ITEM 1. BUSINESS.
INTRODUCTION
Synetic, Inc. ("Synetic") is a Delaware corporation and was incorporated in 1989. Its principal offices are located at 669 River Drive, Elmwood Park, New Jersey 07407, and its telephone number is (201) 703-3400. As used herein, the "Company" means Synetic and its subsidiaries, except where the context otherwise requires.
Synetic is engaged in two principal business activities, plastics technologies and healthcare communications. Porex Technologies Corp. (together with its subsidiaries, "Porex"), a wholly owned subsidiary of the Company, designs, manufactures and distributes porous and solid plastic components and products used in health care, industrial and consumer applications. Porex's principal products, which incorporate porous plastics, are used to filter, wick, drain, vent or control the flow of fluids or gases. Through its wholly owned subsidiary, Avicenna Systems Corporation ("Avicenna"), the Company has directed its efforts in a new area of business relating to the use of Internet technology to expand the channels of communication in the healthcare industry. The creation of these new channels is intended to benefit providers and payors of healthcare services by improving the quality of patient care, securing appropriate utilization of healthcare services, reducing administrative costs and enforcing benefit plan guidelines.
Prior to June 28, 1989, the date of the initial public offering of the Company, the Company was an indirect wholly owned subsidiary of Medco Containment Services, Inc. ("Medco"). Thereafter, the Company became a publicly held, partially owned subsidiary of Medco. Medco provided health care cost containment services, principally managed prescription drug programs, to benefit plan sponsors. On November 18, 1993, Medco was acquired by Merck & Co., Inc. ("Merck") in a merger transaction (the "Merck/Medco Merger"), and as a result, the Company became an indirect, partially owned subsidiary of Merck. Merck is a pharmaceutical manufacturer. Until December 14, 1994, the Company's operations consisted of Porex and a group of subsidiaries that provided institutional pharmacy services (the "Institutional Pharmacies Business").
On December 14, 1994, the Company consummated certain transactions pursuant to which: (1) the Company sold the Institutional Pharmacies Business to Pharmacy Corporation of America, an indirect wholly owned subsidiary of Beverly Enterprises, Inc. (such sale is referred to herein as the "Divestiture"), for approximately $107,300,000; (2) the Company purchased 5,268,463 shares of its Common Stock from Merck for an aggregate purchase price of $37,764,019, pursuant to the Purchase and Sale Agreement, dated as of May 24, 1994, between the Company and Merck; and (3) SN Investors, L.P. ("SN Investors"), a limited partnership the general partner of which is SYNC, Inc. (the "General Partner"), whose sole stockholder is Martin J. Wygod, purchased 5,061,857 shares of Common Stock (the "Wygod Shares") from Merck for an aggregate purchase price of $36,283,079, pursuant to an assignment by the Company of the right to purchase such shares from Merck contained in an Investment Agreement between Mr. Wygod and the Company, dated as of September 13, 1994 (the "Investment Agreement"). The purchases of shares of Common Stock from Merck by the Company and SN Investors are hereinafter referred to as the "Purchase." As a result of the consummation of the Purchase, Mr. Wygod and SN Investors own an aggregate of approximately 29.3% of the outstanding Common Stock as of September 15, 1997 and Merck no longer owns an equity interest in the Company. The shares of Common Stock purchased by the Company are being held as treasury shares and are no longer outstanding or entitled to vote.
The Company maintains an acquisition program and intends to concentrate its acquisition efforts in businesses which are complementary to the Company's healthcare communications strategy. This emphasis, however, is not intended to limit in any manner the Company's ability to pursue acquisition opportunities in other healthcare-related businesses or in other industries. The Company's acquisition program could result in a substantial
change in the businesses, operations and financial condition of the Company. No assurance can be given that the Company will succeed in consummating any acquisitions or that the Company will be able to successfully manage or integrate any business that it acquires. The future growth of the Company will depend primarily on its ability to consummate one or more such acquisitions and to operate such businesses successfully. See "--Acquisition Program".
FORWARD-LOOKING INFORMATION
This report contains certain forward-looking statements and information relating to the Company that are based on the beliefs of the Company's management as well as assumptions made by and information currently available to the Company's management. When used in this report, the words "anticipate", "believe", "estimate", "expect" and similar expressions, as they relate to the Company or the Company's management, are intended to identify forward-looking statements. Such statements reflect the current view of the Company with respect to future events and are subject to certain risks, uncertainties and assumptions. These risks may include product demand and market acceptance risks, the feasibility of developing commercially profitable Internet healthcare services, the effect of economic conditions, user acceptance, the impact of competitive products, services and pricing and product development, commercialization and technological difficulties and other risks described in "Plastic Technologies Business--Regulation", "--Competition", "--Potential Liability Risk and Availability of Insurance", "Healthcare Communications Business--Certain Considerations" and "Management's Discussion and Analysis of Financial Condition and Results of Operations". Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated or expected. The Company does not intend to update these forward-looking statements.
PLASTICS TECHNOLOGIES BUSINESS
GENERAL
Porex Technologies Corp., a wholly owned subsidiary of the Company, designs, manufactures and distributes porous and solid plastic components and products used in health care, industrial and consumer applications. Porex's principal products are porous plastics that are used to filter, wick, drain, diffuse, vent or control the flow of fluids or gases. A large percentage of Porex's products are sold to other manufacturers for incorporation into their products.
Porex's health care products include proprietary products manufactured and sold under Porex's trade names. These products are sold for clinical and medical/surgical use in hospitals, clinics, physicians' offices and laboratories. Porex also manufactures and sells a line of plastic vials and produces components made to the specifications of original equipment manufacturers ("OEMs") for incorporation into their health care products. Porex's industrial and consumer products consist primarily of custom- manufactured components made for manufacturers of industrial and consumer products.
Porous plastics are permeable plastic structures having omni-directional (i.e., porous in all directions to the flow of fluids or gases) interconnecting pores. Porous plastics are manufactured by Porex with pore sizes between approximately 5 and 500 micrometers (one micrometer is equal to one-millionth of a meter; an object of 40 micrometers in size is about as small as can be discerned by the naked eye). Porous plastic materials can be molded from several thermoplastic raw materials and are produced by Porex at its own manufacturing facilities as fabricated devices, custom-molded shapes, sheets, tubes or rods depending on application or manufacturer specifications. Porex also purchases for resale through its distribution channels certain products which are complementary to its manufactured product lines.
HEALTH CARE PRODUCTS
Porex's proprietary products for life sciences, clinical and surgical applications include blood serum filters, blood tube closure devices, pipette tips and a line of medical/surgical products designed primarily for use in plastic and reconstructive surgery and maxillofacial surgery. Porex also manufactures and sells a line of plastic vials and produces components for incorporation into health care products made by OEMs.
LIFE SCIENCES AND CLINICAL PRODUCTS. Porex's blood serum filters are used to separate microscopic particles and fibrous matter (fibrin) from centrifuged blood serum to prevent clogging of automated laboratory chemical analysis equipment. Porex also manufactures a line of closure devices that are used with blood serum filters and tubes. In response to health concerns regarding the handling of human blood, new blood testing equipment has been developed which does not require filtered blood serum for analysis, or which eliminates the need for handling of blood serum by medical personnel. The use of such new equipment has reduced the demand for Porex's current line of blood serum filters.
Porex produces a line of filtered and non-filtered pipette tips which are used for dispensing fluids, primarily in industrial research laboratories.
SURGICAL PRODUCTS. Porex's surgical products are marketed primarily to surgeons who specialize in plastic and reconstructive surgery and maxillofacial surgery. The product line includes MEDPOR(R) Surgical Implant material, which is polymeric biomaterial used for craniofacial reconstruction and augmentation, and TLS(R) Surgical Drainage Systems for small wound sites. Porex also markets TLS(TM) Surgical Marker pens to mark the areas of proposed surgical incision. Porex manufactures MEDPOR(R) Surgical Implant material and distributes, and in some cases assembles, the other items in its surgical product line.
OEM MEDICAL PRODUCTS. Porex manufactures various porous plastic components that it sells to other health care product manufacturers for incorporation into their finished products. These porous plastics are used to vent or diffuse gases or fluids and are used as membrane supports in other manufacturers' products. The components include (i) disks used to support membranes, modules and other filtration devices, (ii) a venting system for catheters which allows air to vent from a catheter as it is inserted into a vein, while at the same time preventing blood spillage and possible contamination of hospital personnel, (iii) a porous disk used in pipette tips to prevent the fluid to be pipetted from passing into the pipette instrument, and (iv) an oxygen diffuser, which is typically used in oxygen therapy equipment to humidify oxygen.
VIAL AND SOLID PLASTIC COMPONENTS. Porex manufactures and sells a full line of plastic vials for pharmaceuticals. Porex also produces close tolerance solid plastic components which use most thermoplastic resins, but primarily polystyrene, polypropylene and thermoplastic rubber for medical and industrial applications. These products are custom designed and produced to satisfy individual customer specifications.
INDUSTRIAL PRODUCTS
Porex manufactures a variety of custom porous plastic components for industrial applications. These components are produced as molded shapes, and in sheets, tubes and rods, individually designed to customer specifications as to size, rigidity, porosity and other needs.
Porex's industrial applications include (i) automotive products, primarily porous plastic vents used in automobile batteries as a flame arrester, (ii) wastewater treatment filter support media, (iii) filters to remove particulate matter, oil and water residues from compressed air lines, (iv) silencers and mufflers to reduce sound levels produced by compressed air exhaust, and (v) products for facilitating the movement of powdered materials. Porex also manufactures a large variety of highly specialized plastic components to meet specific applications for manufacturers.
CONSUMER PRODUCTS
Porex manufactures a line of porous plastic components used in a variety of home and office products and appliances. Porex's consumer products include a variety of writing pen tips or "nibs" which Porex supplies to manufacturers of marking and highlighting pens. The porous nib conducts the ink stored in the pen barrel to the writing surface by capillary action. Porex produces a variety of porous plastic filters used in home water filters and conditioners. The filters are used for particle and sediment removal through devices attached to a sink or faucet. The Company also manufactures filters incorporating activated carbon used to reduce chlorine levels in drinking water thereby improving its taste and odor. Porex's porous plastic components are used in health and beauty aid products (such as deodorant and fragrance applicators).
