ITEM 1. BUSINESS
Overview
Strategic Diagnostics Inc. (the "Company") develops, manufactures, and markets immunoassay-based test kits and strip tests for rapid, cost-effective detection of a wide variety of different analytes in three primary market segments: water quality, industrial testing and agricultural. The Company is the entity resulting from the combination of EnSys Environmental Products, Inc. ("EnSys"), Ohmicron Corporation ("Ohmicron"), HTI BioProducts Inc. ("HTI"), TSD BioServices Inc. ("TSD") and Strategic Diagnostics, Inc. ("SDI"). On August 30, 1996, Ohmicron was merged with and into SDI. On December 30, 1996, SDI was merged with and into EnSys. The surviving entity was then renamed Strategic Diagnostics Inc. HTI and TSD were merged with and into SDI during 1999.
The Company is a recognized leader in the field of immunoassay research, development and manufacturing and develops products in markets where the attributes of immunoassay technology (i.e. speed, ease-of-use, cost-effectiveness, quantitation, and flexibility), meet specific customer needs. The substances detected by the Company's test kits and strip tests include chemicals used to treat drinking water, proprietary chemicals used in industrial processes, environmental contaminants, pesticides, genetically engineered traits in plants, commonly referred to as genetically modified organisms, or GMOs, and diseases of commercial crops.
The Company's tests for the detection of GMOs (Trait Check(R), GMO Check(R)), water-soluble polymers, pesticides and environmental contaminants (D TECH(R), EnviroGard(TM), EnSys RISC(TM) and RaPID Assay(R)) are well recognized in the immunoassay field testing market. The Company sells its environmental products through its direct sales force and through distributors. The Company's "one-step" strip tests hold a leading position in the emerging markets of analytical tests for the detection of water-soluble polymers and specific traits of genetically engineered plants. In addition to products serving the three primary markets, the Company manufactures and sells select immunoassay test kits for medical research applications.
In addition to developing and marketing test kits and strip tests, the Company provides fully integrated antibody development and large scale manufacturing services to pharmaceutical and medical diagnostic companies through its newly formed operating division Strategic BioSolutions. Strategic BioSolutions was formed from consolidating the operations of TSD, HTI, which was purchased February 26, 1999, and the operating assets of the OEM business of Atlantic Antibodies, Inc., which was purchased on May 10, 1999.
Immunoassay Technology
An immunoassay is an analytical test that uses antibodies to detect the presence of a target compound in a complex sample matrix with high degrees of precision and accuracy.
The technology was first developed more than 25 years ago and has replaced many laboratory diagnostic tests in the medical industry. The Company has applied immunoassay technology to a variety of industrial and agricultural applications. As with medical applications, immunoassay technology has demonstrated its value in these markets by virtue of its ability to yield specific, accurate, cost-effective and timely data in a manner previously unavailable.
The major attributes of immunoassay technology can be summarized as follows:
Sensitivity: Immunoassays can measure extremely low concentrations of compounds (routinely as low as parts per billion; i.e., one millionth of one gram in a liter of liquid). Specificity: Immunoassays can measure one specific compound out of a chemical "soup," reducing the need for sample preparation. Speed: Total time to obtain a test result ranges from 1 minute to several hours as compared to several days to several weeks with many competing laboratory testing methods. Cost: Price per test for immunoassays range from $1 to $50; price per test for similar laboratory testing can range from $5 to $1,000. Accuracy: Immunoassays are typically as or more accurate than their laboratory counterparts. Flexibility: Immunoassays can be developed in a wide variety of test formats, including multiple sample laboratory-based tests, disposable, single-use units, and large automated instruments. They can be designed for use by non-technical persons on-site under a variety of field conditions for testing of diverse sample types.
Immunoassay technology relies on the specific binding characteristics of antibodies. Antibodies are proteins made by cells within the bodies of animals as part of the immune response to invasion by foreign substances like bacteria and viruses. An antibody physically binds only to the substance that elicited its production. This characteristic of specific binding makes antibodies useful tools for detecting substances in complex sample matrices (e.g., blood, plant tissue, soil and water). Methods exist for isolating and purifying antibodies from animals, and labeling them in such a way that they can be used as components, or reagents, within a test to detect the presence of the substance of interest. Immunoassay technology has advanced to the point that antibodies can be made to a wide variety of substances including microorganisms, drugs, hormones, proteins, polymers, environmental pollutants and other chemicals.
Once an antibody reagent that has the desired performance characteristics (sensitivity and specificity) has been identified, it can be incorporated into a test format that is appropriate for the customer's application. In the human clinical chemistry market, antibodies are employed as reagents on large, automated instruments that can analyze hundreds of samples per hour. In contrast, antibodies can also be packaged into single use, disposable formats such as home pregnancy tests. Immunoassays can be designed to be highly quantitative or yield a simple yes/no result. The type of test format chosen for any given application depends on the needs of the customer and may include factors such as ease-of-use, cost-per-test, number of samples to be tested, the location the test will be performed and experience of the user.
The Company has expertise and proprietary technology relating to the development and manufacture of primarily five immunoassay formats: latex filtration, magnetic particle, one-step strip tests, coated-tube and microtiter plate. Latex filtration assays offer ease-of-use, field portability and semi-quantitative results and are ideally suited for on-site, field screening applications where limited numbers of samples are to be analyzed.
Magnetic particle assays have a greater number of steps and require more technical expertise to execute than latex filtration assays, but are more suited to the processing of larger number of samples at a single time, can be highly quantitative, and are relatively inexpensive on a cost-per-test basis. These characteristics make magnetic particle immunoassays effective measurement tools in both laboratory and certain field applications, especially where highly precise results are required.
Lateral flow immunoassay strips, often referred to as 'one-step' strip tests, require only that the user apply a prepared sample to the test strip to obtain the test result--much like pH or Litmus paper tests. The low cost and simplicity of these tests make them ideally suited for a wide range of applications in many different markets. The current state-of-the-art of lateral flow immunoassays is such that the results obtained using these tests are qualitative, not quantitative, which imposes some limits on the applicability of the format.
Coated-tube immunoassays are well suited for analyzing relatively large numbers of samples in the field, yield a semi-quantitative result and are intermediate in their ease-of-use and cost-per-test.
Microtiter plate assays are well established in the medical diagnostic industry and offer many of the advantages of magnetic particle assays, including quantitative results and the capacity to analyze large numbers of samples at a relatively low cost-per-test. Special laboratory equipment, relatively high levels of technical training, and a time-to-result measured in hours limits this test format to laboratory applications.
All measurement technologies, including immunoassays, have strengths and limitations. The Company's expertise with multiple immunoassay formats, coupled with a thorough understanding of the needs of a market and specific customer applications, has allowed the Company to develop a diverse array of immunoassay products designed to meet the analytical needs of multiple, sizable markets.
Markets and Products
The Company sells products in the water quality, industrial testing, agricultural and antibody market categories through its direct sales force, through a network of over 40 distributors in Canada, Mexico, Latin America, Europe and Asia, and through its corporate partners. This section describes the Company's current markets and products as well as those in development.
Agricultural
The agricultural market segment includes tests to detect targeted traits in genetically engineered plants, two plant fungi, Rice Blast and Botrytis (crop testing), and tests to detect Genetically Modified Organisms (GMOs) in food and food fractions (food testing).
Seed Testing
Genetically Engineered Crops. Agricultural companies are developing varieties of commercially important crops like corn, cotton and soybeans that have new additional genes which confer some commercial advantage to the plant, such as insect or pesticide resistance or enhanced growth or nutritional characteristics. Industry reports show that approximately 50% of the acreage used to produce soybeans and one quarter of the acreage used to grow corn in the U.S. was planted with genetically engineered seed in 1999, in comparison to only 0.5% in 1996.
In 1995, a large agricultural biotechnology company that has developed proprietary varieties of herbicide and insect-resistant corn and cotton using genetic engineering technology commissioned the Company's first test in this market. Not all the seed produced by a genetically engineered plant contains the gene for the desired trait and therefore testing is required to evaluate the genetic characteristics of seeds. The Company has developed a simple `one-step' strip test that is used at the point of testing to determine if an individual plant contains the new genetic trait. Since 1995, the Company has also developed similar one-step products for other traits and crops. The Company is actively developing and/or manufacturing and/or selling field tests for genetically enhanced products developed by five of the six leading ag-biotech companies. Commercial seed producers use these products to ensure the quality of their products. This type of test can also be used for enforcement purposes in crops to prevent unlicensed application of the genetic technology.
Sales of this strip test and similar products to detect the presence of genetically engineered traits in plants have been increasing rapidly since their introduction in the third quarter of 1995 and the Company believes sales will continue to grow. The number of acres of crops with genetically enhanced traits under cultivation grew rapidly in 1998 and further in 1999, and published reports indicate that the farmers' experience with these products was positive. Acreage is expected to grow further based on these results combined with the introduction of new traits currently under development, and with this increased volume, the Company expects sales of these products to grow. Additional tests for genetically engineered plants are currently under development. The Company estimates the market potential for its commercial crop tests could reach $20 million as planting acreage of genetically engineered plants grows and additional traits are introduced.
Food Testing
In 1998, a significant market opportunity for immunodiagnostic analysis was created. This opportunity arose from regulatory response to public demands to address a consumer's "right-to-know" whether a food product contains concentrations of Genetically Modified Organisms (GMOs). In May 1998, the European Commission enacted food regulations governing the labeling of foodstuffs that are derived from genetically-modified crops. The legislation affects food processors in all fifteen member states within the European Union. Under the European Commission's EC 258/97 and EC 1139/98, beginning March 1, 1999, food processors were required to label food ingredients for the presence of GMOs.
During the second half of 1998, the Company entered into licenses to use proprietary genetic traits with major developers of genetically engineered plants, and began developing an immunodiagnostic test to detect the presence of GMOs at specified concentrations. This research and development was completed and the Company participated in a Joint Research Centre - Institute for Health and Consumer Protection Food Products Unit sponsored validation study of its first test kit. Validation studies are common in the food testing industry and are generally referred to as "Ring Studies." This Ring Study involved 38
qualified laboratories throughout Europe and was completed in December 1998. The JRC has informed the Company that its products have been validated to detect the presence of the tested traits at the thresholds established in the Ring Study protocol.
