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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-21185
APPLIED ANALYTICAL INDUSTRIES, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 04-2687849
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
5051 NEW CENTRE DRIVE, WILMINGTON, NC 28403
(Address of principal executive office) (Zip code)
(910) 392-1606
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
The number of shares of the Registrant's common stock outstanding, as of
July 10, 1999, was 17,205,391 shares.
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APPLIED ANALYTICAL INDUSTRIES, INC.
Table of Contents
The terms "Company", "Registrant" or "AAI" in this Form 10-Q include
Applied Analytical Industries, Inc. and its subsidiaries, except where the
context may indicate otherwise. Any item which is not applicable or to which the
answer is negative has been omitted.
Page No.
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (unaudited).
Condensed Consolidated Statement of Income 3
Condensed Consolidated Balance Sheet 4
Condensed Consolidated Statement of Cash Flows 5
Notes to Condensed Consolidated Financial Statements 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS. 11
PART II. OTHER INFORMATION
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 16
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. 16
SIGNATURES 17
EXHIBIT INDEX 18
2
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
APPLIED ANALYTICAL INDUSTRIES, INC.
Condensed Consolidated Statement of Income
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
---------------------------- --------------------------
1999 1998 1999 1998
------------ ------------ ------------ ----------
<S> <C> <C> <C> <C>
Net sales $ 21,691 $ 23,811 47,806 44,784
------------ ------------ ------------ ----------
Operating costs and expenses:
Direct costs 12,260 11,664 26,858 22,619
Selling 3,407 2,447 6,075 4,931
General and administrative 5,826 5,449 11,089 10,051
Research and development 4,091 1,965 5,959 3,367
Transaction, integration, and restructuring costs -- 6,400 --
------------ ------------ ------------ ----------
25,584 21,525 56,381 40,968
------------ ------------ ------------ ----------
Income (loss) from operations (3,893) 2,286 (8,575) 3,816
Other income:
Interest income, net of expense (255) 131 (434) 261
Other, net (17) (28) (49) (17)
------------ ------------ ------------ ----------
(272) 103 (483) 244
------------ ------------ ------------ ----------
Income (loss) before income taxes (4,165) 2,389 (9,058) 4,060
Provision (benefit) for income taxes (1,192) 941 (2,322) 1,452
------------ ------------ ------------ ----------
Net income (loss) $ (2,973) $ 1,448 (6,736) 2,608
============ ============ ============ ==========
Basic earnings (loss) per share $ (0.17) $ 0.08 (0.39) 0.15
============ ============ ============ ==========
Weighted average shares outstanding 17,205 17,105 17,202 17,102
============ ============ ============ ==========
Diluted earnings (loss) per share $ (0.17) $ 0.08 (0.39) 0.15
============ ============ ============ ==========
Weighted average shares outstanding 17,205 17,657 17,202 17,709
============ ============ ============ ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
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APPLIED ANALYTICAL INDUSTRIES, INC.
Condensed Consolidated Balance Sheet
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
----------------- -----------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 8,774 $ 12,299
Accounts receivable 25,190 26,138
Work-in-progress 16,547 15,570
Prepaid and other current assets 10,341 7,902
----------------- -----------------
Total current assets 60,852 61,909
Property and equipment, net 41,560 38,802
Goodwill and other intangibles 13,541 15,509
Other assets 3,274 3,288
----------------- -----------------
Total assets $ 119,227 $ 119,508
================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt
and short-term debt $ 19,417 $ 7,038
Accounts payable 5,053 7,169
Customer advances 3,882 6,818
Accrued wages and benefits 5,649 4,522
Other accrued liabilities 8,471 7,836
----------------- -----------------
Total current liabilities 42,472 33,383
Long-term debt 5,527 7,749
Other liabilities 3,697 3,254
Commitments and contingencies -- --
Stockholders' equity:
Common stock 17 17
Paid-in capital 69,633 69,570
Retained earnings/(deficit) (1,083) 5,653
Accumulated other comprehensive losses (1,004) (53)
Stock subscriptions receivable (32) (65)
----------------- -----------------
Total stockholders' equity 67,531 75,122
----------------- -----------------
Total liabilities and stockholders' equity $ 119,227 $ 119,508
================= =================
</TABLE>
The accompanying notes are an integral part of these financial statements.
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APPLIED ANALYTICAL INDUSTRIES, INC.