MARKETING AND DISTRIBUTION
As of June 30, 1997, Porex had over 300 customers for its porous and solid plastic products. Porex distributes its proprietary blood serum filters, pipette tips and related products through independent distributors. Porex's surgical products are sold primarily through independent dealers and agents. In the United States, sales of OEM health care products, industrial products and consumer products are made directly by Porex's marketing staff. Internationally, such products are sold by Porex's marketing staff in certain countries and through independent distributors and agents in other countries who work in conjunction with Porex's marketing staff. Export sales, which are made principally to Europe and Asia, consist primarily of Porex's OEM medical product, industrial product and consumer product lines. For the fiscal year ended June 30, 1997, Porex's foreign and export product sales were approximately $14,067,000, or 27% of sales, as compared to approximately $12,270,000, or 27% of sales, for the fiscal year ended June 30, 1996 and approximately $10,403,000 or 27% of sales, for the fiscal year ended June 30, 1995. See Note 6 to the Consolidated Financial Statements. No customer accounted for more than 10% of Porex's total net sales for the fiscal years ended June 30, 1996 and 1997.
Porex has a marketing staff of 16 professional employees, nine of whom work with manufacturers on matters which include development of component products to help solve such manufacturers' problems.
SEASONALITY AND BACKLOG
Sales of certain of Porex's product lines are somewhat seasonal but the overall businesses are not seasonal to any significant extent. At June 30, 1997, Porex's backlog was approximately $9,715,000, as compared to approximately $8,162,000 at June 30, 1996. The backlog consists primarily of blanket orders with release dates of up to 12 months, the full amounts of which are expected to be filled over a 12-month period.
PRODUCT AND PROCESS DEVELOPMENT
Porex maintains a continuing development program devoted primarily to porous materials and their applications and proprietary products for the life sciences and clinical laboratories. Development activities include designing new and improved products, either proprietary or for customers' specific requirements, and new manufacturing processes.
Porex's development expenditures were approximately $1,791,000, $2,014,000 and $1,490,000 for the fiscal years ended June 30, 1997, 1996 and 1995, respectively. Recently, new product development activities have focused on porous components for use in health care and other applications and proprietary products for the life sciences market.
RAW MATERIALS
The principal raw materials used by Porex in its plastic products business are a variety of plastic resins which are generally available from a number of suppliers in the United States in adequate quantities to meet Porex's
needs. Porex has been able to obtain adequate supplies of raw materials and believes that sufficient supplies will be available in the foreseeable future. Porex has no long-term supply contracts for the purchase of raw materials. Because the primary resource used in plastic resins is petroleum, the cost and availability of plastic resins for use in Porex's products varies to a great extent with the price of petroleum. Porex's inability to acquire sufficient plastic resins at a reasonable price would affect Porex's ability to maintain its margins in the short term.
Porex requires high-grade plastic resins with specific properties as raw materials for certain of its porous plastic products. Accordingly, shipments of raw materials from suppliers are closely monitored for compliance with Porex's standards. Porex has routinely rejected pre-shipment samples of product from raw material suppliers. Although there are various suppliers of high-grade plastic resins with specific properties and Porex has not experienced any material difficulty in obtaining adequate supplies of high-grade materials, the inability to obtain such high-grade plastic resins, or any raw materials, could have a material adverse effect on Porex. To ensure the availability of high- grade plastic resins with specific properties, Porex occasionally purchases more than it would otherwise currently require. Porex maintains an inventory of raw materials sufficient to satisfy its production needs for an extended period of time.
For its solid plastic products, Porex utilizes commercial grade thermoplastic resins, including polyethylene, polypropylene and polystyrene. Such materials are readily available from a number of sources and Porex is not dependent on any single source of supply. Because of the ready availability of such materials, Porex does not maintain a significant inventory of such raw materials.
PATENTS AND TRADEMARKS
Porex owns a number of patents and trademarks in the United States and foreign countries. The majority of Porex's patents and patent applications relate to porous plastics and medical devices. Porex is the exclusive licensee of a patented valve device used in one model of its blood serum filters, and of a patent on a surgical drain device. Porex does not consider either license to be material to its business operations. Porex owns one patent on blood serum filters. Although Porex deems its patents to be important to its business and intends to continue to seek patent protection when deemed appropriate, no significant portion of the business of Porex is believed by management to be materially dependent on any particular patent. Porex believes that its non- patented manufacturing processes are protected under contractual and other legal principles which, however, do not afford the statutory exclusivity possible for patented processes.
REGULATION
The developing, testing, marketing and manufacturing of medical devices such as plastic and reconstructive surgical implants and tissue expanders are regulated under the Medical Device Amendments of 1976 to the Federal Food, Drug and Cosmetic Act (the "1976 Amendments") and additional regulations promulgated by the Food and Drug Administration (the "FDA"). In general, these statutes and regulations require that manufacturers adhere to certain standards designed to ensure the safety and effectiveness of medical devices. Compliance with such requirements and the process of obtaining approvals can be costly, complicated and time-consuming and there can be no assurance that such approvals will be granted on a timely basis. When Porex merely distributes devices manufactured by others, the actual manufacturer must bear the cost of achieving compliance with these requirements.
Under the 1976 Amendments, each medical device manufacturer must be a registered device manufacturer and must comply with regulations applicable generally to manufacturing practices and clinical investigations involving humans. The FDA is authorized to obtain and inspect devices, their labeling and advertising, and to inspect the facilities in which they are manufactured in order to ensure that a device is not improperly manufactured or labeled. Porex is registered with the FDA.
In addition, the sale and marketing of specific medical devices are regulated by the FDA under the 1976 Amendments, which classify medical devices based upon the degree of regulation deemed appropriate and necessary. A device is classified as a Class I, II or III device based on recommendations of advisory panels appointed by the FDA. Class I devices are subject only to general controls. Class II devices, in addition to general controls, are subject to performance standards. Class III devices, including most devices used or implanted in the body, require FDA pre-market approval before they may be distributed other than in clinical trials.
Porex's MEDPOR(R) Surgical Implants are regulated as Class II medical devices. Products which Porex may introduce in the future, if any, may also be classified as Class I, Class II or Class III medical devices. The procedure for obtaining classification of a new device as a Class I or Class II device involves the submission of a petition to the FDA. If the FDA determines that the device is substantially equivalent to a pre-enactment device or a device subsequently classified in Class I or Class II, then within 210 days of the filing of the petition it will grant approval to market the device commercially. If the FDA determines the device is not substantially equivalent to a pre- enactment device or a device subsequently classified in Class I or Class II, it is automatically placed into Class III and will either require reclassification or the submission of valid scientific evidence to prove the device is safe and effective for human use. Devices to be implanted will be categorized as Class III unless such classification is not necessary to ensure their safety and effectiveness. For new Class III devices, Porex may submit to the FDA an application for an Investigational Device Exemption ("IDE"). An approved IDE exempts Porex from certain otherwise applicable FDA regulations and grants approval for a clinical investigation, or human study, to generate data to prove safety and effectiveness. In addition, the possibility exists that certain pre- enactment, or substantially equivalent, devices may be placed into Class III by the FDA.
When a manufacturer believes that sufficient clinical data have been generated to prove the safety and effectiveness of the device, it may submit a pre-market approval application ("PMA") to the FDA. The FDA reviews the PMA and determines whether it is in submittable form and all key elements have been included. Following acceptance of the PMA, the FDA continues its review process which includes submission of the PMA to a panel of experts appointed by the FDA to review the PMA and to recommend appropriate action. The panel then recommends that the PMA be approved, not approved or approved subject to conditions. The FDA may act according to the panel's recommendations, or it may overrule the panel. In approving a PMA, the FDA may require some form of post- market surveillance or other restrictions.
Vials that are used to contain and transport pharmaceuticals are not directly regulated by the Food and Drug Administration. The US Pharmacopeia specifies tests and properties that are necessary to maintain the potency and pharmacological properties of the medicine the vial is to be used for. The U.S. Consumer Product Safety Commission specifies in 16 CFR Part 1700 the tests that a vial must pass to be considered child resistant and senior adult user friendly. Porex's vials have been designed to meet such standards.
Certain environmental regulations also apply to Porex's business, and the Company believes that Porex is in substantial compliance with all of such regulations. However, Porex is subject to random and scheduled checks by environmental authorities. The Company does not anticipate that any material capital expenditures will be required to comply with environmental regulations.
COMPETITION
Competition in Porex's plastic products business is characterized by technological change, product obsolescence and the introduction of competitive products at lower prices. The Company believes Porex's principal competitive strengths are its manufacturing processes, quality control, relationship with its customers and distribution of its proprietary healthcare products.
In the porous plastics area, Porex's competitors include other producers of porous plastic materials as well as companies that manufacture and sell products made from materials other than porous plastics which can be used for the same purposes as Porex's products. In this field, Porex has several direct competitors in the United States
and two significant direct competitors in Europe. Porex competes with several manufacturers of blood serum filters whose products perform the same function as Porex's original blood serum filter and its other blood serum filters and which utilize technologies both similar to and different from Porex's products. Porex's porous plastic pen nibs compete with felt and fiber tips manufactured by a variety of suppliers in the United States and other countries. Other of Porex's industrial products made of porous plastic compete, depending on the industrial application, with porous metals, metal screens, fiberglass tubes, pleated paper, resin-impregnated felt, ceramics and other substances and devices.
The market for Porex's injection molded solid plastic components and products is highly competitive and highly fragmented. The MEDPOR(R) Biomaterial products compete for surgical use against autogeneous and allograph materials and alloplastic biomaterials. Autogenous grafts are bone, tissue or cartilage taken from the patient and allographs are donor bone, tissue or cartilage. Competitive alloplastic materials include: solid silicone implant shapes, porous hydroxyapitite shapes and granules, and PTFE sheet material. The Company's surgical drains and markers compete against a variety of products from several manufacturers.