Also during the second half of 1998, the Company began to introduce its technology and product plans to food processors. The reaction from the marketplace was and continues to be positive. Prospective customers have shown interest in the ability of the Company's technology and products to detect the presence of GMOs above a specified threshold level, its fast time-to-result and cost advantages.
The Company estimates the market potential for food test kits could reach $20 million by the end of the year 2001. This estimate is based on the volume of food fractions used by the more than 22,000 European food processors. The Company believes this newly created market opportunity could expand even further. Legislation similar to the European legislation was passed in Australia and New Zealand in December 1998.
Grain Testing
Building on its extensive experience, in 1999 Strategic Diagnostics developed the first GMO test kits for the commodity grain and distribution business. In the same time a grain processor evaluates in-bound shipments for specific characteristics such as moisture content, the Company's test kits provide information as to genetic composition and concentration. Demand for this vital information is growing, as the Company's customers are required to supply genetic identification and concentration data to their customers. The Company currently offers test kits for corn, soybeans, and canola, the three largest agricultural commodities that incorporate genetic enhancements. The Company is actively developing additional products for these and additional crops such as wheat and rice so that as new genetic technology is commercialized in agriculture, the Company will be able to maintain its leadership position and provide the necessary analytical tools to meet the requirements of this large and growing market. The Company estimates the market potential for its grain and seeds tests to reach approximately $60 million as more processors adopt testing of shipments and identity preservation becomes more widespread.
Mycotoxins
Mycotoxins are toxins formed in grains such as corn, barley, and wheat by naturally occurring fungi. Many mycotoxins are associated with adverse health effects in both animals and humans. The FDA, in concert with the USDA, has developed minimum acceptable levels for the mycotoxins aflatoxin and vomitoxin. Testing is mandatory on all U.S. exported grains. Some mycotoxins do not break down upon processing, and therefore testing continues at the food processing level as well. The existing market for mycotoxin testing is greater than $20 million annually. Though it is a developed market in which we will compete with other established test providers, we believe we have an enhanced product with significant competitive advantages, including enhanced ease-of-use and rapid screening applications, and sales could develop rapidly.
Water Quality
The Company believes that all of its products sold in this market are unique to the Company and provide high value testing solutions to fill largely unserviced analytical needs in this critical and highly regulated industry. In this arena, the Company markets established products such as those for the detection of pesticides, as well as emerging products for the detection of pathogenic microorganisms and toxic chemicals resulting from chlorine disinfection of drinking water. Also included in this market category are products developed and others currently under development for the detection of water treatment polymers used to clarify water and prevent scale formation.
Water Treatment Polymers. The water treatment market encompasses both industrial and municipal water treatment systems. Water treatment chemicals, typically polymers, are critical to preparing finished drinking water in municipal settings and to controlling water quality in industrial settings. Competition between water treatment chemical manufacturers is intense and new chemicals have evolved to the point that some of the more effective chemicals are quite expensive. Cost-effective use of these chemicals requires careful control of polymer concentrations throughout the system in which they are being employed. Many of these polymers are toxic and have been implicated in fish kills when industrial effluents have been discharged to natural bodies of water. As a result, there is increased regulatory pressure to measure the amount of chemical being discharged into surface waters. Polymer detection is quite difficult and currently there is no other detection method capable of measuring these substances at the levels at which they are used or discharged in effluents.
The Company, working in collaboration with its corporate partners, has successfully developed highly sensitive and accurate immunoassays for the detection of a number of water treatment polymers. These immunoassays have been demonstrated to be a reliable and cost-effective way to measure water treatment polymers in samples from municipal water supplies, boilers, cooling towers, and other processes and raw water sources. Some specific applications are: (i) measuring concentrations of chemicals to allow more efficacious use of costly compounds, (ii) detecting the presence of particular compounds in effluent discharge in order to gauge regulatory compliance, and (iii) monitoring processes to prevent fouling of highly expensive systems (like reverse osmosis) by excess polymer.
Pesticides. The entrance of pesticides into the water supply as a result of agricultural and residential runoff continues to be a problem requiring analytical testing. In areas of substantial agricultural activity, drinking water is tested for several pesticides in order to ensure compliance with federal regulations. Imported grains, fruits and vegetables are tested for the presence of pesticide residues prior to use in the U.S. In addition, pesticide residues in crops call for extensive testing at the time of pesticide registration or re-registration under the Federal Insecticide, Fungicide, and Rodenticide Act (FIFRA). In spite of their banned status, pesticides such as DDT and chlordane still persist in soil at sites where they were stored or distributed. The clean-up of these sites requires the use of specific analytical methods of pesticide detection.
Total Trihalomethanes. Trihalomethanes are regulated, toxic by-products that result from chlorine disinfection of drinking water. The Company's test is a non-immunoassay-based test for the detection of `total trihalomethanes' (TTHMs). The test is fast, easy, inexpensive and detects TTHMs at levels much lower than the new proposed safe drinking water guideline. The Company's TTHM kit has received US EPA Method Approval (Method 8530).
RaPID Assay(R) and EnviroGard(TM). The RaPID Assay(R) and EnviroGard(TM) pesticide test kits are being used extensively by water quality researchers, resource managers, regulators and drinking water system operators for surface and groundwater monitoring, drinking water source and supply management, and chemical fate and transport studies. Users of the Company's water quality pesticide products include federal agencies, such as the U.S. Geological Survey and Department of Agriculture, state environmental and health departments, drinking water utilities, and environmental engineering companies.
Industrial Testing
The industrial testing market category is comprised of immunoassays for pollutants, proprietary chemicals and industrial markers.
Pollutants. Analysis of soil, water and waste samples to determine the presence of hazardous chemicals has become increasingly important in connection with environmental remediation and environmental monitoring activities. These activities are largely the result of environmental legislation such as RCRA, CERCLA, TSCA, the Safe Drinking Water Act (SDWA) and Federal Water Pollution Control Act (the "Clean Water Act"). The Company believes that approximately 1,200 commercial environmental testing laboratories, as well as "in-house" laboratories at industrial and disposal facilities provide environmental testing.
Environmental remediation activities require a substantial amount of testing in connection with the clean-up of contaminated sites. After initial characterization of toxic chemicals at a site, substantial testing typically is required to complete an assessment of the site to determine the extent and location of contamination and the appropriate remediation plan. Upon the commencement of the remediation project, additional testing is necessary to
determine the effectiveness of the remediation measures. In addition, ongoing testing to monitor soil and groundwater is often required after completion of the remediation activities. The contaminants of primary concern for remediation activities include petroleum fuel products, polyaromatic hydrocarbons (PAHs), polychlorinated biphenyls (PCBs), benzene, certain metals and chlorinated solvents.
Environmental monitoring activities under SDWA and National Pollution Discharge Elimination System (NPDES) legislation require periodic testing for various hazardous chemicals. The nation's 58,000 drinking water systems test for contaminants such as metals, benzene, other volatile organic compounds and microbiological contamination. Approximately 6,400 major industrial and municipal wastewater treatment facilities monitor and test wastewater for contaminants such as chlorinated solvents, metals and volatile organic compounds. Hazardous waste handling and disposal companies carry out large volumes of analytical work, including pre-acceptance testing to determine the suitability of waste streams for disposal and routine testing of incoming shipments. In addition, the ongoing management of chemicals in the petrochemical and pesticide industries also results in the need to test samples at many points in the production, use and disposal cycle. Electrical utilities have ongoing analytical needs pertaining to disposal of PCB-containing materials.
Proprietary Chemicals. The proprietary chemical market category includes tests, commissioned by chemical manufacturers, that specifically measure the particular compound of interest. In the chemical market category the benefits of immunoassay testing have led to three key applications: (i) regulatory registration, in which immunoassay data is generated to support the registration of a product with the EPA; (ii) detection, to determine whether a target compound is present in a complex matrix; and (iii) monitoring, in which tests are performed to determine chemical concentrations for control purposes.
The application of immunoassay technology in conjunction with regulatory registration is significant because of the requirement that large-scale chemical manufacturers register their chemicals under FIFRA with the EPA. As part of this registration process, manufacturers must provide extensive data for both registration and post-registration analyses regarding toxicity and environmental impact. For many new compounds, certain aspects of this analysis require sensitivity which instrument-based testing cannot achieve. For others, no classical analytical methods are available to measure the compound. In either case, EPA requires the manufacturer to supply a method to monitor the compound in the environment. The Company is currently commercializing four tests in this area for two chemical companies. Agreements are in place for the development of seven additional tests.
Industrial Markers. The Company is collaborating with a corporate partner in this market category, which consists of test kits that detect marked products. The product marking technology is based on the incorporation of trace levels of inert chemicals or markers into solid or liquid products or on the surface of the products. The use of these markers, in conjunction with immunoassay techniques for marker detection, allows for the covert marking and testing of nearly any product. This technology can be used to prevent revenue loss due to counterfeiting and product diversion, limit a manufacturer's exposure to unwarranted product liability, and enhance process efficiency and product quality assurance.
Pollutant Test Products. The Company sells four different format immunoassays into the environmental market: (i) D TECH(R) latex filtration tests, (ii) EnSys RISC(TM) and EnviroGard(TM) coated-tube tests, (iii) RaPID Assay(R) magnetic particle tests and (iv) EnviroGard(TM) microtiter plate tests. Each of the four different test formats has performance characteristics that make them more or less suited for a particular customer application. The Company positions the sale of all of its products so as to provide the customer with the best product for its specific application.
The D TECH(R) and EnSys RISC(TM) tests do not require refrigeration which make them ideally suited for on-site, field applications. All of the environmental test kits include components for the extraction of target analytes from the sample and subsequent analysis. Sample preparation time is typically less than five minutes per sample. All of the Company's environmental test kits are capable of analyzing at least ten samples per hour and some allow analysis of as many as forty samples per hour.
D TECH(R). The D TECH(R) tests are a latex filtration immunoassay format and provide for rapid, easy to use, on-site, field screening analysis of soil and water samples containing EPA Priority Pollutants like PCBs, PAHs, TNT, BTEX (benzene, toluene, ethylbenzene and xylene) and others. D TECH is simple to use, requires little or no user training, yields a semi-quantitative result and is ideally suited for true field applications where limited numbers of samples are analyzed at one time.
