as compared to
approximately $1,600,000 of net cash used to acquire SynFine Research,
Inc. in March 2003 and approximately $1,200,000 used to pay the
Charlotte Earn-out. In addition, capital expenditures increased to
approximately $2,150,000 during the first six months of 2003 as
compared to $1,200,000 during the same period in 2002.
During the six months ended June 30, 2003, net cash provided by
financing activities was $1,513,949 compared to net cash provided by
financing activities of $1,441,911 in the corresponding period of
2002. The increase is primarily attributable to drawing down
$1,800,000 from our Credit Facility offset by a reduction in proceeds
of $1,500,000 in stock options and warrants exercised in 2002 to
$178,500 during the same period in 2003.
On September 16, 2002, we entered into a $10 million Revolving Credit
and Security Agreement with Wachovia Bank National Association. The
interest rate on this Credit Facility is LIBOR based and variable.
Currently, our average interest rate on the entire Credit Facility is
approximately 3.5%. This Credit Facility enables SFBC to borrow for
general working capital purposes and for the purpose of financing
acquisitions of companies in related industries. This Credit Facility
is secured by substantially all of our assets. On July 30, 2003
Wachovia Bank increased the Credit Facility to $15,000,000 on
substantially the same terms.
During the three-month period ended June 30, 2003 we utilized the
Credit Facility to pay the Charlotte Earn-out of approximately
$1,200,000 as well as other operating activities. As of June 30, 2003,
the loan balance was $1,800,000. In order to fund the August 1, 2003
CPA purchase price and transaction costs, the Company borrowed an
additional $8,000,000. Under the terms of the Credit Facility, the
$8,000,000 is payable in equal installments along with accrued
interest over a 36 month period. These amounts can be prepaid without
penalty. As of August 13, 2003, the total loan balance outstanding was
approximately $9,900,000.
The Company has been at all times and currently is in compliance with
all required covenants. Based on borrowing formulas contained within
the Credit Facility, as of August 13, 2003, the Company could have
borrowed all of the remaining loan availability of $5,100,000. We
intend to use our cash flow from operations to reduce the loan
balances and related interest expense under the Credit Facility.
23
As of August 13, 2003 we had approximately $4,500,000 in cash on hand.
Based upon our cash balances and our estimated future positive cash
flows from operations, we believe we have enough working capital to
meet our operational needs within the next 12 months. If we consummate
any additional acquisitions, we expect to further use our Credit
Facility and, if necessary, obtain additional debt or equity
financing. Except for the possibility of issuing stock related to
potential Earnouts described in this "Commitments" section of
"Liquidity and Capital Resources" or a potential accretive
acquisition, should one arise we do not anticipate issuing any of our
common stock during 2003.
COMMITMENTS
NDS EARN-OUT
------------
We may pay NDS up to $8 million as an earn-out based upon SFBC NDS'
future operating results over a three year period with the initial
year ending September 30, 2003. Of this $8 million potential earn-out,
$6 million is to be paid in cash and the remaining $2 million will be
paid through the issuance of common stock.
CPA EARN-OUT
------------
Based upon the future revenues of SFBC Miami, we may pay up to $9
million, one-half in cash and one-half in common stock, to the CPA
shareholders over the next three years.
RELATED PARTY TRANSACTIONS
In March 2003, Lisa Krinsky, M.D., our chairman of the board of
directors and president, voluntarily prepaid a note due on July 31,
2003 in the amount of $94,918 including accrued interest. The loan
represented personal expenses we paid for Dr. Krinsky in 1998 prior to
our initial public offering. We will not make any future loans to our
executive officers and directors.
FORWARD-LOOKING STATEMENTS
The statements in this Report relating to our expectations about our
future gross margins, our not incurring future foreign currency
losses, future Canadian tax credits and tax rates, and the nature of
Anapharm's business and its continued generation of tax credits, the
Company's effective future tax rates, the possibility of future
dilution, the adequacy of our working capital, future acquisitions,
and the repurchase of our common stock, are forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of
1995 (the "Act"). Additionally, words such as "expects",
"anticipates", "intends", "believes", "will" and similar words are
used to identify forward-looking statements within the meaning of the
Act.
The results anticipated by any or all of these forward-looking
statements might not occur. Important factors, uncertainties and risks
that may cause actual results to differ materially from these
forward-looking statements include (1) an unanticipated decision to
make an acquisition of a substantially larger competitor, which would
require us to re-allocate our intended uses of our cash resources; (2)
our ability to successfully implement our plans for operational and
geographical expansion; (3) our ability to successfully achieve and
manage the technical requirements of specialized clinical trial
services, while maintaining compliance with applicable rules and
regulations; (4) our ability to compete nationally in attracting
pharmaceutical companies in order to develop additional business; (5)
our continued ability to recruit
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participants for clinical studies; (6) the economic climate nationally
and internationally as it affects drug development operations, (7) our
ability to integrate and absorb our most recent acquisition and any
future acquisitions into our current operational structure, (8) the
changing mix of, and the amount contracts and laboratory services
offered, (9) future legislation in Canada which may affect our ability
to continue to generate tax credits at Anapharm to lower the effective
tax rate, (10) our future stock price, and (11) a variety of economic
factors that may affect the relative values of the United States and
Canadian currencies as well as the results of any hedging strategies
should we employ such strategies..
We undertake no obligation to publicly update or revise any
forward-looking statements, whether as the result of new information,
future events or otherwise. For more information regarding some of the
ongoing risks and uncertainties of our business, see the Form 10-KSB
for the year ended December 31, 2002 and the prospectus in the most
recent Form S-3 we filed with the Securities and Exchange Commission.