POTENTIAL LIABILITY RISK AND AVAILABILITY OF INSURANCE
The products sold by Porex expose it to potential risk for product liability claims, particularly with respect to Porex's Life Sciences, Clinical and Surgical products. The Company believes that Porex carries adequate insurance coverage against product liability claims and other risks. There can be no assurance, however, that claims in excess of Porex's insurance coverage will not arise. In addition, Porex's insurance policies must be renewed annually. In 1994, Porex was notified that its insurance carrier would not renew its then-existing insurance coverage after December 31, 1994 with respect to actions and claims arising out of Porex's distribution of silicone mammary implants. However, Porex has exercised its right to purchase extended reporting period coverage with respect to such actions and claims. Such coverage provides insurance, subject to existing policy limits but for an unlimited time period, with respect to actions and claims made after December 31, 1994 that are based on events that occurred during the policy period. Although Porex has been able to obtain adequate insurance coverage at an acceptable cost in the past and seeks indemnification for products manufactured by others and distributed by it, there can be no assurance that in the future it will be able to obtain such insurance at an acceptable cost or be adequately protected by such indemnification. See "--Health Care Products" and "Item 3. Legal Proceedings-- Mammary Implant Litigation".
HEALTHCARE COMMUNICATIONS BUSINESS
BUSINESS STRATEGY
The Company's objective is to use Internet technology to create an influential interactive health services channel linking physicians with the payors, suppliers and consumers of healthcare in order to control healthcare costs and improve patient outcomes. The Company expects to provide a content- neutral, application rich utility thereby creating a channel which serves as a conduit for the private content that any healthcare organization wishes to communicate to physicians and other healthcare providers. There can be no assurances given as to a specific time frame for the Company's first commercial introduction of its products and services. The Company anticipates that it will incur significant expenses in connection with the development of these products and services. The provision of products and services using Internet technology in the healthcare communications industry is a developing business.
Key elements of the Company's strategy are to:
. Develop and deploy a low-cost service that provides physicians access to a suite of communication, information and transaction functions. This secure, online network will offer physicians one solution to their needs for (i) messaging services such as electronic mail, discussion
groups and forums; (ii) information or content relevant to their practices such as reference materials, medical databases and payor- specific policies and procedures; and (iii) transaction applications covering high volume, routine administrative, financial and clinical transactions. This service is intended to enable physicians to seek information and conduct transactions in a uniform manner for all patients, the results of which should be to help physicians practice medicine more efficiently in today's managed care environment.
. Differentiate this suite of client server applications by its ability to allow physicians and their staffs to conduct not only administrative and financial but also clinical transactions. These transactions would include but not be limited to prescription writing, drug utilization and formulary review, eligibility verification, referrals, treatment authorizations, claims and encounter submissions, as well as laboratory test submission and reporting, and pharmacy routing. The ability to integrate payor-specific content such as benefit rules and care guidelines with patient-specific information at the time of treatment will significantly enhance the delivery of high quality, cost-effective care.
. Contract with managed care organizations, integrated health delivery systems, pharmacy benefit managers and clinical laboratories so that they might provide physicians with access to their proprietary benefit plan information and treatment guidelines as well as their administrative and managed care processes. The Company's management believes that this new channel of communications will allow each of the parties to (i) leverage their existing healthcare information systems infrastructure, (ii) integrate their proprietary rules and guidelines with transactions, and (iii) realize administrative and medical resource savings while improving provider relationships and streamlining managed care processes. The Company anticipates it will be compensated by such parties as a result of the value created.
The Company is not aware of any business which currently provides the scope and breadth of the services described above. However, various companies including, but not limited to, certain physician office management information systems companies, EDI/data networking companies, online medical information service companies, and systems integration companies, some of which may have greater resources than the Company, have announced that they are developing a combination of one or more of these products and services. There can be no assurance that such companies will not develop and successfully market the healthcare communications products and services described herein in a manner which would have a material adverse effect on the Company.
ACQUISITIONS
The Company has completed two acquisitions which form the foundation of its healthcare communications business. On December 24, 1996, the Company acquired all of the outstanding equity and indebtedness (including stock options) of Avicenna, a privately held development stage company located in Cambridge, Massachusetts, for shares of Synetic Common Stock with a market value of $30.5 million at the time of the acquisition. As additional consideration, the Company issued to certain of the sellers nontransferable warrants covering 250,000 shares of Synetic Common Stock, exercisable after December 23, 1998 at a price of $54.50 per share. On January 23, 1997, the Company acquired privately held CareAgents, Inc. ("CareAgents") for shares of Synetic Common Stock with a market value of $5 million at the time of the acquisition. As of June 30, 1997, Avicenna and CareAgents have, collectively, 68 employees.
During the fiscal year ended June 30, 1997, the Company recorded a non- recurring charge of $37.4 million primarily relating to purchased research and development costs in conjunction with its acquisitions of Avicenna and CareAgents. Under generally accepted accounting principles, the amount of purchase price allocable to purchased research and development costs is required to be expensed immediately after the acquisition.
As a result of the acquisitions of Avicenna and CareAgents, the Company expects to incur significant ongoing research and development expenditures in connection with this new area of business. For the six months
ended June 30, 1997, such expenditures were approximately $5.0 million. There can be no assurances that the products or services developed by the Company will be successfully marketed.
The Company is pursuing the development of its healthcare communications business through the use of its internal resources as well as pursuing the acquisition of complementary businesses. The Company anticipates that it may enter into acquisitions, joint ventures, strategic alliances or other business combinations. These transactions may materially change the nature and scope of this business. There can be no assurance that the Company will succeed in consummating such transactions or that such transactions will ultimately provide the Company with the ability to offer the products and services described.
HEALTHCARE COMMUNICATIONS BUSINESS--CERTAIN CONSIDERATIONS
NEW BUSINESS AREA--HEALTHCARE COMMUNICATIONS
INITIAL DEVELOPMENT PHASE. The Company is in the initial development phase of offering products and services to provide inter-enterprise connectivity to payors and providers in the healthcare industry. The provision of products and services using Internet technology in the healthcare communications industry is a developing business. There can be no assurances given as to a specific time frame for the Company's first commercial introduction of its products and services. The Company anticipates that it will incur significant expenses in connection with the development of these products and services. There can be no assurance that these products and services will be successfully developed by the Company. Avicenna, the Company's first acquisition in this area, has operated at a loss since its inception two years ago. CareAgents, the Company's second acquisition in this area, founded in 1996, is a start-up company with a very limited operating history. The Company is pursuing the development of its healthcare communications business through the use of its internal resources as well as pursuing the acquisition of complementary businesses. The Company anticipates that it may enter into acquisitions, joint ventures, strategic alliances or other business combinations. These transactions may materially change the nature and scope of this business. There can be no assurance that the Company will succeed in consummating such transactions or that such transactions will ultimately provide the Company with the ability to offer the products and services described.
UNCERTAINTY OF MARKET ACCEPTANCE. As is typical in a developing business, demand and market acceptance for new and unproven products and services are subject to a high level of uncertainty. Achieving market acceptance for the Company's products and services will require substantial marketing efforts and expenditure of significant funds to create awareness and demand by participants in the healthcare industry. No assurances can be given that the Company's effort in establishing such products and services will be successful, that the Company will be able to succeed in positioning its services as a preferred method for healthcare communications, that there will be significant market acceptance for its products and services or that any pricing strategy developed by the Company will be economically viable or acceptable to the market.
RESEARCH AND DEVELOPMENT EXPENSES; PROFITABILITY. Synetic expects to continue to incur significant research and development expenses in connection with its healthcare communications business until the products and services developed by the Company are successfully marketed. There can be no assurance (i) that the products or services will be successfully marketed or (ii) as to when, and to what extent, if any, the healthcare communications business of the Company will become profitable.
GOVERNMENT REGULATION OF HEALTHCARE
Participants in the heatlthcare industry are subject to extensive and frequently changing regulation under numerous laws administered by governmental entities at the federal, state and local levels. Many current laws and regulations, when enacted, did not anticipate the methods of healthcare communication under development by the Company. The Company believes, however, that those laws and regulations will nonetheless be applied to the
Company's healthcare communications business. Accordingly, the Company's healthcare communications business may be affected by current regulations as well as future regulations specifically targeted to this new segment of the healthcare industry.
Current laws and regulations which may affect the healthcare communications business include (i) the regulation of confidential patient medical record information, (ii) laws relating to the electronic transmission of prescriptions from physicians' offices to pharmacies, (iii) regulations governing the use of software applications in the diagnosis, cure, treatment, mitigation or prevention of disease and (iv) laws or regulations relating to the relationships between or among healthcare providers. In addition, physicians, insurance companies, pharmacies and other participants in the healthcare industry are subject to their own laws and regulations which may affect the Company's healthcare communications business. The Company expects to conduct its healthcare communications business in substantial compliance with all material federal, state and local laws and regulations governing its operations. However, the impact of regulatory developments in the healthcare industry is complex and difficult to predict, and there can be no assurance that the Company will not be materially adversely affected by existing or new regulatory requirements or interpretations.
RELIANCE ON RAPIDLY CHANGING TECHNOLOGY
All businesses which rely on Internet technology, including the healthcare communications business described herein, are subject to rapid technological change, changing customer needs, frequent new product introductions and evolving industry standards. In addition, as the communications, computer and software industries continue to experience rapid technological change, the Company must be able to quickly and successfully adapt its products and services so that they adapt to such changes. There can be no assurance that the Company will not experience difficulties that could delay or prevent the successful development and introduction of its healthcare communications products and services. The Company's inability to respond to technological changes in a timely and cost- effective manner could have a material adverse effect on the Company's business, financial condition and results of operations. Moreover, there can be no assurance that technologically superior products and services will not be developed by competitors, or that any such products and services will not have an adverse effect upon the Company's operating results.
COMPETITION IN HEALTHCARE COMMUNICATIONS
The Company is not aware of any business which currently provides the scope and breadth of the healthcare communications products and services currently being developed by the Company. However, various companies including, but not limited to, certain physician office management information systems companies, EDI/data networking companies, online medical information service companies and system integration companies, some of which may have greater resources than the Company, have announced that they are developing a combination of one or more of these products and services. There can be no assurance that such companies will not develop and successfully market the healthcare communications products and services described herein in a manner which would have a material adverse effect on the Company.