Condensed Consolidated Statement of Cash Flows
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Six months ended
June 30,
--------------------------------
1999 1998
------------ ---------------
<S> <C> <C>
Net income/(loss) $ (6,736) $ 2,608
Adjustments to reconcile to net cash provided
(used) by operating activities:
Depreciation and amortization 3,791 3,084
Other (2) 683
Changes in assets and liabilities:
Trade and other receivables 497 (807)
Work-in-progress (1,377) (3,262)
Prepaid and other assets, net (2,580) (1,220)
Accounts payable (1,887) (80)
Customer advances (2,672) (1,868)
Other accrued liabilities 3,056 1,119
------------ ---------------
Net cash provided (used) by operating activities: (7,910) 257
Cash flows from investing activities:
Purchase of property and equipment (6,763) (5,329)
Other (43) 77
------------ ---------------
Net cash used by investing activities (6,806) (5,252)
Cash flows from financing activities:
Net (payments) proceeds on short-term debt 12,987 999
Net (payments) proceeds on long-term debt (1,644) (588)
Other (44) 76
------------ ---------------
Net cash (used) provided by financing activities 11,299 487
------------ ---------------
Net decrease in cash and cash equivalents (3,417) (4,508)
Effect of exchange rate changes on cash (108)
Cash and cash equivalents, beginning of period 12,299 27,436
------------ ---------------
Cash and cash equivalents, end of period $ 8,774 $ 22,928
============ ===============
Supplemental information, cash paid for:
Interest $ 178 $ 139
Income taxes $ 0 $ 800
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
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APPLIED ANALYTICAL INDUSTRIES, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles and
applicable Securities and Exchange Commission regulations for interim financial
information. These financial statements do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. It is presumed that users of this interim financial
information have read or have access to the audited financial statements for the
preceding fiscal year. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for fair presentation have
been included. Operating results for the interim periods presented are not
necessarily indicative of the results that may be expected for the full year.
2. MERGERS AND ACQUISITIONS
On March 16, 1999, the Company merged with Medical and Technical Research
Associates, Inc. ("MTRA"), a clinical contract research organization located
near Boston, Massachusetts, in exchange for approximately 1.3 million shares of
AAI stock including the conversion of MTRA options. The merger has been
accounted for as a pooling-of-interests. The results of operations for the
separate companies and the combined amounts presented in the consolidated
financial statements are as follows:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
------------------------------ -----------------------------
1999 1998 1999 1998
------------- ------------- ------------ ------------
<S> <C> <C> <C> <C>
Net sales:
AAI $ 17,113 $ 19,426 $ 38,388 $ 36,539
MTRA 4,578 4,385 9,418 8,245
------------- ------------- ------------ ------------
$ 21,691 $ 23,811 $ 47,806 $ 44,784
============= ============= ============ ============
Net income (loss):
AAI (3,200) 1,306 (7,202) 2,379
MTRA 227 142 466 229
------------- ------------- ------------ ------------
$ (2,973) $ 1,448 $ (6,736) $ 2,608
============= ============= ============ ============
</TABLE>
The accompanying consolidated financial statements include operations of the
combined entities for the three months ended June 30, 1999 and 1998.
In connection with the merger, the Company has recorded a non-recurring charge
to operating income reflecting the costs to complete the transaction, integrate
the businesses and realign its workforce to its new combined operating
structure. The items included in this charge are detailed in Note 7.
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3. EARNINGS PER SHARE
The weighted average shares used in the calculation of diluted earnings per
share represents the weighted average shares outstanding plus the dilutive
impact of outstanding stock options. The following table presents the changes
in the weighted shares outstanding.
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
----------------------------- -----------------------------
1999 (1) 1998 1999 (1) 1998
----------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
Basic Earnings per Share:
Weighted average number of shares 17,205 17,105 17,202 17,102
Effect of Dilutive Securities:
Employee and Director stock options 0 552 0 607
----------- ------------ ----------- ------------
Diluted Earnings per Share:
Adjusted weighted average number of
shares and assumed conversions 17,205 17,657 17,202 17,709
=========== ============ =========== ============
(1)Weighted Average Number of Shares Not
Included in Diluted EPS Since Antidilutive 519 0 567 0
=========== ============ =========== ============
</TABLE>
4. COMPREHENSIVE INCOME
Comprehensive income is defined as the change in equity during a period from
transactions and other events and circumstances from non-owner sources. The
following table presents the components of the Company's comprehensive income.
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
(In thousands) (In thousands)
------------------------------ -----------------------------
1999 1998 1999 1998
------------- ------------- ------------ ------------
<S> <C> <C> <C> <C>
Net income (loss) $ (2,973) $ 1,448 $ (6,736) $ 2,608
Other comprehensive income (loss):
Currency translation adjustments (370) 13 (1,004) (1)
------------- ------------- ------------ ------------
Comprehensive income (loss) $ (3,343) $ 1,461 $ (7,740) $ 2,607
============= ============= ============ ============
</TABLE>
7
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5. FINANCIAL INFORMATION BY BUSINESS SEGMENT AND GEOGRAPHIC AREA
(In thousands):
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
----------------------------- ------------------------------
1999 1998 1999 1998
------------ ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net sales:
Clinical $ 5,875 $ 6,107 $ 12,135 $ 12,059
Pharmaceutic 15,195 15,477 31,153 28,963
Internal Product Development 621 2,227 4,518 3,762
------------ ------------- ------------- -------------
$ 21,691 $ 23,811 $ 47,806 $ 44,784
============ ============= ============= =============
United States $ 17,918 $ 18,729 $ 37,989 $ 35,365
Non-U.S. 4,208 5,190 11,256 9,976
Less inter-geographic sales (435) (108) (1,439) (557)
------------ ------------- ------------- -------------
$ 21,691 $ 23,811 $ 47,806 $ 44,784
============ ============= ============= =============
Income (loss) from operations:
Clinical $ (215) $ 447 $ 142 $ 753
Pharmaceutic 1,065 2,157 2,468 3,195
Internal Product Development (3,330) 261 (2,320) 394
Corporate (1,413) (579) (2,465) (526)
Corporate Restructuring Charges 0 0 (6,400) 0
------------ ------------- ------------- -------------
$ (3,893) $ 2,286 $ (8,575) $ 3,816
United States $ (3,030) $ 2,787 $ (9,701) $ 4,234
Non-U.S. (863) (501) 1,126 (418)
------------ ------------- ------------- -------------
$ (3,893) $ 2,286 $ (8,575) $ 3,816
============ ============= ============= =============
</TABLE>
6. INCOME TAX EXPENSE
The Company's effective tax rate has been affected by losses in Europe. These
losses have created a tax asset which has been reserved against, thus no tax
benefit is shown related to the European losses. In the future, as European
operations become profitable, the reserves against these deferred assets will
reverse and will either reduce future tax expense or goodwill.