RaPID Assay(R). The RaPID Assay(R) magnetic particle immunoassay product line currently contains kits and accessories for detection of 21 different pesticides (herbicides, insecticides and fungicides), and 6 toxic organic compounds. The magnetic particle test format is ideally suited for applications requiring highly precise determination of contaminant concentrations. Like the Company's other immunoassay tests, RaPID Assay(R) is fast and easy to perform, but not as field-portable. RaPID Assay(R) pesticide test kits are used for quantitation of pesticides in water, soil and food. RaPID Assay(R) test kits for toxic organic chemicals are used for measuring contaminant concentrations in both water and soil.
EnviroGard(TM) and EnSys RISC(TM). Like D TECH(R) and RaPID Assay(R), these coated-tube and microtiter plate format testing products detect some of the most commonly encountered toxic chemicals found in soil, water and on surfaces at contaminated sites, including PCBs, fuel products, PCP, TNT, benzene, PAHs, crude oil, and pesticides. Additionally, the EnviroGard(TM) products detect pesticides in drinking water and foodstuffs. The coated-tube format tests are used extensively to analyze relatively large numbers of samples in the field and yield a semi-quantitative result. The EnviroGard(TM) microtiter plate kits are designed for use in the laboratory and are ideally suited for analysis of large numbers of samples where determination of exact concentrations of contaminants are required.
Antibody Business
The Company develops, manufactures and markets a comprehensive set of monoclonal and polyclonal antibody products and services through its Strategic BioSolutions division. Specific expertise includes hybridoma development and cell culture expertise, large-scale ascites and antibody production, large-scale purification, characterization and a complete array of related services.
This division serves a wide range of customers including pharmaceutical, biotechnology, diagnostic companies and major research centers in the United States, the European Union and the Pacific Rim. During 1999, the Company significantly enhanced its presence in this market through the acquisition of HTI and the operating assets of the OEM business of Atlantic Antibodies as more fully described in the notes to the consolidated financial statements. The Company believes this division is one of the largest independent custom antibody operations in the United States. Throughout SDI's history, many significant product development and commercial supply agreements have followed from initial projects to develop and supply antibodies. The comprehensive customer base of this division has the potential to provide an even greater number of these meaningful opportunities.
The division employs approximately 90 people and supplies critical reagents used in the Company's test kits in addition to the development and marketing activities described above.
Other Products
RapidChek(R) SRB. Sulfate Reducing Bacteria ("SRBs") are environmentally significant because they generate hydrogen sulfide gas and cause corrosion of stainless steel pumps, pipelines, and drilling rigs and result in the souring of oil reserves. SRBs can be controlled by the addition of treatment chemicals. Historically, the majority of testing in this market was performed using a culture method called the American Petroleum Institute Recommended Procedure No. 38. This method requires that samples be incubated from 14-28 days before a result is obtained. RapidChek(R) SRB test is a simple-to-use, field portable test that provides the user with accurate results in 20 minutes and allows for an immediate, more cost-effective application of treatment chemicals.
Major Customers
In 1999, no customer accounted for 10% of the Company's revenues. In 1998, Delta and Pine Land Company accounted for 10% of the Company's revenues. Delta and Pine Land Company and Rohm and Haas Corp. each accounted for 10% of the Company's 1997 revenues.
Sales and Marketing Strategy
As a result of the consolidation of SDI, EnSys, Ohmicron, EnviroGard(TM) and HTI businesses, the Company has formed an experienced sales and marketing organization of 41 individuals. In addition to its direct sales force, the Company sells product through an extensive network of distributors, and through its corporate partners.
The Company uses a number of strategies for the sale of its products worldwide. In the U.S., the major route of sale of its industrial testing products is through a national field sales force in defined sales territories. The field sales force is augmented by an in-house sales force, which in addition to selling product directly to customers, provide marketing and logistic support to the field sales personnel and interface between customers and technical support.
In 1993 the Company opened a European headquarters and sales operation near London, England, and the sale of the EnSys RISC(TM), RaPID Assay(R) and EnviroGard(TM) products in Europe are principally directed through that office. Sales and distribution of the D TECH product line outside of the U.S. are made exclusively by E. Merck KGaA, Darmstadt, Germany.
Sales of the Company's products for detecting water treatment polymers, proprietary chemicals, industrial markers, genetically engineered crops and Rice Blast are through the Company's corporate partners in selected markets and through the Company's direct organization in others. The RapidChek(R) SRB test kit is sold directly by the Company and through 5 international distributors.
Regulatory Approvals
The environmental legislation and regulations that the Company believes are most applicable to its current business are RCRA, CERCLA, TSCA, FIFRA and the Pure Food and Drug Act. As the Company expands its product line to meet the environmental monitoring needs of municipalities and industrial facilities, the SDWA, the Clean Water Act and the NPDES permitting program under the Clean Water Act also will be significant to the Company's business. These laws regulate the management, disposal and clean-up of hazardous substances and protect the nation's ground and surface water and drinking water supplies. In addition, regulatory responsibilities in a number of areas have been delegated to state agencies and state and local laws and regulations impose additional restrictions and requirements. While environmental regulations overseas vary, many countries, particularly in Europe, have counterparts to the U.S. legislation.
The Company believes that regulatory acceptance, though not required for the use of its products in most cases, is a significant factor in gaining market acceptance. There are two main areas in which the Company is seeking regulatory acceptance for its products: hazardous waste testing methods by the federal and state environmental protection agencies and water testing methods by the federal and state environmental protection agencies. The federal Environmental Protection Agency and some state agencies have evaluated certain of the Company's analytical methods and accepted their use for certain remediation and monitoring activities. Further acceptance by these agencies would further stimulate demand for the Company's products. The Company expects that as its products are subjected to wider use under a variety of conditions and subjected to traditional validation techniques, such acceptance will generally be granted. Such acceptance would serve to strengthen already compelling customer motivations such as the ease-of-use and specificity characteristics of the Company's products and is not a prerequisite to selling the products in the markets the Company serves.
Hazardous Waste Testing Methods. EPA SW-846 is the compendium of analytical and test methods published by the EPA's Office of Solid Waste (OSW). A number of provisions of the EPA's hazardous waste regulations under RCRA mandate the use of SW-846 methods. In other contexts, SW-846 is a guidance document setting forth acceptable, although not required methods to be implemented by the user in response to sampling and analysis requirements. Some states also require the use of SW-846 methods under their hazardous waste programs. While SW-846 methods are technically only applicable to regulatory programs under RCRA, other federal, state and local environmental programs, including CERCLA and TSCA, often refer to and rely on SW-846 methods for purposes of remediation and monitoring.
The process for a method to be incorporated into EPA SW-846 generally takes approximately 24 to 36 months. The OSW evaluates the applicant's test results and obtains additional information or conducts its own tests if necessary. After a method is deemed acceptable, it is published by the EPA in draft form ("EPA Draft Method"). Periodically, the EPA updates SW-846 through a notice in the Federal Register referencing the EPA Draft Methods published since the last update. Following a comment period, the EPA Draft Methods are
referenced in the Federal Register as a Final Rule and incorporated into SW-846. The following table summarizes the EPA acceptance status of the Company's products.
Water Testing Methods. Water testing methods approved for use in compliance with the SDWA are published periodically in the Federal Register. Newly developed methods are reviewed by the EPA's Environmental Monitoring and Systems Laboratory in Cincinnati to determine whether they are (i) an acceptable version of a previously approved method or (ii) a new method in need of a comparability study and proceed through a comment and approval procedure. The EPA has a program aimed at expediting the approval of new methods that involves the cooperation of the Solid Waste, Drinking Water, and Waste Water methods groups.
The TTHM (total trihalomethanes) water test has been accepted as Method 8530. In addition, the RaPID Assay(R) Atrazine test was accepted as the first quantitative immunoassay method. It is anticipated that the EPA Office of Drinking Water will adopt this method for screening according to the Drinking Water Regulations for Triazines under the SDWA. More recently, the Company's RaPID Assay(R) for Spinosad has been adopted by the EPA office of Pesticide Programs as the official enforcement method for this pesticide. The Hydrofluor-Combo(TM) test kit is the ASTM standard method for detection of these pathogenic protozoa and has been designated as the method for use in complying with the EPA's Information Collection Rule to establish the extent of contamination in the nation's drinking water.
Tests for water treatment polymers, genetically engineered traits in plants, and fungal plant pathogens are currently unregulated. However, agencies such as the EPA, the FDA and the Food Safety and Inspection Service of the U.S. Department of Agriculture are engaged in testing environmental samples and, together with the Association of Official Analytical Chemists ("AOAC"), maintain compilations of official methods for use in testing for environmental contaminants in certain market segments. Some of these organizations also issue procedures and guidelines for validating new methods.
Manufacturing
The Company currently manufactures over 270 different test kits for the detection of a wide array of analytes in five immunoassay formats; one-step strip tests, coated-tubes, latex particles, magnetic particles and microtiter plates. In addition to test kits, the Company supplies its customers with ancillary equipment and supplies including spectrophotometers, pipettes, balances and timers among others.
The kit manufacturing process consists mainly of critical reagent production and in-process testing, filling and dispensing, labeling, kit assembly, quality control, packaging and shipping. The Company's Technical Reagents Manufacturing group produces critical reagents from its laboratories in Newark, Delaware. Sub-assemblies and finished kits are manufactured and shipped worldwide out of the Company's headquarters facility in Newark, Delaware.
Biological materials are primarily developed and produced in-house, however, some reagents are licensed from third parties or purchased from commercial sources. A crucial step in the Company's manufacturing process is the stabilization of the immunoreagents utilizing proprietary lyophilization techniques. In general, raw materials used by the Company in its products are obtainable from multiple sources. The Company purchases instruments and ancillary equipment from outside vendors. A number of the instruments sold by the Company were developed to be used exclusively with the Company products and are subject to specific supply agreements. The Company believes that the raw materials, instruments and equipment used in the manufacture of its products are adequately available for the Company's current and foreseeable manufacturing needs.
The Company manufactures its products in accordance with the FDA's Good Manufacturing Practices guidelines and has put in place systems designed to control all elements of the manufacturing process including raw materials, inventory, processes, documents, work-in-process, lot records, equipment and training. Integrated inventory control, purchasing, manufacturing scheduling, order processing, shipping and customer invoicing are elements of the Company's computerized Manufacturing Resource Planning (MRP) systems.