RISKS OF PRODUCT DEVELOPMENT; PROPRIETARY RIGHTS
The Company's future success and ability to compete in the healthcare communications business may be dependent in part upon its proprietary rights to products and services which it develops. The Company may rely on a combination of copyrights, trademarks and trade secrets and contractual restrictions to protect its content and technology and on similar proprietary rights of its content and technology providers. There can be no assurance that the steps taken by the Company or such providers would be adequate to prevent misappropriation of their respective proprietary rights or that the Company's competitors will not independently develop content or technology that are substantially equivalent or superior. In addition, there can be no assurance that licenses for any intellectual property of third parties that might be required for the Company's products or services would be available on commercially reasonable terms or at all. Although the Company intends to take steps to ensure that it is not
infringing the proprietary rights of any third parties, there can be no assurance that patent infringement or other claims will not be asserted against the Company or one of its content or technology providers or that such claims will not be successful. The Company could incur substantial costs and diversion of management resources with respect to the defense of any such claims. Furthermore, parties making such claims against the Company or a content or technology provider could secure a judgment awarding substantial damages, as well as injunctive or other equitable relief which could effectively block the Company's ability to provide products or services in certain of its markets. Such a judgment could have a material adverse effect on the Company's business, financial condition and results of operations.
ACQUISITION PROGRAM
The Company maintains an acquisition program and intends to concentrate its acquisition efforts on businesses which are complementary to the Company's healthcare communications strategy, but such emphasis is not intended to limit in any manner the Company's ability to pursue acquisition opportunities in other healthcare-related businesses or in other industries. The Company anticipates that it may enter into acquisitions, joint ventures, strategic alliances or other business combinations. These transactions may materially change the nature and scope of the business. Any transactions will be limited, as required by agreements to which the Company is a party, to areas of business which would not be competitive with certain businesses of Merck & Co., Inc. and its subsidiaries or with the Institutional Pharmacies Business. Although management of the Company will endeavor to evaluate the risks inherent in any particular transaction, there can be no assurance that the Company will properly ascertain all such risks. In addition, no assurances can be given that the Company will succeed in consummating any such transactions, that such transactions will ultimately provide the Company with the ability to offer the products and services described or that the Company will be able to successfully manage or integrate any resulting business.
The success of the Company's acquisition program will depend on, among other things, the availability of suitable candidates, the availability of funds to finance transactions, and the availability of management resources to oversee the operation of resulting businesses. Financing for such transactions may come from several sources, including, without limitation, (a) cash and cash equivalents on hand and marketable securities and (b) proceeds from the incurrence of indebtedness or the issuance of additional Common Stock, preferred stock, convertible debt or other securities. The issuance of additional securities, including Common Stock, could (i) result in substantial dilution of the percentage ownership of the stockholders of the Company at the time of any such issuance, (ii) result in substantial dilution of the Company's earnings per share and (iii) adversely affect the prevailing market price for the Common Stock. The proceeds from any financing may be used for costs associated with identifying and evaluating prospective candidates, and for structuring, negotiating, financing and consummating any such transactions and for other general corporate purposes. The Company does not intend to seek stockholder approval for any such transaction or security issuance unless required by applicable law or regulation. Although Mr. Martin J. Wygod, Chairman of the Board of the Company, has indicated his intention to assist the Company in its acquisition program by bringing opportunities for potential transactions to the Company and to assist the Company in negotiating such transactions and in seeking financing in the event any such transaction were to be financed by the Company, he is not an officer or an employee of the Company nor is he required pursuant to any contractual obligation to provide such support or assistance.
EMPLOYEES
As of June 30, 1997, the Company had 711 employees.
ITEM 2.
ITEM 2. PROPERTIES.
The Company leases approximately 10,000 square feet of corporate office space in Elmwood Park, New Jersey. Porex owns a total of 71 acres of land at three locations in Georgia with four buildings with an approximate
area of 242,000 square feet, used for manufacturing, research, office space and warehouse purposes. Porex also owns a manufacturing and warehouse facility in Bautzen, Germany with approximately 54,000 square feet in three buildings and leases a 55,000 square feet manufacturing and warehouse facility in College Point, New York and a 4,600 square feet manufacturing and warehouse facility in Kings Lynn, England. Avicenna leases 46,000 square feet of space in Cambridge, Massachusetts used for the operation of the Company's healthcare communications business.
The Company believes its facilities and equipment are well maintained, in good operating condition and, in general, suitable for the Company's purposes and adequate for its present operation.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
The description below of the mammary implant litigation and certain other litigation contain forward-looking statements with respect to possible events, outcomes or results that are, and are expected to continue to be, subject to risks, uncertainties and contingencies, including but not limited to the respective risks, uncertainties and contingencies identified in such descriptions. See "Introduction--Forward-Looking Information".
MAMMARY IMPLANT LITIGATION. During the year ended June 30, 1988, Synetic's subsidiary, Porex began distributing silicone mammary implants ("implants") in the United States pursuant to a distribution arrangement (the "Distribution Agreement") with a Japanese manufacturer (the "Manufacturer"). Because of costs associated with increased government regulation and examination, Porex's supplier determined to withdraw its implants from the United States market. On July 9, 1991, the FDA mandated a recall of all implants manufactured by companies that elected not to comply with certain FDA regulations regarding data collection. Accordingly, Porex notified all of its customers not to use any implants sold by Porex and to return such implants to Porex for a full refund. Porex had ceased offering implants for sale prior to the recall date. Porex believes that after accounting for implants returned to it, the aggregate number of recipients of implants distributed by Porex under the Distribution Agreement in the United States totals approximately 2,500.
Since March 1991, Porex has been named as one of many co-defendants in a number of actions brought by recipients of implants. One of the pending actions, Donna L. Turner v. Porex Technologies Corporation, et al., is styled as a purported class action. Certain of the actions against Porex have been dismissed where it was determined that the implant in question was not distributed by Porex. In addition, as of September 10, 1997, 61 claims have been settled on a favorable basis by the Manufacturer, or by the insurance carriers of Porex, without material cost to Porex. As of September 10, 1997, 225 actions and 31 out-of-court claims were pending against Porex. Of the 225 actions, 108 involve implants identified as distributed by Porex and 84 cases involve implants identified as not having been distributed by Porex. In the remaining 33 actions, the implants have not been identified. The number of claims made by individuals during the fiscal year ended June 30, 1997 was similar to the number of claims made during the fiscal year ended June 30, 1996, both of which were significantly lower than the number of claims made during the fiscal year ended June 30, 1995.
The typical case or claim alleges that the individual's mammary implants caused one or more of a wide range of ailments. These implant cases and claims generally raise difficult and complex factual and legal issues and are subject to many uncertainties and complexities, including, but not limited to, the facts and circumstances of each particular case or claim, the jurisdiction in which each suit is brought, and differences in applicable law. The Company does not have sufficient information to evaluate each case and claim.
In 1994, Porex was notified that its insurance carrier would not renew its then-existing insurance coverage after December 31, 1994 with respect to actions and claims arising out of Porex's distribution of implants. However, Porex has exercised its right, under such policy, to purchase extended reporting period coverage with respect to such actions and claims. Such coverage provides insurance, subject to existing policy limits but for an unlimited time period, with respect to actions and claims made after December 31, 1994 that are based on events
that occurred during the policy period. In addition, Porex has other excess insurance where it has similarly purchased extended reporting period coverage which by its terms would expire December 31, 1997. However, Porex expects to purchase further extended reporting period coverage from the excess insurers to the extent such coverage is reasonably available. The Company believes that its present coverage, together with Porex's insurance policies in effect on or before December 31, 1994, should provide adequate coverage against liabilities that could result from actions or claims arising out of Porex's distribution of implants. To the extent that certain of such actions and claims seek punitive and compensatory damages arising out of alleged intentional torts, if awarded such damages may or may not be covered, in whole or in part, by Porex's insurance policies. In addition, Porex's recovery from its insurance carriers is subject to policy limits and certain other conditions. Porex has been expensing the retention amount under its policies as incurred.
The Company believes that Porex has a valid claim for indemnification under the Distribution Agreement with respect to any liabilities that could result from pending actions or claims by recipients of implants or any similar actions or claims that may be commenced in the future. However, Porex's right to indemnification is subject to a disagreement with the Manufacturer. Pending the resolution of such disagreement, the Manufacturer has been paying a portion of the costs of the settled claims.
Based on the foregoing, the Company believes that the possibility is remote that pending actions and claims by recipients of mammary implant devices or any similar actions and claims that may be commenced or made in the future could pose a material risk to the financial position of the Company or its results of operations.
STOCKHOLDER LITIGATION. On August 18, 1994, an action entitled Fuss v. Wygod, et al. was filed against Synetic, its directors and Merck in the Court of Chancery of the State of Delaware in and for New Castle County (the "Delaware Court"). The action purportedly arose out of the events leading to the Divestiture and the Purchase and was purportedly brought both derivatively on behalf of Synetic and as a class action on behalf of Synetic's stockholders other than the defendants. On March 22, 1996, the parties executed a Stipulation and Agreement of Compromise, Settlement and Release (the "Settlement") and submitted the Settlement for approval by the Delaware Court. After directing notice to the proposed class (the "Class"), on June 4, 1996, the Delaware Court held a hearing and issued a Final Order and Judgment which, inter alia, approved the Settlement as fair, reasonable, adequate and in the best interests of the Class, dismissed the action with prejudice and released defendants from any liability in connection with the Purchase and Divestiture. Pursuant to a supplemental hearing to confirm the Settlement, held on October 22, 1996, the Delaware Court reaffirmed its Final Order and Judgment of June 4, 1996. The Delaware Court's Final Order and Judgment also awarded attorneys' fees and expenses to plaintiff in the amount of $275,000, which was paid by Synetic on November 21, 1996. Pursuant to the Purchase and Sale Agreement, Merck reimbursed Synetic for 58.65% of such amount.
ENFORCEMENT DIVISION INVESTIGATION. On July 6, 1994, the Division of Enforcement of the Securities and Exchange Commission (the "Enforcement Division") began an investigation regarding the trading in securities of Synetic. The Company has cooperated fully with the Enforcement Division's requests for information and, although it cannot predict the ultimate result of the inquiry, the Company believes that such investigation is not directed at the Company and, accordingly, will not have a material adverse effect on its financial position or results of operations.