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7. TRANSACTION, INTEGRATION AND RESTRUCTURING COSTS
In connection with the Company's merger with MTRA, certain expenses of the
transaction, costs to integrate the two organizations and reorganize the
combined business have been accrued and recorded as an expense. The expenses
were recorded in the first quarter of 1999 and are included in the condensed
consolidated statement of income for the six months ended June 30, 1999.
Transaction costs are comprised of amounts owed to investment bankers and
advisors as a percentage of the total merger consideration and other expenses
directly related to the completion of the transaction, including financial
reviews and legal fees. Personnel separation costs include the separation of
approximately 58 employees in the US and Europe to combine the clinical
operations of the companies and realign the workforce in the new organization.
Facility and other costs include lease payments required under non-cancelable
leases for vacant properties and the write off of leasehold improvements and
equipment which will become redundant or obsolete due to the transaction. Other
costs include integration costs directly related to the merger and other costs
resulting from actions taken to merge the operations.
The following table presents the components of the expense recorded and the
amounts paid through June 30, 1999.
Total Paid to
Expense Date
----------- -----------
Transaction costs $ 1,913 $ 596
Personnel separation costs 1,919 467
Facility and other costs 2,568 1,123
=========== ===========
$ 6,400 $ 2,186
=========== ===========
8. TRANSACTIONS WITH RELATED PARTIES
In the second quarter of 1999, the Company advanced $300,000 to Pharmcomm, Inc.
("Pharmcomm"), a company whose principal stockholders include Dr. Frederick
Sancilio, Mr. James Waters and Mr. William Underwood, all directors of AAI.
One other stockholder of Pharmcomm is a member of AAI management.
The advance payment was for services to be rendered by Pharmcomm during 1999 and
2000 for scanning and indexing services required as part of AAI's regulatory
compliance and record retention policies. The services will be performed by
Pharmcomm at market rates after considering the timing of the advance payment.
AAI has engaged Pharmcomm to perform these services since 1996 and has
compensated Pharmcomm at market rates pursuant to written agreements for the
services.
Pharmcomm also provides computer validation services to AAI at market rates.
These validation services are required for compliance with regulatory
requirements.
Total payments for scanning and validation services provided to AAI by Pharmcomm
were approximately $287,000, $214,000, and $436,000 for the years ended December
31, 1996, 1997,
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and 1998, respectively. For the six months ended June 30, 1999, AAI has paid
Pharmcomm approximately $266,000 excluding the advance payment for services
discussed above.
The Company also has work-in-process and receivables due from Aesgen, Inc.
("Aesgen") and Endeavor Pharmaceuticals Inc. ("Endeavor"). Both Endeavor and
Aesgen were organized by AAI and its principal shareholders, and continue to be
related parties. The total amount of work-in-process and receivables at June 30,
1999 related to Aesgen was approximately $661,000 and the amount related to
Endeavor was approximately $1,778,000.
9. DEBT
At June 30, 1999, the Company was not in compliance with a financial covenant in
connection with a credit arrangement with a bank. The credit arrangement
represents a revolving line of credit (the "Revolver") and certain off-balance
sheet leases (the "Leases"). The Revolver is the primary mechanism used by the
Company to fund capital purchases and operating cash needs. The balance owed on
the Revolver at June 30, 1999 was $13,267,000 and is unsecured. The current
Revolver agreement expires on August 31, 1999. If the Revolver is not renewed,
the balance outstanding becomes payable in 60 equal monthly installments.
Covenant compliance on the Revolver is also required under the Leases which are
secured by real estate made up of a headquarters building under construction in
Wilmington, N.C., a laboratory and clinic facility in Research Triangle Park,
N.C. and land purchased for future construction of a laboratory facility in
Shawnee, Kansas. The Leases are operating leases which allow for the purchase of
the facilities at the end of the lease term at fair market value or the balance
of the debt secured by the facilities.
On August 16, 1999, the bank agreed to forebear until November 30, 1999 from
exercising any rights or remedies as a result of the Company's failure to
comply with this financial covenant. The bank has also committed to extend the
Revolver through November 30, 1999, subject to the Company securing the
Revolver with collateral and agreeing to certain additional covenants. During
the term of the extension, the applicable interest rate on the Revolver will be
increased to LIBOR plus 2.25% per annum with the unused commitment fee
increased to 0.375% per annum.
10. CONTINGENCIES
The Company has started a dispute resolution process, seeking to collect
approximately $2.5 million of billings plus interest on past due amounts from a
customer. Even though the process was initiated to protect the Company's
interests and the Company expects to be successful in its efforts, there can be
no assurance that the Company will ultimately be successful in such collection
efforts.