The Company's manufacturing organization, including the Technical Reagents Manufacturing group, consists of 39 individuals. The Company believes the existing facilities and equipment are sufficient to support a significantly larger manufacturing base. Manufacturing operations are currently running a single shift.
Research and Development
The Company engages in substantial research and development activities involving antibody and immunoassay development. In the three years ended December 31, 1999, 1998 and 1997, the Company incurred approximately $2,450,000, $1,922,000 and $1,580,000, respectively, in research and development expenditures, most of which are pursuant to customer research agreements or Corporate Partnerships. The Company's laboratory facilities located in Newark, Delaware were designed and built specifically for conducting research and development relating to antibody and immunoassay technology. These facilities include the state-of-the art, GMP, American Association for Accreditation of Laboratory Animal Care ("AAALAC") approved, Strategic BioSolutions antibody development and large-scale production facility. The Company has assembled a scientific staff with extensive experience in the development of monoclonal and polyclonal antibodies, immunogens and assay reagents.
The Company's assay development scientists are experienced in developing tests in a variety of different immunoassay formats including one-step strips, latex filtration, magnetic particles, coated tubes and microtiter plates. Research and development personnel have complementary skills in several advanced research disciplines, including synthetic organic chemistry, protein chemistry, biochemistry, immunology, immunochemistry, microbiology and soil science. In addition to the technical expertise resident within research and development, Strategic Biosolutions provides the Company, as well as its outside clients, with large-scale GMP production, bioprocessing, purification and quality control of antibodies and reagents.
The Company's research and development activities are focused on developing products to expand its manufacturing base and leverage its Sales and Marketing organization. The Company is a recognized leader in the field of contract antibody and immunoassay research and development in the industrial, water quality and agricultural sectors, and markets its services primarily to large chemical and pharmaceutical companies. Product development is typically performed in collaboration with a corporate partner that has identified a specific market need and provides funds to the Company to develop an assay. Research and development contracts are typically structured so that technology developed within the program is co-owned by the Company and its partner and the Company maintains exclusive manufacturing rights.
To the extent the Company believes that improvements to existing products significantly enhance competitiveness, expand a market or improve market penetration, the Company has periodically funded such efforts. In the markets where the Company has chosen to compete, rapid field screening tests are highly valued and the Company is actively engaged in developing proprietary technology to better meet those needs and enhance the Company's overall performance. Through its continuing development of tests to detect genetically
engineered plants and water treatment polymers, the Company has gained extensive expertise in the development and manufacture of one-step strip tests, and is working aggressively to further develop this technology.
The Company's technology organization, including research and development, Strategic BioSolutions, Technical Reagents Manufacturing, and Technical Marketing Support consists of approximately 59 individuals of which 20 hold advanced academic degrees.
Proprietary Technology and Patents
The Company's products are based on the use of proprietary reagents, technology and test systems developed by Company scientists or acquired externally. Accordingly, the Company has implemented a number of procedures to safeguard the proprietary nature of its technology. The Company requires its employees and consultants to execute confidentiality agreements upon the commencement of an employment or consulting relationship with the Company and all employees are required to agree to assign to the Company all rights to any inventions made during their employment or relating to the Company's activities.
Additionally, the Company seeks to protect its technology and processes through the patent process. The Company currently holds 19 issued U.S. patents and the claims for another are in a state of allowance. Two U.S. patents have been licensed for exclusive use by the Company and 6 U.S. patent applications are pending. Two new applications were filed in 1999 in the field of testing for genetically enhanced agricultural crops.
The Company believes that low-cost, easy to use, rapid field screening tests have the potential to be significant products in its chosen markets. Therefore, the Company is aggressively developing technology relating to immunoassay formats with those features. Two of the Company's pending applications involve one-step strip test formats, one of the applications has to do with a novel latex filtration test format, and one has to do with novel point-of-care diagnostic devices.
There can be no assurance that the Company's patent applications will result in the issuance of any patent or that any patents issued to the Company would provide protection that is sufficiently broad to protect the Company's technology and products. In addition, the Company cannot be certain that it was the first creator of inventions covered by pending patent applications or that it was the first to file patent applications for such inventions.
In addition to seeking patent protection for the Company's proprietary information, the Company also relies upon trade secrets, know-how and continuing technical innovation to maintain competitiveness. The Company has developed a number of proprietary technologies which the Company has chosen not to patent including stabilization systems for reagents, chemical syntheses for conjugates, immunogens and analyte analogs, and strategies relating to antibody development. Regarding the latter, the Company's extensive expertise has enabled it to develop antibodies and products that are unique to the industry including monoclonal antibodies to transgenic plant proteins, water treatment polymers, the explosive RDX, BTEX and TCE.
Under two license agreements, the Company has been granted the right and license throughout the world to use magnetocluster technology in connection with the Company's RaPID Assay(R) products for the detection of environmental analytes. This license carries royalties starting at 4% of net sales of such products each year and declining to 2% based upon the volume of sales in such year.
Competition
Many of the Company's potential competitors are large companies with substantially greater financial and other resources than the Company. To the extent that any such companies enter into one or more of the Company's markets, the Company's operations could be materially, adversely affected. The Company anticipates increased competition as potential competitors perceive that the Company's markets have become commercially proven. Other companies may be developing additional products for one or more of the Company's markets that could be competitive with the Company's products. Nevertheless, the Company believes that its competitiveness has been significantly enhanced as a result of the consolidation of the SDI, EnSys, Ohmicron and EnviroGard(TM) businesses.
Currently, the Company believes that there are no similar competing immunoassay products for the Company's RapidChek(R) Rice Blast, Botrytis and SRB, proprietary chemical, industrial marker or water treatment polymer tests. Competing products have begun to emerge in the testing for GMOs in seed and grain applications. Competitive products have been announced for corn tests by two smaller, privately held companies. The Company believes that it has several competitive advantages, including the specificity and faster time to result of its products over those of the current competing products.
The Company holds U.S. patents relating to the Rice Blast and SRB tests and believes they will help to provide a competitive advantage in the event that competing products enter the market. The Company's water treatment polymer tests are unique to the industry and the Company has secured U.S. patents and an exclusive technology license and believes that such property will help to provide a competitive advantage in the event that competing products enter the market.
A number of companies already have pursued, and are actively pursuing, products for the detection of Cryptosporidium and Giardia in drinking water and it is likely that the Company's Hydrofluor products will face increasing competition in the future. Hydrofluor currently benefits from its designation as the ASTM standard method for detection of these protozoa and from its selection by the EPA as the method for use in complying to the EPA's Information Collection Rule to establish the extent of contamination in the nation's drinking water.
Employees
As of December 31, 1999, the Company employed 193 full time and 2 part time individuals including 185 regular and 10 contract employees. All of the Company's employees have executed agreements with the Company agreeing not to disclose the Company's proprietary information, assigning to the Company all rights to inventions made during their employment, and prohibiting them from competing with the Company. None of the Company's employees are covered by collective bargaining agreements. The Company believes that its relations with its employees are good.
ITEM 2.
ITEM 2. PROPERTIES
The Company is headquartered in Newark, Delaware, and occupies approximately 28,000 square feet of space under an operating lease expiring in December 2007. The Company also leases approximately 26,000 square feet of manufacturing and research space also in Newark, Delaware under three operating leases that expire in October 2000, October 2001 and November 2003, respectively.
The Company leases regional sales offices near London, England, and Chestnut Hill, Massachusetts. The Company also leases warehouse space of 1,600 square feet or less with leases that run one year or less. The Company believes that its equipment and facilities are adequate for its present purposes.
Strategic BioSolutions occupies approximately 8,000 square feet of manufacturing, research and animal facility space, in Newark, DE and owns and occupies approximately 45 acres of farmland near San Diego, California and 120 acres of farmland near Windham, Maine.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's stockholders during the fourth quarter of the fiscal year ended December 31, 1999.
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company, their positions with the Company and ages are as follows:
Richard C. Birkmeyer, age 46, cofounded SDI in 1990 and has served as its President and Chief Executive Officer and a director since its inception. Prior to founding SDI, Mr. Birkmeyer was employed by E.I. du Pont de Nemours ("DuPont") from 1983 to 1990, where he most recently served as Product Manager. Mr. Birkmeyer received a Ph.D. in Biochemistry/Immunology from the State University of New York at Binghamton and his BS in Biology from the State University of New York at Plattsburgh. In addition, Mr. Birkmeyer completed post-doctoral research in immunogenetics at Iowa State University.
Kelly J. Cullum, age 39, joined the Company in February 1998 as Vice President - Sales and Marketing. Prior to joining the Company, Ms. Cullum was employed at Idexx Laboratories in Tokyo, Japan, as Corporate Vice President, Pacific Rim Division. From 1994 to 1995, Ms. Cullum was Global Director of Marketing for Veterinary Products Division at Idexx. Prior to this position and since 1987, Ms Cullum held a variety of sales management positions at Idexx. Ms. Cullum received her BS in Marketing from the University of Massachusetts, Amherst.
Arthur A. Koch, Jr., age 46, joined the Company in April 1997 as Vice President - Finance and Chief Financial Officer. In October 1998, Mr. Koch was appointed the Company's Chief Operating Officer. Prior to joining the Company, Mr. Koch was Vice President and Chief Financial Officer of Paracelsian, Inc., a publicly held biotechnology company. From 1992 to 1995, Mr. Koch was Vice President and Chief Financial Officer of IBAH, Inc. a publicly held contract clinical research corporation. Mr. Koch received a BA in Business Administration from Temple University and is a Certified Public Accountant.
Martha C. Reider, age 45, co-founded SDI in 1990 and served as Vice President - Manufacturing and Secretary since inception through 1998. In 1998 Ms. Reider was appointed Vice President Quality Assurance/Human Resources. Ms. Reider continues to serve as the Corporate Secretary. From inception to December 30, 1996, Ms. Reider was a director of SDI. Prior to founding SDI, Ms. Reider worked for DuPont from 1976 to 1990 where she most recently served as supervisor of Quality Control and Quality Assurance. Ms. Reider received her BA in Biological Sciences from Ohio Northern University.