The Company is not a party of any other legal proceedings which, in its belief, could have a material adverse effect on the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
EXECUTIVE OFFICERS
Pursuant to General Instruction G(3) to the Annual Report on Form 10-K, the information regarding executive officers of the Company required by Item 401 of Regulation S-K is hereby included in Part I of this report. The executive officers of the Company are as follows:
Mr. Manning has been Chief Executive Officer of the Company since January 1995 and President of the Company since July 1996 and has been an executive officer of the Company for more than the last six years and was, until December 1994, an executive officer of Medco for more than five years. He is also Chairman of the Board of COMNET Corporation ("Comnet"), a computer software company.
Mr. Gujral has been Executive Vice President--President of Avicenna of the Company since January 1997. Mr. Gujral was a founder of Avicenna. He was a founder and principal of Lancet Technologies, Inc., a worldwide provider of data management systems for hospital and healthcare-related agencies since 1988.
Dr. Margulies has been Executive Vice President--Chief Scientist of the Company since January 1997. He was founder and president of CareAgents. From 1990 to mid 1996, Dr. Margulies was Executive Vice President and Chief Scientist of the Cerner Corporation, a leading supplier of enterprise-level clinical applications. Prior to such time, he was Vice President and Chief Information Officer at Boston Children's Hospital and on the medical faculties of the Harvard Medical School and Columbia College of Physicians and Surgeons.
Mr. Hannah has been President of Porex since September 1987 and its Chief Executive Officer since November 1992 and an executive officer of the Company since June 1989. Mr. Hannah was the Chief Operating Officer of Porex from November 1984 to November 1992.
Mr. Vuolo has been Vice President and Chief Financial Officer of the Company since May 1997 and has been an officer of the Company for more than the last six years and was, until December 1994, an officer of Medco for more than five years.
Mr. Mele has been Vice President--General Counsel of the Company since July 1995 and was an executive officer of the Company from May 1989 until December 1994 and was an executive officer of Medco for more than five years, until March 1995. Mr. Mele is also a director of Comnet and Group 1 Software, Inc., computer software companies.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock is traded in the over-the-counter market and included in the NASDAQ National Market System under the symbol "SNTC." The following table sets forth, for the periods indicated, the high and low sale prices for the Company's Common Stock as reported by NASDAQ.
The Company's Common Stock was held by 164 stockholders of record as of September 15, 1997. The Company believes that its Common Stock is beneficially held by at least 400 stockholders.
The Company did not pay any dividends to the holders of its Common Stock during the two fiscal years ended June 30, 1997. The Company intends to continue to retain earnings to finance its business and its acquisition program and, accordingly, does not currently anticipate paying cash dividends to holders of its Common Stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth selected consolidated financial data for each of the five years in the period ended June 30, 1997. The selected financial data for the three years in the period ended June 30, 1995 have been restated to reflect the Divestiture.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
As described in "Item 1. Business--Introduction", the Company completed the Divestiture of its Institutional Pharmacies Business on December 14, 1994. The Company's consolidated financial statements for the fiscal year ended June 30, 1995 report separately the results of operations and net assets of the Institutional Pharmacies Business as discontinued operations.
The following table sets forth for the periods indicated the percentage which certain items in the financial statements of the Company bear to net sales.
The historical operations of the Company are primarily related to its plastics technology business. All revenues and a significant majority of operating expenses were derived from these operations. As discussed below, the consolidated financial statements for the fiscal year ended June 30, 1997 include certain costs associated with the Company's activities in developing its healthcare communications business.
Fiscal Years Ended June 30, 1997 and 1996
Consolidated Results of Operations
Net sales for the year ended June 30, 1997 increased by $7,757,000, or 17.2%, over the comparable prior year period. The sales increase was due primarily to increased unit sales in surgical products in the healthcare segment and increased unit sales of writing components, pipette filters and pipette tips in the consumer segment.
Cost of sales for the year ended June 30, 1997 increased by $3,927,000, or 15.6%, over the comparable prior year period due to the increased sales volume noted above and product development costs. As a percent of net sales, cost of sales for the year ended June 30, 1997 decreased to 54.9% from 55.6% in the comparable prior year period principally due to increased leverage of certain fixed costs which do not increase proportionally with sales and improvements in material and labor usage.
Selling, general and administrative expenses for the year ended June 30, 1997 increased by $5,911,000, or 39.6%, over the comparable prior year period due primarily to the inclusion of expenses of $4,628,000 associated with the Company's healthcare communications business which primarily related to research and development activities. Excluding these costs, as a percent of net sales, selling, general and administrative expenses for the year ended June 30, 1997 decreased to 30.7% from 33.1% due principally to increased sales which were not proportionately offset by such expenses, since a portion of these costs is fixed in nature and does not vary directly with sales.
Investment income, which is comprised of interest and other income and dividend income, for the year ended June 30, 1997 increased by $4,782,000, or 58.9%, over the comparable prior year period primarily as a result of the income earned on the proceeds of the Company's $165,000,000 5% Convertible Subordinated Debentures due 2007 (the "Convertible Debentures") issued in February 1997.
Interest expense for the year ended June 30, 1997 increased by $3,116,000 from the prior year period as a result of the interest expense associated with the Company's Convertible Debentures.
During the year ended June 30, 1997, the Company recorded non-recurring charges to income of $37,413,000 related to purchased research and development costs from the acquisitions of Avicenna and CareAgents and the acquisition of rights to certain intellectual property and software technologies to be utilized in the development of the Company's healthcare communications business.
Excluding the portion of the research and development charge relating to the acquisitions of Avicenna and CareAgents for which no tax benefits were recognized, the effective tax rate for the year ended June 30, 1997 increased to 37.5% from 35% in the prior year period primarily as a result of the change in composition of the Company's marketable securities resulting in the decrease in investment income subject to the dividend received deduction.
Fiscal Years Ended June 30, 1996 and 1995
Consolidated Results of Operations
Net sales for the year ended June 30, 1996 increased by $5,949,000, or 15.2%, over the comparable prior year period. The sales increase was due primarily to increased unit sales in medical products and plastic vials in the healthcare segment and, to a lesser extent, to increased unit sales of writing components, personal care items and home water filters in the consumer segment.
Cost of sales for the year ended June 30, 1996 increased by $2,102,000, or 9.1%, over the comparable prior year period due to the increased sales volume noted above and additional depreciation and product development costs. As a percent of net sales, cost of sales for the year ended June 30, 1996 decreased to 55.6% from 58.7% in the comparable prior year period principally due to certain fixed costs which do not increase proportionally with sales and improvements in material and labor usage.
Selling, general and administrative expenses for the year ended June 30, 1996 increased by $2,805,000, or 23.1%, over the comparable prior year period due primarily to an increase in expenses associated with the increase in sales volume noted above and an increase in corporate overhead expense. As a percent of net sales, selling, general and administrative expenses for the year ended June 30, 1996 increased to 33.1% from 31.0% in the prior year primarily due to the increased corporate overhead noted above.
Interest and other income and dividend income for the year ended June 30, 1996 increased by $800,000, or 10.9%, over the comparable prior year period primarily as a result of the income earned on a full year of investment of the net proceeds received from the sale of the Institutional Pharmacies Business.
Interest expense for the year ended June 30, 1996 decreased by $3,619,000 from the prior year period as a result of the conversion and redemption of the Company's Convertible Subordinated Debentures due December 1, 2001 (the "1991 Debentures") into common stock of the Company in February 1995.
Other expenses for the year ended June 30, 1996 decreased by $6,663,000 over the comparable prior year period as a result of the one-time charge in December 1994 related to the issuance of stock options to certain officers as compensation for services in conjunction with the consummation of the Purchase and Sale Agreement and costs associated with the conversion and redemption in February 1995 of the 1991 Debentures.
The effective tax rate for the year ended June 30, 1996 decreased to 35% from 41% in the prior year period primarily due to the nondeductibility of certain conversion and redemption costs in the prior year.
Capital Resources and Liquidity
Cash, cash equivalents and marketable securities increased by $153,350,000 to $315,828,000 during the year ended June 30, 1997 principally due to the proceeds from the issuance in February 1997 of the Convertible Debentures.
As a result of the continuing efforts in developing its healthcare communications business, the Company expects to incur significant research and development expenditures in connection with this new area of business until the products and services are successfully developed and marketed. During the second half of the fiscal year ended June 30, 1997, the Company incurred expenditures of approximately $4,976,000 related to the development of its healthcare communications business. The Company expects to increase the rate of such expenditures during fiscal 1998. The Company believes that its cash flow from operations and the income earned on its investments are sufficient to meet the anticipated working capital requirements of its business, including the research and development expenditures noted above.
The Company continues to pursue an acquisition program pursuant to which it seeks to effect one or more acquisitions or other similar business combinations with businesses it believes have significant growth potential. Financing for such acquisitions may come from several sources, including, without limitation, (a) the Company's cash, cash equivalents and marketable securities and (b) proceeds from the incurrence of additional indebtedness or the issuance of common stock, preferred stock, convertible debt or other securities. There can be no assurance that the Company's acquisition program will be successful. See "Item 1. Business--Acquisition Program".
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Financial statements and supplementary financial information are contained on pages F-l through and S-1 of this Report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this item will be incorporated by reference from the Company's definitive Proxy Statement for its 1997 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A, except that the information regarding the Company's executive officers required by Item 401 of Regulation S-K has been included in Part I of this Report.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item will be incorporated by reference from the Company's definitive Proxy Statement for its 1997 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this item will be incorporated by reference from the Company's definitive Proxy Statement for its 1997 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item will be incorporated by reference from the Company's definitive Proxy Statement for its 1997 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K.
(a)(1)-(2) Financial Statements and Schedules:
The financial statements and schedules listed in the accompanying Index to Consolidated Financial Statements and Supplemental Data at page F-l are filed as part of this Report.
(a)(3) Index to Exhibits:
See Index to Exhibits on page E-1.
(b) Reports on Form 8-K:
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
SYNETIC, INC.
Date: September 24, 1997 By: /s/ James V. Manning ----------------------------- James V. Manning, Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on September 24, 1997.