10
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The Company's quarterly results have been, and are expected to continue to be,
subject to fluctuations. Quarterly results can fluctuate as a result of a number
of factors, including without limitation, the commencement, completion or
cancellation of large contracts, progress of ongoing contracts, achieving
expected levels of licensing and royalty revenues, potential acquisitions, the
timing of start-up expenses for new facilities, timing and level of research and
development expenditures and changes in the mix of services. Since a large
percentage of the Company's operating costs are relatively fixed, variations in
the timing and progress of large contracts or the recognition of licensing and
royalty revenues (on projects for which associated expense may have been
recognized in prior periods) can materially affect quarterly results.
Accordingly, the Company believes that comparisons of its quarterly financial
results may not be meaningful.
RESULTS OF OPERATIONS - SECOND QUARTER 1999 COMPARED TO SECOND QUARTER 1998
Net sales for the second quarter of 1999 decreased 9% to $21.7 million compared
to $23.8 million in 1998. Pharmaceutic revenues were $15.2 million in 1999, down
2% from $15.5 million in 1998 and Clinical revenues were down 4% to $5.9 million
in the first quarter of 1999 from $6.1 million in the same period of 1998.
Revenues from Internal Product Development were $0.6 million in 1999 compared to
$2.2 million last year, reflecting a 72% decrease. The decrease in internal
product development revenues was due to the lack of originating new product
development contracts in the quarter and the relative maturity of existing
development projects. The Company expects that product development revenues will
increase in future quarters as additional agreements are signed but expects that
revenues from these contract signings will be volatile until royalty streams
earned from launched products exceeds the development fees earned. However,
there can be no assurance that the company will be successful in executing
additional product development agreements and increase its future revenue.
Pharmaceutic and Clinical sales were less than in prior quarters, and declined
from the amounts in the second quarter of 1998 due to a number of factors.
Management believes that the rate of new contract signings slowed in the second
quarter due to the relative size of the contracts being negotiated, market
consolidation and the lack of focused selling efforts. However, management has
taken specific steps to increase selling efforts by increasing the number of
professionals devoted to the customer focused selling approach used in the past.
Management believes that with the integration of the European and US clinical
businesses and the increased attention to customer focused selling, growth will
return to historical trends. In the second quarter of 1999, the Company's North
Brunswick, New Jersey facility was fully operational and added to pharmaceutic
capacity. This capacity was utilized almost exclusively in internal product
development activities. As demand increases, the additional capacity provided by
this facility will be used to perform pharmaceutic testing in the fee for
service business.
Overall gross margin was approximately 43% for the second quarter of 1999
compared to 51% for the same period of 1998. The gross margin from Pharmaceutic
work was approximately 7% for the second quarter of 1999 compared to 14% for the
same period of 1998. The difference in gross margin percentage is attributable
to a decrease in the volume of work and increased costs for additional
facilities and capacity and the mix of services provided. Gross margins in the
Clinical business decreased to 4% for the second quarter of 1999 from 7% for the
same period of 1998. The
11
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decrease in gross margin percentage was due to a decrease in the volume of
clinical work without a corresponding decrease in the related direct costs.
Selling, general and administrative costs as a percentage of net sales increased
to approximately 43% in 1999 compared to 33% for the same quarter in 1998.
During the first quarter of 1999, the Company increased the size of its
salesforce by adding additional technical support and expertise from its
operating units. This increase in selling activities combined with a decrease in
overall revenues resulted in an increase in general and administrative costs as
a percentage of sales. However, these additions have added to the Company's
ability to present the highly technical aspects of its work to the scientific
customer base. Management expects this investment in selling expertise to
increase the ability to sign additional business and help identify potential
customer needs for future growth opportunities. Due to the lead time required to
have work available after the increase in salesforce, the expected increase in
sales due to the increased sales efforts did not materialize. However,
management is committed to the increased selling efforts in order to stimulate
demand and return the Company to its historical rate of revenue growth. The
Company expects to continue its efforts at controlling selling, general and
administrative expenses by maintaining such growth at rates equal to or less
than overall net sales growth and will reduce these costs if required to size
them to the available revenue.
Research and development expenses were approximately 19% of net sales in the
second quarter of 1999, compared with approximately 8% of sales for the same
period in 1998. In the second quarter of 1999, research and development expenses
were approximately $2.1 million higher than the second quarter of 1998. This
increase resulted from the dedication of certain facilities to research efforts
and an overall increase in the resources devoted to furthering the Company's
internal product development strategy. Internal product development revenues,
which are the resulting benefit of research expenses, declined to approximately
$600,000 from approximately $2.2 million for the second quarter of 1998. This
decrease resulted from the lack of signing new development contracts and the
timing of milestones and progress on existing contracts. Internal product
development revenues are inherently volatile and contribute to the volatile
nature of the Company's earnings. Management expects internal product
development revenues to exceed research and development expenses in the future
as prior investments in research continue to provide revenues.
Income from operations was a loss of $3.9 million in the second quarter of 1999
and income of $2.3 million for the same period of 1998. The decrease was due to
a decrease in fee for service revenues in the Pharmaceutic business, after the
impact of acquisitions, an increase in facility costs related to the facility in
North Brunswick, New Jersey and an increase in selling, general and
administrative expenses.