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
SFBC is subject to market risks in some of its financial instruments.
These instruments are carried at fair value on its financial
statements. SFBC is subject to currency risk at Anapharm. SFBC is also
subject to interest rate risk on its Credit Facility if it borrows
under it as described below. SFBC has not entered into market risk
sensitive instruments for trading purposes.
In 2002, SFBC purchased certain debt securities. SFBC classifies its
investments in debt securities as available-for-sale in accordance
with SFAS 115, "Accounting for Certain Investments in Debt and Equity
Securities." Investments classified as available-for-sale are carried
at fair value based on quoted market prices. The estimated fair value
of securities for which there are no quoted market prices is based on
similar types of securities that are traded in the market. The
unrealized holding gain (loss) on available-for-sale securities is
reported as a component of accumulated other comprehensive earnings,
net of applicable deferred income taxes. As of June 30, 2003 the
unrealized gain on investments in marketable securities was
insignificant. Cost is determined on the actual purchase price of the
marketable security for determining realized gains and losses. In the
first six months of 2003, there were no realized gains or losses.
Financial instruments that potentially subject SFBC to credit risk
consist principally of trade receivables. SFBC performs services and
extends credit based on an evaluation of the client's financial
condition without requiring collateral. Exposure to losses on
receivables is expected to vary by client due to the financial
condition of each client. SFBC monitors exposure to credit losses and
maintains allowances for anticipated losses considered necessary under
the circumstances. Additionally, SFBC, from time to time, maintains
cash balances with financial institutions in amounts that exceed
federally insured limits.
SFBC's financial instruments consist primarily of cash and cash
equivalents, marketable securities, accounts receivable, notes
receivable, accounts payable, and notes payable. At June 30, 2003, the
fair value of these instruments approximates the carrying amount of
these items due to the short-term maturities of these instruments.
At Anapharm where the local currency is the functional currency,
assets and liabilities are translated into United States dollars at
the exchange rate in effect at the end of the year or
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quarter. Revenues and expenses of Anapharm is translated at the
average exchange rate during the year. The aggregate effect of
translating the financial statements of Anapharm is included in a
separate component of stockholders' equity entitled "Accumulated Other
Comprehensive Earnings." For the quarter ended June 30, 2003, SFBC had
losses from foreign currency transactions of $550,000. Currency
translation risks arise primarily from Anapharm. SFBC does not hedge
its foreign currency risks.
On September 16, 2002, SFBC entered into a $10 million Revolving
Credit and Security Agreement with Wachovia Bank National Association,
which we expanded to $15 million on July 30, 2003. The interest rate
on this Credit Facility is LIBOR based and variable. As of June 30,
2003, our average interest rate on the entire Credit Facility was
3.5%. This Credit Facility enables SFBC to borrow for general working
capital purposes and for the purpose of financing acquisitions of
companies in related industries. This Credit Facility is secured by
substantially all of SFBC's assets. As of the date of this Report,
SFBC had borrowed approximately $9.9 million on this Credit Facility.
Changes in interest rates, and LIBOR in particular, will affect the
cost of funds should SFBC draw on such facility.
ITEM 4.
CONTROLS AND PROCEDURES
In accordance with Section 302 of the Sarbanes-Oxley Act of 2002 and
the rules thereunder, our chief executive officer and chief financial
officer reviewed our disclosure controls and procedures. This review
was completed within the time required by law, and these executive
officers reported the results to our audit committee. Based upon this
review, our chief executive officer and chief financial officer
concluded that our disclosure controls and procedures are effective
and are sufficient to meet the requirements for this report.
In addition, we reviewed our internal controls, and there have been no
significant changes in our internal controls or in other factors that
could significantly affect those controls subsequent to the date we
carried out this evaluation.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable.
ITEM 2. CHANGES IN SECURITIES
During the quarter ended June 30, 2003, we issued shares of our common
stock to the following individuals and corporation upon exercise of
options or warrants which were not covered by an effective
registration statement but were exempt under Section 4(2) of the
Securities Act of 1933:
DATE NAME NUMBER OF SHARES CONSIDERATION
---- ---- ---------------- -------------
June 26 , 2003 Andrew Dorman 1,690 Cashless exercise of
5,000 options
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) EXHIBIT INDEX
Exhibit
Number Description
- ------ ---------------------------------------------------------------------
3.1 Certificate of Incorporation(1)
3.2 First Amendment to Certificate of Incorporation(1)
3.3 Certificate of Correction to Certificate of Incorporation(2)
3.4 Bylaws(1)
3.5 First Amendment to the Bylaws(2)
3.6 Second Amendment to the Bylaws (3)
31.1 Certification of Chief Executive Officer
31.2 Certification of Chief Financial Officer
32.1 Section 1350 Certification of Chief Executive Officer.
32.2 Section 1350 Certification of Chief Financial Officer.
(1) Contained in Form SB-2 filed on August 17, 1999.
(2) Contained in Form SB-2 filed on October 5, 2000.
(3) Contained in Form 10-KSB for the fiscal year ended December 31, 2002 filed
on March 31, 2003.
(b) REPORTS ON FORM 8-K.
On May 6, 2003, we filed a Form 8-K containing a press release dated May 5, 2003
disclosing our first quarter 2003 results of operations.
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, the
registrant caused this report to be signed on its behalf on August 14, 2003 by
the undersigned, thereunto duly authorized.
SFBC INTERNATIONAL, INC.
/s/ Arnold Hantman
---------------------------------------
Arnold Hantman, Chief Executive Officer
/s/ David Natan
------------------------------------
David Natan, Chief Financial Officer
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