James W. Stave, age 45, joined SDI in March 1991 as a research group leader. Subsequently, Dr. Stave was promoted to director of Research and Development, in October 1993 was promoted to Vice President - Research and Development. Prior to joining SDI, Dr. Stave worked for DuPont. Molecular Genetics, Inc. and the U.S. Department of Agriculture. Dr. Stave received his Ph.D. in Microbiology from the University of Maryland and his B.S. in Biology from Michigan Technological University.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on The Nasdaq National Market under the symbol "SDIX". Set forth below are the quarterly high and low bid prices for the shares of Common Stock of the Company as reported by Nasdaq withour retail mark-up, mark-down or commission and may not necessarily represent actual transactions:
Common Stock Price Range High Low ---- --- Fiscal Year Ended
December 31, 1999: First Quarter 3 1 3/4 Second Quarter 3 31/32 2 1/8 Third Quarter 10 1/16 3 3/4 Fourth Quarter 9 1/4 5 1/32
December 31, 1998: First Quarter 4 3/4 2 1/2 Second Quarter 4 2 7/8 Third Quarter 3 5/8 1 29/32 Fourth Quarter 2 5/8 1 5/8
On March 13, 2000 there were approximately 4,712 holders (212 holders of record) of the Common Stock of the Company. The Company has never paid any cash dividends on its Common Stock and pursuant to the Company's acquisition financing agreement with First Union National Bank, the Company's commercial bank, no dividends of distributions may be paid on account of its Common Stock.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
(1) The redeemable convertible preferred stock was reclassified into stockholders' equity in connection with the Ensys merger.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Forward Looking Statements
This Form 10-K contains forward-looking statements reflecting the Company's current expectations. When used in this Form 10-K, the words "anticipate", "enable", "believe", "estimate", "expect", "intend", "potential", "will" and similar expressions as they relate to the Company are intended to identify said forward-looking statements. Investors are cautioned that all forward-looking statements involve risks and uncertainties, which may cause actual results to differ from those anticipated at this time. Such risks and uncertainties include, without limitation, the Company's ability to manage growth, the integration of acquired companies, including HTI, unknown changes related to acquisitions such as the amortization of significant goodwill and other intangible assets, changes in demand for products, delays in product development, delays in market acceptance of new products, inability to obtain required governmental approvals, modifications of governmental regulations, modifications to development and sales relationships, the ability to achieve anticipated growth, seasonality, competition and other factors more fully described in the Company's public filings with the U.S. Securities and Exchange Commission.
Overview
The Company develops, manufactures and markets immunoassay-based test kits for rapid and inexpensive detection of a wide variety of substances in the agricultural, water quality and environmental market segments. Through its Strategic BioSolutions division, the Company also provides antibody and immunoreagent research and development production services.
Since its inception, the Company and its predecessors have in addition to conducting internal research and development of new products, entered into research and development agreements with multiple corporate partners that have led to the introduction of various products to the water quality, environmental testing, agricultural and other markets. These agreements generally provide that sales and marketing costs associated with a new product are borne by the corporate partner. In addition, the Company currently sells directly or through distributors other products that it has independently developed or acquired. The Company believes that its competitiveness has been enhanced through the combinations of talents, technology and resources resulting from the relationships and the acquisitions it concluded during the past four years. These relationships and acquisitions have enabled the Company to achieve meaningful economies of scale for the unique products it offers through the utilization of its consolidated facilites in Newark, Delaware, for the manufacture of test kits, antibodies and biochemicals, its facility located outside of San Diego, California for the manufacture of antibodies and biochemicals and its facility located in Windham, Maine for the manufacture of custom, high-volume bulk polyclonal antibodies. These economies of scale, in turn, enable the Company to offer its customers the most appropriate test for each specific customer application.
Another key strategy that the Company used to develop its business was the formation in 1991 of TSD BioServices, a joint venture between the Company and a subsidiary of Taconic Farms of Germantown, NY. Taconic Farms is a privately held company whose business is the production and sale of mice and rats, primarily to the research community. In 1996, the joint venture was dissolved and the Company's interests were distributed into a wholly owned subsidiary, TSD BioServices, Inc. ("TSD"). With TSD and the 1999 acquisitions of HTI and the operating assets of the OEM business of Atlantic Antibodies, the Company formed a new operating division, Strategic BioSolutions, which has now become one of the largest producers of antibodies in the United States. The mission of Strategic BioSolutions is to supply monoclonal and polyclonal antibodies, immunochemical reagents and related services to medical diagnostic and pharmaceutical companies, as well as research institutions.
The Company believes that its products in the agricultural, water quality and environmental testing markets are unique and fill potentially large, unmet needs. The Company also believes that its products and technology currently being developed have broad application in diverse markets. The Company believes that its established product base, quality manufacturing expertise, experienced sales and marketing organization, established network of distributors, corporate partner relationships and proven research and development expertise will be critical elements of its potential future success.
Revenues in any particular quarter may not be indicative of revenues for any subsequent quarter during the year, or for the year. As sales of the Company's analytical tests for water-soluble polymers (which are generally not affected by seasonal patterns) and agricultural products to other parts of the world develop over the next few years, the Company expects its seasonal fluctuations to become gradually less pronounced.
Results of Operations
Year ended December 31, 1999 versus year ended December 31, 1998
Revenues: Net revenues increased $6.8 million or 43% in 1999 versus 1998. This increase is the result of a $7.1 million or 50% increase in product related revenues offset by a $244 thousand or 16% decrease in contract and other revenues. The growth in product revenues is primarily attributable to increases in sales of products in the agricultural category, (tests to detect genetic traits in genetically engineered plants) as sales in this category of products grew 125% from the levels achieved in 1998, resulting from the expansion of the agricultural product line to include kits designed for the quality assurance of foundation seed and the launch of a product line designed for the food processing and grain industry. 1999 included sales to distributors in the U.S., Japan and parts of Europe and South America. Increases in revenues of antibody products grew 187% from the 1998 levels, due primarily to the inclusion of revenues from the HTI acquisition in February of 1999, and the acquisition of the operating assets of the OEM business of Atlantic Antibodies in May of 1999, for which there were no comparable 1998 revenues. These increases were partially offset by decreases in the Company's industrial/chemical category of 21%, water quality category of 6% and other products category when compared to the 1998 revenues recorded in these categories. Revenues in the other products category in 1998 included the sale of a line of antibodies and pre-commercial Macra Lp(a) testing kits as described below for which there were no comparable amounts in 1999. The decline in contract and other revenues is primarily the result of the Company's continued emphasis on internal research and development programs versus contractual research and development programs.
Operating Expenses: Operating expenses increased $4.9 million or 32% in 1999 to $20.2 million from $15.3 million in 1998, exclusive of the $3.5 million one-time charge for acquired research and development as a result of the HTI acquisition. This increase is primarily attributable to an increase in the general business activity that occurred during the year and is described below.
Manufacturing expenses, which include the cost of products sold, increased $2.9 million or 46% in 1999 to $9.1 million from $6.2 million in 1998. This is primarily the result of the 50% increase in product related revenues the Company experienced in 1999 versus the same period in 1998.
Research and development expenses increased $528 thousand or 27% in 1999 to $2.5 million from $1.9 million in 1998. This increase was due to the Company's continuing investment in new product development for its agricultural category of products (tests to detect genetic traits in genetically engineered plants).
Selling, general and administrative expenses increased $1.5 million or 21% in 1999 to $8.7 million from $7.2 million in 1998. Additional costs and acquired personnel, related to the acquisitions of HTI and the operating assets of the OEM business of Atlantic Antibodies, and the subsequent expansion of the antibody business through Strategic BioSolutions were the primary reasons for the increased costs in this category.
For the year ended December 31, 1999, the Company incurred a one-time special charge of $3.5 million for In-Process Research and Development related to the acquisition of HTI. This item is more fully described in Note 3 to the Financial Statements "Mergers and Acquisitions".
Net Interest and Other Income: Net interest and other income decreased $728 thousand or 204%, due to the interest paid on the $9 million of acquisition financing used in the purchase of HTI and the operating assets of the OEM business of Atlantic Antibodies.
The Company has approximately $8.2 million of gross deferred tax assets consisting primarily of the future tax benefit from net operating loss carryforwards. In the fourth quarter of 1999, the Company concluded that it is more likely than not it will realize a portion of the benefit of such tax
assets. Accordingly, the Company has reduced the valuation allowance against the asset and recorded a tax benefit of $5.3 million in December 1999. Due to the recognition of the Company's tax benefit in 1999, the Company expects that its effective tax rate in future periods will approximate 38 to 40 percent.
The recognition of these deferred tax assets under SFAS 109 has no impact on the company's cash flows for income taxes despite the change in the Company's effective tax rate. The recognition of these deferred tax assets impacted reported earnings per share due to the benefit recorded to the statement of operations.
Net Income: Net income increased $1.2 million or 152%, (exclusive of the $5.3 million income tax benefit and the $3.5 million one-time acquired research and development charge, recorded in connection with the HTI acquisition). This increase is primarily attributable to the increased sales of the Company's agricultural and antibody products, and the corresponding economies of scale realized by the Company's higher level of business activity.
Year ended December 31, 1998 versus year ended December 31, 1997
Revenues: Revenues increased $1.3 million in 1998 or 9% over 1997. This increase is the result of a $1.5 million (12%) increase in product related revenues, offset by a $164 thousand (10%) decrease in contract and other revenues. Product related revenues increased to $14.2 million from $12.7 million in 1998 from 1997. This growth in product revenues is primarily attributable to increases in sales of products in the agricultural category (tests to detect traits in genetically engineered plants) of $1.3 million (62%), TSD BioServices category (custom monoclonal antibody production and purification) of $651 thousand (31%) and Other revenue category (includes the sale of a line of antibodies for $400,000 to a major customer and the $600,000 sale of pre-commercial Macra Lp(a) test kits pursuant to the June 1998 supply agreement with a major customer, both occurring during the second quarter of 1998) $1.1 million (196%), all increases over the 1997 revenues recorded in these categories. These increases were partially offset by decreases in the Industrial/Chemical category $354 thousand (7%), and Water Quality category $1.2 million (41%), when compared to the 1997 revenues recorded in these categories. The decline in contract and other revenues is the result of the Company's focusing its efforts on the food testing market during the second half of 1998.