For the six months ended June 30, 1999, revenues increased $3.0 million to $47.8
million in 1999 from $44.8 million in 1998. The increase was due to an $2.1
million increase in Pharmaceutic revenues, an $0.1 million increase in clinical
revenues and a $0.8 million increase in internal product development revenues.
Operating income for the first six months of 1999 was a loss of $8.6 million
compared with income of $3.8 million in 1998. The loss includes a $6.4 million
charge to operating income related to the consolidation, integration and
acquisition costs of MTRA. The charge also includes certain costs to restructure
existing operations, reduce staff and excess facility costs.
12
<PAGE> 13
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically funded its business through operating cash flows,
proceeds from borrowings and the issuance of equity securities. Working capital
was approximately $18.4 million at June 30, 1999 compared to approximately $28.5
million at December 31, 1998.
The Company was not in compliance with a financial covenant in connection with
the credit facility. The credit facility expires on August 31, 1999. The lender
has committed to forebear and extend the credit facility through November 30,
1999, subject to the Company securing the credit facility with collateral and
agreeing to certain additional covenants. During the term of the extension, the
applicable interest rate on the credit facility will be increased to LIBOR plus
2.25% per annum with the unused commitment fee increased to 0.375% per annum.
Capital expenditures were approximately $6.7 million during the first six months
of 1999 compared to approximately $5.3 million during the same period last year.
The Company anticipates total capital expenditures for 1999 to be approximately
$12 million.
AAI expects that near term growth can be accommodated utilizing existing
facilities. The Company expects future operations to fund capital expenditures
currently in progress but may from time to time seek to supplement cash flow
from operations with the issuance of equity securities and additional
borrowings. The Company believes that such sources of cash and financing
alternatives will be sufficient to fund operations for the current and
foreseeable future and to pay existing debt and other capital obligations. The
Company regularly evaluates acquisition or growth opportunities. At some point
in the future there may be opportunities that require additional external
financing, and the Company may from time-to-time seek to obtain funds through
the public or private issuance of equity or debt securities. There can be no
assurances that such financing will be available on terms acceptable to the
Company.
YEAR 2000 DISCLOSURE
The Company has an active program to assess and where required, remediate,
issues associated with Year 2000 ("Y2K") issues. Generally defined, Y2K issues
arise from computer programs which use only two digits to refer to the year and
which may experience problems when the two digits become "00" in the year 2000.
In addition, imbedded hardware microprocessors may contain time and two-digit
year fields in executing their functions. Much literature has been devoted to
the possible effects such programs may experience in the Year 2000, although
significant uncertainty exists as to the scope and effect the Y2K issues will
have on industry and the Company.
The Company has recognized the need to address the Y2K issue in a comprehensive
and systematic manner and has taken steps to assess the possible Y2K impact on
the Company. The Company has completed a 100% assessment of all its information
technology ("IT") and non-IT systems for Y2K issues. In addition, the Company
has inquired of all its significant vendors and clients their assessment of Y2K
issues on their operations.
In 1996, the Company developed a strategic plan to identify the IT systems
needed to accomplish the Company's overall growth plans. As part of this process
potential Y2K issues were considered and addressed through an enterprise
resource planning process. The Company's Board of Directors authorized spending
to implement portions of this strategic plan over several years.
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<PAGE> 14
In 1997, the Company established an internal multi-discipline task force to
specifically address Y2K issues by implementation of the strategic plans. The
task force has inventoried IT and non-IT systems and made preliminary
assessments as to Y2K compliance. In those instances where a system would be
replaced or eliminated through the implementation of our strategic plan before
being impacted by Y2K issues, no further action was deemed necessary. All
mission-critical systems not being addressed have been further assessed and
protocols have been developed to test compliance. This testing is ongoing. As
issues are identified they are remedied as soon as possible. In addition, as
upgrades are made to the Company's proprietary software, Company employees are
revising the computer code to ensure Y2K compliance. All Company purchase orders
for new equipment and systems contain representations regarding Y2K compliance.
Based on currently available information, the non-IT systems used by the Company
are not expected to cause significant problems or expense to the Company. While
AAI relies heavily on its technical equipment, Company studies have found that
much of it can be upgraded or, for items that are not mission-critical, can
continue to be operated if they are not linked to other systems.
The Company has communicated with its major customers and suppliers and is not
aware of any such business associates that will cause a material third-party
risk to the Company.
The cost of bringing the Company in full compliance should not result in a
material increase in the recent levels of capital spending or any material
one-time expenses. The Company has not been tracking the direct cost of solving
potential Y2K issues. Since 1996, the Company has expensed approximately $8.0
million for all IT items. It is not reasonably possible to determine what
portion of such spending was directly related to correcting Y2K issues. The
future spending on IT items is expected to be approximately $3 million per year.
The Company has not segregated the direct costs associated with Y2K issues in
its IT capital spending plans. However, all current capital additions are Y2K
compliant. Prior to the merger with MTRA, the systems of MTRA were evaluated for
Y2K readiness. MTRA's separate systems are included in AAI's plans and all
significant systems will be replaced or Y2K compliant in accordance with AAI's
previously established timeline.