(1) Principal Executive Officer: (3) A Majority of the Board of Directors:
By: /s/ James V. Manning James V. Manning ---------------------------- Mervyn L. Goldstein James V. Manning Ray E. Hannah Chief Executive Officer Roger H. Licht Charles A. Mele Herman Sarkowsky Martin J. Wygod
(2) Principal Financial and Accounting Officer: By: /s/ James V. Manning ------------------------ James V. Manning Individually and as Attorney-in-Fact
By: /s/ Anthony Vuolo --------------------------- Anthony Vuolo Vice President and Chief Financial Officer
SYNETIC, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
The following financial statements of the Registrant and its subsidiaries required to be included in Item 14.(a) (1) of Form 10-K are listed below:
PAGE ----
Report of Independent Public Accountants...............
Consolidated Balance Sheets at June 30, 1997 and 1996..
Consolidated Statements of Income for the Years Ended June 30, 1997, 1996 and 1995.............
Consolidated Statements of Changes in Stockholders' Equity for the Years Ended June 30, 1997, 1996 and 1995.........................
Consolidated Statements of Cash Flows for the Years Ended June 30, 1997, 1996 and 1995.............
Notes to Consolidated Financial Statements.............
The following financial statement supplementary data of the Registrant and its subsidiaries required to be included in Item 14.(a) (2) of Form 10-K are listed below:
PAGE ---- Schedule II - Valuation and Qualifying Accounts............................................. S-1
All other schedules not listed above have been omitted as not applicable or because the required information is included in the Consolidated Financial Statements or in the notes thereto. Columns omitted from schedules filed have been omitted because the information is not applicable.
These financial statements have been prepared from the Company's books and records after making all necessary adjustments thereto, and they represent the final statements for the period under audit.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO SYNETIC, INC.:
We have audited the accompanying consolidated balance sheets of Synetic, Inc. (a Delaware corporation) and subsidiaries as of June 30, 1997 and 1996, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended June 30, 1997. These consolidated financial statements and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Synetic, Inc. and subsidiaries as of June 30, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1997 in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index to consolidated financial statements and supplemental data is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in our audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
New York, New York September 24, 1997
SYNETIC, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands)
ASSETS
The accompanying notes are an integral part of these consolidated balance sheets.
SYNETIC, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands, except share data)
LIABILITIES AND STOCKHOLDERS' EQUITY
The accompanying notes are an integral part of these consolidated balance sheets.
SYNETIC, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share data)
The accompanying notes are an integral part of these consolidated statements.
SYNETIC, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (in thousands)
The accompanying notes are an integral part of these consolidated statements.
SYNETIC, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
The accompanying notes are an integral part of these consolidated statements.
SYNETIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
On November 18, 1993, Medco Containment Services, Inc. ("Medco") became a wholly-owned subsidiary of Merck & Co., Inc. ("Merck"). As a result of this transaction, Merck acquired voting control of Synetic, Inc. (the "Company").
On May 24, 1994, Merck and the Company entered into a Purchase and Sale Agreement (the "Agreement") by which the Company and its Chairman, Martin J. Wygod, would purchase the Company's common stock owned by Merck. As part of this Agreement, the Company agreed to divest its Institutional Pharmacy business. On December 14, 1994, the Company consummated the transactions described above pursuant to which (1) the Company sold its Institutional Pharmacy business to Pharmacy Corporation of America ("PCA") for $107.3 million, subject to certain closing adjustments, and (2) the Company and a limited partnership, whose general partner is controlled by the Company's Chairman, purchased from Merck the 10,330,320 shares of the Company's common stock held by Merck.
The Company has granted stock options with an exercise price below fair market value on the date of award to certain officers in recognition of their contribution in completing these transactions. Accordingly, included in Purchase and Sale Agreement related expenses and other in the accompanying financial statements for the fiscal year ended June 30, 1995, the Company recorded a non-recurring charge of approximately $5 million relating to such stock options in conjunction with the consummation of these transactions.
Principles of Consolidation--
The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned operating subsidiaries, Porex Technologies Corp. and subsidiaries ("Porex"), Avicenna and CareAgents, after elimination of all material intercompany accounts and transactions. On December 14, 1994, the Company sold its Institutional Pharmacy business to Pharmacy Corporation of America, a wholly-owned subsidiary of Beverly Enterprises, Inc., for approximately $107.3 million in cash, subject to certain closing adjustments. As a result of this transaction, the Company recorded an after-tax gain of $14,496,000. The consolidated financial statements for the fiscal year ended June 30, 1995 report separately as discontinued operations the net assets and operating results of the Institutional Pharmacy business.
For the year ended June 30, 1997, the operations of the Company were primarily related to its plastics technology business. All revenues and a significant majority of operating expenses were derived from these operations. The consolidated financial statements for the fiscal year ended June 30, 1997 include certain costs associated with the Company's efforts in developing its healthcare communications business.
Cash and Cash Equivalents--
The Company considers all liquid investment instruments with an original maturity of three months or less to be the equivalent of cash for purposes of balance sheet presentation and for the consolidated statements of cash flows. These short-term investments are stated at cost, which approximates market.
Marketable Securities--
Marketable securities consisted primarily of U.S. Treasury Notes and Federal Agency Notes at June 30, 1997 and U.S. Treasury Notes, Federal Agency Notes and Money Market Preferred Stock investments at June 30, 1996. These investments, which are carried at a cost of $238,525,000 and $140,268,000, net of unamortized premium, at June 30, 1997 and June 30, 1996, respectively, had an aggregate market value of $238,151,000 and $140,537,000 at June 30, 1997 and 1996, respectively. At June 30, 1997, gross unrealized losses pertaining to marketable securities and other investments were $374,000. Gains and losses on the sale of marketable securities and other investments are calculated using the specific identification method.
SYNETIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
Investments in Debt and Equity Securities--
Effective July 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS No. 115"). This Statement addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. At June 30, 1997, the Company's investments consisted principally of U.S. Treasury Notes and Federal Agency Notes. The U.S. Treasury Notes and Federal Agency Notes maturing January 2002 through March 2002 are classified as held-to-maturity and are carried at cost, net of unamortized premium.
Inventories--
Inventories are stated at the lower of (first-in, first-out) cost or market. Cost includes raw materials, direct labor, and manufacturing overhead. Market is based on current replacement cost for raw materials and supplies and on net realizable value for work-in-process and finished goods. Inventories consisted of the following (in thousands):
Property, Plant and Equipment--
Property, plant and equipment are stated at cost. For financial reporting purposes, depreciation is provided principally on the straight-line method over the estimated useful lives of the assets. Annual depreciation rates range from 2% to 5% for buildings and improvements and from 9% to 33% for machinery and equipment and furniture and fixtures. For income tax purposes, certain assets are depreciated using accelerated methods. Expenditures for maintenance, repair and renewals of minor items are charged to operations as incurred. Major betterments are capitalized.
Development Costs--
The Company capitalizes costs incurred for the production of computer software used in the sale of its services. Costs capitalized include direct labor and related overhead for software produced by the Company and the costs of software purchased from third parties. All costs in the software development process which are classified as research and development are expensed as incurred until technological feasibility has been established. Once technological feasibility has been established, such costs are capitalized until the software is commercially available. Such costs are recorded at the lower of unamortized cost or net realizable value. For the year ended June 30, 1997, capitalized costs were not material and no costs were capitalized in previous years.
Company-sponsored development costs related to both present and future products are expensed currently. Total development expenses were $6,419,000, $2,014,000, and $1,490,000 for the years ended June 30, 1997, 1996 and 1995, respectively, of which $4,628,000 in 1997 related to the healthcare communications business.
SYNETIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
Accrued Liabilities--
Accrued liabilities consisted of the following (in thousands):
Income Taxes--
The Company accounts for income taxes pursuant to Statement of Financial Accounting Standard No. 109, "Accounting for Income Taxes" ("SFAS No. 109"), which uses the liability method to calculate deferred income taxes. The realization of deferred tax assets is based on historical tax positions and expectations about future taxable income.
Foreign Currency Translation--
The financial statements and transactions of Porex's foreign manufacturing facilities are maintained in their functional currency (Deutsche mark and Pound sterling) and translated into U.S. dollars. The adjustments which result from the process of translating these financial statements are not material and, therefore, are not separately disclosed in the accompanying consolidated financial statements.
Revenue Recognition--
The Company designs, manufactures and distributes porous and solid plastic components and products used in healthcare, industrial and consumer applications. Revenue is recognized upon product shipment, net of sales returns and allowances.
Net Income (Loss) Per Share--
Net income (loss) per share is determined by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the fiscal year and, if dilutive, common stock equivalents. Common stock equivalents consist of common stock which may be issuable upon exercise of outstanding stock options as calculated using the treasury stock method. The Debentures, if converted, would not have had a dilutive effect on net income per share for the periods presented.
In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS No. 128"). The new standard simplifies the computation of net income per share and increases comparability to international standards. Under SFAS No. 128, primary net income per share is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted net income per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.
SYNETIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
The Company is required to adopt the new standard during fiscal 1998, beginning with the December 31, 1997 interim consolidated financial statements. All prior periods presented are required to be restated at that time. The pronouncement is not expected to have a material impact on the Company's reported earnings per share.
Reclassifications--
Certain reclassifications have been made to prior year amounts to conform to the current year presentation.
Accounting for Stock-Based Compensation--
Effective July 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"). As permitted by the standard, the Company has elected to continue following the guidance of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25"), for measurement and recognition of stock-based transactions with employees. The Company discloses on a pro-forma basis both net income and earnings per share as if the fair value based accounting method were used and the difference between compensation cost recognized by APB No. 25 and the fair value method of SFAS No. 123. (See Note 9)
Use of Estimates--
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
(2) ACQUISITIONS:
Avicenna --
On December 24, 1996, the Company acquired the outstanding equity and indebtedness (including employee stock options) of Avicenna, a privately-held, developmental-stage company located in Cambridge, Massachusetts, for shares of the Company's stock. As additional consideration, the Company agreed to issue to certain sellers, nontransferable warrants covering 250,000 shares of the Company's common stock, exercisable after December 23, 1998 at a price of $54.50 per share. Avicenna's business plan has been to market and build Intranets for managed care organizations, hospitals and physician groups. The acquisition was accounted for using the purchase method with the purchase price being allocated to assets acquired and liabilities assumed based on their appraised fair values. Avicenna's results of operations have been included in the Company's financial statements since December 24, 1996.