During the second half of 1998, the Company strategically refocused its efforts and devoted significant resources to enter the European Market for food testing to detect the presence of Genetically Modified Organisms (GMOs) in agricultural commodities and food fractions that are used to manufacture finished food products. This focus resulted in a reduction in contract and other revenues and an increase in research and development, selling, general and administrative expenses.
Operating Expenses: Operating expenses increased $2.3 million (18%) in 1998, from $13.0 million in 1997 to $15.3 million in 1998. This increase is primarily related to an increase in the general business activity that occurred during the year and is described below.
Manufacturing expenses, which include the costs of products sold, increased $917 thousand (17%) in 1998 to $6.2 million. Increased costs in materials, labor and overhead were associated with the mix of products sold in 1998 versus 1997.
Research and development expenses increased $342 thousand (22%) to $1.9 million in 1998 from $1.6 million in 1997. This increase was due to the higher costs of labor and materials associated with additional staff required to develop new, and modify existing products for the Company's entry into the European GMO food testing market.
Selling, general and administrative expenses increased $1 million (17%) to $7.2 million in 1998 from $6.1 million in 1997. Increased costs for public relations, sales consulting, advertising and travel were recorded as the Company increased its exposure in the markets it serves. Additional expenses were incurred as efforts in the second half of 1998 were focused on the Company's entry into the European market for GMO testing. The Company reorganized its sales and marketing efforts in the second half of 1998 to focus on this rapidly emerging opportunity. This major reorganization included closing two sales offices in the industrial sales group, consolidating certain sales responsibilities to the Company's headquarters and reassigning other individuals to cover the agricultural market.
Net Interest and Other Income: Net interest and other income increased $82 thousand (30%) in 1998 to $356 thousand, from the $274 thousand earned in 1997. This increase is due to an increase in the level of invested balances maintained throughout the year.
Net Income: Net income decreased $896 thousand (53%) in 1998 to $781 thousand, from income of $1.7 million reported in 1997. This decrease in net income is attributable to the increased costs, particularly research and development and selling, general and administrative expenses, related to the Company's entry into the European Food Market which more than offset increases in revenues, all as described above.
Liquidity and Capital Resources
The Company's working capital which consists principally of cash, accounts receivable and inventory, decreased $28 thousand in 1999 to $10.1 million at December 31, 1999 from $10.2 million at December 31, 1998. This decrease is attributable to the 62% increase in accounts receivable from $3.7 million in 1998 to $6.0 million in 1999, the 58% net decrease in cash, cash equivalents and short-term investments from $5.9 million in 1998 to $2.5 million 1999, and the 198% increase in inventory from $1.9 million in 1998 to $5.5 million in 1999 offset by the increase in current liabilities of $2.5 million. During 1999, the Company began to market certain products in the agricultural products category through independent distributors. Future sales through these additional distribution channels could be substantial but difficult to predict from quarter to quarter, and the terms for payment of these types of sales are somewhat extended from the Company's typical payment terms for direct sales and will continue to evolve as business needs dictate.
For the year ended December 31, 1999, the Company satisfied all of its cash requirements from cash available and on-hand, and from a financing agreement with a commercial bank for $9 million in acquisition financing for the purchase of HTI and the operating assets of the OEM business of Atlantic Antibodies. At December 31, 1999, the Company had $6.3 million in long-term debt and stockholders' equity of $19.2 million.
The Company believes it has, or has access to sufficient assets to meet its operating requirements for the forseeable future. The Company's ability to meet its long-term capital requirements will depend on a number of factors including the success of its current and future products, the focus and direction of its research and development program, competitive and technological advances, future relationships with corporate partners, government regulation, the Company's marketing and distribution strategy and the success of the Company's plan to make future acquisitions. Accordingly, no assurance can be given that the Company will be able to meet the future liquidity requirements that may arise from these inherent and similar uncertainties (see Note 11 to the Consolidated Financial Statements.)
Year 2000 Issues
The Company has not experienced any Year 2000 issue problems or disruptions. The Company will continue to contact critical suppliers, collaborators and partners to determine if their operations, as they relate to the Company, are Year 2000 compliant. The Company cannot presently estimate the impact of the failure of such third parties to be Year 2000 compliant.
Although the Company will take all practical measures to prevent problems related with the Year 2000 programming issues, such problems and failures may occur which could seriously affect the Company's progress. Because of the unprecedented nature of such problems, the extent of the effect on the Company's progress cannot be certain.
New Accounting Pronouncements
On December 3, 1999, the staff of the Securities and Exchange Commission, or SEC, issues Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements," or SAB No. 101. SAB No. 101 provides the SEC staff's views on the recognition of revenue including nonrefundable technology access fees received by biotechnology companies in connection with research collaborations with third parties. SAB No. 101 states that in certain circumstances the SEC staff believes that up-front fees, even if nonrefundable, should be deferred and recognized systematically over the term of the research agreement. SAB No. 101 requires registrants to adopt the accounting guidance contained therein by no later than the first fiscal quarter of the fiscal year beginning after December 15, 1999. The adoption of this standard is not expected to have a material impact on the Company's financial position or results of operations.
In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities ("Statement 133"). Statement 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. Statement 133 requires that an
entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure the instrument at fair value. The accounting changes in the fair value of a derivative depend on the intended use of the derivative and the resulting designation. This Statement, as amended, is effective for the first fiscal quarter beginning after December 31, 2000. The adoption of this standard will not have a material impact on the Company's earnings or financial position.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has exposure to changing interest rates, and is currently not engaged in hedging activities. Interest on $3 million of outstanding indebtedness is at a fixed rate of 8.96% per annum, and the remaining principal bears interest at a variable rate of 3% over the published London Interbank Offered Rate.
The Company conducts operations in Great Britain. The consolidated financial statements of the Company are denominated in U.S. Dollars and changes in exchange rates between foreign countries and the U.S. dollar will affect the translation of financial results of foreign subsidiaries into U.S. dollars for purposes of recording the Company's consolidated financial results. Historically, the effects of translation have not been material to the consolidated financial results.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPLEMENTARY DATA
The following consolidated financial statements and supplemental quarterly financial data of the Company and its subsidiaries are included as part of this Form 10-K:
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
The Company filed a Form 8-K on September 17, 1998, reporting a change in the Company's auditors.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
The information contained under the caption "Election of a Class of Directors" and the information contained under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's Definitive Proxy Statement is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information contained under the caption "Executive Compensation" in the Company's Definitive Proxy Statement is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information contained under the caption "Stock Ownership of Principal Stockholders and Management" in the Company's Definitive Proxy Statement is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information contained under the caption "Certain Relationships and Related Transactions" in the Company's Definitive Proxy Statement is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Financial Statements - ---------------------------
See the Consolidated Financial Statements which begin on page of this Report.
2. Financial Statement Schedules --------------------------------
Financial statement schedules are omitted because they are either not required or not applicable or the required information is reflected in the financial statements or notes thereto.
3. Exhibits -----------
- ---------------------------------------------
(1) Incorporated by reference to the designated exhibit of the EnSys Registration Statement on Form S-4 ( No. 333-17505) filed on December 9, 1996.
(2) Incorporated by reference to the designated exhibit of the EnSys Registration Statement on Form S-1 ( No. 33-68440) filed on September 3, 1993.
(3) Incorporated by reference to Appendix F to the Joint Proxy Statement/Prospectus contained in the EnSys Registration Statement on Form S-4 (No. 333-17505) filed on December 9, 1996.
(4) Incorporated by reference to the designated exhibit of the EnSys Form 10-K for the fiscal year ended December 31, 1994.
(5) Incorporated by reference to the designated exhibit of the EnSys Form 10-Q for the fiscal quarter ended March 31, 1996.
(6) Incorporated by reference to the designated exhibit of the Company's Form 10-K for the fiscal year ended December 31, 1996.
(7) Incorporated by reference to the designated exhibit of the Company's Form 10-K for the fiscal year ended December 31, 1997.
(8) Incorporated by reference to the identically numbered exhibit contained in the Company's Form 8-K filed on May 26, 1999
(9) Incorporated by reference to the identically numbered exhibit contained in the Company's Form 8-K filed on March 15, 1999
*Management contract or compensatory plan.
(b) Reports on Form 8-K (b) - ---------------------------
None.
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders Strategic Diagnostics Inc.:
We have audited the accompanying consolidated balance sheets of Strategic Diagnostics Inc. and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations, stockholders' equity and comprehensive income and cash flows for each of the years in the two-year period ended December 31, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Strategic Diagnostics Inc. and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 1999 in conformity with generally accepted accounting principles.
KPMG LLP
Philadelphia, Pennsylvania February 23, 2000
INDEPENDENT AUDITORS' REPORT
To Strategic Diagnostics Inc.:
We have audited the accompanying consolidated statements of operations, stockholders' equity and comprehensive income and cash flows of Strategic Diagnostics Inc. (a Delaware corporation) and subsidiaries for the year ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the results of operations of Strategic Diagnostics Inc. and subsidiaries and their cash flows for the year ended December 31, 1997, in conformity with generally accepted accounting principles.
Arthur Andersen LLP
Philadelphia, Pennsylvania January 30, 1998
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (in thousands, except share and per share data)
The accompanying notes are an integral part of these statements.
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except share and per share data)
The accompanying notes are an integral part of these statements.
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (in thousands)
The accompanying notes are an integral part of these statements.
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
The accompanying notes are an integral part of these statements
STRATEGIC DIAGNOSTICS INC. AND SUBSIDIARIES -------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 ----------------- (in thousands, except share and per share data)
1. BACKGROUND: -----------
Business - --------
Strategic Diagnostics Inc. (the "Company") develops, manufactures and markets immunoassay based test kits for rapid and inexpensive detection of a wide variety of substances in the water quality, environmental and agricultural markets.
Basis of Presentation - ---------------------
The historical financial statements presented herein include the consolidated financial statements of Strategic Diagnostics Inc. and its subsidiaries. As used herein, unless the context requires otherwise, the Company collectively refers to SDI and its subsidiaries for the periods indicated. All significant intercompany balances and transactions have been eliminated in consolidation.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND CERTAIN BALANCE SHEET -------------------------------------------------------------------- INFORMATION: ------------
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.