The failure of either the Company, its vendors or clients to correct the systems
affected by Y2K issues could result in a disruption or interruption of business
operations. The Company uses computer programs and systems in essentially all of
its operations to collect, assimilate and analyze data. Failure of such programs
and systems could affect the Company's ability to perform contracts to test,
develop, or manufacture pharmaceutical and biotechnology products or perform
clinical trials, thereby causing delays in the development and commercialization
of pharmaceutical and biotechnology products. Similarly, failure of
vendor-provided products and services could result in delay in the Company's
ability to develop pharmaceutical products. Although the Company does not
believe that any of the foregoing worst-case scenarios will occur, there can be
no assurance that unexpected Y2K problems of the Company's and its vendors' and
clients' operations will not have a material adverse effect on the Company.
While it is difficult to classify AAI's state of readiness, the company believes
that its it will have implemented its internal plans and will be able to avoid
any material Y2K issues in September 1999. The company was 78% complete with the
remediation and testing of systems identified as non-compliant during the
assessment at June 30, 1999. Management is in constant communication with the
task force and has made and will continue to make reports to the Company's Board
of Directors.
14
<PAGE> 15
FORWARD LOOKING STATEMENTS
This quarterly report may contain certain forward-looking statements, within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, that are based on the
Company's belief and assumptions, as well as information currently available to
the Company. When or if used herein, the words "anticipate," "estimate,"
"expect," and similar expressions may identify forward-looking statements.
Although the Company believes that the expectations reflected in any such
forward-looking statements are reasonable, there can be no assurance that such
expectations will prove to be correct. Any such statements are subject to
certain risks and uncertainties. Should one or more of these risks or
uncertainties materialize, or should underlying assumptions prove incorrect,
actual results, performance or financial condition may vary materially from
those anticipated, estimated or expected. Key factors that may have a direct
bearing on the Company's results, performance and financial condition include,
but are not limited to, the Company's dependence on and effect of government
regulation; its management of growth and acquisition risks, including its
integration of acquired operations; the level of outsourcing of research,
development and testing activities in the pharmaceutical and biotechnology
industries; its ability to accurately assess and remediate potential year 2000
problems; its dependence on key personnel, and its dependence on third-party
marketing and distribution of internally developed drugs.
PART II. OTHER INFORMATION
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
At June 30, 1999, the Company was not in compliance with a financial covenant in
connection with a credit arrangement with a bank. The credit arrangement
represents a revolving line of credit (the "Revolver") and certain off-balance
sheet leases (the "Leases"). The Revolver is the primary mechanism used by the
Company to fund capital purchases and operating cash needs. The balance owed on
the Revolver at June 30, 1999 was $13,267,000 and is unsecured. The current
Revolver agreement expires on August 31, 1999.
Covenant compliance on the Revolver is also required under the Leases which are
secured by real estate made up of a headquarters building under construction in
Wilmington, N.C., a laboratory and clinic facility in Research Triangle Park,
N.C. and land purchased for future construction of a laboratory facility in
Shawnee, Kansas. The Leases are operating leases which allow for the purchase of
the facilities at the end of the lease term at fair market value or the balance
of the debt secured by the facilities.
On August 16, 1999, the bank agreed to forebear until November 30, 1999 from
exercising any rights or remedies as a result of the Company's failure to
comply with this financial covenant. The bank has also committed to extend the
Revolver through November 30, 1999, subject to the Company securing the
Revolver with collateral and agreeing to certain additional covenants. During
the term of the extension, the applicable interest rate on the Revolver will be
increased to LIBOR plus 2.25% per annum with the unused commitment fee
increased to 0.375% per annum.
15
<PAGE> 16
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 19, 1999, the Company held its annual meeting of stockholders. The total
number of shares outstanding as of the record date, April 8, 1999, was
17,205,391. The matters voted on at the meeting and the results are as follows:
Election of Directors - Terms to expire in 2002:
Joseph H. Gleberman John M. Ryan
Votes For 11,741,126 11,748,196
Votes Against 0 0
Votes Withheld 131,370 124,300
Abstentions 0 0
Ratify the appointment of Ernst & Young LLP as independent auditors for the
Company for the year ending December 31, 1999:
Votes For 11,872,478
Votes Against 0
Votes Withheld 0
Abstentions 18
No other matters were voted on at the meeting.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
EXHIBITS:
A list of the exhibits required to be filed as part of this Report on Form 10-Q
is set forth in the "Exhibit Index", which immediately precedes such exhibits,
and is incorporated herein by reference.
REPORTS ON FORM 8-K:
The Company has recently filed the following Form 8-K's:
Dated June 1 1999, to amend a previous filing announcing the Company's
acquisition of Medical and Technical Research Associates, Inc. as of March 16,
1999.
Dated July 30, 1999, to file a press release reporting the Company's
expected loss for the quarter ended June 30, 1999;
Dated August 2, 1999, to file a press release reporting the Company's
results of operations for the quarter ended June 30, 1999;
16
<PAGE> 17
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
APPLIED ANALYTICAL INDUSTRIES, INC.
Date: August 16, 1999 By: /s/ FREDERICK D. SANCILIO
---------------------------------------------
Frederick D. Sancilio, Ph.D.
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
Date: August 16, 1999 By: /s/ EUGENE T. HALEY
---------------------------------------------
Eugene T. Haley
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
17
<PAGE> 18
APPLIED ANALYTICAL INDUSTRIES, INC.