A summary of the purchase price allocation is as follows (in thousands):
SYNETIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(2) ACQUISITIONS: (CONTINUED)
The amount allocated to purchased research and development of $28,600,000 was determined based on an independent appraisal using established valuation techniques. Remaining amounts have been allocated to intangible assets and goodwill.
CareAgents--
On January 23, 1997, the Company acquired CareAgents for shares of the Company's common stock. CareAgents was an early development stage company focused on Internet-based clinical commerce applications. The acquisition was accounted for using the purchase method with the purchase price being allocated entirely to purchased research and development. CareAgents' results of operations have been included in the Company's financial statements since January 23, 1997. The amount allocated to purchased research and development of $3,585,000 was determined based on an independent appraisal using established valuation techniques.
The following summary, prepared on a pro forma basis, combines the results of operations of the Company, Avicenna and CareAgents assuming the acquisitions were consummated at the beginning of the period presented (in thousands, except per share amount):
Year ended June 30, 1997 ------------- (unaudited) Sales $ 52,885 Net loss $(29,381) Net loss per share $ (1.69)
The pro forma results are not necessarily indicative of what actually would have occurred if the acquisitions had been in effect for the entire period presented. In addition, they are not intended to be a projection of future results. The pro forma impact of the Avicenna and CareAgents acquisitions for the year ended June 30, 1996 was not material.
Purchased Research and Development and Other--
The appraisal amounts allocated to purchased research and development of approximately $28,600,000 and $3,585,000 related to Avicenna and CareAgents, respectively, were expensed in the periods of acquisition, with no corresponding tax benefits, as such research and development was in process at the time of the acquisitions and had no alternative commercial use. In addition, in June 1997, the Company charged to expense research and development costs of $5,228,000 associated with the acquisition of rights to certain intellectual property and software technologies to be utilized in the development of the Company's healthcare communications business.
(3) Stockholders' Equity:
In April 1997, the Company announced that its Board of Directors authorized a repurchase program involving the purchase of the Company's common stock and outstanding convertible debentures not to exceed $15 million in the aggregate. For the year ended June 30, 1997, the Company repurchased 49,506 shares at a cost of approximately $1,858,000 and the Company reissued 17,800 of these shares for employee stock option exercises. As of June 30, 1997, 31,706 of the shares repurchased were included in Treasury stock.
In January 1997, the Company issued 106,029 shares for the acquisition of CareAgents and, in December 1996, the Company issued 428,643 shares for the acquisition of Avicenna.
In February 1995, the Company issued 3,877,607 shares of its common stock resulting from the conversion of $79,104,000 aggregate principle amount of its 7% Convertible Subordinated Debentures due December 1, 2001 (the "1991 Debentures"). (See Note 4.)
SYNETIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(4) LONG-TERM DEBT:
In February 1997, the Company issued to the public $165,000,000 aggregate principal amount of its 5% Convertible Subordinated Debentures due 2007 (the "Convertible Debentures"). The Convertible Debentures are convertible at any time prior to maturity, unless previously redeemed into shares of the Company's common stock, at a conversion price of $60.00 per share, subject to adjustment under certain circumstances. In connection with the issuance of the Convertible Debentures, the Company recorded debt issuance costs of approximately $5.1 million which are included in other assets in the consolidated financial statements. Such costs are being amortized over the life of the Convertible Debentures.
In December 1991, the Company issued to the public $80,500,000 aggregate principal amount of its 1991 Debentures. The 1991 Debentures were convertible at any time prior to maturity, unless previously redeemed, into shares of the Company's common stock at a conversion price of $20.40 per share, subject to adjustment under certain circumstances. On January 27, 1995, the Company called for redemption on February 13, 1995 the 1991 Debentures. Holders of $79,104,000 aggregate principal amount of the 1991 Debentures surrendered them for conversion into an aggregate of 3,877,607 shares of common stock. The remaining $1,396,000 of the outstanding 1991 Debentures were redeemed at the redemption price of 104% plus accrued interest. Included in Purchase and Sale Agreement related expenses and other in the accompanying financial statements for the year ended June 30, 1995 are approximately $1.1 million of costs associated with the call for redemption.
(5) INCOME TAXES:
The income tax provisions are summarized as follows (in thousands):
A reconciliation of the income tax provision, computed by applying the federal statutory rate to income before taxes, and the actual provision for income taxes is as follows:
SYNETIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(5) Income Taxes: (continued)
Temporary differences resulted in the following deferred tax expense (benefit) (in thousands):
Deferred tax liabilities (assets) at June 30, 1997, are comprised of the following (in thousands):
In accordance with the disclosure provisions of SFAS No. 109, the Company has included approximately $2,888,000 and $2,334,000 of deferred tax assets in other current assets and other assets, respectively, representing the effects of temporary differences between carrying amounts of assets and liabilities for financial reporting purposes and the carrying amounts for income tax purposes.
(6) Major Customers and Foreign and Export Product Sales:
For the years ended June 30, 1997, 1996 and 1995, no customer accounted for more than 10% of the Company's net sales.
Foreign product sales and net income of Porex's foreign manufacturing facilities, which are made principally in Europe, amounted to $7,854,000 and $1,247,000; $6,665,000 and $975,000; and $5,381,000 and $397,000 for the fiscal years ended June 30, 1997, 1996 and 1995, respectively. Identifiable assets of this facility were not material for the years presented. Export product sales of Porex, which are made principally to Europe and Asia, were $6,213,000, $5,605,000 and $5,022,000 for the fiscal years ended June 30, 1997, 1996 and 1995, respectively.
(7) Pension and Profit Sharing Plans:
The Company has defined benefit pension plans covering substantially all of its employees. Net pension cost for the years ended June 30, 1997, 1996 and 1995 included the following components (in thousands):
SYNETIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(7) PENSION AND PROFIT SHARING PLANS: (CONTINUED)
The following table sets forth the funded status of the plans and amounts recognized in the Company's consolidated balance sheets (in thousands):
The Company funds the plans through annual contributions representing no less than the minimum amounts required as computed by actuaries to be consistent with the plans' objectives and government regulations. The net pension liability is included in accrued liabilities.
Assumptions used in the accounting for the Company's defined benefit plans as of June 30, 1997 and 1996 were:
Plan assets consist primarily of debt and equity investments.
In addition to the defined benefit pension plans discussed above, the Company maintains a defined contribution profit sharing plan covering substantially all of its employees. Participants must be at least 21 years of age and have completed one year of service and may contribute up to $9,500 of their earnings annually. Effective February 1, 1997 the Company matches 50% of the first 2% and 25% of the second 4% of participants earnings which are contributed to the plan. From July 1, 1996 through January 31, 1997 and for the fiscal years ending June 30, 1996 and June 30, 1995 the Company matched 25% of the first 4% of participants earnings which were contributed to the plan. For the year ended June 30, 1997, the Company issued 3,341 shares of common stock to the plan. For the years ended June 30, 1997, 1996 and 1995, Company contributions were approximately $132,500, $81,000 and $59,100, respectively.
(8) Related Party Transactions:
Tax-sharing agreement--
The Company and Medco had a tax-sharing agreement which provided, among other things, for the allocation of federal income taxes on a separate company basis prior to July 6, 1989 and other related matters with respect to income taxes of the Company.
SYNETIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(8) RELATED PARTY TRANSACTIONS: (CONTINUED)
Services agreement--
Through December 14, 1994, the Company and Medco had a services agreement pursuant to which Medco provided the Company with various services of its management. The Company paid the actual costs of providing these services. Where actual costs were not available, the Company paid amounts based on mutually agreed upon allocation methods. Costs for such services were approximately $337,000 for the year ended June 30, 1995. No costs were incurred under this agreement for the years ended June 30, 1997 and June 30, 1996.
(9) STOCK OPTIONS:
In May 1989, the Company adopted two stock option plans, the 1989 Class A Stock Option Plan (the "Class A Plan") and the 1989 Class B Stock Option Plan (the "Class B Plan"). In September 1991, the Company adopted the 1991 Special Non-qualified Stock Option Plan (the "1991 Special Plan") and in December 1991, the Company adopted the 1991 Director Stock Option Plan (the "Director Plan"). In fiscal 1997, the Company adopted two stock option plans, the 1996 Class C Stock Option Plan (the "Class C Plan") and the 1997 Class D Stock Option Plan (the "Class D Plan"), and upon its acquisition of Avicenna, amended and assumed the Avicenna Systems Corp. 1995 Stock Plan (the "Avicenna Plan"), and converted options to purchase Avicenna shares into options to purchase the Company's shares. Non-Qualified stock options are granted under the Class A Plan, Class C Plan, Class D Plan, the 1991 Special Plan and the Director Plan. Options granted under the Class B Plan may be either incentive stock options or non-qualified stock options. Eligibility for the grant of options under the Class A Plan and the Director Plan are limited to certain of the Company's directors. Eligibility for the grant of options under the Class B Plan, the Class C Plan, the Class D Plan and the 1991 Special Plan are limited to the Company's officers, certain directors, employees, consultants, agents and key contractors. No additional options may be granted under the Avicenna Plan subsequent to the December 24, 1996 acquisition closing date.
Except for the Avicenna Plan, no options under the plans may be exercised during the first year after the date of grant, and options granted under the Plans become exercisable at a rate of either 20% in each successive year after the date of grant, or 40% after the second anniversary of the grant and 20% in each successive year. The Avicenna Plan options vested 50% on December 24, 1996 (the closing date of the Avicenna acquisition) with the remaining 50% vesting on December 24, 1998 (the second anniversary of the closing date). No options may be granted under any of the Plans after January 23, 2007, and all options expire within ten to fifteen years from the date of the grant. Under the Class B, the Class C, the Class D Plans, the 1991 Special Plan and the Director Plan, the exercise price may not be less than 100% of the fair market value of the Company's common stock on the date of grant. Under the Class A Plan, the exercise price may not be less than 85% of the fair market value of the Company's common stock on the date of grant. All options granted under the Class A Plan had an exercise price equal to 100% of the fair market value on the date of grant. The options granted under the Avicenna Plan were assumed and converted to the Company's stock options at an exercise price of $1.25 per share and were included in the acquisition cost of Avicenna. There are 7,920,045 shares reserved for issuance under the Company's plans.