Basic and Diluted Income per Share - ----------------------------------
The Company has adopted Statement of Financial Standards ("SFAS") No. 128, "Earnings per Share," which requires dual presentation of basic and diluted earnings per share ("EPS") for complex capital structures on the face of the statement of operations. Basic EPS is computed by dividing net income or loss by the weighted-average number of common shares outstanding during the period. Diluted EPS is similar to basic EPS except that the effect of converting or exercising all potentially dilutive securities is also included in the denominator. The Company's calculation of diluted EPS includes the effect of converting preferred stock and exercising stock options and warrants into common shares. The following table reflects the basic and diluted per share calculation.
During the third quarter of 1999, the 2,164,362 shares of the Company's Series A preferred stock was converted by its holders into 2,164,362 shares of the Company's common stock.
Statements of Cash Flows - ------------------------
The Company considers all highly liquid instruments purchased with an original maturity of three months or less to be cash equivalents.
Accounts Receivable - -------------------
As of December 31, 1999, 1998 and 1997, the allowance for doubtful accounts was $214, $97 and $120, respectively. In 1999, 1998 and 1997, approximately $64, $23 and $60 of write-offs were charged to this allowance in each of the respective years. If receivables become uncollectible or unbillable, the Company's policy is to charge these write-offs against the allowance. The Company continually reviews the realizability of its receivables and charges current period earnings for the amount deemed unrealizable. At December 31, accounts receivable consisted of the following:
1999 1998 1997 ---------- ---------- ---------- Accounts receivable $ 5,539 $ 3,152 $ 2,745 Unbilled accounts receivable 482 501 414 ---------- ---------- ---------- $ 6,021 $ 3,653 $ 3,159 ========== ========== ==========
Inventories - -----------
The Company's inventories, which consist primarily of test kit components, bulk serum and antibody products are valued at the lower of cost or market. Cost is determined using the first in, first out method. Realization of the Company's inventories is dependent upon the successful marketing of its products. At December 31, inventories consisted of the following:
1999 1998 1997 -------- -------- --------
Raw materials $ 2,258 $ 700 $ 619 Work in progress 804 93 51 Finished goods 2,462 1,062 877 -------- -------- -------- $ 5,524 $ 1,855 $ 1,547 ======== ======== ========
Property and Equipment - ----------------------
Property and equipment are stated at cost. Depreciation and amortization is computed using the straight-line method over the estimated useful lives (generally three to five years) of the assets. Leasehold improvements are depreciated over the shorter of, the lease term or the estimated useful life.
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed of - -----------------------------------------------------------------------
Long-Lived assets and intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the assets to the future undiscounted net cash flows expected to be generated by the assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less the cost to sell.
Revenue Recognition - -------------------
Product related revenues which include the sale of immunoassay-based test kits are generally recognized upon shipment. Included in product related revenues are also the sale of antibodies and immunochemical reagents which are sold through longer term development agreements. These revenues are recognized on a percentage of completion method. Contract revenues recorded under the Company's collaborative agreements are recognized upon the completion of certain performance requirements of the contracts.
Research and Development - ------------------------
Research and development costs are charged to expense as incurred.
Accounting for Income Taxes - ---------------------------
Deferred income tax assets and liabilities are determined based on differences between the financial statement reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The measurement of deferred income tax assets is reduced, if necessary, by a valuation allowance for any tax benefits which are not expected to be realized. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized in the period that such tax rate changes are enacted.
Comprehensive Income - --------------------
The Company adopted FAS No. 130 "Reporting Comprehensive Income" ("FAS 130"). Under FAS 130, the Company is required to display comprehensive income (loss) and its components as part of the Company's full set of financial statements. Comprehensive income (loss) is comprised of net income (loss) and net unrealized gains (losses) on securities and is presented in the consolidated statements of changes in stockholders' equity. The Statement requires only additional disclosures in the consolidated financial statements; it does not affect the Company's financial position or results of operations.
3. MERGERS AND ACQUISITIONS: -------------------------
Acquisition of HTI BioProducts, Inc.. - -------------------------------------
On February 26, 1999, the Company completed the acquisition of HTI Bio-Products Inc. (HTI), a privately held manufacturer of custom and proprietary antibody products and services located near San Diego, California. Under the terms of the agreement to acquire HTI, the Company paid approximately $8.4 million in cash and issued 556,286 shares of Series B preferred stock, with a fair market value of approximately $1.1 million. Under the terms of the agreement, on June 16, 1999, such shares were converted into the Company's common stock on a 1 for 1 basis. The Company is also obligated to pay a percentage of net sales of certain products over the next three years, not to exceed $3 million which will be recorded as additional goodwill. Approximately $6 million of acquisition
financing was provided by a commercial bank under a Term Loan, with the balance coming from existing cash on hand (see Note 8 to the Consolidated Financial Statements).
The Company recorded expenses of $3.5 million of in-process research and development in the quarter ended March 31, 1999. This amount represents an allocation of the purchase price of HTI to projects that are currently under development but have not yet been launched commercially because the development is not complete. Because technological feasibility has not been established and no alternative use determined, the entire amount of in-process research and development has been expensed. The identified research and development consists of in process projects for the development of eleven antibodies, as listed below:
Troponin I Fatty Acid Binding Protein Cystatin C Human Red Blood Cell cAMP Brain Natriuretic Peptide Serum Amyloid A cGMP Phosphorylated Amino Acids Phosphorylated Tau APE
At this time, management believes that Troponin I and Cystatin C have the greatest immediate potential as commercial products. Troponin I has potential use as a diagnostic marker for the coronary care market. Cystatin C has potential use as a diagnostic marker for kidney malfunction. In future years, others of the in-process research and development assets, such as Human Red Blood Cell, may prove to have even greater potential as commercial products.
There is no guarantee that any of these markers will be commercially viable.
The Company commissioned an appraisal of these in-process research and development projects by an independent firm familiar with such appraisals. This independent appraisal valued the in-process research and development projects at $3.5 million by considering, the nature and history of HTI's business, description of the in-process research and development assets, the general economic outlook, the outlook for the antibody production industry, the expected future cash flows of the products and usage of a discounted cash flow analysis. The average completion stage of the products was estimated at 93% and a 20% discount rate was used in computing the present value of the future cash flows of the products.
Acquisition of the Operating Assets of the OEM Business of Atlantic Antibodies, - ------------------------------------------------------------------------------- Inc. - ---
On May 11, 1999, the Company completed the acquisition of the operating assets of the OEM business of Atlantic Antibodies of Windham, Maine, one of the first suppliers of custom and high-volume, bulk polyclonal antibodies for use in diagnostic test kits and research. This unit serves a wide range of customers including pharmaceutical, biotechnology, diagnostic companies and major research centers in the United States and the Pacific Rim. Under the terms of the agreement to acquire the operating assets of the OEM business of Atlantic Antibodies, the Company paid $3.2 million in cash, including closing costs, and has agreed to a deferred payment of $150,000, upon the earlier of the sale of certain real estate or November 11, 2000. The Company's commercial bank provided $3 million of long-term acquisition financing under the Term Loan (see Note 8 to the Consolidated Financial Statements).
Unaudited Pro Forma Combined Results of Operations - --------------------------------------------------
The following unaudited pro forma statement of operations gives effect to the HTI transaction, which was accounted for, using the purchase method of accounting, as if the HTI purchase had occurred on January 1, 1998, and includes certain adjustments, including amortization of goodwill, increased interest expense and preferred stock dividends related to the HTI purchase. The 1999 pro forma results exclude $3.5 million of in-process research and development expenses incurred in connection with the HTI transaction.
Unaudited Pro Forma Combined Results of Operations (unaudited in thousands)
Supplemental Disclosure of Cash Flow Information - ------------------------------------------------
The purchase price of HTI Bio-Products Inc. and certain assets of the OEM business of Atlantic Antibodies Inc. was allocated as follows (in thousands):
HTI ATAB --- ---- Cash $ 249 Land $ 360 Other Assets 1,562 Fixed Assets 1,215 Fixed Assets 1,004 Inventory 1,575 Liabilities (863) ------ In-process research & development 3,500 Cash Paid $3,150 Goodwill 4,044 ====== ------ Total fair value $9,496 ====== Cash Paid $8,429
Series B Preferred Stock Issued $1,067
4. PROPERTY AND EQUIPMENT: ----------------------
As of December 31, property and equipment consisted of the following:
1999 1998 -------- ---------
Equipment $ 3,747 $ 1,518 Furniture and fixtures 81 66 Land 710 - Leasehold improvements 561 502 ------ ------- Less- Accumulated depreciation and amortization (1,810) (1,251) ------ ------- $ 3,289 $ 835 ======= =======
Depreciation expense was $559, $322, and $391 in 1999, 1998, and 1997 respectively.
5. OTHER ASSETS: -------------
As of December 31, other assets consisted of the following:
The Company maintains a note receivable from a former executive of EnSys. The original loan amount was $350 and is secured by the individual's personal residence. The loan bears interest at 5.8% per annum. At December 31, 1999, the outstanding loan balance was approximately $336 of which approximately $6 in principal is payable in the year 2000 with the balance payable in January 2001.
6. INTANGIBLE ASSETS: ------------------
Amortization of these intangible assets was $451, $279 and $278 in 1999, 1998 and 1997, respectively. In the fourth quarter of 1999, approximately $1.3 million of net intangible assets, were eliminated in accordance with SFAS 109, as the Company believes it will utilize the tax benefits of the net operating losses, acquired in the transactions that occurred in 1996.
7. ACCRUED EXPENSES: -----------------
As of December 31, accrued expenses consisted of the following:
1999 1998
Royalties $ 275 $ 291 Accrued purchases 29 185 Accrued other 393 312 ------ ------ $ 697 $ 788 ====== ======
8. LONG-TERM DEBT: ---------------
The Company entered into a financing agreement with a commercial bank during 1999, pursuant to which the Company borrowed a total of $9.0 million, in connection with the acquisitions of HTI and the operating assets of the OEM business of Atlantic AntiBodies. The acquisition financing consists of a five-year term loan (the Term Loan) with monthly amortization of equal principal payments plus interest. Interest on $3 million of original principal amount is at a fixed rate of interest of 8.96% per annum, and the remaining principal bears interest at a variable rate of 3% over the published London Interbank Offered Rate ("LIBOR"). Also under the terms of the financing, the Company is required to meet certain financial covenants including debt to net worth, minimum cash flows and no dividends or distributions may be paid on account of the Company's common stock. At December 31, 1999, the Company is in compliance with all such covenants. The financing is secured by substantially all of the Company's assets.