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION
--- -----------
3.1 - Amended and Restated Certificate of Incorporation of
the Company (incorporated by reference to Exhibit 3.1 to
the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1996)
3.2 - Restated By-laws of the Company (incorporated by reference
to Exhibit 3.2 to the Company's Registration Statement on
Form S-1 (Registration No. 333-5535))
4.1 - Articles Fourth, Seventh, Eleventh and Twelfth of the form
of Amended and Restated Certificate of Incorporation of the
Company (included in Exhibit 3.1)
4.2 - Article II of the form of Restated By-laws of the Company
(included in Exhibit 3.2)
4.3 - Specimen Certificate for shares of Common Stock, $.001 par
value, of the Company (incorporated by reference to
Exhibit 4.3 to the Company's Registration Statement on
Form S-1 (Registration No. 333-5535))
10.1 - Employment Agreement dated November 17, 1995 between the
Company and Frederick D. Sancilio (incorporated by reference
to Exhibit 10.1 to the Company's Registration Statement on
Form S-1 (Registration No. 333-5535))
10.2 - Applied Analytical Industries, Inc. 1995 Stock Option Plan
(incorporated by reference to Exhibit 10.3 to the Company's
Registration Statement on Form S-1 (Registration
No. 333-5535))
10.3 - Applied Analytical Industries, Inc. 1996 Stock Option Plan
(incorporated by reference to Exhibit 10.4 to the Company's
Registration Statement on Form S-1 (Registration
No. 333-5535))
10.4 - Applied Analytical Industries, Inc. 1997 Stock Option Plan,
as amended on May 8, 1998, (incorporated by reference to
Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1998)
10.5 - Stockholder Agreement dated as of November 17, 1995 among
the Company, GS Capital Partners II, L.P., GS Capital
Partners II Offshore, L.P., Goldman, Sachs & Co.
Verwaltungs GmbH, Stone Street Fund 1995, L.P., Bridge
Street Fund 1995, L.P., Noro-Moseley Partners III, L.P.,
Wakefield Group Limited Partnership, James L. Waters,
Frederick D. Sancilio and the parties listed on Schedule 1
thereto (incorporated by reference to Exhibit 10.5 to the
Company's Registration Statement on Form S-1 (Registration
No. 333-5535))
18
<PAGE> 19
10.6 - Lease Agreement dated as of March 7, 1994 between 5051 New
Centre Drive, L.L.C., as landlord, and the Company, as
tenant (incorporated by reference to Exhibit 10.10 to the
Company's Registration Statement on Form S-1 (Registration
No. 333-5535))
10.7 - Development Agreement dated as of April 25, 1994 between the
Company and Endeavor Pharmaceuticals Inc. (formerly,
GenerEst, Inc.) (incorporated by reference to Exhibit 10.12
to the Company's Registration Statement on Form S-1
(Registration No. 333-5535))
10.8 - Development Agreement dated as of April 4, 1995 between the
Company and Aesgen, Inc. (incorporated by reference to
Exhibit 10.13 to the Company's Registration Statement on
Form S-1 (Registration No. 333-5535))
10.9 - Loan Agreement dated as of December 30, 1996 between
NationsBank, N.A. and the Company (incorporated by reference
to Exhibit 10.14 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1996)
10.10 - Amendment No. 1, dated as of February 13, 1998, to the Loan
Agreement dated as of December 30, 1996 between
NationsBank, N.A. and the Company, (incorporated by
reference to exhibit 10.10 of the Company's Quarterly Report
on Form 10-Q for the quarter ended March 31, 1998)
10.11 - Underwriting Agreement dated September 19, 1996 between the
Company and Goldman Sachs & Co., Cowen & Company and Lehman
Brothers, Inc., as representatives of the underwriters
listed on Schedule 1 thereto (incorporated by reference to
Exhibit 10.17 to the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1996)
10.12 - Partnership Agreement dated as of October 2, 1998 between
the Company, First Security Bank, N. A. and the Various
Banks and Other Lending Institutions Which are Parties
Hereto from time to time, as the Holders and as the Lenders
and NationsBank, N. A. (incorporated by reference to
Exhibit 10.12 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1998)
10.13 - Security Agreement dated as of October 2, 1998 between First
Security Bank, N. A., and NationsBank, N. A. (incorporated
by reference to Exhibit 10.13 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1998)
10.14 - Amendment No. 1 to the Employment Agreement dated
November 17, 1995 between the Company and Frederick D.
Sancilio
10.15 - Letter of guarantee from Frederick D. Sancilio dated June
17, 1999
27 - Financial Data Schedule (for SEC use only)
19
<PAGE> 1
EXHIBIT 10.14
AMENDMENT NO. 1 TO:
EMPLOYMENT AGREEMENT BETWEEN
APPLIED ANALYTICAL INDUSTRIES INC.
AND FREDERICK D. SANCILIO
THIS AMENDMENT No. 1 dated March 26, 1999, to this AGREEMENT made as of the
17th day of November, 1995, by and between Applied Analytical Industries, Inc.,
a Delaware corporation (hereinafter referred to as the "Company"), and Frederick
D. Sancilio, Ph.D. (hereinafter referred to as "Employee").
WITNESSETH:
WHEREAS:
A. The Company Board of Directors, has unanimously acted to increase
Employee compensation pursuant to Paragraph 5(A) and to amend Paragraph 5 (d) to
increase the amount of fringe benefits available to Employee.