In addition to the Company's stock option plans, the Company has granted options to certain directors, consultants and key employees. At June 30, 1997, there were 438,000 options granted to these individuals. The terms of these grants are similar to the Company's non-qualified stock option plans.
SYNETIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(9) STOCK OPTIONS: (CONTINUED)
The Company has elected to follow APB No. 25 in accounting for its employee stock options. Accordingly, no compensation cost has been recognized for the Company's option plans. Had the determination of compensation costs for these plans been based on the fair value at the grant dates for awards under these plans, consistent with the method of SFAS No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below:
1997 1996 ---- ---- Net income (loss): As reported $(27,460) $8,585 Pro forma $(30,746) $8,190
Earnings per share: As reported $ (1.60) $ 0.48 Pro forma $ (1.79) $ 0.45
The pro forma results indicated above are not intended to be indicative of or a projection of future results.
The fair value of each option grant is estimated on the date of grant by using the Black-Scholes option-pricing model. The following weighted average assumptions were used for grants in 1997 and 1996:
1997 1996 ---- ---- Expected dividend yield 0% 0% Expected volatility .2722% .2722% Risk-free interest rates 6.5% 6.5% Expected option lives (years) .083-1.74 .083-1.74
Weighted average fair value of options granted during the year $ 10.11 $ 5.08
A summary of the status of the Company's stock option plans for the three year period ended June 30, 1997 is presented below:
SYNETIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(9) STOCK OPTIONS: (CONTINUED)
The following table summarizes information with respect to options outstanding and options exercisable at June 30, 1997:
(10) COMMITMENTS AND CONTINGENCIES:
Leases--
The Company leases office and warehouse space, equipment and automobiles under various noncancellable operating leases. Rental expense was $803,000, $318,000 and $197,000 for the fiscal years ended June 30, 1997, 1996 and 1995, respectively. The minimum aggregate rental commitments under noncancellable leases, excluding renewal options, are as follows (in thousands):
YEARS ENDING JUNE 30, --------------------- 1998........ $2,043 1999........ 2,046 2000........ 2,023 2001........ 1,966 2002........ 1,360 Thereafter.. 3,625
Legal proceedings--
In the normal course of business, the Company is involved in various claims and legal proceedings. While the ultimate resolution of these matters has yet to be determined, the Company does not believe that their outcome will have a material adverse effect on its financial position.
SYNETIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(11) QUARTERLY FINANCIAL DATA (UNAUDITED):
The following table summarizes the quarterly financial data for the fiscal years ended June 30, 1997 and 1996 (in thousands, except per share data). Net income per share, excluding the non-recurring charges discussed in Note (2), are also presented below. Net income (loss) per share calculations for each of the quarters are based on the weighted average number of shares outstanding for each period; therefore, the sum of the quarters may not necessarily be equal to the full fiscal year per share amount.
(a) The per share amounts shown differ from those previously reported to reflect the anti-dilutive impact of common stock equivalents resulting from the net loss caused by the non-recurring charges discussed in Note 2.
(b) The per share amounts shown include expenses of $.09 and $.08 per share in the quarters ended March 31, 1997 and June 30, 1997, respectively, which primarily relate to research and development costs associated with the Company's healthcare communications business activities.
SYNETIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(12) FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments." The estimated fair value amounts have been determined by the Company using available market information. However, considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
AT JUNE 30, 1997 -------------------- CARRYING ESTIMATED AMOUNT FAIR VALUE -------- ---------- (in thousands) Assets: Cash and cash equivalents.. $ 77,303 $ 77,303 Marketable securities...... 238,525 238,151
Liabilities: Long term debt............. 165,000 146,025
Cash and cash equivalents--
The carrying amounts of these items are a reasonable estimate of their fair value.
Marketable securities--
Marketable securities, consisting of publicly-traded U.S. Treasury Notes and Federal Agency Notes, are valued based on quoted market prices or dealer quotes.
Long term debt--
The Convertible Debentures are publicly traded and are valued based on quoted market prices. (See Note (4).)
The fair value estimates presented herein are based on information available to the Company as of June 30, 1997. Although the Company is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been revalued since that date, and current estimates of fair value may differ significantly from the amounts presented herein.
SYNETIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(13) SUPPLEMENTAL CASH FLOW INFORMATION (IN THOUSANDS):
YEARS ENDED JUNE 30, ----------------------- 1997 1996 1995 ------ ------ ------- Interest Paid...... $ - $ 6 $ 2,870 Income Taxes Paid.. 1,788 3,212 27,435
The following non-cash transactions were excluded from the consolidated statements of cash flows for the years ended June 30, 1997, 1996 and 1995:
In fiscal years 1997, 1996 and 1995, the Company recognized tax benefits related to the exercise of stock options as increases to additional paid in capital and decreases to income taxes payable of $7,450,000, $3,833,000 and $835,000, respectively.
In February 1995, in connection with the call for redemption of the Company's 1991 Debentures, holders of $79,104,000 aggregate principal amount of the 1991 Debentures surrendered them for conversion into an aggregate of 3,877,607 shares of common stock. The remaining $1,396,000 of the outstanding 1991 Debentures were redeemed at the redemption price of 104% plus accrued interest. (See Note (4).)
Additional information with respect to the acquisitions referred to in Note (2) above is as follows (in thousands):
Year Ended June 30, 1997 ------------- Fair value of assets acquired $47,537 Net cash paid (10,612) Value of stock paid (24,488) ------- Liabilities assumed $12,437 =======
SYNETIC, INC. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS Years Ended June 30, 1997, 1996 and 1995
- ------------------------------------
(1) Write-off of uncollectible accounts and other reductions, net of recoveries.
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INDEX TO EXHIBITS
Number Title - ------ -----
3.1 Certificate of Incorporation of the Company, as amended. Incorporated by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-1 (No. 33-28654) (the "Registration Statement").
3.2 By-Laws of the Company, as amended. Incorporated by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1994 (the "1994 10-K").
10.1 1989 Class A Non-Qualified Stock Option Plan of the Company. Incorporated by reference to Exhibit 10.1 to the Registration Statement.*
10.2 1989 Class B Non-Qualified Stock Option Plan of the Company. Incorporated by reference to Exhibit 10.2 to the Registration Statement.*
10.3 1991 Director Stock Option Plan of the Company. Incorporated by reference to Exhibit 4.2 to the Company's Registration Statement on Form S-8 (No. 33-46640).*
10.4 Form of Stock Option Agreement dated as of May 17, 1989 between the Company and the members of the Stock Option Committee of the Board of Directors. Incorporated by reference to Exhibit 10.3 to the Registration Statement.*
10.5 Retirement Plan for Salaried Employees of Porex Technologies Corp. of Georgia. Incorporated by reference to Exhibit 10.4 to the Registration Statement.*
10.7 Form of Indemnification Agreement between the Company and the directors and officers of the Company. Incorporated by reference to Exhibit 10.6 to the Registration Statement.
10.8 Form of Services Agreement between the Company and Medco. Incorporated by reference to Exhibit 10.7 to the Registration Statement.
10.9 Form of Tax Sharing Agreement between the Company and Medco. Incorporated by reference to Exhibit 10.8 to the Registration Statement.
10.10 Form of Indemnification Agreement between the Company and Medco. Incorporated by reference to Exhibit 10.9 to the Registration Statement.
10.11 Purchase and Sale Agreement, dated as of May 24, 1994, between Merck & Co., Inc. and the Company (the "Purchase and Sale Agreement"). Incorporated by reference to Exhibit 99.1 to the Company's Current Report on Form 8-K dated June 6, 1994.
E-1
Number Title - ------ -----
10.12 Purchase Agreement, dated as of May 24, 1994, between Medco Containment Services, Inc. and Porex Technologies Corp. Incorporated by reference to Exhibit 10.23 to the 1994 10-K.
10.13 Stock Purchase Agreement, dated as of August 9, 1994, between the Company and Pharmacy Corporation of America. Incorporated by reference to Exhibit 10.24 to the 1994 10-K.
10.14 Amended and Restated Investment Agreement, dated as of September 13, 1994, between Martin J. Wygod and the Company. Incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K dated September 16, 1994.
10.15 Form of Stock Option Agreement, made as of December 7, 1994, between the Company and each of James V. Manning (for 150,000 shares), Paul C. Suthern (for 180,000 shares), Victor L. Marrero (for 125,000 shares), David J. Schlanger (for 125,000 shares), Pamela B. Spira (for 125,000 shares) and Anthony Vuolo (for 125,000 shares). Incorporated by reference to Annex A to the Company's Proxy Statement for its Annual Meeting of Stockholders held on May 17, 1995.*
10.16 Merger Agreement, dated December 23, 1996, among the Company, Synternet Acquisition Corp., a wholly owned subsidiary of the Company, Avicenna and the certain other individuals and entities. Incorporated by reference to Exhibit 10.2 to the Company's Registration Statement on Form S-3 (No. 333-18771).
10.17 1996 Class C Stock Option Plan of the Company. Incorporated by reference to Exhibit 4.1 to the Company's Registration Statement on Form S-8 (No. 333-36041).*
10.18 1997 Class D Stock Option Plan of the Company. Incorporated by reference to Exhibit 4.2 to the Company's Registration Statement on Form S-8 (No. 333-36041).*
10.19 1991 Special Non-Qualified Stock Option Plan of the Company. Incorporated by reference to Exhibit 4.3 to the Company's Registration Statement on Form S-8 (No. 333-36041).*
21.1** Subsidiaries of the Company.
23.1** Consent of Arthur Andersen LLP.
23.2** Consent of Emens, Kegler, Brown, Hill & Ritter Co., L.P.A.
24.1** Powers of Attorney of the Company.
E-2
Number Title - ------ -----
27** Financial Data Schedule.
99.1 Excerpt from the Consulting Agreement between Merck & Co., Inc. and Martin J. Wygod relating to provisions incorporated in the Purchase and Sale Agreement. Incorporated by reference to Exhibit 99.1 to the Company's Current Report on Form 8-K dated June 6, 1994.
___________________________ * Management contract or compensation plan or arrangement.
** Filed herewith.
E-3