The Company also maintains two term loans acquired in 1998, for the purchase of specific equipment and leasehold improvements. The maturities of these loans are 48 and 60 months. These notes are secured with Certificates of Deposit (CD) of
$338 purchased by the Company and bear an interest rate of 1% over the purchased CD rate. As of December 31, 1999, the maturities of long term debt are listed below:
2000 $ 1,898 2001 1,897 2002 1,900 2003 1,865 2004 613 ----------- 8,173 Less- Current portion of long-term debt obligations (1,898) -----------
Long-term debt $ 6,275 ===========
Interest expense was $565, $20 and $36 in 1999, 1998 and 1997 respectively.
9. STOCK OPTIONS: ---------------
The Company has two stock option plans (the "1993 Plan" and the "2000 Plan") which authorize the granting of incentive and nonqualified stock options to officers, key employees, directors and consultants. Incentive stock options are granted at not less than 100% of fair market value at the date of grant (110% for stockholders owning more than 10% of the Company's common stock). Nonqualified stock options are granted at not less than 85% of fair market value at the date of grant. All previously issued SDI options were converted into the 2000 Plan. A maximum of 2,500,000 shares of common stock are issuable under the 2000 Plan.
Certain additional options have been granted outside the plans. These options generally follow the provisions of the 2000 Plan. Information with respect to the stock options granted under the plans and options granted separately from the plans is summarized as follows:
As of December 31, 1999, options covering 848,715 shares were exercisable with an aggregate exercise price of $1,529 and 398,129 shares were available for future grant under the plans. For options granted, the Company recognizes as deferred compensation the excess of the deemed value for accounting purposes of the common stock issuable upon the exercise of options over the aggregate exercise price of such options. The deferred compensation is amortized over the vesting period of the options.
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based Compensation." Effective January 1, 1995, the Company adopted the disclosure requirement of this pronouncement. Had compensation cost for the Company's stock option plans been determined based upon the fair value at the grant date for awards under SFAS 123, the Company's net income applicable to common stockholders for 1999, 1998 and 1997 would have been $3,295, $493, and $1,575 and diluted net income per share applicable to common stockholders would have been $.19, $.03, and $.10, respectively. Because the SFAS 123 method of accounting has not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation cost, and thus pro forma net income (loss), may not be representative of that to be expected in future years.
The weighted average fair value at the date of grant for options granted during 1999, 1998 and 1997 is estimated at $2.76, $1.97 and $1.37 per share, respectively, using the Black-Scholes option-pricing model. The assumptions used in the Black-Scholes model are as follows: dividend yield of 0%, expected volatility of 118% in 1999, 97% in 1998 and 80% in 1997, risk-free interest rate of 6.14% in 1999, 6.14% in 1998 and 6.4% in 1997, and an expected option life of 5 years in 1999, 5 years in 1998 and 6 years in 1997.
10. SEGMENT, GEOGRAPHIC AND CUSTOMER INFORMATION --------------------------------------------
The company has two reportable segments. The Test Kit segment develops, manufactures and markets immunoassay-based test kits for rapid, cost-effective detection of a wide variety of different analytes in three primary market categories: agriculture, water quality and environmental testing.
The Antibody Segment, Strategic BioSolutions (SBS), includes TSD BioServices, HTI and the acquired operating assets of the OEM business of Atlantic Antibodies. These businesses provide fully integrated polyclonal and monoclonal antibody development and large scale manufacturing services to pharmaceutical and medical diagnostic companies.
Geographic:
There were no individual countries outside of the United States that represents more than 10% of the total revenues of the Company. There are no significant long-lived assets located outside the United States.
Information about Major Customers:
In 1999, no customer accounted for 10% of the Company's revenues. In 1998, Delta and Pine Land Company accounted for 10% of the Company's revenues. Delta & Pine Land Company and Rohm and Haas Corp. each accounted for 10% of the Company's 1997 revenues.
Reportable Segments:
For reporting purposes a "pro-rata" share of common costs including a management fee is charged to the Antibody segment by the test kit segment. Segment profit is based on income before income taxes excluding the $3.5 million one time charge for in-process research and development in connection with the acquisition of HTI.
Segment Information:
11. COMMITMENTS AND CONTINGENCIES: ------------------------------
The Company leases its office and manufacturing facilities and other equipment under operating leases. Rent expense for the years ended December 31, 1999, 1998 and 1997, was $684, $598 and $466, respectively. Future commitments under these non-cancelable leases at December 31 are as follows:
2000 $ 436 2001 383 2002 351 2003 362 2004 308 2005 and thereafter 980 ------ $2,820 ------
The Company is party to various claims arising in the ordinary course of business. Although the ultimate outcome of these matters is presently not determinable, management, after consultation with legal counsel, does not believe that the outcome of these matters will have a material adverse effect on the Company's financial position or results of operations.
12. RETIREMENT SAVINGS PLAN: ------------------------
In 1992, the Company instituted a retirement savings plan qualified under Section 401(k) of the Internal Revenue Code. The plan allows for eligible employees to contribute a portion of their gross wages to the plan. The Company matches employees' contributions on a 50% basis up to 6% of gross wages. In 1999, 1998 and 1997, the Company recognized expense of $104, $77 and $76 respectively, associated with this plan.
13. INCOME TAXES: -------------
The provision for income tax (benefit) consists of the following:
1999 1998 ---- ----
Federal Current $ 40 $ - Deferred (5,149) -
State Current 15 - Deferred (223) - -------- ------- $ (5,317) $ - ========= =======
The following table summarizes the significant differences between the U.S. Federal statutory rate and the Company's effective tax rate for financial statement purposes:
1999 1998 1997 ---- ---- ---- Statutory tax rate (34.0)% 34.0% 34.0% State taxes, net of U.S. Federal benefit .6 .5 - Changes in net valuation reserve 316.3) (35.4) (34.9) Other, net 3.1 .9 .9 ------ ----- ----- (346.6)% - % - % ------ ----- -----
Significant components of the Company's deferred tax assets as of December 31 are as follows:
1999 1998 ---- ----
Net operating loss carryforwards $ 5,925 $ 7,288 Credit carryforwards 40 - Amortization and depreciation 2,076 699 Non-deductible reserves 118 55 Inventory costs not currently deductible 130 63 ------ ------- Total deferred tax assets $ 8,289 $ 8,105
Valuation allowance (1,218) (8,105) ------ ------
Net deferred tax assets $ 7,071 $ - ------- ------
Management continually reviews the valuation allowance on the Company's deferred tax assets. In the fourth quarter of 1999 management concluded that it was more likely than not that the Company would realize the tax benefits associated with its federal deferred tax assets and a portion of its state deferred tax assets and recorded a deferred tax benefit. A valuation allowance remains for a portion of the state deferred assets and all of the foreign deferred tax assets.
The reduction of the valuation allowance is attributed to management's belief that, at December 31, 1999, it is more likely than not the deferred tax assets will be realized through future earnings and/or tax planning strategies.
The amount of net operating loss carryforwards which can be utilized in any one period, if any, will be limited by federal tax regulations since a cumulative change in ownership of more than 50% has occurred within a three year period. The fourth quarter reduction in the valuation allowance on the Company's deferred tax assets, included approximately $1.3 million related to net operating losses that were acquired in connection with business acquisitions and mergers. The reduction in the valuation allowance related to the acquired net operating losses was recorded as a reduction in the remaining intangibles associated with the acquisition.
The net operating loss carryforwards differ from the accumulated deficit principally due to differences in the recognition of certain research and development expenses, depreciation and amortization, other non-deductible reserves and the accretion of preferred stock for financial and federal income tax reporting.
As of December 31, 1999, the Company had federal net operating loss carryforwards of approximately $14.1 million, which begin to expire as follows:
2004 $ 922 2005 2,565 2006 2,603 2007 2,584 2008 1,182 2009 2,081 2010 2,183 ------- Total $14,120
14. SALE OF TECHNOLOGY: -------------------
In July 1998, the Company entered into an exclusive agreement to sell its analytical test to detect concentrations of lipoprotein (a) to a biotechnology company.
At December 31, 1999, pursuant to the terms of the July 1998 agreement, the Company and the purchaser expected to determine the purchase price to be paid to the Company for its right, title and interest in the product. Such purchase price is to be based on a multiple of sales volumes achieved during the second half of 1999. In July 1998, the Company purchased intellectual and licensing rights to the product for $380. The Company and purchaser are evaluating the transactions and sales volumes for 1999, and have not yet reached an agreement on the final sales price. Accordingly, the Company has not recognized any gain on the sale of this asset through December 31, 1999. The Company expects to record the sale of the asset during fiscal year 2000, after the sales price has been determined, and expects to report a gain at that time.
15. QUARTERLY FINANCIAL DATA (unaudited): -------------------------------------
(1) Gross profit is net revenues less manufacturing expenses.
Results for the three months ended March 31, 1999, includes a $3.5 million charge for in-process research and development related to the acquisition of HTI on February 26, 1999. Results for the three months ended December 31, 1999 includes a $5.3 million income tax benefit related to the valuation of the Company's deferred tax assets.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
STRATEGIC DIAGNOSTICS INC.
Date: March 30, 2000 /s/ Richard C. Birkmeyer ------------------------- Richard C. Birkmeyer President, Chief Executive Officer (Principal Executive Officer) and Director
Date: March 30, 2000 /s/ Arthur A. Koch, Jr. ------------------------ Arthur A. Koch, Jr. Vice President - Finance, Chief Operating Officer, and Chief Financial Officer (Principal Financial and Accounting Officer)
Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Date: March 30, 2000 /s/ Richard J. Defieux ----------------------- Richard J. Defieux Director
Date: March 30, 2000 /s/ Robert E. Finnigan ----------------------- Robert E. Finnigan Director
Date: March 30, 2000 /s/ Stephen O. Jaeger ---------------------- Stephen O. Jaeger Director
Date: March 30, 2000 /s/ Kathleen E. Lamb --------------------- Kathleen E. Lamb Director
Date: March 30, 2000 /s/ Curtis Lee Smith, Jr. -------------------------- Curtis Lee Smith Jr. Director
Date: March 30, 2000 /s/ Grover C. Wrenn -------------------- Grover C. Wrenn Director