NOW, THEREFORE, in consideration of good and valuable consideration the
receipt and sufficiency of which are hereby acknowledged, the parties hereto
hereby covenant and agree as follows:
1. Paragraph 5 (d) is hereby amended by increasing the aggregate yearly
amount of fringe benefits from $10,000 to $35,000. Thus, original paragraph 5
(d) is replaced in its entirety with the following new paragraph 5 (d):
"(d) Perquisites. During the Term of Employment, Employee shall be
entitled to perquisites of office, including without limitation air travel
privileges, office facilities and secretarial staff, and to fringe benefits
including, without limitation, payment or reimbursement of membership dues
in one country club and one luncheon club, and of tax return preparation
and advisory fees, at least equal to and on the same terms and conditions
as those provided to Employee on the date of this Agreement (all such
fringe benefits, however, not in the aggregate to exceed $35,000 per year),
as well as to reimbursement, upon proper accounting, of all reasonable
expenses and disbursements incurred by him in the course of his
<PAGE> 2
duties, including, without limitation, membership fees and dues in various
professional, trade and civic organizations, societies and associations
which the Company has heretofore paid or reimbursed. Employee agrees to
furnish an appropriate model automobile for his use for business purposes,
for which the Company shall pay Employee a monthly automobile allowance of
$750. The Company shall also pay or reimburse the airfare of Employee's
spouse if she accompanies him on any business trip that exceeds two weeks'
duration, and shall indemnify and hold Employee harmless against any income
tax liability he incurs as a result of such payment or reimbursement or
this indemnity."
2. All other terms and conditions of the Agreement remain in full force and
effect.
IN WITNESS WHEREOF, the Company has caused this Agreement to be signed by
its proper representative and Employee has hereunto set his hand as of the date
first above written.
APPLIED ANALYTICAL INDUSTRIES, INC.
By /s/ Eugene T. Haley
----------------------------------
Title Executive Vice President,
Chief Financial Officer
[Seal]
Attest:
/s/ Albert Cavagnaro
- -----------------------------------
Asst. Secretary
EMPLOYEE:
/s/ Frederick D. Sancilio
---------------------------------------
Frederick D. Sancilio, Ph.D.
<PAGE> 1
June 17, 1999
Applied Analytical Industries, Inc.
5051 New Centre Drive
Wilmington, North Carolina 28403
Re: PharmComm, Inc./Guarantee
Ladies and Gentlemen:
The undersigned acknowledges that Applied Analytical Industries, Inc. ("AAI") is
contemplating making an advance payment of $300,000.00 in cash (the "Advance
Payment") to PharmComm, Inc. ("PharmComm") for the provision by PharmComm to AAI
of certain document scanning services requested by AAI in the future. The
undersigned acknowledges that as a shareholder of PharmComm, the Advance Payment
indirectly benefits the undersigned and that AAI will be acting in reliance of
the undersigned's agreement set forth herein. Accordingly, the undersigned
hereby agrees unconditionally and absolutely to guarantee to AAI repayment to
AAI of the Advance Payment, reduced by the amount of scanning services provided
by PharmComm to AAI at AAI's request after the date hereof at a price of
$0.06176 per scanned page, in the event that either PharmComm fails to provide
scanning services requested by AAI or AAI terminates its relationship with
PharmComm and requests a return of the Advance Payment.
In connection with such guaranty obligation, the undersigned hereby waives (a)
notice of acceptance of this guaranty by AAI; (b) to the extent permitted by
applicable law, all other notices to which the undersigned might otherwise be
entitled; (c) demand for payment under this guaranty; and (d) any right to
assert against AAI, as a defense, counterclaim, set-off, or cross-claim any
defense (legal or equitable), set-off, counterclaim or claim that the
undersigned may now or hereafter have against AAI, other than compulsory
counterclaims. Furthermore, the undersigned agrees that this guaranty may be
enforced by AAI without the necessity at any time of resorting to or exhausting
any other right of recovery against PharmComm, and the undersigned hereby waives
the right to require AAI to proceed against PharmComm or to require AAI to
pursue any other remedy or enforce any other right. Without limiting the
generality of the foregoing, the undersigned hereby specifically waives the
benefits of North Carolina General Statutes. Sections 26-7 through 26-9
inclusive.
Sincerely,
/s/ Frederick D. Sancilio
--------------------------------
Frederick D. Sancilio, Ph. D.
<TABLE> <S> <C>
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THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF APPLIED ANALYTICAL INDUSTRIES, INC. AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 8,774
<SECURITIES> 0
<RECEIVABLES> 27,290
<ALLOWANCES> 2,100
<INVENTORY> 0
<CURRENT-ASSETS> 60,852
<PP&E> 72,257
<DEPRECIATION> 30,697
<TOTAL-ASSETS> 119,227
<CURRENT-LIABILITIES> 42,472
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0
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<COMMON> 17
<OTHER-SE> 67,514
<TOTAL-LIABILITY-AND-EQUITY> 119,227
<SALES> 47,806
<TOTAL-REVENUES> 47,806
<CGS> 26,858
<TOTAL-COSTS> 26,858
<OTHER-EXPENSES> 29,572
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 434
<INCOME-PRETAX> (9,058)
<INCOME-TAX> (2,322)
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